UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON
D.C. 20549





FORM
10-Q





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





For
the quarterly period ended September 30, 2009





OR




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





Commission
File No. 0-30351





DEEP
DOWN, INC.


(Exact
name of registrant as specified in its charter)





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





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





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes  ̈   No x





At
November 16, 2009, there were 180,450,630 shares of common stock
outstanding.


IMPORTANT
INFORMATION REGARDING THIS FORM 10-Q





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




Deep
Down, Inc., a Nevada corporation (“Deep Down”), is the parent company to its
wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down
Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), Mako
Technologies, LLC, a Nevada limited liability company (“Mako”), Flotation
Technologies, Inc., a Maine corporation (“Flotation”), since its acquisition
effective May 1, 2008, and Deep Down International Holdings, LLC, a Nevada
corporation (“DDIH”) since its formation in February 2009.





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





Forward-Looking
Statements





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





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





Subsequent
Events





All
statements contained in this Quarterly Report on Form 10-Q, including the
forward-looking statements discussed above, are made as of November 16, 2009,
unless those statements are expressly made as of another date.  We
disclaim any responsibility for the accuracy of any information contained in
this Quarterly Report on Form 10-Q to the extent such information is affected or
impacted by events, circumstances or developments occurring after November 16,
2009 or by the passage of time after such date.  Except to the extent
required by applicable securities laws, we expressly disclaim any obligation or
undertakings to release publicly any updates or revisions to any statement or
information contained in this Quarterly Report on Form 10-Q, including the
forward-looking statements discussed above, to reflect any change in our
expectations with regard thereto or any change in events, conditions or
circumstances on which any statement or information is based.





Document
Summaries





Descriptions
of documents and agreements contained in this Quarterly Report on Form 10-Q are
provided in summary form only, and such summaries are qualified in their
entirety by reference to the actual documents and agreements filed as exhibits
to our 2008 Annual Report on Form 10-K, other periodic and current reports we
file with the Securities and Exchange Commission (“SEC”) or this Quarterly
Report on Form 10-Q.





Access
to Filings





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











TABLE
OF CONTENTS





PART
I FINANCIAL INFORMATION





Page No.Item
      1.
            Financial
      StatementsUnaudited
      Consolidated Balance Sheets at September 30, 2009 and December 31,
      2008
            1Unaudited
      Consolidated Statements of Operations for the Three and Nine Months Ended
      September 30, 2009 and 2008
            2Unaudited
      Consolidated Statements of Cash Flows for the Nine Months Ended September
      30, 2009 and 2008
            3Notes
      to Unaudited Consolidated Financial Statements
            4Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            12Item
      4.
            Controls
      and Procedures
            17PART
      II OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            18Item
      6.
            Exhibits
            19SignaturesExhibit
      Index





iii





PART
I. FINANCIAL INFORMATION


ITEM
1.  FINANCIAL STATEMENTS





DEEP
DOWN, INC.


CONSOLIDATED
BALANCE SHEETS


(Unaudited)




(In thousands)
              
              September
      30, 2009
              
              
              December
      31, 2008ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              3,896
              
              
              $
              2,495Restricted
      cash
              
              
              -
              
              
              
              136Accounts
      receivable, net
              
              
              4,206
              
              
              
              10,772Inventory
              
              
              1,052
              
              
              
              1,362Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
              
              
              748
              
              
              
              708Deferred
      tax asset
              
              
              2,892
              
              
              
              217Prepaid
      expenses and other current assets
              
              
              921
              
              
              
              634Total
      current assets
              
              
              13,715
              
              
              
              16,324Property
      and equipment, net
              
              
              20,088
              
              
              
              13,799Intangibles,
      net
              
              
              17,109
              
              
              
              18,091Goodwill
              
              
              14,966
              
              
              
              15,024Other
      assets, net
              
              
              1,126
              
              
              
              458Total
      assets
              
              $
              67,004
              
              
              $
              63,696LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable and accrued liabilities
              
              $
              4,030
              
              
              $
              4,319Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
              
              
              3,252
              
              
              
              2,315Current
      portion of long-term debt
              
              
              6,029
              
              
              
              383Total
      current liabilities
              
              
              13,311
              
              
              
              7,017Long-term
      debt, net
              
              
              904
              
              
              
              1,718Deferred
      tax liabilities
              
              
              2,892
              
              
              
              1,126Total
      liabilities
              
              
              17,107
              
              
              
              9,861Commitments
      and contingencies (Note 10)Stockholders'
      equity:Common
      stock, $0.001 par value, 490,000 shares authorized, 180,451and
      177,351 shares issued and outstanding, respectively
              
              
              180
              
              
              
              177Additional
      paid-in capital
              
              
              60,968
              
              
              
              60,328Accumulated
      deficit
              
              
              (11,251
              )
              
              
              (6,670
              )Total
      stockholders' equity
              
              
              49,897
              
              
              
              53,835Total
      liabilities and stockholders' equity
              
              $
              67,004
              
              
              $
              63,696


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


1




DEEP
DOWN, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)





Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,(In thousands except per share
      amounts)
              
              2009
              
              
              2008
              
              
              2009
              
              
              2008Revenues
              
              $
              8,426
              
              
              $
              11,653
              
              
              $
              21,729
              
              
              $
              25,852Cost
      of sales
              
              
              6,276
              
              
              
              6,006
              
              
              
              15,413
              
              
              
              15,462Gross
      profit
              
              
              2,150
              
              
              
              5,647
              
              
              
              6,316
              
              
              
              10,390Operating
      expenses:Selling,
      general & administrative
              
              
              3,585
              
              
              
              3,733
              
              
              
              10,302
              
              
              
              9,414Depreciation
      and amortization
              
              
              415
              
              
              
              362
              
              
              
              1,242
              
              
              
              883Total
      operating expenses
              
              
              4,000
              
              
              
              4,095
              
              
              
              11,544
              
              
              
              10,297Operating
      income (loss)
              
              
              (1,850
              )
              
              
              1,552
              
              
              
              (5,228
              )
              
              
              93Other
      income (expense):Interest
      income
              
              
              3
              
              
              
              37
              
              
              
              9
              
              
              
              103Interest
      expense
              
              
              (118
              )
              
              
              (25
              )
              
              
              (236
              )
              
              
              (3,484
              )Loss
      on debt extinguishment
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (446
              )Other
      income
              
              
              4
              
              
              
              17
              
              
              
              15
              
              
              
              6Total
      other income (expense)
              
              
              (111
              )
              
              
              29
              
              
              
              (212
              )
              
              
              (3,821
              )Income
      (loss) before income taxes
              
              
              (1,961
              )
              
              
              1,581
              
              
              
              (5,440
              )
              
