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

DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSCHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

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

DEEP DOWN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYCASH FLOWS

(UNAUDITED)

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

Unless otherwise indicated, the terms “Deep Down, Inc.”, “Deep Down”, “Company”, “we”, “our” and “us” are used in this Report to refer to Deep Down, Inc., a Nevada corporation (“Deep Down Nevada”), and its directly wholly owned subsidiary, Deep Down, Inc., a Delaware corporation (“Deep Down Delaware”). The accompanying unaudited condensed consolidated financial statements of Deep Down, Inc. 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 notes 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, 2020.2021.

Preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and 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.

Organization

Deep Down is an energy services company that provides equipment and support services to the world’s energy and offshore industries. Deep Down offers innovative solutions to complex customer challenges presented between the production facility and the energy source. Deep Down's core services and technological solutions include distribution system installation support and engineering services, umbilical terminations, loose-tube steel flying leads, and related services. Additionally, Deep Down's highly experienced professionals can support subsea engineering, manufacturing, installation, commissioning, and maintenance projects located anywhere in the world.

On February 22, 2022, Deep Down Nevada entered into an Agreement and Plan of Merger providing for the merger of the Company with the Company’s wholly-owned subsidiary, Koil Energy Solutions, Inc. (the “Merger”). As permitted by Section 92A.180 of the Nevada Revised Statutes, the purpose of the Merger is to effect a change of the Company’s name from Deep Down, Inc., to Koil Energy Solutions, Inc. (the “Name Change”).

On February 25, 2022, in connection with the foregoing, Deep Down Nevada filed an Issuer Company-Related Action Notification Form with the Financial Industry Regulatory Authority (“FINRA”), requesting confirmation of the Name Change. On February 28, 2022, in connection with the foregoing, the Company filed an Issuer Company-Related Action Notification Form with FINRA, requesting a change of the Company’s ticker symbol (the “Symbol Change”). Subject to approval by FINRA, the Name Change and Symbol Change will not affect the rights of the Company’s security holders. The Company’s securities will continue to be quoted on the OTC Markets. Following the Name Change, the stock certificates, which reflect the name of the Company prior to the Merger, will continue to be valid. Certificates reflecting the Name Change will be issued in due course as old stock certificates are tendered for exchange or transfer to the Company’s transfer agent.

Liquidity

The Company’s cash on hand was $3,7083,543 and working capital was $5,7964,471 as of September 30, 2021.2022. As of December 31, 2020,2021, cash on hand and working capital was $3,7453,676 and $4,0807,098, respectively. The Company does not have a credit facility in place and depends on cash on hand, cash flows from operations, and the potential opportunistic sales of property, plant and equipment (“PP&E”). to satisfy its liquidity needs.

The Company believes it will have adequate liquidity to meet its future operating requirements through a combination of cash on hand, cash expected to be generated from ongoing operations, and potential opportunistic sales of PP&E in addition to pursuing a disciplined approach to making capital investments. However, given&E. Given the volatility in oil prices and the impact on global economic activity caused by the COVID-19 pandemic, as well as recent increases in raw materials costs and ongoing supply chain constraints, the Company cannot predict this with certainty. To mitigate this uncertainty and preserve liquidity, the Company will continue to pursueexercise discipline when making capital investments and practice opportunistic cost containment initiatives, which can include workforce alignment and limiting overhead spending and research and development efforts to only critical items, and actively pursuing further cost reduction opportunities as they become available.items.

Principles of Consolidation

The unaudited condensed consolidated financial statements presented herein include the accounts of Deep Down, Inc. and its wholly owned subsidiary.subsidiary for the three and nine months ended September 30, 2022 and 2021. All intercompany transactions and balances have been eliminated.

Segments

For the three and nine months ended September 30, 2021 and 2020, we had one 1 operating and reporting segment.

In February 2016, the Financial Accounting Standards BoardFASB 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 iswill initially 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 iswill 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 then-existingexisting 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 lease 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 September 30, 2021,2022, we do not have any finance lease assets or liabilities, nor do we have any subleases.

