UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
 
FORM 10-Q

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2009March 31, 2010
 
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.  xYes  ¨   No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  o¨ No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
   Large accelerated filer  ¨
Accelerated filer   ¨
 
   
  Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company x
 
                                                                                                                 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes.Yes ¨ No  x
 
At November 16, 2009,May 17, 2010, there were 180,450,630193,933,963 shares of common stock outstanding.
 


IMPORTANT INFORMATION REGARDING THIS FORM 10-Q

Unless otherwise indicated, references to “we,” “us,” and “our” in this Quarterly Report on Form 10-Q refer collectively to Deep Down, Inc., a Nevada corporation, and its wholly-owned subsidiaries.
 
Deep Down, Inc., a Nevada corporation (“Deep Down”), is the parent company to its wholly-owned subsidiaries: Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”), ElectroWave USA, Inc., a Nevada corporation (“ElectroWave”), Mako Technologies, LLC, a Nevada limited liability company (“Mako”), Flotation Technologies, Inc., a Maine corporation (“Flotation”), since its acquisition effective May 1, 2008, and Deep Down International Holdings, LLC, a Nevada corporation (“DDIH”) since its formation in February 2009.

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

Forward-Looking Statements

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

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

Subsequent Events

All statements contained in this Quarterly Report on Form 10-Q, including the forward-looking statements discussed above, are made as of November 16, 2009,May 17, 2010, unless those statements are expressly made as of another date.  We disclaim any responsibility for the accuracy of any information contained in this Quarterly Report on Form 10-Q to the extent such information is affected or impacted by events, circumstances or developments occurring after November 16, 2009May 17, 2010 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 for the year ended December 31, 2009, 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 Statements 
 Unaudited Consolidated Balance Sheets at September 30, 2009March 31, 2010 and December 31, 200820091
 Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30,March 31, 2010 and 2009 and 20082
 Unaudited Consolidated Statements of Cash Flows for the NineThree Months Ended September 30,March 31, 2010 and 2009 and 20083
 Notes to Unaudited Consolidated Financial Statements4
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations1214
Item 4.Controls and Procedures1719
  
PART II OTHER INFORMATION
  
Item 1.Legal Proceedings1821
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds21
Item 5.Other Information21
Item 6.Exhibits1921
   
Signatures 23
Exhibit Index24
 

iii
PART I. FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

DEEP DOWN, INC.
CONSOLIDATED BALANCE SHEETS
 (Unaudited)
 
(In thousands) September 30, 2009  December 31, 2008 
(In thousands, except par value amounts) March 31, 2010  December 31, 2009 
ASSETS            
Current assets:            
Cash and cash equivalents $3,896  $2,495  $703  $912 
Restricted cash  -   136 
Accounts receivable, net  4,206   10,772 
Accounts receivable, net of allowance of $314 and $304, respectively  4,967   7,662 
Inventory  1,052   1,362   978   896 
Costs and estimated earnings in excess of billings on uncompleted contracts  748   708   733   267 
Deferred tax asset  2,892   217 
Prepaid expenses and other current assets  921   634   233   225 
Total current assets  13,715   16,324   7,614   9,962 
Property and equipment, net  20,088   13,799 
Property, plant and equipment, net  19,843   20,011 
Intangibles, net  17,109   18,091   11,817   12,166 
Goodwill  14,966   15,024   9,429   9,429 
Other assets, net  1,126   458   1,470   1,136 
Total assets $67,004  $63,696  $50,173  $52,704 
                
LIABILITIES AND STOCKHOLDERS' EQUITY                
Current liabilities:                
Accounts payable and accrued liabilities $4,030  $4,319  $3,939  $2,865 
Billings in excess of costs and estimated earnings on uncompleted contracts  3,252   2,315   2,889   4,434 
Current portion of long-term debt  6,029   383   1,550   1,497 
Total current liabilities  13,311   7,017   8,378   8,796 
Long-term debt, net  904   1,718   5,176   5,379 
Deferred tax liabilities  2,892   1,126 
Total liabilities  17,107   9,861   13,554   14,175 
                
Commitments and contingencies (Note 10)        
Commitments and contingencies (Note 12)        
                
Stockholders' equity:                
Common stock, $0.001 par value, 490,000 shares authorized, 180,451 and 177,351 shares issued and outstanding, respectively
  180   177 
        
Common stock, $0.001 par value, 490,000 shares authorized, 180,451 shares issued and outstanding
  180   180 
Additional paid-in capital  60,968   60,328   61,387   61,161 
Accumulated deficit  (11,251)  (6,670)  (24,948)  (22,812)
Total stockholders' equity  49,897   53,835   36,619   38,529 
Total liabilities and stockholders' equity $67,004  $63,696  $50,173  $52,704 

The accompanying notes are an integral part of the unaudited consolidated financial statements.
1
 
DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)

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

  For the Three Months Ended 
  March 31, 
(In thousands, except per share amounts) 2010  2009 
       
Revenues $6,644  $7,103 
Cost of sales  4,706   4,799 
Gross profit  1,938   2,304 
Operating expenses:        
Selling, general and administrative  3,483   2,844 
Depreciation and amortization  442   406 
Total operating expenses  3,925   3,250 
Operating loss  (1,987)  (946)
Other income (expense):        
Interest expense, net  (131)  (46)
Other expense  (1)  (3)
Total other expense  (132)  (49)
Loss before income taxes  (2,119)  (995)
Income tax (expense) benefit  (17)  265 
Net loss $(2,136) $(730)
         
Net loss per share, basic and diluted $(0.01) $- 
Weighted-average common shares outstanding, basic and diluted  180,451   177,586 


The accompanying notes are an integral part of the unaudited consolidated financial statements.
2

DEEP DOWN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 

 Nine Months Ended  For the Three Months Ended 
 September 30,  March 31, 
(In thousands) 2009  2008  2010  2009 
Cash flows from operating activities:Cash flows from operating activities:       
Net loss $(4,581) $(3,377) $(2,136) $(730)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Adjustments to reconcile net loss to net cash provided by (used in) operating activities:         
Interest income  -   (55)
Non-cash amortization of debt discount  -   1,817 
Non-cash amortization of deferred financing costs  -   763 
Share-based compensation  643   424 
Share-based compensation expense  226   29 
Bad debt expense  126   1,053   21   60 
Depreciation and amortization  2,389   1,642   978   751 
(Gain) loss on disposal of equipment  (21)  161 
Deferred taxes payable  (909)  - 
Loss (gain) on disposal of equipment  2   (3)
Deferred taxes  -   (282)
Changes in assets and liabilities:Changes in assets and liabilities:         
Accounts receivable  6,440   942   2,674   4,290 
Inventory  310   (821)  (82)  291 
Costs and estimated earnings in excess of billings on uncompleted contracts  (40)  (41)  (466)  542 
Prepaid expenses and other current assets  (287)  (453)  (8)  (30)
Other assets  (112)  -   (17)  - 
Accounts payable and accrued liabilities  (289)  (1,059)  1,074   (795)
Billings in excess of costs and estimated earnings on uncompleted contracts  937   179   (1,546)  (187)
Net cash provided by operating activities  4,606   1,175   720   3,936 
                
Cash flows from investing activities:Cash flows from investing activities:         
Cash paid for acquisition of Flotation, net of cash acquired of $235  -   (22,162)
Proceeds from final settlement of acquisition of Flotation  58   - 
Cash paid for acquisition of Mako, net of expenses  -   (4,237)
Purchases of property and equipment  (5,536)  (2,564)  (563)  (1,428)
Proceeds from sale of property and equipment  53   - 
Purchase of investment  (25)  - 
Cash paid for capitalized software  (383)  -   (91)  - 
Purchase of investment  (150)  - 
Note receivable, net of repayments  (23)  - 
Restricted cash  136   375 
Deposits, related party  -   (470)
Note receivable  (100)  - 
Net cash used in investing activities  (5,845)  (28,588)  (779)  (1,898)
                
Cash flows from financing activities:Cash flows from financing activities:         
Proceeds from sale of common stock, net of expenses  -   37,060 
Proceeds from sales-type lease  -   587 
Borrowings on long-term debt  3,000   5,604 
Repayments on long-term debt  (360)  (12,889)
Net cash provided by financing activities  2,640   30,362 
Borrowings of long-term debt  -   1,840 
Repayments of long-term debt  (150)  (112)
Net cash (used in) provided by financing activities  (150)  1,728 
Change in cash and equivalents  1,401   2,949   (209)  3,766 
Cash and cash equivalents, beginning of period  2,495   2,206   912   2,495 
Cash and cash equivalents, end of period $3,896  $5,155  $703  $6,261 

The accompanying notes are an integral part of the unaudited consolidated financial statements.
3

DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1:
Note 1: Basis of Presentation

Basis of Presentation

The accompanying unaudited consolidated financial statements of Deep Down, Inc. and its wholly-owned subsidiaries (“Deep Down”, “we”, “us” or the “Company”) were prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “Commission”) pertaining to interim financial information and instructions to Form 10-Q.  As permitted under those rules, certain footnotes or other financial information that are normally required by United States generally accepted accounting principles (“US GAAP”) can be condensed or omitted.  Therefore, these statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for theth e year ended December 31, 2008,2009, filed on March 16, 2009April 15, 2010 with the Commission.

Preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, the disclosed amounts of contingent assets and liabilities and the reported amounts of revenues and expenses.  If the underlying estimates and assumptions upon which the financial statements are based change in future periods, actual amounts may differ from those included in the accompanying consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  

Management is also required to consider material events that occur after the date, prior to the issuance, of the financial statements and evaluate whether such events require modification to the reported results or footnote disclosures.  Our subsequent review was conducted through November 16, 2009,May 17, 2010, immediately prior to the filing of the financial statements with the Commission.

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

Reclassifications

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

Principles of consolidation

The unaudited consolidated financial statements include the accounts of Deep Down, Inc. and its wholly-owned subsidiaries for the three and nine months ended September 30, 2009March 31, 2010 and 2008.2009.  All significant inter-companyintercompany transactions and balances have been eliminated in consolidation.eliminated.

