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, 2008




OR




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





Commission
File No. 0-30351




DEEP
DOWN, INC.


(Exact
name of registrant as specified in its charter)




Nevada
            
            75-2263732(State
      or other jurisdiction of incorporation)
            
            (I.R.S.
      Employer Identification No.)15473
      East Freeway Channelview,Texas
            
            77530(Address
      of Principal Executive Office)
            
            (Zip
      Code)




Registrant’s
telephone number, including area code:(281)
862-2201




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.  Yes  xNo   ̈




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 14, 2008, there were 177,350,630 shares of common stock
outstanding.





i


IMPORTANT
INFORMATION REGARDING THIS FORM 10-Q





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





Deep
Down, Inc., a Nevada corporation (“Deep Down Nevada” or “Deep Down” or the
“Company”) is the parent company to its wholly-owned subsidiaries: Deep Down,
Inc., a Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a
Nevada corporation (“ElectroWave”), Mako Technologies, LLC, a Nevada limited
liability company (“Mako”), and Flotation Technologies, Inc., a Maine
corporation (“Flotation”).





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





Forward-Looking
Statements





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





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





Subsequent
Events





All
statements contained in this Quarterly Report on Form 10-Q, including the
forward-looking statements discussed above, are made as of November 14, 2008,
unless those statements are expressly made as of another date.  We
disclaim any responsibility for the accuracy of any information contained in
this Quarterly Report on Form 10-Q to the extent such information is affected or
impacted by events, circumstances or developments occurring after
November 14, 2008 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 2007 Annual Report on Form 10-KSB/A (Amendment No. 4), other periodic and
current reports we file with the Securities and Exchange Commission (“SEC”) or
this Form 10-Q.





Access
to Filings





Access to
our Annual Reports on Form 10-KSB, Quarterly Reports on Forms 10-Q or Form
10-QSB and Current Reports on Form 8-K, and amendments to those reports, filed
with or furnished to the SEC pursuant to Section 13(a) of the Exchange Act, as
well as reports filed electronically pursuant to Section 16(a) of the Exchange
Act, may be obtained through our website
(http://www.deepdowninc.com).  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 such material
with the SEC.  The contents of our website are not, and shall not be
deemed to be, incorporated into this report.




ii


TABLE
OF CONTENTS





PART
I FINANCIAL INFORMATION






Page
      No.Item
      1.
            Financial
      StatementsUnaudited
      Consolidated Balance Sheets - September 30, 2008 and December 31,
      2007
            1Unaudited
      Consolidated Statements of Operations - For the Three and Nine months
      Ended September 30, 2008 and 2007
            2Unaudited
      Consolidated Statements of Stockholders’ Equity - For the Nine months
      Ended September 30, 2008
            3Unaudited
      Consolidated Statements of Cash Flows - For the Nine months Ended
      September 30, 2008 and 2007
            4Notes
      to Unaudited Consolidated Financial Statements
            6Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            21Item
      3.
            Qualitative
      and Quantitative Market Risks
            28Item
      4T.
            Controls
      and Procedures
            28PART
      II OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            29Item
      1A.
            Risk
      Factors
            29Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            29Item
      3.
            Defaults
      Upon Senior Securities
            29Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            29Item
      5.
            Other
      Information
            30Item
      6.
            Exhibits
            31Signatures
            
            31Exhibit
      Index
            32







iii




PART
I. FINANCIAL INFORMATION


ITEM
1.  FINANCIAL STATEMENTS





DEEP
DOWN, INC.


CONSOLIDATED
BALANCE SHEETS


(Unaudited)


September
      30, 2008
                
                
                December
      31, 2007ASSETSCash
      and equivalents
                
                $
                5,155,069
                
                
                $
                2,206,220Restricted
      cash
                
                
                -
                
                
                
                375,000Accounts
      receivable, net of allowance of $345,649 and $139,787
      respectively
                
                
                7,197,552
                
                
                
                7,190,466Prepaid
      expenses and other current assets
                
                
                850,030
                
                
                
                312,058Inventory
                
                
                820,922
                
                
                
                502,253Lease
      receivable, short-term
                
                
                -
                
                
                
                414,000Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                
                
                1,661,829
                
                
                
                749,455Receivable
      from Prospect, net
                
                
                -
                
                
                
                2,687,333Total
      current assets
                
                
                15,685,402
                
                
                
                14,436,785Property
      and equipment, net
                
                
                12,219,276
                
                
                
                5,368,961Other
      assets, net of accumulated amortization of $0 and $54,560
      respectively
                
                
                277,402
                
                
                
                1,109,152Lease
      receivable, long-term
                
                
                -
                
                
                
                173,000Intangibles,
      net
                
                
                18,418,196
                
                
                
                4,369,647Goodwill
                
                
                12,985,718
                
                
                
                10,594,144Total
      assets
                
                $
                59,585,994
                
                
                $
                36,051,689LIABILITIES
      AND STOCKHOLDERS' EQUITYAccounts
      payable and accrued liabilities
                
                $
                3,589,093
                
                
                $
                3,569,826Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                
                
                367,259
                
                
                
                188,030Payable
      to Mako shareholders
                
                
                -
                
                
                
                3,205,667Current
      portion of long-term debt
                
                
                48,816
                
                
                
                995,177Total
      current liabilities
                
                
                4,005,168
                
                
                
                7,958,700Deferred
      tax liabilities, net
                
                
                45,362
                
                
                
                -Long-term
      debt, net of accumulated discount of $0 and $1,703,258
      respectively
                
                
                914,225
                
                
                
                10,698,818Series
      E redeemable exchangeable preferred stock, par value $0.01, face value and
      liquidationpreference
      of $1,000 per share, no dividend preference, authorized 10,000,000
      aggregate shares of all series of preferred stock, -0- and 500 issued and
      outstanding, respectively
                
                
                -
                
                
                
                386,411Total
      liabilities
                
                
                4,964,755
                
                
                
                19,043,929Temporary
      equity:Series
      D redeemable convertible preferred stock, $0.01 par value, face value and
      liquidationpreference
      of $1,000 per share, no dividend preference, authorized 10,000,000
      aggregate shares of all series of preferred stock, -0- and 5,000 issued
      and outstanding, respectively
                
                
                -
                
                
                
                4,419,244Total
      temporary equity
                
                
                -
                
                
                
                4,419,244Stockholders'
      equity:Common
      stock, $0.001 par value, 490,000,000 shares authorized, 177,350,630and
      85,976,526 shares issued and
                    outstanding,
      respectively
                
                
                177,351
                
                
                
                85,977Paid-in
      capital
                
                
                60,167,948
                
                
                
                14,849,847Accumulated
      deficit
                
                
                (5,724,060
                )
                
                
                (2,347,308
                )Total
      stockholders' equity
                
                
                54,621,239
                
                
                
                12,588,516Total
      liabilities and stockholders' equity
                
                $
                59,585,994
                
                
                $
                36,051,689See
      accompanying notes to unaudited consolidated financial
      statements.


1


DEEP
DOWN, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (Unaudited)
 For
      the Three Months Ended
              
              
              For
      the Nine Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007RevenuesContract
      revenue
              
              $
              11,039,041
              
              
              $
              3,819,536
              
              
              $
              22,046,957
              
              
              $
              9,930,453Rental
      revenue
              
              
              613,521
              
              
              
              1,066,019
              
              
              
              3,805,268
              
              
              
              2,198,284Total
      revenues
              
              
              11,652,562
              
              
              
              4,885,555
              
              
              
              25,852,225
              
              
              
              12,128,737Cost
      of sales
              
              
              6,350,318
              
              
              
              3,625,020
              
              
              
              15,462,187
              
              
              
              8,300,707Gross
      profit
              
              
              5,302,244
              
              
              
              1,260,535
              
              
              
              10,390,038
              
              
              
              3,828,030Operating
      expenses:Selling,
      general & administrative
              
              
              3,733,254
              
              
              
              949,376
              
              
              
              9,413,939
              
              
              
              2,712,997Depreciation
      and amortization
              
              
              17,366
              
              
              
              20,861
              
              
              
              882,779
              
              
              
              44,797Total
      operating expenses
              
              
              3,750,620
              
              
              
              970,237
              
              
              
              10,296,718
              
              
              
              2,757,794Operating
      income
              
              
              1,551,624
              
              
              
              290,298
              
              
              
              93,320
              
              
              
              1,070,236Other
      income (expense):Gain
      (loss) on debt extinguishment
              
              
              -
              
              
              
              -
              
              
              
              (446,412
              )
              
              
              2,000,000Interest
      income
              
              
              36,977
              
              
              
              32,645
              
              
              
              103,487
              
              
              
              48,935Interest
      expense
              
              
              (24,704
              )
              
              
              (241,639
              )
              
              
              (3,484,268
              )
              
              
              (1,750,296
              )Other
      income
              
              
              17,060
              
              
              
              15,052
              
              
              
              5,644
              
              
              
              15,052Total
      other income (expense)
              
              
              29,333
              
              
              
              (193,942
              )
              
              
              (3,821,549
              )
              
              
              313,691Income
      (loss) before income taxes
              
              
              1,580,957
              
              
              
              96,356
              
              
              
              (3,728,229
              )
              
              
              1,383,927Benefit
      from (provision for) income taxes
              
              
              (2,889
              )
              
              
              99,613
              
              
              
              351,477
              
              
              
              (347,750
              )Net
      income (loss)
              
              $
              1,578,068
              
              
              $
              195,969
              
              
              $
              (3,376,752
              )
              
              $
              1,036,177Earnings
      (loss) per share:Basic
              
              $
              0.01
              
              
              $
              -
              
              
              $
              (0.03
              )
              
              $
              0.01Weighted-average
      common shares outstanding
              
              
              176,093,714
              
              
              
              68,285,932
              
              
              
              131,744,393
              
              
              
              72,626,591Diluted
              
              $
              0.01
              
              
              $
              -
              
              
              $
              (0.03
              )
              
              $
              0.01Weighted-average
      common shares outstanding
              
              
              177,413,975
              
              
              
              100,307,773
              
              
              
              131,744,393
              
              
              
              100,584,062See
      accompanying notes to unaudited consolidated financial
      statements.
  2
  DEEP
DOWN, INC.
 CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
 (Unaudited)
  For
      the Nine Months Ended September 30, 2008Common
      Stock
                  
                  
                  Paid-in
                  
                  
                  AccumulatedShares
                  
                  
                  Amount
                  
                  
                  Capital
                  
                  
                  Deficit
                  
                  
                  TotalBalance
      at December 31, 2007
                  
                  
                  85,976,532
                  
                  
                  $
                  85,977
                  
                  
                  $
                  14,849,847
                  
                  
                  $
                  (2,347,308
                  )
                  
                  $
                  12,588,516Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,376,752
                  )
                  
                  
                  (3,376,752
                  )Exchange
      of Series D preferred stock
                  
                  
                  25,866,518
                  
                  
                  
                  25,867
                  
                  
                  
                  4,393,377
                  
                  
                  
                  
                  
                  
                  
                  4,419,244Stock
      issued for acquisition of Mako
                  
                  
                  2,802,969
                  
                  
                  
                  2,803
                  
                  
                  
                  1,959,275
                  
                  
                  
                  
                  
                  
                  
                  1,962,078Stock
      issued for acquisition of Flotation
                  
                  
                  1,714,286
                  
                  
                  
                  1,714
                  
                  
                  
                  1,421,143
                  
                  
                  
                  
                  
                  
                  
                  1,422,857Warrants
      issued for acquisition of Flotation
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  121,793
                  
                  
                  
                  
                  
                  
                  
                  121,793Restricted
      stock issued
                  
                  
                  1,200,000
                  
                  
                  
                  1,200
                  
                  
                  
