UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington D.C.,
20549





FORM
10-K/A


(Amendment
No. 5 )





TANNUAL REPORT UNDER SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For
the fiscal year ended December 31, 2007





£TRANSITION REPORT UNDER
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For
the transition period from _________ to _________





Commission
File No. 0-30351





DEEP
DOWN, INC.


(Exact
name of registrant as specified in its charter)




Nevada
            
            75-2263732(State
      of other jurisdiction of incorporation)
            
            (I.R.S.
      Employer Identification No.)8827 W. Sam Houston Pkwy N., Suite
      100
              Houston, Texas
            
            77040(Address
      of Principal Executive Office)
            
            (Zip
      Code)




Registrant’s
telephone number, including area code: (281)
517-5000





Securities
registered pursuant to Section 12(b) of the Act: NONE





Securities
registered pursuant to Section 12(g) of the Act: Common Stock $0.001 par
value




Indicate by
check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act.oYes     
 xNo




Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act. o





Check
whether the issuer (1) filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the preceding 12 months (or such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirement for the past 90 days. Yes T No £





Check if
there is no disclosures of delinquent filers in response to Item 405 of
Regulations S-B not contained in this form, and no disclosure will be contained,
to the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. £




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 o
            Accelerated
      filer oNon-accelerated
      filer o(Do
      not check if a smaller reporting company)
            Smaller
      reporting company x




Indicate
by checkmark whether the registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act).


Yes £ No T





The
aggregate market value of the voting stock and non-voting common equity held by
non-affiliates of the registrant as of March 28, 2008 (based on the closing
price on that date) was $31,406,139.





At March
28, 2008, the issuer had outstanding 115,846,019 shares of Common Stock, par
value $0.001 per share.





DOCUMENTS
INCORPORATED BY REFERENCE


None.











Explanatory
Note







This
Annual Report on Form 10-K/A is filed as an amendment to the Annual Report on
Form 10-KSB filed by Deep Down, Inc. (the “Company” or “Deep Down”) on April 1,
2008 (the “Original 10-KSB”). Deep Down received an SEC comment letter dated
February 26, 2009, stating that the SEC requires that we amend the Form 10-K for
December 31, 2007 to present supplemental audited predecessor financial
statements for Deep Down, Inc. for the period from  January 1, 2006
through November 20, 2006 (the date preceding its purchase by the successor
entity). As a result, the Company has determined to file this Amendment No. 5
(this “Amendment”) to the original Form 10-KSB for the following
reasons: (1) to include the required disclosures under provisions of SFAS
131, “Segment Reporting,”  included in Item.1 Business Overview on
page 5 and Footnote 1 to the Consolidated Financial Statements on page F-9, (2)
to present supplemental audited predecessor company 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 on pages F-4 through F-7,
including the additional required footnote disclosures in Notes 1 and 14 to the
Consolidated Financial Statements on pages F-8 and F-30 through F-32,
respectively and (3) in connection with the SEC comment letter dated February
26, 2009, to change our evaluation of Disclosure Controls and Procedures to
“not-effective” on page 26 in Item 8a.




Except as
presented in this Amendment and except for Exhibits 31.1, 31.2, 32.1 and 32.2,
this Form 10-K/A does not reflect events occurring after the filing of the
original Form 10-KSB or modify or update those disclosures.















TABLE
OF CONTENTS






PART
      IItem
      1
            Description
      of Business
            4Item
      2
            Description
      of Property
            13Item
      3
            Legal
      Proceedings
            13Item
      4
            Submission
      of Matters to a Vote of Security Holders
            13PART
      IIItem
      5
            Market
      for Common Equity, Related Stockholder Matters and Small Business Issuer
      Purchases of Equity Securities
            14Item
      6
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            16Item
      7
            Financial
      Statements
            26Item
      8
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            26Item
      8A
            Controls
      and Procedures
            26Item
      8B
            Other
      Information
            28PART
      IIIItem
      9
            Directors,
      Executive Officers, Promoters, Control Persons and Corporate
      Governance
            29Item
      10
            Executive
      Compensation
            31Item
      11
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            33Item
      12
            Certain
      Relationships and Related Transactions, and Director
      Independence
            33Item
      13
            Exhibits
            33Item
      14
            Principal
      Accountant Fees and Services
            34





-2-


Forward-Looking
Information





Unless
otherwise indicated, the terms “Deep Down, Inc.”, “Deep Down”, “Deep Down
Nevada”, “Company,” “we,” “our” and “us” are used in this report to refer to
Deep Down, Inc., a Nevada corporation, to one or more of our consolidated
subsidiaries or to all of them taken as a whole.





In this
Annual Report on Form 10-KSB/ A document, we may make certain forward-looking
statements, including statements regarding our plans, strategies, objectives,
expectations, intentions and resources that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. We do not
undertake to update, revise or correct any of the forward-looking information.
The following discussion should also be read in conjunction with the audited
consolidated financial statements and the notes thereto.





The
statements contained in this Annual Report on Form 10-KSB/ A that are not
historical fact are forward-looking statements (as such term is defined in the
Private Securities Litigation Reform Act of 1995), within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The forward-looking statements contained
herein are based on current expectations that involve a number of risks and
uncertainties. These statements can be identified by the use of forward-looking
terminology such as “believes,” “expects,” “may,” “will,” “should,” “intend,”
“plan,” “could,” “is likely,” or “anticipates,” or the negative thereof or other
variations thereon or comparable terminology, or by discussions of strategy that
involve risks and uncertainties. The Company wishes to caution the reader that
these forward-looking statements that are not historical facts are only
predictions. No assurances can be given that the future results indicated,
whether expressed or implied, will be achieved. While sometimes presented with
numerical specificity, these projections and other forward-looking statements
are based upon a variety of assumptions relating to the business of the Company,
which, although considered reasonable by the Company, may not be realized.
Because of the number and range of assumptions underlying the Company’s
projections and forward-looking statements, many of which are subject to
significant uncertainties and contingencies that are beyond the reasonable
control of the Company, some of the assumptions inevitably will not materialize,
and unanticipated events and circumstances may occur subsequent to the date of
this report. These forward-looking statements are based on current expectations
and the Company assumes no obligation to update this information. Therefore, the
actual experience of the Company and the results achieved during the period
covered by any particular projections or forward-looking statements may differ
substantially from those projected. Consequently, the inclusion of projections
and other forward-looking statements should not be regarded as a representation
by the Company or any other person that these estimates and projections will be
realized, and actual results may vary materially. There can be no assurance that
any of these expectations will be realized or that any of the forward-looking
statements contained herein will prove to be accurate.

















-3-


PART
I




Item
1.                      Description
of Business.





Corporate
History





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





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





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





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





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





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





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





Since
December 2006, Deep Down has consummated two strategic
acquisitions.  On April 2, 2007, Deep Down acquired substantially all
of the assets of ElectroWave USA, Inc., a Texas corporation.  For
purposes of completing the acquisition, Deep Down formed a wholly-owned
subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a Nevada
corporation.  Effective December 1, 2007, Deep Down acquired all of
the outstanding common stock of Mako Technologies, Inc., a Louisiana
corporation.  For purposes of completing the acquisition, Deep Down
formed a wholly-owned subsidiary, Mako Technologies, LLC (“Mako”), a Nevada
limited liability company, which merged with and into Mako Technologies, Inc.,
with Mako as the surviving entity.





Our
current operations are the result of the recent acquisitions of Deep Down,
ElectroWave and Mako.  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.





-4-


Business
Overview





We
provide both products and services to the offshore energy industry to support
deepwater exploration, development and production of oil and gas and other
maritime operations.  We are primarily a service company and produce
custom engineered products that assist us in fulfilling service objectives for
specific projects on a contractual basis.  We design and manufacture a
broad line of deep water 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.  We also
manufacture monitoring and control systems used by offshore energy and other
maritime operations.  Our products are often initially developed in
direct response to customer requests for solutions to critical problems in the
field.  We also serve the growing offshore petroleum and maritime
industries with technical management and support services.  Set forth
below is a more detailed description of important services and products we
provide.





Our goal
is to provide superior products and services designed to provide safer, more
cost-effective solutions in a quicker timeframe for our clients.  We
believe there is significant demand for, and brand name recognition of, our
established products due to the technological capabilities, reliability, cost
effectiveness, timely delivery and operational timesaving features of these
products. Since our formation, we have introduced many new products that
continue to broaden the market currently served by us.





We market
our products and services primarily through our corporate offices in
Channelview, Texas.  Our sales representatives travel worldwide to the
major international energy and maritime markets.  We generally
manufacture and fabricate our products at our facilities, although we also work
with third parties who provide manufacturing and fabrication support through
their own facilities in the Houston, Texas metroplex.







Segments


For
the fiscal year ended December 31, 2007, the operations of Deep Down’s
subsidiaries have been aggregated into a single reporting segment under the
provisions of SFAS 131 “Disclosures about Segments of an Enterprise and Related
Information” (“SFAS 131”). We determined that the operating segments of
Delaware, ElectroWave, and Mako (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 revolving 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 distribution methods, and their economic characteristics were
similar with regard to their gross margin percentages for the fiscal year ended
December 31, 2007.
 Services and
Products
  The
offshore energy industry is centered around the use of production platforms. A
production platform is a large structure used to house workers and machinery
needed to drill for and produce oil and natural gas from reservoirs below the
ocean floor.  The operations of the production platform can deliver
oil and gas production directly onshore by pipeline or to a floating storage
unit or tanker loading facility.  Historically, production platforms
have been located on the continental shelf, but as technology continues to
improve, drilling and production operations in deeper water have become both
feasible and profitable. A typical production platform may have as many as
thirty wellheads from which it is producing.  Directional drilling
allows subsea reservoirs to be accessed at both different depths and at remote
positions up to 5 miles (8 kilometers) from the production
platform.  Many production platforms have remote wellheads attached by
umbilical connections, which may be single wells or a manifold center for
multiple wells. An umbilical cable supplies necessary requirements to an
apparatus.





Services





We
provide a wide variety of project engineering and management services, including
the design, installation and retrieval of subsea equipment and systems,
connection and termination operations and commissioning.  We pride
ourselves on the ability to collaborate with the engineering departments of oil
and gas operators, installation contractors and subsea equipment manufacturers
to find the quickest, safest, and most cost-effective solutions to address all
manner of issues in the subsea world.  We also provide installation,
retrieval, storage and management services in connection with the use of our
products.





Project Management.
Our installation management team specializes in deep water subsea developments.
We are often contracted by our customers to assist with the preparation and
evaluation of subsea development bids and requests for quotes.  Our
experience comes from working with installation contractors, oil and gas
operators, controls suppliers, umbilical manufacturers and other subsea
equipment manufacturers, who often hire us to help ensure that a project
progresses smoothly, on time and on budget.





Project
Engineering.  Our engineers have experience ranging from the
initial conceptual design phases through manufacturing and installation, and
concluding with topsides connections and commissioning.  Our
experience provides us with a level of “hands on” and practical understanding
that has proven to be indispensable in enabling us to offer customer solutions
to the many problems encountered both subsea and topsides.  Because of
our wide knowledge base, our engineering team is often hired by oil and gas
operators, installation contractors and subsea equipment manufacturers to
provide installation management and engineering support services.  Our
engineering team has been involved in most of the innovative solutions used
today in deepwater subsea systems.  We specialize in offshore
installation engineering and the writing of practical installation
procedures.  We deal with issues involving flying leads, compliant
umbilical splices, bend stiffener latchers, umbilical hardware, hold-back
clamps, and the development of distribution system components.  We are
heavily involved in the fabrication of installation aids to simplify offshore
executions, and offer hydraulic, fiber optic, and electrical testing services
and various contingency testing tools.









-5-




Installation Support and
Management.  Our installation management services are centered
around the utilization of standardized hardware, proven, well-tested
installation techniques, and an experienced, consistent team that has proven to
be safe and skilled in all aspects of the installation process.  We
pride ourselves on supporting installation contractors through our installation
management and engineering services, installation aids and equipment, and our
offshore installation support services, including spooling operations, offshore
testing, and flying lead installation support.  Many installation
contractors find it beneficial to utilize our services to help reduce on-board
personnel since our specialized technicians can perform multiple tasks. We
have designed and fabricated many different installation tools and equipment
over the years. We have been involved in the design of the following pieces of
equipment to help make installations run as smoothly as
possible:  steel flying leads, steel flying lead deployment systems,
umbilical hardware and termination systems, umbilical bell mouths, lay chutes,
rapid deployment cartridges, horizontal drive units, mud mats, flying lead
installation and parking frames, umbilical termination assembly stab & hinge
over systems, and numerous other pieces of offshore equipment.  Our
team has vast experience with the installation of flexible and rigid risers and
flowlines, umbilicals, flexible and rigid jumpers, steel tube and thermoplastic
hose flying leads, pipeline end terminations (“PLETs”) and
manifolds.





Spooling.  Our
experienced personnel are involved in the operation of spooling equipment on
many projects, including operations for other companies to run their spooling
equipment.  We have developed a very efficient (in both time and cost)
system for spooling, utilizing our horizontal drive units, under-rollers,
tensioners, carousels and rapid deployment cartridges.





Pull-In
Operations.  We are involved in the pull-in operations for most
of the major umbilical projects in the Gulf of Mexico.  Our
familiarity with offshore systems is important, and our pull-ins run smoothly
because the same engineers who plan the pull-in operations are also involved in
supervising the offshore operations.  Our offshore servicemen comprise
the topside umbilical support team and are familiar with the umbilical
termination hardware.  These same servicemen are often involved in
terminating the umbilicals at the manufacturers’ yard several weeks prior to the
installation.  Everything is thoroughly tested prior to installation,
including winches at the rental contractor’s yard and after set-up on the
platform. Load cells are tested onshore, and the same load cells are used to
test the system offshore. This eliminates variables and validates the condition
of the pull-in system.  We then perform pull-ins under more controlled
conditions with increased confidence, resulting in safer
operations.





Terminations.  Deep
Down and members of its team have been involved in umbilical terminations since
1988.  The Company’s team was involved with the designs for the
armored thermo plastic umbilicals at Multiflex, the first steel tube umbilical
in the Gulf of Mexico for the Shell Popeye® umbilical, and the standardization
of many steel tube umbilical terminations.   We have also
pioneered the concept of the compliant Moray® section that enables a traditional
helically wound umbilical to be used for direct well step outs, or long field
flying leads.  Our management believes we are the only company that
can terminate umbilicals provided by any manufacturer with the same termination
system.





Testing
Services.  Umbilical manufacturers, control suppliers,
installation contractors, and oil and gas operators utilize our services to
perform all aspects of testing, including initial Factory Acceptance Testing
(“FAT”), Extended Factory Acceptance Testing (“EFAT”) and System Integration
Testing (“SIT”), relating to the connecting of the umbilical termination
assemblies, the performing of installations, and the completion of the
commissioning of the system thereafter.  To execute these services, we
have assembled a variety of personnel and equipment to ensure that all testing
operations are done in the safest and time-efficient manner, ensuring a reduced
overall project cost.  We also work hard to utilize the most detailed
digital testing and monitoring equipment to ensure that the most accurate data
is provided to our clients.  As far as testing is concerned, we have
been hired to perform coiled tubing flushing, cleaning, and hydro testing,
umbilical filling, flushing, pressure, flow rate, and cleanliness testing, load
out monitoring and testing, installation monitoring, post installation testing;
system commissioning, umbilical intermediate testing, and umbilical termination
assembly cleanliness, flow, and leak testing.  We believe we have one of
the best filling, flushing and testing teams in the business. Deep Down employs
a variety of different pumping systems to meet industry needs and offers maximum
flexibility.  Deep Down’s philosophy is to flush through the maximum
number of lines at the highest flow rate possible to maximize
efficiency.  We have assembled a comprehensive list of offshore
pumping units and an assortment of chemical pumping skids.  Our
equipment can be used to pump all of the standard offshore water based chemicals
as well as all offshore commissioning fluids such as Methanol and
diesel.  The Company has been involved in the design, procurement,
testing, installation, and operation of the testing equipment.  Deep
Down’s engineers and service technicians can also assist in writing the testing
procedures and sequences from simple FAT to very extensive multiple pressures
and fluids testing up to full system SIT procedures.




-6-


System Integration
Testing.  We have led the revolution into the digital age with
our use of digital transducers to provide much greater levels of accuracy
compared to information gathered off of conventional chart recorders. We have a
wide variety of digital pressure transducers, flow meters, and temperature
gauges. We have two wire data systems (4 port and one 16 port) as well as 25
individual digital pressure and temperature recorders that are often employed
for installation monitoring activities. In addition to these units, the Company
also has three desks set up with data systems that are capable of tracking from
4 to 15 individual sensors simultaneously. This, in combination with subsea
handling equipment, experienced personnel, and a fully equipped facility, render
Deep Down ideal for managing SIT operations.





Commissioning.  Deep
Down has been involved in most of the topside connections and commissioning
projects in the Gulf of Mexico since its formation in 1997.  Our
commissioning team is often identified early in the project and participates in
all aspects of planning and risk assessment for the project.  Due to
the limited time associated with project commissioning, it is extremely
important to perform detailed planning and engineering prior to arrival at the
offshore production platform location to reduce any possible shut in or down
time.  Our engineers and technicians work closely with the project
managers and production platform engineers to help ensure that all aspects of
the installation or retrieval project, including potential risks and dangers,
are identified, planned for, and eliminated prior to arrival on the production
platform.  Due to the different requirements for testing and
commissioning of subsea systems, we have an assortment of pumps and equipment to
deploy to ensure a safe and efficient commissioning program.  We have
experience handling all types of commissioning fluids, including asphaltine
dispersants, diesel, methanol, xylene, corrosion inhibitors, water-based control
fluids, oil-based control fluids, 100% glycol, paraffin inhibitors, and
alcohol.





Storage
Management.  With more than 50,000 square feet of internal high
quality warehousing capacity and 300,000 square feet of external storage, our
facility in Channelview is strategically located to cover Houston's Ship Channel
area.  Our warehouse is designed to provide clients with flexible and
cost effective warehousing and storage management options. Our professional and
experienced warehouse staff, combined with the very latest in information
technology, results in a fully integrated warehousing package designed to
deliver clever solutions to client needs. Among other capabilities, we are
capable of providing long-term specialized contract warehousing; long and short
term storage; modern materials handling equipment; undercover loading areas;
quality security systems; integrated inventory management; packing and
repacking; computerized stock controls; and labeling.





Products





We
provide installation support equipment and component parts and assemblies for
subsea distribution systems.  We believe the key to successful
installations of hardware is to design the subsea system by considering
installation issues first, working backwards to the design of the hardware
itself.  This is why we have been instrumental in the development of
hardware and techniques to simplify deep water installations.  We
design, manufacture, fabricate, inspect, assemble, test and market subsea
equipment, surface equipment and offshore rig equipment that are used by major
integrated, large independent and foreign national oil and gas companies in
offshore areas throughout the world.  Our products are used during oil
and gas exploration, development and production operations on offshore drilling
rigs, such as floating rigs and jack-ups, and for drilling and production of oil
and gas wells on offshore platforms, tension leg platforms and moored vessels
such as floating production storage and offloading vessels
(“FPSO”).  We have significant involvement in umbilical and steel
flying lead installations in the Gulf of Mexico and throughout the
world.  A few of our major product lines are highlighted
below.





Flying
Leads.  We have developed a method to pull individual steel
tubes, hoses, or electrical cables to create a loose steel tube flying lead or
short umbilical.  We can manufacture steel flying leads up to 10,000
feet in length with any J-plate desired, with or without electrical cables
included.  We have built flying leads with up to 14
tubes.  Additional lines or electrical and fiber optic cables can be
added to produce any combination required for the transportation of various
fluids, chemicals or data.  The flying leads are then fitted with our
terminations and Morays® that are attached to the multiple quick connection
plate, and finished off with the our elastomeric bend limiters.  The
non-helix wound design allows for our flying leads to be very installation
friendly with minimal-bending stiffness.  A compliant Moray® consists
of a 20-foot flexible flying lead with an electro-hydraulic Moray® that is
connected to a full-sized umbilical with the installation tension being applied
through an armor pot and slings extending by the compliant section.  A
Moray® is the termination head on the flying lead and connects the tubing
assembly to the junction plate.





Bend Stiffener
Latchers. Our spring-loaded bend stiffener latcher is used in dynamic
installations on floating vessels.  Umbilical stiffener latching
mechanisms have always caused installation problems as well as expensive diver
operations for expansion developments. We believe we have conceived the very
first remote operated vehicle (“ROV”) installable latching
mechanism.  During the umbilical installation, the bend stiffener
latcher can be latched in with a ROV and the umbilical can be pulled up the
remaining distance and hung off.  This allows the bend stiffener
latcher to fit onto an existing flange, completely eliminating the need for
divers both prior to and during the installation.  The bend stiffener
latcher can be designed to fit onto any existing flange on the bottom of an
existing I-tube.





-7-


Umbilical Hardware.
Our operational team has been involved in more umbilical installations than
probably any other team in the industry.  Our blend of experiences
with drilling contractors, umbilical manufacturers, subsea engineers and
installation contractors has been effective in positioning us to act on behalf
of the oil and gas operator to ensure key hardware installation is performed in
the most efficient and safe manner.  This breadth of experiences gives
us a unique perspective when fabricating and designing terminations for
umbilical manufacturers.  Our designs are often much lighter in weight
and smaller than the typical hardware that has been created and used in the past
by our competitors.  Our engineering team has designed and fabricated
bending restrictors, armor pots, split barrels, tubing fittings and unions,
hinging umbilical splices and topsides terminations with our unique threaded
welded fittings, the compliant umbilical splice, and the bend stiffener
latcher.  Our umbilical hardware is effective in assisting our clients
with installation friendly techniques for deploying hardware on the ocean
floor.





Bend
Limiters.  We offer both electrometric and steel bend
limiters.  Due to our ability to design and manufacture bend limiters
in-house, delivery time is greatly reduced.  Steel bend limiters are
typically utilized for steel tube umbilicals and have been designed with a
simple and reliable hinged attachment system which significantly decreases
installation time.  Electrometric bend limiters are typically provided
for small diameter umbilicals or flying leads, as well as for their compliant
umbilical section, which turns a traditional umbilical into a ROV- friendly,
installable flying lead.





Umbilical
Splice.  We have created a unique method of converting spare
umbilicals into actual production umbilicals by splicing spare umbilicals
together to produce any length required.  This allows oil and gas
operators to save significant costs through utilization of existing capital
investments in spare umbilicals and the reduction of field development costs and
delivery time.  This methodology is achieved through our Compliant Splice,
which is a patent-pending termination system that eliminates the burdens of
dealing with umbilical splices during installation.  This design is
capable of housing both electrical and fiber optic Fiber Termination Assemblies
while still allowing for the splice to be spooled up onto a reel or carousel. An
optional mud mat is used to assist in carrying the splice over the chute and
functions to keep the splice out of the mud for easy inspection.





SeaStax®.  SeaStax
embodies our concept for offshore storage and space management to help optimize
available deck space on offshore installation vessels and
platforms.  The key philosophy behind SEASTAXTM is to take common
offshore items and store them in a standard sized container to allow for the
storage system to be stackable and interchangeable in subsurface
conditions.  The current system utilizes newly designed 550 gallon
tote tanks, baskets, and tool boxes that are all inter-changeable and
stackable.  Using common dimensions and designs allows a variety of
different items to all be commonly stored and stacked, to minimize required
storage area.  The stacking philosophy can be applied to other custom
applications if required. In order to maximize accessibility and to reduce
maintenance, a variety of options are available such as galvanizing, ladders,
and drip pans.





Installation
Aids.  To help our clients and to meet our own internal needs,
we have developed an extensive array of installation aids, including steel
flying lead installation systems, a 5 ton Caterpillar® tensioner, a 10-foot
radius lay chute with work platform, many varieties of buoyancy, clump
weights, VIV strakes, mud mats, dual tank skids, gang boxes, work vans,
pumping and testing skids, control booths, fluid drum carriers, crimping
systems, load cells,  300 and 340 - ton under-rollers, a 200 - ton
carousel, UTA running and parking deployment frames, termination
shelters, pipe straightners, ROV hooks and shackles, stackable SeaStax
tanks, baskets, and boxes, and ballgrab rental rigging.





Services
and Products from Acquisitions





Through
our acquisitions of Mako and ElectroWave we have further increased our service
and product offerings.  Several of such increased offerings are
described below.





Mako





Headquartered
in Morgan City, Louisiana, Mako serves the growing offshore petroleum and marine
industries with technical support services and products vital to offshore
petroleum production.  Mako’s offerings are primarily, through rentals
of its remotely operated vehicles ("ROV"), topside and subsea equipment, and
support systems used in diving operations, maintenance and repair operations,
offshore construction, and environmental/marine surveys.


-8-


Diving Equipment
Rental.  Mako employs a permanent staff of highly qualified
technicians and mechanics to maintain and refurbish its equipment in between
rentals.  Mako carries a wide array of equipment to service the diving
industry including water blasting equipment, breathing air dive
compressors, hot water units with feed pumps, man rider winches, hydraulic
tools and hose reels, underwater video units, sonar units, magnetic
gradiometers, dive radios, lift bags, volume tanks, decompression
chambers, hot water pressure washers, and saturation systems.





Offshore Construction
Equipment Rental.  Mako carries a wide array of equipment to
service the offshore construction industry, including air compressors, air
tuggers, blasting equipment, jet pumps, personnel baskets, air tools, welding
machines, diesel pumps, and air pumps.