              
              (3,728
              )Income
      tax (expense) benefit
              
              
              (129
              )
              
              
              (3
              )
              
              
              859
              
              
              
              351Net
      income (loss)
              
              $
              (2,090
              )
              
              $
              1,578
              
              
              $
              (4,581
              )
              
              $
              (3,377
              )Income
      (loss) per share:Basic
              
              $
              (0.01
              )
              
              $
              0.01
              
              
              $
              (0.03
              )
              
              $
              (0.03
              )Weighted-average
      number of common sharesoutstanding
              
              
              176,522
              
              
              
              176,094
              
              
              
              176,276
              
              
              
              131,744Diluted
              
              $
              (0.01
              )
              
              $
              0.01
              
              
              $
              (0.03
              )
              
              $
              (0.03
              )Weighted-average
      number of common sharesoutstanding
              
              
              176,522
              
              
              
              176,776
              
              
              
              176,276
              
              
              
              131,744






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


2





DEEP
DOWN, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)




Nine
      Months EndedSeptember
      30,(In thousands)
              
              2009
              
              
              2008Cash
      flows from operating activities:Net
      loss
              
              $
              (4,581
              )
              
              $
              (3,377
              )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Interest
      income
              
              
              -
              
              
              
              (55
              )Non-cash
      amortization of debt discount
              
              
              -
              
              
              
              1,817Non-cash
      amortization of deferred financing costs
              
              
              -
              
              
              
              763Share-based
      compensation
              
              
              643
              
              
              
              424Bad
      debt expense
              
              
              126
              
              
              
              1,053Depreciation
      and amortization
              
              
              2,389
              
              
              
              1,642(Gain)
      loss on disposal of equipment
              
              
              (21
              )
              
              
              161Deferred
      taxes payable
              
              
              (909
              )
              
              
              -Changes
      in assets and liabilities:Accounts
      receivable
              
              
              6,440
              
              
              
              942Inventory
              
              
              310
              
              
              
              (821
              )Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
              
              
              (40
              )
              
              
              (41
              )Prepaid
      expenses and other current assets
              
              
              (287
              )
              
              
              (453
              )Other
      assets
              
              
              (112
              )
              
              
              -Accounts
      payable and accrued liabilities
              
              
              (289
              )
              
              
              (1,059
              )Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
              
              
              937
              
              
              
              179Net
      cash provided by operating activities
              
              
              4,606
              
              
              
              1,175Cash
      flows from investing activities:Cash
      paid for acquisition of Flotation, net of cash acquired of
      $235
              
              
              -
              
              
              
              (22,162
              )Proceeds
      from final settlement of acquisition of Flotation
              
              
              58
              
              
              
              -Cash
      paid for acquisition of Mako, net of expenses
              
              
              -
              
              
              
              (4,237
              )Purchases
      of property and equipment
              
              
              (5,536
              )
              
              
              (2,564
              )Proceeds
      from sale of property and equipment
              
              
              53
              
              
              
              -Cash
      paid for capitalized software
              
              
              (383
              )
              
              
              -Purchase
      of investment
              
              
              (150
              )
              
              
              -Note
      receivable, net of repayments
              
              
              (23
              )
              
              
              -Restricted
      cash
              
              
              136
              
              
              
              375Net
      cash used in investing activities
              
              
              (5,845
              )
              
              
              (28,588
              )Cash
      flows from financing activities:Proceeds
      from sale of common stock, net of expenses
              
              
              -
              
              
              
              37,060Proceeds
      from sales-type lease
              
              
              -
              
              
              
              587Borrowings
      on long-term debt
              
              
              3,000
              
              
              
              5,604Repayments
      on long-term debt
              
              
              (360
              )
              
              
              (12,889
              )Net
      cash provided by financing activities
              
              
              2,640
              
              
              
              30,362Change
      in cash and equivalents
              
              
              1,401
              
              
              
              2,949Cash
      and cash equivalents, beginning of period
              
              
              2,495
              
              
              
              2,206Cash
      and cash equivalents, end of period
              
              $
              3,896
              
              
              $
              5,155




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


3





DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS




Note
      1:
            Basis
      of Presentation





Basis
of Presentation





The
accompanying unaudited consolidated financial statements of Deep Down, Inc. and
its wholly-owned subsidiaries (“Deep Down”) were prepared in accordance with the
rules and regulations of the Securities and Exchange Commission (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, 2008,
filed on March 16, 2009 with the Commission.





Preparation
of financial statements in conformity with US GAAP requires 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, actual amounts may differ from those included in the
accompanying consolidated financial statements. In the opinion of management,
all adjustments (consisting of normal recurring adjustments) considered
necessary for a fair presentation have been included.





Management
is also required to consider material events that occur after the date, prior to
the issuance, of the financial statements and evaluate whether such events
require modification to the reported results or footnote
disclosures.  Our subsequent review was conducted through November 16,
2009, immediately prior to the filing of the financial statements with the
Commission.





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





Reclassifications





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





Principles
of consolidation





The
unaudited consolidated financial statements include the accounts of Deep Down,
Inc. and its wholly-owned subsidiaries for the three and nine months ended
September 30, 2009 and 2008.  All significant inter-company
transactions and balances have been eliminated in consolidation.





Accounting
Policy Updates





Capitalized software costs.
We capitalize software for internal use according to the applicable
authoritative guidance.  Other assets include the capitalized cost of
internal-use software. Capitalized software is stated at cost less accumulated
amortization, and totaled $383 and $0 at September 30, 2009 and 2008,
respectively. These software costs include significant purchases of software and
internal and external costs incurred during the application development stage of
software projects. These costs will be amortized on a straight-line basis over
the estimated useful lives of the assets upon implementation.




4




DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Note
      2:
            Recently
      Issued Accounting Standards and
Developments





In
October 2009, the Financial Accounting Standards Board (“FASB”) issued amended
revenue recognition guidance for arrangements with multiple deliverables. The
new guidance eliminates the residual method of revenue recognition and allows
the use of management’s best estimate of selling price for individual elements
of an arrangement when vendor specific objective evidence (“VSOE”), vendor
objective evidence (“VOE”) or third-party evidence (“TPE”) is unavailable.
 This guidance is effective for us for all new or materially modified
arrangements entered into on or after January 1, 2011 with earlier application
permitted as of the beginning of a fiscal year. Full retrospective application
of the new guidance is optional. We are currently assessing its implementation
of this new guidance, but do not expect a material impact on the consolidated
financial statements.





