UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
 
FORM 10-Q

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended JuneSeptember 30, 2008
 
OR
 
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 0-30351
 
DEEP DOWN, INC.
(Exact name of registrant as specified in its charter)
 
Nevada 75-2263732
(State or other jurisdiction of incorporation) (I.R.S. Employer Identification No.)
   
15473 East Freeway Channelview,Texas 77530
(Address of Principal Executive Office) (Zip Code)
 
Registrant’s telephone number, including area code: (281) 862-2201
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.  Yes  x No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  ¨
Accelerated filer  ¨
 
   
Non-accelerated filer    ¨ (Do not check isif a smaller reporting  company)
Smaller reporting company x
 
                                                                                                                 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes ¨ No  x
 
At AugustNovember 14, 2008, there were 177,350,630 shares of common stock outstanding.


i
 

IMPORTANT INFORMATION REGARDING THIS FORM 10-Q

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

Deep Down, Inc., a Nevada corporation (“Deep Down Nevada” or “Deep Down” or the “Company”) is the parent company to its wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), Mako Technologies, LLC, (“Mako”), a Nevada limited liability company (“Mako”), and Flotation Technologies, Inc. (“Flotation”), a Maine corporation.corporation (“Flotation”).

Readers should consider the following information as they review this Quarterly Report on Form 10-Q:

Forward-Looking Statements

The statements contained or incorporated by reference in this Quarterly Report on Form 10-Q that are not historical facts are “forward-looking statements” (as such term is defined in the Private Securities Litigation Reform Act of 1995), within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements.  Forward-looking statements include any statement that may project, indicate or imply future results, events, performance or achievements.  The forward-looking statements contained herein are based on current expectations that involve a number of risks and uncertainties. These statements can be identified by the use of forward-looking terminology such as “believes,” “expect,” “may,” “will,” “should,” “intend,” “plan,” “could,” “estimate” or “anticipate” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties.

Given the risks and uncertainties relating to forward-looking statements, investors should not place undue reliance on such statements.  Forward-looking statements included in this Quarterly Report on Form 10-Q speak only as of the date of this Quarterly Report on Form 10-Q and are not guarantees of future performance.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, such expectations may prove to have been incorrect.  All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements.

Subsequent Events

All statements contained in this Quarterly Report on Form 10-Q, including the forward-looking statements discussed above, are made as of August 15,November 14, 2008, unless those statements are expressly made as of another date.  We disclaim any responsibility for the accuracy of any information contained in this Quarterly Report on Form 10-Q to the extent such information is affected or impacted by events, circumstances or developments occurring after August 15,November 14, 2008 or by the passage of time after such date.  Except to the extent required by applicable securities laws, we expressly disclaim any obligation or undertakings to release publicly any updates or revisions to any statement or information contained in this Quarterly Report on Form 10-Q, including the forward-looking statements discussed above, to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any statement or information is based.

Document Summaries

Descriptions of documents and agreements contained in this Quarterly Report on Form 10-Q are provided in summary form only, and such summaries are qualified in their entirety by reference to the actual documents and agreements filed as exhibits to our 2007 Annual Report on Form 10-KSB/A (Amendment No. 3)4), other periodic and current reports we file with the Securities and Exchange Commission (“SEC”) or this Form 10-Q.

Access to Filings

Access to our Annual Reports on Form 10-KSB, Quarterly Reports on Forms 10-Q or Form 10-QSB and Current Reports on Form 8-K, and amendments to those reports, filed with or furnished to the SEC pursuant to Section 13(a) of the Exchange Act, as well as reports filed electronically pursuant to Section 16(a) of the Exchange Act, may be obtained through our website (http://www.deepdowninc.com ).www.deepdowninc.com).  Our website provides a hyperlink to a third-party website where these reports may be viewed and printed at no cost as soon as reasonably practicable after we have electronically filed such material with the SEC.  The contents of our website are not, and shall not be deemed to be, incorporated into this report.

2ii

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
 
 PART I FINANCIAL INFORMATIONPage No.
   
Item 1.Financial Statements 
 Unaudited Consolidated Balance Sheets - JuneSeptember 30, 2008 and December 31, 200741
 Unaudited Consolidated Statements of Operations - For the Three and Six MonthsNine months Ended JuneSeptember 30, 2008 and 200752
 Unaudited Consolidated Statements of Stockholders’ Equity - For the Six MonthsNine months Ended JuneSeptember 30, 200863
 Unaudited Consolidated Statements of Cash Flows - For the Six MonthsNine months Ended JuneSeptember 30, 2008 and 200774
 Notes to Unaudited Consolidated Financial Statements96
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations21
Item 3. Qualitative and Quantitative Market Risks 28
Item 4T.Controls and Procedures2728
  
PART II OTHER INFORMATION
  
Item 1. Legal Proceedings 29
Item 1A. Risk Factors 29
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds2729
Item 3. Defaults Upon Senior Securities 29
Item 4.Submission of Matters to a Vote of Security Holders2829
Item 5.Other Information2830
Item 6.Exhibits2931
   
Signatures 31
Exhibit Index32

 
3iii
 
PART I. FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

DEEP DOWN, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
  
June 30,
2008
  December 31, 2007 
ASSETS      
Cash and equivalents $4,085,543  $2,206,220 
Restricted cash  -   375,000 
Accounts receivable, net of allowance of $818,992 and $139,787 respectively  8,614,961   7,190,466 
Prepaid expenses and other current assets  710,213   312,058 
Inventory  179,343   502,253 
Lease receivable, short-term  414,000   414,000 
Work in progress  681,790   945,612 
Receivable from Prospect, net  -   2,687,333 
Total current assets  14,685,850   14,632,942 
Property and equipment, net  10,651,053   5,172,804 
Other assets, net of accumulated amortization of $0 and $54,560 respectively  550,819   1,109,152 
Lease receivable, long-term  500   173,000 
Intangibles, net  18,745,713   4,369,647 
Goodwill  13,001,556   10,594,144 
Total assets $57,635,491  $36,051,689 
         
LIABILITIES AND STOCKHOLDER'S EQUITY        
Accounts payable and accrued liabilities $3,070,105  $3,569,826 
Deferred revenue  725,521   188,030 
Payable to Mako shareholders  -   3,205,667 
Current portion of long-term debt  47,477   995,177 
Total current liabilities  3,843,103   7,958,700 
Long-term debt, net of accumulated discount of $0 and $1,703,258 respectively  919,381   10,698,818 
Series E redeemable exchangeable preferred stock, par value $0.01, face value and liquidation        
preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate shares
of all series of preferred stock, -0- and 500 issued and outstanding, respectively		  -   386,411 
Total liabilities  4,762,484   19,043,929 
Temporary equity:        
Series D redeemable convertible preferred stock, $0.01 par value, face value and        
liquidation preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate shares
of all series of preferred stock, -0- and 5,000 issued and outstanding, respectively		  -   4,419,244 
Total temporary equity  -   4,419,244 
Stockholders' equity:        
Common stock, $0.001 par value, 490,000,000 shares authorized, 174,732,501        
and 85,976,526 shares issued and outstanding, respectively  174,733   85,977 
Paid-in capital  60,000,402   14,849,847 
Accumulated deficit  (7,302,128)  (2,347,308)
Total stockholders' equity  52,873,007   12,588,516 
Total liabilities and stockholders' equity $57,635,491  $36,051,689 
         
See accompanying notes to unaudited consolidated financial statements. 

  September 30, 2008  December 31, 2007 
ASSETS      
Cash and equivalents $5,155,069  $2,206,220 
Restricted cash  -   375,000 
Accounts receivable, net of allowance of $345,649 and $139,787 respectively  7,197,552   7,190,466 
Prepaid expenses and other current assets  850,030   312,058 
Inventory  820,922   502,253 
Lease receivable, short-term  -   414,000 
Costs and estimated earnings in excess of billings on uncompleted contracts  1,661,829   749,455 
Receivable from Prospect, net  -   2,687,333 
Total current assets  15,685,402   14,436,785 
Property and equipment, net  12,219,276   5,368,961 
Other assets, net of accumulated amortization of $0 and $54,560 respectively  277,402   1,109,152 
Lease receivable, long-term  -   173,000 
Intangibles, net  18,418,196   4,369,647 
Goodwill  12,985,718   10,594,144 
Total assets $59,585,994  $36,051,689 
         
LIABILITIES AND STOCKHOLDERS' EQUITY        
Accounts payable and accrued liabilities $3,589,093  $3,569,826 
Billings in excess of costs and estimated earnings on uncompleted contracts  367,259   188,030 
Payable to Mako shareholders  -   3,205,667 
Current portion of long-term debt  48,816   995,177 
Total current liabilities  4,005,168   7,958,700 
Deferred tax liabilities, net  45,362   - 
Long-term debt, net of accumulated discount of $0 and $1,703,258 respectively  914,225   10,698,818 
         
Series E redeemable exchangeable preferred stock, par value $0.01, face value and liquidation preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate shares of all series of preferred stock, -0- and 500 issued and outstanding, respectively
  -   386,411 
Total liabilities  4,964,755   19,043,929 
Temporary equity:        
Series D redeemable convertible preferred stock, $0.01 par value, face value and liquidation preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate shares of all series of preferred stock, -0- and 5,000 issued and outstanding, respectively
  -   4,419,244 
Total temporary equity  -   4,419,244 
Stockholders' equity:        
Common stock, $0.001 par value, 490,000,000 shares authorized, 177,350,630 and 85,976,526 shares issued and
outstanding, respectively
  177,351   85,977 
Paid-in capital  60,167,948   14,849,847 
Accumulated deficit  (5,724,060)  (2,347,308)
Total stockholders' equity  54,621,239   12,588,516 
Total liabilities and stockholders' equity $59,585,994  $36,051,689 
         
         
See accompanying notes to unaudited consolidated financial statements. 
 
 
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
             
  For the Three Months Ended  For the Nine Months Ended 
  September 30,  September 30, 
  2008  2007  2008  2007 
Revenues            
Contract revenue $11,039,041  $3,819,536  $22,046,957  $9,930,453 
Rental revenue  613,521   1,066,019   3,805,268   2,198,284 
Total revenues  11,652,562   4,885,555   25,852,225   12,128,737 
Cost of sales  6,350,318   3,625,020   15,462,187   8,300,707 
Gross profit  5,302,244   1,260,535   10,390,038   3,828,030 
Operating expenses:                
Selling, general & administrative  3,733,254   949,376   9,413,939   2,712,997 
Depreciation and amortization  17,366   20,861   882,779   44,797 
Total operating expenses  3,750,620   970,237   10,296,718   2,757,794 
Operating income  1,551,624   290,298   93,320   1,070,236 
Other income (expense):                
Gain (loss) on debt extinguishment  -   -   (446,412)  2,000,000 
Interest income  36,977   32,645   103,487   48,935 
Interest expense  (24,704)  (241,639)  (3,484,268)  (1,750,296)
Other income  17,060   15,052   5,644   15,052 
Total other income (expense)  29,333   (193,942)  (3,821,549)  313,691 
Income (loss) before income taxes  1,580,957   96,356   (3,728,229)  1,383,927 
Benefit from (provision for) income taxes  (2,889)  99,613   351,477   (347,750)
Net income (loss) $1,578,068  $195,969  $(3,376,752) $1,036,177 
Earnings (loss) per share:                
Basic $0.01  $-  $(0.03) $0.01 
Weighted-average common shares outstanding  176,093,714   68,285,932   131,744,393   72,626,591 
                 
Diluted $0.01  $-  $(0.03) $0.01 
Weighted-average common shares outstanding  177,413,975   100,307,773   131,744,393   100,584,062 
                 
See accompanying notes to unaudited consolidated financial statements. 
  For the Three Months Ended  For the Six Months Ended 
  June 30,  June 30, 
  2008  2007  2008  2007 
             
Revenues              
Contract revenue $5,670,385  $4,508,635  $11,007,914  $6,110,916 
Rental revenue  2,249,811   636,153   3,191,747   1,132,266 
Total revenues  7,920,196   5,144,788   14,199,661   7,243,182 
Cost of sales  5,496,427   3,293,313   9,372,798   4,545,402 
Gross profit  2,423,769   1,851,475   4,826,863   2,697,780 
Operating expenses:                
Selling, general & administrative  3,681,643   1,103,902   5,443,890   1,763,622 
Depreciation and amortization  543,128   90,196   841,277   154,221 
Total operating expenses  4,224,771   1,194,098   6,285,167   1,917,843 
Operating income (loss)  (1,801,002)  657,377   (1,458,304)  779,937 
Other income (expense):                
Gain (loss) on debt extinguishment  (446,412)  2,000,000   (446,412)  2,000,000 
Interest income  27,346   16,290   66,510   16,290 
Interest expense  (2,690,534)  (1,276,770)  (3,459,564)  (1,508,657)
Other expense  (39,771)  -   (11,416)  - 
Total other income (expense)  (3,149,371)  739,520   (3,850,882)  507,633 
Income (loss) before income taxes  (4,950,373)  1,396,897   (5,309,186)  1,287,570 
Benefit from (provision for) income taxes  85,000   (447,363)  354,366   (447,363)
Net income (loss) $(4,865,373) $949,534  $(4,954,820) $840,207 
Earnings per share:                
Basic $(0.04) $0.01  $(0.05) $0.01 
Weighted-average common shares outstanding  132,666,860   67,870,171   109,326,053   74,417,132 
                 
Diluted $(0.04) $0.01  $(0.05) $0.01 
Weighted-average common shares outstanding  132,666,860   93,799,839   109,326,053   100,315,405 
                 
See accompanying notes to unaudited consolidated financial statements. 

52

DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
  For the Six Months Ended June 30, 2008 
  Common Stock  Paid-in  Accumulated    
  Shares  Amount  Capital  Deficit  Total 
                
Balance at December 31, 2007  85,976,532  $85,977  $14,849,847  $(2,347,308) $12,588,516 
                     
Net loss  -   -   -   (4,954,820)  (4,954,820)
Exchange of Series D preferred stock  25,866,518   25,867   4,393,377       4,419,244 
Stock issued for acquisition of Mako  2,802,969   2,803   1,959,275       1,962,078 
Stock issued for acquisition of Flotation  1,714,286   1,714   1,421,143       1,422,857 
Warrants issued for acquisition of Flotation      -   121,793       121,793 
Restricted stock issued  1,200,000   1,200   (1,200)      - 
Stock issued in private placement  57,142,857   57,143   37,002,527       37,059,670 
Cashless exercise of stock options  29,339   29   (29)      - 
Stock based compensation  -   -   253,669       253,669 
Balance at June 30, 2008  174,732,501  $174,733  $60,000,402  $(7,302,128) $52,873,007 
                     
See accompanying notes to unaudited consolidated financial statements. 
6
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
 
  Six Months Ended 
  June 30, 
  2008  2007 
Cash flows from operating activities:      
       
Net loss $(4,954,820) $840,208 
Adjustments to reconcile net income to net cash        
used in operating activities:        
Gain on extinguishment of debt  -   (2,000,000)
Interest income  (30,467)  (16,290)
Amortization of debt discount  1,816,847   1,391,506 
Amortization of deferred financing costs  762,700   - 
Share-based compensation  253,669   39,565 
Bad debt expense  832,328   - 
Depreciation and amortization  898,998   154,221 
Loss on disposal of equipment  9,136   - 
Changes in assets and liabilities:        
      Lease receivable  -   (750,000)
      Accounts receivable  (254,958)  (531,356)
      Prepaid expenses and other current assets  (586,618)  1,655 
      Inventory  (179,343)  (472,253)
      Work in progress  1,135,005   (119,552)
      Accounts payable and accrued liabilities  (1,601,586)  1,808,987 
      Deferred revenue  537,491   80,628 
       Net cash provided by operating activities $(1,361,618) $427,319 
Cash flows from investing activities:        
Cash paid for acquisition of Flotation  (22,116,140)  - 
Cash paid for acquisition of Mako  (1,319,967)  - 
Cash paid for third party debt  -   (432,475)
Cash received from sale of ElectroWave receivables  -   261,068 
Cash deficit acquired an acquisition of a business  -   (18,974)
Purchases of equipment  (687,060)  (442,788)
Restricted cash  375,000   - 
       Net cash used in investing activities $(23,748,167) $(633,169)
Cash flows from financing activities:        
Payment for cancellation of common stock  -   (250,000)
Redemption of preferred stock  -   (250,000)
Proceeds from sale of common stock, net of expenses  37,059,670   960,000 
Proceeds from long term debt  2,687,333   - 
Proceeds from sales-type lease  172,500   69,000 
Borrowings on debt - related party  -   150,000 
Payments of long-term debt  (12,930,395)  (222,307)
       Net cash provided by (used in) financing activities $26,989,108  $456,693 
Change in cash and equivalents  1,879,323   250,843 
Cash and equivalents, beginning of period  2,206,220   12,462 
Cash and equivalents, end of period $4,085,543  $263,305 
         
See accompanying notes to unaudited consolidated financial statements. 
  For the Nine Months Ended September 30, 2008 
  Common Stock  Paid-in  Accumulated    
  Shares  Amount  Capital  Deficit  Total 
                
                
Balance at December 31, 2007  85,976,532  $85,977  $14,849,847  $(2,347,308) $12,588,516 
                     
Net loss  -   -   -   (3,376,752)  (3,376,752)
Exchange of Series D preferred stock  25,866,518   25,867   4,393,377       4,419,244 
Stock issued for acquisition of Mako  2,802,969   2,803   1,959,275       1,962,078 
Stock issued for acquisition of Flotation  1,714,286   1,714   1,421,143       1,422,857 
Warrants issued for acquisition of Flotation      -   121,793       121,793 
Restricted stock issued  1,200,000   1,200   (1,200)      - 
Stock issued in private placement  57,142,857   57,143   37,002,527       37,059,670 
Cashless exercise of stock options  29,339   29   (29)      - 
Warrant exercises  2,618,129   2,618   (2,618)      - 
Stock based compensation  -   -   423,833       423,833 
                     
Balance at September 30, 2008  177,350,630  $177,351  $60,167,948  $(5,724,060) $54,621,239 
                     
 
See accompanying notes to unaudited consolidated financial statements.
 
