UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



FORM 10-Q



|þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly
period ended June 30, 2012



OR

| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



Commission File No. 0-30351



DEEP DOWN, INC.

(Exact name of registrant as specified
in its charter)



|Nevada                                                         |  | 75-2263732                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation)                 |  | (I.R.S. Employer Identification No.)
|                                                               |  |                                     
|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





Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for
the past 90 days.þYes    ̈No



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). YesþNo  ̈



Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions
of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act. (Check one):





| | Large accelerated filer   ̈                                            | Accelerated filer   ̈        | 
| | --------------------------------------------------------------------- | --------------------------- | 
| |                                                                       |                             | 
| | Non-accelerated filer  ̈ (Do not check if a smaller reporting company) | Smaller reporting company R | 





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



At August 8,
2012, there were 10,165,916shares of common stock outstanding, par value $0.001 per share.












IMPORTANT INFORMATION REGARDING THIS
FORM 10-Q



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



Deep Down is the parent company to the
following wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”); 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. Effective December 31, 2010,
we engaged in a transaction in which all of the operating assets and substantially all of the liabilities of Flotation were contributed,
along with other contributions we made, to a joint venture entity named Cuming Flotation Technologies, LLC (“CFT”),
in return for a 20 percent common unit ownership interest in CFT. For a more detailed explanation of this transaction, refer to
our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, filed with the Securities
and Exchange Commission (“SEC” or the “Commission”) on April 15, 2011 and to our Current Report on
Form 8-K, filed with the SEC on October 14, 2011. This transaction impacts the presentation of our financial condition and
results of operations because it means that the operations of Flotation are no longer included in such presentation for periods
beginning January 1, 2011, except on the basis of our 20 percent common unit ownership interest in CFT. However, the operations
of Flotation will continue to be fully included in our presentation of historical information for periods ended December 31, 2010
and prior (since the acquisition of Flotation in 2008).



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



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



Forward-Looking Statements



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



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



Document Summaries



Descriptions of documents and agreements
contained in this Report are provided in summary form only, and such summaries are qualified in their entirety by reference to
the actual documents and agreements filed as exhibits to our Annual Report on Form 10-K for the year ended December 31, 2011, other
periodic and current reports we file with the SEC or this Report.



Access to Filings



Access to our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments thereto, filed with or furnished to the SEC pursuant
to Section 13(a) of the Exchange Act, as well as reports filed electronically pursuant to Section 16(a) of the Exchange Act, may
be obtained through our website (http://www.deepdowncorp.com) as soon as reasonably practicable after we have electronically
filed or furnished such material with the SEC. The contents of our website are not, and shall not be deemed to be, incorporated
into this Report.



ii









TABLE OF CONTENTS



PART I. FINANCIAL INFORMATION



|                           |                                                                                                                                     | Page No.
|-------------------------- | ----------------------------------------------------------------------------------------------------------------------------------- | --------
|                           |                                                                                                                                     |         
|Item 1.                    | Financial Statements                                                                                                                |         
|                           |                                                                                                                                     |         
|                           | Unaudited Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011                                              | 1       
|                           |                                                                                                                                     |         
|                           | Unaudited Condensed Consolidated Statements
        of Operations for the Three and Six Months Ended
        June 30, 2012 and 2011 | 2       
|                           |                                                                                                                                     |         
|                           | Unaudited Condensed Consolidated Statements
        of Cash Flows for the Six Months Ended
        June 30, 2012 and 2011           | 3       
|                           |                                                                                                                                     |         
|                           | Notes to Unaudited Condensed Consolidated Financial Statements                                                                      | 4       
|                           |                                                                                                                                     |         
|Item 2.                    | Management’s Discussion and Analysis of Financial Condition and Results of Operations                                               | 10      
|                           |                                                                                                                                     |         
|Item 4.                    | Controls and Procedures                                                                                                             | 15      
|                           |                                                                                                                                    
|PART II. OTHER INFORMATION
|                           |                                                                                                                                    
|Item 1.                    | Legal Proceedings                                                                                                                   | 16      
|                           |                                                                                                                                     |         
|Item 6.                    | Exhibits                                                                                                                            | 16      
|                           |                                                                                                                                     |         
|Signatures                 | 17                                                                                                                                 
|                           |                                                                                                                                    
|Exhibit Index              | 18                                                                                                                                 





iii





PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS



DEEP DOWN, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



|(In thousands, except par value amounts)                                                                                  |  |               |         |   |                   |  
|------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ----------------- | -
|ASSETS                                                                                                                    |  |               |         |   |                   |  
|Current assets:                                                                                                           |  | June 30, 2012 |         |   | December 31, 2011 |  
|Cash and cash equivalents                                                                                                 |  | $             | 4,105   |   |                   | $
|Accounts receivable, net of allowance of $48 and $27, respectively                                                        |  |               | 6,153   |   |                   |  
|Inventory                                                                                                                 |  |               | 254     |   |                   |  
|Costs and estimated earnings in excess of billings on uncompleted contracts                                               |  |               | 327     |   |                   |  
|Prepaid expenses and other current assets                                                                                 |  |               | 63      |   |                   |  
|Total current assets                                                                                                      |  |               | 10,902  |   |                   |  
|Property, plant and equipment, net                                                                                        |  |               | 13,754  |   |                   |  
|Investment in joint venture                                                                                               |  |               | 1,023   |   |                   |  
|Intangibles, net                                                                                                          |  |               | 2,327   |   |                   |  
|Goodwill                                                                                                                  |  |               | 4,916   |   |                   |  
|Other assets                                                                                                              |  |               | 418     |   |                   |  
|Total assets                                                                                                              |  | $             | 33,340  |   |                   | $
|                                                                                                                          |  |               |         |   |                   |  
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                      |  |               |         |   |                   |  
|Current liabilities:                                                                                                      |  |               |         |   |                   |  
|Accounts payable and accrued liabilities                                                                                  |  | $             | 3,458   |   |                   | $
|Billings in excess of costs and estimated earnings on uncompleted contracts                                               |  |               | 1,437   |   |                   |  
|Deferred revenues                                                                                                         |  |               | –       |   |                   |  
|Current portion of long-term debt                                                                                         |  |               | 2,763   |   |                   |  
|Total current liabilities                                                                                                 |  |               | 7,658   |   |                   |  
|Long-term debt, net                                                                                                       |  |               | 270     |   |                   |  
|Total liabilities                                                                                                         |  |               | 7,928   |   |                   |  
|                                                                                                                          |  |               |         |   |                   |  
|Commitments and contingencies (Note 10)                                                                                   |  |               |         |   |                   |  
|                                                                                                                          |  |               |         |   |                   |  
|Stockholders' equity:                                                                                                     |  |               |         |   |                   |  
|Preferred stock, $0.001 par value, 10,000 shares authorized,  0 shares issued and outstanding, respectively               |  |               | –       |   |                   |  
|Common stock, $0.001 par value, 24,500 shares authorized, 10,166  and 10,244 shares, respectively, issued and outstanding |  |               | 10      |   |                   |  
|Additional paid-in capital                                                                                                |  |               | 63,792  |   |                   |  
|Accumulated deficit                                                                                                       |  |               | (38,390 | ) |                   |  
|Total stockholders' equity                                                                                                |  |               | 25,412  |   |                   |  
|Total liabilities and stockholders' equity                                                                                |  | $             | 33,340  |   |                   | $