On
July 1, 2009, the FASB issued the FASB Accounting Standards
Codification (the “Codification”). The Codification became the single source of
authoritative nongovernmental US GAAP, superseding existing FASB, American
Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force
(“EITF”) and related literature. The Codification eliminates the previous US
GAAP hierarchy and establishes one level of authoritative GAAP. All other
literature is considered non-authoritative. The Codification was effective for
interim and annual periods ending after September 15, 2009. We adopted the
Codification for the quarter ended September 30, 2009. There was no impact
to the consolidated financial results.





In
May 2009, the FASB issued guidelines on subsequent event accounting which
sets forth: 1) the period after the balance sheet date during which management
of a reporting entity should evaluate events or transactions that may occur for
potential recognition or disclosure in the financial statements; 2) the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements; and 3) the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. These guidelines were effective for
interim and annual periods ending after June 15, 2009, and we adopted them
in the quarter ended June 30, 2009. The required disclosure is included in
Note 1 to our consolidated financial statements.  There was no impact
on the consolidated financial results.





The FASB
guidance on fair value measurements and disclosures became effective
January 1, 2008. However, in February 2008, the FASB delayed the
effective date regarding fair value measurements and disclosures of nonfinancial
assets and nonfinancial liabilities, except those that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually), to January 1, 2009. The adoption of these provisions
related to nonfinancial assets and nonfinancial liabilities on January 1,
2009 did not have a material impact on the consolidated financial
statements.





In
April 2009, the FASB issued additional requirements regarding interim
disclosures about the fair value of financial instruments which were previously
only disclosed on an annual basis. Entities are now required to disclose the
fair value of financial instruments which are not recorded at fair value in the
financial statements in both their interim and annual financial statements. The
new requirements were effective for interim and annual periods ending after
June 15, 2009 on a prospective basis. We adopted these requirements in the
quarter ended June 30, 2009. There was no impact on the consolidated
financial results.





The
estimated fair value of our financial instruments is as follows at September 30,
2009:





·
            Cash
      and equivalents, accounts receivable and accounts payable - the carrying
      amounts approximated fair value due to the short-term maturity of these
      instruments.·
            Long-term
      debt - the carrying value of our debt instruments closely approximates the
      fair value as the debt instruments include fixed rates consistent with
      current interest rates and the line of credit portion has a LIBOR-based
      rate.





In
April 2009, the FASB issued an amendment to the revised business
combination guidance regarding the accounting for assets acquired and
liabilities assumed in a business combination that arise from contingencies. The
requirements of this amended guidance carry forward without significant revision
the guidance on contingencies which existed prior to January 1, 2009.
Assets acquired and liabilities assumed in a business combination that arise
from contingencies are recognized at fair value if fair value can be reasonably
estimated. If fair value cannot be reasonably estimated, the asset or liability
would generally be recognized in accordance with the Accounting Standards
Codification (“ASC”) Topic 450 on contingencies. We adopted the Codification in
the quarter ended September 30, 2009. There was no impact upon
adoption.




5


DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





On
January 1, 2009, we adopted the revised FASB guidance regarding business
combinations which was required to be applied to business combinations on a
prospective basis. The revised guidance requires that the acquisition method of
accounting be applied to a broader set of business combinations, amends the
definition of a business combination, provides a definition of a business,
requires an acquirer to recognize an acquired business at its fair value at the
acquisition date and requires the assets and liabilities assumed in a business
combination to be measured and recognized at their fair values as of the
acquisition date (with limited exceptions). There was no impact upon adoption
and the effects of this guidance will depend on the nature and significance of
business combinations occurring after the effective date.





In
April 2008, the FASB issued new requirements regarding the determination of
the useful lives of intangible assets. In developing assumptions about renewal
or extension options used to determine the useful life of an intangible asset,
an entity needs to consider its own historical experience adjusted for
entity-specific factors. In the absence of that experience, an entity shall
consider the assumptions that market participants would use about renewal or
extension options. The new requirements apply to intangible assets acquired
after January 1, 2009. There was no impact upon adoption and the effects of
this guidance will depend on the nature and significance of business
combinations occurring after the effective date.





Note
      3:
            Inventory





The
components of inventory are summarized below (in thousands):





September
      30, 2009
              
              
              December
      31, 2008Raw
      materials
              
              $
              748
              
              
              $
              790Work
      in progress
              
              
              235
              
              
              
              426Finished
      goods
              
              
              69
              
              
              
              146Total
      Inventory
              
              $
              1,052
              
              
              $
              1,362





Note
      4:
            Costs
      and Estimated Earnings in Excess of Billings on Uncompleted
      Contracts





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





September
      30, 2009
              
              
              December
      31, 2008Costs
      incurred on uncompleted contracts
              
              $
              4,259
              
              
              $
              2,115Estimated
      earnings
              
              
              282
              
              
              
              4,9694,541
              
              
              
              7,084Less:
      Billings to date
              
              
              7,045
              
              
              
              8,691$
              (2,504
              )
              
              $
              (1,607
              )Included
      in the accompanying unaudited consolidatedbalance sheets under the
      following captions:Costs
      and estimated earnings in excess of billingson uncompleted
      contracts
              
              $
              748
              
              
              $
              708Billings
      in excess of costs and estimated earningson uncompleted
      contracts
              
              
              (3,252
              )
              
              
              (2,315
              )$
              (2,504
              )
              
              $
              (1,607
              )




At
September 30, 2009, the asset balance of $748 was related to several contracts
that are projected to be completed during fiscal 2009. At December 31, 2008, the
asset balance of $708 was related to a contract that was 90 percent complete at
December 2008, based on the percentage-of-completion method. The remainder of
the revenue was recognized in the first quarter of fiscal 2009.





The
balance in billings in excess of costs and estimated earnings on uncompleted
contracts at September 30, 2009 and December 31, 2008, was $3,252 and $2,315,
respectively, and consisted of significant milestone payments, primarily related
to a large contract that is expected to be completed in fiscal year
2010.




6




DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Note
      5:
            Acquisitions





Purchase
of Flotation Technologies, Inc.





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





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





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





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





Fiscal 2008 transactions related to
the purchase of Mako Technologies, Inc.




Effective
December 1, 2007, we purchased 100 percent of the common stock of Mako
Technologies, Inc. for $11,307. Pursuant to the agreement and plan of merger,
final installments of the purchase price were paid to the Mako shareholders
during the nine months ended September 30, 2008. We paid $4,160 cash to the Mako
shareholders plus $77 of transaction expenses during the nine months ended
September 30, 2008. In March 2008, we issued the second installment of 2,803
restricted shares of common stock of Deep Down, valued at $0.70 per share,
totaling $1,962, including non-cash adjustments to purchased asset values in
goodwill totaling $174.





