UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington D.C.,
20549





FORM
10-K





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


For
the fiscal year ended December 31, 2009





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


Commission
File No. 0-30351




DEEP
DOWN, INC.


(Exact
name of registrant as specified in its charter)




Nevada
            
            75-2263732(State
      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.   Yes o
No þ
 
 Indicate by check mark whether the issuer is not
required to file reports pursuant to Section 13 or 15(d) of the
Act.    Yes o No þ
 
 Indicate by check mark whether the issuer (1) filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90
days. Yes þ No
o
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).Yes o No
o
 
 Indicate by check mark if disclosures of delinquent
filers in response to Item 405 of Regulations S-K is not contained in this form,
and will not 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.    o
 
 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
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large
      accelerated filer o
                  Accelerated
      filer o
                  Non-accelerated
      filer o
                  Smaller
      reporting company þ
 
 Indicate by checkmark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act)   
Yes o
Noþ
 
 The
aggregate market value of the voting stock and non-voting common equity held by
non-affiliates, computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of June
30, 2009, the last business day of our most recently completed second quarter,
was approximately $16,051,857.
 
 At
March 31, 2010, the issuer had 180,450,630 shares outstanding of Common Stock,
par value $0.001 per share.
 
 DOCUMENTS
INCORPORATED BY REFERENCE
 None.











TABLE
OF CONTENTS





PART
      IItem
      1
            Description
      of Business
            4Item
      1B
            Unresolved
      Staff Comments
            12Item
      2
            Properties
            12Item
      3
            Legal
      Proceedings
            13Item
      4
            Reserved
            13PART
      IIItem
      5
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            13Item
      6
            Selected
      Financial Data
            14Item
      7
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            15Item
      7A
            Quantitative
      and Qualitative Disclosures About Market Risk
            25Item
      8
            Financial
      Statements and Supplementary Data
            26Item
      9
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            26Item
      9A
            Controls
      and Procedures
            27Item
      9B
            Other
      Information
            28PART
      IIIItem
      10
            Directors,
      Executive Officers and Corporate Governance
            29Item
      11
            Executive
      Compensation
            31Item
      12
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            37Item
      13
            Certain
      Relationships and Related Transactions, and Director
      Independence
            38Item
      14
            Principal
      Accountant Fees and Services
            38Item
      15
            Exhibits
            40Signatures
            43








2





Forward-Looking
Information





Unless
otherwise indicated, the terms “Deep Down, Inc.”, “Deep Down”, “Company,” “we,”
“our” and “us” are used in this report to refer to Deep Down, Inc., a Nevada
corporation, and its wholly-owned subsidiaries.





In this
Annual Report on Form 10-K (“the Report”), 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 Report 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. We wish 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 us, may not be realized. Because of the number
and range of assumptions underlying our projections and forward-looking
statements, many of which are subject to significant uncertainties and
contingencies that are beyond the reasonable control of us, 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 we assume no
obligation to update this information. Therefore, our actual experience 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 us 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.





History





Deep
Down, Inc. is a Nevada corporation engaged in the oilfield services
industry.  As used herein, “Deep Down,” “Company,” “we,” “our” and
“us” may refer to Deep Down, Inc. and/or its subsidiaries.  Deep Down,
Inc. (OTCBB:DPDW), a publicly traded Nevada corporation, was incorporated on
December 14, 2006, through a reverse merger with MediQuip Holdings, Inc.
(“MediQuip”), a publicly-traded Nevada corporation.





Deep Down
is the parent company to its wholly-owned subsidiaries: Deep Down, Inc., a
Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada
corporation, since its acquisition April 2, 2007, Mako Technologies, LLC, a
Nevada limited liability company (“Mako”), since its acquisition effective
December 1, 2007, Flotation Technologies, Inc., a Maine corporation
(“Flotation”), since its acquisition effective May 1, 2008, and Deep Down
International Holdings, LLC, a Nevada limited-liability company (“DDIH”) since
its formation in February 2009. DDIH currently has no material assets or
operations.





On April
2, 2007, we acquired substantially all of the assets of ElectroWave USA, Inc., a
Texas corporation. We formed a wholly-owned subsidiary, ElectroWave USA,
Inc. (“ElectroWave”), a Nevada corporation, to complete the
acquisition.  In 2009 we rebranded ElectroWave as the Marine
Technologies division of Deep Down Delaware, to enhance the clarity of the
products and services offered by this division. Located in Channelview, Texas,
Deep Down Marine Technologies offers products and services in the fields of
electronic monitoring and control systems for the energy, military and
commercial business sectors.





Effective
December 1, 2007, we acquired all of the common stock of Mako Technologies,
Inc.  We formed a wholly-owned subsidiary, Mako Technologies, LLC
(“Mako”) to complete the acquisition.  Located in Morgan City,
Louisiana, Mako serves the offshore petroleum and marine industries with
technical support services, and equipment vital to offshore petroleum
production, through the provision of highly qualified technicians, remotely
operated vehicle (“ROV”) services, topside and subsea equipment and support
systems used in diving operations, maintenance and repair operations, and
offshore construction.





On June
5, 2008, we completed the acquisition of Flotation Technologies, Inc.
(“Flotation”). We effectively dated the acquisition for accounting purposes as
of May 1, 2008 and consummated the closing on June 6, 2008. Flotation engineers,
designs and manufactures deepwater buoyancy systems using high-strength
FlotecTM
syntactic foam and polyurethane elastomers from its facilities in Biddeford,
Maine.





In
February 2009, we formed Deep Down International Holdings, LLC, a Nevada
limited-liability company (“DDIH”) and wholly-owned subsidiary of the Company,
for the purpose of holding securities for foreign companies organized or
acquired by the Company. DDIH currently has no material assets or
operations.





Our
current operations are the result of the significant acquisitions of Deep Down
Delaware, Mako and Flotation.  In addition to our strategy of
continuing to grow and strengthen our operations, including by expanding our
services and products in accordance with our customers’ demands, we intend to
continue to seek strategic acquisitions of complementary service providers,
product manufacturers and technologies that are focused primarily on supporting
offshore deepwater exploration, development and production of oil and gas
reserves and other maritime operations.





Business
Overview





We
provide 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 we also 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, surface and offshore rig equipment, as well as
buoyancy solutions, 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.  One of our greatest strengths is the extensive knowledge
base of our service, engineering and management personnel in many aspects of the
deep water industry. Set forth below is a more detailed description of important
services and products we provide.








4





Our goal
is to provide superior services and products which are 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 services and products primarily through our offices in Houston, Texas,
Biddeford, Maine and Morgan City, Louisiana. Additionally, we added two
foreign sales consultants to more actively pursue the markets in Europe / West
Africa and Brazil.  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.





For the
fiscal years ended December 31, 2009 and 2008, the operations of Deep Down’s
operating segments, Deep Down Delaware, Electro Wave, Mako and Flotation, have
been aggregated into a single reporting segment. Additionally, during the year
ended December 31, 2009, we have aggregated ElectroWave’s operations into Deep
Down Delaware as a single operating segment due to similar production processes
and cost savings related to office and administrative support. While the
operating segments have different product lines; they are very similar. 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
and project management as part of our service revenue to the customer.
Additionally, the segments have similar customers and distribution methods, and
their economic characteristics are similar with regard to their gross margin
percentages. Our operations are located in the United States, though we
occassionally make sales to international customers.





Services
and Products





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, well-commissioning services, as well as construction
support and ROV operations support.  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 various products in
connection with the use of our installation, retrieval, storage and management
services.





Offshore Project
Management.  Our installation management team specializes in
deepwater 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 topside 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 topside.  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
on 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 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.  In addition, we provide 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 and 400-ton carousel, UTA running and parking deployment
frames, termination shelters, pipe straightners, ROV hooks and
shackles, intervention tooling, stackable SeaStax®tanks,
baskets, and boxes, and ballgrab rental rigging.





Spooling
Services.  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.  Our 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.  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.  Our 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.  We have 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.





System Integration
Testing.  We have led the offshore industry move into the
digital age with our use of digital transducers to provide much greater levels
of accuracy compared to information gathered from 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, we
also have three desks set up with data systems that are capable of tracking from
4 to 15 individual sensors simultaneously. These capabilities, in combination
with subsea handling equipment, experienced personnel, and a fully-equipped
facility, render Deep Down ideal for managing SIT
operations.





6








Commissioning.  We
have been involved in most of the topside connections and commissioning (the
removal of inert fluids used during the umbilicals’ transportation and
installation) 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 percent glycol, paraffin inhibitors, and
alcohol.





Storage
Management.  Our facility in Channelview covers more than
50,000 square feet of internal high quality warehousing capacity and 300,000
square feet of external storage and is strategically located in Houston's Ship
Channel area.  Our warehouse is designed to provide clients with
flexible and cost effective warehousing and storage management
alternatives.  Our professional and experienced warehouse staff,
combined with the very latest in information technology, results in a fully
integrated warehousing package designed to deliver effective 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.





Marine
Technical Support Services





We serve
the growing offshore petroleum and marine industries with technical support
services and products vital to offshore petroleum production.  Our
offerings in this area are primarily through the provision of remotely operated
vehicle (“ROV”) services which include the provision of skilled ROV
operators/technicians and ROV equipment, as well as topside and subsea
equipment, and support systems used in diving operations, maintenance and repair
operations, and offshore construction.





ROV and ROV Tooling
Services.  We provide the latest ROV tooling technology as part
of our ROV services.  Our ROV tooling services are constantly growing,
with the addition of tools as they are requested by our customers.  As
part of our ROV services, we have observation and light work class ROV units
capable of operating in depths of 10,000 feet. Our services include platform
inspection (Level I, II and III, jack-up and template), platform installation
and abandonment, search and recovery, salvage, subsea intervention (hot stab
operations, torque tool, well, pipeline commissioning, and stack landings),
telecommunication cable inspections (existing and as built), anchor handling
(mooring and anchor chain monitoring), ROV consulting and project management,
ROV pilots and technicians, and underwater cinematography.  We provide
an extensive line of ROV intervention tooling, ROV clamps and ROV-friendly hooks
and shackles that are state-of-the-art in design.  Recently, we began
providing maintenance and fleet management services to other ROV owners as an
outsourced support function to their ROV fleet.





Offshore Construction
Equipment Rental.  We employ a permanent staff of highly
qualified technicians and mechanics to maintain and refurbish our equipment
in-between rentals. We carry 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,
and hot water pressure washers.





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 deepwater 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.





7








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 electrical lines 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 our
elastomeric bend limiters.  The non-helix wound design allows for our
flying leads to be very installation friendly with minimal-bending
stiffness.  A Moray® is
the termination head on the flying lead and connects the tubing assembly to the
junction plate.  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.





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 oil and gas operators 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 has enabled our clients to use
installation friendly techniques for deploying hardware on the ocean
floor.





Bend Limiters.  We
offer both polymer and steel bend limiters.  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.  Polymer bend limiters are typically provided for
small diameter umbilicals or flying leads, as well as for their compliant
umbilical section, which turn a traditional umbilical into a ROV-friendly,
installable flying lead.  Due to our ability to design and manufacture
bend limiters in-house, delivery time is greatly
reduced.





Compliant
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 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. This allows oil and gas operators to save
significant costs through utilization of existing capital investments in spare
umbilicals, which reduces field development costs and delivery time.   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, drilling rigs and production
platforms.  The key philosophy behind SeaStax® 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.








8





Buoyancy
Products





We
engineer, design and manufacture deepwater buoyancy systems using high-strength
FlotecTMsyntactic foam and polyurethane
elastomers.  Our  product offerings include distributed
buoyancy for flexible pipes and umbilicals, drilling riser buoyancy modules,
CoreTecTM
drilling riser buoyancy modules, ROVitsTM
buoyancy, Hydro-FloatTM
mooring buoys, StablemoorTM
low-drag ADCP deployment solution, Quick-LocTM cable floats, HardballTM
umbilical floats, FlotecTM cable and pipeline protection, InflexTM
polymer bend restrictors, and installation buoyancy of any size and depth
rating.





The
majority of our buoyancy product offerings are made with FlotecTMsyntactic
foam, a product composed of hollow glass microballoons, combined with an epoxy
resin system. These microballoons (also known as “microspheres”) are very small,
20-120 microns in diameter, and provide buoyancy.  The epoxy system
provides the strength to the system.  The result is a light weight
composite with low thermal conductivity and resistance to compressive stress
that far exceeds other types of foams. The foam comes in different densities and
strengths which are required for greater depth applications. In some
applications, the liquid syntactic foam resulting from the combination of
ingredients is poured into high-density polyethylene shells that form the
flotation device and encase and protect the syntactic foam from damage. Some of
our products are produced with proprietary, high-strength
macrospheres.





Our
facility in Biddeford, Maine, has been ISO 9001:2000 certified since 2003. This
certification enables us to provide our buoyancy products to oil and gas
companies, giving us a competitive edge over suppliers who are not
certified.  In 2009 we added an in-house rotational molding facility,
having designed and built one of the largest rotational molding machines in the
world.  This additional capability allows us to control yet another
aspect of the manufacturing process, ensuring better quality and lead
time.  While the majority of our buoyancy products revenue comes from
buoyancy products for the petroleum production sector, we also serve the
oceanographic, industrial and military markets.





Marine
Products





We offer
products and services in the fields of electronic monitoring and control systems
for the energy, military, and commercial business sectors.  We design,
manufacture, install, and commission 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.  We can take projects from conceptual/system design through
installation, commissioning, and support. Our understanding of system
requirements and our ability to quickly understand our customer’s needs allows
us to produce quality products and services on time and on
budget.





We have
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. We are 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 world’s largest hopper dredges, and other
vessels.





Manufacturing





Our
manufacturing facilities in Channelview, Texas, a suburb of Houston, house a
broad variety of processes, including machining, fabrication, inspection,
assembly and testing. We are 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.





Our manufacturing plant is ISO 9001 and
American Petroleum Institute certified.  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 our 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.








9





Our
buoyancy manufacturing facility is located in Biddeford, Maine. We have
designed, developed, and assembled our own enhanced foam production
capabilities.  This allows us to produce the large volume of foam
required to make the 7-14 foot-long drilling pipe flotation risers that appear
to be in high demand for offshore drilling in very deep waters. These drill pipe
risers will operate effectively in water depths of up to 4,000 meters (13,000
feet). Our foam is capable of operating in water depths of up to 7,000 meters
(23,000 feet).  Our drilling riser buoyancy design is unique in the
industry, and our CoreTecTM Drilling Riser Buoyancy Module has been
patented.





Customers





Demand
for our deep water services, surface equipment and offshore rig equipment 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.





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 our significant customers could, at least on a
short-term basis, have an adverse effect on the results of
our operations.





Marketing
and Sales





We market
our products and services throughout the world directly through our sales
personnel in our Houston, Texas, Biddeford, Maine and Morgan City, Louisiana
offices. 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, though we have
accepted several longer-term projects, including one that has exceeded a year
completion.  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 to improve existing products and services to meet our
customers’ specific needs.  We also focus our activities on reducing
the overall cost to the customer, which includes not only the initial capital
cost but also operating costs associated with its
products.








10





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, Biddeford, Maine 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, development and
production and maritime equipment markets are quality, reliability and
reputation of the product, price, technology, and timely delivery.  We
face significant competition from other manufacturers of exploration,
production, buoyancy 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 of these types of equipment.  We compete principally
with Dynacon, FMC, 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.





Our
principal competitors in the polyurethane area are Trelleborg AB, Balmoral
Group, Dunlaw Engineering Ltd., ABCO Industries Limited, and Whitefield Plastics
Corporation. Our principal competitor in the syntactic foam market is Trelleborg
Offshore, Inc. Other competitors include Cumming Corp., located in
Massachusetts; Matrix Composites & Engineering Ltd., located in Australia;
Balmoral Group, located in Scotland; Syntech Materials, Inc., located in
Virginia; and Marine Subsea Group, located in Norway.





Employees





We had
159 employees as of March 31, 2010, of which approximately 156 are full time
employees.  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 that compliance with such laws will require us to make material
expenditures.





We are
also affected by tax policies, price controls and other laws and regulations
generally relating to the oil and gas industry, 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.








11





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.





Patents,
Trademarks and Copyrights





We
currently hold three patents covering riser tensioner sensor assembly, method
and apparatus for manufacture of a non-helical subsea umbilical and method and
apparatus for installing an undersea umbilical.  An additional five
patents have been applied for and are in process.  Trademarked names
of the Company include DEEP DOWN INC TM, FLOTATION
TECHNOLOGIES TM, MAKO
TECHNOLOGIES TM, DRILSYS TM,
ELECTROWAVE TM,
MUDSYS TM,
AQUASOX TM,
MORAY TM and
SEASTAX TM,
QUICK-LOC®,
FLOTEC®, and
PROTEUS TM.





We also
obtained all the rights to the following inventions, including all provisional
applications in connection with the acquisition of
Flotation:





·
            Drilling
      Riser Buoyancy Produced with Plastic Shell (inventors Timothy H. Cook,
      Fred Maguire and David Capotosto);





·
            Drilling
      Riser Auxiliary Claim with Integral Mux Clamp (inventors Timothy H. Cook,
      Fred Maguire and David Capotosto);





·
            Clam
      for Holding Distributed Buoyancy Modules (inventors David Capotosto and
      William Stewart); and





·
            Hinged
      Distributed Buoyancy Module (inventors Timothy H. Cook and David
      Capotosto).





Item
      1B.
            UNRESOLVED
      STAFF COMMENTS





None.





Item
      2.
            DESCRIPTION
      OF PROPERTY





Our
principal corporate offices were relocated to 8827 W. Sam Houston Parkway N.,
Suite 100, Houston, TX  77040 on February 21, 2009. The 89-month lease
term began on that date and includes an allowance for leasehold improvements by
the landlord, plus a charge for monthly common area expenses (“CAM charges”) on
a pro-rata basis of the total building expenses (including insurance, security,
maintenance, property taxes and utilities) beginning on the sixth month of the
lease term. Monthly lease costs range from $12,177 to $14,391 plus CAM charges,
due to a rent escalation clause over the term of the
lease.





Our
operating facilities for Deep Down Delaware continue to be located at 15473 East
Freeway, Channelview, Texas 77530.  We purchased the Channelview
property from the lessor in May 2009, which consists of approximately 8 acres of
land that houses 60,000 square feet of manufacturing space and 7,000 square feet
of office space.   See Item 13 “Certain Relationships and Related
Transactions, and Director Independence” included in this Report for
information regarding the related nature of the former
lessor.





Mako
leases its property and buildings from Sutton Industries at a base rate of
$7,300 per month.  Mako is located at 125 Mako Lane, Morgan City, LA
70380.  The 5-year lease term commenced on June 1, 2006, and includes
an additional 5-year renewal option at the end of the initial
term.








12





In
connection with the purchase of Flotation in May 2008, we acquired the operating
facilities and administrative offices located at 20 Morin Street, Biddeford,
Maine 04005 for a fair market value of $3.3 million. The facility consists of
3.61 acres of land, including a 46,925 square-foot light industrial
manufacturing facility and administrative offices. Additionally, in October
2008, Flotation entered into a 60-month lease for 18,000 square feet of
warehouse space, which was increased to 21,900 square feet in April 2009, within
a 107,000 square foot warehouse located at 26 Morin Street, Biddeford, Maine and
purchased a three-quarter acre parcel, which are both adjacent to Flotation’s
operating facility.





We
believe that our current space is suitable, adequate and of sufficient capacity
to support our current operations.





Item3.
            LEGAL
      PROCEEDINGS





Periodically,
we may be involved in legal proceedings arising in the normal course of
business. As of the date of this Report, we are currently not involved in any
pending, material legal proceedings.





Item4.
            RESERVED





This item
is not applicable.





PART
II





Item
      5.
            MARKET FOR THE REGISTRANT’S COMMON
      EQUITY, RELATED STOCKHOLDER MATTERS AND 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. Beginning December 14, 2006, our common stock was quoted
on the OTC Bulletin Board. 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
      Year 2009:December
      31, 2009
            
            $
            0.28
            
            
            $
            0.11September
      30, 2009
            
            $
            0.16
            
            
            $
            0.10June
      30, 2009
            
            $
            0.17
            
            
            $
            0.10March
      31, 2009
            
            $
            0.19
            
            
            $
            0.08Fiscal
      Year 2008:December
      31, 2008
            
            $
            0.62
            
            
            $
            0.11September
      30, 2008
            
            $
            0.95
            
            
            $
            0.44June
      30, 2008
            
            $
            1.27
            
            
            $
            0.68March
      31, 2008
            
            $
            1.24
            
            
            $
            0.35





Holders





As of
March 31, 2010, there were approximately 1,060 holders of record of our common
stock and we believe there were 1,060 beneficial owners of our common
stock, including shares held in street name.





Dividend
Policy





To date,
we have not paid any cash dividends and our present policy is to retain earnings
for working capital use.  Under the terms of our credit agreement with
Whitney Bank, we are restricted from paying cash dividends on our common stock,
unless no default under the credit agreement exists at the time of or would
arise after giving effect to any such distribution. We intend to retain
operating capital for the growth of the company
operations.





13








Equity
Compensation Plan Information





The
following table sets forth the outstanding equity instruments as of December 31,
2009:





Number
      of securities to
                be
      issued upon exercise
                of
      outstanding options,
              
              Weighted-average
                exercise
      price of
                outstanding
      options,
              
              Number
      of securities
                remaining
      available for
                future
      issuance under
                equity
      compensation plans
                (excluding
      securities reflectedPlan Category
              
              warrants and rights
              
              warrants and rights
              
              in first column)Equity
      compensation plans approved by securityholders
              
              20,025,000
      (1)
              
              $0.35
              
              2,743,000(1)Equity
      compensation plans not approved by securityholders
              
              638,812
      (2)
              
              $0.78
              
              N/ATOTAL
              
              20,663,812
              
              $0.36
              
              2,743,000


(1)       Represents 20,025,000 shares of common
stock that may be issued pursuant to options granted as of December 31, 2009 and
approximately 2,743,000 additional shares of common stock available for future
grant under the 2003 Directors, Officers and Consultants Stock Option, Stock
Warrant and Stock Award Plan (the “Plan”). Shares available for grant is net of
4,300,000 restricted shares that were granted under the Plan to executives and
employees in 2008 and 2009 (see additional discussion of terms and vesting under
Executive Compensation). These restricted shares are included in the shares
outstanding as of December 31, 2009.  Under the Plan, the total number
of shares subject to grants and awards is 15 percent of issued and outstanding
shares of common stock. Effective in March 2010, we cancelled 2,000,000
outstanding options held by two executives which were scheduled to vest on
February 14, 2011, and did not reissue any replacement options, thus increasing
the number of securities available for future issuance. We recorded the
remaining unamortized stock-based compensation in March 2010 when the shares
were cancelled.





(2)       Represents
438,812 shares of common stock underlying warrants, granted in 2007 as part of
our prior borrowing facility, plus an additional 200,000 warrants issued in 2008
in connection with the purchase of Flotation.  See Note 8 to our
consolidated financial statements included in this Report with regard to
material terms of such warrants.





Recent
Sales of Unregistered Securities





None.





Item
      6.
            SELECTED
      FINANCIAL DATA





This item
is not applicable for smaller reporting companies.








14





Item
      7.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS





The
following discussion of our financial condition and results of operations should
be read in conjunction with our consolidated financial statements and the notes
to those financial statements appearing elsewhere in this Form 10-K. This
discussion contains forward-looking statements that involve significant risks
and uncertainties. As a result of many factors, our actual results may differ
materially from those anticipated in our forward-looking
statements.





In this
Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and
Results of Operations,” all dollar and share amounts are in thousands of dollars
and shares, unless otherwise indicated.





General





We are an
oilfield services company specializing in complex deepwater and ultra-deepwater
oil production distribution system support services, serving the worldwide
offshore exploration and production industry. Our services and technological
solutions include distribution system installation support and engineering
services, umbilical terminations, loose-tube steel flying leads, flotation and
drill riser buoyancy, ROVs and toolings. We support subsea engineering,
installation, commissioning, and maintenance projects through specialized,
highly experienced service teams and engineered technological solutions. Our
primary focus is on more complex deepwater and ultra-deepwater oil production
distribution system support services and technologies, used between the platform
and the wellhead.





Executive
Overview





Operations
for the past year have been negatively impacted by the worldwide recession,
lower oil prices and customer-based delays in many of our major projects,
including on a large floatation order. As a result of the current downturn in
the industry, our operations in 2009 were significantly lower than expected,
though we have been proactive in addressing these challenges and are seeing
improved results of operations in the third and fourth quarters of 2009 and
moving into fiscal 2010.





Revenues
and gross profits improved in the third and fourth quarters of 2009 over the
first half of the year, and we expect operations to continue to improve in
fiscal 2010.  We have commenced the production cycle of a large
floatation order, had a majority of our ROVs working at the end of the fourth
quarter and our offshore jobs are increasing.  As of December 31,
2009, our backlog was approximately $16,500.





As part
of our ongoing analysis of all aspects of our business to provide growth and
sustained revenue and generate profit in this difficult economic climate, we
have made several changes in 2009 to enhance our future profitability. The cost
containment program, which was commenced in the second quarter of 2009, is
continuing and beginning to have a positive effect on general and administrative
expenses.  Our ElectroWave subsidiary has been experiencing pricing
and gross profit pressure over the past couple years related to their
computerized marine technology, which intensified in 2009 due to the overall
decline in the economy. We made a business decision in August 2009 to
discontinue production of some products which had declining gross profits, and
we integrated the remaining ElectroWave operations into Deep Down Delaware
during the third quarter of 2009. This change will generate cost savings from
common management and administrative staff.





