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 March 31, 2009
  OR
  ̈
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 Commission
File No. 0-30351
  DEEP
DOWN, INC.
 (Exact
name of registrant as specified in its charter)
  Nevada
                
                75-2263732(State
      or other jurisdiction of incorporation)
                
                (I.R.S.
      Employer Identification No.)8827
      W. Sam Houston Pkwy N., Suite 100,
                  Houston,
      Texas
                
                77040(Address
      of Principal Executive Office)
                
                (Zip
      Code)
  Registrant’s
telephone number, including area code:(281)517-5000
 
  Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.  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  xNon-accelerated
      filer  ̈ (Do not
      check if a smaller reporting company)
              Smaller
      reporting company  ̈
 
 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 May 8,
2009, there were 179,700,630 shares of common stock outstanding.
 
 
 IMPORTANT
INFORMATION REGARDING THIS FORM 10-Q
 
 Unless
otherwise indicated, references to “we,” “us,” and “our” in this Quarterly
Report on Form 10-Q refer collectively to Deep Down, Inc., a Nevada corporation,
and its wholly-owned subsidiaries.
 
 Deep
Down, Inc., a Nevada corporation (“Deep Down”), is the parent company to its
wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down
Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), since
its acquisition effective April 2, 2007, Mako Technologies, LLC, a Nevada
limited liability company (“Mako”), since its acquisition effective December 1,
2007, Flotation Technologies, Inc., a Maine corporation (“Flotation”), since its
acquisition effective May 1, 2008 and Deep Down International Holdings, LLC
since its formation in February 2009.
 
 Readers
should consider the following information as they review this Quarterly Report
on Form 10-Q:
 
 Forward-Looking
Statements
 
 The
statements contained or incorporated by reference in this Quarterly Report on
Form 10-Q that are not historical facts are “forward-looking statements” (as
such term is defined in the Private Securities Litigation Reform Act of 1995),
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange
Act”).  All statements other than statements of historical fact are,
or may be deemed to be, forward-looking statements.  Forward-looking
statements include any statement that may project, indicate or imply future
results, events, performance or achievements.  The forward-looking
statements contained herein are based on current expectations that involve a
number of risks and uncertainties. These statements can be identified by the use
of forward-looking terminology such as “believes,” “expect,” “may,” “will,”
“should,” “intend,” “plan,” “could,” “estimate” or “anticipate” or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy that involve risks and uncertainties.
 
 Given the
risks and uncertainties relating to forward-looking statements, investors should
not place undue reliance on such statements.  Forward-looking
statements included in this Quarterly Report on Form 10-Q speak only as of the
date Report and are not guarantees of future
performance.  Although we believe that the expectations reflected in
the forward-looking statements are reasonable, such expectations may prove to
have been incorrect.  All subsequent written and oral forward-looking
statements attributable to us, or persons acting on our behalf, are expressly
qualified in their entirety by these cautionary statements.
 
 Subsequent
Events
 
 All
statements contained in this Quarterly Report on Form 10-Q, including the
forward-looking statements discussed above, are made as of May 11, 2009, unless
those statements are expressly made as of another date.  We disclaim
any responsibility for the accuracy of any information contained in this
Quarterly Report on Form 10-Q to the extent such information is affected or
impacted by events, circumstances or developments occurring after May 11, 2009
or by the passage of time after such date.  Except to the extent
required by applicable securities laws, we expressly disclaim any obligation or
undertakings to release publicly any updates or revisions to any statement or
information contained in this Quarterly Report on Form 10-Q, including the
forward-looking statements discussed above, to reflect any change in our
expectations with regard thereto or any change in events, conditions or
circumstances on which any statement or information is based.
 
 Document
Summaries
 
 Descriptions
of documents and agreements contained in this Quarterly Report on Form 10-Q are
provided in summary form only, and such summaries are qualified in their
entirety by reference to the actual documents and agreements filed as exhibits
to our 2008 Annual Report on Form 10-K, other periodic and current reports we
file with the Securities and Exchange Commission (“SEC”) or this Quarterly
Report on Form 10-Q.
 
 Access
to Filings
 
 Access to
our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K, and amendments to those reports, filed with or furnished to the SEC
pursuant to Section 13(a) of the Exchange Act, as well as reports filed
electronically pursuant to Section 16(a) of the Exchange Act, may be obtained
through our website (http://www.deepdowncorp.com).  Our website
provides a hyperlink to a third-party website where these reports may be viewed
and printed at no cost as soon as reasonably practicable after we have
electronically filed or furnished such material with the SEC. The
contents of our website are not, and shall not be deemed to be, incorporated
into this Report.
 
 
 
 
 TABLE
OF CONTENTS
 
 PART
I FINANCIAL INFORMATION
   Page
      No.Item
      1.
                Financial
      StatementsUnaudited
      Consolidated Balance Sheets - March 31, 2009 and December 31,
      2008
                1Unaudited
      Consolidated Statements of Operations - For the Three Months Ended March
      31, 2009 and 2008
                2Unaudited
      Consolidated Statements of Cash Flows - For the Three Months Ended March
      31, 2009 and 2008
                3Notes
      to Unaudited Consolidated Financial Statements
                4Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                14Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                18Item
      4.
                Controls
      and Procedures
                19PART
      II OTHER INFORMATIONItem
      1.
                Legal
      Proceedings
                20Item
      1A.
                Risk
      Factors
                20Item
      2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                27Item
      3.
                Defaults
      Upon Senior Securities
                27Item
      4.
                Submission
      of Matters to a Vote of Security Holders
                27Item
      5.
                Other
      Information
                27Item
      6.
                Exhibits
                28Signatures
                
                28Exhibit
      Index
                29
  
 
  PART I.
FINANCIAL INFORMATION
 ITEM
1.  FINANCIAL STATEMENTS
  DEEP DOWN, INC.
 CONSOLIDATED
BALANCE SHEETS
 (Unaudited)
 
 
 March
      31, 2009
                                  
                                  
                                  December
      31, 2008ASSETSCash
      and cash equivalents
                                  
                                  $
                                  6,260,939
                                  
                                  
                                  $
                                  2,495,464Restricted
      cash
                                  
                                  
                                  135,855
                                  
                                  
                                  
                                  135,855Accounts
      receivable, net
                                  
                                  
                                  6,422,509
                                  
                                  
                                  
                                  10,772,097Prepaid
      expenses and other current assets
                                  
                                  
                                  663,342
                                  
                                  
                                  
                                  633,868Inventory
                                  
                                  
                                  993,545
                                  
                                  
                                  
                                  1,224,170Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                                  
                                  
                                  165,454
                                  
                                  
                                  
                                  707,737Work
      in progress
                                  
                                  
                                  78,007
                                  
                                  
                                  
                                  137,940Deferred
      tax asset
                                  
                                  
                                  1,683,806
                                  
                                  
                                  
                                  216,900Total
      current assets
                                  
                                  
                                  16,403,457
                                  
                                  
                                  
                                  16,324,031Property
      and equipment, net
                                  
                                  
                                  14,806,223
                                  
                                  
                                  
                                  13,799,196Other
      assets, net (see Related Party Note 10)
                                  
                                  
                                  928,453
                                  
                                  
                                  
                                  457,836Intangibles,
      net
                                  
                                  
                                  17,763,529
                                  
                                  
                                  
                                  18,090,680Goodwill
                                  
                                  
                                  15,024,300
                                  
                                  
                                  
                                  15,024,300Total
      assets
                                  
                                  $
                                  64,925,962
                                  
                                  
                                  $
                                  63,696,043LIABILITIES
      AND STOCKHOLDERS' EQUITYAccounts
      payable and accrued liabilities
                                  
                                  $
                                  3,522,510
                                  
                                  
                                  $
                                  4,318,394Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                                  
                                  
                                  2,128,356
                                  
                                  
                                  
                                  2,315,043Current
      portion of long-term debt
                                  
                                  
                                  471,015
                                  
                                  
                                  
                                  382,912Total
      current liabilities
                                  
                                  
                                  6,121,881
                                  
                                  
                                  
                                  7,016,349Long-term
      debt
                                  
                                  
                                  3,358,435
                                  
                                  
                                  
                                  1,718,475Deferred
      tax liabilities
                                  
                                  
                                  2,310,728
                                  
                                  
                                  
                                  1,125,945Total
      liabilities
                                  
                                  
                                  11,791,044
                                  
                                  
                                  
                                  9,860,769Stockholders'
      equity:Common
      stock, $0.001 par value, 490,000,000 shares authorized,
      179,700,630and
      177,350,630 shares issued and outstanding, respectively
                                  
                                  
                                  179,701
                                  
                                  
                                  
                                  177,351Additional
      paid-in capital
                                  
                                  
                                  60,355,193
                                  
                                  
                                  
                                  60,328,124Accumulated
      deficit
                                  
                                  
                                  (7,399,976
                                  )
                                  
                                  
                                  (6,670,201
                                  )Total
      stockholders' equity
                                  
                                  
                                  53,134,918
                                  
                                  
                                  
                                  53,835,274Total
      liabilities and stockholders' equity
                                  
                                  $
                                  64,925,962
                                  
                                  
                                  $
                                  63,696,043
 
 See
accompanying notes to unaudited consolidated financial statements.
 
 1
  DEEP
DOWN, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (Unaudited)
 
 For
      the Three Months EndedMarch
      31,2009
                        
                        
                        2008Revenues
                        
                        $
                        7,102,589
                        
                        
                        $
                        6,279,465Cost
      of sales
                        
                        
                        4,798,788
                        
                        
                        
                        3,931,555Gross
      profit
                        
                        
                        2,303,801
                        
                        
                        
                        2,347,910Operating
      expenses:Selling,
      general & administrative
                        
                        
                        2,843,776
                        
                        
                        
                        1,879,409Depreciation
      and amortization
                        
                        
                        406,097
                        
                        
                        
                        125,803Total
      operating expenses
                        
                        
                        3,249,873
                        
                        
                        
                        2,005,212Operating
      income (loss)
                        
                        
                        (946,072
                        )
                        
                        
                        342,698Other
      income (expense):Interest
      income
                        
                        
                        2,228
                        
                        
                        
                        39,164Interest
      expense
                        
                        
                        (48,344
                        )
                        
                        
                        (769,030
                        )Other
      (expense) income
                        
                        
                        (2,910
                        )
                        
                        
                        28,355Total
      other expense
                        
                        
                        (49,026
                        )
                        
                        
                        (701,511
                        )Loss
      before income taxes
                        
                        
                        (995,098
                        )
                        
                        
                        (358,813
                        )Benefit
      from income taxes
                        
                        
                        265,323
                        
                        
                        
                        269,366Net
      loss
                        
                        $
                        (729,775
                        )
                        
                        $
                        (89,447
                        )Loss
      per share:Basic
                        
                        $
                        -
                        
                        
                        $
                        -Weighted-average
      common shares outstanding
                        
                        
                        176,150,630
                        
                        
                        
                        87,185,242Diluted
                        
                        $
                        -
                        
                        
                        $
                        -Weighted-average
      common shares outstanding
                        
                        
                        176,150,630
                        
                        
                        
                        87,185,242
 
 See
accompanying notes to unaudited consolidated financial statements.
  
