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

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2008March 31, 2009
 
OR
¨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,
8827 W. Sam Houston Pkwy N., Suite 100,
Houston, Texas
 7753077040
(Address of Principal Executive Office) (Zip Code)
 
Registrant’s telephone number, including area code: (281) 862-2201517-5000

 
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  ¨ x
 
   
Non-accelerated filer ¨ (Do not check if 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 November 14, 2008,May 8, 2009, there were 177,350,630179,700,630 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., a Nevada corporation, 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”), since its acquisition effective April 2, 2007, Mako Technologies, LLC, a Nevada limited liability company (“Mako”), andsince its acquisition effective December 1, 2007, Flotation Technologies, Inc., a Maine corporation (“Flotation”)., since its acquisition effective May 1, 2008 and Deep Down International Holdings, LLC since its formation in February 2009.

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 November 14, 2008,May 11, 2009, 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 November 14, 2008May 11, 2009 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 20072008 Annual Report on Form 10-KSB/A (Amendment No. 4),10-K, other periodic and current reports we file with the Securities and Exchange Commission (“SEC”) or this Quarterly Report on Form 10-Q.

Access to Filings

Access to our Annual Reports on Form 10-KSB,10-K, Quarterly Reports on FormsForm 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.deepdowncorp.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 or furnished such material with the SEC. The contents of our website are not, and shall not be deemed to be, incorporated into this report.Report.


ii

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
 
 
  Page No.
   
Item 1.Financial Statements 
 Unaudited Consolidated Balance Sheets - September 30, 2008March 31, 2009 and December 31, 200720081
 Unaudited Consolidated Statements of Operations - For the Three Months Ended March 31, 2009 and Nine months Ended September 30, 2008 and 20072
Unaudited Consolidated Statements of Stockholders’ Equity - For the Nine months Ended September 30, 20083
 Unaudited Consolidated Statements of Cash Flows - For the Nine monthsThree Months Ended September 30,March 31, 2009 and 2008 and 200743
 Notes to Unaudited Consolidated Financial Statements64
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations2114
Item 3.Quantitative and Qualitative and QuantitativeDisclosures About Market Risks Risk2818
Item 4T.4.Controls and Procedures2819
  
PART II OTHER INFORMATION
  
Item 1.Legal Proceedings2920
Item 1A.Risk Factors2920
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds2927
Item 3.Defaults Upon Senior Securities2927
Item 4.Submission of Matters to a Vote of Security Holders2927
Item 5.Other Information3027
Item 6.Exhibits3128
   
Signatures 3128
Exhibit Index32
29


 
iii
 
PART I. FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

DEEP DOWN, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)


  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. 
  March 31, 2009  December 31, 2008 
ASSETS      
Cash and cash equivalents $6,260,939  $2,495,464 
Restricted cash  135,855   135,855 
Accounts receivable, net  6,422,509   10,772,097 
Prepaid expenses and other current assets  663,342   633,868 
Inventory  993,545   1,224,170 
Costs and estimated earnings in excess of billings on uncompleted contracts  165,454   707,737 
Work in progress  78,007   137,940 
Deferred tax asset  1,683,806   216,900 
Total current assets  16,403,457   16,324,031 
Property and equipment, net  14,806,223   13,799,196 
Other assets, net (see Related Party Note 10)  928,453   457,836 
Intangibles, net  17,763,529   18,090,680 
Goodwill  15,024,300   15,024,300 
Total assets $64,925,962  $63,696,043 
         
LIABILITIES AND STOCKHOLDERS' EQUITY        
Accounts payable and accrued liabilities $3,522,510  $4,318,394 
Billings in excess of costs and estimated earnings on uncompleted contracts  2,128,356   2,315,043 
Current portion of long-term debt  471,015   382,912 
Total current liabilities  6,121,881   7,016,349 
Long-term debt  3,358,435   1,718,475 
Deferred tax liabilities  2,310,728   1,125,945 
Total liabilities  11,791,044   9,860,769 
         
Stockholders' equity:        
Common stock, $0.001 par value, 490,000,000 shares authorized, 179,700,630        
  and 177,350,630 shares issued and outstanding, respectively  179,701   177,351 
Additional paid-in capital  60,355,193   60,328,124 
Accumulated deficit  (7,399,976)  (6,670,201)
Total stockholders' equity  53,134,918   53,835,274 
Total liabilities and stockholders' equity $64,925,962  $63,696,043 

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. 
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYOPERATIONS
(Unaudited)

  For the Three Months Ended 
  March 31, 
  2009  2008 
Revenues $7,102,589  $6,279,465 
Cost of sales  4,798,788   3,931,555 
Gross profit  2,303,801   2,347,910 
Operating expenses:        
Selling, general & administrative  2,843,776   1,879,409 
Depreciation and amortization  406,097   125,803 
Total operating expenses  3,249,873   2,005,212 
Operating income (loss)  (946,072)  342,698 
Other income (expense):        
Interest income  2,228   39,164 
Interest expense  (48,344)  (769,030)
Other (expense) income  (2,910)  28,355 
Total other expense  (49,026)  (701,511)
Loss before income taxes  (995,098)  (358,813)
Benefit from income taxes  265,323   269,366 
Net loss $(729,775) $(89,447)
         
Loss per share:        
Basic $-  $- 
Weighted-average common shares outstanding  176,150,630   87,185,242 
         
Diluted $-  $- 
Weighted-average common shares outstanding  176,150,630   87,185,242 
         

See accompanying notes to unaudited consolidated financial statements.

DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

  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.
 
  Three Months Ended 
  March 31, 
  2009  2008 
Cash flows from operating activities:      
       
Net loss $(729,775) $(89,447)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:        
Non-cash amortization of debt discount  -   231,760 
Non-cash amortization of deferred financing costs  -   56,915 
Share-based compensation  29,419   105,162 
Bad debt expense  60,000   3,949 
Depreciation and amortization  751,276   298,150 
Loss on disposal of equipment  (3,038)  58,115 
Deferred taxes payable  (282,123)  - 
Changes in assets and liabilities:        
Accounts receivable  4,289,588   (282,869)
Prepaid expenses and other current assets  (30,091)  (107,239)
Inventory  230,625   - 
Costs and estimated earnings in excess of billings on uncompleted contracts  542,283   - 
Work in progress  59,933   (161,279)
Accounts payable and accrued liabilities  (795,884)  (603,631)
Billings in excess of costs and estimated earnings on uncompleted contracts  (186,687)  (53,030)
Net cash provided by (used in) operating activities $3,935,526  $(543,444)
Cash flows used in investing activities:        
Cash paid for acquisition of Mako, net of expenses  -   (2,979,192)
Purchases of equipment  (1,428,114)  (156,958)
Deposits, related party  (470,000)  - 
Restricted cash  -   (187,500)
Net cash used in investing activities $(1,898,114) $(3,323,650)
Cash flows from financing activities:        
Proceeds from sales-type lease  -   103,500 
Borrowings on long-term debt  1,840,000   5,600,000 
Payments of long-term debt  (111,937)  (926,808)
Net cash provided by financing activities $1,728,063  $4,776,692 
Change in cash and equivalents  3,765,475   909,598 
Cash and cash equivalents, beginning of period  2,495,464   2,206,220 
Cash and cash equivalents, end of period $6,260,939  $3,115,818 
         
         
Supplemental schedule of noncash investing and financing activities:
        
Stock issued for acquisition of Mako $-  $1,962,078 
Exchange of Series D preferred stock $-  $4,419,244 
Exchange of Series E preferred stock for subordinated debenture $-  $500,000 
Restricted stock issued for service $2,350  $1,200 
Supplemental Disclosures:        
     Cash paid for interest $55,741  $480,356 
     Cash paid for taxes $198,889  $275,000 
         

See accompanying notes to unaudited consolidated financial statements.
 
DEEP DOWN, INC.
  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. 
  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. 

DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTENote 1: GENERALGeneral

Nature of Business

Deep Down, Inc., a Nevada corporation (“Deep Down”), 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, a Nevada limited liability company (“Mako”), since its acquisition effective December 1, 2007, and Flotation Technologies, Inc., a Maine corporation (“Flotation”), since its acquisition effective May 1, 2008.2008 and Deep Down International Holdings, LLC since its formation in February 2009.
 
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 FlotecTMsyntactic 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 810 of Regulation S-X relating to smaller reporting companies.S-X. 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 or nine-month periodsperiod ended September 30, 2008March 31, 2009 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008.2009.  The balance sheet at December 31, 20072008 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. 4)10-K for the year ended December 31, 20072008 filed on September 30, 2008.March 16, 2009.

Reclassifications

Prior period information presented in these financial statements includes reclassifications which were made to conform to the current period presentation.  These reclassifications had no effect on our previously reported net income (loss) or stockholders' equity. For example, Deep Down reclassified its account previously referred to as Work in Process to its Costs incurred in excessa portion 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 oftotal depreciation expense, $172,346, into Cost of sales from SG&AOperating expenses for the nine-month periodthree months ended September 30,March 31, 2008. As such, $202,706 was reclassifiedThe remainder of depreciation expense for the corresponding nine-months ended September 30, 2007 outthree month period is reported in the Operating expenses section of SG&A to Costthe Statements of sales.Operations.

Principles of Consolidation

The unaudited consolidated financial statements include the accounts of Deep Down’sDown and its wholly-owned subsidiaries after the elimination of significant intercompany balances and transactions.
 

NOTE 2: ACCOUNTS RECEIVABLE
Accounts Receivable

Accounts receivable includesDeep Down provides an allowance for uncollectibledoubtful accounts on trade receivables based on historical collection experience, the level of $345,649past due accounts and $139,787a specific review of each customer’s trade receivable balance with respect to their ability to make payments and expectations of future conditions that could impact the collectability of accounts receivable.  When specific accounts are determined to be uncollectable, they are expensed as of September 30, 2008bad debt expense in that period. At March 31, 2009 and December 31, 2007,2008, Deep Down estimated its allowance for doubtful accounts to be $264,149 and $574,975, respectively. Bad debt expense totaled $1,052,668$60,000 and $16,305$3,949 for the ninethree months ended September 30,March 31, 2009 and 2008, respectively.

Recently Issued Accounting Standards and Developments.

In June 2008, EITF 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” was issued. This standard triggers liability accounting on all options and warrants exercisable at strike prices denominated in any currency other than the Company’s functional currency or warrants with certain reset provisions to the strike price because of a “down-round” financing. This Issue is effective for financial statements issued for fiscal years beginning after December 15, 2008, and 2007, respectively. interim periods within those fiscal years. Early application is not permitted. We adopted EITF 07-5 on January 1, 2009 and analyzed all of the outstanding warrants and none contained down-round reset exercise price provisions which would have precluded equity treatment.  Therefore, the adoption did not have a material impact on our financial position, results of operations or cash flows.

FASB Staff Position FSP No. 141(R)-1 Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, (“FSP 141(R)-1”), issued in February 2009, amends the provisions in Statement 141(R) for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. The FSP eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria in Statement 141(R) and instead carries forward most of the provisions in SFAS 141 for acquired contingencies. FSP 141(R)-1 is effective for contingent assets and contingent liabilities acquired in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Deep Down will integrate the provisions of this FSP as appropriate to future business combinations.