ROV Equipment
Rental.  Mako provides the latest ROV tooling technology as
part of its rental fleet.  Mako's ROV tooling rental fleet is
constantly growing, with the addition of tools as they are requested by our
customers.  Mako has, as part of its rental inventory, a 2000-foot
depth-rated inspection / light work class remotely operated vehicle (ROV)
complete with a control van and launch / recovery system.  Mako also
has, as part of its inventory, a 300 meter depth-rated Seaeye Falcon and a 1500
meter depth rated Seaeye Lynx observation class ROV.  ROV services
offered by Mako include platform inspection [Level I, II and III, jack-up and
template], platform installation and abandonment, surveys [environmental,
pipeline existing and as built, oceanographic, nuclear and hydroelectric],
search and recovery, salvage, subsea intervention [hot stab operations, torque
tool, well, pipeline commissioning, and stack landings], telecommunication cable
inspections [existing and as built], research [fisheries, scientific and marine
archeology], anchor handling [mooring and anchor chain monitoring], ROV
consulting and project management, ROV pilots and technicians, and underwater
cinematography.  Mako provides an extensive line of ROV tools, ROV
clamps and ROV-friendly hooks and shackles.  Mako’s torque tools are
state-of-the-art in design.





Environmental Equipment
Rental.  Mako offers a line of equipment that is specifically
designed and built to service the demanding requirements of the environmental
industry.  Systems are built in-house, housed on skids and include
protective frames to ensure that the equipment is well suited for the job
site.  All rental equipment goes through extensive cleanup and
overhaul between rentals, ensuring that when it arrives on site, its ready to go
and will perform reliably.





Marine
Surveys.  Mako provides the offshore industry with a responsive
marine survey service.  Mako’s surveyors have extensive experience in
the marine industry, and provide a reliable and timely service, encompassing
on-and-off hire surveys, damage surveys, engine surveys, loading / securing of
cargo (warranty), trip and tow, suitability surveys, valuation surveys, hull
audio gauging, owner representatives, and regulatory vessel
compliance.





ElectroWave





ElectroWave
offers products and services in the fields of electronic monitoring and control
systems for the energy, military, and commercial business sectors.
 ElectroWave designs, manufactures, installs, and commissions integrated
Programmable Logic Controller (“PLC”) and Supervisory Control and Data
Acquisition (“SCADA”) based instrumentation and control systems, including
ballast control and monitoring, drilling instrumentation, vessel management
systems, marine advisory systems, machinery plant control and monitoring
systems, and closed circuit television systems.  ElectroWave can take
projects from conceptual/system design through installation, commissioning, and
support. ElectroWave's understanding of system requirements and its ability to
quickly understand its customer’s needs allows them to produce quality products
and services on time and on budget.





ElectroWave
has supplied equipment on drilling production rigs operating throughout the
world including Abu Dhabi, Angola, Australia, Azerbaijan, Brazil, Congo, Dubai,
Egypt, Equatorial Guinea, India, Indonesia, Kuwait, Mexico, Nigeria, Norway,
Russia, the United Kingdom, United States, Vietnam, and other
areas. ElectroWave is also a supplier of integrated marine systems for
ships with design, manufacture, and delivery of machinery plant control and
monitoring systems and/or alarm monitoring systems for 3 Molinari Class Staten
Island ferries, a United States Coast Guard ice breaker, one of the worlds
largest hopper dredges, and other vessels.





Below are
some of ElectroWave’s major products:





Drillers Display
System.  ElectroWave has two proprietary drillers display
systems.  One of the proprietary systems was provided by one of our
customers and is installed only on that customer’s rigs.  The other
proprietary drillers display system was developed internally and is installed in
rigs worldwide. Drillers display systems allow the driller to keep an eye
on all the important parameters required for monitoring activity. Viewing of mud
pits, trip pits, flow rates, weight on bit, hook load, and other activities are
available to the driller at a glance. Logging software provides data analysis at
a whole new level, bringing more efficient drilling operations and increased
production from each working rig. Over 30 of these systems are installed on
our customers' rigs world wide, having over 800 rig-months of operating time,
over 1 million hours of cumulative up-time, with a total down time of 2.5
hours.  Our two largest customers for ElectroWave’s drillers display
systems are Transocean Offshore and Diamond Offshore Drilling.







-9-


Machinery Plant Control
System.  The Machinery Plant Control and Monitoring Systems
(MPCMS) allow the operators of a vessel to reduce manning requirements by
integrating all of the machinery controls and monitoring systems into one. The
MPCMS can reduce the number of crew on one vessel by more than 50%, allowing the
vessel owner to save personnel expenses or allocate personnel to more critical
areas.  ElectroWave's largest MPCMS system consists of over 5,000
points, consisting of hard wired sensors, contacts, and data over industrial
protocols such as Ethernet, Modbus, and Profibus.  We have integrated
systems such as fire, flooding, ballast, fueling, bridge, propulsion, engines,
HVAC, deck machinery, air systems, emergency generators, lighting, and more,
into one system.  An entire vessel can now almost be operated from one
station by a very minimal crew.  Our MPCMS is currently in use on the
United States Coast Guard Ice Breaker Mackinaw.





Ballast
Console.  ElectroWave designs replacement ballast control
consoles for a number of customers. The consoles they are replacing have fallen
out of service and are typically only partially functioning. ElectroWave first
sends out a technician to perform a "site survey" during which our technician
will take copious notes about the existing installation, all of the wiring, and
any manuals that exist for the system. Our team then brings this information
back to our facility where we design replacement consoles that fit exactly where
the old console was, reducing hot work and re-wiring.  After designing
a new console, drawings are sent to the rig managers, electricians, and company
electricians for verification. After drawings are verified, the console is
released for production. Upon receiving the console at our factory, our
electricians (some of which are ex-rig electricians) wire the console to match
the old system wiring. After through testing at our factory, the console is
shipped to the customer where it is installed by our field service personnel.
The new console is wired to operate exactly like the old system to reduce
re-training of ballast control officers and rig hands. After the console is
commissioned, our technicians will provide any support and training necessary
before leaving the site.  We have installed ballast control systems
that are full touch screen capable, operating over 80 valves and more than 30
tanks. We have these type systems installed on the Coast Guard Ice Breaker
Mackinaw, and the 3 Molinari Class Staten Island Ferries, the Molinari, Marchi,
and Spirit of America.





CCTV
System.  ElectroWave has tackled some very difficult CCTV
security and monitoring requirements.  Post-911, the New York
Department of Transportation (NYDOT) wanted cameras to watch every available
compartment of their three new ferries. ElectroWave stepped up to the challenge
and provided NYDOT one of the most sophisticated CCTV systems available on
passenger transportation ferries. A system of cameras, coupled with digital
video recording, allow post-event tracing and security on one of the most-used
transportation devices in New York.  CCTV is more than just security,
many (if not all) oil rigs have CCTV systems installed to keep an eye on the
safety of those working on the rig.  Cameras watch unmanned spaces,
machinery spaces, and potential hazard zones for trouble. This helps to keep the
manning requirement on the rigs to a minimum while allowing for a safer working
environment.  ElectroWave typically provides Pelco camera systems, but
is capable of integrating existing camera systems into new CCTV installations.
ElectroWave has also developed hardware and software in-house to allow the use
of Pan/Tilt/Zoom cameras from hazardous locations where PTZ keyboards cannot be
installed.





Ballast Monitoring
System.  ElectroWave has designed and implemented numerous
ballast monitoring systems.  A ballast monitoring system is a method
of displaying the contents of the tanks on board the vessel.  The
systems provided by ElectroWave ranges from simple racks of bubbler style
display units to integrated PLC touch screen systems visible throughout the
vessel. ElectroWave has also offered automated tank reporting systems with our
electronic PLC monitoring systems, allowing the operators to keep a liquid load
sheet available at any time.





Active Heave
Compensation.  ElectroWave was approached to implement an
algorithm to perform Active Heave Compensation. An "Active Heave Compensator",
or AHC, is designed to reduce or eliminate (in this case eliminate) the effects
of vessel heave during overboarding operations. This means that a package can be
held at a specific location in the water without the motion of the vessel on the
waves affecting the position of the package.  The customer identified
the operational tolerance of the system to be 6" of movement of the package with
vessel heave of approximately 20 feet. The system that was implemented is
accurate to 0.6" of package movement with vessel heave up to 30 feet.
ElectroWave always delivers products to the best of our ability, often exceeding
customer requirements and expectations.  ElectroWave implemented an
Allen Bradley PLC system to take data from a Motion Reference Unit (MRU) and
drive hydraulic actuators to compensate for the movement of the
vessel.


-10-


Manufacturing





Our
manufacturing facilities are in Channelview, Texas, a suburb of Houston, where
we conduct a broad variety of processes, including machining, fabrication,
inspection, assembly and testing. Our Manufactured Systems Division is devoted
to the design, manufacturing, testing, and commissioning of heavy equipment used
in both on- and offshore operations in a variety of markets and industries. The
manufacturing personnel have over 50 years of combined experience serving
commercial, government, military and academic customers in a variety of
applications. The facilities encompass over 8 acres, with approximately
60,000 square feet of manufacturing space with 4 overhead cranes and 7,000
square feet of office space. The Company is ideally located with great access to
both I-10 and the Houston Ship Channel. The facilities have 120V, 240V and 480V
power.  Our manufacturing plant is ISO 9001 and American Petroleum
Institute certified.





Our
manufacturing facility utilizes state-of-the-art computer numerically controlled
("CNC") machine tools and equipment, which contribute to the Company's product
quality and timely delivery.  We maintain our equipment and tooling in
good working condition and upgrade our capabilities as needed to enhance the
cost-efficient manufacture of our specialized products. We purchase quality used
machine tools and equipment as they become available and store them at our
facility to be rebuilt, upgraded or refurbished as needed.  We
maintain our high standards of product quality through the use of quality
assurance specialists who work with product manufacturing personnel throughout
the manufacturing process and inspect and document equipment as it is processed
through the Company's manufacturing facility.  We have the capability
to manufacture various products from each of our product lines at our major
manufacturing facility and believe that this localized manufacturing capability
is essential in order to compete with our major competitors.  We
maintain valuable relationships with several other companies that own additional
fabrication facilities in and around Houston, Texas.  These other
companies provide excellent subcontract manufacturing support on an as-needed
basis.  Our manufacturing process includes heat treatment, machining,
fabrication, inspection, assembly and testing.  Our primary raw
material is steel. We routinely purchase raw materials from many suppliers on a
purchase order basis and do not have any long-term supply
contracts.





Customers





Demand
for our deep water equipment, surface equipment and offshore rig equipment and
services is substantially dependent on the condition of the oil and gas industry
to invest in substantial capital expenditures as well as continual maintenance
and improvements on its offshore exploration, drilling and production
operations. The level of these expenditures is generally dependent upon various
factors such as expected prices of oil and gas, exploration and production costs
of oil and gas, the level of offshore drilling and production
activity.  The prevailing view of future oil and gas prices are
influenced by numerous factors affecting the supply and demand for oil and
gas.  These factors include worldwide economic activity, interest
rates, cost of capital, environmental regulation, tax policies, and production
levels and prices set and maintained by producing nations and
OPEC.  Capital expenditures are also dependent on the cost of
exploring for and producing oil and gas, the sale and expiration dates of
domestic and international offshore leases, the discovery rate of new oil and
gas reserves in offshore areas and technological advances. Oil and gas prices
and the level of offshore drilling and production activity have historically
been characterized by significant volatility.





Our
principal customers are major integrated oil and gas companies, large
independent oil and gas companies, foreign national oil and gas companies,
subsea equipment manufacturers and subsea equipment installation contractors
involved in offshore exploration, development and
production.  Offshore drilling contractors, engineering and
construction companies, the military and other companies involved in maritime
operations represent a smaller customer base.  Our customers include
Acergy SA; Aker Kvaerner ASA; Amerada Hess Corporation; Anadarko Petroleum
Corporation; Atlantic Shipyard; BHP Billiton Limited; BP PLC; Cabett Subsea
Products, Inc.; Cal Dive International, Inc.; Cameron International Corporation;
Chevron Corporation; Devon Energy Corporation; Diamond Offshore Drilling, Inc.;
Dril-Quip, Inc.; Duco Inc.; ExxonMobil Corporation; Helix Energy Solutions Group
Inc.; JDR Cable Systems (Holdings) Ltd; Kerr McGee Corporation; Marathon Oil
Corporation; Marinette Marine Corporation; Nexen Inc.; Noble Energy Inc.;
Oceaneering International, Inc.; Oil States Industries, Inc.; Royal Dutch Shell
PLC; Schlumberger Limited; Subsea 7, Inc.; Technip USA Holdings, Inc.;
TransOcean Offshore Inc.; United States Coast Guard; Veolia Environmental
Services, Inc. and United States Navy.





We are
not dependent on any one customer or group of customers. The number and variety
of our products required in a given period by a customer depends upon their
capital expenditure budget as well as the results of competitive bids.
Consequently, a customer may account for a material portion of revenues in one
period and may represent an immaterial portion of revenues in a subsequent
period. While we are not dependent on any one customer or group of customers,
the loss of one or more of its significant customers could, at least on a
short-term basis, have an adverse effect on the results of
our operations.


-11-


Marketing
and Sales





We market
our products and services throughout the world directly through our sales
personnel in our corporate headquarters in Channelview, Texas. We periodically
advertise in trade and technical publications of our customer
base.  We also participate in industry conferences and trade shows to
enhance industry awareness of our products and services.  Our
customers generally order products and services after consultation with us on
their project.  Orders are typically completed within two weeks to
three months depending on the type of product or service.  Larger and
more complex products may require four to six months to complete.  Our
customers select our products and services based on the quality, reliability and
reputation of the product or service, price, timely delivery and advance
technology.  For large drilling and production system orders, we
engage our project management team to coordinate customer needs with
engineering, manufacturing and service organizations, as well as with
subcontractors and vendors.  Our profitability on projects is
dependent on performing accurate and cost effective bids as well as performing
efficiently in accordance with bid specifications.  Various factors
can adversely affect our performance on individual projects that could
potentially adversely affect the profitability of a project.





Product
Development and Engineering





The
technological demands of the oil and gas industry continue to increase as
offshore exploration and drilling operations expand into deeper and more hostile
environments.  Conditions encountered in these environments include
well pressures of up to 15,000 psi, mixed flows of oil and gas under high
pressure that may also be highly corrosive, and water depths in excess of 5,000
feet.  We are continually engaged in product development activities to
generate new products and improve existing products to meet our customers’
specific needs.  We also focus our activities on reducing the overall
cost to the customer, which includes not only the initial capital cost but also
operating costs associated with its products.





We have
an established track record of introducing new products and product
enhancements.  Our product development work is conducted at our
facilities in Channelview, Texas and in the field.  Our application
engineering staff also provides engineering services to customers in connection
with the design and sales of our products.  Our ability to develop new
products and maintain technological advantages is important to our future
success.





We
believe that the success of our business depends more on the technical
competence, creativity and marketing abilities of our employees than on any
individual patent, trademark or copyright.  Nevertheless, as part of
our ongoing product development and manufacturing activities, our policy is to
seek patents when appropriate on inventions concerning new products and product
improvements.  All patent rights for products developed by employees
are assigned to us.





Competition





The
principal competitive factors in the petroleum drilling and production and
maritime equipment markets are quality, reliability and reputation of the
product, price, technology, the ability to provide quality service and timely
delivery.  We face significant competition from other manufacturers of
exploration, production and maritime equipment.  Several of our
primary competitors are diversified multinational companies with substantially
larger operating staffs and greater capital resources and have a longer history
in the manufacturing.  We compete principally with Dynacon, FMC,
Halliburton Product Pipeline Services, Kvaerner, Norson, Ocean Works,
Oceaneering, VFL, and Halliburton Product Pipeline Services on our umbilical
services; Dynacon, Ocean Works and Odem on our Launch and Recovery Systems; and
Entech, Technip, Manatec and Pegasus on our installation management
services.





Employees





We have
94 employees as of March 31, 2008.  Our employees are not covered by
collective bargaining agreements and we consider our employee relations to be
good.  Our operations depend in part on our ability to attract a
skilled labor force.  While we believe that our wage rates are
competitive and that our relationship with our skilled labor force is good, a
significant increase in the wages paid by competing employers could result in a
reduction of our skilled labor force, increases in the wage rates that we pay or
both.





Governmental
Regulations





A
significant portion of our business activities are subject to federal, state,
local and foreign laws and regulations and similar agencies of foreign
governments.  The technical requirements of these laws and regulations are
becoming increasingly expensive, complex and stringent.  These regulations
are administered by various federal, state and local health and safety and
environmental agencies and authorities, including the Occupational Safety and
Health Administration of the U.S. Department of Labor and the U.S. Environmental
Protection Agency.  From time to time, we are also subject to a wide range
of reporting requirements, certifications and compliance as prescribed by
various federal and state governmental agencies. Expenditures relating to such
regulations are made in the normal course of our business and are neither
material nor place us at any competitive disadvantage. We do not currently
expect compliance with such laws will require us to make material
expenditures.





-12-


We are
also affected by tax policies, price controls and other laws and regulations
relating to the oil and gas industry generally, including those specifically
directed to offshore operations.  Adoption of laws and regulations
that curtail exploration and development drilling for oil and gas could
adversely affect our operations by limiting demand for our services or
products.





Increased
concerns about the environment have resulted in offshore drilling in certain
areas being opposed by environmental groups, and certain areas have been
restricted.  To the extent that new or additional environmental
protection laws that prohibit or restrict offshore drilling are enacted and
result in increased costs to the oil and gas industry in general, our business
could be materially affected.  In addition, these laws may provide for
"strict liability" for damages to natural resources or threats to public health
and safety, rendering a party liable for the environmental damage without regard
to negligence or fault on the part of such party.  Sanctions for
noncompliance may include revocation of permits, corrective action orders,
administrative or civil penalties and criminal prosecution.  Certain
environmental laws provide for joint and several strict liabilities for
remediation of spills and releases of hazardous substances.  In addition,
companies may be subject to claims alleging personal injury or property damage
as a result of alleged exposure to hazardous substances, as well as damage to
natural resources.  Such laws and regulations may also expose us to
liability for the conduct of or conditions caused by others, or for our acts
that were in compliance with all applicable laws at the time such acts were
performed.  Compliance with environmental laws and regulations may require
us to obtain permits or other authorizations for certain activities and to
comply with various standards or procedural requirements.





We cannot
determine to what extent our future operations and earnings may be affected by
new legislation, new regulations or changes in existing
regulations.  We believe that our facilities are in substantial
compliance with current regulatory standards.  Based on our experience
to date, we do not currently anticipate any material adverse effect on our
business or consolidated financial position as a result of future compliance
with existing environmental laws and regulations controlling the discharge of
materials into the environment.  However, future events, such as
changes in existing laws and regulations or their interpretation, more vigorous
enforcement policies of regulatory agencies, or stricter or different
interpretations of existing laws and regulations, may require additional
expenditures which may be material.





Item
2.                      Description
of Property.





Our
principal corporate offices and manufacturing space are located at 15473 East
Freeway, Channelview, Texas 77530.  We lease the Channelview property
which consists of approximately 10.998 acres of land with approximately 60,000
square feet of manufacturing space with four overhead cranes and 7,000 square
feet of office space.  We lease all buildings, structures, fixtures
and other improvements from JUMA, LLC, a company owned by Ronald E. Smith, CEO
and a director of Deep Down, Inc. and Mary L. Budrunas, a vice president and a
director of Deep Down, Inc.  The base rate of $11,000 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.





ElectroWave’s
offices and manufacturing space is located at the same location of Deep Down at
15473 East Freeway, Channelview, Texas 77530.  ElectroWave’s
facilities are also included in the lease with JUMA, LLC.





Mako
Technologies, LLC leases its property and buildings from Sutton
Industries.  Mako is located at 125 Mako Lane, Morgan City, LA
70380.  The lease is for 5 years beginning on June 1,
2006.  There is a 5 year option at the expiration of the initial
lease. At this location, Mako has its administrative offices and buildings
that serves as the support location for the Mako rental equipment.





Item
3.                      Legal
Proceedings.





We are
from time to time involved in legal proceedings arising from the normal course
of business. As of the date of this report, we are not currently involved in any
legal proceedings.





Item
4.                      Submission
of Matters to a Vote of Security Holders.





No matter
was submitted to vote of our security holders during the fourth fiscal quarter
covered by this report.


-13-


PART
II





Item
      5.
            Market
      for Common Equity, Related Stockholder Matters and Small Business Issuer
      Purchases of Equity Securities.





Market
for Common Stock





Our
common stock trades publicly on the OTC Bulletin Board under the symbol “DPDW.”
The OTCBB is a regulated quotation service that displays real-time quotes,
last-sale prices and volume information in over-the-counter equity securities.
The OTCBB securities are traded by a community of market makers that enter
quotes and trade reports. This market is extremely limited and any prices quoted
may not be a reliable indication of the value of our common stock.





Prior to
the reverse merger with MediQuip on December 14, 2006, no public market in our
common stock existed. See the discussion of the reverse merger under Corporate
History in Item 1 and in Note 1 “Nature of Business” of the notes to our audited
consolidated financial statements included elsewhere in this report. Beginning
December 14, 2006, our common stock was quoted on the OTC Bulletin Board. The
high and low bids for the period from January 1 to December 31, 2007 were $2.35
and $0.16, respectively. These quotes represent inter-dealer quotations, without
adjustment for retail mark-up, markdown or commission and may not represent
actual transactions.  The following table sets, for the periods
indicated, the high and low sales prices for our common stock as reported by the
OTC Bulletin Board.





High
            
            
            LowFiscal
      2007:December
      31, 2007
            
            $
            2.35
            
            
            $
            0.76September
      30, 2007
            
            $
            0.94
            
            
            $
            0.51June
      30, 2007
            
            $
            0.78
            
            
            $
            0.27March
      31, 2007
            
            $
            0.42
            
            
            $
            0.16Fiscal
      2006:December
      31, 2006
            
            $
            0.85
            
            
            $
            0.13




Holders





As of
March 31, 2008, there were approximately 1,077 holders of record of our common
stock and we believe there were approximately 6
beneficial owners.




Dividend
Policy




To date,
we have not paid any cash dividends and our present policy is to retain earnings
for use in our business.  Under the terms of a $13 million borrowing
facility from Prospect Capital Corporation, we are restricted from paying any
dividends on our common stock until such time as the borrowing facility is
repaid in full.


-14-


Equity
Compensation Plan Information




Plan
      Category
            
            Number
      of
              securities
              to
      be issued upon
              exercise
      of
              outstanding
              options,
              warrants
      and rights
            
            
            Weighted-average
              exercise
      price of
              outstanding
              options,
              warrants
      and
              rights
            
            
            Number
      of securities
              remaining
      available
              for
      future issuance
              under
      equity
              compensation
      plans
              (excluding
      securities
              reflected
      in first
              column)Equity
      compensation plans approved by securityholders
            
            
            5,500,000
            (1)
            
            
            $  0.49
            
            
            
            7,396,000
            (1)Equity
      compensation plans not approved by securityholders
            
            
            5,399,397
            (2)
            
            
            $  0.52
            
            
            
            N/ATOTAL
            
            
            10,899,397
            
            
            
            $  0.56
            
            
            
            7,396,000


____________


(1)
            Represents
      5,500,000 shares of common stock that may be issued pursuant to options
      granted and available for future grant under - the 2003 Directors,
      Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan
      (the “Plan”). Under the Plan the total number of options permitted is 15%
      of issued and outstanding shares of common stock.(2)
            Represents
      5,399,397 shares of common stock underlying warrants approved by the
      Company’s board of directors, consisting of 4,960,585 warrants granted to
      Prospect Capital Corporation and 320,000 warrants granted to a consultant
      as part of the $6.5 million borrowing facility entered into on August 6,
      2007, plus an additional 118,812 warrants granted to a consultant as part
      of the additional $6.0 million advanced under the amendment to that same
      borrowing facility effective December 31, 2007.  See Note 6 to
      our Consolidated Financial Statements for a detailed description of the
      terms of these warrants.




Recent
Sales of Unregistered Securities





On March
20, 2007, Deep Down completed the sale of 10,000,000 restricted shares of common
stock in a private placement for $1,000,000. A total of 1,025,000 shares were
purchased by the Chief Executive Officer and director, and his wife, a
Vice-President of Deep Down. Funds were used to redeem certain outstanding
exchangeable preferred stock and for working capital.





On March
20, 2007, Deep Down finalized the terms of an agreement with a former director,
who agreed to return 25,000,000 shares of common stock, 1,500 shares of Series F
convertible preferred stock, and 500 shares of Series G exchangeable preferred
stock to the treasury for cancellation in exchange for 1,250 shares of Series E
exchangeable preferred stock and $250,000 cash.  Separately, John C.
Siedhoff, former Deep Down Chief Financial Officer, agreed to exchange 1,500
shares of Series F convertible preferred stock and 500 shares of Series G
exchangeable preferred stock for 2,000 shares of Series E exchangeable preferred
stock.





On May
17, 2007, Deep Down executed a Securities Redemption Agreement with John C.
Siedhoff, former Deep Down CFO, to redeem 4,000 shares of Series E exchangeable
preferred stock at a discounted price of $500 per share for a total of
$2,000,000. 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 which is reflected as other income on
the statement of operations. Deep Down accreted the remaining discount of
$1,102,385 attributable to such shares on the date of redemption. On August 16,
2007, Deep Down made the initial payment of $1,400,000 under the terms of the
securities redemption agreement, and 2 payments of $20,000 each were made during
August and September 2007. The final balance due of $560,000 was paid with
543,789 shares of common stock on October 2, 2007.





On
September 17, 2007 Deep Down exchanged 2,250 shares ($2,250,000 aggregate face
value) of Series E Redeemable Exchangeable Preferred Stock from Ronald E. Smith,
president and chief executive officer of Deep Down, and Mary L. Budrunas,
director of Deep Down, for 2,250,000 shares of common stock.  The
Preferred Stock had a face value and liquidation preference of $1,000 per share,
no dividend preference, and was exchangeable at the holder’s option after June
30, 2007, into 6% subordinated notes due three years from the date of
exchange.


-15-


On
October 2, 2007, Ironman Energy Capital, L.P. agreed to purchase 3,125,000
restricted shares of common stock of the Company at $0.96 per share, or
$3,000,000 in the aggregate.  Proceeds were used primarily for working
capital and other general corporate purposes.





