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

DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED) 

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

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands except per share amounts)

Basis of Presentation

The accompanying unauditedcondensedconsolidated financial statements of Deep Down, Inc. and its directly and indirectly wholly-owned subsidiariessubsidiary (“Deep Down,” “we,”Down”, “we”, “us” or the “Company”) were prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC” or the “Commission”) pertaining to interim financial information and instructions to Form 10-Q. As permitted under those rules, certain footnotesnotes or other financial information that are normally required by United States generally accepted accounting principles (“US GAAP”) can be condensed or omitted. Therefore, these statements should be read in conjunction with the audited consolidated financial statements, and notes thereto, included in our Annual Report on Form 10-K for the year ended December 31, 2016, filed on March 31, 2017 with the Commission.2019.

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

Liquidity

The Company’s cash on hand was $3,664 and working capital was $3,885 as of June 30, 2020. As of December 31, 2019, cash on hand and working capital was $3,523 and $4,939, respectively. The Company does not have a credit facility in place and generally depends on cash on hand, cash flows from operations, and the potential opportunistic sales of property, plant and equipment (“PP&E”) to meet its liquidity needs.

The Company cannot predict with certainty the overall impact of the abrupt decline in oil prices and global economic disruption caused by COVID-19 on the Company’s operations and cash flows. The Company has taken steps to mitigate the challenges presented by the current macro environment, including workforce reductions, wage reductions, rent abatement, and limiting capital expenditures and research and development efforts to only critical items. The Company continues to seek further cost reduction opportunities to preserve liquidity.

The change in operating assets and liabilities for the six months ended June 30, 2020 resulted in a $45 decrease in cash. The decrease in cash was primarily a result of slower collections of accounts receivable. Despite actively engaging our customers, collections were impacted by customers focusing on cash conservation and remote working arrangements impacting our ability to collect. As a result of prolonged customer payment terms and uncertainty around certain customers’ liquidity, the Company recorded a $448 reserve for doubtful accounts receivable for the quarter ended June 30, 2020.

The Company applied for a loan under the Small Business Administration’s Paycheck Protection Program. On April 29, 2020, the Company received a loan in the amount of $1,111, which was used to finance payroll, rent, and utilities over the balance of the second quarter of 2020. The loan principal and related interest accrued may be forgivable, partially or in full, if certain conditions are met.

The Company believes it will have adequate liquidity to meet its future operating requirements arising in the normal course of business for the next twelve months through a combination of current cash on hand, cash expected to be generated from operations, current working capital, and potential opportunistic sales of PP&E in addition to pursuing a disciplined approach to making capital investments.

Principles of Consolidation

The unaudited condensed consolidated financial statements presented herein include the accounts of Deep Down, Inc. andits directly and indirectly wholly-owned subsidiaries.wholly owned subsidiary. All intercompany transactions and balances have been eliminated.

Segments

For the quarters ended September 30, 2017 and 2016, we had one operating and reporting segment, Deep Down Delaware.

Recently Issued Accounting Standards Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). This update provides a five-step approach to be applied to all contracts with customers and requires expanded disclosures about the nature, amount, timing and uncertainty of revenue (and the related cash flows) arising from customer contracts, significant judgments and changes in judgments used in applying the revenue model and the assets recognized from costs incurred to obtain or fulfill a contract. The effective date for this standard was deferred in July 2015 and will now be effective for us beginning January 1, 2018. The standard provides for different application methods during adoption. We are currently in the process of evaluating the potential impact this new pronouncement will have on our financial statements. We are reviewing our existing contracts to identify any that may be impacted by this standard, and evaluating new contracts we are negotiating to ensure compliance with this standard. We have not completed our full evaluation and therefore cannot conclude whether the pronouncement will have a significant impact on our financial statements at this time, but we expect requirements of this standard to significantly enhance our revenue disclosures. We currently anticipate that we will utilize the modified retrospective method of adoption, however, this expectation may change following the completion of our evaluation of the impact of this pronouncement on our financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). The amendments in this update require, among other things, that lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The amendments are effective for us beginning January 1, 2019. We do not anticipate the adoption of ASU 2016-02 will have a material effect on our results of operations, however we are still evaluating the impact on our financial position.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands except per share amounts)

In October 2016, the FASB issued ASU No. 2016-16, “Intra-Entity Transfers of Assets Other Than Inventory.” This update requires that income tax consequences are recognized on an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this ASU are effective for us on January 1, 2018. We are currently evaluating the impact of this ASU on our consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations.” This new ASU clarified the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The new standard is effective for us January 1, 2018 and will be applied prospectively. We are currently evaluating the impact of our pending adoption of the new standard, but do not expect it to have a material impact on our consolidated financial position or results of operations.