Note
      6:
            Property
      and Equipment





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





Prior to
May 29, 2009, we leased the Channelview Property from JUMA at a base rate of $15
per month.  In connection with the purchase of the Channelview
Property, the lease between us and JUMA was terminated.   We
incurred no early termination penalties from JUMA in connection with this
termination.




7


DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Note
      7:
            Long-Term
      Debt





The
following table summarizes long-term debt (in thousands):





September
      30, 2009
              
              
              December
      31, 2008Secured
      credit agreements
              
              $
              5,938
              
              
              $
              1,150Other
      bank loans
              
              
              11
              
              
              
              15Total
      bank debt
              
              
              5,949
              
              
              
              1,1656%
      Subordinated Debenture
              
              
              500
              
              
              
              500Capital
      lease obligations
              
              
              484
              
              
              
              436Total
      debt
              
              
              6,933
              
              
              
              2,101Current
      portion of long-term debt
              
              
              (6,029
              )
              
              
              (383
              )Long-term
      debt, net of current portion
              
              $
              904
              
              
              $
              1,718


Revolving
credit line and term loans





On
November 11, 2008, we entered into a Credit Agreement (the “Revolver”) with
Whitney National Bank (“Whitney”) as the lender. The Revolver provides a
commitment to lend to us the lesser of $2,000 or 80 percent of eligible
receivables (generally defined as current due accounts receivables in which the
lender has a first priority security interest). All of the commitment under the
Revolver is also available in commitments for the lender to issue letters of
credit (“L/C”) for our benefit. Outstanding amounts under the Revolver generally
will bear interest at rates based on the British Bankers Association LIBOR Rate
for dollar deposits with a term of one month plus an applicable rate of 2.00
percent to 3.00 percent based on the leverage ratio of Deep
Down.  Accrued interest under the Revolver is payable monthly. Unused
portions of the commitment generally accrue a commitment fee of 0.25 percent to
0.50 percent based on the leverage ratio of Deep Down and such fee is due and
payable by Deep Down quarterly.  The Revolver has a termination date
of November 11, 2010. There is $850 outstanding under the Revolver as of
September 30, 2009, and we have issued an irrevocable transferrable standby L/C,
with an annual commission rate of 2.4 percent for $1,108 during the nine months
ended September 30, 2009 related to a large contract that is expected to be
completed in fiscal year 2010. The borrowing capacity under the Revolver was
approximately $20 at September 30, 2009.





On
December 18, 2008, we entered into an amendment to the Revolver (the “Term
Loan”), with Whitney which provides for a term loan in the principal amount of
$1,150. Such Term Loan does not impact the availability under the Revolver. We
are obligated to repay the loan, annual interest rate of 6.5 percent, based on a
schedule of monthly installments of $35 with an initial payment on February 1,
2009 and a final payment of the unpaid principal and accrued interest on January
1, 2012.





On May
29, 2009, in connection with the purchase of land and buildings, we entered into
a third amendment to the Revolver (the “Third Amendment”) with Whitney as the
lender.  We paid $570 of the purchase price to JUMA in cash and
financed the balance with an additional term loan in the principal amount of
$2,100. We are obligated to repay the loan based on a schedule of monthly
installments of $18 with an initial payment on June 1, 2009 and a final payment
of all remaining outstanding and unpaid principal and accrued interest on May 1,
2024.  The annual interest rate on the loan is 6.5 percent. Such Term
Loan does not impact the availability under the Revolver. See additional
discussion in Note 6, Property and Equipment.




Each of
our subsidiaries has guaranteed our obligations under the Revolver and as such,
our obligations in connection with the Revolver are generally secured by a first
priority lien on all of our subsidiaries’ non-real property assets. The terms of
the Third Amendment included a Guarantor’s Consent and Agreement, signed by each
of our subsidiaries.  Whitney also required us to enter a second
amendment to our security agreement (the “Security Agreement Amendment”) in
order to reflect our ownership of the Channelview Property.  We also
entered into a Deed of Trust, Security Agreement and UCC Financing Statement for
Fixture Filing (collectively, the “Deed of Trust”), creating a lien on the
Channelview Property.




8




DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




Under the
Revolver, as amended, we are required to meet certain covenants and
restrictions.  The financial covenants are reportable each quarter,
beginning with the quarter ended March 31, 2009.  Financial covenants
include maintaining total debt to consolidated earnings before interest,
taxes, depreciation and amortization (“EBITDA”) below 2.5 to 1.0
(“Leverage Ratio”),
consolidated EBITDA to consolidated net interest expense and principal payments
on the total debt greater than 1.5 to 1.0 (“Fixed Charge Coverage Ratio”), and
consolidated net worth after deducting other assets as are properly classified
as “Intangible Assets” (“Tangible Net Worth”) in excess of $20,000. Other
covenants include limitations on issuance of common stock, liens, transactions
with affiliates, additional indebtedness and permitted investments, among
others.





At
September 30, 2009, we were not in compliance with the Leverage Ratio, Fixed
Charge Coverage Ratio or Tangible Net Worth covenants.  Although
operations are improving, we expect to be in violation of these financial
covenants again at December 31, 2009.  As a result of this and
cross-default provisions in our TD Bank, N.A. loan, amounts outstanding under
these facilities have been classified as current in our consolidated balance
sheet at September 30, 2009.  We are currently seeking a waiver from
Whitney for the quarter ended September 30, 2009, and will do so at year-end if
we are still in default. However, if we are unable to obtain such waiver, debt
outstanding under these facilities could be declared immediately due and
payable. We may consider alternative financings or other transactions to satisfy
such obligations. We continue to remain current on our principal, interest and
fee obligations with Whitney and TD Bank.





Management
believes that we have adequate capital resources when we combine our $3,896 cash
position and improved cash flows from strengthening operations to meet current
operating requirements for the twelve months ending September 30, 2010. The
factors described above create uncertainty and could have a material adverse
impact on our business.





Amendment
to credit agreement and new loan agreement





On
February 13, 2009, we entered into a second amendment to our Revolver (the
“Second Amendment”) in connection with a mortgage and security loan agreement
with TD Bank, N.A. (“TD Bank”).  The terms of the Second Amendment
required a Guarantor’s Consent and Agreement from each of our subsidiaries as
guarantors of the obligations under the Revolver.





On March
5, 2009, Flotation, our wholly-owned subsidiary, obtained loan proceeds in the
principal amount of $1,840 (“TD Bank Loan”).  The loan provides a
further commitment to Flotation for advancement of principal in the amount of
$320, which was accessed in July 2009. We are obligated to repay the TD Bank
Loan based on a schedule of monthly installments of $13, with an initial payment
on March 13, 2009 and a final payment of the unpaid principal and accrued
interest in February 2029.  The interest rate on the TD Bank Loan is
5.75 percent. Advancement of the additional $320 principal amount was added to
the principal balance in July 2009 and will be fully amortized over the
remaining term, thus increasing the payment to $15 effective August
2009.