On
October 2, 2007, Deep Down exchanged 1,250 shares ($1,250,000 aggregate face
value) of Series E Redeemable Exchangeable Preferred Stock for 1,213,592 shares
of common stock.  The Preferred Stock had a face value and liquidation
preference of $1,000 per share, no dividend preference, and was exchangeable at
the holder’s option after June 30, 2007, into 6% subordinated notes due three
years from the date of exchange.





On
October 2, 2007, Deep Down agreed to eliminate an obligation to pay $20,000 per
month for the next 28 months, or an aggregate of $560,000, by exchanging this
obligation for 543,689 shares of common stock.  This obligation arose
out of a series of transactions as disclosed above on May 17, 2007.





On April
22, 2005, MediQuip issued 22,000 Series C convertible preferred stock which
remained after the reverse merger. The Series C shares had a face value and a
liquidation preference of $12.50 per share, a cumulative dividend of 7% payable
at the conversion date, and were convertible into shares of common stock
determined by dividing the face amount by a conversion price of $0.0625. These
shares carried no voting rights.  All of the Series C shares were
converted in the fourth quarter of fiscal 2007 to 4,400,000 shares of Deep
Down’s common stock.





Effective
December 1, 2007, Deep Down purchased 100% of the common stock of Mako
Technologies, Inc. (“Mako”), a Louisiana corporation.  The total
purchase price of Mako was $11,307,000. The first installment of $2,916,667 in
cash and 6,574,074 shares of common stock of Deep Down, valued at $0.76 per
share was paid on January 4, 2008, and the balance of $3,205,667 made up
of $1,243,578 in cash and 2,802,985 shares of common stock of Deep
Down valued at $0.70 will be paid by April 15, 2008.  The second
payment was based on verification of adjusted EBITDA amounts for Mako for
the fiscal year ending December 31, 2007.





In
January and March 2008, Deep Down issued 25,866,518 shares of common stock to
the holders of 5,000 shares of Series D preferred stock.  The Series D
preferred shares had a face and liquidation value of $5,000 per share and were
convertible into common stock at a conversion price of $0.1933 per
share.





Item
6.                      Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.





Corporate
History





During
2006, MediQuip Holdings, Inc. (“MediQuip”), a publicly traded Nevada
corporation, divested Westmeria Healthcare Limited, its wholly-owned operating
subsidiary, and subsequently acquired Deep Down, Inc., a Delaware corporation,
in a transaction that was accounted for as a reverse merger, with Deep Down
being the surviving entity for accounting purposes. The following discussion
describes the history of Deep Down.





On June
29, 2006, Subsea Acquisition Corporation (“Subsea”), a Texas corporation, was
formed with the intent to acquire offshore energy service providers, and
designers and manufacturers of subsea equipment, surface equipment and offshore
rig equipment that are used by major integrated, large independent and foreign
national oil and gas companies in offshore areas throughout the
world.





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





On
November 21, 2006, Subsea also acquired Deep Down, Inc., a Delaware corporation
which was founded in 1997. Under the terms of this transaction, Subsea acquired
all of Deep Down’s common stock in exchange for 5,000 shares of Subsea’s Series
D Preferred Stock and 5,000 shares of Subsea’s Series E Preferred Stock
resulting in Deep Down becoming a wholly-owned subsidiary of
Subsea.  The transaction was accounted for under SFAS 141, “Business
Combinations,” as a purchase as there was a change of control.  The
purchase price, based on the fair value of the Series D and E Preferred stock,
was $7,865,471.





Immediately
after acquiring Deep Down and SOS on November 21, 2006, Subsea merged with SOS,
with Subsea as the surviving company.  Immediately thereafter, Subsea
merged with Deep Down, with Deep Down as the surviving company.


-16-


On
December 14, 2006, after divesting its Westmeria Healthcare Limited subsidiary,
MediQuip acquired all 9,999,999 shares of Deep Down common stock and all 14,000
shares of Deep Down preferred stock for 75,000,000 shares of common stock and
14,000 shares of preferred stock of MediQuip. The preferred shares of MediQuip
were issued with the same designations as Deep Down’s preferred
stock.  As a result of the acquisition, the shareholders of Deep Down
owned a majority of the voting stock of MediQuip, which changed its name to Deep
Down, Inc.





On April
2, 2007, Deep Down acquired substantially all of the assets of ElectroWave USA,
Inc., a Texas corporation for a total purchase price of $171,407. Deep Down
formed a wholly-owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a
Nevada corporation, to complete the acquisition.  Headquartered in
Channelview, Texas, ElectroWave offers products and services involving
electronic monitoring and control systems for the energy, military, and
commercial business markets.





Effective
December 1, 2007, Deep Down acquired all of the common stock of Mako
Technologies, Inc. (“Mako”) for a total purchase price of $11.3 million
including transaction fees.  Deep Down formed a wholly-owned
subsidiary, Mako Technologies, LLC to complete the
acquisition.  Headquartered in Morgan City, Louisiana, Mako serves the
growing offshore petroleum and marine industries with technical support
services, and products vital to offshore petroleum production, through rentals
of its 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.





The
Company’s historical financial statements reflect those of Deep Down, Inc. and
its subsidiaries, and do not include the results of MediQuip or Westmeria
Healthcare Limited for periods prior to the reverse merger date of December 14,
2006.





Critical
Accounting Policies and Estimates





The
accompanying discussion and analysis of our financial condition and results of
operations is based upon our audited consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. Note 1 “Nature of Business and Summary of
Significant Accounting Policies” of the notes to our audited consolidated
financial statements included elsewhere in this report contains a detailed
summary of our significant accounting policies.  We utilize the
following critical accounting policies in the preparation of our financial
statements.




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




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




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




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




Key
assumptions used in the Black-Scholes model for both stock options and warrant
valuations include (1) expected volatility (2) expected term (3) discount
rate and (4) expected dividend yield. Since we do not have a sufficient trading
history to determine the volatility of our own stock, we based our estimates of
volatility on a representative peer group consisting of companies in the same
industry, with similar market capitalizations and similar stage of development.


The fair
value of each stock option or warrant grant is estimated on the date of the
grant using the Black-Scholes model and is based on the following key
assumptions for the year ended December 31, 2007:
  Dividend
      yield
              
              0%Risk
      free interest rate
              
              3.2%
      - 5.0%Expected
      life
              
              3 -
      4 yearsExpected
      volatility
              
              52.7%
      - 61.3%
  Revenue
Recognition  We generally recognize
revenue once the following four criteria are met:  (i) persuasive
evidence of an arrangement exists, (ii) delivery of the equipment has occurred
or services have been rendered, (iii) the price of the equipment or service is
fixed and determinable and (iv) collectability is reasonably
assured.  For certain fabrication projects, revenue is recognized upon
shipment or when customer-specific contract elements, (“milestone(s)”) are
met.   Fabrication and sale of equipment billings are contingent
upon satisfaction of a significant condition of sale milestone, including but
not limited to, factory acceptance testing (FAT) and customer approval, and
recognized upon transfer of title to the customer.   Service revenue
is recognized as the service is provided. Expenses incurred to date that exceed
milestone billings are adjusted during the month-end profitability review and
represent the balance in our work-in-progress (“WIP”) account on the
accompanying balance sheets.
 
 All
intercompany revenue accounts and balances were eliminated in consolidations
during the month-end profitability review.




-17-


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





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





Our
intangible assets consist of assets acquired in the purchase of the Mako
subsidiary and comprised of customer lists, non-compete covenants with key
employees and trademarks related to Mako’s ROVs.  We amortize the
intangible assets over their useful lives ranging from 5 to 25 years on a
straight line basis.





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





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





Pro-Forma
Results of Operations





On
November 21, 2006, Subsea, a company formed on June 29, 2006, acquired Deep
Down, Inc., which was founded in 1997. The transaction was accounted for as a
purchase according to SFAS 141, “Business Combinations”, as there was a change
of control.





As a
result, the audited financial results disclosed herein present operating results
for the period beginning November 21, 2006 and ending December 31, 2006, the
period after which Deep Down was acquired. Management believes this stub period
does not give a full view of the operations of Deep Down and, therefore, present
pro-forma results of operations. The following presentation and discussion of
the unaudited pro-forma consolidated results of operations has been prepared as
if the acquisition of Deep Down had occurred at January 1, 2006. The pro-forma
information is presented for informational purposes only and is not necessarily
indicative of the results of operations that actually would have been achieved
had the acquisition been consummated as of that time, nor is it intended to be a
projection of future results.


-18-


Deep
Down, Inc.


Pro-forma
Statements of Operations






Historical
      Results
            
            
            Unaudited
              Pro-formaYear
      Ended
            
            
            Year
      EndedDecember
      31, 2007
            
            
            December
      31, 2006Revenues
            
            $
            19,389,730
            
            
            $
            8,821,149Cost
      of sales
            
            
            13,020,369
            
            
            
            5,155,399Gross
      profit
            
            
            6,369,361
            
            
            
            3,665,750Operating
      expenses:Selling,
      general & administrative (1)
            
            
            4,284,553
            
            
            
            5,710,324Depreciation
            
            
            426,964
            
            
            
            166,468Total
      operating expenses
            
            
            4,711,517
            
            
            
            5,876,792Operating
      income (loss)
            
            
            1,657,844
            
            
            
            (2,211,042
            )Other
      income (expense):Gain
      on debt extinguishment
            
            
            2,000,000
            
            
            
            -Interest
      income
            
            
            94,487
            
            
            
            -Interest
      expense (2)
            
            
            (2,430,149
            )
            
            
            (578,335
            )Total
      other income (loss)
            
            
            (335,662
            )
            
            
            (578,335
            )Income
      (loss) before income taxes
            
            
            1,322,182
            
            
            
            (2,789,377
            )Income
      tax expense
            
            
            (369,673
            )
            
            
            (22,250
            )Net
      income (loss)
            
            $
            952,509
            
            
            $
            (2,811,627
            )Basic
      earnings per share
            
            $
            0.01
            
            
            $
            (0.04
            )Weighted-average
      shares outstanding
            
            
            73,917,190
            
            
            
            75,862,484Diluted
      earnings per share
            
            $
            0.01
            
            
            $
            (0.04
            )Weighted-average
      shares outstanding
            
            
            104,349,455
            
            
            
            75,862,484(1)
      Includes $3.3 million compensation expense from the issuance of Series F
      and G preferred shares in 2006.(2)
      Includes approximately $423,258 additional interest expense from the
      accretion of the Series E preferred shares in 2006.





-19-


The
following discussion of the unaudited pro-forma consolidated results of
operations has been prepared as if the acquisition of Deep Down had occurred at
January 1, 2006. The pro-forma information is presented for informational
purposes only and is not necessarily indicative of the results of operations
that actually would have been achieved had the acquisition been consummated as
of that time, nor is it intended to be a projection of future
results.





Revenues





2007
            
            Pro-Forma
      2006
            
            Change
            
            %Revenues
            
            $
            19,389,730
            
            $
            8,821,149
            
            $
            10,568,581
            
            
            119.8%




Revenues
increased by approximately $10.6 million, or 119.8% to $19.4 million for the
twelve months ended December 31, 2007 from approximately $8.8 million for the
comparable period in 2006. This increase was due primarily to a significant
increase in the Company’s core operations at its Deep Down Delaware subsidiary,
including increased revenue from the delivery of loose tube steel flying leads;
new products such as launch and retrieval systems and an active heave
compensated in-line winch system, winch system refurbishments, and increased
acceptance of newly developed installation procedures utilizing our rapid
deployment cartridges and subsea deployment baskets.  In addition, we
experienced increased levels of service activity related to installations and
recoveries of various subsea equipment.  These results were further
augmented by ElectroWave revenue of approximately $3.2 million for the nine
months since acquisition and Mako revenue of $0.8 million for the one month
since acquisition.





Cost of
sales





2007
            
            Pro-Forma
      2006
            
            Change
            
            %Cost
      of sales
            
            $
            13,020,369
            
            $
            5,155,399
            
            $
            7,864,970
            
            
            152.6%





As a
percentage of revenues, cost of sales increased to approximately 67.1% in 2007
from approximately 58.4% in 2006. Gross margins were impacted by increased
engineering and other costs associated with new product development, including
our new line of ProteusTM custom-engineered active heave compensated in-line
winches, deep water rated (4000 meter) launch and retrieval systems, and other
products in development. Management expects gross margins on these products to
increase on future orders.  Management also expects overall margins to
increase as a result of its recent acquisition of Mako’s rental and service
operations.





Selling, general and
administrative expenses





2007
            
            Pro-Forma
      2006
            
            Change
            
            %Selling,
      general and administrative
            
            $
            4,284,553
            
            $
            5,710,324
            
            $
            (1,425,771
            )
            
            -25.0%Stock
      based compensation expense
            
            
            (187,394
            )
            
            (3,340,792
            )
            
            3,153,398
            
            
            -94.4%Selling,
      general and administrative
            
            $
            4,097,159
            
            $
            2,369,532
            
            $
            1,727,627
            
            
            72.9%





Selling,
general and administrative expenses include rent, utilities, general office
expenses, insurance, personnel and other costs necessary to conduct business
operations.  Stock-based compensation expense of approximately $0.2
million in fiscal 2007 relates to stock option grants during fiscal 2007 to
various consultants and employees, and the $3.3 million stock-based compensation
expense for fiscal 2006 related to the Series F and G Preferred Stock which was
issued in exchange for the acquisition of 100% of the common stock of Strategic
Offshore Services Corporation.  See further discussion of the fiscal
2006 transaction in Corporate History above.





After
adjusting for the stock based compensation expense, selling, general and
administrative expenses for the year ended December 31, 2007 was approximately
$4.0 million, up approximately $1.7 million from $2.4 million for the comparable
period in 2006.  The increase is primarily the result of an increased
engineering staff to focus on the development of new products and quality
control, increased administrative personnel, increased sales staff, and
increased costs of functioning as a public company and pursuing acquisitions. As
a percentage of revenues, selling, general and administrative expenses decreased
to approximately 22% in 2007 from approximately 26.9% in 2006.


-20-


For
fiscal 2007, the consolidated selling, general and administrative expenses
were as follows: $1.7 million administrative payroll and benefits, $0.2 million
insurance cost, $0.8 million in accounting, legal and expenses related to public
company reporting requirements, $0.1 million in advertising and sales related
expenses, $0.9 million in rental, utility and general office expenses and $0.1
million in property and sales taxes.





Depreciation and
amortization expense





2007
            
            
            Pro-Forma
      2006
            
            
            Change
            
            
            %Depreciation
            
            $
            398,610
            
            
            $
            166,468
            
            
            $
            232,142
            
            
            
            139.5%Amortization
            
            
            28,354
            
            
            
            -
            
            
            
            28,354
            
            
            -Depreciation
      and amortization
            
            $
            426,964
            
            
            $
            166,468
            
            
            $
            260,496
            
            
            
            156.5%





Depreciation
increased by approximately $0.3 million, or 162.% to $0.4 million for the
twelve months ended December 31, 2007 from approximately $0.2 million for the
comparable period in 2006.  During fiscal 2007, we acquired
approximately $3.2 million in fixed assets through the acquisition of the Mako
subsidiary in December 2007 and approximately $45,500 in fixed assets in the
acquisition of ElectroWave in April, 2007.  Additionally, we
purchased approximately $0.8 million in fixed assets during fiscal 2007,
including a 100-ton mobile gantry crane valued at $0.5 million, under a capital
lease.





We
depreciate our assets using the straight-line method over the estimated useful
lives of the respective assets. Buildings are amortized over 36 years, and
leasehold improvements are amortized over the shorter of the assets' useful
lives or lease terms. Equipment lives range from two to seven years, computers
and electronic lives are from two to three years, and furniture and fixtures are
two to seven years.  Deep Down’s intangible assets consist of $4.4
million in specifically identified intangible assets acquired in the purchase of
the Mako subsidiary on December 1, 2007, specifically Mako’s customer list, a
non-compete covenant and trademarks related to Mako’s ROVs.  We are
amortizing the intangible assets over their estimated useful lives on the
straight line basis between five and twenty five years.





Interest
expense





2007
            
            
            Pro-Forma
      2006
            
            
            Change
            
            
            %Cash
      interest expense
            
            $
            594,667
            
            
            $
            155,077
            
            
            $
            439,590
            
            
            
            283.5%Amount
      related to amortization of debt discounts and deferred financing
      costs
            
            
            190,491
            
            
            
            -
            
            
            
            190,491
            
            
            -Amount
      related to accretion
            
            
            1,644,991
            
            
            
            423,258
            
            
            
            1,221,733
            
            
            
            288.6%Total
      interest expense
            
            $
            2,430,149
            
            
            $
            578,335
            
            
            $
            1,851,814
            
            
            
            320.2%





Interest
expense increased by approximately $1.9 million to $2.4 million for
the twelve months ended December 31, 2007 from approximately $0.5 million for
the comparable period in 2006.





During
fiscal 2006, in conjunction with the reverse merger with Subsea, Deep Down
determined that the Series E and Series G Preferred Stock was more like debt
than equity due to their “redeemable exchangeable” nature into
notes.  The fair value calculated for the Series E and G Preferred
Stock issued in exchange for 100% of the Deep Down Delaware common stock and
Strategic Offshore Services Corporation using a 20% discount rate which was
significantly greater than the 6% interest on the three-year term note into
which those preferred shares were exchangeable. Deep Down has been accreting the
difference between the determined value and the face value of $1000 per share
for which we are obligated as interest expense. During fiscal 2007, we redeemed
all of the Series G Preferred Stock in exchange for 3,250 shares of Series E
Preferred Stock. Additionally, a total of 7,750 shares of Series E Preferred
Shares were redeemed, which generated non-cash interest expense of $1.6 million,
plus approximately $42,000 of non-cash interest expense on the 500 shares of
Series E Preferred Stock which remain outstanding at December 31,
2007.  The amount of discount associated with the Series E Preferred
stock outstanding at December 31, 2007 is $0.1 million.





On August
6, 2007, Deep Down entered into a $6.5 million secured Credit Agreement with
Prospect and received an advance of $6.0 million on that date.  The
Credit Agreement provides for a 4-year term, an annual interest rate of 15.5%,
with the ability to defer up to 3.0% of interest through a PIK (paid-in-kind)
feature and principal payments of $250,000 per quarter beginning September 30,
2008, with the remaining balance outstanding due August 6, 2011. Interest
payments are payable monthly, in arrears, on each month end commencing on August
31, 2007.  Interest paid through December 31, 2007 was
$377,167.  Deep Down paid the full 15.5% and did not exercise the PIK
feature for the monthly periods through December 2007.






-21-





On
December 21, 2007, Deep Down entered into an amendment to the Credit Agreement
(the “Amendment”) to provide the funding for the cash portion of the purchase of
Mako. The total commitment available under the Amendment was increased to $13.0
million, and the quarterly principal payments increased to $250,000, with the
payment dates remaining the same. The interest terms and loan covenants also
remained substantially the same under the Amendment. Deep Down was advanced an
additional $6.0 million on January 4, 2008 under terms of the
Amendment.





Terms of
the Credit Agreement also include a detachable warrant to purchase up to
4,960,585 shares of common stock at an exercise price of $0.507 per
share.  The warrant has a five-year term and becomes exercisable on
the two-year anniversary of the original financing, August 6,
2009.  The proceeds of the debt were allocated to the warrants based
on its estimated relative fair value at the measurement date of when the final
agreement was signed and announced and reflected as a discount to the debt. The
relative fair market value of these warrants was $1.5 million and is being
amortized as interest expense. Interest expense associated with the fair market
value of the warrant was $135,931 during 2007.





Additionally,
in connection with the initial advance in August 2007, Deep Down pre-paid
$180,000 in points to the lender which was treated as a discount to the
note.  The discount associated with the value of the warrants and the
pre-paid points are being amortized into interest expense over the life of the
note agreement using the effective interest method.  A total of
$135,931 has been amortized into interest expense through December 31,
2007.





In
connection with the second advance in January 4, 2008, Deep Down pre-paid
$180,000 in points to the lender which was treated as a discount to the
note.





Deep Down
capitalized a total of $555,314 in deferred financing costs related to the
original amounts borrowed under the Credit Agreement.  Of this amount,
$442,194 was paid in cash to various third parties related to the financing, and
the remainder of $113,120 represents the Black Scholes valuation of warrants
issued to one of these third party vendors.  The warrant is a
detachable warrant to purchase up to 320,000 shares of common stock at an
exercise price of $0.75 per share (calculated as the volume weighted average
closing price of the common stock for the ten days immediately preceding the
closing of the Credit Agreement which took place on August 6,
2007).  The warrant has a five-year term and becomes exercisable on
the two-year anniversary of the original financing, August 6,
2009.  The assumptions used in the Black Scholes model included (1)
expected volatility of 52.7%, (2) expected term of 3.5 years, (3) discount rate
of 5% and (4) zero expected dividends.  The deferred financing cost is
being amortized using the effective interest method over the term of the
note.  A total of $54,560 of deferred financing cost was amortized
into interest expense through December 31, 2007.





In
connection with the second advance under the Credit Agreement on January 4,
2008, Deep Down capitalized an additional $261,941 in deferred financing
costs.  Of this amount, $216,000 was paid in cash to various third
parties related to the financing, and the remainder of $45,946 represents the
Black Scholes valuation of warrants issued to one of these third party
vendors.  The detachable warrant was granted to purchase up to 118,812
shares of common stock at an exercise price of $1.01 per share.  The
warrant has a five-year term and is immediately exercisable.  The fair
value of the warrant was estimated to be $45,946 based on the Black Scholes
pricing model.  The assumptions used in the model included (1)
expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount rate
of 3.2% and (4) zero expected dividends.  Provisions in the warrant
agreement allow for a cashless exercise provision, not to exceed 2% of
outstanding common stock at the time of exercise.





Net Income
(loss)


Net
income increased by approximately $3. 8 million to $1.0 million for the twelve
months ended December 31, 2007 as compared to a loss of approximately $2.8
million for the comparable period in 2006 due to the items discussed above
..




-22-








EBITDA




2007
            
            
            Pro-Forma
      2006
            
            
            Change
            
            
            %Net
      income (loss)
            
            $
            952,509
            
            
            $
            (2,811,627
            )
            
            $
            3,764,136
            
            
            
            133.9%Tax
      expense
            
            
            369,673
            
            
            
            22,250
            
            
            
            347,423
            
            
            
            -Interest
            
            
            2,335,662
            
            
            
            578,335
            
            
            
            1,757,327
            
            
            
            303.9%Depreciation
      and amortization expense
            
            
            426,964
            
            
            
            166,468
            
            
            
            260,496
            
            
            
            156.5%EBITDA
            
            $
            4,084,808
            
            
            $
            2,044,574
            
            
            $
            6,129,382
            
            
            
            299.8%







Earnings
before interest, taxes, depreciation, and amortization ("EBITDA") is a
non-GAAP financial measure. Deep Down uses EBITDA as an
unaudited supplemental financial measure to assess the financial
performance of its assets without regard to financing methods, capital
structures, taxes or historical cost basis; its liquidity and operating
performance over time in relation to other companies that own similar assets and
that the Company believes calculate EBITDA in a similar manner; and the ability
of Deep Down assets to generate cash sufficient for Deep Down to pay potential
interest costs. Deep Down also understands that such data are used by investors
to assess the Company's performance. However, the term EBITDA is not defined
under generally accepted accounting principles and EBITDA is not a measure of
operating income, operating performance or liquidity presented in accordance
with generally accepted accounting principles. When assessing Deep Down’s
operating performance or liquidity, investors should not consider this data in
isolation or as a substitute for net income, cash flow from operating
activities, or other cash flow data calculated in accordance with generally
accepted accounting principles. EBITDA increased by approximately $6.1 million
to $4.1 million for the twelve months ended December 31, 2007 from approximately
$(2.0) million for the comparable period in 2006.





-23-


Sources
and Uses of Cash for the year ended December 31, 2007




Cash
flows for the period through the year ended December 31, 2007, were as
follows:





Operating Cash
Flows


Cash
required by operating activities of continuing operations was $3,006,136. Our
working capital balances vary due to on delivery terms and payments on key
contracts; work in process, and outstanding receivables and payables.  The
increase in accounts receivable is primarily due to our sales and deliveries to
large integrated international oil companies. Historically, due to the credit
strength of our customers, we have not experienced material adjustments to our
accounts receivable and believe our accounts receivables from our customers are
collectible.





Investing Cash
Flows


The cash
used from investing activities of $1,358,429 is primarily due to purchases of
equipment of $830,965 and restricted cash of $375,000 plus $152,464 related to
acquisition costs.





Financing Cash
Flows


Net cash
provided from financing activities was $6,558,323.  This was primarily due
to long-term debt issuance of $6,204,799 and common stock proceeds net of
expenses of $3,960,000.





Liquidity and Capital
Resources


We
generate our liquidity and capital resources primarily through operations and,
when needed, through debt issues and equity offerings. Our total
bank loans outstanding at December 31, 2007 was $916,044 which were Mako
bank loans that were paid in full from the Prospect Capital loan. During 2007,
we paid approximately $2.7 million in outstanding debt including bank loans,
equipment lease obligations, and redemption of Series E preferred
stock.





Debt and
Liquidity





Total
borrowings at December 31, 2007, comprised the following:





A
long-term debt obligation to Prospect Capital Corporation with monthly principal
and interest payments, interest fixed at 15.5%, with the ability to defer up to
3.0% of interest through a PIK (paid-in-kind) feature and principal payments of
$250,000 per quarter beginning September 30, 2008, with the remaining balance
outstanding due August 6, 2011. We borrowed a total of $12.5 million on the
$13.0 million facility from Prospect Capital.





At
December 31, 2007 certain bank debt of Mako was outstanding in the aggregate of
$916,044 which was paid in full with the advance of funds from the Prospect
Capital loan in January 2008.