In February 2017, the FASB issued ASU No. 2017-05, “Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets” (“ASU 2017-05”). This update clarifies the scope of accounting for the derecognition or partial sale of nonfinancial assets to exclude all businesses and nonprofit activities. ASU 2017-05 also provides a definition for in-substance nonfinancial assets and additional guidance on partial sales of nonfinancial assets. We are currently evaluating the effect of ASU No. 2017-05 on our consolidated financial statements and will adopt ASU 2017-05 in conjunction with ASU 2014-09 on January 1, 2018.

In May 2017, the FASB issued ASU No. 2017-09, “Scope of Modification Accounting” (“ASU 2017-09”), which amends the scope of modification accounting for share-based payment arrangements. This update clarifies when a change to the terms or conditions of a share-based payment award should be accounted for as a modification. An entity should account for the effects of a modification unless the fair value, vesting conditions and classification, as an entity instrument or a liability instrument, of the modified award are the same before and after a change to the terms or conditions of the share-based payment award. The new standard is effective for us January 1, 2018. We do not expect ASU 2017-09 to have a material impact on our consolidated financial position or results of operations.

The components of billings, costs and estimated earnings on uncompleted contracts are summarized below:

The balance in costs and estimated earnings in excess of billings on uncompleted contracts at September 30, 2017 and December 31, 2016 consisted primarily of earned but unbilled revenues related to fixed-price projects.

The balance in billings in excess of costs and estimated earnings on uncompleted contracts at September 30, 2017 and December 31, 2016 consisted primarily of unearned billings related to fixed-price projects.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands except per share amounts)Segments

For the three and six months ended June 30, 2020 and 2019, the Company had one operating and reporting segment, Deep Down Delaware.

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, Leases (“ASC Topic 842”). Under this guidance, lessees are required to recognize on the balance sheet a lease liability and a right-of-use (“ROU”) asset for all leases, except for short-term leases with terms of twelve months or less. The lease liability represents the lessee’s obligation to make lease payments arising from a lease and will be measured as the present value of the lease payments. The ROU asset represents the lessee’s right to use a specified asset for the lease term, and will be measured at the lease liability amount, adjusted for lease prepayment, lease incentives received and the lessee’s initial direct costs.

ASC Topic 842 provides for certain practical expedients when adopting the guidance. The Company elected the package of practical expedients allowing the Company, for all leases that commenced prior to the adoption date, to not reassess whether any expired or existing contracts are, or contain, leases, the lease classification for any expired or existing leases, or initial direct costs for any expired or existing leases.

The Company utilizes the land easements practical expedient allowing the Company to not assess whether any expired or existing land easements are, or contain, leases if they were not previously accounted for as leases under the existing leasing guidance. Instead, the Company will continue to apply its existing accounting policies to historical land easements. The Company elects to apply the short-term lease exception; therefore, the Company will not record an ROU asset or corresponding lease liability for leases with an initial term of twelve months or less that are not reasonably certain of being renewed and instead will recognize a single lease cost allocated over the lease term, generally on a straight-line basis. The Company elects to apply the practical expedient to not separate lease components from non-lease components and instead account for both as a single lease component for all asset classes.

The Company elects to not capitalize any lease in which the estimated value of the underlying asset at the commencement date is less than the Company’s capitalization threshold. A lease would need to qualify for the low value exception based on various criteria.

ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term and include options to extend or terminate the lease when they are reasonably certain to be exercised. The present value of lease payments is determined primarily using the incremental borrowing rate based on the information available at the lease commencement date. Lease agreements with lease and non-lease components are generally accounted for as a single lease component. The Company’s operating lease expense is recognized on a straight-line basis over the lease term and a portion is recorded in cost of sales, and the remainder is recorded in selling, general and administrative expenses. The accounting for some leases may require significant judgment, which includes determining whether a contract contains a lease, determining the incremental borrowing rate to utilize in our net present value calculation of lease payments for lease agreements which do not provide an implicit rate, and assessing the likelihood of renewal or termination options.