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





Net
interest expense during the nine months ended September 30, 2008





For the
nine months ended September 30, 2008, we amortized into net interest expense
$1,703 of debt discount and $763 of deferred financing costs associated with the
fair market value of warrants and the cash-based expenses, related to third
party fees and prepaid lender fees, over the life of a secured credit agreement,
which was entered into in August 2007 and amended in December 2007, using the
effective interest rate method. During the nine months ended September 30, 2008,
we paid $13,275 to the lender to pay the outstanding balance under the credit
agreement, related interest of $829 and early termination fees, recognized as a
loss on early extinguishment of debt, of $446. Additionally, during the nine
months ended September 30, 2008, we recorded $114 in net interest expense for
the accretion of the Series E Preferred Stock up to face value, that was
exchanged into a 6 percent subordinated debenture in the amount of
$500.




9




DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Note
      8:
            Stock-Based
      Compensation





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





Restricted
Stock




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





On
September 3, 2009, we granted 750 restricted shares, par value $1, to an
executive in connection with his severance and separation agreement. The shares
were valued at $0.10 based on the closing price of common stock on September 3,
2009. The shares vest on the anniversary of the grant date, and we are
amortizing the related stock-based compensation of $75 over the one-year
requisite service period.





In
connection with the departure of two executives during the third quarter of
2009, we accelerated the vesting of 850 shares of restricted stock granted on
March 29, 2009, and 350 shares granted in February 2008, and recognized the
related stock-based compensation of $106.  For the nine months ended
September 30, 2009 and 2008, we recognized a total of $377 and $158,
respectively, in stock-based compensation related to all outstanding shares of
restricted stock. The unamortized portion of the estimated fair value of
restricted stock was $273 at September 30, 2009.





Summary
of Stock Options





During
the nine months ended September 30, 2009, we granted 14,475 options. Based on
the shares of common stock outstanding at September 30, 2009, there were
approximately 1,809 options available for grant under the Plan as of that date.
We expense all stock options on a straight-line basis, net of forfeitures, over
the requisite expected service periods. Additionally, during the nine months
ended September 30, 2009, we revised the estimated rate of forfeitures to 30
percent from 0 percent based on the history of stock option cancellations and
management’s estimates of expected future forfeiture rates, resulting in a
reduction of stock-based compensation expense of $116 for the nine months ended
September 30, 2009. The total stock-based compensation expense recognized
for stock options for the nine months ended September 30, 2009 and 2008 was
$266, respectively.  As of September 30, 2009, the unamortized portion of
the estimated fair value of outstanding stock options was $1,339.




Note
      9:
            Income
  Taxes


Income
tax expense during interim periods is based on applying the estimated annual
effective income tax rate on interim period operations, which may vary from the
statutory rate due to the impact of permanent 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 liabilities and assets
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. A valuation allowance of $286 was
recorded for deferred tax assets in excess of deferred tax liabilities at
September 30, 2009.


Note
      10:
            Commitments
      and Contingencies





Litigation





Periodically,
we are involved in legal proceedings arising from 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.





Operating
Leases





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





10





DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Concluded)




Letters
of Credit





Certain
customers require us to issue a standby L/C to ensure we will perform under
terms of the contract and with associated vendors and subcontractors. In the
event of default, the creditor may demand payment from the issuing bank for the
amount of the L/C. There were no significant expenses related to L/Cs for the
nine months ended September 30, 2009. In December 2008, we amended our Revolver
with Whitney to provide for L/Cs. During the nine months ended September 30,
2009, we issued an irrevocable transferrable standby L/C in the normal course of
business, with an annual commission rate of 2.4 percent, for
$1,108.  This L/C reduces the borrowing capacity under the
Revolver.





Note
      11:
            Income
      (loss) per Common Share





Basic EPS
is calculated by dividing net income (loss) by the weighted-average number of
common shares outstanding for the period. Diluted EPS is calculated by dividing
net income (loss) by the weighted-average number of common shares and dilutive
common stock equivalents (convertible notes and interest on the notes, stock
awards and stock options) outstanding during the period. Dilutive EPS reflects
the potential dilution that could occur if options to purchase common stock were
exercised for shares of common stock. Potentially dilutive securities
representing 1,121 shares of common stock for the nine months ended September
30, 2008 were excluded from the computation of diluted earnings per share
because their effect would have been anti-dilutive.








11


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, 2008 filed with the
Commission on March 16, 2009 and our unaudited consolidated financial
statements and notes thereto included with this Quarterly Report on Form 10-Q in
Part I, Item 1.





General





We are an
oilfield services company serving the worldwide offshore exploration and
production industry. Our services and technological solutions include
distribution system installation support and engineering services, umbilical
terminations, loose-tube steel flying leads, flotation and drill riser buoyancy,
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.





Industry
Outlook





Business
conditions in our industry continued to decline in the first nine months of
2009.  The financial markets, which are critical to the funding of the
major offshore and deepwater projects, have not stabilized yet. According to the
International Energy Agency, worldwide demand for oil will decline by 3 percent
in 2009 as a result of the economic downturn.  These business
conditions have had a major impact on our customers worldwide.  New
projects are being delayed and existing projects are slowing
down.  The domestic offshore projects have incurred the worst decline
while the international projects have mostly slowed down.





We
believe that the economy will continue to struggle during the last quarter of
2009, but should show signs of stabilizing thereafter. The price of oil has
increased in the first nine months of 2009, the financial markets also show
signs of improving, and we are currently seeing improvement in several areas of
our activity. We believe the longer term outlook is still very positive for the
offshore and deepwater drilling and we will continue to focus on this sector of
the industry.





Segments





For the
nine months ended September 30, 2009 and the fiscal year ended December 31,
2008, our operations have been aggregated into a single reporting segment. While
our operating segments have different product lines, they are very similar with
regards to the five criteria for aggregation. They are all service-based
operations revolving around our personnel’s expertise in the deep water
industry, and equipment is produced to a customer specified design and
engineered and installed using our personnel’s expertise.





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





Results of
Operations





Three
Months Ended September 30, 2009 Compared to Three Months Ended September 30,
2008





Revenue.  Revenue
for the three months ended September 30, 2009 decreased approximately $3,227 to
approximately $8,426, a decrease of approximately 28 percent over the same prior
year period. The reduction in revenue over the same prior year period was a
result of customers delaying future projects or slowing down many of their
offshore and deepwater projects.  Additionally, our ROV rentals and
operator charges were reduced compared to the prior year due to the economic
conditions affecting our customers.