 
73
 
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
 
  Six Months Ended 
  June 30, 
  2008  2007 
Supplemental schedule of noncash investing      
   and financing activities:      
Acquisition of a business $-  $(190,381)
Exchange of receivables for acquisition of a business $-  $171,407 
Warrants issued for acquisition of Flotation $121,793  $- 
Stock issued for acquisition of Flotation $1,422,857  $- 
Stock issued for acquisition of Mako $1,962,078  $- 
Fixed assets purchased with capital lease $-  $525,000 
Fixed assets transferred from Inventory $502,253  $- 
Exchange of Series D preferred stock $4,419,244     
Exchange of Series E preferred stock $-  $3,366,778 
Redemption of Series E preferred stock $-  $2,000,000 
Exchange of Series E preferred stock for subordinated debenture $500,000  $- 
Common shares issued as restricted stock $1,200  $- 
Supplemental Disclosures:        
Cash paid for interest $880,017  $117,151 
Cash paid for pre-payment penalties $446,413  $- 
Cash paid for taxes $275,000  $- 
         
See accompanying notes to unaudited consolidated financial statements. 

  Nine Months Ended 
  September 30, 
  2008  2007 
Cash flows from operating activities:      
       
Net loss $(3,376,752) $1,036,176 
Adjustments to reconcile net income to net cash provided by        
(used in) operating activities:        
Gain on extinguishment of debt  -   (2,000,000)
Interest income  (54,975)  - 
Amortization of debt discount  1,816,847   1,427,960 
Amortization of deferred financing costs  762,700   15,988 
Share-based compensation  423,833   113,480 
Bad debt expense  1,052,668   16,305 
Depreciation and amortization  1,641,508   247,503 
Loss on disposal of equipment  160,692   7,948 
Changes in assets and liabilities:        
Lease receivable  -   (788,520)
Accounts receivable  942,111   (2,006,548)
Prepaid expenses and other current assets  (453,018)  (96,581)
Inventory  (820,922)  45,000 
Finished goods  -   (515,601)
Costs and estimated earnings in excess of billings on uncompleted contracts  (41,191)  (913,435)
Accounts payable and accrued liabilities  (1,058,090)  2,072,684 
Billings in excess of costs and estimated earnings on uncompleted contracts  179,229   (190,000)
Net cash provided by (used in) operating activities $1,174,640  $(1,527,641)
Cash flows from (used in) investing activities:        
Cash paid for acquisition of Flotation  (22,161,863)  - 
Cash paid for acquisition of Mako  (1,319,967)  - 
Cash paid for third party debt  -   (432,475)
Cash received from sale of ElectroWave receivables  -   261,068 
Cash deficit acquired an acquisition of a business  -   (18,974)
Purchases of equipment  (2,564,114)  (600,636)
Restricted cash  375,000   (375,000)
Net cash used in investing activities $(25,670,944) $(1,166,017)
Cash flows from financing activities:        
Payment for cancellation of common stock  -   (250,000)
Redemption of preferred stock  -   (250,000)
Proceeds from sale of common stock, net of expenses  37,059,670   960,000 
Proceeds from long term debt  2,687,333   - 
Proceeds from sales-type lease  587,000   172,500 
Borrowings on debt - related party  -   150,000 
Payments on debt - related party  -   (150,000)
Borrowings on long-term debt  -   6,000,000 
Increase in deferred financing fees  -   (442,198)
Creation of debt discount due to lender's fees  -   (180,000)
Payments of long-term debt  (12,888,850)  (2,641,671)
Net cash provided by financing activities $27,445,153  $3,368,631 
Change in cash and equivalents  2,948,849   674,973 
Cash and equivalents, beginning of period  2,206,220   12,462 
Cash and equivalents, end of period $5,155,069  $687,435 
         
See accompanying notes to unaudited consolidated financial statements. 
84

DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
  Nine Months Ended 
  September 30, 
  2008  2007 
Supplemental schedule of noncash investing      
and financing activities:      
Acquisition of a business $-  $(190,381)
Exchange of receivables for acquisition of a business $-  $171,407 
Warrants issued for acquisition of Flotation $121,793  $- 
Stock issued for acquisition of Flotation $1,422,857  $- 
Stock issued for acquisition of Mako $1,962,078  $- 
Correction of common stock per value to paid in capital $-  $114,750 
Fixed assets purchased with capital lease $-  $525,000 
Fixed assets transferred from Inventory $502,253  $- 
Exchange of Series D preferred stock $4,419,244  $- 
Exchange of Series E preferred stock $-  $3,366,778 
Redemption of Series E preferred stock $-  $3,685,463 
Exchange of Series E preferred stock for subordinated debenture $500,000  $- 
Common shares issued as restricted stock $1,200  $- 
Creation of debt discount due to warrants issued to lender $-  $1,479,189 
Creation of deferred financing fee due to warrants issued to third party $-  $113,120 
Supplemental Disclosures:        
Cash paid for interest $904,721  $306,349 
Cash paid for pre-payment penalties $446,413  $- 
Cash paid for taxes $275,000  $14,970 
         
See accompanying notes to unaudited consolidated financial statements. 
5

DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1: GENERAL

Nature of Business

Deep Down, Inc., a Nevada corporation, (“Deep Down Nevada” or “Deep Down” or the “Company”), is the parent company to its wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation, (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada corporation, (“ElectroWave”),since its acquisition effective April 2, 2007, Mako Technologies, LLC, (“Mako”), a Nevada limited liability company, since its acquisition effective December 1, 2007, and Flotation Technologies, Inc. (“Flotation”), a Maine corporation. The results of Flotation are included in the consolidated financial statements hereincorporation, since its acquisition effective May 1, 2008, the effective date of acquisition for accounting purposes.2008.
 
Deep Down Delaware provides installation management, engineering services, support services and storage management services for the subsea controls, umbilicals and offshore pipeline industries. Deep Down Delaware also fabricates component parts for subsea distribution systems and assemblies.

ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, marine and commercial business sectors.

Mako serves the growing offshore petroleum and marine industries with technical support services and products vital to offshore petroleum production, through rentals of its remotely operated vehicles (“ROV”), topside and subsea equipment and diving support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys.

Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers.  Flotation’s  product offerings include distributed buoyancy for flexible pipes and umbilicals, drilling riser buoyance modules, CoreTecTM drilling riser buoyancy modules, ROVitsTM buoyancy, Hydro-Float mooring buoys, StablemoorTM low-drag ADCP deployment solution, Quick-Loc™ cable floats, HardballTM umbilical floats, Flotec™ cable and pipeline protection, InflexTM polymer bend restrictors, and installation buoyancy of any size and depth rating.
 
Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X relating to smaller reporting companies.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three-month periodor nine-month periods ended JuneSeptember 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008.  The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
 
For further information, refer to the audited consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-KSB/A (Amendment No. 3)4) for the year ended December 31, 2007 filed on August 8,September 30, 2008.

Reclassifications

Prior period information presented in these financial statements includes reclassifications which were made to conform such information to the current period presentation.  These reclassifications had no material effect on our previously reported net lossincome (loss) or stockholders' equity. For example, Deep Down reclassified its account previously referred to as Work in Process to its Costs incurred in excess of earnings and billings line item in order to more accurately reflect the nature of these unbilled balances.  In addition, Deep Down reclassified $758,728 of depreciation expense into Cost of sales from SG&A for the nine-month period ended September 30, 2008.  As such, $202,706 was reclassified for the corresponding nine-months ended September 30, 2007 out of SG&A to Cost of sales.

Principles of Consolidation

The unaudited consolidated financial statements include the accounts of Deep Down’s wholly-owned subsidiaries after the elimination of significant intercompany accountsbalances and transactions.
 
96

NOTE 2: ACCOUNTS RECEIVABLE

Accounts receivable includes an allowance for uncollectible accounts of $818,992$345,649 and $139,787 as of JuneSeptember 30, 2008 and December 31, 2007, respectively. Bad debt expense totaled $832,328$1,052,668 and $11,555$16,305 for the sixnine months ended JuneSeptember 30, 2008 and June 30, 2007, respectively. 

NOTE 3: COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS

Deep Down entered into a large fixed price contract during the nine months ended September 30, 2008.  As such, Deep Down determined that recognizing revenues for this contract was appropriate using the percentage-of-completion method under Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (“SOP 81-1”), measured by the percentage of costs incurred to date to estimated total costs for the contract.  This method is used because management considers total cost to be the best available measure of progress on the contracts. 

Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as supplies, equipment repairs, employee travel and supervisor time. Selling, general and administrative costs are charged to expense as incurred.  Provisions for estimated losses on uncompleted contracts (if any) are made in the period in which such losses are determined.  Changes in job performance, job conditions, and total contract values may result in revisions to costs and income and are recognized in the period in which the revisions are determined.  Unapproved change orders are accounted for in revenue and cost when it is probable that the costs will be recovered through a change in the contract price. In circumstances where recovery is considered probable but the revenues cannot be reliably estimated, costs attributable to change orders are deferred pending determination of contract price.
Costs and estimated earnings in excess of billings on uncompleted contracts arise when revenues are recorded on a percentage-of-completion basis but cannot be invoiced under the terms of the contract. Such amounts are invoiced upon completion of contractual milestones.  Billings in excess of costs and estimated earnings on uncompleted contracts arise when milestone billings are permissable under the contract, but the related costs have not yet been incurred.  All contract costs are recognized currently on jobs formally approved by the customer and contracts are not shown as complete until virtually all anticipated costs have been incurred and the items are shipped to the customer.
The asset balance of $1,661,829 at September 30, 2008 includes approximately $1,360,000 related to a large contract that is expected to be completed during December 2008 or January 2009. Deep Down has recognized approximately 72% of the related revenue based on the percentage-of-completion method.
In accordance with industry practice, assets and liabilities related to costs and estimated earnings in excess of billings on uncompleted contracts, as well as billings in excess of costs and estimated earnings on uncompleted contracts, have been classified as current. The contract cycle for certain long-term contracts may extend beyond one year, thus collection of amounts related to these contracts may extend beyond one year.
7

NOTE 3:4: PROPERTY AND EQUIPMENT

Property and equipment include the following:
 
  September 30, 2008  December 31, 2007 
Land $461,955  $- 
Building  3,242,351   195,305 
Leasehold improvements  342,430   75,149 
Furniture and fixtures  143,509   63,777 
Vehicles and trailers  105,836   112,161 
Equipment  3,691,527   1,809,474 
Rental Equipment  4,741,084   3,144,559 
Computer and office equipment  446,563   194,693 
Construction in progress  358,910   196,157 
         
Total  13,534,165   5,791,275 
Less: Accumulated depreciation  (1,314,889)  (422,314)
Property and equipment, net $12,219,276  $5,368,961 
  June 30, 2008  December 31, 2007 
Land $2,270,439  $13,148 
Building  1,246,072   182,156 
Furniture and fixtures  139,044   63,777 
Vehicles and trailers  99,837   112,162 
Leasehold improvements  301,919   75,149 
Equipment  3,834,594   2,004,167 
Rental Equipment  3,659,714   3,144,559 
  Total  11,551,619   5,595,117 
  Less: Accumulated depreciation  (900,566)  (422,314)
     Property and equipment, net $10,651,053  $5,172,804 

Depreciation expense for the sixnine months ended JuneSeptember 30, 2008 and June 30, 2007 was approximately $505,063$920,056 and $154,221,$247,503, respectively.  For the nine months ended September 30, 2008 and 2007, Deep Down recorded $758,728 and $202,706, respectively, of the total depreciation as Cost of Sales on the accompanying statements of operations.
 
To accommodate our growth in operations duringDuring the sixnine months ended JuneSeptember 30, 2008, we leased additional property from JUMA, LLC, a related party, and incurred $98,139$342,430 in leasehold improvements to stabilizeimprovements. See additional discussion in Note 12 regarding the ground and prepare the surface for the movement and storagenature of the heavy equipment we manufacture and rent at our corporate headquarters.
related party.
 
In connection with the purchase of Flotation, Deep Down acquired land along with a building and improvements with a fair market value of $3,264,100 whichapproximately $3,300,000. This 3.61 acre site in Maine houses itsa 46,925 square foot light industrial manufacturing facility on a 3.61 acre site in Maine.facility.

On June 30, 2008, Deep Down transferred equipment with a cost basis of $502,253 from inventory to its rental equipment fleet.
10

NOTE 4: LONG-TERM DEBT

The following table summarizes long-term debt:
  June 30, 2008  December 31, 2007 
Secured credit agreement with Prospect Capital Corporation      
quarterly principal payments of $250,000 beginning      
September 30, 2008; monthly interest payments,      
interest fixed at 15.5%; balance due August 2011;      
secured by all assets $-  $12,000,000 
Debt discount, net of amortization of $254,101 and $135,931 respectively  -   (1,703,258)
Note payable to a bank, payable in monthly        
installments bearing interest at 8.25% per annum,        
maturing June 10, 2008, cross-collateralized        
by Mako assets, paid January 2008.  -   289,665 
Note payable to a bank, payable in monthly        
installments bearing interest at 7.85% per annum,        
maturing September 28, 2010, collateralized by Mako        
life insurance policy and equipment, paid January 2008.  -   320,027 
Revolving line-of-credit of $500,000 from a bank,        
matured October 13, 2007 or on demand, interest rate is        
at a variable rate resulting in a rate of 8.30% as of        
September 30, 2007, collateralized by Mako equipment,        
paid January 2008.  -   151,705 
Note payable to a bank payable in monthly        
installments bearing interest at 7.85% per annum,        
maturing January 25, 2011, collateralized by Mako        
equipment and life insurance policy, paid January 2008  -   154,647 
Total secured credit agreement and bank debt  -   11,212,786 
6% Subordinated Debenture beginning March 31, 2008; annual      - 
interest payments, interest fixed at 6%; matures March 31, 2011  507,479   - 
Capital lease of equipment, monthly lease payments,        
interest imputed at 11.2%  459,379   481,209 
Total long-term debt  966,858   11,693,995 
Current portion of long-term debt  (47,477)  (995,177)
Long-term debt, net of current portion $919,381  $10,698,818 
Secured Credit Agreement
On August 6, 2007, Deep Down entered into a $6.5 million secured credit agreement, (the “Credit Agreement”) with Prospect Capital Corporation, (“Prospect”) and received an advance of $6.0 million on that date.  The Credit Agreement provided for a 4-year term, an annual interest rate of 15.5%, with the ability to defer up to 3.0% of interest through a PIK (paid-in-kind) feature and principal payments of $75,000 per quarter beginning September 30, 2008, with the remaining balance outstanding due August 6, 2011. Interest payments were payable monthly, in arrears, on each month-end commencing on August 31, 2007. Deep Down paid the full 15.5% and did not exercise the PIK feature for the monthly periods through June 2008.   

On December 21, 2007, Deep Down entered into an amendment to the Credit Agreement (the “Amendment”) to provide the funding for the cash portion of the purchase of Mako. The total commitment available under the Amendment was increased from $6.5 million to $13.0 million. Amounts borrowed were $6.0 million.  Quarterly principal payments increased to $250,000 beginning September 30, 2008.  Cash interest paid for the three and six months ended June 30, 2008 was $361,667 and $821,500, respectively. Under the Credit Agreement, Deep Down was required to meet certain covenants and restrictions as well as maintain a debt service reserve account.  As of December 31, 2007, $375,000 is separately classified as “Restricted cash” on the accompanying balance sheets. 

