UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C., 20549

FORM 10-KSB/A
(Amendment No. 1)

T   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007

£   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________to _________

Commission File No. 0-30351

DEEP DOWN, INC.
(Exact name of registrant as specified in its charter)
 
Nevada
 
75-2263732
(State of other jurisdiction of incorporation)
 
(I.R.S. Employer Identification No.)
     
15473 East Freeway Channelview, Texas
 
77530
(Address of Principal Executive Office)
 
(Zip Code)
 
Registrant’s telephone number, including area code: (281) 862-2201

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act: Common Stock $0.001 par value

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. £

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes T No £

Check if there is no disclosures of delinquent filers in response to Item 405 of Regulations S-B not contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. £

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

The issuer’s revenues for the year ended December 31, 2007 were $19,389,730.

The aggregate market value of the voting stock and non-voting common equity held by non-affiliates of the registrant as of March 28, 2008 (based on the closing price on that date) was approximately $31,406,139.

At March 28 , 2008, the issuer had outstanding 115,846,019 shares of Common Stock, par value $0.001 per share.

DOCUMENTS INCORPORATED BY REFERENCE
None.

Transitional Small Business Disclosure Format: Yes £ No T
 
 



 
 
 

Explanatory Note

The registrant previously filed with the Securities and Exchange Commission (the “SEC”) an Annual Report on Form 10-KSB for the year ended December 31, 2007.  The registrant has determined to file this Amendment No. 1 (this “Amendment”) to the Form 10-KSB for the following reasons:  (1) to correct the Commission File No., aggregate market value of voting and non-voting common stock held by non-affiliates and the number of outstanding shares of Common Stock, in each case as was set forth on the cover to the previously filed Form 10-KSB, (2) to correct information presented in Item 6 of the Form 10-KSB relating to percentage variances in the table presented on page 24 (relating to EBITDA), (3) to include the information in Part III of this Amendment, which the registrant previously expected to incorporate by reference from a definitive proxy statement the registrant expected to file, (4) to reformat the Exhibit Index included in the Form 10-KSB and include several additional exhibits (also being filed with this Amendment) on such index, and (5) to make other typographical corrections or adjustments.

Except as presented in this Amendment and except for Exhibits 31.1, 31.2, 32.1 and 32.2, this Form 10-KSB/A does not reflect events occurring after the filing of the Form 10-KSB or modify or update those disclosures .

 
 

 

TABLE OF CONTENTS
 
 
PART I
 
Item 1
Description of Business
4
Item 2
Description of Property
14
Item 3
Legal Proceedings
14
Item 4
Submission of Matters to a Vote of Security Holders
14
     
PART II
 
Item 5
Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities
15
Item 6
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
Item 7
Financial Statements
27
Item 8
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
27
Item 8A
Controls and Procedures
27
Item 8B
Other Information
29
     
PART III
     
Item 9
Directors, Executive Officers, Promoters, Control Persons and Corporate Governance
30
Item 10
Executive Compensation
32
Item 11
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
33
Item 12
Certain Relationships and Related Transactions, and Director Independence
34
Item 13
Exhibits
34
Item 14
Principal Accountant Fees and Services
34
 
 
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Forward-Looking Information

Unless otherwise indicated, the terms “Deep Down, Inc.”, “Deep Down”, “Deep Down Nevada”, “Company,” “we,” “our” and “us” are used in this report to refer to Deep Down, Inc., a Nevada corporation, to one or more of our consolidated subsidiaries or to all of them taken as a whole.

In this Annual Report on Form 10-KSB/ A document, we may make certain forward-looking statements, including statements regarding our plans, strategies, objectives, expectations, intentions and resources that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We do not undertake to update, revise or correct any of the forward-looking information. The following discussion should also be read in conjunction with the audited consolidated financial statements and the notes thereto.

The statements contained in this Annual Report on Form 10-KSB/ A that are not historical fact 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 forward-looking statements contained herein are based on current expectations that involve a number of risks and uncertainties. These statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “intend,” “plan,” “could,” “is likely,” or “anticipates,” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. The Company wishes to caution the reader that these forward-looking statements that are not historical facts are only predictions. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. While sometimes presented with numerical specificity, these projections and other forward-looking statements are based upon a variety of assumptions relating to the business of the Company, which, although considered reasonable by the Company, may not be realized. Because of the number and range of assumptions underlying the Company’s projections and forward-looking statements, many of which are subject to significant uncertainties and contingencies that are beyond the reasonable control of the Company, some of the assumptions inevitably will not materialize, and unanticipated events and circumstances may occur subsequent to the date of this report. These forward-looking statements are based on current expectations and the Company assumes no obligation to update this information. Therefore, the actual experience of the Company and the results achieved during the period covered by any particular projections or forward-looking statements may differ substantially from those projected. Consequently, the inclusion of projections and other forward-looking statements should not be regarded as a representation by the Company or any other person that these estimates and projections will be realized, and actual results may vary materially. There can be no assurance that any of these expectations will be realized or that any of the forward-looking statements contained herein will prove to be accurate.

 
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PART I
 
Item 1.                 Description of Business.

Corporate History

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

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

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

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

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

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

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

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

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

Business Overview

We provide both products and services to the offshore energy industry to support deepwater exploration, development and production of oil and gas and other maritime operations.  We are primarily a service company and produce custom engineered products that assist us in fulfilling service objectives for specific projects on a contractual basis.  We design and manufacture a broad line of deep water equipment, surface equipment and offshore rig equipment that are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world.  We also manufacture monitoring and control systems used by offshore energy and other maritime operations.  Our products are often initially developed in direct response to customer requests for solutions to critical problems in the field.  We also serve the growing offshore petroleum and maritime industries with technical management and support services.  Set forth below is a more detailed description of important services and products we provide.

Our goal is to provide superior products and services designed to provide safer, more cost-effective solutions in a quicker timeframe for our clients.  We believe there is significant demand for, and brand name recognition of, our established products due to the technological capabilities, reliability, cost effectiveness, timely delivery and operational timesaving features of these products. Since our formation, we have introduced many new products that continue to broaden the market currently served by us.

We market our products and services primarily through our corporate offices in Channelview, Texas.  Our sales representatives travel worldwide to the major international energy and maritime markets.  We generally manufacture and fabricate our products at our facilities, although we also work with third parties who provide manufacturing and fabrication support through their own facilities in the Houston, Texas metroplex.

Services and Products

The offshore energy industry is centered around the use of production platforms. A production platform is a large structure used to house workers and machinery needed to drill for and produce oil and natural gas from reservoirs below the ocean floor.  The operations of the production platform can deliver oil and gas production directly onshore by pipeline or to a floating storage unit or tanker loading facility.  Historically, production platforms have been located on the continental shelf, but as technology continues to improve, drilling and production operations in deeper water have become both feasible and profitable. A typical production platform may have as many as thirty wellheads from which it is producing.  Directional drilling allows subsea reservoirs to be accessed at both different depths and at remote positions up to 5 miles (8 kilometers) from the production platform.  Many production platforms have remote wellheads attached by umbilical connections, which may be single wells or a manifold center for multiple wells. An umbilical cable supplies necessary requirements to an apparatus.

Services

We provide a wide variety of project engineering and management services, including the design, installation and retrieval of subsea equipment and systems, connection and termination operations and commissioning.  We pride ourselves on the ability to collaborate with the engineering departments of oil and gas operators, installation contractors and subsea equipment manufacturers to find the quickest, safest, and most cost-effective solutions to address all manner of issues in the subsea world.  We also provide installation, retrieval, storage and management services in connection with the use of our products.

Project Management . Our installation management team specializes in deep water subsea developments. We are often contracted by our customers to assist with the preparation and evaluation of subsea development bids and requests for quotes.  Our experience comes from working with installation contractors, oil and gas operators, controls suppliers, umbilical manufacturers and other subsea equipment manufacturers, who often hire us to help ensure that a project progresses smoothly, on time and on budget.

 
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Project Engineering .  Our engineers have experience ranging from the initial conceptual design phases through manufacturing and installation, and concluding with topsides connections and commissioning.  Our experience provides us with a level of “hands on” and practical understanding that has proven to be indispensable in enabling us to offer customer solutions to the many problems encountered both subsea and topsides.  Because of our wide knowledge base, our engineering team is often hired by oil and gas operators, installation contractors and subsea equipment manufacturers to provide installation management and engineering support services.  Our engineering team has been involved in most of the innovative solutions used today in deepwater subsea systems.  We specialize in offshore installation engineering and the writing of practical installation procedures.  We deal with issues involving flying leads, compliant umbilical splices, bend stiffener latchers, umbilical hardware, hold-back clamps, and the development of distribution system components.  We are heavily involved in the fabrication of installation aids to simplify offshore executions, and offer hydraulic, fiber optic, and electrical testing services and various contingency testing tools.

Installation Support and Management .  Our installation management services are centered around the utilization of standardized hardware, proven, well-tested installation techniques, and an experienced, consistent team that has proven to be safe and skilled in all aspects of the installation process.  We pride ourselves on supporting installation contractors through our installation management and engineering services, installation aids and equipment, and our offshore installation support services, including spooling operations, offshore testing, and flying lead installation support.  Many installation contractors find it beneficial to utilize our services to help reduce on-board personnel since our specialized technicians can perform multiple tasks. We have designed and fabricated many different installation tools and equipment over the years. We have been involved in the design of the following pieces of equipment to help make installations run as smoothly as possible:  steel flying leads, steel flying lead deployment systems, umbilical hardware and termination systems, umbilical bell mouths, lay chutes, rapid deployment cartridges, horizontal drive units, mud mats, flying lead installation and parking frames, umbilical termination assembly stab & hinge over systems, and numerous other pieces of offshore equipment.  Our team has vast experience with the installation of flexible and rigid risers and flowlines, umbilicals, flexible and rigid jumpers, steel tube and thermoplastic hose flying leads, pipeline end terminations (“PLETs”) and manifolds.

Spooling .  Our experienced personnel are involved in the operation of spooling equipment on many projects, including operations for other companies to run their spooling equipment.  We have developed a very efficient (in both time and cost) system for spooling, utilizing our horizontal drive units, under-rollers, tensioners, carousels and rapid deployment cartridges.

Pull-In Operations .  We are involved in the pull-in operations for most of the major umbilical projects in the Gulf of Mexico.  Our familiarity with offshore systems is important, and our pull-ins run smoothly because the same engineers who plan the pull-in operations are also involved in supervising the offshore operations.  Our offshore servicemen comprise the topside umbilical support team and are familiar with the umbilical termination hardware.  These same servicemen are often involved in terminating the umbilicals at the manufacturers’ yard several weeks prior to the installation.  Everything is thoroughly tested prior to installation, including winches at the rental contractor’s yard and after set-up on the platform. Load cells are tested onshore, and the same load cells are used to test the system offshore. This eliminates variables and validates the condition of the pull-in system.  We then perform pull-ins under more controlled conditions with increased confidence, resulting in safer operations.

Terminations .  Deep Down and members of its team have been involved in umbilical terminations since 1988.  The Company’s team was involved with the designs for the armored thermo plastic umbilicals at Multiflex, the first steel tube umbilical in the Gulf of Mexico for the Shell Popeye® umbilical, and the standardization of many steel tube umbilical terminations.   We have also pioneered the concept of the compliant Moray® section that enables a traditional helically wound umbilical to be used for direct well step outs, or long field flying leads.  Our management believes we are the only company that can terminate umbilicals provided by any manufacturer with the same termination system.

Testing Services .  Umbilical manufacturers, control suppliers, installation contractors, and oil and gas operators utilize our services to perform all aspects of testing, including initial Factory Acceptance Testing (“FAT”), Extended Factory Acceptance Testing (“EFAT”) and System Integration Testing (“SIT”), relating to the connecting of the umbilical termination assemblies, the performing of installations, and the completion of the commissioning of the system thereafter.  To execute these services, we have assembled a variety of personnel and equipment to ensure that all testing operations are done in the safest and time-efficient manner, ensuring a reduced overall project cost.  We also work hard to utilize the most detailed digital testing and monitoring equipment to ensure that the most accurate data is provided to our clients.  As far as testing is concerned, we have been hired to perform coiled tubing flushing, cleaning, and hydro testing, umbilical filling, flushing, pressure, flow rate, and cleanliness testing, load out monitoring and testing, installation monitoring, post installation testing; system commissioning, umbilical intermediate testing, and umbilical termination assembly cleanliness, flow, and leak testing.  We believe we have one of the best filling, flushing and testing teams in the business. Deep Down employs a variety of different pumping systems to meet industry needs and offers maximum flexibility.  Deep Down’s philosophy is to flush through the maximum number of lines at the highest flow rate possible to maximize efficiency.  We have assembled a comprehensive list of offshore pumping units and an assortment of chemical pumping skids.  Our equipment can be used to pump all of the standard offshore water based chemicals as well as all offshore commissioning fluids such as Methanol and diesel.  The Company has been involved in the design, procurement, testing, installation, and operation of the testing equipment.  Deep Down’s engineers and service technicians can also assist in writing the testing procedures and sequences from simple FAT to very extensive multiple pressures and fluids testing up to full system SIT procedures.
 
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System Integration Testing .  We have led the revolution into the digital age with our use of digital transducers to provide much greater levels of accuracy compared to information gathered off of conventional chart recorders. We have a wide variety of digital pressure transducers, flow meters, and temperature gauges. We have two wire data systems (4 port and one 16 port) as well as 25 individual digital pressure and temperature recorders that are often employed for installation monitoring activities. In addition to these units, the Company also has three desks set up with data systems that are capable of tracking from 4 to 15 individual sensors simultaneously. This, in combination with subsea handling equipment, experienced personnel, and a fully equipped facility, render Deep Down ideal for managing SIT operations.

Commissioning .  Deep Down has been involved in most of the topside connections and commissioning projects in the Gulf of Mexico since its formation in 1997.  Our commissioning team is often identified early in the project and participates in all aspects of planning and risk assessment for the project.  Due to the limited time associated with project commissioning, it is extremely important to perform detailed planning and engineering prior to arrival at the offshore production platform location to reduce any possible shut in or down time.  Our engineers and technicians work closely with the project managers and production platform engineers to help ensure that all aspects of the installation or retrieval project, including potential risks and dangers, are identified, planned for, and eliminated prior to arrival on the production platform.  Due to the different requirements for testing and commissioning of subsea systems, we have an assortment of pumps and equipment to deploy to ensure a safe and efficient commissioning program.  We have experience handling all types of commissioning fluids, including asphaltine dispersants, diesel, methanol, xylene, corrosion inhibitors, water-based control fluids, oil-based control fluids, 100% glycol, paraffin inhibitors, and alcohol.