Segments





For the
fiscal years ended December 31, 2009 and 2008, the operations of Deep Down’s
operating segments, Deep Down Delaware, ElectroWave, Mako and Flotation, have
been aggregated into a single reporting segment. Additionally, during the year
ended December 31, 2009, we have aggregated ElectroWave’s operations into Deep
Down Delaware as a single operating segment due to similar production processes
and cost savings related to office and administrative support. While the
operating segments have different product lines; they are very similar. 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
and project management as part of our service revenue to the customer.
Additionally, the segments have similar customers and distribution methods, and
their economic characteristics are similar with regard to their gross margin
percentages. Our operations are located in the United States though we
occasionally make sales to international customers.














15








Results
of Operations





Revenues





2009
              
              
              2008
              
              
              Change
              
              
              %Revenues
              
              $
              29,449
              
              
              $
              35,770
              
              
              $
              6,321
              
              
              
              -17.7%





Revenues
decreased by approximately $6,321, or 17.7 percent to approximately $29,449 for
the year ended December 31, 2009 from approximately $35,770 for the previous
year. However, revenues improved in the third and fourth quarters of 2009 to
approximately $8,426 and $7,720, respectively, over approximately $6,201 in the
second quarter. The annual reduction in revenue over the same prior year period
was primarily a result of customers delaying ongoing projects or slowing down
many of their offshore and deepwater projects. Specifically, our ROV technician
charges and tooling were reduced compared to the prior year due to the economic
conditions affecting our customers, which accounted for approximately $3,100 of
the current year decrease. Though we had more ROV jobs during the year, the
revenue per job tended to be less than the previous year. Additionally, due to
pricing pressures related to marine technology as discussed above, we made a
business decision in August 2009 to discontinue production of some products
which had declining gross profits, and we integrated the remaining ElectroWave
operations into Deep Down Delaware during the third quarter of 2009. Also during
2009, a large buoyancy job that was originally scheduled to be completed late in
2009 was delayed to fiscal 2010 due to customer delays. This job is progressing
in the first quarter of 2010 and is approximately 46 percent complete at the end
of March 2010.





Cost of
sales





2009
              
              
              2008
              
              
              Change
              
              
              %Cost
      of sales
              
              $
              19,888
              
              
              $
              21,686
              
              
              $
              (1,798
              )
              
              
              -8.3%Gross
      Profit
              
              $
              9,561
              
              
              $
              14,084
              
              
              $
              (4,523
              )
              
              
              -32.1%Gross
      Profit %
              
              
              33%
              
              
              
              39%
              
              
              
              72%


Gross
profit was approximately $9,561 for the year ended December 31, 2009 compared to
approximately $14,084 for the previous year, reflecting an overall reduction in
gross profit margin from 39 percent to 33 percent. The decrease in cost of sales
over the prior year was partially driven by the decrease in total revenue as
discussed above, offset by increases as discussed in more detail below. Our
gross profit has begun to improve in the fourth quarter of 2009 compared to the
third quarter, due to our efforts at close review of gross profit by job and
specific costs, increased ROV tooling and technician billings, and the
discontinuation of low-gross profit products as discussed in Revenue
above.





For the
year ended December 31, 2009, the cost of sales increase that was not related to
revenue, and the resulting gross profit margin decrease, was impacted by several
factors. Our ROV revenues decreased due to customer delays, while we have fixed
costs of sales expenses related to ROV technician retainers and maintenance that
continue even when the ROVs do not generate revenue. During the year ended
December 31, 2008, we completed a high gross profit buoyancy job which was not
repeated during 2009, which had increased the prior year margins. The gross
profit on our other service and product offerings improved slightly from the
prior year to partially offset these decreases.





We record
depreciation expense related to revenue-generating fixed assets as cost of
sales, which totaled approximately $1,616 and $1,078 for the years ended
December 31, 2009 and 2008, respectively. The increase in 2009 resulted from the
addition of assets from the Flotation acquisition in May 2008, and the purchase
of ROVs and other capital expenditures to increase capacity in
2009.








16





Selling, general and
administrative expenses





2009
              
              
              2008
              
              
              Change
              
              
              %Selling,
      general & administrative
              
              $
              14,371
              
              
              $
              14,295
              
              
              $
              76
              
              
              
              0.5%


Selling,
general and administrative expenses (“SG&A”) included rent, utilities,
general office expenses, insurance, personnel and other costs necessary to
conduct business operations.  SG&A for the year ended December 31,
2009 was approximately $14,371 compared to approximately $14,295 for the same
period last year for an increase of approximately $76. Management began a
company-wide cost reduction program during the second quarter of 2009 which will
continue through 2010, which accounted for a reduction of approximately $367 in
2009. During fiscal 2009, bad debt expense was reduced by approximately $1,315
due to some customer bankruptcy-related writeoffs in the prior year, which was
offset by personnel and related cost increases of approximately $1,921 due to
the expansion of our businesses, thereby requiring more personnel, including the
addition of Flotation for the full year in 2009 compared to eight months in the
prior year.  In fiscal 2009, we paid approximately $415 less than the
prior year in professional, accounting and legal fees, which in 2008 partially
related to the updating of a registration statement. In 2009, stock-based
compensation increased by approximately $252 over the same prior year period,
due to stock options that were issued during 2009 and due to the accelerated
vesting of restricted stock in 2009.





Depreciation and
amortization expense (excluded from Cost of
sales)





2009
            
            
            2008
            
            
            Change
            
            
            %Depreciation
            
            $
            343
            
            
            $
            236
            
            
            $
            107
            
            
            
            45.3%Amortization
            
            
            6,195
            
            
            
            1,049
            
            
            
            5,146
            
            
            
            490.6%Depreciation
      and amortization
            
            $
            6,538
            
            
            $
            1,285
            
            
            $
            5,253
            
            
            
            408.8%





Depreciation
and amortization expense consists primarily of depreciation of our fixed assets
that are not related to revenue generation, plus amortization of intangible
assets, including our customer lists, technology and trademarks. Depreciation
and amortization expense, excluded from “Cost of sales” in the accompanying
statements of operations, was approximately $6,538 and $1,285 for the years
ended December 31, 2009 and 2008, respectively. The increase in depreciation
expense detailed in the table above, resulted from the addition of assets from
the Flotation acquisition in May 2008, and the purchases of furniture and
fixtures and office equipment during 2009.





In
addition, amortization of intangible assets for the year ended December 31, 2009
was approximately $1,309 compared to approximately $1,049 for the year ended
2008 due to amortizing the Flotation intangible assets for a full year in 2009
compared to eight months for fiscal 2008. Also included in amortization for 2009
was an impairment charge to certain long-lived intangible assets totaling
$4,616, due partially to a change in the estimated useful life of some
technology intangible assets from twenty-five years to ten years, which impacted
the undiscounted cash flows from that asset over a shorter time-frame, thereby
reducing the fair value of the asset. See further discussion regarding the
specific assumptions and test results in Note 5 to the consolidated financial
statements included in this Report.





Goodwill
impairment





As of
December 31, 2009, we recognized an impairment to goodwill in the amount of
$5,537 related to the Deep Down Delaware and Mako reporting units. See further
discussion of the related analysis in Note 5 to the consolidated financial
statements included in this Report.





Net interest expense and
loss on extinguishment of debt





Net
interest expense for the year ended December 31, 2009 was approximately $356
compared to approximately $3,401 for the same prior year period.  Net
interest expense for the year ended December 31, 2009 was generated by our
outstanding bank debt, capital leases and subordinated debenture. For the year
ended December 31, 2008, net interest expense was generated mainly by borrowings
under a secured credit agreement. On June 12, 2008, we paid the balance due
under that credit agreement, thus there were no related expenses since that
date. For the year ended December 31, 2008, cash interest approximated $932.
During 2008, we incurred non-cash deferred financing and debt discount
amortization approximating $2,466, plus paid early termination fees of
approximately $446 recognized as a loss on early extinguishment of debt. We
completed the accretion of preferred stock issued in 2006 and recognized
approximately $114 as interest expense.





17








Adjusted
EBITDA





Our
management evaluates our performance based on a non-GAAP measure, Adjusted
EBITDA, which consists of earnings (net income or loss) available to common
shareholders before cumulative effect of accounting change, net interest
expense, income taxes, non-cash stock compensation expense, non-cash
impairments, depreciation and amortization and other non-cash items. This
measure may not be comparable to similarly titled measures employed by other
companies and is not a measure of performance calculated in accordance with U.S.
GAAP. The measure should not be considered in isolation or as a substitute for
operating income, net income or loss, cash flows provided by operating,
investing or financing activities, or other cash flow data prepared in
accordance with U.S. GAAP. The amounts included in the Adjusted EBITDA
calculation, however, are derived from amounts included in the historical
Consolidated Statements of Operations data.





We
believe Adjusted EBITDA is useful to an investor in evaluating our operating
performance because it is widely used by investors in our industry to measure a
company’s operating performance without regard to items such as income taxes,
net interest expense, depreciation and amortization, and non-cash stock
compensation expense which can vary substantially from company to company
depending upon accounting methods and book value of assets, financing methods,
capital structure and the method by which assets were acquired; it helps
investors more meaningfully evaluate and compare the results of our operations
from period to period by removing the impact of our capital structure (primarily
interest) and asset base (primarily depreciation and amortization) and actions
that do not affect liquidity (stock compensation expense and goodwill
impairment) from our operating results; and it helps investors identify items
that are within our operational control. Depreciation and amortization charges,
while a component of operating income, are fixed at the time of the asset
purchase or acquisition in accordance with the depreciable lives of the related
asset and as such are not a directly controllable period operating
charge.





The
following is a reconciliation of net loss to Adjusted EBITDA for the years ended
December 31, 2009 and 2008 (in thousands, except
percentages):





2009
              
              
              2008
              
              
              Change
              
              
              %Net
      loss
              
              $
              16,142
              
              
              $
              (4,323
              )
              
              $
              11,819
              
              
              
              273.4%Add
      back interest expense, net of interest income
              
              
              356
              
              
              
              3,401
              
              
              
              (3,045
              )
              
              
              -89.5%Add
      back depreciation and amortization
              
              
              8,154
              
              
              
              2,363
              
              
              
              5,791
              
              
              
              245.1%Deduct
      income tax benefit
              
              
              (1,026
              )
              
              
              (1,042
              )
              
              
              16
              
              
              
              -1.5%Add
      back stock based compensation - non-cash
              
              
              836
              
              
              
              584
              
              
              
              252
              
              
              
              43.2%Add
      back goodwill impairment - non-cash
              
              
              5,537
              
              
              
              -
              
              
              
              5,537
              
              
              
              100.0%Adjusted
      EBITDA
              
              $
              (2,285
              )
              
              $
              983
              
              
              $
              (3,268
              )
              
              
              (332.5%
              )





Adjusted
EBITDA decreased by approximately $3,268 to $(2,285) for the year ended December
31, 2009 from approximately $983 positive EBITDA for the previous year. This
decrease was impacted by the reduced revenues in 2009, particularly in the first
two quarters, and has been improving since the end of June 2009. Amortization
expense, which is added back to net loss for Adjusted EBITDA, was higher in 2009
due to the impairment to two intangible assets, as discussed above, and the
goodwill impairment was the result of our impairment test as of December 31,
2009.





Capital
Resources and Liquidity





Overview





As a deep
water service provider, our revenue, profitability, cash flows, and future rate
of growth are substantially dependent on the condition of the oil and gas
industry generally and our customers ability to invest capital for offshore
exploration, drilling and productions and maintain or increase levels of
expenditures for maintenance of offshore drilling and production
facilities.  Oil and gas prices and the level of offshore drilling and
production activity have historically been characterized by significant
volatility.  We enter into large, fixed-price contracts which may
require significant lead time and investment.  A decline in offshore
drilling and production activity could result in lower contract volume or delays
in significant contracts which could negatively impact our earnings and cash
flows. Our earnings and cash flows could also be negatively affected by delays
in payments by significant customers or delays in completion of our contracts
for any reason.   We are dependent on our cash flows from
operations to fund our working capital requirements and the uncertainties noted
above create risk that we may not achieve our planned earnings or cash flows
from operations, which could result in violation of certain of our loan
covenants and require us to raise additional debt or equity
capital.  There can be no assurance that we could raise additional
capital.
  Our
Credit Agreement imposes covenant restrictions on us that increase our
vulnerability in the current adverse economic and industry climate, and limits
our ability to obtain additional financing. We have recently obtained amendments
to our credit facility, as discussed below and in
Note 6, Long-Term Debt, to waive our covenant noncompliance as of
December 31, 2009 and to provide us more latitude in our covenants through
the term of the agreement. Our ability to meet these covenants is primarily
dependent on the adequacy of earnings before interest, taxes, depreciation and
amortization. Our inability to satisfy the covenants contained in our Credit
Agreement would constitute an event of default. An uncured default could result
in our outstanding debt becoming immediately due and payable. If this were to
occur, we may not be able to obtain waivers or secure alternative financing to
satisfy our obligations, either of which would have a material adverse impact on
our business.
  Although
we believe that we will have adequate liquidity to meet our future operating
requirements and to remain compliant with the covenants under our Credit
Agreement, the factors described above create uncertainty.





18





As
discussed in Note 6, Long-Term Debt, in the notes to our consolidated financial
statements, we have entered into an Amended and Restated Credit Agreement, dated
as of April 14, 2010, to address covenant violations we have had under our
Credit Agreement with Whitney National Bank (“Whitney”) that we originally
entered into on November 11, 2008.  Under the new Amended and Restated
Credit Agreement (the “New Agreement”), we no longer have any further capacity
to draw upon a revolving line of credit and the maturity of all outstanding debt
under the New Agreement is scheduled to mature on April 15,
2011.  Under the terms of the New Agreement, our noncompliance with
the prior terms of the financial covenants and certain other covenants under the
Credit Agreement have been waived (the effect of such noncompliance would have
entitled the holders of all debt under the Credit Agreement and under a loan
agreement between Flotation and TD Bank, N.A. (“TD Bank”) to call such debt
immediately due and payable and would have required us to classify all debt
outstanding under these facilities as current in our audited consolidated
balance sheet at December 31, 2009).  We continue to remain current on
payments of our principal, interest and fee obligations with Whitney and TD
Bank.  However, under the terms of the New Agreement, all of the
indebtedness outstanding under such agreement, which is a currently
approximately an aggregate principal amount of $3,592, will all be due on April
15, 2011, unless we are able to refinance all or a portion of such
indebtedness.





Furthermore,
Flotation was not in compliance as of December 31, 2009 with its covenant
obligations under the TD Bank loan.  The noncompliance with such
covenants under either of the Credit Agreement with Whitney and the loan
agreement with TD Bank would constitute cross defaults for purposes of the other
debt facility.  Flotation has also obtained a waiver of its
noncompliance so that such cross default has not occurred with respect to our
fiscal quarter ended December 31, 2009.




The
effect of our entry into the New Agreement means that we no longer have access
to a line of credit for capital resources and we must rely solely on our cash
position and cash flows to fund our operating requirements. The New Agreement
provides for a letter of credit facility of $1,150.





Whitney
Credit Agreement





We
originally entered into our Credit Agreement with Whitney in November
2008.  The Credit Agreement originally provided a commitment to lend
to us the lesser of $2,000 or 80 percent of eligible receivables (generally
defined as current due accounts receivables in which the lender has a first
priority security interest).  All of this commitment was also
available for Whitney to issue letters of credit (“L/C”) for our
benefit.  In December 2008, we then entered into an amendment of the
Credit Agreement that provided for us to receive a term loan in the principal
amount of $1,150.  Then, in May 2009, we entered into another
amendment to the Credit Agreement providing for us to receive another term loan
in the principal amount of $2,100.  We used the proceeds from the
December 2008 term loan to purchase a piece of equipment (a remotely operated
vehicle) and we used the proceeds of the May 2009 term loan to purchase real
property in Channelview, Texas from JUMA (see additional discussion in Note 4,
Property and Equipment).  There was $850 and $0 outstanding under the
revolving credit line available under the Credit Agreement on December 31, 2009
and 2008, respectively.  We have issued an irrevocable transferable
standby L/C, with an annual commission rate of 2.4 percent for $1,107 during the
year ended December 31, 2009 related to a large contract that is expected to be
completed in fiscal year 2010.  The borrowing capacity under the
revolving line of credit was approximately $43 at December 31,
2009.





We were
originally obligated to repay the December 2008 term loan on the basis of
monthly installments of approximately $35, with the initial payment on February
1, 2009 and a final payment of all unpaid principal and accrued interest on
January 2, 2012.  Outstanding amounts of principal of the December
2008 term loan accrue interest at a rate of 6.5 percent per annum.  As
of the entry into the New Agreement, the outstanding principal amount of the
December 2008 term loan is approximately $730.  Under the terms of the
New Agreement, we are required to continue to make monthly installment payments
for the December 2008 term loan in the amount of approximately $35 and the
outstanding principal amount of such loan continues to accrue interest at the
rate of 6.5 percent per annum.  However, the final payment of all
unpaid principal and accrued interest on the December 2008 term loan of
approximately $343 is now due on April 15, 2011.





We were
originally obligated to repay the May 2009 term loan on the basis of monthly
installments of approximately $18, with the initial payment on June 1, 2009 and
a final payment of all unpaid principal and accrued interest on May 1,
2024.  Outstanding amounts of principal of the May 2009 term loan
accrue interest at a rate of 6.5percent per annum.  As of the entry
into the New Agreement, the outstanding principal amount of the December 2008
term loan is approximately $2,012.  Under the terms of the New
Agreement, we are required to continue to make monthly installment payments for
the May 2009 term loan in the amount of approximately $18 and the outstanding
principal amount of such loan continues to accrue interest at the rate of 6.5
percent per annum.  However, the final payment of all unpaid principal
and accrued interest on the May 2009 term loan of approximately $1,927 is now
due on April 15, 2011.





Upon
entry into the New Agreement, our indebtedness in the amount of $850 outstanding
under the revolving credit line of the Credit Agreement was converted to a term
loan. This April 2010 term loan requires us to make monthly installments in the
amount of $40 plus the amount of accrued and unpaid interest beginning on May 1,
2010 and a final payment of all unpaid principal and accrued interest on April
15, 2011.  Outstanding amounts of principal of the April 2010 term
loan accrue interest at a rate of 6.5 percent per
annum.





The
amounts of L/Cs issued under the New Agreement accrue fees at a rate of 3.5
percent to 2.5 percent (based on our leverage ratio) of the principal amount of
the applicable L/C, and unused amounts under the letter of credit facility incur
unused fees of 0.5 percent to 0.25 percent (based on our leverage
ratio).





Each of
our subsidiaries has guaranteed our obligations under the Credit Agreement,
including as amended and restated under the New Agreement, and as such, our
obligations in connection with the New Agreement are generally secured by a
first priority lien on all of our subsidiaries’ non-real property
assets.  With regard to the Channelview, Texas property purchased with
the proceeds of the May 2009 term loan, we also entered into a Deed of Trust,
Security Agreement and UCC Financing Statement for Fixture Filing (collectively,
the “Deed of Trust”) creating a lien on such
property.





19





As noted
above, under the Credit Agreement, including as amended and restated under the
New Agreement, we have and continue to have certain covenant obligations,
including certain leverage ratio, fixed charge coverage ratio and tangible net
worth covenants.  Prior to entry into the New Agreement, we were not
in compliance with these covenants as of December 31, 2009.  However,
the New Agreement provides for the waiver of such noncompliance and establishes
new covenants in this regard.  From and after April 1, 2010, for each
quarter we are obligated to adhere to the following:  (i) total debt
to consolidated earnings before interest, taxes, depreciation and amortization
(“EBITDA”) of not greater than 3.0 to 1.0 (“Leverage Ratio”), consolidated
EBITDA to consolidated net interest expense and principal payments on the total
debt greater than 1.5 to 1.0 (“Fixed Charge Coverage Ratio”), and consolidated
net worth after deducting other assets as are properly classified as “Intangible
Assets” (“Tangible Net Worth”) in excess of $15,000.  The calculation
of EBITDA for purposes of the Leverage Ratio and Fixed Charge Coverage Ratio
provides for adding back amounts deducted from net income related to charges we
have taken in regards to the financial statements as of December 31, 2009
relating to impairment of goodwill and other intangible assets.  Under
the New Agreement, we continue to have obligations for other covenants,
including limitations on issuance of common stock, liens, transactions with
affiliates, additional indebtedness and permitted investments, among
others.





The New
Agreement also removed a provision that permitted us to obtain other funded
indebtedness from a third party in the event we had requested Whitney to
increase the amount of its commitment or approve additional credit extensions
under the Credit Agreement and Whitney refused to do so.  Thus, we
expect to have to refinance the indebtedness outstanding under the New Agreement
at any such time as we seek to obtain new financing from a third
party.





TD
Bank Loan Agreement





On March
5, 2009, Flotation, our wholly-owned subsidiary, obtained loan proceeds from TD
Bank in the principal amount of $1,840.  The TD Bank loan also
provided a further commitment to Flotation for advancement of principal in the
amount of $320. Under the terms of the TD Bank loan agreement we are obligated
to make payments in monthly installments of approximately $13, with an initial
payment on March 13, 2009 and a final payment of the unpaid principal and
accrued interest in February 2029. We drew the additionally committed $320
principal amount in July 2009.  As a result, our monthly installment
payments increased effective August 2009 to approximately $15.  The
interest rate on the TD Bank Loan is 5.75 percent.





The TD
Bank loan is secured by Flotation’s operational premises in Biddeford, Maine
under a mortgage and security agreement and a collateral assignment of leases
and rents.  The TD Bank loan required us to enter into a debt
subordination agreement that subordinated any debt Flotation owes to Deep Down,
other than accounts payable between them arising in the ordinary course of
business.  Additionally, the TD Bank Loan required a “negative pledge”
that prohibits Flotation and Deep Down from granting security interests in
Flotation’s personal property, other than such security interests granted in
respect of our Revolver with Whitney.





On
February 13, 2009, we entered into an amendment to our Credit Agreement in
connection with our entry into the TD Bank loan.  This amendment
permitted Flotation to incur the TD Bank loan and provide the mortgage and
security arrangements required for such loan.





Under the
TD Bank loan, we are required to meet certain covenants and
restrictions.  The financial covenants are reportable annually
beginning with the year ended December 31, 2009, and are specific to the
Flotation subsidiary financials.  The TD Bank Loan financial covenants
include maintaining debt service coverage ratios, pre and post
distributions, which are ratios of Flotation’s earnings after tax plus interest,
depreciation, amortization and distributions to consolidated net interest
expense and principal payments on the total debt, below 1.5 to
1.0  and including distributions of 2.0 to 1.0, and consolidated net
worth after deducting other assets as are properly classified as “Intangible
Assets” (“Tangible Net Worth”) in excess of $9,500.  Other covenants
include limitations on issuance of liens, transactions with affiliates, and
additional indebtedness among others.  At December 31, 2009, we were
not in compliance with the debt service coverage ratios or the Tangible Net
Worth covenant, and on April 15, 2010, we have obtained a waiver for these
covenants as of December 31, 2009.








20





Cash
Flows





For the
year ended December 31, 2009, cash provided by operating activities was
approximately $2,532 as compared to cash used of approximately $202 for the
prior year. Our working capital balances vary due to delivery terms and payments
on key contracts, costs and estimated earnings in excess of billings on
uncompleted contracts, and outstanding receivables and payables. We used some of
the operating cash flow to reduce accounts payable and accrued liabilities by
approximately $1,454 compared to approximately $328 in 2008. Billings in excess
of costs on uncompleted contracts increased by approximately $2,119 for 2009
compared to approximately $2,127 for 2008 mostly related to a large job that
will be completed during 2010, while increases in costs and estimated earnings
in excess of billings of $441 for 2009 was compared to increases of $1,483 for
2008 due to timing of various jobs in process at each year end. Additionally, we
recorded the following non-cash charges during 2009: goodwill impairment of
approximately $5,537, share-based compensation of approximately $836, bad debt
expense of approximately $192 and depreciation and amortization of approximately
$8,154, which included $4,616 additional amortization due to the impairment of
two long-lived intangible assets. For the year ended December 31, 2008, we
recorded the following non-cash charges: share-based compensation of
approximately $584, bad debt expense of approximately $1,507 due to some
customer-related bankruptcy write-offs, depreciation and amortization of
approximately $2,363, and amortization of deferred financing costs and debt
discount related to the extinguishment of long-term debt totaling approximately
$2,580.





For the
year ended December 31, 2009, cash used in investing activities was
approximately $6,611 compared to approximately $30,964 for the prior year. The
majority of the 2008 activity related to the cash paid to Flotation shareholders
offset by cash acquired, which totaled approximately $22,162, and was funded by
the net proceeds of the Private Placement. Additionally, in accordance with the
terms of the purchase of Mako, we made the final cash payment to the original
Mako shareholders in the amount of approximately $4,237 net of some adjustments
to purchase price expenses. The restricted cash balance of approximately
$375 as of December 31, 2007 was released during 2008 in connection with the
payoff of the Credit Agreement, offset by the increase in restricted cash of
approximately $136 required under a letter of credit entered into during fiscal
year 2008. The restriction was released during 2009 after the related building
project was completed. We used approximately $6,117 for equipment purchases
for the year ended December 31, 2009 as compared to approximately $4,804 for the
prior year period. During 2009, we used approximately $614 cash to fund our new
ERP system, which is projected to be installed in early fiscal
2010.