11
In connection with the second advance under the Credit Agreement on January 4, 2008, Deep Down capitalized an additional $261,946 in deferred financing costs.  Of this amount, $216,000 was paid in cash to various third parties related to the financing, and the remainder of $45,946 represents the Black-Scholes valuation of warrants issued to one of these third party vendors.  The warrant was issued to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share.

On June 12, 2008, Deep Down paid $12,492,912 to Prospect to pay the balance outstanding under the Credit Agreement and related interest and early termination fees.  In connection with the early payoff, Deep Down accelerated the remaining deferred financing costs totaling $661,149 and recorded this charge as interest expense. Additionally, $1,490,955 in debt discounts were accelerated and recorded as interest expense. Early termination fees of approximately $446,412 were recognized as a loss on early extinguishment of debt.  Since the warrants issued in connection with the original Credit Agreement and the Amendment dated January 4, 2008 were detachable, there was no change to these equity instruments.

On July 3, 2008, Prospect exercised their outstanding 4,960,585 warrants in a cashless exercise for a total of 2,618,129 shares of Deep Down common stock.

In January 2008, in accordance with the terms of the purchase of Mako, Deep Down paid $916,044 of notes payable plus accrued interest of $2,664.

Exchange of Series E Redeemable Exchangeable Preferred Stock to 6% Subordinated Debenture

On March 31, 2008, 500 shares of the Series E Redeemable Exchangeable Preferred Stock (“Series E”) were exchanged into a 6% Subordinated Debenture (the “Debenture”) in an outstanding principal amount of $500,000.  The Debenture has a fixed interest rate of 6% interest per annum to be paid annually on March 31st through maturity on March 31, 2011. Upon exchange into the Debenture, Deep Down recorded $113,589 in interest expense for the accretion up to face value. See the additional discussion of the terms of the Series E preferred stock at Note 6. Interest expense on the Debenture of approximately $7,479 has been recognized for the three and six months ended June 30, 2008.

NOTE 5: ACQUISITIONS

Purchase of Mako Technologies, Inc.

Effective December 1, 2007, Deep Down purchased 100% of the common stock of Mako. Two installments were paid to the Mako shareholders. The first installment of $2,916,667 in cash and 6,574,074 restricted shares of common stock of Deep Down, valued at $0.76 per share, was paid on January 4, 2008. The second installment of 2,802,969 restricted shares of common stock of Deep Down, valued at $0.70 per share, was issued on March 28, 2008. The final cash payment of $1,243,571, which was paid on April 11, 2008, was included in the “Payable to Mako shareholders” balance on the accompanying balance sheet at December 31, 2007.

The allocation of the purchase price was based on preliminary unaudited estimates.  Estimates and assumptions are subject to change upon the receipt of management’s review of final amounts and final tax returns.  This final evaluation of net assets acquired will be offset by a corresponding change in goodwill and is expected to be complete within one year from the purchase date.

The acquistionacquisition of Mako was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) 141, “Business Combinations” (“SFAS 141”) since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Mako.

8

Purchase of Flotation Technologies, Inc.

On June 5, 2008, Deep Down completed the acquisition of 100% of the capital of Flotation, pursuant to the Stock Purchase Agreement entered into on April 17, 2008. The equity interest was acquiredDeep Down purchased Flotation from the three individual shareholder members of the same family and purchased related technology was acquired from an entity affiliated with the selling stockholders. No prior material relationship existed between the selling shareholders andshareholders. Deep Down any of our affiliates, or any of our directors or officers, or any associate of any of our officers or directors.  Deep Down executed the definitive agreement to purchase Flotation on April 17, 2008 and effectively dated the acquisition for accounting purposes as of May 1, 2008. Deep Down announcedconsummated the closing on June 6, 2008.

The acquisition of Flotation has been accounted for using the purchase method of accounting in accordance with SFAS 141 since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Flotation.

12

The purchase price of Flotation was $23,895,830$23,941,554 and consisted of $22,100,000 cash and 1,714,286 shares of common stock valued at $0.83 per common share plus transaction costs of $251,180.$296,904. In addition, warrants to purchase 200,000 shares of common stock at $0.70 per share were issued to an entity affiliated with the selling shareholders for acquisition of the related technology. The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock. Deep Down valued the warrants at $121,793 based on the Black-Scholes option pricing model. Flotation’s selling shareholders used approximately $1,800,000 of the $22,100,000 cash received to pay outstanding debt of Flotation. The purchase price may be adjusted upward or downward, dependant on certain working capital targets.  Both parties are in preliminary negotiations concerning this adjustment and as of the current date, there has been no agreement as to the adjustment.

Deep Down sold 57,142,857 shares to accredited investors on June 5, 2008, for approximately $37,059,670 in net proceeds, at a price of $0.70 per share. Deep Down used $22,100,000 in proceeds from this private placement to fund the cash requirement of the Flotation acquisition.

Deep Down also issued 600,000 incentive common stock purchase options to employees of Flotation for their continued services with an exercise price of $1.15 per share. The employee options vest one-third of the original amount each year and may be exercised in whole or in part after vesting. Deep Down valued the options at $264,335 based on the Black-Scholes option pricing model, and will recognize the related compensation cost ratably over the requisite service period.

The table below reflects the breakdown of the purchase price as noted above:
 
Summary of purchase price:   
Cash $22,100,000 
Certain transaction costs  251,180 
Fair market value of common stock  1,422,857 
Fair market value of warrants issued  121,793 
Total purchase price $23,895,830 
Summary of purchase price:
   
Cash $22,100,000 
Certain transaction costs  296,904 
Fair market value of common stock  1,422,857 
Fair market value of warrants issued  121,793 
Total purchase price $23,941,554 
 
The payment of the purchase price of $23,895,830$23,941,554 was in exchange for all of the outstanding capital stock of Flotation. The acquisition price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values with the excess being recorded in goodwill.  The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition on May 1, 2008:
 
Summary of net assets acquired:   
Summary of net assets acquired:
   
Cash and cash equivalents $235,040  $235,040 
Accounts receivable 2,105,519   2,105,519 
Construction in progress 871,183   871,183 
Prepaid expenses 15,904   15,904 
Property, plant and equipment, net 4,846,190   4,907,752 
Intangibles 14,797,000   14,797,000 
Goodwill  2,157,307   2,141,469 
Total assets acquired $25,028,143  $25,073,867 
        
Accounts payable and accrued liabilities  1,132,313   1,132,313 
Total liabilities acquired $1,132,313  $1,132,313 
Net assets acquired $23,895,830  $23,941,554 
 
Deep Down obtained an independent valuation of the assets and liabilities as of the purchase date of May 1, 2008. Based on the independent valuation, the fair value of the property, plant and equipment was increased by approximately $1,200,000$1,258,000 and will be depreciated over the estimated useful lives of 3 to 40 years using the straight-line method.

139

Deep Down has estimated the fair value of Flotation’s identifiable intangible assets as follows:
 
   Estimated  Average Remaining 
   Fair Value  Useful Life 
  Trademarks $2,039,000   40 
  Technology  11,209,000   25
 
  Non-compete covenant  879,000     3
 
  Customer relationship  670,000   25 
   $14,797,000     
The table below reflects the assumptions used for warrant and option grants related to Flotation during the nine months ended September 30, 2008:
Dividend yield0%
Risk free interest rate2.52% - 3.18%
Expected life of options2 - 2.5 years
Expected volatility51.7% - 61.3%
 
The allocation of the purchase price was based on preliminary unaudited estimates.  Estimates and assumptions are subject to change upon the receipt of management’s review of final amounts and final tax returns.  This final evaluation of net assets acquired will be offset by a corresponding change in goodwill and is expected to be complete within one year of the purchase date.

10

Unaudited pro forma condensed combined financial statements

The following unaudited pro forma combined condensed financial statements include Flotation and Mako for the periods presented as if the acquisitions had occurred on the first date of the respective periods and are presented for informational purposes only. These results are not necessarily indicative of the results of operations that actually would have been achieved had the acquisitions been consummated as of the beginning of the period presented, or are they intended to be a projection of future results. The unaudited pro forma results were as follows:
 
Unaudited Pro Forma Combined Condensed Statements of Operations 
For the Nine Months ended September 30, 2008 
              
  Historical          
     Four Months        Combined 
     April 30,  Flotation     Condensed 
     2008  Pro Forma     Pro Forma 
  Deep Down  Flotation  Entries     Results 
                
                
Revenues $25,852,225  $5,941,472  $-     $31,793,697 
Cost of sales  15,462,187   4,005,179   -      19,467,366 
Gross profit  10,390,038   1,936,293   -      12,326,331 
Total operating expenses  10,296,718   968,179   302,416   (d/e)   11,567,313 
                     
Operating income (loss)  93,320   968,114   (302,416)      759,018 
                     
Total other expense  (3,821,549)  (57,335)  -       (3,878,884)
Income (loss) from                    
continuing operations  (3,728,229)  910,779   (302,416)      (3,119,866)
                     
Benefit from (provision for) income taxes  351,477   -   (225,094) (f)   126,383 
Net income (loss) $(3,376,752) $910,779  $(527,510)     $(2,993,483)
                     
Basic earnings (loss) per share $(0.03)             $(0.02)
Shares used in computing                    
basic per share amounts  131,744,393               166,174,982 
                     
Diluted earnings (loss) per share $(0.03)             $(0.02)
Shares used in computing                    
diluted per share amounts  131,744,393               166,174,982 
                     
See accompanying notes to unaudited pro forma combined condensed financial statements. 
Unaudited Pro Forma Combined Condensed Statements of Operations 
                     
 For the Three Months ended June 30, 2008 For the Six Months ended June 30, 2008 
 Historical       Historical       
   One Month         Four Months     Combined 
   April 30, Flotation   Combined   April 30, Flotation   Condensed 
   2008 Pro Forma   Pro Forma   2008 Pro Forma   Pro Forma 
 Deep Down Flotation Entries   Results Deep Down Flotation Entries   Results 
                     
Revenues$7,920,196 $1,064,364 $-   $8,984,560 $14,199,661 $5,941,472 $-   $20,141,133 
Cost of sales 5,496,427  627,224  -    6,123,651  9,372,798  4,005,179  -    13,377,977 
                             
Gross profit 2,423,769  437,140  -    2,860,909  4,826,863  1,936,293  -    6,763,156 
                             
Total operating expenses 4,224,771  305,220  75,604 (d/e) 4,605,595  6,285,167  968,179  302,416 (d/e) 7,555,762 
                             
Operating income (loss) (1,801,002) 131,920  (75,604)   (1,744,686) (1,458,304) 968,114  (302,416)   (792,606)
                             
Total other income (expense) (3,149,371) (22,467) -    (3,171,838) (3,850,882) (57,335) -    (3,908,217)
Income (loss) from                            
continuing operations (4,950,373) 109,453  (75,604)   (4,916,524) (5,309,186) 910,779  (302,416)   (4,700,823)
                             
Income tax benefit (expense) 85,000  -  (12,524)(f)  72,476  354,366  -  (225,094)(f)  129,272 
Net income (loss)$(4,865,373)$109,453 $(88,128)  $(4,844,048)$(4,954,820)$910,779 $(527,510)  $(4,571,551)
                             
Basic earnings (loss) per share$(0.04)        $(0.03)$(0.05)        $(0.03)
Shares used in computing                            
basic per share amounts 132,666,860       (g)  174,707,676  109,326,053       (g)  161,161,117 
                             
Diluted earnings (loss) per share$(0.04)        $(0.03)$(0.05)        $(0.03)
Shares used in computing                            
diluted per share amounts 132,666,860       (g)  174,707,676  109,326,053       (g)  161,161,117 

The historical results of Deep Down for the three and sixnine months ended JuneSeptember 30, 2008 contain twofive months of results for Flotation operations since its acquisition was effective May 1, 2008. The historical results of Deep Down for the quarter ended September 30, 2008 contain the results of Flotation operations for the full three months, so only the nine-months ended September 30, 2008 is presented as pro forma. The weighted-average shares of stock used in computing basic and diluted per share amounts give effect to the 2,802,969 Mako shares issued on March 31, 2008 and the total of 58,857,143 common shares of Deep Down issued in June 2008;2008, of which such amount 57,142,857 were issued in connection with the Private Placement and 1,714,286 were issued to FlotationFlotation’s prior shareholders, as if all these shares were issued January 1, 2008. Taxes are calculated on the pro forma entries at Deep Down’s estimated combined effective rate of 37%.

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Unaudited Pro Forma Combined Condensed Statement of Operations
For the Three Months ended September 30, 2007
             Combined 
  Historical Mako   Flotation   Condensed 
           Pro Forma   Pro Forma   Pro Forma 
  Deep Down  Mako  Flotation  Entries   Entries   Results 
                     
                     
Revenues $4,885,555  $1,672,457  $4,635,810  $-   $-   $11,193,822 
Cost of sales  3,625,020   710,822   2,744,365   -    -    7,080,207 
Gross profit  1,260,535   961,635   1,891,445   -    -    4,113,615 
                           
Total operating expenses  970,237   648,756   463,023   122,367  (a)  226,812  (d/e)  2,431,195 
                           
Operating income (loss)  290,298   312,879   1,428,422   (122,367)   (226,812)   1,682,420 
                           
Total other income (expense)  (193,942)  (9,156)  (613,878)  (266,410) (b)  -    (1,083,386)
Income (loss) from continuing operations  96,356   303,723   814,544   (388,777)   (226,812)   599,034 
                           
Benefit from (provision for) income taxes  99,613   (205,567)  -   143,847    (217,461) (f)  (179,568)
Net income (loss) $195,969  $98,156  $814,544  $(244,930)  $(444,273)  $419,466 
                           
Basic earnings (loss) per share $-                    $- 
Shares used in computing                          
basic per share amounts  68,285,932                   (c/g)  136,520,118 
                           
Diluted earnings (loss) per share $-                    $- 
Shares used in computing                          
diluted per share amounts  100,307,773                   (c/g)  168,541,959 
                           
See accompanying notes to unaudited pro forma combined condensed financial statements. 
Unaudited Pro Forma Combined Condensed Statement of Operations 
For the Nine Months ended September 30, 2007 
             Combined 
  Historical  Mako   Flotation   Condensed 
           Pro Forma   Pro Forma   Pro Forma 
  Deep Down  Mako  Flotation  Entries   Entries   Results 
                     
                     
Revenues $12,128,737  $4,291,262  $6,986,867  $-   $-   $23,406,866 
Cost of sales  8,300,707   1,833,323   4,510,795   -    -    14,644,825 
Gross profit  3,828,030   2,457,939   2,476,072   -    -    8,762,041 
Total operating expenses  2,757,794   2,013,261   1,536,860   367,101    680,436  (d/e)  7,355,452 
                           
Operating income (loss)  1,070,236   444,678   939,212   (367,101) (a)  (680,436)   1,406,589 
                           
Total other income (expense)  313,691   (55,700)  776,661   (790,118) (b)  -    244,534 
Income (loss) from continuing operations  1,383,927   388,978   1,715,873   (1,157,219)   (680,436)   1,651,123 
                           
Benefit from (provision for) income taxes  (347,750)  (222,876)  -   428,171    (383,112) (f)  (525,567)
Net income (loss) $1,036,177  $166,102  $1,715,873  $(729,048)  $(1,063,548)  $1,125,556 
                           
Basic earnings per share $0.01                    $0.01 
Shares used in computing                          
basic per share amounts  72,626,591                   (c/g)  140,860,777 
                           
Diluted earnings per share $0.01                    $0.01 
Shares used in computing                          
diluted per share amounts  100,584,062                   (c/g)  168,818,248 
                           
See accompanying notes to unaudited pro forma combined condensed financial statements. 
 