NOTE 3: COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTSNote 2: 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 StatementThe components 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 are summarized below:
  March 31, 2009  December 31, 2008 
Costs incurred on uncompleted contracts $1,032,120  $2,114,714 
Estimated earnings  757,837   4,969,444 
   1,789,957   7,084,158 
Less: Billings to date  3,752,859   8,691,464 
  $(1,962,902) $(1,607,306)
         
Included in the accompanying consolidated balance sheets under the following captions:     
Costs and estimated earnings in excess of billings on uncompleted contracts  165,454   707,737 
Billings in excess of costs and estimated earnings on uncompleted contracts  (2,128,356)  (2,315,043)
  $(1,962,902) $(1,607,306)
The asset balance of $165,454 at March 31, 2009 relates to several contracts that are projected to be completed during fiscal 2009. Deep Down has completed several of the included jobs subsequent to March 31, 2009, while other jobs are more long term in nature.
5

The asset balance of $707,737 at December 31, 2008 was related to a large contract that was completed during December 2008 except for the final documentation. This retention amount is in accordance with applicable provisions of engineering and construction contracts and became due upon completion of contractual requirements in January 2009. Deep Down had recognized approximately 90% of the related revenue based on the percentage-of-completion method as well asof December 31, 2008 and recognized the remainder in the first quarter of fiscal 2009.

The billings in excess of costs and estimated earnings on uncompleted contracts haveof $2,128,356 and $2,315,043 at March 31, 2009 and December 31, 2008, respectively, consisted mainly of a deposit on a large job that will be completed in fiscal year 2009.

Note 3: Acquisition

Purchase of Flotation Technologies, Inc.

On June 5, 2008, Deep Down completed the acquisition of Flotation, pursuant to the Stock Purchase Agreement entered into on April 17, 2008. Deep Down assumed effective control and dated the acquisition for accounting purposes on May 1, 2008. As such, the consolidated statement of operations includes the operating results of Flotation from May 1, 2008.

The acquisition of Flotation has been classifiedaccounted 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 Flotation.

The purchase price of Flotation was $23,941,554 and consisted of $22,100,000 cash and 1,714,286 shares of common stock valued at $0.83 per common share plus transaction costs of $296,904. In addition, warrants to purchase 200,000 shares of common stock at $0.70 per share were issued to an entity affiliated with the Selling Shareholders for the acquisition of the related technology. The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock. Deep Down valued the warrants at $121,793 based on the Black-Scholes option pricing model. The purchase price may be adjusted upward or downward, dependant on certain working capital targets. Both parties are in preliminary negotiations concerning this adjustment and as current.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 $37,100,000 in net proceeds, at a price of $0.70 per share. Deep Down used $22,100,000 in proceeds from this Private Placement to fund the cash requirement of the Flotation acquisition.

Deep Down also issued 600,000 incentive common stock purchase options to employees of Flotation for their continued services with an exercise price of $1.15 per share. The contract cycle for certain long-term contractsemployee options vest one-third of the original amount each year and may extend beyondbe exercised in whole or in part after vesting. Deep Down valued the options at $264,335 based on the Black-Scholes option pricing model, and will recognize the related compensation cost ratably over the requisite service period and not in the purchase price of the transaction.

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

Unaudited pro-forma combined condensed financial statements
 
The unaudited pro-forma combined condensed financial statements are presented for informational purposes only and are not necessarily indicative of the results of operations that actually would have been achieved had each acquisition been consummated as of that time, nor are they intended to be a projection of future results.
6
The unaudited combined condensed pro-forma results were as follows:
Unaudited Pro Forma Combined Condensed Statements of Operations
For the Three Months ended March 31, 2008

  Historical       
           Combined 
        Flotation  Condensed 
        Pro Forma  Pro Forma 
  Deep Down  Flotation  Entries  Results 
             
             
Revenues $6,279,465  $4,877,108  $-  $11,156,573 
Cost of sales  3,931,555   3,377,955   -   7,309,510 
Gross profit  2,347,910   1,499,153   -   3,847,063 
Total operating expenses  2,005,212   662,959   226,812  (a/b) 2,894,983 
Operating income (loss)  342,698   836,194   (226,812)  952,080 
                 
Total other expense  (701,511)  (34,868)  -   (736,379)
Income (loss) from                
continuing operations  (358,813)  801,326   (226,812)  215,701 
                 
Benefit from (provision for) income taxes  269,366   -   (212,570) (c) 56,796 
Net income (loss) $(89,447) $801,326  $(439,382) $272,497 
                 
Basic earnings (loss) per share $-          $- 
Weighted-average common shares outstanding  87,185,242          (d) 148,814,558 
                 
Diluted earnings (loss) per share $-          $- 
Weighted-average common shares outstanding  87,185,242          (d) 159,644,348 

See accompanying notes to unaudited pro forma combined condensed financial statements.

The historical results of Deep Down for the three months ended March 31, 2009 contain the results for Flotation operations since its acquisition was effective May 1, 2008, thus the three months ending March 31, 2008 are presented as pro-forma. The weighted-average shares of stock used in computing basic and diluted per share amounts give effect to the 2,802,969 Mako shares issued on March 28, 2008 and the total of 58,857,143 common shares of Deep Down issued in June 2008, of which such amount 57,142,857 were issued in connection with the Private Placement and 1,714,286 were issued to Flotation’s prior shareholders, as if all these shares were issued January 1, 2008. Taxes are calculated on the pro-forma entries at Deep Down’s estimated combined effective rate of 37%.
The Unaudited Pro-Forma Combined Condensed Statements include the following pro-forma assumptions and entries for Flotation:
(a)  Recognition of stock-based compensation from employee stock options issued in connection with the acquisition of Flotation. Deep Down estimated $7,343 per month for the respective time periods.
(b)  Amortization of the intangible assets at a rate of $68,261 per month based on the remaining useful lives of the acquired assets.
(c)  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.
(d)  A total of 58,857,143 common shares of Deep Down were issued connected to Flotation and Private Placement; 57,142,857 in connection with the Private Placement, and 1,714,286 to former Flotation shareholders. These pro-forma amounts give effect as if shares were issued January 1, 2008. Additionally, 2,802,969 shares were issued to the Mako shareholders in connection with the final payment for that acquisition.
 


NOTENote 4: PROPERTY AND EQUIPMENTProperty and Equipment

Property and equipment includeconsisted of the following:
  March 31, 2009  December 31, 2008  Useful Life 
Land $461,955  $461,955  - 
Building  3,204,836   3,201,301  7 - 36 years 
Leasehold improvements  428,691   344,485  2 - 5 years 
Furniture and fixtures  372,697   160,443  2 - 7 years 
Vehicles and trailers  127,107   120,847  3 - 5 years 
Equipment  3,955,561   3,897,475  2 - 10 years 
Rental Equipment  4,892,232   4,694,681  7 - 10 years 
Computer and office equipment  536,981   473,518  2 - 5 years 
Construction in progress  2,935,282   2,130,068     
  Total  16,915,342   15,484,773     
  Less: Accumulated depreciation  (2,109,119)  (1,685,577)    
Property and equipment, net $14,806,223  $13,799,196     
Depreciation expense for the ninethree months ended September 30,March 31, 2009 and 2008 was $424,125 and 2007 was $920,056 and $247,503,$213,090, respectively.  For the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, Deep Down recorded $758,728$345,179 and $202,706,$172,346, respectively, of the total depreciation as Cost of Sales on the accompanying statements of operations.
During the nine months ended September 30, 2008, we leased additional property from JUMA, LLC, a related party, and incurred $342,430 in leasehold improvements. See additional discussion in Note 12 regarding the nature of the related party.
In connection with the purchase of Flotation, Deep Down acquired land along with a building and improvements with a fair market value of approximately $3,300,000. This 3.61 acre site in Maine houses a 46,925 square foot light industrial manufacturing facility.
On June 30, 2008, Deep Down transferred equipment with a cost basis of $502,253 from inventory to its rental equipment fleet.

 NOTE 5: ACQUISITIONS

Purchase of Mako Technologies, Inc.

Effective December 1, 2007, Deep Down purchased 100% 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 acquisition of Mako was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) 141, “Business Combinations” (“SFAS 141”) since Deep Down acquired substantially all of the assets, certain liabilities, employees, and business of Mako.

Purchase of Flotation Technologies, Inc.

On June 5, 2008, Deep Down completed the acquisition of Flotation, pursuant to the Stock Purchase Agreement entered into on April 17, 2008. Deep Down purchased Flotation from three individual shareholder members of the same family and purchased related technology from an entity affiliated with the selling shareholders. Deep Down effectively dated the acquisition for accounting purposes as of May 1, 2008. Deep Down consummated the closing on June 6, 2008.

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

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

Deep Down sold 57,142,857 shares to accredited investors on June 5, 2008, for approximately $37,059,670 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  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 $23,941,554 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:
Deep Down obtained an independent valuation of the assets and liabilities as of the purchase date of May 1, 2008. Based on the independent valuation, the fair value of the property, plant and equipment was increased by approximately $1,258,000 and will be depreciated over the estimated useful lives of 3 to 40 years using the straight-line method.
Deep Down has estimated the fair value of Flotation’s identifiable intangible assets as follows:
   Estimated  Average Remaining 
   Fair Value  Useful Life 
  Trademarks $2,039,000   40 
  Technology  11,209,000   25
 
  Non-compete covenant  879,000     3
 
  Customer relationship  670,000   25 
   $14,797,000     
The 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.


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. 
The historical results of Deep Down for the nine months ended September 30, 2008 contain five 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, of which such amount 57,142,857 were issued in connection with the Private Placement and 1,714,286 were issued to Flotation’s prior shareholders, as if all these shares were issued January 1, 2008. Taxes are calculated on the pro forma entries at Deep Down’s estimated combined effective rate of 37%.

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. 
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 was payable at 15.5% on the outstanding principal, and the related fees were 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.