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



1





DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS

(Unaudited)





|                                                              |  | For the Three Months Ended
June 30, |        |   | For the Six Months Ended
June 30, |  
|------------------------------------------------------------- |  | ----------------------------------- | ------ | - | --------------------------------- | -
|(In thousands, except per share amounts)                      |  | 2012                                |        |   | 2011                              |  
|                                                              |  |                                     |        |   |                                   |  
|Revenues                                                      |  | $                                   | 7,904  |   |                                   | $
|Cost of sales:                                                |  |                                     |        |   |                                   |  
|Cost of sales                                                 |  |                                     | 4,714  |   |                                   |  
|Depreciation expense                                          |  |                                     | 319    |   |                                   |  
|Total cost of sales                                           |  |                                     | 5,033  |   |                                   |  
|Gross profit                                                  |  |                                     | 2,871  |   |                                   |  
|Operating expenses:                                           |  |                                     |        |   |                                   |  
|Selling, general and administrative                           |  |                                     | 2,013  |   |                                   |  
|Depreciation and amortization                                 |  |                                     | 143    |   |                                   |  
|Total operating expenses                                      |  |                                     | 2,156  |   |                                   |  
|Operating income (loss)                                       |  |                                     | 715    |   |                                   |  
|Other income (expense):                                       |  |                                     |        |   |                                   |  
|Interest expense, net                                         |  |                                     | (34    | ) |                                   |  
|Equity in net loss of joint venture                           |  |                                     | (32    | ) |                                   |  
|Other, net                                                    |  |                                     | 5      |   |                                   |  
|Total other income (expense)                                  |  |                                     | (61    | ) |                                   |  
|Income (loss) before income taxes                             |  |                                     | 654    |   |                                   |  
|Income tax expense                                            |  |                                     | (15    | ) |                                   |  
|Net income (loss)                                             |  | $                                   | 639    |   |                                   | $
|                                                              |  |                                     |        |   |                                   |  
|Net income (loss) per share, basic and diluted                |  | $                                   | 0.06   |   |                                   | $
|Weighted-average common shares outstanding, basic and diluted |  |                                     | 10,197 |   |                                   |  





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





2





DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS

(Unaudited)



|                                                                                                           |  | For the Six Months Ended |       
|---------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------
|                                                                                                           |  | June 30,                 |       
|(In thousands)                                                                                             |  | 2012                     |       
|Cash flows from operating activities:                                                                      |  |                          |       
|Net income (loss)                                                                                          |  | $                        | 339   
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:         |  |                          |       
|Equity in net loss of joint venture                                                                        |  |                          | 140   
|Share-based compensation                                                                                   |  |                          | 377   
|Debt forgiveness                                                                                           |  |                          | (10   
|Bad debt expense (credit)                                                                                  |  |                          | 92    
|Depreciation and amortization                                                                              |  |                          | 927   
|Gain on sale of property, plant and equipment                                                              |  |                          | (52   
|Changes in assets and liabilities:                                                                         |  |                          |       
|Accounts receivable                                                                                        |  |                          | (432  
|Inventory                                                                                                  |  |                          | (22   
|Costs and estimated earnings in excess of billings on uncompleted contracts                                |  |                          | (243  
|Prepaid expenses and other current assets                                                                  |  |                          | 199   
|Other assets                                                                                               |  |                          | 73    
|Accounts payable and accrued liabilities                                                                   |  |                          | 892   
|Deferred revenues                                                                                          |  |                          | (260  
|Billings in excess of costs and estimated earnings on uncompleted contracts                                |  |                          | (330  
|Net cash provided by (used in) operating activities                                                        |  |                          | 1,690 
|                                                                                                           |  |                          |       
|Cash flows from investing activities:                                                                      |  |                          |       
|Purchases of property, plant and equipment                                                                 |  |                          | (1,250
|Proceeds from sale of property, plant and equipment                                                        |  |                          | 72    
|Cash paid for patents                                                                                      |  |                          | (40   
|Cash paid for exclusive product rights                                                                     |  |                          | (125  
|Cash paid for capitalized software                                                                         |  |                          | –     
|Repayments on (cash paid for) notes receivable                                                             |  |                          | 50    
|Net cash used in investing activities                                                                      |  |                          | (1,293
|                                                                                                           |  |                          |       
|Cash flows from financing activities:                                                                      |  |                          |       
|Funds used for purchase of our common stock                                                                |  |                          | (48   
|Proceeds from bank term loan                                                                               |  |                          | –     
|Repayments of long-term debt                                                                               |  |                          | (1,223
|Net cash (used in) provided by financing activities                                                        |  |                          | (1,271
|Change in cash and equivalents                                                                             |  |                          | (874  
|Cash and cash equivalents, beginning of period                                                             |  |                          | 4,979 
|Cash and cash equivalents, end of period                                                                   |  | $                        | 4,105 
|                                                                                                           |  |                          |       
|Supplemental schedule of significant noncash transactions:                                                 |  |                          |       
|Property, plant and equipment acquired via capital lease                                                   |  | $                        | 1,200 
|Shares of common stock surrendered by employees related to payroll taxes on vested restricted stock awards |  | $                        | 41    





The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements

.