For the
year ended December 31, 2009, cash provided by financing activities
was approximately $2,496 compared to approximately $31,455 for the prior year
period. During the year ended December 31, 2009, we borrowed approximately
$3,000 and made principle payments of approximately $504. During the year ended
December 31, 2008, we completed the Private Placement of our common stock for
net proceeds of approximately $37,060. In 2008, we paid approximately $13,275,
to a secured creditor to pay the balance due under a credit agreement and
related interest and early termination fees (such early termination fees were
included in operations as loss on debt extinguishment). In January 2008, in
accordance with the terms of the purchase of Mako, we paid approximately $916 of
notes payable and received proceeds from a secured creditor totaling
approximately $5,604.





Critical
Accounting Policies





The
discussion and analysis of our financial condition and results of operations is
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements in accordance with US GAAP
requires us to make estimates and judgments that may affect assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to revenue recognition and related allowances, costs and estimated
earnings incurred in excess of billings on uncompleted contracts, inventory,
impairments of long-lived assets, including intangible assets, impairments of
goodwill, income taxes including the valuation allowance for deferred tax
assets, billings in excess of costs and estimated earnings on uncompleted
contracts; contingencies and litigation, and share-based payments. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable, the results of which form the basis for making
judgments about the carrying values of assets and liabilities. Actual results
may differ from these estimates under different assumptions or
conditions.





We
believe the following accounting policies are critical to our business
operations and the understanding of our operations and include the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.  The consolidated financial statements include
the accounts of Deep Down, Inc. and its wholly-owned
subsidiaries.





All
intercompany transactions and balances have been eliminated in
consolidation.








21





Collectability
of Accounts Receivable





Accounts
receivable are reduced by an allowance for amounts that may become uncollectible
in the future.  Estimates are used in determining our allowance for
doubtful accounts and are based on our historical level of write-offs and
judgments management makes about the creditworthiness of significant customers
based on ongoing credit evaluations.  Further, we monitor current
economic trends that might impact the level of credit losses in the
future.  Since we cannot predict with certainty future changes in the
financial stability of our customers, actual future losses from uncollectible
accounts may differ from our estimates.  Additional allowances may be
required if the economy or the financial condition of our customers
deteriorates.  If we determined that a smaller or larger allowance was
appropriate, we would record a credit or a charge to selling, general and
administrative expense in the period in which we made such a
determination.





Revenue
Recognition





We
recognize revenue once the following four criterions are met:  (i)
persuasive evidence of an arrangement exists, (ii) delivery of the equipment has
occurred or services have been rendered, (iii) the price of the equipment or
service is fixed and determinable and (iv) collectability is reasonably
assured.  For certain fabrication projects, revenue is recognized upon
shipment or when customer-specific contract elements (“milestone(s)”) are
met.   Fabrication and sale of equipment billings are contingent
upon satisfaction of a significant condition of sale milestone, including but
not limited to, factory acceptance testing and customer approval, and recognized
upon transfer of title to the customer.  Service revenue is recognized
as the service is provided, and “time and material” contracts are billed on a
monthly basis as costs are incurred. Customer billings for shipping and handling
charges are included in revenue.





From time
to time, we enter into large fixed price contracts which we determine that
recognizing revenues for these types of contracts is appropriate using the
percentage-of-completion method, which compares the percentage of costs incurred
to date to the estimated total costs for the contract.  This method is
preferred because management considers total costs the best available measure of
progress.





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





Costs and
estimated earnings in excess of billings on uncompleted contracts arise when
revenues are recorded on a percentage-of-completion basis but cannot be invoiced
under the terms of the contract. Such amounts are invoiced upon completion of
contractual milestones. Billings in excess of costs and estimated earnings on
uncompleted contracts arise when milestone billings are permissible under the
contract, but the related costs have not yet been incurred. All contract costs
are recognized currently on jobs formally approved by the customer and contracts
are not shown as complete until virtually all anticipated costs have been
incurred and the items are shipped to the customer.





Assets
and liabilities related to costs and estimated earnings in excess of billings on
uncompleted contracts, as well as billings in excess of costs and estimated
earnings on uncompleted contracts, have been classified as current. The contract
cycle for certain long-term contracts may extend beyond one year, thus complete
collection of amounts related to these contracts may extend beyond one year,
though such long-term contracts include contractual milestone billings as
discussed above.





All
intercompany revenue balances and transactions were eliminated in
consolidation.





Long-Lived
Assets





Long-lived
assets include property, plant and equipment and long-lived intangible assets.
Our intangible assets generally consist of assets acquired in the purchases of
the Mako and Flotation subsidiaries and are comprised of customer lists,
non-compete covenants with key employees and trademarks related to Mako’s ROVs
and to Flotation’s branding, processes, materials and technology.  We
amortize intangible assets over their useful lives ranging from three to forty
years on a straight-line basis.  We make judgments and estimates in
conjunction with the carrying value of these assets, including amounts to be
capitalized, depreciation and amortization methods, useful lives and the
valuation of acquired long-lived intangible assets.








22





We test
for the impairment of long-lived assets upon the occurrence of a triggering
event. We base our evaluation on impairment indicators such as the nature of the
assets, the future economic benefit of the assets, any historical or future
profitability measurements and other external market conditions or factors that
may be present. If these impairment indicators are present or other factors
exist that indicate the carrying amount of an asset may not be recoverable, we
determine whether an impairment has occurred through the use of an undiscounted
cash flows analysis of the asset at the lowest level for which identifiable cash
flows exist. The undiscounted cash flow analysis consists of estimating the
future cash flows that are directly associated with and expected to arise from
the use and eventual disposition of the asset over its remaining useful life.
These cash flows are inherently subjective and require significant estimates
based upon historical experience and future expectations reflected in our
budgets and internal projections. If the undiscounted cash flows do not exceed
the carrying value of the long-lived asset, an impairment has occurred, and we
recognize a loss for the difference between the carrying amount and the
estimated fair value of the asset. The fair value of the asset is measured using
quoted market prices or, in the absence of quoted market prices, is based on an
estimate of discounted cash flows. Cash flows are generally discounted at an
interest rate commensurate with our weighted average cost of capital for a
similar asset.





We have
assessed the current market conditions and have concluded, as of December 31,
2009, that a triggering event had occurred that required an impairment analysis
of long-lived intangible assets (see further discussion below related to
Goodwill annual testing). For the year ended December 31, 2009, we recorded
impairment charges totaling $4,616 to several long-lived intangible assets,
which total impairment charges were recorded on the statement of operations as
amortization expense. There was no impairment of long-lived assets for the year
ended December 31, 2008.  Unanticipated changes in revenue, gross
margin, or long-term growth factor could result in a material impact on the
estimated fair values of our long-lived assets which could result in long-lived
asset impairments in future periods. See further discussion in Note 5 to the
consolidated financial statements included in this
Report.





Goodwill





Goodwill
represents the cost in excess of the fair value of net assets acquired in
business combinations. We evaluate the carrying value of goodwill annually on
December 31 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.





The test
for goodwill impairment is a two-step approach. The first step is to compare the
estimated fair value of any reporting units within the Company that have
goodwill with the recorded net book value (including the goodwill) of the
reporting unit. If the estimated fair value of the reporting unit is higher than
the recorded net book value, no impairment is deemed to exist and no further
testing is required. If, however, the estimated fair value of the reporting unit
is below the recorded net book value, then a second step must be performed to
determine the goodwill impairment required, if any. In this second step, the
estimated fair value from the first step is used as the purchase price in a
hypothetical acquisition of the reporting unit. Purchase business combination
accounting rules are followed to determine a hypothetical purchase price
allocation to the reporting unit’s assets and liabilities. The residual amount
of goodwill that results from this hypothetical purchase price allocation is
compared to the carrying value of goodwill for the reporting unit, and the
carrying value is written down to the hypothetical amount, if
lower.





At
December 31, 2009, our management completed the annual impairment test of
goodwill. Management’s calculations indicated, due to a number of factors,
including the current global economic environment, increased costs of capital
and the decrease in our market capitalization, that the calculations for the
reporting units of Deep Down Delaware, Mako and Flotation each indicated their
respective net book value exceeded its fair value and, accordingly, goodwill for
each unit was considered to be potentially impaired. We used the estimated fair
value of each reporting unit from the first step as the purchase price in a
hypothetical acquisition of the respective reporting unit. See Note 5 to the
consolidated financial statements for a discussion of testing inputs and
assumptions. We recognized a goodwill impairment of $3,056 for Deep Down
Delaware, $2,481 for Mako and $0 for Flotation for the year ended
December 31, 2009. Remaining goodwill by reporting unit was $4,472, $2,874
and $2,083 for the Deep Down Delaware, Mako and Flotation reporting units,
respectively, as of December 31, 2009. Determining the fair value of a reporting
unit is judgmental in nature and requires the use of significant estimates and
assumptions, including revenue growth rates and operating margins, discount
rates and future market conditions, among others. Unanticipated changes in
revenue, gross margin, long-term growth factor or discount rate could result in
a material impact on the estimated fair values of our reporting units, which
could result in additional goodwill impairments in future
periods.








23





Stock-Based
Compensation





We record
share-based payment awards exchanged for employee services at fair value on the
date of grant and expense the awards in the consolidated statements of
operations over the requisite employee service period.  Stock-based
compensation expense includes an estimate for forfeitures and is generally
recognized over the expected term of the award on a straight-line
basis.  At December 31, 2009, we had two types of stock-based employee
compensation: stock options and restricted stock.





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.  Additionally, we continue to use the simplified method
related to employee option grants.





Income
Taxes





We follow
the liability method of accounting for income taxes.  This method
takes into account the differences between financial statement treatment and tax
treatment of certain transactions. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect of a
change in tax rates is recognized as income or expense in the period that
includes the enactment date. Our effective tax rates for 2009 and 2008
were 5.98 percent, and 19.6 percent,
respectively.





We record
a valuation allowance to reduce the carrying value of our deferred tax assets
when it is more likely than not that some or all of the deferred tax assets will
expire before realization of the benefit or that future deductibility is not
probable. The ultimate realization of the deferred tax assets depends upon our
ability to generate sufficient taxable income of the appropriate character in
the future. This requires management to use estimates and make assumptions
regarding significant future events such as the taxability of entities operating
in the various taxing jurisdictions. In evaluating our ability to recover our
deferred tax assets, we consider all reasonably available positive and negative
evidence, including our past operating results, the existence of cumulative
losses in the most recent years and our forecast of future taxable income. In
estimating future taxable income, we develop assumptions, including the amount
of future state, and federal pretax operating income, the reversal of temporary
differences and the implementation of feasible and prudent tax planning
strategies. These assumptions require significant judgment. When the likelihood
of the realization of existing deferred tax assets changes, adjustments to the
valuation allowance are charged, in the period in which the determination is
made, either to income or goodwill, depending upon when that portion of the
valuation allowance was originally created.





We record
an estimated tax liability or tax benefit for income and other taxes based on
what we determine will likely be paid in the various tax jurisdictions in which
we operate.  We use our best judgment in the determination of these
amounts.  However, the liabilities ultimately realized and paid are
dependent upon various matters, including resolution of tax audits, and may
differ from amounts recorded.  An adjustment to the estimated
liability would be recorded as a provision or benefit to income tax expense in
the period in which it becomes probable that the amount of the actual liability
or benefit differs from the recorded amount.





Our
future effective tax rates could be adversely affected by changes in the
valuation of our deferred tax assets or liabilities or changes in tax laws or
interpretations thereof.  At such time, if any, that we no longer have
a reserve for our deferred tax assets, we will begin to provide for taxes at the
full statutory rate.  In addition, we are subject to the examination
of our income tax returns by the Internal Revenue Service and other tax
authorities.  We regularly assess the likelihood of adverse outcomes
resulting from these examinations to determine the adequacy of our provision for
income taxes.





Recent
Accounting Pronouncements





Recent
Accounting Pronouncements are included in “Part II, Item 8. Financial
Statements” Note 1 to the consolidated financial statements, “Summary of
Significant Accounting Policies.”





24








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.





Inflation
and Seasonality





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





Item
      7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
  RISK





This item
is not applicable for smaller reporting companies.





25





Item
      8.
            FINANCIAL
      STATEMENTS





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





Reports
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Balance Sheets
            F-4Consolidated
      Statements of Operations
            F-5Consolidated
      Statements of Changes in Stockholders’ Equity
            F-6Consolidated
      Statements of Cash Flows
            F-7Notes
      to Consolidated Financial Statements
            F-8





Item
      9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





None.








26





Item
      9A.
            CONTROLS
      AND PROCEDURES





Evaluation of Disclosure Controls
and Procedures.   We carried out an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)). Based upon that evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that, as of the end of the period covered in
this report, our disclosure controls and procedures were not effective due to
the material weakness described below to ensure that information required to be
disclosed in reports filed under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the required
time periods and is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure.





Changes in Internal Control Over
Financial Reporting.    There have been no changes to
our internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) that occurred during the fiscal quarter ended
December 31, 2009 which have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.





Management’s Report on Internal
Control Over Financial Reporting.Management is
responsible for the fair presentation of the consolidated financial statements
of Deep Down, Inc.  Management is also responsible for establishing
and maintaining a system of internal control over financial reporting as defined
in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended.  Our internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.  Our internal control
over financial reporting includes those policies and procedures
that:




(i)          
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the
company;
 
 (ii)        
 provide reasonable assurance that transactions are recorded as necessary
to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of our management
and directors; and
 
 (iii)         provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of assets that could have a material effect on
the financial statements.


Management
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control—Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission.  Based on this evaluation, our management
concluded our internal control over financial reporting was not effective as of
December 31, 2009.





A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of our annual or interim financial statements will
not be prevented or detected on a timely basis.  We have identified
the following material weakness.





As of
December 31, 2009, 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 our employees, officers and
directors.  Further, the Board of Directors does not currently have
any independent members and no director qualifies as an audit committee
financial expert as defined in Item 407(d)(5)(ii) of Regulation
S-B.  We did not maintain the following controls: sufficient policies
and procedures over the administration of our accounting and fraud risk
policies, and a sufficient segregation of duties to decrease the risk of
inappropriate accounting. Since these entity level programs have a pervasive
effect across the organization, management has determined that these
circumstances constitute a material weakness. Additionally, this control
deficiency could result in another material weakness that could result in a
material misstatement of the consolidated financial statements that would not be
prevented or detected.





As a
result of the material weakness described above, we concluded that we did not
maintain effective internal control over financial reporting as of
December 31, 2009 based on criteria established in the
Framework.





This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting.  Management's report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the SEC that
permit us to provide only the management's report in this annual
report.








27








Management’s remediation
plans.In our efforts to continuously improve our internal
controls, management has taken steps to enhance the following controls and
procedures subsequent to December 31, 2009 as part of our remediation efforts in
addressing the material weakness above:




·      Management
is in the process of increasing the Board of Directors with independent members,
including a financial expert as defined in Item 407(d)(5)(ii) of Regulation S-B.
An independent director was appointed by the Board effective April 12, 2010;
Mark R. Hollinger has joined the Board as an independent director and was
appointed Chairman of the Audit Committee of the Board of
Directors.


·      Management
has prepared a Code of Conduct for Management and Board of Directors and
circulated these documents and obtain signed acknowledgements from management
and the Board of Directors in April 2010. See Corporate Governance under Item
10. Directors, Executives Officers and Corporate Governance included in this
Report for a description of the codes, which are filed as Exhibits to this
Report.


·      Management
implemented an anonymous “whistleblower” hotline effective April
2010.





Item
      9B.
            OTHER
      INFORMATION





None.








28








PART
III





Item
      10.
            DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE





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





Name
            
            Age
            
            Position Held With Deep
  DownRonald
      E. Smith*
            
            51
            
            President,
      Chief Executive Officer and DirectorEugene
      L. Butler(1)
            
            68
            
            Chief
      Financial Officer and Chairman of the BoardMary
      L. Budrunas*
            
            58
            
            Vice
      President, Corporate Secretary and DirectorMichael
      J. Newbury
            
            42
            
            Vice
      President Business DevelopmentMark
      R Hollinger
            
            52
            
            Director


_________________________





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


(1)
            Mr.
      Butler was appointed our Chairman of the Board effective September 1,
      2009.





Biographical
information regarding each of our directors is as follows.  The
following paragraphs also include specific information about each director’s
experience, qualifications, attributes or skills that led the Board of Directors
to the conclusion that the individual should serve on the Board as of the time
of this filing, in light of our business and
structure:





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





Mr. Smith
is qualified for service on the Board due to his extensive background in many
aspects of the offshore industry, spanning almost three decades. Mr. Smith’s
wide range of knowledge and experience with the various technologies and
platforms in the deep water industry brings invaluable expertise to our
Board.





Eugene
L. Butler, Chief Financial Officer and Chairman of the Board.  Mr. Butler has served as Chief Financial Officer and Director
with Deep Down since June 2007, and was appointed Chairman of the Board
effective September 1, 2009. Mr. Butler was Managing Director of CapSources,
Inc., an investment banking firm specializing in mergers, acquisitions and
restructurings, from 2002 until 2007. Prior to this, he has served in various
capacities as a director, president, chief executive officer, chief financial
officer and chief operating officer for Weatherford International, Inc.,
a  multi-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. Mr. Butler also serves on the Board of Powell Industries, Inc. since
1991, where he is the Chairman of the Audit Committee and on the Governance
Committee.





In
addition to his extensive knowledge of us, Mr. Butler is qualified for service
on the Board based on his leadership skills and long-standing senior management
experience in the energy and petroleum industries.  Additionally, his
background in public accounting and investment banking, familiarity with complex
accounting issues and financial statements, as well as his service on the board,
including various committees, of another public company, provide invaluable
financial expertise and overall insight to our Board.








29





Mary L.
Budrunas, Vice-President, Corporate Secretary and Director. Ms. Budrunas,
co-founder of Deep Down, Inc. along with current chief executive officer Ronald
E. Smith, and has served as our Vice-President, Corporate Secretary and Director
since December 2006.  Ms. Budrunas is responsible for our
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.





Ms.
Budrunas is qualified for service on the Board based on her extensive oil and
gas industry experience. Such expertise provides valuable insight to the
Board.





Michael
J. Newbury, Vice President Business Development.  Mr. Newbury joined
Deep Down in March 2009 in the role of Corporate Business Development Manager,
bringing more than 19 years of international experience and relationships in
offshore business development, sales and marketing, and subsea service project
support.  Mr. Newbury’s initial role at Deep Down was the improvement in
our marketing, sales and commercial aspects, additionally to oversee large
project opportunities and to strengthen our contractual functions.  In
February 2010, Mr. Newbury was promoted to Vice President Business Development
and was tasked with the additional responsibilities of corporate operations and
interfacing with all of our business units.  Prior to joining us, Mr.
Newbury held various positions with increasing authority and responsibility with
such companies as Subsea 7 from 2002 to 2009, a $2 billion multi-national
service and equipment corporation serving the worldwide energy market, General
Manager, North and Central America – i-Tech Division, Commercial Manager, North
and Central America – ROV, Survey & DGPS, Business Development Manager,
North America; Halliburton Subsea (US) 1999 – 2002, Senior Manager – Business
Development, Operations Project Manager – ROV and Marine; Subsea International
(US) 1997 – 1999,  Safety, Quality and Environmental Group Manager &
Human Resources & Payroll Manager, and Subsea Offshore Limited (Great
Yarmouth and Aberdeen UK) 1990-1997, General Manager, HSEQ Global Manager,
Quality Assurance Global Manager, Quality Assurance Engineer.  Mr. Newbury
has worked in most major oil producing regions of the world, including the Gulf
of Mexico, Central America, North Sea, Asia, and Australia.  Mr. Newbury’s
main areas of focus over the past eight years have been in offshore business
development, tendering, and contract negotiation.  Mr. Newbury graduated in
1990 with a Bachelor of Science in Business
Management.





Mark R.Hollinger,Director.  Mr.
Hollinger joined the Board as an independent director effective April 12, 2010,
and was appointed Chairman of the Audit Committee of the Board of Directors. Mr.
Hollinger is currently President of Offshore Solutions at MacDermid, Inc.
(“MacDermid”), which provides specialty fluids to hydraulic controls of valves
in the offshore drilling and production systems; a position he has held since
September 2007.  Prior to MacDermid, Mr. Hollinger served as
President of Merix Corporation, a holding company of Merix Asia (formerly,
Eastern Pacific Circuits Limited) from May 1999 to January 2007 and Chief
Executive Officer from September 1999 to January 2007.  During the
past five years, Mr. Hollinger served on the board of directors of Merix
Corporation and Simple Tech, as well as several non-profit board of
directors.





Mr.
Hollinger is qualified for service on the Board based on his experience and
expertise in management, plus his knowledge of the international energy market
and business strategy. Also, Mr. Hollinger’s past and current service on the
Boards of other public companies brings a depth of experience and perspective to
our Board.





Corporate
Governance





We
promote accountability for adherence to honest and ethical conduct; we endeavor
to provide full, fair, accurate, timely and understandable disclosure in reports
and documents that we file with the SEC and in other public communications made
by us and strive to be compliant with applicable governmental laws, rules and
regulations. We have adopted a Directors Code of Business Conduct to promote
honest and ethical conduct and compliance with applicable laws, rules,
regulations and standards on the part of our board of directors. This code
addresses several matters, including conflicts of interest, corporate
opportunities, confidentiality, fair dealing, protection and proper use of
Company assets, compliance with laws, rules and regulations (including insider
trading laws), and encouraging the reporting of any illegal or unethical
behavior. We have
also adopted Financial Officer’s Code of Business Conduct to promote honest and
ethical conduct, proper disclosure of financial information in the Company’s
periodic reports, and compliance with applicable laws, rules, and regulations by
the Company’s officers and management personnel, including the Company’s chief
executive officer, chief financial officer and controller.  The policies
established by this code are aimed at preventing wrongdoing and at promoting
honest and ethical conduct, including ethical handling of actual and apparent
conflicts of interest, the full, fair, accurate, timely and understandable
disclosure in public communications, compliance with applicable laws, rules and
regulations, and accountability for adherence to the code through prompt
internal reporting of violations of the code.
  Until the
addition of Mr. Hollinger to our Board, in lieu of an Audit Committee, our Board
of Directors was responsible for reviewing and making recommendations concerning
the selection of outside auditors, reviewing the scope, results and
effectiveness of the annual audit of our financial statements and other services
provided by our independent public accountants. We created an Audit Committee in
April 2010 who will perform these functions. The Board of Directors reviews our
internal accounting controls, practices and policies. Our Board of Directors has
determined that no director qualifies as an independent audit committee
financial expert as defined in Item 407(d) (5) (ii) of Regulation
S-K.








30





Section
16(a) Beneficial Ownership Reporting Compliance





Section 16(a)
of the Exchange Act requires our officers and directors, and persons who own
more than ten percent of a registered class of our equity securities, to file
reports of securities ownership and changes in such ownership with the SEC.
Officers, directors and greater than ten percent shareholders also are required
by rules promulgated by the SEC to furnish us with copies of all
Section 16(a) forms they file.





Based
solely upon a review of the copies of such forms furnished to us or written
representations of our officers and directors, we believe that all
Section 16(a) filing requirements were filed on a timely basis, except two
Form 4 filings for Mr. Chamberlain for two transactions regarding sales of
common stock, which were subsequently filed November 18, 2009, and one late Form
4 filing for Mr. Butler related to one transaction regarding the issuance of
stock options on September 1, 2009 which was subsequently filed on October 27,
2009.





Item
      11.
            EXECUTIVE
      COMPENSATION





The
following table sets forth information concerning the total compensation earned
in the years ended December 31, 2009 and 2008 by our Chief Executive Officer,
our two highest compensated executive officers other than our CEO and one
additional individual who would have qualified as one of the two highest
compensated executive officers but for the fact that he was not serving as an
executive officer of Deep Down as the end of fiscal year 2009 (collectively, our
“Named Executive Officers” or “NEOs”).





Summary
Compensation Table





Name
      and Principal Position
              Year
              
              Salary
      ($)
              
              
              Bonus
                ($)
      (6)
              
              
              Stock
                Awards
                ($)
      (1)
              
              
              Option
      Awards
                ($)
      (1)
              
              
              All
      Other Compensation
                ($)
      (2)
              
              
              TotalRonald
      E. Smith
              2009
              
              $
              345,000
              
              
              $
              -
              
              
              $
              93,000
              
              
              $
              -
              
              
              $
              12,000
              
              
              $
              450,000President,
      Chief Executive Officer and Director
              2008
              
              $
              250,000
              
              
              $
              175,000
              
              
              $
              147,000
              
              
              $
              48,588
              
              
              $
              12,000
              
              
              $
              632,588Eugene
      L. Butler
              2009
              
              $
              310,000
              
              
              $
              -
              
              
              $
              93,000
              
              
              $
              771,600
              
              
              $
              24,348
              
              
              $
              1,198,948Chairman
      of the Board andChief
      Financial Officer (4)
              2008
              
              $
              225,000
              
              
              $
              175,000
              
              
              $
              147,000
              
              
              $
              48,588
              
              
              $
              28,204
              
              
              $
              623,792Michael
      J. Newbury
              2009
              
              $
              109,615
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              109,615Vice
      President of Business Development (5)
              2008
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -Robert
      E. Chamberlain, Jr.
              2009
              
              $
              302,889
              
              
              $
              -
              
              
              $
              93,000
              
              
              $
              -
              
              
              $
              24,074
              
              
              $
              419,963Former
      Chairman of the Board and Chief Acquisitions Officer (3)
              2008
              
              $
              225,000
              
              
              $
              175,000
              
              
              $
              147,000
              
              
              $
              48,588
              
              
              $
              32,440
              
              
              $
              628,028
 
 (1)           Included
in the “Stock Awards” and “Option Awards” columns are the aggregate grant date
fair values of restricted stock awards and option awards made in 2009 and
2008.  The grant date fair values of the awards were computed in
accordance with FASB ASC Topic 718.  A total of 1,000,000 and 0 option
awards granted to NEOs were forfeited during 2009 and 2008, respectively. A
total of 2,000,000 option awards which were originally issued on February 14,
2008 were cancelled in March 2010 and not reissued, see discussion below (such
cancellation has no impact on compensation, since we are required to expense the
remaining unamortized stock based compensation at the time of cancellation). For
a discussion of the assumptions and methodologies used to value the stock and
option awards reported in the table above, see Note 7 “Stock-Based Compensation”
to our consolidated financial statements included in this Report. All options
are for the purchase of our common stock. Stock awards are grants of restricted
stock representing time-vesting shares.