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

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

NOTE 6: INTANGIBLE ASSETS AND GOODWILLNote 5: 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 process of finalizing the valuations of certain intangible assets related to the Mako and Flotation acquisitions;acquisition; consequently, the initial allocations of the respective purchase price amounts are preliminary and subject to change for a period of one year following the acquisitions, although management believes amounts are materially accurate as of September 30, 2008.March 31, 2009. Estimated intangible asset values, net of recognized amortization expense include the following:
   March 31, 2009  December 31, 2008 
 
Estimated
Useful Life
 
Gross Carrying
Value
  
Accumulated
Amortization
  
Net Carrying
Amount
  
Gross Carrying
Value
  
Accumulated
Amortization
  
Net Carrying
Amount
 
                    
Customer relationship8-25 Years $3,515,000  $(498,735) $3,016,265  $3,515,000  $(403,131) $3,111,869 
Non-Compete Covenant3-5 Years  1,334,000   (389,916)  944,084   1,334,000   (293,916)  1,040,084 
Trademarks25-40 Years  3,110,000   (103,847)  3,006,153   3,110,000   (80,393)  3,029,607 
Technology25 Years  11,209,000   (411,973)  10,797,027   11,209,000   (299,880)  10,909,120 
                          
Total  $19,168,000  $(1,404,471) $17,763,529  $19,168,000  $(1,077,320) $18,090,680 
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 
NOTE 7: LONG-TERM DEBTNote 6: 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 
  March 31, 2009  December 31, 2008 
       
Bank term loan $1,062,476  $1,150,000 
Secured bank loan  1,829,638   - 
Other bank loans  13,065   15,087 
Total bank debt  2,905,179   1,165,087 
6% Subordinated Debenture  500,000   500,000 
Capital lease obligation  424,271   436,300 
Total long-term debt  3,829,450   2,101,387 
Current portion of long-term debt  (471,015)  (382,912)
Long-term debt, net of current portion $3,358,435  $1,718,475 
Secured Credit Agreement
Revolving credit line and term loan

On August 6, 2007,November 11, 2008, Deep Down entered into a $6.5 million secured credit agreement,Credit Agreement (the “Credit Agreement”“Revolver”) with Prospect Capital CorporationWhitney National Bank (“Prospect”Whitney Bank”) and received an advance of $6.0 million on that date.as lender. The Credit Agreement provided forRevolver provides a 4-year term, an annual interest rate of 15.5%, with the abilitycommitment to defer uplend 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 paidof the full 15.5%lesser of $2,000,000 and did not exercise80% of eligible receivables (generally defined as current due accounts receivables in which the PIK featurelender has a first priority security interest).  All of the commitment under the Revolver is also available in commitments for the monthly periods through June 2008 whenlender to issue letters of credit for 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 sharesbenefit of Deep Down common stock. See Note 10 for additional discussion of the terms of these warrants.

Down. On December 21, 2007,18, 2008, Deep Down entered into an amendment to the Credit AgreementRevolver, (the “Amendment”“Term Loan”) to provide the fundingwith Whitney Bank which provides for the cashincurrence by Deep Down of a term loan in the principal amount of $1,150,000 under, and subject to the terms and conditions of, Deep Down’s secured credit agreement. Such Term Loan does not impact the availability under the Revolver.

Each of Deep Down’s subsidiaries has guaranteed the obligations of Deep Down under the Revolver and as such, Deep Down’s obligations in connection with the Revolver are secured by a first priority lien generally on all of their non real property assets. Under the Revolver, Deep Down is required to meet certain covenants and restrictions.  The financial covenants are reportable each quarter, beginning with the quarter ending March 31, 2009.  Financial covenants include maintaining total debt to consolidated EBITDA below 2.5 to 1, consolidated EBITDA to consolidated net interest expense and principal payments on the total debt greater than 1.5 to 1, and tangible net worth in excess of $20,000,000 as each term is defined in the Credit Agreement. Other covenants include limitations on issuance of common stock, liens, transactions with affiliates, additional indebtedness and permitted investments, among others.  Deep Down was in compliance with the financial covenants at March 31, 2009.

Amendment to credit agreement and new loan agreement

On March 5, 2009, Deep Down’s wholly-owned subsidiary, Flotation, obtained loan proceeds in the principal amount of $1,840,000 pursuant to a loan agreement Flotation and Deep Down entered into with TD Bank, N.A. (“TD Bank”) as of February 13, 2009.  This loan agreement provides a further commitment to Flotation for advancement of principal in the amount of $320,000. Loans under the loan agreement are generally secured by Flotation’s operational premises in Biddeford, Maine under a mortgage and security agreement and a collateral assignment of leases and rents.  In connection with the loan agreement, TD Bank required that Deep Down enter into a debt subordination agreement that subordinated any debt Flotation owes to Deep Down other than accounts payable between them arising in the ordinary course of business.  Furthermore, as part of the loan agreement, TD Bank required a “negative pledge” that prohibits Flotation and Deep Down from granting security interests in Flotation’s personal property, other than such security interests granted in respect of Deep Down’s primary facility for borrowed money (as currently held with Whitney Bank). Deep Down is obligated to repay proceeds funded on March 5, 2009 based on a schedule of monthly installments of $13,007, with an initial payment on March 13, 2009 and a final payment of all remaining outstanding and unpaid principal and accrued interest in February 2016.  However, upon advancement of any portion of the purchase of Mako. The total commitment$320,000 additional principal amount available under the Amendment was increased from $6.5 millionloan agreement, TD Bank will recalculate the monthly installments to $13.0 million. Amounts borrowedan amount that will fully amortize the then outstanding principal balance over a 20-year amortization schedule.

In connection with such loan for Flotation, Deep Down entered into a second amendment of its existing credit facility with Whitney Bank to permit such loan and the security and other arrangements relating to Flotation’s loan agreement.  The terms of the second amendment also included a guarantor’s consent and agreement, to be signed by each of Deep Down’s subsidiaries as guarantors of the obligations of Deep Down under such existing credit facility, that Whitney Bank required as a condition to the effectiveness of the second amendment. Additionally, Whitney Bank required that Deep Down International Holdings, LLC, a Nevada limited liability company and wholly-owned subsidiary of Deep Down formed in February 2009, enter into joinder agreements for the guaranty and security agreement arrangements generally required of Deep Down’s subsidiaries under the existing credit facility. Deep Down International Holdings, LLC currently has no material assets or operations.

Interest expense during the three months ended March 31, 2008

During the three months ended March 31, 2008, Deep Down amortized the discounts and deferred financing costs associated with the fair market value of warrants and the cash-based expenses related to third party fees and prepaid lender fees into interest expense over the life of a Credit Agreement using the effective interest rate method.  The discounts and deferred financing costs were $6.0 million.  Quarterly principal payments increased to $250,000 beginning September 30,associated with a secured credit agreement entered into in August 2007 and December 2007.  A total of $118,171 of debt discount and $56,915 of deferred financing costs were amortized into interest expense for the three months ended March 31, 2008.  Cash interest paid for the three and nine months ended September 30,March 31, 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. 
 In connection with the second advance$459,833 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 thestated terms of the purchase of Mako, Deep Down paid $916,044 of notes payable plus accrued interest of $2,664.note.

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

OnAt March 31, 2008, upon the exchange of 500 shares of the Series E Redeemable Exchangeable Preferred Stock (“Series E”) were exchanged into a 6% Subordinated Debenture (the “Debenture”)subordinated debenture in an outstanding principalthe 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,$500,000, Deep Down recorded $113,589 in interest expense for the accretion of the Series E Preferred Stock 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

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 shares of common stock.  The Series D had a face value and liquidation preference of $1,000 per share, no dividend preference, and were convertible into shares of common stock determined by dividing the face amount by a conversion price of $0.1933.  The Series D had been valued at inception at $4,419,244 based on the Black-Scholes fair value of the Series D.

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

On March 31, 2008, 500 shares of the Series E preferred stock were exchanged into a 6% Subordinated Debenture in an outstanding principal amount of $500,000.  The Series E had a face value and liquidation preference of $1,000 per share, no dividend preference, and were exchangeable at the holder’s option into a 6% debenture due three years from the date of the exchange. See additional discussion of the Subordinated Debenture in Note 7.

NOTE 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 of $37,059,670. Dahlman Rose & Company, LLC acted as exclusive placement agent for the equity financing.

Deep Down used $22,100,000 of the net proceeds to fund the cash portion of the Flotation purchase, and used $12,492,912 to repay outstanding debt, along with early termination fees, to Prospect on June 12, 2008. Deep Down retained the remaining net proceeds for working capital purposes.
In connection with the Private Placement, Deep Down entered into a registration rights agreement where the holder has certain demand registration rights. Deep Down filed an S-1 Registration Statement on July 21, 2008. Deep Down was obligated to have the Registration Statement declared effective by September 3, 2008 (the “Required Effective Date”), or the Company would be required to pay 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. Deep Down has 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 meet the definition of a liability under the authoritative guidance and has reserved $359,640 in potential damages under terms of the Private Placement for the period September 4 to September 30, 2008.

NOTE 10: STOCK-BASED COMPENSATION AND WARRANTS7: Stock-Based Compensation

Deep Down has a stock-based compensation plan - the 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). We accountDeep Down accounts for stock-based compensation expense under SFAS No. 123 (Revised 2004), “Share-based“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 ninethree months ended September 30, 2008,March 31, 2009, Deep Down granted 4,200,0004,450,000 options and 1,200,0002,350,000 shares of restricted stock, and cancelled 875,000 options subject to forfeitures under the Plan.stock. Based on the shares of common stock outstanding at September 30, 2008,March 31, 2009, there were approximately 16,628,00010,990,000 options available for grant under the Plan as of that date.

Restricted Stock

On February 14, 2008,March 23, 2009, Deep Down issued an aggregate of 1,200,000granted 2,350,000 restricted shares of restricted common stock to Ronald E. Smith, CEO, Robert E. Chamberlain, Chairman,executives and Eugene L. Butler, CFO, under terms of the Plan.employees which vest on March 23, 2011, provided such respective recipient remains employed with Deep Down on such date. The shares were valued at a price of $0.42$0.124 based on the closing price of common stock on that date.the preceding business day, March 20, 2009. The shares vest on the second anniversary of the grant date, and Deep Down is amortizing the related stock-based compensation of $504,000$291,400 over the 2 yeartwo-year requisite service period. For the ninethree months ended September 30,March 31, 2009 and 2008, Deep Down recognized a total of $157,500$66,525 and $31,500, respectively, in stock-based compensation related to these issuedall outstanding shares of restricted stock. Thestock; the unamortized portion of the estimated fair value of restricted stock is $346,500$508,375 at September 30, 2008.March 31, 2009.

The following table summarizes Deep Down’s restricted stock activity for the ninethree months ended September 30, 2008:March 31, 2009:
 

Stock Option Activity During 20082009

During the nine months ended September 30, 2008, Deep Down granted 4,200,000 options under the Plan as detailed 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 stock issued in accordance with terms of the Plan.

During the nine months ended September 30, 2008,March 31, 2009, Deep Down granted an aggregate of 350,0004,450,000 stock options to various employees with exercise prices between $0.71 and $0.88,of $0.124, reflecting the respectivecommon stock closing price on the applicablebusiness date ofbefore the grant. The fair value of such options was approximately $114,737$395,160 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 ofmodel, using 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.following input values:
 
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.
Dividend yield0%
Risk free interest rate1.69%
Expected life of options3 years
Expected volatility88.50%

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

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

Summary of Stock Options

Deep Down is expensing all stock options on a straight linestraight-line basis over the requisite expected service periods. The total stock-based compensation expense for stock options for the ninethree months ended September 30,March 31, 2009 and 2008 was $79,140 and September 30, 2007, was $286,333$73,662, respectively.  Additionally, during the three months ended March 31, 2009, Deep Down revised the estimated rate of forfeitures to 30% from 0% based on the history of stock option cancellations and $113,480, respectively.management’s estimates of expected future forfeiture rates. This change in estimate resulted in a cumulative reduction of $116,246 during the three months ending March 31, 2009. The unamortized portion of the estimated fair value of outstanding stock options is $842,722was $1,151,177 at September 30, 2008.March 31, 2009.

