PART
I
Forward-Looking
Information
The
statements contained in this Annual Report on Form 10-KSB that are not
historical fact are forward-looking statements (as such term is defined in
the
Private Securities Litigation Reform Act of 1995), within the meaning of
Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The forward-looking statements contained
herein are based on current expectations that involve a number of risks and
uncertainties. These statements can be identified by the use of forward-looking
terminology such as “believes,” “expects,” “may,” “will,” “should,” “intend,”
“plan,” “could,” “is likely,” or “anticipates,” or the negative thereof or other
variations thereon or comparable terminology, or by discussions of strategy
that
involve risks and uncertainties. The Company wishes to caution the reader
that
these forward-looking statements that are not historical facts are only
predictions. No assurances can be given that the future results indicated,
whether expressed or implied, will be achieved. While sometimes presented
with
numerical specificity, these projections and other forward-looking statements
are based upon a variety of assumptions relating to the business of the Company,
which, although considered reasonable by the Company, may not be realized.
Because of the number and range of assumptions underlying the Company’s
projections and forward-looking statements, many of which are subject to
significant uncertainties and contingencies that are beyond the reasonable
control of the Company, some of the assumptions inevitably will not materialize,
and unanticipated events and circumstances may occur subsequent to the date
of
this report. These forward-looking statements are based on current expectations
and the Company assumes no obligation to update this information. Therefore,
the
actual experience of the Company and the results achieved during the period
covered by any particular projections or forward-looking statements may differ
substantially from those projected. Consequently, the inclusion of projections
and other forward-looking statements should not be regarded as a representation
by the Company or any other person that these estimates and projections will
be
realized, and actual results may vary materially. There can be no assurance
that
any of these expectations will be realized or that any of the forward-looking
statements contained herein will prove to be accurate.
Item
1. Description of Business.
Corporate
History
During
2006, MediQuip Holdings, Inc. (“MediQuip”), a publicly traded company, divested
its operating subsidiary and subsequently entered into a merger agreement
with
Deep Down, Inc. which was accounted for as a reverse merger with Deep Down,
Inc.
being the surviving entity for accounting purposes. The following discussion
describes the history of Deep Down, Inc. (“we” or “the Company”)
On
June
29, 2006, Subsea Acquisition Corporation (“Subsea”) was formed by three
shareholders with the intent to acquire service providers to the offshore
industry, and designers and manufacturers of subsea equipment, surface equipment
and offshore rig equipment that are used by major integrated, large independent
and foreign national oil and gas companies in offshore areas throughout the
world. In November 2006, Subsea On June 29, 2006, Subsea Acquisition Corporation
(“Subsea”) was formed by three shareholders with the intent to acquire service
providers to the offshore industry, and designers and manufacturers of subsea
equipment, surface equipment and offshore rig equipment that are used by
major
integrated, large independent and foreign national oil and gas companies
in
offshore areas throughout the world. On November 21, 2006, Subsea acquired
Deep
Down, Inc, a Delaware corporation founded in 1997. Under the terms of this
transaction, all of Deep Down, Inc.’s shareholders transferred ownership of all
of Deep Down Inc.’s common stock to Subsea in exchange for 5,000 shares of
Subsea’s Series D Preferred Stock and 5,000 shares of Subsea’s Series E
Preferred Stock resulting in Deep Down Inc. becoming a wholly owned subsidiary
of Subsea. On the same day, Subsea then merged with Deep Down, with the
surviving company operating as Deep Down Inc. Unless specifically stated
otherwise, all references to Deep Down refer to the combined entity comprising
Subsea and Deep Down Inc. This transaction was accounted for as a purchase
with
Subsea being the acquirer based on a change in voting control. Under purchase
accounting, we have included the results of operations of the entity formerly
operating as Deep Down from the acquisition date of November 21, 2006 forward.
As Subsea was formed on June 29, 2006, the financial statements included
herein
reflect the results of the operations from the date of inception to December
31,
2006.
Additionally
on November 21, 2006, Subsea acquired all the common stock of Strategic Offshore
Services Corporation (“SOS”) for 3,000 Series F Preferred Stock and 1,000 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 charged compensation expense to shareholders for the fair value
of
both series totaling $3,340,792 million.
On
December 14, 2006 Deep Down exchanged all 9,999,999 shares of Deep Down common
stock and all 14,000 shares of Deep Down preferred stock for 75,000,000 shares
of common stock and 14,000 shares of preferred stock of MediQuip. The preferred
shares of MediQuip have the same designations as Deep Down’s preferred stock. As
a result of the acquisition, the shareholders of Deep Down will own a majority
of the voting stock of MediQuip, which changed its name to Deep Down, Inc.
The
merger has been accounted for as a reverse merger whereby Deep Down is the
accounting acquirer resulting in a recapitalization of Deep Down’s equity. The
acquisition did not require the approval of shareholders of MediQuip. In
connection and simultaneously with this reverse merger, Westmeria Healthcare
Limited, a wholly owned subsidiary of MediQuip was transferred to MediQuip’s
majority shareholder in exchange for the cancellation of 31,351,256 common
share
equivalents. The MediQuip Series C convertible preferred stock outstanding
prior
to the reverse merger remains outstanding.
The
Company’s historical financial statements reflect those of Deep Down, Inc, and
do not include the results of MediQuip or Westmeria Healthcare Limited for
periods prior to the merger date.
Company
Overview
Our
strategy is to consolidate service providers to the offshore industry, and
designers and manufacturers of subsea equipment, surface equipment and offshore
rig equipment that are used by major integrated, large independent and foreign
national oil and gas companies in offshore areas throughout the world. Our
current operations are the result of a recent acquisition of Deep Down founded
by Ronald E. Smith. Mr. Smith is well known in the industry for his unique
ability to address and solve mission-critical issues confronted by offshore
energy companies. Mr. Smith and his key managers have over 113 years of combined
experience in the oilfield equipment industry, either with Deep Down or its
competitors.
We
are an
umbilical and flexible pipe installation engineering and installation management
company. We also fabricate component parts for subsea distribution systems
and
assemblies that specialize in the development of offshore subsea fields and
tie
backs. These items include umbilicals, flow lines, distribution systems,
pipeline terminations, controls, winches, and launch and retrieval systems,
among others. We provide these services from the initial field conception
phase,
thru manufacturing, site integration testing, installation, topsides
connections, and the final commissioning of a project. Our products and services
serve the offshore industry and are used in deep-water exploration and
production of oil and gas.
Business
Overview
We
are an
installation engineering and management company focused on the offshore segment
of the energy industry. We can custom design and manufacture product or modify
existing equipment to meet customer specifications. We design, manufacture,
fabricate, sell and service highly-engineered subsea equipment, surface
equipment and offshore rig equipment for use in deepwater, harsh environment
and
severe service applications. Our principal products consist of flying lead
installation, maintenance and termination systems; buoyancy and rigging systems;
high and low pressure testing and monitoring systems; latch systems; lay
chutes;
rollers; tensioners; and offshore storage and space management systems. We
also
provide installation, retrieval, storage and management services in connection
with the use of our products.
Deep
Down
has developed its broad line of subsea equipment, surface equipment and offshore
rig equipment primarily through internal product development efforts in
Channelview, Texas. In many cases, these products were developed in direct
response to customer requests for solutions to critical problems in the field.
We are instrumental in achieving solutions for our clients to simplify
installation procedures and reduce costs.
We
believe that we have achieved significant market share and brand name
recognition with respect to our established products due to the technological
capabilities, reliability, cost effectiveness, timely delivery and operational
timesaving features of these products. Since our formation, we have introduced
many new products that continue to broaden the market currently served by
us.
Deep
Down
markets its products through its offices in Channelview, Texas. Its sales
representatives travel to all of the major international energy markets
throughout the world. We manufacture and fabricate our products at facilities
located in Channelview, Texas and maintain valuable relationships with several
other companies that own additional manufacturing and fabrication facilities
in
and around Houston, Texas. These other companies provide excellent subcontract
manufacturing support on an as needed basis. Our manufacturing operations
are
vertically integrated. We perform substantially all of our own heat-treating,
machining, fabrication, inspection, assembly and testing at our
facilities.
Industry
Overview
The
offshore energy industry is centered around the use of platforms. An oil
platform is a large structure used to house workers and machinery needed
to
drill and then produce oil and natural gas in the ocean. Depending on the
circumstances, the platform may be attached to the ocean floor, consist of
an
artificial island, or be floating. Generally, oil platforms are located on
the
continental shelf, though as technology improves, drilling and production
in
deeper waters becomes both feasible and profitable. A typical platform may
have
around thirty wellheads located on the platform and directional drilling
allows
reservoirs to be accessed at both different depths and at remote positions
up to
5 miles (8 kilometers) from the platform. Many platforms also have remote
wellheads attached by umbilical connections, which may be single wells or
a
manifold centre for multiple wells. An umbilical cable supplies necessary
requirements to an apparatus.
There
are
several distinct types of platforms and rigs: fixed platforms, compliant
towers,
semi-submersible platforms, jack-up platforms, drillships, floating production
systems, tension-leg platforms, and Spar platforms.
•
Fixed
Platforms
are
built on concrete and/or steel legs anchored directly onto the seabed, and
support a deck with space for drilling rigs, production facilities and crew
quarters. Such platforms are, by virtue of their immobility, designed for
very
long-term use. Fixed platforms are economically feasible for installation
in
water depths up to about 1,700 feet.
•
Compliant
Towers
consist
of narrow, flexible towers and a piled foundation supporting a conventional
deck
for drilling and production operations. Compliant towers are designed to
sustain
significant lateral deflections and forces, and are typically used in water
depths ranging from 1,500 and 3,000 feet.
•
Semi-submersible
Platforms
have
legs of sufficient buoyancy to cause the structure to float, but of weight
sufficient to keep the structure upright. Semi-submersible rigs can be moved
from place to place; and can ballasted up or down by altering the amount
of
flooding in buoyancy tanks. They are generally secured in position by cable
anchors during drilling operations, though they can also be kept in place
by the
use of dynamic positioning. Semi-submersibles can be used in depths from
600 to
6,000 feet.
•
Jack-up
Platforms
are
platforms that can be jacked up above the sea by dint of legs that can be
lowered like jacks. These platforms, used in relatively low depths, are designed
to move from place to place, and then anchor themselves by deploying the
jack-like legs.
•
Drillships
are
maritime vessels that have been fitted with drilling apparatus. They are
often
used for exploratory drilling of new oil or gas wells in deep water but can
also
be used for scientific drilling. They are often built on a modified tanker
hull
and outfitted with dynamic positioning systems to maintain their position
over a
well.
•
Floating
production systems
are
large ships equipped with processing facilities and moored to a location
for a
long period. The main types of floating production systems are FPSO (floating
production, storage, and offloading system), FSO (floating storage and
offloading system), and FSU (floating storage unit).
•
Tension-leg
Platforms (“TLPs”)
consist
of floating rigs tethered to the seabed in a manner that eliminates most
vertical movement of the structure. TLPs are used in water depths up to about
6,000 feet. The "conventional" TLP is a 4-column design which looks similar
to a
semi-submersible. • Spar Platforms are moored to the seabed like the TLP, but
whereas the TLP has vertical tension tethers the Spar has more conventional
mooring lines. Spars have been designed in three configurations: the
"conventional" one-piece cylindrical hull, the "truss spar" where the midsection
is composed of truss elements connecting the upper buoyant hull (called a
hard
tank) with the bottom soft tank containing permanent ballast, and the "cell
spar" which is built from multiple vertical cylinders. The Spar may be more
economical to build for small and medium sized rigs than the TLP, and has
more
inherent stability than a TLP since it has a large counterweight at the bottom
and does not depend on the mooring to hold it upright. It also has the ability,
by use of chain-jacks attached to the mooring lines, to move horizontally
over
the oil field.
The
market for subsea equipment, surface equipment and offshore rig equipment
and
services and the Company's business are substantially dependent on the condition
of the oil and gas industry and, in particular, the willingness of oil and
gas
companies to make capital expenditures on exploration, drilling and production
operations offshore. The level of capital expenditures is generally dependent
upon the prevailing view of future oil and gas prices, which are influenced
by
numerous factors affecting the supply and demand for oil and gas, including
worldwide economic activity, interest rates and the cost of capital,
environmental regulation, tax policies, and the ability of OPEC and other
producing nations to set and maintain production levels and prices. Capital
expenditures are also dependent on the cost of exploring for and producing
oil
and gas, the sale and expiration dates of offshore leases in the United States
and other countries overseas, the discovery rate of new oil and gas reserves
in
offshore areas and technological advances. Oil and gas prices and the level
of
offshore drilling and production activity have historically been characterized
by significant volatility.
Services
Deep
Down’s engineering team can provide project engineering, installation and
pull-in engineering, project management, installation management, and
commissioning services. We pride ourselves on collaborating with engineers
from
the installation contractors and manufacturing side of the industry to find
the
most effective solutions to address installation problems in the subsea world.
We also provide installation, retrieval, storage and management services
in
connection with the use of our products. Approximately 60% of our revenue
is
derived from services.
Project
Management.
Our
installation management and engineering team specializes in deep water subsea
developments. We are often contracted by our customers to assist with the
preparation and evaluation of subsea development tenders and Requests for
Quotes. Our experience comes from working with installation contractors,
operators, controls suppliers, and umbilical manufacturers. Our engineers
have
experience ranging from the initial conceptual design phases through
manufacturing and installation, and concluding with topsides connections
and
commissioning. This experience provides us with a level of “hands on and
practical” experience that has proven to be in-dispensable in enabling us to
offer customer solutions to the many problems encountered both subsea and
topsides. Because of this wide knowledge base, our engineering team is often
hired by operators and installation contractors to provide installation
management and engineering support services.
Project
Engineering.
Our
engineering team has been involved in most of the innovative solutions used
today in deepwater subsea systems. We are unique in the fact that we are
often
hired by the controls and umbilical manufacturers, installation contractors,
and
the operators to help ensure that the project progresses smoothly, on time
and
on budget.
Our
team
specializes in offshore installation engineering and the writing of practical
installation procedures. We deal with issues involving flying leads; compliant
umbilical splices; bend stiffener latches; umbilical hardware; hold-back
clamps;
and the development of distribution system components, among others. We are
heavily involved in the fabrication of installation aids to simplify offshore
executions, and offer hydraulic, fiber optic, and electrical testing services
and various contingency testing tools.
Installation
Support and Management.
Deep
Down’s installation management is centered around the utilization of
standardized hardware, proven installation techniques, and an experienced,
consistent team that has proven to be safe and skilled in the various areas
of
all installation phases. We pride ourselves on supporting installation
contractors through its installation management and engineering services,
installation aids and equipment, and its offshore installation support services,
including spooling operators, offshore testing, and flying lead installation
support. We have extensive “Hands-On” experience in the field. Many installation
contractors find it beneficial to utilize our services to help reduce personnel
on board by allowing a few specialized technicians to perform multiple roles
such as performing the offshore testing services, as well as operation of
the
lay system and equipment.