3







NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(Dollars in thousands except per share
amounts)



NOTE 1: BASIS OF PRESENTATION



Basis of Presentation



The accompanying
unauditedcondensedconsolidated financial statements of Deep Down, Inc. and its wholly-owned
subsidiaries (“Deep Down,” “we,” “us” or the “Company”) were prepared in accordance
with the rules and regulations of the Securities and Exchange Commission (“SEC” or the “Commission”) pertaining
to interim financial information and instructions to Form 10-Q.  As permitted under those rules, certain footnotes or other
financial information that are normally required by United States generally accepted accounting principles (“US GAAP”)
can be condensed or omitted.  Therefore, these statements should be read in conjunction with the audited consolidated
financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed
on March 29, 2012 with the Commission.



Preparation
of financial statements in conformity withUS GAAPrequires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, the disclosed amounts of contingent assets and liabilities
and the reported amounts of revenues and expenses. If the underlying estimates and assumptions upon which the financial statements
are based change in future periods, then the actual amounts realized may differ from those included in the accompanying condensed
consolidated financial statements.



In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Certain
prior period amounts have been reclassified to conform to current period presentation.



Principles of Consolidation



The unaudited condensed consolidated financial
statements presented herein include the accounts of Deep Down, Inc. and its wholly-owned subsidiaries. Our investment in a joint
venture is accounted for using the equity method. All material intercompany accounts and transactions have been eliminated in consolidation.



Segments



For the six months ended June 30, 2012
and 2011, our operating segments, Deep Down Delaware and Mako, have been aggregated into a single reporting segment. While the
operating segments have different product lines, they are similar. They are both service-based operations revolving around our
personnel’s expertise in the deepwater and ultra-deepwater industry, and any equipment is produced to a customer’s
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 operating 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, although we occasionally generate sales to international customers.



Subsequent Events



We have evaluated subsequent events from
July 1, 2012 through the date of this Report. See Note 13, “Subsequent Events”, for
a discussion of our reverse stock split (the “Reverse Stock Split”), which occurred July 18, 2012. As a result, the
share and per share amounts in this Quarterly Report on Form 10-Q have been retroactively restated.



NOTE 2: LIQUIDITY AND FINANCIAL CONDITION



On October 12, 2011, we received a cash
distribution of $6,375 from Cuming Flotation Technologies, LLC, a Delaware limited liability company (“CFT”) in which
we own a 20 percent common unit ownership interest. We believe the receipt of this cash distribution, in addition to cash we have
generated and expect to generate from operations, should ensure that we will have adequate liquidity to meet our future operating
requirements.



4







NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(Dollars in thousands except per share
amounts)



Historically, we have supplemented the
financing of our capital requirements through a combination of debt and equity transactions. Most significant in this regard has
been the credit facility we have maintained with Whitney Bank (“Whitney”). Our loan outstanding under our existing
credit agreement with Whitney becomes due April 15, 2013. We believe we will have sufficient liquidity to be able to repay this
loan, plus accrued interest thereon, monthly as scheduled through April 15, 2013, including a balloon principal payment of $1,708
due on that date if no extension is negotiated. We fully expect, however, that we will be able to negotiate an extension of the
due date of this loan.



At June 30, 2012, we had working capital (excluding the current
portion of long-term debt) of $6,007, including cash and cash equivalents of $4,105. Our total long-term debt at June 30, 2012
was $3,033.



NOTE 3: 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.



Ourfinancial
instruments consist primarily of cash and cash equivalents, trade receivables and payables and debt instruments.The
carrying values approximate their fair values due to the short-term maturities of these instruments.



NOTE 4: BILLINGS IN EXCESS OFCOSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS AND DEFERRED REVENUES



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



|                                                                                                 |  | June 30, 2012 |        |   | December 31, 2011 |  
|------------------------------------------------------------------------------------------------ |  | ------------- | ------ | - | ----------------- | -
|Costs incurred on uncompleted contracts                                                          |  | $             | 728    |   |                   | $
|Estimated earnings on uncompleted contracts                                                      |  |               | 489    |   |                   |  
|                                                                                                 |  |               | 1,217  |   |                   |  
|Less: Billings to date on uncompleted contracts                                                  |  |               | (2,327 | ) |                   |  
|                                                                                                 |  | $             | (1,110 | ) |                   | $
|Included in the accompanying condensed consolidated balance sheets under the following captions: |  |               |        |   |                   |  
|Costs and estimated earnings in excess of billings on uncompleted contracts                      |  | $             | 327    |   |                   | $
|Billings in excess of costs and estimated earnings on uncompleted contracts                      |  |               | (1,437 | ) |                   |  
|                                                                                                 |  | $             | (1,110 | ) |                   | $



The balance in billings in excess of costs and estimated earnings
on uncompleted contracts at June 30, 2012 and December 31, 2011 consisted
primarily of unearned milestone billings on fixed-price contracts.



5







NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(Dollars in thousands except per share
amounts)



NOTE 5: INVESTMENT IN JOINT VENTURE



Effective December 31, 2010, we engaged
in a transaction in which all of the operating assets and substantially all of the liabilities of Flotation were contributed, along
with other contributions we made, to a joint venture entity named Cuming Flotation Technologies, LLC, in return for a 20 percent
common unit ownership interest.



On October 7, 2011, CFT consummated a transaction
pursuant to that certain Stock Purchase Agreement (the “Purchase Agreement”), by and between CFT and a Houston-based
company (“Buyer”)  pursuant to which Buyer purchased from CFT (i) all of the issued and outstanding shares
of capital stock of Cuming Corporation (“Cuming”), the principal operating subsidiary of CFT, (ii) the shares of 230
Bodwell Corporation, a Massachusetts corporation and subsidiary of Cuming, and (iii) certain assets that, immediately prior to
closing, were acquired by Cuming, for a purchase price of $60,000 (less certain debt and subject to purchase price adjustment for
working capital and potential earn-out payments).



We are entitled to 20 percent of future
earn-out proceeds from the sale. The amount of earn-out earned by CFT for the period October 7, 2011 through December 31, 2012
will not be known until March 31, 2013. As a result, the results of CFT presented below do not include any accrual of potential
earn-out proceeds.