The following tables present information about our operating leases:

The components of our lease expense were as follows:

Lease term and discount rate:

During the three months ended September 30, 2021,2022, the Company did not have any sale/leaseback transactions.

Present value of lease liabilities:

Present value of lease liabilities:

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 eacha 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 whenon a daily basis as the services are rendered to the customer on a daily basis.customer. Specifically, we recognize revenue as the services are provided as we have the right to invoice the customer for the services performed. Services are invoiced and are payablebilled on a monthly basis. Payment terms for services are usually 30 days from invoice receipt.receipt but can increase to 45 or 60 days depending on the customer.

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 September 30, 20212022 and December 31, 2020,2021, there were no contracts with terms that extended beyond one year.

The following table summarizes our 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 September 30, 20212022 and December 31, 20202021 consisted primarily of 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 Company transfers a promised good or service to a customer and when the customer pays for that good or service is expected to 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.

Property, plant and equipment consisted of the following:

Share-based compensation is included in selling, general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations and in additional paid-in capital in the accompanying unaudited consolidated balance sheets. During the three and nine months ended September 30, 2022, the Company recognized no share-based compensation and $71 of share-based compensation expense, respectively. During the three and nine months ended September 30, 2021, the Company recognized a total of $9 and $46 of share-based compensation expense, respectively. During the three and nine months ended September 30, 2020, the Company recognized a total of $39 and $113, respectively, of share-based compensation expense. The unamortized estimated fair value of nonvested shares of restricted stock and stock options was $2 and $48zero at September 30, 2021 and December 31, 2020, respectively. These costs are expected to be recognized as expenses over a weighted-average period of 0.31 years.2022.

On December 23, 2019, the Board authorized the repurchase of up to 500 shares of the Company’s outstanding common stock (the “Repurchase Program”). 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 three months ended March 31, 2020, in a privately negotiated transaction. During the three months ended March 31, 2020, 744No shares of common stock were purchased during the three and nine months ended September 30, 2021. No shares of common stock were purchased during the three months ended September 30, 2022, and during the nine months ended September 30, 2022, 500 shares of common stock were purchased in privately negotiated transactions for an aggregate amount of $524326. The repurchase program was exhausted as of March 31, 2020. Treasury shares are accounted for using the cost method. See further discussion in Note 10.

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. At September 30, 20212022 and December 31, 2020,2021, management has recorded a full deferred tax asset valuation allowance.

Letters of Credit

Certain customers could require us to issue standby letters of credit in the normal course of business to ensure performance under terms of contracts or as a form of product warranty. The beneficiary of a letter of credit could demand payment from the issuing bank for the amount of the outstanding letter of credit. We had 0 outstanding letters of credit at September 30, 2021 or December 31, 2020.

Employment Agreement

Our Chief Executive Officer is employed under an employment agreement containing severance provisions. In the event of termination of the CEO’s employment for any reason, the CEO will be entitled to receive all accrued, unpaid salary and vacation time through the date of termination and all benefits to which the CEO is entitled or vested under the terms of all employee benefit and compensation plans, agreements, and arrangements in which the CEO participantsparticipates as of the date of termination.

In addition, subject to executing a general release in favor of the Company, the CEO will be entitled to receive certain severance payments in the event his employment is terminated by the Company “other than for cause” or by the CEO with “good reason.” These severance payments include: (i) a lump sum in cash equal to one to two times the CEO’s annual base salary; (ii) a lump sum in cash equal to one to two times the average annual bonus paid to the CEO for the prior two full fiscal years preceding the date of termination; (iii) a lump 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 the CEO’s annual base salary; and (iv) if the CEO’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 CEO 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 made payments to the former COO equal to one time his contractual annual base salary of $245 over 12 months.

Litigation

From time to time, the Company is party to various legal proceedings arising in the ordinary course of business. The Company expenses or accrues legal costs as incurred and is not involved in only oneany material legal proceedingproceedings as of the date of this Report.