 2
  DEEP DOWN, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (Unaudited)
 
 Three
      Months EndedMarch
      31,2009
                          
                          
                          2008Cash
      flows from operating activities:Net
      loss
                          
                          $
                          (729,775
                          )
                          
                          $
                          (89,447
                          )Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Non-cash
      amortization of debt discount
                          
                          
                          -
                          
                          
                          
                          231,760Non-cash
      amortization of deferred financing costs
                          
                          
                          -
                          
                          
                          
                          56,915Share-based
      compensation
                          
                          
                          29,419
                          
                          
                          
                          105,162Bad
      debt expense
                          
                          
                          60,000
                          
                          
                          
                          3,949Depreciation
      and amortization
                          
                          
                          751,276
                          
                          
                          
                          298,150Loss
      on disposal of equipment
                          
                          
                          (3,038
                          )
                          
                          
                          58,115Deferred
      taxes payable
                          
                          
                          (282,123
                          )
                          
                          
                          -Changes
      in assets and liabilities:Accounts
      receivable
                          
                          
                          4,289,588
                          
                          
                          
                          (282,869
                          )Prepaid
      expenses and other current assets
                          
                          
                          (30,091
                          )
                          
                          
                          (107,239
                          )Inventory
                          
                          
                          230,625
                          
                          
                          
                          -Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                          
                          
                          542,283
                          
                          
                          
                          -Work
      in progress
                          
                          
                          59,933
                          
                          
                          
                          (161,279
                          )Accounts
      payable and accrued liabilities
                          
                          
                          (795,884
                          )
                          
                          
                          (603,631
                          )Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                          
                          
                          (186,687
                          )
                          
                          
                          (53,030
                          )Net
      cash provided by (used in) operating activities
                          
                          $
                          3,935,526
                          
                          
                          $
                          (543,444
                          )Cash
      flows used in investing activities:Cash
      paid for acquisition of Mako, net of expenses
                          
                          
                          -
                          
                          
                          
                          (2,979,192
                          )Purchases
      of equipment
                          
                          
                          (1,428,114
                          )
                          
                          
                          (156,958
                          )Deposits,
      related party
                          
                          
                          (470,000
                          )
                          
                          
                          -Restricted
      cash
                          
                          
                          -
                          
                          
                          
                          (187,500
                          )Net
      cash used in investing activities
                          
                          $
                          (1,898,114
                          )
                          
                          $
                          (3,323,650
                          )Cash
      flows from financing activities:Proceeds
      from sales-type lease
                          
                          
                          -
                          
                          
                          
                          103,500Borrowings
      on long-term debt
                          
                          
                          1,840,000
                          
                          
                          
                          5,600,000Payments
      of long-term debt
                          
                          
                          (111,937
                          )
                          
                          
                          (926,808
                          )Net
      cash provided by financing activities
                          
                          $
                          1,728,063
                          
                          
                          $
                          4,776,692Change
      in cash and equivalents
                          
                          
                          3,765,475
                          
                          
                          
                          909,598Cash
      and cash equivalents, beginning of period
                          
                          
                          2,495,464
                          
                          
                          
                          2,206,220Cash
      and cash equivalents, end of period
                          
                          $
                          6,260,939
                          
                          
                          $
                          3,115,818Supplemental schedule of noncash investing and
      financing activities:Stock
      issued for acquisition of Mako
                          
                          $
                          -
                          
                          
                          $
                          1,962,078Exchange
      of Series D preferred stock
                          
                          $
                          -
                          
                          
                          $
                          4,419,244Exchange
      of Series E preferred stock for subordinated debenture
                          
                          $
                          -
                          
                          
                          $
                          500,000Restricted
      stock issued for service
                          
                          $
                          2,350
                          
                          
                          $
                          1,200Supplemental
      Disclosures:Cash
      paid for interest
                          
                          $
                          55,741
                          
                          
                          $
                          480,356Cash
      paid for taxes
                          
                          $
                          198,889
                          
                          
                          $
                          275,000
 
 See
accompanying notes to unaudited consolidated financial
statements.
    3
 DEEP
DOWN, INC.
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  Note
1: General
 
 Nature
of Business
  Deep
Down, Inc., a Nevada corporation (“Deep Down”), is the parent company to its
wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down
Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), since
its acquisition effective April 2, 2007, Mako Technologies, LLC, a Nevada
limited liability company (“Mako”), since its acquisition effective December 1,
2007, Flotation Technologies, Inc., a Maine corporation (“Flotation”), since its
acquisition effective May 1, 2008 and Deep Down International Holdings, LLC
since its formation in February 2009.
  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 FlotecTM
syntactic 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 10 of Regulation
S-X. 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 period ended March 31, 2009 are not necessarily indicative of the
results that may be expected for the year ended December 31,
2009.  The balance sheet at December 31, 2008 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-K for the year ended
December 31, 2008 filed on March 16, 2009.
 
 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 a portion of total depreciation expense, $172,346, into Cost of
sales from Operating expenses for the three months ended March 31,
2008. The remainder of depreciation expense for the three month period is
reported in the Operating expenses section of the Statements of
Operations.
 
 Principles
of Consolidation
 
 The
unaudited consolidated financial statements include the accounts of Deep Down
and its wholly-owned subsidiaries after the elimination of significant
intercompany balances and transactions.
  4
  Accounts
Receivable
 
 Deep Down
provides an allowance for doubtful accounts on trade receivables based on
historical collection experience, the level of past due accounts and a specific
review of each customer’s trade receivable balance with respect to their ability
to make payments and expectations of future conditions that could impact the
collectability of accounts receivable.  When specific accounts are
determined to be uncollectable, they are expensed as bad debt expense in that
period. At March 31, 2009 and December 31, 2008, Deep Down estimated its
allowance for doubtful accounts to be $264,149 and $574,975, respectively. Bad
debt expense totaled $60,000 and $3,949 for the three months ended March 31,
2009 and 2008, respectively.
 
 Recently
Issued Accounting Standards and Developments.
 
 In June
2008, EITF 07-5, “Determining Whether an Instrument (or Embedded Feature) Is
Indexed to an Entity’s Own Stock” was issued. This standard triggers liability
accounting on all options and warrants exercisable at strike prices denominated
in any currency other than the Company’s functional currency or warrants with
certain reset provisions to the strike price because of a “down-round”
financing. This Issue is effective for financial statements issued for fiscal
years beginning after December 15, 2008, and interim periods within those fiscal
years. Early application is not permitted. We adopted EITF 07-5 on January 1,
2009 and analyzed all of the outstanding warrants and none contained down-round
reset exercise price provisions which would have precluded equity
treatment.  Therefore, the adoption did not have a material impact on
our financial position, results of operations or cash flows.
 
 FASB
Staff Position FSP No. 141(R)-1 Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from Contingencies,
(“FSP 141(R)-1”), issued in February 2009, amends the provisions in
Statement 141(R) for the initial recognition and measurement, subsequent
measurement and accounting, and disclosures for assets and liabilities arising
from contingencies in business combinations. The FSP eliminates the distinction
between contractual and non-contractual contingencies, including the initial
recognition and measurement criteria in Statement 141(R) and instead carries
forward most of the provisions in SFAS 141 for acquired contingencies. FSP
141(R)-1 is effective for contingent assets and contingent liabilities acquired
in business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008. Deep Down will integrate the provisions of this FSP as
appropriate to future business combinations.
 
  Note 2:
Costs and Estimated Earnings in Excess of Billings on Uncompleted
Contracts
 
 The
components of costs and estimated earnings in excess of billings on uncompleted
contracts are summarized below:
 March
      31, 2009
                                    
                                    
                                    December
      31, 2008Costs
      incurred on uncompleted contracts
                                    
                                    $
                                    1,032,120
                                    
                                    
                                    $
                                    2,114,714Estimated
      earnings
                                    
                                    
                                    757,837
                                    
                                    
                                    
                                    4,969,4441,789,957
                                    
                                    
                                    
                                    7,084,158Less:
      Billings to date
                                    
                                    
                                    3,752,859
                                    
                                    
                                    
                                    8,691,464$
                                    (1,962,902
                                    )
                                    
                                    $
                                    (1,607,306
                                    )Included
      in the accompanying consolidated balance sheets under the following
      captions:Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                                    
                                    
                                    165,454
                                    
                                    
                                    
                                    707,737Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                                    
                                    
                                    (2,128,356
                                    )
                                    
                                    
                                    (2,315,043
                                    )$
                                    (1,962,902
                                    )
                                    
                                    $
                                    (1,607,306
                                    )
 The asset
balance of $165,454 at March 31, 2009 relates to several contracts that are
projected to be completed during fiscal 2009. Deep Down has completed several of
the included jobs subsequent to March 31, 2009, while other jobs are more long
term in nature.
  5
 
 The asset
balance of $707,737 at December 31, 2008 was related to a large contract that
was completed during December 2008 except for the final documentation. This
retention amount is in accordance with applicable provisions of engineering and
construction contracts and became due upon completion of contractual
requirements in January 2009. Deep Down had recognized approximately 90% of the
related revenue based on the percentage-of-completion method as of December 31,
2008 and recognized the remainder in the first quarter of fiscal
2009.
 
 The
billings in excess of costs and estimated earnings on uncompleted contracts of
$2,128,356 and $2,315,043 at March 31, 2009 and December 31, 2008, respectively,
consisted mainly of a deposit on a large job that will be completed in fiscal
year 2009.
 
 Note
3: Acquisition
 
 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 assumed effective
control and dated the acquisition for accounting purposes on May 1, 2008. As
such, the consolidated statement of operations includes the operating results of
Flotation from May 1, 2008.
 
 The
acquisition of Flotation has been 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
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 the 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 $37,100,000 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 and not
in the purchase price of the transaction.
 
 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 audited 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.
 