Storage Management .  With more than 50,000 square feet of internal high quality warehousing capacity and 300,000 square feet of external storage, our facility in Channelview is strategically located to cover Houston's Ship Channel area.  Our warehouse is designed to provide clients with flexible and cost effective warehousing and storage management options. Our professional and experienced warehouse staff, combined with the very latest in information technology, results in a fully integrated warehousing package designed to deliver clever solutions to client needs. Among other capabilities, we are capable of providing long-term specialized contract warehousing; long and short term storage; modern materials handling equipment; undercover loading areas; quality security systems; integrated inventory management; packing and repacking; computerized stock controls; and labeling.

Products

We provide installation support equipment and component parts and assemblies for subsea distribution systems.  We believe the key to successful installations of hardware is to design the subsea system by considering installation issues first, working backwards to the design of the hardware itself.  This is why we have been instrumental in the development of hardware and techniques to simplify deep water installations.  We design, manufacture, fabricate, inspect, assemble, test and market subsea equipment, surface equipment and offshore rig equipment that are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world.  Our products are used during oil and gas exploration, development and production operations on offshore drilling rigs, such as floating rigs and jack-ups, and for drilling and production of oil and gas wells on offshore platforms, tension leg platforms and moored vessels such as floating production storage and offloading vessels (“FPSO”).  We have significant involvement in umbilical and steel flying lead installations in the Gulf of Mexico and throughout the world.  A few of our major product lines are highlighted below.

 
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Flying Leads .  We have developed a method to pull individual steel tubes, hoses, or electrical cables to create a loose steel tube flying lead or short umbilical.  We can manufacture steel flying leads up to 10,000 feet in length with any J-plate desired, with or without electrical cables included.  We have built flying leads with up to 14 tubes.  Additional lines or electrical and fiber optic cables can be added to produce any combination required for the transportation of various fluids, chemicals or data.  The flying leads are then fitted with our terminations and Morays® that are attached to the multiple quick connection plate, and finished off with the our elastomeric bend limiters.  The non-helix wound design allows for our flying leads to be very installation friendly with minimal-bending stiffness.  A compliant Moray® consists of a 20-foot flexible flying lead with an electro-hydraulic Moray® that is connected to a full-sized umbilical with the installation tension being applied through an armor pot and slings extending by the compliant section.  A Moray® is the termination head on the flying lead and connects the tubing assembly to the junction plate.

Bend Stiffener Latchers . Our spring-loaded bend stiffener latcher is used in dynamic installations on floating vessels.  Umbilical stiffener latching mechanisms have always caused installation problems as well as expensive diver operations for expansion developments. We believe we have conceived the very first remote operated vehicle (“ROV”) installable latching mechanism.  During the umbilical installation, the bend stiffener latcher can be latched in with a ROV and the umbilical can be pulled up the remaining distance and hung off.  This allows the bend stiffener latcher to fit onto an existing flange, completely eliminating the need for divers both prior to and during the installation.  The bend stiffener latcher can be designed to fit onto any existing flange on the bottom of an existing I-tube.

Umbilical Hardware . Our operational team has been involved in more umbilical installations than probably any other team in the industry.  Our blend of experiences with drilling contractors, umbilical manufacturers, subsea engineers and installation contractors has been effective in positioning us to act on behalf of the oil and gas operator to ensure key hardware installation is performed in the most efficient and safe manner.  This breadth of experiences gives us a unique perspective when fabricating and designing terminations for umbilical manufacturers.  Our designs are often much lighter in weight and smaller than the typical hardware that has been created and used in the past by our competitors.  Our engineering team has designed and fabricated bending restrictors, armor pots, split barrels, tubing fittings and unions, hinging umbilical splices and topsides terminations with our unique threaded welded fittings, the compliant umbilical splice, and the bend stiffener latcher.  Our umbilical hardware is effective in assisting our clients with installation friendly techniques for deploying hardware on the ocean floor.

Bend Limiters .  We offer both electrometric and steel bend limiters.  Due to our ability to design and manufacture bend limiters in-house, delivery time is greatly reduced.  Steel bend limiters are typically utilized for steel tube umbilicals and have been designed with a simple and reliable hinged attachment system which significantly decreases installation time.  Electrometric bend limiters are typically provided for small diameter umbilicals or flying leads, as well as for their compliant umbilical section, which turns a traditional umbilical into a ROV- friendly, installable flying lead.

Umbilical Splice .  We have created a unique method of converting spare umbilicals into actual production umbilicals by splicing spare umbilicals together to produce any length required.  This allows oil and gas operators to save significant costs through utilization of existing capital investments in spare umbilicals and the reduction of field development costs and delivery time.  This methodology is achieved through our Compliant Splice, which is a patent-pending termination system that eliminates the burdens of dealing with umbilical splices during installation.  This design is capable of housing both electrical and fiber optic Fiber Termination Assemblies while still allowing for the splice to be spooled up onto a reel or carousel. An optional mud mat is used to assist in carrying the splice over the chute and functions to keep the splice out of the mud for easy inspection.

SeaStax® .  SeaStax embodies our concept for offshore storage and space management to help optimize available deck space on offshore installation vessels and platforms.  The key philosophy behind SEASTAX™ is to take common offshore items and store them in a standard sized container to allow for the storage system to be stackable and interchangeable in subsurface conditions.  The current system utilizes newly designed 550 gallon tote tanks, baskets, and tool boxes that are all inter-changeable and stackable.  Using common dimensions and designs allows a variety of different items to all be commonly stored and stacked, to minimize required storage area.  The stacking philosophy can be applied to other custom applications if required. In order to maximize accessibility and to reduce maintenance, a variety of options are available such as galvanizing, ladders, and drip pans.

 
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Installation Aids .  To help our clients and to meet our own internal needs, we have developed an extensive array of installation aids, including steel flying lead installation systems, a 5 ton Caterpillar® tensioner, a 10-foot radius lay chute with work platform, many varieties of buoyancy, clump weights, VIV strakes, mud mats, dual tank skids, gang boxes, work vans, pumping and testing skids, control booths, fluid drum carriers, crimping systems, load cells,  300 and 340 - ton under-rollers, a 200 - ton carousel, UTA running and parking deployment frames, termination shelters, pipe straightners, ROV hooks and shackles, stackable SeaStax tanks, baskets, and boxes, and ballgrab rental rigging.

Services and Products from Acquisitions

Through our acquisitions of Mako and ElectroWave we have further increased our service and product offerings.  Several of such increased offerings are described below.

Mako

Headquartered in Morgan City, Louisiana, Mako serves the growing offshore petroleum and marine industries with technical support services and products vital to offshore petroleum production.  Mako’s offerings are primarily, through rentals of its remotely operated vehicles ("ROV"), topside and subsea equipment, and support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys.

Diving Equipment Rental.   Mako employs a permanent staff of highly qualified technicians and mechanics to maintain and refurbish its equipment in between rentals.  Mako carries a wide array of equipment to service the diving industry including water blasting equipment, breathing air dive compressors, hot water units with feed pumps, man rider winches, hydraulic tools and hose reels, underwater video units, sonar units, magnetic gradiometers, dive radios, lift bags, volume tanks, decompression chambers, hot water pressure washers, and saturation systems.

Offshore Construction Equipment Rental.   Mako carries a wide array of equipment to service the offshore construction industry, including air compressors, air tuggers, blasting equipment, jet pumps, personnel baskets, air tools, welding machines, diesel pumps, and air pumps.

ROV Equipment Rental.   Mako provides the latest ROV tooling technology as part of its rental fleet.  Mako's ROV tooling rental fleet is constantly growing, with the addition of tools as they are requested by our customers.  Mako has, as part of its rental inventory, a 2000-foot depth-rated inspection / light work class remotely operated vehicle (ROV) complete with a control van and launch / recovery system.  Mako also has, as part of its inventory, a 300 meter depth-rated Seaeye Falcon and a 1500 meter depth rated Seaeye Lynx observation class ROV.  ROV services offered by Mako include platform inspection [Level I, II and III, jack-up and template], platform installation and abandonment, surveys [environmental, pipeline existing and as built, oceanographic, nuclear and hydroelectric], search and recovery, salvage, subsea intervention [hot stab operations, torque tool, well, pipeline commissioning, and stack landings], telecommunication cable inspections [existing and as built], research [fisheries, scientific and marine archeology], anchor handling [mooring and anchor chain monitoring], ROV consulting and project management, ROV pilots and technicians, and underwater cinematography.  Mako provides an extensive line of ROV tools, ROV clamps and ROV-friendly hooks and shackles.  Mako’s torque tools are state-of-the-art in design.

Environmental Equipment Rental.   Mako offers a line of equipment that is specifically designed and built to service the demanding requirements of the environmental industry.  Systems are built in-house, housed on skids and include protective frames to ensure that the equipment is well suited for the job site.  All rental equipment goes through extensive cleanup and overhaul between rentals, ensuring that when it arrives on site, its ready to go and will perform reliably.

Marine Surveys.   Mako provides the offshore industry with a responsive marine survey service.  Mako’s surveyors have extensive experience in the marine industry, and provide a reliable and timely service, encompassing on-and-off hire surveys, damage surveys, engine surveys, loading / securing of cargo (warranty), trip and tow, suitability surveys, valuation surveys, hull audio gauging, owner representatives, and regulatory vessel compliance.

 
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ElectroWave

ElectroWave offers products and services in the fields of electronic monitoring and control systems for the energy, military, and commercial business sectors.  ElectroWave designs, manufactures, installs, and commissions integrated Programmable Logic Controller (“PLC”) and Supervisory Control and Data Acquisition (“SCADA”) based instrumentation and control systems, including ballast control and monitoring, drilling instrumentation, vessel management systems, marine advisory systems, machinery plant control and monitoring systems, and closed circuit television systems.  ElectroWave can take projects from conceptual/system design through installation, commissioning, and support. ElectroWave's understanding of system requirements and its ability to quickly understand its customer’s needs allows them to produce quality products and services on time and on budget.

ElectroWave has supplied equipment on drilling production rigs operating throughout the world including Abu Dhabi, Angola, Australia, Azerbaijan, Brazil, Congo, Dubai, Egypt, Equatorial Guinea, India, Indonesia, Kuwait, Mexico, Nigeria, Norway, Russia, the United Kingdom, United States, Vietnam, and other areas. ElectroWave is also a supplier of integrated marine systems for ships with design, manufacture, and delivery of machinery plant control and monitoring systems and/or alarm monitoring systems for 3 Molinari Class Staten Island ferries, a United States Coast Guard ice breaker, one of the worlds largest hopper dredges, and other vessels.

Below are some of ElectroWave’s major products:

Drillers Display System .  ElectroWave has two proprietary drillers display systems.  One of the proprietary systems was provided by one of our customers and is installed only on that customer’s rigs.  The other proprietary drillers display system was developed internally and is installed in rigs worldwide. Drillers display systems allow the driller to keep an eye on all the important parameters required for monitoring activity. Viewing of mud pits, trip pits, flow rates, weight on bit, hook load, and other activities are available to the driller at a glance. Logging software provides data analysis at a whole new level, bringing more efficient drilling operations and increased production from each working rig. Over 30 of these systems are installed on our customers' rigs world wide, having over 800 rig-months of operating time, over 1 million hours of cumulative up-time, with a total down time of 2.5 hours.  Our two largest customers for ElectroWave’s drillers display systems are Transocean Offshore and Diamond Offshore Drilling.

Machinery Plant Control System .  The Machinery Plant Control and Monitoring Systems (MPCMS) allow the operators of a vessel to reduce manning requirements by integrating all of the machinery controls and monitoring systems into one. The MPCMS can reduce the number of crew on one vessel by more than 50%, allowing the vessel owner to save personnel expenses or allocate personnel to more critical areas.  ElectroWave's largest MPCMS system consists of over 5,000 points, consisting of hard wired sensors, contacts, and data over industrial protocols such as Ethernet, Modbus, and Profibus.  We have integrated systems such as fire, flooding, ballast, fueling, bridge, propulsion, engines, HVAC, deck machinery, air systems, emergency generators, lighting, and more, into one system.  An entire vessel can now almost be operated from one station by a very minimal crew.  Our MPCMS is currently in use on the United States Coast Guard Ice Breaker Mackinaw.

Ballast Console .  ElectroWave designs replacement ballast control consoles for a number of customers. The consoles they are replacing have fallen out of service and are typically only partially functioning. ElectroWave first sends out a technician to perform a "site survey" during which our technician will take copious notes about the existing installation, all of the wiring, and any manuals that exist for the system. Our team then brings this information back to our facility where we design replacement consoles that fit exactly where the old console was, reducing hot work and re-wiring.  After designing a new console, drawings are sent to the rig managers, electricians, and company electricians for verification. After drawings are verified, the console is released for production. Upon receiving the console at our factory, our electricians (some of which are ex-rig electricians) wire the console to match the old system wiring. After through testing at our factory, the console is shipped to the customer where it is installed by our field service personnel. The new console is wired to operate exactly like the old system to reduce re-training of ballast control officers and rig hands. After the console is commissioned, our technicians will provide any support and training necessary before leaving the site.  We have installed ballast control systems that are full touch screen capable, operating over 80 valves and more than 30 tanks. We have these type systems installed on the Coast Guard Ice Breaker Mackinaw, and the 3 Molinari Class Staten Island Ferries, the Molinari, Marchi, and Spirit of America.

 
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CCTV System .  ElectroWave has tackled some very difficult CCTV security and monitoring requirements.  Post-911, the New York Department of Transportation (NYDOT) wanted cameras to watch every available compartment of their three new ferries. ElectroWave stepped up to the challenge and provided NYDOT one of the most sophisticated CCTV systems available on passenger transportation ferries. A system of cameras, coupled with digital video recording, allow post-event tracing and security on one of the most-used transportation devices in New York.  CCTV is more than just security, many (if not all) oil rigs have CCTV systems installed to keep an eye on the safety of those working on the rig.  Cameras watch unmanned spaces, machinery spaces, and potential hazard zones for trouble. This helps to keep the manning requirement on the rigs to a minimum while allowing for a safer working environment.  ElectroWave typically provides Pelco camera systems, but is capable of integrating existing camera systems into new CCTV installations. ElectroWave has also developed hardware and software in-house to allow the use of Pan/Tilt/Zoom cameras from hazardous locations where PTZ keyboards cannot be installed.