The following table summarizes Deep Down’s stock option activity for the ninethree months ended September 30, 2008:March 31, 2009:
 
  
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 
  Shares Underlying Options  Weighted- Average Exercise Price  
Weighted- Average Remaining Contractual Term
(in years)
  
Aggregate Intrinsic Value
(In-The-Money)
 
Outstanding at December 31, 2008  8,066,667  $0.96   2.3  $- 
Grants  4,450,000   0.12         
Exercises  -   -         
Cancellations & Forfeitures  (116,667)  0.50         
Outstanding at March 31, 2009  12,400,000  $0.66   2.7  $160,200 
Exerciseable at March 31, 2009  2,666,666  $0.93   2.4  $- 

The following summarizes Deep Down’s outstanding options and their respective exercise prices at September 30, 2008:March 31, 2009:
 
Exercise
Price
Shares
Underlying
Options
 $   0.300.10 - 0.49175,000      4,550,000
 $   0.50 - 0.694,125,000      3,600,000
 $   0.70 - 0.99525,000         450,000
 $   1.00 - 1.29950,000         800,000
 $   1.30 - 1.503,000,000
      12,400,0008,775,000
The fair value of each stock option grant is estimated on the date of the grant using the Black-Scholes model and is based on the following key assumptions for the 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%

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 to an entity affiliated with the selling shareholders 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 7, Deep Down issued 4,960,585 detachable warrants. Deep Down issued all of such warrants with an exercise price of $0.507, for terms of five years, with vesting occurring on the earlier of the second anniversary of the agreement or upon payment in full of the debt. On July 3, 2008, the holder of these warrants exercised all of them for a total of 2,618,129 shares of Deep Down’s common stock in a cashless exercise.8: Warrants

A summary of warrant transactions follows:follows. The aggregate intrinsic value is based on the closing price of $0.16 on March 31, 2009.
 
  
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  $- 
  Shares Underlying Warrants  Weighted- Average Exercise Price  Weighted- Average Remaining Contractual Term (in years)  Aggregate Intrinsic Value (In-The-Money) 
Outstanding at December 31, 2008  638,812  $0.78       
Outstanding at March 31, 2009  638,812  $0.78   3.8  $- 
Exerciseable at March 31, 2009  438,812  $0.82   3.8  $- 

The following summarizes Deep Down’s outstanding warrants and their respective exercise prices at September 30, 2008:March 31, 2009:
 
Exercise
Price
 Shares Underlying Warrants
 $   0.70 - 0.99 520,000
 $             1.01 118,812
  638,812
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 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%

Exercise Price Shares Underlying Warrants 
 $   0.70 - 0.99          520,000 
 $              1.01          118,812 
           638,812 
18

NOTE 11: COMMITMENTS AND CONTINGENCIES

Note 9: Commitments and Contingencies

Litigation and Disputes

Deep Down is from time to time involved in other legal proceedings arising infrom the normal course of business. As of the date of this Quarterly Report on Form 10-Q, there are no other pending or threatenedreport, Deep Down is not currently involved in any material legal proceedings.proceedings except as noted below.

Registration RightsAt March 31, 2009, Deep Down was in the arbitration process with the former stockholders of Flotation Technologies, Inc. regarding the proper calculation of the “Cash Price Adjustment” pursuant to the Stock Purchase Agreement Penaltiesby and between Deep Down, Flotation Technologies, Inc. and its former stockholders dated April 17, 2008. Any purchase price adjustment will be allocated to the goodwill balance once the preliminary estimates are finalized.  No changes to this potential contingency existed at May 11, 2009.

In connection with the Private Placement in June 2008, Deep Down filed an initial Registration Statement on ScheduleForm S-1 on July 21, 2008 to register the 57,142,857 shares issued. Terms ofissued in the Private Placement state that ifoffering. Pursuant to the Registration Rights Agreement, Deep Down was obligated to have the Registration Statement is not declared effective by September 3, 2008, (thethe “Required Effective Date”), thenor the Company would be required to pay liquidated damages to the Selling Shareholders 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,evaluated this obligation under the Registration Rights Agreement for each such day, pay each Purchaser with respect to any such failure, as liquidated damages, an amount equal to 0.0333%liability treatment under FASB Statement No. 5, “Accounting for Contingencies” (“SFAS 5”) and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights met the definition of a liability under the purchase price paid by such Purchaser for the shares purchased pursuant to the Purchase Agreement, or $13,320 per day.  Deep Down hasauthoritative guidance, and at December 31, 2008  reserved $359,640$1,212,120 in potential damages under terms of the Private Placement for the 90-day period from September 4 to September 30, 2008,December 3, 2008. Deep Down obtained an opinion from legal counsel allowing removal of the related stock’s restrictive legend under Rule 144, which was deemed to be equivalent, and will continue to accrue such liability untilthus satisfied the registration rights requirements.
The SEC declared the Registration Statement for such shares is declared effective.  Ason Form S-1 effective on April 16, 2009.  Pursuant to section 7.1 (c) of November 14, 2008, an additional $599,400 has accrued as the Registration StatementRights Agreement and based on opinion of counsel, as of March 31, 2009 Deep Down’s management has not yet been declared effective.adjusted the liquidated damages reserve to 47 days, or $626,040. Deep Down recorded the reduction during the three months ended March 31, 2009 and initiated payment to the Selling Shareholders subsequent to that date.

Operating Leases

Deep Down leases landcertain offices, facilities, equipment and vehicles under non-cancelable operating and capital leases expiring at various dates through 2016.

Letters of Credit

Certain customers require Deep Down to post a bank letter of credit (“LC”) guarantee. These LCs assure Deep Down’s creditors that they will perform under terms of the contract and with associated vendors and subcontractors. In the event of default, the creditor may demand payment from the bank under an operating leaseLC. There was no significant expense related to LCs for the three months ended March 31, 2009. Deep Down was contingently liable for secured and unsecured LCs of $135,855 as of March 31, 2009, which is responsible for related maintenance, insurance and property taxes.  On May 1,offset by restricted cash in the same amount.

In December 2008, Deep Down and JUMA, LLC, a related party, amended the original lease that begancredit agreement with Whitney Bank as more fully described in Note 6. The amended credit agreement provides for LCs. Deep Down executed an irrevocable transferrable standby LC with a customer for $1,107,456 in the normal course of September, 2006 to provide forbusiness during the additional acreage leased resulting in a $4,000 per month increase in rent.  See below for further discussion ofthree months ended March 31, 2009. This standby LC reduces the related party.borrowing capacity under the Whitney Bank Revolver.

NOTE 12:  RELATED PARTY TRANSACTIONSNote 10:  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 President and Corporate 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.

OnDuring the three months ended March 28, 2008,31, 2009, Deep Down redeemed 4,500 sharesexecuted a memorandum of Series D preferred stock owned by Ronald Smith and Mary Budrunas.  The Series D preferred shares were redeemedunderstanding to purchase these assets from JUMA for 23,279,876 sharesapproximately $2,600,000 which is expected to include an assumption of common stock.

Duringbank debt in the nineapproximate amount of $1,800,000. Deep Down received a third party appraisal of the property in the amount of $3,100,000. Deep Down made earnest-money deposit payments during the three months ended September 30, 2008, Deep Down granted an aggregate of 1,200,000 restricted shares of common stock and an aggregate of 3,000,000 stock optionsMarch 31, 2009 totaling $470,000 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. Deep Down also awardedwhich are included in recognition of their completion of the acquisition of Flotation and Private Placement of common stock, a performance bonus of $300,000 in the aggregate.

NOTE 13:  SUBSEQUENT EVENTS

New Corporate Revolver

On November 11, 2008, Deep 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 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 will generally bear interest at rates basedOther Assets on the British Bankers Association LIBOR Rate for dollar deposits with a termaccompanying balance sheets as 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.March 31, 2009.

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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 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. 4)10-K for the fiscal year ended December 31, 20072008 filed with the SEC on September 30, 2008March 16, 2009 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,Deep Down, Inc., (“Deep Down” or “the Company”) (OTCBB: DPDW), a publicly traded Nevada corporation, originated on December 14, 2006, through a reverse merger with MediQuip Holdings, Inc. (“MediQuip”), divested Westmeria Healthcare Limited, its wholly-owned subsidiary representing substantially all of its preceding operations, and subsequently acquireda publicly traded Nevada corporation.  Deep Down, Inc., the operating company, was originally a Delaware corporation founded in 1997, but had been acquired in a reverse merger transaction with Deep Down as the surviving entity for accounting purposes.  MediQuip was renamed Deep Down in connection with such transaction. Due to the structureseries of such Decembertransactions on November 21, 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,by Subsea Acquisition Corporation (“Subsea”),.

On June 29, 2006, Subsea, a Texas corporation, was formed forby three shareholders with the purpose of acquiring service providersintent to theacquire 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.

service providers. On November 21, 2006, Subsea acquired all the outstanding capitalcommon stock of Strategic Offshore Services Corporation (“SOS”), a Texas corporation, for 3,000 shares of Subsea’s Series F Preferred Stockpreferred stock and 1,000 shares of Subsea’s Series G Preferred Stockpreferred stock from two of the three principalcommon shareholders (who were also shareholders of Subsea.Subsea).  Since both Subsea and SOSthe entities were then under common control, and the operations of SOS did not constitute a business, the Company recognizedwas charged compensation expense to such principal shareholders for the fair value of both series of preferred stock totaling $3,340,792.$3.3 million.

On the same day as its acquisition of SOS,Additionally, on November 21, 2006, Subsea also acquired Deep Down, Inc., (“Deep Down Delaware”) a Delaware corporation founded in 1997. Under the terms of this transaction, Subsea acquired all of Deep Down’s outstanding capitalDown Delaware’s shareholders transferred ownership of all of Deep Down Delaware’s common stock to Subsea in exchange for 5,000 shares of Subsea’s Series D Preferred Stockpreferred 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 Preferredpreferred stock was $7,865,471.

Immediately after the completion of the acquisitions ofresulting in Deep Down and SOS on November 21, 2006, Subsea merged with and into itsDelaware becoming a wholly-owned subsidiary SOS, withof Subsea. On the same day, Subsea continuing as the surviving company.  Immediately thereafter, Subseathen merged with and into its wholly-owned subsidiary Deep Down, with Deep Down continuing asDelaware, with the surviving company.company operating as Deep Down Delaware. This transaction was accounted for as a purchase, with Subsea being the accounting acquirer based on a change in voting control.

On December 14, 2006, after 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 merger was accounted for as a reverse merger whereby Deep Down was the accounting acquirer resulting in a recapitalization of Deep Down’s equity.

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 purposescorporation for a total purchase price of completing the acquisition,$0.2 million. Deep Down formed a wholly-owned subsidiary, ElectroWave USA, Inc., (“ElectroWave”), a Nevada corporation.  corporation, to complete the acquisition.  Located in Channelview, Texas, ElectroWave offers design, assembly, installation and commissioning of electronic monitoring and control systems for the energy, military, and commercial business markets.
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Effective December 1, 2007, Deep Down acquired all of the outstanding common stock of Mako Technologies, Inc., (“Mako”) for a Louisiana corporation.  For purposestotal purchase price of completing the acquisition, Deep Down formed$11.3 million including transaction fees, forming a wholly-owned subsidiary to complete the acquisition.  Located in Morgan City, Louisiana, Mako Technologies,serves the offshore petroleum and marine industries with technical support services, and equipment vital to offshore petroleum production, through rentals of its remotely operated vehicles (“ROV”), topside and subsea equipment and support systems used in diving operations, maintenance and repair operations, offshore construction and environmental and marine surveys.