Deep
Down
has designed and fabricated many different installation tools and equipment
over
the years. We have been involved in the design of the following pieces of
equipment to help make installations go as smoothly as possible: steel flying
leads; steel flying lead deployment systems; umbilical hardware and termination
systems; umbilical bell mouths; lay chutes; Mud Mats; flying lead installation
and parking frames; Umbilical Termination Assembly Stab & Hinge Over
Systems; and numerous other pieces of offshore equipment. Deep Down’s team has
vast experience with the installation of flexible and rigid risers and flow
lines, umbilicals, flexible and rigid jumpers, steel tube and thermoplastic
hose
flying leads, pipeline end terminations (“PLETs”) and manifolds.
Spooling.
Our
experienced personnel have been involved in running spooling equipment on
many
projects. Deep Down has also been employed by other companies to run their
spooling equipment. Many installation contractors find it beneficial to use
the
same team to run the spooling equipment as well as function as the umbilical
support team to do installation testing and monitoring as required. Our
technicians are often hired by the umbilical manufacturers and the installation
contractors to provide spooling support. Our team runs two under roller units,
electrically- powered reels, and the Company’s five (5) steel flying lead
installation systems.
Systems
operated include:
•
Technip’s TR-10 and TR-45
•
Cal-Dive's Reel System 1 and 2
•
Cal-Dive’s Big Boy Pipe Lay System on the Intrepid
•
New
Cal-Dive Carousel system
•
Coflexip Offshore TR-45 and 1200 ton carousel
•
Deep
Down's 200 ton carousel and four (4) additional Horizontal Drive
Units
•
Deep
Down's 300 and 340 ton under rollers
•
Topside
pull-in winches for umbilical pull-in operations
Deep
Down
is also a main supplier of high tension spooling services, allowing full
dive
simulation and tensioning for deep water ROV operations.
Pull-In
Operations.
Deep
Down’s team has been involved in the pull-in operations for many umbilical
projects in the Gulf of Mexico. Deep Down pull-ins run smoothly because the
same
engineers who are planning the pull-in operation are also supervising the
offshore operation. Familiarity with the system is important. The offshore
servicemen are also the topside umbilical support team familiar with the
umbilical termination hardware, and most often were involved in terminating
the
umbilicals at the manufacturers’ yard weeks prior to the installation.
Remediation is a large part of Deep Down services. If a system does not work
properly, Deep Down retrofit kits designed for effective ROV installations
can
help convert potential failures into positive successes. Everything is
thoroughly tested prior to installation, including winches at the rental
contractor’s yard and after set-up on the platform. Load cells are tested
onshore, and the same load cells are used to test the system offshore. This
eliminates variables and validates the condition of the pull-in system. Pull-ins
are then performed under more control and with increased confidence resulting
in
safer operations.
Termination.
Deep
Down and/or its employees have been involved in umbilical terminations since
1988. The Company’s team was involved with the designs for the armored thermo
plastic umbilicals at Multiflex, the first steel tube umbilical in the Gulf
of
Mexico for the Shell Popeye umbilical, and the standardization of many steel
tube umbilical terminations. Deep Down has also pioneered the concept of
the
compliant Moray® section that enables a traditional helically wound umbilical to
be used for direct well step outs, or long field flying leads. Management
believes Deep Down is the only Company that can terminate anyone else’s
umbilicals with the same Deep Down termination system.
Testing
Services.
Deep
Down’s service team is often utilized by the umbilical manufacturers, control
suppliers, installation contractors, and operators to perform all aspects
of
testing, beginning with the initial Factory Acceptance Testing (“FAT”) of the
system, connecting the umbilical termination assemblies and performing Extended
Factory Acceptance Testing (“EFAT”) throughout the process to System Integration
(“SIT”), to the installation, and finally commissioning. To execute these
services, the Company has assembled a variety of personnel and equipment
to
ensure that all testing operations are done in the most safe and time-efficient
manner, ensuring a reduced overall project cost. We also work hard to utilize
the most detailed digital testing and monitoring equipment to ensure that
the
most accurate data is provided to our clients. We have been hired to perform
coiled tubing flushing, cleaning, and hydro testing; umbilical filling,
flushing, pressure, flow rate, and cleanliness testing; load out monitoring
and
testing; installation monitoring; post installation testing; system
commissioning; umbilical intermediate testing; and umbilical and umbilical
termination assembly cleanliness, flow, and leak testing, among others.
We
believe we have one of the best filling, flushing and testing teams in the
business. Deep Down employs a variety of different pumping systems to meet
industry needs and offers maximum flexibility. Deep Down’s philosophy is to
flush through the maximum number of lines at the highest flow rate possible
to
maximize efficiency. Deep Down has assembled a comprehensive list of offshore
pumping units from Babe, Rambo, and an assortment of chemical pumping skids.
The
Company’s equipment can be used to pump all of the standard offshore water based
chemicals as well as all offshore commissioning fluids such as Methanol and
diesel.
System
Integration Testing (“SIT”).
We
have lead the revolution into the digital age with our use of digital
transducers to provide much greater levels of accuracy compared to information
gathered off of conventional chart recorders. Deep Down has a wide variety
of
digital pressure transducers, flow meters, and temperature gauges. Deep Down
has
two wire data systems (4 port and one 16 port) as well as 25 individual digital
pressure and temperature recorders that are often employed for installation
monitoring activities. In addition to these units, the Company also has three
desks set up with data systems that are capable of tracking from 4 to 15
individual sensors simultaneously. This, in combination with Subsea handling
equipment, experienced personnel, and a fully equipped facility, make Deep
Down
ideal to manage SIT operations either at their location or abroad.
Deep
Down’s team has been involved in the pull-in operations for many umbilical
projects in the Gulf of Mexico. The Company has been involved in the design,
procurement, testing, installation, and operation of the testing equipment.
Deep
Down’s engineers and service technicians can also assist in writing the testing
procedures and sequences from simple FAT to very extensive multiple pressures
and fluids test up to full system Site Integration Testing procedures.
Commissioning.
Deep
Down has been involved in most of the topsides connections and commissioning
in
the Gulf of Mexico since its conception in 1997. The commissioning team is
often
identified early on in the project and participates in all aspects of planning
and risk assessment for the project. Due to the limited time associated with
project commissioning it is extremely important to do detailed planning and
engineering prior to arrival at the offshore platform location to reduce
any
possible shut in or down time on the platform. The Company’s engineers and
technicians work hand in hand with the project managers and platform engineers
to help ensure that all aspects and dangers are identified, planned for,
and
eliminated prior to arrival on the platform. Deep Down has been involved
in most
of the topsides connections and commissioning activities in the Gulf of Mexico
and often participate in all aspects of planning and risk assessments for
the
project. Due to the different requirements for testing and commissioning
of
subsea systems, Deep Down has an assortment of pumps and equipment to pull
from
to ensure a safe and efficient commissioning program. Deep Down has experience
handling all types of commissioning fluids, including asphaltine Dispersants,
diesel, methanol, xylene, corrosion inhibitors, water-based control fluids,
oil-based control fluids, 100% Glycol, paraffin inhibitors, and alcohol,
among
others.
Storage
Management.
With
more than 50,000 sq. ft. of internal high quality warehousing capacity &
300,000 sq. ft. of external storage, Deep Down's facility in Channelview
is
strategically located to cover Houston's Ship Channel area. Our warehouse
is
designed to provide clients with flexible and cost effective warehousing
and
storage management options. Our professional and experienced warehouse staff,
combined with the very latest in information technology, results in a fully
integrated warehousing package designed to deliver clever solutions to client
needs. Deep Down is capable of providing long-term specialized contract
warehousing; long and short term storage; modern materials handling equipment;
undercover loading areas; quality security systems; integrated inventory
management; packing and repacking; computerized stock controls; and labeling,
among others.
Products
We
provide installation support equipment and component parts and assemblies
for
subsea distribution systems. We believe the key to successful installations
of
hardware is to design the subsea system, considering installation issues
first,
working backwards to the design of the hardware itself. This is why we have
been
instrumental in the development of hardware and techniques to simplify deep
water installations. We design, manufacture, fabricate, inspect, assemble,
test
and market subsea equipment, surface equipment and offshore rig equipment
that
are used by major integrated, large independent and foreign national oil
and gas
companies in offshore areas throughout the world. Our products are used during
oil and gas exploration, development and production operations on offshore
drilling rigs, such as floating rigs and jack-ups, and for drilling and
production of oil and gas wells on offshore platforms, TLPs, Spars and moored
vessels such as FPSOs. We have been involved in almost every Umbilical
installation and Steel Flying Lead installation and development in the Gulf
of
Mexico. Approximately 40% of our revenue is from product sales. A few of
our
major product lines are highlighted below.
Flying
Leads.
We have
developed a method to pull individual steel tubes, hoses, or electrical cables
to create a loose steel tube flying lead or short umbilical. This method
is
utilized to build the Loose Steel Flying Leads up to 10,000 feet long. We
have
built flying leads with up to 14 tubes and compliant sections with 22 - ½”
tubes. Additional lines or electrical and fiber optic cables can be added
to
produce any combination required for the transportation of various fluids,
chemicals or data. The flying leads are then fitted with our terminations
and
Morays® that are attached to the Multiple Quick Connection plate, and finished
off with the our elastometric bend limiters. The non-helixly wound design
allows
for our flying leads to be very installation friendly with minimal-bending
stiffness. A compliant Moray consists of a 20-foot flexible flying lead with
an
electro-hydraulic Moray that is connected to a full-sized umbilical with
the
installation tension being applied through an armor pot and slings extending
by
the compliant section. A Moray is the termination head on the flying lead
and
connects the tubing assembly to the junction plate. Flying leads account
for
approximately 50% of our product revenue.
Bend
Stiffener Latcher ™.
The
latcher is used in dynamic installations on floating vessels. Umbilical
stiffener latching mechanisms have always caused installation problems as
well
as expensive diver operations for expansion developments. Deep Down management
believes it has conceived the very first remote operated vehicle (“ROV”)
installable latching mechanism. Divers installed a Bell mouth with locking
dogs
on the bottom of the I-tube. During the umbilical installation, the bend
stiffener could be latched in with a ROV and the umbilical could be pulled
up
the remaining distance and hung off. For example, during the BP Aspen
installation, a competitive version of Bell mouth failed allowing Deep Down
the
opportunity to develop a new type of latcher which was spring loaded. This
allowed the latcher to fit onto an existing flange, completely eliminating
the
need for divers both prior to and during the installation. The BS Latcher
can be
designed to fit onto any existing flange on the bottom of an existing
I-tube.
Umbilical
Hardware.
Our
management team has been involved in more umbilical installations then probably
any other team in the industry. Our unique blend of drilling contractor,
umbilical manufacturing, subsea engineering, and installation contractor
experience has been effective in acting on behalf of the operator to ensure
key
hardware installation is performed in the most efficient and safe manner.
Due to
our strong foundation and experience with the offshore umbilicals industry,
we
have recently begun to fabricate and design terminations for umbilical
manufacturers. The designs are often much lighter in weight and smaller than
the
typical hardware that has been created and used in the past. Our engineering
team has designed and fabricated bending restrictors, armor pots, split barrels,
tubing fittings and unions, compliant umbilical splices and topsides
terminations with our unique threaded welded fittings, the compliant umbilical
splice, and the Bend Stiffener Latcher; all which assist our clients with
installation friendly hardware.
Bend
Limiters.
We
offer both plastic and steel bend limiters. Due to our ability to design
and
manufacture bend limiters in house, delivery time is greatly reduced. Steel
bend
limiters are typically utilized for steel tube umbilicals and have been designed
with a simple and reliable hinged attachment system which significantly
decreases installation time. Plastic bend limiters are typically provided
for
small diameter umbilicals or flying leads, as well as for their compliant
umbilical section, which turns a traditional umbilical into a ROV- friendly,
installable flying lead.
Compliant
Umbilical Splice.
Deep
Down has formed a unique concept of turning spare umbilicals into actual
production umbilicals by splicing spares together to produce the required
length. This allows operators to save significant costs by utilizing existing
investments as well as reducing field development costs and delivery time.
This
concept, for example, along with our new articulating umbilical splice kit,
allowed the King West project to save millions of dollars and months in delivery
time by combining the existing BP Nile and BP King spare
umbilicals.
The
Compliant splice is a new patent- pending termination system that eliminates
the
burdens of dealing with umbilical splices during installation. The compliant
splice allows clients to join two umbilicals together. This design is capable
of
housing both electrical and fiber optic Fiber Termination Assemblies while
still
allowing for the splice to be spooled up onto a reel or carousel. The optional
mud mat is used to assist in carrying the splice over the chute and functions
to
keep the splice out of the mud for easy inspection.
SeaStax®
is a new
concept in offshore storage and space management to help optimize available
deck
space on offshore installation vessels and platforms. The key philosophy
behind
SEASTAX™ is to take common offshore items and standardize a size for each of the
pieces to allow for the system to be stackable and interchangeable in subsurface
conditions. The current system utilizes newly designed 550 gallon Tote Tanks,
Baskets, and Tool Boxes that are all inter-changeable and stackable. Using
common dimensions and designs allows a variety of different items to all
be
commonly stored and stacked, to minimize required storage area. Currently
available products include 550-gallon totes, baskets with hinged ramps, tool
boxes. The stacking philosophy can be applied to other custom applications
if
required. In order to maximize accessibility and to reduce maintenance, a
variety of options are available such as galvanizing, ladders, and drip
pans.
Installation
Aids.
To help
our clients and our own internal needs, we have developed several installation
aids. Following is a brief summary of the equipment currently
available:
•
Steel
Flying Lead Installation Systems
•
5
ton
Caterpillar Tensioner
•
10
-
foot radius Lay Chute with Work Platform
•
Buoyancy
•
Clump
Weights
•
Crimping Systems
•
Load
Cells
•
300
& 340 - ton Under Rollers
•
200
-
ton Carousel
•
Three
(3) 300 - ton Horizontal Drive Units (HDU)
•
One
(1)
500 - ton Horizontal Drive Unit (HDU)
•
Deployment Frames
•
Termination Shelters
•
Pipe
Straightener
•
ROV
Hooks and Shackles
•
Stackable SeaStax: tanks, baskets, and boxes
Manufacturing
Deep
Down
has major manufacturing facilities in Channelview, Texas, a suburb of Houston,
where it conducts a broad variety of processes, including machining,
fabrication, inspection, assembly and testing. Deep Down’s Manufactured Systems
Division is devoted to the design, manufacturing, testing, and commissioning
of
heavy equipment used in both on- and offshore operations in a variety of
markets
and industries. The manufacturing personnel have over 50 years of combined
experience serving commercial, government, and academic customers in a variety
of applications.
The
facilities encompass over 8 acres, with approximately 60,000 square feet
of
manufacturing space with 4 overhead cranes and 7,000 square feet of office
space. The Company is ideally located with great access to both I-10 and
the
Houston Ship Channel. The facilities have 120V, 240V and 480V power.
Deep
Down’s personnel have been utilized in the development and fabrication of many
tools to aid in the installation process. These tools have varied from UTA
running and parking frames, to VIV strakes, mud mats, as well as the Deep
Down
Flying Lead Deployment system. We have also designed and fabricated many
of our
own equipment frames such as the dual tank skid, gang boxes, testing units,
and
work vans. Deep Down has also built, maintained and manufactured equipment
such
as under rollers, control booths, fluid drum carriers, and stainless steel
tote
tanks.