Gross
Profit.  Gross profit decreased approximately $3,497 to
approximately $2,150 for the three months ended September 30, 2009, a decrease
of approximately 62 percent over the same prior year period.  For the
three months ended September 30, 2009, gross margins were negatively impacted by
our large floatation order and by two other floatation orders, all which have
incurred more costs than originally estimated.  As such, gross margins
decreased to 26 percent of revenue for the third quarter of 2009.





12





Selling, General and Administrative
Expenses.Selling, general and administrative expenses (“SG&A”)
include rent, utilities, general office expenses, insurance, personnel, bad debt
and other costs necessary to conduct business operations.  SG&A
for the three months ended September 30, 2009 was approximately $3,585, a
decrease of approximately 4 percent over the same prior year period. Overall,
the decrease was driven by management’s continuing focus on cost containment and
by reduced professional fees which in the three months ended September 30, 2008,
related to the acquisition of Flotation. Additionally, professional, accounting
and legal fees relating to the updating of the registration statement decreased
by approximately $614 compared to the three months ended September 30, 2008. Bad
debt expense decreased approximately $190 for the three months ended September
30, 2009 compared to the three months ended September 30, 2008, due to a
customer that filed bankruptcy in 2008. Personnel and related costs, attributed
to the expansion of our businesses, increased by approximately $626. Stock-based
compensation increased by approximately $151 for the three months ended
September 30, 2009, due to stock options issued after September 30, 2008, and to
the accelerated vesting of restricted stock.





Depreciation and
amortization. Depreciation and amortization expense, excluded from “Cost
of sales” in the accompanying statements of operations, was approximately $415
and $362 for the three months ended September 30, 2009 and 2008, respectively.
This increase resulted from the purchase of office buildings and property
previously leased and other capital expenditures. Depreciation expense, included
in “Cost of sales” in the accompanying statements of operations, was
approximately $450 and $381 for the three months ended September 30, 2009 and
2008, respectively.





Net interest expense. Net
interest expense for the three months ended September 30, 2009 was approximately
$115 compared to net interest income of approximately $12 for the same prior
year period.  Net interest expense for the three months ended
September 30, 2009 and 2008 was generated by our outstanding bank debt, capital
leases and subordinated debenture, offset by interest income on cash
balances.





Net income (loss). Net loss
for the three months ended September 30, 2009 was approximately $2,090, compared
to net income of approximately $1,578 for the same prior year
period.





EBITDA. EBITDA is a non-US
GAAP financial measure. We use EBITDA as an unaudited supplemental
financial measure to assess the financial performance of our assets without
regard to financing methods, capital structures, taxes or historical cost basis;
our liquidity and operating performance over time in relation to other companies
that own similar assets and that we believe calculate EBITDA in a similar
manner; and the ability of our assets to generate cash sufficient for us to pay
potential interest costs. We also understand that such data are used by
investors to assess our performance. However, the term EBITDA is not defined
under US GAAP and EBITDA is not a measure of operating income, operating
performance or liquidity presented in accordance with US GAAP. When assessing
our operating performance or liquidity, investors should not consider this data
in isolation or as a substitute for net income, cash flow from operating
activities, or other cash flow data calculated in accordance with US GAAP.
EBITDA for the three months ended September 30, 2009 was negative $981 compared
to positive $2,312 for the same prior year period.  This reduction was
primarily driven by the decrease in net income, offset by an increase in
interest expense on outstanding debt.





Three
      Months EndedSeptember
      30,2009
              
              
              2008Net
      income (loss)
              
              $
              (2,090
              )
              
              $
              1,578Add
      back interest expense, net of interest income
              
              
              115
              
              
              
              (12
              )Add
      back depreciation and amortization
              
              
              865
              
              
              
              743Add
      back income tax expense
              
              
              129
              
              
              
              3EBITDA
              
              $
              (981
              )
              
              $
              2,312





Nine
Months Ended September 30, 2009 Compared to Nine Months Ended September 30,
2008





Revenue.  Revenue
for the nine months ended September 30, 2009 decreased approximately $4,123 to
approximately $21,729, a 16 percent decrease over the same prior year period.
The reduction in revenue over the same prior year period was a result of
customers delaying future projects or slowing down many of their offshore and
deepwater projects. Additionally, our ROV rentals and operator charges were
reduced compared to the prior year due to the economic conditions affecting our
customers.




13




Gross
Profit.  Gross profit decreased approximately $4,074 to
approximately $6,316 for the nine months ended September 30, 2009, a decrease of
39 percent compared to the nine months ended September 30, 2008. This decrease
in gross profit was partially driven by the decrease in total revenue,
particularly our large floatation order.  Accordingly, our gross
margins decreased to 29 percent of revenue for the nine months ended September
30, 2009.





Selling, General and Administrative
Expenses.SG&A
includes rent, utilities, general office expenses, insurance, personnel and
other costs necessary to conduct business operations.  SG&A for
the nine months ended September 30, 2009 was approximately $10,302 compared to
approximately $9,414 for the same prior year period, an increase of
approximately 9 percent. For the nine months ended September 30, 2009,
additional expenses of approximately $1,695 related to the acquired operations
of Flotation were offset by approximately $927 reduction in bad debt expense.
Personnel and related costs of approximately $856 were attributed to the
expansion of our businesses, requiring more personnel, and the related
requirements to administer a public company and comply with reporting
requirements. We paid approximately $63 less than the same prior year period in
professional, accounting and legal fees relating to the updating of the
registration statement in fiscal 2008 and increased annual audit fees due to
company growth. Office expenses increased approximately $206 due to the addition
of our new corporate offices.  For the nine months ended September 30,
2009, stock-based compensation increased by approximately $219 over the same
prior year period, due to stock options that were issued after September 30,
2008 and the accelerated vesting of restricted stock.





Depreciation and
amortization. Depreciation and amortization expense, excluded from “Cost
of sales” in the accompanying statements of operations, was $1,242 and $883 for
the nine months ended September 30, 2009 and 2008, respectively. Depreciation
expense, included in “Cost of sales” in the accompanying statements of
operations, was approximately $1,147 and $759 for the nine months ended
September 30, 2009 and 2008, respectively. This overall increase resulted from
the addition of assets from the Flotation acquisition in May 2008, the purchase
of office buildings and property previously leased and other capital
expenditures.





Net interest expense and loss on
extinguishment of debt. Net interest expense for the nine months ended
September 30, 2009 was approximately $227 compared to approximately $3,381 for
the same prior year period.  Net interest expense for the nine months
ended September 30, 2009 was generated by our outstanding bank debt, capital
leases and subordinated debenture. For the nine months ended September 30, 2008,
net interest expense was generated mainly by borrowings under a secured credit
agreement. On June 12, 2008, we paid the balance due under that credit
agreement, thus there were no related expenses since that date. For the nine
months ended September 30, 2008, cash interest approximated $905. We incurred
non-cash deferred financing and debt discount amortization approximating $2,466,
plus paid early termination fees of approximately $446 recognized as a loss on
early extinguishment of debt.