On June 5, 2008, Deep Down completed the acquisition of Flotation for a total purchase price of $23.9 million. Deep Down also purchased related technology from an entity affiliated with the Selling Shareholders. Deep Down effectively dated the acquisition for accounting purposes as of May 1, 2008 and consummated the closing on June 6, 2008. Flotation engineers, designs and manufactures deepwater buoyancy systems using high-strength FlotecTM syntactic foam and polyurethane elastomers from its facilities in Biddeford, Maine.

In February 2009, we formed Deep Down International Holdings, LLC, a Nevada limited liability company which merged with and into Mako Technologies, Inc., with Mako aswholly-owned subsidiary of the surviving entity. Effective May 1, 2008,Company, for the purpose of holding securities for foreign companies organized or acquired by Deep Down. Deep Down acquired all of the outstanding common stock of Flotation Technologies, Inc., a Maine corporation.  International Holdings, LLC currently has no assets or operations.
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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.

Segments

For the three months ended March 31, 2009 and the fiscal year ended December 31, 2007, we operated2008, the operations of Deep Down’s subsidiaries have been aggregated into a single reporting segment under one operating segment based on analysisthe provisions of SFAS 131 “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). TheWe determined that the operating segments of Delaware, ElectroWave, Mako and Flotation (as of their respective acquisition dates) may be aggregated into a single reporting segment because aggregation is consistent with the objective and basic principles of paragraph 17 of SFAS 131. While the operating segments have different product lines, they are very similar with regards to the five criteria for aggregation. They are all service-based operations ofrevolving around our personnel’s expertise in the deep water industry, and any equipment is produced to a customer specified design and engineered using Deep Down personnel’s expertise, with installation as part of our service revenue to the customer. Additionally, the segments have similar customers and ElectroWavedistribution methods, and their economic characteristics were reviewed collectively by Deep Down, Inc’s management duesimilar with regard to similarities in products 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.their gross margin percentages.

Recent developments

New Corporate Revolver

On November 11, 2008, we entered intoDuring the Revolver with Whitney National Bank as lender.  The Revolver providesthree months ended March 31, 2009, Deep Down executed a commitmentmemorandum of understanding to lendpurchase these assets from JUMA for approximately $2.6 million which is expected to usinclude an assumption of bank debt in the approximate amount of $1.8 million.  Deep Down received a third party appraisal of the lesserproperty in the amount 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$3.1 million. 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.

Each of our subsidiaries has guaranteedmade earnest-money deposit payments during 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 us and our subsidiariesthree months ended March 31, 2009 totaling $0.5 million 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 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 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.

Registration Rights Agreement PenaltiesRonald E. Smith.

In connection with the Private Placement in June 2008, weDeep Down filed an initial Registration Statement on Form S-1 on July 21, 2008 to register the shares issued. Terms of the Private Placement state that ifThe SEC declared the Registration Statement is not declaredon Form S-1 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, we 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.  We have 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.  We cannot estimate at this time when the Registration Statement will be delared effective.
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Payment of long term debt and exercise of Prospect warrants:

On June 12, 2008, we paid approximately $12.5 million to Prospect Capital Corporation to pay the balance due under our 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 our common stock.on April 16, 2009.

Results of operations

Three Months Ended September 30, 2008March 31, 2009 Compared to Three Months Ended September 30, 2007March 31, 2008

Revenue.  Revenue for the three months ended September 30, 2008March 31, 2009 increased $6.8approximately $0.8 million to $11.7$7.1 million, a 51%13.1% increase over the same three-month period in 2007.2008. The increase in revenue included $8.5$2.6 million from the acquisitionsacquisition of Mako and Flotation, while our historical service lines had an aggregatedFlotation. The reduction in revenue of $1.7 million. The reduction in revenuefrom the other subsidiaries 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 customers’ delaying many of their major projects due to the softening of the world oil price and the impact it had on customers’ anticipated cash flow.
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Gross Profit.  Gross profit increased by $4.0 million to $5.3remained relatively consistent at approximately $2.3 million for the three months ended September 30, 2008 as compared to the same period last year.March 31, 2009 and March 31, 2008. Gross margins for the same period improveddecreased from 25.8%37.4% to 45.5%32.4%.  The inclusion of Mako and Flotation for the three months ended September 2008March 2009 increased the gross profit by $4.8 million whileapproximately $0.8 million; however, gross profit was negatively impacted by higher repair and maintenance costs and increased depreciation expense from 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 a year ago.Mako acquisition.
 
Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) includes rent, utilities, general office expenses, insurance, personnel and other costs necessary to conduct business operations.  SG&A for the three months ended September 30, 2008March 31, 2009 was $3.7$2.8 million compared to $0.9$1.9 million for the same period last year, for an increasedue in part to the acquisition of $2.8 million. The acquisitions of Mako and Flotation, which represented $1.3$0.9 million of the increase. Bad debt increased by $0.2 million due to the write off of certain accounts.expense. Personnel and related costs increased by $0.3(not included in the Flotation amount) of $0.5 million primarily duewas attributed to anthe 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 $0.6$0.2 million more than the same period for thecomparable prior year period in professional, accounting and legal fees to support our various initiatives during the quarter relating to the filingupdating of athe registration statement and increased annual audit fees due to support the related acquisitions.company growth. Stock-based compensation related to employee stock options and restricted stock was approximately $170,160 in$29,419 for the current fiscal quarterthree months ended March 31, 2009 compared to approximately $74,000$0.1 million for the comparable prior period. Insurance costs increased by approximately $0.2 million, partyear period, due to a change in management’s estimate of expected future forfeiture rates which is included in the acquisition related expenses noted above.generated a reduction of expense approximating $0.1 million.

Depreciation and amortization. Depreciation expense for the three months ended September 30, 2008March 31, 2009 was $0.4 million compared to $0.1$0.2 million for the same prior year period due mainly to the acquisitions in fiscal year 2008.of Mako and Flotation. In addition, intangible assets purchased in the Mako and Flotation acquisitions total $19.2 million in the aggregate, and the related amortization for the quarterthree months ended September 30, 2008March 31, 2009 was $0.3 million.million compared to the prior year period of $0.1 million, since the Flotation acquisition was completed in May 2008.

Interest Expense. Interest expense for the three months ended September 30, 2008March 31, 2009 was $24,704$48,344 compared to $0.2$0.8 million for the same prior year period.  Interest expense for the three months ended March 31, 2009 was generated by our outstanding bank debt, capital lease and subordinated debenture. For the three months ended March 31, 2008, interest expense was generated mainly by a secured credit agreement; cash interest approximated $0.5 million, and we incurred non-cash deferred financing and debt discount amortization approximating $0.2 million. On June 12, 2008, we paid the balance due under the Credit Agreement,that 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.since that date.

Net income (loss). Net incomeloss for the three months ended September 30, 2008March 31, 2009 was $1.6$­­0.7 million, compared to net income of $0.2$0.1 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, 2008March 31, 2009 was $2.3$(0.2) million compared to $0.4$0.7 million, an increasea decrease of $1.9$0.9 million from the same prior year period.
   2009   2008  
Net loss  (729,775)  (89,447)
Add back interest expense, net of interest income  46,116   729,866 
Add back depreciation and amortization  751,276   298,149 
Deduct tax benefit  (265,323)  (269,366)
EBITDA $(197,706) $669,202 

 
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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 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 of 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, $1.5 million in debt discounts were accelerated and recorded to interest expense.  We paid cash interest related to the Credit Agreement totaling $0.8 million for the nine months ended September 30, 2008 compared to $139,500 in the prior year. 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, we executed a Securities Redemption Agreement with the former CFO of Deep Down 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.  
Net income (loss). Net loss for the nine months ended September 30, 2008 was $3.4 million, compared to a net income of $1.0 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 our assets without regard to financing methods, capital structures, taxes or historical cost basis; our liquidity and operating performance over time in relation to other companies that own similar assets and that we believe calculate EBITDA in a similar manner; and the ability of our assets to generate cash sufficient for us to pay potential interest costs. We also understand that such data are used by investors to assess our performance. However, the term EBITDA is not defined under generally accepted accounting principles and EBITDA is not a measure of operating income, operating performance or liquidity presented in accordance with generally accepted accounting principles. When assessing our operating performance or liquidity, investors should not consider this data in isolation or as a substitute for net income, cash flow from operating activities, or other cash flow data calculated in accordance with generally accepted accounting principles. EBITDA for the nine months ended September 30, 2008 was $1.3 million compared to $3.3 million for the same prior year period, a decrease of $2.0 million from the same prior year period due to the items discussed above.
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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 stockPrivate Placement 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 acquisitionsgenerated our liquidity and joint ventures in the ordinary coursecapital resources primarily through operations and available capital markets. At March 31, 2009, long-term debt was $3.8 million, 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.which $0.5 million was current.

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,May 11, 2009, we have not drawn on any amounts available under this Revolver.

Our credit agreement with Whitney Bank provides for letters of credit (“LCs”), which we executed an irrevocable transferrable standby LC with a customer for $1.1 million on February 10, 2009. The LC was executed as a guarantee of performance by Deep Down and its subsidiaries on a long-term contract, allows partial and multiple drawings, and expires August 31, 2009 with an automatic one-year extension period unless cancelled 90 days in advance of the expiration date. This standby LC reduces the $2.0 million borrowing capacity under the Whitney Bank Revolver.

On March 5, 2009, Flotation obtained loan proceeds in the principal amount of approximately $1.8 million pursuant to a loan agreement Flotation and the Company entered into with TD Bank as of February 13, 2009. This loan agreement provides a further commitment to Flotation for advancement of principal in the amount of $0.3 million. In connection with the loan agreement, TD Bank required that the Company enter into a debt subordination agreement that subordinated any debt Flotation owes to the Company other than accounts payable between them arising in the ordinary course of business.  Furthermore, as part of the loan agreement TD Bank required a “negative pledge” that prohibits Flotation and the Company from granting security interests in Flotation’s personal property, other than such security interests granted in respect of the Company’s primary facility for borrowed money (as currently held with Whitney Bank).  See Note 6 to the unaudited consolidated financial statements included in this Form 10-Q for further information on this loan agreement.

As of September 30, 2008,March 31, 2009, our cash and cash equivalents were $5.2$6.4 million, which includes restricted cash of $0.1 million.  Cash and cash equivalents were $2.2$2.6 million plusincluding restricted cash of $0.4$0.1 million as of December 31, 2007.  We believe2008.  This increase was largely due to collection of outstanding accounts receivable. Management believes that we have adequate capital resources when combined with our cash position and cash flow from operations to meet current operating requirements.
On June 5, 2008, we sold 57,142,857 shares of our common stock in a private placement at a price of $0.70 per share,requirements for a total purchase price of $40.0 million and net proceeds to us of approximately $37.1 million. We used $22.1 million of the net proceeds to fund the cash portion of the Flotation purchase, and used approximately $12.5 million to repay outstanding debt, interest and early termination fees on June 12 2008. We retained the remaining 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.months ending March 31, 2010.