The components of our Investment
in joint ventureare summarized below:



|Investment in joint venture, December 31, 2011                             |  | $ | 1,163 |  
|-------------------------------------------------------------------------- |  | - | ----- | -
|Equity in net loss of joint venture for the six months ended June 30, 2012 |  |   | (140  | )
|Investment in joint venture, June 30, 2012                                 |  | $ | 1,023 |  



Summary joint venture financial data is as follows:



|             |  | For the Three Months Ended
June 30, |       |  | For the Six Months Ended
June 30, |  
|------------ |  | ----------------------------------- | ----- |  | --------------------------------- | -
|             |  | 2012                                |       |  | 2011                              |  
|Revenues     |  | $                                   | 1,257 |  |                                   | $
|             |  |                                     |       |  |                                   |  
|Gross profit |  | $                                   | 526   |  |                                   | $
|             |  |                                     |       |  |                                   |  
|Net loss     |  | $                                   | 159   |  |                                   | $



NOTE 6: PROPERTY, PLANT AND EQUIPMENT



The components of net property, plant and
equipment are summarized below:



|                                          |  | June 30, 2012 |        |   | December 31, 2011 |   |        | Range of Asset Lives | 
|----------------------------------------- |  | ------------- | ------ | - | ----------------- | - | ------ | -------------------- | 
|Land                                      |  | $             | 1,582  |   |                   | $ | 1,492  |                      | 
|Buildings and improvements                |  |               | 1,555  |   |                   |   | 1,540  |                      | 
|Leasehold improvements                    |  |               | 221    |   |                   |   | 221    |                      | 
|Equipment                                 |  |               | 13,467 |   |                   |   | 12,113 |                      | 
|Furniture, computers and office equipment |  |               | 1,235  |   |                   |   | 1,101  |                      | 
|Construction in progress                  |  |               | 1,234  |   |                   |   | 440    |                      | 
|Total property, plant and equipment       |  |               | 19,294 |   |                   |   | 16,907 |                      | 
|Less: Accumulated depreciation            |  |               | (5,540 | ) |                   |   | (4,871 | )                    | 
|Property, plant and equipment, net        |  | $             | 13,754 |   |                   | $ | 12,036 |                      | 



6







NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(Dollars in thousands except per share
amounts)



NOTE 7: LONG-TERM DEBT



The components of long-term debt are summarized
below:



|                                        |  | June 30, 2012 |        |   | December 31, 2011 |  
|--------------------------------------- |  | ------------- | ------ | - | ----------------- | -
|Secured credit agreement - Whitney Bank |  | $             | 1,884  |   |                   | $
|6% Subordinated debenture               |  |               | –      |   |                   |  
|Capital lease obligations               |  |               | 1,149  |   |                   |  
|Total debt                              |  |               | 3,033  |   |                   |  
|Less: Current portion of long-term debt |  |               | (2,763 | ) |                   |  
|Long-term debt, net of current portion  |  | $             | 270    |   |                   | $



Whitney Credit Agreement



We originally entered into our credit agreement
with Whitney in November 2008 to provide us with revolving and letter of credit facilities for our operations.  Our credit
facility has been amended and/or restated four times, most recently on May 14, 2012, when we entered into the Fourth Amendment
to the Amended and Restated Credit Agreement (“Fourth Amended Credit Agreement”) with Whitney effective as of April
15, 2012.  The Fourth Amended Credit Agreement (i) converted our original $1,150 term loan to a revolving loan amount
of $2,000 (“Revolving Loan”), (ii) extended the maturity date of existing indebtedness to April 15, 2013, (iii) and
lowered the interest rate of all loans from 6.5 percent fixed annual rate to a 4.0 percent fixed annual rate.



As of June 30, 2012, the outstanding indebtedness
to Whitney under the Fourth Amended Credit Agreement consisted of $85 for a term loan, which was paid in full on August 1, 2012,
and $1,799 for a real estate loan related to our Channelview, Texas facility land and buildings. There was no indebtedness related
to the Revolving Loan at June 30, 2012.



The Fourth Amended Credit Agreement obligates
us to comply with the following financial covenants:



| | — | Leverage Ratio - The ratio of total debt to consolidated EBITDA must be less than 3.0 to 1.0.                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | — | Fixed Charge Coverage Ratio -The ratio of consolidated EBITDA to consolidated net interest expense, plus principal payments on total debt, must be greater than 1.5 to 1.0.                                             
| | — | Tangible Net Worth - Our consolidated net worth, after deducting other assets as are properly classified as “intangible assets,” plus 50 percent of net income, after provision for taxes, must be in excess of $13,000.
| | — | Moreover, we continue to have obligations for other covenants, including, among others, limitations on issuance of common stock, liens, transactions with affiliates, additional indebtedness and permitted investments.

As of June 30, 2012, we were in compliance
with all of the aforementioned financial covenants.



Other Debt



We had a subordinated debenture in the
original outstanding principal amount of $500 that originated from the exchange of preferred stock in a prior year. The subordinated
debenture had a fixed annual interest rate of 6.0 percent per annum, and interest was required to be paid annually on March 31st.
The subordinated debenture matured on March 31, 2011 and we made the payment of accrued interest as required. However, we agreed
to terms for an extension of the maturity of the subordinated debenture to May 2012. On February 8, 2012, we settled the remaining
$160 balance of the subordinated debenture for a cash payment of $150. The holder of the subordinated debenture forgave the remaining
$10 principal balance.



7







NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(Dollars in thousands except per share
amounts)



NOTE 8: SHARE-BASED COMPENSATION



We have a share-based compensation plan, the “2003 Directors,
Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan” (the “Plan”). Awards of stock options
and stock granted under the Plan have vesting periods of three years. Some awards of stock have performance criteria as an additional
condition of vesting. Once vested, stock options may be exercised for up to five years. Share-based compensation expense related
to awards is based on the fair value at the date of grant, and is recognized over the vesting periods, net of estimated forfeitures.
The value of performance-based awards is recognized as expense only when it is considered probable that the performance criteria
will be met.



Summary of Shares of Restricted Stock



For the six months ended June 30, 2012
and 2011, we recognized a total of $172and $45, respectively,
of share-based compensation expense related to restricted stock awards, which is included in selling, general and administrative
expenses in the accompanying condensed consolidated statements of operations. There was no unamortized estimated fair value of
non-vested stock awards at June 30, 2012.



Summary of Stock Options



For the six months ended June 30, 2012
and 2011, we recognized a total of $205 and $114, respectively,
of share-based compensation expense related to restricted stock option awards, which is included in selling, general and administrative
expenses in the accompanying condensed consolidated statements of operations. The unamortized portion of the estimated fair value
of non-vested stock options was $239at June 30, 2012.