Ballast Monitoring System .  ElectroWave has designed and implemented numerous ballast monitoring systems.  A ballast monitoring system is a method of displaying the contents of the tanks on board the vessel.  The systems provided by ElectroWave ranges from simple racks of bubbler style display units to integrated PLC touch screen systems visible throughout the vessel. ElectroWave has also offered automated tank reporting systems with our electronic PLC monitoring systems, allowing the operators to keep a liquid load sheet available at any time.

Active Heave Compensation .  ElectroWave was approached to implement an algorithm to perform Active Heave Compensation. An "Active Heave Compensator", or AHC, is designed to reduce or eliminate (in this case eliminate) the effects of vessel heave during overboarding operations. This means that a package can be held at a specific location in the water without the motion of the vessel on the waves affecting the position of the package.  The customer identified the operational tolerance of the system to be 6" of movement of the package with vessel heave of approximately 20 feet. The system that was implemented is accurate to 0.6" of package movement with vessel heave up to 30 feet. ElectroWave always delivers products to the best of our ability, often exceeding customer requirements and expectations.  ElectroWave implemented an Allen Bradley PLC system to take data from a Motion Reference Unit (MRU) and drive hydraulic actuators to compensate for the movement of the vessel.

Manufacturing

Our manufacturing facilities are in Channelview, Texas, a suburb of Houston, where we conduct a broad variety of processes, including machining, fabrication, inspection, assembly and testing. Our Manufactured Systems Division is devoted to the design, manufacturing, testing, and commissioning of heavy equipment used in both on- and offshore operations in a variety of markets and industries. The manufacturing personnel have over 50 years of combined experience serving commercial, government, military and academic customers in a variety of applications. The facilities encompass over 8 acres, with approximately 60,000 square feet of manufacturing space with 4 overhead cranes and 7,000 square feet of office space. The Company is ideally located with great access to both I-10 and the Houston Ship Channel. The facilities have 120V, 240V and 480V power.  Our manufacturing plant is ISO 9001 and American Petroleum Institute certified.

Our manufacturing facility utilizes state-of-the-art computer numerically controlled ("CNC") machine tools and equipment, which contribute to the Company's product quality and timely delivery.  We maintain our equipment and tooling in good working condition and upgrade our capabilities as needed to enhance the cost-efficient manufacture of our specialized products. We purchase quality used machine tools and equipment as they become available and store them at our facility to be rebuilt, upgraded or refurbished as needed.  We maintain our high standards of product quality through the use of quality assurance specialists who work with product manufacturing personnel throughout the manufacturing process and inspect and document equipment as it is processed through the Company's manufacturing facility.  We have the capability to manufacture various products from each of our product lines at our major manufacturing facility and believe that this localized manufacturing capability is essential in order to compete with our major competitors.  We maintain valuable relationships with several other companies that own additional fabrication facilities in and around Houston, Texas.  These other companies provide excellent subcontract manufacturing support on an as-needed basis.  Our manufacturing process includes heat treatment, machining, fabrication, inspection, assembly and testing.  Our primary raw material is steel. We routinely purchase raw materials from many suppliers on a purchase order basis and do not have any long-term supply contracts.

 
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Customers

Demand for our deep water equipment, surface equipment and offshore rig equipment and services is substantially dependent on the condition of the oil and gas industry to invest in substantial capital expenditures as well as continual maintenance and improvements on its offshore exploration, drilling and production operations. The level of these expenditures is generally dependent upon various factors such as expected prices of oil and gas, exploration and production costs of oil and gas, the level of offshore drilling and production activity.  The prevailing view of future oil and gas prices are influenced by numerous factors affecting the supply and demand for oil and gas.  These factors include worldwide economic activity, interest rates, cost of capital, environmental regulation, tax policies, and production levels and prices set and maintained by producing nations and OPEC.  Capital expenditures are also dependent on the cost of exploring for and producing oil and gas, the sale and expiration dates of domestic and international offshore leases, the discovery rate of new oil and gas reserves in offshore areas and technological advances. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility.

Our principal customers are major integrated oil and gas companies, large independent oil and gas companies, foreign national oil and gas companies, subsea equipment manufacturers and subsea equipment installation contractors involved in offshore exploration, development and production.  Offshore drilling contractors, engineering and construction companies, the military and other companies involved in maritime operations represent a smaller customer base.  Our customers include Acergy SA; Aker Kvaerner ASA; Amerada Hess Corporation; Anadarko Petroleum Corporation; Atlantic Shipyard; BHP Billiton Limited; BP PLC; Cabett Subsea Products, Inc.; Cal Dive International, Inc.; Cameron International Corporation; Chevron Corporation; Devon Energy Corporation; Diamond Offshore Drilling, Inc.; Dril-Quip, Inc.; Duco Inc.; ExxonMobil Corporation; Helix Energy Solutions Group Inc.; JDR Cable Systems (Holdings) Ltd; Kerr McGee Corporation; Marathon Oil Corporation; Marinette Marine Corporation; Nexen Inc.; Noble Energy Inc.; Oceaneering International, Inc.; Oil States Industries, Inc.; Royal Dutch Shell PLC; Schlumberger Limited; Subsea 7, Inc.; Technip USA Holdings, Inc.; TransOcean Offshore Inc.; United States Coast Guard; Veolia Environmental Services, Inc. and United States Navy.

We are not dependent on any one customer or group of customers. The number and variety of our products required in a given period by a customer depends upon their capital expenditure budget as well as the results of competitive bids. Consequently, a customer may account for a material portion of revenues in one period and may represent an immaterial portion of revenues in a subsequent period. While we are not dependent on any one customer or group of customers, the loss of one or more of its significant customers could, at least on a short-term basis, have an adverse effect on the results of our operations.

Marketing and Sales

We market our products and services throughout the world directly through our sales personnel in our corporate headquarters in Channelview, Texas. We periodically advertise in trade and technical publications of our customer base.  We also participate in industry conferences and trade shows to enhance industry awareness of our products and services.  Our customers generally order products and services after consultation with us on their project.  Orders are typically completed within two weeks to three months depending on the type of product or service.  Larger and more complex products may require four to six months to complete.  Our customers select our products and services based on the quality, reliability and reputation of the product or service, price, timely delivery and advance technology.  For large drilling and production system orders, we engage our project management team to coordinate customer needs with engineering, manufacturing and service organizations, as well as with subcontractors and vendors.  Our profitability on projects is dependent on performing accurate and cost effective bids as well as performing efficiently in accordance with bid specifications.  Various factors can adversely affect our performance on individual projects that could potentially adversely affect the profitability of a project.

 
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Product Development and Engineering

The technological demands of the oil and gas industry continue to increase as offshore exploration and drilling operations expand into deeper and more hostile environments.  Conditions encountered in these environments include well pressures of up to 15,000 psi, mixed flows of oil and gas under high pressure that may also be highly corrosive, and water depths in excess of 5,000 feet.  We are continually engaged in product development activities to generate new products and improve existing products to meet our customers’ specific needs.  We also focus our activities on reducing the overall cost to the customer, which includes not only the initial capital cost but also operating costs associated with its products.

We have an established track record of introducing new products and product enhancements.  Our product development work is conducted at our facilities in Channelview, Texas and in the field.  Our application engineering staff also provides engineering services to customers in connection with the design and sales of our products.  Our ability to develop new products and maintain technological advantages is important to our future success.

We believe that the success of our business depends more on the technical competence, creativity and marketing abilities of our employees than on any individual patent, trademark or copyright.  Nevertheless, as part of our ongoing product development and manufacturing activities, our policy is to seek patents when appropriate on inventions concerning new products and product improvements.  All patent rights for products developed by employees are assigned to us.

Competition

The principal competitive factors in the petroleum drilling and production and maritime equipment markets are quality, reliability and reputation of the product, price, technology, the ability to provide quality service and timely delivery.  We face significant competition from other manufacturers of exploration, production and maritime equipment.  Several of our primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources and have a longer history in the manufacturing.  We compete principally with Dynacon, FMC, Halliburton Product Pipeline Services, Kvaerner, Norson, Ocean Works, Oceaneering, VFL, and Halliburton Product Pipeline Services on our umbilical services; Dynacon, Ocean Works and Odem on our Launch and Recovery Systems; and Entech, Technip, Manatec and Pegasus on our installation management services.

Employees

We have 94 employees as of March 31, 2008.  Our employees are not covered by collective bargaining agreements and we consider our employee relations to be good.  Our operations depend in part on our ability to attract a skilled labor force.  While we believe that our wage rates are competitive and that our relationship with our skilled labor force is good, a significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force, increases in the wage rates that we pay or both.

Governmental Regulations

A significant portion of our business activities are subject to federal, state, local and foreign laws and regulations and similar agencies of foreign governments.  The technical requirements of these laws and regulations are becoming increasingly expensive, complex and stringent.  These regulations are administered by various federal, state and local health and safety and environmental agencies and authorities, including the Occupational Safety and Health Administration of the U.S. Department of Labor and the U.S. Environmental Protection Agency.  From time to time, we are also subject to a wide range of reporting requirements, certifications and compliance as prescribed by various federal and state governmental agencies.  Expenditures relating to such regulations are made in the normal course of our business and are neither material nor place us at any competitive disadvantage. We do not currently expect compliance with such laws will require us to make material expenditures.

We are also affected by tax policies, price controls and other laws and regulations relating to the oil and gas industry generally, including those specifically directed to offshore operations.  Adoption of laws and regulations that curtail exploration and development drilling for oil and gas could adversely affect our operations by limiting demand for our services or products.

 
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Increased concerns about the environment have resulted in offshore drilling in certain areas being opposed by environmental groups, and certain areas have been restricted.  To the extent that new or additional environmental protection laws that prohibit or restrict offshore drilling are enacted and result in increased costs to the oil and gas industry in general, our business could be materially affected.  In addition, these laws may provide for "strict liability" for damages to natural resources or threats to public health and safety, rendering a party liable for the environmental damage without regard to negligence or fault on the part of such party.  Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative or civil penalties and criminal prosecution.  Certain environmental laws provide for joint and several strict liabilities for remediation of spills and releases of hazardous substances.  In addition, companies may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, as well as damage to natural resources.  Such laws and regulations may also expose us to liability for the conduct of or conditions caused by others, or for our acts that were in compliance with all applicable laws at the time such acts were performed.  Compliance with environmental laws and regulations may require us to obtain permits or other authorizations for certain activities and to comply with various standards or procedural requirements.

We cannot determine to what extent our future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations.  We believe that our facilities are in substantial compliance with current regulatory standards.  Based on our experience to date, we do not currently anticipate any material adverse effect on our business or consolidated financial position as a result of future compliance with existing environmental laws and regulations controlling the discharge of materials into the environment.  However, future events, such as changes in existing laws and regulations or their interpretation, more vigorous enforcement policies of regulatory agencies, or stricter or different interpretations of existing laws and regulations, may require additional expenditures which may be material.

Item 2. Description of Property.

Our principal corporate offices and manufacturing space are located at 15473 East Freeway, Channelview, Texas 77530.  We lease the Channelview property which consists of approximately 10.998 acres of land with approximately 60,000 square feet of manufacturing space with four overhead cranes and 7,000 square feet of office space.  We lease all buildings, structures, fixtures and other improvements from JUMA, LLC, a company owned by Ronald E. Smith, CEO and a director of Deep Down, Inc. and Mary L. Budrunas, a vice president and a director of Deep Down, Inc.  The base rate of $11,000 per month is payable to JUMA through September 1, 2011, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.

ElectroWave’s offices and manufacturing space is located at the same location of Deep Down at 15473 East Freeway, Channelview, Texas 77530.  ElectroWave’s facilities are also included in the lease with JUMA, LLC.

Mako Technologies, LLC leases its property and buildings from Sutton Industries.  Mako is located at 125 Mako Lane, Morgan City, LA 70380.  The lease is for 5 years beginning on June 1, 2006.  There is a 5 year option at the expiration of the initial lease. At this location, Mako has its administrative offices and buildings that serves as the support location for the Mako rental equipment.

Item 3.                 Legal Proceedings.

We are from time to time involved in legal proceedings arising from the normal course of business. As of the date of this report, we are not currently involved in any legal proceedings.

Item 4.                 Submission of Matters to a Vote of Security Holders.

No matter was submitted to vote of our security holders during the fourth fiscal quarter covered by this report.

 
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PART II

Item 5.                 Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities.

Market for Common Stock

Our common stock trades publicly on the OTC Bulletin Board under the symbol “DPDW.” The OTCBB is a regulated quotation service that displays real-time quotes, last-sale prices and volume information in over-the-counter equity securities. The OTCBB securities are traded by a community of market makers that enter quotes and trade reports. This market is extremely limited and any prices quoted may not be a reliable indication of the value of our common stock.

Prior to the reverse merger with MediQuip on December 14, 2006, no public market in our common stock existed. See the discussion of the reverse merger under Corporate History in Item 1 and in Note 1 “Nature of Business” of the notes to our audited consolidated financial statements included elsewhere in this report. Beginning December 14, 2006, our common stock was quoted on the OTC Bulletin Board. The high and low bids for the period from January 1 to December 31, 2007 were $2.35 and $0.16, respectively. These quotes represent inter-dealer quotations, without adjustment for retail mark-up, markdown or commission and may not represent actual transactions.  The following table sets, for the periods indicated, the high and low sales prices for our common stock as reported by the OTC Bulletin Board.

   
High
   
Low
 
Fiscal 2007:
           
December 31, 2007
 
$
2.35
   
$
0.76
 
September 30, 2007
 
$
0.94
   
$
0.51
 
June 30, 2007
 
$
0.78
   
$
0.27
 
March 31, 2007
 
$
0.42
   
$
0.16
 
Fiscal 2006:
               
December 31, 2006
 
$
0.85
   
$
0.13
 
 
Holders

As of March 31, 2008, there were approximately 1,077 holders of record of our common stock and we believe there were approximately 6 beneficial owners.
 
Dividend Policy
 
To date, we have not paid any cash dividends and our present policy is to retain earnings for use in our business.  Under the terms of a $13 million borrowing facility from Prospect Capital Corporation, we are restricted from paying any dividends on our common stock until such time as the borrowing facility is repaid in full.

 
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Equity Compensation Plan Information
 
Plan Category
 
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
   
Weighted-average
exercise price of
outstanding options,
warrants and rights
   
Number of securities
remaining available
for future issuance
under equity compensation plans
(excluding securities reflected in first column)
 
Equity compensation plans approved by securityholders
    5,500,000 (1)   $ 0.49       7,396,000 (1)
Equity compensation plans not approved by securityholders
    5,399,397 (2)   $ 0.52       N/A  
TOTAL
    10,899,397     $ 0.56       7,396,000  
____________
(1)
Represents 5,500,000 shares of common stock that may be issued pursuant to options granted and available for future grant under - the 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan (the “Plan”). Under the Plan the total number of options permitted is 15% of issued and outstanding shares of common stock.
   