As of June 30, 2020, the Company does not have any finance lease assets or liabilities, nor does the Company have any subleases.

The following tables present information about our operating leases:

The components of the Company’s lease expense are as follows:

Lease term and discount rate:

During the quarter ended June 30, 2020, the Company did not have any sale/leaseback transactions.

Present value of lease liabilities:

NOTE 3: REVENUE FROM CONTRACTS WITH CUSTOMERS

Revenues are recognized when control of the promised goods or services is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. To determine the proper revenue recognition method for our customer contracts, we evaluate whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period.

For most of our fixed price contracts, the customer contracts with us to provide a significant service of integrating a complex set of tasks and components into a single project or capability even if that single project results in the delivery of multiple units. Hence, the entire contract is accounted for as one performance obligation. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

Disaggregation of Revenue

The following table presents the Company’s revenues disaggregated by fixed price and service contracts. Sales taxes are excluded from revenues.

Fixed price contracts

For fixed price contracts, we generally recognize revenue over time as we perform because of continuous transfer of control to the customer. This continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. In our fixed price contracts, the customer either controls the work in process or we deliver products with no alternative use to the Company and have rights to payment for work performed to date plus a reasonable profit as evidenced by contractual termination clauses.

Because of control transferring over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. We generally use the cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues, including estimated fees or profits, are recorded proportionally as costs are incurred.

Contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new, or changes the existing, enforceable rights and obligations. Most of our contract modifications are for goods or services that are not distinct from the existing contract due to the significant integration service provided in the context of the contract and are accounted for as if they were part of that existing contract. The effect of a contract modification on the transaction price, and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

We have a company-wide standard and disciplined quarterly estimate at completion process in which management reviews the progress and execution of our performance obligations. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenues and costs. Changes in estimates of net sales, cost of sales and the related impact to operating income are recognized quarterly on a cumulative catch-up basis, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a performance obligation’s percentage of completion. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. When estimates of total costs to be incurred exceed total estimates of revenue to be earned on a performance obligation related to fixed price contracts, a provision for the entire loss on the performance obligation is recognized in the period the loss is estimated.

Service Contracts

We recognize revenue for service contracts measuring progress toward satisfying the performance obligation in a manner that best depicts the transfer of goods or services to the customer. The control over services is transferred over time when the services are rendered to the customer on a daily basis. Specifically, we recognize revenue as the services are provided as we have the right to invoice the customer for the services performed. Services are billed and paid on a monthly basis. Payment terms for services are usually 30 days from invoice receipt.

Contract balances

Costs and estimated earnings in excess of billings on uncompleted contracts arise when revenues are recorded based on the extent of progress towards completion but cannot be invoiced under the terms of the contract. Such amounts are invoiced upon completion of contractual milestones. Billings in excess of costs and estimated earnings on uncompleted contracts arise when milestone billings are permissible under the contract, but the related costs have not yet been incurred. All contract costs are recognized currently on jobs formally approved by the customer and contracts are not shown as complete until virtually all anticipated costs have been incurred and the risk of loss has passed to the customer.

Assets related to costs and estimated earnings in excess of billings on uncompleted contracts, as well as liabilities related to billings in excess of costs and estimated earnings on uncompleted contracts, have been classified as current. The contract cycle for certain long-term contracts may extend beyond one year; thus, complete collection of amounts related to these contracts may extend beyond one year though such long-term contracts include contractual milestone billings as discussed above. At June 30, 2020 and December 31, 2019, there were no contracts with terms that extended beyond one year.

The following table summarizes the Company’s contract assets, which are “Costs and estimated earnings in excess of billings on uncompleted contracts” and our contract liabilities, which are “Billings in excess of costs and estimated earnings on uncompleted contracts”.

The contract asset and liability balances at June 30, 2020 and December 31, 2019 are primarily associated with revenue related to fixed-price projects.

Remaining Performance Obligations

Remaining performance obligations represent the transaction price of firm orders for which work has not been performed and excludes unexercised contract options, potential orders, and any remaining performance obligations for any sales arrangements that had not fully satisfied the criteria to be considered a contract with a customer pursuant to the requirements of ASC 606.

Practical Expedients and Exemptions

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within selling, general and administrative expenses.

Many of our services contracts are short-term in nature with a contract term of one year or less. For those contracts, we have utilized the practical expedient in ASC 606-10-50-14 exempting the Company from disclosure of the transaction price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected duration of one year or less.