Accounting Policy UpdatesSegments

Capitalized software costs. We capitalize software for internal use accordingDuring the three months ended March 31, 2010 and 2009, the operations of Deep Down’s operating segments, Deep Down Delaware, ElectroWave, Mako and Flotation, have been aggregated into a single reporting segment. Additionally, we have aggregated ElectroWave’s operations into Deep Down Delaware as a single operating segment due to similar production processes and cost savings related to office and administrative support. While the operating segments have different product lines; they are very similar. They are all service-based operations revolving around our personnel’s expertise in the deep water industry, and any equipment is produced to a customer specified design and engineered using Deep Down personnel’s expertise, with installation and project management as part of our service revenue to the applicable authoritative guidance.  Other assets includecustomer. Additionally, the capitalized cost of internal-use software. Capitalized software is stated at cost less accumulated amortization,segments have similar customers and totaled $383distribution methods, and $0 at September 30, 2009 and 2008, respectively. These software costs include significant purchases of software and internal and external costs incurred duringtheir economic characteristics are similar with regard to their gross margin percentages. Our operations are located in the application development stage of software projects. These costs will be amortized on a straight-line basis over the estimated useful lives of the assets upon implementation.
United States though we occasionally make sales to international customers.
4
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Note 2:Recently Issued Accounting Standards and Developments
Note 2:  Liquidity and Financial Condition

As a deep water service provider, our revenue, profitability, cash flows, and future rate of growth are substantially dependent on the condition of the oil and gas industry generally, and our customers’ ability to invest capital for offshore exploration, drilling and productions, and maintain or increase levels of expenditures for maintenance of offshore drilling and production facilities.  Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility.  We enter into large, fixed-price contracts which may require significant lead time and investment. A decline in offshore drilling and production activity could result in lower contract volume or delays in significant contracts, which could negatively impact our ear nings and cash flows. Our earnings and cash flows could also be negatively affected by a continued delay in a payment by a significant customer or delays in completion of our contracts for any reason.  While our objective is to enter into contracts with our customers that are cash flow positive, we may not always be able to achieve this objective.  Our current financial condition may limit our ability to enter into contracts that are not cash flow positive.

We will need to raise additional debt or equity capital or renegotiate or refinance our existing debt to fund working capital requirements, to support SG&A and to pay all outstanding debt maturing on April 15, 2011 under the Whitney National Bank (“Whitney”) New Amended and Restated Credit Agreement (“New Agreement”). We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such financing could be dilutive to our shareholders.  If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain SG&A; (ii) expand operations; (iii) hire and train new employees; (iv) respond to competitive pressures or unanticipated capital requirements; or (v) pay all outstanding debt m aturing under the New Agreement. Per the terms of the New Agreement, we no longer have access to a line of credit and must rely solely on our cash position and operating cash flows for liquidity.

While we believe that our results of operations, including gross profit and operating cash flow, will improve over the remainder of the year, additional debt or equity capital may be necessary to fund working capital requirements, to support SG&A and to pay all outstanding debt under the New Agreement if our planned results of operations are not achieved.  Further, failure to achieve our planned results could result in violation of certain of our loan covenants and require us to raise additional debt or equity capital.

We currently plan to use our available cash for our SG&A, debt service payments and working capital. The actual allocation of and the timing of the expenditures will be dependent on various factors, including changes in our strategic relationships, industry conditions, and other factors that we cannot currently predict.

Our Credit Agreement imposes covenant restrictions on us that increase our vulnerability in the current adverse economic and industry climate, and limits our ability to obtain additional financing. We have recently amended and restated our credit facility, as discussed below and in Note 8, Long-Term Debt, to waive our covenant noncompliance as of December 31, 2009 and to provide us more latitude in our covenants through the term of the agreement. Our ability to meet these covenants is primarily dependent on the adequacy of earnings before interest, taxes, depreciation and amortization. Our inability to satisfy the covenants contained in our Credit Agreement would constitute an event of default. An uncured default could result in our outstanding debt becoming immediately due and payable. If this were to occur, we may not be able to obtain waivers or secure alternative financing to satisfy our obligations, either of which would have a material adverse impact on our business or our ability to continue as a going concern.

We believe that we will have adequate liquidity to meet our future operating requirements if we meet our goals for results of operations, including gross profit and operating cash flows, and we remain compliant with the covenants under our Credit Agreement, however, the factors described above create uncertainty.

5
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As discussed in Note 8, Long-Term Debt, we entered into the New Agreement with Whitney, dated as of April 14, 2010, to address covenant violations we had under our Credit Agreement which we originally entered into on November 11, 2008.   Under the terms of the New Agreement, our noncompliance with the prior terms of the financial covenants and certain other covenants under the Credit Agreement have been waived (the effect of such noncompliance would have entitled the holders of all debt under the Credit Agreement and under a loan agreement between Flotation and TD Bank, N.A. (“TD Bank”) to call such debt immediately due and payable and would have required us to classify all debt outstanding under these facilities as current in our audited consolidated balance sheet at December 31, 2009). 60; We continue to remain current on payments of our principal, interest and fee obligations with Whitney and TD Bank.  However, under the terms of the New Agreement, all of the indebtedness outstanding under such agreement, which is an aggregate principal amount of $3,583 as of March 31, 2010, will all be due on April 15, 2011 and reclassified as current on our balance sheet on June 30, 2010, unless we are able to refinance all or a portion of such indebtedness, and we no longer have any further capacity to draw upon a revolving line of credit under the New Agreement.

Note 3:  Recent Accounting Pronouncements

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

On July 1, 2009,Note 4:  Fair Value of Financial Instruments

Fair value is defined as the FASB issuedexchange price that would be received for an asset or paid to transfer a liability (an exit price) in the FASB Accounting Standards Codification (the “Codification”). The Codification became the single source of authoritative nongovernmental US GAAP, superseding existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”) and related literature. The Codification eliminates the previous US GAAP hierarchy and establishes one level of authoritative GAAP. All other literature is considered non-authoritative. The Codification was effective for interim and annual periods ending after September 15, 2009. We adopted the Codificationprincipal or most advantageous market for the quarter ended September 30, 2009. There was no impactasset or liability in an orderly transaction between market participants on the measurement date.  We utilize a fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.  The fair value hierarchy has three levels of inputs that may be used to the consolidated financial results.measure fair value:

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

The FASB guidance on fair value measurements and disclosures became effective January 1, 2008. However,Level 2 - Quoted prices in February 2008, the FASB delayed the effective date regarding fair value measurements and disclosures of nonfinancial assets and nonfinancial liabilities, except thosemarkets that are recognizednot active; or disclosed at fair value inother inputs that are observable, either directly or indirectly, for substantially the financial statements on a recurring basis (at least annually), to January 1, 2009. The adoptionfull term of these provisions related to nonfinancial assets and nonfinancial liabilities on January 1, 2009 did not have a material impact on the consolidated financial statements.asset or liability.

In April 2009, the FASB issued additional requirements regarding interim disclosures aboutLevel 3 - Prices or valuation techniques that require inputs that are both significant to the fair value ofmeasurement and unobservable.

Our financial instruments which were previously only disclosed on an annual basis. Entitiesconsist primarily of cash equivalents, trade receivables and payables and debt instruments.  The carrying values of cash, accounts receivable, and accounts payable approximate their fair values due to the short-term maturity of these instruments. Our long term debt was valued using techniques that require inputs that are now requiredboth significant to disclose the fair value measurement and unobservable (Level 3), specifically treasury rates adjusted for our credit risk premium.  At March 31, 2010, our debt, excluding capital leases, had a carrying value of financial instruments which$6,250 and a fair value of $5,849.

Considerable judgment is required in interpreting data to develop the estimates of fair value. Accordingly, the estimates presented above are not recorded at fair valuenecessarily indicative of the amounts we could realize in the financial statements in both their interim and annual financial statements. The new requirements were effectivea current market exchange. As no active market exists for interim and annual periods ending after June 15, 2009 on a prospective basis. We adopted these requirements in the quarter ended June 30, 2009. There was no impact on the consolidated financial results.

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

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

In April 2009, the FASB issued an amendment to the revised business combination guidance regarding the accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies. The requirements of this amended guidance carry forward without significant revision the guidance on contingencies which existed prior to January 1, 2009. Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can be reasonably estimated. If fair valueestimates were based on judgments regarding current economic conditions, future expected cash flows and loss experience, risk characteristics and other factors. These estimates are subjective in nature and involve uncertainties and therefore cannot be reasonably estimated, the asset or liability would generallycalculated with precision (Level 3). There may be recognizedinherent weaknesses in accordance with the Accounting Standards Codification (“ASC”) Topic 450 on contingencies. We adopted the Codificationcalculation techniques, and changes in the quarter ended September 30, 2009. There was no impact upon adoption.
underlying assumptions used, including discount rates and estimates of future cash flows, which could significantly affect the results.
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DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


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

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

Note 3:Note 5:  Inventory

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

  March 31, 2010  December 31, 2009 
Raw materials $743  $765 
Work in progress  167   84 
Finished goods  68   47 
Total Inventory $978  $896 
   September 30, 2009  December 31, 2008  
 Raw materials $748  $790  
 Work in progress  235   426  
 Finished goods  69   146  
 Total Inventory $1,052  $1,362  


Note 4:
Note 6: Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts

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

  March 31, 2010  December 31, 2009 
Costs incurred on uncompleted contracts $6,057  $4,051 
Estimated earnings  937   2,212 
   6,994   6,263 
Less: Billings to date  (9,150)  (10,430)
  $(2,156) $(4,167)
         
Included in the accompanying consolidated        
balance sheets under the following captions:        
Costs and estimated earnings in excess of billings        
on uncompleted contracts $733  $267 
Billings in excess of costs and estimated earnings        
on uncompleted contracts  (2,889)  (4,434)
  $(2,156) $(4,167)

   September 30, 2009  December 31, 2008  
 Costs incurred on uncompleted contracts $4,259  $2,115  
 Estimated earnings  282   4,969  
    4,541   7,084  
 Less: Billings to date  7,045   8,691  
   $(2,504) $(1,607) 
           
 
Included in the accompanying unaudited consolidated balance sheets under the following captions:
   ��     
 
Costs and estimated earnings in excess of billings on uncompleted contracts
 $748  $708  
 
Billings in excess of costs and estimated earnings on uncompleted contracts
  (3,252)  (2,315) 
   $(2,504) $(1,607) 
At September 30,March 31, 2010 and December 31, 2009, the asset balancebalances of $748 was$733 and $267, respectively, were related to several contracts that are projected to be completed during fiscal 2009. At December 31, 2008, the asset balance of $708 was related to a contract that was 90 percent complete at December 2008, based on the percentage-of-completion method. The remainder of the revenue was recognized in the first quarter of fiscal 2009.

2010. The balance in billings in excess of costs and estimated earnings on uncompleted contracts at September 30, 2009March 31, 2010 and December 31, 2008,2009, was $3,252$2,889 and $2,315,$4,434, respectively, and consisted of significant milestone payments,billings, primarily related to a large contractfabrication project for which we have suspended work until we receive payment from the customer, plus several smaller contracts that isare expected to be completed in fiscal year 2010. We now anticipate recommencing work on the large fabrication project during the second quarter or early third quarter of 2010 and expect to complete this work early next year.
 
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DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note 5:Acquisitions

Purchase of Flotation Technologies, Inc.