(2)
Represents 5,399,397 shares of common stock underlying warrants approved by the Company’s board of directors, consisting of 4,960,585 warrants granted to Prospect Capital Corporation and 320,000 warrants granted to a consultant as part of the $6.5 million borrowing facility entered into on August 6, 2007, plus an additional 118,812 warrants granted to a consultant as part of the additional $6.0 million advanced under the amendment to that same borrowing facility effective December 31, 2007.  See Note 6 to our Consolidated Financial Statements for a detailed description of the terms of these warrants.
 
Recent Sales of Unregistered Securities

On March 20, 2007, Deep Down completed the sale of 10,000,000 restricted shares of common stock in a private placement for $1,000,000. A total of 1,025,000 shares were purchased by the Chief Executive Officer and director, and his wife, a Vice-President of Deep Down. Funds were used to redeem certain outstanding exchangeable preferred stock and for working capital.

On March 20, 2007, Deep Down finalized the terms of an agreement with a former director, who agreed to return 25,000,000 shares of common stock, 1,500 shares of Series F convertible preferred stock, and 500 shares of Series G exchangeable preferred stock to the treasury for cancellation in exchange for 1,250 shares of Series E exchangeable preferred stock and $250,000 cash.  Separately, John C. Siedhoff, former Deep Down Chief Financial Officer, agreed to exchange 1,500 shares of Series F convertible preferred stock and 500 shares of Series G exchangeable preferred stock for 2,000 shares of Series E exchangeable preferred stock.

On May 17, 2007, Deep Down executed a Securities Redemption Agreement with John C. Siedhoff, former Deep Down CFO, to redeem 4,000 shares of Series E exchangeable preferred stock at a discounted price of $500 per share for a total of $2,000,000. The discount of $500 per share from the face value of $1,000 was accounted for as a substantial modification of debt, thereby generating a gain on extinguishment of debt which is reflected as other income on the statement of operations. Deep Down accreted the remaining discount of $1,102,385 attributable to such shares on the date of redemption. On August 16, 2007, Deep Down made the initial payment of $1,400,000 under the terms of the securities redemption agreement, and 2 payments of $20,000 each were made during August and September 2007. The final balance due of $560,000 was paid with 543,789 shares of common stock on October 2, 2007.

 
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On September 17, 2007 Deep Down exchanged 2,250 shares ($2,250,000 aggregate face value) of Series E Redeemable Exchangeable Preferred Stock from Ronald E. Smith, president and chief executive officer of Deep Down, and Mary L. Budrunas, director of Deep Down, for 2,250,000 shares of common stock.  The Preferred Stock had a face value and liquidation preference of $1,000 per share, no dividend preference, and was exchangeable at the holder’s option after June 30, 2007, into 6% subordinated notes due three years from the date of exchange.

On October 2, 2007, Ironman Energy Capital, L.P. agreed to purchase 3,125,000 restricted shares of common stock of the Company at $0.96 per share, or $3,000,000 in the aggregate.  Proceeds were used primarily for working capital and other general corporate purposes.

On October 2, 2007, Deep Down exchanged 1,250 shares ($1,250,000 aggregate face value) of Series E Redeemable Exchangeable Preferred Stock for 1,213,592 shares of common stock.  The Preferred Stock had a face value and liquidation preference of $1,000 per share, no dividend preference, and was exchangeable at the holder’s option after June 30, 2007, into 6% subordinated notes due three years from the date of exchange.

On October 2, 2007, Deep Down agreed to eliminate an obligation to pay $20,000 per month for the next 28 months, or an aggregate of $560,000, by exchanging this obligation for 543,689 shares of common stock.  This obligation arose out of a series of transactions as disclosed above on May 17, 2007.

On April 22, 2005, MediQuip issued 22,000 Series C convertible preferred stock which remained after the reverse merger. The Series C shares had a face value and a liquidation preference of $12.50 per share, a cumulative dividend of 7% payable at the conversion date, and were convertible into shares of common stock determined by dividing the face amount by a conversion price of $0.0625. These shares carried no voting rights.  All of the Series C shares were converted in the fourth quarter of fiscal 2007 to 4,400,000 shares of Deep Down’s common stock.

Effective December 1, 2007, Deep Down purchased 100% of the common stock of Mako Technologies, Inc. (“Mako”), a Louisiana corporation.  The total purchase price of Mako was $11,307,000. The first installment of $2,916,667 in cash and 6,574,074 shares of common stock of Deep Down, valued at $0.76 per share was paid on January 4, 2008, and the balance of $3,205,667 made up of $1,243,578  in cash and 2,802,985 shares of common stock of Deep Down valued at $0.70 will be paid by April 15, 2008.  The second payment was based on verification of adjusted EBITDA amounts for Mako for the fiscal year ending December 31, 2007.

In January and March 2008, Deep Down issued 25,866,518 shares of common stock to the holders of 5,000 shares of Series D preferred stock.  The Series D preferred shares had a face and liquidation value of $5,000 per share and were convertible into common stock at a conversion price of $0.1933 per share.

Item 6.                 Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Corporate History

During 2006, MediQuip Holdings, Inc. (“MediQuip”), a publicly traded Nevada corporation, divested Westmeria Healthcare Limited, its wholly-owned operating subsidiary, and subsequently acquired Deep Down, Inc., a Delaware corporation, in a transaction that was accounted for as a reverse merger, with Deep Down being the surviving entity for accounting purposes. The following discussion describes the history of Deep Down.

On June 29, 2006, Subsea Acquisition Corporation (“Subsea”), a Texas corporation, was formed with the intent to acquire offshore energy service providers, and designers and manufacturers of subsea equipment, surface equipment and offshore rig equipment that are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world.

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

On November 21, 2006, Subsea also acquired Deep Down, Inc., a Delaware corporation which was founded in 1997. Under the terms of this transaction, Subsea acquired all of Deep Down’s common stock in exchange for 5,000 shares of Subsea’s Series D Preferred Stock and 5,000 shares of Subsea’s Series E Preferred Stock resulting in Deep Down becoming a wholly-owned subsidiary of Subsea.  The transaction was accounted for under SFAS 141, “Business Combinations,” as a purchase as there was a change of control.  The purchase price, based on the fair value of the Series D and E Preferred stock, was $7,865,471.
 
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Immediately after acquiring Deep Down and SOS on November 21, 2006, Subsea merged with SOS, with Subsea as the surviving company.  Immediately thereafter, Subsea merged with Deep Down, with Deep Down as the surviving company.

On December 14, 2006, after divesting its Westmeria Healthcare Limited subsidiary, MediQuip acquired all 9,999,999 shares of Deep Down common stock and all 14,000 shares of Deep Down preferred stock for 75,000,000 shares of common stock and 14,000 shares of preferred stock of MediQuip. The preferred shares of MediQuip were issued with the same designations as Deep Down’s preferred stock.  As a result of the acquisition, the shareholders of Deep Down owned a majority of the voting stock of MediQuip, which changed its name to Deep Down, Inc.

On April 2, 2007, Deep Down acquired substantially all of the assets of ElectroWave USA, Inc., a Texas corporation for a total purchase price of $171,407. Deep Down formed a wholly-owned subsidiary, ElectroWave USA, Inc. (“ElectroWave”), a Nevada corporation, to complete the acquisition.  Headquartered in Channelview, Texas, ElectroWave offers products and services involving electronic monitoring and control systems for the energy, military, and commercial business markets.

Effective December 1, 2007, Deep Down acquired all of the common stock of Mako Technologies, Inc. (“Mako”) for a total purchase price of $11.3 million including transaction fees.  Deep Down formed a wholly-owned subsidiary, Mako Technologies, LLC to complete the acquisition.  Headquartered in Morgan City, Louisiana, Mako serves the growing offshore petroleum and marine industries with technical support services, and products vital to offshore petroleum production, through rentals of its remotely operated vehicles (“ROV”), topside and subsea equipment, and diving support systems used in diving operations, maintenance and repair operations, offshore construction, and environmental/marine surveys.

The Company’s historical financial statements reflect those of Deep Down, Inc. and its subsidiaries, and do not include the results of MediQuip or Westmeria Healthcare Limited for periods prior to the reverse merger date of December 14, 2006.

Critical Accounting Policies

The accompanying discussion and analysis of our financial condition and results of operations is based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 1 “Nature of Business and Summary of Significant Accounting Policies” of the notes to our audited consolidated financial statements included elsewhere in this report contain a detailed summary of our significant accounting policies. We utilize the following critical accounting policies in the preparation of our financial statements.

Accounts Receivable   We provide an allowance for doubtful accounts on trade receivables based on historical collection experience and a specific review of each customer’s trade receivable balance.

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

Long-Lived Assets   We evaluate long-lived assets for impairment whenever changes in circumstances indicate that the carrying amount of the asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset.  If assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts exceed the fair values of the assets.  Assets to be disposed are reported at the lower of carrying values or fair values, less costs of disposal.

Stock-Based Compensation   We account for stock-based compensation issued to employees and non-employees as required by SFAS No. 123(R) “Accounting for Stock Based Compensation.” Under these provisions, we record expense ratably over the requisite service period based on the fair value of the awards determined at the grant date (net of estimated forfeitures) utilizing the Black-Scholes-Merton pricing model for options and warrants.  Key assumptions include (1) expected volatility (2) expected term (3) discount rate and (4) expected dividend yield.
 
-18-

 
Revenue Recognition   We recognize fabrication and sale of equipment revenue upon transfer of title to the customer which is upon shipment or when customer-specific acceptance requirements are met. Service revenue is recognized as the service is provided. All intercompany revenues are eliminated in consolidation for those periods for which consolidated results are applicable.

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

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

Our intangible assets consist of assets acquired in the purchase of the Mako subsidiary and comprised of customer lists, non-compete covenants with key employees and trademarks related to Mako’s ROVs.  We amortize the intangible assets over their useful lives ranging from 5 to 25 years on a straight line basis.

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

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

Pro-Forma Results of Operations

On November 21, 2006, Subsea, a company formed on June 29, 2006, acquired Deep Down, Inc., which was founded in 1997. The transaction was accounted for as a purchase according to SFAS 141, “Business Combinations”, as there was a change of control.

As a result, the audited financial results disclosed herein present operating results for the period beginning November 21, 2006 and ending December 31, 2006, the period after which Deep Down was acquired. Management believes this stub period does not give a full view of the operations of Deep Down and, therefore, present pro-forma results of operations. The following presentation and discussion of the unaudited pro-forma consolidated results of operations has been prepared as if the acquisition of Deep Down had occurred at January 1, 2006. The pro-forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

 
-19-

 

Deep Down, Inc.
Pro-forma Statements of Operations
 
 
   
Historical Results
   
Unaudited
Pro-forma
 
   
Year Ended
   
Year Ended
 
   
December 31, 2007
   
December 31, 2006
 
             
Revenues
 
$
19,389,730
   
$
8,821,149
 
Cost of sales
   
13,020,369
     
5,155,399
 
Gross profit
   
6,369,361
     
3,665,750
 
                 
Operating expenses:
               
Selling, general & administrative (1)
   
4,284,553
     
5,710,324
 
Depreciation
   
426,964
     
166,468
 
Total operating expenses
   
4,711,517
     
5,876,792
 
                 
Operating income (loss)
   
1,657,844
     
(2,211,042
)
                 
Other income (expense):
               
Gain on debt extinguishment
   
2,000,000
     
-
 
Interest income
   
94,487
     
-
 
Interest expense (2)
   
(2,430,149
)
   
(578,335
)
Total other income (loss)
   
(335,662
)
   
(578,335
)
                 
Income (loss) before income taxes
   
1,322,182
     
(2,789,377
)
                 
Income tax expense
   
(369,673
)
   
(22,250
)
Net income (loss)
 
$
952,509
   
$
(2,811,627
)
                 
                 
Basic earnings per share
 
$
0.01
   
$
(0.04
)
Weighted-average shares outstanding
   
73,917,190
     
75,862,484
 
                 
Diluted earnings per share
 
$
0.01
   
$
(0.04
)
Weighted-average shares outstanding
   
104,349,455
     
75,862,484
 
                 
 
(1) Includes $3.3 million compensation expense from the issuance of Series F and G preferred shares in 2006.
 
(2) Includes approximately $423,258 additional interest expense from the accretion of the Series E preferred shares in 2006.
 
 
 
-20-

 

The following discussion of the unaudited pro-forma consolidated results of operations has been prepared as if the acquisition of Deep Down had occurred at January 1, 2006. The pro-forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

Revenues

   
2007
 
Pro-Forma 2006
 
Change
 
%
 
Revenues
 
$
19,389,730
 
$
8,821,149
 
$
10,568,581
   
119.8%
 
 
Revenues increased by approximately $10.6 million, or 119.8% to $19.4 million for the twelve months ended December 31, 2007 from approximately $8.8 million for the comparable period in 2006. This increase was due primarily to a significant increase in the Company’s core operations at its Deep Down Delaware subsidiary, including increased revenue from the delivery of loose tube steel flying leads; new products such as launch and retrieval systems and an active heave compensated in-line winch system, winch system refurbishments, and increased acceptance of newly developed installation procedures utilizing our rapid deployment cartridges and subsea deployment baskets.  In addition, we experienced increased levels of service activity related to installations and recoveries of various subsea equipment.  These results were further augmented by ElectroWave revenue of approximately $3.2 million for the nine months since acquisition and Mako revenue of $0.8 million for the one month since acquisition.

Cost of sales

   
2007
 
Pro-Forma 2006
 
Change
 
%
 
Cost of sales
 
$
13,020,369
 
$
5,155,399
 
$
7,864,970
   
152.6%
 

As a percentage of revenues, cost of sales increased to approximately 67.1% in 2007 from approximately 58.4% in 2006.  Gross margins were impacted by increased engineering and other costs associated with new product development, including our new line of Proteus™ custom-engineered active heave compensated in-line winches, deep water rated (4000 meter) launch and retrieval systems, and other products in development. Management expects gross margins on these products to increase on future orders.  Management also expects overall margins to increase as a result of its recent acquisition of Mako’s rental and service operations.