Deep
Down
manufactures DnV certified systems and is in the process of obtaining ISO
9001
certification, at its Channelview, Texas facility. Deep Down maintains its
high
standards of product quality through the use of quality assurance specialists
who work with product manufacturing personnel throughout the manufacturing
process by inspecting and documenting equipment as it is processed through
the
Company's manufacturing facility. The Company has the capability to manufacture
various products from each of its product lines at its major manufacturing
facility and believes that this localized manufacturing capability is essential
in order to compete with the Company's major competitors. The Company maintains
valuable relationships with several other companies that own additional
fabrication facilities in and around Houston, Texas. These other companies
provide excellent subcontract manufacturing support on an as-needed basis.
The
Company's manufacturing process is vertically integrated, producing, in house,
essentially all of its heat treatment, machining, fabrication, inspection,
assembly and testing requirements. The Company's primary raw material is
steel.
The Company routinely purchases raw materials from many suppliers on a purchase
order basis and does not have any long-term supply contracts.
Deep
Down’s manufacturing facility utilizes state-of-the-art computer numerically
controlled ("CNC") Plasma Burn Table, which contributes to the Company's
product
quality and timely delivery. The Company maintains its equipment and tooling
and
upgrades its capabilities as needed to enhance the economic manufacture of
its
specialized products. The Company purchases quality used machine tools and
equipment as they become available and stores them at its facility to be
rebuilt, upgraded or refurbished as needed.
Customers
The
Company's principal customers are major integrated oil and gas companies,
large
independent oil and gas companies and foreign national oil and gas companies
involved in offshore exploration and production. Offshore drilling contractors
and engineering and construction companies also represent a smaller customer
base. The Company’s customers include Shell; Amerada Hess; Marathon; ExxonMobil;
Cal Dive; Devon; BHP; Anadarko; Texaco; Chevron; British Petroleum; Kerr
McGee;
Unocal; Noble Energy; Cameron and Aker Kvaerner, Technip, Oceaneering, Subsea
7,
Helix, among others.
The
Company is not dependent on any one customer or group of customers. The number
and variety of the Company's products required in a given year by any one
customer depends upon the amount of that customer's capital expenditure budget
devoted to offshore exploration and production in any single year and on
the
results of competitive bids for major projects. Consequently, a customer
that
accounts for a significant portion of revenues in one fiscal year may represent
an immaterial portion of revenues in subsequent years. While the Company
is not
dependent on any one customer or group of customers, the loss of one or more
of
its significant customers could, at least on a short-term basis, have an
adverse
effect on the Company's results of operations.
Marketing
and Sales
Deep
Down
markets its products and services throughout the world directly through its
sales personnel out of the Channelview office. The Company also places print
advertising from time to time in trade and technical publications targeted
to
its customer base. It also participates in industry conferences and trade
shows
to enhance industry awareness of its products.
The
Company's customers generally order products and services after consultation
with the Company on project specifics. Orders are typically filled within
two
weeks to three months after receipt of an order, depending on the type of
product or service. Contracts for certain of the Company's larger, more complex
products, can take as long as four to six months to complete. The primary
factors influencing a customer's decision to purchase the Company's products
and
services are the quality, reliability and reputation of the product or service,
price, timely delivery and technologically superior features. For large drilling
and production system orders, project management teams coordinate customer
needs
with engineering, manufacturing and service organizations, as well as with
subcontractors and vendors.
A
portion
of the Company's business consists of designing, manufacturing, selling and
installing equipment for major projects pursuant to competitive bids, and
the
number of such projects in any year fluctuates. The Company's profitability
on
such projects is critically dependent on making accurate and cost effective
bids
and performing efficiently in accordance with bid specifications. Various
factors can adversely affect the Company's performance on individual projects,
with potential adverse effects on project profitability.
Product
Development and Engineering
The
technological demands of the oil and gas industry continue to increase as
offshore exploration and drilling operations expand into deeper and more
hostile
environments. Conditions encountered in these environments include well
pressures of up to 15,000 psi, mixed flows of oil and gas under high pressure
that may also be highly corrosive, and water depths in excess of 8,000 feet.
Deep Down is continually engaged in product development activities to generate
new products and improve existing products to meet its customers’ specific
needs. The Company also focuses its 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.
Deep
Down
has an established track record of introducing new products and product
enhancements. Our product development work is conducted at its facilities
in
Channelview, Texas and in the field. The Company's application engineering
staff
also provides engineering services to customers in connection with the design
and sales of its products. The Company's ability to develop new products
and
maintain technological advantages is important to its future
success.
The
Company believes that the success of its business depends more on the technical
competence, creativity and marketing abilities of its employees than on any
individual patent, trademark or copyright. Nevertheless, as part of its ongoing
product development and manufacturing activities, Deep Down’s 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 the Company.
Competition
The
principal competitive factors in the petroleum drilling and production equipment
markets are quality, reliability and reputation of the product, price,
technology, service and timely delivery. Deep Down faces significant competition
from other manufacturers of exploration and production equipment. Several
of its
primary competitors are diversified multinational companies with substantially
larger operating staffs and greater capital resources than those of the Company
and which, in many instances, have been engaged in the manufacturing business
for a much longer time than the Company. The Company competes principally
with
FMC; Kvaerner and Oceaneering on its steel flying leads; Norson; VFL and
Halliburton Product Pipeline Services on its umbilical services; Dynacon
and
Ocean Works on its Launch and Recovery Systems..
Employees
The
total
number of the Company's employees as of April 12, 2007 was 49. The Company's
employees are not covered by collective bargaining agreements, and the Company
considers its employee relations to be good. The Company's operations depend
in
part on its ability to attract a skilled labor force. While the Company believes
that its wage rates are competitive and that its relationship with its skilled
labor force is good, a significant increase in the wages paid by competing
employers could result in a reduction of the Company's skilled labor force,
increases in the wage rates paid by the Company or both.
Governmental
Regulations
Many
aspects of the Company's operations are affected by political developments
and
are subject to both domestic and foreign governmental regulations, including
those relating to oilfield operations, worker safety and the protection of
the
environment. In addition, the Company depends on the demand for its services
from the oil and gas industry and, therefore, is affected by changing taxes,
price controls and other laws and regulations relating to the oil and gas
industry generally, including those specifically directed to offshore
operations. The adoption of laws and regulations curtailing exploration and
development drilling for oil and gas for economic or other policy reasons
could
adversely affect the Company's operations by limiting demand for the Company's
products.
In
recent
years, increased concern has been raised over the protection of the environment.
Offshore drilling in certain areas has been opposed by environmental groups
and,
in certain areas, has been restricted. To the extent that new laws or other
governmental actions prohibit or restrict offshore drilling or impose additional
environmental protection requirements that result in increased costs to the
oil
and gas industry in general and the offshore drilling industry in particular,
the business of the Company could be adversely affected. The Company cannot
determine to what extent its future operations and earnings may be affected
by
new legislation, new regulations or changes in existing regulations.
The
Company's operations are affected by numerous foreign, federal, state and
local
environmental laws and regulations. The technical requirements of these laws
and
regulations are becoming increasingly expensive, complex and stringent. 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 the Company
to
liability for the conduct of or conditions caused by others, or for acts
of the
Company that were in compliance with all applicable laws at the time such
acts
were performed. Compliance with environmental laws and regulations may require
the Company to obtain permits or other authorizations for certain activities
and
to comply with various standards or procedural requirements. The Company
believes that its facilities are in substantial compliance with current
regulatory standards.
Based
on
the Company's experience to date, the Company does not currently anticipate
any
material adverse effect on its 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 by the Company, which may be
material.
Item
2. Description of Property.
The
Company’s offices are located at 15473 East Freeway; Channelview, Texas 77530.
The subject property consists of approximately 55,252 square feet of
manufacturing and office space on approximately 7.71 acres of land.
Item
3. Legal Proceedings.
We
are
from time to time involved in legal proceedings arising from the normal course
of business. As of the date of this report, we are not currently involved
in any
legal proceedings.
Item
4. Submission of Matters to a Vote of Security Holders.
No
matter
was submitted to vote of our security holders during the fourth fiscal quarter
covered by this report.
PART
II
Item
5. Market for Common Equity, Related Stockholder Matters and Small Business
Issuer Purchases of Equity Securities.
Market
for Common Stock
Our
common stock trades publicly on the OTC Bulletin Board under the symbol “DPDW.”
The OTCBB is a regulated quotation service that displays real-time quotes,
last-sale prices and volume information in over-the-counter equity securities.
The OTCBB securities are traded by a community of market makers that enter
quotes and trade reports. This market is extremely limited and any prices
quoted
are not a reliable indication of the value of our common stock.
Prior
to the reverse merger with MediQuip on December 14, 2006, no public market
in
our common stock existed. See the discussion of the reverse merger under
Corporate History in Item 1 and in Note 1 “Description 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 period from December 14 to December
31, 2006 were $0.85 and $0.13 respectively. These quotes represent inter-dealer
quotations, without adjustment for retail mark-up, markdown or commission
and
may not represent actual transactions.
Holders
As
of
April 12, 2007, there were approximately 1,050 holders of record of our common
stock and we believe there were approximately 1,676 beneficial
owners.
Dividend
Policy
To
date,
we have not paid any cash dividends and our present policy is to retain earnings
for use in our business.
Equity
Compensation Plan Information
The
Company has no outstanding equity compensation plan and therefore no outstanding
options or rights to purchase common stock under a compensation plan as of
December 31, 2006.
Recent
Sales of Unregistered Securities
On
March
20, 2007, the Company completed the sale of 10,000,000 shares of common stock
in
a private placement for $1,000,000. This private placement was initiated
prior
to the closing of the Agreement and Plan of Reorganization between Deep Down
(Nevada), formerly MediQuip Holdings, Inc., and Deep Down (Delaware). Pursuant
to the terms thereof, 10,000,000 shares of common stock were reserved to
complete this private placement. The shares are restricted as defined in
Rule
144 of the Securities Act of 1933 and contain a restrictive legend, which
restricts the ability of the holders to sell these shares for a period of
no
less than one year. Funds will be used to redeem certain outstanding
exchangeable preferred stock and for working capital.
The
Company finalized the terms of an agreement with Daniel L. Ritz, Jr.
(shareholder and director), who agreed to surrender 25,000,000 shares of
common
stock; 1,500 shares of Series F convertible preferred stock and 500 shares
of
Series G exchangeable preferred stock to the Company for cancellation. For
these
actions, Mr. Ritz will receive 1,250 shares of Series E exchangeable preferred
stock and $250,000 cash. In addition, Mr. Ritz will keep 500 shares of Series
E
exchangeable preferred stock he currently owns and agreed to tender his
resignation from the Board. As a result of this exchange, Mr. Ritz will own
1,750 shares of Series E exchangeable preferred stock.
The
Company agreed to issue 2,000 shares of Series E exchangeable preferred stock
to
John C. Siedhoff (shareholder, Chief Financial Officer, and director) for
the
surrender of his ownership of 1,500 shares of Series F convertible preferred
stock and 500 shares of Series G exchangeable preferred stock, which will
be
returned to the transfer agent for cancellation.
The
offers and sales of the securities in the private placement are exempt from
the
registration requirements of the Securities Act of 1933 (the “Act”) pursuant to
Rule 506 and Section 4(2) of the Act. In connection with the offers and sales,
we did not conduct any general solicitation or advertising, and we complied
with
the requirements of Regulation D relating to the restrictions on the
transferability of the shares issued.
Item
6. Management’s Discussion and Analysis or Plan of
Operation.
Cautionary
Note Regarding Forward-Looking Statements
Statement
under the safe harbor provisions of the Private Securities Litigation Reform
Act
of 1995: Deep Down, Inc. and its representatives may from time to time make
written or oral statements that are “forward-looking” and provide information
that is not historical in nature, including statements that are or will be
contained in this report, the notes to our consolidated financial statements,
our other filings with the Securities and Exchange Commission, our press
releases and conference call presentations and our other communications to
our
stockholders. These statements involve known and unknown risks, uncertainties
and other factors that may be outside of our control and may cause actual
results to differ materially from any results, levels of activity, performance
or achievements expressed or implied by any forward-looking statement. These
factors include, among other things, those described under Risk Factors in
Item 1A of this Annual Report on Form 10-K.
In
some
cases, forward-looking statements can be identified by such words or phrases
as
“will likely result,” “is confident that,” “expects,” “should,” “could,” “may,”
“will continue to,” “believes,” “anticipates,” “predicts,” “forecasts,”
“estimates,” “projects,” “potential,” “intends” or similar expressions
identifying “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995, including the negative of those
words
and phrases. Such forward-looking statements are based on our current views
and
assumptions regarding future events, future business conditions and our outlook
based on currently available information. We wish to caution you not to place
undue reliance on any such forward-looking statements, which speak only as
of
the date made and involve judgments.
The
following discussion and analysis provides information that management believes
is relevant to an assessment and understanding of our results of operations
and
financial condition. The following selected financial information is
derived from our historical financial statements, and proforma financial
statements where noted, and should be read in conjunction with such financial
statements and notes thereto set forth elsewhere herein and the “Forward-Looking
Statements” explanation included herein.
Executive
Overview
We
are an
installation engineering and management company focused on the offshore segment
of the energy industry. We can custom design and manufacture product or modify
existing equipment to meet customer specifications. We design, manufacture,
fabricate, sell and service highly-engineered subsea equipment, surface
equipment and offshore rig equipment for use in deepwater, harsh environment
and
severe service applications. Our principal products consist of flying lead
installation, maintenance and termination systems; buoyancy and rigging systems;
high and low pressure testing and monitoring systems; latch systems; lay
chutes;
rollers; tensioners; and offshore storage and space management systems. We
also
provide installation, retrieval, storage and management services in connection
with the use of our products.
Deep
Down
has developed its broad line of subsea equipment, surface equipment and offshore
rig equipment primarily through internal product development efforts in
Channelview, Texas. In many cases, these products were developed in direct
response to customer requests for solutions to critical problems in the field.
We are instrumental in achieving solutions for our clients to simplify
installation procedures and reduce costs.
In
2006,
we continued our focus on customer service, expanded our customer base and
went
public through a reverse merger, thereby giving Deep Down access to additional
sources of capital. Nevertheless, our banking relationships continue to grow
as
well, giving us continued access to traditional sources of capital to help
us
expand our operations. The infrastructure we have in place has enabled us
to
increase our revenue over 63% from 2005 to 2006, after a 52% increase in
the
prior period.
Our
new
product line of Launch and Recovery Systems (LARS) have started shipping
to our
customers, including a Saturation Diving LARS, a Sea-eye LARS and a 3,000
meter
rated LARS. We are currently manufacturing two (2) 4,000 meter rated LARS
for
extreme water depths and geophysical installation equipment for an international
customer.
Product
innovations continued during 2006 with the patent-pending SubSea Deployment
Baskets (SDB), a new Bend Stiffener Latcher that is enjoying wide acceptance
in
the market for subsea connections, a fleet of rapid deployment cartridges
for
Steel Flying Leads, special Hold Back Clamps, and delivery of the first
Electrical Hydraulic Loose Steel Flying Leads in the industry.
We
continue to support our installation contracting customers with installations
of
Steel Flying Leads (SFL’s), and our major operating customers with the provision
of offshore testing, monitoring, remediation and/or commissioning work. Our
equipment rental fleet has been expanded to now include five (5) Horizontal
Drive Unit systems to provide flying lead and specialty cable installation
deployment capabilities with our fleet of pumps, under rollers, buoyancy
compensators and other tools and equipment.