On May 1, 2008, we acquired Flotation Technologies, Inc. (“Flotation”), pursuant to the stock purchase agreement.  Under the terms of the agreement, the purchase price may be adjusted upward or downward, depending on certain working capital targets.  We resolved a dispute concerning the working capital adjustment for the purchase pursuant to the arbitration proceeding in May 2009. The arbitrator awarded us a cash purchase price adjustment of $84. The impact of this adjustment after legal expenses was $58Note 7: Property, Plant and was recorded as a reduction to goodwill as of the balance sheet date.  The acquisition of Flotation has been accounted for using the purchase method of accounting since we acquired substantially all of the assets, certain liabilities, employees, and business of Flotation.Equipment

The purchase pricecomponents of Flotationnet property, plant and equipment are summarized below (in thousands):
  March 31, 2010  December 31, 2009 
Land $1,954  $1,954 
Buildings and improvements  5,458   5,458 
Leasehold improvements  278   313 
Equipment  13,808   13,772 
Furniture, computers and office equipment  1,120   1,154 
Construction in progress  1,347   955 
Total property, plant and equipment  23,965   23,606 
Less: Accumulated depreciation  (4,122)  (3,595)
Property, plant and equipment, net $19,843  $20,011 

Depreciation expense, excluded from “Cost of sales” in the accompanying statements of operations, was $23,883$93 and consisted of $22,016 in cash and 1,714 shares of common stock valued at $0.83 per common share, plus transaction costs of $323. In addition, warrants to purchase 200 shares of common stock at $0.70 per share were issued to an entity affiliated with the Selling Shareholders$79 for the acquisitionthree months ended March 31, 2010 and 2009, respectively, and depreciation expense included in “Cost of technology related to the operations of Flotation. The warrants are exercisable at any time from June 3, 2009 through September 3, 2011 and include piggyback registration rights with respect to the underlying shares of common stock. We valued the warrants at $122 based on the Black-Scholes option pricing model.

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

We also issued 600 options to employees of Flotation for their continued services with an exercise price of $1.15 per share. These options vest one-third of the original amount each year and may be exercised in whole or in part after vesting. We valued these options at $264 based on the Black-Scholes option pricing model, and are recognizing the related compensation cost ratably over the requisite service period and notsales” in the purchase priceaccompanying statements of the transaction.

Fiscal 2008 transactions related to the purchase of Mako Technologies, Inc.
Effective December 1, 2007, we purchased 100 percent of the common stock of Mako Technologies, Inc.operations, was $536 and $345 for $11,307. Pursuant to the agreement and plan of merger, final installments of the purchase price were paid to the Mako shareholders during the nine months ended September 30, 2008. We paid $4,160 cash to the Mako shareholders plus $77 of transaction expenses during the nine months ended September 30, 2008. In March 2008, we issued the second installment of 2,803 restricted shares of common stock of Deep Down, valued at $0.70 per share, totaling $1,962, including non-cash adjustments to purchased asset values in goodwill totaling $174.

Note 6:Property and Equipment
same respective periods.

On May 29, 2009, we consummated a purchase transaction with JUMA Properties, LLC (“JUMA”), a company owned by Ronald E. Smith, President, CEO and Director of Deep Down and wife Mary L. Budrunas, Vice President, Corporate Secretary and Director of Deep Down.  Pursuant to a Purchase and Sale Agreement dated May 22, 2009, we acquired certain property and improvements located in Channelview, Texas, where certain of our operations are currently located (the “Channelview Property”). The Channelview Property consists of 8.203 acres and was purchased for $2,600. The transaction was conducted on an arms-length basis and in accordance with normal terms and conditions. See additional discussion in Note 7,8, Long-Term Debt.
Prior to May 29, 2009, we leased the Channelview Property from JUMA at a base rate of $15 per month.  In connection with the purchase of the Channelview Property, the lease between us and JUMA was terminated.   We incurred no early termination penalties from JUMA in connection with this termination.

Note 8: Long-Term Debt

The components of long-term debt are summarized below (in thousands):
  March 31, 2010  December 31, 2009 
Secured credit agreement - Whitney Bank $3,583  $3,694 
Secured credit agreement - TD Bank  2,110   2,125 
Other bank loans  57   63 
Total bank debt  5,750   5,882 
6% Subordinated Debenture  500   500 
Capital lease obligations  476   494 
Total debt  6,726   6,876 
Less: Current portion of long-term debt  (1,550)  (1,497)
Long-term debt, net of current portion $5,176  $5,379 
7
Overview

We entered into the New Agreement with Whitney, dated as of April 14, 2010, to address covenant violations we had under our Credit Agreement which we originally entered into on November 11, 2008.  Under the terms of the New Agreement, our noncompliance with the prior terms of the financial covenants and certain other covenants under the Credit Agreement has been waived (the effect of such noncompliance would have entitled the holders of all debt under the Credit Agreement and under a loan agreement between Flotation and TD Bank, to call such debt immediately due and payable and would have required us to classify all debt outstanding under these facilities as current in our audited consolidated balance sheet at December 31, 2009).  We continue to remain current on payments of our principal, interes t and fee obligations with Whitney and TD Bank.  However, under the terms of the New Agreement, all of the indebtedness outstanding under such agreement, which is an aggregate principal amount of $3,583 at March 31, 2010, will all be due on April 15, 2011, unless we are able to refinance all or a portion of such indebtedness and we no longer have access to a line of credit under the New Agreement.
8

DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Whitney Credit Agreement

Note 7:Long-Term Debt

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

   September 30, 2009  December 31, 2008  
 Secured credit agreements $5,938  $1,150  
 Other bank loans  11   15  
 Total bank debt  5,949   1,165  
 6% Subordinated Debenture  500   500  
 Capital lease obligations  484   436  
 Total debt  6,933   2,101  
 Current portion of long-term debt  (6,029)  (383) 
 Long-term debt, net of current portion $904  $1,718  
Revolving credit line and term loans

On November 11, 2008, weWe originally entered into aour Credit Agreement (the “Revolver”) with Whitney National Bank (“Whitney”) as the lender.in November 2008.  The Revolver providesCredit Agreement originally provided a commitment to lend to us the lesser of $2,000 or 80 percent of eligible receivables (generally defined as current due accounts receivablesreceivable in which the lender has a first priority security interest).  All of thethis commitment under the Revolver iswas also available in commitments for the lenderWhitney to issue letters of credit (“L/C”) for our benefit.  Outstanding amounts underIn December 2008, we then entered into an amendment of the Revolver generally will bear interest at rates based on the British Bankers Association LIBOR RateCredit Agreement that provided for dollar deposits withus to receive a term loan in the principal amount of one month plus an applicable rate$1,150.  Then, in May 2009, we entered into another amendment to the Credit Agreement providing for us to receive another term loan in the principal amount of 2.00 percent$2,100.  We used the proceeds from the December 2008 term loan to 3.00 percent based onpurchase a piece of equipment (a remotely operated vehicle) and we used the leverage ratio of Deep Down.  Accrued interest under the Revolver is payable monthly. Unused portionsproceeds of the commitment generally accrue a commitment fee of 0.25 percentMay 2009 term loan to 0.50 percent based on the leverage ratio of Deep Down and such fee is due and payable by Deep Down quarterly.  The Revolver has a termination date of November 11, 2010.purchase real property in Channelview, Texas.  There iswas $850 outstanding under the Revolver as of September 30,revolving credit line available under the Credit Agreement on March 31, 2010 and December 31, 2009, and werespectively. We have issued an irrevocable transferrabletransferable standby L/C in the ordinary course of business, with an annual commission rate of 2.4 percent for $1,108$1,107 during the nine monthsyear ended September 30,December 31, 2009 related to a large contract that is expected to be completed induring the first fiscal year 2010. The borrowing capacity underquarter of 2011. Under the Revolver was approximately $20 at September 30, 2009.New Agreement there is no further revolving line of credit available.

On December 18, 2008, we entered into an amendment to the Revolver (the “Term Loan”), with Whitney which provides for a term loan in the principal amount of $1,150. Such Term Loan does not impact the availability under the Revolver. We arewere originally obligated to repay the December 2008 term loan annual interest rate of 6.5 percent, based on a schedulethe basis of monthly installments of $35, with anthe initial payment on February 1, 2009 and a final payment of theall unpaid principal and accrued interest on January 1,2, 2012.

On May 29, 2009, in connection with the purchase  Outstanding amounts of land and buildings, we entered into a third amendment to the Revolver (the “Third Amendment”) with Whitney as the lender.  We paid $570principal of the purchase priceDecember 2008 term loan accrue interest at a rate of 6.5 percent per annum.  Under the terms of the New Agreement, we are required to JUMA in cash and financedcontinue to make monthly installment payments for the balance with an additionalDecember 2008 term loan in the amount of $35 and the outstanding principal amount of $2,100. such loan continues to accrue interest at the rate of 6.5 percent per annum.  However, the final payment of all unpaid principal and accrued interest on the December 2008 term loan of $343 is now due on April 15, 2011. As of March 31, 2010, th e outstanding principal amount of the December 2008 term loan was $730.

We arewere originally obligated to repay the May 2009 term loan based on a schedulethe basis of monthly installments of $18, with anthe initial payment on June 1, 2009 and a final payment of all remaining outstanding and unpaid principal and accrued interest on May 1, 2024.  The annualOutstanding amounts of principal of the May 2009 term loan accrue interest at a rate of 6.5 percent per annum.  Under the terms of the New Agreement, we are required to continue to make monthly installment payments for the May 2009 term loan in the amount of $18 and the outstanding principal amount of such loan continues to accrue interest at the rate of 6.5 percent per annum. However, the final payment of all unpaid principal and accrued interest on the May 2009 term loan of $1,928 is now due on April 15, 2011.  As of March 31, 2010, the outstanding principal am ount of the May 2009 term loan is 6.5 percent. Such Term Loan does not impact$2,003.

Upon entry into the availabilityNew Agreement, our indebtedness in the amount of $850 outstanding under the Revolver. See additional discussionrevolving credit line of the Credit Agreement was converted to a term loan. This April 2010 term loan requires us to make monthly installments in Note 6, Propertythe amount of $40 plus the amount of accrued and Equipment.unpaid interest beginning on May 1, 2010 and a final payment of all unpaid principal and accrued interest of $450 on April 15, 2011.  Outstanding amounts of principal of the April 2010 term loan accrue interest at a rate of 6.5 percent per annum.