31





(2)           The
amounts in the “All Other Compensation” column for 2009 were attributed to the
following:




·
            Mr.
      Butler: Amounts included for the year ended 2009 consisted of a vehicle
      allowance ($1,000 per month) and $12,348 for reimbursement for federal and
      state payroll withholdings customarily withheld for an
      employee.


·
            Mr.
      Smith: Amounts included for the year ended 2009 consisted of a vehicle
      allowance ($1,000 per month).


·
            Mr.
      Chamberlain: Amounts for the year ended 2009 included a vehicle allowance
      ($1,000 per month) and $12,074 for reimbursement for federal and state
      payroll withholdings customarily withheld for an
  employee.





(3)           Mr.
Chamberlain resigned as Chairman of the Board and Chief Acquisitions Officer
effective as of August 31, 2009. There were no severance or other payments made
to Mr. Chamberlain in connection with his separation, though he will remain a
consultant of the Company through August 2010 under terms of a Severance and
Separation Agreement.  A portion of Mr. Chamberlain’s consulting
payments, included in the Salary column above, were made with restricted stock.
The fair value of the shares granted totals $75,000, which is being amortized
over the one year remaining term of Mr. Chamberlain’s consulting agreement, and
$25,000 was included in the Salary column above for the appropriate months in
fiscal 2009.





Mr.
Chamberlain forfeited a total of 1,000,000 options which were originally granted
February 14, 2008 in connection with his resignation (666,667 options were
unvested, and 333,333 were vested, which were cancelled 90 days after his
resignation, under terms of the Plan). See further discussion
below.





(4)           Mr.
Butler was appointed Chairman of the Board effective September 1,
2009.





(5)           Mr.
Newbury was hired by Deep Down effective March 30, 2009. His original title was
Manager of Business Development, which was changed to Vice President of Business
Development effective February 17, 2010.





(6)           In
June 2008, Messrs. Smith, Chamberlain and Butler were each awarded and paid a
cash performance bonus in the amount of $100,000. Additionally, in December
2008, Deep Down awarded Messrs. Smith, Chamberlain and Butler with cash
performance bonuses of $75,000 relating to fiscal year 2008 (the amounts were
paid in January 2009).  There were no bonuses granted for 2009 due to
our current cost containment efforts.





Narrative
Disclosure to Summary Compensation Table





All of
the compensation described in the foregoing table, other than those amounts
shown in the “Bonus”, “Stock Awards” and “Option Awards” columns, was paid to
the NEOs pursuant to agreements with Deep Down, with the exception of Mr.
Newbury, who signed  an employment agreement effective February 17,
2010.





Mr. Smith
has an employment agreement to serve as our President and Chief Executive
Officer, which provides for annual cash compensation of $345,000, and a monthly
vehicle allowance of $1,000.  Effective January 1, 2010, Mr. Smith’s
annual cash compensation was increased to $362,250, and a monthly vehicle
allowance of $1,500. The term of Mr. Smith’s employment agreement is through
January 1, 2013, and is subject to further automatic renewals for annual periods
up to an additional two years.





For the
years ended December 31, 2008 and 2009, Mr. Butler had a consulting agreement
between Deep Down and Eugene L. Butler & Associates to serve as our Chief
Financial Officer. Mr. Butler’s consulting agreement provided for annual cash
compensation of $225,000, which was increased to $310,000 effective January 1,
2009; also a monthly vehicle allowance of $1,000 and reimbursement for federal
and state payroll withholdings customarily withheld for an employee which are
included in the “All Other Compensation” column. Effective January 1, 2010, Mr.
Butler’s consulting agreement was replaced by an employment
agreement.  The employment agreement provides cash compensation of
$325,500 and a monthly vehicle allowance of $1,500. The term of Mr. Butler’s
employment agreement is through January 1, 2013, and is subject to further
automatic renewals for annual periods up to an additional two
years.





Mr.
Chamberlain served as our Chairman of the Board and Chief Acquisitions Officer
pursuant to a consulting agreement we had with Strategic Capital Services, Inc.
(“Strategic”).  The consulting agreement with Strategic provided that
we pay Mr. Chamberlain an annual base salary of $180,000, which was increased to
$225,000 effective as of January 1, 2008 and to $310,000 effective as of January
1, 2009. Additionally, Mr. Chamberlain received a vehicle allowance of $1,000
per month and reimbursement for federal and state payroll withholdings
customarily withheld for an employee, which are included in the “All Other
Compensation” column. The consulting agreement with Strategic for Mr.
Chamberlain’s services had an initial term through August 6,
2010.





32





On
September 3, 2009, we accepted the resignation of Mr. Chamberlain as Chief
Acquisitions Officer and Chairman; such resignation was effective on August 31,
2009.  The resignation of Mr. Chamberlain did not involve any
disagreement with us. We continue to engage Mr. Chamberlain’s services under the
Severance and Separation Agreement with Strategic which replaced the original
consulting agreement dated August 6, 2007, and expires August 5, 2010. Under
terms of the Agreement, we will pay Strategic a total of 22 bi-monthly payments
of $10,910 plus a final payment on August 5, 2010 of $3,519. Additionally, Mr.
Chamberlain was granted 750,000 restricted shares of common stock at a price of
$0.10, which will vest in full on August 5, 2010 provided he remains our
consultant through such date, and all previously granted restricted shares
vested immediately on September 1, 2009.





The
amounts included for 2008 in the “Bonus” column reflect the following: in June
2008, Messrs. Smith, Chamberlain and Butler were each awarded and paid a cash
performance bonus in the amount of $100,000 related to fiscal 2008 achievements.
Additionally, in December 2008, Deep Down awarded Messrs. Smith, Chamberlain and
Butler with cash performance bonuses of $75,000 relating to fiscal year 2008
(the amounts were paid in January 2009).  There were no bonuses
granted for 2009 due to our current cost containment
efforts.





The
amounts included for 2008 in the “Stock Awards” and the “Option Awards” columns
above reflect awards to purchase 1,000,000 shares of our common stock and grants
of 350,000 restricted shares of our common stock provided to each of Messrs.
Smith, Chamberlain and Butler on February 14, 2008. In each case, the awards and
grants were made under the Plan. The options vest over three years and have an
exercise price of $1.50. Each of the grants of restricted shares of our common
stock was scheduled to vest in its entirety on February 14, 2010, provided that
the officer continues to be employed with Deep Down through the vesting
date.  Mr. Chamberlain’s 350,000 restricted shares vested on September
1, 2009 under terms of his Severance and Separation Agreement.  The
remaining 700,000 restricted shares vested upon their original schedule on
February 14, 2010.  Mr. Chamberlain forfeited 1,000,000 options in
connection with his resignation September 1, 2009, and the 1,000,000 options
granted to each of Mr. Smith and Mr. Butler were cancelled and not reissued,
effective March 5, 2010.





The
amounts included for 2009 in the “Stock Awards” column above reflect grants of
750,000 restricted shares of our common stock provided to each of Messrs. Smith,
Chamberlain and Butler on March 29, 2009. In each case, grants were made under
the Plan. Each of the grants of restricted shares of our common stock is
scheduled to vest in its entirety on March 29, 2011, provided that the officer
continues to be employed with Deep Down through the vesting date. Mr.
Chamberlain’s restricted shares were accelerated in vesting on September 1, 2009
under terms of his Severance and Separation Agreement; such shares have a grant
date fair value of $93,000.





The
amounts included for Mr. Butler for 2009 in the “Option Awards” column above
reflect awards to purchase 2,000,000 and 10,000,000 shares of our common stock
granted to Mr. Butler on March 29, 2009 and September 1, 2009, respectively. In
each case, grants were made under the Plan. The options vest over three years
ratably beginning one year from grant date, and have an exercise price of $0.124
and $0.10, respectively.








33





Outstanding
Equity Awards at December 31, 2009





The
following tables present information regarding the outstanding equity awards
held by each of the NEOs as of December 31, 2009. Messrs. Chamberlain and
Newbury had no outstanding option awards as of that date; Mr. Chamberlain had
outstanding restricted stock as noted on the Stock Awards table
below.





Option
Awards





Name
              
              Option
      Grant
                Date
              
              Number
      of Securities Underlying Unexercised Options Exercisable
    (#)
              
              
              Number
      of Securities Underlying Unexercised Options
                Unexercisable
      (#)
              
              Option
                Exercise
                Price
                ($/Sh)
              
              Option
                Expiration
                DateRonald
      E. Smith
              
              2/14/2008
              
              
              333,333
              
              
              
              666,667
              (1)
              
              
              1.50
              
              2/14/2013Eugene
      L. Butler
              
              9/1/2009
              
              
              -
              
              
              
              10,000,000
              (4)
              
              
              0.10
              
              9/1/20143/23/2009
              
              
              -
              
              
              
              2,000,000
              (3)
              
              
              0.12
              
              3/23/20142/14/2008
              
              
              333,333
              
              
              
              666,667
              (1)
              
              
              1.50
              
              2/14/20135/31/2007
              
              
              2,000,000
              
              
              
              1,000,000
              (2)
              
              
              0.52
              
              8/31/2010





(1)
            These
      options were vesting over three years, with substantially one-third
      vesting on the first, second and third anniversary of the date of grant,
      provided that the officer continued to be employed with Deep Down through
      each vesting date. We cancelled these options on March 5, 2010 and did not
      issue replacement options.





(2)
            The
      remaining unvested portion of this option award is scheduled to vest on
      May 31, 2010, provided that Mr. Butler continues to be employed with Deep
      Down through that vesting date.





(3)
            The
      remaining unvested portion of this option award is scheduled to vest in
      equal installments on March 29, 2010, March 29, 2011 and March 29, 2012,
      provided that Mr. Butler continues to be employed with Deep Down through
      those vesting dates.





(4)
            The
      remaining unvested portion of this option award is scheduled to vest in
      equal installments on September 1, 2010, September 1, 2011 and September
      1, 2012, provided that Mr. Butler continues to be employed with Deep Down
      through those vesting dates.





Stock
Awards





Name
              
              Award
                Grant
      Date
              
              Number
      of
                Shares
      or
                Units
      of Stock
                That
      Have Not
                Vested
                (#)
              
              Market
      Value of
                Shares
      or Units of
                Stock
      that Have
                Not
      Vested
                ($)
      (1)Ronald
      E. Smith
              
              3/29/2009
              
              
              750,000
              (3)
              
              
              97,5002/14/2008
              
              
              350,000
              (2)
              
              
              45,500Robert
      E. Chamberlain, Jr.
              
              9/1/2009
              
              
              750,000
              (4)
              
              
              97,5003/29/2009
              
              
              -
              (3)
              
              
              -2/14/2008
              
              
              -
              (3)
              
              
              -Eugene
      L. Butler
              
              3/29/2009
              
              
              750,000
              (3)
              
              
              97,5002/14/2008
              
              
              350,000
              (2)
              
              
              45,500


(1)
            The
      market value is calculated by multiplying the number of shares by the
      closing price of our common stock of $ 0.13 on December 31,
      2009.


(2)
            This
      restricted stock award is scheduled to vest in its entirety on February
      14, 2010, provided that the officer continues to be employed with Deep
      Down through the vesting date. Mr. Chamberlain’s shares granted on this
      date were accelerated on September 1, 2009 in connection with his
      Severance and Separation Agreement. The award vested for Messrs. Smith and
      Butler on February 10, 2010.


(3)
              This
      restricted stock award is scheduled to vest in its entirety on March 29,
      2012, provided that the officer continues to be employed with Deep Down
      through the vesting date. Mr. Chamberlain’s shares granted on this date
      were accelerated on September 1, 2009 in connection with his Severance and
      Separation Agreement.
 (4)
              This
      restricted stock award is was issued in connection with Mr. Chamberlain’s
      Severance and Separation Agreement and is scheduled to vest in its
      entirety on September 1, 2010, provided that he continues as a consultant
      under terms of his Severance and Separation Agreement through such
      date.


34





Benefits
payable upon change in control





Both Mr.
Butler and Mr. Smith’s (the “Executive”) employment agreements contain
provisions related to change in control.


In the
event of termination of the Executive’s employment for any reason, he will be
entitled to receive all accrued, unpaid salary and vacation time through the
date of termination and all benefits to which the Executive is entitled or
vested under the terms of all employee benefit and compensation plans,
agreements and arrangements in which the Executive is a participant as of the
date of termination.  In addition, subject to executing a general
release in favor of us, the Executive will be entitled to receive certain
severance payments in the event his employment is terminated by the Company
“other than for cause” or by the Executive with “good reason.”  These
severance payments include the following:





(i) a
lump sum in cash equal to one times the Executive’s annual base salary (at the
rate in effect on the date of termination), provided, however, that is such
termination occurs prior to the date that is twelve months following a change of
control, then such payment will be equal to three times the Executive’s annual
base salary (at the rate in effect on the date of
termination);





(ii) a
lump sum in cash equal to the average annual bonus paid to the Executive for the
prior two full fiscal years preceding the date of termination; provided,
however, that is such termination occurs prior to the date that is twelve months
following a change of control, then such payment will be equal to two times the
average annual bonus paid to the Executive for the prior two full fiscal years
preceding the date of termination;





(iii) a
lump sum in cash equal to a pro rata portion of the annual bonus payable for the
period in which the date of termination occurs based on the actual performance
under our annual incentive bonus arrangement; provided, however, that such pro
rata portion shall be calculated based on the Executive’s annual bonus for the
previous fiscal year; provided further that if no previous annual bonus has been
paid to the Executive, then the lump sum cash payment shall be no less than
fifty percent of Executive’ annual base salary; and





(iv) if
the Executive’s termination occurs prior to the date that is twelve months
following a Change of Control (as defined in the Employment Agreement), then
each and every share option, restricted share award and other equity-based award
that is outstanding and held by the Executive shall immediate vest and become
exercisable.





Each of
the Executives have agreed to not, during the respective term of his employment
and for a one-year period after his termination, engage in Competition (as
defined in the Employment Agreement) with us, solicit business from any of our
customer or potential customers, solicit the employment or services of any
person employed by or a consultant us on the date of termination or with six
months prior thereto, or otherwise knowingly interfere with our business or
accounts or any of our subsidiaries.





The
Employment Agreements also provide that we, to the extent permitted by
applicable law and our by-laws, will defend, indemnify and hold harmless the
Executive from any and all claims, demands or causes of action, including
reasonable attorneys’ fees and expenses, suffered or incurred by the Executive
as a result of the assertion or filing of any claim, demand, litigation or other
proceedings based upon statements, acts or omissions made by or on behalf of the
Executive pursuant to the Employment Agreement or in the course and scope of the
Executive’s employment with us.  We will also maintain and pay all
applicable premiums for directors’ and officers’ liability insurance which shall
provide full coverage for the defense and indemnification of the Executives, to
the fullest extent permitted by applicable law.





Compensation
Committee Interlocks and Insider Participation





None of
our directors or executive officers served as members of the board of directors
of another entity that has or had an executive officer who served as a member of
our Board during 2009.  We do not have a separate compensation
committee.  The entire board participated in deliberations concerning
executive officer compensation in the fiscal year ended December 31,
2009.








35





Compensation
Committee Report





We do not
have a separate compensation committee. Accordingly, to the extent that
decisions are made regarding the compensation policies pursuant to which our
named executive officers are compensated, they are made by our
Board.





In light
of the foregoing, the Board has reviewed and discussed with management the
Compensation Discussion and Analysis set forth above and determined that it be
included in this annual report for the year ended December 31,
2009.





Submitted
by:


Ronald E.
Smith


Mary L.
Budrunas


Eugene L.
Butler


Mark R.
Hollinger





Notwithstanding
anything to the contrary set forth in any previous filings under the Securities
Act, as amended, or the Exchange Act, as amended, that incorporate future
filings, including this annual report, in whole or in part, the foregoing
Compensation Committee Report shall not be incorporated by reference into any
such filings.





Option
Exercises and Stock Vested During the Year Ended December 31,
2009





There
were no options exercised by NEOs during the yearended December 31, 2009.
All of the restricted stock issued on February 14, 2008 becomes fully vested on
February 14, 2010, except the 350,000 shares issued to Mr. Chamberlain, which
vested September 1, 2009 in connection with his Severance and Separation
Agreement. All of the restricted stock issued on March 29, 2009 becomes fully
vested on March 29, 2012, except the 750,000 shares issued to Mr. Chamberlain,
which vested September 1, 2009 in connection with his Severance and Separation
Agreement.  All of the restricted stock issued on September 1, 2009
becomes fully vested on September 1, 2010.





Compensation
of Directors





Each of
our directors who also serve as our executive officers do not receive any
additional compensation for their performance of services as
directors.  We may agree to provide compensation to these directors in
the future. We are in the process of determining the form and amounts of
compensation for our independent directors.




Compensation Policy Related to Risk
Management




We do not
believe that there are any risks arising from our compensation policies and
practices for our employees that are reasonably likely to have a material
adverse effect on us.







36





Item
      12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS





The
following table sets forth certain information, as of March 31, 2010, concerning
the beneficial ownership of shares of Common Stock of Deep Down by (i) each
person known by us to beneficially own more than 5 percent of
the  outstanding shares of our common stock; (ii) each Director; (iii)
our “Named Executive Officers” (as determined under Item 402(m) of Regulation
S-K); and (iv) all directors and executive officers of Deep Down as a group. To
our knowledge, 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. In addition, all
persons named below can be reached at Deep Down, Inc., 8827 W. Sam Houston Pkwy
N., Suite 100, Houston, Texas 77040.





Name
      of Beneficial Owner (1)
                Shares
      of
                  Common
                  Stock
                  Beneficially
                  Owned
                
                Percent
      of
                  CommonStock
                  OutstandingRonald
      E. Smith (2)
                45,229,876
                
                25.1%Mary
      L. Budrunas (2)
                45,229,876
                
                25.1%Robert
      E. Chamberlain, Jr. (3)(5)
                23,064,975
                
                12.8%Eugene
      L. Butler (4)
                3,766,667
                
                2.1%Michael
      J. Newbury
                -
                
                *Mark
      D. Hollinger
                -
                
                *All
      directors and officers as a group (5 persons)
                72,061,518
                (5)
                39.4%
 * - Less
than 1%


(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 180,450,630 shares of common stock
      outstanding as of March 31, 2010.


(2)
            Mr.
      Smith and Ms. Budrunas are husband and wife. Shares include 26,816,871
      shares owned directly by Mr. Smith and 18,413,005 shares owned directly by
      Ms. Budrunas. Such shares also include 350,000 shares of restricted stock
      issued to Mr. Smith on February 14, 2008 which became fully vested on the
      second anniversary of the grant, February 14, 2010, and 750,000 shares of
      restricted stock issued to Mr. Smith on March 29, 2009 which w fully
      vested on the second anniversary of the grant, March 29,
    2011.


(3)
            Shares
      include 350,000 shares of restricted stock issued to Mr. Chamberlain on
      February 14, 2008, and 750,000 shares of restricted stock issued to Mr.
      Chamberlain on March 29, 2009 which were fully vested on September 1, 2009
      in connection with Mr. Chamberlain’s Severance and Separation Agreement,
      plus 750,000 shares of restricted stock issued to Mr. Chamberlain on
      September 1, 2009 which will vest on the one year anniversary of the
      grant, September 1, 2010, in connection with such Severance and Separation
      Agreement.


(4)
            Shares
      include 350,000 shares of restricted stock issued to Mr. Butler on
      February 14, 2008 which become fully vested on the second anniversary of
      the grant, February 14, 2010, and 750,000 shares of restricted stock
      issued to Mr. Butler on March 29, 2009 which will be fully vested on the
      second anniversary of the grant, March 29, 2011, plus 2,666,667 shares of
      Deep Down’s common stock that Mr. Butler has the right to acquire by
      exercise of stock options which vested during 2008 and
    2009.


(5)
            Shares
      include 2,666,667 shares of Deep Down’s common stock that executive
      officers and directors have the right to acquire by exercise of stock
      options.





Disclosure
regarding our equity compensation plans as required by this item is incorporated
by reference to the information set forth under Item 5 “Market for the
Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities” in Part II of this report.





37





Item
      13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE





Review
and Approval of Related Person Transactions





Our Board
of Directors and Management recognize that related person transactions present a
heightened risk of conflicts of interest, and therefore we review all
relationships and transactions in which we and our directors, director nominees
and executive officers or their immediate family members, as well as holders of
more than 5% of any class of our voting securities and their family members,
have a direct or indirect material interest.  As required under SEC
rules, transactions that are determined to be directly or indirectly material to
us or a related person are disclosed in our annual Form 10-K
statement.





Ron
Smith, Eugene Butler and Robert Chamberlain (until his resignation from
this partnership effective September 1, 2009) are partners in Ship and Sail,
Inc., a vendor of Deep Down. During 2009, we made payments of $582,851 to Ship
and Sail, and we had a prepaid balance of $37,500 as of December 31, 2009 which
has been expensed in 2010. The payments to Ship and Sail related to services
provided by that entity for the  support of the development of marine
technology which is planned for production in fiscal 2010, including specialized
services for provision of vessel access for design and testing, and office space
and related utilities, plus a down-payment for a fixed asset under construction
that will be completed in 2010.  All transactions were conducted on an
arms-length basis and in accordance with normal terms and
conditions.





On May
29, 2009, we consummated a purchase transaction with JUMA Properties, LLC
(“JUMA”), a company owned by Ronald E. Smith, President, CEO and Director of
Deep Down and wife Mary L. Budrunas, Vice President, Corporate Secretary and
Director of Deep Down.  Pursuant to a Purchase and Sale Agreement dated May
22, 2009, we acquired certain property and improvements located in Channelview,
Texas, where certain of our operations are currently located (the “Channelview
Property”). The Channelview Property consists of 8.203 acres and was purchased
for $2,600,000. The transaction was conducted on an arms-length basis and in
accordance with normal terms and conditions. See additional discussion in Note
6, Long-Term Debt.





Until the
addition of Mr. Hollinger to our Board in April 2010, none of our Directors was
independent. We feel independent directors will add strength and perspective to
our Board of Directors and will increase our internal control process as
discussed above in Item 9A Controls and Procedures in this Report, thus we are
actively working towards adding additional independent members to our Board,
including member(s) who qualify as an audit committee financial expert as
defined in Item 407(d)(5)(ii) of Regulation
S-B.





Item
      14.
            PRINCIPAL
      ACCOUNTANT FEES AND
SERVICES





We
retained PricewaterhouseCoopers LLP (“PwC”) as our principal accountant in
2009.  We had no relationship with PwC prior to their retention as our
principal accountant. The following table sets forth the aggregate fees paid to
PwC for audit services rendered in connection with our consolidated financial
statements and reports for the year ended December 31, 2009, and for other
services rendered during that year on behalf of Deep Down and its subsidiaries,
and fees billed to us by Malone & Bailey, PC for audit and other services
during 2008:





December
      31, 2009
              
              
              December
      31, 2008(i)
      Audit Fees
              
              $
              502,023
              
              
              $
              503,714(ii)
      Audit Related Fees
              
              
              -
              
              
              
              86,634(iii)
      Tax Fees
              
              
              5,250
              
              
              
              49,130(iv)
      All Other Fees
              
              
              -
              
              
              
              -


38





Audit Fees: Consists of fees
billed for professional services rendered for the audit of Deep Down’s
consolidated financial statements, the review of interim condensed consolidated
financial statements included in quarterly reports, registration statements and
other offering documentation, services that are normally provided 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 Deep Down’s consolidated financial
statements and are not reported under "Audit Fees." These services include
auditing work on proposed transactions, including the audit of Mako
Technologies, Inc., and Flotation 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.





All Other
Fees:  None.





Pre-Approval
of Audit and Permissible Non-Audit Services of Independent
Auditors





The Board
of Directors pre-approves all audit and permissible non-audit services provided
by PwC. 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.











39





PART
IV





Item
      15.
            Exhibits,
      Financial Statement Schedules





(a)
            Financial
      Statements and Schedules.  See the consolidated financial
      statements and related schedules commencing on page F-1 of this
      report.(b)
            Exhibits.