We
remain
committed to supporting the operator, installation contractor, and umbilical
and
controls supplier to enhance the progression and completion of major offshore
oil and gas exploration and production projects.
Corporate
History
During
2006, MediQuip Holdings, Inc. (“MediQuip”), a publicly traded company, divested
its operating subsidiary and subsequently entered into a merger agreement
with
Deep Down, Inc. which was accounted for as a reverse merger with Deep Down,
Inc.
being the surviving entity for accounting purposes. The following discussion
describes the history of Deep Down, Inc. (“we” or “the Company”)
On
June
29, 2006, Subsea Acquisition Corporation (“Subsea”) was formed by three
shareholders with the intent to acquire service providers to the offshore
industry, and designers and manufacturers of subsea equipment, surface equipment
and offshore rig equipment that are used by major integrated, large independent
and foreign national oil and gas companies in offshore areas throughout the
world. In November 2006, Subsea On June 29, 2006, Subsea Acquisition Corporation
(“Subsea”) was formed by three shareholders with the intent to acquire service
providers to the offshore industry, and designers and manufacturers of subsea
equipment, surface equipment and offshore rig equipment that are used by
major
integrated, large independent and foreign national oil and gas companies
in
offshore areas throughout the world. On November 21, 2006, Subsea acquired
Deep
Down, Inc, a Delaware corporation founded in 1997. Under the terms of this
transaction, all of Deep Down, Inc.’s shareholders transferred ownership of all
of Deep Down Inc.’s common stock to Subsea in exchange for 5,000 shares of
Subsea’s Series D Preferred Stock and 5,000 shares of Subsea’s Series E
Preferred Stock resulting in Deep Down Inc. becoming a wholly owned subsidiary
of Subsea. On the same day, Subsea then merged with Deep Down, with the
surviving company operating as Deep Down Inc. Unless specifically stated
otherwise, all references to Deep Down refer to the combined entity comprising
Subsea and Deep Down Inc. This transaction was accounted for as a purchase
with
Subsea being the acquirer based on a change in voting control. Under purchase
accounting, we have included the results of operations of the entity formerly
operating as Deep Down from the acquisition date of November 21, 2006 forward.
As Subsea was formed on June 29, 2006, the financial statements included
herein
reflect the results of the operations from the date of inception to December
31,
2006.
Additionally
on November 21, 2006, Subsea acquired all the common stock of Strategic Offshore
Services Corporation (“SOS”) for 3,000 Series F Preferred Stock and 1,000 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 charged compensation expense to shareholders for the fair value
of
both series totaling $3,340,792 million.
On
December 14, 2006 Deep Down exchanged all 9,999,999 shares of Deep Down common
stock and all 14,000 shares of Deep Down preferred stock for 75,000,000 shares
of common stock and 14,000 shares of preferred stock of MediQuip. The preferred
shares of MediQuip have the same designations as Deep Down’s preferred stock. As
a result of the acquisition, the shareholders of Deep Down will own a majority
of the voting stock of MediQuip, which changed its name to Deep Down, Inc.
The
merger has been accounted for as a reverse merger whereby Deep Down is the
accounting acquirer resulting in a recapitalization of Deep Down’s equity. The
acquisition did not require the approval of shareholders of MediQuip. In
connection and simultaneously with this reverse merger, Westmeria Healthcare
Limited, a wholly owned subsidiary of MediQuip was transferred to MediQuip’s
majority shareholder in exchange for the cancellation of 31,351,256 common
share
equivalents. The MediQuip Series C convertible preferred stock outstanding
prior
to the reverse merger remains outstanding.
The
Company’s historical financial statements reflect those of Deep Down, Inc, and
do not include the results of MediQuip or Westmeria Healthcare Limited for
periods prior to the merger date.
Critical
Accounting Policies
The
accompanying discussion and analysis of our financial condition and results
of
operations is based upon our audited consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. Note 2 “Summary of Significant Accounting
Policies” of the notes to our audited consolidated financial statements included
elsewhere in this report contain a detailed summary of our significant
accounting policies. We utilize the following critical accounting policies
in
the preparation of our financial statements.
Accounts
Receivable We
provide an allowance for doubtful accounts on trade receivables based on
historical collection experience and a specific review of each customer’s trade
receivable balance.
Inventory
Inventory
is stated at the lower of cost (first-in, first out) or net realizable value.
Inventory mainly consists of supplies used in the offshore industry such
as
fittings and valves.
Revenue
Recognition Revenue
from fabrication and sale of equipment is recognized upon transfer of title
to
the customer (which is upon shipment or when customer-specific acceptance
requirements are met). Service revenue is recognized as the service is provided.
Impairment
of Long-Lived Assets Long-lived
assets, including property, plant and equipment, capitalized software costs,
and
assets held for sale are reviewed for impairment whenever events or changes
in
circumstances indicate that the carrying amount of the long-lived asset may
not
be recoverable. The carrying amount of a long-lived asset is not recoverable
if
it exceeds the sum of the undiscounted cash flows expected to result from
the
use and eventual disposition of the asset. If it is determined that an
impairment loss has occurred, the loss is measured as the amount by which
the
carrying amount of the long-lived asset exceeds its fair value.
Goodwill
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, 2006.
The
Company evaluates the carrying value of goodwill during the fourth quarter
of
each year and between annual evaluations if events occur or circumstances
change
that would more likely than not reduce the fair value of the reporting unit
below its carrying amount. Such circumstances could include a significant
adverse change in legal factors or in business or the business climate or
unanticipated competition. When evaluating whether goodwill is impaired,
the
Company compares the fair value of the business to its carrying amount,
including goodwill. The fair value of the reporting unit is estimated using
a
combination of the income, or discounted cash flows, approach and the market
approach, which utilizes comparable companies’ data. If the carrying amount of
the business exceeds its fair value, then the amount of the impairment loss
must
be measured. The impairment loss would be calculated by comparing the implied
fair value of reporting unit goodwill to its carrying amount.
Income
Taxes We
have
adopted the provisions of SFAS No. 109, “Accounting for Income Taxes" which
requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the consolidated
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the difference between the financial
statement and tax basis of assets and liabilities using enacted tax rates
in
effect for the year in which the differences are expected to
reverse.
Pro-forma
Results of Operations
Under
purchase accounting rules, 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
the
Company 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, 2005. 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.
Additionally, on November 21, 2006, Subsea acquired all the common stock
of
Strategic Offshore Services Corporation (“SOS”) for 3,000 Series F Preferred
Stock and 1,000 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 charged non-cash, non-operating compensation
expense to shareholders for the fair value of both series totaling $3,340,792.
Pro
forma Statements of Operations
|
|
|
Year
Ended December 31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
Revenues
|
$
8,821,149
|
|
$
5,417,872
|
Cost
of sales
|
5,155,399
|
|
2,531,148
|
Gross
profit
|
3,665,750
|
|
2,886,724
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
Selling,
general & administrative (2)
|
5,710,324
|
|
1,819,103
|
|
Depreciation
|
166,468
|
|
200,313
|
|
Loss
on sale of assets
|
-
|
|
14,293
|
|
|
Total
operating expenses
|
5,876,792
|
|
2,033,709
|
|
|
|
|
|
|
Operating
income (loss)
|
(2,211,042)
|
|
853,015
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
Interest
expense (1)
|
(578,335)
|
|
(555,087)
|
Total
other income (expense)
|
(578,335)
|
|
(555,087)
|
|
|
|
|
|
|
Income
(loss) from continuing operations
|
(2,789,377)
|
|
297,928
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
Loss
from operations of discontinued businesses
|
-
|
|
(5,292)
|
|
Loss
on disposal of business segment
|
-
|
|
(72,107)
|
Loss
on discontinued operations
|
-
|
|
(77,399)
|
Income
tax provision
|
(22,250)
|
|
-
|
Net
income (loss)
|
$
(2,811,627)
|
|
$
220,529
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
Basic
and diluted
|
$
(0.04)
|
|
$
0.00
|
|
|
|
|
|
|
Weighted
average common shares outstanding
|
|
|
|
|
Basic
and diluted
|
75,862,484
|
|
75,000,000
|
|
|
|
|
|
|
(1)
Includes approximately $423,258 and $381,310, respectively, additional
interest
expense from
the
accretion of the Series E preferred shares.
(2)
Includes $3.3 million compensation expense from the issuance of Preferred
series
F and G stock
in
2006 and $237,430 in 2005
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, 2005. 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
|
2006
|
2005
|
Change
|
%
|
Revenues
|
$
8,821,149
|
$
5,417,872
|
$
3,403,277
|
62.8%
|
Revenues
increased by approximately $3.40 million, or 62.8% for the twelve months
ended
December 31, 2006 from approximately $5.42 million for the comparable period
in
2005. This increase was due in part to the hiring of a sales manager to bring
increased focus to the sales effort; the generation of a new product line
of
manufactured Launch And Recovery Systems (LARS); increased capital expenditures
to expand our equipment rental fleet of spooling and handling equipment;
and a
continued focus on customer service to increase both orders and order size.
Cost
of sales
|
2006
|
2005
|
Change
|
%
|
Cost
of sales
|
$
5,155,399
|
$
2,531,148
|
$
2,624,251
|
103.7%
|
As
a
percentage of revenues, cost of sales increased from approximately 46.7%
in 2005
to approximately 58.4% in 2006. This increase was due in part to the
manufacturing of LARS, which has a higher cost of goods sold than the rental
fleet and service work. As a result, gross margins decreased from approximately
53.3% in 2005 to approximately 41.6% in 2006.
Selling,
general and administrative expenses
|
2006
|
2005
|
Change
|
%
|
Selling,
general and administrative
|
$
5,710,324
|
$
1,819,103
|
$
3,891,221
|
|
Stock
based compensation expense
|
(3,340,792)
|
(237,430)
|
(3,103,362)
|
|
Adjusted
selling, general and administrative
|
$
2,369,532
|
$
1,581,673
|
$
787,859
|
49.8%
|
Selling,
general and administrative expenses include rent, utilities, general office
expenses, insurance, personnel and other costs necessary to conduct business
operations. Also included in selling, general and administrative expenses
for
the year ended December 31, 2006 is a non-cash, non-operating compensation
expense of approximately $3.34 million 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
in
Corporate History above.
After
adjusting for this non-cash, non-operating expense of approximately $3.34
million, selling, general and administrative expenses for the year ended
December 31, 2006 was approximately $2.37 million, up approximately $0.79
million or 49.8% from $1.58 million for the comparable period in 2005. 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 rent expense (see related party transactions related
to the
land and building in the footnotes to the financials) and increased bonuses.
Additionally, the Company recorded stock based compensation of $237,430 in
fiscal 2005.
Depreciation
expense
|
2006
|
2005
|
Change
|
%
|
Depreciation
expense
|
$
166,468
|
$
200,313
|
$
(33,845)
|
(16.9)%
|
Depreciation
expense is related primarily to equipment used in manufacturing
operations.
Interest
expense
|
2006
|
2005
|
Change
|
%
|
Interest
expense
|
$
578,335
|
$
555,087
|
$
23,248
|
|
Less
amounts related to accretion
|
(423,258)
|
(381,310)
|
(41,948)
|
|
Interest
expense on long term debt
|
$
155,077
|
$
173,777
|
$
(18,700)
|
(10.8)%
|
The
Company completed a detailed debt consolidation program in November 2005
which
led to both a lower fixed interest rate and the decrease in actual interest
expense in 2006, despite an increase in debt. The Company added one loan
for
approximately $496,000.
The
Company calculated the fair value for the Series E and G Preferred Stock
issued
in exchange for 100% of the common stock of Deep Down, Inc. (Delaware) and
Strategic Offshore Services Corporation using a discount rate significantly
greater than the 6% interest on the three-year term note into which those
preferred shares are exchangeable. The Company must accrete the difference
between the determined value and the face value for which the Company is
obligated as interest expense.
After
adjusting for this non-cash, non-operating expense, the interest expense
for the
year ended December 31, 2006 was approximately $155,077, down approximately
$18,700, or 10.8%, from the comparable period in 2005.
Loss
on discontinued operations
|
2006
|
2005
|
Change
|
%
|
Loss
on discontinued operations
|
$
-
|
$
77,399
|
$
(77,399)
|
(100.0)%
|
During
the year ended December 31, 2005 the Company discontinued operations that were
not part of the core business. These two operations included a vending company
and a sales distribution company of Jet Dock equipment.
Net
Income (loss)
|
2006
|
2005
|
Change
|
%
|
Net
income (loss)
|
$
(2,811,627)
|
$
220,529
|
$
(3,032,156)
|
|
Stock
based compensation expense
|
3,340,792
|
237,430
|
3,103,362
|
|
Amounts
related to accretion
|
423,258
|
381,310
|
41,948
|
|
Adjusted
net income
|
$
952,423
|
$
839,269
|
$
113,154
|
13.5%
|
The
increase in net loss from normal operations includes the proforma and
non-recurring non-cash, non-operating expense items noted above arising out
of
the accounting treatment of the Series D, E, F and G Preferred Stock. After
adjusting for these non-cash, non-operating expenses, the Company has net
income
of approximately $0.95 million, up approximately $0.11 million, or 13.5%,
from
$0.83 million for the comparable period in 2005.
EBITDA
|
2006
|
2005
|
Change
|
%
|
Operating
income (loss)
|
$
(2,211,042)
|
$
853,015
|
$
(3,064,057)
|
|
Depreciation
expense
|
166,468
|
200,313
|
(33,845)
|
|
Stock
based compensation expense
|
3,340,792
|
237,430
|
3,103,362
|
|
EBITDA
|
$
1,296,218
|
$
1,290,758
|
$
5,460
|
0.4%
|
After
adjusting for all non-cash, non-operating expenses related to the Series
D, E, F
and G preferred stock, the Company has EBITDA for the year ended December
31,
2006 of $1,296,218, up $5,460, or 0.4%, from $1,290,758 for the comparable
period in 2005.
EBITDA
is
a non-GAAP financial measure. The Company defines EBITDA as net income plus
interest expense, income taxes, depreciation, amortization and other non-cash,
non-operating expense. The Company uses EBITDA as a 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 the Company's assets to generate cash
sufficient for the Company to pay potential interest costs. The Company 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 the Company's operating performance
or
liquidity, investors and others 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.
Sources
and Uses of Cash for the period from inception, June 29, 2006 through December
31, 2006
Cash
flows for the period from inception, June 29, 2006 through December 31, 2006,
were as follows:
Operating
Cash Flows
Cash
required by operating activities of continuing operations was $56,242. Our
working capital balances can vary depending on the payment and delivery terms
on
key contracts; work in process, and outstanding receivables and
payables.
Investing
Cash Flows
The
increase in cash from investing activities of $101,497 is primarily due to
cash
acquired in the acquisition of a business.
Financing
Cash Flows
Cash
required by financing activities was $32,893 which reflects payments on long
term debt.
Liquidity
and Capital Resources
We
generate our capital resources primarily through operations and, when needed,
through bank loans. Our total bank loans due at December 31, 2006 was
$1,168,348, of which $410,731 was short term. During the period from November
21, 2006 through December 31, 2006, we made $32,893 in bank debt
payments.
Debt
and Liquidity
Total
borrowings at December 31, 2006, comprised the following:
A
note
payable with a bank, monthly principal and interest payments, interest fixed
at
7.5%, due September 2008, secured by equipment under lease contract to a
third
party in the amount of $438,812.