Cash Flow from Operating Activities

For the ninethree months ended September 30, 2008,March 31, 2009, cash provided by operating activities was $1.2$3.9 million as compared to cash used in operating activities for the same prior year period of 2007 of $1.5$0.5 million. Our working capital balances vary due to delivery terms and payments on key contracts, costs and estimated earnings in excess of billings on uncompleted contracts, and outstanding receivables and payables. We collected approximately $4.3 million in accounts receivable during the three months ended March 31, 2009. We used some of the operating cash flow to reduce accounts payable and accrued liabilities by $1.1$0.8 million compared to an increase of $2.1$0.6 million in fiscal 2007.2008. Additionally, we recorded the following non-cash charges in fiscal 2008:the three months ended March 31, 2009: share based compensation of $29,419, bad debt expense of $60,000 and depreciation and amortization of $0.8 million. In the three months ended March 31, 2008, we recorded amortization of deferred financing costs and debt discount related to the Prospect loan payoff totaling $2.6a secured credit agreement which totaled $0.2 million, share based compensation of $0.4$0.1 million, bad debt expense of $1.1 million$3,949 and depreciation and amortization of $1.6 million. In fiscal 2007, we had a gain on extinguishment of debt of $2.0$0.3 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 ninethree months ended September 30, 2008,March 31, 2009, cash used in investing activities was $25.7$1.9 million as compared to $1.2$3.3 million for the same prior year period. For the three months ended March 31, 2009, we used $1.4 million for the purchase of fixed assets, and made $0.5 million in deposits to a related party for purchase of land and buildings. The majority of the 2008 activity related to the final cash paid to FlotationMako shareholders totaling $22.1 million offset by cash acquired, which was funded by the net proceeds of the Private Placement as discussed above. Additionally, we made the final cash payment to the original Mako shareholders in the amount of $1.2$2.9 million plus some adjustments to purchase price expenses. The restricted cash balance at March 31, 208 was increased by $0.2 million related to requirements of $0.4 million was released in connection with the payoff of the Credit Agreement.a secured credit agreement. We used $2.6$0.2 million for equipment purchases compared toduring the same prior year period totaling $0.6 million.of 2008.

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Cash Flow from Financing Activities

For the ninethree months ended September 30, 2008,March 31, 2009, cash provided by financing activities was $27.4$1.7 million compared to $3.4$4.8 million for the same prior year period.  DuringFor the nine months ended September 30, 2008,2009 period, we completed the foregoing described Private Placement for net proceedsborrowed $1.8 million and made principle payments of $37.1$0.1 million. In June, 2008, we paid approximately $12.5 million to Prospect to pay the balance due under its Credit Agreement and related interest and early termination fees. In January 2008, in accordance with the terms of the purchase of Mako, we paid $0.9 million of notes payable plus accrued interest of $2,664, and received proceeds from Prospect totaling $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$5.6 million.

Capital Resources and Requirements

We generate our liquidity and capital resources primarily through operations and, when needed, through available capital markets. At September 30, 2008, long-term debt was $0.9 million, of which $48,816 was the current portion.Critical Accounting Policies
   
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Critical Accounting Policies
We utilize the following critical accounting policies in the preparationThe discussion and analysis of our financial statements.

Accounts Receivable   Trade accounts receivable are recorded at the invoiced amountcondition and do not bear interest.  The allowance for doubtful accounts on trade receivables is our best estimateresults of the probable amount of credit losses in our existing accounts receivables.  A considerable amount of judgment is required in assessing the realization of receivables.  Relevant assessment factors include the credit worthiness of the customers and prior collection history.  Account balances are charged off against the allowance after all reasonable means are exhausted and the potential for recovery is considered remote.  The allowance requirements are based on the most current facts available and are re-evaluated and adjusted on a regular basis and as additional information is received.  We do not expect to have any off-balance sheet credit exposure related to our customers.

Consolidation The accompanying financial statements include the accounts of Deep Down and all of its wholly-owned subsidiaries, including Deep Down Delaware since its inception on June 29, 2006, ElectroWave since its acquisition on April 2, 2007, 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 andoperations 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 servicesour consolidated financial statements, which have been rendered, (iii)prepared in accordance with accounting principles generally accepted in the priceUnited States. The preparation of the equipment or service is fixedthese financial statements in accordance with generally accepted accounting principles requires us to make estimates and determinablejudgments that may affect assets and (iv) collectability is reasonably assured.  For certain fabrication projects,liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue is recognized upon shipment or when customer-specific contract elements, (“milestone(s)”) are met.   Fabricationrecognition 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 “Costsrelated allowances, 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, inventory, impairments of long-lived assets, including intangible assets, impairments of goodwill, income taxes including the termsvaluation allowance for deferred tax assets, valuation 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,long-lived 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 cyclecontracts; contingencies and litigation, and share-based payments.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis 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 evaluatemaking judgments about 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 basisvalues of assets and liabilities using enacted tax ratesliabilities. Actual results may differ from these estimates under different assumptions or conditions.

Refer to Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in effectour Annual Report on Form 10-K for the year in which the differences are expected to reverse.ended December 31, 2008 for a discussion of our critical accounting estimates.

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.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

ITEM 3.  QUANTITATIVE AND QUALITATIVE AND QUANTITATIVEDISCLOSURES ABOUT MARKET RISKSRISK

Financial market risks relating to our operations result primarily from changes in interest rates. We hold no securities for purposes of trading. Our cash and cash equivalents representing bank deposits at March 31, 2009 are not restricted as to withdrawal except for $135,855 related to an LC for a vendor. Interest earned on our cash equivalents is sensitive to changes in interest rates. We have no variable rate debt outstanding as of March 31, 2009. The $2.0 million Revolver with Whitney Bank has a LIBOR-based interest rate. Outstanding amounts under the Revolver generally will bear interest at rates based on the British Bankers Association LIBOR Rate for dollar deposits with a term of one month plus an applicable rate of 2.00% to 3.00% based on the leverage ratio of Deep Down.
 
Not applicable for smaller reporting companies.
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ITEM 4T.4. 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 officerPrincipal Executive Officer and principal financial officer,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 officerPrincipal Executive Officer and principal financial officerPrincipal Financial Officer concluded that, as of the end of the period covered in this report,March 31, 2009, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officerPrincipal Executive Officer and principal financial officer,Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure. This determination was in response to the SEC comment letter received February 26, 2009, in which the SEC stated that they require that we present the audited predecessor financial statements for Deep Down, Inc. for the period from January 1, 2006 through November 20, 2006, in accordance with Rule 310(a) of Regulation S-B. We remediated this on March 31, 2009 by supplementing the amounts reported in Form 10-K for December 31, 2007 with the predecessor audited financial information for Deep Down, Inc. from January 1, 2006 to November 20, 2006 and our Registration Statement on Form S-1 was declared effective on April 16, 2009.

Our management, including our principal executive officerPrincipal Executive Officer and principal financial officer,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 ReportingReporting.   

There were no changes in Deep Down’sIn our efforts to continuously improve our internal control over financial reporting (as defined in Rules 13a-15(f)controls, management has taken steps to enhance the following controls 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 likelyprocedures subsequent 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.
as part of our remediation efforts in addressing material weaknesses:
·  Management is in the process of implementing a new system-wide accounting and management software program to address the revenue recognition and gross margin analysis of projects accounted for under the percentage-of-completion method.
·  Management has prepared an Employee Handbook and circulated these documents throughout the organization and obtained signed acknowledgements from employees.
·  Management has increased documentation around certain authorization and review controls.
 
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PART II – OTHER INFORMATION
 
ITEM 1.  LEGAL PROCEEDINGS
 
We are from time to time involved in legal proceedings arising in the normal course of business. As of the date of this Form 10-Q, we are currently not involved in any pending, material legal proceedings except as noted below.

At March 31, 2009, Deep Down was in the arbitration process with the former stockholders of Flotation Technologies, Inc. regarding the proper calculation of the “Cash Price Adjustment” pursuant to the Stock Purchase Agreement by and between Deep Down, Flotation Technologies, Inc. and its former stockholders dated April 17, 2008.
Not applicable.In connection with the Private Placement in June 2008, Deep Down filed an initial Registration Statement on Form S-1 on July 21, 2008 to register the 57,142,857 shares issued in the offering. Pursuant to the Registration Rights Agreement, Deep Down was obligated to have the Registration Statement declared effective by September 3, 2008, the “Required Effective Date”, or the Company would be required to pay liquidated damages to the Selling Shareholders in the Private Placement for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective. Deep Down evaluated this obligation under the Registration Rights Agreement for liability treatment under FASB Statement No. 5, “Accounting for Contingencies” (“SFAS 5”) and Financial Statement Staff Position (FSP) EITF 00-19(2) “Accounting for Registration Payment Arrangements” and determined that the registration rights met the definition of a liability under the authoritative guidance, and at December 31, 2008  reserved $1.2 million in potential damages under terms of the Private Placement for the 90-day period from September 4 to December 3, 2008. Deep Down obtained an opinion from legal counsel allowing removal of the related stock’s restrictive legend under Rule 144, which was deemed to be equivalent, and thus satisfied the registration rights requirements.
The SEC declared the Registration Statement on Form S-1 effective on April 16, 2009. Pursuant to section 7.1 (c) of the Registration Rights Agreement and based on opinion of counsel, as of March 31, 2009 Deep Down’s management has adjusted the liquidated damages reserve to 47 days, or $0.6 million. Deep Down recorded the reduction during the three months ended March 31, 2009 and initiated payment to the Selling Shareholders subsequent to that date.

ITEM 1A. ��RISK FACTORS
 
Pursuant to subsection (3) of “Not applicableAccelerated Filer and Large Accelerated Filer” as defined under Rule 12(b)-2 of the Exchange Act, Deep Down, Inc. is filing this Quarterly Report on Form 10-Q for its fiscal quarter ended March 31, 2009 with a determination that we have become an “accelerated filer” after having been a “smaller reporting company” for Exchange Act reporting purposes. Since we filed our Form 10-K for the fiscal year ended December 31, 2008 in accordance with subsection (4) of “Smaller Reporting Company”, and reflected our status as a smaller reporting companies.company in the disclosure we provided in that Annual Report, we did not previously present the Risk Factor disclosures. As such, we are presenting the requirements of this section in full herein.