2.1
                
                Agreement
      and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc.,
      and the majority shareholders of Deep Down, Inc. (incorporated by
      reference from Exhibit 2.1 to our Form 10-KSB/A filed with the Commission
      on May 1, 2008).3.1
                
                Articles
      of Incorporation of Deep Down, Inc. (conformed to include the amendment of
      the Articles of Incorporation filed with the Secretary of State of the
      State of Nevada on September 29, 2008 (incorporated by reference from
      Exhibit A to our Schedule 14C filed on August 15,
2008).3.2
                
                Amended
      and Restated By Laws of Deep Down, Inc. (incorporated by reference from
      Exhibit B to our Schedule 14C filed on August 15,
2008).3.3
                
                Form
      of Certificate of Designations of Series D Redeemable Convertible
      Preferred Stock (incorporated herein by reference from Exhibit 3.4 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).3.4
                
                Form
      of Certificate of Designations of Series E Redeemable Exchangeable
      Preferred Stock (incorporated herein by reference from Exhibit 3.5 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).3.5
                
                Form
      of Certificate of Designations of Series F Redeemable Convertible
      Preferred Stock (incorporated herein by reference from Exhibit 3.6 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).3.6
                
                Form
      of Certificate of Designations of Series G Redeemable Exchangeable
      Preferred Stock (incorporated herein by reference from Exhibit 3.7 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).4.1
                
                Common
      Stock Purchase Warrant for 320,000 shares of common stock of Deep Down,
      Inc. issued to Dragonfly Capital Partners, LLC dated August 6, 2007
      (incorporated herein by reference from Exhibit 4.2 to our Form 10-KSB
      filed with the Commission on April 1, 2008).4.2
                
                Common
      Stock Purchase Warrant for 118,812 shares of common stock of Deep Down,
      Inc. issued to Dragonfly Capital Partners, LLC dated January 4, 2008
      (incorporated herein by reference from Exhibit 4.3 to our Form 10-KSB
      filed with the Commission on April 1, 2008).4.3
                
                Common
      Stock Purchase Warrant for 200,000 shares of common stock of Deep Down,
      Inc. issued to Subsea, LLC dated June 6, 2008 (incorporated herein by
      reference from Exhibit 4.1 to our Form 8-K/A (Amendment No. 2) filed with
      the Commission on June 9, 2008).4.4
                
                Registration
      Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect
      Capital Corporation (incorporated herein by reference from Exhibit 4.4 to
      our Form 10-KSB/A filed with the Commission on May 1,
    2008).4.5
                
                Private
      Placement Memorandum, dated May 16, 2008 (incorporated herein by reference
      from Exhibit 20.1 to our Form 8-K/A (Amendment No. 2) filed with the
      Commission on June 9, 2008).4.6
                
                Amended
      and Restated Supplement No. 1 to Private Placement Memorandum, dated June
      2, 2008 (incorporated herein by reference from Exhibit 4.6 to our Form S-1
      Registration Statement (file no. 333-152435) filed with the Commission on
      July 21, 2008).4.7
                
                Purchase
      Agreement, dated June 2, 2008, among Deep Down, Inc., and the Purchasers
      named therein (incorporated herein by reference from Exhibit 10.1 to our
      Form 8-K/A (Amendment No. 2) filed with the Commission on June 9,
      2008).4.8
                
                6%
      Subordinated Debenture of Deep Down, Inc. dated March 31, 2008
      (incorporated herein by reference from Exhibit 4.1 to our Form 10-Q filed
      with the Commission on May 16, 2008).4.9†
                
                Stock
      Option, Stock Warrant and Stock Award Plan (incorporated herein by
      reference from Exhibit 4.10 to our Form S-1 Registration Statement (file
      no. 333-152435) filed with the Commission on July 21,
    2008).4.10
                
                Certificate
      of Articles of Organization of Deep Down International Holdings, LLC
      (filed with the Secretary of State for the state of Nevada on February 3,
      2009) (incorporated by reference from Exhibit 4.11 to Amendment No. 3 to
      our Form S-1/A filed on April 10, 2009).4.11
                
                Operating
      Agreement of Deep Down International Holdings, LLC, a Nevada limited
      liability company (incorporated by reference from Exhibit 4.11 to
      Amendment No. 3 to our Form S-1/A filed on April 9,
  2009).  10.1
                
                Credit
      Agreement, dated as of November 11, 2008, among Deep Down, Inc. as
      borrower and Whitney National Bank, as lender (incorporated herein by
      reference from Exhibit 10.1 to our Form 10-Q filed with the Commission on
      November 14, 2008).  40
  10.2
                
                First
      Amendment to Credit Agreement entered into as of December 18, 2008, among
      Deep Down, Inc. as borrower and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc. (incorporated herein by reference from Exhibit 10.1 to our Form 8-K
      filed with the Commission on December 19, 2008).10.3
                
                Second
      Amendment to Credit Agreement entered into as of February 13, 2009, among
      Deep Down, Inc., as borrower, and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc. (incorporated herein by reference from Exhibit 10.3 to our Form 10-K
      filed with the Commission on March 16, 2009).10.4
                
                Guaranty,
      dated as of November 11, 2008, by ElectroWave USA, Inc., Flotation
      Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the
      benefit of Whitney National Bank (incorporated herein by reference from
      Exhibit 10.2 to our Form 10-Q filed with the Commission on November 14,
      2008).10.5
                
                Joinder
      to Guaranty, dated as of February 13, 2009, by Deep Down International
      Holdings, LLC (incorporated herein by reference from Exhibit 10.5 to our
      Form 10-K filed with the Commission on March 16, 2009).10.6
                
                Security
      Agreement, dated as of November 11, 2008, among Deep Down, Inc.,
      ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies,
      LLC and Deep Down, Inc. for the benefit of Whitney National Bank
      (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed
      with the Commission on November 14, 2008).10.7
                
                Joinder
      to Security Agreement, dated as of February 13, 2009, by Deep Down
      International Holdings, LLC (incorporated herein by reference from Exhibit
      10.7 to our Form 10-K filed with the Commission on March 16,
      2009).10.8
                
                Second
      Amendment to Security Agreement, dated as of February 13, 2009, by Deep
      Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako
      Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National
      Bank (incorporated herein by reference from Exhibit 10.3 to our Form 8-K
      filed with the Commission on December 19, 2008).10.9
                
                Term
      Note, dated December 18, 2008, executed by Deep Down, Inc. and paid to
      order to Whitney National Bank (incorporated herein by reference from
      Exhibit 10.2 to our Form 8-K filed with the Commission on December 19,
      2008).10.10†
                
                Consulting
      Agreement, dated as of August 6, 2007, between Deep Down, Inc. and
      Strategic Capital Services, Inc. regarding the services of Robert
      Chamberlain (incorporated herein by reference from Exhibit 10.1 to our
      Form 10-KSB filed with the Commission on April 1,
2008).10.11†
                
                Employment
      Agreement, dated as of August 6, 2007, between Deep Down, Inc. and Ronald
      E. Smith (incorporated herein by reference from Exhibit 10.2 to our Form
      10-KSB filed with the Commission on April 1, 2008).10.12
                
                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 herein by reference from Exhibit 2.1 to
      our Form 10-KSB filed with the Commission on April 1,
    2008).10.13
                
                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 (incorporated herein
      by reference from Exhibit 10.10 to our Form 10-KSB/A filed with the
      Commission on May 1, 2008).10.14
                
                Office
      Building Lease, dated November 24, 2008, between Deep Down, Inc. and
      A-K-S-L 49 Beltway 8, L.P. (incorporated herein by reference from Exhibit
      10.18 to our Form 10-K filed with the Commission on March 16,
      2009).10.15†
                
                Severance
      and Separation Agreement, dated September 1, 2009, by and between
      Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr.
      (“Consultant”) and Deep Down, Inc. (incorporated herein by reference from
      Exhibit 10.3 to our Form 10-Q filed with the Commission on November 16,
      2009).10.16
                
                Stock
      Purchase Agreement, dated April 17, 2008, among Deep Down, Inc., Flotation
      Technologies, Inc. and the selling stockholders named therein
      (incorporated herein by reference from Exhibit 10.1 to our Form 8-K filed
      with the Commission on April 21, 2008).10.17†
                
                Employment
      Agreement with David A. Capotosto, dated June 5, 2008 (incorporated herein
      by reference from Exhibit 10.12 to our Form S-1 Registration Statement
      (file no. 333-152435) filed with the Commission on July 21,
      2008).10.18
                
                Loan
      Agreement entered into as of February 13, 2009, by and among Flotation
      Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated
      herein by reference from Exhibit 10.22 to our Form 10-K filed with the
      Commission on March 16, 2009).10.19
                
                Mortgage
      and Security Agreement entered into as of February 13, 2009, by Flotation
      Technologies in favor of TD Bank, N.A. (incorporated herein by reference
      from Exhibit 10.23 to our Form 10-K filed with the Commission on March 16,
      2009).10.20
                
                Collateral
      Assignment of Leases and Rents entered as of February 13, 2009, by
      Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated
      herein by reference from Exhibit 10.24 to our Form 10-K filed with the
      Commission on March 16, 2009).10.21
                
                Commercial
      Note entered into as of February 13, 2009 by Flotation Technologies, Inc.
      in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit
      10.25 to our Form 10-K filed with the Commission on March 16,
      2009).10.22
                
                Debt
      Subordination Agreement entered into as of February 13, 2009, by and among
      Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A.
      (incorporated herein by reference from Exhibit 10.26 to our Form 10-K
      filed with the Commission on March 16, 2009).10.23
                
                Purchase
      and Sale Agreement, dated May 22, 2009, by and between Deep Down, Inc. and
      JUMA Properties, LLC (incorporated by reference from Exhibit 10.1 to our
      Form 8-K filed on June 2, 2009).10.24
                
                Deed
      of Trust, Security Agreement and UCC Financing Statement for Fixture
      Filing, executed as of May 29, 2009, by Deep Down, Inc., as grantor, in
      favor of Gary M. Olander, as trustee, for the benefit of Whitney National
      Bank, as beneficiary (incorporated by reference from Exhibit 10.2 to our
      Form 8-K filed on June 2, 2009).  41
  10.25
                
                Third
      Amendment to Credit Agreement, entered into as of May 29, 2009, between
      Deep Down, Inc., as borrower, and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc. (incorporated by reference from Exhibit 10.3 to our Form 8-K filed on
      June 2, 2009).10.26
                
                Second
      Amendment to Security Agreement, executed as of May 29, 2009, by Deep
      Down, Inc. ElectroWave USA, Inc., Flotation Technologies, Inc., Mako
      Technologies, LLC and Deep Down, Inc., for the benefit of Whitney National
      Bank (incorporated by reference from Exhibit 10.4 to our Form 8-K filed on
      June 2, 2009).10.27†
                
                Employment
      Agreement, dated effective as of January 1, 2010, between Deep Down, Inc.
      and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our
      Form 8-K filed on January 15, 2010).10.28†
                
                Amended
      and Restated Employment Agreement, dated effective as of January 1, 2010,
      between Deep Down, Inc. and Ronald E. Smith (incorporated by reference
      from Exhibit 10.1 to our Form 8-K filed on January 15,
    2010).10.29
                
                Environmental
      Indemnity Agreement entered as of February 13, 2009 in favor of TD Bank,
      N.A. (incorporated herein by reference from Exhibit 10.27 to our Form 10-K
      filed with the Commission on March 16, 2009).10.30*†
                
                Employment
      Agreement, dated effective as of February 17, 2010, between Deep Down,
      Inc. and Michael J. Newbury.  10.31*
                
                Amended
      and Restated Credit Agreement, entered into as of April 14, 2010, between
      Deep Down, Inc., as borrower, and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc.10.32*
                
                ROV
      Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to
      the order of Whitney National Bank.10.33*
                
                RE
      Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to
      the order of Whitney National Bank.10.34*
                
                RLOC
      Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to
      the order of Whitney National Bank.10.35*
                
                LC
      Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the
      order of Whitney National Bank.10.36*
                
                Ratification
      of Guaranty, Security Agreement, and Intercreditor Agreement, dated April
      14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and
      Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies,
      LLC, Deep Down Inc., a Delaware corporation, each a guarantor, and Whitney
      National Bank, a national banking association, as
  lender.10.37*
                
                First
      Modification to Deed of Trust, dated April 14, 2010, executed by Deep
      Down, Inc., as grantor, for the benefit of Whitney National Bank, as
      lender.10.38*
                
                First
      Modification to Assignment of Leases and Rents, dated April 14, 2010,
      executed by Deep Down, Inc., as assignor, and Whitney National Bank, as
      assignee.14.1*
                
                Directors
      Code of Business Conduct.14.2*
                
                Financial
      Officer's Code of Business Conduct.16.1
                
                Letter,
      dated July 14, 2009, from Malone & Bailey, PC to the Securities and
      Exchange Commission (incorporated by reference from Exhibit 16.1 to our
      Form 8-K filed on July 14, 2009).21.1*
                
                Subsidiary
      list.24.1*
                
                Power
      of Attorney (set forth immediately following the registrant’s signatures
      to this report).31.1*
                
                Rule
      13a-14(a)/15d-14(a) Certification of the President and Chief Executive
      Officer of Deep Down, Inc.31.2*
                
                Rule
      13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep
      Down, Inc.32.1*
                
                Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
                
                Section
      1350 Certification of the Chief Financial Officer of Deep Down,
      Inc.
 * Filed
or furnished herewith.


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





42





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.


(Registrant)








/s/ RONALD E. SMITH


Ronald E.
Smith, President and Chief Executive Officer


Dated:
April 15, 2010








/s/ EUGENE L. BUTLER


Eugene L.
Butler


Chief
Financial Officer


Dated:
April 15, 2010








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-substitution for him or her and in his or her name, place
and stead, in any and all capacities, to sign any and all amendments to this
Annual Report on Form 10-K, 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 DirectorRonald
      E. Smith
            
            (Principal
      Executive Officer)
            April
      15, 2010/s/ EUGENE L.
      BUTLER
            
            Chief
      Financial Officer and DirectorEugene
      L. Butler
            
            (Principal
      Financial Officer and Principal Accounting Officer)
            April
      15, 2010/s/ MARY L.
      BUDRUNAS
            
            Vice-President,
      Corporate Secretary and DirectorMary
      L. Budrunas
            
            
            April
      15, 2010/s/ MARK D.
      HOLLINGER
            
            DirectorMark
      D. Hollinger
            
            
            April
      15, 2010








43





EXHIBIT
INDEX





Exhibit
                Number
              
              Description
      of Exhibit2.1
              
              Agreement
      and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc.,
      and the majority shareholders of Deep Down, Inc. (incorporated by
      reference from Exhibit 2.1 to our Form 10-KSB/A filed with the Commission
      on May 1, 2008).3.1
              
              Articles
      of Incorporation of Deep Down, Inc. (conformed to include the amendment of
      the Articles of Incorporation filed with the Secretary of State of the
      State of Nevada on September 29, 2008 (incorporated by reference from
      Exhibit A to our Schedule 14C filed on August 15,
2008).3.2
              
              Amended
      and Restated By Laws of Deep Down, Inc. (incorporated by reference from
      Exhibit B to our Schedule 14C filed on August 15,
2008).3.3
              
              Form
      of Certificate of Designations of Series D Redeemable Convertible
      Preferred Stock (incorporated herein by reference from Exhibit 3.4 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).3.4
              
              Form
      of Certificate of Designations of Series E Redeemable Exchangeable
      Preferred Stock (incorporated herein by reference from Exhibit 3.5 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).3.5
              
              Form
      of Certificate of Designations of Series F Redeemable Convertible
      Preferred Stock (incorporated herein by reference from Exhibit 3.6 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).3.6
              
              Form
      of Certificate of Designations of Series G Redeemable Exchangeable
      Preferred Stock (incorporated herein by reference from Exhibit 3.7 to our
      Form 10-KSB/A filed with the Commission on May 1,
2008).4.1
              
              Common
      Stock Purchase Warrant for 320,000 shares of common stock of Deep Down,
      Inc. issued to Dragonfly Capital Partners, LLC dated August 6, 2007
      (incorporated herein by reference from Exhibit 4.2 to our Form 10-KSB
      filed with the Commission on April 1, 2008).4.2
              
              Common
      Stock Purchase Warrant for 118,812 shares of common stock of Deep Down,
      Inc. issued to Dragonfly Capital Partners, LLC dated January 4, 2008
      (incorporated herein by reference from Exhibit 4.3 to our Form 10-KSB
      filed with the Commission on April 1, 2008).4.3
              
              Common
      Stock Purchase Warrant for 200,000 shares of common stock of Deep Down,
      Inc. issued to Subsea, LLC dated June 6, 2008 (incorporated herein by
      reference from Exhibit 4.1 to our Form 8-K/A (Amendment No. 2) filed with
      the Commission on June 9, 2008).4.4
              
              Registration
      Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect
      Capital Corporation (incorporated herein by reference from Exhibit 4.4 to
      our Form 10-KSB/A filed with the Commission on May 1,
    2008).4.5
              
              Private
      Placement Memorandum, dated May 16, 2008 (incorporated herein by reference
      from Exhibit 20.1 to our Form 8-K/A (Amendment No. 2) filed with the
      Commission on June 9, 2008).4.6
              
              Amended
      and Restated Supplement No. 1 to Private Placement Memorandum, dated June
      2, 2008 (incorporated herein by reference from Exhibit 4.6 to our Form S-1
      Registration Statement (file no. 333-152435) filed with the Commission on
      July 21, 2008).4.7
              
              Purchase
      Agreement, dated June 2, 2008, among Deep Down, Inc., and the Purchasers
      named therein (incorporated herein by reference from Exhibit 10.1 to our
      Form 8-K/A (Amendment No. 2) filed with the Commission on June 9,
      2008).4.8
              
              6%
      Subordinated Debenture of Deep Down, Inc. dated March 31, 2008
      (incorporated herein by reference from Exhibit 4.1 to our Form 10-Q filed
      with the Commission on May 16, 2008).4.9†
              
              Stock
      Option, Stock Warrant and Stock Award Plan (incorporated herein by
      reference from Exhibit 4.10 to our Form S-1 Registration Statement (file
      no. 333-152435) filed with the Commission on July 21,
    2008).4.10
              
              Certificate
      of Articles of Organization of Deep Down International Holdings, LLC
      (filed with the Secretary of State for the state of Nevada on February 3,
      2009) (incorporated by reference from Exhibit 4.11 to Amendment No. 3 to
      our Form S-1/A filed on April 10, 2009).4.11
              
              Operating
      Agreement of Deep Down International Holdings, LLC, a Nevada limited
      liability company (incorporated by reference from Exhibit 4.11 to
      Amendment No. 3 to our Form S-1/A filed on April 9,
  2009).   44
  10.1
              
              Credit
      Agreement, dated as of November 11, 2008, among Deep Down, Inc. as
      borrower and Whitney National Bank, as lender (incorporated herein by
      reference from Exhibit 10.1 to our Form 10-Q filed with the Commission on
      November 14, 2008).10.2
              
              First
      Amendment to Credit Agreement entered into as of December 18, 2008, among
      Deep Down, Inc. as borrower and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc. (incorporated herein by reference from Exhibit 10.1 to our Form 8-K
      filed with the Commission on December 19, 2008).10.3
              
              Second
      Amendment to Credit Agreement entered into as of February 13, 2009, among
      Deep Down, Inc., as borrower, and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc. (incorporated herein by reference from Exhibit 10.3 to our Form 10-K
      filed with the Commission on March 16, 2009).10.4
              
              Guaranty,
      dated as of November 11, 2008, by ElectroWave USA, Inc., Flotation
      Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. for the
      benefit of Whitney National Bank (incorporated herein by reference from
      Exhibit 10.2 to our Form 10-Q filed with the Commission on November 14,
      2008).10.5
              
              Joinder
      to Guaranty, dated as of February 13, 2009, by Deep Down International
      Holdings, LLC (incorporated herein by reference from Exhibit 10.5 to our
      Form 10-K filed with the Commission on March 16, 2009).10.6
              
              Security
      Agreement, dated as of November 11, 2008, among Deep Down, Inc.,
      ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies,
      LLC and Deep Down, Inc. for the benefit of Whitney National Bank
      (incorporated herein by reference from Exhibit 10.3 to our Form 10-Q filed
      with the Commission on November 14, 2008).10.7
              
              Joinder
      to Security Agreement, dated as of February 13, 2009, by Deep Down
      International Holdings, LLC (incorporated herein by reference from Exhibit
      10.7 to our Form 10-K filed with the Commission on March 16,
      2009).10.8
              
              Second
      Amendment to Security Agreement, dated as of February 13, 2009, by Deep
      Down, Inc., ElectroWave USA, Inc., Flotation Technologies, Inc., Mako
      Technologies, LLC and Deep Down, Inc. for the benefit of Whitney National
      Bank (incorporated herein by reference from Exhibit 10.3 to our Form 8-K
      filed with the Commission on December 19, 2008).10.9
              
              Term
      Note, dated December 18, 2008, executed by Deep Down, Inc. and paid to
      order to Whitney National Bank (incorporated herein by reference from
      Exhibit 10.2 to our Form 8-K filed with the Commission on December 19,
      2008).10.10†
              
              Consulting
      Agreement, dated as of August 6, 2007, between Deep Down, Inc. and
      Strategic Capital Services, Inc. regarding the services of Robert
      Chamberlain (incorporated herein by reference from Exhibit 10.1 to our
      Form 10-KSB filed with the Commission on April 1,
2008).10.11†
              
              Employment
      Agreement, dated as of August 6, 2007, between Deep Down, Inc. and Ronald
      E. Smith (incorporated herein by reference from Exhibit 10.2 to our Form
      10-KSB filed with the Commission on April 1, 2008).10.12
              
              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 herein by reference from Exhibit 2.1 to
      our Form 10-KSB filed with the Commission on April 1,
    2008).10.13
              
              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 (incorporated herein
      by reference from Exhibit 10.10 to our Form 10-KSB/A filed with the
      Commission on May 1, 2008).10.14
              
              Office
      Building Lease, dated November 24, 2008, between Deep Down, Inc. and
      A-K-S-L 49 Beltway 8, L.P. (incorporated herein by reference from Exhibit
      10.18 to our Form 10-K filed with the Commission on March 16,
      2009).10.15†
              
              Severance
      and Separation Agreement, dated September 1, 2009, by and between
      Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr.
      (“Consultant”) and Deep Down, Inc. (incorporated herein by reference from
      Exhibit 10.3 to our Form 10-Q filed with the Commission on November 16,
      2009).10.16
              
              Stock
      Purchase Agreement, dated April 17, 2008, among Deep Down, Inc., Flotation
      Technologies, Inc. and the selling stockholders named therein
      (incorporated herein by reference from Exhibit 10.1 to our Form 8-K filed
      with the Commission on April 21, 2008).10.17†
              
              Employment
      Agreement with David A. Capotosto, dated June 5, 2008 (incorporated herein
      by reference from Exhibit 10.12 to our Form S-1 Registration Statement
      (file no. 333-152435) filed with the Commission on July 21,
      2008).10.18
              
              Loan
      Agreement entered into as of February 13, 2009, by and among Flotation
      Technologies, Inc., Deep Down, Inc., and TD Bank, N.A. (incorporated
      herein by reference from Exhibit 10.22 to our Form 10-K filed with the
      Commission on March 16, 2009).10.19
              
              Mortgage
      and Security Agreement entered into as of February 13, 2009, by Flotation
      Technologies in favor of TD Bank, N.A. (incorporated herein by reference
      from Exhibit 10.23 to our Form 10-K filed with the Commission on March 16,
      2009).10.20
              
              Collateral
      Assignment of Leases and Rents entered as of February 13, 2009, by
      Flotation Technologies, Inc. in favor of TD Bank, N.A. (incorporated
      herein by reference from Exhibit 10.24 to our Form 10-K filed with the
      Commission on March 16, 2009).10.21
              
              Commercial
      Note entered into as of February 13, 2009 by Flotation Technologies, Inc.
      in favor of TD Bank, N.A. (incorporated herein by reference from Exhibit
      10.25 to our Form 10-K filed with the Commission on March 16,
      2009).10.22
              
              Debt
      Subordination Agreement entered into as of February 13, 2009, by and among
      Flotation Technologies, Inc., Deep Down, Inc., and TD Bank, N.A.
      (incorporated herein by reference from Exhibit 10.26 to our Form 10-K
      filed with the Commission on March 16,
2009).  45
  10.23
              
              Purchase
      and Sale Agreement, dated May 22, 2009, by and between Deep Down, Inc. and
      JUMA Properties, LLC (incorporated by reference from Exhibit 10.1 to our
      Form 8-K filed on June 2, 2009).  10.24
              
              Deed
      of Trust, Security Agreement and UCC Financing Statement for Fixture
      Filing, executed as of May 29, 2009, by Deep Down, Inc., as grantor, in
      favor of Gary M. Olander, as trustee, for the benefit of Whitney National
      Bank, as beneficiary (incorporated by reference from Exhibit 10.2 to our
      Form 8-K filed on June 2, 2009).10.25
              
              Third
      Amendment to Credit Agreement, entered into as of May 29, 2009, between
      Deep Down, Inc., as borrower, and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc. (incorporated by reference from Exhibit 10.3 to our Form 8-K filed on
      June 2, 2009).10.26
              
              Second
      Amendment to Security Agreement, executed as of May 29, 2009, by Deep
      Down, Inc. ElectroWave USA, Inc., Flotation Technologies, Inc., Mako
      Technologies, LLC and Deep Down, Inc., for the benefit of Whitney National
      Bank (incorporated by reference from Exhibit 10.4 to our Form 8-K filed on
      June 2, 2009).10.27†
              
              Employment
      Agreement, dated effective as of January 1, 2010, between Deep Down, Inc.
      and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our
      Form 8-K filed on January 15, 2010).10.28†
              
              Amended
      and Restated Employment Agreement, dated effective as of January 1, 2010,
      between Deep Down, Inc. and Ronald E. Smith (incorporated by reference
      from Exhibit 10.1 to our Form 8-K filed on January 15,
    2010).10.29
              
              Environmental
      Indemnity Agreement entered as of February 13, 2009 in favor of TD Bank,
      N.A. (incorporated herein by reference from Exhibit 10.27 to our Form 10-K
      filed with the Commission on March 16, 2009).10.30*†
              
              Employment
      Agreement, dated effective as of February 17, 2010, between Deep Down,
      Inc. and Michael J. Newbury.  10.31*
              
              Amended
      and Restated Credit Agreement, entered into as of April 14, 2010, between
      Deep Down, Inc., as borrower, and Whitney National Bank, including the
      Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA,
      Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down,
      Inc.10.32*
              
              ROV
      Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to
      the order of Whitney National Bank.10.33*
              
              RE
      Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to
      the order of Whitney National Bank.10.34*
              
              RLOC
      Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to
      the order of Whitney National Bank.10.35*
              
              LC
      Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the
      order of Whitney National Bank.10.36*
              
              Ratification
      of Guaranty, Security Agreement, and Intercreditor Agreement, dated April
      14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and
      Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies,
      LLC, Deep Down Inc., a Delaware corporation, each a guarantor, and Whitney
      National Bank, a national banking association, as
  lender.10.37*
              
              First
      Modification to Deed of Trust, dated April 14, 2010, executed by Deep
      Down, Inc., as grantor, for the benefit of Whitney National Bank, as
      lender.10.38*
              
              First
      Modification to Assignment of Leases and Rents, dated April 14, 2010,
      executed by Deep Down, Inc., as assignor, and Whitney National Bank, as
      assignee.14.1*
              
              Directors
      Code of Business Conduct.14.2*
              
              Financial
      Officer's Code of Business Conduct.16.1
              
              Letter,
      dated July 14, 2009, from Malone & Bailey, PC to the Securities and
      Exchange Commission (incorporated by reference from Exhibit 16.1 to our
      Form 8-K filed on July 14, 2009).21.1*
              
              Subsidiary
      list.24.1*
              
              Power
      of Attorney (set forth immediately following the registrant’s signatures
      to this report).31.1*
              
              Rule
      13a-14(a)/15d-14(a) Certification of the President and Chief Executive
      Officer of Deep Down, Inc.31.2*
              
              Rule
      13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep
      Down, Inc.32.1*
              
              Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
              
              Section
      1350 Certification of the Chief Financial Officer of Deep Down,
      Inc.
 