A
note
payable with a bank, monthly principal and interest payment, interest fixed
at
7.5%, due November 2010, secured by machinery, equipment, and furniture in
the
amount of $729,536.
Of
the
total of $1,168,348 in debt, $410,731 is short term debt, and $757,617 is
long
term debt.
Outlook
for 2007
We
plan
to meet our cash requirements in 2007 with cash generated from operations.
We
will continue to expand our product line offerings, and we are projecting
to
spend approximately $250,000 to expand our rental fleet and approximately
$150,000 to develop new products.
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
The
company has no off-balance sheet arrangements that have or are reasonably
likely
to have a current or future effect on the Company’s financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.
Certain
Factors That May Affect Future Operating Results
Our
business is subject to various risks, including those described below. You
should carefully consider the following risk factors, together with all of
the
other information included in this Form 10-KSB. Any of these risks could
materially adversely affect our business, operating results and financial
condition.
Risks
Related to Our Business
A
material or extended decline in expenditures by the oil and gas industry
could
significantly reduce our revenue and income.
Our
business depends upon the condition of the oil and gas industry and, in
particular, the willingness of oil and gas companies to make capital
expenditures on exploration, drilling and production operations offshore.
The
level of capital expenditures is generally dependent on the prevailing view
of
future oil and gas prices, which are influenced by numerous factors affecting
the supply and demand for oil and gas, including:
•
Worldwide economic activity;
•
The
level of exploration and production activity;
•
Interest rates and the cost of capital;
•
Environmental regulation;
•
Federal, state and foreign policies regarding exploration and development
of oil
and gas;
•
The
ability of the Organization of Petroleum Exporting Countries to set and maintain
production levels and pricing;
•
The
cost of exploring for and producing oil and gas;
•
The
cost of developing alternative energy sources;
•
The
sale and expiration dates of offshore leases in the United States and
overseas;
•
The
discovery rate of new oil and gas reserves in offshore areas;
•
Technological advances; and
•
Weather
conditions.
Oil
and
gas prices and the level of offshore drilling and production activity have
been
characterized by significant volatility in recent years. Worldwide military,
political and economic events have contributed to oil and natural gas price
volatility and are likely to continue to do so in the future. Although
hydrocarbon prices have improved in recent years and the level of offshore
exploration, drilling and production activity has increased, we cannot assure
you that such price and activity levels will be sustained and that there
will
not be continued volatility in the level of drilling and production related
activities. Even during periods of high prices for oil and natural gas,
companies exploring for oil and gas may cancel or curtail programs, or reduce
their levels of capital expenditures for exploration and production for a
variety of reasons. In addition, a significant and prolonged decline in
hydrocarbon prices would likely have a material adverse effect on our results
of
operations.
Our
business involves numerous operating hazards that may not be covered by
insurance. The occurrence of an event not fully covered by insurance could
have
a material adverse effect on our financial conditions and results of
operations.
Our
products are used in potentially hazardous drilling, completion and production
applications that can cause personal injury, product liability and environmental
claims. A catastrophic occurrence at a location where our equipment and/or
services are used may expose us to substantial liability for personal injury,
wrongful death, product liability or commercial claims. To the extent available,
we maintain insurance coverage that we believe is customary in the industry.
Such insurance does not, however, provide coverage for all liabilities, and
we
cannot assure you that our insurance coverage will be adequate to cover claims
that may arise or that we will be able to maintain adequate insurance at
rates
we consider reasonable. The occurrence of an event not fully covered by
insurance could have a material adverse effect on our financial condition
and
results of operations.
We
may lose money on fixed-price contracts.
A
portion
of our business consists of designing, manufacturing, selling and installing
equipment for major projects pursuant to competitive bids, and is performed
on a
fixed-price basis. Under these contracts, we are typically responsible for
all
cost overruns, other than the amount of any cost overruns resulting from
requested changes in order specifications. Our actual costs and any gross
profit
realized on these fixed price contracts will often vary from the estimated
amounts on which these contracts were originally based.
This
may
occur for various reasons, including:
•
Errors
in estimates or bidding;
•
Changes
in availability and cost of labor and materials; and
•
Variations in productivity from our original estimates.
These
variations and the risks inherent in our projects may result in reduced
profitability or losses on projects. Depending on the size of a project,
variations from estimated contract performance could have a significant impact
on our operating results.
Our
business could be adversely affected if we do not develop new
products
Technology
is an important component of our business and growth strategy, and our success
as a company depends to a significant extent on the development and
implementation of new product designs and improvements. Whether we can continue
to develop systems and services and related technologies to meet evolving
industry requirements and, if so, at prices acceptable to our customers will
be
significant factors in determining our ability to compete in the industry
in
which we operate. Many of our competitors are large multinational companies
that
may have significantly greater financial resources than we have, and they
may be
able to devote greater resources to research and development of new systems,
services and technologies than we are able to do.
Loss
of our key management or other personnel could adversely impact our
business
We
depend
on the services of our executive management team, including Ronald E. Smith,
John C. Siedhoff and Robert E. Chamberlain, Jr. The loss of any of these
officers could have a material adverse effect on our operations and financial
condition. In addition, competition for skilled machinists, fabricators and
technical personnel among companies that rely heavily on engineering and
technology is intense, and the loss of qualified employees or an inability
to
attract, retain and motivate additional highly skilled employees required
for
the operation and expansion of our business could hinder our ability to conduct
research activities successfully and develop and produce marketable products
and
services. While we believe that our wage rates are competitive and that our
relationship with our skilled labor force is good, a significant increase
in the
wages paid by competing employers could result in a reduction of our skilled
labor force, increases in the wage rates paid by us, or both. If either of
these
events were to occur, in the near-term, the profits realized by us from work
in
progress would be reduced and, in the long-term, our production capacity
and
profitability could be diminished, and our growth potential could be
impaired.
Our
operations and our customers’ operations are subject to a variety of
governmental laws and regulations that may increase our costs, limit the
demand
for our products and services or restrict our operations.
Our
business and our customers’ businesses may be significantly affected
by:
•
Federal, state and local and foreign laws and other regulations relating
to the
oilfield operations, worker safety and the protection of the
environment;
•
Changes
in these laws and regulations; and
•
The
level of enforcement of these laws and regulations.
In
addition, we depend on the demand for our products and services from the
oil and
gas industry. This demand is affected by changing taxes, price controls and
other laws and regulations relating to the oil and gas industry generally,
including those specifically directed to offshore operations. For example,
the
adoption of laws and regulations curtailing exploration and development drilling
for oil and gas for economic or other policy reasons could adversely affect
our
operations by limiting demand for our products. We cannot determine the extent
to which our future operations and earnings may be affected by new legislation,
new regulations or changes in existing regulations.
Our
businesses and our customers’ businesses are subject to environmental laws and
regulation that may increase our costs, limit the demand for our products
and
services or restrict our operations.
Our
operations and the operations of our customers are subject to federal, state
and
local and foreign laws and regulations relating to the protection of the
environment. These environmental laws and regulations affect the products
and
services we design, market and sell, as well as the facilities where we
manufacture our products. In addition, environmental laws and regulations
could
limit our customers’ exploration and production activities. We are required to
invest financial and managerial resources to comply with environmental laws
and
regulations and anticipate that we will continue to be required to do so
in the
future. These laws and regulations change frequently, which makes it impossible
for us to predict their cost or impact on our future operations. The
modification of existing laws or regulations or the adoption of new laws
or
regulations imposing more stringent environmental restrictions could adversely
affect our operations.
These
laws may provide for “strict liability” for damages to natural resources or
threats to public health and safety, rendering a party liable for 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. Some
environmental laws and regulations provide for joint and several strict
liability for remediation of spills and releases of hazardous substances.
In
addition, we 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. These laws and regulations also may 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 and regulations at the time
such acts were performed. Any of these laws and regulations could result
in
claims, fines or expenditures that could be material to our earnings, financial
condition or cash flow.
We
may be unable to successfully compete with other manufacturers of drilling
and
production equipment.
Several
of our primary competitors are diversified multinational companies with
substantially larger operating staffs and greater capital resources than
ours
and which have been engaged in the manufacturing business for a much longer
time
than us. If these competitors substantially increase the resources they devote
to developing and marketing competitive products and services, we may not
be
able to compete effectively. Similarly, consolidation among our competitors
could enhance their product and service offerings and financial resources,
further intensifying competition.
The
loss of a significant customer could have an adverse impact on our financial
results.
Our
principal customers are major integrated oil and gas companies, large
independent oil and gas companies and foreign national oil and gas companies.
Offshore drilling contractors and engineering and construction companies
also
represent a portion of our customer base. During the period from inception,
June
29, 2006 to December 31, 2006, our top 3 customers represented approximately
43%
of total revenues, with our largest customer accounting for approximately
16% of
our total revenues. While we are not dependent on any one customer or group
of
customers, the loss of one or more of our significant customers could, at
least
on a short-term basis, have an adverse effect on our results of
operations.
Our
customers’ industries are undergoing continuing consolidation that may impact
our results of operations.
The
oil
and gas industry is rapidly consolidating and, as a result, some of our largest
customers have consolidated and are using their size and purchasing power
to
seek economies of scale and pricing concessions. This consolidation may result
in reduced capital spending by some of our customers or the acquisition of
one
or more of our primary customers, which may lead to decreased demand for
our
products and services. We cannot assure you that we will be able to maintain
our
level of sales to a customer that has consolidated or replace that revenue
with
increased business activity with other customers. As a result, the acquisition
of one or more of our primary customers may have a significant negative impact
on our results of operations or our financial condition. We are unable to
predict what effect consolidations in the industry may have on price, capital
spending by our customers, our selling strategies, our competitive position,
our
ability to retain customers or our ability to negotiate favorable agreements
with our customers.
Increases
in the cost of raw materials and energy used in our manufacturing processes
could negatively impact our profitability.
During
2005 and 2006, commodity prices for items such as nickel, molybdenum and
heavy
metal scrap that are used to make the steel alloys required for our products
increased significantly, resulting in an increase in our raw material costs.
Similarly, energy costs to produce our products have increased significantly.
If
we are not successful in raising our prices on products, our margins will
be
negatively impacted.
Future
Capital Needs
Our
growth and continued operations could be impaired by limitations on our access
to the capital markets. There can be no assurance that capital from outside
sources will be available, or if such financing is available, it may involve
issuing securities senior to the Common Stock or equity financings which
are
dilutive to holders of the Common Stock.
We
depend on third party suppliers for timely deliveries of raw materials, and
our
results of operations could be adversely affected if we are unable to obtain
adequate supplies in a timely manner.
Our
manufacturing operations depend upon obtaining adequate supplies of raw
materials from third parties. The ability of these third parties to deliver
raw
materials may be affected by events beyond our control. Any interruption
in the
supply of raw materials needed to manufacture our products could adversely
affect our business, results of operations and reputation with our
customers.
Limitation
on Remedies, Indemnification
The
Company’s Bylaws provide that the officers and directors will only be liable to
the Company for acts or omissions that constitute actual fraud, gross negligence
or willful and wanton misconduct. Thus, the Company may be prevented from
recovering damages for certain alleged errors or omissions by the officers
and
directors for liabilities incurred in connection with their good faith acts
for
the Company. Such an indemnification payment might deplete the Company’s assets.
Stockholders who have questions regarding the fiduciary obligations of the
officers and directors of the Company should consult with independent legal
counsel. It is the position of the Securities and Exchange Commission that
exculpation from and indemnification for liabilities arising under the 1933
Act
and the rules and regulations hereunder is against public policy and therefore
unenforceable.
Risks
Related to our Principal Stockholders
We
are controlled by our principal stockholders, and our other stockholders
are
unable to affect the outcome of stockholder voting.
Officers
and directors, as a group, own approximately 74.5% of our outstanding common
stock on a primary basis and approximately 74.7% on a fully diluted basis.
As
long as they continue to own, directly or indirectly, a majority of our
outstanding common stock, they will be able to exert significant control
over
us. Our other stockholders, by themselves, will not be able to affect the
outcome of any stockholder vote. As a result, the principal stockholders
will be
able to control all matters affecting us, including:
•
The
composition of our board of directors and, through it, any determination
with
respect to our business direction and policies, including the appointment
and
removal of officers;
•
Any
determinations with respect to mergers or other business
combinations;
•
Our
acquisition or disposition of assets;
•
Our
financing decisions and our capital raising activities;
•
The
payment of dividends on our common stock;
•
Amendments to our restated certificate of incorporation or bylaws;
and
•
Determinations with respect to our tax returns.
In
addition, such ownership may have the effect of delaying or preventing a
change
of control. The principal stockholders are generally not prohibited from
selling
a controlling interest in us to a third party.
Our
shares that are eligible for future sale may have an adverse effect on the
price
of our common stock.
Future
sales of substantial amounts of our common stock, or a perception that such
sales could occur, could adversely affect the market price of our common
stock
and could impair our ability to raise capital through the sale of our equity
securities. Officers and directors, as a group, own approximately 74.5% of
our
common stock outstanding. The market price of our stock could be adversely
impacted if, in the future, they should obtain piggyback and/or demand
registration rights that provide for the registration of the resale of those
shares to allow those shares to be sold in the public market without
restriction.
Risks
related to the market
The
market price of our common stock is volatile.
The
trading price of our common stock and the price at which we may sell common
stock in the future are subject to large fluctuations in response to any
of the
following:
•
Limited
trading volume in our common stock;
•
Quarterly variations in operating results;
•
General
financial market conditions;
•
The
prices of natural gas and oil;
•
Announcements by us and our competitors;
•
Our
liquidity;
•
Changes
in government regulations;
•
Our
ability to raise additional funds;
•
Our
involvement in litigation; and
•
Other
events.
Risks
Related to our Common Stock
We
do not expect to pay dividends on our common stock for the foreseeable
future.
We
do not
expect to pay cash or other dividends on our common stock for the foreseeable
future. Our board of directors reviews this policy on a regular basis in
light
of our earnings, financial condition and market opportunities. We currently
intend to retain any earnings for the future operation and development of
our
business.
There
is a limited public market for our shares of common stock.
There
is
presently a limited public market for our common stock. There is no assurance
that an active trading market will develop or be sustained. Accordingly,
you may have to hold the shares of common stock indefinitely and may have
difficulty selling them if an active trading market does not development.
The
current capitalization could delay, defer, or prevent a change of
control.
We
are
authorized to issue up to 490,000,000 shares of common stock and up to
10,000,000 shares of preferred stock, in one or more series, and to determine
the price, rights, preferences and privileges of the shares of each such
series
without any further vote or action by the stockholders. The issuance of
preferred stock could have the effect of making it more difficult for a third
party to acquire a majority of our outstanding voting stock, thereby delaying,
deferring, or preventing a change of control that might be beneficial to
investors.
Recent
Accounting Pronouncements
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
157, Fair Value Measurements (“SFAS 157”), which provides enhanced guidance for
using fair value to measure assets and liabilities. SFAS 157 also responds
to
investors’ requests for expanded information about the extent to which company’s
measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. SFAS 157
applies whenever other standards require (or permit) assets or liabilities
to be
measured at fair value, but does not expand the use of fair value in any
new
circumstances. SFAS 157 is effective for financial statements issued for
fiscal
years beginning after November 15, 2007. We have not yet determined the impact,
if any, of adopting SFAS 157 on our consolidated financial
statements.