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Unaudited Pro Forma Combined Condensed Statement of Operations 
For the Three Months ended June 30, 2007 
               Combined 
 Historical Mako   Flotation   Condensed 
       Pro Forma   Pro Forma   Pro Forma 
 Deep Down Mako Flotation Entries   Entries   Results 
                 
Revenues$5,144,788 $1,768,876 $1,329,446 $-   $-   $8,243,110 
Cost of sales 3,293,313  561,385  974,265  -    -    4,828,963 
                       
Gross profit 1,851,475  1,207,491  355,181  -    -    3,414,147 
                       
Total operating expenses 1,177,876  957,572  711,176  122,367 (a)  226,811 (d/e) 3,195,802 
                       
Operating income (loss) 673,599  249,919  (355,995) (122,367)   (226,811)   218,345 
                       
Total other income (expense) 723,230  (28,571) 1,399,087  (266,269)(b)  -    1,827,477 
Income (loss) from                      
continuing operations 1,396,829  221,348  1,043,092  (388,636)   (226,811)   2,045,822 
                       
Income tax benefit (expense) (447,363) (17,309) -  143,795    (302,024)(f)  (622,901)
Net income (loss)$949,466 $204,039 $1,043,092 $(244,841)  $(528,835)  $1,422,921 
                       
Basic earnings (loss) per share$0.01                 $0.01 
Shares used in computing                      
basic per share amounts 67,870,171               (c/g) 136,104,357 
                       
Diluted earnings (loss) per share$0.01                 $0.01 
Shares used in computing                      
diluted per share amounts 93,799,839               (c/g) 162,034,025 
 
Unaudited Pro Forma Combined Condensed Statement of Operation 
For the Six Months ended June 30, 2007 
               Combined 
 Historical Mako   Flotation   Condensed 
       Pro Forma   Pro Forma   Pro Forma 
 Deep Down Mako Flotation Entries   Entries   Results 
                 
Revenues$7,243,182 $2,618,805 $2,351,057 $-   $-   $12,213,044 
Cost of sales 4,545,402  1,122,501  1,463,530  -    -    7,131,433 
                       
Gross profit 2,697,780  1,496,304  887,527  -    -    5,081,611 
                       
Total operating expenses 1,901,552  1,364,505  1,376,736  244,734 (a)  453,624 (d/e) 5,341,151 
                       
Operating income (loss) 796,228  131,799  (489,209) (244,734)   (453,624)   (259,540)
                       
Total other income (expense) 491,343  (46,545) 1,390,538  (532,391)(b)  -    1,302,945 
Income (loss) from
continuing operations
 1,287,571  85,254  901,329  (777,125)   (453,624)   1,043,405 
                       
Income tax expense (447,363) (17,309) -  287,536    (165,651)(f)  (342,787)
Net income (loss)$840,208 $67,945 $901,329 $(489,589)  $(619,275)  $700,618 
                       
Basic earnings per share$0.01                 $- 
Shares used in computing                      
basic per share amounts 74,417,132               (c/g) 142,651,318 
                       
Diluted earnings per share$0.01                 $- 
Shares used in computing                      
diluted per share amounts 100,315,405               (c/g) 168,549,591 
The unaudited pro forma combined condensed statements include the following pro forma assumptions and entries for Mako:

a)Amortization of the intangible assets at a rate of $40,789 per month for the respective periods.
b)Represents cash interest plus amortization of deferred financing costs and debt discounts for the Credit Agreement.  Interest iswas payable at 15.5% on the outstanding principal, and the related fees arewere amortized using the effective interest method over the applicable four-year life of the loan.
c)A total of 9,377,043 shares were issued for the total transaction. These pro forma amounts give effect as if shares were issued January 1, 2007.
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Taxes are calculated on the pro forma entries at Deep Down’s estimated combined effective rate of 37%.

The unaudited pro forma combined condensed statements include the following pro forma assumptions and entries for Flotation:

d)Recognition of stock basedstock-based compensation from employee stock options issued in connection with the acquisition of Flotation. Deep Down estimated $7,343 per month for the respective time periods.
e)Amortization of the intangible assets at a rate of $68,261 per month based on the remaining useful lives in the table above.
f)Represents estimated income tax accruals for the historical income plus all pro forma adjustments for the respective periods at Deep Down’s estimated combined effective rate of 37%. Flotation was an S-Corp, and as such did not accrue income taxes in its historical financial statements.
g)A total of 58,857,143 common shares of Deep Down were issued; 57,142,857 in connection with the Private Placement, and 1,714,286 to Flotation shareholders. These pro forma amounts give effect as if shares were issued January 1, 2007.

The table below reflectsNOTE 6: INTANGIBLE ASSETS AND GOODWILL

Amounts allocated to intangible assets are amortized on a straight-line basis over their estimated useful lives. Deep Down is in the assumptions used for warrant and option grantsprocess of finalizing the valuations of certain intangible assets related to the Mako and Flotation duringacquisitions; consequently, the six months ended Juneinitial allocations of the respective purchase price amounts are preliminary and subject to change for a period of one year following the acquisitions, although management believes amounts are materially accurate as of September 30, 2008:2008. Estimated intangible asset values, net of recognized amortization expense include the following:
 
Risk free interest rate2.52% - 3.18%
Expected life of options2 - 2.5 years
Expected volatility51.7% - 61.3%
 Average      
 Remaining      
 Useful Life September 30, 2008  December 31, 2007 
        
Customer relationship8-25 Years $3,515,000  $2,869,000 
Non-Compete Covenant3-5 Years  1,334,000   458,000 
Trademarks25-40 Years  3,110,000   1,071,000 
Technology25 Years  11,209,000   - 
Total gross balances   19,168,000   4,398,000 
Less: Accumulated amortization   (749,804)  (28,353)
Intangible assets, net  $18,418,196  $4,369,647 
 
The following table presents goodwill as of the dates indicated, as well as changes in the account during the period shown.
  Amount 
    
Carrying amount as of December 31, 2007 $10,594,144 
Goodwill acquired during the year  2,391,574 
Carrying amount as of September 30, 2008 $12,985,718 
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NOTE 6:7: LONG-TERM DEBT

The following table summarizes long-term debt:
  September 30, 2008  December 31, 2007 
Secured credit agreement with Prospect Capital Corporation    
quarterly principal payments of $250,000 beginning      
September 30, 2008; monthly interest payments,      
interest fixed at 15.5%; balance due August 2011;      
secured by all assets $-  $12,000,000 
Debt discount, net of amortization of $254,101 and $135,931 respectively  -   (1,703,258)
Note payable to a bank, payable in monthly        
installments bearing interest at 8.25% per annum,        
maturing June 10, 2008, cross-collateralized        
by Mako assets, paid January 2008.  -   289,665 
Note payable to a bank, payable in monthly        
installments bearing interest at 7.85% per annum,        
maturing September 28, 2010, collateralized by Mako        
life insurance policy and equipment, paid January 2008.  -   320,027 
Revolving line-of-credit of $500,000 from a bank,        
matured October 13, 2007 or on demand, interest rate is        
at a variable rate resulting in a rate of 8.30% as of        
September 30, 2007, collateralized by Mako equipment,        
paid January 2008.  -   151,705 
Note payable to a bank payable in monthly        
installments bearing interest at 7.85% per annum,        
maturing January 25, 2011, collateralized by Mako        
equipment and life insurance policy, paid January 2008  -   154,647 
Total secured credit agreement and bank debt  -   11,212,786 
6% Subordinated Debenture beginning March 31, 2008; annual   - 
interest payments, interest fixed at 6%; matures March 31, 2011  515,041   - 
Capital lease of equipment, monthly lease payments,        
interest imputed at 11.2%  448,000   481,209 
Total long-term debt  963,041   11,693,995 
Current portion of long-term debt  (48,816)  (995,177)
Long-term debt, net of current portion $914,225  $10,698,818 
Secured Credit Agreement
On August 6, 2007, Deep Down entered into a $6.5 million secured credit agreement, (the “Credit Agreement”) with Prospect Capital Corporation (“Prospect”) and received an advance of $6.0 million on that date.  The Credit Agreement provided for a 4-year term, an annual interest rate of 15.5%, with the ability to defer up to 3.0% of interest through a PIK (paid-in-kind) feature and principal payments of $75,000 per quarter beginning September 30, 2008, with the remaining balance outstanding due August 6, 2011. Interest payments were payable monthly, in arrears, on each month-end commencing on August 31, 2007. Deep Down paid the full 15.5% and did not exercise the PIK feature for the monthly periods through June 2008 when the debt was paid in full, see details below.   

On July 3, 2008, Prospect exercised their outstanding 4,960,585 warrants in a cashless exercise for a total of 2,618,129 shares of Deep Down common stock. See Note 10 for additional discussion of the terms of these warrants.

On December 21, 2007, Deep Down entered into an amendment to the Credit Agreement (the “Amendment”) to provide the funding for the cash portion of the purchase of Mako. The total commitment available under the Amendment was increased from $6.5 million to $13.0 million. Amounts borrowed were $6.0 million.  Quarterly principal payments increased to $250,000 beginning September 30, 2008.  Cash interest paid for the three and nine months ended September 30, 2008 was $0 and $821,500, respectively, and was $139,500 for the three and nine months ended September 30, 2007, respectively. Under the Credit Agreement, Deep Down was required to meet certain covenants and restrictions as well as maintain a debt service reserve account.  As of December 31, 2007, $375,000 is separately classified as “Restricted cash” on the accompanying balance sheets. 
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 In connection with the second advance under the Credit Agreement on January 4, 2008, Deep Down capitalized an additional $261,946 in deferred financing costs.  Of this amount, $216,000 was paid in cash to various third parties related to the financing, and the remainder of $45,946 represents the Black-Scholes valuation of warrants issued to one of these third party vendors.  The warrant was issued to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share.
On June 12, 2008, Deep Down paid $12,492,912 to Prospect to pay off the balance outstanding under the Credit Agreement and related interest and early termination fees. In connection with the early payoff, Deep Down accelerated the remaining deferred financing costs totaling $661,149 and recorded this charge as interest expense. Additionally, $1,490,955 in debt discounts were accelerated and recorded as interest expense. Early termination fees of approximately $446,412 were recognized as a loss on early extinguishment of debt.  Since the warrants issued in connection with the original Credit Agreement and the Amendment dated January 4, 2008 were detachable, there was no change to these equity instruments.
In January 2008, in accordance with the terms of the purchase of Mako, Deep Down paid $916,044 of notes payable plus accrued interest of $2,664.

Exchange of Series E Redeemable Exchangeable Preferred Stock to 6% Subordinated Debenture

On March 31, 2008, 500 shares of the Series E Redeemable Exchangeable Preferred Stock (“Series E”) were exchanged into a 6% Subordinated Debenture (the “Debenture”) in an outstanding principal amount of $500,000.  The Debenture has a fixed interest rate of 6% interest per annum to be paid annually on March 31st through maturity on March 31, 2011. Upon exchange into the Debenture, Deep Down recorded $113,589 in interest expense for the accretion of the Series E up to face value. See the additional discussion of the terms of the Series E preferred stock at Note 8. Interest expense on the Debenture of approximately $7,560 and $15,040 has been recognized for the three- and nine-month periods ended September 30, 2008, respectively.

Revolving Credit Line

On November 11, 2008, Deep Down entered into a new credit agreement with Whitney National Bank, as lender, to provide Deep Down with a revolving credit line.  See Note 13 for a brief and general description of certain material terms and provisions of such credit agreement.

NOTE 8: PREFERRED STOCK

Series D Redeemable Convertible Preferred Stock Classified as Temporary Equity Instruments

On March 28,During the first quarter of fiscal 2008, the outstanding 5,000 shares of Series D redeemable convertible preferred stock (“Series D”) were converted into 25,866,518 restricted shares of common stock.  The Series D had a face value and liquidation preference of $1,000 per share, no dividend preference, and were convertible into shares of common stock determined by dividing the face amount by a conversion price of $0.1933.  The Series D had been valued at inception at $4,419,244 based on the Black-Scholes fair value of the Series D.

Exchange of Series E Redeemable Exchangeable Preferred Stock Classified as Debt Instruments to 6% Subordinated Debenture

On March 31, 2008, 500 shares of the Series E Preferred Stockpreferred stock were exchanged into thea 6% Subordinated Debenture in an outstanding principal amount of $500,000.  The Series E had a face value and liquidation preference of $1,000 per share, no dividend preference, and were exchangeable at the holder’s option into a 6% Subordinated Debenturedebenture due three years from the date of the exchange. See additional discussion of the Subordinated Debenture in Note 4.7.

NOTE 7:9: COMMON STOCK

Private Placement
 
On June 5, 2008, Deep Down sold 57,142,857 shares of its common stock to accredited investors, for $40,000,000 at a per-share price of $0.70. After transaction costs, Deep Down had net proceeds wereof $37,059,670. Dahlman Rose & Company, LLC acted as exclusive placement agent for the equity financing.

Deep Down used $22,100,000 of the net proceeds to fund the cash portion of the Flotation purchase, and used $12,492,912 to repay outstanding debt, along with early termination fees, to Prospect on June 12, 2008, with2008. Deep Down retained the remainder being retainedremaining net proceeds for working capital purposes.

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In connection with the private placement,Private Placement, Deep Down entered into a registration rights agreement where the holder has certain demand registration rights. Deep Down filed an S-1 Registration Statement on July 21, 2008. IfDeep Down was obligated to have the Registration Statement is not declared effective by September 3, 2008 (the “Required Effective Date”), thenor the Company would be required to pay daily damages to the purchasers in the Private Placement for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective,effective. Deep Down shall be required to pay daily damages to the purchasers.  Deep Downhas evaluated this obligation under the registration rights agreement for liability treatment under Financial Accounting Standards Board (“FASB”) Statement No. 5, “Accounting for Contingencies” (“SFAS 5”) and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights did not meet the definition of a liability under the authoritative guidance since management believesand has reserved $359,640 in potential damages under terms of the liability is not estimable at this time.Private Placement for the period September 4 to September 30, 2008.

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NOTE 8: STOCK BASED10: STOCK-BASED COMPENSATION AND WARRANTS

Deep Down has a stock basedstock-based compensation plan - the 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). We account for stock-based compensation expense under Statement of Financial Accounting (“SFAS”)SFAS No. 123 (Revised 2004), “Share-based Payment,” (“SFAS No. 123(R)”). The exercise price of the options, as well as the vesting period, is established by Deep Down’s Board of Directors. The options granted under the Plan have vesting periods that range from immediate vesting to vesting over five years, and the contract terms of the options granted are up to ten years. Under the Plan, the total number of options permitted is 15% of issued and outstanding common shares. During the sixnine months ended JuneSeptember 30, 2008, Deep Down granted 4,200,000 options and 1,200,000 shares of restricted stock, and cancelled 875,000 options duesubject to forfeitures under the Plan. Based on the shares of common stock outstanding at JuneSeptember 30, 2008, there arewere approximately 16,235,00016,628,000 options available for grant under the Plan as of that date.

Restricted Stock

On February 14, 2008, Deep Down issued an aggregate of 1,200,000 shares of restricted common stock to Ronald E. Smith, CEO;CEO, Robert E. Chamberlain, Chairman;Chairman, and Eugene L. Butler, CFO, under terms of the Plan. The shares were valued at a price of $0.42 based on the closing price of common stock on that date. The shares vest on the second anniversary of the grant date, and Deep Down is amortizing the related stock basedstock-based compensation of $504,000 over the 2 year period. For the sixnine months ended JuneSeptember 30, 2008, Deep Down recognized a total of $94,500$157,500 in stock basedstock-based compensation related to these issued shares of restricted stock. The unamortized portion of the estimated fair value of restricted stock is $346,500 at September 30, 2008.

The following table summarizes Deep Down’s restricted stock activity for the sixnine months ended JuneSeptember 30, 2008:
 
  Restricted Shares  Weighted- Average Grant Price  Aggregate Intrinsic Value 
Outstanding at December 31, 2007  -       
Grants  1,200,000  $0.42    
Outstanding at June 30,2008  1,200,000  $0.42  $624,000 

  
Restricted
Shares
  
Weighted-
 Average
Grant Price
  
Aggregate
 Intrinsic Value
 
Outstanding at December 31, 2007  -       
Grants  1,200,000  $0.42    
Outstanding at September 30,2008  1,200,000  $0.42  $228,000 
Stock Option Activity During 2008

During the sixnine months ended JuneSeptember 30, 2008, Deep Down granted 4,200,000 options under the Plan as detailed below.below (no grants were issued during the three months ended September 30, 2008).  On June 17, 2008, Deep Down effected a cashless exercise of 50,000 employee stock options for 29,339 net shares of common shares wasstock issued in accordance with terms of the Plan.

During the sixnine months ended JuneSeptember 30, 2008, Deep Down granted an aggregate of 350,000 stock options to various employees with exercise prices between $0.71 and $0.88, reflecting the respective days’ closing prices.price on the applicable date of grant. The fair value of such options was approximately $114,737 based on the Black-Scholes option pricing model.  Additionally, Deep Down issued 600,000 stock options to employees of Flotation in connection with that acquisition.