 * Filed
or furnished herewith.
 
 † Exhibit
constitutes a management contract or compensatory plan or
arrangement.


46








INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS








Reports
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Balance Sheets
            F-4Consolidated
      Statements of Operations
            F-5Consolidated
      Statements of Changes in Stockholders’ Equity
            F-6Consolidated
      Statements of Cash Flows
            F-7Notes
      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.





We have
audited the accompanying consolidated balance sheet of Deep Down, Inc. and its
subsidiaries as of December 31, 2009, and the related consolidated statement of
income, shareholders' equity and cash flows for the year ended December 31,
2009.  These financial statements are the responsibility of the
Company’s management.  Our responsibility is to express an opinion on
these financial statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audit provides a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Deep Down, Inc. and their
subsidiaries at December 31, 2009, and the results of their operations and their
cash flows for the year ended December 31, 2009 in conformity with accounting
principles generally accepted in the United States of
America.








/s/  PRICEWATERHOUSE COOPERS,
LLP


Houston,
Texas


April 15,
2010











F-2





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 sheet of Deep Down, Inc. (the
"Company") as of December 31, 2008 and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for the year then
ended. These consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.





We
conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audit provides a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company, as of December
31, 2008, and the results of its operations and its cash flows for the year
then ended in conformity with accounting principles generally accepted in
the United States of America.








/s/  MALONE &
BAILEY, PC


www.malone-bailey.com


Houston,
Texas





March 12,
2009




















F-3





Deep Down,
Inc. Consolidated
Balance Sheets





(In
      thousands, except par value amounts)
              
              December
      31, 2009
              
              
              December
      31, 2008ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              912
              
              
              $
              2,495Restricted
      cash
              
              
              -
              
              
              
              136Accounts
      receivable, net
              
              
              7,662
              
              
              
              10,772Inventory
              
              
              896
              
              
              
              1,362Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
              
              
              267
              
              
              
              708Deferred
      tax asset
              
              
              -
              
              
              
              217Prepaid
      expenses and other current assets
              
              
              225
              
              
              
              634Total
      current assets
              
              
              9,962
              
              
              
              16,324Property,
      plant and equipment, net
              
              
              20,011
              
              
              
              13,799Intangibles,
      net
              
              
              12,166
              
              
              
              18,091Goodwill
              
              
              9,429
              
              
              
              15,024Other
      assets, net
              
              
              1,136
              
              
              
              458Total
      assets
              
              $
              52,704
              
              
              $
              63,696LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable and accrued liabilities
              
              $
              2,865
              
              
              $
              4,319Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
              
              
              4,434
              
              
              
              2,315Current
      portion of long-term debt
              
              
              1,497
              
              
              
              383Total
      current liabilities
              
              
              8,796
              
              
              
              7,017Long-term
      debt, net
              
              
              5,379
              
              
              
              1,718Deferred
      tax liabilities
              
              
              -
              
              
              
              1,126Total
      liabilities
              
              
              14,175
              
              
              
              9,861Commitments
      and contingencies (Note 11)Stockholders'
      equity:Common
      stock, $0.001 par value, 490,000 shares authorized, 180,451and
      177,351 shares issued and outstanding, respectively
              
              
              180
              
              
              
              177Additional
      paid-in capital
              
              
              61,161
              
              
              
              60,328Accumulated
      deficit
              
              
              (22,812
              )
              
              
              (6,670
              )Total
      stockholders' equity
              
              
              38,529
              
              
              
              53,835Total
      liabilities and stockholders' equity
              
              $
              52,704
              
              
              $
              63,696
 
 The
accompanying notes are an integral part of the financial
statements.


F-4





Deep
Down, Inc.
 Consolidated Statements of Operations For
the Years Ended December 31, 2009 and
2008





Years
      EndedDecember
      31,(In
      thousands, except per share amounts)
              
              2009
              
              
              2008Revenues
              
              $
              29,449
              
              
              $
              35,770Cost
      of sales
              
              
              19,888
              
              
              
              21,686Gross
      profit
              
              
              9,561
              
              
              
              14,084Operating
      expenses:Selling,
      general & administrative
              
              
              14,371
              
              
              
              14,295Depreciation
      and amortization
              
              
              6,538
              
              
              
              1,285Goodwill
      impairment
              
              
              5,537
              
              
              
              -Total
      operating expenses
              
              
              26,446
              
              
              
              15,580Operating
      loss
              
              
              (16,885
              )
              
              
              (1,496
              )Other
      income (expense):Interest
      income
              
              
              10
              
              
              
              110Interest
      expense
              
              
              (366
              )
              
              
              (3,511
              )Loss
      on debt extinguishment
              
              
              -
              
              
              
              (446
              )Other
      income (expense)
              
              
              73
              
              
              
              (22
              )Total
      other expense
              
              
              (283
              )
              
              
              (3,869
              )Loss
      before income taxes
              
              
              (17,168
              )
              
              
              (5,365
              )Income
      tax benefit
              
              
              1,026
              
              
              
              1,042Net
      loss
              
              $
              (16,142
              )
              
              $
              (4,323
              )Net
      loss per share, basic and diluted
              
              $
              (0.09
              )
              
              $
              (0.03
              )Weighted-average
      common sharesoutstanding,
      basic and diluted
              
              
              179,430
              
              
              
              143,962


The
accompanying notes are an integral part of the financial
statements.


F-5





Deep
Down, Inc.
 Statements
of Changes in Stockholders'
Equity
 For
the Years Ended December 31, 2009 and 2008
 
 AdditionalCommon
      Stock
              
              
              Paid-in
              
              
              Accumulated(In
      thousands)
              
              Shares
      (#)
              
              
              Amount
      ($)
              
              
              Capital
              
              
              Deficit
              
              
              TotalBalance
      at December 31, 2007
              
              
              85,977
              
              
              $
              86
              
              
              $
              14,850
              
              
              $
              (2,347
              )
              
              $
              12,589Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (4,323
              )
              
              
              (4,323
              )Exchange
      of Series D preferred stock
              
              
              25,867
              
              
              
              26
              
              
              
              4,393
              
              
              
              
              
              
              
              4,419Stock
      issued for acquisition of Mako
              
              
              2,803
              
              
              
              3
              
              
              
              1,959
              
              
              
              
              
              
              
              1,962Stock
      issued for acquisition of Flotation
              
              
              1,714
              
              
              
              2
              
              
              
              1,421
              
              
              
              
              
              
              
              1,423Warrants
      issued for acquisition of Flotation
              
              
              -
              
              
              
              -
              
              
              
              122
              
              
              
              
              
              
              
              122Restricted
      stock issued for service
              
              
              1,200
              
              
              
              1
              
              
              
              (1
              )
              
              
              
              
              
              
              -Stock
      issued in private placement, net of $2,940 fees
              
              
              57,143
              
              
              
              57
              
              
              
              37,003
              
              
              
              
              
              
              
              37,060Cashless
      exercise of stock options
              
              
              29
              
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              -Stock
      issued for exercise of warrants
              
              
              2,618
              
              
              
              2
              
              
              
              (3
              )
              
              
              
              
              
              
              (1
              )Stock-based
      compensation
              
              
              -
              
              
              
              -
              
              
              
              584
              
              
              
              
              
              
              
              584Balance
      at December 31, 2008
              
              
              177,351
              
              
              $
              177
              
              
              $
              60,328
              
              
              $
              (6,670
              )
              
              $
              53,835Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (16,142
              )
              
              
              (16,142
              )Restricted
      stock issued for service
              
              
              3,100
              
              
              
              3
              
              
              
              (3
              )
              
              
              -
              
              
              
              -Stock-based
      compensation
              
              
              -
              
              
              
              -
              
              
              
              836
              
              
              
              -
              
              
              
              836Balance
      at December 31, 2009
              
              
              180,451
              
              
              $
              180
              
              
              $
              61,161
              
              
              $
              (22,812
              )
              
              $
              38,529


The
accompanying notes are an integral part of the financial
statements.


F-6





Deep
Down, Inc.
 Consolidated Statement of Cash
Flows
 For
the Years Ended December 31, 2009 and 2008





Years
      EndedDecember
      31,(In
      thousands)
              
              2009
              
              
              2008Cash
      flows from operating activities:Net
      loss
              
              $
              (16,142
              )
              
              $
              (4,323
              )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Interest
      income
              
              
              -
              
              
              
              (55
              )Non-cash
      amortization of debt discount
              
              
              -
              
              
              
              1,817Non-cash
      amortization of deferred financing costs
              
              
              -
              
              
              
              763Non-cash
      impairment of goodwill
              
              
              5,537
              
              
              
              -Share-based
      compensation
              
              
              836
              
              
              
              584Bad
      debt expense
              
              
              192
              
              
              
              1,507Depreciation
      and amortization
              
              
              8,154
              
              
              
              2,363Loss
      on disposal of equipment
              
              
              78
              
              
              
              228Deferred
      taxes
              
              
              (909
              )
              
              
              (856
              )Changes
      in assets and liabilities:Accounts
      receivable
              
              
              2,918
              
              
              
              (3,087
              )Inventory
              
              
              466
              
              
              
              (1,932
              )Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
              
              
              441
              
              
              
              1,483Prepaid
      expenses and other current assets
              
              
              409
              
              
              
              (493
              )Other
      assets
              
              
              (113
              )
              
              
              -Accounts
      payable and accrued liabilities
              
              
              (1,454
              )
              
              
              (328
              )Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
              
              
              2,119
              
              
              
              2,127Net
      cash provided by (used in) operating activities
              
              
              2,532
              
              
              
              (202
              )Cash
      flows from investing activities:Cash
      paid for acquisition of Flotation, net of cash acquired of
      $235
              
              
              -
              
              
              
              (22,162
              )Proceeds
      from final settlement of acquisition of Flotation
              
              
              58
              
              
              
              -Cash
      paid for acquisition of Mako, net of expenses
              
              
              -
              
              
              
              (4,237
              )Purchases
      of property and equipment
              
              
              (6,117
              )
              
              
              (4,804
              )Proceeds
      from sale of property and equipment
              
              
              148
              
              
              
              -Cash
      paid for capitalized software
              
              
              (614
              )
              
              
              -Purchase
      of investment
              
              
              (200
              )
              
              
              -Note
      receivable, net of repayments
              
              
              (22
              )
              
              
              -Change
      in restricted cash
              
              
              136
              
              
              
              239Net
      cash used in investing activities
              
              
              (6,611
              )
              
              
              (30,964
              )Cash
      flows from financing activities:Proceeds
      from sale of common stock, net of expenses
              
              
              -
              
              
              
              37,060Proceeds
      from sales-type lease
              
              
              -
              
              
              
              587Borrowings
      on long-term debt
              
              
              3,000
              
              
              
              6,769Repayments
      on long-term debt
              
              
              (504
              )
              
              
              (12,961
              )Net
      cash provided by financing activities
              
              
              2,496
              
              
              
              31,455Change
      in cash and equivalents
              
              
              (1,583
              )
              
              
              289Cash
      and cash equivalents, beginning of period
              
              
              2,495
              
              
              
              2,206Cash
      and cash equivalents, end of period
              
              $
              912
              
              
              $
              2,495Supplemental
      Disclosures:Cash
      paid for interest
              
              $
              373
              
              
              $
              909Cash
      paid for taxes
              
              $
              -
              
              
              $
              332Cash
      paid for pre-payment penalties
              
              $
              -
              
              
              $
              446
  The
accompanying notes are an integral part of the financial
statements.


F-7





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008








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





Description
of Business





Deep
Down, Inc., and its wholly-owned subsidiaries (“Deep Down”, “we”, “us” or the
“Company”) is an oilfield services company serving the worldwide offshore
exploration and production industry. Our services and technological solutions
include distribution system installation support and engineering services,
umbilical terminations, loose-tube steel flying leads, flotation and drill riser
buoyancy, Remote Operated Vehicles (“ROVs”) and toolings. We support subsea
engineering, installation, commissioning, and maintenance projects through
specialized, highly experienced service teams and engineered technological
solutions. Deep Down’s primary focus is on more complex deepwater and
ultra-deepwater oil production distribution system support services and
technologies, used between the platform and the
wellhead.





In the
notes to the consolidated financial statements, all dollar and share amounts are
in thousands of dollars and shares, unless otherwise
indicated.


Liquidity
  As a deep
water service provider, our revenue, profitability, cash flows, and future rate
of growth are substantially dependent on the condition of the oil and gas
industry generally and our customers ability to invest capital for offshore
exploration, drilling and productions and maintain or increase levels of
expenditures for maintenance of offshore drilling and production facilities. Oil
and gas prices and the level of offshore drilling and production activity have
historically been characterized by significant volatility. We enter into large,
fixed-price contracts which may require significant lead time and investment. A
decline in offshore drilling and production activity could result in lower
contract volume or delays in significant contracts which could negatively impact
our earnings and cash flows. Our earnings and cash flows could also be
negatively affected by delays in payments by significant customers or delays in
completion of our contracts for any reason. We are dependent on our cash flows
from operations to fund our working capital requirements and the uncertainties
noted above create risk that we may not achieve our planned earnings or cash
flows from operations, which could result in violation of certain of our loan
covenants and require us to raise additional debt or equity capital. There can
be no assurance that we could raise additional capital.
  Our
Credit Agreement imposes covenant restrictions on us that increase our
vulnerability in the current adverse economic and industry climate, and limits
our ability to obtain additional financing. We have recently obtained amendments
to our credit facility, as discussed in Note 6, to waive our covenant
noncompliance as of December 31, 2009 and to provide us more latitude in our
covenants through the term of the agreement. Our ability tomeet these covenants is
primarily dependent on the adequacy of earnings before interest, taxes,
depreciation and amortization. Our inability to satisfy the covenants contained
in our Credit Agreement would constitute an event of default. An uncured default
could result in our outstanding debt becoming immediately due and payable. If
this were to occur, we may not be able to obtain waivers or secure alternative
financing to satisfy our obligations, either of which would have a material
adverse impact on our business.
  Although
we believe that we will have adequate liquidity to meet our future operating
requirements and to remain compliant with the covenants under our Credit
Agreement, the factors described above create uncertainty.





Summary
of Significant Accounting Policies





Principles
of consolidation





The
consolidated financial statements include the accounts of Deep Down and its
wholly-owned subsidiaries for the years ended December 31, 2009 and 2008. All
intercompany transactions and balances have been
eliminated.





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 years ended December 31, 2009 and 2008, the operations of our operating
segments, Deep Down Delaware, ElectroWave, Mako and Flotation, have been
aggregated into a single reporting segment. Additionally, during the year ended
December 31, 2009, we have combined ElectroWave’s operations into Deep Down
Delaware as a single operating segment due to similar production processes and
cost savings related to office and administrative support. While the operating
segments have different product lines; they are very similar. 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 and project
management as part of our service revenue to the customer. Additionally, the
segments have similar customers and distribution methods, and their economic
characteristics are similar with regard to their gross margin
percentages.





Other
comprehensive income





Deep Down
has no items that comprise other comprehensive income for the years ended
December 31, 2009 and 2008.





Reclassifications





Prior
period information presented in these financial statements includes
reclassifications which were made to conform to the current period
presentation.  These reclassifications had no effect on our previously
reported net loss or stockholders' equity.





F-8





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Cash
and Cash Equivalents and Restricted Cash





We
consider 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.





At
December 31, 2008, we had restricted cash of $136 related to a letter of credit
for a vendor, which was released due to completion of the project during 2009.
See further details at Note 11 Commitments and
Contingencies.





Fair
Value of Financial Instruments





Fair
value is defined as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date.  We utilize a fair value
hierarchy, which maximizes the use of observable inputs and minimizes the use of
unobservable inputs when measuring fair value.  The fair value
hierarchy has three levels of inputs that may be used to measure fair
value:





Level 1 -
Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or
liabilities.





Level 2 -
Quoted prices in markets that are not active; or other inputs that are
observable, either directly or indirectly, for substantially the full term of
the asset or liability.





Level 3 -
Prices or valuation techniques that require inputs that are both significant to
the fair value measurement and unobservable.





Our
financial instruments consist primarily of cash equivalents, trade receivables
and payables and debt instruments.  The carrying values of cash,
accounts receivable, and accounts payable approximate their fair values due to
the short-term maturity of these instruments. Our long term debt was valued
using techniques that require inputs that are both significant to the fair value
measurement and unobservable (Level 3), specifically treasury rates adjusted for
our credit risk premium.  At December 31, 2009, our debt, excluding
capital leases, had a carrying value of approximately $6,383 and a fair value of
approximately $5,710.





Considerable
judgment is required in interpreting data to develop the estimates of fair
value. Accordingly, the estimates presented above are not necessarily indicative
of the amounts we could realize in a current market exchange. As no active
market exists for a significant portion of our financial instruments, fair value
estimates were based on judgments regarding current economic conditions, future
expected cash flows and loss experience, risk characteristics and other factors.
These estimates are subjective in nature and involve uncertainties and therefore
cannot be calculated with precision (Level 3). There may be inherent weaknesses
in calculation techniques, and changes in the underlying assumptions used,
including discount rates and estimates of future cash flows, which could
significantly affect the results.





For
discussion of assets and liabilities measured at fair value on a non-recurring
basis, see Note 5 Goodwill and Intangibles.





Accounts
Receivable





We
provide an allowance for doubtful accounts on trade receivables based on
historical collection experience, the level of past due accounts and a specific
review of each customer’s trade receivable balance with respect to their ability
to make payments and expectations of future conditions that could impact the
collectability of accounts receivable.  When specific accounts are
determined to be uncollectable, they are expensed as bad debt expense in that
period. At December 31, 2009 and 2008, we estimated the allowance for
doubtful accounts to be $304 and $575, respectively. Bad debt expense totaled
$192 and $1,507 for the years ended December 31, 2009 and 2008,
respectively.








F-9





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Concentration
of Credit Risk





As of
December 31, 2009, four of our customers accounted for 22 percent, 9 percent, 8
percent and 5 percent of total accounts receivable, respectively. For the year
ended December 31, 2009, our five largest customers accounted for 12 percent, 10
percent, 8 percent, 6 percent and 5 percent of total revenues,
respectively.  For the year ended December 31, 2008, our four largest
customers accounted for 20 percent, 11 percent, 9 percent and 4 percent of total
revenues, respectively.





Inventory
and Work in Progress





Inventory
is stated at lower of cost (first-in, first out) or net realizable value (in
thousands).





December
      31, 2009
              
              
              December
      31, 2008Raw
      materials
              
              $
              765
              
              
              $
              790Work
      in progress
              
              
              84
              
              
              
              426Finished
      goods
              
              
              47
              
              
              
              146Total
      Inventory
              
              $
              896
              
              
              $
              1,362





A portion
of work in progress represents costs that have been incurred for time and
materials that are not appropriate to be billed to customers at such date,
according to the contractual terms.  Some of the billings are
contingent upon satisfaction of a significant condition of sale (“milestone”),
including but not limited to, factory acceptance testing (“FAT”) and customer
approval. Milestone billings at December 31, 2009 and 2008 were $29 and $136,
respectively.





Long-Lived
Assets





Property, Plant and
Equipment  Property, plant and equipment are stated at cost,
net of accumulated depreciation. Depreciation and amortization are computed
using the straight-line method over the estimated useful lives of the respective
assets. Buildings are depreciated between seven and thirty-six years, and
leasehold improvements are amortized over the shorter of the assets' useful
lives or lease terms. Equipment lives range from two to ten years, computers and
office equipment lives are generally from two to three years, and furniture and
fixtures are two to seven years. Replacements and betterments are
capitalized, while maintenance and repairs are expensed as incurred. It is our
policy to include depreciation expense on assets acquired under capital leases
with depreciation expense on owned assets. Additionally, we record depreciation
expense related to revenue-generating assets as Cost of Sales on the
accompanying statements of operations.





Other AssetsWe capitalize
certain internal and external costs related to the acquisition and development
of internal use software during the application development stages of projects.
Such costs consist primarily of custom-developed and packaged software and the
direct labor costs of internally-developed software and are included with Other
Assets on the accompanying balance sheets.  Capitalized costs are
amortized using the straight-line method over the estimated lives of the
software, which range from three to five years.  The costs capitalized
in the application development stage include the costs of design, coding,
installation of hardware and testing. We capitalize costs incurred during the
development phase of the project as permitted. Costs incurred during the
preliminary project or the post-implementation/operation stages of the project
are expensed as incurred.








F-10





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Long-lived intangible assets.
Our intangible assets generally consist of assets acquired in the purchases of
the Mako and Flotation subsidiaries and are comprised of customer lists,
non-compete covenants with key employees and trademarks related to Mako’s ROVs
and to Flotation’s branding, processes, materials and technology.  We
amortize intangible assets over their useful lives ranging from three to forty
years on a straight-line basis.  We make judgments and estimates in
conjunction with the carrying value of these assets, including amounts to be
capitalized, depreciation and amortization methods, useful lives and the
valuation of acquired long-lived intangible assets.





We test
for the impairment of long-lived assets upon the occurrence of a triggering
event. We base our evaluation on impairment indicators such as the nature of the
assets, the future economic benefit of the assets, any historical or future
profitability measurements and other external market conditions or factors that
may be present. If these impairment indicators are present or other factors
exist that indicate the carrying amount of an asset may not be recoverable, we
determine whether an impairment has occurred through the use of an undiscounted
cash flows analysis of the asset at the lowest level for which identifiable cash
flows exist. The undiscounted cash flow analysis consists of estimating the
future cash flows that are directly associated with and expected to arise from
the use and eventual disposition of the asset over its remaining useful life.
These cash flows are inherently subjective and require significant estimates
based upon historical experience and future expectations reflected in our
budgets and internal projections. If the undiscounted cash flows do not exceed
the carrying value of the long-lived asset, an impairment has occurred, and we
recognize a loss for the difference between the carrying amount and the
estimated fair value of the asset. The fair value of the asset is measured using
quoted market prices or, in the absence of quoted market prices, is based on an
estimate of discounted cash flows. Cash flows are generally discounted at an
interest rate commensurate with our weighted average cost of capital for a
similar asset.





We have
assessed the current market conditions and have concluded, as of December 31,
2009, that a triggering event had occurred that required an impairment analysis
of long-lived intangible assets. For the year ended December 31, 2009, we
recorded impairment charges totaling $4,616 to several long-lived intangible
assets, which total impairment charges were recorded on the statement of
operations as amortization expense. There was no impairment of long-lived assets
for the year ended December 31, 2008.  See further discussion in Note
5 regarding the testing and conclusions.





Goodwill





Goodwill
represents the cost in excess of the fair value of net assets acquired in
business combinations. We evaluate the carrying value of goodwill annually on
December 31 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. For purposes of our annual impairment test, our
reporting units are the same as our operating segments discussed
above.





The test
for goodwill impairment is a two-step approach. The first step is to compare the
estimated fair value of any reporting units within the Company that have
goodwill with the recorded net book value (including the goodwill) of the
reporting unit. If the estimated fair value of the reporting unit is higher than
the recorded net book value, no impairment is deemed to exist and no further
testing is required. If, however, the estimated fair value of the reporting unit
is below the recorded net book value, then a second step must be performed to
determine the goodwill impairment required, if any. In this second step, the
estimated fair value from the first step is used as the purchase price in a
hypothetical acquisition of the reporting unit. Purchase business combination
accounting rules are followed to determine a hypothetical purchase price
allocation to the reporting unit’s assets and liabilities. The residual amount
of goodwill that results from this hypothetical purchase price allocation is
compared to the carrying value of goodwill for the reporting unit, and the
carrying value is written down to the hypothetical amount, if
lower.