Selling, general and administrative expenses

   
2007
 
Pro-Forma 2006
 
Change
 
%
 
Selling, general and administrative
 
$
4,284,553
 
$
5,710,324
 
$
(1,425,771
 
-25.0%
 
Stock based compensation expense
   
(187,394
)
 
(3,340,792
)
 
3,153,398
   
-94.4%
 
Selling, general and administrative
 
$
4,097,159
 
$
2,369,532
 
$
1,727,627
   
72.9%
 

Selling, general and administrative expenses include rent, utilities, general office expenses, insurance, personnel and other costs necessary to conduct business operations.  Stock-based compensation expense of approximately $0.2 million in fiscal 2007 relates to stock option grants during fiscal 2007 to various consultants and employees, and the $3.3 million stock-based compensation expense for fiscal 2006 related to the Series F and G Preferred Stock which was issued in exchange for the acquisition of 100% of the common stock of Strategic Offshore Services Corporation.  See further discussion of the fiscal 2006 transaction in Corporate History above.

After adjusting for the stock based compensation expense, selling, general and administrative expenses for the year ended December 31, 2007 was approximately $4.0 million, up approximately $1.7 million from $2.4 million for the comparable period in 2006.  The increase is primarily the result of an increased engineering staff to focus on the development of new products and quality control, increased administrative personnel, increased sales staff, and increased costs of functioning as a public company and pursuing acquisitions. As a percentage of revenues, selling, general and administrative expenses decreased to approximately 22% in 2007 from approximately 26.9% in 2006.

 
-21-

 

For fiscal 2007, the consolidated selling, general and administrative expenses were as follows: $1.7 million administrative payroll and benefits, $0.2 million insurance cost, $0.8 million in accounting, legal and expenses related to public company reporting requirements, $0.1 million in advertising and sales related expenses, $0.9 million in rental, utility and general office expenses and $0.1 million in property and sales taxes.

Depreciation and amortization expense

   
2007
   
Pro-Forma 2006
   
Change
   
%
 
Depreciation
 
$
398,610
   
$
166,468
   
$
232,142
     
139.5%
 
Amortization
   
28,354
     
-
     
28,354
   
-
 
Depreciation and amortization
 
$
426,964
   
$
166,468
   
$
260,496
     
156.5%
 

Depreciation increased by approximately $0.3 million, or 162.% to $0.4 million for the twelve months ended December 31, 2007 from approximately $0.2 million for the comparable period in 2006.  During fiscal 2007, we acquired approximately $3.2 million in fixed assets through the acquisition of the Mako subsidiary in December 2007 and approximately $45,500 in fixed assets in the acquisition of ElectroWave in April, 2007.  Additionally, we purchased approximately $0.8 million in fixed assets during fiscal 2007, including a 100-ton mobile gantry crane valued at $0.5 million, under a capital lease.

We depreciate our assets using the straight-line method over the estimated useful lives of the respective assets. Buildings are amortized over 36 years, and leasehold improvements are amortized over the shorter of the assets' useful lives or lease terms. Equipment lives range from two to seven years, computers and electronic lives are from two to three years, and furniture and fixtures are two to seven years.  Deep Down’s intangible assets consist of $4.4 million in specifically identified intangible assets acquired in the purchase of the Mako subsidiary on December 1, 2007, specifically Mako’s customer list, a non-compete covenant and trademarks related to Mako’s ROVs.  We are amortizing the intangible assets over their estimated useful lives on the straight line basis between five and twenty five years.

Interest expense

   
2007
   
Pro-Forma 2006
   
Change
   
%
 
Cash interest expense
 
$
594,667
   
$
155,077
   
$
439,590
     
283.5%
 
Amount related to amortization of debt discounts and deferred financing costs
   
190,491
     
-
     
190,491
   
-
 
Amount related to accretion
   
1,644,991
     
423,258
     
1,221,733
     
288.6%
 
Total interest expense
 
$
2,430,149
   
$
578,335
   
$
1,851,814
     
320.2%
 

Interest expense increased by approximately $1.9 million to $2.4 million for the twelve months ended December 31, 2007 from approximately $0.5 million for the comparable period in 2006.

During fiscal 2006, in conjunction with the reverse merger with Subsea, Deep Down determined that the Series E and Series G Preferred Stock was more like debt than equity due to their “redeemable exchangeable” nature into notes.  The fair value calculated for the Series E and G Preferred Stock issued in exchange for 100% of the Deep Down Delaware common stock and Strategic Offshore Services Corporation using a 20% discount rate which was significantly greater than the 6% interest on the three-year term note into which those preferred shares were exchangeable. Deep Down has been accreting the difference between the determined value and the face value of $1000 per share for which we are obligated as interest expense. During fiscal 2007, we redeemed all of the Series G Preferred Stock in exchange for 3,250 shares of Series E Preferred Stock. Additionally, a total of 7,750 shares of Series E Preferred Shares were redeemed, which generated non-cash interest expense of $1.6 million, plus approximately $42,000 of non-cash interest expense on the 500 shares of Series E Preferred Stock which remain outstanding at December 31, 2007.  The amount of discount associated with the Series E Preferred stock outstanding at December 31, 2007 is $0.1 million.

 
-22-

 

On August 6, 2007, Deep Down entered into a $6.5 million secured Credit Agreement with Prospect and received an advance of $6.0 million on that date.  The Credit Agreement provides for a 4-year term, an annual interest rate of 15.5%, with the ability to defer up to 3.0% of interest through a PIK (paid-in-kind) feature and principal payments of $250,000 per quarter beginning September 30, 2008, with the remaining balance outstanding due August 6, 2011. Interest payments are payable monthly, in arrears, on each month end commencing on August 31, 2007.  Interest paid through December 31, 2007 was $377,167.  Deep Down paid the full 15.5% and did not exercise the PIK feature for the monthly periods through December 2007.   

On December 21, 2007, Deep Down entered into an amendment to the Credit Agreement (the “Amendment”) to provide the funding for the cash portion of the purchase of Mako. The total commitment available under the Amendment was increased to $13.0 million, and the quarterly principal payments increased to $250,000, with the payment dates remaining the same. The interest terms and loan covenants also remained substantially the same under the Amendment. Deep Down was advanced an additional $6.0 million on January 4, 2008 under terms of the Amendment.

Terms of the Credit Agreement also include a detachable warrant to purchase up to 4,960,585 shares of common stock at an exercise price of $0.507 per share.  The warrant has a five-year term and becomes exercisable on the two-year anniversary of the original financing, August 6, 2009.  The proceeds of the debt were allocated to the warrants based on its estimated relative fair value at the measurement date of when the final agreement was signed and announced and reflected as a discount to the debt. The relative fair market value of these warrants was $1.5 million and is being amortized as interest expense. Interest expense associated with the fair market value of the warrant was $135,931 during 2007.

Additionally, in connection with the initial advance in August 2007, Deep Down pre-paid $180,000 in points to the lender which was treated as a discount to the note.  The discount associated with the value of the warrants and the pre-paid points are being amortized into interest expense over the life of the note agreement using the effective interest method.  A total of $135,931 has been amortized into interest expense through December 31, 2007.

In connection with the second advance in January 4, 2008, Deep Down pre-paid $180,000 in points to the lender which was treated as a discount to the note.  

Deep Down capitalized a total of $555,314 in deferred financing costs related to the original amounts borrowed under the Credit Agreement.  Of this amount, $442,194 was paid in cash to various third parties related to the financing, and the remainder of $113,120 represents the Black Scholes valuation of warrants issued to one of these third party vendors.  The warrant is a detachable warrant to purchase up to 320,000 shares of common stock at an exercise price of $0.75 per share (calculated as the volume weighted average closing price of the common stock for the ten days immediately preceding the closing of the Credit Agreement which took place on August 6, 2007).  The warrant has a five-year term and becomes exercisable on the two-year anniversary of the original financing, August 6, 2009.  The assumptions used in the Black Scholes model included (1) expected volatility of 52.7%, (2) expected term of 3.5 years, (3) discount rate of 5% and (4) zero expected dividends.   The deferred financing cost is being amortized using the effective interest method over the term of the note.  A total of $54,560 of deferred financing cost was amortized into interest expense through December 31, 2007.

In connection with the second advance under the Credit Agreement on January 4, 2008, Deep Down capitalized an additional $261,941 in deferred financing costs.  Of this amount, $216,000 was paid in cash to various third parties related to the financing, and the remainder of $45,946 represents the Black Scholes valuation of warrants issued to one of these third party vendors.  The detachable warrant was granted to purchase up to 118,812 shares of common stock at an exercise price of $1.01 per share.  The warrant has a five-year term and is immediately exercisable.  The fair value of the warrant was estimated to be $45,946 based on the Black Scholes pricing model.  The assumptions used in the model included (1) expected volatility of 61.3%, (2) expected term of 2.5 years, (3) discount rate of 3.2% and (4) zero expected dividends.   Provisions in the warrant agreement allow for a cashless exercise provision, not to exceed 2% of outstanding common stock at the time of exercise.

 
-23-

 

Net Income (loss)

   
2007
   
Pro-Forma 2006
   
Change
   
%
 
Net income (loss)
 
$
952,509
   
$
(2,811,627
)
 
$
3,764,136
     
133.9%
 
Stock based compensation expense
   
187,394
     
3,340,792
     
(3,153,398
)
   
(94.4)%
 
Amount related to debt discounts
   
190,491
     
-
     
190,491
   
-
 
Amount related to accretion
   
1,644,991
     
423,258
     
1,221,733
     
288.6%
 
Gain on debt extinguishment
   
(2,000,000
)
   
-
     
(2,000,000
)
 
-
 
Net income
 
$
975,385
   
$
952,423
   
$
22,962
     
2.4%
 
 
Net income increased by approximately $3.7 million to nearly $1.0 million for the twelve months ended December 31, 2007 as compared to a loss of approximately $2.8 million for the comparable period in 2006.

The increase in net loss from operations includes the pro-forma and non-recurring, non-cash, non-operating expense items noted above arising out of the accounting treatment of the Series E and G Preferred Stock. After adjusting for these non-cash, non-operating expenses, the Company has net income of approximately $1.0 million, up approximately $0.1 million, or 8%, from $0.9 million for the comparable period in 2006.

During the second quarter of 2007, Deep Down executed a Securities Redemption Agreement (the “Agreement”) with the former Deep Down CFO to redeem 4,000 shares of Series E exchangeable preferred stock at a discounted price of $500 per share for a total of $2.0 million.  The discount of $500 per share from the face value of $1,000 was accounted for as a substantial modification of debt, thereby generating a gain on extinguishment of debt which is reflected as other income on the statement of operations.  Deep Down accreted the remaining discount of $1.1 million attributable to such shares on the date of redemption.  On August 16, 2007, Deep Down made the initial payment of $1.4 million under the terms of the securities redemption agreement, and 2 payments of $20,000 each were made during August and September 2007.  The final balance due of $0.5 million was paid with 543,789 shares of common stock on October 2, 2007.

EBITDA
 
   
2007
   
Pro-Forma 2006
   
Change
   
%
 
Net income (loss)
 
$
952,509
   
$
(2,811,627
)
 
$
3,764,136
     
133.9%
 
Tax expense
   
369,673
     
22,250
     
347,423
     
 -
 
Gain on debt extinguishment
   
(2,000,000
)
   
-
     
(2,000,000
)
   
-
 
Interest
   
2,335,662
     
578,335
     
1,757,327
     
303.9%
 
Depreciation and amortization expense
   
426,964
     
166,468
     
260,496
     
156.5%
 
Stock based compensation expense
   
187,394
     
3,340,792
     
(3,153,398
)
 
(94.4)%
 
EBITDA
 
$
2,272,202
   
$
1,296,218
   
$
975,984
     
75.3%
 

EBITDA increased by approximately $0.9 million to $2.2 million for the twelve months ended December 31, 2007 from approximately $1.3 million for the comparable period in 2006.  Excluding the one-time gain on debt extinguishment discussed above and non-cash interest and stock based compensation charges, earnings before depreciation, interest, amortization, taxes and other non-cash charges ( “EBITDA” ) for the twelve months ended December 31, 2007 was $2.2 million, an increase of $0.9 million from $1.3 million for the comparable period in 2006.

EBITDA is a non-GAAP financial measure. Deep Down defines EBITDA as net income plus interest expense, income taxes, depreciation, amortization and other non-cash, non-operating expense. Deep Down uses EBITDA as an unaudited supplemental financial measure to assess the financial performance of its assets without regard to financing methods, capital structures, taxes or historical cost basis; its liquidity and operating performance over time in relation to other companies that own similar assets and that the Company believes calculate EBITDA in a similar manner; and the ability of Deep Down assets to generate cash sufficient for Deep Down to pay potential interest costs. Deep Down also understands that such data are used by investors to assess the Company's performance. However, the term EBITDA is not defined under generally accepted accounting principles and EBITDA is not a measure of operating income, operating performance or liquidity presented in accordance with generally accepted accounting principles. When assessing Deep Down’s operating performance or liquidity, investors and others should not consider this data in isolation or as a substitute for net income, cash flow from operating activities, or other cash flow data calculated in accordance with generally accepted accounting principles.
 
-24-

 
Sources and Uses of Cash for the year ended December 31, 2007
 
Cash flows for the period through the year ended December 31, 2007, were as follows:

Operating Cash Flows
Cash required by operating activities of continuing operations was $3,006,136. Our working capital balances vary due to on delivery terms and payments on key contracts; work in process, and outstanding receivables and payables.  The increase in accounts receivable is primarily due to our sales and deliveries to large integrated international oil companies. Historically, due to the credit strength of our customers, we have not experienced material adjustments to our accounts receivable and believe our accounts receivables from our customers are collectible.

Investing Cash Flows
The cash used from investing activities of $1,358,429 is primarily due to purchases of equipment of $830,965 and restricted cash of $375,000 plus $152,464 related to acquisition costs.

Financing Cash Flows
Net cash provided from financing activities was $6,558,323.  This was primarily due to long-term debt issuance of $6,204,799 and common stock proceeds net of expenses of $3,960,000. 

Liquidity and Capital Resources
We generate our liquidity and capital resources primarily through operations and, when needed, through debt issues and equity offerings. Our total bank loans outstanding at December 31, 2007 was $916,044 which were Mako bank loans that were paid in full from the Prospect Capital loan. During 2007, we paid approximately $2.7 million in outstanding debt including bank loans, equipment lease obligations, and redemption of Series E preferred stock.

Debt and Liquidity

Total borrowings at December 31, 2007, comprised the following:

A long-term debt obligation to Prospect Capital Corporation with monthly principal and interest payments, interest fixed at 15.5%, with the ability to defer up to 3.0% of interest through a PIK (paid-in-kind) feature and principal payments of $250,000 per quarter beginning September 30, 2008, with the remaining balance outstanding due August 6, 2011. We borrowed a total of $12.5 million on the $13.0 million facility from Prospect Capital.