On February 14, 2008, Deep Down issued an aggregate of 3,000,000 stock options to Ronald E. Smith, Robert E. Chamberlain, and Eugene L. Butler, with an exercise price per share of $1.50, which was in excess of the day’s closing price of $0.42. The fair value of such options was approximately $145,764 based on the Black-Scholes option pricing model.
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Additionally, on January 22, 2008, Deep Down issued 250,000 stock options to an officer with an exercise price of $0.70, the closing price of Deep Down’s common stock on that date.  These options have since been forfeited due to the officer’s departure in May 2008.

All of the options issued during 2008 have terms for vesting at the rate of one third of the total grant annually on the anniversary of their respective grant dates.

Since Deep Down does not have a sufficient trading history to determine the volatility of its own stock, it based its estimates of volatility on a representative peer group consisting of companies in the same industry, with similar market capitalizations and similar stage of development.

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Summary of Stock Options

Deep Down is expensing all stock options on a straight line basis over their respectivethe requisite expected service periods. The total stock basedstock-based compensation expense for stock options for the sixnine months ended JuneSeptember 30, 2008 and JuneSeptember 30, 2007, was $159,169$286,333 and $39,565,$113,480, respectively.  The unamortized portion of the estimated fair value of outstanding stock options is $949,885$842,722 at JuneSeptember 30, 2008.

The following table summarizes Deep Down’s stock option activity for the sixnine months ended JuneSeptember 30, 2008:
 
 Shares Underlying Options Weighted- Average Exercise Price Weighted- Average Remaining Contractual Term (in years) 
Aggregate Intrinsic Value
(In-The-Money)
 
Outstanding at December 31, 2007 5,500,000 $0.58     
Grants 4,200,000  1.35     
Exercises (50,000) 0.50     
Forfeitures (875,000) 0.74     
Outstanding at June 30,2008 8,775,000 $0.93  3.0 $1,944,750 
Exerciseable at June 30,2008 1,970,834 $0.60  2.7 $729,292 
  
Shares
 Underlying
Options
  
Weighted-
Average
Exercise
Price
  
Weighted-
Average Remaining Contractual
Term (in years)
  
Aggregate
Intrinsic Value
 (In-The-Money)
 
Outstanding at December 31, 2007  5,500,000  $0.58       
Grants  4,200,000   1.35       
Exercises  (50,000)  0.50       
Forfeitures  (875,000)  0.74       
Outstanding at September 30, 2008  8,775,000  $0.93   3.0  $463,000 
Exerciseable at September 30, 2008  2,033,334  $0.60   2.7  $194,167 
 
The following summarizes Deep Down’s outstanding options and their respective exercise prices at JuneSeptember 30, 2008:
 
Exercise
Price
Shares
Underlying
Options
$0.30 - 0.49175,000
$0.50 - 0.694,125,000
$0.70 - 0.99525,000
$1.00 - 1.29950,000
$1.30 - 1.503,000,000
   8,775,000
 
The fair value of each stock option grant is estimated on the date of the grant using the Black-Scholes model and is based on the following key assumptions for the sixnine months ended JuneSeptember 30, 2008:
 
Dividend yield0%
Risk free interest rate2.64% - 2.84%
Expected life of options3 years
Expected volatility53.3% - 63.3%
 
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Summary of Warrants

In connection with the purchase of Flotation, Deep Down issued warrants to purchase 200,000 common shares at $0.70 per share were issued to an entity affiliated with the selling stockholdersshareholders in consideration for the acquisition of related technology. The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock. Deep Down valued the warrants at $121,793 based on the Black-Scholes option pricing model and included this value in the purchase price allocation related to Flotation.

On August 6, 2007, as part of the Credit Agreement described above in Note 4,7, Deep Down issued 4,960,585 detachable warrants. Deep Down issued all of such warrants to its creditor. All warrants were issued with an exercise price of $0.507, expired infor terms of five years, (or earlier in the event of termination) and vestedwith vesting occurring on the earlier of the second anniversary of the agreement or upon payment in full of the debt. On July 3, 2008, the creditorholder of these warrants exercised all of its outstanding 4,960,585 warrantsthem for a total of 2,618,129 restricted shares of Deep DownDown’s common stock in a cashless exercise.

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Additionally, related to the Credit Agreement described in Note 4, Deep Down issued 320,000 detachable warrants at an exercise price of $0.75 per share to a third party related to the financing. The warrant has a five-year term and became exercisable in connection with the early payoff of the debt.  Also, in connection with the Amendment to the Credit Agreement, Deep Down issued detachable warrants to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share to the same third party. The warrant has a five-year term and was immediately exercisable. See the additional discussion concerning such warrants in Note 4.

A summary of warrant transactions follows:

 Shares Underlying Warrants Weighted- Average Exercise Price Weighted- Average Remaining Contractual Term (in years) 
Aggregate
Intrinsic Value
(In-The-Money)
 
Outstanding at December 31, 2007 5,399,397 $0.53     
Grants 200,000  0.70     
Outstanding at June 30,2008 5,599,397 $0.54  4.4 $2,241,852 
Exerciseable at June 30,2008 5,399,397 $0.54  4.4 $2,193,852 
  
Shares
 Underlying
Warrants
  
Weighted-
Average
Exercise
Price
  
Weighted-
Average
Remaining Contractual
Term (in years)
  
Aggregate
 Intrinsic Value
(In-The-Money)
 
Outstanding at December 31, 2007  5,399,397  $0.53       
Grants  200,000   0.70       
Exercised  (4,960,585)  0.51       
Outstanding at September 30, 2008  638,812  $0.78   4.3  $- 
Exerciseable at September 30, 2008  438,812  $0.82   4.3  $- 
 
The following summarizes Deep Down’s outstanding warrants and their respective exercise prices at JuneSeptember 30, 2008:
 
Exercise
Price
 Shares Underlying Warrants
 $   0.70 - 0.99 520,000
 $             1.01 118,812
  638,812
Exercise Price Shares Underlying Warrants 
$0.51  4,960,585 
$0.70 - 0.99  520,000 
$1.01  118,812 
    5,599,397 
The fair value of each warrant grant is estimated on the date of the grant using the Black-Scholes model and is based on the following key assumptions for the sixnine months ended JuneSeptember 30, 2008:
 
Dividend yield0%
Risk free interest rate2.52% - 3.18%
Expected life of options2 - 2.5 years
Expected volatility51.7% - 61.3%
 

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NOTE 9:11: COMMITMENTS AND CONTINGENCIES

Litigation and Disputes
 
We areDeep Down is from time to time involved in other legal proceedings arising in the normal course of business. As of the date of this Quarterly Report on Form 10-Q, there are no other pending or threatened material legal proceedings.

Registration Rights Agreement Penalties

In connection with the Private Placement in June 2008, Deep Down filed an initial Registration Statement on Schedule S-1 to register the shares issued. Terms of the Private Placement state that if the Registration Statement is not declared effective by September 3, 2008 (the “Required Effective Date”), then for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective, Deep Down shall, for each such day, pay each Purchaser with respect to any such failure, as liquidated damages, an amount equal to 0.0333% of the purchase price paid by such Purchaser for the shares purchased pursuant to the Purchase Agreement, or $13,320 per day.  Deep Down has reserved $359,640 in potential damages under terms of the Private Placement for the period September 4 to September 30, 2008, and will continue to accrue such liability until the Registration Statement for such shares is declared effective.  As of November 14, 2008, an additional $599,400 has accrued as the Registration Statement has not yet been declared effective.

Operating Leases

Deep Down leases land under an operating lease and is responsible for related maintenance, insurance and property taxes.  On May 1, 2008, Deep Down and JUMA, LLC, a related party, amended the original lease that began as of September, 2006 to provide for the additional acreage leased resulting in a $4,000 per month increase in rent.  See Note 10 below for further discussion of the related party.

NOTE 10:12:  RELATED PARTY TRANSACTIONS
 
Deep Down leases all buildings, structures, fixtures and other improvements at the Channelview, Texas location from JUMA, LLC, a limited-liability company (“JUMA”) owned by Ronald E. Smith, President and CEO and a director of Deep Down and Mary L. Budrunas, a vice presidentVice President and a directorCorporate Secretary of Deep Down. The base rate of $15,000 per month is payable to JUMA through September 1, 2011, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.

On March 28, 2008, Deep Down redeemed 4,500 shares of Series D preferred stock owned by Ronald Smith and Mary Budrunas.  The Series D preferred shares were redeemed for 23,279,876 shares of common stock.
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During the sixnine months ended JuneSeptember 30, 2008, Deep Down granted an aggregate of 1,200,000 restricted shares of common stock and an aggregate of 3,000,000 stock options to Ronald E. Smith, President and Chief Executive Officer, Robert E. Chamberlain, Jr., Chairman and Chief Acquisition Officer, and Eugene L. Butler, Chief Financial Officer, under the terms of the Deep Down, Inc. Stock Option Plan.Officer. Deep Down also awarded in recognition of their completion of the acquisition of Flotation and private placementPrivate Placement of common stock, a performance bonus of $300,000 in the aggregate.

NOTE 11:13:  SUBSEQUENT EVENTS

New Corporate Revolver

On July 3,November 11, 2008, Prospect exercised their outstanding 4,960,585 warrantsDeep Down entered into a new Credit Agreement (the “Revolver”) with Whitney National Bank as lender. The Revolver provides a commitment to lend to Deep Down of the lesser of $2,000,000 and 80% of eligible receivables (generally defined as current due accounts receivables in which the lender has a cashless exercisefirst priority security interest).  All of the commitment under the Revolver is also available in commitments for the lender to issue letters of credit for the benefit of Deep Down.  Outstanding amounts under the Revolver will generally bear interest at rates based on the British Bankers Association LIBOR Rate for dollar deposits with a totalterm of 2,618,129 sharesone month plus an applicable rate of 2.00% to 3.00% based on the leverage ratio of Deep Down.  Accrued interest under the Revolver is payable monthly.  Unused portions of the commitment generally accrue a commitment fee of 0.25% to 0.50% based on the leverage ratio of Deep Down common stock.and such fee is due and payable by Deep Down quarterly.  The Revolver has a termination date of November 11, 2010.  At November 14, 2008, Deep Down has not drawn on any amounts available under this Revolver.

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Each of Deep Down’s subsidiaries has guaranteed the obligations of Deep Down under the Revolver and as such Deep Down’s obligations in connection with the Revolver are secured by a first priority lien generally on all of their non real property assets. The terms of the Revolver and the related loan documents subject Deep Down to several covenants, including requirement to:  provide security generally on all of their non real property assets, cause Deep Down’s subsidiaries to provide guarantees, provide certain financial information to the lender, give inspection rights to the lender, and apply insurance and eminent domain proceeds to repayment of amounts outstanding under the Revolver.  Furthermore, the terms of the Revolver impose restrictions on the ability of Deep Down and its subsidiaries to incur further indebtedness or liens, to make investments in other businesses, to pay dividends, to engage in mergers, acquisitions or dispositions or other lines of businesses, to enter into transactions with their affiliates, to prepay other indebtedness or to make any change in their respective fiscal year or method of accounting (other than changes as required by generally accepted accounting principles in the U.S.).

The Revolver also contains provisions in reference to a term loan with a maturity date of five years from the date on which such loan is committed, but there is no actual commitment under the Revolver for such a term loan.
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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis provides information that management believes is relevant for an assessment and understanding of our results of operations.operations and financial condition. This information should be read in conjunction with our audited historical consolidated financial statements which are included in our Form 10-KSB/A (Amendment No. 3)4) for the fiscal year ended December 31, 2007 filed with the Securities and Exchange Commission (“SEC”)SEC on August 8,September 30, 2008 and our unaudited condensed consolidated financial statements and notes thereto included with this Quarterly Report on Form 10-Q in Part I, Item 1.

Corporate History

In December 2006, MediQuip Holdings, Inc. (“MediQuip”), a publicly traded Nevada corporation (“MediQuip”), divested Westmeria Healthcare Limited, its wholly-owned subsidiary representing substantially all of its preceding operations, and subsequently acquired Deep Down, Inc. ("Deep Down"), a Delaware corporation, in a reverse merger transaction so thatwith Deep Down wasas the surviving entity for accounting purposes.  MediQuip was renamed Deep Down in connection with such transaction. Due to the structure of such December 2006 transactions, the discussion and disclosure in this report relates to Deep Down and its operations unless otherwise specified.

In June 2006, the former parent entity of Deep Down, Subsea Acquisition Corporation (“Subsea”), a Texas corporation, was formed for the purpose of acquiring service providers to the offshore energy industry and designers and manufacturers of subsea equipment, surface equipment and offshore rig equipment that are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world.

On November 21, 2006, Subsea acquired all the outstanding capital stock of Strategic Offshore Services Corporation (“SOS”), a Texas corporation, for 3,000 shares of Subsea’s Series F Preferred Stock and 1,000 shares of Subsea’s Series G Preferred Stock from two of the three principal shareholders of Subsea.  Since both Subsea and SOS were then under common control and the operations of SOS did not constitute a business, the Company recognized compensation expense to such principal shareholders for the fair value of both series of preferred stock totaling $3,340,792.

On the same day as its acquisition of SOS, Subsea also acquired Deep Down, Inc., a Delaware corporation founded in 1997.  Under the terms of this transaction, Subsea acquired all of Deep Down’s outstanding capital stock in exchange for 5,000 shares of Subsea’s Series D Preferred Stock and 5,000 shares of Subsea’s Series E Preferred Stock.  The purchase price, based on the fair value of the Series D and E Preferred stock, was $7,865,471.

Immediately after the completion of the acquisitions of Deep Down and SOS on November 21, 2006, Subsea merged with and into its wholly-owned subsidiary SOS, with Subsea continuing as the surviving company.  Immediately thereafter, Subsea merged with and into its wholly-owned subsidiary Deep Down, with Deep Down continuing as the surviving company.

On December 14, 2006, after divesting its Westmeria Healthcare Limited subsidiary, MediQuip acquired all 9,999,999 outstanding shares of Deep Down common stock and all 14,000 outstanding shares of Deep Down preferred stock in exchange for 75,000,000 shares of common stock and 14,000 shares of preferred stock of MediQuip.  The shares of preferred stock of MediQuip were issued with the same designations, rights and privileges as the Deep Down preferred stock existing immediately prior to such transaction.  As a result of the acquisition, the shareholders of Deep Down obtained ownership of a majority of the outstanding voting stock of MediQuip.  MediQuip changed its name to Deep Down, Inc. as part of the transaction, and Deep Down, Inc. continued as a Nevada corporation following consummation of the acquisition.

The financial information and the financial statements of the Company presented in this report reflect those of Deep Down, Inc. and its subsidiaries, and do not include the financial condition and results of operations of MediQuip or Westmeria Healthcare Limited for periods prior to the December 2006 merger date.

Since December 2006, Deep Down has consummated three strategic acquisitions.  On April 2, 2007, Deep Down acquired substantially all of the assets of ElectroWave USA, Inc., a Texas corporation.  For purposes of completing the acquisition, Deep Down formed a wholly-owned subsidiary, ElectroWave USA, Inc., a Nevada corporation.  Effective December 1, 2007, Deep Down acquired all of the outstanding common stock of Mako Technologies, Inc., a Louisiana corporation.  For purposes of completing the acquisition, Deep Down formed a wholly-owned subsidiary, Mako Technologies, LLC, a Nevada limited liability company, which merged with and into Mako Technologies, Inc., with Mako as the surviving entity. Effective May 1, 2008, Deep Down acquired all of the outstanding common stock of Flotation Technologies, Inc., a Maine corporation.  
 
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Our current operations are the result of the recent acquisitions of Deep Down, ElectroWave, Mako and Flotation.  In addition to our strategy of continuing to grow and strengthen our operations, including by expanding our services and products in accordance with our customers’ demands, we intend to continue to seek strategic acquisitions of complementary service providers, product manufacturers and technologies that are focused primarily on supporting offshore deepwater exploration, development and production of oil and gas reserves and other maritime operations.

Recent EventsSegments

Amendments to BylawsFor the fiscal year ended December 31, 2007, we operated under one operating segment based on analysis of SFAS 131 “Disclosures about Segments of an Enterprise and Articles of Incorporation

In May 2008, the Board of Directors amended the Bylaws and approved amendments to our Articles of Incorporation subject to shareholder approval, which was obtained on May 16, 2008.Related Information” (“SFAS 131”). The amendments are designed to discourage any tender offer or other attempt to gain controloperations of Deep Down and ElectroWave were reviewed collectively by Deep Down, Inc’s management due to similarities in a transaction that is not approved by our Board of Directors, by making it more difficult for a person or group to obtain controlproducts and production processes. The Mako subsidiary was included in the consolidated operations of Deep Down, Inc. since its acquisition effective December 1, 2007, but constitutes less than 10% of the total revenues for the fiscal year ended December 31, 2007. Therefore, Mako did not meet the quantitative thresholds for segment reporting for the fiscal year ended December 31, 2007.