Lease
Obligations





We lease
land, buildings, vehicles and certain equipment under non-cancellable operating
leases.  Until the purchase of the facilities in May 2009, we leased
our Channelview, Texas, operating location from JUMA Properties, LLC (“JUMA”), a
company owned by Ronald E. Smith, President, CEO and Director of Deep Down and
his wife Mary L. Budrunas, Vice President, Corporate Secretary and Director of
Deep Down.  See further discussion in Note 4 Property, Plant and
Equipment. Additionally, since February 2009, we lease our corporate
headquarters in Houston, Texas, under a non-cancellable operating lease. Mako
leases office, warehouse and operating space in Morgan City, Louisiana, under a
non-cancellable operating lease, and Flotation leases their manufacturing,
warehousing and office locations in Biddeford, Maine under non-cancellable
operating leases. We also lease certain office and other operating equipment
under capital leases; the related assets are included with Property, Plant and
Equipment on the consolidated balance sheets.





F-11


Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008


At the
inception of a lease, we evaluate each agreement to determine whether the lease
will be accounted for as an operating or capital lease. The term of the lease
used for such an 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





We
recognize revenue once the following four criterions are met:  (i)
persuasive evidence of an arrangement exists, (ii) delivery of the equipment has
occurred or services have been rendered, (iii) the price of the equipment or
service is fixed and determinable and (iv) collectability is reasonably assured.
For certain fabrication projects, revenue is recognized upon shipment or when
customer-specific contract elements (“milestone(s)”) are met. Fabrication and
sale of equipment billings are contingent upon satisfaction of a significant
condition of sale milestone, including but not limited to, factory acceptance
testing and customer approval, and recognized upon transfer of title to the
customer.  Service revenue is recognized as the service is provided,
and “time and material” contracts are billed on a monthly basis as costs are
incurred. Customer billings for shipping and handling charges are included in
revenue.





From time
to time, we enter into large fixed price contracts which we determine that
recognizing revenues for these types of contracts is appropriate using the
percentage-of-completion method, which compares the percentage of costs incurred
to date to the estimated total costs for the contract.  This method is
preferred because management considers total costs the best available measure of
progress.





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





Costs and
estimated earnings in excess of billings on uncompleted contracts arise when
revenues are recorded on a percentage-of-completion basis but cannot be invoiced
under the terms of the contract. Such amounts are invoiced upon completion of
contractual milestones. Billings in excess of costs and estimated earnings on
uncompleted contracts arise when milestone billings are permissible under the
contract, but the related costs have not yet been incurred. All contract costs
are recognized currently on jobs formally approved by the customer and contracts
are not shown as complete until virtually all anticipated costs have been
incurred and the items are shipped to the customer.





Assets
and liabilities related to costs and estimated earnings in excess of billings on
uncompleted contracts, as well as billings in excess of costs and estimated
earnings on uncompleted contracts, have been classified as current. The contract
cycle for certain long-term contracts may extend beyond one year, thus complete
collection of amounts related to these contracts may extend beyond one year,
though such long-term contracts include contractual milestone billings as
discussed above.





All
intercompany revenue balances and transactions were eliminated in
consolidation.








F-12





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Income
Taxes





We follow
the liability method of accounting for income taxes.  This method
takes into account the differences between financial statement treatment and tax
treatment of certain transactions. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect of a
change in tax rates is recognized as income or expense in the period that
includes the enactment date. Our effective tax rates for 2009 and 2008 were 5.98
percent, and 19.6 percent, respectively.





We record
a valuation allowance to reduce the carrying value of our deferred tax assets
when it is more likely than not that some or all of the deferred tax assets will
expire before realization of the benefit or that future deductibility is not
probable. The ultimate realization of the deferred tax assets depends upon our
ability to generate sufficient taxable income of the appropriate character in
the future. This requires management to use estimates and make assumptions
regarding significant future events such as the taxability of entities operating
in the various taxing jurisdictions. In evaluating our ability to recover our
deferred tax assets, we consider all reasonably available positive and negative
evidence, including our past operating results, the existence of cumulative
losses in the most recent years and our forecast of future taxable income. In
estimating future taxable income, we develop assumptions, including the amount
of future state, and federal pretax operating income, the reversal of temporary
differences and the implementation of feasible and prudent tax planning
strategies. These assumptions require significant judgment. When the likelihood
of the realization of existing deferred tax assets changes, adjustments to the
valuation allowance are charged, in the period in which the determination is
made, either to income or goodwill, depending upon when that portion of the
valuation allowance was originally created.





We record
an estimated tax liability or tax benefit for income and other taxes based on
what we determine will likely be paid in the various tax jurisdictions in which
we operate.  We use our best judgment in the determination of these
amounts.  However, the liabilities ultimately realized and paid are
dependent upon various matters, including resolution of tax audits, and may
differ from amounts recorded.  An adjustment to the estimated
liability would be recorded as a provision or benefit to income tax expense in
the period in which it becomes probable that the amount of the actual liability
or benefit differs from the recorded amount.





Our
future effective tax rates could be adversely affected by changes in the
valuation of our deferred tax assets or liabilities or changes in tax laws or
interpretations thereof.  At such time, if any, that we no longer have
a reserve for our deferred tax assets, we will begin to provide for taxes at the
full statutory rate.  In addition, we are subject to the examination
of our income tax returns by the Internal Revenue Service and other tax
authorities.  We regularly assess the likelihood of adverse outcomes
resulting from these examinations to determine the adequacy of our provision for
income taxes.








F-13





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Stock-Based
Compensation





We record
share-based payment awards exchanged for employee services at fair value on the
date of grant and expense the awards in the consolidated statements of
operations over the requisite employee service period.  Stock-based
compensation expense includes an estimate for forfeitures and is generally
recognized over the expected term of the award on a straight-line
basis.  At December 31, 2009, we had two types of stock-based employee
compensation: stock options and restricted stock.





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.  Additionally, we continue to use the simplified method
related to employee option grants.





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, 2009 and
2008:





December
      31, 2009
              
              December
      31, 2008Dividend
      yield
              0%
              
              0%Risk
      free interest rate
              1.69%
      - 2.33%
              
              2.52%
      - 2.84%Expected
      life of options
              3
      years
              
              2-3
      yearsExpected
      volatility
              88.5%
      - 92.8%
              
              51.7%
      - 63.3%
 Earnings/(Loss)
per Common Share





Basic EPS
is calculated by dividing net income/(loss) by the weighted average number of
common shares outstanding for the period. Diluted EPS is calculated by dividing
net income/(loss) by the weighted average number of common shares and dilutive
common stock equivalents (stock awards and stock options) outstanding during the
period. Dilutive EPS reflects the potential dilution that could occur if options
and warrants to purchase common stock were exercised for shares of common stock.
The following is a reconciliation of the number of shares (denominator) used in
the basic and diluted EPS computations (in thousands, except per share
amounts):





Years
      EndedDecember
      31,In
      thousands, except per share amounts
              
              2009
              
              
              2008Numerator:Net
      loss
              
              $
              (16,663
              )
              
              $
              (4,323
              )Denominator:Weighted
      average number ofcommon
      shares outstanding
              
              
              179,430
              
              
              
              143,962Effect
      of dilutive securities
              
              
              -
              
              
              
              -Denominator
      for diluted earnings per share
              
              
              179,430
              
              
              
              143,962Net
      loss per common share outstanding,basic
      and diluted
              
              $
              (0.09
              )
              
              $
              (0.03
              )


Potentially
dilutive securities representing 0 and 502 shares of common stock for the years
ended December 31, 2009 and 2008, respectively, were excluded from the
computation of diluted earnings per share because their effect would have been
anti-dilutive.








F-14





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Recent
Accounting Pronouncements





In June
2009, the FASB approved the FASB Accounting Standards Codification (“the
Codification”) as the single source of authoritative nongovernmental GAAP. All
existing accounting standard documents, such as the FASB, American Institute of
Certified Public Accountants, Emerging Issues Task Force and other related
literature, excluding guidance from the SEC, will be superseded by the
Codification. All non-grandfathered, non-SEC accounting literature not included
in the Codification will become non-authoritative.  The Codification does
not change GAAP, but instead introduces a new structure that will combine all
authoritative standards into a comprehensive, topically organized online
database.  The
Codification was effective for interim and annual periods ending after
September 15, 2009. We adopted the Codification during the third quarter of
fiscal 2009.The Codification impact is limited to financial statement
disclosures, as all references to authoritative accounting literature are
referenced in accordance with the Codification.





In
October 2009 the FASB issued Accounting Standards Update No. 2009-13,
"Multiple-Deliverable Revenue Arrangements"   ("ASU No. 2009-13"). ASU No.
2009-13 provides principles for allocation of consideration among its
multiple-elements, allowing more flexibility in identifying and accounting for
separate deliverables under an arrangement.  The statement also
introduces an estimated selling price method for valuing the elements of a
bundled arrangement if vendor-specific objective evidence or third-party
evidence of selling price is not available, and significantly expands related
disclosure requirements.  ASU No. 2009-13 is effective prospectively
for revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010.  This guidance is effective
for us for all new or materially modified arrangements entered into on or after
January 1, 2011 with earlier application permitted as of the beginning of a
fiscal year. Full retrospective application of the new guidance is optional. We
are currently assessing implementation of this new guidance, but do not expect a
material impact on our consolidated financial
statements.





In
April 2008, the FASB issued amendments to ASC 350, “Intangibles — Goodwill
and Other.” These provisions amend the factors that should be considered in
developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset. The intent of the position is to improve the
consistency between the determination of the useful life of a recognized
intangible asset and the period of expected cash flows used to measure the fair
value of the asset. The amended guidance is effective for fiscal years beginning
after December 15, 2008. We adopted these provisions effective January 1,
2009; there was no impact to our consolidated financial
statements.





In
December 2007, the FASB issued guidance included in ASC Topic 805, "Business
Combinations" (formerly FASB Staff Position SFAS No. 141R-1), which amends
and clarifies SFAS No. 141R, "Business Combinations"). The new provisions
of ASC Topic 805 require the acquiring entity in a business combination to
record all assets acquired and liabilities assumed at their respective
acquisition-date fair values if fair value can be reasonably estimated, changes
the recognition of assets acquired and liabilities assumed arising from
contingencies, changes the recognition and measurement of contingent
consideration, and requires the expensing of acquisition-related costs as
incurred. If the fair value cannot be reasonably estimated, the asset or
liability would generally be recognized in accordance with ASC Topic 450,
"Contingencies". ASC Topic 805 also requires additional disclosure of
information surrounding a business combination, such that users of the entity's
financial statements can fully understand the nature and financial impact of the
business combination. The new provisions of ASC Topic 805 applies prospectively
to business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008; we adopted the new provisions of ASC Topic 805 effective
January 1, 2009. There was no impact to our consolidated financial
statements.








F-15





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Note
2:                      Costs
and Estimated Earnings in Excess of Billings on Uncompleted
Contracts





The
components of costs and estimated earnings in excess of billings on uncompleted
contracts are summarized below (in thousands):





December
      31, 2009
            
            
            December
      31, 2008Costs
      incurred on uncompleted contracts
            
            $
            4,051
            
            
            $
            2,115Estimated
      earnings
            
            
            2,212
            
            
            
            4,9696,263
            
            
            
            7,084Less:
      Billings to date
            
            
            10,430
            
            
            
            8,691$
            (4,167
            )
            
            $
            (1,607
            )Included
      in the accompanying consolidatedbalance sheets under the following
      captions:Costs
      and estimated earnings in excess of billingson uncompleted
      contracts
            
            $
            267
            
            
            $
            708Billings
      in excess of costs and estimated earningson uncompleted
      contracts
            
            
            (4,434
            )
            
            
            (2,315
            )$
            (4,167
            )
            
            $
            (1,607
            )





At
December 31, 2009, the asset balance of $267 was related to two contracts that
are projected to be completed during fiscal 2010. At December 31, 2008, the
asset balance of $708 was related to a contract that was 90 percent complete at
December 2008, based on the percentage-of-completion method. The remainder of
the revenue was recognized in the first quarter of fiscal 2009. The balance in
billings in excess of costs and estimated earnings on uncompleted contracts at
December 31, 2009 and 2008, was $4,434 and $2,315, respectively, and consisted
of significant milestone payments, primarily related to a large contract that is
expected to be completed in fiscal year 2010.





Note
3:                      Acquisitions





Purchase
of Flotation Technologies, Inc.





On May 1,
2008, we acquired Flotation Technologies, Inc. (“Flotation”), pursuant to the
stock purchase agreement.  Under the terms of the agreement, the
purchase price may be adjusted upward or downward, depending on certain working
capital targets. We resolved a dispute concerning the working capital adjustment
for the purchase pursuant to the arbitration proceeding in May 2009. The
arbitrator awarded us a cash purchase price adjustment of $84. The impact of
this adjustment after legal expenses was $58 and was recorded as a reduction to
goodwill as of the balance sheet date.  The acquisition of Flotation
has been accounted for using the purchase method of accounting since we acquired
substantially all of the assets, certain liabilities, employees, and business of
Flotation. The allocation of the purchase price was finalized upon the receipt
of management’s review of final amounts and recording of the net goodwill
adjustment discussed above in June 2009.





The
purchase price of Flotation was $23,883 and consisted of $22,016 in cash and
1,714 shares of common stock valued at $0.83 per common share, plus transaction
costs of $323. In addition, warrants to purchase 200 shares of common stock at
$0.70 per share were issued to an entity affiliated with the selling
shareholders for the acquisition of technology related to the operations of
Flotation. The warrants are exercisable at any time from June 3, 2009 through
September 3, 2011 and include piggyback registration rights with respect to the
underlying shares of common stock. We valued the warrants at $122 based on the
Black-Scholes option pricing model.





We sold
57,143 shares of common stock to accredited investors on June 5, 2008, at a
price of $0.70 per share, for approximately $37,060 in net proceeds. We used
approximately $22,100 in proceeds from this Private Placement to fund the cash
requirement of the Flotation acquisition.





We also
issued 600 options to employees of Flotation for their continued services with
an exercise price of $1.15 per share. These options vest one-third of the
original amount each year and may be exercised in whole or in part after
vesting. We valued these options at $264 based on the Black-Scholes option
pricing model, and are recognizing the related compensation cost ratably over
the requisite service period and not in the purchase price of the
transaction.





F-16





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Mako Technologies,
Inc.





Effective
December 1, 2007, we purchased 100 percent of the common stock of Mako
Technologies, Inc. for $11,307. Pursuant to the agreement and plan of merger,
final installments of the purchase price were paid to the Mako shareholders
during the year ended December 31, 2008, which included $4,160 cash to the Mako
shareholders plus $77 of transaction expenses. In March 2008, we issued the
second installment of 2,803 restricted shares of common stock of Deep Down,
valued at $0.70 per share, totaling $1,962, including non-cash adjustments to
purchased asset values in goodwill totaling $174. See Note 5 regarding the
adjustment to goodwill related to final tax return adjustments during 2008. The
allocation of the purchase price was finalized upon the receipt of management’s
review of final amounts and final tax returns in December
2008.





Note
4:                      Property,
Plant and Equipment





Property
and equipment consisted of the following as of December 31, 2009 and 2008 (in
thousands):





December
      31, 2009
              
              
              December
      31, 2008
              
              
              Useful
      LifeLand
              
              $
              1,954
              
              
              $
              482
              
              
              
              -Buildings
      and improvements
              
              
              5,458
              
              
              
              3,181
              
              
              7 -
      36 yearsLeasehold
      improvements
              
              
              313
              
              
              
              344
              
              
              2 -
      5 yearsEquipment
              
              
              13,773
              
              
              
              8,713
              
              
              2 -
      10 yearsFurniture,
      computers and office equipment
              
              
              1,154
              
              
              
              634
              
              
              2 -
      7 yearsConstruction
      in progress
              
              
              954
              
              
              
              2,131Total
              
              
              23,606
              
              
              
              15,485Less:
      Accumulated depreciation
              
              
              (3,595
              )
              
              
              (1,686
              )Property
      and equipment, net
              
              $
              20,011
              
              
              $
              13,799


Depreciation
expense, excluded from “Cost of sales” in the accompanying statements of
operations, was approximately $343 and $236 for the years ended December 31,
2009 and 2008, respectively. Depreciation expense, included in “Cost of sales”
in the accompanying statements of operations, was approximately $1,616 and
$1,078 for the years ended December 31, 2009 and 2008, respectively. During the
year ended December 31, 2009, we acquired the following assets under capital
leases: $92 in office equipment and $32 in equipment. Accumulated depreciation
on equipment under capital leases was $247 and $138 at December 31, 2009 and
2008, respectively.





On May
29, 2009, we consummated a purchase transaction with JUMA; pursuant to a
Purchase and Sale Agreement dated May 22, 2009, we acquired certain property and
improvements located in Channelview, Texas, where certain of our operations are
currently located (the “Channelview Property”). The Channelview Property
consists of 8.203 acres and was purchased for $2,600. The transaction was
conducted on an arms-length basis and in accordance with normal terms and
conditions. We used $2,100 loan proceeds from Whitney Bank as discussed in Note
6, Long-Term Debt.  Prior to the purchase, we leased the Channelview
Property from JUMA at a base rate of $15 per month.  In connection
with the purchase of the Channelview Property, the lease between us and JUMA was
terminated.  We incurred no early termination penalties from JUMA in
connection with this termination.





At
December 31, 2009 and 2008, construction in progress represents assets that are
not ready for service or are in the construction stage. The 2009 balance
included approximately $954 for equipment in progress that will be placed in
service in 2010. The 2008 balance included approximately $1,509 for a new ROV
which was completed in September 2009. We will begin depreciating these assets
once they are ready for or put into use.








F-17





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Note
5:                      Intangible
Assets and Goodwill





Goodwill





Goodwill
represents the excess of the cost over the net tangible and identifiable
intangible assets of acquired businesses.





The
change in the carrying value of goodwill during the years ended December 31,
2009 and 2008 is set forth below (in thousands):





Carrying
      amount as of December 31, 2007
              
              $
              10,594Adjustments
      to previously reporting purchase price
              
              
              2,289Adjustments
      related to acquisitions, net
              
              
              2,141Carrying
      amount as of December 31, 2008
              
              
              15,024Adjustments
      to previously reporting purchase price
              
              
              (58
              )Goodwill
      impairment
              
              
              (5,537
              )Carrying
      amount as of December 31, 2009
              
              $
              9,429





The
increases to goodwill in 2008 include an adjustment to the Mako purchase price
due to the finalization of tax returns, whereby we determined that approximately
$1,840 of the purchase price was to be allocated to a deferred tax liability due
to the difference in the tax balance sheet and book balance sheet related to the
intangible and fixed assets.  The remainder of the 2008 increases
relate to the purchase of Flotation and to the final adjustments to net asset
values of Mako. The decrease in 2009 was primarily due to the non-cash
impairment charge as discussed below, plus an adjustment to reduce the purchase
price of Flotation by $58, net of legal fees, due to the resolution of a dispute
concerning the working capital adjustment for the purchase price
calculation.





Because
quoted market prices for our individual reporting units are not available,
management must apply judgment in determining the estimated fair value of our
reporting units for purposes of performing the annual goodwill impairment test.
Management uses all available information to make these fair value
determinations, including the discounting of reporting units’ projected cash
flow, publicly traded company multiples and recent merger and acquisition
transaction values as a multiple of earnings.  A key component of
these fair value determinations is an assessment of the fair value using
discounted cash flows and other market-related valuation models in relation to
our market capitalization.





The
accounting principles regarding goodwill acknowledge that the observed market
prices of individual trades of a company’s stock (and thus its computed market
capitalization) may not be representative of the fair value of the entity as a
whole. Substantial value may arise from the ability to take advantage of
synergies and other benefits that flow from control over another entity.
Consequently, measuring the fair value of a collection of assets and liabilities
that operate together in a controlled entity is different from measuring the
fair value of that entity’s individual common stock. In most industries,
including Deep Down’s, an acquiring entity typically is willing to pay more for
equity securities that give it a controlling interest than an investor would pay
for a number of equity securities representing less than a controlling interest.
Therefore, the above fair value calculations using discounted cash flows and
other market-related valuation models are compared to market capitalization plus
a control premium.





At
December 31, 2009, our management completed the annual impairment test of
goodwill. Management’s calculations indicated, due to a number of factors,
including the current global economic environment, increased costs of capital
and the decrease in our market capitalization, that the calculations for the
reporting units of Deep Down Delaware, Mako and Flotation each indicated their
respective net book value exceeded its fair value and, accordingly, we estimated
the implied fair value of the goodwill for each reporting unit. We used the
estimated fair value of each reporting unit from the first step as the purchase
price in a hypothetical acquisition of the respective reporting unit. We
recognized a goodwill impairment of $3,056 for Deep Down Delaware, $2,481 for
Mako and $0 for Flotation reporting units for the year ended December 31,
2009. After adjusting the Flotation carrying value of intangible assets to fair
value, there was no goodwill impairment for that reporting unit.  See
detailed discussion of intangible asset impairment below. The impairment was
recorded in operating expenses in the consolidated statement of operations for
the year ended December 31, 2009. This non-cash charge did not impact our
liquidity position, debt covenants or cash flows.





F-18





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





We
estimated the fair value of the reporting units using discounted cash flows and
earnings multiples of comparable publicly traded companies. The key discounted
cash flow assumptions used to determine the fair value of our reporting units
included: a) cash flow periods of six years with a four percent estimated
annual growth rate, b) terminal values based on the terminal cash flow growth
rate and the capitalization rate (weighted average cost of capital – terminal
growth rate) and c) a weighted average cost of capital of 20.8 percent. The
remaining goodwill by reporting unit was $4,472, $2,874 and $2,083 for the
Delaware, Mako and Flotation reporting units, respectively, as of December 31,
2009. As a result of the adjustments discussed above, approximately $7,346 of
our goodwill is recorded at fair value as of December 31, 2009, based upon Level
3 inputs.  Determining the fair value of a reporting unit is
judgmental in nature and requires the use of significant estimates and
assumptions, including revenue growth rates and operating margins, discount
rates and future market conditions, among others. Unanticipated changes in
revenue, gross margin, long-term growth factor or discount rate could result in
a material impact on the estimated fair values of our reporting units which
could result in additional goodwill impairment in future
periods.





Intangible
Assets





Identifiable
intangible assets acquired in business combinations are recorded based upon fair
market value at the date of acquisition.  Amounts allocated to
intangible assets are amortized on a straight-line basis over their estimated
useful lives. Estimated intangible asset values, net of recognized amortization
expense include the following (in thousands):


December
      31, 2009
              
              
              December
      31, 2008Estimated
              
              Gross
      Carrying
              
              
              Accumulated
              
              
              Net
      Carrying
              
              
              Gross
      Carrying
              
              
              Accumulated
              
              
              Net
      CarryingUseful
      Life
              
              Value
              
              
              Amortization
              
              
              Amount
              
              
              Value
              
              
              Amortization
              
              
              AmountCustomer
      relationship
              6-14
      Years
              
              $
              3,515
              
              
              $
              (786
              )
              
              $
              2,729
              
              
              $
              3,515
              
              
              $
              (403
              )
              
              $
              3,112Non-compete
      covenant
              3-5
      Years
              
              
              1,334
              
              
              
              (893
              )
              
              
              441
              
              
              
              1,334
              
              
              
              (294
              )
              
              
              1,040Trademarks
              25-40
      Years
              
              
              3,110
              
              
              
              (174
              )
              
              
              2,936
              
              
              
              3,110
              
              
              
              (80
              )
              
              
              3,030Technology
              10
      Years
              
              
              11,209
              
              
              
              (5,149
              )
              
              
              6,060
              
              
              
              11,209
              
              
              
              (300
              )
              
              
              10,909Total
              
              
              $
              19,168
              
              
              $
              (7,002
              )
              
              $
              12,166
              
              
              $
              19,168
              
              
              $
              (1,077
              )
              
              $
              18,091





We have
assessed the current market conditions and have concluded, as of December 31,
2009, that a triggering event had occurred that required an impairment analysis
of long-lived intangible assets. Specifically, recent developments in technology
have shortened the estimated useful life (and related projected cash flows) of
certain intangible assets. Fair values for technology and customer relationships
were based upon an excess earnings methodology. Fair value for non-compete
agreements was based on the expected differential cash flow of the reporting
unit between “with non-compete agreements” and “without” non-compete agreements
scenarios.





For the
year ended December 31, 2009, we recorded impairment charges totaling
$4,616 to the following long-lived intangible assets: $4,401 reduction in the
carrying value of the technology intangibles primarily due to a change in the
estimated useful life from twenty-five years to ten years based on recent
technology developments in the buoyancy industry, which shorter life lessened
the projected cash flows generated by this asset, and $215 reduction in the
non-compete covenants. As a result, approximately $6,110 of long-lived
intangible assets are recorded at fair value based upon Level 3 inputs at
December 31, 2009.  We recorded the adjustment as amortization expense
on the statement of operations.  Additionally, we reduced the
estimated useful lives of the following intangible assets based upon current
market trends and estimated future cash flows: customer lists from a range of
eight to twenty-five years to a range of six to fourteen years, and technology
from twenty-five to ten years. The estimated amortization expense below reflects
the adjusted carrying values and useful lives.