 Unaudited pro-forma combined
condensed financial statements
  The
unaudited pro-forma combined condensed financial statements are presented for
informational purposes only and are not necessarily indicative of the results of
operations that actually would have been achieved had each acquisition been
consummated as of that time, nor are they intended to be a projection of future
results.
  6
  The
unaudited combined condensed pro-forma results were as follows:
 Unaudited Pro Forma Combined Condensed Statements of
Operations
 For
the Three Months ended March 31, 2008
 
 HistoricalCombinedFlotation
                          
                          
                          CondensedPro
      Forma
                          
                          
                          Pro
      FormaDeep
      Down
                          
                          
                          Flotation
                          
                          
                          Entries
                          
                          
                          ResultsRevenues
                          
                          $
                          6,279,465
                          
                          
                          $
                          4,877,108
                          
                          
                          $
                          -
                          
                          
                          $
                          11,156,573Cost
      of sales
                          
                          
                          3,931,555
                          
                          
                          
                          3,377,955
                          
                          
                          
                          -
                          
                          
                          
                          7,309,510Gross
      profit
                          
                          
                          2,347,910
                          
                          
                          
                          1,499,153
                          
                          
                          
                          -
                          
                          
                          
                          3,847,063Total
      operating expenses
                          
                          
                          2,005,212
                          
                          
                          
                          662,959
                          
                          
                          
                          226,812
                          
                          (a/b)
                          
                          2,894,983Operating
      income (loss)
                          
                          
                          342,698
                          
                          
                          
                          836,194
                          
                          
                          
                          (226,812
                          )
                          
                          
                          952,080Total
      other expense
                          
                          
                          (701,511
                          )
                          
                          
                          (34,868
                          )
                          
                          
                          -
                          
                          
                          
                          (736,379
                          )Income
      (loss) fromcontinuing
      operations
                          
                          
                          (358,813
                          )
                          
                          
                          801,326
                          
                          
                          
                          (226,812
                          )
                          
                          
                          215,701Benefit
      from (provision for) income taxes
                          
                          
                          269,366
                          
                          
                          
                          -
                          
                          
                          
                          (212,570
                          )
                          (c)
                          
                          56,796Net
      income (loss)
                          
                          $
                          (89,447
                          )
                          
                          $
                          801,326
                          
                          
                          $
                          (439,382
                          )
                          
                          $
                          272,497Basic
      earnings (loss) per share
                          
                          $
                          -
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          $
                          -Weighted-average
      common shares outstanding
                          
                          
                          87,185,242
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (d)
                          
                          148,814,558Diluted
      earnings (loss) per share
                          
                          $
                          -
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          $
                          -Weighted-average
      common shares outstanding
                          
                          
                          87,185,242
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (d)
                          
                          159,644,348
 
 See
accompanying notes to unaudited pro forma combined condensed financial
statements.
  The
historical results of Deep Down for the three months ended March 31, 2009
contain the results for Flotation operations since its acquisition was effective
May 1, 2008, thus the three months ending March 31, 2008 are 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 28, 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%.
  The
Unaudited Pro-Forma Combined Condensed Statements include the following
pro-forma assumptions and entries for Flotation:
  (a)
              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.
  (b)
              Amortization
      of the intangible assets at a rate of $68,261 per month based on the
      remaining useful lives of the acquired
assets.
  (c)
              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.
  (d)
              A
      total of 58,857,143 common shares of Deep Down were issued connected to
      Flotation and Private Placement; 57,142,857 in connection with the Private
      Placement, and 1,714,286 to former Flotation shareholders. These pro-forma
      amounts give effect as if shares were issued January 1, 2008.
      Additionally, 2,802,969 shares were issued to the Mako shareholders in
      connection with the final payment for that
  acquisition.
  7
 
 Note 4:
Property and Equipment
 
 Property
and equipment consisted of the following:
 March
      31, 2009
                                  
                                  
                                  December
      31, 2008
                                  
                                  
                                  Useful
      LifeLand
                                  
                                  $
                                  461,955
                                  
                                  
                                  $
                                  461,955
                                  
                                  
                                  -Building
                                  
                                  
                                  3,204,836
                                  
                                  
                                  
                                  3,201,301
                                  
                                  
                                  7 -
      36 yearsLeasehold
      improvements
                                  
                                  
                                  428,691
                                  
                                  
                                  
                                  344,485
                                  
                                  
                                  2 -
      5 yearsFurniture
      and fixtures
                                  
                                  
                                  372,697
                                  
                                  
                                  
                                  160,443
                                  
                                  
                                  2 -
      7 yearsVehicles
      and trailers
                                  
                                  
                                  127,107
                                  
                                  
                                  
                                  120,847
                                  
                                  
                                  3 -
      5 yearsEquipment
                                  
                                  
                                  3,955,561
                                  
                                  
                                  
                                  3,897,475
                                  
                                  
                                  2 -
      10 yearsRental
      Equipment
                                  
                                  
                                  4,892,232
                                  
                                  
                                  
                                  4,694,681
                                  
                                  
                                  7 -
      10 yearsComputer
      and office equipment
                                  
                                  
                                  536,981
                                  
                                  
                                  
                                  473,518
                                  
                                  
                                  2 -
      5 yearsConstruction
      in progress
                                  
                                  
                                  2,935,282
                                  
                                  
                                  
                                  2,130,068Total
                                  
                                  
                                  16,915,342
                                  
                                  
                                  
                                  15,484,773Less:
      Accumulated depreciation
                                  
                                  
                                  (2,109,119
                                  )
                                  
                                  
                                  (1,685,577
                                  )Property
      and equipment, net
                                  
                                  $
                                  14,806,223
                                  
                                  
                                  $
                                  13,799,196
 Depreciation
expense for the three months ended March 31, 2009 and 2008 was $424,125 and
$213,090, respectively.  For the three months ended March 31, 2009 and
2008, Deep Down recorded $345,179 and $172,346, respectively, of the
total depreciation as Cost of Sales on the accompanying statements of
operations.
 
 Note
5: 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 Flotation acquisition; 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 March 31,
2009. Estimated intangible asset values, net of recognized amortization expense
include the following:
 March
      31, 2009
                            
                            
                            December
      31, 2008Estimated
                              Useful
      Life
                            
                            Gross
      Carrying
                              Value
                            
                            
                            Accumulated
                              Amortization
                            
                            
                            Net
      Carrying
                              Amount
                            
                            
                            Gross
      Carrying
                              Value
                            
                            
                            Accumulated
                              Amortization
                            
                            
                            Net
      Carrying
                              AmountCustomer
      relationship
                            8-25
      Years
                            
                            $
                            3,515,000
                            
                            
                            $
                            (498,735
                            )
                            
                            $
                            3,016,265
                            
                            
                            $
                            3,515,000
                            
                            
                            $
                            (403,131
                            )
                            
                            $
                            3,111,869Non-Compete
      Covenant
                            3-5
      Years
                            
                            
                            1,334,000
                            
                            
                            
                            (389,916
                            )
                            
                            
                            944,084
                            
                            
                            
                            1,334,000
                            
                            
                            
                            (293,916
                            )
                            
                            
                            1,040,084Trademarks
                            25-40
      Years
                            
                            
                            3,110,000
                            
                            
                            
                            (103,847
                            )
                            
                            
                            3,006,153
                            
                            
                            
                            3,110,000
                            
                            
                            
                            (80,393
                            )
                            
                            
                            3,029,607Technology
                            25
      Years
                            
                            
                            11,209,000
                            
                            
                            
                            (411,973
                            )
                            
                            
                            10,797,027
                            
                            
                            
                            11,209,000
                            
                            
                            
                            (299,880
                            )
                            
                            
                            10,909,120Total
                            
                            
                            $
                            19,168,000
                            
                            
                            $
                            (1,404,471
                            )
                            
                            $
                            17,763,529
                            
                            
                            $
                            19,168,000
                            
                            
                            $
                            (1,077,320
                            )
                            
                            $
                            18,090,680
 8
 Note
6: Long-Term Debt
 
 The
following table summarizes long-term debt:
 March
      31, 2009
                          
                          
                          December
      31, 2008Bank
      term loan
                          
                          $
                          1,062,476
                          
                          
                          $
                          1,150,000Secured
      bank loan
                          
                          
                          1,829,638
                          
                          
                          
                          -Other
      bank loans
                          
                          
                          13,065
                          
                          
                          
                          15,087Total
      bank debt
                          
                          
                          2,905,179
                          
                          
                          
                          1,165,0876%
      Subordinated Debenture
                          
                          
                          500,000
                          
                          
                          
                          500,000Capital
      lease obligation
                          
                          
                          424,271
                          
                          
                          
                          436,300Total
      long-term debt
                          
                          
                          3,829,450
                          
                          
                          
                          2,101,387Current
      portion of long-term debt
                          
                          
                          (471,015
                          )
                          
                          
                          (382,912
                          )Long-term
      debt, net of current portion
                          
                          $
                          3,358,435
                          
                          
                          $
                          1,718,475
  Revolving
credit line and term loan
 
 On
November 11, 2008, Deep Down entered into a Credit Agreement (the “Revolver”)
with Whitney National Bank (“Whitney 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. On December 18, 2008, Deep Down
entered into an amendment to the Revolver, (the “Term Loan”) with Whitney Bank
which provides for the incurrence by Deep Down of a term loan in the principal
amount of $1,150,000 under, and subject to the terms and conditions of, Deep
Down’s secured credit agreement. Such Term Loan does not impact the availability
under the Revolver.
 
 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. Under the
Revolver, Deep Down is required to meet certain covenants and
restrictions.  The financial covenants are reportable each quarter,
beginning with the quarter ending March 31, 2009.  Financial covenants
include maintaining total debt to consolidated EBITDA below 2.5
to 1, consolidated EBITDA to consolidated net interest expense and principal
payments on the total debt greater than 1.5 to 1, and tangible net worth in
excess of $20,000,000 as each term is defined in the Credit
Agreement. Other covenants include limitations on issuance of common stock,
liens, transactions with affiliates, additional indebtedness and permitted
investments, among others.  Deep Down was in compliance with the
financial covenants at March 31, 2009.
 
 Amendment
to credit agreement and new loan agreement
 
 On March
5, 2009, Deep Down’s wholly-owned subsidiary, Flotation, obtained loan proceeds
in the principal amount of $1,840,000 pursuant to a loan agreement Flotation and
Deep Down entered into with TD Bank, N.A. (“TD Bank”) as of February 13,
2009.  This loan agreement provides a further commitment to Flotation
for advancement of principal in the amount of $320,000. Loans under the loan
agreement are generally secured by Flotation’s operational premises in
Biddeford, Maine under a mortgage and security agreement and a collateral
assignment of leases and rents.  In connection with the loan
agreement, TD Bank required that Deep Down enter into a debt subordination
agreement that subordinated any debt Flotation owes to Deep Down other than
accounts payable between them arising in the ordinary course of
business.  Furthermore, as part of the loan agreement, TD Bank
required a “negative pledge” that prohibits Flotation and Deep Down from
granting security interests in Flotation’s personal property, other than such
security interests granted in respect of Deep Down’s primary facility for
borrowed money (as currently held with Whitney Bank). Deep Down is obligated to
repay proceeds funded on March 5, 2009 based on a schedule of monthly
installments of $13,007, with an initial payment on March 13, 2009 and a final
payment of all remaining outstanding and unpaid principal and accrued interest
in February 2016.  However, upon advancement of any portion of the
$320,000 additional principal amount available under the loan agreement, TD Bank
will recalculate the monthly installments to an amount that will fully amortize
the then outstanding principal balance over a 20-year amortization
schedule.
  9
 
 In
connection with such loan for Flotation, Deep Down entered into a second
amendment of its existing credit facility with Whitney Bank to permit such loan
and the security and other arrangements relating to Flotation’s loan
agreement.  The terms of the second amendment also included a
guarantor’s consent and agreement, to be signed by each of Deep Down’s
subsidiaries as guarantors of the obligations of Deep Down under such existing
credit facility, that Whitney Bank required as a condition to the effectiveness
of the second amendment. Additionally, Whitney Bank required that Deep Down
International Holdings, LLC, a Nevada limited liability company and wholly-owned
subsidiary of Deep Down formed in February 2009, enter into joinder agreements
for the guaranty and security agreement arrangements generally required of Deep
Down’s subsidiaries under the existing credit facility. Deep Down International
Holdings, LLC currently has no material assets or operations.
 