                  (1,200
                  )
                  
                  
                  
                  
                  
                  
                  -Stock
      issued in private placement
                  
                  
                  57,142,857
                  
                  
                  
                  57,143
                  
                  
                  
                  37,002,527
                  
                  
                  
                  
                  
                  
                  
                  37,059,670Cashless
      exercise of stock options
                  
                  
                  29,339
                  
                  
                  
                  29
                  
                  
                  
                  (29
                  )
                  
                  
                  
                  
                  
                  
                  -Warrant
      exercises
                  
                  
                  2,618,129
                  
                  
                  
                  2,618
                  
                  
                  
                  (2,618
                  )
                  
                  
                  
                  
                  
                  
                  -Stock
      based compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  423,833
                  
                  
                  
                  
                  
                  
                  
                  423,833Balance
      at September 30, 2008
                  
                  
                  177,350,630
                  
                  
                  $
                  177,351
                  
                  
                  $
                  60,167,948
                  
                  
                  $
                  (5,724,060
                  )
                  
                  $
                  54,621,239See
      accompanying notes to unaudited consolidated financial
      statements.
 3
  DEEP
DOWN, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOW
 (Unaudited)
  Nine
      Months EndedSeptember
      30,2008
                
                
                2007Cash
      flows from operating activities:Net
      loss
                
                $
                (3,376,752
                )
                
                $
                1,036,176Adjustments
      to reconcile net income to net cash provided by(used
      in) operating activities:Gain
      on extinguishment of debt
                
                
                -
                
                
                
                (2,000,000
                )Interest
      income
                
                
                (54,975
                )
                
                
                -Amortization
      of debt discount
                
                
                1,816,847
                
                
                
                1,427,960Amortization
      of deferred financing costs
                
                
                762,700
                
                
                
                15,988Share-based
      compensation
                
                
                423,833
                
                
                
                113,480Bad
      debt expense
                
                
                1,052,668
                
                
                
                16,305Depreciation
      and amortization
                
                
                1,641,508
                
                
                
                247,503Loss
      on disposal of equipment
                
                
                160,692
                
                
                
                7,948Changes
      in assets and liabilities:Lease
      receivable
                
                
                -
                
                
                
                (788,520
                )Accounts
      receivable
                
                
                942,111
                
                
                
                (2,006,548
                )Prepaid
      expenses and other current assets
                
                
                (453,018
                )
                
                
                (96,581
                )Inventory
                
                
                (820,922
                )
                
                
                45,000Finished
      goods
                
                
                -
                
                
                
                (515,601
                )Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                
                
                (41,191
                )
                
                
                (913,435
                )Accounts
      payable and accrued liabilities
                
                
                (1,058,090
                )
                
                
                2,072,684Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                
                
                179,229
                
                
                
                (190,000
                )Net
      cash provided by (used in) operating activities
                
                $
                1,174,640
                
                
                $
                (1,527,641
                )Cash
      flows from (used in) investing activities:Cash
      paid for acquisition of Flotation
                
                
                (22,161,863
                )
                
                
                -Cash
      paid for acquisition of Mako
                
                
                (1,319,967
                )
                
                
                -Cash
      paid for third party debt
                
                
                -
                
                
                
                (432,475
                )Cash
      received from sale of ElectroWave receivables
                
                
                -
                
                
                
                261,068Cash
      deficit acquired an acquisition of a business
                
                
                -
                
                
                
                (18,974
                )Purchases
      of equipment
                
                
                (2,564,114
                )
                
                
                (600,636
                )Restricted
      cash
                
                
                375,000
                
                
                
                (375,000
                )Net
      cash used in investing activities
                
                $
                (25,670,944
                )
                
                $
                (1,166,017
                )Cash
      flows from financing activities:Payment
      for cancellation of common stock
                
                
                -
                
                
                
                (250,000
                )Redemption
      of preferred stock
                
                
                -
                
                
                
                (250,000
                )Proceeds
      from sale of common stock, net of expenses
                
                
                37,059,670
                
                
                
                960,000Proceeds
      from long term debt
                
                
                2,687,333
                
                
                
                -Proceeds
      from sales-type lease
                
                
                587,000
                
                
                
                172,500Borrowings
      on debt - related party
                
                
                -
                
                
                
                150,000Payments
      on debt - related party
                
                
                -
                
                
                
                (150,000
                )Borrowings
      on long-term debt
                
                
                -
                
                
                
                6,000,000Increase
      in deferred financing fees
                
                
                -
                
                
                
                (442,198
                )Creation
      of debt discount due to lender's fees
                
                
                -
                
                
                
                (180,000
                )Payments
      of long-term debt
                
                
                (12,888,850
                )
                
                
                (2,641,671
                )Net
      cash provided by financing activities
                
                $
                27,445,153
                
                
                $
                3,368,631Change
      in cash and equivalents
                
                
                2,948,849
                
                
                
                674,973Cash
      and equivalents, beginning of period
                
                
                2,206,220
                
                
                
                12,462Cash
      and equivalents, end of period
                
                $
                5,155,069
                
                
                $
                687,435See
      accompanying notes to unaudited consolidated financial
      statements.
  4
  DEEP
DOWN, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOW
 (Unaudited)
  Nine
      Months EndedSeptember
      30,2008
                
                
                2007Supplemental
      schedule of noncash investingand
      financing activities:Acquisition
      of a business
                
                $
                -
                
                
                $
                (190,381
                )Exchange
      of receivables for acquisition of a business
                
                $
                -
                
                
                $
                171,407Warrants
      issued for acquisition of Flotation
                
                $
                121,793
                
                
                $
                -Stock
      issued for acquisition of Flotation
                
                $
                1,422,857
                
                
                $
                -Stock
      issued for acquisition of Mako
                
                $
                1,962,078
                
                
                $
                -Correction
      of common stock per value to paid in capital
                
                $
                -
                
                
                $
                114,750Fixed
      assets purchased with capital lease
                
                $
                -
                
                
                $
                525,000Fixed
      assets transferred from Inventory
                
                $
                502,253
                
                
                $
                -Exchange
      of Series D preferred stock
                
                $
                4,419,244
                
                
                $
                -Exchange
      of Series E preferred stock
                
                $
                -
                
                
                $
                3,366,778Redemption
      of Series E preferred stock
                
                $
                -
                
                
                $
                3,685,463Exchange
      of Series E preferred stock for subordinated debenture
                
                $
                500,000
                
                
                $
                -Common
      shares issued as restricted stock
                
                $
                1,200
                
                
                $
                -Creation
      of debt discount due to warrants issued to lender
                
                $
                -
                
                
                $
                1,479,189Creation
      of deferred financing fee due to warrants issued to third
      party
                
                $
                -
                
                
                $
                113,120Supplemental
      Disclosures:Cash
      paid for interest
                
                $
                904,721
                
                
                $
                306,349Cash
      paid for pre-payment penalties
                
                $
                446,413
                
                
                $
                -Cash
      paid for taxes
                
                $
                275,000
                
                
                $
                14,970See
      accompanying notes to unaudited consolidated financial
      statements.




5





DEEP
DOWN, INC.


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS




NOTE
1: GENERAL





Nature
of Business





Deep
Down, Inc., a Nevada corporation, is the parent company to its wholly-owned
subsidiaries: Deep Down, Inc., a Delaware corporation, ElectroWave USA, Inc., a
Nevada corporation, since its acquisition effective April 2, 2007, Mako
Technologies, LLC, a Nevada limited liability company, since its acquisition
effective December 1, 2007, and Flotation Technologies, Inc., a Maine
corporation, since its acquisition effective May 1, 2008.




Deep Down
Delaware provides installation management, engineering services, support
services and storage management services for the subsea controls, umbilicals and
offshore pipeline industries. Deep Down Delaware also fabricates component
parts for subsea distribution systems and assemblies.




ElectroWave
offers products and services in the fields of electronic monitoring and control
systems for the energy, military, marine and commercial business
sectors.




Mako
serves the growing offshore petroleum and marine industries with technical
support services and products vital to offshore petroleum production, through
rentals of its remotely operated vehicles (“ROV”), topside and subsea equipment
and diving support systems used in diving operations, maintenance and repair
operations, offshore construction, and environmental/marine
surveys.




Flotation
engineers, designs and manufactures deepwater buoyancy systems using
high-strength FlotecTMsyntactic foam and polyurethane
elastomers.  Flotation’s  product offerings include
distributed buoyancy for flexible pipes and umbilicals, drilling riser buoyance
modules, CoreTecTM
drilling riser buoyancy modules, ROVitsTM
buoyancy, Hydro-Float mooring buoys, StablemoorTM
low-drag ADCP deployment solution, Quick-LocTM cable floats, HardballTM
umbilical floats, FlotecTM cable and pipeline protection, InflexTM polymer
bend restrictors, and installation buoyancy of any size and depth
rating.




Basis
of Presentation





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted for interim financial
information and with the instructions to Form 10-Q and Article 8 of Regulation
S-X relating to smaller reporting companies.  Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles (“GAAP”) for complete financial statements.  In
the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been
included.  Operating results for the three-month or nine-month periods
ended September 30, 2008 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2008.  The balance sheet
at December 31, 2007 has been derived from the audited financial statements at
that date but does not include all of the information and footnotes required by
GAAP for complete financial statements.




For
further information, refer to the audited consolidated financial statements and
footnotes thereto included in our Annual Report on Form 10-KSB/A (Amendment No.
4) for the year ended December 31, 2007 filed on September 30,
2008.





Reclassifications





Prior
period information presented in these financial statements includes
reclassifications which were made to conform to the current period
presentation.  These reclassifications had no effect on our previously
reported net income (loss) or stockholders' equity. For example, Deep Down
reclassified its account previously referred to as Work in Process to its Costs
incurred in excess of earnings and billings line item in order to more
accurately reflect the nature of these unbilled balances.  In addition,
Deep Down reclassified $758,728 of depreciation expense into Cost of sales from
SG&A for the nine-month period ended September 30, 2008.  As such,
$202,706 was reclassified for the corresponding nine-months ended September 30,
2007 out of SG&A to Cost of sales.





Principles
of Consolidation





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




6


NOTE
2: ACCOUNTS RECEIVABLE





Accounts
receivable includes an allowance for uncollectible accounts of $345,649 and
$139,787 as of September 30, 2008 and December 31, 2007, respectively. Bad debt
expense totaled $1,052,668 and $16,305 for the nine months ended September
30, 2008 and 2007, respectively.





NOTE
3: COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED
CONTRACTS





Deep Down
entered into a large fixed price contract during the nine months ended September
30, 2008.  As such, Deep Down determined that recognizing revenues for this
contract was appropriate using the percentage-of-completion method under
Statement of Position 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts (“SOP 81-1”), measured by the percentage of
costs incurred to date to estimated total costs for the contract.  This
method is used because management considers total cost to be the best available
measure of progress on the contracts.





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




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




The asset
balance of $1,661,829 at September 30, 2008 includes approximately $1,360,000
related to a large contract that is expected to be completed during December
2008 or January 2009. Deep Down has recognized approximately 72% of the related
revenue based on the percentage-of-completion method.




In
accordance with industry practice, assets and liabilities related to costs and
estimated earnings in excess of billings on uncompleted contracts, as well as
billings in excess of costs and estimated earnings on uncompleted contracts,
have been classified as current. The contract cycle for certain long-term
contracts may extend beyond one year, thus collection of amounts related to
these contracts may extend beyond one year.