NOTE 9: INCOME TAXES



Income tax expense during interim periods
is based on applying the estimated annual effective income tax rate to interim period operations. The estimated annual effective
income tax rate may vary from the statutory rate due to the impact of permanent tax difference items relative to our net income,
as well as by any valuation allowance recorded.  We employ an asset and liability approach that results in the recognition
of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial
basis and the tax basis of those assets and liabilities. A valuation allowance is established when it is more likely than not that
some of the deferred tax assets will not be realized.  Although our future projections indicate that we may be able to
realize some of these deferred tax assets, due to the degree of uncertainty of these projections, at June 30, 2012 management has
recorded a full deferred tax asset valuation allowance.



NOTE 10:COMMITMENTS
AND CONTINGENCIES



Litigation



From time to time, we are involved in legal
proceedings arising in the normal course of business. As of the date of this Report, we are not currently involved in any material
actual or pending legal proceedings.



Operating Leases



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



Letters of Credit



Certain of our customers could require
us to issue standby letters of credit (“LC”) in the ordinary course of business to ensure performance under terms of
a contract or as a form of product warranty. We are able to do this through our facility with Whitney. The beneficiary could demand
payment from Whitney for the amount of the outstanding LC. There was $470 in performance-related LC’s outstanding and $592
in warranty-related LC’s outstanding at both June 30, 2012 and December 31, 2011.



8







NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

(Dollars in thousands except per share
amounts)



NOTE 11: EARNINGS PER COMMON SHARE



Basic earnings per share (“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 plus dilutive common stock equivalents
(warrants and stock options) outstanding during the period. Diluted EPS reflects the potential dilution that could occur if warrants
and options to purchase common stock were exercised.



At June 30, 2012 and 2011, there were outstanding
warrants convertible to 22 shares of common stock. At June 30, 2012 and 2011, there were outstanding stock options convertible
to 609 and 287 shares of common stock, respectively. For the six months ended June 30, 2012 and 2011, there were no potentially
dilutive common stock equivalents that were included in the computation of diluted earnings per share because the exercise price
for the outstanding warrants and options exceeded the average market price for our common stock.



NOTE 12: STOCKHOLDERS’ EQUITY



Common Stock



The number of shares of common stock outstanding
is as follows:



|Balance, December 31, 2011                                      |  |  | 10,244 |  
|--------------------------------------------------------------- |  |  | ------ | -
|Shares purchased and retired, March 2, 2012                     |  |  | (40    | )
|Shares surrendered for payroll taxes and retired, June 13, 2012 |  |  | (38    | )
|Balance, June 30, 2012                                          |  |  | 10,166 |  



NOTE 13: SUBSEQUENT EVENTS



On July 17, 2012, we filed a Certificate
of Change with the Nevada Secretary of State for the purposes of reducing the number of authorized and outstanding shares of the
Company’s common stock, on a basis of one share of common stock for each twenty shares of common stock outstanding. The change
was effective as of July 18, 2012.



Immediately before the Reverse Stock Split,
the Company had 490,000 shares of common stock authorized, of which 203,318 shares of common stock were outstanding. As a result
of the Reverse Stock Split, the Company now has 24,500 authorized shares of common stock, of which 10,166 shares were outstanding
as of June 30, 2012.



The share and per share amounts in this Quarterly Report on
Form 10-Q have been retroactively restated to reflect the effect of the Reverse Stock Split.







9





ITEM 2. MANAGEMENT’S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The following discussion and analysis provides
information that management believes is relevant for an assessment and understanding of our results of operations and financial
condition. This information should be read in conjunction with our audited historical consolidated financial statements, which
are included in our Form 10-K for the fiscal year ended December 31, 2011, filed with the Securities and Exchange Commission on
March 29, 2012, and our unaudited condensed consolidated financial statements and notes thereto included with this Quarterly Report
on Form 10-Q in Part I. Item 1 “Financial Statements.”



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, buoyancy products and services, remotely operated vehicles (“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.



In Part I. Item 2 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” all dollar and share amounts are in thousands
unless otherwise indicated.



Industry and Executive Outlook



During the three months ended June 30,
2012, our subsea solutions services performed robustly due to continued strong demand for our technologically innovative solutions.
We expect this strong demand to continue during the remainder of 2012 and beyond, as evidenced by the addition of more than $6,300
to backlog since our last Report, bringing our total backlog to approximately $17,700 as of the date of this Report.



During the three months ended June 30,
2012, our ROV and topside equipment rental services were adversely affected by decreased demand caused by the slow permitting
process impacting offshore installation and construction activities in the Gulf of Mexico. We believe the permitting process is
improving, which we anticipate will benefit our operating results for the remainder of 2012 and beyond.



The deepwater and ultra-deepwater industry
remains one of the best frontiers for adding large hydrocarbon reserves with high production flow rates. We are well positioned
to supply services and products required to support safe offshore and deepwater projects of our customers. We anticipate demand
for our deepwater and ultra-deepwater services and products will continue to grow and we will continue to focus on this sector
of the industry worldwide.



Our focus remains on successful execution
of our projects, obtaining new project awards and effective cash management.



Recent Events



On July 18, 2012, we completed a one-for-twenty
reverse stock split of our authorized and outstanding common stock (the “Reverse Stock Split”). Immediately before
the Reverse Stock Split, the Company had 490,000 shares of common stock authorized, of which 203,318 shares were outstanding. As
a result of the Reverse Stock Split, the Company has 24,500 authorized shares of common stock, of which 10,166 shares are outstanding.
The purpose of the Reverse Stock Split was to increase the per share trading price of common stock in an effort to attract a larger
pool of investors.



On July 20, 2012, we announced that we
received multiple contracts from an international operator and a major international controls manufacturer for the manufacture
of flying leads and associated services for which we expect to charge in excess of $2,300.



The first contract is for additional flying
leads, equipment and services in support of a project located offshore Ghana, West Africa with delivery scheduled in the third
quarter of 2012. The second contract, which is also scheduled for delivery in the third quarter of 2012, is for installation on
a project in the U.S. Gulf of Mexico. The third contract is for a project on the Northwest Coast of Australia, with delivery scheduled
in the first quarter of 2013.



10











On August 8, 2012, we announced that we
were successful in our proposal to a major international umbilical manufacturer for the manufacture, installation and commissioning
of a portable umbilical carousel. The project is expected to generate approximately $4,000 in revenue and is scheduled for delivery
in the second quarter of 2013.