Estimated
amortization expense for each of the five subsequent fiscal years is expected to
be (in thousands):





Years
      ended December 31,:2010
              
              $
              1,2302011
              
              
              1,1432012
              
              
              1,0992013
              
              
              1,0992014
              
              
              1,099Thereafter
              
              
              6,496$
              12,166


F-19





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Note
6:                      Long-Term
Debt





At
December 31, 2009 and 2008 long-term debt consisted of the following (in
thousands):





December
      31, 2009
              
              
              December
      31, 2008Secured
      credit agreements
              
              $
              5,819
              
              
              $
              1,150Other
      bank loans
              
              
              63
              
              
              
              15Total
      bank debt
              
              
              5,882
              
              
              
              1,1656%
      Subordinated Debenture
              
              
              500
              
              
              
              500Capital
      lease obligations
              
              
              494
              
              
              
              436Total
      debt
              
              
              6,876
              
              
              
              2,101Current
      portion of long-term debt
              
              
              (1,497
              )
              
              
              (383
              )Long-term
      debt, net of current portion
              
              $
              5,379
              
              
              $
              1,718


Overview





We have
entered into an Amended and Restated Credit Agreement, dated as of April 14,
2010, to address covenant violations we have had under our Credit Agreement with
Whitney National Bank (“Whitney”) that we originally entered into on November
11, 2008.  Under the new Amended and Restated Credit Agreement (the
“New Agreement”), we no longer have any further capacity to draw upon a
revolving line of credit and the maturity of all outstanding debt under the New
Agreement is scheduled to mature on April 15, 2011.  Under the terms
of the New Agreement, our noncompliance with the prior terms of the financial
covenants and certain other covenants under the Credit Agreement have been
waived (the effect of such noncompliance would have entitled the holders of all
debt under the Credit Agreement and under a loan agreement between Flotation and
TD Bank, N.A. (“TD Bank”) to call such debt immediately due and payable and
would have required us to classify all debt outstanding under these facilities
as current in our audited consolidated balance sheet at December 31,
2009).  We continue to remain current on payments of our principal,
interest and fee obligations with Whitney and TD Bank.  However, under
the terms of the New Agreement, all of the indebtedness outstanding under such
agreement, which is a currently approximately an aggregate principal amount of
$3,592, will all be due on April 15, 2011, unless we are able to refinance all
or a portion of such indebtedness.





Furthermore,
Flotation was not in compliance as of December 31, 2009 with its covenant
obligations under the TD Bank loan.  The noncompliance with such
covenants under either of the Credit Agreement with Whitney and the loan
agreement with TD Bank would constitute cross defaults for purposes of the other
debt facility.  Flotation has also obtained a waiver of its
noncompliance so that such cross default has not occurred with respect to our
fiscal quarter ended December 31, 2009. The
effect of our entry into the New Agreement means that we no longer have access
to a line of credit for capital resources and we must rely solely on our cash
position and cash flows to fund our operating requirements.


Whitney
Credit Agreement





We
originally entered into our Credit Agreement with Whitney in November
2008.  The Credit Agreement originally provided a commitment to lend
to us the lesser of $2,000 or 80 percent of eligible receivables (generally
defined as current due accounts receivables in which the lender has a first
priority security interest).  All of this commitment was also
available for Whitney to issue letters of credit (“L/C”) for our
benefit.  In December 2008, we then entered into an amendment of the
Credit Agreement that provided for us to receive a term loan in the principal
amount of $1,150.  Then, in May 2009, we entered into another
amendment to the Credit Agreement providing for us to receive another term loan
in the principal amount of $2,100.  We used the proceeds from the
December 2008 term loan to purchase a piece of equipment (a remotely operated
vehicle) and we used the proceeds of the May 2009 term loan to purchase real
property in Channelview, Texas from JUMA (see additional discussion in Note 4,
Property and Equipment).  There was $850 and $0 outstanding under the
revolving credit line available under the Credit Agreement on December 31, 2009
and 2008, respectively.  We have issued an irrevocable transferable
standby L/C, with an annual commission rate of 2.4 percent for $1,107 during the
year ended December 31, 2009 related to a large contract that is expected to be
completed in fiscal year 2010.  The borrowing capacity under the
revolving line of credit was approximately $43 at December 31,
2009.








F-20





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





We were
originally obligated to repay the December 2008 term loan on the basis of
monthly installments of approximately $35, with the initial payment on February
1, 2009 and a final payment of all unpaid principal and accrued interest on
January 2, 2012.  Outstanding amounts of principal of the December
2008 term loan accrue interest at a rate of 6.5 percent per annum.  As
of the entry into the New Agreement, the outstanding principal amount of the
December 2008 term loan is approximately $730.  Under the terms of the
New Agreement, we are required to continue to make monthly installment payments
for the December 2008 term loan in the amount of approximately $35 and the
outstanding principal amount of such loan continues to accrue interest at the
rate of 6.5 percent per annum.  However, the final payment of all
unpaid principal and accrued interest on the December 2008 term loan of
approximately $343 is now due on April 15, 2011.





We were
originally obligated to repay the May 2009 term loan on the basis of monthly
installments of approximately $18, with the initial payment on June 1, 2009 and
a final payment of all unpaid principal and accrued interest on May 1,
2024.  Outstanding amounts of principal of the May 2009 term loan
accrue interest at a rate of 6.5 percent per annum.  As of the entry
into the New Agreement, the outstanding principal amount of the December 2008
term loan is approximately $2,012.  Under the terms of the New
Agreement, we are required to continue to make monthly installment payments for
the May 2009 term loan in the amount of approximately $18 and the outstanding
principal amount of such loan continues to accrue interest at the rate of 6.5
percent per annum.  However, the final payment of all unpaid principal
and accrued interest on the May 2009 term loan of approximately $1,927 is now
due on April 15, 2011.





Upon
entry into the New Agreement, our indebtedness in the amount of $850 outstanding
under the revolving credit line of the Credit Agreement was converted to a term
loan. This April 2010 term loan requires us to make monthly installments in the
amount of $40 plus the amount of accrued and unpaid interest beginning on May 1,
2010 and a final payment of all unpaid principal and accrued interest on April
15, 2011.  Outstanding amounts of principal of the April 2010 term
loan accrue interest at a rate of 6.5 percent per
annum.





The
amounts of L/Cs issued under the New Agreement accrue fees at a rate of 3.5
percent to 2.5 percent (based on our leverage ratio) of the principal amount of
the applicable L/C, and unused amounts under the letter of credit facility incur
unused fees of 0.5 percent to 0.25 percent (based on our leverage
ratio).





Each of
our subsidiaries has guaranteed our obligations under the Credit Agreement,
including as amended and restated under the New Agreement, and as such, our
obligations in connection with the New Agreement are generally secured by a
first priority lien on all of our subsidiaries’ non-real property
assets.  With regard to the Channelview, Texas property purchased with
the proceeds of the May 2009 term loan, we also entered into a Deed of Trust,
Security Agreement and UCC Financing Statement for Fixture Filing (collectively,
the “Deed of Trust”) creating a lien on such
property.





As noted
above, under the Credit Agreement, including as amended and restated under the
New Agreement, we have and continue to have certain covenant obligations,
including certain leverage ratio, fixed charge coverage ratio and tangible net
worth covenants.  Prior to entry into the New Agreement, we were not
in compliance with these covenants as of December 31, 2009.  However,
the New Agreement provides for the waiver of such noncompliance and establishes
new covenants in this regard.  From and after April 1, 2010, for each
quarter we are obligated to adhere to the following:  (i) total debt
to consolidated earnings before interest, taxes, depreciation and amortization
(“EBITDA”) of not greater than 3.0 to 1.0 (“Leverage Ratio”), consolidated
EBITDA to consolidated net interest expense and principal payments on the total
debt greater than 1.5 to 1.0 (“Fixed Charge Coverage Ratio”), and consolidated
net worth after deducting other assets as are properly classified as “Intangible
Assets” (“Tangible Net Worth”) in excess of $15,000.  The calculation
of EBITDA for purposes of the Leverage Ratio and Fixed Charge Coverage Ratio
provides for adding back amounts deducted from net income related to charges we
have taken in regards to the financial statements as of December 31, 2009
relating to impairment of goodwill and other intangible assets.  Under
the New Agreement, we continue to have obligations for other covenants,
including limitations on issuance of common stock, liens, transactions with
affiliates, additional indebtedness and permitted investments, among
others.





The New
Agreement also removed a provision that permitted us to obtain other funded
indebtedness from a third party in the event we had requested Whitney to
increase the amount of its commitment or approve additional credit extensions
under the Credit Agreement and Whitney refused to do so.  Thus, we
expect to have to refinance the indebtedness outstanding under the New Agreement
at any such time as we seek to obtain new financing from a third
party.








F-21





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





TD
Bank Loan Agreement





On March
5, 2009, Flotation, our wholly-owned subsidiary, obtained loan proceeds from TD
Bank in the principal amount of $1,840.  The TD Bank loan also
provided a further commitment to Flotation for advancement of principal in the
amount of $320. Under the terms of the TD Bank loan agreement we are obligated
to make payments in monthly installments of approximately $13, with an initial
payment on March 13, 2009 and a final payment of the unpaid principal and
accrued interest in February 2029.  We drew the additionally committed
$320 principal amount in July 2009.  As a result, our monthly
installment payments increased effective August 2009 to approximately
$15.  The interest rate on the TD Bank Loan is 5.75
percent.





The TD
Bank loan is secured by Flotation’s operational premises in Biddeford, Maine
under a mortgage and security agreement and a collateral assignment of leases
and rents.  The TD Bank loan required us to enter into a debt
subordination agreement that subordinated any debt Flotation owes to Deep Down,
other than accounts payable between them arising in the ordinary course of
business.  Additionally, the TD Bank Loan required a “negative pledge”
that prohibits Flotation and Deep Down from granting security interests in
Flotation’s personal property, other than such security interests granted in
respect of our Revolver with Whitney.





On
February 13, 2009, we entered into an amendment to our Credit Agreement in
connection with our entry into the TD Bank loan. This amendment permitted
Flotation to incur the TD Bank loan and provide the mortgage and security
arrangements required for such loan.





Under the
TD Bank loan, we are required to meet certain covenants and
restrictions.  The financial covenants are reportable annually
beginning with the year ended December 31, 2009, and are specific to the
Flotation subsidiary financials.  The TD Bank Loan financial covenants
include maintaining debt service coverage ratios, pre and post
distributions, which are ratios of Flotation’s earnings after tax plus interest,
depreciation, amortization and distributions to consolidated net interest
expense and principal payments on the total debt, below 1.5 to
1.0  and including distributions of 2.0 to 1.0, and consolidated net
worth after deducting other assets as are properly classified as “Intangible
Assets” (“Tangible Net Worth”) in excess of $9,500.  Other covenants
include limitations on issuance of liens, transactions with affiliates, and
additional indebtedness among others.  At December 31, 2009, we were
not in compliance with the debt service coverage ratios or the Tangible Net
Worth covenant, and on April 15, 2010, we have obtained a waiver for these
covenants as of December 31, 2009.





Net
interest expense, fiscal 2008 debt transactions and loss on debt
extinguishment





For the
year ended December 31, 2008, we amortized into net interest expense $1,703 of
debt discount and $763 of deferred financing costs associated with the fair
market value of warrants and the cash-based expenses, related to third party
fees and prepaid lender fees, over the life of a secured credit agreement, which
was entered into in August 2007 and amended in December 2007, using the
effective interest rate method. During the year ended December 31, 2008, we paid
$13,275 to the lender to pay the outstanding balance under the credit agreement,
related interest of $829 and early termination fees, recognized as a loss on
early extinguishment of debt, of $446. Additionally, during the year ended
December 31, 2008, we recorded $114 in net interest expense for the accretion of
the Series E Preferred Stock up to face value, that was exchanged into a 6
percent subordinated debenture in the amount of $500.





Payment
table





Aggregate
principal maturities of long-term debt, excluding capital leases which are
detailed in Note 11, were as follows for years ended December
31:





Long-Term
      DebtMaturitiesYears
      ended December 31,:2010
              
              $
              1,3982011
              
              
              1,0942012
              
              
              2252013
              
              
              1852014
              
              
              197Thereafter
              
              
              3,283$
              6,382


F-22





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Note
7:                      Stock-Based
Compensation





We have a
stock-based compensation plan, the “2003 Directors, Officers and Consultants
Stock Option, Stock Warrant and Stock Award Plan” (the “Plan”). Stock based
compensation is recognized as provided under the applicable authoritative
guidance which requires all share-based payments to employees, including grants
of employee stock options, to be recognized as compensation expense over the
requisite service period (generally the vesting period) in the financial
statements based on their fair values. The impact of forfeitures that may occur
prior to vesting is also estimated and considered in the amount recognized. In
addition, the realization of tax benefits in excess of amounts recognized for
financial reporting purposes will be recognized as a financing activity. The
options granted under the Plan have vesting periods that range from immediate
vesting to vesting over five years, and the contract terms of the options
granted are up to ten years. Under the Plan, the total number of options
permitted is 15 percent of issued and outstanding common
shares.





During
the year ended December 31, 2009, we granted 14,475 options and 3,100 shares of
restricted stock, and cancelled 2,517 options subject to forfeitures under the
Plan. Based on the shares of common stock outstanding at December 31, 2009,
there were approximately 2,743 options available for grant under the Plan as of
that date.





Restricted
Stock





On March
23, 2009, we granted 2,350 restricted shares, total par value $2, to executives
and employees which vest on March 23, 2011, with continued employment. The
shares had a fair value grant price of $0.12 per share based on the closing
price of common stock on March 20, 2009. The shares vest on the second
anniversary of the grant date, and we are amortizing the related stock-based
compensation of $291 over the two-year requisite service
period.





On
September 1, 2009, we granted 750 restricted shares, total par value $1, to an
executive in connection with his Severance and Separation Agreement. The shares
had a fair value grant price of  $0.10 per share based on the closing
price of common stock on September 1, 2009. The shares vest on the anniversary
of the grant date, and we are amortizing the related stock-based compensation of
$75 over the one-year requisite service period.





In
connection with the departure of two executives during the third quarter of
2009, we accelerated the vesting of 850 shares of restricted stock granted on
March 29, 2009, and 350 shares granted in February 2008, and recognized the
related stock-based compensation of $106.  During the year ended
December 31, 2009 and 2008, we recognized a total of $464 and $221,
respectively, in stock-based compensation related to all outstanding shares of
restricted stock. The unamortized portion of the estimated fair value of
restricted stock was $186 at December 31, 2009.





The
following table summarizes our restricted stock activity for the year ended
December 31, 2009. The aggregate intrinsic value is based upon the closing price
of $0.13 of our common stock on December 31, 2009.





In
      thousands, except per share amounts
              
              Restricted
                Shares
              
              
              Weighted-
                Average
      Fair
                Value
      Grant
                Price
              
              Aggregate
                Intrinsic
                ValueOutstanding
      at December 31, 2007
              
              
              -
              
              
              $
              -Grants
              
              
              1,200
              
              
              $
              0.42Outstanding
      at December 31, 2008
              
              
              1,200
              
              
              $
              0.42Grants
              
              
              3,100
              
              
              $
              0.12Outstanding
      at December 31, 2009
              
              
              4,300
              
              
              $
              0.20
              
              $
              37





F-23





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Summary
of Stock Options





During
the years ended December 31, 2009 and 2008, we granted 14,475 and 4,200 options,
respectively. Based on the shares of common stock outstanding at December
31, 2009, there were approximately 2,743 options available for grant under the
Plan as of that date. We expense all stock options on a straight-line basis, net
of forfeitures, over the requisite expected service periods. Additionally,
during the year ended December 31, 2009, we revised the estimated rate of
forfeitures to 30 percent from 0 percent based on the history of stock option
cancellations and management’s estimates of expected future forfeiture rates,
resulting in a reduction of stock-based compensation expense of $116 for the
year ended December 31, 2009. The total stock-based compensation expense
recognized for stock options for the years ended December 31, 2009 and 2008 was
$372 and $364, respectively.  As of December 31, 2009, the unamortized
portion of the estimated fair value of outstanding stock options was
$1,189.





The
following table summarizes our stock option activity for the year ended December
31, 2009. The aggregate intrinsic value is based on the closing price of $0.13
on December 31, 2009.





In
      thousands, except per share amounts
            
            Shares
      Underlying Options
            
            
            Weighted-
      Average
              Exercise
      Price
            
            
            Weighted-
      Average Remaining Contractual Term (in years)
            
            
            Aggregate
      Intrinsic Value (In-The-Money)Outstanding
      at December 31, 2007
            
            
            5,500
            
            
            $
            0.58Grants
            
            
            4,200
            
            
            
            1.35Exercises
            
            
            (50
            )
            
            
            0.50Cancellations
      & Forfeitures
            
            
            (1,583
            )
            
            
            0.70Outstanding
      at December 31, 2008
            
            
            8,067
            
            
            $
            0.96
            
            
            
            2.3
            
            
            $
            -Grants
            
            
            14,475
            
            
            
            0.11Exercises
            
            
            -
            
            
            
            -Cancellations
      & Forfeitures
            
            
            (2,517
            )
            
            
            0.90Outstanding
      at December 31, 2009
            
            
            20,025
            
            
            $
            0.35
            
            
            
            2.5
            
            
            $
            323Exerciseable
      at December 31, 2009
            
            
            3,225
            
            
            $
            0.75
            
            
            
            1.8
            
            
            $
            -





The
following summarizes our outstanding options and their respective exercise
prices at December 31, 2009 (shares in thousands):





Exercise
                Price
              
              Shares
                Underlying
                Options$   0.10
      - 0.49
              
              13,850$   0.50
      - 0.69
              
              3,525$   0.70
      - 0.99
              
              50$   1.00
      - 1.29
              
              600$   1.30
      - 1.50
              
              2,00020,025





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, 2009:





December
      31, 2009Dividend
      yield
              0%Risk
      free interest rate
              1.69%
      - 2.33%Expected
      life of options
              3
      yearsExpected
      volatility
              88.5%
      - 92.8%


F-24





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Note
8:                      Warrants





In
connection with the purchase of Flotation during the year ended December 31,
2008, we issued warrants to purchase 200 common shares at $0.70 per share to an
entity affiliated with the selling shareholders in consideration for the
acquisition of related technology. The warrants are exercisable at any time from
June 3, 2009 through September 3, 2011 and include piggyback registration rights
with respect to the underlying shares of common stock. We valued the warrants at
$122 based on the Black Scholes option pricing model and included this value in
the purchase price allocation relating to Flotation.





A summary
of warrant transactions follows. The aggregate intrinsic value is based on the
closing price of $0.13 on December 31, 2009.




In
      thousands, except per share amounts
            
            Shares
      Underlying Warrants
            
            
            Weighted-
      Average Exercise Price
            
            
            Weighted-
      Average Remaining Contractual Term (in years)
            
            
            Aggregate
      Intrinsic Value (In-The-Money)Outstanding
      at December 31, 2007
            
            
            5,399
            
            
            $
            0.53Grants
            
            
            200
            
            
            $
            0.70Exercised
            
            
            (4,960
            )
            
            $
            0.51Outstanding
      at December 31, 2008
            
            
            639
            
            
            $
            0.78
            
            
            
            4.0
            
            
            $
            -Outstanding
      and exercisable at December 31, 2009
            
            
            639
            
            
            $
            0.78
            
            
            
            2.3
            
            
            $
            -





The
following summarizes our outstanding warrants and their respective exercise
prices at December 31, 2009 (share amounts in
thousands):




Exercise
      Price
              
              
              Shares
                Underlying
      Warrants$
              0.70
      – 0.99
              
              
              
              520$
              1.01
              
              
              
              119639





Note
9:                      Common
Stock





Private
Placement, fiscal year 2008





On June
5, 2008, we sold 57,143 shares of our common stock in a private placement to
accredited investors, for $40,000 at a per-share price of $0.70 (the “Private
Placement”). After transaction costs, we had net proceeds of $37,060. Dahlman
Rose & Company, LLC acted as exclusive placement agent for the equity
financing.





We used
approximately $22,100 of the net proceeds to fund the cash portion of the
Flotation purchase, and used approximately $12,493 to repay outstanding debt,
along with early termination fees, to Prospect in June, 2008. We retained the
remaining net proceeds for working capital purposes.








F-25





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Note
10:                      Income
Taxes





The
provision for income taxes on income from continuing operations is comprised of
the following for the years ended December 31, 2009 and 2008.  The
provision for income taxes differs from the amount computed by applying the U.S.
statutory income tax rate to income from continuing operations before income
taxes for the reasons set forth below for the years ended December 31, 2009 and
2008. Amounts are in thousands, except
percentages.





December
      31, 2009
              
              
              December
      31, 2008Federal:Current
              
              $
              603
              
              
              $
              (453
              )Deferred
              
              
              (1,474
              )
              
              
              (856
              )Total
      Federal
              
              $
              (871
              )
              
              $
              (1,309
              )State:Current
              
              $
              50
              
              
              $
              267Deferred
              
              
              (205
              )
              
              
              -Total
      State
              
              $
              (155
              )
              
              $
              267Total
      income tax benefit
              
              $
              (1,026
              )
              
              $
              (1,042
              )
 
 Year
      endedDecember
      31, 2009
                
                December
      31, 2008Income
      tax expense at federal statutory rate
                34.00%
                
                34.00%State
      taxes, net of federal expense
                0.98%
                
                (3.30%
                )Goodwill
      impairment
                (10.27%
                )
                0.00%Deferred
      financing
                0.00%
                
                (7.60%
                )Accretion
                0.00%
                
                (2.10%
                )Valuation
      allowance
                (15.44%
                )
                0.00%Permanent
      differences
                (2.5%
                )
                0.00%Other,
      net
                (0.79%
                )
                (1.40%
                )Total
      effective rate
                5.98%
                
                19.60%
  Income
tax benefit was $1,026 and $1,042, respectively, for the years ended December
31, 2009 and 2008.





Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes, as well as operating loss and tax
credit carry forwards.  The tax effects of the temporary differences and
carry forwards are as follow at December 31, 2009 and 2008 (in
thousands):





December
      31, 2009
              
              
              December
      31, 2008Deferred
      tax assets:Allowance
      for bad debt
              
              $
              106
              
              
              $
              195Net
      operating loss
              
              
              3,779
              
              
              
              1,061Stock
      based compensation
              
              
              546
              
              
              
              316Section
      263 (a) adjustment
              
              
              52
              
              
              
              21Other
              
              
              48
              
              
              
              -Total
      deferred tax assets
              
              $
              4,531
              
              
              $
              1,593Deferred
      tax liabilities:Depreciation
      on property and equipment
              
              $
              (1,874
              )
              
              $
              (797
              )Intangible
      amortization
              
              
              314
              
              
              
              (1,390
              )Total
      deferred tax liabilities
              
              $
              (1,560
              )
              
              $
              (2,187
              )Less:
      valuation allowance
              
              
              (2,971
              )
              
              
              (316
              )Net
      deferred tax liabilities
              
              $
              -
              
              
              $
              (910
              )




We have
$10,605 in net operating loss (“NOL”) carry forwards available to offset future
or prior taxable income.  These federal NOL’s will expire in 2028. As of
December 31, 2009, these NOL’s are not limited under Section
382.





F-26





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





During
the year ended December 31, 2008, we recorded a deferred tax liability of $1,841
for the temporary difference arising from the intangible assets acquired in the
Mako transaction.





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 full
valuation allowance was needed due to our cumulative losses in recent
years.





Note
11:                       Related
Party Transactions





Ron
Smith, Eugene Butler and Robert Chamberlain (until his resignation from
this partnership effective September 1, 2009), are partners in Ship and Sail,
Inc., a vendor of Deep Down.  During 2009, we made payments of $583 to
Ship and Sail, and we had a prepaid balance of $38 as of December 31, 2009 which
has been expensed in 2010. The payments to Ship and Sail related to services
provided by that entity for the  support of the development of marine
technology which is planned for production in fiscal 2010, including specialized
services for provision of vessel access for design and testing, and office space
and related utilities.





On May
29, 2009, we consummated a purchase transaction with JUMA.  Pursuant to a
Purchase and Sale Agreement dated May 22, 2009, we acquired the Channelview
Property, which consists of 357 square feet and was purchased for $2,600. The
transaction was conducted on an arms-length basis and in accordance with normal
terms and conditions. See additional discussion in Note 5, Property, Plant and
Equipment and Note 6, Long-Term Debt.





Note
12:                       Commitments
and Contingencies





Litigation





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
material legal proceedings.





Leases





We lease
certain offices, facilities, equipment and vehicles under non-cancellable
operating and capital leases expiring at various dates through
2016.





At
December 31, 2009, future minimum contractual obligations were as follows (in
thousands):





Years
      ended December 31,:
              
              Capital Leases
              
              
              Operating Leases2010
              
              $
              143
              
              
              $
              5182011
              
              
              143
              
              
              
              3802012
              
              
              125
              
              
              
              3252013
              
              
              109
              
              
              
              2872014
              
              
              20
              
              
              
              175Thereafter
              
              
              -
              
              
              
              226Total
      minimum lease payments
              
              $
              540
              
              
              $
              1,911Residual
      principal balance
              
              
              105Amount
      representing interest
              
              
              (151
              )Present
      value of minimum lease payments
              
              $
              494Less
      current maturities of capital lease obligations
              
              
              88Long-term
      contractal obligations
              
              $
              406


F-27





Notes
to Consolidated Financial Statements for the Years ended December 31, 2009 and
2008





Rent
expense totaled $711 and $526 for the years ended December 31, 2009 and 2008,
respectively. The increase is due partially to increased leased space at
Flotation, and their inclusion for the full year in 2009, plus the new corporate
offices in Houston, Texas.





Letters
of Credit





Certain
customers could require us to issue a standby letter of credit (“L/C”) to ensure
performance under terms of the contract and with associated vendors and
subcontractors. In the event of default, the creditor could demand payment from
the issuing bank for the amount of the L/C.





In
December 2008, we amended the Revolver with Whitney to provide for L/Cs. During
the year ended December 31, 2009, we issued an irrevocable transferrable standby
L/C in the normal course of business, with an annual commission rate of 2.4
percent, for $1,107.  This L/C reduces the borrowing capacity under
the Revolver.

























F-28