Risks Related to Our Business
We derive most of our revenues from companies in the offshore oil and gas industry, a historically cyclical industry with levels of activity that are significantly affected by the levels and volatility of oil and gas prices.
We derive most of our revenues from customers in the offshore oil and gas exploration, development and production industry.  The offshore oil and gas industry is a historically cyclical industry characterized by significant changes in the levels of exploration and development activities.  Oil and gas prices, and market expectations of potential changes in those prices, significantly affect the levels of those activities.  Worldwide political, economic and military events have contributed to oil and gas price volatility and are likely to continue to do so in the future. Any prolonged reduction in the overall level of offshore oil and gas exploration and development activities, whether resulting from changes in oil and gas prices or otherwise, could materially and adversely affect our financial condition and results of operations in our segments within our offshore oil and gas business.
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Some factors that have affected and are likely to continue affecting oil and gas prices and the level of demand for our services and products include the following:
●worldwide demand for oil and gas;
●the ability of the Organization of Petroleum Exporting Countries, or OPEC, to set and maintain production levels and pricing;
●the level of production by non-OPEC countries;
●domestic and foreign tax policy;
●laws and governmental regulations that restrict exploration and development of oil and gas in various offshore jurisdictions;
●advances in exploration and development technology;
●the political environment of oil-producing regions;
●the price and availability of alternative fuels; and
●overall economic conditions.
Our business involves numerous operating hazards that may not be covered by insurance.  The occurrence of an event not fully covered by insurance could have a material adverse effect on our financial condition and results of operations.
Our products are used in potentially hazardous drilling, completion and production applications that can cause personal injury, product liability and environmental claims.  A catastrophic occurrence at a location where our equipment and/or services are used may expose us to substantial liability for personal injury, wrongful death, product liability or commercial claims.  To the extent available, we maintain insurance coverage that we believe is customary in the industry.  Such insurance does not, however, provide coverage for all liabilities, and we cannot assure you that our insurance coverage will be adequate to cover claims that may arise or that we will be able to maintain adequate insurance at rates we consider reasonable.  The occurrence of an event not fully covered by insurance could have a material adverse effect on our financial condition and results of operations.

We may lose money on fixed-price contracts.
A portion of our business consists of designing, manufacturing, selling and installing equipment for major projects pursuant to competitive bids, and is performed on a fixed-price basis.  Under these contracts, we are typically responsible for all cost overruns, other than the amount of any cost overruns resulting from requested changes in order specifications.  Our actual costs and any gross profit realized on these fixed-price contracts will often vary from the estimated amounts on which these contracts were originally based.  This may occur for various reasons, including:
●errors in estimates or bidding;
●changes in availability and cost of labor and materials; or
●variations in productivity from our original estimates.
These variations and the risks inherent in our projects may result in reduced profitability or losses on projects. Depending on the size of a project, variations from estimated contract performance could have a significant impact on our operating results.
Our business could be adversely affected if we do not develop new products.
Technology is an important component of our business and growth strategy, and our success as a company depends to a significant extent on the development and implementation of new product designs and improvements. Whether we can continue to develop systems and services and related technologies to meet evolving industry requirements and, if so, at prices acceptable to our customers will be significant factors in determining our ability to compete in the industry in which we operate. Many of our competitors are large multinational companies that may have significantly greater financial resources than we have, and they may be able to devote greater resources to research and development of new systems, services and technologies than we are able to do.
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Loss of our key management or other personnel could adversely impact our business.
We depend on the services of our executive management team, including Ronald E. Smith, Robert E. Chamberlain, Jr. and Eugene L. Butler. The loss of any of these officers could have a material adverse effect on our operations and financial condition. In addition, competition for skilled machinists, fabricators and technical personnel among companies that rely heavily on engineering and technology is intense, and the loss of qualified employees or an inability to attract, retain and motivate additional highly skilled employees required for the operation and expansion of our business could hinder our ability to conduct research activities successfully and develop and produce marketable products and services. While we believe that our wage rates are competitive and that our relationship with our skilled labor force is good, a significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force, increases in the wage rates paid by us, or both. If either of these events were to occur, in the near-term, the profits realized by us from work in progress would be reduced and, in the long-term, our production capacity and profitability could be diminished, and our growth potential could be impaired.  Additionally, if we were to lose the services of our officers for any reason, we could face substantial costs and expenses to locate individuals with similar capabilities and/or may not be able to find suitable candidates to fill the vacancies left by such individuals, either of which could have a material adverse effect on our results of operations.
We may not be successful in integrating business that we acquire.
The successful integration of acquired businesses is important to our future financial performance.  We may not achieve the anticipated benefits from any acquisition unless the operations of the acquired business are successfully combined with ours in a timely manner. The integration of our acquisitions will require substantial attention from our management.  The diversion of the attention of our management, and any difficulties encountered in the transition process, could have a material adverse effect on our operations and financial results.  The difficulties of integration may be increased by the necessity of coordinating geographically separated organizations, integrating personnel with disparate business backgrounds and combining different corporate cultures.  There can be no assurance that there will not be substantial costs associated with such activities or that there will not be other material adverse effects of these integration efforts. In addition, the process of integrating the various businesses could also cause the interruption of, or a loss of momentum in, the activities of some or all of these businesses, which could have a material adverse effect on our operations and financial results. There can be no assurance that we will realize any of the anticipated benefits from our acquisitions.  The acquisition of oil service companies that are not profitable, or the acquisition of new facilities that result in significant integration costs and inefficiencies, could also adversely affect our profitability.

Our current and anticipated future growth has placed, and will continue to place, significant demands on our management, operational and financial resources.  Our ability to manage our growth effectively will require us to continue to improve our operational, financial and management information systems and to continue to attract, train, motivate, manage and retain key employees.  We may not be able to manage our expanded operations effectively.
We may not be successful in implementing our strategy or in responding to ongoing changes in the oil service industry which may require adjustments to our strategy.  If we are unable to implement our strategy successfully or do not respond timely and adequately to ongoing changes in the healthcare industry, our business, financial condition and results of operations will be materially adversely affected.
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If we undertake international operations, it will involve additional risks not associated with our domestic operations.
If we become involved in international operations, the effect on our business from the risks we described will not be the same in all countries and jurisdictions.  By way of example, recently there has been political instability and civil unrest in Indonesia and West Africa and general economic downturns in Asia and Brazil.  However, the specific risks associated with our operations in foreign areas will include risks of:
●multiple, conflicting, and changing laws and regulations, export and import restrictions, and employment laws;
●regulatory requirements, and other government approvals, permits, and licenses;
●potentially adverse tax consequences;
●political and economic instability, including wars and acts of terrorism; political unrest, boycotts, curtailments of trade, and other business restrictions;
●expropriation, confiscation or nationalization of assets;
●renegotiation or nullification of existing contracts;
●difficulties and costs in recruiting and retaining individuals skilled in international business operations;
●foreign exchange restrictions;
●foreign currency fluctuations;
●foreign taxation;
●the inability to repatriate earnings or capital;
●changing political conditions;
●changing foreign and domestic monetary policies;
●regional economic downturns; and
●foreign governmental regulations favoring or requiring the awarding of contracts to local contractors or requiring foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction that may harm our ability to compete.

Our offshore oilfield operations involve a variety of operating hazards and risks that could cause losses.
Our operations are subject to the hazards inherent in the offshore oilfield business.  These include blowouts, explosions, fires, collisions, capsizing and severe weather conditions.  These hazards could result in personal injury and loss of life, severe damage to or destruction of property and equipment, pollution or environmental damage and suspension of operations. We may incur substantial liabilities or losses as a result of these hazards.  While we maintain insurance protection against some of these risks, and seek to obtain indemnity agreements from our customers requiring the customers to hold us harmless from some of these risks, our insurance and contractual indemnity protection may not be sufficient or effective to protect us under all circumstances or against all risks.  The occurrence of a significant event not fully insured or indemnified against or the failure of a customer to meet its indemnification obligations to us could materially and adversely affect our results of operations and financial condition.
Laws and government regulations may add to our costs or adversely affect our operations.
Our business is affected by changes in public policy and by federal, state, local and foreign laws and regulations relating to the energy industry.  Oil and gas exploration and production operations are affected by tax, environmental and other laws relating to the petroleum industry, by changes in those laws and changes in related administrative regulations. It is also possible that these laws and regulations may in the future add significantly to our operating costs or those of our customers or otherwise directly or indirectly affect our operations.
Environmental laws and regulations can increase our costs, and our failure to comply with those laws and regulations can expose us to significant liabilities.
Risks of substantial costs and liabilities related to environmental compliance issues are inherent in our operations. Our operations are subject to extensive federal, state, local and foreign laws and regulations relating to the generation, storage, handling, emission, transportation and discharge of materials into the environment.  Permits are required for the operation of various facilities, and those permits are subject to revocation, modification and renewal. Governmental authorities have the power to enforce compliance with their regulations, and violations are subject to fines, injunctions or both. In some cases, those governmental requirements can impose liability for the entire cost of cleanup on any responsible party without regard to negligence or fault and impose liability on us for the conduct of or conditions others have caused, or for our acts that complied with all applicable requirements when we performed them.  It is possible that other developments, such as stricter environmental laws and regulations, and claims for damages to property or persons resulting from our operations, would result in substantial costs and liabilities.  Our insurance policies and the contractual indemnity protection we seek to obtain from our customers may not be sufficient or effective to protect us under all circumstances or against all risks involving compliance with environmental laws and regulations.
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Provisions recently added to our corporate documents and Nevada law could delay or prevent a change in control of our Company, even if that change would be beneficial to our shareholders.
The Board of Directors and a majority of the shareholders recently approved amendments to our articles of incorporation and bylaws that, along with Nevada law could delay or prevent a change in control of our company, even if that change would be beneficial to our shareholders.  The provisions are designed to discourage any tender offer or other attempt to gain control of the Company in a transaction that is not approved by our Board of Directors, by making it more difficult for a person or group to obtain control of the Company in a short time and then impose its will on the remaining stockholders, including:
Classified Board of Directors and Removal of Directors.  Our Board of Directors is divided into three classes which shall be as nearly equal in number as possible.  The directors in each class serve for terms of three years, with the terms of one class expiring each year.  Each class currently consists of approximately one-third of the number of directors.  Each director will serve until his successor is elected and qualified.  A director may not be removed except for cause by the affirmative vote of the holders of 75% of the outstanding shares of capital stock entitled to vote at an election of directors.

Advance Notice Requirements for Nomination of Directors and Proposal of New Business at Annual Stockholder Meetings.  Any stockholder desiring to make a nomination for the election of directors or a proposal for new business at a stockholder meeting must submit written notice not less than 30 or more than 60 days in advance of the meeting.
 
Supermajority Voting Requirement for Amendment of Certain Provisions of the Articles of Incorporation.  Specified provisions contained in the articles of incorporation and bylaws may not be repealed or amended 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.