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

Each of our subsidiaries has guaranteed our obligations under the RevolverCredit Agreement, including as amended and restated under the New Agreement, and as such, our obligations in connection with the RevolverNew Agreement are generally secured by a first priority lien on all of our subsidiaries’ non-real property assets.  The termsWith regard to the Channelview, Texas property purchased with the proceeds of the Third Amendment included a Guarantor’s Consent and Agreement, signed by each of our subsidiaries.  Whitney also required us to enter a second amendment to our security agreement (the “Security Agreement Amendment”) in order to reflect our ownership of the Channelview Property.  WeMay 2009 term loan, we also entered into a Deed of Trust, Security Agreement and UCC Financing Statement for Fixture Filing (collectively, the “Deed of Trust”), creating a lien on the Channelview Property.
such property.
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DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 

UnderPrior to entry into the Revolver, as amended,New Agreement, we are required to meet certain covenants and restrictions.  Thewere not in compliance with the financial covenants are reportable each quarter, beginningof the original Credit Agreement as of December 31, 2009.  However, the New Agreement provides for the waiver of such noncompliance and establishes new financial covenants in this regard.  Beginning with the quarter ended March 31, 2009.  Financial covenants include maintainingJune 30, 2010, and for each quarter thereafter, we will be obligated to comply with the following financial covenants: (i) total debt to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) below 2.5of not greater than 3.0 to 1.0 (“Leverage Ratio”), consolidated EBITDA to consolidated net interest expense and principal payments on the total debt greater than 1.5 to 1.0 (“Fixed Charge Coverage Ratio”), and consolidated net worth after deducting other assetsasse ts as are properly classified as “Intangible Assets” (“Tangible Net Worth”) in excess of $20,000. Other$15,000.  The calculation of EBITDA, with regards to the Leverage Ratio and Fixed Charge Coverage Ratio, allows us to deduct certain non-cash items, specifically asset impairment charges as of December 31, 2009.  Under the New Agreement, we continue to have obligations for other covenants, includeincluding limitations on issuance of common stock, liens, transactions with affiliates, additional indebtedness and permitted investments, among others.

At September 30, 2009, we were notThe New Agreement also removed a provision that permitted us to obtain additional indebtedness from a third party in compliance with the Leverage Ratio, Fixed Charge Coverage Ratio or Tangible Net Worth covenants.  Although operations are improving,event Whitney declined to increase its commitment of indebtedness to us.  As such, we expect to be in violation of these financial covenants again at December 31, 2009.  As a result of this and cross-default provisions in our TD Bank, N.A. loan, amountshave to refinance the indebtedness outstanding under these facilities have been classifiedthe New Agreement at any such time as current in our consolidated balance sheet at September 30, 2009.  We are currently seeking a waiver from Whitney for the quarter ended September 30, 2009, and will do so at year-end if we are still in default. However, if we are unableseek to obtain such waiver, debt outstanding under these facilities could be declared immediately due and payable. We may consider alternative financings or other transactions to satisfy such obligations. We continue to remain current on our principal, interest and fee obligations with Whitney and TD Bank.new financing from a third party.

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

Amendment to credit agreement and new loan agreement

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

On March 5,During fiscal 2009, Flotation, our wholly-owned subsidiary, obtained loan proceeds from TD Bank in the principal amount of $1,840 (“$2,160.  Under the terms of the TD Bank Loan”).  The loan provides a further commitment to Flotation for advancement of principal in the amount of $320, which was accessed in July 2009. Weagreement, we are obligated to repay the TD Bank Loan based on a schedule ofmake payments in monthly installments of $13,$15, with an initial payment on March 13, 2009 and a final payment of the unpaid principal and accrued interest in February 2029.  The interest rate on the TD Bank Loan is 5.75 percent. Advancement of the additional $320 principal amount was added to the principal balance in July 2009 and will be fully amortized over the remaining term, thus increasing the payment to $15 effective August 2009.

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

NetUnder the TD Bank loan, we are required to meet certain covenants and restrictions.  The financial covenants are reportable annually beginning with the year ended December 31, 2009, and are specific to the Flotation subsidiary financials.  The TD Bank Loan financial covenants include maintaining debt service coverage ratios, pre and post distributions, which are ratios of Flotation’s earnings after tax plus interest, expense during the nine months ended September 30, 2008

For the nine months ended September 30, 2008, we amortized intodepreciation, amortization and distributions to consolidated net interest expense $1,703and principal payments on the total debt, below 1.5 to 1.0 and including distributions of debt discount2.0 to 1.0, and $763consolidated net worth after deducting other assets as are properly classified as “Intangible Assets” (“Tangible Net Worth”) in excess of deferred financing costs associated$9,500.  Ot her covenants include limitations on issuance of liens, transactions with affiliates, and additional indebtedness among others.  At December 31, 2009, we were not in compliance with the fair market valuefinancial covenants, and on April 15, 2010, we obtained a waiver for these covenants as of warrantsDecember 31, 2009.

Other debt

We have several vehicle loans outstanding with aggregated principal balances of $57 as of March 31, 2010. Interest rates on these loans are between 5.5 and 6.0 percent, and the cash-based expenses, related to third party feesmaturities are on various dates between January 2011 and prepaid lender fees, overSeptember 2012.  Additionally, we have a subordinated debenture with a principal amount of $500 which originated from the lifeexchange of preferred stock in a secured credit agreement, which was entered into in August 2007 and amended in December 2007, using the effectiveprevious year.  The debenture has a fixed interest rate method. Duringof 6.0 percent per annum, which is required to be paid annually on March 31st through maturity on March 31, 2011, when the nine months ended September 30, 2008, we paid $13,275 to the lender to pay the outstandingunpaid principal balance under the credit agreement, related interest of $829 and early termination fees, recognized as a loss on early extinguishment of debt, of $446. Additionally, during the nine months ended September 30, 2008, we recorded $114 in net interest expense for the accretion of the Series E Preferred Stock up to face value, that was exchanged into a 6 percent subordinated debenture in the amount of $500.
is due. 
910
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Note 8:
Note 9: Stock-Based Compensation

We have a stock-based compensation plan, the “2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan” (the “Plan”). Stock basedStock-based compensation is recognized as provided under the applicable authoritative guidance which requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense over the requisite service period (generally the vesting period) in the financial statements based on their fair values. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized. In addition, the realization of tax benefits in excess of amounts recognized for financial reporting purposes will be recognized as a financing activity. The options granted under thet he 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. We expense all stock options on a straight-line basis, net of forfeitures, over the requisite expected service periods.  Under the Plan, the total number of options permitted is 15 percent of issued and outstanding common shares. Based on the shares of common stock outstanding at March 31, 2010, there were approximately 4,493 options available for grant under the Plan as of that date.

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

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

In connection with the departure of two executives during the third quarter of 2009, we accelerated the vesting of 850 shares of restricted stock granted on March 29, 2009, and 350 shares granted in February 2008, and recognized the related stock-based compensation of $106.  For the ninethree months ended September 30,March 31, 2010 and 2009, and 2008, we recognized a total of $377$64 and $158,$66, respectively, in stock-based compensation related to all outstanding shares of restricted stock. The unamortized portion of the estimated fair value of restricted stock was $273$122 at September 30, 2009.March 31, 2010.

Summary of Stock Options

During the ninethree months ended September 30, 2009,March 31, 2010, we granted 14,475250 options. BasedAdditionally, a total of 2,000 option awards which were originally issued on February 14, 2008 to two executives were cancelled in March 2010 and not reissued; the sharesrelated accelerated expense of common stock outstanding at September 30, 2009, there were approximately 1,809 options available$47 is included in the total stock-based option expense noted below for grant under the Plan as of that date. We expense all stock options on a straight-line basis, net of forfeitures, over the requisite expected service periods. Additionally, during the ninethree months ended September 30,March 31, 2010.  During the three months ended March 31, 2009, we revised the estimated rate of forfeitures to 30 percent from 0 percent based on the history of stock option cancellations and management’s estimates of expected future forfeiture rates, resulting in a reduction of stock-based compensation expense of $116 for the ninethree months ended September 30,March 31, 2009. The total stock-based compensation expense recognized for stock options for the ninethr ee months ended September 30,March 31, 2010 and 2009 was $162 and 2008 was $266, respectively.$(37), respectively, which for 2009 is net of the forfeiture adjustment of $116.  As of September 30, 2009,March 31, 2010, the unamortized portion of the estimated fair value of outstanding stock options was $1,339.$1,046.

Note 9:
Note 10: Income Taxes

Income tax expense during interim periods is based on applying the estimated annual effective income tax rate on interim period operations, which may vary from the statutory rate due to the impact of permanent items relative to our net income as well as by any valuation allowance recorded.  We employ an asset and liability approach that results in the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial basis and the tax basis of those assets and liabilities.  A valuation allowance is established when it is more likely than not that some of the deferred tax assets will not be realized.  AManagement analyzed its current operating results and future projections and determined that a full valuation allowance was need ed due to our cumulative losses in recent years.  We have $12,930 in net operating loss (“NOL”) carry forwards available to offset future or prior taxable income.  These federal NOL’s will begin to expire in 2028. As of $286 was recorded for deferred tax assetsMarch 31, 2010, these NOL’s are not limited under Section 382 of the Internal Revenue Code. 

Note 11: Related Party Transactions

Our Board of Directors and Management recognize that related person transactions present a heightened risk of conflicts of interest, and therefore we review all relationships and transactions in excesswhich we and our directors, director nominees and executive officers or their immediate family members, as well as holders of deferred tax liabilities at September 30, 2009.more than 5% of any class of our voting securities and their family members, have a direct or indirect material interest.  As required under SEC rules, transactions that are determined to be directly or indirectly material to us or a related person are disclosed in the appropriate annual and/or quarterly statements filed with the SEC.
 
11
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Ronald E. Smith, President, CEO and Director of Deep Down and Eugene Butler, Chairman of Deep Down, are partners in Ship and Sail, Inc. (“Ship and Sail”), a vendor of Deep Down. During the three months ended March 31, 2010, we made payments of $10 to Ship and Sail, and we expensed the prepaid balance of $38 as of December 31, 2009 during the first quarter of 2010. The payments and expense to Ship and Sail related to services provided by that entity for the support of the development of marine technology which is planned for production during fiscal 2010, including specialized services for provision of vessel access for design and testing, and office space and related utilities.
Additionally, during the three months ended March 31, 2010, we recorded expenses to JUMA, a company owned by Ronald E. Smith, and his wife Mary L. Budrunas, Vice President, Corporate Secretary and Director of Deep Down, in the amount of $13, which amount is included in accounts payable as of March 31, 2010 and was paid in April 2010.  Payments relate to the monthly rental of a boat owned by JUMA, in connection with the development of marine technology as discussed above.
In January 2010, we loaned South Texas Yacht Services, a vendor of Deep Down, $100.  The owner of South Texas Yacht Services is in a business alliance with Ship and Sail.  The final principal and interest payment is due March 24, 2015; the note bears interests of 5.5 percent and is payable monthly in the amount of $2 beginning in April 2010. As of May 17, 2010, the payments on the note were current.

Note 10:
Note 12: Commitments and Contingencies

Litigation

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

Operating Leases

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

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DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Concluded)
Letters of Credit

Certain customers could require us to issue a standby letter of credit (“L/CC”) in the ordinary course of business to ensure we will performperformance under terms of the contract and with associated vendors and subcontractors. In the event of default, the creditor maycould demand payment from the issuing bank for the amount of the L/C. There were no significant expenses related toOur revolving line of credit (“Revolver”) and subsequent New Agreement with Whitney, provides for L/Cs, for the nine months ended September 30, 2009. In December 2008, we amended our Revolver with Whitney to provide for L/Cs.as discussed in Note 8 above. During the nine monthsyear ended September 30,December 31, 2009, we issued ana $1,107 irrevocable transferrable standby L/C in the normal course of business, with an annual commission rate of 2.4 percent, for $1,108.percent. This L/C reduces the borrowing capacity under the Revolver.remains outstanding as of March 31, 2010.