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 ultimately filed suit on November 16, 2012, in the Harris County District Court. Aker subsequently filed a counterclaimcounter claim 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 resolutionconvened for mediation on this matter. At this point, it is not clear as to whether an unfavorable outcome is either probable or remote,March 9, 2022, and on May 9, 2022, the Company is unable to determineand Aker finalized the likelihoodterms of an unfavorable outcome or the amount or rangea definitive settlement agreement with a mutual dismissal with prejudice of potential loss if the outcome should be unfavorable.all claims by and between them. The Company subsequently reversed a liability accrual of $100, and no liability remained as of September 30, 2022.

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 paypaid GE an aggregate of $750 in total, which shall be paid, on a monthly basis, through December 2021. The Company accrued a liability related to this matter in the amount of $750 for the year ended December 31, 2019. The remaining liability was $90 at September 30, 2021.2021, and no liability remained at September 30, 2022.

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 the dilutive effect of common stock equivalents (warrants, nonvested stock awards and stock options) using the treasury method.

In each relevant period, the net income used in the basic and diluted EPS calculations is the same. The following table reconciles the weighted-average basic number of common shares outstanding and the weighted-average diluted number of common shares deemed outstanding for the purpose of calculating basic and diluted EPS.

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 with him, effective as of September 1, 2019 (the “Transition Agreement”). The Transition Agreement providesprovided 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 $42 per month, from September 1, 2019 through December 31, 2019, and $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 $135 for the three and nine months ended September 30, 2021.31, 2021, 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 occursoccurred prior to December 31, 2021, unless those assets areand subject to certain other conditions. Such carousels were not sold or leasedprior to December 31, 2021. No commissions were paid during the three months ended September 30, 2022, and a commission in conjunction with a salethe amount of all or substantially all the assets or stock of Deep Down.

As part of the Transition Agreement,$4 was paid to Mr. Smith is bound by certain non-disclosure and confidentiality provisions, and a non-compete and non-hire agreement.

The Company obtained a $1,111 loan under the Small Business Administration’s (“SBA”) Paycheck Protection Program in April 2020 (“April 2020 PPP Loan”). The April 2020 PPP Loan was used to finance covered payroll expenses during the second and third quarters of 2020. The Company applied for forgiveness of the April 2020 PPP Loan in October 2020 and received forgiveness of $1,111 from the SBA on June 29, 2021. The amount of loan forgiveness, including accrued interest, is presented as a component of other income on the condensed consolidated statement of operations for the nine months ended September 30, 2021.

The Company obtained a second $1,111 PPP loan in March 2021 (“March 2021 PPP Loan”). The March 2021 PPP Loan2022 and was usedrelated to finance covered payroll expensesthe lease of one of the carousels during the first and second quarters ofquarter ended December 31, 2021. The Company applied for forgiveness ofA commission in the March 2021 PPP Loan in August 2021 and received forgivenessamount of $1,1115 from the SBA on September 10, 2021. The amount of loan forgiveness, including accrued interest, is presented as a component of other income on the condensed consolidated statement of operations forwas paid during the three and nine months ended September 30, 2021.

On January 5, 2022, the Company repurchased 234 shares of common stock from Mr. Smith at a total cost of $150. On March 24, 2022, the Company repurchased 119 shares of common stock from Mr. Smith in exchange for several long-lived assets that were non-strategic to the core operations of the business. On June 3, 2022, the Company repurchased 147 shares of common stock from Mr. Smith at a total cost of $100. The price per share used for each transaction was market price, and the average price per share paid to Mr. Smith was $0.65.

NOTE 11:          EMPLOYEE RETENTION CREDIT

Under the provisions of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) signed into law on March 27, 2020 and the subsequent extension of the CARES Act, the Company was eligible for a refundable employee retention credit subject to certain criteria. Since there are no generally accepted accounting principles for for-profit business entities that receive government assistance that is not in the form of a loan, an income tax credit or revenue from a contract with a customer, we determined the appropriate accounting treatment by analogy to other guidance. The Company accounted for the employee retention credit by analogy to International Accounting Standards (“IAS”) 20, “Accounting for Government Grants and Disclosure of Government Assistance, of International Financial Reporting Standards (IFRS).”

Under an IAS 20 analogy, a business entity would recognize the employee retention credit on a systematic basis over the periods in which the entity recognizes the payroll expenses for which the grant (i.e., tax credit) is intended to compensate when there is reasonable assurance (i.e., it is probable) that the entity will comply with any conditions attached to the grant and the grant will be received.