Net loss. Net loss for the
nine months ended September 30, 2009 was approximately $4,581, compared to
approximately $3,377 for the same prior year period.





EBITDA. EBITDA is a non-US
GAAP financial measure. We use EBITDA as an unaudited supplemental
financial measure to assess the financial performance of our assets without
regard to financing methods, capital structures, taxes or historical cost basis;
our liquidity and operating performance over time in relation to other companies
that own similar assets and that we believe calculate EBITDA in a similar
manner; and the ability of our assets to generate cash sufficient for us to pay
potential interest costs. We also understand that such data are used by
investors to assess our performance. However, the term EBITDA is not defined
under US GAAP and EBITDA is not a measure of operating income, operating
performance or liquidity presented in accordance with US GAAP. When assessing
our operating performance or liquidity, investors should not consider this data
in isolation or as a substitute for net income, cash flow from operating
activities, or other cash flow data calculated in accordance with US GAAP.
EBITDA for the nine months ended September 30, 2009 was negative $2,824 compared
to positive $1,295 for the same prior year period.




Nine
      Months EndedSeptember
      30,2009
              
              
              2008Net
      loss
              
              $
              (4,581
              )
              
              $
              (3,377
              )Add
      back interest expense, net of interest income
              
              
              227
              
              
              
              3,381Add
      back depreciation and amortization
              
              
              2,389
              
              
              
              1,642Deduct
      income tax benefit
              
              
              (859
              )
              
              
              (351
              )EBITDA
              
              $
              (2,824
              )
              
              $
              1,295




14





Capital
Resources and Liquidity





Operations
for the past nine months have been negatively impacted by the worldwide
recession, lower oil prices and customer-based delays in many of our major
projects, including on our large floatation order.  As a result of
this downturn in the industry, our operations in the first nine months of 2009
were significantly lower than expected, resulting in a negative EBITDA of
approximately $2,824. As discussed in Note 7, Long-Term Debt, in the notes to
unaudited consolidated financial statements, we were in default of our $2,000
Revolver agreement at September 30, 2009, and we anticipate to be in default at
December 31, 2009 even though operations are improving and we expect them to
continue improving in the fourth quarter.  As a result of this default
at September 30, 2009, and cross-default provisions in our TD Bank facility,
amounts outstanding under these facilities have been classified as current in
our consolidated balance sheet at September 30, 2009. We are seeking a waiver
from Whitney and will do so at year end, if we are still in
default.  If we are unable to obtain such a waiver, debt under these
facilities could be declared immediately due and payable. We may
consider alternative financings or other transactions to satisfy such
obligations. The
borrowing capacity under the Revolver was approximately $20 at September 30,
2009. We
continue to remain current on our principal, interest and fee obligations with
Whitney and TD Bank. Revenues
in the third quarter improved by $2,225 over the second quarter and we expect
operations to continue to improve in the fourth quarter.  The cost
containment program, which was commenced in the second quarter is continuing and
beginning to have a positive effect on general and administrative expenses. We have
commenced the production cycle of a large flotation order and had a majority of
our ROVs working at the end of the third quarter, and our offshore jobs are
increasing. As of September 30, 2009 our backlog was approximately
$20,000.




Management
believes that we have adequate capital resources when we combine our $3,896 cash
position and improved cash flows from strengthening operations to meet current
operating requirements for the twelve months ending September 30, 2010. The
factors described above create uncertainty and could have a material adverse
impact on our business.





Cash
Flow from Operating Activities





For the
nine months ended September 30, 2009, cash provided by operating activities was
approximately $4,606 as compared to cash provided by operating activities
for the same prior year period of approximately $1,175. Our working capital
balances vary due to delivery terms and payments on key contracts, costs and
estimated earnings in excess of billings on uncompleted contracts, and
outstanding receivables and payables. We collected approximately $6,440 in
accounts receivable during the nine months ended September 30, 2009 compared to
approximately $942 in the same prior year period. We used some of the operating
cash flow to reduce accounts payable and accrued liabilities by approximately
$289 compared to approximately $1,059 in the same prior year period.
Additionally, we recorded the following non-cash charges in the nine months
ended September 30, 2009: stock-based compensation of approximately $643, bad
debt expense of approximately $126 and depreciation and amortization of
approximately $2,389. In the nine months ended September 30, 2008, we recorded
amortization of deferred financing costs and debt discount related to a secured
credit agreement which totaled approximately $2,580, stock-based compensation of
approximately $424, bad debt expense of approximately $1,053 and depreciation
and amortization of approximately $1,642.





Cash
Flow from Investing Activities





For the
nine months ended September 30, 2009, cash used in investing activities was
approximately $5,845 compared to approximately $28,588 for the same prior year
period. For the nine months ended September 30, 2009, we used approximately
$5,536 to purchase property and equipment, which included approximately $570 in
deposits for the purchase of land and buildings. We also capitalized
approximately $383 in software costs related to a company-wide implementation of
our new ERP system, and invested $150 in a third party, offset by a decrease in
restricted cash for a letter of credit of $136. The majority of the 2008
activity related to cash paid for the purchase of Flotation totaling
approximately $22,162, cash paid to Mako shareholders totaling approximately
$4,237, net of expenses and purchase price adjustments. The change in the
restricted cash balance of approximately $375, related to requirements of a
secured credit agreement, which was released when the debt was paid in June
2008. We used approximately $2,564 for equipment purchases during the same
period of 2008.





Cash
Flow from Financing Activities





For the
nine months ended September 30, 2009, cash provided by financing
activities was approximately $2,640 compared to approximately $30,362 for the
same prior year period.  During the nine months ended September 30,
2009, we borrowed approximately $3,000 and made principle payments of
approximately $360. During the nine months ended September 30, 2008, we
completed a Private Placement of our stock for net proceeds of approximately
$37,060. We also paid approximately $12,493 to a secured creditor to pay the
balance due under a credit agreement and related interest and early termination
fees (such early termination fees were included in operations as loss on debt
extinguishment). In January 2008, in accordance with the terms of the purchase
of Mako, we paid approximately $916 of notes payable and received proceeds from
a secured creditor totaling approximately $5,604.




15




Critical
Accounting Policy Updates





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





See Note
2, “Recently Issued Accounting Standards and Developments”, in the notes to
unaudited consolidated financial statements for information regarding recently
issued accounting standards.





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, 2008 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 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.