7


NOTE
4: PROPERTY AND EQUIPMENT





Property
and equipment include the following:




September
      30, 2008
                
                
                December
      31, 2007Land
                
                $
                461,955
                
                
                $
                -Building
                
                
                3,242,351
                
                
                
                195,305Leasehold
      improvements
                
                
                342,430
                
                
                
                75,149Furniture
      and fixtures
                
                
                143,509
                
                
                
                63,777Vehicles
      and trailers
                
                
                105,836
                
                
                
                112,161Equipment
                
                
                3,691,527
                
                
                
                1,809,474Rental
      Equipment
                
                
                4,741,084
                
                
                
                3,144,559Computer
      and office equipment
                
                
                446,563
                
                
                
                194,693Construction
      in progress
                
                
                358,910
                
                
                
                196,157Total
                
                
                13,534,165
                
                
                
                5,791,275Less:
      Accumulated depreciation
                
                
                (1,314,889
                )
                
                
                (422,314
                )Property
      and equipment, net
                
                $
                12,219,276
                
                
                $
                5,368,961


Depreciation
expense for the nine months ended September 30, 2008 and 2007 was $920,056 and
$247,503, respectively.  For the nine months ended September 30, 2008 and
2007, Deep Down recorded $758,728 and $202,706, respectively, of the total
depreciation as Cost of Sales on the accompanying statements of
operations.




During
the nine months ended September 30, 2008, we leased additional property from
JUMA, LLC, a related party, and incurred $342,430 in leasehold improvements. See
additional discussion in Note 12 regarding the nature of the related
party.




In
connection with the purchase of Flotation, Deep Down acquired land along with a
building and improvements with a fair market value of approximately $3,300,000.
This 3.61 acre site in Maine houses a 46,925 square foot light industrial
manufacturing facility.




On June
30, 2008, Deep Down transferred equipment with a cost basis of $502,253 from
inventory to its rental equipment fleet.





NOTE
5: ACQUISITIONS





Purchase of Mako
Technologies, Inc.





Effective
December 1, 2007, Deep Down purchased 100% of Mako. Two installments were paid
to the Mako shareholders. The first installment of $2,916,667 in cash and
6,574,074 restricted shares of common stock of Deep Down, valued at $0.76 per
share, was paid on January 4, 2008. The second installment of 2,802,969
restricted shares of common stock of Deep Down, valued at $0.70 per share, was
issued on March 28, 2008. The final cash payment of $1,243,571, which was paid
on April 11, 2008, was included in the “Payable to Mako shareholders” balance on
the accompanying balance sheet at December 31, 2007.





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





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




8


Purchase of Flotation
Technologies, Inc.





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





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





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





Deep Down
sold 57,142,857 shares to accredited investors on June 5, 2008, for
approximately $37,059,670 in net proceeds, at a price of $0.70 per share. Deep
Down used $22,100,000 in proceeds from this private placement to fund the cash
requirement of the Flotation acquisition.





Deep Down
also issued 600,000 incentive common stock purchase options to employees of
Flotation for their continued services with an exercise price of $1.15 per
share. The employee options vest one-third of the original amount each year and
may be exercised in whole or in part after vesting. Deep Down valued the options
at $264,335 based on the Black-Scholes option pricing model, and will recognize
the related compensation cost ratably over the requisite service
period.





The table
below reflects the breakdown of the purchase price as noted above:


Summary
      of purchase price:Cash
                
                $
                22,100,000Certain
      transaction costs
                
                
                296,904Fair
      market value of common stock
                
                
                1,422,857Fair
      market value of warrants issued
                
                
                121,793Total
      purchase price
                
                $
                23,941,554


The
payment of the purchase price of $23,941,554 was in exchange for all of the
outstanding capital stock of Flotation. The acquisition price was allocated to
the assets acquired and liabilities assumed based upon their estimated fair
values with the excess being recorded in goodwill.  The following
table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition on May 1, 2008:




Summary
      of net assets acquired:Cash
      and cash equivalents
                
                $
                235,040Accounts
      receivable
                
                
                2,105,519Construction
      in progress
                
                
                871,183Prepaid
      expenses
                
                
                15,904Property,
      plant and equipment, net
                
                
                4,907,752Intangibles
                
                
                14,797,000Goodwill
                
                
                2,141,469Total
      assets acquired
                
                $
                25,073,867Accounts
      payable and accrued liabilities
                
                
                1,132,313Total
      liabilities acquired
                
                $
                1,132,313Net
      assets acquired
                
                $
                23,941,554


Deep Down
obtained an independent valuation of the assets and liabilities as of the
purchase date of May 1, 2008. Based on the independent valuation, the fair value
of the property, plant and equipment was increased by approximately $1,258,000
and will be depreciated over the estimated useful lives of 3 to 40 years using
the straight-line method.




9




Deep Down
has estimated the fair value of Flotation’s identifiable intangible assets as
follows:


Estimated
                
                
                Average
      RemainingFair
      Value
                
                
                Useful
      LifeTrademarks
                
                $
                2,039,000
                
                
                
                40Technology
                
                
                11,209,000
                
                
                
                25Non-compete
      covenant
                
                
                879,000
                
                
                
                3Customer
      relationship
                
                
                670,000
                
                
                
                25$
                14,797,000


The table
below reflects the assumptions used for warrant and option grants related to
Flotation during the nine months ended September 30, 2008:




Dividend
      yield
                0%Risk
      free interest rate
                2.52%
      - 3.18%Expected
      life of options
                2 -
      2.5 yearsExpected
      volatility
                51.7%
      - 61.3%


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









10


Unaudited pro forma
condensed combined financial statements





The
following unaudited pro forma combined condensed financial statements include
Flotation and Mako for the periods presented as if the acquisitions had occurred
on the first date of the respective periods and are presented for informational
purposes only. These results are not necessarily indicative of the results of
operations that actually would have been achieved had the acquisitions been
consummated as of the beginning of the period presented, or are they intended to
be a projection of future results. The unaudited pro forma results were as
follows:




Unaudited
      Pro Forma Combined Condensed Statements of OperationsFor
      the Nine Months ended September 30, 2008HistoricalFour
      Months
                
                
                
                
                
                
                
                
                CombinedApril
      30,
                
                
                Flotation
                
                
                
                
                
                Condensed2008
                
                
                Pro
      Forma
                
                
                
                
                
                Pro
      FormaDeep
      Down
                
                
                Flotation
                
                
                Entries
                
                
                
                
                
                ResultsRevenues
                
                $
                25,852,225
                
                
                $
                5,941,472
                
                
                $
                -
                
                
                
                
                
                $
                31,793,697Cost
      of sales
                
                
                15,462,187
                
                
                
                4,005,179
                
                
                
                -
                
                
                
                
                
                
                19,467,366Gross
      profit
                
                
                10,390,038
                
                
                
                1,936,293
                
                
                
                -
                
                
                
                
                
                
                12,326,331Total
      operating expenses
                
                
                10,296,718
                
                
                
                968,179
                
                
                
                302,416
                
                
                
                (d/e)
                
                
                
                11,567,313Operating
      income (loss)
                
                
                93,320
                
                
                
                968,114
                
                
                
                (302,416
                )
                
                
                
                
                
                
                759,018Total
      other expense
                
                
                (3,821,549
                )
                
                
                (57,335
                )
                
                
                -
                
                
                
                
                
                
                
                (3,878,884
                )Income
      (loss) fromcontinuing
      operations
                
                
                (3,728,229
                )
                
                
                910,779
                
                
                
                (302,416
                )
                
                
                
                
                
                
                (3,119,866
                )Benefit
      from (provision for) income taxes
                
                
                351,477
                
                
                
                -
                
                
                
                (225,094
                )
                
                (f)
                
                
                
                126,383Net
      income (loss)
                
                $
                (3,376,752
                )
                
                $
                910,779
                
                
                $
                (527,510
                )
                
                
                
                
                
                $
                (2,993,483
                )Basic
      earnings (loss) per share
                
                $
                (0.03
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (0.02
                )Shares
      used in computingbasic
      per share amounts
                
                
                131,744,393
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                166,174,982Diluted
      earnings (loss) per share
                
                $
                (0.03
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (0.02
                )Shares
      used in computingdiluted
      per share amounts
                
                
                131,744,393
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                166,174,982See
      accompanying notes to unaudited pro forma combined condensed financial
      statements.


The
historical results of Deep Down for the nine months ended September 30, 2008
contain five months of results for Flotation operations since its acquisition
was effective May 1, 2008. The historical results of Deep Down for the quarter
ended September 30, 2008 contain the results of Flotation operations for the
full three months, so only the nine-months ended September 30, 2008 is presented
as pro forma. The weighted-average shares of stock used in computing basic and
diluted per share amounts give effect to the 2,802,969 Mako shares issued on
March 31, 2008 and the total of 58,857,143 common shares of Deep Down issued in
June 2008, of which such amount 57,142,857 were issued in connection with the
Private Placement and 1,714,286 were issued to Flotation’s prior shareholders,
as if all these shares were issued January 1, 2008. Taxes are calculated on the
pro forma entries at Deep Down’s estimated combined effective rate of
37%.





11




Unaudited
      Pro Forma Combined Condensed Statement of OperationsFor
      the Three Months ended September 30,
2007
  CombinedHistorical
                        
                        Mako
                        
                        
                        
                        Flotation
                        
                        
                        
                        CondensedPro
      Forma
                        
                        
                        
                        Pro
      Forma
                        
                        
                        
                        Pro
      FormaDeep
      Down
                        
                        
                        Mako
                        
                        
                        Flotation
                        
                        
                        Entries
                        
                        
                        
                        Entries
                        
                        
                        
                        ResultsRevenues
                        
                        $
                        4,885,555
                        
                        
                        $
                        1,672,457
                        
                        
                        $
                        4,635,810
                        
                        
                        $
                        -
                        
                        
                        
                        $
                        -
                        
                        
                        
                        $
                        11,193,822Cost
      of sales
                        
                        
                        3,625,020
                        
                        
                        
                        710,822
                        
                        
                        
                        2,744,365
                        
                        
                        
                        -
                        
                        
                        
                        
                        -
                        
                        
                        
                        
                        7,080,207Gross
      profit
                        
                        
                        1,260,535
                        
                        
                        
                        961,635
                        
                        
                        
                        1,891,445
                        
                        
                        
                        -
                        
                        
                        
                        
                        -
                        
                        
                        
                        
                        4,113,615Total
      operating expenses
                        
                        
                        970,237
                        
                        
                        
                        648,756
                        
                        
                        
                        463,023
                        
                        
                        
                        122,367
                        
                        (a)
                        
                        
                        226,812
                        
                        (d/e)
                        
                        
                        2,431,195Operating
      income (loss)
                        
                        
                        290,298
                        
                        
                        
                        312,879
                        
                        
                        
                        1,428,422
                        
                        
                        
                        (122,367
                        )
                        
                        
                        
                        (226,812
                        )
                        
                        
                        
                        1,682,420Total
      other income (expense)
                        
                        
                        (193,942
                        )
                        
                        
                        (9,156
                        )
                        
                        
                        (613,878
                        )
                        
                        
                        (266,410
                        )
                        (b)
                        
                        
                        -
                        
                        
                        
                        
                        (1,083,386
                        )Income
      (loss) from continuing operations
                        
                        
                        96,356
                        
                        
                        
                        303,723
                        
                        
                        
                        814,544
                        
                        
                        
                        (388,777
                        )
                        
                        
                        
                        (226,812
                        )
                        
                        
                        
                        599,034Benefit
      from (provision for) income taxes
                        
                        
                        99,613
                        
                        
                        
                        (205,567
                        )
                        
                        
                        -
                        
                        
                        
                        143,847
                        
                        
                        
                        
                        (217,461
                        )
                        (f)
                        
                        
                        (179,568
                        )Net
      income (loss)
                        
                        $
                        195,969
                        
                        
                        $
                        98,156
                        
                        
                        $
                        814,544
                        
                        
                        $
                        (244,930
                        )
                        