A capital
lease obligation was outstanding for approximately $481,000 for the lease of a
crane.





Outlook for
2008





We plan
to meet our cash requirements in 2008 with cash generated from operations. 
Due to the expanding growth of our company and the strength of the industry in
which we operate, we believe that we have access to capital to fund and expand
our operations.  In addition, we continue to evaluate acquisitions and
joint ventures in the ordinary course of business. When opportunities for
business acquisitions meet our standards, we believe we will have access to
capital sources necessary to take advantage of those opportunities.





Off-Balance Sheet
Arrangements





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


-24-


Recent
Accounting Pronouncements





In July
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) – an
interpretation of FASB Statement No. 109, Accounting for Income Taxes (“SFAS No.
109”) (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in accordance with SFAS No. 109 and prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a return.
Guidance is also provided on de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006.  Deep
Down adopted the provisions of FIN 48 in 2007 and no material uncertain tax
positions were identified.  Thus, the adoption of FIN 48 did not have
an impact on Deep Down’s financial statements.





In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No.
157”). SFAS No. 157 establishes a framework for measuring fair value under
generally accepted accounting procedures and expands disclosures on fair value
measurements. This statement applies under previously established valuation
pronouncements and does not require the changing of any fair value measurements,
though it may cause some valuation procedures to change. Under SFAS No. 157,
fair value is established by the price that would be received to sell the item
or the amount to be paid to transfer the liability of the asset as opposed to
the price to be paid for the asset or received to transfer the liability.
Further, it defines fair value as a market specific valuation as opposed to an
entity specific valuation, though the statement does recognize that there may be
instances when the low amount of market activity for a particular item or
liability may challenge an entity’s ability to establish a market amount. In the
instances that the item is restricted, this pronouncement states that the owner
of the asset or liability should take into consideration what affects the
restriction would have if viewed from the perspective of the buyer or assumer of
the liability. This statement is effective for all assets valued in financial
statements for fiscal years beginning after November 15, 2007. Deep Down is
currently evaluating the impact of SFAS No. 157 on its financial position and
result of operations.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS No. 159”), which provides companies with
an option to report selected financial assets and liabilities at fair
value.  SFAS No. 159 also establishes presentation and disclosure
requirements designed to facilitate comparisons between companies that choose
different measurement attributes for similar types of assets and
liabilities.  SFAS No. 159 is effective as of the beginning of an
entity’s first fiscal year beginning after November 15, 2007 with early adoption
allowed.  Deep Down has not yet determined the impact, if any, that
adopting this standard might have on its financial statements.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (“SFAS No. 141(R)”) and No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”).
SFAS No. 141(R) and SFAS No. 160 are products of a joint project between the
FASB and the International Accounting Standards Board.  The revised
standards continue the movement toward the greater use of fair values in
financial reporting. SFAS No. 141(R) will significantly change how business
acquisitions are accounted for and will impact financial statements both on the
acquisition date and in subsequent periods. These changes include the expensing
of acquisition related costs and restructuring costs when incurred, the
recognition of all assets, liabilities and noncontrolling interests at fair
value during a step-acquisition, and the recognition of contingent consideration
as of the acquisition date if it is more likely than not to be
incurred.  SFAS No. 160 will change the accounting and reporting for
minority interests, which will be recharacterized as noncontrolling interests
and classified as a component of equity.  SFAS No. 141(R) and SFAS No.
160 are effective for both public and private companies for fiscal years
beginning on or after December 15, 2008 (January 1, 2009 for companies with
calendar year-ends). SFAS No. 141(R) will be applied prospectively. SFAS No. 160
requires retroactive adoption of the presentation and disclosure requirements
for existing minority interests. All other requirements of SFAS No. 160 shall be
applied prospectively. Early adoption is prohibited for both
standards.  Deep Down is currently evaluating the effects of these
pronouncements on its financial position and results of operations.





In
December 2007, the SEC staff issued Staff Accounting Bulletin (“SAB”) 110,
Share-Based Payment, which amends SAB 107, Share-Based Payment, to permit public
companies, under certain circumstances, to use the simplified method in SAB 107
for employee option grants after December 31, 2007. Use of the simplified method
after December 2007 is permitted only for companies whose historical data about
their employees’ exercise behavior does not provide a reasonable basis for
estimating the expected term of the options. Deep Down did not have stock
options outstanding until fiscal 2007, and has not exercised any shares, thus
does not have adequate historical data to determine option lives. Therefore,
Deep Down will continue to use the simplified method as allowed under the
provision of SAB 110.


-25-


Inflation
and Seasonality





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





Item
7.                      Financial
Statements.




The
financial statements and schedules are included herewith commencing on page
F-1.




Report
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Balance Sheets
            F-3Consolidated
      Statements of Operations
            F-4Consolidated
      Statements of Changes in Stockholders’ Equity (Deficit)
            F-5Consolidated
      Statements of Cash Flows
            F-6Notes
      to Consolidated Financial Statements
            F-8





Item
8.                      Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure.





None.





Item
8A.                      Controls
and Procedures.





Evaluation
of Disclosure Controls and Procedures





We
carried out an evaluation, under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer, of the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)).  Based upon that evaluation, our principal executive
officer and principal financial officer concluded that, as of the end of the
period covered in this report, our disclosure controls and procedures were 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 from January 1, 2006 through November 20, 2006 prior to its
purchase by the successor entity, in accordance with Rule 310(a) of Regulation
S-B.  We have supplemented this Form 10-K/A with this required
information.





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





Management’s
Report on Internal Control Over Financial Reporting.





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) under the
Securities Exchange Act, as amended.  Our management assessed the
effectiveness of our internal control over financial reporting as of December
31, 2007. In making this assessment, our management used the criteria set forth
by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)
in Internal Control-Integrated Framework.  A material weakness is a
deficiency, or a combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a material
misstatement of the company's annual or interim financial statements will not be
prevented or detected on a timely basis.  We have identified the
following material weaknesses.




1.
            As
      of December 31, 2007, we did not maintain effective controls over the
      control environment.  Specifically, we have not formally adopted
      a written code of business conduct and ethics that governs to the
      Company’s employees, officers and directors.  Additionally, we
      have not developed and effectively communicated to our employees its
      accounting policies and procedures.  This has resulted in
      inconsistent practices particularly at its ElectroWave
      division.  Further, the Board of Directors does not currently
      have any independent members and no director qualifies as an audit
      committee financial expert as defined in Item 407(d)(5)(ii) of Regulation
      S-B.  Since these entity level programs have a pervasive effect
      across the organization, management has determined that these
      circumstances constitute a material
weakness.


-26-





2.
            As
      of December 31, 2007, at the ElectroWave subsidiary, we did not maintain
      effective controls over revenue recognition.  Specifically,
      controls were not designed and in place to ensure that billing activities
      were conducted in a timely manner resulting in contract services revenues
      being recognized in an incorrect reporting
      period.  Additionally, the lack of consistency applied
      procedures also resulted in the double billing of a
      customer.  This control deficiency resulted in an adjustment to
      the consolidated financial statements.  Accordingly, management
      has determined that this control deficiency constitutes a material
      weakness.3.
            As
      of December 31, 2007, we did not maintain effective controls over payables
      processing.  Specifically, controls were not designed and in
      place to ensure that vender-related and employee-related cash
      disbursements were appropriately authorized and adequately supported by
      receiving reports and other supporting documentation.  A budget
      process is not currently in place to monitor spending
      levels.  This material weakness could result in errors in the
      accounting for accounts payable and expenses. Accordingly, management has
      determined that this control deficiency constitutes a material
      weakness.





Because
of these material weaknesses, management has concluded that the Company did not
maintain effective internal control over financial reporting as of December 31,
2007, based on the criteria established in "Internal Control-Integrated
Framework" issued by the COSO.





Changes
in Internal Control Over Financial Reporting.





In our
efforts to continuously improve our internal controls, management has taken
steps to enhance the following controls and procedures subsequent to the end of
fiscal 2007 as part of our remediation efforts:




·
              The
      ElectroWave division was re-structured and re-organized in the fourth
      quarter of 2007.  A majority of the accounting activities have
      been transferred to Deep Down Delaware’s accounting department to
      streamline and centralize
accounting.
 
 ·
              In
      response to the further growth of the business, management hired a
      corporate controller in January 2008.  He is responsible for the
      coordination and integration of the accounting activities of each of our
      current and future subsidiary operations. With his relevant experience
      with the policies and procedures for compliance with regulations
      promulgated by Sarbanes-Oxley, our goal is to reach full compliance during
      2008.
 
 ·
              Management
      hired a corporate human resource and safety manager in March 2008 who will
      be responsible for designing, planning and implementing human resource
      programs and policies including benefits, staffing, compensation, employee
      relations, training, and health and safety programs.  She will
      oversee the human resource functions for our current and future subsidiary
      operations.
 
 ·
              Management
      has prepared an Employee Handbook and Code of Conduct and plans to
      circulate these documents throughout the organization and obtain signed
      acknowledgements from employees.
 
 ·
              Management
      plans to document its accounting policies and procedures to increase
      consistency among divisions.  This includes the creation or
      expansion of checklists which serve to manage close
    processes.
 
 ·
              Management
      has increased documentation around certain authorization and review
      controls.


This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.


-27-


Item
8B.                      Other
Information.





None.

























-28-


PART
III




Item
      9.
            Directors,
      Executive Officers, Promoters, Control Persons and Corporate Governance;
      Compliance with Section 16(a) of the Exchange
  Act.





The
following table sets forth the names, ages and positions of all of our directors
and executive officers.





Name
            
            Age
            
            Position Held With The
    CompanyRobert
      E. Chamberlain, Jr.
            
            48
            
            Chairman
      of the Board, Chief Acquisitions Officer, and DirectorRonald
      E. Smith*
            
            49
            
            Chief
      Executive Officer and DirectorEugene
      L. Butler
            
            65
            
            Chief
      Financial Officer and DirectorMary
      L. Budrunas*
            
            56
            
            Vice-President,
      Director, and Corporate SecretaryMichael
      D. Teal
            
            51
            
            Corporate
      Controller


_________________________





*  Ronald
E. Smith and Mary L. Budrunas are married to each other.





Robert
E. Chamberlain, Jr., Chairman of the Board, Chief Acquisitions Officer, and
Director. Mr. Chamberlain has served as Chairman and Director of the
Company since December 2006.  Mr. Chamberlain has a B.S. in Chemical
Engineering and a B.S. in Biomedical Engineering from Northwestern University's
Technological Institute and an MBA from Northwestern University's Kellogg
Graduate School of Management. Mr. Chamberlain served as Vice President with
Solomon Brothers Inc. (1986 to 1992), where his responsibilities included
mergers, acquisitions, leveraged buyouts, merchant banking, divestitures,
corporate finance, capital raises, restructurings and new product development in
both the private and public markets. From 1992 through 1995, Mr. Chamberlain
served as Vice President for Laidlaw Securities and Dickinson & Co. where he
was responsible for generating public and private equity transactions. Since
1995, Mr. Chamberlain has assisted small emerging growth companies gain access
to the capital markets and develop well articulated strategic objectives through
consulting companies he controlled. Most recently, Mr. Chamberlain served as
Chairman, CEO, CFO and Director of a publicly traded energy company involved in
the development of oil and gas opportunities, primarily in the Barnett Shale of
Texas.





Ronald
E. Smith, President, Chief Executive Officer and Director . Mr. Smith
co-founded Deep Down in 1997 and has served as President and Director of the
Company since December 2006. Mr. Smith graduated from Texas A&M University
with a Bachelor of Science degree in Ocean Engineering in 1981. Mr. Smith worked
both onshore and offshore in management positions for Ocean Drilling and
Exploration Company (ODECO), Oceaneering Multiflex, Mustang Engineering and
Kvaerner before founding Deep Down. Mr. Smith’s interests include all types of
offshore technology, nautical innovations, state of the art communications,
diving technology, hydromechanics, naval architecture, dynamics of offshore
structures, diving technology and marketing of new or innovative concepts. Mr.
Smith is directly responsible for the invention or development of many
innovative solutions for the offshore industry, including the first steel tube
flying lead installation system.





Eugene
L. Butler, Chief Financial Officer.   Mr. Butler has served as
Chief Financial officer with Deep Down, Inc. since
June 2007.  Prior, he has served in various capacities as a
director, president, chief executive officer, chief financial officer and chief
operating officer for Weatherford International, Inc., a $2 billion
multinational service and equipment corporation serving the worldwide energy
market, from 1974 to 1991.  He was elected to Weatherford’s board of
directors in May of 1978, elected president and chief operating officer in 1979,
and president and chief executive officer in 1984.  He successfully
developed and implemented a turnaround strategy eliminating debt and returning
the company to profitability during a severe energy recession.  Mr.
Butler also expanded operations into international markets allowing Weatherford
to become a major worldwide force with its offshore petroleum products and
services.  Mr. Butler graduated from Texas A&M University in
1963, and served as an officer in the U.S. Navy until 1969 when he joined Arthur
Andersen & Co.  Mr. Butler is distinguished by numerous
medals and decorations, including the Bronze Star with combat “V” and the
Presidential Unit Citation for his service with the river patrol force in
Vietnam.





Mary L.
Budrunas, Vice-President and Director. Ms. Budrunas,
co-founder of Deep Down, Inc. along with current chief executive officer Ron
Smith, has served as Vice-President and director of the Company since December
2006.  Ms. Budranus is responsible for the Company’s administrative
functions including human resources and accounting.  Ms. Budrunas has
more than 30-years of logistical management experience in manufacturing,
fabrication, and industrial sourcing in the oil and gas industry. Prior to Ms.
Budrunas co-founding Deep Down in 1997, she managed the purchasing efforts of
many projects over a 10-year period for Mustang Engineering, and previously
directed procurement for a large petroleum drilling and production facility
project in Ulsan, Korea.


-29-


Michael
D. Teal, Corporate Controller.   Mr. Teal has served as
corporate controller since January 2008.  Mr. Teal has significant
experience in mergers and acquisitions, business development, business
valuations, investment analysis, strategic planning, debt financing, equity
issues, bank lines, and financial planning.  His background has
primarily been in the energy industry encompassing refining, natural gas, power
generation, oil and gas exploration, marine services, and risk
management.  Since 1984, Mr. Teal has held various corporate-level
positions in accounting, treasury, and corporate finance functions with major
energy companies, most notably Valero Energy Corporation, The Coastal
Corporation, and El Paso Corporation.  He also was a consultant
providing consultation services to major Houston and Dallas corporations and was
recently a Senior Consultant with Sirius Solutions.  Mr. Teal
graduated from the University of Texas at San Antonio in 1981 with a Bachelor of
Business Administration degree in financial accounting.  He earned his
Master of Business Administration degree from Our Lady of the Lake University in
San Antonio, Texas in 1984.  In 1988, he became a Texas-licensed
Certified Public Accountant.




Corporate
Governance




The
Company promotes accountability for adherence to honest and ethical conduct;
endeavors to provide full, fair, accurate, timely and understandable disclosure
in reports and documents that the Company files with the SEC and in other public
communications made by the Company; strive to be compliant with applicable
governmental laws, rules and regulations. The Company has not formally adopted a
written code of business conduct and ethics that governs to the Company’s
employees, officers and directors as the Company is not required to do
so.





There
were no material changes to the procedures by which shareholders may recommend
nominees to the Company’s board of directors.




In lieu
of an Audit Committee, the Company’s Board of Directors is responsible for
reviewing and making recommendations concerning the selection of outside
auditors, reviewing the scope, results and effectiveness of the annual audit of
the Company's financial statements and other services provided by the Company’s
independent public accountants. The Board of Directors reviews the Company's
internal accounting controls, practices and policies. Our Board of Directors has
determined that no director qualifies as an audit committee financial expert as
defined in Item 407(d) (5) (ii) of Regulation S-B.




Section
16(a) Beneficial Ownership Reporting Compliance




Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our directors
and executive officers, as well as persons beneficially owning more than 10% of
our outstanding common stock, to file reports of ownership and changes in
ownership with the SEC within specified time periods. Such officers, directors
and shareholders are required to furnish us with copies of all Section 16(a)
forms they file.




Based
solely on its review of such forms received by us, or written representations
from certain reporting persons, not all Section 16(a) filing requirements
applicable to our officers, directors and 10% shareholders were complied within
a timely manner during the fiscal year ended December 31,
2007.  During 2007, the number of Form 3 that were filed late totaled
six; the number of Form 4 that were filed late totaled six; and the number of
Form 5 that were filed late totaled seven.  However all required
reports have been filed by December 31, 2007.


-30-


Item
10.                     Executive Compensation.




The
following table summarizes all compensation paid to our Chief Executive Officer
and our two highest compensated named executive officers (the “Named Executive
Officers”) for the year ended December 31, 2007 and the period from inception
June 29, 2006 to December 31, 2006, respectively.





SUMMARY
COMPENSATION TABLE






Name
      and Principal
              Position
            Year
            
            
            Salary
      ($)
            
            
            Bonus
              ($)
            
            
            Stock
              Awards
              ($)(4)
            
            
            Option
              Awards
              ($)(3)
            
            
            All
      Other Compensation
              ($)
            
            
            
            Total
      ($)Ronald
      E. Smith(4)
            2007
            
            $
            269,231
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            
            $
            269,231President,
      Chief Executive Officer and Director
            2006
            
            $
            27,110
            
            $
            1,710
            
            $
            -
            
            $
            -
            
            $
            -
            
            
            $
            28,820Robert
      E. Chamberlain, Jr. (1)
      (4)
            2007
            
            $
            180,000
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            20,655
            
            
            $
            200,655Chairman,
      Chief Acquisition Officer and Director
            2006
            
            $
            16,670
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            
            $
            16,670Mary
      L. Budrunas
            2007
            
            $
            134,615
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            
            $
            134,615Vice-President,
      Corporate Secretary and Director
            2006
            
            $
            13,070
            
            $
            12,670
            
            $
            -
            
            $
            -
            
            $
            -
            
            
            $
            25,740Eugene
      L. Butler (2)
      (4)
            2007
            
            $
            105,000
            
            $
            -
            
            $
            -
            
            $
            618,300
            
            $
            14,568
            
            
            $
            737,868Chief
      Financial Officer and Director
            2006
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            
            $
            -





(1)           Mr.
Chamberlain was paid for consulting services he performed through Strategic
Capital Services, Inc. Other compensation consists of auto allowance payments of
$1,000 per month and $8,655 for payroll tax reimbursement which were paid during
fiscal 2008.   Effective January 1, 2008, Mr. Chamberlain’s annual fee
for consulting services was increased to $225,000.





(2)           Mr.
Butler began drawing an annual salary of $180,000 beginning May 31, 2007. Option
awards consist of 3,000,000 options granted on that date which vest in three
equal annual installments on the first three anniversary dates of the grant
date.  Other compensation consists of auto allowance payments of
$1,000 per month and $7,568 for payroll tax reimbursement which were paid during
fiscal 2008.  Effective January 1, 2008, Mr. Butler’s annual fee for
consulting services was increased to $225,000.





(3)           Option
awards are based on expense recognized under FAS123(R).  Awards
granted to Mr. Butler during fiscal year 2007 were granted with a strike price
equal to the quoted market price on the day of the grant and were valued at date
of grant using Black-Scholes option pricing models with the following
assumptions: 5% risk free rate, 52.7% volatility, expected life of 3 years and
zero dividends.





On
February 14, 2008, Deep Down issued 1,000,000 stock options to Msrs Smith,
Chamberlain and Butler with an exercise price of $1.50, which was in excess of
the day’s closing price of $0.42.  The aggregate fair value of such
options (excluding estimated forfeitures) was approximately $145,764 based on
the Black-Scholes option pricing model using the following
estimates:  2.8% risk free rate, 61.3% volatility, an expected life of
3 years and zero dividends.  These options are not reflected on the
table above since the grant occurred after December 31, 2007.





(4)          
On February 14, 2008, Deep Down issued 350,000 shares of restricted common stock
to Msrs Smith, Chamberlain and Butler at a price of $0.42, the closing price of
Deep Down’s stock on that day.  These restricted shares vest over a
period of two years.  The aggregate fair value of such restricted
stock was approximately $441,000.  These shares are not reflected on
the table above since the grant occurred after December 31, 2007.


-31-








OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END





The
following table sets forth information concerning equity incentive plan awards
for each of the Named Executive Officers, outstanding as of December 31,
2007.  The amounts reflected as Market Value are based on the closing
price of our Common Shares of $ 0.98 on December 31, 2007 (the last trading day
of our fiscal year ended December 31, 2007).





Option
      Awards




Name
            
            Number
      of
              Securities
              Underlying
              Unexercised
              Options
              (#)
              Exercisable
            
            Number
      of
              Securities
              Underlying
              Unexercised
              Options
              (#)
              Unexercisable
            
            Equity
      Incentive
              Plan
              Awards: Number
              of
      Securities
              Underlying
              Unexercised
              Unearned
              Options
              (#)
            
            Option
              Exercise
      Price
              ($)
            
            Option
              Expiration
              DateEugene
      L. Butler, Chief Financial Officer
            
            
            -
            
            
            3,000,000
            
            
            -
            
            $
            0.515
            
            May
      31, 2010




The
vesting provisions for the Company’s stock options noted above will vest over a
three year period.





Employment
Agreements





Effective
August 6, 2007, we signed an employment agreement with Ronald E. Smith, our
President and Chief Executive Officer (“CEO”) for an initial term through August
6, 2010 with automatic annual renewals for an additional two years. Under terms
of the employment agreement, Mr. Smith will receive an annual base salary of
$250,000 plus $1,000 per month auto allowance.





Effective
August 6, 2007, we signed a consulting agreement with Strategic Capital
Services, Inc. (“Strategic”) to provide the services of  Robert E.
Chamberlain, who is our Chairman of the Board and Chief Acquisitions Officer
(“CAO”)  for an initial term through August 6, 2010 with automatic
annual renewals for an additional two years. Under terms of the consulting
agreement, Mr. Chamberlain will receive an annual base salary of $180,000, which
was increased to $270,000 as of January 1, 2008, plus $1,000 per month auto
allowance, and payment to Strategic of an amount equal to Federal and State
payroll withholdings customarily withheld for an employee. Such amounts totaling
approximately $8,655 were paid in February 2008.





Effective
May 31, 2007, we hired Eugene L. Butler as our Chief Financial Officer (“CFO”)
for an initial term through May 31, 2010 with automatic annual renewals for an
additional two years. Under Mr. Butler's employment agreement, he will receive
an annual base salary of $180,000, which was increased to $270,000 as of January
1, 2008. He received an aggregate of 3,000,000 stock options, of which the first
33% will vest on the first anniversary of the agreement, the second 33% on the
second anniversary of the agreement and the remaining 33% will vest on the third
anniversary of the agreement. The exercise price for the options was determined
by the closing market price of the common stock on the date of
grant.   Mr. Butler’s employment agreement contains an
indemnification provision that may require us to, among other things: indemnify
Mr. Butler against liabilities that may arise by reason of his status or service
as an officer to the fullest extent permitted under law.  Effective
August 6, 2007, Mr. Butler’s employment agreement was replaced by a consulting
agreement with all the same provisions as the previous employment
agreement.  The consulting agreement contains a provision that Deep
Down will remit to Mr. Butler an amount equal to Federal and State payroll
withholdings customarily withheld for an employee. Such amounts totaling
approximately $7,568 were paid in February 2008.




Compensation
of Directors





For the
year ended December 31, 2007, there were no cash payments or equity grants for
compensation to the Company’s former non-employee director, Daniel L. Ritz, Jr.
Mr. Ritz resigned as a director of the Company effective March 20,
2007.  The other directors of the Company are all also executive
officers of the Company and as directors do not receive any additional
compensation related to the performance of services as directors.  The
Company may agree to provide compensation to non-employee directors in the
future.


-32-


Item
      11.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.




The
following table sets forth certain information, as of March 31, 2008, concerning
the beneficial ownership of shares of Common Stock of the Company by (i) each
person known by the Company to beneficially own more than 5% of the Company’s
Common Stock; (ii) each Director; (iii) the Company’s Named Executive Officers;
and (iv) all directors and executive officers of the Company as a group. To the
knowledge of the Company, all persons listed in the table have sole voting and
investment power with respect to their shares, except to the extent that
authority is shared with their respective spouse under applicable
law.




Name
      and address of
              beneficial
      owner (2)
            Shares
            Options
      /
              Warrants
            Percent
      (1)Ronald
      E. Smith (3)(4)
            44,629,876
            -
            38.5%Mary
      L. Budrunas (3)(4)
            44,629,876
            -
            38.5%Robert
      E. Chamberlain, Jr. (4)
            25,350,000
            -
            21.9%Eugene
      L. Butler (4)
            350,000
            -
            0.3%All
      directors and officers as a group
            70,329,876
            -
            60.7%





(1)           A
person is deemed to be the beneficial owner of securities that can be acquired
within 60 days from the date set forth above through the exercise of any option,
warrant or right. Shares of common stock subject to options, warrants or rights
that are currently exercisable or exercisable within 60 days are deemed
outstanding for computing the percentage of the person holding such options,
warrants or rights, but are not deemed outstanding for computing the percentage
of any other person. The amounts and percentages are based upon 115,846,019
shares of common stock outstanding as of March 28, 2008.




(2)           The
address of each of the beneficial owners is c/o Deep Down, Inc., 15473 East
Freeway, Channelview, Texas 77530.




(3)           Reflects
6,652,871 shares owned by Ron Smith and 16,627,005 shares owned by Mary L.
Budrunas through the conversion of Series D Preferred Stock on March 28, 2008,
plus 19,564,000 shares owned by Ron Smith and 1,786,000 shares owned by Mary L.
Budrunas directly.





(4)           Shares
owned include 350,000 shares of restricted stock issued on February 14, 2008
which become fully vested on the second anniversary of the grant, February 14,
2010.