Note 11:Income (loss)Note 13: Earnings per Common Share

Basic EPSearnings per share (“EPS”) is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net income (loss) by the weighted-average number of common shares and dilutive common stock equivalents (convertible notes and interest on the notes,(warrants, stock awards and stock options) outstanding during the period. Dilutive EPS reflects the potential dilution that could occur if options to purchase common stock were exercised for shares of common stock. PotentiallyThere were no potentially dilutive securities representing 1,121 shares of common stock for the ninethree months ended September 30, 2008March 31, 2010 and 2009 that were excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive.
anti-dilutive or the exercise price for the outstanding warrants and options exceeded the average mark et price for our common stock.
1112
DEEP DOWN, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 14: Subsequent Events

Business Combination

On May 3, 2010, we announced the execution of a Stock Purchase Agreement, effective as of May 3, 2010 (the “Purchase Agreement”), by and among Deep Down, Cuming Corporation, a Massachusetts corporation (“Cuming”), and the stockholders of Cuming (the “Selling Stockholders”), pursuant to which we have agreed to purchase all of the issued and outstanding shares of Cuming’s common stock (the “Acquisition”) for a purchase price of  $47,000 (less an amount of certain liabilities to be assumed, estimated to be an approximate amount of $13,000 based upon Cuming’s balance sheet as of December 31, 2009 and further subject to a purchase price adjustment for working capital) (“Cash Price”), plus 25,000 shares of common stock of Deep Down to be deli vered to the Selling Stockholders at the closing.  Upon the signing of the Purchase Agreement, Deep Down and the Selling Stockholders entered into an Escrow Agreement (the “Escrow Agreement”) pursuant to which Deep Down has deposited with an escrow agent 8,333 shares of its common stock (“Escrowed Stock”) to be (i) delivered to the Selling Stockholders if Deep Down does not meet certain conditions and the Purchase Agreement is terminated or (ii) applied against Deep Down’s obligation to deliver 25,000 shares of common stock at closing.

Consummation of the Acquisition is subject to certain conditions, including the following (among other customary conditions for a transaction of this type):

·    Deep Down’s obtaining cash funds necessary to close the transaction;
·    certain employees of Cuming shall have entered into new employment agreements;
·    Cuming’s entering into a new lease agreement for its main manufacturing facility in Avon, Massachusetts;
·    an environmental assessment of Cuming’s main properties does not indicate circumstances or conditions which could result in (i) any criminal prosecution of Cuming, any of its subsidiaries or any director, officer or employee, or (ii) any suspension or closure of operations at Cuming’s main facilities;
·    the absence of any order or injunction prohibiting the consummation of the Acquisition; and
·    subject to certain exceptions, the accuracy of representations and warranties with respect to Deep Down’s or Cuming’s business, as applicable.

The Purchase Agreement contains customary representations and warranties that the parties have made to each other.  The Purchase Agreement also contains standard indemnification provisions that require the indemnifying party to pay for any losses in excess of $500 that result from the failure of any representation or warranty to be true and correct.  The indemnification is subject to a cap of $25,000 other than for certain fundamental representations and warranties (for which case there is no capped limitation).  At closing a portion of the Cash Price will be deposited in an escrow account for purposes of the purchase price adjustment and for potential indemnity claims.

Either of Deep Down or the Selling Stockholders may terminate the Purchase Agreement if the Acquisition is not completed by June 30, 2010, provided the party wishing to terminate is not in breach of the Purchase Agreement.  In the event of a termination of the Purchase Agreement as a result of a breach of our obligations under the Purchase Agreement or inability to obtain funds to pay the Cash Price, the escrow agent will release the Escrowed Stock to the Selling Stockholders.  If the Purchase Agreement is terminated by either Deep Down or Cuming under certain circumstances the parties will be obligated to reimburse the other’s expenses incurred in connection with the transactions contemplated by the Purchase Agreement in an aggregate amount not to exceed $275.

On April 28, 2010, we obtained a waiver from Whitney from a covenant provision in the New Agreement that prohibits us from committing to make an investment in or purchase any equity interest in another entity.

Private Placement

Between April 25 and April 30, 2010, we sold 5,150 shares of our common stock in a private placement to accredited investors at a per-share price of $0.10 resulting in total proceeds of $515, which we will use for working capital purposes.
 
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ITEM 2.
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, 20082009 filed with the Commission on March 16, 2009April 15, 2010 and our unaudited consolidated financial statements and notes thereto included with this Quarterly Report on Form 10-Q in Part I,I. Item 1.

General

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

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

Business conditions in our industry continued to decline inimpact our customers operations worldwide during the first ninethree months of 2009.2010. The financial markets, which are critical to the funding of the major offshore and deepwater projects, have not stabilized yet.  According to the International Energy Agency, worldwide demand for oil will decline by 3 percent in 2009 as a result of the economic downturn.  These business conditions have had a major impact on our customers worldwide.  NewAlthough some new projects are being delayed and some existing projects slowed down generally, some of our customers began accelerating their projects in the fourth quarter of 2009 to meet their internal deadlines, which thereby reduced our revenue in the first quarter of fiscal 2010 compared to the first quarter of 2009.

On April 20, 2010, a semi-submersible drilling rig operating in the deepwater Gulf of Mexico exploded, burned for two days and sank, resulting in an oil spill in the Gulf of Mexico.  In response to this accident, the U.S. Secretary of the Interior, on May 6, 2010, announced a moratorium on U.S. offshore drilling permits issued after April 20, 2010 until May 28, 2010, when a report on the accident is expected to be completed.  Such permits, among other required approval, are slowing down.  The domesticnecessary prior to commencement of offshore drilling operation and could impact our customers’ deepwater operations in the Gulf of Mexico.  It remains to be seen how the industry and our company will be impacted by the oil spill in the Gulf of Mexico over the short and long term, with respect to clean up operati ons, potential delays on other projects in the Gulf of Mexico due to allocation of resources or access to the region, potential new U.S. government regulations and the increased focus on safety and maintenance. In response to the oil spill, we, like several others in the industry, have incurredprovided and will continue to provide our services and equipment to support the worst decline whileongoing efforts related to this accident.  Additionally, we believe that the international projects have mostly slowed down.markets will be more important to our operations going forward as we continue our focus on Brazil and West Africa deepwater projects.

We believe that the economy will continue to struggle during the last quarter of 2009, but should showis showing signs of stabilizing thereafter.and recovery. The price of oil has increased in the first ninethree months of 2009,2010; the financial markets also show signs of improving, and we are currently seeing improvement in several areas of our activity.bidding activity is increasing. We believe the longer term outlook is still very positive for the offshore and deepwater drilling and we will continue to focus on this sector of the industry.industry worldwide.

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Segments

ForDuring the ninethree months ended September 30,March 31, 2010 and 2009, the operations of Deep Down’s operating segments, Deep Down Delaware, ElectroWave, Mako and the fiscal year ended December 31, 2008, our operationsFlotation, have been aggregated into a single reporting segment. Additionally, we have aggregated ElectroWave’s operations into Deep Down Delaware as a single operating segment due to similar production processes and cost savings related to office and administrative support. While ourthe operating segments have different product lines,lines; they are very similar with regards to the five criteria for aggregation.similar. They are all service-based operations revolving around our personnel’s expertise in the deep water industry, and any equipment is produced to a customer specified design and engineered using Deep Down personnel’s expertise, with installation and installed usingproject management as part of our personnel’s expertise.service revenue to the customer. Additionally, the segments have similar customers and distribution methods, and their economic characteristics are similar with regard to their gross margin percentages. Our operations are located in the United States though we occasionally make sales to international customers.

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

On April 28, 2010, we obtained a waiver from Whitney National Bank relating to a covenant provision in the Amended and Restated Credit Agreement dated April 14, 2010 (the “Waiver Agreement”) that prohibits us from committing to make an investment or purchase any equity interest in another entity.
On May 3, 2010, we announced the execution of a Stock Purchase Agreement, effective as of May 3, 2010 (the “Purchase Agreement”), by and among Deep Down, Cuming Corporation, a Massachusetts corporation (“Cuming”), and the stockholders of Cuming (the “Selling Stockholders”), pursuant to which we have agreed to purchase all of the issued and outstanding shares of Cuming’s common stock (the “Acquisition”) for a purchase price of approximately $47,000 (less an amount of certain liabilities to be assumed, estimated to be an approximate amount of $13,000 based upon Cuming’s balance sheet as of December 31, 2009 and further subject to a purchase price adjustment for working capital) (“Cash Price”), plus 25,000 shares of common stock of Deep Down to be d elivered to the Selling Stockholders at the closing.  Upon the signing of the Purchase Agreement, Deep Down and the Selling Stockholders entered into an Escrow Agreement (the “Escrow Agreement”) pursuant to which Deep Down has deposited with an escrow agent 8,333 shares of its common stock (“Escrowed Stock”) to be (i) delivered to the Selling Stockholders if Deep Down does not meet certain conditions and the Purchase Agreement is terminated or (ii) applied against Deep Down’s obligation to deliver 25,000 shares of common stock at closing.

Consummation of the Acquisition is subject to certain conditions, including the following (among other customary conditions for a transaction of this type):

·    Deep Down’s obtaining cash funds necessary to close the transaction;
·    certain employees of Cuming shall have entered into new employment agreements;
·    Cuming’s entering into a new lease agreement for its main manufacturing facility in Avon, Massachusetts;
·    an environmental assessment of Cuming’s main properties does not indicate circumstances or conditions which could result in (i) any criminal prosecution of Cuming, any of its subsidiaries or any director, officer or employee, or (ii) any suspension or closure of operations at Cuming’s main facilities;
·    the absence of any order or injunction prohibiting the consummation of the Acquisition; and
·    subject to certain exceptions, the accuracy of representations and warranties with respect to Deep Down’s or Cuming’s business, as applicable.

The Purchase Agreement contains customary representations and warranties that the parties have made to each other.  The Purchase Agreement also contains standard indemnification provisions that require the indemnifying party to pay for any losses in excess of $500 that result from the failure of any representation or warranty to be true and correct.  The indemnification is subject to a cap of $25,000 other than for certain fundamental representations and warranties (for which case there is no capped limitation).  At closing a portion of the Cash Price will be deposited in an escrow account for purposes of the purchase price adjustment and for potential indemnity claims.