 Interest
expense during the three months ended March 31, 2008
 
 During
the three months ended March 31, 2008, Deep Down amortized the discounts and
deferred financing costs associated with the fair market value of warrants and
the cash-based expenses related to third party fees and prepaid lender fees into
interest expense over the life of a Credit Agreement using the effective
interest rate method.  The discounts and deferred financing costs were
associated with a secured credit agreement entered into in August 2007 and
December 2007.  A total of $118,171 of debt discount and $56,915 of
deferred financing costs were amortized into interest expense for the three
months ended March 31, 2008.  Cash interest paid for the three months
ended March 31, 2008 was $459,833 under the original stated terms of the
note.
 
 At March
31, 2008, upon the exchange of 500 shares of Series E Redeemable Exchangeable
Preferred Stock (“Series E”) into a 6% subordinated debenture in the amount of
$500,000, Deep Down recorded $113,589 in interest expense for the accretion of
the Series E Preferred Stock up to face value.
 
 Note
7: Stock-Based Compensation
 
 Deep Down
has a stock-based compensation plan - the 2003 Directors, Officers and
Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). Deep
Down accounts 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 three
months ended March 31, 2009, Deep Down granted 4,450,000 options and 2,350,000
shares of restricted stock. Based on the shares of common stock outstanding
at March 31, 2009, there were approximately 10,990,000 options available for
grant under the Plan as of that date.
 
 Restricted
Stock
 
 On March
23, 2009, Deep Down granted 2,350,000 restricted shares to executives and
employees which vest on March 23, 2011, provided such respective recipient
remains employed with Deep Down on such date. The shares were valued at a price
of $0.124 based on the closing price of common stock on the preceding business
day, March 20, 2009. The shares vest on the second anniversary of the grant
date, and Deep Down is amortizing the related stock-based compensation of
$291,400 over the two-year requisite service period. For the three months ended
March 31, 2009 and 2008, Deep Down recognized a total of $66,525 and $31,500,
respectively, in stock-based compensation related to all outstanding shares of
restricted stock; the unamortized portion of the estimated fair value of
restricted stock is $508,375 at March 31, 2009.
 
 The
following table summarizes Deep Down’s restricted stock activity for the three
months ended March 31, 2009:
  Restricted
                            Shares
                          
                          
                          Weighted-Average
      Grant Price
                          
                          
                          Aggregate
      Intrinsic ValueOutstanding
      at December 31, 2008
                          
                          
                          1,200,000
                          
                          
                          $
                          0.42Grants
                          
                          
                          2,350,000
                          
                          
                          $
                          0.12Outstanding
      at March 31, 2009
                          
                          
                          3,550,000
                          
                          
                          $
                          0.22
                          
                          
                          $
                          -
 10
  Stock
Option Activity During 2009
 
 During
the three months ended March 31, 2009, Deep Down granted an aggregate of
4,450,000 stock options to various employees with exercise prices of $0.124,
reflecting the common stock closing price on the business date before the grant.
The fair value of such options was approximately $395,160 based on the
Black-Scholes option pricing model, using the following input
values:
  Dividend
      yield
                      0%Risk
      free interest rate
                      1.69%Expected
      life of options
                      3
      yearsExpected
      volatility
                      88.50%
  
 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 three months ended March 31, 2009 and 2008 was $79,140
and $73,662, respectively.  Additionally, during the three months ended
March 31, 2009, Deep Down revised the estimated rate of forfeitures to 30% from
0% based on the history of stock option cancellations and management’s estimates
of expected future forfeiture rates. This change in estimate resulted in a
cumulative reduction of $116,246 during the three months ending March 31, 2009.
The unamortized portion of the estimated fair value of outstanding stock options
was $1,151,177 at March 31, 2009.
 
 The
following table summarizes Deep Down’s stock option activity for the three
months ended March 31, 2009:
  Shares
      Underlying Options
                        
                        
                        Weighted-
      Average Exercise Price
                        
                        
                        Weighted-
      Average Remaining Contractual Term
                          (in
      years)
                        
                        
                        Aggregate
      Intrinsic Value
                          (In-The-Money)Outstanding
      at December 31, 2008
                        
                        
                        8,066,667
                        
                        
                        $
                        0.96
                        
                        
                        
                        2.3
                        
                        
                        $
                        -Grants
                        
                        
                        4,450,000
                        
                        
                        
                        0.12Exercises
                        
                        
                        -
                        
                        
                        
                        -Cancellations
      & Forfeitures
                        
                        
                        (116,667
                        )
                        
                        
                        0.50Outstanding
      at March 31, 2009
                        
                        
                        12,400,000
                        
                        
                        $
                        0.66
                        
                        
                        
                        2.7
                        
                        
                        $
                        160,200Exerciseable
      at March 31, 2009
                        
                        
                        2,666,666
                        
                        
                        $
                        0.93
                        
                        
                        
                        2.4
                        
                        
                        $
                        -
  
 The
following summarizes Deep Down’s outstanding options and their respective
exercise prices at March 31, 2009:
  Exercise
                                          Price
                                        
                                        Shares
      Underlying
                                          Options$   0.10
      - 0.49
                                        
                                        4,550,000$   0.50
      - 0.69
                                        
                                        3,600,000$   0.70
      - 0.99
                                        
                                        450,000$   1.00
      - 1.29
                                        
                                        800,000$   1.30
      - 1.50
                                        
                                        3,000,00012,400,000


11
  
 Note
8: Warrants
 
 A summary
of warrant transactions follows. The aggregate intrinsic value is based on the
closing price of $0.16 on March 31, 2009.
  Shares
      Underlying Warrants
                        
                        
                        Weighted-
      Average Exercise Price
                        
                        
                        Weighted-
      Average Remaining Contractual Term (in years)
                        
                        
                        Aggregate
      Intrinsic Value (In-The-Money)Outstanding
      at December 31, 2008
                        
                        
                        638,812
                        
                        
                        $
                        0.78Outstanding
      at March 31, 2009
                        
                        
                        638,812
                        
                        
                        $
                        0.78
                        
                        
                        
                        3.8
                        
                        
                        $
                        -Exerciseable
      at March 31, 2009
                        
                        
                        438,812
                        
                        
                        $
                        0.82
                        
                        
                        
                        3.8
                        
                        
                        $
                        -
 
  The
following summarizes Deep Down’s outstanding warrants and their respective
exercise prices at March 31, 2009:
  Exercise
      Price
                                
                                Shares
      Underlying Warrants$   0.70
      - 0.99
                                
                                520,000$           
        1.01
                                
                                118,812638,812
  
 Note 9: Commitments
and Contingencies
 
 Litigation
 
 Deep Down
is from time to time involved in legal proceedings arising from the normal
course of business. As of the date of this report, Deep Down is not currently
involved in any material legal proceedings except as noted below.
 
 At March
31, 2009, Deep Down was in the arbitration process with the former stockholders
of Flotation Technologies, Inc. regarding the proper calculation of the “Cash
Price Adjustment” pursuant to the Stock Purchase Agreement by and between Deep
Down, Flotation Technologies, Inc. and its former stockholders dated April 17,
2008. Any purchase price adjustment will be allocated to the goodwill balance
once the preliminary estimates are finalized.  No changes to this
potential contingency existed at May 11, 2009.
  In
connection with the Private Placement in June 2008, Deep Down filed an initial
Registration Statement on Form S-1 on July 21, 2008 to register the 57,142,857
shares issued in the offering. Pursuant to the Registration Rights Agreement,
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 liquidated damages to the Selling Shareholders in the Private
Placement for each day following the Required Effective Date, until but
excluding the date the Commission declares the Registration Statement effective.
Deep Down evaluated this obligation under the Registration Rights Agreement for
liability treatment under 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 met the definition of a liability under the
authoritative guidance, and at December 31, 2008  reserved $1,212,120
in potential damages under terms of the Private Placement for the 90-day period
from September 4 to December 3, 2008. Deep Down obtained an opinion from legal
counsel allowing removal of the related stock’s restrictive legend under Rule
144, which was deemed to be equivalent, and thus satisfied the registration
rights requirements.
  12
  The SEC
declared the Registration Statement on Form S-1 effective on April 16,
2009.  Pursuant to section 7.1 (c) of the Registration Rights
Agreement and based on opinion of counsel, as of March 31, 2009 Deep Down’s
management has adjusted the liquidated damages reserve to 47 days, or $626,040.
Deep Down recorded the reduction during the three months ended March 31, 2009
and initiated payment to the Selling Shareholders subsequent to that
date.
 
 Operating
Leases
 
 Deep Down
leases certain offices, facilities, equipment and vehicles under non-cancelable
operating and capital leases expiring at various dates through
2016.
 
 Letters
of Credit
 
 Certain
customers require Deep Down to post a bank letter of credit (“LC”) guarantee.
These LCs assure Deep Down’s creditors that they will perform under terms of the
contract and with associated vendors and subcontractors. In the event of
default, the creditor may demand payment from the bank under an LC. There was no
significant expense related to LCs for the three months ended March 31, 2009.
Deep Down was contingently liable for secured and unsecured LCs of $135,855 as
of March 31, 2009, which is offset by restricted cash in the same
amount.
 
 In
December 2008, Deep Down amended the credit agreement with Whitney Bank as more
fully described in Note 6. The amended credit agreement provides for LCs. Deep
Down executed an irrevocable transferrable standby LC with a customer for
$1,107,456 in the normal course of business during the three months ended March
31, 2009. This standby LC reduces the borrowing capacity under the Whitney Bank
Revolver.
 
 Note
10:  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.
 
 During
the three months ended March 31, 2009, Deep Down executed a memorandum of
understanding to purchase these assets from JUMA for approximately $2,600,000
which is expected to include an assumption of bank debt in the approximate
amount of $1,800,000. Deep Down received a third party appraisal of the property
in the amount of $3,100,000. Deep Down made earnest-money deposit payments
during the three months ended March 31, 2009 totaling $470,000 to Ronald E.
Smith, which are included in Other Assets on the accompanying balance sheets as
of March 31, 2009.
 
 13
 
 ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
 The
following discussion and analysis provides information that management believes
is relevant for an assessment and understanding of our results of operations and
financial condition.   This information should be read in
conjunction with our audited historical consolidated financial statements which
are included in our Form 10-K for the fiscal year ended December 31, 2008 filed
with the SEC on March 16, 2009 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
 
 Deep
Down, Inc., (“Deep Down” or “the Company”) (OTCBB: DPDW), a publicly traded
Nevada corporation, originated on December 14, 2006, through a reverse merger
with MediQuip Holdings, Inc. (“MediQuip”), a publicly traded Nevada
corporation.  Deep Down, Inc., the operating company, was originally a
Delaware corporation founded in 1997, but had been acquired in a series of
transactions on November 21, 2006, by Subsea Acquisition Corporation
(“Subsea”).
 