Disclosure
regarding our equity compensation plans as required by this item is incorporated
by reference to the information set forth in Part II, Item 5 of this
report.





Item
12.                      Certain
Relationships and Related Transactions, and Director Independence.




We lease
all buildings, structures, fixtures and other improvements from JUMA, LLC, a
company owned by Ronald E. Smith, CEO and a director of Deep Down, Inc. and Mary
L. Budrunas, a vice president and a director of Deep Down, Inc.  The
base rate of $11,000 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.





The
Company is a party to the employment agreements described above in Item
10.





None of
the Company’s directors is independent.  However, the Company believes
that it would be exempt from some of the independence requirements of NASDAQ ®
due to the Company’s being a controlled company as defined in the NASDAQ®
rules.  Under the NASDAQ® standards for “independence”, none of our
directors would qualify as independent generally or with respect to any specific
independence requirements for any committee member.





Item
13.                      Exhibits.




The
exhibits as indexed immediately following the signature page of this Report are
included as part of this Form 10-KSB/A.


-33-


Item
14.                      Principal
Accountant Fees and Services.




The
following table sets forth the aggregate fees paid to Malone & Bailey, PC
for audit services rendered in connection with the Company's consolidated
financial statements and reports for the year ended December 31, 2007 and the
period ended December 31, 2006 and for other services rendered during those
years on behalf of the Company and its subsidiaries:




December
      31,
              2007
            
            
            December
      31,
              2006(i)
      Audit Fees
            
            $
            205,967
            
            
            $
            164,695(ii)
      Audit Related Fees
            
            
            165,931
            
            
            
            -(iii)
      Tax Fees
            
            
            16,260
            
            
            
            -(iv)
      All Other Fees
            
            
            -
            
            
            
            -





Audit
Fees: Consists of fees billed for professional services rendered for the audit
of the Company’s consolidated financial statements, the review of interim
condensed consolidated financial statements included in quarterly reports and
other offering documentation, services that are normally provided by Malone
& Bailey, PC in connection with statutory and regulatory filings or
engagements and attest services, except those not required by statute or
regulation.





Audit-Related
Fees: Consists of fees billed for assurance and related services that are
reasonably related to the performance of the audit and review of the Company’s
consolidated financial statements and are not reported under "Audit Fees." These
services include auditing work on proposed transactions, including the audit of
Mako Technologies, Inc., attest services that are not required by statute or
regulation, and consultations concerning financial accounting and reporting
standards.





Tax Fees:
Consists of tax compliance, tax preparation and other tax services. Tax
compliance and tax preparation consists of fees billed for professional services
related to assistance with tax returns. Other tax services consist of fees
billed for other miscellaneous tax consulting.





The Board
of Directors pre-approves all audit and permissible non-audit services provided
by Malone & Bailey, PC. These services may include audit services,
audit-related services, tax services and other services. The Board of Directors
may also pre-approve particular services on a case-by-case basis and may
delegate pre-approval authority to one or more directors. If so delegated, the
director must report any pre-approval decision to the Board of Directors at its
first meeting after the pre-approval was obtained.


-34-


SIGNATURES




In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.





DEEP
DOWN, INC.








/s/ RONALD E.
SMITH


Ronald E.
Smith, President and Chief Executive Officer


(Principal
Executive Officer)





Dated: March
31, 2009








/s/ EUGENE L.
BUTLER


Eugene L.
Butler


Chief
Financial Officer (Principal Financial Officer)





Dated: March
31, 2009







POWER
OF ATTORNEY





KNOWN ALL
MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints RONALD E. SMITH and EUGENE L. BUTLER, and each of them,
his or her true and lawful attorneys-in-fact and agents, with full power of
substitution and re-substititon for him or her and in his or her name, place and
stead, in any and all capacities, to sign any and all amendments to this Annual
Report on Form 10-K/A, and to file the same, with all exhibits thereto, and
other documents in connection therewith with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully and to
all intents and purposes as he might or could do in person hereby ratifying and
confirming all that said attorneys-in-fact and agents, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.




Signatures
            
            Title
            Date/s/ RONALD E.
      SMITH
            
            President,
      Chief Executive Officer and Director
            March
      31, 2009Ronald
      E. Smith
            
            (Principal
      Executive Officer)/s/ EUGENE L.
      BUTLER
            
            Chief
      Financial Officer and Director
            March
      31, 2009Eugene
      L. Butler
            
            (Principal
      Financial Officer)/s/ ROBERT E. CHAMBERLAIN,
      JR.
            
            Chairman,
      Chief Acquisitions Officer and Director
            March
      31, 2009Robert
      E. Chamberlain, Jr./s/ MARY L.
      BUDRUNAS
            
            Vice-President,
      Director, and Corporate Secretary
            March
      31, 2009Mary
      L. Budrunas





-35-


EXHIBIT
INDEX








Exhibit
      Number
            Description of
      Exhibit*2.1
            Agreement
      and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc.,
      and the majority shareholders of Deep Down, Inc.3.1
            Certificate
      of Incorporation of MediQuip Holdings, Inc. (incorporated by reference
      from Exhibit 3.1 to our Annual Report on Form 10-KSB for the fiscal year
      ended December 31, 2007 filed on March 31, 2008).3.2
            Certificate
      of Amendment to Articles of Incorporation providing for Change of Name to
      Deep Down, Inc. (incorporated by reference from Exhibit 3.2 to our Annual
      Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on
      March 31, 2008).*3.3
            By
      Laws of Deep Down, Inc.*3.4
            Form
      of Certificate Designation of Series D Redeemable Convertible Preferred
      Stock*3.5
            Form
      of Certificate Designation of Series E Redeemable Exchangeable Preferred
      Stock*3.6
            Form
      of Certificate Designation of Series F Redeemable Convertible Preferred
      Stock*3.7
            Form
      of Certificate Designation of Series G Redeemable Exchangeable Preferred
      Stock*4.1
            Common
      Stock Purchase Warrant for 4,960,585 common stock of Deep Down, Inc.
      issued to Prospect Capital Corporation effective May 25,
2007.4.2
            Common
      Stock Purchase Warrant for 320,000 shares issued to Dragonfly Capital
      Partners, LLC dated August 6, 2007 (incorporated by reference from Exhibit
      4.2 to our Annual Report on Form 10-KSB for the fiscal year ended December
      31, 2007 filed on March 31, 2008).4.3
            Common
      Stock Purchase Warrant for 118, 812 shares issued to Dragonfly Capital
      Partners, LLC dated January 4, 2008 (incorporated by reference from
      Exhibit 4.3 to our Annual Report on Form 10-KSB for the fiscal year ended
      December 31, 2007 filed on March 31, 2008).*4.4
            Registration
      Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect
      Capital Corporation.*10.1
            Credit
      Agreement, dated as of August 6, 2007, among Deep Down, Inc., as borrower,
      the financial institutions from time to time party thereto, and Prospect
      Capital Corporation.10.2
            First
      Amendment to Credit Agreement, dated as of December 21, 2007, among Deep
      Down, Inc., as borrower, and Prospect Capital Corporation, as agent and
      lender (incorporated by reference from Exhibit 4.1 to our Annual Report on
      Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31,
      2008).


-36-





Exhibit
      Number
            Description of
      Exhibit*10.3
            Guarantee
      and Collateral Agreement, dated as of August 6, 2007, among Deep Down,
      Inc., as borrower and as Grantor, and Prospect Capital Corporation as
      Administrative Agent10.4†
            Consulting
      Agreement, dated as of August 6, 2007, between Deep Down, Inc. and
      Strategic Capital Services, Inc. regarding the services of Robert
      Chamberlain (incorporated by reference from Exhibit 10.1 to our Annual
      Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on
      March 31, 2008).10.5†
            Employment
      Agreement, dated as of August 6, 2007, between Deep Down, Inc. and Ronald
      E. Smith (incorporated by reference from Exhibit 10.2 to our Annual Report
      on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March
      31, 2008).10.6†
            Consulting
      Agreement, dated as of August 6, 2007, between Deep Down, Inc. and Eugene
      L. Butler & Associates regarding the services of Eugene L. Butler
      (incorporated by reference from Exhibit 10.3 to our Annual Report on Form
      10-KSB for the fiscal year ended December 31, 2007 filed on March 31,
      2008).*10.7†
            2003
      Directors, Officers and Consultants Stock Option, Stock Warrant and Stock
      Award Plan.*10.8†
            Form
      of Option Grant Agreement under 2003 Directors, Officers and Consultants
      Stock Option, Stock Warrant and Stock Award Plan.10.9
            Agreement
      and Plan of Merger among Deep Down, Inc., Mako Technologies, LLC, Mako
      Technologies, Inc. and the shareholders of Mako Technologies, Inc. dated
      December 17, 2007 (incorporated by reference from Exhibit 2.1 to our
      Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007
      filed on March 31, 2008).*10.10
            Agreement
      and Plan of Reorganization among Deep Down, Inc., ElectroWave (USA), Inc.,
      a Nevada corporation, ElectroWave (USA) Inc., a Texas corporation,
      Pinemont IV, Martin L. Kershman and Ronald W. Nance.10.11
            Lease
      Agreement dated September 1, 2006 between Deep Down, Inc., a Delaware
      corporation, as tenant, and JUMA, L.L.C. (incorporated by reference from
      Exhibit 10.4 to our Annual Report on Form 10-KSB for the fiscal year ended
      December 31, 2007 filed on March 31, 2008).*10.12
            Lease
      Agreement dated June 1, 2006, between Mako Technologies, Inc., as Lessee
      and Sutton Industries, as Lessor.*21.1
            Subsidiary
      List24.1
            Power
      of Attorney (set forth immediately following the signatures to this
      report).*31.1
            Rule
      13a-14(a)/15d-14(a) Certification of the President and Chief Executive
      Officer of Deep Down, Inc.*31.2
            Rule
      13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep
      Down, Inc.*32.1
            Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.*32.2
            Section
      1350 Certification of the Chief Financial Officer of Deep Down,
      Inc.




* Filed or
furnished herewith.





† Exhibit
constitutes a management contract or compensatory plan or
arrangement.


-37-





INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS








Report
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Balance Sheets
            F-3Consolidated
      Statements of Operations
            F-4Consolidated
      Statements of Changes in Stockholders’ Equity
            F-5Consolidated
      Statements of Cash Flows
            F-6Notes
      to the Consolidated Financial Statements
            F-8


F-1


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Stockholders of Deep Down, Inc., Houston,
Texas




We
have audited the accompanying consolidated balance sheets of Deep Down, Inc.
(the “Company”), as of December 31, 2007 and 2006 and the related consolidated
statements of operations, changes in stockholders’ equity (deficit), and cash
flows for the year ended December 31, 2007. We have also audited the
accompanying statements of operations, changes stockholders’ deficit and cash
flows for the period from inception (June 29, 2006) through December 31, 2006
(Successor), and for the 324 day period from January 1, 2006 to November 20,
2006 (Predecessor).  These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.


We
conducted our audits in accordance with the standards of Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. Deep Down is not required to have,
nor were we engaged to perform an audit of internal control over financial
reporting.  Our audits included the consideration of internal control
over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of Deep Down’s internal control over financial
reporting.  Accordingly, we express no such opinion.  An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation.  We
believe that our audit provides a reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Deep Down, Inc. as of December 31,
2007 and 2006, and the results of its operations and cash flows for the periods
described, in conformity with U.S. generally accepted accounting
principles.








/s/ MALONE & BAILEY,
PC


www.malone-bailey.com


Houston,
Texas





March
31, 2008
 Except
for Note 14 which is dated March 30, 2009


F-2





Deep
      Down, Inc.Consolidated
      Balance Sheets




December
      31,
              2007
            
            
            December
      31,
              2006AssetsCash
      and equivalents
            
            $
            2,206,220
            
            
            $
            12,462Restricted
      cash
            
            
            375,000
            
            
            
            -Accounts
      receivable, net of allowance of $139,787 and $81,809
            
            
            7,190,466
            
            
            
            1,264,228Prepaid
      expenses and other current assets
            
            
            312,058
            
            
            
            156,975Inventory
            
            
            502,253
            
            
            
            -Lease
      receivable, short term
            
            
            414,000
            
            
            
            -Work
      in progress
            
            
            945,612
            
            
            
            916,485Receivable
      from Prospect, net
            
            
            2,687,333
            
            
            
            -Total
      current assets
            
            
            14,632,942
            
            
            
            2,350,150Property
      and equipment, net
            
            
            5,172,804
            
            
            
            845,200Other
      assets, net of accumulated amortization of $54,560 and $0
            
            
            1,109,152
            
            
            
            -Lease
      receivable, long term
            
            
            173,000
            
            
            
            -Intangibles,
      net
            
            
            4,369,647
            
            
            
            -Goodwill
            
            
            10,594,144
            
            
            
            6,934,213Total
      assets
            
            $
            36,051,689
            
            
            $
            10,129,563Liabilities
      and Stockholders' Equity (Deficit)Accounts
      payable and accrued liabilities
            
            $
            3,569,826
            
            
            $
            816,490Deferred
      revenue
            
            
            188,030
            
            
            
            190,000Payable
      to Mako Shareholders
            
            
            3,205,667
            
            
            
            -Current
      portion of long-term debt
            
            
            995,177
            
            
            
            410,731Total
      current liabilities
            
            
            7,958,700
            
            
            
            1,417,221Long-term
      debt, net of accumulated discount of $1,703,258 and $0
            
            
            10,698,818
            
            
            
            757,617Series
      E redeemable exchangeable preferred stock, face value andliquidation
      preference of $1,000 per share, no dividend preference,authorized
      10,000,000 aggregate shares of all series of Preferred
    stock500
      and 5,000 issued and outstanding, respectively
            
            
            386,411
            
            
            
            3,486,376Series
      G redeemable exchangeable preferred stock, face value andliquidation
      preference of $1,000 per share, no dividend preference,authorized
      10,000,000 aggregate shares of all series of Preferred
    stock-0-
      and 1,000 issued and outstanding, respectively
            
            
            -
            
            
            
            697,275Total
      liabilities
            
            
            19,043,929
            
            
            
            6,358,489Temporary
      equity:Series
      D redeemable convertible preferred stock, $0.01 par value, face value and
      liquidation preference of $1,000 per share, no dividend preference,
      authorized 10,000,000 aggregate shares of all series of Preferred stock
      5,000 issued and outstanding
            
            
            4,419,244
            
            
            
            4,419,244Series
      F redeemable convertible preferred stock, $0.01 par value, face value and
      liquidation preference of $1,000 per share, no dividend preference,
      authorized 10,000,000 aggregate
              of
      all series of Preferred stock -0- and 3,000 issued and outstanding,
      respectively
            
            
            -
            
            
            
            2,651,547Total
      temporary equity
            
            
            4,419,244
            
            
            
            7,070,791Stockholders'
      equity (deficit):Series
      C convertible preferred stock, $0.001 par value, 7% cumulative
      dividend,authorized
      10,000,000 aggregate shares of all series of Preferred
    stock-0-
      and 22,000 shares issued and outstanding, respectively
            
            
            -
            
            
            
            22Common
      stock, $0.001 par value, 490,000,000 shares authorized,
      85,976,526and
      82,870,171 shares issued and outstanding, respectively
            
            
            85,977
            
            
            
            82,870Paid
      in capital
            
            
            14,849,847
            
            
            
            (82,792
            )Accumulated
      deficit
            
            
            (2,347,308
            )
            
            
            (3,299,817
            )Total
      stockholders' equity (deficit)
            
            
            12,588,516
            
            
            
            (3,299,717
            )Total
      liabilities and stockholders' equity
            
            $
            36,051,689
            
            
            $
            10,129,563


F-3





Deep
      Down, Inc.Consolidated
      Statements of Operations




Successor
                                                                
                                                                
                                                                Successor
                                                                
                                                                
                                                                PredecessorCompany
                                                                
                                                                
                                                                Company
                                                                
                                                                
                                                                CompanyYear
      Ended
                                                                  December
      31, 2007
                                                                
                                                                
                                                                Period
      since inception,
                                                                  June 29, 2006 to
                                                                  December
      31, 2006 (1)
                                                                
                                                                
                                                                For
      the 324-Day
                                                                  Period
      from
                                                                  January 1, 2006
                                                                  to
      November 20, 2006RevenuesContract
      revenue
                                                                
                                                                $
                                                                15,652,848
                                                                
                                                                
                                                                $
                                                                978,047
                                                                
                                                                
                                                                $
                                                                7,843,102Rental
      revenue
                                                                
                                                                
                                                                3,736,882
                                                                
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                -Total
      revenues
                                                                
                                                                
                                                                19,389,730
                                                                
                                                                
                                                                
                                                                978,047
                                                                
                                                                
                                                                
                                                                7,843,102Cost
      of sales
                                                                
                                                                
                                                                13,020,369
                                                                
                                                                
                                                                
                                                                565,700
                                                                
                                                                
                                                                
                                                                4,589,699Gross
      profit
                                                                
                                                                
                                                                6,369,361
                                                                
                                                                
                                                                
                                                                412,347
                                                                
                                                                
                                                                
                                                                3,253,403Operating
      expenses:Selling,
      general & administrative
                                                                
                                                                
                                                                4,284,553
                                                                
                                                                
                                                                
                                                                3,600,627
                                                                
                                                                
                                                                
                                                                2,115,947Depreciation
                                                                
                                                                
                                                                426,964
                                                                
                                                                
                                                                
                                                                27,161
                                                                
                                                                
                                                                
                                                                139,307Total
      operating expenses
                                                                
                                                                
                                                                4,711,517
                                                                
                                                                
                                                                
                                                                3,627,788
                                                                
                                                                
                                                                
                                                                2,255,254Operating
      income (loss)
                                                                
                                                                
                                                                1,657,844
                                                                
                                                                
                                                                
                                                                (3,215,441
                                                                )
                                                                
                                                                
                                                                998,149Other
      income (expense):Gain
      on debt extinguishment
                                                                
                                                                
                                                                2,000,000
                                                                
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                -Interest
      income
                                                                
                                                                
                                                                94,487
                                                                
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                -Interest
      expense
                                                                
                                                                
                                                                (2,430,149
                                                                )
                                                                
                                                                
                                                                (62,126
                                                                )
                                                                
                                                                
                                                                (141,130
                                                                )Total
      other income (expense)
                                                                
                                                                
                                                                (335,662
                                                                )
                                                                
                                                                
                                                                (62,126
                                                                )
                                                                
                                                                
                                                                (141,130
                                                                )Income
      (loss) from continuing operations
                                                                
                                                                
                                                                1,322,182
                                                                
                                                                
                                                                
                                                                (3,277,567
                                                                )
                                                                
                                                                
                                                                857,019Income
      tax provision
                                                                
                                                                
                                                                (369,673
                                                                )
                                                                
                                                                
                                                                (22,250
                                                                )
                                                                
                                                                
                                                                -Net
      income (loss)
                                                                
                                                                $
                                                                952,509
                                                                
                                                                
                                                                $
                                                                (3,299,817
                                                                )
                                                                
                                                                $
                                                                857,019Basic
      earnings (loss) per share
                                                                
                                                                $
                                                                0.01
                                                                
                                                                
                                                                $
                                                                (0.04
                                                                )Weighted
      average common shares outstanding
                                                                
                                                                
                                                                73,917,190
                                                                
                                                                
                                                                
                                                                76,701,659Diluted
      earnings (loss) per share
                                                                
                                                                $
                                                                0.01
                                                                
                                                                
                                                                $
                                                                (0.04
                                                                )Weighted
      average common shares outstanding
                                                                
                                                                
                                                                104,349,455
                                                                
                                                                
                                                                
                                                                76,701,569
 
 
 (1)
Consistent with the provisions of FAS 141 regarding Business Combinations, this
column contains the operating results of SubSea Acquisition Corporation
("Subsea") since its inception on June 29, 2006, plus the operating results of
Deep Down, Inc. from November 21, 2006, its acquisition date by
Subsea.
 
 Deep
Down, Inc. and Subsea subsequently completed a parent subsidiary merger with its
parent assuming the name Deep Down, Inc.
 
 See
accompanying notes to financial statements.  F-4





Deep
      Down, Inc.Statements
      of Changes in Stockholders'
Equity




AdditionalCommon
      Stock
                    
                    
                    Series
      C Preferred Stock
                    
                    
                    Paid-in
                    
                    
                    AccumulatedShares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    Amount
                    
                    
                    Capital
                    
                    
                    Deficit
                    
                    
                    TotalBalance
      at December 31, 2005(Predecessor)
                    
                    
                    1,000
                    
                    
                    $
                    201,000
                    
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    37,430
                    
                    
                    $
                    693,951
                    
                    
                    $
                    932,381Contribution
      to capital - Juma gain
                    
                    
                    -
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    191,766
                    
                    
                    
                    
                    
                    
                    
                    191,766Distribution
      of capital - Juma
                    
                    
                    -
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (492,406
                    )
                    
                    
                    (492,406
                    )Distributions
      of capital
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (557,502
                    )
                    
                    
                    (557,502
                    )Net
      income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    857,019
                    
                    
                    
                    857,019Balance
      November 21, 2006(Predecessor)
                    
                    
                    1,000
                    
                    
                    
                    201,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    229,196
                    
                    
                    
                    501,062
                    
                    
                    
                    931,258Purchase
      accounting
                    
                    
                    (1,000
                    )
                    
                    
                    (201,000
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (229,196
                    )
                    
                    
                    (501,062
                    )
                    
                    
                    (931,258
                    )Purchase
      by Subsea
                    
                    
                    9,999,999
                    
                    
                    
                    100
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    100Exchange
      shares by DDI
                    
                    
                    (9,999,999
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    -Exchange
      adjustment
                    
                    
                    75,000,000
                    
                    
                    
                    749,900
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (749,900
                    )
                    
                    
                    
                    
                    
                    
                    -Reclassification
      of par value (a)
                    
                    
                    
                    
                    
                    
                    (675,000
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    675,000
                    
                    
                    
                    
                    
                    
                    
                    -Balance
      at June 29, 2006 (inception)(Successor)
                    
                    
                    75,000,000
                    
                    
                    
                    75,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (74,900
                    )
                    
                    
                    -
                    
                    
                    
                    100Reverse
      merger with MediQuip
                    
                    
                    7,870,171
                    
                    
                    
                    7,870
                    
                    
                    
                    22,000
                    
                    
                    
                    22
                    
                    
                    
                    (7,892
                    )
                    
                    
                    -
                    
                    
                    
                    -Net
      loss
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (3,299,817
                    )
                    
                    
                    (3,299,817
                    )Balance
      at December 31, 2006 (Successor)
                    
                    
                    82,870,171
                    
                    
                    
                    82,870
                    
                    
                    
                    22,000
                    
                    
                    
                    22
                    
                    
                    
                    (82,792
                    )
                    
                    
                    (3,299,817
                    )
                    
                    
                    (3,299,717
                    )Net
      income
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    952,509
                    
                    
                    
                    952,509Shares
      repurchased
                    
                    
                    (25,000,000
                    )
                    
                    
                    (25,000
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (225,000
                    )
                    
                    
                    
                    
                    
                    
                    (250,000
                    )Redemption
      of Preferred
                    
                    
                    3,463,592
                    
                    
                    
                    3,464
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,840,314
                    
                    
                    
                    
                    
                    
                    
                    3,843,778Redemption
      of Preferred C
                    
                    
                    4,400,000
                    
                    
                    
                    4,400
                    
                    
                    
                    (22,000
                    )
                    
                    
                    (22
                    )
                    
                    
                    (4,378
                    )
                    
                    
                    
                    
                    
                    
                    -Stock
      issued for debt payment
                    
                    
                    543,689
                    
                    
                    
                    544
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    559,456
                    
                    
                    
                    
                    
                    
                    
                    560,000Stock
      issued for acquisition of a business
                    
                    
                    6,574,074
                    
                    
                    
                    6,574
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4,989,723
                    
                    
                    
                    
                    
                    
                    
                    4,996,297Private
      Placement offering
                    
                    
                    13,125,000
                    
                    
                    
                    13,125
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,946,875
                    
                    
                    
                    
                    
                    
                    
                    3,960,000Stock
      based compensation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    187,394
                    
                    
                    
                    
                    
                    
                    
                    187,394Debt
      discount
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,638,255
                    
                    
                    
                    
                    
                    
                    
                    1,638,255Balance
      at December 31, 2007 (Successor)
                    
                    
                    85,976,526
                    
                    
                    $
                    85,977
                    
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    14,849,847
                    
                    
                    $
                    (2,347,308
                    )
                    
                    $
                    12,588,516
  (a)
Shares were stated at par value of $0.01 in error. The correct par value of
$0.001 has been reclassified with offset to additional paid-in
capital.
 See
accompanying notes to financial statements.