                        
                        $
                        (444,273
                        )
                        
                        
                        $
                        419,466Basic
      earnings (loss) per share
                        
                        $
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        $
                        -Shares
      used in computingbasic
      per share amounts
                        
                        
                        68,285,932
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (c/g)
                        
                        
                        136,520,118Diluted
      earnings (loss) per share
                        
                        $
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        $
                        -Shares
      used in computingdiluted
      per share amounts
                        
                        
                        100,307,773
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (c/g)
                        
                        
                        168,541,959See
      accompanying notes to unaudited pro forma combined condensed financial
      statements.
 Unaudited
      Pro Forma Combined Condensed Statement of OperationsFor
      the Nine Months ended September 30, 2007CombinedHistorical
                
                
                Mako
                
                
                
                Flotation
                
                
                
                CondensedPro
      Forma
                
                
                
                Pro
      Forma
                
                
                
                Pro
      FormaDeep
      Down
                
                
                Mako
                
                
                Flotation
                
                
                Entries
                
                
                
                Entries
                
                
                
                ResultsRevenues
                
                $
                12,128,737
                
                
                $
                4,291,262
                
                
                $
                6,986,867
                
                
                $
                -
                
                
                
                $
                -
                
                
                
                $
                23,406,866Cost
      of sales
                
                
                8,300,707
                
                
                
                1,833,323
                
                
                
                4,510,795
                
                
                
                -
                
                
                
                
                -
                
                
                
                
                14,644,825Gross
      profit
                
                
                3,828,030
                
                
                
                2,457,939
                
                
                
                2,476,072
                
                
                
                -
                
                
                
                
                -
                
                
                
                
                8,762,041Total
      operating expenses
                
                
                2,757,794
                
                
                
                2,013,261
                
                
                
                1,536,860
                
                
                
                367,101
                
                
                
                
                680,436
                
                (d/e)
                
                
                7,355,452Operating
      income (loss)
                
                
                1,070,236
                
                
                
                444,678
                
                
                
                939,212
                
                
                
                (367,101
                )
                (a)
                
                
                (680,436
                )
                
                
                
                1,406,589Total
      other income (expense)
                
                
                313,691
                
                
                
                (55,700
                )
                
                
                776,661
                
                
                
                (790,118
                )
                (b)
                
                
                -
                
                
                
                
                244,534Income
      (loss) from continuing operations
                
                
                1,383,927
                
                
                
                388,978
                
                
                
                1,715,873
                
                
                
                (1,157,219
                )
                
                
                
                (680,436
                )
                
                
                
                1,651,123Benefit
      from (provision for) income taxes
                
                
                (347,750
                )
                
                
                (222,876
                )
                
                
                -
                
                
                
                428,171
                
                
                
                
                (383,112
                )
                (f)
                
                
                (525,567
                )Net
      income (loss)
                
                $
                1,036,177
                
                
                $
                166,102
                
                
                $
                1,715,873
                
                
                $
                (729,048
                )
                
                
                $
                (1,063,548
                )
                
                
                $
                1,125,556Basic
      earnings per share
                
                $
                0.01
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                0.01Shares
      used in computingbasic
      per share amounts
                
                
                72,626,591
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (c/g)
                
                
                140,860,777Diluted
      earnings per share
                
                $
                0.01
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                0.01Shares
      used in computingdiluted
      per share amounts
                
                
                100,584,062
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (c/g)
                
                
                168,818,248See
      accompanying notes to unaudited pro forma combined condensed financial
      statements.
  12


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





a)
            Amortization
      of the intangible assets at a rate of $40,789 per month for the respective
      periods.


b)
            Represents
      cash interest plus amortization of deferred financing costs and debt
      discounts for the Credit Agreement.  Interest was payable at
      15.5% on the outstanding principal, and the related fees were amortized
      using the effective interest method over the applicable four-year life of
      the loan.


c)
            A
      total of 9,377,043 shares were issued for the total transaction. These pro
      forma amounts give effect as if shares were issued January 1,
      2007.





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





d)
            Recognition
      of stock-based compensation from employee stock options issued in
      connection with the acquisition of Flotation. Deep Down estimated $7,343
      per month for the respective time
periods.


e)
            Amortization
      of the intangible assets at a rate of $68,261 per month based on the
      remaining useful lives in the table
above.


f)
            Represents
      estimated income tax accruals for the historical income plus all pro forma
      adjustments for the respective periods at Deep Down’s estimated combined
      effective rate of 37%. Flotation was an S-Corp, and as such did not accrue
      income taxes in its historical financial
  statements.


g)
            A
      total of 58,857,143 common shares of Deep Down were issued; 57,142,857 in
      connection with the Private Placement, and 1,714,286 to Flotation
      shareholders. These pro forma amounts give effect as if shares were issued
      January 1, 2007.





NOTE
6: INTANGIBLE ASSETS AND GOODWILL





Amounts
allocated to intangible assets are amortized on a straight-line basis over their
estimated useful lives. Deep Down is in the process of finalizing the valuations
of certain intangible assets related to the Mako and Flotation acquisitions;
consequently, the initial allocations of the respective purchase price amounts
are preliminary and subject to change for a period of one year following the
acquisitions, although management believes amounts are materially accurate as of
September 30, 2008. Estimated intangible asset values, net of recognized
amortization expense include the following:




AverageRemainingUseful
      Life
                
                September
      30, 2008
                
                
                December
      31, 2007Customer
      relationship
                8-25
      Years
                
                $
                3,515,000
                
                
                $
                2,869,000Non-Compete
      Covenant
                3-5
      Years
                
                
                1,334,000
                
                
                
                458,000Trademarks
                25-40
      Years
                
                
                3,110,000
                
                
                
                1,071,000Technology
                25
      Years
                
                
                11,209,000
                
                
                
                -Total
      gross balances
                
                
                
                19,168,000
                
                
                
                4,398,000Less:
      Accumulated amortization
                
                
                
                (749,804
                )
                
                
                (28,353
                )Intangible
      assets, net
                
                
                $
                18,418,196
                
                
                $
                4,369,647


The
following table presents goodwill as of the dates indicated, as well as changes
in the account during the period shown.


AmountCarrying
      amount as of December 31, 2007
                
                $
                10,594,144Goodwill
      acquired during the year
                
                
                2,391,574Carrying
      amount as of September 30, 2008
                
                $
                12,985,718




13




NOTE
7: LONG-TERM DEBT





The
following table summarizes long-term debt:




September
      30, 2008
                
                
                December
      31, 2007Secured
      credit agreement with Prospect Capital Corporationquarterly
      principal payments of $250,000 beginningSeptember
      30, 2008; monthly interest payments,interest
      fixed at 15.5%; balance due August 2011;secured
      by all assets
                
                $
                -
                
                
                $
                12,000,000Debt
      discount, net of amortization of $254,101 and $135,931
      respectively
                
                
                -
                
                
                
                (1,703,258
                )Note
      payable to a bank, payable in monthlyinstallments
      bearing interest at 8.25% per annum,maturing
      June 10, 2008, cross-collateralizedby
      Mako assets, paid January 2008.
                
                
                -
                
                
                
                289,665Note
      payable to a bank, payable in monthlyinstallments
      bearing interest at 7.85% per annum,maturing
      September 28, 2010, collateralized by Makolife
      insurance policy and equipment, paid January 2008.
                
                
                -
                
                
                
                320,027Revolving
      line-of-credit of $500,000 from a bank,matured
      October 13, 2007 or on demand, interest rate isat
      a variable rate resulting in a rate of 8.30% as ofSeptember
      30, 2007, collateralized by Mako equipment,paid
      January 2008.
                
                
                -
                
                
                
                151,705Note
      payable to a bank payable in monthlyinstallments
      bearing interest at 7.85% per annum,maturing
      January 25, 2011, collateralized by Makoequipment
      and life insurance policy, paid January 2008
                
                
                -
                
                
                
                154,647Total
      secured credit agreement and bank debt
                
                
                -
                
                
                
                11,212,7866%
      Subordinated Debenture beginning March 31, 2008; annual
                
                
                
                -interest
      payments, interest fixed at 6%; matures March 31, 2011
                
                
                515,041
                
                
                
                -Capital
      lease of equipment, monthly lease payments,interest
      imputed at 11.2%
                
                
                448,000
                
                
                
                481,209Total
      long-term debt
                
                
                963,041
                
                
                
                11,693,995Current
      portion of long-term debt
                
                
                (48,816
                )
                
                
                (995,177
                )Long-term
      debt, net of current portion
                
                $
                914,225
                
                
                $
                10,698,818


Secured
Credit Agreement




On August
6, 2007, Deep Down entered into a $6.5 million secured credit agreement, (the
“Credit Agreement”) with Prospect Capital Corporation (“Prospect”) and received
an advance of $6.0 million on that date.  The Credit Agreement
provided for a 4-year term, an annual interest rate of 15.5%, with the ability
to defer up to 3.0% of interest through a PIK (paid-in-kind) feature and
principal payments of $75,000 per quarter beginning September 30, 2008, with the
remaining balance outstanding due August 6, 2011. Interest payments were payable
monthly, in arrears, on each month-end commencing on August 31, 2007. Deep Down
paid the full 15.5% and did not exercise the PIK feature for the monthly periods
through June 2008 when the debt was paid in full, see details
below.





On July
3, 2008, Prospect exercised their outstanding 4,960,585 warrants in a cashless
exercise for a total of 2,618,129 shares of Deep Down common stock. See Note 10
for additional discussion of the terms of these warrants.





On
December 21, 2007, Deep Down entered into an amendment to the Credit
Agreement (the “Amendment”) to provide the funding for the cash portion of the
purchase of Mako. The total commitment available under the Amendment was
increased from $6.5 million to $13.0 million. Amounts borrowed were $6.0
million.  Quarterly principal payments increased to $250,000
beginning September 30, 2008.  Cash interest paid for the three and
nine months ended September 30, 2008 was $0 and $821,500, respectively, and was
$139,500 for the three and nine months ended September 30, 2007, respectively.
Under the Credit Agreement, Deep Down was required to meet certain
covenants and restrictions as well as maintain a debt service reserve
account.  As of December 31, 2007, $375,000 is separately classified
as “Restricted cash” on the accompanying balance sheets.




14




In
connection with the second advance under the Credit Agreement on January 4,
2008, Deep Down capitalized an additional $261,946 in deferred financing
costs.  Of this amount, $216,000 was paid in cash to various third
parties related to the financing, and the remainder of $45,946 represents the
Black-Scholes valuation of warrants issued to one of these third party
vendors.  The warrant was issued to purchase up to 118,812 shares of
common stock at an exercise price of $1.01 per share.




On June
12, 2008, Deep Down paid $12,492,912 to Prospect to pay off the balance
outstanding under the Credit Agreement and related interest and early
termination fees. In connection with the early payoff, Deep Down accelerated the
remaining deferred financing costs totaling $661,149 and recorded this charge as
interest expense. Additionally, $1,490,955 in debt discounts were accelerated
and recorded as interest expense. Early termination fees of approximately
$446,412 were recognized as a loss on early extinguishment of
debt.  Since the warrants issued in connection with the original
Credit Agreement and the Amendment dated January 4, 2008 were detachable, there
was no change to these equity instruments.




In
January 2008, in accordance with the terms of the purchase of Mako, Deep Down
paid $916,044 of notes payable plus accrued interest of $2,664.