Management is currently reviewing all operations related to segment reporting under the guidelines of SFAS 131, paragraphs 25 and 26(a) and plans to begin reporting operating segment(s) by the end of the 2008 fiscal year.

Recent developments

New Corporate Revolver

On November 11, 2008, we entered into the Revolver with Whitney National Bank as lender.  The Revolver provides a commitment to lend to us of the lesser of $2,000,000 and 80% of eligible receivables (generally defined as current due accounts receivables in which the lender has a short time and then impose its willfirst priority security interest). All of the commitment under the Revolver is also available in commitments for the lender to issue letters of credit for the benefit of Deep Down. Outstanding amounts under the Revolver generally bear interest at rates based on the remaining stockholders, including:British Bankers Association LIBOR Rate for dollar deposits with a term of one month plus an applicable rate of 2.00% to 3.00% based on the leverage ratio of Deep Down.  Accrued interest under the Revolver is payable monthly.  Unused portions of the commitment generally accrue a commitment fee of 0.25% to 0.50% based on the leverage ratio of Deep Down and such fee is due and payable by Deep Down quarterly.  The Revolver has a termination date of November 11, 2010.  At November 14, 2008, Deep Down has not drawn on any amounts available under this Revolver.

Classified BoardEach of Directorsour subsidiaries has guaranteed the obligations of Deep Down under the Revolver and RemovalDeep Down’s and such subsidiaries’ obligations in connection with the Revolver are secured by a first priority lien generally on all of Directors.  Our Board of Directors is divided into three classes which shall be as nearly equal in number as possible.their non real property assets. The directors in each class serve for terms of three years, withthe Revolver and the related loan documents subject us and our subsidiaries to several covenants, including requirement to:  provide security generally on all of their non real property assets, cause Deep Down’s subsidiaries to provide guarantees, provide certain financial information to the lender, give inspection rights to the lender, and apply insurance and eminent domain proceeds to repayment of amounts outstanding under the Revolver.  Furthermore, the terms of one class expiring each year.  Each class currently consiststhe Revolver impose restrictions on our ability to incur further indebtedness or liens, to make investments in other businesses, to pay dividends, to engage in mergers, acquisitions or dispositions or other lines of approximately one-thirdbusinesses, to enter into transactions with their affiliates, to prepay other indebtedness or to make any change in their respective fiscal year or method of accounting (other than changes as required by generally accepted accounting principles in the number of directors.  Each director will serve until his successor is elected and qualified.  A director may not be removed except for cause by the affirmative vote of the holders of 75% of the outstanding shares of capital stock entitled to vote at an election of directors.U.S.).
 
Advance Notice RequirementsThe Revolver also contains provisions in reference to a term loan with a maturity date of five years from the date on which such loan is committed, but there is no actual commitment under the Revolver for Nomination of Directors and Proposal of New Business at Annual Stockholder Meetings.  Any stockholder desiring to makesuch a nomination for the election of directors or a proposal for new business at a stockholder meeting must submit written notice not less than 30 or more than 60 days in advance of the meeting.
Supermajority Voting Requirement for Amendment of Certain Provisions of the Certificate of Incorporation.  Specified provisions contained in the articles of incorporation and bylaws may not be repealed or amended by action of our stockholders except upon the affirmative vote of the holders of not less than seventy-five percent of the outstanding stock entitled to vote.  This requirement exceeds the majority vote that would otherwise be required by Nevada law for the repeal or amendment of the articles or bylaws.term loan.

Private PlacementRegistration Rights Agreement Penalties

On June 5, 2008, Deep Down entered into the Purchase Agreement to sell and issue to the certain purchasers, purchasing in reliance on the exemption from registration in Section 4(2) of the Securities Act of 1933, as amended, an aggregate of 57,142,857 shares, of Deep Down’s common stock at a price of $0.70 per share, for a total purchase price of $40.0 million and net proceeds to Deep Down of approximately $37.1 million.  Completion of the private placement was subject to completion of the acquisition of Flotation, as described below.  Dahlman Rose & Company, LLC acted as exclusive placement agent for the financing.

Deep Down used $22.1 million of the net proceeds to fund the cash portion of the Flotation purchase, and used approximately $12.5 million to repay outstanding debt, interest and early termination fees to Prospect Capital Corporation on June 12, 2008, with the remainder being retained for working capital purposes.

In connection with the private placement, Deep Down entered into a registration rights agreement where the holder has certain demand registration rights. Deep DownPrivate Placement in June 2008, we filed an S-1initial Registration Statement on July 21, 2008. IfForm S-1 to register the shares issued. Terms of the Private Placement state that if the Registration Statement is not declared effective by September 3, 2008 (the “Required Effective Date”), then for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective, Deep Downwe shall, be requiredfor each such day, pay each Purchaser with respect to pay dailyany such failure, as liquidated damages, an amount equal to the purchasers.  Deep Down evaluated the registration rights agreement for liability treatment under FASB Statement No. 5, “Accounting for Contingencies” and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights did not meet the definition of a liability under the authoritative guidance since management believes the liability is not estimable at this time.

Purchase of Flotation.

On June 5, 2008, Deep Down completed the acquisition on 100%0.0333% of the capital stock of Flotation,purchase price paid by such Purchaser for the shares purchased pursuant to the Stock Purchase Agreement, entered into on April 17, 2008. The stock was acquired from three individual shareholder membersor $13,320 per day.  We have reserved $359,640 in potential damages under terms of the same family and related technology was acquired from an entity affiliated with such selling shareholders. Deep Down announcedPrivate Placement for the closing on June 6,period September 4 to September 30, 2008, and effectively datedwill continue to accrue such liability until the acquisitionRegistration Statement for accounting purposessuch shares is declared effective.  As of November 14, 2008, an additional $599,400 has accrued as of May 1, 2008.the Registration Statement has not yet been declared effective.  We cannot estimate at this time when the Registration Statement will be delared effective.


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Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers. Flotation’s product offerings include distributed buoyancy for flexible pipes and umbilicals, Core Tec™ drilling riser buoyancy modules, ROVitsTM buoyancy, Hydro-Float mooring buoys, StablemoorTM  low-drag ADCP deployment solution, Quick-LocTM  and cable floats, HardBall TM umbilical floats , FlotectTM  cable and pipeline protection, InFlex TM  polymer static bend restrictors, and installation buoyancy of any size and depth rating.

We have accounted for the acquisition of Flotation using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (FASB) No. 141, Business Combinations (FASB 141) since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Flotation.

The purchase price of Flotation was $23.9 million and consisted of $22.1 million cash and 1,714,286 shares of common stock valued at $0.83 per common share plus transaction costs of $251,180. In addition, warrants to purchase 200,000 shares of common stock at $0.70 per share were issued to an entity affiliated with the selling shareholders for the acquisition of technology. The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock. Deep Down valued the warrants at $121,793 based on the Black-Scholes option pricing model. Flotation’s selling shareholders used $1.8 million of the $22.1 million cash received to pay outstanding debt of Flotation. The purchase price may be adjusted upward or downward, dependant on the amount of Flotation’s working capital on June 6, 2008.

Deep Down also issued 600,000 incentive common stock purchase options to employees of Flotation for future services with an exercise price of $1.15 per share. The employee options vest one-third of the original amount each year and may be exercised in whole or in part after vesting. Deep Down valued the options at $264,335 based on the Black-Scholes option pricing model, and will recognize the related compensation cost ratably over the requisite service period.

Payment of long term debt and exercise of Prospect warrants:

On June 12, 2008, Deep Downwe paid approximately $12.5 million to Prospect Capital Corporation to pay the balance due under itsour Credit Agreement and related interest and early termination fees.  Since the warrants issued in connection with the original Credit Agreement and the Amendment dated January 4, 2008 were detachable, there was no change to these equity instruments.  On July 3, 2008, Prospect exercised their outstanding 4,960,585 warrants in a cashless exercise for a total of 2,618,129 restricted shares of Deep Downour common stock.

Results of operations
 
Three monthsMonths Ended JuneSeptember 30, 2008 Compared to Three Months Ended JuneSeptember 30, 2007

Revenue.  RevenuesRevenue for the three months ended JuneSeptember 30, 2008 increased $2.8$6.8 million to $7.9$11.7 million, a 54% increase. Revenues contributed by51% increase over the same three-month period in 2007. The increase in revenue included $8.5 million from the acquisitions for the three months ended June 30, 2008 represented $3.0 millionof Mako and Flotation, while there was a slight decreaseour historical service lines had an aggregated reduction in the core businessrevenue of $0.2$1.7 million. The slight decreasereduction in revenue over the same three-month period in 2007 was partially a result of two major engineering and product development projects which were completed prior to the third quarter of 2008, with very low margins, and as such, we chose to not make these products in 2008. The remaining reduction of revenues was a result of certain customerscustomers’ delaying scheduled projects.many of their major projects due to the softening of the world oil price and the impact it had on anticipated cash flow.
 
Gross Profit.  Gross profit increased by $0.6$4.0 million to $2.4$5.3 million for the three months ended JuneSeptember 30, 2008 as compared to the same period last year.  Gross margins for the same period improved from 25.8% to 45.5%.  The acquisitioninclusion of Mako and Flotation for the three months ended September 2008 increased the gross profit by $1.0 million. ElectroWave decreased by $0.2$4.8 million versuswhile our historical service lines had an aggregated decrease of $0.8 million due to a reduction in revenue for this period as compared to the same period lasta year and the core business declined by $0.2 million. The slight decline on the core business was due to delays in certain projects which caused the gross profit margin to drop slightly. Gross margins for the period were 31% for the current fiscal quarter, and are expected to increase during the second half of the year.ago.

Selling, General and Administrative Expenses. SG&A for the three months ended JuneSeptember 30, 2008 was $3.7 million compared to $1.1$0.9 million for the same period last year for an increase of $2.6$2.8 million. The acquisitions of Mako and Flotation represented $0.9$1.3 million of the increase. Bad debt increased by $0.8$0.2 million due to the write off of two accounts, one of which filed for bankruptcy protection during the quarter ($0.2 million of the total bad debt is included in the Mako subsidiary).certain accounts. Personnel and related costs increased by $0.6$0.3 million primarily due to an expansion of our businesses requiring more personnel and the related requirements to administer a public company and comply with reporting requirements. Additionally, we paid approximately $0.4$0.6 million more than the same period for the prior year in professional, accounting and legal fees to support our various initiatives during the quarter relating to the filing of a registration statement and to support the related acquisitions. Stock basedStock-based compensation related to employee stock options and restricted stock was approximately $148,500$170,160 in the current fiscal quarter compared to approximately $40,000$74,000 for the comparable prior period. Insurance costs increased by approximately $0.2 million, part of which is included in the acquisition related expenses noted above.
 
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Depreciation and amortization. Depreciation expense for the three months ended JuneSeptember 30, 2008 was $0.3$0.4 million compared to $0.1 million for the same prior year period due mainly to the acquisitions in fiscal year 2008. Fixed assets acquired in the Mako and Flotation subsidiaries totaled $8.1 million. In addition, intangible assets purchased in the Mako and Flotation acquisitions total $19.2 million in the aggregate. Amortizationaggregate, and the related amortization for the quarter ended JuneSeptember 30, 2008 was $0.3 million.

Interest Expense. Interest expense for the three months ended JuneSeptember 30, 2008 was $2.7 million$24,704 compared to $1.3$0.2 million for the same prior year period.  On June 12, 2008, Deep Downwe paid the balance due under the Credit Agreement, thus there were no related expenses for the current fiscal quarter. For the three months ended September 30, 2007, cash interest on the Credit Agreement totaled $139,500, and deferred financing and debt discount amortization approximated $69,000.
Net income. Net income for the three months ended September 30, 2008 was $1.6 million, compared to net income of $0.2 million for the same prior year period as discussed above.  
EBITDA. Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is a non-GAAP financial measure. We use EBITDA as an unaudited supplemental financial measure to assess the financial performance of its assets without regard to financing methods, capital structures, taxes or historical cost basis; its liquidity and operating performance over time in relation to other companies that own similar assets and that we believe calculate EBITDA in a similar manner; and the ability of our assets to generate cash sufficient for us to pay potential interest costs. We also understand that such data are used by investors to assess our performance. However, the term EBITDA is not defined under generally accepted accounting principles and EBITDA is not a measure of operating income, operating performance or liquidity presented in accordance with generally accepted accounting principles. When assessing our operating performance or liquidity, investors should not consider this data in isolation or as a substitute for net income, cash flow from operating activities, or other cash flow data calculated in accordance with generally accepted accounting principles.  EBITDA for the three months ended September 30, 2008 was $2.3 million compared to $0.4 million, an increase of $1.9 million from the same prior year period.
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Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007

Revenue.  Total revenue generated in the nine months ended September 30, 2008 was $25.9 million compared to $12.1 million for the same period last year, an increase of $13.8 million or 113%. This increase in revenue was primarily attributable to strong demand for equipment from our customers in the oil and gas industry and the impact of the inclusion of our acquisitions of Mako and Flotation, which accounted for $12.8 million of the increase.
Gross Profit. Gross profit was $10.4 million for the nine months ended September 30, 2008 compared to $3.8 million for the same period in fiscal 2007, reflecting an overall improvement in gross profit margin from 31.6% to 40.2%. Gross profit margins were positively impacted by improved pricing of all product lines.
Selling, General and Administrative Expenses. SG&A for the nine months ended September 30, 2008 was $9.4 million compared to $2.7 million for the same period last year for an increase of $6.7 million. The acquisitions of Mako and Flotation represented $2.8 million of the increase. Bad debt increased by $1.0 million due to the write off of certain accounts, one of which filed for bankruptcy protection. Personnel and related interest.costs increased by $1.5 million due to expansion of our businesses requiring more personnel and the related requirements to administer a public company and comply with reporting requirements. Additionally, we paid approximately $0.9 million more than the same period for the prior year in professional, accounting and legal fees to support our various initiatives during the nine-month period relating to the filing of a registration statement and to support the referenced acquisitions. Stock-based compensation related to employee stock options and restricted stock was approximately $0.4 million in the current fiscal year compared to approximately $0.1 million for the comparable prior year period.
Depreciation and amortization. Depreciation expense for the nine months ended September 30, 2008 was $0.9 million compared to $0.2 million for the same prior year period due mainly to the acquisitions of Mako and Flotation, though Flotation has only five months of depreciation expense since it was acquired May 1, 2008. Fixed assets acquired in the Mako and Flotation subsidiaries totaled $8.9 million. A total of $0.8 million of the depreciation expense is recorded as cost of sales related to revenue-producing assets, compared to $0.2 million for the previous comparable period. In addition, amortization of intangible assets for the nine months ended September 30, 2008 was $0.7 million.
Interest Expense. Interest expense for the nine months ended September 30, 2008 was $3.5 million compared to $1.8 million for the same prior year period.  In connection with the early payoff Deep Downof the Credit Agreement in June 2008, we accelerated the remaining deferred financing costs totaling $0.7 million and recorded this charge to interest expense. Additionally, $1.4$1.5 million in debt discounts were accelerated and recorded to interest expense.  CashWe paid cash interest onrelated to the Credit Agreement totaled $0.4totaling $0.8 million for the threenine months ended JuneSeptember 30, 2008.2008 compared to $139,500 in the prior year. For the three months ended June 30, 2007, $1.2comparable period of the prior year, $1.4 million of the total interest related to accretion on the redemption of Series G and Series E Preferred Stock.

Gain/(loss) on debt extinguishment.  In connection with the early payoff of the Credit Agreement in June 2008, early termination fees of approximately $446,412 were recognized as a loss on early extinguishment of debt. In the prior year, Deep Downwe executed a Securities Redemption Agreement with the former CFO of Deep Down CFO to redeem 4,000 shares of Series E exchangeable preferred stock at a discounted price of $500 per share for a total of $2.0 million.  The discount of $500 per share from the face value of $1,000 was accounted for as a substantial modification of debt, thereby generating a gain on extinguishment of debt.  Deep Down accreted the remaining discount of $1.1 million attributable to such shares on the date of redemption.  
 
Net lossincome (loss). Net loss for the threenine months ended JuneSeptember 30, 2008 was $4.9$3.4 million, compared to a net income of $0.9$1.0 million for the same prior year period, as discussed above.
 