At December 31, 2007 certain bank debt of Mako was outstanding in the aggregate of $916,044 which was paid in full with the advance of funds from the Prospect Capital loan in January 2008.
 
A capital lease obligation was outstanding for approximately $481,000 for the lease of a crane.

Outlook for 2008

We plan to meet our cash requirements in 2008 with cash generated from operations.  Due to the expanding growth of our company and the strength of the industry in which we operate, we believe that we have access to capital to fund and expand our operations.  In addition, we continue to evaluate acquisitions and joint ventures in the ordinary course of business. When opportunities for business acquisitions meet our standards, we believe we will have access to capital sources necessary to take advantage of those opportunities.

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.

 
-25-

 

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) – an interpretation of FASB Statement No. 109, Accounting for Income Taxes (“SFAS No. 109”) (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109 and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return. Guidance is also provided on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.  Deep Down adopted the provisions of FIN 48 in 2007 and no material uncertain tax positions were identified.  Thus, the adoption of FIN 48 did not have an impact on Deep Down’s financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value under generally accepted accounting procedures and expands disclosures on fair value measurements. This statement applies under previously established valuation pronouncements and does not require the changing of any fair value measurements, though it may cause some valuation procedures to change. Under SFAS No. 157, fair value is established by the price that would be received to sell the item or the amount to be paid to transfer the liability of the asset as opposed to the price to be paid for the asset or received to transfer the liability. Further, it defines fair value as a market specific valuation as opposed to an entity specific valuation, though the statement does recognize that there may be instances when the low amount of market activity for a particular item or liability may challenge an entity’s ability to establish a market amount. In the instances that the item is restricted, this pronouncement states that the owner of the asset or liability should take into consideration what affects the restriction would have if viewed from the perspective of the buyer or assumer of the liability. This statement is effective for all assets valued in financial statements for fiscal years beginning after November 15, 2007. Deep Down is currently evaluating the impact of SFAS No. 157 on its financial position and result of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value.  SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities.  SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 with early adoption allowed.  Deep Down has not yet determined the impact, if any, that adopting this standard might have on its financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”) and No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”). SFAS No. 141(R) and SFAS No. 160 are products of a joint project between the FASB and the International Accounting Standards Board.  The revised standards continue the movement toward the greater use of fair values in financial reporting. SFAS No. 141(R) will significantly change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. These changes include the expensing of acquisition related costs and restructuring costs when incurred, the recognition of all assets, liabilities and noncontrolling interests at fair value during a step-acquisition, and the recognition of contingent consideration as of the acquisition date if it is more likely than not to be incurred.  SFAS No. 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity.  SFAS No. 141(R) and SFAS No. 160 are effective for both public and private companies for fiscal years beginning on or after December 15, 2008 (January 1, 2009 for companies with calendar year-ends). SFAS No. 141(R) will be applied prospectively. SFAS No. 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS No. 160 shall be applied prospectively. Early adoption is prohibited for both standards.  Deep Down is currently evaluating the effects of these pronouncements on its financial position and results of operations.

In December 2007, the SEC staff issued Staff Accounting Bulletin (“SAB”) 110, Share-Based Payment, which amends SAB 107, Share-Based Payment, to permit public companies, under certain circumstances, to use the simplified method in SAB 107 for employee option grants after December 31, 2007. Use of the simplified method after December 2007 is permitted only for companies whose historical data about their employees’ exercise behavior does not provide a reasonable basis for estimating the expected term of the options. Deep Down did not have stock options outstanding until fiscal 2007, and has not exercised any shares, thus does not have adequate historical data to determine option lives. Therefore, Deep Down will continue to use the simplified method as allowed under the provision of SAB 110.
 
-26-

 
Inflation and Seasonality

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

Item 7.                 Financial Statements.
 
The financial statements and schedules are included herewith commencing on page F-1.
 
Report of Independent Registered Public Accounting Firm
 
F-2
 
Consolidated Balance Sheets
 
F-3
 
Consolidated Statements of Operations
 
F-4
 
Consolidated Statements of Changes in Stockholders’ Equity (Deficit)
 
F-5
 
Consolidated Statements of Cash Flows
 
F-6
 
Notes to Consolidated Financial Statements
F-8

Item 8.                 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 8A.              Controls and Procedures.

Evaluation of disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).  Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs.  Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. To address the material weaknesses, we performed additional analysis and other post-closing procedures in an effort to ensure our consolidated financial statements included in this annual report have been prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.

 
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Management’s Report on Internal Control Over Financial Reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act, as amended.  Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework.  A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.  We have identified the following material weaknesses.
 
 
1.
As of December 31, 2007, we did not maintain effective controls over the control environment.  Specifically, we have not formally adopted a written code of business conduct and ethics that governs to the Company’s employees, officers and directors.  Additionally, we have not developed and effectively communicated to our employees its accounting policies and procedures.  This has resulted in inconsistent practices particularly at its ElectroWave division.  Further, the Board of Directors does not currently have any independent members and no director qualifies as an audit committee financial expert as defined in Item 407(d)(5)(ii) of Regulation S-B.  Since these entity level programs have a pervasive effect across the organization, management has determined that these circumstances constitute a material weakness.
     
 
2.
As of December 31, 2007, at the ElectroWave subsidiary, we did not maintain effective controls over revenue recognition.  Specifically, controls were not designed and in place to ensure that billing activities were conducted in a timely manner resulting in contract services revenues being recognized in an incorrect reporting period.  Additionally, the lack of consistency applied procedures also resulted in the double billing of a customer.  This control deficiency resulted in an adjustment to the consolidated financial statements.  Accordingly, management has determined that this control deficiency constitutes a material weakness.
     
 
3.
As of December 31, 2007, we did not maintain effective controls over payables processing.  Specifically, controls were not designed and in place to ensure that vender-related and employee-related cash disbursements were appropriately authorized and adequately supported by receiving reports and other supporting documentation.  A budget process is not currently in place to monitor spending levels.  This material weakness could result in errors in the accounting for accounts payable and expenses. Accordingly, management has determined that this control deficiency constitutes a material weakness.

Because of these material weaknesses, management has concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2007, based on the criteria established in "Internal Control-Integrated Framework" issued by the COSO.

 
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Changes in Internal Control Over Financial Reporting.    

In our efforts to continuously improve our internal controls, management has taken steps to enhance the following controls and procedures subsequent to the end of fiscal 2007 as part of our remediation efforts:

·      
The ElectroWave division was re-structured and re-organized in the fourth quarter of 2007.  A majority of the accounting activities have been transferred to Deep Down Delaware’s accounting department to streamline and centralize accounting.

·      
In response to the further growth of the business, management hired a corporate controller in January 2008.  He is responsible for the coordination and integration of the accounting activities of each of our current and future subsidiary operations. With his relevant experience with the policies and procedures for compliance with regulations promulgated by Sarbanes-Oxley, our goal is to reach full compliance during 2008.

·      
Management hired a corporate human resource and safety manager in March 2008 who will be responsible for designing, planning and implementing human resource programs and policies including benefits, staffing, compensation, employee relations, training, and health and safety programs.  She will oversee the human resource functions for our current and future subsidiary operations.

·      
Management has prepared an Employee Handbook and Code of Conduct and plans to circulate these documents throughout the organization and obtain signed acknowledgements from employees.

·      
Management plans to document its accounting policies and procedures to increase consistency among divisions.  This includes the creation or expansion of checklists which serve to manage close processes.

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

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
 
Item 8B.              Other Information.

None.
 
 
-29-

 

PART III
 
Item 9.                 Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) of the Exchange Act.

The following table sets forth the names, ages and positions of all of our directors and executive officers.

Name
 
Age
 
Position Held With The Company
Robert E. Chamberlain, Jr.
 
48
 
Chairman of the Board, Chief Acquisitions Officer,  and Director
Ronald E. Smith*
 
49
 
Chief Executive Officer and Director
Eugene L. Butler
 
65
 
Chief Financial Officer and Director
Mary L. Budrunas*
 
56
 
Vice-President, Director, and Corporate Secretary
Michael D. Teal
 
51
 
Corporate Controller
_________________________

*  Ronald E. Smith and Mary L. Budrunas are married to each other.

Robert E. Chamberlain, Jr., Chairman of the Board, Chief Acquisitions Officer, and Director . Mr. Chamberlain has served as Chairman and Director of the Company since December 2006.  Mr. Chamberlain has a B.S. in Chemical Engineering and a B.S. in Biomedical Engineering from Northwestern University's Technological Institute and an MBA from Northwestern University's Kellogg Graduate School of Management. Mr. Chamberlain served as Vice President with Solomon Brothers Inc. (1986 to 1992), where his responsibilities included mergers, acquisitions, leveraged buyouts, merchant banking, divestitures, corporate finance, capital raises, restructurings and new product development in both the private and public markets. From 1992 through 1995, Mr. Chamberlain served as Vice President for Laidlaw Securities and Dickinson & Co. where he was responsible for generating public and private equity transactions. Since 1995, Mr. Chamberlain has assisted small emerging growth companies gain access to the capital markets and develop well articulated strategic objectives through consulting companies he controlled. Most recently, Mr. Chamberlain served as Chairman, CEO, CFO and Director of a publicly traded energy company involved in the development of oil and gas opportunities, primarily in the Barnett Shale of Texas.

Ronald E. Smith, President, Chief Executive Officer and Director . Mr. Smith co-founded Deep Down in 1997 and has served as President and Director of the Company since December 2006. Mr. Smith graduated from Texas A&M University with a Bachelor of Science degree in Ocean Engineering in 1981. Mr. Smith worked both onshore and offshore in management positions for Ocean Drilling and Exploration Company (ODECO), Oceaneering Multiflex, Mustang Engineering and Kvaerner before founding Deep Down. Mr. Smith’s interests include all types of offshore technology, nautical innovations, state of the art communications, diving technology, hydromechanics, naval architecture, dynamics of offshore structures, diving technology and marketing of new or innovative concepts. Mr. Smith is directly responsible for the invention or development of many innovative solutions for the offshore industry, including the first steel tube flying lead installation system.

Eugene L. Butler, Chief Financial Officer.   Mr. Butler has served as Chief Financial officer with Deep Down, Inc. since June 2007.  Prior, he has served in various capacities as a director, president, chief executive officer, chief financial officer and chief operating officer for Weatherford International, Inc., a $2 billion multinational service and equipment corporation serving the worldwide energy market, from 1974 to 1991.  He was elected to Weatherford’s board of directors in May of 1978, elected president and chief operating officer in 1979, and president and chief executive officer in 1984.  He successfully developed and implemented a turnaround strategy eliminating debt and returning the company to profitability during a severe energy recession.  Mr. Butler also expanded operations into international markets allowing Weatherford to become a major worldwide force with its offshore petroleum products and services.  Mr. Butler graduated from Texas A&M University in 1963, and served as an officer in the U.S. Navy until 1969 when he joined Arthur Andersen & Co.  Mr. Butler is distinguished by numerous medals and decorations, including the Bronze Star with combat “V” and the Presidential Unit Citation for his service with the river patrol force in Vietnam.
 
-30-

 
Mary L. Budrunas, Vice-President and Director.   Ms. Budrunas, co-founder of Deep Down, Inc. along with current chief executive officer Ron Smith, has served as Vice-President and director of the Company since December 2006.  Ms. Budranus is responsible for the Company’s administrative functions including human resources and accounting.  Ms. Budrunas has more than 30-years of logistical management experience in manufacturing, fabrication, and industrial sourcing in the oil and gas industry. Prior to Ms. Budrunas co-founding Deep Down in 1997, she managed the purchasing efforts of many projects over a 10-year period for Mustang Engineering, and previously directed procurement for a large petroleum drilling and production facility project in Ulsan, Korea .

Michael D. Teal, Corporate Controller.      Mr. Teal has served as corporate controller since January 2008.  Mr. Teal has significant experience in mergers and acquisitions, business development, business valuations, investment analysis, strategic planning, debt financing, equity issues, bank lines, and financial planning.  His background has primarily been in the energy industry encompassing refining, natural gas, power generation, oil and gas exploration, marine services, and risk management.  Since 1984, Mr. Teal has held various corporate-level positions in accounting, treasury, and corporate finance functions with major energy companies, most notably Valero Energy Corporation, The Coastal Corporation, and El Paso Corporation.  He also was a consultant providing consultation services to major Houston and Dallas corporations and was recently a Senior Consultant with Sirius Solutions.  Mr. Teal graduated from the University of Texas at San Antonio in 1981 with a Bachelor of Business Administration degree in financial accounting.  He earned his Master of Business Administration degree from Our Lady of the Lake University in San Antonio, Texas in 1984.  In 1988, he became a Texas-licensed Certified Public Accountant.
 
Corporate Governance
 
The Company promotes accountability for adherence to honest and ethical conduct; endeavors to provide full, fair, accurate, timely and understandable disclosure in reports and documents that the Company files with the SEC and in other public communications made by the Company; strive to be compliant with applicable governmental laws, rules and regulations. The Company has not formally adopted a written code of business conduct and ethics that governs to the Company’s employees, officers and directors as the Company is not required to do so.

There were no material changes to the procedures by which shareholders may recommend nominees to the Company’s board of directors.
 
In lieu of an Audit Committee, the Company’s Board of Directors is responsible for reviewing and making recommendations concerning the selection of outside auditors, reviewing the scope, results and effectiveness of the annual audit of the Company's financial statements and other services provided by the Company’s independent public accountants. The Board of Directors reviews the Company's internal accounting controls, practices and policies. Our Board of Directors has determined that no director qualifies as an audit committee financial expert as defined in Item 407(d) (5) (ii) of Regulation S-B.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and executive officers, as well as persons beneficially owning more than 10% of our outstanding common stock, to file reports of ownership and changes in ownership with the SEC within specified time periods. Such officers, directors and shareholders are required to furnish us with copies of all Section 16(a) forms they file.
 
Based solely on its review of such forms received by us, or written representations from certain reporting persons, not all Section 16(a) filing requirements applicable to our officers, directors and 10% shareholders were complied within a timely manner during the fiscal year ended December 31, 2007.  During 2007, the number of Form 3 that were filed late totaled six; the number of Form 4 that were filed late totaled six; and the number of Form 5 that were filed late totaled seven.  However all required reports have been filed by December 31, 2007.
 
-31-

 
Item 10.                Executive Compensation.
 
The following table summarizes all compensation paid to our Chief Executive Officer and our two highest compensated named executive officers (the “Named Executive Officers”) for the year ended December 31, 2007 and the period from inception June 29, 2006 to December 31, 2006, respectively .