Either of Deep Down or the Selling Stockholders may terminate the Purchase Agreement if the Acquisition is not completed by June 30, 2010, provided the party wishing to terminate is not in breach of the Purchase Agreement.  In the event of a termination of the Purchase Agreement as a result of a breach of our obligations under the Purchase Agreement or inability to obtain funds to pay the Cash Price, the escrow agent will release the Escrowed Stock to the Selling Stockholders.  If the Purchase Agreement is terminated by either Deep Down or Cuming under certain circumstances the parties will be obligated to reimburse the other’s expenses incurred in connection with the transactions contemplated by the Purchase Agreement in an aggregate amount not to exceed $275.
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Results of Operations

Three Months Ended September 30, 2009March 31, 2010 Compared to Three Months Ended September 30, 2008March 31, 2009

Revenue.Revenues.   RevenueRevenues decreased by $459, or 6.5 percent to $6,644 for the three months ended September 30, 2009 decreased approximately $3,227 to approximately $8,426, a decrease of approximately 28 percent overfirst quarter 2010 from $7,103 for the same priorquarter last year.  The decrease was primarily due to a delay in the need for our services related to new offshore developments during the first quarter of this year period. The reduction in revenue over the same prior year period was a result of customers delaying future projects or slowing down many of their offshore and deepwater projects.  Additionally, our ROV rentals and operator charges were reduced compared to the prior year and the continued delay of work due to non-payment by a customer for a large fabrication project, which we now anticipate recommencing during the economic conditions affecting our customers.second quarter or early third quarter 2010.  The decrease was offset by increased revenues from production buoyancy projects and ROV services in the Gulf of Mexico as compared to the same quarter last year.

Gross Profit.  Gross profit decreased approximately $3,497$366 to approximately $2,150$1,938 for the three months ended September 30, 2009,first quarter 2010, a decrease of approximately 6216 percent over the same period of the prior year, period.  Forreflecting an overall reduction in the three months ended September 30, 2009, gross margins were negatively impacted by our large floatation orderprofit margin from 32 percent to 29 percent.  The decrease in gross profit was primarily a result of the decrease in total revenues as discussed above. The decrease in the gross margin percent was due primarily to the increase in depreciation expense of $191 to $536 which was included in cost of sales. The increase in depreciation for 2010 resulted from depreciation associated with the purchase of ROVs and by two other floatation orders, all which have incurred more costs than originally estimated.  As such, gross margins decreased to 26 percent of revenue forcapital expenditures during the third quarterlatter half of 2009. Depreciation expense related to revenue-generating fixed assets is recorded as cost of sale s.
12

Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) include rent, utilities, general office expenses, insurance, personnel bad debt and other costs necessary to conduct business operations.  SG&A for the three months ended September 30, 2009first quarter 2010 was approximately $3,585, a decrease of approximately 4 percent over$3,483 compared to $2,844 for the same prior year period. Overall,quarter last year; an increase of $639, or 22 percent. Management began a company-wide cost reduction program during the decrease was driven by management’ssecond quarter of 2009 which is continuing focus on cost containment and by reduced professional fees whichduring 2010. While we had reduction in certain SG&A of $278 during the three months ended September 30, 2008, related to the acquisition of Flotation. Additionally, professional, accounting and legal fees relating to the updating of the registration statement decreased by approximately $614first quarter 2010 compared to the three months ended September 30,first quarter of last year, this reduction was offset by an increase in non-cash stock-based compensation of $197 and expenses associated with the purchase o f Cuming Corporation of $134. Additionally, during the first quarter 2009, we received a different interpretation of the penalty clause in the 2008 private placement which resulted in a reversal of an accrual of $586 for registration penalty expense that was accrued during fiscal 2008. Bad debt expense decreased approximately $190 for the three months ended September 30, 2009 compared to the three months ended September 30, 2008, due to a customer that filed bankruptcy in 2008. Personnel and related costs, attributed to the expansion of our businesses, increased by approximately $626. Stock-based compensation increased by approximately $151 for the three months ended September 30, 2009, due to stock options issued after September 30, 2008, and to the accelerated vesting of restricted stock.

Depreciation and amortization.amortization expense (excluded from Cost of sales). Depreciation and amortization expense excluded from “Cost of sales” in the accompanying statements of operations was approximately $415$442 and $362$406 for the first quarter of 2010 and 2009, respectively.  Depreciation expense represented $93 and $79 of this total for the three months ended September 30,March 31, 2010 and 2009, and 2008, respectively. ThisThe increase in depreciation expense resulted from the purchase of furniture and fixtures and office buildingsequipment during 2009.

In addition, amortization of intangible assets for the first quarter 2010 was $349 compared to $327 for the first quarter 2009. The increase was due to a change during the fourth quarter of 2009, based upon current market trends and property previously leased and other capital expenditures. Depreciation expense, included in “Cost of sales”estimated future cash flows, in the accompanying statementsestimated useful life of operations, was approximately $450some technology intangible assets from twenty-five years to ten years and $381 forcustomer lists from a range of eight to twenty-five years to a range of six to fourteen years, which accelerated the three months ended September 30, 2009 and 2008, respectively.amortization of the related assets.

Net interest expense. Net interest expense for the three months ended September 30, 2009first quarter 2010 was approximately $115$131 compared to net interest income of approximately $12$46 for the same prior year period.  Net interest expense for the three months ended September 30, 2009 and 2008each period was generated by our outstanding bank debt, capital leases and subordinated debenture, offset by interest income on cash balances.

Net income (loss)Income tax expense.. Net loss for  For the three months ended September 30, 2009 was approximately $2,090, comparedfirst quarter 2010, we have recorded a full valuation allowance of our deferred tax assets. For the previous year period we reserved only a portion of the deferred tax assets related to net incomestock based compensation in the amount of approximately $1,578 for the same prior year period.  $272.
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EBITDA. EBITDA is a non-US GAAP financial measure. We use EBITDA as an unaudited supplemental financial measure to assess the financial performance of our assets without regard to financing methods, capital structures, taxes or historical cost basis; and to assess our liquidity and operating performance over time in relation to other companies that own similar assets and that we believe calculate EBITDA in a similar manner; and to assess the ability of our assets to generate cash sufficient for us to pay potential interest costs. We also understand that such data are used by investors to assess our performance. However, the term EBITDA is not defined under US GAAP and EBITDA is not a measure of operating income, operating performance or liquidity presentedpres ented in accordance with US GAAP. When assessing our operating performance or liquidity, investors should not consider this data in isolation or as a substitute for net income, cash flow from operating activities, or other cash flow data calculated in accordance with US GAAP. EBITDA for the three months ended September 30, 2009first quarter 2010 was negative $981$1,010 compared to positive $2,312negative $198 for the same prior year period.period last year.  This reduction was primarily driven by the decrease in net income, offset by an increase in interest expense on outstanding debt.

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

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

Revenue.  Revenue for the nine months ended September 30, 2009 decreased approximately $4,123 to approximately $21,729, a 16 percent decrease over the same prior year period. Thedebt, depreciation and amortization expense and reduction in revenue over the same prior year period was a result of customers delaying future projects or slowing down many of their offshore and deepwater projects. Additionally, our ROV rentals and operator charges were reduced compared to the prior yearincome tax benefit due to the economic conditions affecting our customers.
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Gross Profit.  Gross profit decreased approximately $4,074 to approximately $6,316recording of a valuation allowance for the nine months ended September 30, 2009, a decrease of 39 percent compared to the nine months ended September 30, 2008. This decrease in gross profit was partially driven by the decrease in total revenue, particularly our large floatation order.  Accordingly, our gross margins decreased to 29 percent of revenue for the nine months ended September 30, 2009.

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

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

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

Net loss. Net loss for the nine months ended September 30, 2009 was approximately $4,581, compared to approximately $3,377 for the same prior year period.  
EBITDA. EBITDA is a non-US GAAP financial measure. We use EBITDA as an unaudited supplemental financial measure to assess the financial performance of our assets without regard to financing methods, capital structures, taxes or historical cost basis; our liquidity and operating performance over time in relation to other companies that own similar assets and that we believe calculate EBITDA in a similar manner; and the ability of our assets to generate cash sufficient for us to pay potential interest costs. We also understand that such data are used by investors to assess our performance. However, the term EBITDA is not defined under US GAAP and EBITDA is not a measure of operating income, operating performance or liquidity presented in accordance with US GAAP. When assessing our operating performance or liquidity, investors should not consider this data in isolation or as a substitute for net income, cash flow from operating activities, or other cash flow data calculated in accordance with US GAAP. EBITDA for the nine months ended September 30, 2009 was negative $2,824 compared to positive $1,295 for the same prior year period.first quarter 2010.
 
   Nine Months Ended  
   September 30,  
   2009  2008  
 Net loss $(4,581) $(3,377) 
 Add back interest expense, net of interest income  227   3,381  
 Add back depreciation and amortization  2,389   1,642  
 Deduct income tax benefit  (859)  (351) 
 EBITDA $(2,824) $1,295  
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  For the Three Months Ended 
  March 31, 
  2010  2009 
Net loss $(2,136) $(730)
Add back interest expense, net of interest income  131   46 
Add back depreciation and amortization  978   751 
Add back (deduct) income tax expense (benefit)  17   (265)
EBITDA $(1,010) $(198)

Capital Resources and Liquidity

OperationsOverview

As a deep water service provider, our revenue, profitability, cash flows, and future rate of growth are substantially dependent on the condition of the oil and gas industry generally, and our customers’ ability to invest capital for the past nine months have been negatively impacted by the worldwide recession, lower oiloffshore exploration, drilling and productions and maintain or increase levels of expenditures for maintenance of offshore drilling and production facilities.  Oil and gas prices and customer-basedthe level of offshore drilling and production activity have historically been characterized by significant volatility.  We enter into large, fixed-price contracts which may require significant lead time and investment. A decline in offshore drilling and production activity could result in lower contract volume or delays in manysignificant contracts which could negatively impact our earni ngs and cash flows. Our earnings and cash flows could also be negatively affected by a continued delay in a payment by a significant customer or delays in completion of our major projects, includingcontracts for any reason.   While our objective is to enter into contracts with our customers that are cash flow positive, we may not always be able to achieve this objective.  Our current financial condition may limit our ability to enter into contracts that are not cash flow positive.

We will need to raise additional debt or equity capital or renegotiate or refinance our existing debt to fund working capital requirements, to support SG&A and to pay all outstanding debt maturing on April 15, 2011 under the Whitney National Bank (“Whitney”) New Amended and Restated Credit Agreement (“New Agreement”). We cannot provide any assurance that any financing will be available to us in the future on acceptable terms or at all. Any such financing could be dilutive to our shareholders.  If we cannot raise required funds on acceptable terms, we may not be able to, among other things, (i) maintain SG&A; (ii) expand operations; (iii) hire and train new employees; (iv) respond to competitive pressures or unanticipated capital requirements; or (v) pay all outstanding debt m aturing under the New Agreement. Per the terms of the New Agreement, we no longer have access to a line of credit and must rely solely on our large floatation order.  As acash position and operating cash flows for liquidity.

While we believe that our results of operations, including gross profit and operating cash flow, will improve over the remainder of the year, additional debt or equity capital may be necessary to fund working capital requirements, to support SG&A and to pay all outstanding debt under the New Agreement if our planned results of operations are not achieved.  Further, failure to achieve our planned results could result in violation of this downturncertain of our loan covenants and require us to raise additional debt or equity capital.