EBITDA.  EBITDAEBITDA. Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is a non-GAAP financial measure. Deep Down defines EBITDA as net income plus interest expense, income taxes, depreciation, amortization and other non-cash, non-operating expense. Deep Down usesWe use EBITDA as an unaudited supplemental financial measure to assess (1) the financial performance of itsour assets without regard to financing methods, capital structures, taxes or historical cost basis, (2) itsbasis; our liquidity and operating performance over time in relation to other companies that own similar assets and that we believe calculate EBITDA in a similar manner,manner; and (3) the ability of Deep Down’sour assets to generate cash sufficient for Deep Downus to pay potential interest costs. Deep DownWe also understandsunderstand that such data are used by investors to assess our performance. However, the term EBITDA is not defined under generally accepted accounting principles and EBITDA is not a measure of operating income, operating performance or liquidity presented in accordance with generally accepted accounting principles. When assessing Deep Down’sour operating performance or liquidity, investors should not consider this data in isolation or as a substitute for net income, cash flow from operating activities, or other cash flow data calculated in accordance with generally accepted accounting principles. Excluding the one-time gain and non-cash interest and stock based compensation charges, EBITDA for the threenine months ended JuneSeptember 30, 2008 was $(1.0)$1.3 million compared to $0.8$3.3 million for the same prior year period, a decrease of $1.8$2.0 million from the same prior year period due in part to the significant bad debt expense and other SG&A expensesitems discussed above.

Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007

Revenue.  Revenue generated in the six months ended June 30, 2008 was $14.2 million compared to $7.2 million for the same period last year, an increase of 96%. Our acquisitions accounted for $5.1 million of this increase. Mako was included for the entire period and accounted for $2.7 million of the increase. Flotation was included for two months and accounted for $1.5 million of the increase and ElectroWave was included for six months, but included for only three months in the same period last year and accounted for $0.9 million of the increase. Our existing businesses continued to strengthen with a $1.8 million increase, for a 29% increase over last year’s six month revenues. Contract revenues were up 25% while rentals were up 47%.  Our offshore market continues to be strong and we continue to expand our customer base.

Gross Profit. Gross margin for the six months ended June 30, 2008 increased $2.1 million to $4.8 million, for a 79% increase. $1.4 million of the increase is attributable to the inclusion of the acquisitions in this period.  The overall gross margin was 34 % for the first six months of 2008 as compared to 37% for the same period last year. The gross margin is slightly lower due to an increase in personnel and personnel related costs for the continued growth.
 
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Selling, General and Administrative Expenses. SG&A for the six months ended June 30, 2008 was $5.4 million compared to $1.8 million for the same period last year for an increase of $3.6 million. The acquisitions of Mako and Flotation represented $1.5 million of the increase. Bad debt increased by $0.8 million due to the write off of two accounts, one of which filed for bankruptcy protection during the quarter ($0.2 million of the total bad debt is included in the Mako subsidiary). Personnel and related costs increased by $1.0 million primarily due to an expansion of our businesses requiring more personnel and the related requirements to administer a public company and comply with reporting requirements. Additionally, we paid approximately $0.7 million to in professional accounting, and legal fees to support our various initiatives during the six months ended June 30, 2008 relating to the filing of a registration statement and acquisitions and reporting requirements. Stock based compensation related to employee stock options and restricted stock was approximately $0.3 million in the current fiscal year compared to approximately $40,000 for the comparable prior year period.

Depreciation and amortization. Depreciation expense for the six months ended June 30, 2008 was $0.5 million compared to $0.2 million for the same prior year period due mainly to the acquisitions in fiscal year 2008, though Flotation has only 2 months of depreciation expense since they were acquired May 1, 2008. Fixed assets acquired in the Mako and Flotation subsidiaries totaled $8.1 million. In addition, intangible assets purchased in the Mako and Flotation acquisitions total $19.2 million in the aggregate. Amortization of intangible assets for the quarter ended June 30, 2008 was $0.4 million.

Interest Expense. Interest expense for the six months ended June 30, 2008 was $3.9 million compared to $1.5 million for the same prior year period.  In connection with the early payoff of the Credit Agreement, Deep Down accelerated the remaining deferred financing costs totaling $0.7 million and recorded this charge to interest expense. Additionally, $1.5 million in debt discounts were accelerated and recorded to interest expense, along with early termination fees of approximately $446,412.  Deep Down paid cash interest related to the Credit Agreement totaling $0.8 million for the six months ended June 30, 2008. For the comparable period of the prior year, $1.4 million of the total interest related to accretion on the redemption of Series G and Series E Preferred Stock.
Gain/(loss) on debt extinguishment.  In connection with the early payoff of the Credit Agreement in June 2008, early termination fees of approximately $446,412 were recognized as a loss on early extinguishment of debt. In the prior year, Deep Down executed a Securities Redemption Agreement with the former Deep Down CFO to redeem 4,000 shares of Series E exchangeable preferred stock at a discounted price of $500 per share for a total of $2.0 million.  The discount of $500 per share from the face value of $1,000 was accounted for as a substantial modification of debt, thereby generating a gain on extinguishment of debt.  Deep Down accreted the remaining discount of $1.1 million attributable to such shares on the date of redemption.  

Net loss. Net loss for the six months ended June 30, 2008 was $5.0 million, compared to a net income of $0.8 million for the same prior year period, as discussed above.
EBITDA.  Excluding the one-time gain and non-cash interest and stock based compensation charges, EBITDA for the six months ended June 30, 2008 was $(0.3) million compared to $1.0 million, a decrease of $1.3 million from the same prior year period.

Capital Resources and Liquidity

Financing for our operations consists primarily of cash flows attributable to our operations. We believe that the liquidity we derived from the private placement of our common stock in June 2008 and cash flows attributable to our operations is more than sufficient to fund our capital expenditures, debt maturities and other business needs. We continue to evaluate acquisitions and joint ventures in the ordinary course of business. When opportunities for business acquisitions meet our standards, we believe we will have access to capital sources necessary to take advantage of those opportunities.

Notwithstanding the foregoing, on November 11, 2008, we entered into the Revolver with Whitney National Bank as lender, and we expect such financing to provide thereafter for a portion of our working capital needs.  At November 14, 2008, we have not drawn on any amounts available under this Revolver.
As of JuneSeptember 30, 2008, our cash and cash equivalents were $4.1$5.2 million.  Cash and cash equivalents were $2.2 million plus restricted cash of $0.4 million as of December 31, 2007.  Management believesWe believe that we have adequate capital resources when combined with itsour cash position and cash flow from operations to meet current operating requirements.

On June 5, 2008, we sold 57,142,857 shares of Deep Down’sour common stock in a private placement at a price of $0.70 per share, for a total purchase price of $40.0 million and net proceeds to us of approximately $37.1 million. We used $22.1 million of the net proceeds to fund the cash portion of the Flotation purchase, and used approximately $12.5 million to repay outstanding debt, interest and early termination fees to Prospect on June 12, 2008, with2008. We retained the remainder being retainedremaining net proceeds for working capital purposes.

On April 11, 2008, the original shareholders of Mako received the final cash installment of $1.2 million under the terms of the securities redemption and shareholder payable agreement.

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Cash Flow from Operating Activities

For the sixnine months ended JuneSeptember 30, 2008, cash used inprovided by operating activities was $1.4$1.2 million as compared to cash provided byused in operating activities for the same prior year period of 2007 of $0.4$1.5 million. Our working capital balances vary due to delivery terms and payments on key contracts, workcosts and estimated earnings in progress,excess of billings on uncompleted contracts, and outstanding receivables and payables. We used some of the operating cash flow to reduce accounts payable and accrued liabilities by $1.1 million compared to an increase of $2.1 million in fiscal 2007. Additionally, we recorded the following non-cash charges:charges in fiscal 2008: amortization of deferred financing costs and debt discount related to the Prospect loan payoff totaling $2.6 million, share based compensation of $0.3$0.4 million, bad debt expense of $1.1 million and depreciation and amortization of $0.9$1.6 million. In fiscal 2007, we had a gain on extinguishment of debt of $2.0 million related to the redemption of preferred stock at a discount, recognition of a sales type lease receivable of $0.8 million, an increase of finished goods of $0.5 million, and amortization of deferred financing costs, debt discounts and accretion on preferred stock totalling $1.4 million.

Cash Flow from Investing Activities

For the sixnine months ended JuneSeptember 30, 2008, cash used in investing activities was $23.7$25.7 million as compared to $0.6$1.2 million for the same prior year period. The majority of the 2008 activity related to the cash paid to Flotation shareholders totaling $22.1 million offset by $0.2 million cash acquired, which was funded by the net proceeds of the private placementPrivate Placement as discussed above. Additionally, Deep Downwe made the final cash payment to the original Mako shareholders in the amount of $1.2 million.million plus some adjustments to purchase price expenses. The restricted cash balance of $0.4 million was released in connection with the payoff of the Credit Agreement. Deep DownWe used $0.7$2.6 million for equipment purchases compared to the same prior year period totaling $0.4$0.6 million.

Cash Flow from Financing Activities

For the sixnine months ended JuneSeptember 30, 2008, cash provided by financing activities was $27.0$27.4 million compared to $0.5$3.4 million for the same prior year period.  During the sixnine months ended JuneSeptember 30, 2008, Deep Downwe completed the foregoing described private placementPrivate Placement for net proceeds of $37.1 million. In June, 2008, Deep Downwe paid approximately $12.5 million to Prospect to pay the balance due under its Credit Agreement and related interest and early termination fees. In January 2008, in accordance with the terms of the purchase of Mako, Deep Downwe paid $0.9 million of notes payable plus accrued interest of $2,664, and received proceeds from Prospect totaling $2.7 million. During the third quarter of 2008, we received the balance due under the sales lease receivable, bringing the annual receipts to $0.6 million.

Capital Resources and Requirements

We generate our liquidity and capital resources primarily through operations and, when needed, through available capital markets. At JuneSeptember 30, 2008, long-term debt was $1.0$0.9 million, of which $47,477$48,816 was the current portion.
 
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Critical Accounting Policies
   
For a discussionWe utilize the following critical accounting policies in the preparation of our critical accounting matters, please refer to Item 7, “Management’s Discussionfinancial statements.

Accounts Receivable   Trade accounts receivable are recorded at the invoiced amount and Analysisdo not bear interest.  The allowance for doubtful accounts on trade receivables is our best estimate of Financial Condition and Resultsthe probable amount of Operation,”credit losses in our 2007 Annual Reportexisting accounts receivables.  A considerable amount of judgment is required in assessing the realization of receivables.  Relevant assessment factors include the credit worthiness of the customers and prior collection history.  Account balances are charged off against the allowance after all reasonable means are exhausted and the potential for recovery is considered remote.  The allowance requirements are based on Form 10-KSB/A (Amendment No.3) filedthe most current facts available and are re-evaluated and adjusted on August 8, 2008.a regular basis and as additional information is received.  We do not expect to have any off-balance sheet credit exposure related to our customers.

Consolidation The accompanying financial statements include the accounts of Deep Down and all of its wholly-owned subsidiaries, including Deep Down Delaware since its inception on June 29, 2006, ElectroWave since its acquisition on April 2, 2007, Mako since its acquisition on December 1, 2007 and Flotation since its acquisition on May 1, 2008.  All significant intercompany accounts and transactions have been eliminated.

Long-Lived Assets  We evaluate long-lived assets for impairment whenever changes in circumstances indicate that the carrying amount of the asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset.  If assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts exceed the fair values of the assets.  Assets to be disposed are reported at the lower of carrying values or fair values, less costs of disposal. We found no significant adjustments during our review of fixed assets.

Stock-Based Compensation  We account for stock-based compensation issued to employees and non-employees as required by SFAS No. 123(R) “Accounting for Stock Based Compensation.” Under these provisions, we record expense ratably over the requisite service period based on the fair value of the awards determined at the grant date utilizing the Black-Scholes pricing model for options and warrants.  We first granted stock options in April 2007, and thus do not have extensive history upon which to evaluate our estimates. For fiscal 2007, we estimated forfeitures to be 0%, which was an accurate amount for that fiscal year. We expect to increase our forfeiture estimate in future periods as we accumulate our history with regard to forfeitures.

Key assumptions used in the Black-Scholes model for both stock options and warrant valuations include (1) expected volatility (2) expected term (3) discount rate and (4) expected dividend yield. Since we do not have a sufficient trading history to determine the volatility of our own stock, we based our estimates of volatility on a representative peer group consisting of companies in the same industry, with similar market capitalizations and similar stage of development.
The fair value of each stock option or warrant grant is estimated on the date of the grant using the Black-Scholes model and is based on the following key assumptions for the nine months ended September 30, 2008:
Dividend yield0%
Risk free interest rate2.64% - 2.84%
Expected life of options3 years
Expected volatility53.3% - 63.3%
Revenue Recognition   We generally recognize revenue once the following four criteria are met:  (i) persuasive evidence of an arrangement exists, (ii) delivery of the equipment has occurred or services have been rendered, (iii) the price of the equipment or service is fixed and determinable and (iv) collectability is reasonably assured.  For certain fabrication projects, revenue is recognized upon shipment or when customer-specific contract elements, (“milestone(s)”) are met.   Fabrication and sale of equipment billings are contingent upon satisfaction of a significant condition of sale milestone, including but not limited to, factory acceptance testing and customer approval, and recognized upon transfer of title to the customer.  Service revenue is recognized as the service is provided. Costs incurred to date that exceed milestone billings are adjusted during the month end profitability review and are recorded in “Costs and estimated earnings in excess of billings on uncompleted contracts” on the accompanying balance sheets.
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We entered into a large fixed price contract during the nine months ended September 30, 2008.  As such, we determined that recognizing revenues for this contract was appropriate using the percentage-of-completion method under Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (“SOP 81-1”), measured by the percentage of costs incurred to date to estimated total costs for the contract.  This method is used because management considers total cost to be the best available measure of progress on the contracts. 

Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as supplies, equipment repairs, employee travel and supervisor time. Selling, general and administrative costs are charged to expense as incurred.  Provisions for estimated losses on uncompleted contracts (if any) are made in the period in which such losses are determined.  Changes in job performance, job conditions, and total contract values may result in revisions to costs and income and are recognized in the period in which the revisions are determined.  Unapproved change orders are accounted for in revenue and cost when it is probable that the costs will be recovered through a change in the contract price. In circumstances where recovery is considered probable but the revenues cannot be reliably estimated, costs attributable to change orders are deferred pending determination of contract price.

Costs and estimated earnings in excess of billings on uncompleted contracts arise when revenues are recorded on a percentage-of-completion basis but cannot be invoiced under the terms of the contract. Such amounts are invoiced upon completion of contractual milestones. Billings in excess of costs and estimated earnings on uncompleted contracts arise when milestone billings are permissable under the contract, but the related costs have not yet been incurred.  All contract costs are recognized currently on jobs formally approved by the customer and contracts are not shown as complete until virtually all anticipated costs have been incurred and the items are shipped to the customer.
In accordance with industry practice, assets and liabilities related to costs and estimated earnings in excess of billings on uncompleted contracts, as well as billings in excess of costs and estimated earnings on uncompleted contracts, have been classified as current. The contract cycle for certain long-term contracts may extend beyond one year, thus collection of amounts related to these contracts may extend beyond one year.
All intercompany revenue accounts and balances were eliminated in consolidation.

Goodwill and Intangible Assets  Goodwill represents the cost in excess of the fair value of net assets acquired in business combinations. Statement of financial accounting standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), prescribes the process for impairment testing of goodwill on an annual basis or more often if a triggering event occurs. Goodwill is not amortized, and there were no indicators of impairment at December 31, 2007.

We evaluate the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include a significant adverse change in legal factors or in business or the business climate or unanticipated competition. When evaluating whether goodwill is impaired, we compare the fair value of the business to its carrying amount, including goodwill. The fair value of the reporting unit is estimated using the income or discounted cash flows. If the carrying amount of the business exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount.

Our intangible assets consist of assets acquired in the purchase of the Mako and Flotation subsidiaries and comprised of customer lists, non-compete covenants with key employees and trademarks related to Mako’s ROVs and Flotation’s processes and materials, and technology.  We amortize the intangible assets over their useful lives ranging from 3 to 40 years on a straight-line basis.

Income Taxes  We have adopted the provisions of SFAS No. 109, “Accounting for Income Taxes" which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes,” by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. If a tax position is more likely than not to be sustained upon examination, then an enterprise would be required to recognize in its financial statements the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
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Inflation and Seasonality

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

ITEM 3.  QUALITATIVE AND QUANTITATIVE MARKET RISKS
 
Not applicable for smaller reporting companies.
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ITEM 4T. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).  Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in reports filed under the Exchange Act is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs.  Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
 
Changes in Internal Control Over Financial Reporting

There were no changes in Deep Down’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that occurred during the quarterly period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, Deep Down’s internal control over financial reporting except for the impact of its new acquisition of Flotation. With its new acquisition, Deep Down’s management will conduct its annual assessment for its inclusion in its December 31, 2008 Annual Report on Form 10-K.