SUMMARY COMPENSATION TABLE


Name and Principal Position
Year
 
Salary ($)
 
Bonus ($)
 
Stock Awards ($)
 
Option Awards (3) ($)
 
All Other Compensation ($)
   
Total ($)
 
Ronald E. Smith
2007
  $ 269,231   $ -   $ -   $ -   $ -     $ 269,231  
President, Chief Executive Officer and Director
2006
  $ 27,110   $ 1,710   $ -   $ -   $ -     $ 28,820  
Robert E. Chamberlain, Jr. (1)
2007
  $ 180,000   $ -   $ -   $ -   $ 12,000     $ 192,000  
Chairman
2006
  $ 16,670   $ -   $ -   $ -   $ -     $ 16,670  
Mary L. Budrunas
2007
  $ 134,615   $ -   $ -   $ -   $ -     $ 134,615  
Vice-President and Director
2006
  $ 13,070   $ 12,670   $ -   $ -   $ -     $ 25,740  
Eugene L. Butler (2)
2007
  $ 105,000   $ -   $ -   $ 618,300   $ 7,000     $ 730,300  
Chief Financial Officer
2006
  $ -   $ -   $ -   $ -   $ -     $ -  
Martin L. Kershman (3)
2007
  $ 74,400   $ -   $ -   $ 39,950   $ -     $ 114,350  
ElectroWave President and Chief Executive Officer
2006
  $ -   $ -   $ -   $ -   $ -     $ -  
Ron Nance (4)
2007
  $ 80,000   $ -   $ -   $ 39,950   $ -     $ 119,950  
ElectroWave Executive Vice-President
2006
  $ -   $ -   $ -   $ -   $ -     $ -  

(1)            Mr. Chamberlain was paid for consulting services he performed through Strategic Capital Services, Inc. Other compensation consists of auto allowance payments of $1,000 per month and $8,655 for payroll tax reimbursement which were paid during fiscal 2008.  Other compensation includes a monthly vehicle allowance.
(2)            Mr. Butler began drawing an annual salary of $180,000 beginning May 31, 2007. Option awards consist of 3,000,000 options granted on that date which vest in three equal annual installments on the first three anniversary dates of the grant date.  Other compensation consists of auto allowance payments of $1,000 per month and $7,568 for payroll tax reimbursement which were paid during fiscal 2008. Other compensation includes a monthly vehicle allowance.
(3)           Option awards are based on expense recognized under FAS123(R).  Awards were granted with a strike price equal to the quoted market price on the day of the grant and were valued at date of grant using Black-Scholes option pricing models with the following assumptions: 5% risk free rate, 52.7-53.3% volatility, expected life of 3-4 years and zero dividends.

NARRATIVE DISCLOSURE TO SUMMARY COMPENSATION TABLE

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

The following table sets forth information concerning equity incentive plan awards for each of the Named Executive Officers, outstanding as of December 31, 2007.  The amounts reflected as Market Value are based on the closing price of our Common Shares of $ 0.98 on December 31, 2007 (the last trading day of our fiscal year ended December 31, 2007) .

 
  Option Awards
 
 
 
Name                     
 
Number of Securities Underlying Unexercised Options
(#)
Exercisable
 
Number of Securities Underlying Unexercised Options
(#)
Unexercisable
 
Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options
(#)
 
 
Option Exercise Price
 ($)
 
 
 
 
Option Expiration
      Date     
Gene Butler, Chief Financial Officer
   
-
    3,000,000    
-
  $ 0.515  
May 31, 2010
 
The vesting provisions for the Company’s stock options noted above will vest over a three year period.
 
-32-

 

Employment Agreements

Effective August 6, 2007, we signed an employment agreement with Ronald E. Smith, our President and Chief Executive Officer (“CEO”) for an initial term through August 6, 2010 with automatic annual renewals for an additional two years. Under terms of the employment agreement, Mr. Smith will receive an annual base salary of $250,000 plus $1,000 per month auto allowance.

Effective August 6, 2007, we signed a consulting agreement with Strategic Capital Services, Inc. (“Strategic”) to provide the services of  Robert E. Chamberlain, who is our Chairman of the Board and Chief Acquisitions Officer (“CAO”)  for an initial term through August 6, 2010 with automatic annual renewals for an additional two years. Under terms of the consulting agreement, Mr. Chamberlain will receive an annual base salary of $180,000, which was increased to $270,000 as of January 1, 2008, plus $1,000 per month auto allowance, and payment to Strategic of an amount equal to Federal and State payroll withholdings customarily withheld for an employee. Such amounts totaling approximately $8,655 were paid in February 2008.

Effective May 31, 2007, we hired Eugene L. Butler as our Chief Financial Officer (“CFO”) for an initial term through May 31, 2010 with automatic annual renewals for an additional two years. Under Mr. Butler's employment agreement, he will receive an annual base salary of $180,000, which was increased to $270,000 as of January 1, 2008. He received an aggregate of 3,000,000 stock options, of which the first 33% will vest on the first anniversary of the agreement, the second 33% on the second anniversary of the agreement and the remaining 33% will vest on the third anniversary of the agreement. The exercise price for the options was determined by the closing market price of the common stock on the date of grant.   Mr. Butler’s employment agreement contains an indemnification provision that may require us to, among other things: indemnify Mr. Butler against liabilities that may arise by reason of his status or service as an officer to the fullest extent permitted under law.  Effective August 6, 2007, Mr. Butler’s employment agreement was replaced by a consulting agreement with all the same provisions as the previous employment agreement.  The consulting agreement contains a provision that Deep Down will remit to Mr. Butler an amount equal to Federal and State payroll withholdings customarily withheld for an employee. Such amounts totaling approximately $7,568 were paid in February 2008.
 
Compensation of Directors

For the year ended December 31, 2007, there were no cash payments or equity grants for compensation to the Company’s former non-employee director, Daniel L. Ritz, Jr. Mr. Ritz resigned as a director of the Company effective March 20, 2007.  The other directors of the Company are all also executive officers of the Company and as directors do not receive any additional compensation related to the performance of services as directors.  The Company may agree to provide compensation to non-employee directors in the future.
 
Item 11.                 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
 
The following table sets forth certain information, as of March 31, 2008, concerning the beneficial ownership of shares of Common Stock of the Company by (i) each person known by the Company to beneficially own more than 5% of the Company’s Common Stock; (ii) each Director; (iii) the Company’s Named Executive Officers; and (iv) all directors and executive officers of the Company as a group. To the knowledge of the Company, all persons listed in the table have sole voting and investment power with respect to their shares, except to the extent that authority is shared with their respective spouse under applicable law.
 
-33-


 
Name and address of
beneficial owner (2)
Shares
Options /
Warrants
Percent (1)
Ronald E. Smith (3)(4)
44,629,876
-
38.5%
Mary L. Budrunas (3)(4)
44,629,876
-
38.5%
Robert E. Chamberlain, Jr.(4)
25,350,000
-
21.9%
Eugene L. Butler (4)
350,000
-
0.3%
All directors and officers as a group
70,329,876
-
60.7%

(1)             A person is deemed to be the beneficial owner of securities that can be acquired within 60 days from the date set forth above through the exercise of any option, warrant or right. Shares of common stock subject to options, warrants or rights that are currently exercisable or exercisable within 60 days are deemed outstanding for computing the percentage of the person holding such options, warrants or rights, but are not deemed outstanding for computing the percentage of any other person. The amounts and percentages are based upon 115,846,019 shares of common stock outstanding as of March 28, 2008.
 
(2)             The address of each of the beneficial owners is c/o Deep Down, Inc., 15473 East Freeway, Channelview, Texas 77530.
 
(3)           Reflects 6,652,871 shares owned by Ron Smith and 16,627,005 shares owned by Mary L. Budrunas through the conversion of Series D Preferred Stock on March 28, 2008, plus 19,564,000 shares owned by Ron Smith and 1,786,000 shares owned by Mary L. Budrunas directly .

(4)           Shares owned include 350,000 shares of restricted stock issued on February 14, 2008 which become fully vested on the second anniversary of the grant, February 14, 2010.

Disclosure regarding our equity compensation plans as required by this item is incorporated by reference to the information set forth in Part II, Item 5 of this report.

Item 12.                 Certain Relationships and Related Transactions, and Director Independence.
 
We lease all buildings, structures, fixtures and other improvements from JUMA, LLC, a company owned by Ronald E. Smith, CEO and a director of Deep Down, Inc. and Mary L. Budrunas, a vice president and a director of Deep Down, Inc.  The base rate of $11,000 per month is payable to JUMA through September 1, 2011, together with all costs of maintaining, servicing, repairing and operating the premises, including insurance, utilities and property taxes.

The Company is a party to the employment agreements described above in Item 10.

None of the Company’s directors is independent.  However, the Company believes that it would be exempt from some of the independence requirements of NASDAQ ® due to the Company’s being a controlled company as defined in the NASDAQ® rules.  Under the NASDAQ® standards for “independence”, none of our directors would qualify as independent generally or with respect to any specific independence requirements for any committee member.

Item 13.                 Exhibits.
 
The exhibits as indexed immediately following the signature page of this Report are included as part of this Form 10-KSB/ A .
 
Item 14.                 Principal Accountant Fees and Services.
 
The following table sets forth the aggregate fees paid to Malone & Bailey, PC for audit services rendered in connection with the Company's consolidated financial statements and reports for the year ended December 31, 2007 and the period ended December 31, 2006 and for other services rendered during those years on behalf of the Company and its subsidiaries:
 
-34-


 
   
December 31,
2007
   
December 31,
2006
 
(i) Audit Fees
  $ 205,967     $ 164,695  
(ii) Audit Related Fees
    165,931       -  
(iii) Tax Fees
    16,260       -  
(iv) All Other Fees
    -       -  


Audit Fees: Consists of fees billed for professional services rendered for the audit of the Company’s consolidated financial statements, the review of interim condensed consolidated financial statements included in quarterly reports and other offering documentation, services that are normally provided by Malone & Bailey, PC in connection with statutory and regulatory filings or engagements and attest services, except those not required by statute or regulation.

Audit-Related Fees: Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit and review of the Company’s consolidated financial statements and are not reported under "Audit Fees." These services include auditing work on proposed transactions, including the audit of Mako Technologies, Inc., attest services that are not required by statute or regulation, and consultations concerning financial accounting and reporting standards.

Tax Fees: Consists of tax compliance, tax preparation and other tax services. Tax compliance and tax preparation consists of fees billed for professional services related to assistance with tax returns. Other tax services consist of fees billed for other miscellaneous tax consulting.

The Board of Directors pre-approves all audit and permissible non-audit services provided by Malone & Bailey, PC. These services may include audit services, audit-related services, tax services and other services. The Board of Directors may also pre-approve particular services on a case-by-case basis and may delegate pre-approval authority to one or more directors. If so delegated, the director must report any pre-approval decision to the Board of Directors at its first meeting after the pre-approval was obtained.
 
 
-35-

 

SIGNATURES
 
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

DEEP DOWN, INC.

/s/ RONALD E. SMITH                                                             
Ronald E. Smith, President and Chief Executive Officer
(Principal Executive Officer)

Dated: April 30, 2008

/s/ EUGENE L. BUTLER                                                             
Eugene L. Butler
Chief Financial Officer (Principal Financial Officer)

Dated: April 30, 2008

 
POWER OF ATTORNEY

KNOWN ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints RONALD E. SMITH and EUGENE L. BUTLER, and each of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstititon for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-KSB/A, and to file the same, with all exhibits thereto, and other documents in connection therewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person hereby ratifying and confirming all that said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
Signatures
 
Title
 
Date
 
/s/ RONALD E. SMITH                                        
President, Chief Executive Officer and Director
April 30, 2008
Ronald E. Smith
 
(Principal Executive Officer)
 
 
     
/s/ EUGENE L. BUTLER                                       
Chief Financial Officer and Director
April 30, 2008
Eugene L. Butler 
(Principal Financial Officer) 
 
     
     
/s/ ROBERT E. CHAMBERLAIN, JR.                
Chairman, Chief Acquisitions Officer and Director
April 30, 2008
Robert E. Chamberlain, Jr. 
   
     
     
/s/ MARY L. BUDRUNAS                                  
Vice-President, Director, and Corporate Secretary
April 30, 2008
Mary L. Budrunas
   
 
 
-36-

 

EXHIBIT INDEX


Exhibit Number
Description of Exhibit
   
* 2.1
Agreement and Plan of Reorganization among MediQuip Holdings, Inc., Deep Down, Inc., and the majority shareholders of Deep Down, Inc.
 
3.1
Certificate of Incorporation of MediQuip Holdings, Inc. (incorporated by reference from Exhibit 3.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
3.2
Certificate of Amendment to Articles of Incorporation providing for Change of Name to Deep Down, Inc. (incorporated by reference from Exhibit 3.2 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
* 3.3
By Laws of Deep Down, Inc.
 
* 3.4
Form of Certificate Designation of Series D Redeemable Convertible Preferred Stock
 
* 3.5
Form of Certificate Designation of Series E Redeemable Exchangeable Preferred Stock
 
* 3.6
Form of Certificate Designation of Series F Redeemable Convertible Preferred Stock
 
* 3.7
Form of Certificate Designation of Series G Redeemable Exchangeable Preferred Stock
 
*4.1
Common Stock Purchase Warrant for 4,960,585 common stock of Deep Down, Inc. issued to Prospect Capital Corporation effective May 25, 2007.
 
4.2
Common Stock Purchase Warrant for 320,000 shares issued to Dragonfly Capital Partners, LLC dated August 6, 2007 (incorporated by reference from Exhibit 4.2 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
4.3
Common Stock Purchase Warrant for 118, 812 shares issued to Dragonfly Capital Partners, LLC dated January 4, 2008 (incorporated by reference from Exhibit 4.3 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
*4.4
Registration Rights Agreement, dated August 6, 2007, among Deep Down, Inc. and Prospect Capital Corporation.
 
* 10.1
Credit Agreement, dated as of August 6, 2007, among Deep Down, Inc., as borrower, the financial institutions from time to time party thereto, and Prospect Capital Corporation.
 
10.2
First Amendment to Credit Agreement, dated as of December 21, 2007, among Deep Down, Inc., as borrower, and Prospect Capital Corporation, as agent and lender (incorporated by reference from Exhibit 4.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
-37-

 
 Exhibit Number
Description of Exhibit
   
* 10.3
Guarantee and Collateral Agreement, dated as of August 6, 2007, among Deep Down, Inc., as borrower and as Grantor, and Prospect Capital Corporation as Administrative Agent
 
10.4†
Consulting Agreement, dated as of August 6, 2007, between Deep Down, Inc. and Strategic Capital Services, Inc. regarding the services of Robert Chamberlain (incorporated by reference from Exhibit 10.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
10.5†
Employment Agreement, dated as of August 6, 2007, between Deep Down, Inc. and Ronald E. Smith (incorporated by reference from Exhibit 10.2 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008)
 
10.6†
Consulting Agreement, dated as of August 6, 2007, between Deep Down, Inc. and Eugene L. Butler & Associates regarding the services of Eugene L. Butler (incorporated by reference from Exhibit 10.3 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
* 10.7†
2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan.
 