In
July
2006, the FASB issued FASB Interpretation No. 48 “Accounting For Uncertain Tax
Positions” (“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”. It 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 tax return.
FIN
48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure, and transition. FIN
48 is
effective for fiscal years beginning after December 15, 2006. We are currently
evaluating the impact of FIN 48 on our financial position and results of
operations.
Inflation
and Seasonality
We
do not
believe that our operations are significantly impacted by inflation. Our
business is not seasonal in nature.
Item
7. Financial Statements.
The
financial statements and schedules are included herewith commencing on page
F-1.
Independent
Auditors’ Report
|
F-1
|
Consolidated
Balance Sheet
|
F-2
|
Consolidated
Statement of Operations
|
F-3
|
Consolidated
Statement of Changes in Stockholders’ Equity (Deficit)
|
F-4
|
Consolidated
Statement of Cash Flows
|
F-5
|
Notes
to Financial Statements
|
F-6
|
Item
8. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
None.
Item
8A. Controls and Procedures.
We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms, and that such information
is accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow for timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognizes that any controls
and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship
of
possible controls and procedures.
As
of the
end of the period covered by this report (the “Evaluation Date” ), we carried
out an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and our Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures. Based on the foregoing, our Chief Executive Officer
and
Chief Financial Officer concluded that, as of the Evaluation Date, our
disclosure controls and procedures were not effective at the reasonable
assurance level and in compliance with Section 404 of the Sarbanes-Oxley
Act.
While conducting the audit of the financial statements as of and for the
period
ended December 31, 2006, our independent auditors found numerous audit
adjustments that indicated a material weakness in our controls over financial
reporting. It is our plan with additional funding to devote more resources
to
this very critical function.
To
the
best of our knowledge and belief, there has been no change in our internal
controls over financial reporting during the period ended December 31, 2006
that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reports.
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.
Robert
E. Chamberlain, Jr., Chairman & Director.
Mr.
Chamberlain has a B.S. in Chemical Engineering and a B.S. in Biomedical
Engineering from Northwestern University's Technological Institute and an
MBA
from Northwestern University's Kellogg Graduate School of Management. Mr.
Chamberlain served as Vice President with Solomon Brothers Inc. (1986 to
1992),
where his responsibilities included mergers, acquisitions, leveraged buyouts,
merchant banking, divestitures, corporate finance, capital raises,
restructurings and new product development in both the private and public
markets. From 1992 through 1995, Mr. Chamberlain served as Vice President
for
Laidlaw Securities and Dickinson & Co. where he was responsible for
generating public and private equity transactions. Since 1995, Mr. Chamberlain
has assisted small emerging growth companies gain access to the capital markets
and develop well articulated strategic objectives through consulting companies
he controlled. Most recently, Mr. Chamberlain served as Chairman, CEO, CFO
and
Director of a publicly traded energy company involved in the development
of oil
and gas opportunities, primarily in the Barnett Shale of Texas.
Ronald
E. Smith, President, Chief Executive Officer and Director.
Mr.
Smith co-founded Deep Down in 1997. 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.
Mary
L. Budrunas, Vice-President. Ms.
Budrunas, co-founder of Deep Down, Inc. along with current chief executive
officer Ron Smith, is currently responsible for the Company’s administrative
functions including human resources and accounting. Ms. Budrunas has more
than
30-years of logistical management experience in manufacturing, fabrication,
and
industrial sourcing in the oil and gas industry. Prior to Ms. Budrunas
co-founding Deep Down in 1997, she managed the purchasing efforts of many
projects over a 10-year period for Mustang Engineering, and also previously
directed procurement for a large petroleum drilling and production facility
project in Ulsan, Korea.
John
C. Siedhoff, Chief Financial Officer and Director.
Mr.
Siedhoff graduated from Iowa State University in 1982 and holds a Bachelor
of
Science degree in Mechanical Engineering. Mr. Siedhoff has spent the past
24
years with manufacturing companies in the petrochemical, industrial and offshore
domains. He started working in operations with his first turnaround opportunity
and has purchased and operated six manufacturing companies since 1996. He
has
served on the Board of Directors for many different companies and has spent
considerable time assisting companies in need of his operational and financial
skills.
Steven
C. Pahls, Sales Manager.
Mr.
Pahls graduated from Widener University in 1970 and holds a Bachelor of Arts
degree and an MBA. He has a wide range of sales experience in the offshore
oil
industry selling and managing product lines for Linnenbank International,
Hamanaka International, Technor Wire Rope, Wellstream Corporation and Kvaerner
Oilfield before joining Deep Down. His expertise is in syntactic foam buoyancy
products, mooring hardware, wire products and flexible pipe
applications.
John
B. VanHyfte, Vice President.
Mr.
VanHyfte graduated from Texas A&M University in 1997 and holds a Master of
Science degree and a Bachelor of Science degree in Bioengineering. While
working
for Texas A & M University, Motorola, Linntech Engineering and Deep Down,
John has been published many times on topics ranging from “A New Microfluidic
System for the Detection of Biological Agents on Contaminated Surfaces” to
“Removal of Contaminants from Soil Using an Enhanced Phytoextraction Process”
along with patents such as “Electric Winching System for the Deployment and
Retrieval of Subsea and Subterranean Packages”. John was a National Science
Foundation Fellow and is affiliated with the Institute for Electrical &
Electronics Engineering and the Biomedical Engineering Society.
David
C. Allensworth, Engineering Manager.
Mr.
Allensworth graduated from Texas A&M University in 1991 and holds a Bachelor
of Science degree in Ocean Engineering. He has many years of design, engineering
and project management experience for the manufacturing of umbilicals, bend
stiffener latches, flying lead heads, cablers and carousels while with
Oceaneering Multiflex, Western Atlas International, Kvaerner, FMC Kongsberg
and
DUCO before arriving at Deep Down. He is also proficient in Solid Works 3D
solid
modeling, Pro-Engineer Wildfire, Algor Linear FEA and AutoCAD.
Stanley
O. Stuckey, Jr., Operations Manager.
Mr.
Stuckey is a graduate of Cleveland High School and has spent the past 19
years
servicing the offshore oil industry. He has worked offshore for Oceaneering
Multiflex, KD Services and Deep Down. His strengths are in manpower utilization,
umbilical installations, SIT services, FAT testing, fabrication and welding.
Like all of his service technicians, Mr. Stuckey has Water Survival Training
and
is a Level 1 Service Technician.
Corporate
Governance
The
Company promotes accountability for adherence to honest and ethical conduct;
endeavors to provide full, fair, accurate, timely and understandable disclosure
in reports and documents that the Company files with the Commission and in
other
public communications made by the Company; strive to be compliant with
applicable governmental laws, rules and regulations; and promotes prompt
internal reporting of violations of the code of ethics to an appropriate
person
or persons. The Company has not formally adopted a written code of business
conduct and ethics that governs to the Company’s employees, officers and
directors as the Company is not required to do so.
There
were no material changes to the procedures by which shareholders may recommend
nominees to the Company’s board of directors.
In
lieu
of an Audit Committee, the Company’s Board of Directors is responsible for
reviewing and making recommendations concerning the selection of outside
auditors, reviewing the scope, results and effectiveness of the annual audit
of
the Company's financial statements and other services provided by the Company’s
independent public accountants. The Board of Directors also reviews the
Company's internal accounting controls, practices and policies. No director
qualifies as an audit committee financial expert as defined in Item 407(d)
(5)
(ii) of Regulation S-B.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our directors
and executive officers, as well as persons beneficially owning more than
10% of
our outstanding common stock, to file reports of ownership and changes in
ownership with the Securities and Exchange Commission (the “SEC”) within
specified time periods. Such officers, directors and shareholders are also
required to furnish us with copies of all Section 16(a) forms they
file.
Based
solely on its review of such forms received by us, or written representations
from certain reporting persons, we believe that all Section 16(a) filing
requirements applicable to our officers, directors and 10% shareholders were
complied with during the fiscal year ended December 31, 2006.
Item
10. Executive Compensation.
The
following table summarizes all compensation paid to our Chief Executive Officer,
our two highest compensated named executive officers, and our two highest
compensated non-executives for the period from inception June 29, 2006 through
December 31, 2006. The Company does not currently have a stock compensation
plan; there were no non-equity incentive compensation grants, or deferred
compensation earnings by the executives of the Company. Additionally, there
have
been no warrant or option grants to executives during the period
noted.
SUMMARY
COMPENSATION TABLE
Name
and Principal Position
|
Salary
($)
|
Bonus
($)
|
Ronald
E. Smith (1)
President,
Chief Executive Officer and Director
|
$
27,110
|
$
1,710
|
John
C. Siedhoff (2)
Chief
Financial Officer, Treasurer and Director
|
$
20,220
|
$
12,415
|
Robert
E. Chamberlain
Chairman
(1)
|
$
16,670
|
$
0
|
Mary
L. Budrunas
Vice-President
|
$
13,070
|
$
12,670
|
Stanley
O. Stuckey, Jr.
Operations
Manager
|
$
16,040
|
$
4,065
|
----------
(1)
|
Mr.
Chamberlain was paid for consulting services he performed through
Strategic Capital Services, Inc.
|
Employment
Agreements
None
Compensation
of Directors
For
the
period from inception June 29, 2006 to December 31, 2006, there were no cash
payments or equity grants for compensation to the Company’s non-employee
director, Daniel L. Ritz, Jr. Mr. Ritz resigned as a director of the Company
effective March 20, 2007.
Item
11. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
EQUITY
COMPENSATION PLAN INFORMATION
As
of
December 31, 2006, the Company had no equity compensation plans.
Item
12. Certain Relationships and Related Transactions, and Director
Independence.
The
following table sets forth certain information, as of March 31, 2007, concerning
the beneficial ownership of shares of Common Stock of the Company by (i)
each
person known by the Company to beneficially own more than 5% of the Company’s
Common Stock; (ii) each Director; (iii) the Company’s Chief Executive Officer;
and (iv) all directors and executive officers of the Company as a group.
To the
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.
|
Amount
and Nature of Beneficially Ownership(1)
|
Name
and Address of Beneficial Owner(2)
|
Shares
|
Options/Warrants
|
Percent(1)
|
Ronald
E. Smith (3)
|
23,287,500
|
0
|
25.8%
|
John
C. Siedhoff
|
25,000,000
|
0
|
37.2%
|
Robert
E. Chamberlain, Jr.
|
25,000,000
|
0
|
37.2%
|
All
directors and officers as a group
|
73,287,500
|
0
|
76.7%
|
----------
(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 67,142,673 shares of common stock
outstanding as of March 31, 2007.
|
(2)
|
The
address of each of the beneficial owners is c/o Deep Down, Inc.,
15473
East Freeway, Channelview, Texas
77530.
|
(3)
|
Reflects
6,655,050 shares owned by Ron Smith and 16,632,450 shares owned
by Mary L.
Budrunas through the conversion of Series D Preferred Stock. Ron
Smith and
Mary Budrunas are married.
|
Item
13. Exhibits.
The
exhibits as indexed immediately following the signature page of this Report
are
included as part of this Form 10-KSB.
Item
14. Principal Accountant Fees and Services.
The
following table sets forth fees billed to us by our auditors during the period
from inception, June 29, 2006 to December 31, 2006 for: (i) services rendered
for the audit of our annual financial statements and the review of our quarterly
financial statements, (ii) services by our auditors that are reasonably related
to the performance of the audit or review of our financial statements and
that
are not reported as Audit Fees, (iii) services rendered in connection with
tax
compliance, tax advice and tax planning, and (iv) all other fees for services
rendered.
|
|
December
31, 2006
|
(i)
|
Audit
Fees
|
$
42,000
|
(ii)
|
Audit
Related Fees
|
$
118,000
|
(iii)
|
Tax
Fees
|
$
-
|
(iv)
|
All
Other Fees
|
$
-
|
SIGNATURES
In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the
Registrant caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
DEEP
DOWN, INC.
/s/
RONALD E. SMITH
Ronald
E.
Smith, President and Chief Executive Officer and Director (Principal Executive
Officer)
Dated:
April 24, 2007
/s/
JOHN C. SIEDHOFF
John
C.
Siedhoff, Chief Financial Officer and Director (Principal Financial
Officer)
Dated:
April 24, 2007
POWER
OF ATTORNEY
KNOWN
ALL
MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints RONALD E. SMITH and JOHN C. SIEDHOFF, and each of
them,
his or her true and lawful attorneys-in-fact and agents, with full power
of
substitution and resubstititon 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-KSB, and to file the same, with all exhibits thereto, and
other documents in connection therewith with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of
them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully and
to
all intents and purposes as he might or could do in person hereby ratifying
and
confirming all that said attorneys-in-fact and agents, or his substitute
or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
Signatures
|
Title
|
Date
|
/s/
RONALD E. SMITH
|
President,
CEO and Director
|
April
24, 2007
|
Ronald
E. Smith
|
(Principal
Executive Officer)
|
|
|
|
|
/s/
JOHN C. SIEDHOFF
|
Chief
Financial Officer and Director
|
April
24, 2007
|
John
C. Siedhoff
|
(Principal
Financial Officer)
|
|
/s/
ROBERT E. CHAMBERLAIN, JR.
|
Chairman
and Director
|
April
24, 2007
|
Robert
E. Chamberlain, Jr.
|
|
|
INDEX
TO FINANCIAL STATEMENTS
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
|
Balance
Sheet
|
F-2
|
|
|
Statements
of Operations
|
F-3
|
|
|
Statements
of Stockholders’ Equity (Deficit)
|
F-4
|
|
|
Statements
of Cash Flows
|
F-5
|
|
|
Notes
to the Financial Statements
|
F-6
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Stockholders of Deep Down, Inc. Houston,
Texas
We
have
audited the accompanying balance sheet of Deep Down, Inc. (the “Company”), as of
December 31, 2006 and the related statements of operations, stockholders’
equity, and cash flows for the period of inception, June 29, 2006 to December
31, 2006. 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 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 financial statements referred to above present fairly, in all
material respects, the financial position of Deep Down, Inc. as of December
31,
2006, and the results of its operations and cash flows for the period of
inception, June 29, 2006 to December 31, 2006, in conformity with U.S. generally
accepted accounting principles.
/s/
Malone & Bailey, PC
Malone
& Bailey, PC
www.malone-bailey.com
Houston,
Texas
April
15,
2007
Deep
Down, Inc.