 On June
29, 2006, Subsea, a Texas corporation, was formed by three shareholders with the
intent to acquire offshore energy service providers. On November 21, 2006,
Subsea acquired all the common stock of Strategic Offshore Services Corporation
(“SOS”), a Texas corporation, for 3,000 shares of Subsea’s Series F preferred
stock and 1,000 shares of Series G preferred stock from two common shareholders
(who were also shareholders of Subsea).  Since the entities were under
common control, and SOS did not constitute a business, the Company was charged
compensation expense to shareholders for the fair value of both series of
preferred stock totaling $3.3 million.
  Additionally,
on November 21, 2006, Subsea acquired Deep Down, Inc., (“Deep Down Delaware”) a
Delaware corporation founded in 1997. Under the terms of this transaction, all
of Deep Down Delaware’s shareholders transferred ownership of all of Deep Down
Delaware’s common stock to Subsea in exchange for 5,000 shares of Subsea’s
Series D preferred stock and 5,000 shares of Subsea’s Series E preferred stock
resulting in Deep Down Delaware becoming a wholly-owned subsidiary of Subsea. On
the same day, Subsea then merged with Deep Down Delaware, with the surviving
company operating as Deep Down Delaware. This transaction was accounted for as a
purchase, with Subsea being the accounting acquirer based on a change in voting
control.
 
 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 merger was
accounted for as a reverse merger whereby Deep Down was the accounting acquirer
resulting in a recapitalization of Deep Down’s equity.
 
 On April
2, 2007, Deep Down acquired substantially all of the assets of ElectroWave USA,
Inc., a Texas corporation for a total purchase price of $0.2 million. Deep Down
formed a wholly-owned subsidiary, ElectroWave USA, Inc., (“ElectroWave”), a
Nevada corporation, to complete the acquisition.  Located in
Channelview, Texas, ElectroWave offers design, assembly, installation and
commissioning of electronic monitoring and control systems for the energy,
military, and commercial business markets.
  14
  Effective
December 1, 2007, Deep Down acquired all of the common stock of Mako
Technologies, Inc. (“Mako”) for a total purchase price of $11.3 million
including transaction fees, forming a wholly-owned subsidiary to complete the
acquisition.  Located in Morgan City, Louisiana, Mako serves the
offshore petroleum and marine industries with technical support services, and
equipment vital to offshore petroleum production, through rentals of its
remotely operated vehicles (“ROV”), topside and subsea equipment and support
systems used in diving operations, maintenance and repair operations, offshore
construction and environmental and marine surveys.
 
 On June
5, 2008, Deep Down completed the acquisition of Flotation for a total purchase
price of $23.9 million. Deep Down also 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 and consummated the
closing on June 6, 2008. Flotation engineers, designs and manufactures deepwater
buoyancy systems using high-strength FlotecTM
syntactic foam and polyurethane elastomers from its facilities in Biddeford,
Maine.
 
 In
February 2009, we formed Deep Down International Holdings, LLC, a Nevada limited
liability company and wholly-owned subsidiary of the Company, for the purpose of
holding securities for foreign companies organized or acquired by Deep Down.
Deep Down International Holdings, LLC currently has no assets or
operations.
 
 Our
current operations are the result of the 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
three months ended March 31, 2009 and the fiscal year ended December 31, 2008,
the operations of Deep Down’s subsidiaries have been aggregated into a single
reporting segment under the provisions of SFAS 131 “Disclosures about Segments
of an Enterprise and Related Information” (“SFAS 131”). We determined that the
operating segments of Delaware, ElectroWave, Mako and Flotation (as of their
respective acquisition dates) may be aggregated into a single reporting segment
because aggregation is consistent with the objective and basic principles of
paragraph 17 of SFAS 131. While the operating segments have different product
lines, they are very similar with regards to the five criteria for aggregation.
They are all service-based operations revolving around our personnel’s expertise
in the deep water industry, and any equipment is produced to a customer
specified design and engineered using Deep Down personnel’s expertise, with
installation as part of our service revenue to the customer. Additionally, the
segments have similar customers and distribution methods, and their economic
characteristics were similar with regard to their gross margin
percentages.
 
 Recent
developments
 
 During
the three months ended March 31, 2009, Deep Down executed a memorandum of
understanding to purchase these assets from JUMA for approximately $2.6 million
which is expected to include an assumption of bank debt in the approximate
amount of $1.8 million.  Deep Down received a third party appraisal of
the property in the amount of $3.1 million. Deep Down made earnest-money deposit
payments during the three months ended March 31, 2009 totaling $0.5 million to
Ronald E. Smith.
 
 In
connection with the Private Placement in June 2008, Deep Down filed an initial
Registration Statement on Form S-1 on July 21, 2008 to register the shares
issued. The SEC declared the Registration Statement on Form S-1 effective
on April 16, 2009.
 
 Results of
operations
 
 Three
Months Ended March 31, 2009 Compared to Three Months Ended March 31,
2008
 
 Revenue.  Revenue
for the three months ended March 31, 2009 increased approximately $0.8 million
to $7.1 million, a 13.1% increase over the same three-month period in 2008. The
increase in revenue included $2.6 million from the acquisition of Flotation. The
reduction in revenue from the other subsidiaries over the same three-month
period in 2008 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 customers’
anticipated cash flow.
  15
  Gross
Profit.  Gross profit remained relatively consistent at
approximately $2.3 million for the three months ended March 31, 2009 and
March 31, 2008. Gross margins for the same period decreased from 37.4% to
32.4%.  The inclusion of Flotation for the three months ended March
2009 increased the gross profit by approximately $0.8 million; however, gross
profit was negatively impacted by higher repair and maintenance costs and
increased depreciation expense from our Mako acquisition.
  Selling, General and Administrative
Expenses.Selling,
general and administrative expenses (“SG&A”) includes rent, utilities,
general office expenses, insurance, personnel and other costs necessary to
conduct business operations.  SG&A for the three months ended
March 31, 2009 was $2.8 million compared to $1.9 million for the same period
last year, due in part to the acquisition of Flotation, which represented $0.9
million of the increased expense. Personnel and related costs (not included in
the Flotation amount) of $0.5 million was attributed to the 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 $0.2 million more than the comparable prior year period in
professional, accounting and legal fees relating to the updating of the
registration statement and increased annual audit fees due to company growth.
Stock-based compensation was $29,419 for the three months ended March 31, 2009
compared to approximately $0.1 million for the comparable prior year period, due
to a change in management’s estimate of expected future forfeiture rates which
generated a reduction of expense approximating $0.1 million.
 
 Depreciation and
amortization. Depreciation expense for the three months ended March 31,
2009 was $0.4 million compared to $0.2 million for the same prior year period
due mainly to the acquisitions of Mako and Flotation. In addition, intangible
assets purchased in the Mako and Flotation acquisitions total $19.2 million in
the aggregate, and the related amortization for the three months ended March 31,
2009 was $0.3 million compared to the prior year period of $0.1 million, since
the Flotation acquisition was completed in May 2008.
 
 Interest Expense. Interest
expense for the three months ended March 31, 2009 was $48,344 compared to $0.8
million for the same prior year period.  Interest expense for the
three months ended March 31, 2009 was generated by our outstanding bank debt,
capital lease and subordinated debenture. For the three months ended March 31,
2008, interest expense was generated mainly by a secured credit agreement; cash
interest approximated $0.5 million, and we incurred non-cash deferred financing
and debt discount amortization approximating $0.2 million. On June 12, 2008, we
paid the balance due under that credit agreement, thus there were no related
expenses since that date.
 
 Net income (loss). Net loss
for the three months ended March 31, 2009 was $­­0.7 million, compared
to $0.1 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 March 31, 2009 was $(0.2) million
compared to $0.7 million, a decrease of $0.9 million from the same prior year
period.
 2009
                                      
                                      
                                      
                                      2008Net
      loss
                                      
                                      
                                      (729,775
                                      )
                                      
                                      
                                      (89,447
                                      )Add
      back interest expense, net of interest income
                                      
                                      
                                      46,116
                                      
                                      
                                      
                                      729,866Add
      back depreciation and amortization
                                      
                                      
                                      751,276
                                      
                                      
                                      
                                      298,149Deduct
      tax benefit
                                      
                                      
                                      (265,323
                                      )
                                      
                                      
                                      (269,366
                                      )EBITDA
                                      
                                      $
                                      (197,706
                                      )
                                      
                                      $
                                      669,202
  
 16
  
 Capital
Resources and Liquidity
 
 We
believe that the liquidity we derived from the Private Placement 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 generated
our liquidity and capital resources primarily through operations and available
capital markets. At March 31, 2009, long-term debt was $3.8 million, of which
$0.5 million was current.
 
 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 May 11, 2009, we have not drawn any
amounts available under this Revolver.
 
 Our
credit agreement with Whitney Bank provides for letters of credit (“LCs”), which
we executed an irrevocabletransferrable
standby LC with a customer for $1.1 million on February 10, 2009. The LC was
executed as a guarantee of performance by Deep Down and its subsidiaries on a
long-term contract, allows partial and multiple drawings, and expires August 31,
2009 with an automatic one-year extension period unless cancelled 90 days in
advance of the expiration date. This standby LC reduces the $2.0 million
borrowing capacity under the Whitney Bank Revolver.
 
 On March
5, 2009, Flotation obtained loan proceeds in the principal amount of
approximately $1.8 million pursuant to a loan agreement Flotation and the
Company entered into with TD Bank as of February 13, 2009. This loan agreement
provides a further commitment to Flotation for advancement of principal in the
amount of $0.3 million. In connection with the loan agreement, TD Bank required
that the Company enter into a debt subordination agreement that subordinated any
debt Flotation owes to the Company other than accounts payable between them
arising in the ordinary course of business.  Furthermore, as part of
the loan agreement TD Bank required a “negative pledge” that prohibits Flotation
and the Company from granting security interests in Flotation’s personal
property, other than such security interests granted in respect of the Company’s
primary facility for borrowed money (as currently held with Whitney
Bank).  See Note 6 to the unaudited consolidated financial statements
included in this Form 10-Q for further information on this loan
agreement.
 
 As of
March 31, 2009, our cash and cash equivalents were $6.4 million, which includes
restricted cash of $0.1 million.  Cash and cash equivalents were $2.6
million including restricted cash of $0.1 million as of December 31,
2008.  This increase was largely due to collection of outstanding
accounts receivable. Management believes that we have adequate capital resources
when combined with our cash position and cash flow from operations to meet
current operating requirements for the 12 months ending March 31,
2010.
 