F-5





Deep
      Down, Inc.Consolidated
      Statements of Cash Flows






Successor
                      
                      
                      Successor
                      
                      
                      PredecessorCompany
                      
                      
                      Company
                      
                      
                      CompanyYear
      Ended
                        December
      31, 2007
                      
                      
                      Period
      since
                        inception,
                        June 29, 2006 to
                        December
      31, 2006
                      
                      
                      For
      the 324-Day
                        Period from
                        January 1, 2006
                        to
      November 20, 2006Cash
      flows from operating activities:Net
      income (loss)
                      
                      $
                      952,509
                      
                      
                      $
                      (3,299,817
                      )
                      
                      $
                      857,019Adjustments
      to reconcile net income to net cash used inoperating
      activities:Gain
      on extinguishment of debt
                      
                      
                      (2,000,000
                      )Non-cash
      amortization of debt discount
                      
                      
                      1,780,922
                      
                      
                      
                      48,179
                      
                      
                      
                      -Non-cash
      amortization of deferred financing costs
                      
                      
                      54,016
                      
                      
                      
                      -
                      
                      
                      
                      -Share-based
      compensation
                      
                      
                      187,394
                      
                      
                      
                      3,340,792
                      
                      
                      
                      -Allowance
      for doubtful accounts
                      
                      
                      108,398
                      
                      
                      
                      -
                      
                      
                      
                      75,880Depreciation
      and amortization
                      
                      
                      426,964
                      
                      
                      
                      27,163
                      
                      
                      
                      139,307Gain
      on disposal of equipment
                      
                      
                      24,336
                      
                      
                      
                      -
                      
                      
                      
                      -Changes
      in assets and liabilities:Lease
      receivable
                      
                      
                      (863,000
                      )
                      
                      
                      -
                      
                      
                      
                      -Accounts
      receivable
                      
                      
                      (4,388,146
                      )
                      
                      
                      (251,001
                      )
                      
                      
                      (166,724
                      )Prepaid
      expenses and other current assets
                      
                      
                      (54,310
                      )
                      
                      
                      23,335
                      
                      
                      
                      34,469Inventory
                      
                      
                      (502,253
                      )
                      
                      
                      -
                      
                      
                      
                      238Work
      in progress
                      
                      
                      246,278
                      
                      
                      
                      (90,326
                      )
                      
                      
                      (826,159
                      )Accounts
      payable and accrued liabilities
                      
                      
                      1,022,726
                      
                      
                      
                      145,433
                      
                      
                      
                      255,243Deferred
      revenue
                      
                      
                      (1,970
                      )
                      
                      
                      -
                      
                      
                      
                      190,000Net
      cash used in operating activities
                      
                      $
                      (3,006,136
                      )
                      
                      $
                      (56,242
                      )
                      
                      $
                      559,273Cash
      flows used in investing activities:Cash
      acquired in acquisiion of a business
                      
                      
                      261,867
                      
                      
                      
                      101,497
                      
                      
                      
                      -Cash
      paid for third party debt
                      
                      
                      (432,475
                      )
                      
                      
                      -
                      
                      
                      
                      -Cash
      received from sale of ElectroWave receivables
                      
                      
                      261,068
                      
                      
                      
                      -
                      
                      
                      
                      -Cash
      paid for final acquisition costs
                      
                      
                      (242,924
                      )
                      
                      
                      -
                      
                      
                      
                      -Purchases
      of equipment
                      
                      
                      (830,965
                      )
                      
                      
                      -
                      
                      
                      
                      (360,978
                      )Proceeds
      from sale of land and building
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      78,419Restricted
      cash
                      
                      
                      (375,000
                      )
                      
                      
                      -
                      
                      
                      
                      -Net
      cash used in investing activities
                      
                      $
                      (1,358,429
                      )
                      
                      $
                      101,497
                      
                      
                      $
                      (282,559
                      )Cash
      flows from financing activities:Payment
      for cancellation of common stock
                      
                      
                      (250,000
                      )
                      
                      
                      -
                      
                      
                      
                      -Distributions
      of capital
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (557,502
                      )Redemption
      of preferred stock
                      
                      
                      (250,000
                      )
                      
                      
                      -
                      
                      
                      
                      -Proceeds
      from sale of common stock, net of expenses
                      
                      
                      3,960,000
                      
                      
                      
                      -
                      
                      
                      
                      -Proceeds
      from sales-type lease
                      
                      
                      276,000
                      
                      
                      
                      -
                      
                      
                      
                      -Borrowings
      on debt - related party
                      
                      
                      150,000
                      
                      
                      
                      -
                      
                      
                      
                      -Payments
      on debt - related party
                      
                      
                      (150,000
                      )
                      
                      
                      -
                      
                      
                      
                      -Borrowings
      on long-term debt
                      
                      
                      6,204,779
                      
                      
                      
                      -
                      
                      
                      
                      512,212Payments
      of long-term debt
                      
                      
                      (2,760,258
                      )
                      
                      
                      (32,893
                      )
                      
                      
                      (212,091
                      )Borrowings
      on line of credit
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      950,004Payments
      on line of credit
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (1,000,004
                      )Deferred
      financing fees
                      
                      
                      (442,198
                      )
                      
                      
                      -
                      
                      
                      
                      -Prepaid
      points
                      
                      
                      (180,000
                      )
                      
                      
                      -
                      
                      
                      
                      -Net
      cash provided by financing activities
                      
                      $
                      6,558,323
                      
                      
                      $
                      (32,893
                      )
                      
                      $
                      (307,381
                      )Change
      in cash and equivalents
                      
                      
                      2,193,758
                      
                      
                      
                      12,362
                      
                      
                      
                      (30,667
                      )Cash
      and cash equivalents, beginning of period
                      
                      
                      12,462
                      
                      
                      
                      100
                      
                      
                      
                      132,264Cash
      and cash equivalents, end of period
                      
                      $
                      2,206,220
                      
                      
                      $
                      12,462
                      
                      
                      $
                      101,597


See
accompanying notes to financial statements.


F-6





Deep
      Down, Inc.Consolidated
      Statements of Cash
Flows




Successor
                                
                                
                                Successor
                                
                                
                                PredecessorCompany
                                
                                
                                Company
                                
                                
                                CompanyYear
      Ended
                                  December
      31, 2007
                                
                                
                                Period
      since
                                  inception,
                                  June 29, 2006 to
                                  December
      31, 2006
                                
                                
                                For
      the 324-Day
                                  Period from
                                  January 1, 2006
                                  to
      November 20, 2006Supplemental
      schedule of noncash investingand
      financing activities:Stock
      issued for acquisition of Mako
                                
                                $
                                4,996,297
                                
                                
                                $
                                -
                                
                                
                                $
                                -Receivable
      from lender - Prospect Capital Corporation
                                
                                $
                                5,604,000
                                
                                
                                $
                                -
                                
                                
                                $
                                -Payable
      to Mako Shareholders
                                
                                $
                                (2,916,667
                                )
                                
                                $
                                -
                                
                                
                                $
                                -Acquisition
      of a business - Electrowave
                                
                                $
                                (190,381
                                )
                                
                                $
                                -
                                
                                
                                $
                                -Exchange
      of receivables for acquisition of a business
                                
                                $
                                280,680
                                
                                
                                $
                                -
                                
                                
                                $
                                -Correction
      of common stock par value to paid in capital
                                
                                $
                                114,750
                                
                                
                                $
                                -
                                
                                
                                $
                                -Fixed
      assets purchased with capital lease
                                
                                $
                                525,000
                                
                                
                                $
                                -
                                
                                
                                $
                                -Transfer
      work in progress to fixed assets
                                
                                $
                                110,181
                                
                                
                                $
                                -
                                
                                
                                $
                                -Exchange
      of Series E preferred stock
                                
                                $
                                3,366,778
                                
                                
                                $
                                -
                                
                                
                                $
                                -Redemption
      of Series E preferred stock
                                
                                $
                                4,935,463
                                
                                
                                $
                                -
                                
                                
                                $
                                -Common
      stock issued for notes payable
                                
                                $
                                560,000
                                
                                
                                $
                                -
                                
                                
                                $
                                -Creation
      of debt discount due to warrants issued to lender
                                
                                $
                                1,479,189
                                
                                
                                $
                                -
                                
                                
                                $
                                -Creation
      of deferred financing fee due to warrants issued to third
      party
                                
                                $
                                159,066
                                
                                
                                $
                                -
                                
                                
                                $
                                -Supplemental
      Disclosures:Cash
      paid for interest
                                
                                $
                                594,667
                                
                                
                                $
                                -
                                
                                
                                $
                                -Cash
      paid for taxes
                                
                                $
                                114,970
                                
                                
                                $
                                -
                                
                                
                                $
                                -
 See accompanying notes to
financial statements.





F-7




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Note
1:                      Nature
of Business and Summary of Significant Accounting Policies





Nature
of Business





Deep
Down, Inc. (“Deep Down Nevada”), a Nevada corporation, is the parent company to
its wholly owned subsidiaries: Deep Down, Inc. (“Deep Down Delaware”) a Delaware
corporation, ElectroWave USA, Inc., a Texas corporation, (“ElectroWave”), and
Mako Technologies, LLC (“Mako”).




·
              Deep
      Down Delaware provides installation management, engineering services,
      support services and storage management services for the subsea controls,
      umbilicals and pipeline industries offshore. Deep Down Delaware also
      fabricates component parts for subsea distribution systems and
      assemblies.
 ·
              ElectroWave
      offers products and services in the fields of electronic monitoring and
      control systems for the energy, military, and commercial business
      sectors.
 ·
              Mako
      serves the growing offshore petroleum and marine industries with technical
      support services, and products vital to offshore petroleum production,
      through rentals of its remotely operated vehicles (“ROV’s”) , topside and
      subsea equipment, and diving support systems used in diving operations,
      maintenance and repair operations, offshore construction, and
      environmental/marine surveys.




On June
29, 2006, Subsea Acquisition Corporation (“Subsea”) was formed with the intent
to acquire service providers to the offshore industry, and designers and
manufacturers of subsea equipment, surface equipment and offshore rig equipment
that are used by major integrated, large independent and foreign national oil
and gas companies in offshore areas throughout the world. On November 21, 2006,
Subsea acquired Deep Down, Inc., a Delaware corporation founded in 1997. Under
the terms of this transaction, all of Deep Down, Inc.’s shareholders transferred
ownership of all of Deep Down, Inc.’s common stock to Subsea in exchange for
5,000 shares of Subsea’s Series D Preferred Stock and 5,000 shares of Subsea’s
Series E Preferred Stock resulting in Deep Down, Inc. becoming a wholly owned
subsidiary of Subsea. On the same day, Subsea then merged with Deep Down, with
the surviving company operating as Deep Down Inc. The purchase price was based
on the fair value of the Series D and E Preferred stock of
$7,865,471.
 
 Consistent
with the provisions of SFAS 141 “Business Combinations,” the successor company’s
financial statements contain the operating results of Subsea since its inception
on June 29, 2006, plus the operating results of Deep Down, Inc. from November
21, 2006, (its acquisition date by Subsea.) The predecessor company’s financial
statements are presented in accordance with Rule 310(a) of Regulation S-B, and
contain the operating results of Deep Down, Inc. from January 1, 2006 to
November 20, 2006. Per Rule 405 of Regulation C, the term “predecessor” means a
person the major portion of the business and assets of which another person
acquired in a single succession, or in a series of related successions in each
of which the acquiring person acquired the major portion of the business and
assets of the acquired person.


On April
2, 2007, Deep Down purchased all of the assets and certain liabilities of
ElectroWave USA, Inc. a Texas corporation for $171,407.  Deep Down
formed a wholly-owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a
Nevada corporation, to complete the acquisition.





On
December 1, 2007, Deep Down purchased 100% of the common stock of Mako
Technologies, Inc., a Louisiana corporation for a total purchase price of
$11,307,000, including transaction fees of $188,369.  Deep Down formed
a wholly-owned subsidiary, Mako, LLC (“Mako”), a Nevada limited liability
corporation, to complete the acquisition. See further discussion in Note 3
“Business Combinations”.





Summary
of Significant Accounting Policies





Principles
of consolidation:





The
consolidated financial statements include the accounts of Deep Down Nevada and
its wholly-owned subsidiaries for the year ended December 31, 2007 and the
period from inception June 29, 2006 to December 31, 2006.





All
significant inter-company transactions and balances have been eliminated in
consolidation.





Use
of Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.




Segments
 
 For
the fiscal year ended December 31, 2007, the operations of Deep Down’s
subsidiaries have been aggregated into a single reporting segment under the
provisions of SFAS 131 “Disclosures about Segments of an Enterprise and Related
Information” (“SFAS 131”). We determined that the operating segments of
Delaware, ElectroWave, and Mako (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 revolving 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 distribution methods, and their economic characteristics were
similar with regard to their gross margin percentages for the fiscal year ended
December 31, 2007.


F-8




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Cash
and Equivalents and Restricted Cash





Deep Down
considers all highly liquid investments with maturities from date of purchase of
three months or less to be cash equivalents. Cash and equivalents consist of
cash on deposit with foreign and domestic banks and, at times, may exceed
federally insured limits.





Per the
terms of its secured credit agreement, Deep Down is required to keep cash on
hand equal to the previous six months interest payment on the debt arising under
such credit agreement. At December 31, 2007, this amount approximated $375,000
which is reflected on the balance sheet as restricted cash.





Fair
Value of Financial Instruments





The
estimated fair value of Deep Down’s financial instruments is as follows at
December 31, 2007:





·
              Cash
      and equivalents, accounts receivable and accounts payable - The carrying
      amounts approximated fair value due to the short-term maturity of these
      instruments.
 ·
              Preferred
      Stock - Series D, E, F and G – The carrying amounts approximate the fair
      value
 ·
              Long-term
      debt - The fair value closely approximates the carrying value of Deep
      Down’s debt instruments due to the short time the debt has been
      outstanding and that similar debt was issued under an Amendment to the
      Credit Agreement dated December 21, 2007.  See discussion of the
      terms at Note 6.





Accounts
Receivable





Deep Down
provides an allowance for doubtful accounts on trade receivables based on
historical collection experience and a specific review of each customer’s trade
receivable balance. When specific accounts are determined to be uncollectable,
they are expensed to bad debt expense in that period. Until August 2007, Deep
Down had factored some of its receivables with a bank.  See further
discussion in Note 4.  At December 31, 2007 and 2006, Deep Down
estimated its allowance for doubtful accounts to be $139,787 and $81,809,
respectively.





Concentration
of Credit Risk





Deep Down
maintains cash balances at several banks. Accounts at the institution are
insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000. Deep
Down had approximately $2.6 million of uninsured cash balances at December 31,
2007.





As of
December 31, 2007, four of Deep Down’s customers accounted for 11%, 9%, 7% and
7% of total accounts receivable, respectively. For the year ended December 31,
2007, Deep Down’s four largest customers accounted for 7%, 7%, 6% and 6% of
total revenues, respectively.  For the period from inception June 29,
2006 to December 31, 2006, Deep Down’s four largest customers accounted for 16%,
14%, 13% and 11% of total revenues, respectively.





Inventory
and Work in Progress




Inventory
is stated at lower of cost (first-in, first out) or net realizable
value.  Inventory consists of an A-frame that is being marketed to
customers requiring off-shore launching or overboarding activities. Work in
Progress is made up primarily unbilled amounts of labor and third party material
costs that are in process but not yet billed to a customer. Amounts at December
31, 2007 and 2006 were $945,612 and $916,485, respectively.





Property
and Equipment





Property
and equipment are stated at cost, net of accumulated depreciation. Depreciation
and amortization is computed using the straight-line method over the estimated
useful lives of the respective assets. Buildings are amortized over 36 years,
and leasehold improvements are amortized over the shorter of the assets' useful
lives or lease terms. Equipment lives range from two to seven years, computers
and electronic lives are from two to three years, and furniture and fixtures are
two to seven years.


F-9




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Replacements
and betterments are capitalized, while maintenance and repairs are expensed as
incurred. It is Deep Down’s policy to include amortization expense on assets
acquired under capital leases with depreciation expense on owned
assets.





Goodwill
and Intangible Assets





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





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





Deep
Down’s intangible assets consist of assets acquired in the purchase of the Mako
subsidiary, specifically customer list, a non-compete covenant and trademarks
related to Mako’s ROVs.  Deep Down is amortizing the intangible assets
over their useful lives ranging from 5 to 25 years on the straight line
basis





Long-Lived
Assets





SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," requires
that Deep Down periodically review the carrying amounts of its property and
equipment and its finite-lived intangible assets to determine whether current
events or circumstances indicate that such carrying amounts may not be
recoverable. The carrying amount of a long-lived asset is not recoverable if it
exceeds the sum of the undiscounted cash flows expected to result from the use
and eventual disposition of the asset. If it is determined that an impairment
loss has occurred, the loss is measured as the amount by which the carrying
amount of the long-lived asset exceeds its fair value.





Lease
Obligations





Deep Down
leases land and buildings under noncancelable operating leases.  Deep
Down leases its corporate headquarters from an entity owned by the CEO and his
wife, a vice president and director.  in addition to several vehicles,
modular office buildings and office equipment which are also recorded as
operating leases and are expensed.  Deep Down also leases a 100-ton
mobile gantry crane under a capital lease, which is included with Equipment on
the consolidated balance sheet.





At the
inception of the lease, Deep Down evaluates each agreement to determine whether
the lease will be accounted for as an operating or capital lease. The term of
the lease used for this evaluation includes renewal option periods only in
instances in which the exercise of the renewal option can be reasonably assured
and failure to exercise such option would result in an economic
penalty.





Revenue
Recognition





Deep
Down’s contract revenue is made up of customized product and service
revenue.  Revenue from fabrication and sale of equipment is recognized
upon transfer of title to the customer which is upon shipment or when
customer-specific acceptance requirements are met. Service revenue is recognized
as the service is provided.  Rental revenue is recognized pro-rata
over the period the rental occurs based on daily or monthly
rates.  Shipping and handling charges paid by Deep Down are included
in cost of goods sold.


F-10




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Income
Taxes





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





Stock
Based Compensation





Effective
with its inception, June 29, 2006, Deep Down accounts for stock-based
compensation issued to employees and non-employees as required by SFAS No.
123(R) “Accounting for Stock Based Compensation” (“SFAS No. 123(R)”). Under
these provisions, Deep Down records expense based on the fair value of the
awards utilizing the Black-Scholes pricing model for options and
warrants.





Earnings
per Common Share




SFAS No. 128,
Earnings Per Share(“EPS”) requires earnings per share to be computed and reported as both
basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted EPS
is computed by dividing net income by the weighted average number of common
shares and dilutive common stock equivalents (convertible notes and interest on
the notes, stock awards and stock options) outstanding during the period.
Dilutive EPS reflects the potential dilution that could occur if options to
purchase common stock were exercised for shares of common stock. Deep Down had
no dilutive securities as of December 31, 2006. The following is a
reconciliation of the number of shares (denominator) used in the basic and
diluted EPS computations:




From
      InceptionYear
      Ended
            
            
            June
      26, 2006 toDecember
      31, 2007
            
            
            December
      31, 2006Numerator
      for basic and diluted earnings per share:Net
      income (loss)
            
            $
            952,509
            
            
            $
            (3,299,817
            )Denominator
      for basic earnings per share:Weighted
      average shares outstanding (basic)
            
            
            73,917,190
            
            
            
            76,701,659Denominator
      for diluted earnings per share:Weighted
      average shares outstanding (basic)
            
            
            73,917,190
            
            
            
            76,701,659Effect
      of dilutive securities
            
            
            30,432,265
            
            
            
            -Weighted
      average shares outstanding (diluted)
            
            
            104,349,455
            
            
            
            76,701,659





Dividends





Deep Down
has no formal dividend policy or obligations. Our loan documents have a
restrictive provision whereby dividends are not permitted to be paid on the
Company’s common stock.





Reclassifications:




Certain
amounts have been reclassified to be consistent with the presentation for all
periods, with no effect on the net loss or stockholders’ equity.




Advertising
costs:




Advertising
and promotion costs, which totaled approximately $58,303 and $0 during the
twelve months ended December 31, 2007 and the period from inception June 29,
2006 to December 31, 2006, respectively, are expensed as
incurred.


F-11




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Recent
Accounting Pronouncements




In July
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) – an
interpretation of FASB Statement No. 109, Accounting for Income Taxes (“SFAS No.
109”) (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in accordance with SFAS No. 109 and prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a return.
Guidance is also provided on de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006.  Deep
Down adopted the provisions of FIN 48 in 2007 and no material uncertain tax
positions were identified.  Thus, the adoption of FIN 48 did not have
an impact on Deep Down’s financial statements.




In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No.
157”). SFAS No. 157 establishes a framework for measuring fair value under
generally accepted accounting procedures and expands disclosures on fair value
measurements. This statement applies under previously established valuation
pronouncements and does not require the changing of any fair value measurements,
though it may cause some valuation procedures to change. Under SFAS No. 157,
fair value is established by the price that would be received to sell the item
or the amount to be paid to transfer the liability of the asset as opposed to
the price to be paid for the asset or received to transfer the liability.
Further, it defines fair value as a market specific valuation as opposed to an
entity specific valuation, though the statement does recognize that there may be
instances when the low amount of market activity for a particular item or
liability may challenge an entity’s ability to establish a market amount. In the
instances that the item is restricted, this pronouncement states that the owner
of the asset or liability should take into consideration what affects the
restriction would have if viewed from the perspective of the buyer or assumer of
the liability. This statement is effective for all assets valued in financial
statements for fiscal years beginning after November 15, 2007. Deep Down is
currently evaluating the impact of SFAS No. 157 on its financial position and
result of operations.




In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS No. 159”), which provides companies with
an option to report selected financial assets and liabilities at fair
value.  SFAS No. 159 also establishes presentation and disclosure
requirements designed to facilitate comparisons between companies that choose
different measurement attributes for similar types of assets and
liabilities.  SFAS No. 159 is effective as of the beginning of an
entity’s first fiscal year beginning after November 15, 2007 with early adoption
allowed.  Deep Down has not yet determined the impact, if any, that
adopting this standard might have on its financial statements.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (“SFAS No. 141(R)”) and No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”).
SFAS No. 141(R) and SFAS No. 160 are products of a joint project between the
FASB and the International Accounting Standards Board.  The revised
standards continue the movement toward the greater use of fair values in
financial reporting. SFAS No. 141(R) will significantly change how business
acquisitions are accounted for and will impact financial statements both on the
acquisition date and in subsequent periods. These changes include the expensing
of acquisition related costs and restructuring costs when incurred, the
recognition of all assets, liabilities and noncontrolling interests at fair
value during a step-acquisition, and the recognition of contingent consideration
as of the acquisition date if it is more likely than not to be
incurred.  SFAS No. 160 will change the accounting and reporting for
minority interests, which will be recharacterized as noncontrolling interests
and classified as a component of equity.  SFAS No. 141(R) and SFAS No.
160 are effective for both public and private companies for fiscal years
beginning on or after December 15, 2008 (January 1, 2009 for companies with
calendar year-ends). SFAS No. 141(R) will be applied prospectively. SFAS No. 160
requires retroactive adoption of the presentation and disclosure requirements
for existing minority interests. All other requirements of SFAS No. 160 shall be
applied prospectively. Early adoption is prohibited for both
standards.  Deep Down is currently evaluating the effects of these
pronouncements on its financial position and results of
operations.





In
December 2007, the SEC staff issued Staff Accounting Bulletin (“SAB”) 110,
Share-Based Payment, which amends SAB 107, Share-Based Payment, to permit public
companies, under certain circumstances, to use the simplified method in SAB 107
for employee option grants after December 31, 2007. Use of the simplified method
after December 2007 is permitted only for companies whose historical data about
their employees’ exercise behavior does not provide a reasonable basis for
estimating the expected term of the options. Deep Down did not have stock
options outstanding until fiscal 2007, and has not exercised any shares, thus
does not have adequate historical data to determine option lives. Therefore,
Deep Down will continue to use the simplified method as allowed under the
provision of SAB 110.


F-12




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Note
2:                      Lease
receivable





On May
18, 2007, Deep Down entered into a sales lease agreement with an unrelated third
party. The leased equipment includes an a-frame, winching system, and hydraulic
power unit, all constructed by Deep Down. The term of the lease is two years,
and includes a purchase option for $35,000 at the conclusion of this term.
Monthly rental payments, in the amount of $34,500 are due beginning May, 2007
through April 2009.  The lease has been accounted for as a sales-type
lease under the rules of FASB No. 13, Accounting for Leases.




Principal
            
            
            Unearned
      incomeMinimum
      lease payments receivable
            
            $
            828,000Estimated
      residual value of leased property
            
            
            35,000863,000
            
            
            $
            863,000
            
            
            $
            (113,000
            )Less:
      Unearned interest income
            
            
            (113,000
            )Net
      investment in sales-type leases
            
            
            750,000Net
      payments received
            
            
            (217,975
            )
            
            
            (276,000
            )
            
            
            58,025Lease
      balance December 31, 2007
            
            $
            532,025
            
            
            $
            587,000
            
            
            $
            (54,975
            )Current
      portion
            
            
            
            
            
            $
            414,000
            
            
            $
            (54,975
            )Long-term
      portion
            
            
            
            
            
            $
            173,000





Note
3:                      Business
Combinations





Purchase
of Mako Technologies, Inc.





Effective
December 1, 2007, Deep Down purchased 100% of the common stock of Mako,
Technologies Inc., a Louisiana corporation. Deep Down formed a wholly owned
subsidiary, Mako Technologies, LLC, (“Mako”) a Nevada limited liability
corporation, to complete the acquisition. Headquartered in Morgan City,
Louisiana, Mako serves the growing offshore petroleum and marine industries with
technical support services, and products vital to offshore petroleum production,
through rentals of its ROV’s, topside and subsea equipment, and diving support
systems used in diving operations, maintenance and repair operations, offshore
construction, and environmental/marine surveys.





The
acquisition of Mako has been accounted for using purchase accounting since Deep
Down acquired substantially all of the assets, debts, employees, intangible
contracts and business of Mako.





The
purchase price in the original agreement was based on a maximum of
$5.0 million in cash and 11,269,841 restricted shares of common stock of Deep
Down valued at $0.76 per share, the market price of Deep Down’s common stock on
December 18, 2007, the date of the press release announcing the purchase, for a
value of $8.6 million for a total potential purchase price of approximately
$13.6 million.  Included in the purchase price is approximately
$188,369 of transaction costs incurred by Deep Down.





The first
installment of $2,916,667 in cash and 6,574,074 shares of restricted common
stock of Deep Down, valued at $0.76 per share was paid on January 4, 2008 and
the balance of $3,205,667 made up of $1,243,578 in cash and 2,802,985 shares of
restricted common stock of Deep Down valued at $0.70 will be paid by April 15,
2008. This second installment was based on verification of adjusted EBITDA
amounts of Mako for the fiscal year ending December 31,
2007.   These amounts were verified and agreed upon by all the
parties on March 27, 2008 and the total $3,025,667 is presented as a payable to
Mako shareholders at December 31, 2007.