16





ITEM
      4.
              CONTROLS
      AND PROCEDURES


Evaluation
of Disclosure Controls and Procedures





We
carried out an evaluation, under the supervision and with the participation of
our management, including our Principal Executive Officer and Principal
Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)).  Based upon that evaluation, our Principal Executive
Officer and Principal Financial Officer concluded that because material
weaknesses existed, as of September 30, 2009, our disclosure controls and
procedures were not effective to ensure that information required to be
disclosed in reports filed under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the required time periods
and is accumulated and communicated to our management, including our Principal
Executive Officer and Principal Financial Officer, as appropriate to allow
timely decisions regarding required disclosure. As disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2008, we determined that we
did not maintain an effective entity level control environment and did not
maintain effective controls over the accuracy of revenue recognition. Our
management, including our Principal Executive Officer and Principal Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error or fraud. A control system, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met.  Further,
the design of a control system must reflect the fact that there are resource
constraints and the benefits of controls must be considered relative to their
costs.  Due to the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, have been detected.





Changes in Internal Control Over
Financial Reporting.





In our
efforts to continuously improve our internal controls, management has taken
steps to enhance the following controls and procedures during the third quarter
of 2009, as part of our remediation efforts in addressing material
weaknesses:




·
            Management
      is in the process of implementing a new system-wide accounting and
      management software program to address the revenue recognition and gross
      margin analysis of projects accounted for under the
      percentage-of-completion method.


·
            Management
      prepared an employee handbook, distributed the handbook to all employees
      throughout the organization and obtained signed acknowledgements from each
      employee.


·
            Management
      has increased documentation around certain authorization and review
      controls.





Accordingly,
there have been changes in our internal controls over financial reporting that
have or are reasonably likely to materially affect our internal controls over
financial reporting.







17





PART II – OTHER
INFORMATION





ITEM
      1.
            LEGAL
      PROCEEDINGS




Periodically,
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 except as noted
below.




In
connection with the Private Placement in June 2008, we filed an initial
Registration Statement on Form S-1 on July 21, 2008 to register the 57,142,857
shares issued in the offering. Pursuant to the Registration Rights Agreement, we
were obligated to have the Registration Statement declared effective by
September 3, 2008, the “Required Effective Date”, or the Company would be
required to pay liquidated damages to the Selling Shareholders in the Private
Placement for each day following the Required Effective Date, until but
excluding the date the Commission declares the Registration Statement effective.
We evaluated this obligation under the Registration Rights Agreement for
liability treatment under ASC 450-20 “Contingencies” and ASC 825-20 “Financial
Instruments”, and determined the registration rights met the definition of a
liability under the authoritative guidance.  Accordingly, at December
31, 2008 we reserved $1,212,120 in potential damages under terms of the Private
Placement for the 90-day period from September 4 to December 3, 2008. On May 5,
2009, we obtained an opinion from legal counsel allowing removal of the related
stock’s restrictive legend under Rule 144, which was deemed to be equivalent,
and thus satisfied the registration rights requirements. As such, management
reduced the liquidated damages reserve to 47 days, or $626,040 in the first
quarter of 2009.




The
Commission declared the Registration Statement on Form S-1 effective on April
16, 2009 pursuant to Section 7.1(c) of the Registration Rights Agreement. We
initiated payment to the Selling Shareholders effective May 12,
2009.





18





ITEM
      6.
              EXHIBITS


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





Exhibit
      Number
              
              Description
      of Exhibit3.1
              
              Articles
      of Incorporation of Deep Down, Inc. (conformed to include the amendment of
      the Articles of Incorporation filed with the Secretary of State of the
      State of Nevada on September 29, 2008) (incorporated by reference from
      Exhibit A to our Schedule 14C filed on August 15,
2008).3.2
              
              Amended
      and Restated ByLaws of Deep Down, Inc. (incorporated by reference from
      Exhibit B to our Schedule 14C filed on August 15,
2008).10.1*
              
              Waiver
      Agreement, dated September 10, 2009 and effective as of September 1, 2009,
      by and between Whitney National Bank, as lender and Deep Down, Inc., as
      borrower.10.2*
              
              Waiver
      of Loan Covenants, dated August 7, 2009 and effective as of June 30, 2009,
      by and between Whitney National Bank, as lender and Deep Down, Inc., as
      borrower.10.3*†
              
              Severance
      and Separation Agreement, dated September 1, 2009, by and between
      Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr.
      (“Consultant”) and Deep Down, Inc.,31.1*
              
              Certification
      of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of
      the Securities Exchange Act of 1934.31.2*
              
              Certification
      of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the
      Securities Exchange Act of 1934.32.1*
              
              Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
              
              Section
      1350 Certification of the Chief Financial Officer of Deep Down,
      Inc.


________________


* Filed
or furnished herewith.


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





19


SIGNATURES





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








DEEP
      DOWN, INC.(Registrant)





Signature
            
            Title
            
            Date/s/
      RONALD E. SMITH
            
            President,
      CEO and Director
            
            November
      16, 2009Ronald
      E. Smith
            
            (Principal
      Executive Officer)/s/
      EUGENE L. BUTLER
            
            Chief
      Financial Officer and Director
            
            November
      16, 2009Eugene
      L. Butler
            
            (Principal
      Financial Officer)







20





INDEX
TO EXHIBITS




Exhibit
      Number
              
              Description
      of Exhibit3.1
              
              Articles
      of Incorporation of Deep Down, Inc. (conformed to include the amendment of
      the Articles of Incorporation filed with the Secretary of State of the
      State of Nevada on September 29, 2008) (incorporated by reference from
      Exhibit A to our Schedule 14C filed on August 15,
2008).3.2
              
              Amended
      and Restated ByLaws of Deep Down, Inc. (incorporated by reference from
      Exhibit B to our Schedule 14C filed on August 15,
2008).10.1*
              
              Waiver
      Agreement, dated September 10, 2009 and effective as of September 1, 2009,
      by and between Whitney National Bank, as lender and Deep Down, Inc., as
      borrower.10.2*
              
              Waiver
      of Loan Covenants, dated August 7, 2009 and effective as of June 30, 2009,
      by and between Whitney National Bank, as lender and Deep Down, Inc., as
      borrower.10.3*†
              
              Severance
      and Separation Agreement, dated September 1, 2009, by and between
      Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr.
      (“Consultant”) and Deep Down, Inc.,31.1*
              
              Certification
      of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of
      the Securities Exchange Act of 1934.31.2*
              
              Certification
      of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the
      Securities Exchange Act of 1934.32.1*
              
              Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
              
              Section
      1350 Certification of the Chief Financial Officer of Deep Down,
      Inc.


_________________


* Filed
or furnished herewith.


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







21