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





On March
31, 2008, 500 shares of the Series E Redeemable Exchangeable Preferred Stock
(“Series E”) were exchanged into a 6% Subordinated Debenture (the
“Debenture”) in an outstanding principal amount of $500,000.  The
Debenture has a fixed interest rate of 6% interest per annum to be paid annually
on March 31st through maturity on March 31, 2011. Upon exchange into the
Debenture, Deep Down recorded $113,589 in interest expense for the accretion of
the Series E up to face value. See the additional discussion of the terms of the
Series E preferred stock at Note 8. Interest expense on the Debenture of
approximately $7,560 and $15,040 has been recognized for the three- and
nine-month periods ended September 30, 2008, respectively.





Revolving
Credit Line





On
November 11, 2008, Deep Down entered into a new credit agreement with Whitney
National Bank, as lender, to provide Deep Down with a revolving credit
line.  See Note 13 for a brief and general description of certain
material terms and provisions of such credit agreement.





NOTE
8: PREFERRED STOCK





Series
D Redeemable Convertible Preferred Stock Classified as Temporary Equity
Instruments





During
the first quarter of fiscal 2008, the outstanding 5,000 shares of Series D
redeemable convertible preferred stock (“Series D”) were converted into
25,866,518 shares of common stock.  The Series D had a face value and
liquidation preference of $1,000 per share, no dividend preference, and were
convertible into shares of common stock determined by dividing the face amount
by a conversion price of $0.1933.  The Series D had been valued at
inception at $4,419,244 based on the Black-Scholes fair value of the Series
D.





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





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





NOTE
9: COMMON STOCK





Private
Placement




On June
5, 2008, Deep Down sold 57,142,857 shares of its common stock to accredited
investors, for $40,000,000 at a per-share price of $0.70. After transaction
costs, Deep Down had net proceeds of $37,059,670. Dahlman Rose & Company,
LLC acted as exclusive placement agent for the equity financing.





Deep Down
used $22,100,000 of the net proceeds to fund the cash portion of the Flotation
purchase, and used $12,492,912 to repay outstanding debt, along with early
termination fees, to Prospect on June 12, 2008. Deep Down retained the remaining
net proceeds for working capital purposes.




15




In
connection with the Private Placement, Deep Down entered into a registration
rights agreement where the holder has certain demand registration rights. Deep
Down filed an S-1 Registration Statement on July 21, 2008. Deep Down was
obligated to have the Registration Statement declared effective by September 3,
2008 (the “Required Effective Date”), or the Company would be required to pay
daily damages to the purchasers in the Private Placement for each day following
the Required Effective Date, until but excluding the date the Commission
declares the Registration Statement effective. Deep Down has evaluated this
obligation under the registration rights agreement for liability treatment under
Financial Accounting Standards Board (“FASB”) Statement No. 5,“Accounting for
Contingencies” (“SFAS 5”) and Financial Statement Staff Position (FSP) EITF
00-19(2) “Accounting for Registration Payment Arrangements” and determined that
the registration rights meet the definition of a liability under the
authoritative guidance and has reserved $359,640 in potential damages under
terms of the Private Placement for the period September 4 to September 30,
2008.





NOTE
10: STOCK-BASED COMPENSATION AND WARRANTS





Deep Down
has a stock-based compensation plan - the 2003 Directors, Officers and
Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). We
account for stock-based compensation expense under SFAS No. 123 (Revised 2004),
“Share-based Payment,” (“SFAS No. 123(R)”). The exercise price of the options,
as well as the vesting period, is established by Deep Down’s Board of Directors.
The options granted under the Plan have vesting periods that range from
immediate vesting to vesting over five years, and the contract terms of the
options granted are up to ten years. Under the Plan, the total number of options
permitted is 15% of issued and outstanding common shares. During the nine months
ended September 30, 2008, Deep Down granted 4,200,000 options and 1,200,000
shares of restricted stock, and cancelled 875,000 options subject to forfeitures
under the Plan. Based on the shares of common stock outstanding at
September 30, 2008, there were approximately 16,628,000 options available for
grant under the Plan as of that date.





Restricted
Stock





On
February 14, 2008, Deep Down issued an aggregate of 1,200,000 shares of
restricted common stock to Ronald E. Smith, CEO, Robert E. Chamberlain,
Chairman, and Eugene L. Butler, CFO, under terms of the Plan. The shares were
valued at a price of $0.42 based on the closing price of common stock on that
date. The shares vest on the second anniversary of the grant date, and Deep Down
is amortizing the related stock-based compensation of $504,000 over the 2 year
period. For the nine months ended September 30, 2008, Deep Down recognized a
total of $157,500 in stock-based compensation related to these issued shares of
restricted stock. The unamortized portion of the estimated fair value of
restricted stock is $346,500 at September 30, 2008.





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


Restricted
                  Shares
                
                
                Weighted-
                  Average
                  GrantPrice
                
                
                Aggregate
                  IntrinsicValueOutstanding
      at December 31, 2007
                
                
                -Grants
                
                
                1,200,000
                
                
                $
                0.42Outstanding
      at September 30,2008
                
                
                1,200,000
                
                
                $
                0.42
                
                
                $
                228,000


Stock
Option Activity During 2008





During
the nine months ended September 30, 2008, Deep Down granted 4,200,000 options
under the Plan as detailed below (no grants were issued during the three months
ended September 30, 2008).  On June 17, 2008, Deep Down effected a
cashless exercise of 50,000 employee stock options for 29,339 net shares of
common stock issued in accordance with terms of the Plan.





During
the nine months ended September 30, 2008, Deep Down granted an aggregate of
350,000 stock options to various employees with exercise prices between $0.71
and $0.88, reflecting the respective closing price on the applicable date of
grant. The fair value of such options was approximately $114,737 based on the
Black-Scholes option pricing model.  Additionally, Deep Down issued
600,000 stock options to employees of Flotation in connection with that
acquisition.





On
February 14, 2008, Deep Down issued an aggregate of 3,000,000 stock options to
Ronald E. Smith, Robert E. Chamberlain, and Eugene L. Butler, with an exercise
price per share of $1.50, which was in excess of the day’s closing price of
$0.42. The fair value of such options was approximately $145,764 based on the
Black-Scholes option pricing model.




16




Additionally,
on January 22, 2008, Deep Down issued 250,000 stock options to an officer with
an exercise price of $0.70, the closing price of Deep Down’s common stock on
that date.  These options have since been forfeited due to the
officer’s departure in May 2008.





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





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





Summary
of Stock Options





Deep Down
is expensing all stock options on a straight line basis over the requisite
expected service periods. The total stock-based compensation expense
for stock options for the nine months ended September 30, 2008 and
September 30, 2007, was $286,333 and $113,480, respectively.  The
unamortized portion of the estimated fair value of outstanding stock options is
$842,722 at September 30, 2008.





The
following table summarizes Deep Down’s stock option activity for the nine months
ended September 30, 2008:




Shares
                  Underlying
                  Options
                
                
                Weighted-
                  Average
                  Exercise
                  Price
                
                
                Weighted-
                  Average
      Remaining Contractual
                  Term
      (in years)
                
                
                Aggregate
                  Intrinsic
      Value
                  (In-The-Money)Outstanding
      at December 31, 2007
                
                
                5,500,000
                
                
                $
                0.58Grants
                
                
                4,200,000
                
                
                
                1.35Exercises
                
                
                (50,000
                )
                
                
                0.50Forfeitures
                
                
                (875,000
                )
                
                
                0.74Outstanding
      at September 30, 2008
                
                
                8,775,000
                
                
                $
                0.93
                
                
                
                3.0
                
                
                $
                463,000Exerciseable
      at September 30, 2008
                
                
                2,033,334
                
                
                $
                0.60
                
                
                
                2.7
                
                
                $
                194,167


The
following summarizes Deep Down’s outstanding options and their respective
exercise prices at September 30, 2008:


Exercise
                  Price
                Shares
                  Underlying
                  Options$   0.30
      - 0.49
                175,000$   0.50
      - 0.69
                4,125,000$   0.70
      - 0.99
                525,000$   1.00
      - 1.29
                950,000$   1.30
      - 1.50
                3,000,0008,775,000


The fair
value of each stock option grant is estimated on the date of the grant using the
Black-Scholes model and is based on the following key assumptions for the nine
months ended September 30, 2008:




Dividend
      yield
                0%Risk
      free interest rate
                2.64%
      - 2.84%Expected
      life of options
                3
      yearsExpected
      volatility
                53.3%
      - 63.3%


17




Summary
of Warrants





In
connection with the purchase of Flotation, Deep Down issued warrants to purchase
200,000 common shares at $0.70 per share to an entity affiliated with the
selling shareholders in consideration for the acquisition of related technology.
The warrants are exercisable at any time from June 3, 2009 through September 3,
2011 and include piggyback registration rights with respect to the underlying
shares of common stock. Deep Down valued the warrants at $121,793 based on the
Black-Scholes option pricing model and included this value in the purchase price
allocation related to Flotation.





On August
6, 2007, as part of the Credit Agreement described above in Note 7, Deep Down
issued 4,960,585 detachable warrants. Deep Down issued all of such warrants
with an exercise price of $0.507, for terms of five years, with vesting
occurring on the earlier of the second anniversary of the agreement or upon
payment in full of the debt. On July 3, 2008, the holder of these warrants
exercised all of them for a total of 2,618,129 shares of Deep Down’s common
stock in a cashless exercise.





A summary
of warrant transactions follows:




Shares
                    Underlying
                    Warrants
                  
                  
                  Weighted-
                    Average
                    Exercise
                    Price
                  
                  
                  Weighted-
                    Average
                    Remaining
      Contractual
                    Term
      (in years)
                  
                  
                  Aggregate
                    Intrinsic
      Value
                    (In-The-Money)Outstanding
      at December 31, 2007
                  
                  
                  5,399,397
                  
                  
                  $
                  0.53Grants
                  
                  
                  200,000
                  
                  
                  
                  0.70Exercised
                  
                  
                  (4,960,585
                  )
                  
                  
                  0.51Outstanding
      at September 30, 2008
                  
                  
                  638,812
                  
                  
                  $
                  0.78
                  
                  
                  
                  4.3
                  
                  
                  $
                  -Exerciseable
      at September 30, 2008
                  
                  
                  438,812
                  
                  
                  $
                  0.82
                  
                  
                  
                  4.3
                  
                  
                  $
                  -


The
following summarizes Deep Down’s outstanding warrants and their respective
exercise prices at September 30, 2008:




Exercise
                  Price
                
                Shares
      Underlying Warrants$   0.70
      - 0.99
                
                520,000$             1.01
                
                118,812638,812


The fair
value of each warrant grant is estimated on the date of the grant using the
Black-Scholes model and is based on the following key assumptions for the nine
months ended September 30, 2008:




Dividend
      yield
                0%Risk
      free interest rate
                2.52%
      - 3.18%Expected
      life of options
                2 -
      2.5 yearsExpected
      volatility
                51.7%
      - 61.3%
  18
  NOTE11:COMMITMENTS AND
CONTINGENCIES





Litigation
and Disputes




Deep Down
is from time to time involved in other legal proceedings arising in the normal
course of business. As of the date of this Quarterly Report on Form 10-Q, there
are no other pending or threatened material legal proceedings.





Registration
Rights Agreement Penalties





In
connection with the Private Placement in June 2008, Deep Down filed an initial
Registration Statement on Schedule S-1 to register the shares issued. Terms of
the Private Placement state that if the Registration Statement is not declared
effective by September 3, 2008 (the “Required Effective Date”), then for each
day following the Required Effective Date, until but excluding the date the
Commission declares the Registration Statement effective, Deep Down shall, for
each such day, pay each Purchaser with respect to any such failure, as
liquidated damages, an amount equal to 0.0333% of the purchase price paid by
such Purchaser for the shares purchased pursuant to the Purchase Agreement, or
$13,320 per day.  Deep Down has reserved $359,640 in potential damages
under terms of the Private Placement for the period September 4 to September 30,
2008, and will continue to accrue such liability until the Registration
Statement for such shares is declared effective.  As of November 14, 2008,
an additional $599,400 has accrued as the Registration Statement has not yet
been declared effective.