* 10.8†
Form of Option Grant Agreement under 2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan.
 
10.9
Agreement and Plan of Merger among Deep Down, Inc., Mako Technologies, LLC, Mako Technologies, Inc. and the shareholders of Mako Technologies, Inc. dated December 17, 2007 (incorporated by reference from Exhibit 2.1 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
* 10.10
Agreement and Plan of Reorganization among Deep Down, Inc., ElectroWave (USA), Inc., a Nevada corporation, ElectroWave (USA) Inc., a Texas corporation, Pinemont IV, Martin L. Kershman and Ronald W. Nance.
 
10.11
Lease Agreement dated September 1, 2006 between Deep Down, Inc., a Delaware corporation, as tenant, and JUMA, L.L.C. (incorporated by reference from Exhibit 10.4 to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 filed on March 31, 2008).
 
*10.12
Lease Agreement dated June 1, 2006, betwen Mako Technologies, Inc., as Lessee and Sutton Industries, as Lessor.
 
*21.1
Subsidiary List
 
24.1
Power of Attorney (set forth immediately following the signatures to this report).
 
* 31.1
Rule 13a-14(a)/15d-14(a) Certification of the President and Chief Executive Officer of Deep Down, Inc.
 
* 31.2
Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer of Deep Down, Inc.
 
* 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.
 
 
-38-

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


Report of Independent Registered Public Accounting Firm
F-2
   
Consolidated Balance Sheets
F-3
   
Consolidated Statements of Operations
F-4
   
Consolidated Statements of Stockholders’ Equity (Deficit)
F-5
   
Consolidated Statements of Cash Flows
F-6
   
Notes to the Consolidated Financial Statements
F-8
 
 
F-1

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Deep Down, Inc., Houston, Texas
 
We have audited the accompanying consolidated balance sheets of Deep Down, Inc. (the “Company”), as of December 31, 2007 and 2006 and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the year ended December 31, 2007. We have also audited the accompanying statements of operations, stockholders’ deficit and cash flows for the period from inception (June 29, 2006) through December 31, 2006.  These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. Deep Down is not required to have, nor were we engaged to perform an audit of internal control over financial reporting.  Our audits included the consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of Deep Down’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Deep Down, Inc. as of December 31, 2007 and 2006, and the results of its operations and cash flows for the periods described, in conformity with U.S. generally accepted accounting principles.
 
/s/ MALONE & BAILEY, PC                    
www.malone-bailey.com
Houston, Texas

March 31, 2008

 
F-2

 

Deep Down, Inc.
       
Consolidated Balance Sheets
       
 
   
December 31, 2007
   
December 31, 2006
 
Assets
           
Cash and equivalents
 
$
2,206,220
   
$
12,462
 
Restricted cash
   
375,000
     
-
 
Accounts receivable, net of allowance of $139,787 and $81,809
   
7,190,466
     
1,264,228
 
Prepaid expenses and other current assets
   
312,058
     
156,975
 
Inventory
   
502,253
     
-
 
Lease receivable, short term
   
414,000
     
-
 
Work in progress
   
945,612
     
916,485
 
Receivable from Prospect, net
   
2,687,333
     
-
 
Total current assets
   
14,632,942
     
2,350,150
 
Property and equipment, net
   
5,172,804
     
845,200
 
Other assets, net of accumulated amortization of $54,560 and $0
   
1,109,152
     
-
 
Lease receivable, long term
   
173,000
     
-
 
Intangibles, net
   
4,369,647
     
-
 
Goodwill
   
10,594,144
     
6,934,213
 
Total assets
 
$
36,051,689
   
$
10,129,563
 
                 
Liabilities and Stockholders' Equity (Deficit)
               
Accounts payable and accrued liabilities
 
$
3,569,826
   
$
816,490
 
Deferred revenue
   
188,030
     
190,000
 
Payable to Mako Shareholders
   
3,205,667
     
-
 
Current portion of long-term debt
   
995,177
     
410,731
 
Total current liabilities
   
7,958,700
     
1,417,221
 
Long-term debt, net of accumulated discount of $1,703,258 and $0
   
10,698,818
     
757,617
 
Series E redeemable exchangeable preferred stock, face value and
               
liquidation preference of $1,000 per share, no dividend preference,
               
authorized 10,000,000 aggregate shares of all series of Preferred stock
               
500 and 5,000 issued and outstanding, respectively
   
386,411
     
3,486,376
 
Series G redeemable exchangeable preferred stock, face value and
               
liquidation preference of $1,000 per share, no dividend preference,
               
authorized 10,000,000 aggregate shares of all series of Preferred stock
               
-0- and 1,000 issued and outstanding, respectively
   
-
     
697,275
 
Total liabilities
   
19,043,929
     
6,358,489
 
                 
Temporary equity:
               
 Series D redeemable convertible preferred stock, $0.01 par value, face value and liquidation preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate shares of all series of Preferred stock 5,000 issued and outstanding
   
4,419,244
     
4,419,244
 
 Series F redeemable convertible preferred stock, $0.01 par value, face value and liquidation preference of $1,000 per share, no dividend preference, authorized 10,000,000 aggregate of all series of Preferred stock -0- and 3,000 issued and outstanding, respectively
   
-
     
2,651,547
 
Total temporary equity
   
4,419,244
     
7,070,791
 
                 
Stockholders' equity (deficit):
               
Series C convertible preferred stock, $0.001 par value, 7% cumulative dividend,
               
authorized 10,000,000 aggregate shares of all series of Preferred stock
               
-0- and 22,000 shares issued and outstanding, respectively
   
-
     
22
 
Common stock, $0.001 par value, 490,000,000 shares authorized, 85,976,526
               
and 82,870,171 shares issued and outstanding, respectively
   
85,977
     
82,870
 
Paid in capital
   
14,849,847
     
(82,792
)
Accumulated deficit
   
(2,347,308
)
   
(3,299,817
)
Total stockholders' equity (deficit)
   
12,588,516
     
(3,299,717
)
Total liabilities and stockholders' equity
 
$
36,051,689
   
$
10,129,563
 
 
See accompanying notes to consolidated financial statements.
 
F-3

 
 
Deep Down, Inc.
 
Consolidated Statements of Operations
 
For the Year Ended December 31, 2007 and
 
For the Period Since Inception (June 29, 2006) to December 31, 2006
 
 
         
From Inception
 
   
Year Ended
   
June 29, 2006 to
 
   
December 31, 2007
   
December 31, 2006
 
             
Revenues
           
Contract revenue
 
$
15,652,848
   
$
978,047
 
Rental revenue
   
3,736,882
     
-
 
     
   
     
   
 
Total revenues
   
19,389,730
     
978,047
 
Cost of sales
   
13,020,369
     
565,700
 
     
   
     
   
 
Gross profit
   
6,369,361
     
412,347
 
                 
Operating expenses:
               
Selling, general & administrative
   
4,284,553
     
3,600,627
 
Depreciation and amortization
   
426,964
     
27,161
 
                 
Total operating expenses
   
4,711,517
     
3,627,788
 
                 
Operating income (loss)
   
1,657,844
     
(3,215,441
)
                 
Other income (expense):
               
Gain on debt extinguishment
   
2,000,000
     
-
 
Interest income
   
94,487
     
-
 
Interest expense
   
(2,430,149
)
   
(62,126
)
                 
Total other income (expense)
   
(335,662
)
   
(62,126
)
                 
Income (loss) before income taxes
   
1,322,182
     
(3,277,567
)
                 
Income tax expense
   
(369,673
)
   
(22,250
)
Net income (loss)
 
$
952,509
   
$
(3,299,817
)
                 
                 
Basic earnings (loss) per share
 
$
0.01
   
$
(0.04
)
Weighted-average shares outstanding, basic
   
73,917,190
     
76,701,569
 
                 
Diluted earnings (loss) per share
 
$
0.01
   
$
(0.04
)
Weighted-average shares outstanding, fully-diluted
   
104,349,455
     
76,701,569
 
 
See accompanying notes to consolidated financial statements.
 
F-4

 


Deep Down, Inc.
Statements of Stockholders' Equity
For the Year Ended December 31, 2007 and
For the Period Since Inception (June 29, 2006) to December 31, 2006
 
   
Common Stock
   
Series C Preferred Stock
   
Paid-in
   
Retained
       
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Earnings
   
Total
 
                                           
Balance at June 29, 2006 (inception) (a)
   
75,000,000
   
$
75,000
     
-
   
$
-
   
$
(74,900
)
 
$
-
   
$
100
 
                                                         
Net income (loss)
   
-
     
-
     
-
     
-
     
-
     
(3,299,817
)
   
(3,299,817
)
Reverse merger with MediQuip (a)
   
7,870,171
     
7,870
     
22,000
     
22
     
(7,892
)
   
-
     
-
 
     
   
     
   
     
   
     
   
     
   
     
   
     
     
 
Balance at
December 31, 2006
   
82,870,171
     
82,870
     
22,000
     
22
     
(82,792
)
 
$
(3,299,817
)
   
(3,299,717
)
                                                         
Net income (loss)
   
-
     
-
     
-
     
-
     
-
     
952,509
     
952,509
 
Shares repurchased
   
(25,000,000
)
   
(25,000
)
   
-
     
-
     
(225,000
)
   
-
     
(250,000
)
Redemption of Series E Preferred Stock
   
3,463,592
     
3,464
     
-
     
-
     
3,840,314
     
-
     
3,843,778
 
Redemption of Series C Preferred Stock
   
4,400,000
     
4,400
     
(22,000
)
   
(22
)
   
(4,378
)
   
-
     
-
 
Stock issued for debt payment
   
543,689
     
544
                     
559,456
     
-
     
560,000
 
Stock issued for acquisition of a business
   
6,574,074
     
6,574
     
-
     
-
     
4,989,723
     
-
     
4,996,297
 
Private Placement offering
   
13,125,000
     
13,125
     
-
     
-
     
3,946,875
     
-
     
3,960,000
 
Stock based compensation
   
-
     
-
     
-
     
-
     
187,394
     
-
     
187,394
 
Warrants issued to lender
   
-
     
-
     
-
     
-
     
1,479,189
     
-
     
1,479,189
 
Warrants issued to third party for deferred financing costs
   
-
     
-
     
-
     
-
     
159,066
     
-
     
159,066
 
                                                         
                                                         
Balance at
December 31, 2007
   
85,976,526
   
$
85,977
     
-
   
$
-
   
$
14,849,847
   
$
(2,347,308
)
 
$
12,588,516
 
 
(a) Shares were stated at par value of $0.01 in error, the correct par value of $0.001 is reflected, with the offset to Paid-in Capital
 
See accompanying notes to consolidated financial statements.
 
F-5

 

Deep Down, Inc.
 
Consolidated Statement of Cash Flows
 
For the Year Ended December 31, 2007 and
 
For the Period Since Inception (June 29, 2006) to December 31, 2006
 
 
                 
     
For the Year Ended
December 31, 2007  
     
From Inception
June 29, 2006 to
December 31, 2006 
 
Cash flows from operating activities:  
               
Net income (loss)
  $ 952,509     $ (3,299,817 )
Adjustments to reconcile net income to net cash
               
used in operating activities:
               
Gain on extinguishment of debt
    (2,000,000 )     -  
Amortization of debt discount
    1,780,922       48,179  
Amortization of deferred financing costs
    54,016       -  
Share-based compensation
    187,394       3,340,792  
Allowance for doubtful accounts
    108,398       -  
Depreciation and amortization
    426,964       27,163  
Gain on disposal of equipment
    24,336       -  
Changes in assets and liabilities:
               
      Lease receivable
    (863,000 )     -  
      Accounts receivable
    (4,388,146 )     (251,001 )
      Prepaid expenses and other current assets
    (54,310 )     23,335  
      Inventory
    (502,253 )     -  
      Work in progress
    246,278       (90,326 )
      Accounts payable and accrued liabilities
    1,022,726       145,433  
      Deferred revenue
    (1,970 )     -  
                 
Net cash used in operating activities
    (3,006,136 )     (56,242 )
                 
Cash flows from investing activities:
               
Cash acquired in acquisition of a business
    261,867       101,497  
Cash paid for third party debt
    (432,475 )     -  
Cash received from sale of ElectroWave receivables
    261,068       -  
Cash paid for final acquisition costs
    (242,924 )     -  
Purchases of equipment
    (830,965 )     -  
Restricted cash
    (375,000 )     -  
                 
Net cash (used in) provided by investing activities
    (1,358,429 )     101,497  
                 
Cash flows from financing activities:
               
Payment for cancellation of common stock
    (250,000 )     -  
Redemption of preferred stock
    (250,000 )     -  
Proceeds from sale of common stock, net of expenses
    3,960,000       -  
Proceeds from sales-type lease
    276,000       -  
Borrowings on debt - related party
    (150,000 )     -  
Payments on debt - related party
    150,000       -  
Borrowings on long-term debt
    6,204,779       -  
Deferred financing fees
    (442,198 )     -  
Prepaid points
    (180,000 )     -  
Payments of long-term debt
    (2,760,258 )     (32,893 )
                 
Net cash provided by (used in) financing activities
    6,558,323       (32,893 )
                 
Change in cash and equivalents
    2,193,758       12,362  
                 
Cash and equivalents at beginning of year
    12,462       100  
                 
Cash and equivalents at end of period
  $ 2,206,220     $ 12,462  
 
See accompanying notes to consolidated financial statements.
 
F-6

 


Deep Down, Inc.
Consolidated Statements of Cash Flows
For the Year Ended December 31, 2007 and
For the Period Since Inception (June 29, 2006) to December 31, 2006
 
 
         
From Inception
 
   
Year Ended
 
June 29, 2006 to
 
   
December 31, 2007
 
December 31, 2006
 
             
Supplemental schedule of noncash investing
           
   and financing activities:
           
Acquisition of a business – Electrowave
 
$
(190,381
)
 
$
-
 
Exchange of receivables for acquisition of a business
 
$
171,407
   
$
-
 
Acquisition of a business – Mako 
 
 280,680
   
 -
 
Net receivable from lender-Prospect Capital 
 
 2,687,333
   
 -