The Company recognized a $650 employee retention credit as other income on its consolidated statement of operations for the year ended December 31, 2021, and the Company has a $650 employee retention tax credit receivable balance recorded on its consolidated balance sheet at September 30, 2022. The Company filed for refunds of the employee retention credits and as of the date of this Report, has not received any refunds.

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 provides information that management believes is relevant for an assessment and understanding of Deep Down’s results of operations and financial condition. This information should be read in conjunction with the Company’s audited historical consolidated financial statements, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 20202021 and which is available on the SEC’s website, and the Company’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.” 

General

Deep Down is a leadingan energy services company offering subseathat provides equipment and support services to the world’s energy and offshore industries. We provideDeep Down offers innovative solutions to complex customer challenges presented between the production facility and the energy source. OurDeep Down's core services and technological solutions include distribution system installation support and engineering services, umbilical terminations, loose-tube steel flying leads, and related services. Additionally, ourDeep Down's highly experienced teamprofessionals can support subsea engineering, manufacturing, installation, commissioning, and maintenance projects located anywhere in the world.  

Industry and Executive Outlook

The oilfieldenergy services industry is dependent on the capital and operating expenditure programs of oil and gasenergy companies. The decision for oil and gas operators to cut back or accelerate their exploration, drilling, and production operations is substantially driven by the overall condition of the energy industry. Particularly, the oil and gas industry. This industry has historically been characterized by fluctuations in oil and gascommodity prices, which are driven by a variety of market forces.

In March 2020,Deep Down’s third quarter results reflect the ongoing challenges that face the offshore industry. Our revenues continue to be impacted by global demand and delays in customer drilling schedules. Inflation, certain geopolitical events, and the lingering effects of the pandemic, all of which continue to weigh on our customers’ abilities to commit to long-term deepwater projects. Despite the broader economic dynamics, we believe that the energy industry encounteredmarkets will remain productive. We suspect that the combination of OPEC+’s current proactive stance to reduce production, underperforming US production, and limited non-OPEC+ production capacity will encourage increased investment to bring balance to the markets. Our participation in this potential supply-led upcycle is essential for our business to achieve a significant economic disruption caused by the COVID-19 pandemic, which continues to impact markets globally. The low oil price environment caused by the pandemic, when coupled with restricted travel to mitigate against the spreadsustained level of COVID-19, triggered many exploration and production companies to either significantly reduce, delay, or cancel their operating and capital spending programs. This decline in offshore drilling and production activity resulted in lower contract volumes or delays in significant contracts, which negatively impacted our earnings and cash flows. Our earnings and cash flows could also be negatively impacted by delays in payments by significant customers or delays in completion of our contracts for any reason.growth.

OilTo further enhance our growth prospects, we made two significant announcements this year: a relocation of the business and gas operators, equipment providers, and services companies had to quickly adapt to overcomea rebranding of the challenges presented by these unprecedented times, and Deep Down was no exception. Our primary focus since this global economic disruption has been to improve our cost structure and manage our cash flows, which will remain a priority as we look toward the future.Company.

The initial loantransition to our newly leased premises was completed in October. As we received undersettle into the Paycheck Protection Program (“PPP”) in April 2020 supplemented our cash flows to fund payroll as revenues declined, and our second PPP loan in March 2021 provided a needed buffer to fund working capital whilenew space, we continue to strengthenreceive positive feedback from our workforce.customers. In the second quarter of 2022, we received our first purchase order to provide hydrogen energy services. The scope of this project initially focuses on storage, management and enhancement of customer furnished materials utilizing our alloy welding and other fabrication capabilities. Following validation of these early-stage activities, future phases could lead to systems integration activities potentially including the commissioning of systems being developed for the retail consumer market.

Rebranding the Company from Deep Down, Inc. to Koil Energy Solutions, Inc. was the next step in promoting our core competencies to expand our product and service offerings into new markets. We are still awaiting approval from the Financial Industry Regulatory Authority (FINRA) for our name and ticker symbol change, but we have moved forward with this change operationally and are currently working with our customers under the new brand.