On
December 21, 2007, Deep Down signed an amendment to its original credit
agreement with Prospect Capital for an additional $6.5 million for the Mako
acquisition.  On January 4, 2008, Deep Down received an additional
advance of $6.0 million under its secured credit agreement (the “Credit
Agreement”) with Prospect Capital Corporation (“Prospect”) to fund the cash
portion of its acquisition of Mako.


F-13


Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006






The first
payment to shareholders of Mako is reflected on the accompanying consolidated
balance sheet as of December 31, 2007 due to the certainty of payment, and the
intention of all parties to complete this payment prior to fiscal year end. The
second payment of $3,025,667 is reflected as a payable to shareholders due to
the timing of payments in the subsequent fiscal year.  The financing
with Prospect is also reflected as of December 31, 2007 since the funds were
generally used to pay the shareholders of Mako. The net proceeds received from
Prospect of $5,604,000 are offset by the first cash payment to shareholders of
Mako of $2,916,667 resulting in a balance of $2,687,333 reflected as “Receivable
from Prospect” on the consolidated balance sheet at December 31,
2007.





The table
below reflects the breakdown of the purchase price payments:




1st
      Installment
            
            
            2nd
      Installment
            
            
            TotalCommon
      Stock Par
            
            $
            6,574
            
            
            $
            2,803
            
            
            $
            9,377Common
      Stock Paid in Capital
            
            
            4,989,723
            
            
            
            1,959,287
            
            
            
            6,949,010Cash
            
            
            2,916,667
            
            
            
            1,243,577
            
            
            
            4,160,244Amounts
      for Mako Shareholders
            
            $
            7,912,964
            
            
            $
            3,205,667
            
            
            $
            11,118,631




The
purchase price of $11,307,000 included approximately $188,369 of transaction
expenses, plus the assumption of leases of real and personal property and
ongoing accounts payable and bank loans in exchange for substantially all of the
assets, including construction in progress, fixed assets and accounts receivable
and the transfer of all employees. The acquisition price was allocated to the
assets acquired and liabilities assumed based upon their estimated fair values
with the excess being recorded in goodwill.  The following table
summarizes the estimated fair values of the assets acquired and liabilities
assumed at the date of acquisition:





Cash
      and cash equivalents
            
            $
            280,841Accounts
      receivable
            
            
            1,515,074Construction
      in progress
            
            
            279,590Prepaid
      expenses
            
            
            179,583Property,
      plant and equipment
            
            
            3,235,456Intangibles
            
            
            4,398,000Goodwill
            
            
            3,066,153Total
      assets acquired
            
            
            12,954,697Accounts
      payable and accrued expenses
            
            
            828,313Long
      term debt
            
            
            819,384Total
      liabilities acquired
            
            
            1,647,697Net
      assets acquired
            
            $
            11,307,000




Deep Down
hired an independent valuation expert to provide a preliminary estimate for the
fair market value of the assets purchased. As a result, part of the purchase
price was allocated to specifically identified intangible assets.  The
following table below summarizes the intangible assets purchased in the
transaction:







Estimated
            
            
            RemainingFair
      Value
            
            
            Useful
      LifeCustomer
      List
            
            $
            1,071,000
            
            
            
            8Non-Compete
      Covenant
            
            
            458,000
            
            
            
            5Trademarks
            
            
            2,869,000
            
            
            
            25$
            4,398,000





F-14


Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006






The
allocation of the purchase price was based on preliminary
estimates.  Estimates and assumptions are subject to change upon the
receipt of management’s review of the final amounts and final tax
returns.  This final evaluation of net assets acquired is expected to
be completed no later than one year from the acquisition date and any future
changes in the value of the net assets acquired will be offset by a
corresponding change in goodwill.





Additionally,
as part of Prospect’s requirements, Deep Down paid $918,709, as the remaining
balances due on Mako’s long-term debt and accrued interest, in January
2008.





The
following unaudited pro-forma combined condensed financial statements are based
on the historical financial statements of Mako and Deep Down after giving effect
to the acquisition of Mako. The unaudited pro-forma condensed combined
statements of operations for the twelve months ended December 31, 2007 is
presented as if the acquisition had taken place on January 1, 2007 by combining
the historical results of Mako and Deep Down.




The
unaudited pro-forma results were as follows:





Deep
      Down, Inc.Unaudited
      Pro-forma Statements of Operations




HistoricalHistorical
            
            
            MakoDeep
      Down
            
            
            Eleven
      Months
            
            
            
            
            
            
            Pro-FormaYear
      Ended
            
            
            Ended
            
            
            
            
            
            
            Year
      EndedDecember
      31,
            
            November
      30,
            
            
            Pro-Forma
            
            
            
            December
      31,2007
            
            
            2007
            
            
            Adjustments
            
            
            
            2007Revenues
            
            $
            19,389,730
            
            
            $
            5,494,388
            
            
            $
            -
            
            
            
            $
            24,884,118Cost
      of sales
            
            
            13,020,369
            
            
            
            2,298,597
            
            
            
            -
            
            
            
            
            15,318,966Gross
      profit
            
            
            6,369,361
            
            
            
            3,195,791
            
            
            
            -
            
            
            
            
            9,565,152Operating
      expenses
            
            
            4,711,517
            
            
            
            2,455,728
            
            
            
            311,882
            
            (c)
            
            
            7,479,127Total
      other income
            
            
            (335,662
            )
            
            
            (65,705
            )
            
            
            (1,059,573
            )
            (d)
            
            
            (1,460,940
            )Income
      tax expense
            
            
            (369,673
            )
            
            
            (319,432
            )
            
            
            -
            
            
            
            
            (689,105
            )Net
      income (loss)
            
            $
            952,509
            
            
            $
            354,926
            
            
            $
            (1,371,455
            )
            
            
            $
            (64,020
            )Basic
      earnings per share
            
            $
            0.01
            
            
            
            
            
            
            
            
            
            
            
            $
            -Shares
      used in computing basic per share amounts
            
            
            73,917,190
            
            
            
            
            
            
            
            
            
            (e)
            
            
            83,276,238Diluted
      earnings per share
            
            $
            0.01
            
            
            
            
            
            
            
            
            
            
            
            $
            -Shares
      used in computing diluted per share amounts
            
            
            104,349,455
            
            
            
            
            
            
            
            
            
            (e)
            
            
            113,708,503




(c)
            Amortization
      of the intangible assets at a rate of $28,353 per month for eleven months.
      One month is included in the historical Deep Down
  total.




(d)
            Represents
      cash interest plus amortization of deferred financing costs and debt
      discounts.  Interest is payable at 15.5% on the outstanding
      principal, and the related fees are amortized using the effective interest
      method over the four-year life of the
loan.




(e)
            A
      total of 9,377,059 shares were issued for the total transaction. These
      pro-forma amounts give effect as if shares were issued January 1,
      2007.





F-15






Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006


Purchase of ElectroWave USA,
Inc.





On April
2, 2007, Deep Down purchased all of the assets and certain liabilities of
ElectroWave USA, Inc., a Texas corporation.  Deep Down formed a wholly
owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a Nevada corporation,
to complete the acquisition. ElectroWave offers products and services in the
fields of electronic monitoring and control systems for the energy, military,
and commercial business sectors.





The
acquisition of ElectroWave has been accounted for using purchase accounting as
Deep Down acquired substantially all of the assets, debts, employees, intangible
contracts and business of ElectroWave.





The
purchase price of $171,407 includes the payment of bank and other debts of
ElectroWave totaling $432,475, net of $261,068 received from the factoring of
ElectroWave’s receivables. The purchase included the assumption of leases of
real and personal property and ongoing accounts payable in exchange for
substantially all of the assets, including inventory, fixed assets and accounts
receivable and the transfer of all employees. The acquisition price was
allocated to the assets acquired and liabilities assumed based upon their
estimated fair values with the excess being recorded in goodwill.  The
following table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition:





Purchase
      Price:Cash
      paid for third party debt
            
            $
            432,475Cash
      received from sale of ElectroWave receivables
            
            
            (261,068
            )Cash
      purchase price
            
            $
            171,407Accounts
      receivable
            
            $
            133,587Construction
      in progress
            
            
            105,723Property,
      plant and equipment, net
            
            
            45,502Capitalized
      R&D assets
            
            
            270,094Goodwill
            
            
            350,854Total
      assets acquired
            
            
            905,760Cash
      deficit
            
            $
            18,974Accrued
      liabilities
            
            
            715,379Total
      liabilities acquired
            
            
            734,353Net
      assets acquired
            
            $
            171,407




The
allocation of the purchase price was based on preliminary
estimates.  Estimates and assumptions are subject to change upon the
receipt of management’s review of the final amounts and final tax
returns.  This final evaluation of net assets acquired is expected to
be completed no later than one year from the acquisition date and any future
changes in the value of the net assets acquired will be offset by a
corresponding change in goodwill.





No
pro-forma amounts are presented as the impact would not be
material.





In
addition, Deep Down may issue up to an aggregate of 460 shares of convertible
preferred stock over the next two years, as an additional contingent purchase
cost, if the operations of ElectroWave reach certain financial milestones based
on net income for the fiscal years ending December 31, 2008 and
2009.  For the period from acquisition April 2, 2007 through December
31, 2007, ElectroWave had a net loss, so no additional consideration is due for
that time frame. The contingent consideration for the fiscal years ending
December 31, 2008 and 2009 is not considered in the initial purchase price
allocation due to its uncertain nature.


F-16




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Purchase of Deep Down, Inc.
by Subsea on November 21, 2006





On
November 21, 2006, Subsea acquired Deep Down, Inc., a Delaware corporation
founded in 1997. Under the terms of this transaction, all of Deep Down, Inc.’s
shareholders transferred ownership of all of Deep Down, Inc.’s common stock to
Subsea in exchange for 5,000 shares of Subsea’s Series D Preferred Stock and
5,000 shares of Subsea’s Series E Preferred Stock resulting in Deep Down, Inc.
becoming a wholly owned subsidiary of Subsea. On the same day, Subsea then
merged with Deep Down, Inc., with the surviving company operating as Deep Down,
Inc. The purchase price based on the fair value of the Series D and E Preferred
stock was $7,865,471. This transaction was accounted for as a purchase, with
Subsea being the acquirer based on the change in voting control. The acquisition
price was allocated to the assets acquired and liabilities assumed based upon
their estimated fair values with the excess being recorded in goodwill. The
following table summarizes the estimated preliminary fair values of the assets
acquired and liabilities assumed at the date of acquisition:





Cash
      and cash equivalents
            
            $
            101,497Accounts
      receivable
            
            
            1,013,227Inventory
            
            
            168,672Prepaid
      expenses
            
            
            11,638Construction
      in progress
            
            
            826,159Property,
      plant and equipment, net
            
            
            872,363Goodwill
            
            
            7,177,137Total
      assets acquired
            
            
            10,170,693Accounts
      payable
            
            
            671,057Accrued
      liabilities
            
            
            432,924Current
      portion of long term debt
            
            
            403,057Long
      term debt
            
            
            798,184Total
      liabilities acquired
            
            
            2,305,222Net
      assets acquired
            
            $
            7,865,471





During
fiscal 2007, Deep Down paid approximately $242,924 to the former shareholders of
the Sub-chapter S corporation Deep Down, Inc. (Delaware), which represents the
income taxes due on the income from the time of purchase through the filing of
revised tax status as a C-Corporation, which is reflected as an adjustment to
goodwill since these payments related to the original agreements. There will be
no further adjustments to goodwill as the one year period of evaluation has
passed, and the final tax returns have been filed.





Note
4:                      Accounts
Receivable





Management
has established an allowance for uncollectible accounts of $139,787 and $81,809
as of December 31, 2007 and 2006. Bad debt expense totaled $ 110,569 and $1,294
for the year ended December 31, 2007 and the period from inception June 29, 2006
to December 31, 2006, respectively.





Until
August 2007, Deep Down factored certain accounts receivables with a bank. Under
the terms of the arrangement, Deep Down received proceeds equal to 80% of the
value of the receivable at the date of transfer. Upon collection of the
receivable, the bank remits the remaining 20%, less fees and interest. Fees
ranged from 0.25% to 2% depending on the age of the receivable and interest is
prime plus 2%. The arrangement contained provisions that indicated Deep Down was
responsible for up to 20% of end-user customer payment defaults on factored
receivables.  As of December 31, 2007, all receivables under this
arrangement have been collected and Deep Down no longer has a factoring
program.


F-17




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Note
5:                      Property
and Equipment





Property
and equipment consisted of the following as of December 31, 2007 and
2006:





December
      31,
              2007
            
            
            December
      31,
              2006Building
            
            $
            195,305
            
            
            $
            46,474Furniture
      and fixtures
            
            
            63,777
            
            
            
            11,806Vehicles
      and trailers
            
            
            112,162
            
            
            
            66,662Leasehold
      improvements
            
            
            75,149
            
            
            
            -Rental
      equipment
            
            
            3,144,559
            
            
            
            -Equipment
            
            
            2,004,166
            
            
            
            747,419Total
            
            
            5,595,118
            
            
            
            872,361Less:
      Accumulated depreciation
            
            
            (422,314
            )
            
            
            (27,161
            )Property
      and equipment, net
            
            $
            5,172,804
            
            
            $
            845,200





In
February 2007, Deep Down entered into a capital lease transaction for the lease
of a 100-ton mobile gantry crane valued at $525,000, which is included with
Equipment above.





Depreciation
expense was $426,964 and $27,161 for the year ended December 31, 2007 and the
period from inception June 29, 2006 to December 31, 2006,
respectively.  Accumulated depreciation on equipment under capital
lease is $62,500 at December 31, 2007.


F-18




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Note
6:                      Long-Term
Debt





At
December 31, 2007 and 2006 long-term debt consisted of the
following:




December
      31,
              2007
            
            
            December
      31,
              2006Secured
      credit agreement withquarterly
      principal payments of $250,000 beginningSeptember
      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 $135,931
            
            
            (1,703,258
            )
            
            
            -Note
      payable to a bank, payable in monthlyinstallments
      bearing interest at 8.25% per annum,maturing
      June 10, 2008, cross-collateralizedby
      Mako assets, paid January 2008.
            
            
            289,665
            
            
            
            -Note
      payable to a bank, payable in monthlyinstallments
      bearing interest at 7.85% per annum,maturing
      September 28, 2010, collateralized by Makolife
      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 isat
      a variable rate resulting in a rate of 8.30% as ofSeptember
      30, 2007, collateralized by Mako equipment,paid
      January 2008.
            
            
            151,705
            
            
            
            -Note
      payable to a bank payable in monthlyinstallments
      bearing interest at 7.85% per annum,maturing
      January 25, 2011, collateralized by Makoequipment
      and life insurance policy, paid January 2008
            
            
            154,647
            
            
            
            -Note
      payable with a bank, monthly principal andinterest
      payments, interest fixed at 7.5%,paid
      in full August 2007
            
            
            -
            
            
            
            438,812Note
      payable with a bank, monthly principal andinterest
      payments, interest fixed at 7.5%,paid
      in full August 2007
            
            
            -
            
            
            
            729,536Total
      secured credit agreement and bank debt
            
            
            11,212,786
            
            
            
            1,168,348Capital
      lease of equipment, monthly lease payments,interest
      imputed at 11.2%
            
            
            481,209
            
            
            
            -Total
      long-term debt
            
            
            11,693,995
            
            
            
            1,168,348Current
      portion of long-term debt
            
            
            (995,177
            )
            
            
            (410,731
            )Long-term
      debt, net of current portion
            
            $
            10,698,818
            
            
            $
            757,617





F-19




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Secured
credit agreement





On August
6, 2007, Deep Down entered into a $6.5 million secured Credit Agreement with
Prospect, and received an advance of $6.0 million on that date. Funds were used
to pay off other bank indebtedness, redeem $1,400,000 of the Series E Preferred
Shares outstanding, payoff $150,000 owing to an officer, and to provide working
capital to accelerate development of its corporate growth strategies.
Indebtedness through the Credit Agreement is secured by all of Deep Down’s
assets.





The
original Credit Agreement provides for a 4-year term, an annual interest rate of
15.5%, with the ability to defer up to 3.0% of interest through a PIK
(paid-in-kind) feature and principal payments of $75,000 per quarter beginning
September 30,2008, with the remaining balance outstanding due August 6,
2011.  Interest payments are payable monthly, in arrears, on each
month end commencing on August 31, 2007.  Interest paid through
December 31, 2007 was $377,167.  Deep Down paid the full 15.5% and did
not exercise the PIK feature for the monthly periods through December
2007.





On
December 21, 2007, Deep Down entered into an amendment to the Credit Agreement
(the “Amendment”) to provide the funding for the cash portion of the purchase of
Mako. The total commitment available under the Amendment was increased to $13.0
million, and the quarterly principal payments increased to $250,000, with the
dates of all payments remaining the same. The interest terms and loan covenants
also remained substantially the same under the Amendment. Deep Down was advanced
an additional $6.0 million on January 4, 2008 under terms of the
Amendment.  As discussed in Note 3, this additional advance and the
related debt discounts and deferred financing cost have been reflected as of
December 31, 2007.  The revised payment terms and increase in
principal and debt discount balances are reflected in the 5-year schedule of
required payments below.





Terms of
the Credit Agreement also include a detachable warrant to purchase up to
4,960,585 shares of common stock at an exercise price of $0.507 per
share.  The warrant has a five-year term and becomes exercisable on
the two-year anniversary of the original financing, August 6,
2009.  The proceeds of the debt were allocated to the warrants based
on its estimated relative fair value at the measurement date of when the final
agreement was signed and announced and reflected as a discount to the
debt.  Although the terms of the warrant were agreed to on May 24,
2007, the measurement date for valuation was determined to be the date of
closing of the Credit Agreement.  The relative fair value of the
warrant was estimated to be $1,479,189 based on the Black Scholes pricing
model.  The assumptions used in the model included (1) expected
volatility of 52.7%, (2) expected term of 3.5 years, (3) discount rate of 5% and
(4) zero expected dividends.   Provisions in the warrant
agreement allow for a cashless exercise provision, not to exceed 2% of
outstanding common stock at the time of exercise.





Additionally,
in connection with the initial advance in August 2007, Deep Down pre-paid
$180,000 in points to the lender which was treated as a discount to the
note.  The discount associated with the value of the warrants and the
pre-paid points are being amortized into interest expense over the life of the
note agreement using the effective interest method.  A total of
$135,931 has been amortized into interest expense through December 31,
2007.





In
connection with the second advance in January 4, 2008, Deep Down pre-paid
$180,000 in points to the lender which was treated as a discount to the
note.  This addition to the debt discount is included in the 5-year
payment schedule below.





In
connection with the warrant, Deep Down entered into a registration rights
agreement where the holder has certain demand registration rights in the
future.  There are no stipulated liquidated damages in the
agreement.  Deep Down evaluated the warrants and the registration
rights agreement for liability treatment under SFAS 133 and EITF 00-19 and
determined that the warrants and registration rights did not meet the definition
of a liability under the authoritative guidance.


F-20




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006


Under the
Credit Agreement, Deep Down is required to meet certain covenants and
restrictions, in addition to maintaining “key man” life insurance with respect
to the CEO in the amount of at least $3.0 million.  The financial
covenants are reportable each quarter, and fluctuate over defined time frames,
with the initial period being the quarters ending December 31, 2007 through June
30, 2008.  Financial covenants include maintaining total debt to
consolidated EBITDA below 3.5 to 1, consolidated EBITDA to
consolidated net interest expense on the total debt greater than 2 to 1, free
cash flow to debt service greater than 1 to 1, and EBITDA in excess of
$2,000,000 (annual calculation only) 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 must also maintain a
debt service reserve account of $375,000 which is reflected as restricted cash
on the balance sheet.  At December 31, 2007, Deep Down was in
compliance with the financial covenants and restricted cash requirement,
however, it has obtained life insurance for the CEO in the amount of $2.0
million so it is not in compliance with that restriction. Deep Down obtained a
waiver from the lender on March 28, 2008. Deep Down is working on obtaining the
additional $1.0 million required life insurance.





Deep Down
capitalized a total of $555,314 in deferred financing costs related to the
original amounts borrowed under the Credit Agreement.  Of this amount,
$442,194 was paid in cash to various third parties related to the financing, and
the remainder of $113,120 represents the Black Scholes valuation of warrants
issued to one of these third party vendors.  The warrant is a
detachable warrant to purchase up to 320,000 shares of common stock at an
exercise price of $0.75 per share (calculated as the volume weighted average
closing price of the common stock for the ten days immediately preceding the
closing of the Credit Agreement which took place on August 6,
2007).  The warrant has a five-year term and becomes exercisable on
the two-year anniversary of the original financing, August 6,
2009.  The assumptions used in the Black Scholes model included (1)
expected volatility of 52.7%, (2) expected term of 3.5 years, (3) discount rate
of 5% and (4) zero expected dividends.  The deferred financing cost is
being amortized using the effective interest method over the term of the
note.  A total of $54,560 of deferred financing cost was amortized
into interest expense through December 31, 2007.





In
connection with the second advance under the Credit Agreement on January 4,
2008, Deep Down capitalized an additional $261,941 in deferred financing
costs.  Of this amount, $216,000 was paid in cash to various third
parties related to the financing, and the remainder of $45,946 represents the
Black Scholes valuation of warrants issued to one of these third party
vendors.  The detachable warrant was granted to purchase up to 118,812
shares of common stock at an exercise price of $1.01 per share.  The
warrant has a five-year term and is immediately exercisable.  The fair
value of the warrant was estimated to be $45,946 based on the Black Scholes
pricing model.  The assumptions used in the model included (1)
expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount rate
of 3.2% and (4) zero expected dividends.  Provisions in the warrant
agreement allow for a cashless exercise provision, not to exceed 2% of
outstanding common stock at the time of exercise.





Payment
of bank loans and accounts receivable factoring arrangement





On August
7, 2007, Deep Down paid the remaining balances due on prior bank loans for a
total of $936,073, including accrued interest through that date. Total principal
payments on these loans for the twelve months ended December 31, 2007 were
$1,168,348. Additionally, as of August 2007, Deep Down is no longer factoring
accounts receivable with this bank. As of December 31, 2007, all receivables
under this arrangement have been collected.





Payment
of shareholder payable





During
the second quarter of fiscal 2007, Deep Down executed a Securities Redemption
Agreement (the “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 $2,000,000.  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 which is reflected as
other income on the income statement.  Deep Down accreted the
remaining discount of $1,102,385 attributable to such shares on the date of
redemption.  On August 16, 2007, Deep Down made the initial payment of
$1,400,000 under the terms of the securities redemption agreement, and 2
payments of $20,000 each were made during August and September
2007.  The final balance due of $560,000 was paid with 543,689 shares
of common stock on valued at the closing market price on October 2,
2007.


F-21




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Payment
of subsidiary debt





As part
of the net assets acquired in the purchase of Mako, Deep Down assumed notes
payable in the amount of approximately $916,044 plus accrued interest. Deep Down
paid the remaining balances due for a total of $918,709, including accrued
interest, in January 2008; the principal balance of these notes is included in
the current portion of long-term debt on the accompanying consolidated balance
sheet.





Payment
table





The table
below includes the additional advance of $6.0 million under the Amendment to the
Credit Agreement in January 2008, plus the related debt discount of
approximately $180,000 in lenders’ fees related to that additional advance.
Aggregate principal maturities of long-term debt were as follows for years ended
December 31:





Years
      ended December 31,
            
            Principal
            
            Unamortized
              Debt
      Discount
            
            Total2008
            
            $
            1,416,044
            
            $
            (465,776
            )
            $
            950,2682009
            
            
            1,000,000
            
            
            (468,291
            )
            
            531,7092010
            
            
            1,000,000
            
            
            (461,413
            )
            
            538,5872011
            
            
            9,500,000
            
            
            (307,778
            )
            
            9,192,222$
            12,916,044
            
            $
            (1,703,258
            )
            $
            11,212,786





Capital
lease





In
February 2007, Deep Down purchased under a seller-financed capital lease, a
100-ton mobile gantry crane and related equipment.  The equipment was
delivered and placed into service in March 2007.  In accordance with
Financial Accounting Standards Board SFAS 13 “Accounting for Leases” as amended,
the lease was capitalized and the lease obligation and related assets recognized
on Deep Down’s consolidated balance sheet.  The total value of the
lease payments discounted at an 11.2% interest rate, or $525,000, was
capitalized.  The off-setting lease obligation is $481,209 at December 31,
2007.




Note
7:                      Stock
Options and Warrants





Adoption
of FAS 123(R)





Effective
April 21, 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS
123(R), which is a revision of SFAS 123. SFAS 123(R) supersedes APB 25 and
amends Statement of Accounting Standards No. 95, “Statement of Cash Flows”.
Generally, the approach in SFAS 123(R) is similar to the approach described in
SFAS 123. However, SFAS123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in Deep Down’s
Statement of Operations based on their fair values.  Deep Down adopted
the provisions of SFAS 123(R) in the first quarter of 2007.  As Deep
Down had no outstanding stock options at December 31, 2006, the initial adoption
of SFAS 123(R) had no impact to Deep Down.





Stock
Options Granted During 2007





Deep Down
has a stock based compensation plan - the 2003 Directors, Officers and
Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). 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 lives
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
year ended December 31, 2007, Deep Down granted 5,500,000 options under the
Plan.  Deep Down issued an aggregate of 1,500,000 stock options to
various consultants, of which 300,000 were issued with an exercise price of
$0.30, $0.50, $0.75, $1.00, and $1.25, respectively.  Additionally,
Deep Down issued an aggregate of 1,000,000 stock options to various
employees with an exercise price of $0.50 and 3,000,000 stock options to an
officer and director with an exercise price of $0.515.


F-22




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





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 similar industry, with similar market
capitalizations and similar stage of development.  Deep Down is
expensing all stock options on a straight line basis over their respective
expected service periods.  Total stock based compensation expense for
the year ended December 31, 2007 was $187,394.  Deep Down had no stock
based grants prior to fiscal 2007.