Additionally, our payment terms are short-term in nature with settlements of one year or less. We have, therefore, utilized the practical expedient in ASC 606-10-32-18 exempting the Company from adjusting the promised amount of consideration for the effects of a significant financing component given that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less.

Further, in many of our service contracts, we have a right to consideration from a customer in an amount that corresponds directly with the value to the customer of our performance completed to date (for example, a service contract in which we bill a fixed amount for each hour of service provided). For those contracts, we have utilized the practical expedient in ASC 606-10-55-18, which allows us to recognize revenue in the amount for which we have the right to invoice.

Accordingly, we do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

The components of net property,Property, plant and equipment are summarized below:consisted of the following:

From 2008 throughImpairment of Long-lived Assets

As a result of unfavorable market conditions primarily due to the COVID-19 pandemic and developments in global oil markets, which triggered historically low crude oil prices and decreases in our customers’ capital budgets, the Company determined the carrying amount of certain idle long-lived assets exceeded their respective values and therefore recorded an impairment charge of $4,490 related to idle fixed assets during the three months ended June 30, 2016, we maintained2020.

The Company owns, and routinely invests in, a credit facility (the “Facility”)portfolio of long-lived assets which are used both internally for product manufacturing and externally to perform services in the field. We evaluate for impairment our property and equipment that is held and used whenever changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability is assessed based on estimated undiscounted future net cash flows. Estimating future net cash flows requires us to make assumptions and estimates including, but not limited to, cash flows associated with Whitney Bank.  In March 2016, we paid all borrowings under the Facility with proceeds received from the sale of our Channelview location.Following the expirationfuture use and eventual disposal of the Facility onasset group and determination of the primary asset of the group. Should the review indicate that the carrying value is not fully recoverable, the amount of the impairment loss is determined by comparing the carrying value to the estimated fair value. No impairment was recorded related to the long-lived assets held and used during the three and six months ended June 30, 2016, we no longer have any credit facilities available to us.2020.

Share-based Compensation Plan

We have a share-based compensation plan, the “2003 Directors, Officers and Consultants Stock Option, Stock Warrant and Stock Award Plan” (the “Plan”). Awards of common stock and options to purchase common stock granted under the Plan have vesting periods of three years and options are exercisable for two years once fully vested. Share-based compensation expense related to awards is based on the fair value at the date of grant, and is recognized over the requisite expected service period, net of estimated forfeitures. Under the Plan, the total number of options permitted is 15 percent of issued and outstanding common shares.

Summary of Nonvested Shares of Restricted Stock

On May 2, 2017, we granted 30 shares of restricted stock to an independent director. These shares have a fair value grant price of $1.15 per share, based on the closing price of our common stock on that day. These shares vest over three years in equal tranches on the grant date anniversary, subject to continued service on our Board of Directors. We are amortizing the related share-based compensation of $33 over the three-year requisite service period.

For the nine months endedSeptember 30, 2017 and 2016, we recognized a total of $101 and $309, respectively, of share-based compensation expense related to restricted stock awards, which is included in selling, general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations.operations and additional paid in capital in the accompanying unaudited consolidated balance sheets. During the three and six months ended June 30, 2020, the Company recognized a total of $24 and $50, respectively, of share-based compensation expense, which includes $23 of credits to compensation expense related to the forfeiture of restricted stock awards of our former Chief Operating Officer in the second quarter of 2020. During the three and six months ended June 30, 2019, the Company recognized a total of $24 and $128, respectively, of share-based compensation expense. The unamortized estimated fair value of nonvested shares of restricted stock awardsand stock options was $73$133 and $134 atSeptember June 30,, 2017. 2020 and December 31, 2019, respectively. These costs are expected to be recognized as expense over a weighted-average period of 0.301.17 years.

On MayDecember 23, 2016, our2019, the Board authorized the repurchase of Directors authorized a repurchase programup to 500 shares of the Company’s outstanding common stock (the “Repurchase Program”) under which we were originally authorized to repurchase up to $1,000 of our outstanding stock. Subsequently, on March 29, 2017, our Board of Directors authorized a renewal and extension of the Repurchase Program for an additional $1,000 until March 31, 2018. The purchases could be made from time to time in the open market, through privately negotiated transactions and Rule 10b5-1 trading plans in accordance with applicable laws, rules and regulations.. The Repurchase Program was funded from cash on hand and cash provided by operating activities. The Board separately authorized the repurchase of additional shares during the quarter ended March 31, 2020, in a privately negotiated transaction. As of SeptemberMarch 31, 2020, the repurchase program has been exhausted.