As we look towards the future, our growth efforts will revolve around three pillars: (i) Systems, (ii) Technology and (iii) Partnerships. These three pillars will be energy source agnostic.

Systems primarily relates to our legacy offerings in the oil and gas segment but represents the shift in our approach to becoming a provider of integrated systems instead of providing only individual components. We have now received confirmation of the forgiveness for both loans, which solidifies our working capital position as we evaluate future growth opportunities. One area wepreviously realized success with this strategy and have been ableidentified several opportunities to capitalizepursue on has been the workforce reductions at other organizations, which has provided us the opportunity to add high caliber individuals to our team who possess a wealth of industry knowledge and experience.

During the first nine months of 2021, oil prices progressively rebounded to healthier levels as demand continued to strengthen and travel restrictions continued to ease. As a result, we managed to safely send teams to various international locations. We are cautiously optimistic that the prevalence of vaccines and the downward trend in COVID cases will continue to encourage border controls to be loosened. However, the cautious return to increased activities by our customers has presented margin pressures to us, as evidenced by our reduced gross margins despite increased revenue levels. Aside from pricing pressure from customers, margin compression has also come in the form of low margin pass-through third-party costs on select projects.systematic basis.

We have seen an increaseTechnology entails the development of new equipment and associated services that straddle both traditional oil and gas as well as renewable energy sources. Our product development team is already hard at work and, in bidding activity and executionjust a short amount of contract awards this year as operators mobilizetime, has already identified a potentially patentable offering. This pillar will also include our ongoing efforts to complete a backlog of projects, especially infurther enhance the current favorable oil price environment. The Company received an order at the beginning of the year for the rental of oneenvironmental friendliness of our two carousels that are suitable for large umbilical or cable projects. Certain aspects of this project have not been performed before, which further solidifies our reputation as a service provider of choice for unique offshore installation projects. We envisioned that the successful execution of this project will provide further opportunities to utilize our carousels in the future, and our visions turned into reality when we received a contract award for the rental of the second carousel and associated umbilical spooling services in the fourth quarter of 2021. We are also actively engaged in multiple conversations with different customers to discuss additional rental opportunities for our carousels and associated cable management services.equipment.

The growth of our business remains a top priority and generating free cash flow and preservation of liquidity remains of critical importance to achieve this desired growth, especially in this current environment. We are keenly focused onPartnerships involve the levers within our control, and we are experiencing an increase in requests for short-cycle service work, an areacollaboration with like-minded organizations where we have a proven track record. We also believe customers will continue to be heavily focused on efficiency and shorter lead times without sacrificing quality and safety. As such, we are confident our streamlined operations and continued focus on our core strengths will enable us to be the primary choice for our customers.

Looking towards the future, we continue to engage with a variety of companies on different aspects of the transition to renewable energy with increasing interest in our installation capabilities, equipment, and knowledge of the subsea environment. There are several areas we see as potential growth opportunities, though the timing of these opportunities and associated cash flows is uncertain. As such, we are pursuing different partnerships especially around new technologies as we seek to leverage our core competencies to increase the market potentialjointly capitalize on future opportunities. This will likely be a longer-term strategy and could develop in a variety of our current product and service offerings. We are also working on developing the next generation of our equipment by incorporating designs that utilize a reduced carbon footprint.ways, such as project specific consortia, strategic alliances, or operational joint ventures.

We maintainwill continue to provide additional details in due course as we work with our commitmentteam to ensuring we continuously enhance valueaccomplish our vision of having the most experienced, professional and dependable team, who seek to develop the most innovative solutions, including the most efficient and reliable equipment, with the ultimate goal of providing best-in-class returns for our stockholders, while being an employer of choice in the industry.stockholders.

Results of Operations

Three Months Ended September 30, 20212022 Compared to Three Months Ended September 30, 20202021

Revenues

The 36 percent decrease in revenues was primarily driven by an overall decline in project activity characterized by a shift from product oriented, fixed price contracts to short duration projects utilizing our support services and rental solutions.

Revenues.Cost of Sales Revenues