The
unamortized portion of the estimated fair value of these stock options is
$636,656 at December 31, 2007. Based on the common shares outstanding at
December 31, 2007, there are 7,396,000 available for grant under the Plan as of
that date.





Summary
of Stock Options





A summary
of stock option transactions follows:




Number
      of
              Shares
            
            
            Weighted-
              Average
              Exercise
      Price
            
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
      (in years)
            
            
            Aggregate
              Intrinsic
      Value
              (In-The-Money)
              OptionsOutstanding
      at December 31, 2006
            
            
            -
            
            
            $
            -Grants
            
            
            5,500,000
            
            
            $
            0.58Outstanding
      at December 31, 2007
            
            
            5,500,000
            
            
            $
            0.58
            
            
            
            3.2
            
            
            $
            2,292,000Exercisable
      at December 31, 2007
            
            
            562,500
            
            
            $
            0.76
            
            
            
            4.3
            
            
            $
            156,375




The
following summarizes Deep Down’s outstanding options and their respective
exercise prices at December 31, 2007:




Exercise
      Price
            
            Number
      of Shares$
            0.30
            
            
            300,000$
            0.50
      - 0.52
            
            
            4,300,000$
            0.75
            
            
            300,000$
            1.00
            
            
            300,000$
            1.25
            
            
            300,0005,500,000




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 year
ended December 31, 2007:




Dividend
      yield
            
            0%Risk
      free interest rate
            
            5%Expected
      life of options
            3 -
      4 yearsExpected
      volatility
            
            53%
      - 55%





F-23






Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006


Summary
of Warrants:





On August
6, 2007, as part of the secured Credit Agreement described in Note 6, Deep Down
issued 4,960,585 warrants to its creditor.  All warrants were issued with
an exercise price of $0.507, expire in five years (or earlier in the event of
termination) and vest on the second anniversary of the agreement.  The
aggregate relative fair value of such warrants (excluding estimated forfeitures)
was approximately $1,479,189 based on the Black-Scholes option pricing model
using the following estimates:  5% risk free rate, 52.7% volatility, and an
expected life of 3.5 years.





Deep Down
issued warrants to a third party related to the financing.  The
warrant is a detachable warrant to purchase up to 320,000 shares of common stock
at an exercise price of $0.75 per share (calculated as the volume weighted
average closing price of the common stock for the ten days immediately preceding
the closing of the Prospect financing which took place on August 6,
2007).  The warrant has a five-year term and becomes exercisable on
the two-year anniversary of the financing, August 6, 2009.  The
assumptions used in the Black Scholes model included (1) expected volatility of
52.7%, (2) expected term of 3.5 years, (3) discount rate of 5% and (4) zero
expected dividends.





Related
to the secured Credit Agreement Amendment and second advance described in Note
6, Deep Down issued warrants to a third party related to the
financing.  The warrant is a detachable warrant to purchase up to
118,812 shares of common stock at an exercise price of $1.01 per
share.  The warrant has a five-year term and is immediately
exercisable.  The assumptions used in the Black Scholes model included
(1) expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount
rate of 3.18% and (4) zero expected dividends.





A summary
of warrant transactions follows:




Number
      of
              Shares
            
            
            Weighted-
              Average
              Exercise
              Price
            
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
              (in
      years)
            
            
            Aggregate
              Intrinsic
      Value
              (In-The-Money)
              OptionsOutstanding
      at December 31, 2006
            
            
            -
            
            
            $
            -Grants
            
            
            5,399,397
            
            
            $
            0.53Outstanding
      at December 31, 2007
            
            
            5,399,397
            
            
            $
            0.53
            
            
            
            4.6
            
            
            $
            2,405,075Exercisable
      at December 31, 2007
            
            
            -
            
            
            
            
            
            
            
            
            
            
            $
            -





The
following summarizes Deep Down’s outstanding warrants and their respective
exercise prices at December 31, 2007:




Exercise
      Price
            
            Number
      of Shares$
            0.51
            
            
            4,960,585$
            0.75
            
            
            320,000$
            1.01
            
            
            118,8125,399,397





F-24




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





Note
8:                      Preferred
Stock





Series
E and G Classified as Liabilities





The
Series E and G redeemable exchangeable preferred stock have a face value and
liquidation preference of $1,000 per share, no dividend preference, and are
exchangeable at the holder’s option into 6% Subordinated Notes due three years
from the date of the exchange. These shares carry voting rights equal to 690
votes per share. The Series E and G preferred stock were valued based on the
discounted value of their expected future cash flows (using a discount rate of
20%).  Deep Down evaluated the Series E and G preferred stock and has
classified them as debt instruments from the date of issuance due to the fact
that they are exchangeable at the option of the holder thereof into
Notes.  The difference between the face value of the Series E and G
preferred stock and the discounted book value recorded on the balance sheet, or
original issue discount, is deemed to be non-cash interest expense from the date
of issuance through the term of the Stock.





Deep Down
has been accreting this original issue discount using the effective interest
method.  Interest expense related to the accretion of the original
issue discount totaled approximately $1,644,990 and $40,149 for the year ended
December 31, 2007 and 2006 respectively. This total includes the accelerated
accretion of approximately $1,017,707 to accrete to face value 4,000 shares plus
approximately $72,799 to accrete to face value 250 shares, plus approximately
$260,520 to accrete to face value 1,250 shares, respectively, of Series E
preferred stock that were redeemed during the year ended December 31, 2007, as
further detailed below.





In
February 2007, Deep Down redeemed 250 shares of Series E redeemable,
exchangeable preferred stock held by its CEO at the face value of $1,000 per
share for a total of $250,000.  Deep Down accreted the remaining
discount of $72,799 attributable to such shares on the date of redemption as
interest expense.





In May
2007, Deep Down executed a Securities Redemption Agreement (the “Agreement”)
with a stockholder (the former CFO of Deep Down) to redeem 4,000 shares of
Series E redeemable, exchangeable preferred stock at a discounted price of $500
per share for a total of $2,000,000.  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 which is reflected in
other income.  Deep Down accreted the remaining discount of $1,017,707
attributable to such shares on the date of redemption as interest
expense.  The shareholder placed all 4,000 shares into an escrow
account as of the execution of this agreement. Terms of the payment to the
shareholder are: 2,800 shares at $500 for a total of $1,400,000 paid in August
2007, with the remaining shares to being redeemed monthly beginning August 31,
2007 at a rate of 40 shares at $500 per share, or $20,000 per
month.  The final balance outstanding of $560,000 was paid with
543,689 shares of common stock in October 2007.





On
September 13, 2007, Deep Down redeemed 2,250 shares owned by the CEO and
director, and his wife, a Vice-President and director of Deep
Down.  The Series E preferred shares were redeemed for 2,250,000
shares of common stock at the closing price of $0.66 totaling
$1,473,750.  Since the shareholders are related parties, no accretion
interest was recorded related to the redemption.  The difference
between the carrying value of the Series E shares of $1,685,463 and the common
stock market value was recorded to Paid in Capital.





Additionally,
in October 2007, Deep Down redeemed 1,250 shares of Series E redeemable,
exchangeable preferred stock at the face value of $1,000 per share for a total
of $1,250,000. The Series E preferred shares were redeemed for 1,213,592 shares
of common stock at the closing price of $1.03.  Deep Down accreted the
remaining discount of $260,520 attributable to such shares on the date of
redemption and recorded it as interest expense.





All
Series G preferred shares were cancelled and exchanged during the first quarter
of 2007. Accordingly, there is no future discount accretion relating to the
Series G preferred shares.  See “Series F and G Cancellation and
Issuance of Additional Series E” below.


F-25




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006





The
unamortized discounts related to the Series E and Series G preferred stock
were as follows:




December
      31,
              2007
            
            
            December
      31,
              2006Series
      E preferred stock - face value at $1,000 per share
            
            $
            500,000
            
            
            $
            5,000,000Less
      unamortized discount
            
            
            (113,589
            )
            
            
            (1,513,624
            )Balance
      net of unamortized discount
            
            
            386,411
            
            
            
            3,486,376Series
      G preferred stock - face value at $1,000 per share
            
            
            -
            
            
            
            1,000,000Less
      unamortized discount
            
            
            -
            
            
            
            (302,725
            )Balance
      net of unamortized discount
            
            
            -
            
            
            
            697,275$
            386,411
            
            
            $
            4,183,651





A summary
of Series E and Series G preferred stock transactions follows:





Series
      E
            
            
            Series
      GOutstanding
      at December 31, 2006
            
            
            5,000
            
            
            
            1,000Shares
      issued
            
            
            3,250
            
            
            
            -Shares
      redeemed
            
            
            (7,750
            )
            
            
            (1,000
            )Outstanding
      at December 31, 2007
            
            
            500
            
            
            
            -




Series
F and G Cancellation and Issuance of Additional Series E





On March
20, 2007, Deep Down finalized the terms of an agreement with a former
non-employee director who surrendered 25,000,000 shares of common stock for
$250,000 in cash. The market value of those shares was $7,250,000. Additionally,
he surrendered 1,500 shares of Series F convertible preferred stock with a value
of $1,325,773 and 500 shares of Series G exchangeable preferred stock with a
value of $357,615 to Deep Down for cancellation in exchange for 1,250 shares of
Series E exchangeable preferred stock valued at $945,563. The Series E Preferred
Stock was valued based on the discounted value of its expected future cash flows
(using a discount rate of 20%).  The difference between the values of
the preferred shares surrendered and the newly issued was $737,826 which is
reflected in paid in capital on the accompanying consolidated balance sheet. In
addition, he also kept 500 shares of Series E exchangeable preferred stock he
previously owned and agreed to tender his resignation from the
Board.




On March
20, 2007, Deep Down issued 2,000 shares of Series E exchangeable preferred stock
to John C. Siedhoff, then Chief Financial Officer, and director, valued at
$1,512,901 for the surrender of his ownership of 1,500 shares of Series F
convertible preferred stock valued at $1,325,773 and 500 shares of Series G
exchangeable preferred stock valued at $357,616, which were returned to the
transfer agent for cancellation.  The Series E Preferred Stock was
valued based on the discounted value of its expected future cash flows (using a
discount rate of 20%).  The difference between the values of the
surrendered shares and the newly issued was $170,489 which is reflected in paid
in capital on the accompanying consolidated balance sheet. Deep Down has treated
this as a modification of a share-based payment in accordance with the
provisions of SFAS No. 123R, “Share-Based Payments”.





Series
D and F Classified as Temporary Equity





The
Series D redeemable convertible preferred stock have a face value and
liquidation preference of $1,000 per share, no dividend preference, and are
convertible into shares of common stock determined by dividing the face amount
by a conversion price of $0.1933.  These shares carry voting rights
equal to one vote for every share of common stock into which the preferred stock
is convertible.  These shares are redeemable at their face value on an
annual basis within 120 days after each calendar year-end beginning with the
year ending December 31, 2007 based on an amount equal to 15.625% of annual net
income.  In the event that a holder declines redemption, such amounts
are reallocated to the other preferred stock holders that have elected to
redeem.


F-26






Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006


The
Series F preferred stock has the same terms as described above, with the
exception of the amount of redemption is equal to 9.375% of annual net
income.





Deep Down
evaluated the Series D and F preferred stock for liability or equity
presentation and determined that the instruments were more appropriately
classified as temporary equity due to the conditional redemption
feature.





On March
28, 2008, holders of the Series D preferred stock converted 5,000 of the
outstanding shares into 25,866,518 shares of common stock.





Series
C Preferred Stock





On April
22, 2005, MediQuip issued 22,000 Series C convertible preferred stock which
remained after the reverse merger. The Series C shares had a face value and a
liquidation preference of $12.50 per share, a cumulative dividend of 7% payable
at the conversion date, and were convertible into shares of common stock
determined by dividing the face amount by a conversion price of $0.0625. These
shares carried no voting rights.  All of the Series C shares were
converted in the fourth quarter of fiscal 2007 to 4,400,000 shares of Deep
Down’s common stock.





Note
9:                      Common
Stock





Private
Placements




On March
20, 2007, Deep Down completed the sale of 10,000,000 shares of common stock in a
private placement for $1,000,000. A total of 1,025,000 shares were purchased by
the CEO and director, and his wife, a Vice-President and director of
Deep Down. The shares are restricted securities as defined in Rule 144 of the
Securities Act of 1933 and contain a restrictive legend, which restricts the
ability of the holders to sell these shares for a period of no less than six
months. Funds from such private placement sale were used to redeem certain
outstanding exchangeable preferred stock and for working capital.





On
October 12, 2007, Deep Down closed an agreement with Ironman Energy Capital,
L.P. for a private placement of 3,125,000 shares of common stock at $0.96 per
share, or $3,000,000 in the aggregate, pursuant to an agreement reached on
October 2, 2007 when the closing price was $1.03 per share.





In
connection with this private placement, the Deep Down entered into registration
rights agreement, under which, upon demand registration by the holder after
December 31, 2008, Deep Down could be subject to liquidating damages in the
amount of 1% of the proceeds for every 30 days a registration statement is not
declared effective. Deep Down is currently evaluating the probability of
incurring these liquidated damages as a contingent liability and not yet
determined the potential impact on the financial statements.





Other
stock issuances





On
September 13, 2007, Deep Down redeemed 2,250 shares of Series E preferred stock
owned by the Chief Executive Officer and director, and his wife, a
Vice-President of Deep Down.  The Series E preferred shares were
redeemed for 2,250,000 shares of common stock at the closing price of
$0.66.





On
October 2, 2007, Deep Down made the final payment of $560,000 under the terms of
a securities redemption and shareholder payable agreement by issuing 543,689
shares of common stock valued at the closing price of $1.03 on the same
day.


F-27




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006


Note
10:                      Income
Taxes





Prior to
the reverse merger, Deep Down was a Subchapter S entity and the tax attributes
flowed through to the individual owners. Thus any prior net operating losses
will not be available to be utilized to offset future taxable
income.




Income
tax expense for the year ended December 31, 2007 and period from inception June
29, 2006 to December 31, 2007 totaled $ 369,673 and $22,250,
respectively.





A
reconciliation of the differences between the effective and statutory income tax
rates are as follows for the year ended December 31, 2007 and the period from
inception June 29, 2006 to December 31, 2006:





From
      InceptionYear
      Ended
            
            
            Tax
            
            
            June
      26,
              2006
      to
            
            
            TaxDecember
      31, 2007
            
            
            Rate
            
            
            December
      31, 2006
            
            
            RateFederal
      statutory rates
            
            $
            449,540
            
            
            
            34%
            
            
            $
            (1,121,938
            )
            
            
            34%Stock
      based compensation
            
            
            69,335
            
            
            
            5%
            
            
            
            1,135,869
            
            
            
            -35%Goodwill
            
            
            (189,829
            )
            
            
            -14%
            
            
            
            -
            
            
            
            0%Other
            
            
            40,627
            
            
            
            3%
            
            
            
            8,319
            
            
            
            0%Effective
      rate
            
            $
            369,673
            
            
            
            28%
            
            
            $
            22,250
            
            
            
            -1%





Net
deferred tax assets at December 31, 2007 totaled $75,823 and consisted primarily
of deferred tax assets related to timing differences associated with the
recognition of debt discount and deferred financing costs.  Deferred
tax assets are included in other long-term assets in the accompanying
consolidated balance sheet.  Deferred tax assets at December 31, 2007
and 2006 are not material.





A
valuation allowance is established when it is more likely than not that some of
the deferred tax assets will not be realized.  Management analyzed its
current operating results and future projections and determined that a valuation
allowance was not needed at December 31, 2007.





Note
11:                       Related
party transactions





Deep Down
borrowed $150,000 from an officer, with no stated interest, due on demand, as of
June 30, 2007 which was used for working capital purposes.  Deep Down
paid the loan balance in full during the third quarter of 2007.




On
September 13, 2007, Deep Down redeemed 2,250 shares of Series E preferred stock
owned by the Chief Executive Officer and director, and his wife, a
Vice-President of Deep Down.  The Series E preferred shares were
redeemed for 2,250,000 shares of common stock at the closing price of
$0.655.  See further discussion under Note 8.




We lease
all buildings, structures, fixtures and other improvements from JUMA, LLC, a
limited liability company owned by Ronald E. Smith, CEO and director of Deep
Down, Inc., and Mary L. Budrunas, a vice-president and a director of Deep Down,
Inc. The base rate of $11,000 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.





Deep Down
paid approximately $82,000 to JUMA for costs associated with the preparation of
the additional land recently purchased by JUMA for Deep Down’s
operations.  The costs were associated with permitting, land clearing
and preparation.


F-28




Notes
to Consolidated Financial Statements for the year ended December 31,
2007
 and
the period from inception (June 29, 2006) through December 31,
2006


Note
12:                       Commitments
and Contingencies





Litigation





Deep Down
is from time to time involved in legal proceedings arising from the normal
course of business. As of the date of this report, Deep Down is not currently
involved in any legal proceedings.





Capital
Lease





In
February 2007, Deep Down purchased under a seller-financed capital lease, a
100-ton mobile gantry crane and related equipment.  The equipment was
delivered and placed into service in March, 2007.  In accordance with
Financial Accounting Standards Board SFAS 13 “Accounting for Leases” as amended,
the lease was capitalized and the lease obligation and related assets recognized
on Deep Down’s consolidated balance sheet.  The total value of the
lease payments discounted at an 11.2% interest rate, or $525,000, was
capitalized.  The off-setting lease obligation is $481,209 at December 31,
2007.





Operating
Leases





Deep Down
leases land and buildings under two noncancelable operating leases and is
responsible for the related maintenance, insurance and property taxes. One of
these leases is with a company that is wholly owned by one of our officer’s, who
is also a Director, of Deep Down. This lease calls for 60 monthly payments of
$11,000 and began as of September, 2006.





Deep Down
also leases several trucks under a 36 month noncancelable operating lease with a
third party.  Monthly payments of $7,657 began in April 2007.
Additionally, Deep Down leases 2 modular office buildings from a third party
under noncancelable operating leases.  The initial term of each lease
is two years with three extensions of 1 year each available.  The
leases began in April and July 2007, respectively, and have monthly payments of
$1,849 and $1,518, respectively. Deep Down was required to pay for site
preparations, installation and city permits for the buildings, which have been
recorded as leasehold improvements and are being depreciated over the two-year
initial lease terms.





Mako
leases office space under a five year operating lease which began in June 2006
and terminates on May 31, 2011, at $7,300 per month. Mako may renew this lease
for two additional terms of five years upon the expiration of the initial term.
Should this option be exercised, the base monthly rental shall be increased or
decreased by the Consumer Price Index net change as of the starting date of any
renewal term. Basic rent expense charged to operations for the month ended
December 31, 2007 was $7,300.





At
December 31, 2007, future minimum lease obligations were as
follows:




Years
      ended December 31,:
            
            Capital
            
            
            Operating2008
            
            $
            96,428
            
            
            $
            403,6842009
            
            
            96,428
            
            
            
            333,9742010
            
            
            96,428
            
            
            
            234,9152011
            
            
            96,428
            
            
            
            124,5002012
            
            
            96,428
            
            
            
            -Thereafter
            
            
            112,501
            
            
            
            -Total
      minimum lease payments
            
            
            594,641
            
            
            $
            1,097,073Residual
      principal balance
            
            
            105,000Amount
      representing interest
            
            
            (218,432
            )Present
      value of minimum lease payments
            
            
            481,209Less
      current maturities of capital lease obligations
            
            
            44,909Long-term
      capital lease obligations
            
            $
            436,300





Rent
expense totaled $186,866 and $69,856 for the year ended December 31, 2007 and
the period from inception June 29, 2006 to December 31, 2006,
respectively.


F-29


Note
13:                      Subsequent
Events





Redemption
of Series D Preferred Stock





The
Series D preferred stock have a face value and a liquidation preference of
$1,000 per share, and are convertible into shares of common stock determined by
dividing the face amount by a conversion price of $0.1933. These shares carried
no voting rights.  In January and March 2008, Deep Down converted all
5,000 of the Series D shares to 25,866,518 shares of Deep Down’s common stock.
The CEO and director, and his wife, a vice president and director, converted
4,500 of the 5,000 shares of Series D Preferred Stock.





Stock
based compensation





During
the first quarter of 2008, Deep Down issued stock options and shares of
restricted stock to certain executives and employees. In conjunction with his
employment on January 22, 2008, Michael Teal, the Corporate Controller, was
issued 250,000 options at a vesting price of $0.70.  All of the shares
underlying the stock options granted were Incentive Stock Options as defined by
the Internal Revenue Code. One third of the options will vest on January
22, 2008, 2009 and 2010, and will expire on January 22, 2013.  Deep
Down estimated that the aggregate fair value of such stock options totaled
$74,900 based on the Black-Scholes option pricing model using the following
estimates:  2.64% risk free rate, 61.3% volatility, expected life of 3
years and zero dividends.





Additionally,
on February 14, 2009, Deep Down issued a total of 3.0 million options to certain
executives, with a vesting price of $1.50. The closing stock price on that day
was $0.42.  One third of the options will vest on February 14, 2008,
2009 and 2010, and will expire on February 14, 2013.  Deep Down
estimated that the aggregate fair value of such stock options was $145,764 based
on the Black-Scholes option pricing model using the following key assumptions
of:   2.81% risk free rate, 61.3% volatility, expected life of 3
years and zero dividends.





Deep Down
issued a total of 1.2 million shares of restricted stock to certain executives
and employees on February 14, 2008. These shares become exercisable on the two
year anniversary of the grant, February 14, 2010. The shares were valued at the
closing stock price on that day of $0.42, and Deep Down valued the shares at
$504,000 which will be amortized over the two year period until the shares are
fully vested.




Note
14:                      Predecessor
Company Financial Statements
 
 Basis
of Presentation
 
 Deep
Down has presented the supplemental audited predecessor company financial
statements for Deep Down, Inc., a Delaware corporation ("Deep Down Delaware")
for the period from January 1, 2006 through November 20, 2006, in accordance
with Rule 310(a) of Regulation S-B.  Per Rule 405 of Regulation C, the
definition of a predecessor is a person the major portion of the business and
assets of which another person acquired in a single succession, or in a series
of related successions in each of which the acquiring person acquired the major
portion of the business and assets of the acquired person.On June 29, 2006, Subsea
was formed by three shareholders with the intent to acquire offshore
energy service providers. On November 21, 2006, Subsea acquired Deep Down
Delaware, a Sub chapter S corporation founded in 1997. Under the terms of
this transaction, all of Deep Down 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 stock and 5,000 shares of Subsea’s Series
E preferred stock resulting in Deep Down Delaware becoming a wholly-owned
subsidiary of Subsea. On the same day, Subsea then merged with Deep Down
Delaware, with the surviving company operating as Deep Down Delaware. Each share
of common stock of Subsea was converted into 3,333.33 shares of common stock of
Deep Down Delaware; and each share of preferred stock of Subsea was converted
into one share of the identical series of preferred stock of Deep Down Delaware.
This transaction was accounted for as a purchase, with Subsea being the
accounting acquirer based on a change in voting control. Consistent with the
provisions of SFAS 141 “Business Combinations,” the successor company’s
financial statements contain the operating results of Subsea since its inception
on June 29, 2006, plus the operating results of Deep Down Delaware from November
21, 2006 (its acquisition date by Subsea).
 
 Significant
Accounting Policies
 
 See
Note 1 for a description of significant accounting policies followed by the
predecessor entity.
  Concentrations
 
 Deep
Down Delaware maintained cash balances with several banks. Accounts at each
institution were insured by the Federal Deposit Insurance Corporation (FDIC) up
to $100,000. At November 20, 2006, Deep Down Delaware had uninsured cash
balances approximating $1,597.
 
 For
the period from January 1, 2006 to November 20, 2006, Deep Down Delaware’s four
largest customers accounted for 16%, 12%, 10% and 5% of total
revenues.
   F-30
 
 Sale-Leaseback
 
 In
September 2006, Deep Down Delaware sold to and leased back from JUMA, LLC
its building and land that serves as its primary operating facilities. Under the
terms of the agreement, consideration received was in the form of $492,406 of
cash and $686,463 of debt assumed, totaling $1,178,869. The consideration or
sales price, net of related expenses, exceeded the net book value of the land
and buildings by $191,766. This amount was recorded as a contribution to capital
on Deep Down Delaware’s balance sheet due to the related party nature (See
Related Party Footnote Note 11) of the transaction. The related lease calls for
60 monthly payments of $11,000. The lessee is responsible for maintenance,
insurance and property taxes.
 
 Capital
Resources and Liquidity
 
 Management
of Deep Down Delaware established an allowance for uncollectible accounts of
$80,515 as of November 20, 2006. Bad debt expense totaled $75,880 for the period
from January 1, 2006 to November 20, 2006.  Depreciation expense on
fixed assets totaled $139,307, and cash totaling $360,978 was used for purchase
of fixed assets.
 
 During
the period from January 1, 2006 to November 20, 2006, Deep Down
Delaware entered into a new loan agreement with a bank and received gross
proceeds of $496,800. Such proceeds were used for working capital and to repay
existing debt balances.  Deep Down Delaware was required to make
monthly principal and interest payments with a fixed interest rate of 7.5%; with
the final payment due in September, 2008. A total of $212,091 was paid as
principal payments on all outstanding long-term debt during the
period.
 
 Additionally,
during that same period, Deep Down Delaware amended its line of credit agreement
with a bank. Under the terms of the amended agreement, Deep Down Delaware was
permitted to borrow up a maximum of the lesser of either: 80% of Deep Down
Delaware’s third party receivables or $1,000,000. The line of credit was
due on demand or at its maturity date of June 22, 2007. Outstanding balances
accrued interest at a rate of prime (8.25% at September 30, 2006) plus 1%.
During the period, Deep Down Delaware borrowed $950,004 under the line of
credit, and paid back the total outstanding of $1,000,004.
 
 Distributions
of $557,502 were paid to the original owners of Deep Down
Delaware.




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