We may be unable to successfully compete with other manufacturers of drilling and production equipment.
Several of our primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources than ours and which have been engaged in the manufacturing business for a much longer time than us. If these competitors substantially increase the resources they devote to developing and marketing competitive products and services, we may not be able to compete effectively. Similarly, consolidation among our competitors could enhance their product and service offerings and financial resources, further intensifying competition.
The loss of a significant customer could have an adverse impact on our financial results.
Our principal customers are major integrated oil and gas companies, large independent oil and gas companies and foreign national oil and gas companies. Offshore drilling contractors and engineering and construction companies also represent a portion of our customer base. During the last 12 months, our top 5 customers represented approximately 41% of total revenues, with our largest customer accounting for more than 20% of our total revenues. While we are not dependent on any one customer or group of customers, the loss of one or more of our significant customers could, at least on a short-term basis, have an adverse effect on our results of operations.
Our customers’ industries are undergoing continuing consolidation that may impact our results of operations.
The oil and gas industry is rapidly consolidating and, as a result, some of our largest customers have consolidated and are using their size and purchasing power to seek economies of scale and pricing concessions. This consolidation may result in reduced capital spending by some of our customers or the acquisition of one or more of our primary customers, which may lead to decreased demand for our products and services. We cannot assure you that we will be able to maintain our level of sales to a customer that has consolidated or replace that revenue with increased business activity with other customers. As a result, the acquisition of one or more of our primary customers may have a significant negative impact on our results of operations or our financial condition. We are unable to predict what effect consolidations in the industry may have on price, capital spending by our customers, our selling strategies, our competitive position, our ability to retain customers or our ability to negotiate favorable agreements with our customers.
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Increases in the cost of raw materials and energy used in our manufacturing processes could negatively impact our profitability.
During 2006, 2007, and 2008, commodity prices for items such as nickel, molybdenum and heavy metal scrap that are used to make the steel alloys required for our products increased significantly, resulting in an increase in our raw material costs. Similarly, energy costs to produce our products have increased significantly.  If we are not successful in raising our prices on products, our margins will be negatively impacted.
Future capital needs.
Our growth and continued operations could be impaired by limitations on our access to the capital markets.  There can be no assurance that capital from outside sources will be available, or if such financing is available, it may involve issuing securities senior to the common stock or equity financings which are dilutive to holders of the common stock.
We depend on third party suppliers for timely deliveries of raw materials, and our results of operations could be adversely affected if we are unable to obtain adequate supplies in a timely manner.
Our manufacturing operations depend upon obtaining adequate supplies of raw materials from third parties. The ability of these third parties to deliver raw materials may be affected by events beyond our control. Any interruption in the supply of raw materials needed to manufacture our products could adversely affect our business, results of operations and reputation with our customers.
If we are not able to adequately protect our intellectual property, we may not be able to compete effectively.

Our success depends, to a significant degree, upon the protection of our proprietary technologies. While we currently own one U.S. patent and there are no foreign counterparts relating to our products and techniques and have applied for five U.S. patents and there are no foreign counterparts related to our products and techniques, we will need to pursue additional protections for our intellectual property as we develop new products or techniques and enhance existing products or techniques. We may not be able to obtain appropriate protections for our intellectual property in a timely manner, or at all. Our inability to obtain appropriate protections for our intellectual property may allow competitors to enter our markets and produce or sell the same or similar products.

If we are forced to resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome and expensive.  In addition, our proprietary rights could be at risk if we are unsuccessful in, or cannot afford to pursue, those proceedings.
We also rely on trade secrets and contract law to protect some of our proprietary technology. Nevertheless, our unpatented trade secrets and know-how may not be effectively protected.
Moreover, others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets and know-how.
Drilsys™, ElectroWave™, Mudsys™, Aquasox™, Moray®, SeaStax®, Quick-Loc™, Flotec™, Proteus™ and Flotect™ are our trademarks.
In 1995, the U.S. Patent and Trademark Office adopted changes to the U.S. patent law that made the term of issued patents 20 years from the date of filing rather than 17 years from the date of issuance, subject to specified transition periods. Beginning in June 1995, the patent term became 20 years from the earliest effective filing date of the underlying patent application.  These changes may reduce the effective term of protection for patents that are pending for more than three years. In addition, as of January 1996, all inventors who work outside of the United States are able to establish a date of invention on the same basis as those working in the United States.  This change could adversely affect our ability to prevail in a priority of invention dispute with a third party located or doing work outside of the United States.  While we cannot predict the effect that these changes will have on our business, they could have a material adverse effect on our ability to protect our proprietary information. Furthermore, the possibility of extensive delays in the patent issuance process could effectively reduce the term during which a marketed product is protected by patents.
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We may need to obtain licenses to patents or other proprietary rights from third parties.  We may not be able to obtain the licenses required under any patents or proprietary rights, or they may not be available on acceptable terms. If we do not obtain required licenses, we may encounter delays in product development or find that the development, manufacture or sale of products requiring licenses could be foreclosed. We may, from time to time, support and collaborate in research conducted by universities and governmental research organizations. We may not be able to acquire exclusive rights to the inventions or technical information derived from these collaborations, and disputes may arise over rights in derivative or related research programs conducted by us or our collaborators.

If we infringe on the rights of third parties, we may not be able to sell our products, and we may have to defend against litigation and pay damages.
If a competitor were to assert that our products infringe on its patent or other intellectual property rights, we could incur substantial litigation costs and be forced to pay substantial damages.  Third-party infringement claims, regardless of their outcome, would not only consume significant financial resources, but would also divert our management’s time and attention. Such claims could also cause our customers or potential customers to purchase competitors’ products or defer or limit their purchase or use of our affected products until resolution of the claim.  If any of our products are found to violate third-party intellectual property rights, we may have to re-engineer one or more of our products, or we may have to obtain licenses from third parties to continue offering our products without substantial re-engineering.  Our efforts to re-engineer or obtain licenses could require significant expenditures and may not be successful.
Limitation on Remedies, Indemnification
The Company’s Bylaws provide that the officers and directors will only be liable to the Company for acts or omissions that constitute actual fraud, gross negligence or willful and wanton misconduct. Thus, the Company may be prevented from recovering damages for certain alleged errors or omissions by the officers and directors for liabilities incurred in connection with their good faith acts for the Company. Such an indemnification payment might deplete the Company’s assets. Stockholders who have questions regarding the fiduciary obligations of the officers and directors of the Company should consult with independent legal counsel. It is the position of the Securities and Exchange Commission that exculpation from and indemnification for liabilities arising under the 1933 Act and the rules and regulations hereunder is against public policy and therefore unenforceable.

Our internal controls may be inadequate, which could cause our financial reporting to be unreliable and lead to misinformation being disseminated to the public.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Exchange Act Rule 13(a)-15(f), internal control over financial reporting is a process designed by, or under the supervision of, the principal executive and principal financial officer and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of Deep Down; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Deep Down are being made only in accordance with authorizations of management and directors of Deep Down, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Deep Down’s assets that could have a material effect on the financial statements.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2008 and identified material weaknesses. Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of December 31, 2008, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. This determination was in response to the SEC comment letter received February 26, 2009, in which the SEC stated that they require that we present the audited predecessor financial statements for Deep Down, Inc. for the period January 1, 2006 through November 20, 2006, in accordance with Rule 310(a) of Regulation S-B. Management remediated this on March 31, 2009 by presenting the amounts reported in Form 10-K/A for December 31, 2007 with the predecessor audited financial information for Deep Down from January 1, 2006 to November 20, 2006.
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Additionally, we did not maintain effective controls over the control environment.  Specifically, we have not formally adopted a written code of business conduct and ethics that governs the Company’s employees, officers and directors.  Further, the Board of Directors does not currently have any independent members and no director qualifies as an audit committee financial expert as defined in Item 407(d)(5)(ii) of Regulation S-B.  We did not maintain the following controls: sufficient policies and procedures over the administration of an accounting and fraud risk policy, sufficient documentation on the review and follow-up on the remediation of deficiencies, and a sufficient segregation of duties to decrease the risk of inappropriate accounting. Management has also determined that we did not maintain effective controls over the accuracy of revenue recognition. Specifically, there was not sufficient review, supervision, and monitoring in regards to projects accounted for under the percentage-of-completion method. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Controls and Procedures — Changes in Internal Control over Financial Reporting”). Our internal controls may be inadequate or ineffective, which could cause our financial reporting to be unreliable and lead to misinformation being disseminated to the public. Investors relying upon this misinformation may make an uninformed investment decision.

As permitted by SEC rules, we and our independent registered public accountants excluded Flotation, which represented 43% and 32% of our combined assets and revenue, respectively at December 31, 2008, from our management’s report on internal control over financial reporting and their audit of our internal control over financial reporting. As a result, it is possible that, as we continue to integrate Flotation into our business, we will identify internal control issues related to Flotation’s financial reporting.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Effective July 3, 2008, Prospect Capital Corporation, the holders of 4,960,585 warrants originally issued in connection with Deep Down’s 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.None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
 
Not applicable.None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
Deep Down first mailed an information statement to its stockholders on September 15, 2008 that described several amendments to our Articles of Incorporation and Bylaws previously adopted pursuant to a 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 SEC on August 15, 2008 concerning a more complete statement and description concerning the amendments to the Articles of Incorporation and the Bylaws that were adopted pursuant to such stockholder written consent.  In summary, the amendments provided for:None.

-    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 Deep Down holding 70,338,251 shares of our outstanding common stock provided a written consent to approve the amendments to our Articles of Incorporation and Bylaws.  On May 16, 2008, the 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 RevolverNone.

On November 11, 2008, Deep Down entered into 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 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 special meeting, the stockholder must give notice in writing (delivered or mailed by first class United States mail, postage prepaid, to the Secretary of Deep Down) of any nomination for election as a 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 date Deep Down provided such notice of such meeting).  A nomination by a stockholder of a person to be elected to our board of directors must 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 stockholder shall promptly provide any other 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, which is incorporated herein by reference.

Exhibit NumberDescription of Exhibit
2.13.1Agreement and PlanArticles of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholdersIncorporation of Deep Down, Inc. (conformed to include the amendment of the Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008) (incorporated by reference from Exhibit A to our Schedule 14C filed on August 15, 2008).
10.1*3.2Credit Agreement, dated asAmended and Restated ByLaws of November 11, 2008, between Deep Down, Inc., as borrower, and Whitney National Bank, as lender (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008).
10.2*4.1Guaranty, dated asOperating Agreement 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,International Holdings, LLC, and Deep Down, Inc. for the benefit of Whitney National Banka Nevada limited liability company (incorporated by reference from Exhibit 4.11 to Amendment No. 3 to our Form S-1/A filed on April 10, 2009).
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.

_________________
* Filed or furnished herewith.



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 November 14, 2008May 11, 2009
Ronald E. Smith 
(Principal Executive Officer)
 
  
     
/s/ EUGENE L. BUTLER Chief Financial Officer and Director November 14, 2008May 11, 2009
Eugene L. Butler (Principal Financial Officer)  


 
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INDEX TO EXHIBITS

Exhibit NumberDescription of Exhibit
2.13.1Agreement and PlanArticles of Reorganization among MediQuip Holdings, Inc.,Incorporation of Deep Down, Inc., (conformed to include the amendment of the Articles of Incorporation filed with the Secretary of State of the State of Nevada on September 29, 2008) (incorporated by reference from Exhibit A to our Schedule 14C filed on August 15, 2008).
3.2Amended and the majority shareholdersRestated ByLaws of Deep Down, Inc. (incorporated by reference from Exhibit 2.1B to our Annual Report on Form 10-KSB/A (Amendment No. 2) for the fiscal year ended December 31, 2007Schedule 14C filed on May 1,August 15, 2008).
10.1*4.1CreditOperating Agreement dated as of November 11, 2008, between Deep Down Inc., as borrower, and Whitney National Bank, as lender
10.2*Guaranty, dated as of November 11, 2008,International Holdings, LLC, a Nevada limited liability company (incorporated 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 Bankreference from Exhibit 4.11 to Amendment No. 3 to our Form S-1/A filed on April 10, 2009).
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 Down, Inc.

_________________
* Filed or furnished herewithherewith.
 
 
 
 
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