Balance
Sheet
|
|
|
December
31,
|
|
|
|
|
2006
|
|
Assets
|
|
|
|
|
|
Cash
and equivalents
|
|
$
12,462
|
|
Receivables
|
|
1,264,228
|
|
Inventory
|
|
145,487
|
|
Prepaid
expenses and other current assets
|
|
11,488
|
|
Construction
in progress
|
|
916,485
|
|
|
Total
current assets
|
|
2,350,150
|
|
Property
and equipment, net
|
|
845,200
|
|
Goodwill
|
|
6,934,213
|
|
|
|
|
|
|
|
Total
assets
|
|
$
10,129,563
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders' Equity
|
|
|
|
|
|
|
|
|
Accounts
payable and accrued liabilities
|
|
$
816,490
|
|
Deferred
Revenue
|
|
190,000
|
|
Current
portion of long-term debt
|
|
410,731
|
|
|
Total
current liabilities
|
|
1,417,221
|
|
Long-term
debt
|
|
757,617
|
|
Series
E redeemable exchangeable preferred stock, face value and liquidation
preference of 1,000 per share, no dividend preference, 5,000 shares
authorized, issued and outstanding
|
|
3,486,376
|
|
|
|
|
|
Series
G redeemable exchangeable preferred stock, face value and liquidation
preference of 1,000 per share, no dividend preference, 1,000 shares
authorized, issued and outstanding
|
|
697,275
|
|
|
Total
liabilities
|
|
6,358,489
|
|
|
|
|
|
|
Commitments
and contingencies (Note 10)
|
|
|
|
|
|
|
|
|
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,
5,000
shares authorized, issued and outstanding
|
|
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,
3,000
shares authorized, issued and outstanding
|
|
2,651,547
|
|
|
Total
temporary equity
|
|
7,070,791
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
Series
C convertible preferred stock, $0.001 par value, 7% cumulative
dividend,
30,000 shares authorized, 22,000 shares issued and
outstanding
|
|
22
|
|
|
|
|
|
Common
stock, 0.01 par value, 490,000,000 shares authorized, 82,870,171
shares
issued and outstanding
|
|
828,702
|
|
Paid
in capital
|
|
(828,624)
|
|
Retained
earnings
|
|
(3,299,817)
|
|
|
Total
stockholders' equity
|
|
(3,299,717)
|
|
|
|
|
|
|
|
Total
liabilities and stockholders' equity
|
|
$
10,129,563
|
|
|
|
|
|
|
See
accompanying notes to financial statements.
Deep
Down, Inc.
Statement
of Operations
For
the Period Since Inception, June 29, 2006 to December 31,
2006
|
|
|
|
|
Revenues
|
$
978,047
|
|
Cost
of sales
|
565,700
|
|
Gross
profit
|
412,347
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
Selling,
general & administrative
|
3,600,627
|
|
|
Depreciation
|
27,161
|
|
|
|
Total
operating expenses
|
3,627,788
|
|
|
|
|
|
|
Operating
income (loss)
|
(3,215,441)
|
|
Other
income (expense):
|
|
|
|
Interest
expense
|
(62,126)
|
|
Total
other income (expense)
|
(62,126)
|
|
Income
(loss) from continuing operations
|
(3,277,567)
|
|
Income
tax provision
|
(22,250)
|
|
Net
income (loss)
|
$
(3,299,817)
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
Basic
and diluted
|
$
(0.04)
|
|
|
|
|
|
|
Weighted
average common shares outstanding
|
|
|
|
Basic
and diluted
|
76,701,659
|
|
|
|
|
|
|
See
accompanying notes to financial statements.
|
|
|
Common
Stock(a)
|
|
Series
C Preferred Stock
|
Paid-in
|
|
Retained
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
Capital
|
|
Earnings
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at June 29, 2006 (inception)
|
|
75,000,000
|
|
$
750,000
|
|
-
|
|
$
-
|
$
(749,900)
|
|
$
-
|
|
$
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
-
|
|
-
|
|
-
|
|
-
|
-
|
|
(3,299,817)
|
|
(3,299,817)
|
|
Reverse
merger with MediQuip
|
|
7,870,171
|
|
78,702
|
|
22,000
|
|
22
|
(78,724)
|
|
-
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2006
|
|
82,870,171
|
|
$
828,702
|
|
22,000
|
|
$
22
|
$
(828,624)
|
|
$
(3,299,817)
|
|
$
(3,299,717)
|
(a)
Par
value changed from $0.00 to $0.01 per share in connection with reverse
merger
See
accompanying notes to financial statements
Deep
Down, Inc.
Statements
of Cash Flows
For
the Period Since Inception, June 29, 2006 to December 31,
2006
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
loss
|
|
$
(3,299,817)
|
|
Adjustments
to reconcile net loss to net cash
|
|
|
|
used
in operating activities:
|
|
|
|
Depreciation
|
|
27,163
|
|
Share-based
compensation
|
|
3,340,792
|
|
Amortization
of debt discount
|
|
48,179
|
|
Changes
in assets and liabilities:
|
|
|
|
Accounts
receivable
|
|
(251,001)
|
|
Inventory
|
|
23,185
|
|
Prepaid
expenses and other current assets
|
|
150
|
|
Construction
in progress
|
|
(90,326)
|
|
Accounts
payable
|
|
145,433
|
|
Net
cash used in operating activities
|
|
(56,242)
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
Cash
acquired in acquisition of a business
|
|
101,497
|
|
Net
cash provided by investing activities
|
|
101,497
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
Payments
of long-term debt
|
|
(32,893)
|
|
Net
cash used in financing activities
|
|
(32,893)
|
|
|
|
|
|
Change
in cash and equivalents
|
|
12,362
|
|
|
|
|
|
Cash
and equivalents, beginning of year
|
|
100
|
|
|
|
|
|
Cash
and equivalents, end of year
|
|
$
12,462
|
|
|
|
|
|
See
accompanying notes to financial statements.
Note
1: Description of Business
Deep
Down, Inc, (“the Company”) a Nevada corporation, provides installation
management, engineering services, support services and storage management
services for the subsea controls, umbilicals & pipeline industries offshore.
The Company also fabricates component parts for subsea distribution systems
and
assemblies.
On
June
29, 2006, Subsea Acquisition Corporation (“Subsea”) was formed by three
shareholders with the intent to acquire service providers to the offshore
industry, and designers and manufacturers of subsea equipment, surface equipment
and offshore rig equipment that are used by major integrated, large independent
and foreign national oil and gas companies in offshore areas throughout the
world. On November 21, 2006, Subsea acquired Deep Down, Inc, a Delaware
corporation founded in 1997. Under the terms of this transaction, all of
Deep
Down, Inc.’s shareholders transferred ownership of all of Deep Down Inc.’s
common stock to Subsea in exchange for 5,000 shares of Subsea’s Series D
Preferred Stock and 5,000 shares of Subsea’s Series E Preferred Stock resulting
in Deep Down Inc. becoming a wholly owned subsidiary of Subsea. On the same
day,
Subsea then merged with Deep Down, with the surviving company operating as
Deep
Down Inc. Unless specifically stated otherwise, all references to Deep Down
refer to the combined entity comprising Subsea and Deep Down Inc. This
transaction was accounted for as a purchase with Subsea being the acquirer
based
on a change in voting control .Under purchase accounting; we have included
the
results of operations of the entity formerly operating as Deep Down from
the
acquisition date of November 21, 2006 forward. As Subsea was formed on June
29,
2006, the financial statements included herein reflect the results of the
operations from the date of inception to December 31, 2006.
Additionally
on November 21, 2006 Subsea acquired all the common stock of Strategic Offshore
Services Corporation (“SOS”) for 3,000 Series F Preferred Stock and 1,000 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 charged compensation expense to shareholders for the fair value
of
both series totaling $3,340,792 million.
On
December 14, 2006 Deep Down exchanged all 9,999,999 shares of Deep Down common
stock and all 14,000 shares of Deep Down preferred stock for 75,000,000 shares
of common stock and 14,000 shares of preferred stock of MediQuip Holdings,
Inc.
(“MediQuip”) The preferred shares of MediQuip have the same designations as Deep
Down’s preferred stock. As a result of the acquisition, the shareholders of Deep
Down own a majority of the voting stock of MediQuip, which changed its name
to
Deep Down, Inc. The merger has been accounted for as a reverse merger whereby
Deep Down is the accounting acquirer resulting in a recapitalization of Deep
Down’s equity. The acquisition did not require the approval of shareholders of
MediQuip. In connection and simultaneously with this reverse merger, Westmeria
Healthcare Limited, a wholly owned subsidiary of MediQuip was transferred
to
MediQuip’s majority shareholder in exchange for the cancellation of 31,351,256
common share equivalents. The MediQuip Series C convertible preferred stock
outstanding prior to the reverse merger remains outstanding.
The
Company’s historical financial statements reflect those of Deep Down, Inc, and
do not include the results of MediQuip or Westmeria Healthcare Limited for
periods prior to the merger date.
Note
2: Summary of Significant Accounting Policies
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements
and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash
and Equivalents
The
Company considers all highly liquid investments with maturities from date
of
purchase of three months or less to be cash equivalents. Cash and equivalents
consist of cash on deposit with foreign and domestic banks and, at times,
may
exceed federally insured limits.
Accounts
Receivable
The
Company provides an allowance for doubtful accounts on trade receivables
based
on historical collection experience and a specific review of each customer’s
trade receivable balance.
Inventory
Inventory
is stated at the lower of cost (first-in, first out) or net realizable value.
Inventory mainly consists of supplies used in the offshore industry such
as
fittings and valves.
Property
and Equipment
Property
and equipment are stated at cost, net of accumulated depreciation. Depreciation
and amortization is computed using the straight-line method over the estimated
useful lives of the respective assets, generally three to seven years. Leasehold
improvements are amortized on a straight-line basis over the shorter of the
assets' useful lives or lease terms.
Goodwill
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, 2006.
The
Company evaluates the carrying value of goodwill during the fourth quarter
of
each year and between annual evaluations if events occur or circumstances
change
that would more likely than not reduce the fair value of the reporting unit
below its carrying amount. Such circumstances could include a significant
adverse change in legal factors or in business or the business climate or
unanticipated competition. When evaluating whether goodwill is impaired,
the
Company compares the fair value of the business to its carrying amount,
including goodwill. The fair value of the reporting unit is estimated using
a
combination of the income, or discounted cash flows, approach and the market
approach, which utilizes comparable companies’ data. If the carrying amount of
the business exceeds its fair value, then the amount of the impairment loss
must
be measured. The impairment loss would be calculated by comparing the implied
fair value of reporting unit goodwill to its carrying amount.
Revenue
Recognition
Revenue
from fabrication and sale of equipment is recognized upon transfer of title
to
the customer (which is upon shipment or when customer-specific acceptance
requirements are met). Service revenue is recognized as the service is provided.
Impairment
of Long-Lived Assets
Long-lived
assets, including property, plant and equipment, capitalized software costs,
and
assets held for sale are reviewed for impairment whenever events or changes
in
circumstances indicate that the carrying amount of the long-lived asset may
not
be recoverable. The carrying amount of a long-lived asset is not recoverable
if
it exceeds the sum of the undiscounted cash flows expected to result from
the
use and eventual disposition of the asset. If it is determined that an
impairment loss has occurred, the loss is measured as the amount by which
the
carrying amount of the long-lived asset exceeds its fair value.
Income
Taxes
The
Company has adopted the provisions of SFAS No. 109, “Accounting
for Income Taxes"
which
requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the consolidated
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the difference between the financial
statement and tax basis of assets and liabilities using enacted tax rates
in
effect for the year in which the differences are expected to reverse.
Earnings
per Common Share
Earnings
per common share are computed based on the weighted average number of common
shares outstanding during each period. There were no dilutive securities
outstanding during any periods presented.
Dividends
The
Company has no formal dividend policy or obligations. Dividends are paid
solely
at the discretion of management.
Stock
Based Compensation
Effective
with it’s inception, June 29, 2006, the Company accounts for stock-based
compensation issued to employees and non-employees as required by SFAS No.
123(R) “Accounting for Stock Based Compensation” (“SFAS No. 123(R)”). Under
these provisions, the Company records expense based on the fair value of
the
awards utilizing the Black-Scholes pricing model for options and warrants.
There
were no stock based compensation grants for the period from inception June
29,
2006 to December 31, 2006.
Recent
Accounting Pronouncements
In
December 2004, the Financial Accounting Standards Board issued SFAS No. 123R,
“Share-Based Payment”. Under this new standard, companies will no longer be able
to account for share-based compensation transactions using the intrinsic
method
in accordance with APB 25. Instead, companies will be required to account
for
such transactions using a fair-value method and to recognize the expense
over
the service period. This new standard also changes the way in which companies
account for forfeitures of share-based compensation instruments. The Company
adopted the provisions of SFAS No. 123R from the date of inception, June
29,
2006.
In
July
2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertain Tax
Positions” (“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”. It 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 tax return.
FIN
48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure, and transition. FIN
48 is
effective for fiscal years beginning after December 15, 2006. We are currently
evaluating the impact, if any, of FIN 48 on our financial position and results
of operations.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
157, Fair Value Measurements (“SFAS 157”), which provides enhanced guidance for
using fair value to measure assets and liabilities. SFAS 157 also responds
to
investors’ requests for expanded information about the extent to which company’s
measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. SFAS 157
applies whenever other standards require (or permit) assets or liabilities
to be
measured at fair value, but does not expand the use of fair value in any
new
circumstances. SFAS 157 is effective for financial statements issued for
fiscal
years beginning after November 15, 2007. The Company has not yet determined
the
impact, if any, of adopting SFAS 157 on its consolidated financial
statements.
Note
3: Business Combination
On
November 21, 2006, Subsea acquired Deep Down, Inc, a Delaware corporation
founded in 1997. Under the terms of this transaction, all of Deep Down, Inc.’s
shareholders transferred ownership of all of Deep Down Inc.’s common stock to
Subsea in exchange for 5,000 shares of Subsea’s Series D Preferred Stock and
5,000 shares of Subsea’s Series E Preferred Stock resulting in Deep Down Inc.
becoming a wholly owned subsidiary of Subsea. On the same day, Subsea then
merged with Deep Down, with the surviving company operating as Deep Down
Inc.
The purchase price based on the fair value of the Series D and E Preferred
stock
was $7,865,471. This transaction was accounted for as a purchase, with Subsea
being the acquirer based on the change in voting control. The acquisition
price
was allocated to the assets acquired and liabilities assumed based upon their
estimated fair values with the excess being recorded in goodwill. The following
table summarizes the estimated preliminary fair values of the assets acquired
and liabilities assumed at the date of acquisition:
Cash
and cash equivalents
|
$
101,497
|
Accounts
receivable
|
1,013,227
|
Inventory
|
168,672
|
Prepaid
expenses
|
11,638
|
Construction
in progress
|
826,159
|
Property,
plant and equipment, net
|
872,363
|
Goodwill
|
6,934,213
|
Total
assets acquired
|
$
9,927,869
|
|
|
Accounts
payable and accrued liabilities
|
671,057
|
Deferred
Revenue
|
190,000
|
Current
portion of long term debt
|
403,057
|
Long
term debt
|
798,184
|
Total
liabilities acquired
|
$
2,062,298
|
Net
assets acquired
|
$
7,865,471
|
The
allocation of the purchase price was based upon preliminary valuations.
Estimates and assumptions are subject to change upon the receipt and
management’s review of the final valuations and final tax returns. The final
valuation of net assets is expected to be completed no later than one year
from
the acquisition date and any future changes in the value of net assets will
be
offset by a corresponding chance in goodwill.
The
following unaudited pro forma consolidated results of operations have been
prepared as if the acquisition of Deep Down had occurred at January 1, 2005.
The
pro forma information is presented for informational purposes only and is
not
necessarily indicative of the results of operations that actually would have
been achieved had the acquisition been consummated as of that time, nor is
it
intended to be a projection of future results. The unaudited pro forma results
were as follows:
Note
3: Business Combination (continued):
Deep
Down, Inc.