PART II – OTHER INFORMATION
 
ITEM 1.  LEGAL PROCEEDINGS
Not applicable.
ITEM 1A. RISK FACTORS
Not applicable for smaller reporting companies.
ITEM 2. UNREGISTERED SALES OF EQUITY AND USE OF PROCEEDS

On June 5, 2008, Deep Down entered into the Purchase Agreement to sell and issue to certain purchasers, purchasing in reliance on the exemption from registration in Section 4(2) of the Securities Act of 1933, an aggregate of 57,142,857 shares, of Deep Down’s common stock at a price of $0.70 per share. The net proceeds for Deep Down from such private placement was approximately $37.1 million. Dahlman Rose & Company, LLC acted as exclusive placement agent for the financing. Deep Down used $22.1 million of the net proceeds to fund the cash portion of the Flotation purchase, and used approximately $12.5 million to repay outstanding debt to Prospect Capital Corporation on June 12, 2008, with the remainder being retained for working capital purposes.

In June 2008, in connection with the acquisition of Flotation, Deep Down issued an aggregate of 1,714,286 shares of common stock to shareholders of Flotation, valued at $0.83 per share, and 600,000 incentive common stock purchase options to employees of Flotation with an exercise price of $1.15 per share.  In addition, warrants to purchase 200,000 common shares at $0.70 per share were issued to an entity affiliated with the selling shareholders for acquisition of the related technology.  The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock.   These shares of restricted common stock are exempt from registration requirements provided by Section 4(2) of the Securities Act and/or Regulation D promulgated thereunder.

On June 17, 2008, Deep Down effected a cashless exercise of 50,000 employee stock options for a non-insider employee at an exercise price of $0.50 per share for net common shares issued totaling 29,339. These shares of common stock are exempt from registration requirements provided by Section 4(2) of the Securities Act and/or Regulation D promulgated thereunder.

Effective July 3, 2008, Prospect Capital Corporation, the holders of 4,960,585 warrants originally issued in connection with Deep Down’s secured credit agreement,Credit Agreement, effected a cashless exercise of all of their warrants for 2,618,129 shares of common stock of Deep Down at an exercise price of $0.507. These shares of common stock are exempt from registration requirements provided by Section 4(2) of the Securities Act and/or Regulation D promulgated thereunder. For a further discussion of these warrants, see Note 10 to our unaudited consolidated financial statements included in Part I, Item 1 of this report.
ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
 
Not applicable.
 
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ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.HOLDERS

On May 16, 2008 (the “Record Date”), Deep Down received written consents fromfirst mailed an information statement to its stockholders representing a majority of our outstanding voting interests on the close of business on the Record Date, in lieu of a meeting, approvingSeptember 15, 2008 that described several amendments to our Articles of Incorporation and Bylaws previously adopted pursuant to provide the following: i) A division of the board of directors into three classes, approximately equal in size and each director to serve for a three year term ; ii) Prohibiting  action by written consent of a majority of our stockholders in lieu of a special meeting of our stockholders on May 16, 2008.  Reference is hereby made to our Definitive Information Statement on Schedule 14C filed with the shareholders without prior approval bySEC on August 15, 2008 concerning a more complete statement and description concerning the board of directors; iii) Limiting authority for the call of special meetings of the shareholdersamendments to the boardArticles of directors or a committeeIncorporation and the Bylaws that were adopted pursuant to such stockholder written consent.  In summary, the amendments provided for:
-    the division of our board of directors into three classes approximately equal in size, with each director to serve for a three-year term,
-    the prohibition of action taken by written consent of Deep Down’s stockholders without the prior approval of Deep Down’s board of directors,
-    the prohibition on removal of directors except for cause by the affirmative vote of the holders of 75% of the outstanding shares of our capital stock entitled to vote on the election of directors, and
-    the requirement that any stockholder nominations for election as a director or proposals of new business to be delivered or mailed to Deep Down not less than 30 or more than 60 days prior to the meeting proposed for taking action on such matter,
-    the prohibition on repealing or amending provisions contained in the Articles of Incorporation and Bylaws without the affirmative vote of holders of 75% of the outstanding shares of our capital stock entitled to vote with regard to such matter.
Stockholders of the board; and iv) Requiring shareholder nominations for election of directors or proposals for new business to be delivered or mailed to the company not less than 30 or more sixty days prior to the meeting.

On July 21, 2008, Deep Down Inc. filed Schedule 14Cholding 70,338,251 shares of our outstanding common stock provided a written consent to reportapprove the resultsamendments to our Articles of Incorporation and Bylaws.  On May 16, 2008, the actions related to these matters.date of such action, Deep Down had a total of 115,846,019 shares of common stock outstanding.

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ITEM 5.  OTHER INFORMATION
New Corporate Revolver

On May 16,November 11, 2008, Deep Down entered into the BoardRevolver with Whitney National Bank as lender.  The Revolver provides a commitment to lend to Deep Down of Directors amended the Bylaws.lesser of $2,000,000 and 80% of eligible receivables (generally defined as current due accounts receivables in which the lender has a first priority security interest).  All of the commitment under the Revolver is also available in commitments for the lender to issue letters of credit for the benefit of Deep Down.  Outstanding amounts under the Revolver generally bear interest at rates based on the British Bankers Association LIBOR Rate for dollar deposits with a term of one month plus an applicable rate of 2.00% to 3.00% based on the leverage ratio of Deep Down.  Accrued interest under the Revolver is payable monthly.  Unused portions of the commitment generally accrue a commitment fee of 0.25% to 0.50% based on the leverage ratio of Deep Down and such fee is due and payable by Deep Down quarterly.  The Revolver has a termination date of November 11, 2010.

Each of Deep Down’s subsidiaries has guaranteed the obligations of Deep Down under the Revolver and Deep Down’s and such subsidiaries’ obligations in connection with the Revolver are secured by a first priority lien generally on all of their non real property assets. The terms of the Revolver and the related loan documents subject Deep Down and its subsidiaries to several covenants, including requirement to:  provide security generally on all of their non real property assets, cause Deep Down’s subsidiaries to provide guarantees, provide certain financial information to the lender, give inspection rights to the lender, and apply insurance and eminent domain proceeds to repayment of amounts outstanding under the Revolver.  Furthermore, the terms of the Revolver impose restrictions on the ability of Deep Down and its subsidiaries to incur further indebtedness or liens, to make investments in other businesses, to pay dividends, to engage in mergers, acquisitions or dispositions or other lines of businesses, to enter into transactions with their affiliates, to prepay other indebtedness or to make any change in their respective fiscal year or method of accounting (other than changes as required by generally accepted accounting principles in the U.S.).

The Revolver also contains provisions in reference to a term loan with a maturity date of five years from the date on which such loan is committed, but there is no actual commitment under the Revolver for such a term loan.

Copies of the Revolver and the related Guaranty, and Security Agreement are set forth as exhibits to this report.

Updates to Procedures for Nominating Directors

Pursuant to the written consent of stockholders described under Item 4 above, Deep Down’s procedures by which security holders may recommend nominees to Deep Down’s board of directors were approved.  Under such amendments, in order for a stockholder of Deep Down to make any nomination for a person to be elected as a director of Deep Down at any annual meeting or a committee appointedspecial meeting, the stockholder must give notice in writing (delivered or mailed by first class United States mail, postage prepaid, to the boardSecretary of directors shall act as nominating committee for selecting the management nomineesDeep Down) of any nomination for election as directors. The nominating committee shall deliver written nominations to the secretary at least twentya director not less than 30 days nor more than 60 days prior to the date of an applicable meeting (or, if Deep Down gives less than 40 days’ prior notice of such a meeting, delivered or mailed within 10 days following the annual meeting. Provideddate Deep Down provided such committee makesnotice of such nominations, no nominations formeeting).  A nomination by a stockholder of a person to be elected to our board of directors except those mademust contain (i) the name, age, business address, and, if known, residence address of the nominee, (ii) the principal occupation or employment of such nominee, and (iii) the number of shares of our capital stock beneficially owned by such nominee.  Additionally, the nominating committeestockholder shall be voted upon at the annual meeting unlesspromptly provide any other nominations by stockholders are made in writing and delivered to the secretary in accordance with the provisions of the Articles of Incorporation.information that Deep Down reasonably requests.

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ITEM 6. EXHIBITS

Exhibits required to be attached by Item 601 of Regulation S-K are listed in the Index of Exhibits of this Quarterly Report on Form 10-Q.  Those exhibits below10-Q, which is incorporated herein by reference herein are indicated as such by the information supplied in the parenthetical thereafter. If no parenthetical appears after an exhibit, such exhibit is filed herewith.reference.

Exhibit NumberDescription of Exhibit
2.1 (1)
Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc.
3.1 (1)10.1*
Certificate of Incorporation of MediQuip Holdings, Inc.
3.2 (2)
Certificate of Amendment to Articles of Incorporation providing for Change of Name to Deep Down, Inc.
3.3 (1)
By Laws of Deep Down, Inc.
3.4 (1)
Form of Certificate Designation of Series D Redeemable Convertible Preferred Stock
3.5 (1)
Form of Certificate Designation of Series E Redeemable Exchangeable Preferred Stock
3.6 (1)
Form of Certificate Designation of Series F Redeemable Convertible Preferred Stock
3.7 (1)
Form of Certificate Designation of Series G Redeemable Exchangeable Preferred Stock
3.8(7)
Amendment to Articles of Incorporation
3.9(7)
Amended and Restated Bylaws
4.7 (3)
Securities Purchase Agreement
4.8 (3)Common Stock Purchase Warrant (No. 4), dated June 5, 2008
  4.9 † (6)
2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan.
5.1 (6)Opinion of Sonfield & Sonfield, counsel to the Company, as to the legality of the Common Stock being registered. 
10.1 (3)Private Placement Memorandum 
10.2 (6)Supplement No. 1 to Private Placement Memorandum
10.4*
Dahlman Rose Underwriting Agreement 
10.5 (4)Stock PurchaseCredit Agreement, dated April 17, 2008, among Deep down, Inc., Flotation Technologies, Inc. and the selling stockholders named therein.
10.6 † (6)Employment Agreement with David A. Capotosto
10.7 † (6)Employment Agreement with Bradley M. Parro
10.8*Amended Lease Agreement dated May 1,as of November 11, 2008, between Deep Down, Inc., a Delaware corporation, as tenant,borrower, and JUMA, L.L.C. December 31, 2007 filed on March 31, 2008).Whitney National Bank, as lender
10.2*Guaranty, dated as of November 11, 2008, by Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, and Deep Down, Inc. for the benefit of Whitney National Bank
10.3*Security Agreement, dated as of November 11, 2008, among Deep Down, Inc., Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, and Deep Down, Inc. for the benefit of Whitney National Bank
31.1*Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934.
31.2*Certification of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934.
32.1*Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc.
32.2*Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc.

(1) Filed as an exhibit to our Report on Form 10-KSB/A, filed with the Commission on May 1, 2008, and incorporated herein by reference.
(2) Filed as an exhibit to our Report on Form 10-KSB, filed with the Commission on April 1, 2008, and incorporated herein by reference.
(3) Filed as an exhibit to our Report on Form 8-K/A, filed with the Commission on June 9, 2008, and incorporated herein by reference.
(4) Filed as an exhibit to our Report on Form 8-K, filed with the Commission on April 21, 2008, and incorporated herein by reference.
(5) Filed as an exhibit to our Quarterly Report on Form 10-Q, filed with the Commission on May 16, 2008, and incorporated herein by reference.
(6) Filed as an exhibit to our Registration Statement on Form S-1, filed with the Commission on July 21, 2008, and incorporated herein by reference.
(7) Filed as an exhibit to our Schedule 14C, filed with the Commission on June 19, 2008 and revised and re-filed on August 8, 2008
_________________
* Filed or furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement


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SIGNATURES

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

DEEP DOWN, INC.
(Registrant)
 
Signature Title Date
     
/s/ RONALD E. SMITH President, CEO and Director August 15,November 14, 2008
Ronald E. Smith 
(Principal Executive Officer)
 
  
/s/ EUGENE L. BUTLER Chief Financial Officer August 15,November 14, 2008
Eugene L. Butler (Principal Financial Officer)  

 
 
INDEX TO EXHIBITS

Exhibit NumberDescription of Exhibit
2.1Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc. (incorporated by reference from Exhibit 2.1 to our Annual Report on Form 10-KSB/A (Amendment No. 2) for the fiscal year ended December 31, 2007 filed on May 1, 2008).
3.110.1*Certificate of Incorporation of MediQuip Holdings, Inc. (incorporated by reference from Exhibit 3.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
3.2Certificate of Amendment to Articles of Incorporation providing for Change of Name to Deep Down, Inc. (incorporated by reference from Exhibit 3.2 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
3.3By Laws of Deep Down, Inc. (incorporated by reference from Exhibit 3.3 to our Annual Report on Form 10-KSB/A (Amendment No. 1) for the fiscal year ended December 31, 2007 filed on May 1, 2008).
3.4Form of Certificate of Designation of Series D Redeemable Convertible Preferred Stock (incorporated by reference from Exhibit 3.4 to our Annual Report on Form 10-KSB/A (Amendment No. 1) for the fiscal year ended December 31, 2007 filed on May 1, 2008).
3.5Form of Certificate of Designation of Series E Redeemable Exchangeable Preferred Stock (incorporated by reference from Exhibit 3.5 to our Annual Report on Form 10-KSB/A (Amendment No. 1) for the fiscal year ended December 31, 2007 filed on May 1, 2008).
3.6Form of Certificate of Designation of Series F Redeemable Convertible Preferred Stock (incorporated by reference from Exhibit 3.6 to our Annual Report on Form 10-KSB/A (Amendment No. 1) for the fiscal year ended December 31, 2007 filed on May 1, 2008).
3.7Form of Certificate of Designation of Series G Redeemable Exchangeable Preferred Stock (incorporated by reference from Exhibit 3.7 to our Annual Report on Form 10-KSB/A (Amendment No. 1) for the fiscal year ended December 31, 2007 filed on May 1, 2008).
3.8Amendment to Articles of Incorporation (incorporated by reference from Exhibit A to our Preliminary Information Statement filed on June 19, 2008 and revised and re-filed on July 21, 2008).
3.9Amended and Restated Bylaws (incorporated by reference from Exhibit B to our Preliminary Information Statement filed on June 19, 2008 and revised and re-filed on July 21, 2008).
4.1Common Stock Purchase Warrant (No. 4) dated June 5, 2008 (incorporated by reference from Exhibit 4.1 to our Form 8-K/A filed on June 9, 2008).
4.2Stock Option, Stock Warrant and Stock Award Plan (incorporated by reference from Exhibit 4.10 to our Registration Statement on Form S-1, filed on July 21, 2008).
10.1Confidential Private Placement Memorandum dated May 16, 2008 (incorporated by reference from Exhibit 20.1 to our Form 8-K/A filed on June 9, 2008).
10.2Supplement No.1 to Confidential Private Placement Memorandum dated June 2, 2008 (incorporated by reference from Exhibit 4.6 to our Registration Statement on Form S-1, filed on July 21, 2008).
10.3PurchaseCredit Agreement, dated as of June 2, 2008 (incorporated by reference from Exhibit 10.1 to our Form 8-K/A filed on June 9, 2008).
10.4Dahlman Rose Underwriting Agreement dated May 6, 2008
10.5Stock Purchase Agreement dated April 17, 2008, among Deep down, Inc., Flotation Technologies, Inc. and the selling stockholders named therein (incorporated by reference  to our Report on Form 8-K, filed with the Commission on April 21, 2008)
10.6 †Employment Agreement with David A. Capotosto (incorporated by reference from Exhibit 4.10 to our Registration Statement on Form S-1, filed on July 21, 2008).
10.7 †Employment Agreement with Bradley M. Parro (incorporated by reference from Exhibit 4.10 to our Registration Statement on Form S-1, filed on July 21, 2008).
10.8*Amended Lease Agreement dated May 1,November 11, 2008, between Deep Down, Inc., a Delaware corporation, as tenant,borrower, and JUMA, L.L.C. December 31, 2007 filed on March 31, 2008).Whitney National Bank, as lender
31.1†10.2*Guaranty, dated as of November 11, 2008, by Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, and Deep Down, Inc. for the benefit of Whitney National Bank
10.3*Security Agreement, dated as of November 11, 2008, among Deep Down, Inc., Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, and Deep Down, Inc. for the benefit of Whitney National Bank
31.1*Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934.
31.2†31.2*Certification of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934.
32.1†32.1*Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc.
32.2†32.2*Section 1350 Certification of the Chief Financial Officer of Deep Down Down, Inc.

* Filed or furnished herewith
† Exhibit constitutes a management contract or compensatory plan or arrangement
 
 
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