Results of Operations



Three Months Ended June 30, 2012 Compared
to Three Months Ended June 30, 2011



Revenues.Revenues for the three
months ended June 30, 2012 were $7,904. Revenues for the three months ended June 30, 2011 were $7,094. The $810 increase in revenues
in the 2012 period was due to an increase of $2,319 in our subsea solutions operating segment due to continued strong demand for
our technologically innovative solutions, offset by a decrease of $1,509 in our ROV and topside equipment rental services due to
decreased demand. During the three months ended June 30, 2011, we were still renting equipment and performing services related
to the Macondo well spill cleanup activities.



Gross Profit. Gross profit for the
three months ended June 30, 2012 was $2,871, or 36 percent of revenues. Gross profit for the three months ended June 30, 2011 was
$1,857, or 26 percent of revenues. The $1,014, or 10 percentage-point, increase in gross profit in the 2012 period compared to
the same period in 2011, was due primarily to a $1,863 increase related to our subsea solutions operating segment, due to strong
demand for our services. In addition, under a previously existing intercompany agreement which was contributed by Flotation to
CFT on December 31, 2010, in the 2011 period, we sub-contracted $2,519 of work on a major fabrication contract to CFT, on which
we realized no gross profit. This increase was offset by an $849 decrease related to our ROV and topside equipment rental services
due, as previously mentioned, to much weaker demand in the 2012 period than in the 2011 period.



Selling, general and administrative
expenses. Selling, general and administrative expenses (“SG&A”) for the three months ended June 30, 2012 were
$2,013. SG&A for the three months ended June 30, 2011 was $1,433. The $580 increase in SG&A in the 2012 period compared
to the 2011 period was due primarily to a $271 increase in bad debt expense, and a $218 increase in share-based compensation expense.
We also had no reimbursements from CFT (our joint venture) for management services in the 2012 period, compared to $169 in the
2011 period. Partially offsetting these increases was a $144 decrease in professional services fees primarily as a result of a
reduction in accounting and auditing fees.



Depreciation and amortization expense.Depreciation and amortization expense (“D&A”) for the three months ended June 30, 2012 was $143, consisting
of amortization expense of $107, and non-cost of sales depreciation expense of $36. D&A for the three months ended June 30,
2011 was $201, consisting of amortization expense of $103, and non-cost of sales depreciation expense of $98. The amortization
relates to our intangible assets and the depreciation relates to property, plant and equipment not used in the generation of revenue.
The $62 reduction in non-cost of sales depreciation expense is the result of many of our non-revenue generating assets becoming
fully depreciated.



Interest expense, net. Interest
expense, net was $34 for the three months ended June 30, 2012. Interest expense, net was $58 for the three months ended June 30,
2011. Net interest expense for each period was generated by outstanding bank debt and capital lease obligations, offset by interest
income earned on cash and short-term investments. The $24 decrease in the 2012 period compared to the 2011 period is due primarily
to the company having lower average interest-bearing obligations in the 2012 period than in the 2011 period.



Equity in net loss of joint venture.
Equity in net loss of joint venture for the three months ended June 30, 2012 was $32.  At
June 30, 2012, no accrual for potential earn-out proceeds has been recorded because the amount will not be known until March 31,
2013. Equity in net loss of joint venture for the three months ended June 30, 2011 was $202. The joint
venture sold its primary operating subsidiary on October 7, 2011, thereby causing the joint venture to have minimal activity subsequent
to that date.



Modified EBITDA. Our management
evaluates our performance based on a non-GAAP measure, which consists of earnings (net income or loss) available to common shareholders
before net interest expense, income taxes, non-cash share-based compensation expense, equity in net income or loss of joint venture,
non-cash impairments, depreciation and amortization, other non-cash items and one-time charges (“Modified EBITDA”).  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 US 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
US GAAP. The amounts included in the Modified EBITDA calculation, however, are derived from amounts included in the accompanying
consolidated statements of operations.



11







We believe Modified EBITDA is useful to
investors in evaluating our operating performance because it is widely used to measure a company’s operating performance,
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); asset base (primarily
depreciation and amortization); actions that do not affect liquidity (share-based compensation expense, equity in net income or
loss of joint venture) 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
income (loss) to Modified EBITDA for the three months ended June 30, 2012 and 2011:



|                                                  |  | For the Three Months Ended June 30, |      
|------------------------------------------------- |  | ----------------------------------- | -----
|                                                  |  | 2012                                |      
|Net income (loss)                                 |  | $                                   | 639  
|Add back interest expense, net of interest income |  |                                     | 34   
|Add back depreciation and amortization            |  |                                     | 462  
|Add back income tax expense                       |  |                                     | 15   
|Add back share-based compensation                 |  |                                     | 246  
|Add back equity in net loss of joint venture      |  |                                     | 32   
|Modified EBITDA                                   |  | $                                   | 1,428



Modified EBITDA for the three months ended
June 30, 2012 was $1,428. Modified EBITDA for the three months ended June 30, 2011 was $768.
Modified EBITDA increased $660 from the 2011 period to the 2012 period primarily due to increased gross profit before depreciation
expense of $1,023, partially offset by increased SG&A before share-based compensation expense of $362.



Six Months Ended June 30, 2012 Compared
to Six Months Ended June 30, 2011



Revenues.Revenues for the six months
ended June 30, 2012 were $12,777. Revenues for the six months ended June 30, 2011 were $13,378. The decrease of $601 is due primarily
to a reduction of $2,434 as a result of decreased demand for our ROV and topside equipment rental services in the first half of
2012 compared to the same period in 2011. During the six months ended June 30, 2011 we were still renting equipment and performing
services related to the Macondo well spill cleanup activities. The reduction is partially offset by an increase of $1,833 in our
subsea solutions operating segment, due to continued strong demand for our technologically innovative solutions.



Gross Profit. Gross profit for the
six months ended June 30, 2012 was $ 4,806, or 38 percent of revenues. Gross profit for the six months ended June 30, 2011 was
$3,044 or 23 percent of revenues. The $1,762, or 15 percentage-point, increase in gross profit in the 2012 period compared to the
same period in 2011, was due primarily to a $3,295 increase related to our subsea solutions operating segment, due to strong demand
for our services. In addition, under a previously existing intercompany agreement which was contributed by Flotation to CFT on
December 31, 2010, in the 2011 period, we sub-contracted $4,691 of work on a major fabrication contract to CFT, on which we realized
no gross profit. This increase was offset by a $1,533 decrease related to our ROV and topside equipment rental services due, as
previously mentioned, to much weaker demand in the 2012 period than in the 2011 period.