 Cash
Flow from Operating Activities
 
 For the
three months ended March 31, 2009, cash provided by operating activities was
$3.9 million as compared to cash used in operating activities for the same
prior year period of $0.5 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 collected approximately $4.3 million in accounts receivable during
the three months ended March 31, 2009. We used some of the operating cash flow
to reduce accounts payable and accrued liabilities by $0.8 million compared to
$0.6 million in fiscal 2008. Additionally, we recorded the following non-cash
charges in the three months ended March 31, 2009: share based compensation of
$29,419, bad debt expense of $60,000 and depreciation and amortization of $0.8
million. In the three months ended March 31, 2008, we recorded amortization of
deferred financing costs and debt discount related to a secured credit
agreement which totaled $0.2 million, share based compensation of $0.1
million, bad debt expense of $3,949 and depreciation and amortization of $0.3
million
 
 Cash
Flow from Investing Activities
 
 For the
three months ended March 31, 2009, cash used in investing activities was $1.9
million compared to $3.3 million for the same prior year period. For the three
months ended March 31, 2009, we used $1.4 million for the purchase of fixed
assets, and made $0.5 million in deposits to a related party for purchase of
land and buildings. The majority of the 2008 activity related to the final cash
paid to Mako shareholders totaling $2.9 million plus some adjustments to
purchase price expenses. The restricted cash balance at March 31, 208
was increased by $0.2 million related to requirements of a secured credit
agreement. We used $0.2 million for equipment purchases during the
same period of 2008.
  17
  Cash
Flow from Financing Activities
 
 For the
three months ended March 31, 2009, cash provided by financing
activities was $1.7 million compared to $4.8 million for the same prior year
period.  For the 2009 period, we borrowed $1.8 million and made
principle payments of $0.1 million. 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 $5.6
million.
 
 Critical
Accounting Policies
 
 The
discussion and analysis of our financial condition and results of operations is
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements in accordance with generally
accepted accounting principles requires us to make estimates and judgments that
may affect assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to revenue recognition and related
allowances, costs and estimated earnings incurred in excess of billings on
uncompleted contracts , inventory, impairments of long-lived assets, including
intangible assets, impairments of goodwill, income taxes including the valuation
allowance for deferred tax assets, valuation of long-lived assets, billings in
excess of costs and estimated earnings on uncompleted contracts; contingencies
and litigation, and share-based payments.  We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable, the results of which form the basis for making judgments about the
carrying values of assets and liabilities. Actual results may differ from these
estimates under different assumptions or conditions.
 
 Refer to
Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” in our Annual Report on Form 10-K for the year ended
December 31, 2008 for a discussion of our critical accounting
estimates.
 
 Inflation
and Seasonality
 
 We do not
believe that our operations are significantly impacted by
inflation.  Our business is not seasonal in nature.
 
 Off-Balance
Sheet Arrangements
 
 We have
no off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that is material to investors.
 
 ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
 
 Financial
market risks relating to our operations result primarily from changes in
interest rates. We hold no securities for purposes of trading. Our cash and cash
equivalents representing bank deposits at March 31, 2009 are not restricted as
to withdrawal except for $135,855 related to an LC for a vendor. Interest earned
on our cash equivalents is sensitive to changes in interest rates. We have no
variable rate debt outstanding as of March 31, 2009. The $2.0 million Revolver
with Whitney Bank has a LIBOR-based interest rate. Outstanding amounts under the
Revolver generally will bear interest at rates based on the British Bankers
Association LIBOR Rate for dollar deposits with a term of one month plus an
applicable rate of 2.00% to 3.00% based on the leverage ratio of Deep
Down.
  18
  ITEM 4. CONTROLS AND PROCEDURES
  Evaluation
of Disclosure Controls and Procedures
 
 We
carried out an evaluation, under the supervision and with the participation of
our management, including our Principal Executive Officer and Principal
Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)).  Based upon that evaluation, our Principal Executive
Officer and Principal Financial Officer concluded that, as of March 31, 2009,
our disclosure controls and procedures were not effective to ensure that
information required to be disclosed in reports filed under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
required time periods and is accumulated and communicated to our management,
including our Principal Executive Officer and Principal Financial Officer, as
appropriate to allow timely decisions regarding required disclosure. This
determination was in response to the SEC comment letter received February 26,
2009, in which the SEC stated that they require that we present the audited
predecessor financial statements for Deep Down, Inc. for the period from January
1, 2006 through November 20, 2006, in accordance with Rule 310(a) of Regulation
S-B. We remediated this on March 31, 2009 by supplementing the amounts reported
in Form 10-K for December 31, 2007 with the predecessor audited financial
information for Deep Down, Inc. from January 1, 2006 to November 20, 2006 and
our Registration Statement on Form S-1 was declared effective on April 16,
2009.
 
 Our
management, including our Principal Executive Officer and Principal Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error or fraud. A control system, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met.  Further,
the design of a control system must reflect the fact that there are resource
constraints and the benefits of controls must be considered relative to their
costs.  Due to the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, have been detected.
 
 Changes in Internal Control Over
Financial Reporting.
 
 In our
efforts to continuously improve our internal controls, management has taken
steps to enhance the following controls and procedures subsequent to December
31, 2008 as part of our remediation efforts in addressing material
weaknesses:
 ·
              Management
      is in the process of implementing a new system-wide accounting and
      management software program to address the revenue recognition and gross
      margin analysis of projects accounted for under the
      percentage-of-completion method.
 ·
              Management
      has prepared an Employee Handbook and circulated these documents
      throughout the organization and obtained signed acknowledgements from
      employees.
 ·
              Management
      has increased documentation around certain authorization and review
      controls.
  19
 
 PART II–OTHER
INFORMATION
  ITEM
1.  LEGAL PROCEEDINGS
  We are
from time to time involved in legal proceedings arising in the normal course of
business. As of the date of this Form 10-Q, we are currently not involved in any
pending, material legal proceedings except as noted below.
 
 At March
31, 2009, Deep Down was in the arbitration process with the former stockholders
of Flotation Technologies, Inc. regarding the proper calculation of the “Cash
Price Adjustment” pursuant to the Stock Purchase Agreement by and between Deep
Down, Flotation Technologies, Inc. and its former stockholders dated April 17,
2008.
  In
connection with the Private Placement in June 2008, Deep Down filed an initial
Registration Statement on Form S-1 on July 21, 2008 to register the 57,142,857
shares issued in the offering. Pursuant to the Registration Rights Agreement,
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 liquidated damages to the Selling Shareholders in the Private
Placement for each day following the Required Effective Date, until but
excluding the date the Commission declares the Registration Statement effective.
Deep Down evaluated this obligation under the Registration Rights Agreement for
liability treatment under 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 met the definition of a liability under the
authoritative guidance, and at December 31, 2008  reserved $1.2
million in potential damages under terms of the Private Placement for the
90-day period from September 4 to December 3, 2008. Deep Down obtained an
opinion from legal counsel allowing removal of the related stock’s restrictive
legend under Rule 144, which was deemed to be equivalent, and thus satisfied the
registration rights requirements.
  The SEC
declared the Registration Statement on Form S-1 effective on April 16, 2009.
Pursuant to section 7.1 (c) of the Registration Rights Agreement and based on
opinion of counsel, as of March 31, 2009 Deep Down’s management has adjusted the
liquidated damages reserve to 47 days, or $0.6 million. Deep Down recorded the
reduction during the three months ended March 31, 2009 and initiated payment to
the Selling Shareholders subsequent to that date.
 
 ITEM
1A.  RISK FACTORS
  Pursuant
to subsection (3) of “Accelerated Filer and Large
Accelerated Filer” as defined under Rule 12(b)-2 of the Exchange Act,
Deep Down, Inc. is filing this Quarterly Report on Form 10-Q for its fiscal
quarter ended March 31, 2009 with a determination that we have become an
“accelerated filer” after having been a “smaller reporting company” for Exchange
Act reporting purposes. Since we filed our Form 10-K for the fiscal year ended
December 31, 2008 in accordance with subsection (4) of “Smaller Reporting Company”,
and reflected our status as a smaller reporting company in the disclosure we
provided in that Annual Report, we did not previously present the Risk Factor
disclosures. As such, we are presenting the requirements of this section in full
herein.
 
 Risks
Related to Our Business
  We
derive most of our revenues from companies in the offshore oil and gas industry,
a historically cyclical industry with levels of activity that are significantly
affected by the levels and volatility of oil and gas prices.
  We derive
most of our revenues from customers in the offshore oil and gas exploration,
development and production industry.  The offshore oil and gas
industry is a historically cyclical industry characterized by significant
changes in the levels of exploration and development activities.  Oil
and gas prices, and market expectations of potential changes in those prices,
significantly affect the levels of those activities.  Worldwide
political, economic and military events have contributed to oil and gas price
volatility and are likely to continue to do so in the future. Any prolonged
reduction in the overall level of offshore oil and gas exploration and
development activities, whether resulting from changes in oil and gas prices or
otherwise, could materially and adversely affect our financial condition and
results of operations in our segments within our offshore oil and gas
business.
  20
  Some
factors that have affected and are likely to continue affecting oil and gas
prices and the level of demand for our services and products include the
following:
  ●
              worldwide
      demand for oil and gas;●
              the
      ability of the Organization of Petroleum Exporting Countries, or OPEC, to
      set and maintain production levels and pricing;●
              the
      level of production by non-OPEC countries;●
              domestic
      and foreign tax policy;●
              laws
      and governmental regulations that restrict exploration and development of
      oil and gas in various offshore jurisdictions;●
              advances
      in exploration and development technology;●
              the
      political environment of oil-producing regions;●
              the
      price and availability of alternative fuels; and●
              overall
      economic conditions.
  Our
business involves numerous operating hazards that may not be covered by
insurance.  The occurrence of an event not fully covered by insurance
could have a material adverse effect on our financial condition and results of
operations.
  Our
products are used in potentially hazardous drilling, completion and production
applications that can cause personal injury, product liability and environmental
claims.  A catastrophic occurrence at a location where our equipment
and/or services are used may expose us to substantial liability for personal
injury, wrongful death, product liability or commercial claims.  To
the extent available, we maintain insurance coverage that we believe is
customary in the industry.  Such insurance does not, however, provide
coverage for all liabilities, and we cannot assure you that our insurance
coverage will be adequate to cover claims that may arise or that we will be able
to maintain adequate insurance at rates we consider reasonable.  The
occurrence of an event not fully covered by insurance could have a material
adverse effect on our financial condition and results of
operations.
 