We currently plan to use our available cash for our SG&A, debt service payments and working capital. The actual allocation of and the timing of the expenditures will be dependent on various factors, including changes in our strategic relationships, industry conditions, and other factors that we cannot currently predict.

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Our Credit Agreement imposes covenant restrictions on us that increase our vulnerability in the current adverse economic and industry climate, and limits our ability to obtain additional financing. We have recently amended and restated our credit facility, as discussed below and in Note 8, Long-Term Debt, to waive our covenant noncompliance as of December 31, 2009 and to provide us more latitude in our covenants through the term of the agreement. Our ability to meet these covenants is primarily dependent on the adequacy of earnings before interest, taxes, depreciation and amortization. Our inability to satisfy the covenants contained in our Credit Agreement would constitute an event of default. An uncured default could result in our outstanding debt becoming immediately due and payable. If this were to occur, we may not be able to obtain waivers or secure alternative financing to satisfy our obligations, either of which would have a material adverse impact on our business or our ability to continue as a going concern.

Although we believe that we will have adequate liquidity to meet our future operating requirements if our planned results of operations, inincluding gross profit and operating cash flows, are achieved and to remain compliant with the first nine months of 2009 were significantly lower than expected, resulting in a negative EBITDA of approximately $2,824. covenants under our Credit Agreement, the factors described above create uncertainty.

As discussed in Note 7,8, Long-Term Debt, inwe have entered into the notesNew Agreement to unaudited consolidatedaddress covenant violations we had under our Credit Agreement with Whitney that we originally entered into on November 11, 2008.  Under the terms of the New Agreement, our noncompliance with the prior terms of the financial statements, we were in defaultcovenants and certain other covenants under the Credit Agreement have been waived (the effect of our $2,000 Revolversuch noncompliance would have entitled the holders of all debt under the Credit Agreement and under a loan agreement at September 30, 2009,between Flotation and we anticipate to be in default at December 31, 2009 even though operations are improving and we expect them to continue improving in the fourth quarter.  As a result of this default at September 30, 2009, and cross-default provisions in our TD Bank, facility, amountsN.A. (“TD Bank”) to call such debt immediately due and payable and would have required us to classify all debt outstanding under these facilities have been classified as current in our audited consolidated balance sheet at September 30, 2009. We are seeking a waiver from Whitney and will do so at year end, if we are still in default.  If we are unable to obtain such a waiver, debt under these facilities could be declared immediately due and payable. We may consider alternative financings or other transactions to satisfy such obligations. The borrowing capacity under the Revolver was approximately $20 at September 30, 2009. December 31, 2009).  We continue to remain current on payments of our principal, interest and fee obligations with Whitney and TD Bank.  Revenues inHowever, under the third quarter improved by $2,225 overterms of the second quarterNew Agreement, all of the indebtedness outstanding under such agreement, which is an aggregate principal amount of $3,583 as of March 31, 2010, will all be due on April 15, 2011 and reclassified as current on our balance sheet on June 30, 2010, unless we are able to refinance all or a portion of such indebtedness, and we expect operationsno longer have any further capacity to continuedraw upon a revolving line of credit under the New Agreement.

Furthermore, as of December 31, 2009, Flotation was not in compliance with its covenant obligations under the TD Bank loan.  The noncompliance with such covenants under either of the Credit Agreement with Whitney and the loan agreement with TD Bank would constitute cross defaults for purposes of the other debt facility.  Flotation also obtained a waiver of its noncompliance so that such cross default has not occurred with respect to improve inour fiscal quarter ended December 31, 2009. Compliance testing is required only at year end so no compliance test was performed at March 31, 2010. Indebtedness outstanding under the fourth quarter.  The cost containment program, whichTD bank loan was commenced in the second quarter is continuing$2,110 at March 31, 2010.

Between April 25 and beginning to have a positive effect on general and administrative expenses. We have commenced the production cycle of a large flotation order and had a majorityApril 30, 2010, we sold 5,150 shares of our ROVscommon stock in a private placement to accredited investors at a per-share price of $0.10 resulting in total proceeds of $515, which we will use for working at the end of the third quarter, and our offshore jobs are increasing. As of September 30, 2009 our backlog was approximately $20,000.
Management believes that we have adequate capital resources when we combine our $3,896 cash position and improved cash flows from strengthening operations to meet current operating requirements for the twelve months ending September 30, 2010. The factors described above create uncertainty and could have a material adverse impact on our business.purposes.

Cash Flow from Operating Activities

ForDuring the nine months ended September 30, 2009,first quarter 2010, cash provided byfrom operating activities was approximately $4,606$720 as compared to cash provided by operating activities for the same prior year period of approximately $1,175. Our working capital balances vary due to delivery terms and payments on key contracts, costs and estimated earnings in excess of billings on uncompleted contracts, and outstanding receivables and payables. We collected approximately $6,440 in accounts receivable$3,936 during the nine months ended September 30, 2009 compared to approximately $942 in the same prior year period.  We used someCash flow from operating activities declined due to an increase in our net loss and a decrease in cash provided by changes in working capital.  Working capital declined primarily in an effort to manage short term liquidity and as a result of the operating cash flow to reduce accounts payable and accrued liabilities by approximately $289 compared to approximately $1,059decline in the same prior year period. Additionally, we recorded the following non-cash chargesnet billings in the nine months ended September 30, 2009: stock-based compensationexcess of approximately $643, bad debt expense of approximately $126 and depreciation and amortization of approximately $2,389. In the nine months ended September 30, 2008, we recorded amortization of deferred financing costs and debt discount relatedestimated earnings on uncompleted contracts, which relates to a secured credit agreement which totaled approximately $2,580, stock-based compensationseveral large projects that are expected to be completed in fiscal year 2010 and one that is expected to be completed during the first quarter of approximately $424, bad debt expense of approximately $1,053 and depreciation and amortization of approximately $1,642.2011.

Cash Flow from Investing Activities

ForDuring the nine months ended September 30, 2009,first quarter 2010, cash used in investing activities was approximately $5,845$779 compared to approximately $28,588 for$1,898 during the same prior year period.quarter last year. During the first quarter 2010, we used $563 to purchase property and equipment and $91 for capitalized software.  We also incurred a note of $100 related to a vendor receivable, which is a related party (see further discussion in Note 11- Related Party Transactions in this Form 10-Q).  For the nine months ended September 30,first quarter 2009, we used approximately $5,536$1,898 to purchase property and equipment, which included approximately $570$470 in deposits for the purchase of land and buildings. We also capitalized approximately $383buildings, which transaction was completed in software costs related to a company-wide implementation of our new ERP system, and invested $150 in a third party, offset by a decrease in restricted cash for a letter of credit of $136. The majority of the 2008 activity related to cash paid for the purchase of Flotation totaling approximately $22,162, cash paid to Mako shareholders totaling approximately $4,237, net of expenses and purchase price adjustments. The change in the restricted cash balance of approximately $375, related to requirements of a secured credit agreement, which was released when the debt was paid in June 2008. We used approximately $2,564 for equipment purchases during the same period of 2008.May 2009.

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Cash Flow from Financing Activities

ForDuring the nine months ended September 30,first quarter 2010, cash used in financing activities was $150 which represented principal payments on long term debt.  During the first quarter 2009, cash provided by financing activities was approximately $2,640 compared to approximately $30,362 for the same prior year period.  During the nine months ended September 30, 2009, we borrowed approximately $3,000$1,728 which consisted of borrowings of $1,840 and made principle payments of approximately $360. During the nine months ended September 30, 2008, we completed a Private Placement of our stock for net proceeds of approximately $37,060. We also paid approximately $12,493 to a secured creditor to pay the balance due under a credit agreement and related interest and early termination fees (such early termination fees were included in operations as loss on debt extinguishment). In January 2008, in accordance with the terms of the purchase of Mako, we paid approximately $916 of notes payable and received proceeds from a secured creditor totaling approximately $5,604.$112.
15

Critical Accounting Policy Updates

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

See Note 2, “Recently Issued3, “Recent Accounting Standards and DevelopmentsPronouncements,”, in the notes to unaudited consolidated financial statements for information regarding recently issued accounting standards.

Refer to Part II,II. Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 20082009 for a discussion of our Critical Accounting Policies.

Inflation and Seasonality

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

Off-Balance Sheet Arrangements

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

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ITEM 4.CONTROLS AND PROCEDURES
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 PrincipalChief Executive Officer and PrincipalChief 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 PrincipalChief Executive Officer and PrincipalChief Financial Officer concluded that, because material weaknesses existed, as of September 30, 2009,the end of the period covered in this report, our disclosure controls and procedures were not effective due to the material weakness described below to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized andan d reported within the required time periods and is accumulated and communicated to our management, including our PrincipalChief Executive Officer and PrincipalChief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As disclosed

Changes in Internal Control Over Financial Reporting.    There have been no changes to our Annualinternal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the fiscal quarter ended March 31, 2010 which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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

(ii)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of our management and directors; and

(iii)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.
During the Annual 10-K review process for the year ended December 31, 2008,2009, management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this evaluation, our management concluded our internal control over financial reporting was not effective as of December 31, 2009 and the deficiencies reported continue to be deficiencies as of March 31, 2010. 

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

As of March 31, 2010, we determined that we did not maintain an effective entity level control environment and did not maintain effective controls over the accuracycontrol environment.  Specifically, we had not formally adopted a written code of revenue recognition. Our management, includingbusiness conduct and ethics that governs our Principal Executive Officeremployees, officers and Principal Financial Officer, doesdirectors.  Further, the Board of Directors did not expect that our disclosure controlshave any independent members and no director qualified 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 orover the administration of our internal controls will prevent all error or fraud. Aaccounting and fraud risk policies, and a sufficient segregation of duties to decrease the risk of inappropriate accounting. Since these entity level programs have a pervasive effect across the organization, management has determined that these circumst ances constitute a material weakness. Additionally, this control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurancedeficiency could result in another material weakness that the objectivescould result in a material misstatement of the control system are met.  Further, the design of a control system must reflect the factconsolidated financial statements that there are resource constraints and the benefits of controls mustwould not 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 beenprevented or detected.

Changes in Internal Control Over Financial Reporting.   

Management’s remediation plans. In our efforts to continuously improve our internal controls, management has taken steps to enhance the following controls and procedures, during the third quarter of 2009,subsequent to March 31, 2010 as part of our remediation efforts in addressing the material weaknesses:weakness above:

·Management is in the process of implementingincreasing the Board of Directors with independent members, including a new system-wide accountingfinancial expert as defined in Item 407(d)(5)(ii) of Regulation S-B. An independent director was appointed by the Board effective April 12, 2010; Mark R. Hollinger has joined the Board as an independent director and management software program to addresswas appointed Chairman of the revenue recognition and gross margin analysisAudit Committee of projects accounted for under the percentage-of-completion method.Board of Directors.