For the three months ended June 30, 2017, we had exhausted2020, no shares of common stock were purchased by the Repurchase Program. AsCompany. For the six months ended June 30, 2020, the Company purchased 744 shares of the date of this report no decisions have been made on any furthercommon stock repurchases. Theat an average price of approximately $0.70 per share totaling $524 in a privately negotiated transaction.

For the three months ended June 30, 2019, the Company purchased 60 shares of treasurycommon stock throughSeptemberat an average price of approximately $0.80 per share totaling $48. For the six months ended June 30,, 2017 was $1.02. 2019, the Company purchased 288 shares of common stock at an average price of approximately $0.76 per share totaling $218.

Treasury shares are accounted for using the cost method.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands except per share amounts)

Income tax expense during interim periods is based on applying the estimated annual effective income tax rate to interim period operations. The estimated annual effective income tax rate may vary from the statutory rate due to the impact of permanent items relative to our pre-tax income, as well as by any valuation allowance recorded. We employ an asset and liability approach that results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial basis and the tax basis of those assets and liabilities. A valuation allowance is established when it is more likely than not that some of the deferred tax assets will not be realized. Although our future projections indicate that we may be able to realize some of these deferred tax assets, due to the degree of uncertainty of these projections, atSeptemberAt June 30,, 2017 2020 and December 31, 20162019, management has recorded a full deferred tax asset valuation allowance.

Employment Agreements

The Company entered into employment agreements with the Chief Executive Officer and former Chief Operating Officer (the “Executives”) containing severance provisions. In the event of termination of the Executives’ employment for any reason, the Executives would be entitled to receive all accrued, unpaid salary and vacation time through the date of termination and all benefits to which the Executives are entitled or vested under the terms of all employee benefit and compensation plans, agreements and arrangements in which the Executives are participants as of the date of termination.

In addition, subject to executing a general release in favor of the Company, the Executives would be entitled to receive certain severance payments in the event of termination of the Executive’s employment by the Company “other than for cause” or by the Executive with “good reason.” These severance payments include: (i) a sum in cash equal to one to two times the Executive’s annual base salary; (ii) a sum in cash equal to one to two times the average annual bonus paid to the Executive for the prior two full fiscal years preceding the date of termination; (iii) a sum in cash equal to a pro rata portion of the annual bonus payable for the period in which the date of termination occurs based on the actual performance under the Company’s annual incentive bonus arrangement, but no less than fifty percent of Executive’s annual base salary; and (iv) if the Executive’s termination occurs prior to the date that is twelve months following a change of control, then each and every share option, restricted share award and other equity-based award that is outstanding and held by the Executive shall immediately vest and become exercisable.

On April 1, 2020, the Company eliminated the position of Chief Operating Officer (“COO”) and relieved the COO of his duties pursuant to the terms of his employment agreement. In addition to payment of accrued and unpaid salary, vacation time, and other benefits referred to above, the Company is required to pay the former COO one time his contractual annual base salary of $245, payable over 12 months. This amount is included in selling, general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations for the three and six months ended June 30, 2020.

Litigation

From time to time, we are involved inthe Company is party to various legal proceedings arising fromin the normalordinary course of business. AsThe Company expenses or accrues legal costs as incurred. The Company resolved a material legal proceeding during the quarter ended June 30, 2020 and is involved in only one material legal proceeding as of the date of this Report, we were not involved in any material legal proceedings.

Operating LeasesReport.

We lease certain offices, facilities,In November 2011, the Company delivered equipment to Aker Solutions, Inc. (“Aker”), but Aker declined to pay the final invoice in the aggregate amount of $270 alleging some warranty items needed to be repaired. The Company made repairs, but Aker continued to claim further work was required. The Company repeatedly attempted to collect on the receivable and vehicles under non-cancellable operatingultimately filed suit on November 16, 2012, in the Harris County District Court. Aker subsequently filed a counterclaim on March 20, 2013 in the aggregate amount of $1,000 for reimbursement of insurance payments allegedly made for repairs. The parties have not reached a resolution on this matter. At this point, it is not clear as to whether an unfavorable outcome is either probable or remote, and capital leases expiring at various dates through 2023.the Company is unable to determine the likelihood of an unfavorable outcome or the amount or range of potential loss if the outcome should be unfavorable.