Operating
Leases





Deep Down
leases land under an operating lease and is responsible for related maintenance,
insurance and property taxes.  On May 1, 2008, Deep Down and JUMA,
LLC, a related party, amended the original lease that began as of September,
2006 to provide for the additional acreage leased resulting in a $4,000 per
month increase in rent.  See below for further discussion of the
related party.





NOTE
12:  RELATED PARTY TRANSACTIONS




Deep Down
leases all buildings, structures, fixtures and other improvements at the
Channelview, Texas location from JUMA, LLC, a limited-liability company (“JUMA”)
owned by Ronald E. Smith, President and CEO and a director of Deep Down and Mary
L. Budrunas, a Vice President and Corporate Secretary of Deep Down. The
base rate of $15,000 per month is payable to JUMA through September 1, 2011,
together with all costs of maintaining, servicing, repairing and operating the
premises, including insurance, utilities and property taxes.





On March
28, 2008, Deep Down redeemed 4,500 shares of Series D preferred stock owned by
Ronald Smith and Mary Budrunas.  The Series D preferred shares were
redeemed for 23,279,876 shares of common stock.





During
the nine months ended September 30, 2008, Deep Down granted an aggregate of
1,200,000 restricted shares of common stock and an aggregate of 3,000,000 stock
options to Ronald E. Smith, President and Chief Executive Officer, Robert E.
Chamberlain, Jr., Chairman and Chief Acquisition Officer, and Eugene L. Butler,
Chief Financial Officer. Deep Down also awarded in recognition of their
completion of the acquisition of Flotation and Private Placement of common
stock, a performance bonus of $300,000 in the aggregate.





NOTE 13:  SUBSEQUENT EVENTS





New
Corporate Revolver





On
November 11, 2008, Deep Down entered into a new Credit Agreement (the
“Revolver”) with Whitney National Bank as lender. The Revolver provides a
commitment to lend to Deep Down of the lesser of $2,000,000 and 80% of eligible
receivables (generally defined as current due accounts receivables in which the
lender has a first priority security interest).  All of the commitment
under the Revolver is also available in commitments for the lender to issue
letters of credit for the benefit of Deep Down.  Outstanding amounts
under the Revolver will generally bear interest at rates based on the British
Bankers Association LIBOR Rate for dollar deposits with a term of one month plus
an applicable rate of 2.00% to 3.00% based on the leverage ratio of Deep
Down.  Accrued interest under the Revolver is payable
monthly.  Unused portions of the commitment generally accrue a
commitment fee of 0.25% to 0.50% based on the leverage ratio of Deep Down and
such fee is due and payable by Deep Down quarterly.  The Revolver has
a termination date of November 11, 2010.  At November 14, 2008, Deep Down
has not drawn on any amounts available under this Revolver.




19




Each of
Deep Down’s subsidiaries has guaranteed the obligations of Deep Down under the
Revolver and as such Deep Down’s obligations in connection with the Revolver are
secured by a first priority lien generally on all of their non real property
assets. The terms of the Revolver and the related loan documents subject
Deep Down to several covenants, including requirement to:  provide
security generally on all of their non real property assets, cause Deep Down’s
subsidiaries to provide guarantees, provide certain financial information to the
lender, give inspection rights to the lender, and apply insurance and eminent
domain proceeds to repayment of amounts outstanding under the
Revolver.  Furthermore, the terms of the Revolver impose restrictions
on the ability of Deep Down and its subsidiaries to incur further indebtedness
or liens, to make investments in other businesses, to pay dividends, to engage
in mergers, acquisitions or dispositions or other lines of businesses, to enter
into transactions with their affiliates, to prepay other indebtedness or to make
any change in their respective fiscal year or method of accounting (other than
changes as required by generally accepted accounting principles in the
U.S.).





The
Revolver also contains provisions in reference to a term loan with a maturity
date of five years from the date on which such loan is committed, but there is
no actual commitment under the Revolver for such a term loan.








20


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





The
following discussion and analysis provides information that management believes
is relevant for an assessment and understanding of our results of operations and
financial condition. This information should be read in conjunction with
our audited historical consolidated financial statements which are included in
our Form 10-KSB/A (Amendment No. 4) for the fiscal year ended December 31, 2007
filed with the SEC on September 30, 2008 and our unaudited condensed
consolidated financial statements and notes thereto included with this Quarterly
Report on Form 10-Q in Part I, Item 1.





Corporate
History





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





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





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





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





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





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





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





Since
December 2006, Deep Down has consummated three strategic
acquisitions.  On April 2, 2007, Deep Down acquired substantially all
of the assets of ElectroWave USA, Inc., a Texas corporation.  For
purposes of completing the acquisition, Deep Down formed a wholly-owned
subsidiary, ElectroWave USA, Inc., a Nevada corporation.  Effective
December 1, 2007, Deep Down acquired all of the outstanding common stock of Mako
Technologies, Inc., a Louisiana corporation.  For purposes of
completing the acquisition, Deep Down formed a wholly-owned subsidiary, Mako
Technologies, LLC, a Nevada limited liability company, which merged with and
into Mako Technologies, Inc., with Mako as the surviving entity. Effective May
1, 2008, Deep Down acquired all of the outstanding common stock of Flotation
Technologies, Inc., a Maine corporation.




21




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





Segments





For the
fiscal year ended December 31, 2007, we operated under one operating segment
based on analysis of SFAS 131 “Disclosures about Segments of an Enterprise and
Related Information” (“SFAS 131”). The operations of Deep Down and ElectroWave
were reviewed collectively by Deep Down, Inc’s management due to similarities in
products and production processes. The Mako subsidiary was included in the
consolidated operations of Deep Down, Inc. since its acquisition effective
December 1, 2007, but constitutes less than 10% of the total revenues for the
fiscal year ended December 31, 2007. Therefore, Mako did not meet the
quantitative thresholds for segment reporting for the fiscal year ended December
31, 2007.





Management
is currently reviewing all operations related to segment reporting under the
guidelines of SFAS 131, paragraphs 25 and 26(a) and plans to begin reporting
operating segment(s) by the end of the 2008 fiscal year.





Recent
developments





New
Corporate Revolver





On
November 11, 2008, we entered into the Revolver with Whitney National Bank as
lender.  The Revolver provides a commitment to lend to us of the
lesser of $2,000,000 and 80% of eligible receivables (generally defined as
current due accounts receivables in which the lender has a first priority
security interest). All of the commitment under the Revolver is also available
in commitments for the lender to issue letters of credit for the benefit of Deep
Down. Outstanding amounts under the Revolver generally bear interest at rates
based on the British Bankers Association LIBOR Rate for dollar deposits with a
term of one month plus an applicable rate of 2.00% to 3.00% based on the
leverage ratio of Deep Down.  Accrued interest under the Revolver is
payable monthly.  Unused portions of the commitment generally accrue a
commitment fee of 0.25% to 0.50% based on the leverage ratio of Deep Down and
such fee is due and payable by Deep Down quarterly.  The Revolver has
a termination date of November 11, 2010.  At November 14, 2008, Deep Down
has not drawn on any amounts available under this Revolver.





Each of
our subsidiaries has guaranteed the obligations of Deep Down under the Revolver
and Deep Down’s and such subsidiaries’ obligations in connection with the
Revolver are secured by a first priority lien generally on all of their non real
property assets. The terms of the Revolver and the related loan documents
subject us and our subsidiaries to several covenants, including requirement
to:  provide security generally on all of their non real property
assets, cause Deep Down’s subsidiaries to provide guarantees, provide certain
financial information to the lender, give inspection rights to the lender, and
apply insurance and eminent domain proceeds to repayment of amounts outstanding
under the Revolver.  Furthermore, the terms of the Revolver impose
restrictions on our ability to incur further indebtedness or liens, to make
investments in other businesses, to pay dividends, to engage in mergers,
acquisitions or dispositions or other lines of businesses, to enter into
transactions with their affiliates, to prepay other indebtedness or to make any
change in their respective fiscal year or method of accounting (other than
changes as required by generally accepted accounting principles in the
U.S.).




The
Revolver also contains provisions in reference to a term loan with a maturity
date of five years from the date on which such loan is committed, but there is
no actual commitment under the Revolver for such a term loan.





Registration
Rights Agreement Penalties





In
connection with the Private Placement in June 2008, we filed an initial
Registration Statement on Form S-1 to register the shares issued. Terms of the
Private Placement state that if the Registration Statement is not declared
effective by September 3, 2008 (the “Required Effective Date”), then for each
day following the Required Effective Date, until but excluding the date the
Commission declares the Registration Statement effective, we shall, for
each such day, pay each Purchaser with respect to any such failure, as
liquidated damages, an amount equal to 0.0333% of the purchase price paid by
such Purchaser for the shares purchased pursuant to the Purchase Agreement, or
$13,320 per day.  We have reserved $359,640 in potential damages under
terms of the Private Placement for the period September 4 to September 30,
2008, and will continue to accrue such liability until the Registration
Statement for such shares is declared effective.  As of November 14,
2008, an additional $599,400 has accrued as the Registration Statement has
not yet been declared effective.  We cannot estimate at this time when
the Registration Statement will be delared effective.




22


Payment
of long term debt and exercise of Prospect warrants:





On June
12, 2008, we paid approximately $12.5 million to Prospect Capital Corporation to
pay the balance due under our Credit Agreement and related interest and early
termination fees.  Since the warrants issued in connection with the
original Credit Agreement and the Amendment dated January 4, 2008 were
detachable, there was no change to these equity instruments.  On July
3, 2008, Prospect exercised their outstanding 4,960,585 warrants in a cashless
exercise for a total of 2,618,129 restricted shares of our common
stock.





Results
of operations




Three
Months Ended September 30, 2008 Compared to Three Months Ended September 30,
2007





Revenue.  Revenue
for the three months ended September 30, 2008 increased $6.8 million to $11.7
million, a 51% increase over the same three-month period in 2007. The increase
in revenue included $8.5 million from the acquisitions of Mako and Flotation,
while our historical service lines had an aggregated reduction in revenue of
$1.7 million. The reduction in revenue over the same three-month period in 2007
was partially a result of two major engineering and product development projects
which were completed prior to the third quarter of 2008, with very low margins,
and as such, we chose to not make these products in 2008. The remaining
reduction of revenues was a result of customers’ delaying many of their major
projects due to the softening of the world oil price and the impact it had on
anticipated cash flow.




Gross
Profit.  Gross profit increased by $4.0 million to $5.3 million
for the three months ended September 30, 2008 as compared to the same period
last year.  Gross margins for the same period improved from 25.8% to
45.5%.  The inclusion of Mako and Flotation for the three months ended
September 2008 increased the gross profit by $4.8 million while our historical
service lines had an aggregated decrease of $0.8 million due to a reduction in
revenue for this period as compared to the same period a year ago.




Selling, General and Administrative
Expenses.SG&A
for the three months ended September 30, 2008 was $3.7 million compared to $0.9
million for the same period last year for an increase of $2.8 million. The
acquisitions of Mako and Flotation represented $1.3 million of the increase. Bad
debt increased by $0.2 million due to the write off of certain accounts.
Personnel and related costs increased by $0.3 million primarily due to an
expansion of our businesses requiring more personnel and the related
requirements to administer a public company and comply with reporting
requirements. Additionally, we paid approximately $0.6 million more than the
same period for the prior year in professional, accounting and legal fees to
support our various initiatives during the quarter relating to the filing of a
registration statement and to support the related acquisitions. Stock-based
compensation related to employee stock options and restricted stock was
approximately $170,160 in the current fiscal quarter compared to approximately
$74,000 for the comparable prior period. Insurance costs increased by
approximately $0.2 million, part of which is included in the acquisition related
expenses noted above.




Depreciation and
amortization. Depreciation expense for the three months ended September
30, 2008 was $0.4 million compared to $0.1 million for the same prior year
period due mainly to the acquisitions in fiscal year 2008. In addition,
intangible assets purchased in the Mako and Flotation acquisitions total $19.2
million in the aggregate, and the related amortization for the quarter ended
September 30, 2008 was $0.3 million.




Interest Expense. Interest
expense for the three months ended September 30, 2008 was $24,704 compared to
$0.2 million for the same prior year period.  On June 12,
2008, we paid the balance due under the Credit Agreement, thus there were
no related expenses for the current fiscal quarter. For the three months ended
September 30, 2007, cash interest on the Credit Agreement totaled $139,500, and
deferred financing and debt discount amortization approximated
$69,000.




Net income. Net income for
the three months ended September 30, 2008 was $1.6 million, compared to net
income of $0.2 million for the same prior year period as discussed
above.




EBITDA. Earnings before
interest, taxes, depreciation and amortization (“EBITDA”) is a non-GAAP
financial measure. We use EBITDA as an unaudited supplemental financial
measure to assess the financial performance of its assets without regard to
financing methods, capital structures, taxes or historical cost basis; its
liquidity and operating performance over time in relation to other companies
that own similar assets and that we believe calculate EBITDA in a similar
manner; and the ability of our assets to generate cash sufficient for us to pay
potential interest costs. We also understand that such data are used by
investors to assess our performance. However, the term EBITDA is not defined
under generally accepted accounting principles and EBITDA is not a measure of
operating income, operating performance or liquidity presented in accordance
with generally accepted accounting principles. When assessing our operating
performance or liquidity, investors should not consider this data in isolation
or as a substitute for net income, cash flow from operating activities, or other
cash flow data calculated in accordance with generally accepted accounting
principles.  EBITDA for the three months ended September 30, 2008 was
$2.3 million compared to $0.4 million, an increase of $1.9 million from the same
prior year period.




23


Nine
Months Ended September 30, 2008 Compared to Nine Months Ended September 30,
2007





Revenue.  Total
revenue generated in the nine months ended September 30, 2008 was $25.9 million
compared to $12.1 million for the same period last year, an increase of $13.8
million or 113%. This increase in revenue was primarily attributable to strong
demand for equipment from our customers in the oil and gas industry and the
impact of the inclusion of our acquisitions of Mako and Flotation, which
accounted for $12.8 million of the increase.




Gross Profit. Gross
profit was $10.4 million for the nine months ended September 30, 2008 compared
to $3.8 million for the same period in fiscal 2007, reflecting an overall
improvement in gross profit margin from 31.6% to 40.2%. Gross profit margins
were positively impacted by improved pricing of all product lines.




Selling, General and Administrative
Expenses.SG&A
for the nine months ended September 30, 2008 was $9.4 million compared to $2.7
million for the same period last year for an increase of $6.7 million. The
acquisitions of Mako and Flotation represented $2.8 million of the increase. Bad
debt increased by $1.0 million due to the write off of certain accounts, one of
which filed for bankruptcy protection. Personnel and related costs increased by
$1.5 million due to expansion of our businesses requiring more personnel and the
related requirements to administer a public company and comply with reporting
requirements. Additionally, we paid approximately $0.9 million more than the
same period for the prior year in professional, accounting and legal fees to
support our various initiatives during the nine-month period relating to the
filing of a registration statement and to support the referenced acquisitions.
Stock-based compensation related to employee stock options and restricted stock
was approximately $0.4 million in the current fiscal year compared to
approximately $0.1 million for the comparable prior year period.




Depreciation and
amortization. Depreciation expense for the nine months ended September
30, 2008 was $0.9 million compared to $0.2 million for the same prior year
period due mainly to the acquisitions of Mako and Flotation, though Flotation
has only five months of depreciation expense since it was acquired May 1, 2008.
Fixed assets acquired in the Mako and Flotation subsidiaries totaled $8.9
million. A total of $0.8 million of the depreciation expense is recorded as cost
of sales related to revenue-producing assets, compared to $0.2 million for the
previous comparable period. In addition, amortization of intangible assets for
the nine months ended September 30, 2008 was $0.7 million.




Interest Expense. Interest
expense for the nine months ended September 30, 2008 was $3.5 million compared
to $1.8 million for the same prior year period.  In connection with
the early payoff of the Credit Agreement in June 2008, we accelerated the
remaining deferred financing costs totaling $0.7 million and recorded this
charge to interest expense. Additionally, $1.5 million in debt discounts were
accelerated and recorded to interest expense.  We paid cash interest
related to the Credit Agreement totaling $0.8 million for the nine months ended
September 30, 2008 compared to $139,500 in the prior year. For the comparable
period of the prior year, $1.4 million of the total interest related to
accretion on the redemption of Series G and Series E Preferred
Stock.




Gain/(loss) on debt
extinguishment.  In connection with the early payoff of the
Credit Agreement in June 2008, early termination fees of approximately $446,412
were recognized as a loss on early extinguishment of debt. In the prior year, we
executed a Securities Redemption Agreement with the former CFO of Deep Down to
redeem 4,000 shares of Series E exchangeable preferred stock at a discounted
price of $500 per share for a total of $2.0 million.  The discount of
$500 per share from the face value of $1,000 was accounted for as a substantial
modification of debt, thereby generating a gain on extinguishment of
debt.




Net income (loss). Net loss
for the nine months ended September 30, 2008 was $3.4 million, compared to a net
income of $1.0 million for the same prior year period, as discussed
above.




EBITDA. Earnings before
interest, taxes, depreciation and amortization (“EBITDA”) is a non-GAAP
financial measure. We use EBITDA as an unaudited supplemental financial
measure to assess the financial performance of our assets without regard to
financing methods, capital structures, taxes or historical cost basis; our
liquidity and operating performance over time in relation to other companies
that own similar assets and that we believe calculate EBITDA in a similar
manner; and the ability of our assets to generate cash sufficient for us to pay
potential interest costs. We also understand that such data are used by
investors to assess our performance. However, the term EBITDA is not defined
under generally accepted accounting principles and EBITDA is not a measure of
operating income, operating performance or liquidity presented in accordance
with generally accepted accounting principles. When assessing our operating
performance or liquidity, investors should not consider this data in isolation
or as a substitute for net income, cash flow from operating activities, or other
cash flow data calculated in accordance with generally accepted accounting
principles. EBITDA for the nine months ended September 30, 2008 was $1.3 million
compared to $3.3 million for the same prior year period, a decrease of $2.0
million from the same prior year period due to the items discussed
above.




24


Capital
Resources and Liquidity





Financing
for our operations consists primarily of cash flows attributable to our
operations. We believe that the liquidity we derived from the private placement
of our common stock in June 2008 and cash flows attributable to our operations
is more than sufficient to fund our capital expenditures, debt maturities and
other business needs. We continue to evaluate acquisitions and joint ventures in
the ordinary course of business. When opportunities for business acquisitions
meet our standards, we believe we will have access to capital sources necessary
to take advantage of those opportunities.




Notwithstanding
the foregoing, on November 11, 2008, we entered into the Revolver with Whitney
National Bank as lender, and we expect such financing to provide thereafter for
a portion of our working capital needs.  At November 14, 2008, we
have not drawn on any amounts available under this Revolver.




As of
September 30, 2008, our cash and cash equivalents were $5.2
million.  Cash and cash equivalents were $2.2 million plus restricted
cash of $0.4 million as of December 31, 2007.  We believe that we have
adequate capital resources when combined with our cash position and cash
flow from operations to meet current operating requirements.




On June
5, 2008, we sold 57,142,857 shares of our common stock in a private placement at
a price of $0.70 per share, for a total purchase price of $40.0 million and net
proceeds to us of approximately $37.1 million. We used $22.1 million of the
net proceeds to fund the cash portion of the Flotation purchase, and used
approximately $12.5 million to repay outstanding debt, interest and early
termination fees on June 12, 2008. We retained the remaining net proceeds for
working capital purposes.




On April
11, 2008, the original shareholders of Mako received the final cash installment
of $1.2 million under the terms of the securities redemption and shareholder
payable agreement.





Cash
Flow from Operating Activities





For the
nine months ended September 30, 2008, cash provided by operating activities was
$1.2 million as compared to cash used in operating activities for the same prior
year period of 2007 of $1.5 million. Our working capital balances vary due to
delivery terms and payments on key contracts, costs and estimated earnings in
excess of billings on uncompleted contracts, and outstanding receivables and
payables. We used some of the operating cash flow to reduce accounts payable and
accrued liabilities by $1.1 million compared to an increase of $2.1 million in
fiscal 2007. Additionally, we recorded the following non-cash charges in fiscal
2008: amortization of deferred financing costs and debt discount related to the
Prospect loan payoff totaling $2.6 million, share based compensation of $0.4
million, bad debt expense of $1.1 million and depreciation and amortization of
$1.6 million. In fiscal 2007, we had a gain on extinguishment of debt of $2.0
million related to the redemption of preferred stock at a discount, recognition
of a sales type lease receivable of $0.8 million, an increase of finished goods
of $0.5 million, and amortization of deferred financing costs, debt discounts
and accretion on preferred stock totalling $1.4 million.





Cash
Flow from Investing Activities





For the
nine months ended September 30, 2008, cash used in investing activities was
$25.7 million as compared to $1.2 million for the same prior year period. The
majority of the 2008 activity related to the cash paid to Flotation shareholders
totaling $22.1 million offset by cash acquired, which was funded by the net
proceeds of the Private Placement as discussed above. Additionally, we made the
final cash payment to the original Mako shareholders in the amount of $1.2
million plus some adjustments to purchase price expenses. The restricted
cash balance of $0.4 million was released in connection with the payoff of the
Credit Agreement. We used $2.6 million for equipment purchases compared to
the same prior year period totaling $0.6 million.





Cash
Flow from Financing Activities





For the
nine months ended September 30, 2008, cash provided by financing
activities was $27.4 million compared to $3.4 million for the same prior year
period.  During the nine months ended September 30, 2008, we completed
the foregoing described Private Placement for net proceeds of $37.1 million. In
June, 2008, we paid approximately $12.5 million to Prospect to pay the balance
due under its Credit Agreement and related interest and early termination fees.
In January 2008, in accordance with the terms of the purchase of Mako, we paid
$0.9 million of notes payable plus accrued interest of $2,664, and received
proceeds from Prospect totaling $2.7 million. During the third quarter of 2008,
we received the balance due under the sales lease receivable, bringing the
annual receipts to $0.6 million.





Capital
Resources and Requirements





We
generate our liquidity and capital resources primarily through operations and,
when needed, through available capital markets. At September 30, 2008, long-term
debt was $0.9 million, of which $48,816 was the current portion.




25


Critical Accounting
Policies





We
utilize the following critical accounting policies in the preparation of our
financial statements.





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





Consolidation The accompanying
financial statements include the accounts of Deep Down and all of its
wholly-owned subsidiaries, including Deep Down Delaware since its inception on
June 29, 2006, ElectroWave since its acquisition on April 2, 2007, Mako since
its acquisition on December 1, 2007 and Flotation since its acquisition on May
1, 2008.  All significant intercompany accounts and transactions have
been eliminated.





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





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





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




The fair
value of each stock option or warrant grant is estimated on the date of the
grant using the Black-Scholes model and is based on the following key
assumptions for the nine months ended September 30, 2008:




Dividend
      yield
                  0%Risk
      free interest rate
                  2.64%
      - 2.84%Expected
      life of options
                  3
      yearsExpected
      volatility
                  53.3%
      - 63.3%




Revenue
Recognition   We generally recognize revenue once the following
four criteria are met:  (i) persuasive evidence of an arrangement
exists, (ii) delivery of the equipment has occurred or services have been
rendered, (iii) the price of the equipment or service is fixed and determinable
and (iv) collectability is reasonably assured.  For certain
fabrication projects, revenue is recognized upon shipment or when
customer-specific contract elements, (“milestone(s)”) are
met.   Fabrication and sale of equipment billings are contingent
upon satisfaction of a significant condition of sale milestone, including but
not limited to, factory acceptance testing and customer approval, and recognized
upon transfer of title to the customer.  Service revenue is recognized
as the service is provided. Costs incurred to date that exceed milestone
billings are adjusted during the month end profitability review and are recorded
in “Costs and estimated earnings in excess of billings on uncompleted contracts”
on the accompanying balance sheets.




26




We
entered into a large fixed price contract during the nine months ended September
30, 2008.  As such, we determined that recognizing revenues for this
contract was appropriate using the percentage-of-completion method under
Statement of Position 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts (“SOP 81-1”), measured by the percentage of
costs incurred to date to estimated total costs for the contract.  This
method is used because management considers total cost to be the best available
measure of progress on the contracts.





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





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




In
accordance with industry practice, assets and liabilities related to costs and
estimated earnings in excess of billings on uncompleted contracts, as well as
billings in excess of costs and estimated earnings on uncompleted contracts,
have been classified as current. The contract cycle for certain long-term
contracts may extend beyond one year, thus collection of amounts related to
these contracts may extend beyond one year.




All
intercompany revenue accounts and balances were eliminated in
consolidation.





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





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





Our
intangible assets consist of assets acquired in the purchase of the Mako and
Flotation subsidiaries and comprised of customer lists, non-compete covenants
with key employees and trademarks related to Mako’s ROVs and Flotation’s
processes and materials, and technology.  We amortize the intangible
assets over their useful lives ranging from 3 to 40 years on a straight-line
basis.





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





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




27


Inflation
and Seasonality





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


ITEM
3.  QUALITATIVE AND QUANTITATIVE MARKET RISKS
  Not
applicable for smaller reporting companies.
  ITEM 4T. CONTROLS AND PROCEDURES




Evaluation
of Disclosure Controls and Procedures




We
carried out an evaluation, under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer, of the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)).  Based upon that evaluation, our principal executive
officer and principal financial officer concluded that, as of the end of the
period covered in this report, our disclosure controls and procedures were
effective to ensure that information required to be disclosed in reports filed
under the Exchange Act 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.




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





There
were no changes in Deep Down’s internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act)
that occurred during the quarterly period covered by this Quarterly Report on
Form 10-Q that have materially affected, or are reasonably likely to materially
affect, Deep Down’s internal control over financial reporting except for the
impact of its new acquisition of Flotation. With its new acquisition, Deep
Down’s management will conduct its annual assessment for its inclusion in its
December 31, 2008 Annual Report on Form 10-K.


28


PART
II – OTHER INFORMATION




ITEM
1.  LEGAL PROCEEDINGS
  Not
applicable.
 ITEM
1A. RISK FACTORS
  Not
applicable for smaller reporting companies.
 ITEM 2.
UNREGISTERED SALES OF EQUITY AND USE OF PROCEEDS





Effective
July 3, 2008, Prospect Capital Corporation, the holders of 4,960,585 warrants
originally issued in connection with Deep Down’s Credit Agreement, effected a
cashless exercise of all of their warrants for 2,618,129 shares of common stock
of Deep Down at an exercise price of $0.507. These shares of common stock are
exempt from registration requirements provided by Section 4(2) of the Securities
Act and/or Regulation D promulgated thereunder. For a further discussion of
these warrants, see Note 10 to our unaudited consolidated financial statements
included in Part I, Item 1 of this report.


ITEM
3.  DEFAULTS UPON SENIOR SECURITIES
  Not
applicable.


ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS




Deep Down
first mailed an information statement to its stockholders on September 15, 2008
that described several amendments to our Articles of Incorporation and Bylaws
previously adopted pursuant to a written consent of a majority of our
stockholders in lieu of a special meeting of our stockholders on May 16,
2008.  Reference is hereby made to our Definitive Information
Statement on Schedule 14C filed with the SEC on August 15, 2008 concerning a
more complete statement and description concerning the amendments to the
Articles of Incorporation and the Bylaws that were adopted pursuant to such
stockholder written consent.  In summary, the amendments provided
for:




-
            the
      division of our board of directors into three classes approximately equal
      in size, with each director to serve for a three-year
  term,




-
            the
      prohibition of action taken by written consent of Deep Down’s stockholders
      without the prior approval of Deep Down’s board of
    directors,




-
            the
      prohibition on removal of directors except for cause by the affirmative
      vote of the holders of 75% of the outstanding shares of our capital stock
      entitled to vote on the election of directors,
  and




-
            the
      requirement that any stockholder nominations for election as a director or
      proposals of new business to be delivered or mailed to Deep Down not less
      than 30 or more than 60 days prior to the meeting proposed for taking
      action on such matter,




-
            the
      prohibition on repealing or amending provisions contained in the Articles
      of Incorporation and Bylaws without the affirmative vote of holders of 75%
      of the outstanding shares of our capital stock entitled to vote with
      regard to such matter.




Stockholders of Deep Down holding
70,338,251 shares of our outstanding common stock provided a written consent to
approve the amendments to our Articles of Incorporation and
Bylaws.  On May 16, 2008, the date of such action, Deep Down had a
total of 115,846,019 shares of common stock outstanding.




29




ITEM
5.  OTHER INFORMATION




New Corporate Revolver





On
November 11, 2008, Deep Down entered into the Revolver with Whitney National
Bank as lender.  The Revolver provides a commitment to lend to Deep
Down of the lesser of $2,000,000 and 80% of eligible receivables (generally
defined as current due accounts receivables in which the lender has a first
priority security interest).  All of the commitment under the Revolver
is also available in commitments for the lender to issue letters of credit for
the benefit of Deep Down.  Outstanding amounts under the Revolver
generally bear interest at rates based on the British Bankers Association LIBOR
Rate for dollar deposits with a term of one month plus an applicable rate of
2.00% to 3.00% based on the leverage ratio of Deep Down.  Accrued
interest under the Revolver is payable monthly.  Unused portions of
the commitment generally accrue a commitment fee of 0.25% to 0.50% based on the
leverage ratio of Deep Down and such fee is due and payable by Deep Down
quarterly.  The Revolver has a termination date of November 11,
2010.





Each of
Deep Down’s subsidiaries has guaranteed the obligations of Deep Down under the
Revolver and Deep Down’s and such subsidiaries’ obligations in connection with
the Revolver are secured by a first priority lien generally on all of their non
real property assets. The terms of the Revolver and the related loan documents
subject Deep Down and its subsidiaries to several covenants, including
requirement to:  provide security generally on all of their non real
property assets, cause Deep Down’s subsidiaries to provide guarantees, provide
certain financial information to the lender, give inspection rights to the
lender, and apply insurance and eminent domain proceeds to repayment of amounts
outstanding under the Revolver.  Furthermore, the terms of the
Revolver impose restrictions on the ability of Deep Down and its subsidiaries to
incur further indebtedness or liens, to make investments in other businesses, to
pay dividends, to engage in mergers, acquisitions or dispositions or other lines
of businesses, to enter into transactions with their affiliates, to prepay other
indebtedness or to make any change in their respective fiscal year or method of
accounting (other than changes as required by generally accepted accounting
principles in the U.S.).





The
Revolver also contains provisions in reference to a term loan with a maturity
date of five years from the date on which such loan is committed, but there is
no actual commitment under the Revolver for such a term loan.





Copies of
the Revolver and the related Guaranty, and Security Agreement are set forth as
exhibits to this report.





Updates
to Procedures for Nominating Directors





Pursuant to the written consent of
stockholders described under Item 4 above, Deep Down’s procedures by which
security holders may recommend nominees to Deep Down’s board of directors were
approved.  Under such amendments, in order for a stockholder of Deep
Down to make any nomination for a person to be elected as a director of Deep
Down at any annual meeting or special meeting, the stockholder must give notice
in writing (delivered or mailed by first class United States mail, postage
prepaid, to the Secretary of Deep Down) of any nomination for election as a
director not less than 30 days nor more than 60 days prior to the date of an
applicable meeting (or, if Deep Down gives less than 40 days’ prior notice of
such a meeting, delivered or mailed within 10 days following the date Deep Down
provided such notice of such meeting).  A nomination by a stockholder
of a person to be elected to our board of directors must contain (i) the name,
age, business address, and, if known, residence address of the nominee, (ii) the
principal occupation or employment of such nominee, and (iii) the number of
shares of our capital stock beneficially owned by such
nominee.  Additionally, the nominating stockholder shall promptly
provide any other information that Deep Down reasonably requests.






30




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 Exhibit2.1
            Agreement
      and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc.,
      and the majority shareholders of Deep Down, Inc.10.1*
            Credit
      Agreement, dated as of November 11, 2008, between Deep Down, Inc., as
      borrower, and Whitney National Bank, as lender10.2*
            Guaranty,
      dated as of November 11, 2008, by Electrowave USA, Inc., Flotation
      Technologies, Inc., Mako Technologies, LLC, and Deep Down, Inc. for the
      benefit of Whitney National Bank10.3*
            Security
      Agreement, dated as of November 11, 2008, among Deep Down, Inc.,
      Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies,
      LLC, and Deep Down, Inc. for the benefit of Whitney National
      Bank31.1*
            Certification
      of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of
      the Securities Exchange Act of 1934.31.2*
            Certification
      of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the
      Securities Exchange Act of 1934.32.1*
            Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
            Section
      1350 Certification of the Chief Financial Officer of Deep Down,
      Inc.





_________________


* Filed
or furnished herewith.








SIGNATURES





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





DEEP
      DOWN, INC.(Registrant)




Signature
            
            Title
            
            Date/s/
      RONALD E. SMITH
            
            President,
      CEO and Director
            
            November
      14, 2008Ronald
      E. Smith
            
            (Principal
      Executive Officer)/s/
      EUGENE L. BUTLER
            
            Chief
      Financial Officer
            
            November
      14, 2008Eugene
      L. Butler
            
            (Principal
      Financial Officer)







31




INDEX
TO EXHIBITS





Exhibit
      Number
            Description
      of Exhibit2.1
            Agreement
      and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc.,
      and the majority shareholders of Deep Down, Inc. (incorporated by
      reference from Exhibit 2.1 to our Annual Report on Form 10-KSB/A
      (Amendment No. 2) for the fiscal year ended December 31, 2007 filed on
      May 1, 2008).10.1*
            Credit
      Agreement, dated as of November 11, 2008, between Deep Down, Inc., as
      borrower, and Whitney National Bank, as lender10.2*
            Guaranty,
      dated as of November 11, 2008, by Electrowave USA, Inc., Flotation
      Technologies, Inc., Mako Technologies, LLC, and Deep Down, Inc. for the
      benefit of Whitney National Bank10.3*
            Security
      Agreement, dated as of November 11, 2008, among Deep Down, Inc.,
      Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies,
      LLC, and Deep Down, Inc. for the benefit of Whitney National
      Bank31.1*
            Certification
      of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of
      the Securities Exchange Act of 1934.31.2*
            Certification
      of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the
      Securities Exchange Act of 1934.32.1*
            Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
            Section
      1350 Certification of the Chief Financial Officer of Deep Down Down,
      Inc.





* Filed
or furnished herewith










32