·Management has prepared an employee handbook, distributed the handbook to all employees throughout the organizationa Code of Conduct for Management and Board of Directors and circulated these documents and obtained signed acknowledgements from each employee.
·Management has increased documentation around certain authorizationmanagement and review controls.the Board of Directors in April 2010.  See Corporate Governance under Item 10. Directors, Executive Officers and Corporate Governance included in our Annual Report on Form 10-K for the year ended December 31, 2009 for a description of the Codes.

Accordingly, there have been changes in our internal controls over financial reporting that have or are reasonably likely to materially affect our internal controls over financial reporting.
·    Management implemented an anonymous “whistleblower” hotline effective April 2010.


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 PART II – OTHER INFORMATION
ITEM 1.
ITEM 1.  LEGAL PROCEEDINGS
 
Periodically, we are involved in legal proceedings arising in the normal course of business. As of the date of this Quarterly Report on Form 10-Q, we are currently not involved in any pending, material legal proceedings except as noted below.proceedings.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
In connectionBetween April 25 and April 30, 2010, we sold 5,150,000 shares of our common stock in a private placement to accredited investors, who purchased in reliance on the exemption from registration in Section 4(2) of the Securities Act of 1933, at a per-share price of $0.10 resulting in total proceeds of $515,000.  We did not use an underwriter for this private placement. The proceeds will be used for working capital purposes; the private placement is closed as of April 30, 2010. Investors in this private placement included certain related parties, however, no purchases by any individual investor equaled or exceeded $120,000 in this private placement.

ITEM 5.  OTHER INFORMATION
On May 3, 2010, Deep Down entered into a Stock Purchase Agreement (the “Purchase Agreement”), with Cuming Corporation, a Massachusetts corporation (“Cuming”), and the Private Placementstockholders of Cuming (the “Selling Stockholders”), pursuant to which Deep Down has agreed to purchase all of the issued and outstanding shares of Cuming’s common stock (the “Cuming Acquisition”) for total consideration of approximately $50 million.  With the assumption of certain liabilities Deep Down will pay approximately $34 million in June 2008, we filed an initial Registration Statement on Form S-1 on July 21, 2008 to register the 57,142,857cash and deliver 25,000,000 shares issued in the offering. Pursuant to the Registration Rights Agreement, we were obligated to have the Registration Statement declared effective by September 3, 2008, the “Required Effective Date”, or the Company would be required to pay liquidated damagesof common stock of Deep Down to the Selling Shareholders inStockholders at the Private Placement for each day following the Required Effective Date, until but excluding the date the Commission declares the Registration Statement effective. We evaluated this obligation under the Registration Rights Agreement for liability treatment under ASC 450-20 “Contingencies” and ASC 825-20 “Financial Instruments”, and determined the registration rights met the definition of a liability under the authoritative guidance.  Accordingly, at December 31, 2008 we reserved $1,212,120 in potential damages under terms of the Private Placement for the 90-day period from September 4 to December 3, 2008. On May 5, 2009, we obtained an opinion from legal counsel allowing removal of the related stock’s restrictive legend under Rule 144, which was deemed to be equivalent, and thus satisfied the registration rights requirements. As such, management reduced the liquidated damages reserve to 47 days, or $626,040 in the first quarter of 2009.closing.  

The Commission declared the Registration Statement on Form S-1 effective on April 16, 2009 pursuant to Section 7.1(c) of the Registration Rights Agreement. We initiated payment to the Selling Shareholders effective May 12, 2009.
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ITEM 6.
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 NumberDescription of Exhibit
3.1Articles 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).
3.2Amended and Restated ByLaws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008).
10.1*10.1 †Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 15, 2010).
10.2 †Amended and Restated Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Ronald E. Smith (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 15, 2010).
10.3 †Employment Agreement, dated effective as of February 17, 2010, between Deep Down, Inc. and Michael J. Newbury (incorporated herein by reference from Exhibit 10.30 to our Form 10-K filed with the Commission on April 15, 2010).
10.4Amended and Restated Credit Agreement, entered into as of April 14, 2010, between Deep Down, Inc., as borrower, and Whitney National Bank, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. (incorporated herein by reference from Exhibit 10.31 to our Form 10-K filed with the Commission on April 15, 2010).
10.5ROV Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.32 to our Form 10-K filed with the Commission on April 15, 2010).
10.6RE Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.33 to our Form 10-K filed with the Commission on April 15, 2010).
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10.7RLOC Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.34 to our Form 10-K filed with the Commission on April 15, 2010).
10.8LC Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.35 to our Form 10-K filed with the Commission on April 15, 2010).
10.9Ratification of Guaranty, Security Agreement, and Intercreditor Agreement, dated April 14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down Inc., a Delaware corporation, each a guarantor, and Whitney National Bank, a national banking association, as lender (incorporated herein by reference from Exhibit 10.36 to our Form 10-K filed with the Commission on April 15, 2010).
10.10First Modification to Deed of Trust, dated April 14, 2010, executed by Deep Down, Inc., as grantor, for the benefit of Whitney National Bank, as lender (incorporated herein by reference from Exhibit 10.37 to our Form 10-K filed with the Commission on April 15, 2010).
10.11First Modification to Assignment of Leases and Rents, dated April 14, 2010, executed by Deep Down, Inc., as assignor, and Whitney National Bank, as assignee (incorporated herein by reference from Exhibit 10.38 to our Form 10-K filed with the Commission on April 15, 2010).
10.12 †Employment Agreement, dated effective as of April 29, 2010, between Deep Down, Inc. and Gay Stanley Mayeux (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010).
10.13Stock Purchase Agreement, dated May 3, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 6, 2010).
10.14Waiver Agreement, dated September 10, 2009 and effective as of September 1, 2009,April 28, 2010, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower.borrower (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on May 6, 2010).
10.2*10.15Waiver of Loan Covenants,Escrow Agreement, dated August 7, 2009 and effective as of June 30, 2009, by and between Whitney National Bank, as lender andMay 3, 2010, among Deep Down, Inc., as borrower.the Selling Stockholders, and Casner & Edwards, LLP (incorporated by reference from Exhibit 10.3 to our Form 8-K filed on May 6, 2010).
10.3*†Severance and Separation Agreement, dated September 1, 2009, by and between Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr. (“Consultant”) and Deep Down, Inc.,
31.1*Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934.
31.2*Certification of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934.
32.1*Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc.
32.2*Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc.
________________
* Filed or furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement.

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SIGNATURES

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


DEEP DOWN, INC.
(Registrant)
 
 
Signature Title Date
     
/s/ RONALD E. SMITH President, CEO and Director November 16, 2009May 17, 2010
Ronald E. Smith 
(Principal Executive Officer)
 
  
     
/s/ EUGENE L. BUTLERGAY STANLEY MAYEUX Chief Financial Officer and Director November 16, 2009May 17, 2010
Eugene L. ButlerGay Stanley Mayeux (Principal Financial Officer)  
 

 
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INDEX TO EXHIBITS


Exhibit NumberDescription of Exhibit
3.1Articles 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).
3.2Amended and Restated ByLaws of Deep Down, Inc. (incorporated by reference from Exhibit B to our Schedule 14C filed on August 15, 2008).
10.1*10.1 †Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Eugene L. Butler (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on January 15, 2010).
10.2 †Amended and Restated Employment Agreement, dated effective as of January 1, 2010, between Deep Down, Inc. and Ronald E. Smith (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on January 15, 2010).
10.3 †Employment Agreement, dated effective as of February 17, 2010, between Deep Down, Inc. and Michael J. Newbury (incorporated herein by reference from Exhibit 10.30 to our Form 10-K filed with the Commission on April 15, 2010).
10.4Amended and Restated Credit Agreement, entered into as of April 14, 2010, between Deep Down, Inc., as borrower, and Whitney National Bank, including the Guarantor’s Consent and Agreement as signed on behalf of ElectroWave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC and Deep Down, Inc. (incorporated herein by reference from Exhibit 10.31 to our Form 10-K filed with the Commission on April 15, 2010).
10.5ROV Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.32 to our Form 10-K filed with the Commission on April 15, 2010).
10.6RE Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.33 to our Form 10-K filed with the Commission on April 15, 2010).
10.7RLOC Term Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.34 to our Form 10-K filed with the Commission on April 15, 2010).
10.8LC Note, dated April 14, 2010, executed by Deep Down, Inc. and paid to the order of Whitney National Bank (incorporated herein by reference from Exhibit 10.35 to our Form 10-K filed with the Commission on April 15, 2010).
10.9Ratification of Guaranty, Security Agreement, and Intercreditor Agreement, dated April 14, 2010, among Deep Down, Inc., a Nevada corporation, as borrower, and Electrowave USA, Inc., Flotation Technologies, Inc., Mako Technologies, LLC, Deep Down Inc., a Delaware corporation, each a guarantor, and Whitney National Bank, a national banking association, as lender (incorporated herein by reference from Exhibit 10.36 to our Form 10-K filed with the Commission on April 15, 2010).
10.10First Modification to Deed of Trust, dated April 14, 2010, executed by Deep Down, Inc., as grantor, for the benefit of Whitney National Bank, as lender (incorporated herein by reference from Exhibit 10.37 to our Form 10-K filed with the Commission on April 15, 2010).
10.11First Modification to Assignment of Leases and Rents, dated April 14, 2010, executed by Deep Down, Inc., as assignor, and Whitney National Bank, as assignee (incorporated herein by reference from Exhibit 10.38 to our Form 10-K filed with the Commission on April 15, 2010).
10.12 †Employment Agreement, dated effective as of April 29, 2010, between Deep Down, Inc. and Gay Stanley Mayeux (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 5, 2010).
10.13Stock Purchase Agreement, dated May 3, 2010, among Deep Down, Inc., Cuming Corporation and the Selling Stockholders named therein (incorporated by reference from Exhibit 10.1 to our Form 8-K filed on May 6, 2010).
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10.14Waiver Agreement, dated September 10, 2009 and effective as of September 1, 2009,April 28, 2010, by and between Whitney National Bank, as lender, and Deep Down, Inc., as borrower.borrower (incorporated by reference from Exhibit 10.2 to our Form 8-K filed on May 6, 2010).
10.2*10.15Waiver of Loan Covenants,Escrow Agreement, dated August 7, 2009 and effective as of June 30, 2009, by and between Whitney National Bank, as lender andMay 3, 2010, among Deep Down, Inc., as borrower.the Selling Stockholders, and Casner & Edwards, LLP (incorporated by reference from Exhibit 10.3 to our Form 8-K filed on May 6, 2010).
10.3*†Severance and Separation Agreement, dated September 1, 2009, by and between Strategic Capital Services, Inc. and Robert E. Chamberlain, Jr. (“Consultant”) and Deep Down, Inc.,
31.1*Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934.
31.2*Certification of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934.
32.1*Section 1350 Certification of the President and Chief Executive Officer of Deep Down, Inc.
32.2*Section 1350 Certification of the Chief Financial Officer of Deep Down, Inc.
_________________________________
* Filed or furnished herewith.
† Exhibit constitutes a management contract or compensatory plan or arrangement.
25

 
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