On August 6, 2018, GE Oil and Gas UK Ltd. (“GE”) requested that the Company mediate a dispute between the parties in the ICC International Centre for ADR (“ICC”). The dispute involved alleged delays and defects in products manufactured by the Company for GE dating back to 2013. During the second quarter of 2020, the parties finalized the terms of a definitive settlement agreement which is now final and binding. Per the terms of the settlement, the Company shall pay GE the total amount of $750 on a monthly basis through February 2022. The Company accrued a liability related to this matter in the amount of $750 for the year ended December 31, 2019.

Basic earnings per share (“EPS”) is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net income (loss) by the weighted-average number of common shares and dilutive common stock equivalents (warrants, nonvested stock awards and stock options) outstanding during the period. Diluted EPS reflects the potential dilution that could occur if options to purchase common stock were exercised for shares of common stock and all nonvested stock awards vest.

At June 30, 2020 and 2019, all such securities were anti-dilutive.

On August 15, 2019, Mr. Ronald E. Smith, the Company's Founder, resigned as Chief Executive Officer and as a member of the Board, effective as of August 31, 2019. In connection with Mr. Smith's resignation, the Company and Mr. Smith entered into a Transition Agreement, effective as of September 1, 2019 (the “Transition Agreement”). The Transition Agreement provides for Mr. Smith to serve as an independent consultant to the Company from September 1, 2019 through December 31, 2021. The Company agreed to pay Mr. Smith $15 per month, from January 1, 2020 through December 31, 2021, in exchange for his future services. The Company therefore recorded consulting expenses related to the Transition Agreement totaling $45 and $90 for the three and six months ended June 30, 2017 and 2016, there were potentially dilutive securities outstanding, but they were not taken into consideration in calculating diluted EPS because there were losses, so including them would have been anti-dilutive.2020, respectively.

In addition to the other payments provided for under the Transition Agreement, the Company also agreed to pay Mr. Smith 1.5% of the net sale or lease value of two carousels owned by Company, if such sale or lease occurs prior to December 31, 2021, unless those assets are sold or leased in conjunction with a sale of all or substantially all of the assets or stock of Deep Down, in which case no commission is due.

As part of the Transition Agreement, Mr. Smith is bound by certain non-disclosure and confidentiality provisions, and a non-compete and non-hire agreement.

As a result of the abrupt decline in oil prices and global economic activity caused by COVID-19, the Company applied for a loan under the Small Business Administration’s Paycheck Protection Program, and on April 29, 2020, the Company received a loan (“PPP loan”) in the amount of $1,111, which was used to finance payroll, rent, and utilities through the second quarter of 2020. The PPP loan is evidenced by a promissory note, dated to be effective as of April 27, 2020, between the Company and the lender. The PPP loan matures on April 27, 2022 and bears interest at a fixed rate of 1.00 percent per annum, payable in 18 monthly payments commencing on November 27, 2020. The loan principal and related interest accrued may be forgivable, partially or in full, if certain conditions are met.

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

(Amounts in thousands except per share amounts)

The following discussion and analysis providesprovide information that management believes is relevant for an assessment and understanding of ourthe Deep Down’s results of operations and financial condition. This information should be read in conjunction with ourthe Company’s audited historical consolidated financial statements, which are included in ourthe Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with2019, and the Securities and Exchange Commission (“SEC”) on March 31, 2017 and ourCompany’s unaudited condensed consolidated financial statements, and notes thereto, included with this Quarterly Report on Form 10-Q (“Report”) in Part I. Item 1. “Financial Statements.Statements,” and is available on the SEC’s website.

General

We areDeep Down is an oilfield product and services company specializing in complex deepwater and ultra-deepwater oil production distribution system support services servingand subsea distribution products used between the worldwide offshore explorationproduction facility and production industry.the wellhead. Our core services and technological solutions include distribution system installation support and engineering services, umbilical terminations, loose-tube steel flying leads, buoyancy products and services, remotely operated vehicles (“ROVs”) and toolings. Werelated services. Additionally, our highly experienced, specialized service teams can support subsea engineering, installation, commissioning, and maintenance projects through specialized, highlylocated anywhere in the world.

Industry and Executive Outlook

The dual challenges of the global COVID-19 pandemic and the sharp decline in oil prices continue to impact our business and that of our customers. Our service business is particularly dependent on our personnel being able to travel domestically and internationally, and travel restrictions imposed by various governments partially contributed to reduced revenues during the second quarter of 2020.