Selling, general and administrative
expenses. Selling, general and administrative expenses (“SG&A”) for the six months ended June 30, 2012 were
$3,982. SG&A for the six months ended June 30, 2011 was $4,005. The $23 decrease was driven primarily by an $810 reduction
in professional fees primarily due to decreased accounting and auditing fees, and $137 in savings associated with our cost containment
program. These decreases were offset by a $389 reduction in management services reimbursements from CFT; a $317 increase in bad
debt expense; and a $218 increase in share-based compensation expense.



12







Depreciation and amortization expense.Depreciation and amortization expense (“D&A”) for the six months ended June 30, 2012 was $292, consisting of
amortization expense of $215, and non-cost of sales depreciation expense of $77. D&A for the six months ended June 30, 2011
was $367, consisting of amortization expense of $207, and non-cost of sales depreciation expense of $160. The $83 reduction in
non-cost of sales depreciation expense is the result of many of our non-revenue generating assets becoming fully depreciated.



Interest expense, net. Interest expense, net for the
six months ended June 30, 2012 was $86. Interest expense, net for the six months ended June 30, 2011 was $148. Net interest expense
for each period was generated by outstanding bank debt and capital lease obligations, offset by interest income earned on cash
and short-term investments. The $62 decrease in the 2012 period compared to the 2011 period is due primarily to the company having
lower average interest-bearing obligations in the 2012 period than in the 2011 period.



Equity in net loss of joint venture.
Equity in net loss of joint venture for the six months ended June 30, 2012 was $140.  At
June 30, 2012, no accrual for potential earn-out proceeds has been recorded because the amount will not be known until March 31,
2013. Equity in net loss of joint venture for the six months ended June 30, 2011 was $316. The joint
venture sold its primary operating subsidiary on October 7, 2011, thereby causing the joint venture to have minimal activity subsequent
to that date.



Modified EBITDA. As noted above,
our management evaluates our performance based on Modified EBITDA.  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 US 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 US GAAP. The amounts included in the Modified EBITDA
calculation, however, are derived from amounts included in the accompanying consolidated statements of operations.



We believe Modified EBITDA is useful to
investors in evaluating our operating performance because it is widely used to measure a company’s operating performance,
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); asset base (primarily
depreciation and amortization); actions that do not affect liquidity (share-based compensation expense, equity in net income or
loss of joint venture) 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
income (loss) to Modified EBITDA for the six months ended June 30, 2012 and 2011:



|                                                  |  | For the Six Months Ended June 30, |      
|------------------------------------------------- |  | --------------------------------- | -----
|                                                  |  | 2012                              |      
|Net income (loss)                                 |  | $                                 | 339  
|Add back interest expense, net of interest income |  |                                   | 86   
|Add back depreciation and amortization            |  |                                   | 927  
|Add back income tax expense                       |  |                                   | 19   
|Add back share-based compensation                 |  |                                   | 377  
|Add back equity in net loss of joint venture      |  |                                   | 140  
|Modified EBITDA                                   |  | $                                 | 1,888



Modified EBITDA for the six months ended
June 30, 2012 was $1,888. Modified EBITDA for the six months ended June 30, 2011 was $(195).
Modified EBITDA increased $2,083 from the 2011 period to the 2012 period primarily due to increased gross profit before depreciation
expense of $1,806 and reduced SG&A before share-based compensation expense of $241.



13







Liquidity and Capital Resources



Overview



As a deepwater 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 production, and to 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 payment by a significant customer or delays in completion
of our contracts for any reason. While our objective is to enter into contracts with our customers that are cash flow positive,
we may not always be able to achieve this objective.



On October 12, 2011, we received a cash
distribution of $6,375 from Cuming Flotation Technologies, LLC, a Delaware limited liability company (“CFT”) in which
we own a 20 percent common unit ownership interest. We believe the receipt of this cash distribution, in addition to cash we have
generated and expect to generate from operations, should ensure that we will have adequate liquidity to meet our future operating
requirements.



Historically, we have supplemented the
financing of our capital requirements through a combination of debt and equity transactions. Most significant in this regard has
been the credit facility we have maintained with Whitney Bank (“Whitney”). Our loan outstanding under our existing
credit agreement with Whitney becomes due April 15, 2013. We believe we will have sufficient liquidity to be able to repay this
loan, plus accrued interest thereon, monthly as scheduled through April 15, 2013, including a balloon principal payment of $1,708
due on that date if no extension is negotiated. We fully expect, however, that we will be able to negotiate an extension of the
due date of this loan.



Our credit agreement with Whitney obligates
us to comply with the following financial covenants:



| | — | Leverage Ratio - The ratio of total debt to consolidated EBITDA must be less than 3.0 to 1.0; actual Leverage Ratio at June 30, 2012: 0.38 to 1.0.                                                                                                                              
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | — | Fixed Charge Coverage Ratio -The ratio of consolidated EBITDA to consolidated net interest expense, plus principal payments on total debt, must be greater than 1.5 to 1.0; actual Fixed Charge Coverage Ratio as of June 30, 2012: 3.00 to 1.0.                                
| | — | Tangible Net Worth - Our consolidated net worth, after deducting other assets as are properly classified as “intangible assets,” plus 50 percent of net income, after provision for taxes, must be in excess of $13,000; actual Tangible Net Worth as of June 30, 2012: $18,439.

As of June 30, 2012, we were in compliance
with all of the aforementioned financial covenants.



At June 30, 2012, we had working capital (excluding the current
portion of long-term debt) of $6,007, including cash and cash equivalents of $4,105. Our total long-term debt at June 30, 2012
was $3,033.



14





Critical Accounting Policy Updates



The discussion and analysis of our financial
condition and results of operations is based on our unaudited condensed 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, impairments of long-lived assets, including
intangibles and 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.



Refer to Part II. Item 2 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year
ended December 31, 2011 for a discussion of our Critical Accounting Policies.



Inflation and Seasonality



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



Off-Balance Sheet Arrangements



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



ITEM 4. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and
Procedures.   The Company’s disclosure controls and procedures are designed to ensure that such information
required to be disclosed by the Company in reports filed or submitted under the Exchange Act as amended, is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and forms. The Company’s disclosure controls
and procedures are also designed to ensure that such information is accumulated and communicated to management, including the principal
executive and the principal financial officer, as appropriate to allow timely decisions regarding required disclosures. There are
inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human
error and the circumvention or overriding of controls and procedures. Accordingly, even effective disclosure controls and procedures
can only provide reasonable assurance that control objectives are attained. The Company’s disclosure controls and procedures
are designed to provide such reasonable assurance.