Pro
forma Statements of Operations
|
|
|
Year
Ended December 31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
Revenues
|
$
8,821,149
|
|
$
5,417,872
|
Cost
of sales
|
5,155,399
|
|
2,531,148
|
Gross
profit
|
3,665,750
|
|
2,886,724
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
Selling,
general & administrative (2)
|
5,710,324
|
|
1,819,103
|
|
Depreciation
|
166,468
|
|
200,313
|
|
Loss
on sale of assets
|
-
|
|
14,293
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
5,876,792
|
|
2,033,709
|
|
|
|
|
|
|
Operating
income (loss)
|
(2,211,042)
|
|
853,015
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
Interest
expense (1)
|
(578,335)
|
|
(555,087)
|
Total
other income (expense)
|
(578,335)
|
|
(555,087)
|
|
|
|
|
|
|
Income
(loss) from continuing operations
|
(2,789,377)
|
|
297,928
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
Loss
from operations of discontinued businesses
|
-
|
|
(5,292)
|
|
Loss
on disposal of business segment
|
-
|
|
(72,107)
|
Loss
on discontinued operations
|
-
|
|
(77,399)
|
Income
tax provision
|
(22,250)
|
|
-
|
Net
income (loss)
|
$
(2,811,627)
|
|
$
220,529
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
Basic
and diluted
|
$
(0.04)
|
|
$
0.00
|
|
|
|
|
|
|
Weighted
average common shares outstanding
|
|
|
|
|
Basic
and diluted
|
75,862,484
|
|
75,000,000
|
|
|
|
|
|
|
(1)
Includes approximately $423,258 and $381,310, respectively, additional
interest
expense from the accretion of the Series E preferred shares.
(2)
Includes $3.3 million compensation expense from the issuance of Preferred
series
F and G stock in 2006 and $237,430 in 2005.
Note
4: Accounts Receivable
Management
has established an allowance for uncollectible accounts of $81,809 as of
December 31, 2006. Bad debt expense totaled $1,294 for the period from inception
June 29, 2006 to December 31, 2006.
The
Company factors certain accounts receivables with a bank. Under the terms
of the
arrangement, the Company receives proceeds equal to 80% of the value of the
receivable at the date of transfer. Upon collection of the receivable, the
bank
remits the remaining 20%, less fees and interest. Fees range from 0.25% to
2%
depending on the age of the receivable and interest is prime plus 2%. The
arrangement contains provisions that indicate the Company is responsible
for up
to 20% of end-user customer payment defaults on factored receivables.
Accounts
receivable are comprised of the following:
|
|
December
31, 2006
|
Receivables
assigned to factor
|
|
$
1,245,183
|
Advances
from factor
|
|
(996,147)
|
Amounts
due from factor
|
|
249,036
|
Unfactored
accounts receivable
|
|
1,097,001
|
Reserve
for uncollectible accounts
|
|
(81,809)
|
Accounts
receivable, net
|
|
$
1,264,228
|
|
|
|
Note
5: Property and Equipment
Property
and equipment consisted of the following as of December 31, 2006:
|
December
31, 2006
|
Building
|
$
46,474
|
Furniture
and fixtures
|
11,806
|
Vehicles
and trailers
|
66,662
|
Equipment
|
747,419
|
Total
|
872,361
|
Less:
Accumulated depreciation
|
(27,161)
|
Property
and equipment, net
|
$
845,200
|
|
|
Depreciation
expense was $27,161 for the period from inception June 29, 2006 to December
31,
2006.
Note
6: Concentrations
The
Company maintains cash balances at one bank. Accounts at the institution
are
insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000.
The
Company had no uninsured cash balances at December 31, 2006.
As
of
December 31, 2006, four of the Company’s customers accounted for 15%, 13%, 9%
and 8% of total accounts receivable, respectively. For the period from inception
June 29, 2006 to December 31, 2006, the Company’s four largest customers
accounted for 16%, 14%, 13% and 11% of total revenues,
respectively.
Note
7: Long-Term Debt
During
2006, the Company entered into a loan agreement with a bank and received
gross
proceeds of $496,800 which were used for working capital and to repay existing
debt balances. The debt is secured by the assignment of a lease for equipment
date August 1, 2006 and the related equipment.
Under
both its long-term debt agreements, the Company is required to maintain certain
financial covenants, including maintaining a current ratio in excess of 1
to 1,
debt service coverage in excess of 1.3 to 1, tangible net worth in excess
of
$850,000, and debt/net worth ratio less than 2 to 1, as each term is defined
in
the credit agreement
At
December 31, 2006 long-term debt consisted of the following:
|
|
|
December
31, 2006
|
Note
payable with a bank, monthly principal and
|
|
interest
payments, interest fixed at 7.5%,
|
|
|
due
September 2008; secured by equipment
|
|
|
under
lease contract to a third party
|
|
$
438,812
|
|
|
|
|
Note
payable with a bank, monthly principal and
|
|
interest
payments, interest fixed at 7.5%,
|
|
|
due
November 2010; secured by machinery,
|
|
|
equipment,
furniture and fixtures
|
|
|
729,536
|
|
|
|
|
Total
|
|
|
1,168,348
|
Current
portion of long-term debt
|
|
(410,731)
|
Long-term
debt, net of current portion
|
|
$
757,617
|
|
|
|
|
As
of
December 31, 2006, aggregate principal maturities of long-term debt were
as
follows for years ended December 31:
|
|
2007
|
$
410,731
|
2008
|
375,412
|
2009
|
194,140
|
2010
|
188,065
|
Thereafter
|
-
|
|
$
1,168,348
|
Note
8: Income Taxes
Prior
to
the reverse merger, the Company was a Subchapter S entity and the tax attributes
flowed through to the individual owners. Thus any prior net operating losses
will not be available to be utilized to offset future taxable
income.
Income
tax expense for the period from inception June 29, 2006 to December 31, 2006
totaled $22,250.
Note
8: Income Taxes (continued)
A
reconciliation of the differences between the effective and statutory income
tax
rates are as follows for the period from inception June 29, 2006 to December
31,
2006:
|
Amount
|
Percent
|
Federal
statutory rates
|
$
(1,121,938)
|
(34.0)%
|
Stock
based compensation
|
1,135,869
|
35.0%
|
Other
|
8,319
|
0.0%
|
Effective
rate
|
$
22,250
|
0.01%
|
Deferred
tax assets (liabilities) at December 31, 2006 are not significant.
Note
9: Preferred Stock
As
discussed in Note 1, in November 2006, all of Deep Down’s shareholders
transferred ownership of all of Deep Down’s common stock to Subsea a newly
formed acquisition corporation two-thirds owned by two shareholders who also
owned in aggregate 25% of Deep Down, in exchange for 5,000 shares of Subsea’s
Series D Preferred Stock and 5,000 shares of Subsea’s Series E Preferred Stock
resulting in Deep Down becoming a wholly owned subsidiary of Subsea. On the
same
day, Subsea then merged with Deep Down; with the surviving company operating
as
Deep Down Inc. Subsea also issued 3,000 Series F shares and 1,000 Series
G
shares to two common shareholders of Subsea.
Series
E and G Classified as Liabilities
The
Series E and G redeemable exchangeable preferred stock have a face value
and
liquidation preference of $1,000 per share, no dividend preference, and are
exchangeable at the holder’s option after June 30, 2007 into 6% Subordinated
Notes due three years from the date of the exchange. These shares carry voting
rights equal to 690 votes per share.
The
Series E and G Preferred Stock was valued based on the discounted value of
its
expected future cash flows (using a discount rate of 20%). The fair value
of the Series E and G were $3,446,227 and $689,245, respectively, at November
21, 2006 and is reflected as a liability in the accompanying balance sheet.
For
the Series G shares, the Company reflected a charge to compensation expense
which is included in the statement of operations under Selling, general and
administrative expenses. The Company evaluated Series E and G and has classified
them as debt instruments at inception due to the fact that they are exchangeable
into Notes or redeemable at the Company’s option.
The
Company will accrete the discount on Series E and G of $1,864,500 on the
instruments up to their face value of $6,000,000 using the effective interest
method from the date of issuance over the term of the Note. Interest expense
related to the accretion of the discount totaled $48,179 for the period ending
December 31, 2006.
Series
D and F Classified as Temporary equity
The
Series D redeemable convertible preferred stock have a face value and
liquidation preference of $1,000 per share, no dividend preference, and are
convertible into shares of common stock determined by dividing the face amount
by a conversion price of $0.1933. These shares carry voting rights equal
to one
vote for every share of common stock into which the preferred stock is
convertible. These shares are redeemable at their face value on an annual
basis
within 120 days after each calendar year-end beginning with the year ending
December 31, 2007 based on an amount equal to 15.625% of annual net income.
In
the event that a holder declines redemption, such amounts are reallocated
to the
other preferred stock holders that have elected to redeem.
The
Series F redeemable convertible preferred stock have a face value and
liquidation preference of $1,000 per share, no dividend preference, and are
convertible into shares of common stock determined by dividing the face amount
by a conversion price of $0.1933. These shares carry voting rights equal
to one
vote for every share of common stock into which the preferred stock is
convertible. These shares are redeemable at their face value on an annual
basis
within 120 days after each calendar year-end beginning with the year ending
December 31, 2007 based on an amount equal to 9.375% of annual net income.
In
the event that a holder declines redemption, such amounts are reallocated
to the
other preferred stock holders that have elected to redeem
As
the
Series D and F Preferred Stock functions as a debt instrument with an embedded
option, the Company valued this instrument based on the discounted value
of its
expected future cash flows (using a discount rate of 20%) attributable to
its
redemption feature plus the value of the embedded option using the Black
Scholes
option pricing model with the following assumptions - exercise price $0.1933,
stock price $0.10, volatility 200%, risk free rate 5%. Based on these
assumptions, the fair value of Series D and Series F were $4,419,244 and
$2,651,547 respectively at November 21, 2006 and reflected as temporary equity
in the accompanying balance sheet. For the Series F shares, the Company
reflected a charge to compensation expense which is included in the statement
of
operations under Selling, general and administrative expenses.
The
Company evaluated Series D and F for liability or equity presentation and
determined that the instruments were more appropriately classified as temporary
equity due to the conditionality of the instruments, as events triggering
the
redemption or conversion were uncertain at inception.
Series
C Preferred Stock Classified as Equity
On
April
22, 2005 MediQuip issued 22,000 Series C convertible preferred stock which
remained after the reverse merger. The Series C shares have a face value
and a
liquidation preference of $12.50 per share, a cumulative dividend of 7% payable
at the conversion date, and are convertible into shares of common stock
determined by dividing the face amount by a conversion price of $0.0625.
These
shares carry no voting rights.
Note
10: Commitments and Contingencies
Litigation
The
Company is from time to time involved in legal proceedings arising from the
normal course of business. As of the date of this report, the Company is
not
currently involved in any legal proceedings.
Operating
Leases
The
Company leases land and buildings under two noncancelable operating leases
and
is responsible for the related maintenance, insurance and property taxes.
One of
these leases is with a company that is wholly owned by one of the Officer’s and
a Director of the Company. This lease calls for 60 monthly payments of $11,000
and began as of September, 2006.
At
December 31, 2006, future minimum lease payments were as follows:
2007
|
$
194,908
|
2008
|
174,769
|
2009
|
132,000
|
2010
|
132,000
|
2011
|
88,000
|
Thereafter
|
-
|
|
$
721,677
|
Rent
expense totaled $69,856 for the period from inception June 29, 2006 to December
31, 2006.
Note
11: Fair Value of Financial Instruments
The
estimated fair value of the Company’s financial instruments is as follows at
December 31, 2006:
w |
Cash
and equivalents, accounts receivable and accounts payable - The carrying
amounts approximated fair value due to the short-term maturity of
these
instruments.
|
w |
Preferred
Stock - Series D, E, F and G - The carrying amounts approximate the
fair
value given the limited time the instruments have been
outstanding.
|
w |
Long-term
debt - The fair value closely approximates the carrying value of
the
Company’s debt instruments.
|
Note
12: Subsequent Events
Private
Placement
On
March
20, 2007, the Company completed the sale of 10,000,000 shares of common stock
in
a private placement for $1,000,000. This private placement was initiated
prior
to the closing of the Agreement and Plan of Reorganization between the Company
and Deep Down. Pursuant to the terms thereof, 10,000,000 shares of common
stock
were reserved to complete this private placement. The shares are restricted
as
defined in Rule 144 of the Securities Act of 1933 and contain a restrictive
legend, which restricts the ability of the holders to sell these shares for
a
period of no less than one year. Funds will be used to redeem certain
outstanding exchangeable preferred stock and for working capital.
Stock
Transactions
In
March,
2007 the Company finalized the terms of an agreement with Daniel L. Ritz,
Jr.
(shareholder and director), who agreed to surrender 25,000,000 shares of
common
stock; 1,500 shares of Series F convertible preferred stock and 500 shares
of
Series G exchangeable preferred stock to the Company for cancellation. For
these
actions, Mr. Ritz will receive 1,250 shares of Series E exchangeable preferred
stock and $250,000 cash. In addition, Mr. Ritz will keep 500 shares of Series
E
exchangeable preferred stock he currently owns and agreed to tender his
resignation from the Board. As a result of this exchange, Mr. Ritz will own
1,750 shares of Series E exchangeable preferred stock.
In
March,
2007 the Company agreed to issue 2,000 shares of Series E exchangeable preferred
stock to John C. Siedhoff (shareholder, Chief Financial Officer, and director)
for the surrender of his ownership of 1,500 shares of Series F convertible
preferred stock and 500 shares of Series G exchangeable preferred stock,
which
will be returned to the transfer agent for cancellation.
In
February the Company redeemed 250 shares of Series E exchangeable preferred
stock at the face value of $1,000 per share for a total of
$250,000.
Acquisition
of ElectroWave
On
April
2, 2007, the Company consummated an Asset Purchase Agreement with ElectroWave
USA, Inc. (“ElectroWave”) a Texas corporation that provided for the acquisition
of substantially all of the assets of ElectroWave. The Company formed a
wholly-owned subsidiary, ElectroWave USA, Inc., a Nevada Corporation, to
complete the acquisition. ElectroWave offers products and services in the
fields
of electronic monitoring and control systems for the energy, military, and
commercial business sectors.
The
purchase price the payment of approximately $400,000 in bank and other debts
of
ElectroWave and the assumption of leases of real and personal property and
ongoing accounts payable in exchange for substantially all of the assets,
including inventory, fixed assets and accounts receivable and the transfer
of
all employees. In addition, the Company may issue up to an aggregate of 517
shares of Series H Redeemable Convertible Preferred Stock (redeemable at
$1,000
per share at the Company’s option) over the next three years, as an additional
contingent purchase cost, if the operations of ElectroWave reach certain
financial milestones based on net income for the fiscal years ending December
31, 2007, 2008 and 2009. Such Redeemable Convertible Preferred Stock, if
issued
in the future, would have a conversion price equal to the greater of (a)
$0.50
per share or (b) 120% of the volume weighted average price of the last reported
trades for the 20 consecutive trading days immediately prior to December
31 of
the respective year for which the Redeemable Convertible Preferred Shares
are
issued.
The
Company funded the payments of the bank and other debt primarily through
the
sale of the accounts receivable of ElectroWave to a bank. The terms of this
factoring agreement are substantially the same as the Company’s other agreements
with the same bank as described in Note 4.