We experienced service teamsadditional headwinds as our customers scaled back their operations based on the current oil price environment. This includes customers delaying new purchase orders, extending timelines for existing purchase orders, and engineered technological solutions.delaying the payment of outstanding invoices. We expect that customer spending will increase if oil prices stabilize and there is an overall improvement in global economic activity.

In Part I. Item 2. “Management’s Discussionresponse to these new challenges, we successfully adjusted our strategy to operate in this cycle of lower oil prices. During the second quarter of 2020, we implemented workforce reductions, wage reductions, rent abatement, and Analysislimited capital expenditures and R&D efforts to only critical items. We were not able to accomplish this without our team of Financial Conditionhighly capable individuals who were able to respond quickly to the global pandemic pressures; however, there is much more work to do. Despite the reduction in our second quarter revenues, as compared to the same period in 2019, we are encouraged by the improvement in our margins, which is a direct result of the cost mitigation efforts we have implemented and Results of Operations,” all dollar and share amounts are in thousands of dollars and shares, respectively, unless otherwise indicated.continue to pursue. We will continue to seek further cost reduction opportunities to streamline our cost structure to preserve our liquidity.

IndustryThe Company also applied for and Executive Outlookreceived a loan in the amount of $1,111 under the Small Business Administration’s Paycheck Protection Program. The loan proceeds were used to finance payroll, rent, and utilities through the second quarter of 2020. The loan principal and related interest accrued may be forgivable, partially or in full, if certain conditions are met.

Three years intoDuring the downturnsecond quarter of 2020, we analyzed the carrying value of our long-lived assets and recorded an impairment charge for certain idle fixed assets given our inability to objectively project cash flows related to those assets. We are still in oil prices,discussions with various potential customers for the industry has largely comesale or rental of these assets and do not expect the results of this impairment to terms withhave an impact on the lower prices, and adjusted accordingly. So much so, that the recent slight uptick in prices is giving rise to optimism about the future. However, even without increases in prices, oil companies have modified their strategies to manage their operations with the lower prices, with projects being executed at breakeven prices as low as $50 a barrel.

One key strategy being employed across the industry is the increased use of strategic partnerships. Whether between oil and gas operators and their suppliers, or between suppliers who serve different steps along the value chain, these partnerships are realizing increased value due to the alignment of incentives, while spreading project risks.discussions.

While increasing revenue remains our top priority, generating free cash flow and preservation of liquidity remains a high priority in the current environment. We are keenly focused on the levers within our control, and we are disheartened by delays in some key projects we expect to be working on, and the resulting disappointing results, we are cautiously optimistic that partnerships we are pursuing will provide material benefits for us in 2018 and beyond, even as we continue to engage with our existing and new customers on their projects. We are especially looking to take advantage of such partnerships to pursue opportunities in international markets, where there isseeing an increase in requests for short-cycle service work, an area where we have a proven track record. We, therefore, see this as an area of further growth for the Company. We also believe customers on the other side of the downturn will be heavily focused on efficiency and shorter lead times, without sacrificing quality and safety, and are confident our streamlined operations and renewed focus on local content regulations, in orderour cost drivers will enable us to enhance local capacity.be a solid choice for our customers.

We arecontinue to be encouraged by the future of the Company and look forward to continuing to engage in more discussions with different customers on what is commonly referred to as brownfield work, which is where operators seek to derive further benefit from their existing infrastructure, rather than develop new fields. We continue to view this asbe a growth opportunity for us, especially as a mitigation for continued delays in new projects, and are making concerted efforts to enhance our market position in this area.

Our balance sheet continues to be strong, we continue to evaluate opportunities to optimize our cost structure, and we are continuing to engage with our customers as they make plans for their projects in 2018 and beyond. Through these efforts we remain strongly committed to creating the most valueservice provider of choice for our customers, shareholdersan employer of choice for our current and employees.future employees, and a good value for shareholders. 