The Company’s management, with the
participation of the principal executive and principal financial officer, evaluated the effectiveness of the design and operation
of the Company’s disclosure controls and procedures as of June 30, 2012, as required by Rule 13a-15(e) of the Exchange
Act. Based upon that evaluation, the principal executive and the principal financial officer have concluded that the Company’s
disclosure controls and procedures were effective as of June 30, 2012.



Management’s Report on Internal
Control Over Financial Reporting.The Company’s management is responsible
for establishing and maintaining adequate internal controls over financial reporting, as defined in Rule 13a-15(f) of the
Exchange Act. Although the internal controls over financial reporting were not audited, the Company’s management, including
the principal executive and principal financial officer, assessed the effectiveness of internal controls over financial reporting
as of June 30, 2012, based on criteria issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO) entitledInternal Control-Integrated Framework.” Upon evaluation, the Company’s
management has concluded that the Company’s internal controls over financial reporting were effective as of June 30, 2012.

Changes in Internal Control Over Financial Reporting.   The Company’s management,
with the participation of the principal executive and principal financial officer, has concluded that there were no changes in
internal control over financial reporting during the fiscal quarter ended June 30, 2012.



15





PART II. – OTHER INFORMATION



ITEM 1. LEGAL
PROCEEDINGS

From time to time, we are involved in legal
proceedings arising in the normal course of business. As of the date of this Quarterly Report on Form 10-Q, we are currently not
involved in any pending, material legal proceedings.



ITEM 6. EXHIBITS



Exhibits required to be attached by Item
601 of Regulation S-K are listed in the Index of Exhibits of this Quarterly Report on Form 10-Q, which is incorporated herein by
reference.



|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       | Certificate of Change filed the Secretary of State of the State of Nevada on July 17, 2012 (incorporated by reference from Form 8-K filed on July 19, 2012).                                                                                                                              
|          |                                                                                                                                                                                                                                                                                           
|3.3       | Amended and Restated ByLaws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008).                                                                                                                                                   
|          |                                                                                                                                                                                                                                                                                           
|31.1*     | Certification of Ronald E. Smith, President and Chief Executive Officer, furnished pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.                                                                                                          
|          |                                                                                                                                                                                                                                                                                           
|31.2*     | Certification of Eugene L. Butler, Chief Financial Officer, furnished pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.                                                                                                                       
|          |                                                                                                                                                                                                                                                                                           
|32.1*     | Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc.                                                                                                                                                                                                
|          |                                                                                                                                                                                                                                                                                           
|32*       | Statement of Ronald E. Smith, President and Chief Executive Officer and Eugene L. Butler, Chief Financial Officer, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                    
|          |                                                                                                                                                                                                                                                                                           
|101.INS** | XBRL Instance Document                                                                                                                                                                                                                                                                    
|          |                                                                                                                                                                                                                                                                                           
|101.SCH** | XBRL Schema Document                                                                                                                                                                                                                                                                      
|          |                                                                                                                                                                                                                                                                                           
|101.CAL** | XBRL Calculation Linkbase Document                                                                                                                                                                                                                                                        
|          |                                                                                                                                                                                                                                                                                           
|101.DEF** | XBRL Definition Linkbase Document                                                                                                                                                                                                                                                         
|          |                                                                                                                                                                                                                                                                                           
|101.LAB** | XBRL Label Linkbase Document                                                                                                                                                                                                                                                              
|          |                                                                                                                                                                                                                                                                                           
|101.PRE** | XBRL Presentation Linkbase Document                                                                                                                                                                                                                                                       










* Filed or furnished herewith.



** Pursuant to Rule 405(a)(2) of Regulation S-T, the Company
will furnish the XBRL Interactive Data Files with detailed footnote tagging as Exhibit 101 in an amendment to this Form 10-Q within
the permitted 30-day grace period for the first quarterly period in which detailed footnote tagging is required after the filing
date of this Form 10-Q.









16





SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





|                      | DEEP DOWN, INC.
        (Registrant)
|--------------------- | ------------------------------------
|Date:  August 9, 2012 |                                     
|                      | By:                                 
|                      |                                     
|                      |                                     













17





INDEX TO EXHIBITS



|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       | Certificate of Change filed the Secretary of State of the State of Nevada on July 17, 2012 (incorporated by reference from Form 8-K filed on July 19, 2012).                                                                                                                              
|          |                                                                                                                                                                                                                                                                                           
|3.3       | Amended and Restated ByLaws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008).                                                                                                                                                   
|          |                                                                                                                                                                                                                                                                                           
|31.1*     | Certification of Ronald E. Smith, President and Chief Executive Officer, furnished pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.                                                                                                          
|          |                                                                                                                                                                                                                                                                                           
|31.2*     | Certification of Eugene L. Butler, Chief Financial Officer, furnished pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.                                                                                                                       
|          |                                                                                                                                                                                                                                                                                           
|32.1*     | Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc.                                                                                                                                                                                                
|          |                                                                                                                                                                                                                                                                                           
|32*       | Statement of Ronald E. Smith, President and Chief Executive Officer and Eugene L. Butler, Chief Financial Officer, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                    
|          |                                                                                                                                                                                                                                                                                           
|101.INS** | XBRL Instance Document                                                                                                                                                                                                                                                                    
|          |                                                                                                                                                                                                                                                                                           
|101.SCH** | XBRL Schema Document                                                                                                                                                                                                                                                                      
|          |                                                                                                                                                                                                                                                                                           
|101.CAL** | XBRL Calculation Linkbase Document                                                                                                                                                                                                                                                        
|          |                                                                                                                                                                                                                                                                                           
|101.DEF** | XBRL Definition Linkbase Document                                                                                                                                                                                                                                                         
|          |                                                                                                                                                                                                                                                                                           
|101.LAB** | XBRL Label Linkbase Document                                                                                                                                                                                                                                                              
|          |                                                                                                                                                                                                                                                                                           
|101.PRE** | XBRL Presentation Linkbase Document                                                                                                                                                                                                                                                       










* Filed or furnished herewith.

** Pursuant to Rule 405(a)(2) of Regulation S-T, the Company
will furnish the XBRL Interactive Data Files with detailed footnote tagging as Exhibit 101 in an amendment to this Form 10-Q within
the permitted 30-day grace period for the first quarterly period in which detailed footnote tagging is required after the filing
date of this Form 10-Q.









18