 We
may lose money on fixed-price contracts.
  A portion
of our business consists of designing, manufacturing, selling and installing
equipment for major projects pursuant to competitive bids, and is performed on a
fixed-price basis.  Under these contracts, we are typically
responsible for all cost overruns, other than the amount of any cost overruns
resulting from requested changes in order specifications.  Our actual
costs and any gross profit realized on these fixed-price contracts will often
vary from the estimated amounts on which these contracts were originally
based.  This may occur for various reasons, including:
  ●
              errors
      in estimates or bidding;●
              changes
      in availability and cost of labor and materials; or●
              variations
      in productivity from our original estimates.
  These
variations and the risks inherent in our projects may result in reduced
profitability or losses on projects. Depending on the size of a project,
variations from estimated contract performance could have a significant impact
on our operating results.
  Our
business could be adversely affected if we do not develop new
products.
  Technology
is an important component of our business and growth strategy, and our success
as a company depends to a significant extent on the development and
implementation of new product designs and improvements. Whether we can continue
to develop systems and services and related technologies to meet evolving
industry requirements and, if so, at prices acceptable to our customers will be
significant factors in determining our ability to compete in the industry in
which we operate. Many of our competitors are large multinational companies that
may have significantly greater financial resources than we have, and they may be
able to devote greater resources to research and development of new systems,
services and technologies than we are able to do.
  21
  Loss
of our key management or other personnel could adversely impact our
business.
  We depend
on the services of our executive management team, including Ronald E. Smith,
Robert E. Chamberlain, Jr. and Eugene L. Butler. The loss of any of these
officers could have a material adverse effect on our operations and financial
condition. In addition, competition for skilled machinists, fabricators and
technical personnel among companies that rely heavily on engineering and
technology is intense, and the loss of qualified employees or an inability to
attract, retain and motivate additional highly skilled employees required for
the operation and expansion of our business could hinder our ability to conduct
research activities successfully and develop and produce marketable products and
services. While we believe that our wage rates are competitive and that our
relationship with our skilled labor force is good, a significant increase in the
wages paid by competing employers could result in a reduction of our skilled
labor force, increases in the wage rates paid by us, or both. If either of these
events were to occur, in the near-term, the profits realized by us from work in
progress would be reduced and, in the long-term, our production capacity and
profitability could be diminished, and our growth potential could be
impaired.  Additionally, if we were to lose the services of our
officers for any reason, we could face substantial costs and expenses to locate
individuals with similar capabilities and/or may not be able to find suitable
candidates to fill the vacancies left by such individuals, either of which could
have a material adverse effect on our results of operations.
  We
may not be successful in integrating business that we acquire.
  The
successful integration of acquired businesses is important to our future
financial performance.  We may not achieve the anticipated benefits
from any acquisition unless the operations of the acquired business are
successfully combined with ours in a timely manner. The integration of our
acquisitions will require substantial attention from our
management.  The diversion of the attention of our management, and any
difficulties encountered in the transition process, could have a material
adverse effect on our operations and financial results.  The
difficulties of integration may be increased by the necessity of coordinating
geographically separated organizations, integrating personnel with disparate
business backgrounds and combining different corporate
cultures.  There can be no assurance that there will not be
substantial costs associated with such activities or that there will not be
other material adverse effects of these integration efforts. In addition, the
process of integrating the various businesses could also cause the interruption
of, or a loss of momentum in, the activities of some or all of these businesses,
which could have a material adverse effect on our operations and financial
results. There can be no assurance that we will realize any of the anticipated
benefits from our acquisitions.  The acquisition of oil service
companies that are not profitable, or the acquisition of new facilities that
result in significant integration costs and inefficiencies, could also adversely
affect our profitability.
 
 Our
current and anticipated future growth has placed, and will continue to place,
significant demands on our management, operational and financial
resources.  Our ability to manage our growth effectively will require
us to continue to improve our operational, financial and management information
systems and to continue to attract, train, motivate, manage and retain key
employees.  We may not be able to manage our expanded operations
effectively.
  We may
not be successful in implementing our strategy or in responding to ongoing
changes in the oil service industry which may require adjustments to our
strategy.  If we are unable to implement our strategy successfully or
do not respond timely and adequately to ongoing changes in the healthcare
industry, our business, financial condition and results of operations will be
materially adversely affected.
  22
  If
we undertake international operations, it will involve additional risks not
associated with our domestic operations.
  If we
become involved in international operations, the effect on our business from the
risks we described will not be the same in all countries and
jurisdictions.  By way of example, recently there has been political
instability and civil unrest in Indonesia and West Africa and general economic
downturns in Asia and Brazil.  However, the specific risks associated
with our operations in foreign areas will include risks of:
  ●
              multiple,
      conflicting, and changing laws and regulations, export and import
      restrictions, and employment laws;●
              regulatory
      requirements, and other government approvals, permits, and
      licenses;●
              potentially
      adverse tax consequences;●
              political
      and economic instability, including wars and acts of terrorism; political
      unrest, boycotts, curtailments of trade, and other business
      restrictions;●
              expropriation,
      confiscation or nationalization of assets;●
              renegotiation
      or nullification of existing contracts;●
              difficulties
      and costs in recruiting and retaining individuals skilled in international
      business operations;●
              foreign
      exchange restrictions;●
              foreign
      currency fluctuations;●
              foreign
      taxation;●
              the
      inability to repatriate earnings or capital;●
              changing
      political conditions;●
              changing
      foreign and domestic monetary policies;●
              regional
      economic downturns; and●
              foreign
      governmental regulations favoring or requiring the awarding of contracts
      to local contractors or requiring foreign contractors to employ citizens
      of, or purchase supplies from, a particular jurisdiction that may harm our
      ability to compete.
 
 Our
offshore oilfield operations involve a variety of operating hazards and risks
that could cause losses.
  Our
operations are subject to the hazards inherent in the offshore oilfield
business.  These include blowouts, explosions, fires, collisions,
capsizing and severe weather conditions.  These hazards could result
in personal injury and loss of life, severe damage to or destruction of property
and equipment, pollution or environmental damage and suspension of operations.
We may incur substantial liabilities or losses as a result of these
hazards.  While we maintain insurance protection against some of these
risks, and seek to obtain indemnity agreements from our customers requiring the
customers to hold us harmless from some of these risks, our insurance and
contractual indemnity protection may not be sufficient or effective to protect
us under all circumstances or against all risks.  The occurrence of a
significant event not fully insured or indemnified against or the failure of a
customer to meet its indemnification obligations to us could materially and
adversely affect our results of operations and financial condition.
  Laws
and government regulations may add to our costs or adversely affect our
operations.
  Our
business is affected by changes in public policy and by federal, state, local
and foreign laws and regulations relating to the energy industry.  Oil
and gas exploration and production operations are affected by tax, environmental
and other laws relating to the petroleum industry, by changes in those laws and
changes in related administrative regulations. It is also possible that these
laws and regulations may in the future add significantly to our operating costs
or those of our customers or otherwise directly or indirectly affect our
operations.
  Environmental
laws and regulations can increase our costs, and our failure to comply with
those laws and regulations can expose us to significant
liabilities.
  Risks of
substantial costs and liabilities related to environmental compliance issues are
inherent in our operations. Our operations are subject to extensive federal,
state, local and foreign laws and regulations relating to the generation,
storage, handling, emission, transportation and discharge of materials into the
environment.  Permits are required for the operation of various
facilities, and those permits are subject to revocation, modification and
renewal. Governmental authorities have the power to enforce compliance with
their regulations, and violations are subject to fines, injunctions or both. In
some cases, those governmental requirements can impose liability for the entire
cost of cleanup on any responsible party without regard to negligence or fault
and impose liability on us for the conduct of or conditions others have caused,
or for our acts that complied with all applicable requirements when we performed
them.  It is possible that other developments, such as stricter
environmental laws and regulations, and claims for damages to property or
persons resulting from our operations, would result in substantial costs and
liabilities.  Our insurance policies and the contractual indemnity
protection we seek to obtain from our customers may not be sufficient or
effective to protect us under all circumstances or against all risks involving
compliance with environmental laws and regulations.
  23
  Provisions
recently added to our corporate documents and Nevada law could delay or prevent
a change in control of our Company, even if that change would be beneficial to
our shareholders.
  The Board
of Directors and a majority of the shareholders recently approved amendments to
our articles of incorporation and bylaws that, along with Nevada law could delay
or prevent a change in control of our company, even if that change would be
beneficial to our shareholders.  The provisions are designed to
discourage any tender offer or other attempt to gain control of the Company in a
transaction that is not approved by our Board of Directors, by making it more
difficult for a person or group to obtain control of the Company in a short time
and then impose its will on the remaining stockholders, including:
  Classified Board of Directors and
Removal of Directors.  Our Board of Directors is divided into
three classes which shall be as nearly equal in number as
possible.  The directors in each class serve for terms of three years,
with the terms of one class expiring each year.  Each class currently
consists of approximately one-third of the number of directors.  Each
director will serve until his successor is elected and qualified.  A
director may not be removed except for cause by the affirmative vote of the
holders of 75% of the outstanding shares of capital stock entitled to vote at an
election of directors.
 
 Advance Notice Requirements for
Nomination of Directors and Proposal of New Business at Annual Stockholder
Meetings.  Any stockholder desiring to make a nomination for
the election of directors or a proposal for new business at a stockholder
meeting must submit written notice not less than 30 or more than 60 days in
advance of the meeting.
  Supermajority Voting Requirement for
Amendment of Certain Provisions of the Articles of
Incorporation.  Specified provisions contained in the articles
of incorporation and bylaws may not be repealed or amended except upon the
affirmative vote of the holders of not less than seventy-five percent of the
outstanding stock entitled to vote.  This requirement exceeds the
majority vote that would otherwise be required by Nevada law for the repeal or
amendment of the articles or bylaws.
 
 We
may be unable to successfully compete with other manufacturers of drilling and
production equipment.
  Several
of our primary competitors are diversified multinational companies with
substantially larger operating staffs and greater capital resources than ours
and which have been engaged in the manufacturing business for a much longer time
than us. If these competitors substantially increase the resources they devote
to developing and marketing competitive products and services, we may not be
able to compete effectively. Similarly, consolidation among our competitors
could enhance their product and service offerings and financial resources,
further intensifying competition.
  The
loss of a significant customer could have an adverse impact on our financial
results.
  Our
principal customers are major integrated oil and gas companies, large
independent oil and gas companies and foreign national oil and gas companies.
Offshore drilling contractors and engineering and construction companies also
represent a portion of our customer base. During the last 12 months, our top 5
customers represented approximately 41% of total revenues, with our largest
customer accounting for more than 20% of our total revenues. While we are not
dependent on any one customer or group of customers, the loss of one or more of
our significant customers could, at least on a short-term basis, have an adverse
effect on our results of operations.
  Our
customers’ industries are undergoing continuing consolidation that may impact
our results of operations.
  The oil
and gas industry is rapidly consolidating and, as a result, some of our largest
customers have consolidated and are using their size and purchasing power to
seek economies of scale and pricing concessions. This consolidation may result
in reduced capital spending by some of our customers or the acquisition of one
or more of our primary customers, which may lead to decreased demand for our
products and services. We cannot assure you that we will be able to maintain our
level of sales to a customer that has consolidated or replace that revenue with
increased business activity with other customers. As a result, the acquisition
of one or more of our primary customers may have a significant negative impact
on our results of operations or our financial condition. We are unable to
predict what effect consolidations in the industry may have on price, capital
spending by our customers, our selling strategies, our competitive position, our
ability to retain customers or our ability to negotiate favorable agreements
with our customers.
  24
  Increases
in the cost of raw materials and energy used in our manufacturing processes
could negatively impact our profitability.
  During
2006, 2007, and 2008, commodity prices for items such as nickel, molybdenum and
heavy metal scrap that are used to make the steel alloys required for our
products increased significantly, resulting in an increase in our raw material
costs. Similarly, energy costs to produce our products have increased
significantly.  If we are not successful in raising our prices on
products, our margins will be negatively impacted.
  Future
capital needs.
  Our
growth and continued operations could be impaired by limitations on our access
to the capital markets.  There can be no assurance that capital from
outside sources will be available, or if such financing is available, it may
involve issuing securities senior to the common stock or equity financings which
are dilutive to holders of the common stock.
  We
depend on third party suppliers for timely deliveries of raw materials, and our
results of operations could be adversely affected if we are unable to obtain
adequate supplies in a timely manner.
  Our
manufacturing operations depend upon obtaining adequate supplies of raw
materials from third parties. The ability of these third parties to deliver raw
materials may be affected by events beyond our control. Any interruption in the
supply of raw materials needed to manufacture our products could adversely
affect our business, results of operations and reputation with our
customers.
  If
we are not able to adequately protect our intellectual property, we may not be
able to compete effectively.
 
 Our
success depends, to a significant degree, upon the protection of our proprietary
technologies. While we currently own one U.S. patent and there are no foreign
counterparts relating to our products and techniques and have applied for five
U.S. patents and there are no foreign counterparts related to our products and
techniques, we will need to pursue additional protections for our intellectual
property as we develop new products or techniques and enhance existing products
or techniques. We may not be able to obtain appropriate protections for our
intellectual property in a timely manner, or at all. Our inability to obtain
appropriate protections for our intellectual property may allow competitors to
enter our markets and produce or sell the same or similar products.
 
 If we are
forced to resort to legal proceedings to enforce our intellectual property
rights, the proceedings could be burdensome and expensive.  In
addition, our proprietary rights could be at risk if we are unsuccessful in, or
cannot afford to pursue, those proceedings.
  We also
rely on trade secrets and contract law to protect some of our proprietary
technology. Nevertheless, our unpatented trade secrets and know-how may not be
effectively protected.
  Moreover,
others may independently develop substantially equivalent proprietary
information and techniques or otherwise gain access to our trade secrets and
know-how.
  DrilsysTM,
ElectroWaveTM, MudsysTM, AquasoxTM, Moray®, SeaStax®, Quick-LocTM, FlotecTM, ProteusTM
and FlotectTMare
our trademarks.
  In 1995,
the U.S. Patent and Trademark Office adopted changes to the U.S. patent law that
made the term of issued patents 20 years from the date of filing rather than 17
years from the date of issuance, subject to specified transition periods.
Beginning in June 1995, the patent term became 20 years from the earliest
effective filing date of the underlying patent application.  These
changes may reduce the effective term of protection for patents that are pending
for more than three years. In addition, as of January 1996, all inventors who
work outside of the United States are able to establish a date of invention on
the same basis as those working in the United States.  This change
could adversely affect our ability to prevail in a priority of invention dispute
with a third party located or doing work outside of the United
States.  While we cannot predict the effect that these changes will
have on our business, they could have a material adverse effect on our ability
to protect our proprietary information. Furthermore, the possibility of
extensive delays in the patent issuance process could effectively reduce the
term during which a marketed product is protected by patents.
  25
 
 We may
need to obtain licenses to patents or other proprietary rights from third
parties.  We may not be able to obtain the licenses required under any
patents or proprietary rights, or they may not be available on acceptable terms.
If we do not obtain required licenses, we may encounter delays in product
development or find that the development, manufacture or sale of products
requiring licenses could be foreclosed. We may, from time to time, support and
collaborate in research conducted by universities and governmental research
organizations. We may not be able to acquire exclusive rights to the inventions
or technical information derived from these collaborations, and disputes may
arise over rights in derivative or related research programs conducted by us or
our collaborators.
 
 If
we infringe on the rights of third parties, we may not be able to sell our
products, and we may have to defend against litigation and pay
damages.
  If a
competitor were to assert that our products infringe on its patent or other
intellectual property rights, we could incur substantial litigation costs and be
forced to pay substantial damages.  Third-party infringement claims,
regardless of their outcome, would not only consume significant financial
resources, but would also divert our management’s time and attention. Such
claims could also cause our customers or potential customers to purchase
competitors’ products or defer or limit their purchase or use of our affected
products until resolution of the claim.  If any of our products are
found to violate third-party intellectual property rights, we may have to
re-engineer one or more of our products, or we may have to obtain licenses from
third parties to continue offering our products without substantial
re-engineering.  Our efforts to re-engineer or obtain licenses could
require significant expenditures and may not be successful.
  Limitation
on Remedies, Indemnification
  The
Company’s Bylaws provide that the officers and directors will only be liable to
the Company for acts or omissions that constitute actual fraud, gross negligence
or willful and wanton misconduct. Thus, the Company may be prevented from
recovering damages for certain alleged errors or omissions by the officers and
directors for liabilities incurred in connection with their good faith acts for
the Company. Such an indemnification payment might deplete the Company’s assets.
Stockholders who have questions regarding the fiduciary obligations of the
officers and directors of the Company should consult with independent legal
counsel. It is the position of the Securities and Exchange Commission that
exculpation from and indemnification for liabilities arising under the 1933 Act
and the rules and regulations hereunder is against public policy and therefore
unenforceable.
 
 Our
internal controls may be inadequate, which could cause our financial reporting
to be unreliable and lead to misinformation being disseminated to the
public.
  Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. As defined in Exchange Act Rule 13(a)-15(f),
internal control over financial reporting is a process designed by, or under the
supervision of, the principal executive and principal financial officer and
effected by the board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles and includes those policies and
procedures that: (i) pertain to the maintenance of records that in reasonable
detail accurately and fairly reflect the transactions and dispositions of the
assets of Deep Down; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of Deep Down are being made only in accordance with authorizations
of management and directors of Deep Down, and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use or
disposition of Deep Down’s assets that could have a material effect on the
financial statements.
  Our
management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2008 and identified material weaknesses. Based upon
that evaluation, our principal executive officer and principal financial officer
concluded that, as of December 31, 2008, our disclosure controls and procedures
were not effective to ensure that information required to be disclosed in
reports filed under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the required time periods and is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosure. This determination was in response to the SEC comment
letter received February 26, 2009, in which the SEC stated that they require
that we present the audited predecessor financial statements for Deep Down, Inc.
for the period January 1, 2006 through November 20, 2006, in accordance with
Rule 310(a) of Regulation S-B. Management remediated this on March 31, 2009 by
presenting the amounts reported in Form 10-K/A for December 31, 2007 with the
predecessor audited financial information for Deep Down from January 1, 2006 to
November 20, 2006.
  26
 
 Additionally,
we did not maintain effective controls over the control
environment.  Specifically, we have not formally adopted a written
code of business conduct and ethics that governs the Company’s employees,
officers and directors.  Further, the Board of Directors does not
currently have any independent members and no director qualifies as an audit
committee financial expert as defined in Item 407(d)(5)(ii) of Regulation
S-B.  We did not maintain the following controls: sufficient policies
and procedures over the administration of an accounting and fraud risk policy,
sufficient documentation on the review and follow-up on the remediation of
deficiencies, and a sufficient segregation of duties to decrease the risk of
inappropriate accounting. Management has also determined that we did not
maintain effective controls over the accuracy of revenue recognition.
Specifically, there was not sufficient review, supervision, and monitoring in
regards to projects accounted for under the percentage-of-completion method.
(See “Management’s Discussion and Analysis of Financial Condition and Results of
Operations — Controls and Procedures — Changes in Internal Control over
Financial Reporting”). Our internal controls may be inadequate or ineffective,
which could cause our financial reporting to be unreliable and lead to
misinformation being disseminated to the public. Investors relying upon this
misinformation may make an uninformed investment decision.
 
 As
permitted by SEC rules, we and our independent registered public accountants
excluded Flotation, which represented 43% and 32% of our combined assets and
revenue, respectively at December 31, 2008, from our management’s report on
internal control over financial reporting and their audit of our internal
control over financial reporting. As a result, it is possible that, as we
continue to integrate Flotation into our business, we will identify
internal control issues related to Flotation’s financial reporting.
 
 ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
 None.
 
 ITEM
3.  DEFAULTS UPON SENIOR SECURITIES
  None.
 
 ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  None.
 
 ITEM
5.  OTHER INFORMATION
  None.
  27
  ITEM
6. EXHIBITS
 
 Exhibits
required to be attached by Item 601 of Regulation S-K are listed in the Index of
Exhibits of this Quarterly Report on Form 10-Q, which is incorporated herein by
reference.
 
 Exhibit
      Number
              Description
      of Exhibit3.1
              Articles
      of Incorporation of Deep Down, Inc. (conformed to include the amendment of
      the Articles of Incorporation filed with the Secretary of State of the
      State of Nevada on September 29, 2008) (incorporated by reference from
      Exhibit A to our Schedule 14C filed on August 15,
2008).3.2
              Amended
      and Restated ByLaws of Deep Down, Inc. (incorporated by reference from
      Exhibit B to our Schedule 14C filed on August 15,
2008).4.1
              Operating
      Agreement of Deep Down International Holdings, LLC, a Nevada limited
      liability company (incorporated by reference from Exhibit 4.11 to
      Amendment No. 3 to our Form S-1/A filed on April 10,
  2009).31.1*
              Certification
      of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of
      the Securities Exchange Act of 1934.31.2*
              Certification
      of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the
      Securities Exchange Act of 1934.32.1*
              Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
              Section
      1350 Certification of the Chief Financial Officer of Deep Down,
      Inc.
 _________________
 * Filed
or furnished herewith.
 
 
 
 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
              
              May
      11, 2009Ronald
      E. Smith
              
              (Principal
      Executive Officer)/s/
      EUGENE L. BUTLER
              
              Chief
      Financial Officer and Director
              
              May
      11, 2009Eugene
      L. Butler
              
              (Principal
      Financial Officer)
  
 28
 
 INDEX
TO EXHIBITS
 
 Exhibit
      Number
              Description
      of Exhibit3.1
              Articles
      of Incorporation of Deep Down, Inc. (conformed to include the amendment of
      the Articles of Incorporation filed with the Secretary of State of the
      State of Nevada on September 29, 2008) (incorporated by reference from
      Exhibit A to our Schedule 14C filed on August 15,
2008).3.2
              Amended
      and Restated ByLaws of Deep Down, Inc. (incorporated by reference from
      Exhibit B to our Schedule 14C filed on August 15,
2008).4.1
              Operating
      Agreement of Deep Down International Holdings, LLC, a Nevada limited
      liability company (incorporated by reference from Exhibit 4.11 to
      Amendment No. 3 to our Form S-1/A filed on April 10,
  2009).31.1*
              Certification
      of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of
      the Securities Exchange Act of 1934.31.2*
              Certification
      of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the
      Securities Exchange Act of 1934.32.1*
              Section
      1350 Certification of the President and Chief Executive Officer of Deep
      Down, Inc.32.2*
              Section
      1350 Certification of the Chief Financial Officer of Deep Down Down,
      Inc.
 _________________
 * Filed
or furnished herewith.
        29