Results of Operations

Three Months Ended SeptemberJune 30, 20172020 Compared to Three Months Ended SeptemberJune 30, 20162019

Revenues. Revenues for the three months ended SeptemberJune 30, 20172020 were $3,470$2,725 compared to revenues of $9,165$5,269 for the three months ended SeptemberJune 30, 2016.2019. The $5,695,$2,544, or 6248 percent, decrease from the same period in 2019 was primarily the result of delays in the commencement of certain customer projects, and fewer projects in process, in 2017, coupled withCOVID-19 related travel restrictions, and the commencement of procurement and manufacturing activities on certain customer orders that resulted in higher than normal revenuesrecent developments in the three month period ended September 30, 2016.global oil markets.

Gross profit. Gross profit for the three months ended SeptemberJune 30, 20172020 was $1,034,$1,267, or 3046 percent of revenues, compared to $3,297,$1,965, or 3637 percent of revenues, for the three months ended SeptemberJune 30, 2016.2019. The $2,2639 percent increase in gross profit percentage was primarily due to a higher proportion of rental revenue and receiving rent abatements during the three months ended June 30, 2020, compared to the three months ended June 30, 2019. Despite the increase in gross profit percentage, the $698 decrease in gross profit or 6 percent decrease in gross profit percentage respectively, was due todriven by lower revenues in the three months ended September 30, 2017.2020 period, compared to the 2019 period.

Selling, general and administrative expenses.Selling, general and administrative (“SG&A”) expenses were $2,264,$2,005, or 6574 percent of revenues, for the three months ended SeptemberJune 30, 20172020 compared to $2,210,$2,007, or 2438 percent of revenues, for the three months ended SeptemberJune 30, 2016.2019. The $54 increase in 2017 resulted primarily from labor costs directed to SG&A activitiesexpenses as a percent of revenues was due to lower manufacturing and/revenues, a $245 severance charge related to the elimination of the Company’s COO position, and a $448 reserve for doubtful accounts receivable related to prolonged customer payment terms and uncertainty around certain customers’ liquidity affected by the COVID-19 pandemic. Excluding these charges, SG&A expenses for the three months ended June 30, 2020 were $1,312, or service activities.48 percent of revenues, which represents a $695, or 35 percent, reduction from the same period in 2019 and a $381, or 23 percent, reduction from the first quarter of 2020.

Other income (expense)Asset Impairment.. During the three months ended SeptemberJune 30, 2017,2020, we recognized a gain onrecorded charges of $4,490 for the impairment of certain idle long-lived assets. The impairment was the result of an analysis of the carrying value of the assets and our inability to objectively project future cash flows from the sale or lease of property, plantthese assets, particularly in light of the impact of the COVID-19 pandemic and equipmentresulting global economic disruption. No impairment of $559 related to the sale of one of our ROVs.Therelong-lived assets was no gain or loss on the sale of property, plant and equipmentrecorded during the three months ended SeptemberJune 30, 2016.2019.

Modified EBITDA. Our management evaluates our performance based on a non-GAAPnon-US GAAP measure which consists of earnings (net income or loss) available to common shareholders before net interest expense,income, income taxes, depreciation and amortization, non-cash share-based compensation expense, equity in net income or loss of joint venture, non-cash impairments, depreciation and amortization,non-cash gains or losses on the sale of PP&E, other non-cash items and one-time charges (“Modified EBITDA”). This measure may not be comparable to similarly titled measures employed by other companies and is not a measure of performance calculated in accordance with US GAAP. The measure should not be considered in isolation or as a substitute for operating income or loss, net income or loss, cash flows provided by operating, investing or financing activities, or other cash flow data prepared in accordance with US GAAP. The amounts included in the Modified EBITDA calculation, however, are derived from amounts included in the accompanying unaudited condensed consolidated statements of operations.

We believe Modified EBITDA is a useful to investors in evaluating our operating performance because it is widely used to measure of a company’s operating performance, which can vary substantially from company to company depending upon accounting methods and book value of assets, financing methods, capital structure and the method by which assets were acquired. It helps investors more meaningfully evaluate and compare the results of our operations from period to period by removing the impact of our capital structure (primarily interest);, asset base (primarily depreciation and amortization);, and actions that do not affect liquidity (share-based compensation expense, equity in net income or loss of joint venture)expense) from our operating results; andresults. Additionally, it helps investors identify items that are within our operational control. Depreciation and amortization charges, while a component of operating income, are fixed at the time of the asset purchase or acquisition in accordance with the depreciable lives of the related asset and as such are not a directly controllable period operating charge.

The following is a reconciliation of net income (loss) to Modified EBITDA (EBITDA loss)(loss) for the three months ended SeptemberJune 30, 20172020 and 2016:2019: