GEOSPACE TECHNOLOGIES CORP - Quarter Report: 2018 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

for the Quarterly Period Ended June 30, 2018 OR

for the transition period from ____ to ____

Commission file number 001-13601

GEOSPACE TECHNOLOGIES CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

7007 Pinemont Drive

Houston, Texas  77040-6601

(Address of Principal Executive Offices) (Zip Code)

(713) 986-4444

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes    X    No    

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes    X    No    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes    No    X

There were 13,597,041 shares of the Registrant’s Common Stock outstanding as of the close of business on July 31, 2018.

Table of Contents

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands except share amounts)

(unaudited)

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

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

(unaudited)

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

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

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

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

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

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1.   Significant Accounting Policies

Basis of Presentation

The consolidated balance sheet of Geospace Technologies Corporation and its subsidiaries (the “Company”) at September 30, 2017 was derived from the Company’s audited consolidated financial statements at that date.  The consolidated balance sheet at June 30, 2018 and the consolidated statements of operations, comprehensive loss and the consolidated statements of cash flows for the three and nine months ended June 30, 2018 and 2017 were prepared by the Company without audit.  In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the consolidated financial position, results of operations and cash flows were made.  The results of operations for the three and nine months ended June 30, 2018 are not necessarily indicative of the operating results for a full year or of future operations.

Certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America were omitted pursuant to the rules of the Securities and Exchange Commission.  The accompanying consolidated financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the Company’s fiscal year ended September 30, 2017.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  The Company considers many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the estimates and assumptions that are used in the preparation of these consolidated financial statements.  The Company continually evaluates its estimates, including those related to bad debt reserves, inventory obsolescence reserves, self-insurance reserves, product warranty reserves, impairment of long-lived assets and deferred income tax assets.  The Company bases its estimates on historical experience and various other factors that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates under different conditions or assumptions.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original or remaining maturity at the time of purchase of three months or less to be cash equivalents.  Cash and cash equivalents include $8.1 million held by the Company’s foreign subsidiaries and branch offices.  If the Company were to repatriate the cash held by its foreign subsidiaries, it would be required to accrue and pay taxes on any amount repatriated.

Revenue Recognition – Products and Services

The Company primarily derives revenue from the sale of its manufactured products, including revenue derived from the sale of its manufactured rental equipment.  In addition, the Company generates revenue from the short-term rental under operating leases of its manufactured products.  The Company recognizes revenue from product sales, including the sale of used rental equipment, when all of the following have occurred: (i) title passes to the customer, (ii) the customer assumes the risks and rewards of ownership, (iii) the product sales price has been determined, (iv) collectability of the sales price is reasonably assured, and (v) product delivery occurs as directed by the customer.  Although infrequent, in cases where collectability is not reasonably assured, the installment or cost recovery method is used.  Except for certain of the Company’s reservoir characterization products, the Company’s products are generally sold without any customer acceptance provisions, and the Company’s standard terms of sale do not allow customers to return products for credit.  The Company recognizes rental revenue as earned over the rental period.  Rentals of the Company’s equipment generally range from daily rentals to rental periods of up to six months or longer.  Revenue from engineering services is recognized as services are rendered over the duration of a project, or as billed on a per hour basis.  Field service revenue is recognized when services are rendered and is generally priced on a per day rate.

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Recently Adopted Accounting Pronouncements

In October 2016, the Financial Accounting Standards Board (“FASB”) issued guidance which eliminates the exception of recognizing, at the time of transfer, current and deferred income taxes for intercompany profits on intra-entity asset transfers other than inventory.  The Company adopted this guidance in its first quarter of its fiscal year ending September 30, 2018 using the modified retrospective approach.  The adoption resulted in a cumulative-effect charge to opening retained earnings of $0.4 million.  Under prior guidance, the Company maintained a non-current prepaid income tax asset on its consolidated balance sheets representing income taxes paid in the U.S. on profits realized from the sale of rental equipment to its foreign subsidiaries.  As this rental equipment was depreciated, the prepaid tax was recognized as a current income tax expense in the Company’s consolidated statement of operations.  Under the new guidance, the Company is required to recognize a deferred tax asset related to the intercompany profits realized on the sale of non-inventory assets to its subsidiaries; however, profits realized from the intercompany sale of inventories will continue to be accounted for as a prepaid income tax asset in accordance with the prior guidance.  Under the new guidance, the deferred tax asset resulting from the sale of non-inventory assets is recognized at the jurisdictional tax rate of the subsidiary which purchased the asset.  Any differences between the subsidiary’s jurisdictional tax rate and the seller’s tax rate pertaining to the intercompany profit are charged to seller’s current income tax expense at the time of the sale.  With the recent reduction in the U.S. income tax rate to 21%, and assuming that a majority of the Company’s future intercompany equipment sales will continue to be made to its Canadian subsidiary having a higher statutory tax rate, the new guidance is expected to have a favorable impact on the Company’s provision for income taxes in future periods.  Due to the fact the Company has a valuation allowance against most of its net deferred tax assets, the adoption of this guidance had no impact upon the Company’s income tax expense for the three and nine months ended June 30, 2018.  

In March 2016, the FASB issued guidance to simplify key components of employee share-based payment accounting.  The new guidance simplifies several aspects of the accounting for share-based payment transactions, including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification of excess tax benefits from share-based payments on the statement of cash flows.  The Company adopted this guidance in the first quarter of its fiscal year ending September 30, 2018.  No cumulative effect adjustment to retained earnings was needed upon adoption since the Company had no unrecorded excess tax benefits residing in its additional paid-in-capital account.  Under the prior standard, the Company was required to track and record as a component of additional paid-in capital the tax impact of cumulative windfalls, net of any shortfalls, which resulted from excess tax benefits from share-based payments. As a result, the impact of net windfalls has not historically affected the Company’s provision for income taxes or its effective income tax rate.  Under the new guidance, the Company will no longer track windfalls or shortfalls resulting from share-based payments since all future windfalls and shortfalls will be recorded as a component of the Company’s current provision for income taxes.  Depending on the magnitude of future windfalls or shortfalls, this change could significantly affect the Company’s provision for income taxes in a positive or negative direction.  Since the Company had a valuation allowance against the value of its cumulative U.S. net operating losses, the adoption of this guidance had no impact upon the Company’s income tax expense for the three and nine months ended June 30, 2018.

In July 2015, the FASB issued guidance requiring management to measure inventory at the lower of cost or net realizable value.  Under the new guidance, net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.    Since the Company is a manufacturer and the nature of its inventory is generally unique to its designs and applications thus preventing the gathering of relevant external market data, its existing practice for calculating net realizable value under the current standard is consistent with the practice prescribed by the new guidance.  The Company adopted this standard in its first quarter of its fiscal year ending September 30, 2018. The adoption of this guidance had no impact upon the Company’s consolidated financial statements.

Recently Issued Accounting Pronouncements

In November 2016, the FASB issued guidance which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents.  Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.  This guidance must be adopted by the Company no later than its first quarter of fiscal year 2019 and should be applied on a retrospective transition basis.  The Company has historically not held restricted cash balances and, therefore, does not expect the adoption of this guidance to have a material effect on its consolidated financial statements.  However, upon adoption of this guidance, the Company will make any necessary changes to present restricted cash balances in accordance with the guidance.  

In June 2016, the FASB issued guidance surrounding credit losses for financial instruments that replaces the incurred loss impairment methodology in current U.S. generally accepted accounting principles (“GAAP”).  The new impairment model requires immediate recognition of estimated credit losses expected to occur for most financial assets and certain other financial instruments.  For available-for-sale debt securities with unrealized losses, credit losses will be recognized as allowances rather than reductions in

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the amortized cost of the securities.  The standard is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those annual periods.  Early adoption for a fiscal year beginning after December 15, 2018 is permitted.  Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first effective reporting period.  The Company expects to adopt this standard during the first quarter of its fiscal year ending September 30, 2021 and is currently evaluating the impact of this new guidance on its consolidated financial statements.     

In February 2016, the FASB issued guidance requiring a lessee to recognize assets and liabilities for leases with lease terms of more than 12 months.  Consistent with current GAAP, the recognition, measurement and presentation of expense and cash flows arising from a lease by a lessee primarily will depend on its classification of the lease as a finance or operating lease.  However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, the new guidance will also require operating leases of the lessee to be recognized on the balance sheet if the operating lease term is more than 12 months.  The guidance also requires disclosures to help investors and other financial statement users to better understand the amount, timing and uncertainty of cash flows arising from leases.  These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.  The guidance is effective for fiscal years, and interim reporting periods therein, beginning after December 15, 2018 and is to be applied using the modified retrospective approach.  The Company expects to adopt this standard in its first quarter of its fiscal year ending September 30, 2020.  The Company currently is not a lessee under any lease agreements with a term longer than one year.  The Company is routinely a lessor in its rental contracts with customers; however, these rental agreements are generally short-term in nature, and the Company believes would be treated as operating leases under the new guidance; however, the Company has not completed a detailed review of its lease arrangements, and these conclusions are subject to change.    

In May 2014, the FASB issued guidance requiring entities to recognize revenue from contracts with customers by applying a five-step model in accordance with the core principle to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  In addition, this guidance specifies the accounting for some costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition.  In August 2015, the FASB issued guidance deferring the effective date of this guidance to annual periods beginning after December 15, 2017, including interim reporting periods therein.  Entities have the option to adopt this guidance either retrospectively or through a modified retrospective transition method.  This new standard will supersede existing revenue guidance and affect the Company's revenue recognition process and the presentations or disclosures of the Company's consolidated financial statements and footnotes.  The Company recognizes revenue through three primary transactions types:  (i) the immediate recognition of revenue through the routine delivery of products to its customers, (ii) the rental of equipment to its customers through short-term operating leases, and (iii) the recognition of revenue utilizing the percentage of completion method for the delivery of complex products requiring long manufacturing times and substantial engineering resources.  The Company will adopt this standard in the first quarter of its fiscal year ending September 30, 2019 using the modified retrospective method.  The Company’s evaluation of the standard is largely complete. At this point in the evaluation, the Company has not identified a transaction that will have a material effect on its consolidated financial statements.  The Company continues to evaluate the standard’s potential effects on its consolidated financial statements.

2.   Short-term Investments

  The Company’s short-term investments have contractual maturities ranging from July 2018 to March 2020. 

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3.   Derivative Financial Instruments

At June 30, 2018 and September 30, 2017, the Company’s Canadian subsidiary had CAN$38.9 million and CAD$26.1 million, respectively, of Canadian dollar denominated intercompany accounts payable owed to one of the Company’s U.S subsidiaries.  In order to mitigate its exposure to movements in foreign currency rates between the U.S. dollar and Canadian dollar, the Company routinely enters into foreign currency forward contracts to hedge a portion of its exposure to changes in the value of the Canadian dollar.  On March 28, 2018, the Company entered into $30.0 million Canadian dollar short-term hedge contract with a United States bank to reduce the impact on cash flows from movements in the Canadian dollar/U.S. dollar currency exchange rate, but has not been designated as a hedge for accounting purposes.     

The following table summarizes the gross fair value of all derivative instruments, which are not designated as hedging instruments and their location in the consolidated balance sheets (in thousands).      

The following table summarizes the Company’s gains on derivative instruments in the consolidated statements of operations for the three and nine month periods ended June 30, 2018 and 2017 (in thousands):

Amounts in the above table include realized and unrealized derivative gains and losses.

4.   Trade Accounts and Financing Receivables

Trade accounts receivable are reflected in the following table (in thousands):

The allowance for doubtful accounts represents the Company’s best estimate of probable credit losses.  The Company determines the allowance based upon historical experience and a current review of its balances.  Accounts receivable balances are charged off against the allowance whenever it is probable that the receivable will not be recoverable.  During the three months ended June 30, 2018, the Company recorded bad debt expense of $2.7 million primarily attributable to a trade accounts receivable from a customer which filed for bankruptcy protection during the period.   While the Company is uncertain of the ultimate amount of bad debt that will result from the bankruptcy proceedings, it has provided a bad debt allowance for all of its pre-petition bankruptcy receivable claims.  Should any portion of these pre-petition claims be recovered in the future, the Company will reverse such bad debt expenses.

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Financing receivables are reflected in the following table (in thousands):

During the nine months ended June 30, 2018, the Company issued promissory notes to customers totaling $4.0 million in connection with the sale of rental equipment.  Cash flows from financing receivables related to the sale of rental equipment for the nine months ended June 30, 2018 of $3.6 million are included in proceeds from the sale of used rental equipment in the consolidated statements of cash flows.

5.   Inventories

Inventories consist of the following (in thousands):

During the nine months ended June 30, 2018 and 2017, the Company made non-cash inventory transfers of $23.5 million and $1.6 million, respectively, to rental equipment.  Raw materials include semi-finished goods and component parts which totaled approximately $28.7 million and $48.2 million at June 30, 2018 and September 30, 2017, respectively.             

6.   Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss consisted of the following (in thousands):

7.   Stock-Based Compensation

During the nine months ended June 30, 2018, the Company issued 155,450 shares of restricted stock under its 2014 Long Term Incentive Plan, as amended.  The weighted average grant date fair value of the restricted stock was $15.21 per share.  The grant date fair value of these awards was $2.4 million, which will be charged to expense over the next four years as the restrictions lapse.  Compensation expense for restricted stock awards was determined based on the closing market price of the Company’s stock on the

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date of grant applied to the total number of shares that are anticipated to fully vest.  Recipients of restricted stock awards are entitled to vote such shares and are entitled to dividends, if paid.    

As of June 30, 2018, the Company had unrecognized compensation expense of $4.1 million relating to restricted stock awards.  This unrecognized compensation expense is expected to be recognized over a weighted average period of 2.7 years.  In addition, the Company had $0.1 million of unrecognized compensation expense related to nonqualified stock option awards which is expected to be recognized over a weighted average period of 1.0 years.       

As of June 30, 2018, a total of 309,725 shares of restricted stock and 194,600 nonqualified stock options shares were outstanding.

8.   Loss Per Common Share

The Company applies the two-class method in calculating per share data.  The following table summarizes the calculation of net loss and weighted average common shares and common equivalent shares outstanding for purposes of the computation of loss per share (in thousands, except share and per share data):

For the calculation of diluted loss per share for the three and nine months ended June 30, 2018 and 2017, 194,600 and 201,800 stock options, respectively, were excluded in the calculation of weighted average shares outstanding as a result of their impact being antidilutive.   

9.   Segment Information

The Company reports and evaluates financial information for two segments:  Seismic and Non-Seismic. Seismic product lines include: land and marine wireless data acquisition systems, permanent land and seabed reservoir monitoring products and services, geophones and geophone strings, hydrophones, leader wire, connectors, telemetry cables, marine streamer retrieval and steering devices and various other products.  The Non-Seismic product lines include imaging products and industrial products.

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The following table summarizes the Company’s segment information (in thousands):

10.   Income Taxes

The Company’s statutory U.S. income tax rate for the nine months ended June 30, 2018 was impacted by the Tax Cuts and Jobs Act (the “Act”), which was enacted into law on December 22, 2017.  Income tax effects resulting from changes in tax laws are accounted for by the Company in accordance with the authoritative guidance, which requires that these tax effects be recognized in the period in which the law is enacted and the effects are recorded as a component of the provision for income taxes from continuing operations.  As a result, the Company made changes to its provision for income tax resulting from the enactment of the Act for the nine months ended June 30, 2018.

The Act includes significant changes to the U.S. corporate income tax system which (i) reduces the U.S. federal corporate tax rate from 35% to 21% as of January 1, 2018, (ii) shifts to a modified territorial tax regime which requires companies to pay a one-time transition tax on the cumulative earnings of certain foreign subsidiaries that were previously tax deferred and (iii) creates new taxes on certain foreign-sourced earnings.  The decrease in the U.S. federal corporate tax rate from 35% to 21% results in a blended statutory tax rate of 24.5% for the Company’s fiscal year ending September 30, 2018. The new taxes for certain foreign-sourced earnings under the Act are effective for the Company beginning after the fiscal year ending September 30, 2018.

The Company is currently evaluating the impact of the Act on its consolidated financial statements.  Based on the Company’s assessments to date, it expects the one-time deemed repatriation tax on certain foreign earnings and profits to not have a cash impact since it anticipates, that it will be able to utilize existing net operating loss carryforwards to substantially offset any taxes payable on foreign earnings and profits.  Additionally, the Company has adjusted its U.S. gross deferred tax assets and liabilities to the new 21% statutory tax rate; however, it also recorded a corresponding adjustment to a valuation allowance which resulted in no net impact to deferred tax assets or provision for income taxes.  Except for, the adjustments referred to above, the Company does not expect any further adjustments relating to tax effects of the Act in its consolidated financial statements (including any provisional amounts) based on the Company’s analysis of its current and expected tax attributes.

   The Company’s effective tax rates for the three months ended June 30, 2018 and 2017 were (1.1)% and (4.7)%, respectively.  The Company’s effective tax rates for the nine months ended June 30, 2018 and 2017 were 3.1% and (3.9)%, respectively.  The United States statutory rate for the three and nine months ended June 30, 2018 and 2017 was 24.5% (blended) and 35%,  respectively.  Compared to the United States statutory rate, the lower effective tax rates resulted primarily from the provision of a valuation allowance against the Company’s U.S. and Canadian deferred tax assets, due to the uncertainty surrounding the Company’s ability to utilize such deferred tax assets in the future to offset taxable income.  In addition, for the three months ended March 31, 2018, the Company amended its prior year U.S. tax return to claim a $0.7 million refund.  

11.   Exit and Disposal Activities

In December 2017, the Company initiated a program to reduce operating costs in light of expected and continuing low levels of seismic product demand.  The program is expected to produce approximately $6 million of annualized cash savings.  The majority of the cost reductions were realized through a reduction of over 60 employees from the Company’s Houston area workforce.   In connection with the workforce reductions, the Company incurred $0.7 million of termination costs in its first quarter of fiscal year

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2018.  The termination costs were recorded to both cost of revenue and operating expenses in the consolidated statement of operations.  No further termination costs are expected and there are no outstanding liabilities related to this program as of June 30, 2018.    

12.   Subsequent Event

On July 27, 2018, the Company acquired Quantum Technology Sciences, Inc., a Florida-based tactical security and surveillance systems solutions provider (“Quantum”) through a merger of the Company’s subsidiary with and into Quantum, with Quantum as the surviving corporation.  Quantum’s operations will remain in Florida, performing as a wholly-owned subsidiary of the Company.

The acquisition purchase price for Quantum consisted of a cash down payment at closing of approximately $4.4 million and contingent earn-out payments of up to $23.5 million over a four-year period.  The contingent payments, if any, which may be paid in the form of cash or Company stock, will be derived from certain eligible revenue that may be generated during the four-year earn-out period.            

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of the major elements of our consolidated financial statements.  You should read this discussion and analysis together with our consolidated financial statements, including the accompanying notes, and other detailed information appearing elsewhere in this Quarterly Report on Form 10-Q and our annual report on Form 10-K for the year ended September 30, 2017.

Forward-Looking Statements

This Quarterly Report on Form 10-Q and the documents incorporated by reference herein, if any, contain “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  These forward-looking statements can be identified by terminology such as “may”, “will”, “should”, “intend”, “expect”, “plan”, “budget”, “forecast”, “anticipate”, “believe”, “estimate”, “predict”, “potential”, “continue”, “evaluating” or similar words.  Statements that contain these words should be read carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial position or state other forward-looking information.  Examples of forward-looking statements include, among others, statements that we make regarding our expected operating results, the adoption and sale of our products in various geographic regions, anticipated levels of capital expenditures and the sources of funding therefore, and our strategy for growth, product development, market position, financial results and the provision of accounting reserves.  These forward-looking statements reflect our best judgment about future events and trends based on the information currently available to us.  However, there will likely be events in the future that we are not able to predict or control.  The factors listed under the caption “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, as well as other cautionary language in such Annual Report and this Quarterly Report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements.  Such examples include, but are not limited to, decreases in commodity price levels, which could reduce demand for our products, the failure of our products to achieve market acceptance, despite substantial investment by us, our sensitivity to short term backlog, delayed or cancelled customer orders, product obsolescence resulting from poor industry conditions or new technologies, bad debt write-offs associated with customer accounts, lack of further orders for our OBX systems, failure of our non-seismic products to be adopted by the border and security perimeter market, infringement or failure to protect intellectual property, the failure of the acquisition transaction to yield positive operating results, and any negative impact from our restatement of our financial statements regarding current assets.  The occurrence of the events described in these risk factors and elsewhere in this Quarterly Report on Form 10-Q could have a material adverse effect on our business, results of operations and financial position, and actual events and results of operations may vary materially from our current expectations.  We assume no obligation to revise or update any forward-looking statement, whether written or oral, that we may make from time to time, whether as a result of new information, future developments or otherwise.

Business Overview

Geospace Technologies Corporation reincorporated as a Texas corporation on April 16, 2015.  We originally incorporated as a Delaware corporation on September 27, 1994.  Unless otherwise specified, the discussion in this Quarterly Report on Form 10-Q refers to Geospace Technologies Corporation and its subsidiaries.  We design and manufacture instruments and equipment used in the oil and gas industry to acquire seismic data in order to locate, characterize and monitor hydrocarbon producing reservoirs.  We also design and manufacture non-seismic products, including industrial products, offshore cables and imaging equipment.  We report and categorize our customers and products into two different segments: Seismic and Non-Seismic.

We have engaged in the seismic instrument and equipment business since 1980 and market our products primarily to the oil and gas industry.  Demand for our products has been, and will likely continue to be, vulnerable to downturns in the economy and the oil and gas industry in general.  For more information, please refer to the risks discussed under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017.

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”).  Our SEC filings are available to the public over the Internet at the SEC’s website at http://www.sec.gov.  You may also read and copy any document we file at the SEC’s public reference room at 100 F Street, NE, Washington, DC 20549.  Please call the SEC at 1-800-SEC-0330 for further information on their public reference room.  Our SEC filings are also available to the public on our website at http://www.geospace.com.  From time to time, we may post investor presentations on our website under the “Investor Relations” tab.  Please note that information contained on our website, whether currently posted or posted in the future, is not a part of this Quarterly Report on Form 10-Q or the documents incorporated by reference in this Quarterly Report on Form 10-Q.

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Products and Product Development

Seismic Products

Our seismic business segment has historically accounted for the majority of our revenue.  Geoscientists use seismic data primarily in connection with the exploration, development and production of oil and gas reserves to map potential and known hydrocarbon bearing formations and the geologic structures that surround them.  Our seismic product lines currently consist of land and marine nodal data acquisition systems, permanent land and seabed reservoir monitoring products and services, geophones and geophone strings, hydrophones, leader wire, connectors, telemetry cables, marine streamer retrieval and steering devices and various other products.  Our seismic products are compatible with most major competitive seismic data acquisition systems currently in use.  We believe that our seismic products are among the most technologically advanced instruments and equipment available for seismic data acquisition.

Traditional Products

An energy source and a data recording system are combined to acquire seismic data.  We provide many of the components of seismic data recording systems, including geophones, hydrophones, multi-component sensors, leader wire, geophone strings, connectors, seismic telemetry cables and other seismic related products.  On land, our customers use geophones, leader wire, cables and connectors to receive and measure seismic reflections resulting from an energy source into data recording units, which store the seismic information for subsequent processing and analysis.  In the marine environment, large ocean-going vessels tow long seismic cables known as “streamers” containing hydrophones which are used to detect pressure changes.  Hydrophones transmit electrical impulses back to the vessel’s data recording unit where the seismic data is stored for subsequent processing and analysis.  Our marine seismic products also help steer streamers while being towed and help recover streamers if they become disconnected from the vessel.

Our seismic sensor, cable and connector products are compatible with most major competitive seismic data acquisition systems currently in use.  Revenue from these products results primarily from seismic contractors purchasing our products as components of new seismic data acquisition systems or to repair and replace components of seismic data acquisition systems already in use.

Our products used in marine seismic data acquisition include our seismic streamer retrieval devices (“SRDs”).  Occasionally, streamer cables are severed and become disconnected from the vessel as a result of obstacles, inclement weather, vessel traffic or human error.  Our SRDs, which are attached to the streamer cables, contain air bags which are designed to inflate automatically at a given water depth, bringing the severed streamer cables to the surface.  These SRDs save the seismic contractors significant time and money compared to the alternative of losing the streamer cable.  We also produce seismic streamer steering devices, or “birds,” which are fin-like devices that attach to the streamer cable.  These birds help maintain the streamer cable at a certain desired depth as it is being towed through the water.

Wireless Products

We have developed a land-based wireless (or nodal) seismic data acquisition system called the GSX.  Rather than utilizing interconnecting cables as required by most traditional land data acquisition systems, each GSX station operates as an independent data collection system, allowing our GSX stations to be deployed in virtually unlimited channel configurations.  As a result, our GSX system requires less maintenance, which we believe allows our customers to operate more effectively and efficiently because of its reduced environmental impact, lower weight and ease of operation.  Our GSX system is designed into configurations ranging from one to four channels per station.  Since its introduction in 2008 and through June 30, 2018, we have sold 417,000 GSX channels and we have 92,000 GSX channels in our rental fleet.

We have also developed a marine-based wireless seismic data acquisition system called the OBX.  Similar to our GSX land-based wireless system, the marine OBX system can be deployed in virtually unlimited channel configurations and does not require interconnecting cables between each station.  Our deep water versions of the OBX system can be deployed in depths of up to 3,450 meters.  Through June 30, 2018, we have sold approximately 600 OBX stations and we have 13,000 OBX stations in our rental fleet.  

Reservoir Products

Seismic surveys repeated over selected time intervals show dynamic changes within the reservoir and can be used to monitor the effects of oil and gas development and production.  In this regard, we have developed permanently installed high-definition reservoir monitoring systems for land and ocean-bottom applications in producing oil and gas fields.  We also produce a retrievable version of our ocean-bottom system for use on fields where permanently installed systems are not appropriate or economical.  Utilizing these tools, producers can enhance the recovery of oil and gas deposits over the life of a reservoir.

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Our high-definition reservoir monitoring products include the HDSeis™ product line and a suite of borehole and reservoir monitoring products and services.  Our HDSeis™ system is a high-definition seismic data acquisition system with flexible architecture that allows it to be configured as a borehole seismic system or as a subsurface system for both land and marine reservoir-monitoring projects.  The scalable architecture of the HDSeis™ system enables custom designed system configuration for applications ranging from low-channel engineering and environmental-scale surveys requiring a minimum number of recording channels to high-channel surveys required to efficiently conduct permanent reservoir monitoring (“PRM”).  Modular architecture allows virtually unlimited channel expansion.  In addition, multi-system synchronization features make the HDSeis™ system well suited for multi-well or multi-site acquisition, simultaneous surface and downhole acquisition and continuous reservoir monitoring projects.

Reservoir monitoring requires special purpose or custom designed systems in which portability becomes less critical and functional reliability assumes greater importance.  This reliability factor helps assure successful operations in inaccessible locations over a considerable period of time.  Additionally, reservoirs located in deep water or harsh environments require special instrumentation and new techniques to maximize recovery.  Reservoir monitoring also requires high-bandwidth, high-resolution seismic data for engineering project planning and reservoir management.  We believe our HDSeis™ System and tools, designed for cost-effective deployment and lifetime performance, will make borehole and seabed seismic acquisition a cost-effective and reliable process for the challenges of reservoir monitoring.  Our multi-component seismic product developments include an omni-directional geophone for use in reservoir monitoring, a compact marine three-component or four-component gimbaled sensor and special-purpose connectors, connector arrays and cases.

We have not received orders for any permanent reservoir monitoring systems since November 2012.

In addition, we produce seismic borehole acquisition systems which employ a fiber optic augmented wireline capable of very high data transmission rates.  These systems are used for several reservoir monitoring applications, including an application pioneered by us allowing operators and service companies to monitor and measure the results of fracturing operations.

Non-Seismic Products

Our non-seismic businesses leverage upon our existing manufacturing facilities and engineering capabilities.  We have found that many of our seismic products, with little or no modification, have direct application to industries beyond those involved in oil and gas exploration and development.  For example, our customers utilize our borehole tools to monitor subsurface carbon dioxide injections and for mine safety applications.

Our non-seismic products include electronic pre-press products that employ direct thermal imaging and digital inkjet printing technologies targeted at the commercial graphics, industrial graphics, textile and flexographic printing industries.  Our other non-seismic products consist of (i) sensors and tools for vibration monitoring, mine safety, earthquake detection and security applications, (ii) cables for power and communication for the offshore oil and gas and offshore construction industries, (iii) water meter cables and connectors, and (iv) other specialty industrial cable and connector products.

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Consolidated Results of Operations

We report and evaluate financial information for two segments: Seismic and Non-Seismic.  Summary financial data by business segment follows (in thousands):

Overview

Early in calendar year 2014, we experienced a softening in the demand for our seismic exploration products, particularly in North America, as capital budgets for oil and gas producers were trending away from exploration-focused activities toward production and exploitation activities.  During this period oil production in North America’s unconventional shale reservoirs increased, as did oil production from other non-OPEC countries, resulting in an oversupply of crude oil in the world market.  Market prices for a barrel of crude oil declined from over $100 in July 2014 to approximately $27 in January 2016, and have recovered to approximately $69 today.  With this decline in oil and natural gas prices, oil and gas exploration and production companies experienced a significant reduction in cash flows, which resulted in sharp reductions in their capital spending budgets for oil and gas exploration-focused activities, including seismic activities.  While we are seeing some signs of increased seismic activity around the world, the need for new seismic equipment remains restrained due to capital limitations affecting many of our customers along with excess unutilized equipment.  We expect revenue from our seismic products, and in particular our traditional and wireless products, to remain low until exploration-focused seismic activities increase which we believe will result from the ongoing depletion of existing reservoirs prompting the need to find new sources of oil and gas.  We expect these challenging industry conditions will continue for the remaining months of fiscal year 2018 and into fiscal year 2019.  

In September 2017, we were notified by Statoil that it would soon request quotes for two new PRM systems which were required to utilize fiber optic sensor technology.  This contract was subsequently awarded to Alcatel in January 2018.  Since our PRM designs utilize electrical sensor technology, we were not able to participate with a quotation for the design and manufacture of these PRM systems.  We believe that our PRM system designs, which utilize electrical sensor technology, provide the best long-term functionality and performance of any PRM system, and we continue to aggressively market our PRM systems to major oil and gas companies.  However, the occurrence of this notice from Statoil, combined with the absence of any new PRM orders of any technology type since November 2012, caused us to record $5.1 million of obsolescence reserves and $5.3 million of impairment reserves in September 2017 related to our PRM inventories and manufacturing equipment, respectively.  

In December 2017, we initiated a program to reduce operating costs in light of expected and continuing low levels of seismic product demand.  The program is expected to produce approximately $6 million of annualized cash savings.  The majority of the future cost reductions will be realized through the reduction of over 60 employees from our Houston area workforce.  In connection with the workforce reductions, we incurred $0.7 million of termination costs in our first quarter of fiscal year 2018.  The termination costs were recorded to both cost of revenue and operating expenses in the consolidated statement of operations.  No further termination costs are expected and there are no outstanding liabilities related to this program as of June 30, 2018.      

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Three and nine months ended June 30, 2018 compared to the three and nine months ended June 30, 2017

Consolidated revenue for the three months ended June 30, 2018 increased $7.1 million, or 49.8%, from the corresponding period of the prior fiscal year.  This increase was due to significant increases in both our seismic and non-seismic product revenue.  Consolidated revenue for the nine months ended June 30, 2018, increased $5.1 million, or 10.2%, from the corresponding period of the prior fiscal year.  The increase in revenue for the nine months ended June 30, 2018 was primarily due to an increase in our non-seismic product revenue.    

Consolidated gross profit (loss) for the three months ended June 30, 2018 was $4.7 million, compared to a loss of ($5.1) million for the corresponding period of prior fiscal year.  Consolidated gross profit (loss) for the nine months ended June 30, 2018 was $5.7 million, compared to a loss of ($11.0) million for the corresponding period of prior fiscal year.  The improvement in gross profit (loss) for both periods resulted from (i) an increase in revenue, and principally an increase in rental revenue combined with declining depreciation expense associated with rental equipment, (ii) a $3.0 and $8.1 million decrease in inventory obsolescence expense for the three months and nine months ended June 30, 2018, and (iii) a reduction in fixed manufacturing costs derived from workforce reductions occurring in the first quarter of fiscal year 2018.  Until seismic product demand increases resulting in increased utilization of our factory, we expect our consolidated gross margins to remain below historic norms.

In light of current market conditions, our seismic product inventories at June 30, 2018 continue to exceed levels considered appropriate for our current level of product demand.  While we are aggressively working to reduce these legacy inventory balances, we are also adding new inventories for recent product developments and other product demand.  During periods of excessive inventory levels, our policy has been, and will continue to be, to record obsolescence expense in our consolidated income statement as we experience reduced levels of inventory turnover and as our inventories continue to age.  If difficult market conditions continue, we expect to record additional inventory obsolescence expense in fiscal year 2018 and beyond until seismic product demand and resulting seismic inventory turnover returns to acceptable levels.

Consolidated operating expenses for the three months ended June 30, 2018 were $9.8 million, an increase of $1.2 million, or 13.3%, from the corresponding period of the prior fiscal year.  Consolidated operating expenses for the nine months ended June 30, 2018 were $25.7 million, an increase of $0.5 million, or 2.1%, from the corresponding period of the prior fiscal year.  The increase in operating expenses for both periods was primarily due to a $2.6 million bad debt expense attributable to a trade accounts receivable from a customer which filed for bankruptcy protection during the quarter ended June 30, 2018.  Excluding bad debt expense (recovery), operating expenses decreased $1.6 million and $3.3 million, respectively, for the three and nine months ended June 30, 2018.  This decrease was primarily due to lower stock-based compensation expense, workforce reductions and a decline in research and development project costs.  

Consolidated other income for the three months ended June 30, 2018 was $0.4 million, compared to $46,000 from the corresponding period of the prior fiscal year.  The increase in other income was primarily due to an increase in foreign exchange gains and foreign currency hedge financing fees offset by an increase in interest income resulting from increased financing receivables.  Consolidated other income (expense) for the nine months ended June 30, 2018 was $0.3 million, compared to ($16,000) from the corresponding period of the prior fiscal year.  The increase was primarily due to an increase in interest income resulting from increased financing receivables and a decrease in foreign exchange losses, and was partially offset by an increase in foreign currency hedge financing fees.  

Consolidated income tax expense for the three months ended June 30, 2018 was $0.1 million compared to $0.6 million for the corresponding period of the prior fiscal year.  Consolidated income tax expense (benefit) for the nine months ended June 30, 2018 was $(0.6) million compared to $1.4 million for the corresponding period of the prior fiscal year.  Our effective tax rates for the three months ended June 30, 2018 and 2017 were (1.1)% and (4.7)%, respectively.  Our effective tax rates for the nine months ended June 30, 2018 and 2017 were 3.1% and (3.9)%, respectively.  The United States statutory tax rate for the three and nine months ended March 31, 2018 and 2017 were 24.5% (blended) and 35%, respectively.  Compared to the United States statutory rate, the lower effective tax rates for the three and nine months ended June 30, 2018 and 2017 primarily resulted from our inability to recognize any tax benefits for the tax losses we incurred in the U.S. and Canada due to the uncertainty surrounding our ability to utilize these losses in the future to offset taxable income.  In addition, for the three months ended March 31, 2018, the Company amended its prior year U.S. tax return to claim a $0.7 million refund.  

Seismic Products

Revenue

Revenue from our seismic products for the three months ended June 30, 2018 increased $5.0 million, or 68.9%, from the corresponding period of the prior fiscal year.  Revenue from our seismic products for the nine months ended June 30, 2018 increased

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$1.0 million, or 3.3%, from the corresponding period of the prior fiscal year.  The components of these increases include the following:

Operating Loss

Our operating loss associated with our seismic products for the three months ended June 30, 2018 decreased $7.9 million, or 65.6%, from the corresponding period of the prior year.  Our operating loss associated with our seismic products for the nine months ended June 30, 2018 decreased $15.0 million, or 49.1%, from the corresponding period of the prior year. The decrease in operating loss for both periods resulted from increased revenue and both cash and non-cash cost reductions.  These cost improvements were partially offset by increased bad debt expense in both periods.  

Non-Seismic Products

Revenue

Revenue from our non-seismic products for the three months ended June 30, 2018 increased $2.0 million, or 30.2%, from the corresponding period of the prior fiscal year.  Revenue from our non-seismic products for the nine months ended June 30, 2018 increased $4.1 million, or 21.7%, from the corresponding period of the prior fiscal year.  The components of these increases included the following:

Operating Income

Our operating income associated with revenue from our non-seismic products for the three months ended June 30, 2018 increased $0.4 million, or 42.2%, from the corresponding period of the prior fiscal year.  Our operating income associated with sales of our non-seismic products for the nine months ended June 30, 2018 increased $0.7 million, or 23.6%, from the corresponding period of the prior fiscal year.  The increase for both periods primarily resulted from increased industrial product revenue.    

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Liquidity and Capital Resources

At June 30, 2018, we had approximately $12.6 million in cash and cash equivalents and $27.0 million in short-term investments.  For the nine months ended June 30, 2018, we used $12.1 million of cash in operating activities.  Our net loss of $19.0 million was offset by (i) net non-cash charges of $20.0 million from deferred income taxes, depreciation, impairment, accretion, inventory obsolescence, stock-based compensation and bad debt expense and (ii) a $1.4 million increase in accounts payable associated with inventory purchases and the timing of payments to suppliers.  Other uses of cash in our operations included (i) a $3.9 million increase in trade accounts receivable resulting from the timing of collections from customers, (ii) a $5.7 increase in inventories for the production of OBX products and recently introduced land-based wireless seismic products, (iii) a $1.2 million increase in prepaid and other assets primarily due an increase in deferred rent receivable and (iv) the removal of a $5.0 million gross profit from the sale of used rental equipment since such gross profit is reflected in the proceeds from the sale of used rental equipment under investing activities.  

For the nine months ended June 30, 2018, we generated cash of $9.8 million from investing activities.  Sources of cash included (i) $9.0 million of net proceeds from the sale of short-term investments and (ii) $4.3 million of proceeds from the sale of rental equipment and (iii) $1.7 million in insurance proceeds and claims receivable related to a property insurance claim.  These sources of cash were partially offset by (i) $2.5 million to expand our rental fleet, (ii) $1.0 million for additions to our property, plant and equipment and (iii) $2.0 in payments for damages related to the insurance claim.  We expect fiscal year 2018 cash investments into our rental fleet to be approximately $4 million.  We estimate total fiscal year 2018 cash investments in property, plant and equipment will be approximately $2 million.  Our capital expenditures are expected to be funded from our cash on hand, internal cash flow or, if necessary, from borrowings under our credit agreement.

For the nine months ended June 30, 2018, we generated cash proceeds of $19,000 from financing activities from the exercise of stock options by our employees.  We had no long-term debt outstanding throughout the fiscal year ended September 30, 2017 or for the nine months ended June 30, 2018.

Crude oil prices have recently increased to their highest level in three years, although the current price level of crude oil remains significantly below the peak price levels seen in 2014.  OPEC and other crude oil producing/exporting nations appear united in their efforts to maintain agreed-upon supply cuts aimed at reducing the glut of crude oil in storage around the world.  If these efforts to obtain an economic equilibrium in worldwide crude oil supplies are successful, crude oil prices may stabilize or even drift higher in the months to come.  These factors and developing trends bode well for the oil and gas geophysical industry and we expect to participate in any resurgence in seismic equipment demand that may be forthcoming.  While we are seeing some signs of increased seismic activity around the world, the need for new seismic equipment remains restrained due to capital limitations affecting many of our customers along with excess unutilized equipment.  We expect revenue from our seismic products, and in particular our traditional and wireless products, to remain low until exploration-focused seismic activities increase which we believe will result from the ongoing depletion of existing reservoirs prompting the need to find new sources of oil and gas.  We expect these challenging industry conditions will continue for the remaining months of fiscal year 2018 and into fiscal year 2019.  

Our available cash, cash equivalents and short-term investments totaled $39.5 million at June 30, 2018, including $8.1 million of cash and cash equivalents held by our foreign subsidiaries and branch offices.  In light of the Tax Cuts and Jobs Act signed into law on December 22, 2017 which requires companies to pay a one-time transition tax on undistributed earnings of foreign subsidiaries, we are currently re-evaluating our prior intent to permanently reinvest these undistributed earnings.  If we were to repatriate the cash held by our foreign subsidiaries, we would be required to accrue and pay taxes on any amounts repatriated.

Our credit agreement allows for borrowings of up to $30.0 million with such amounts available for borrowing determined by a borrowing base.  In October 2017, we extended the maturity of the credit agreement from May 2018 to April 2019.  At June 30, 2018, we had no outstanding borrowings under the credit agreement and, after consideration of $0.3 million of outstanding letters of credit, our borrowing availability under the credit facility was $21.9 million.  At June 30, 2018, we were in compliance with all covenants under the credit agreement.  We currently do not anticipate the need to borrow under the credit agreement; however, we can make no assurance that we will not do so.  

In fiscal years 2016 and 2017, we received income tax refunds of $18.3 million and $12.8 million, respectively, from the U.S. Department of Treasury.  These refunds were a result of the significant tax losses we experienced in fiscal year 2016 and 2015, which we elected to carryback and recoup taxes previously paid.  For U.S. income tax purposes, we are now in a loss carryforward position in regards to our tax losses for fiscal year 2017 and beyond.  As a result, our current tax losses will not result in any additional U.S. federal income tax refunds.  The tax refunds we received in fiscal years 2016 and 2017 have been significant contributors to our overall liquidity.  In the absence of future profitable results of operations, we may need to rely on other sources of liquidity to fund our future operating results, including liquidating short-term investments, executed rental contracts, available borrowings under our credit agreement through its expiration in April 2019, leveraging or sale of real estate assets, sales of rental assets and other liquidity sources which may be available to us.  However, currently we believe that our cash and short-term investment balances will be sufficient to finance our operating losses and planned capital expenditures through the next twelve months.

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Critical Accounting Policies

During the nine months ended June 30, 2018, there has been no material change to our critical accounting policies discussed in Item 7 of our Annual Report on Form 10-K for the fiscal year ended September 30, 2017 other than the adoption of Accounting Standards Update 2016-09, “Improvements to Employee Share-Based Payment Accounting” and 2016-16, “Accounting for Income Taxes:  Intra-Entity Transfers of Assets Other Than Inventory”.

Recent Accounting Pronouncements

Please refer to Note 1 to our consolidated financial statements contained in this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements.

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

We have market risk relative to our short-term investments, foreign currency rates and interest rates.  We do not engage in commodity or commodity derivative instrument purchase or sales transactions.  Because of the inherent unpredictability of foreign currency rates and interest rates, as well as other factors, actual results could differ materially from those projected in this Item.

Foreign Currency and Operations Risk

One of our wholly-owned subsidiaries, Geospace Technologies Eurasia, is located in the Russian Federation.  In addition, we operate a branch office, Geospace Technologies Sucursal Sudamericana, in Colombia.  Our financial results for these entities may be affected by factors such as changes in foreign currency exchange rates, weak economic conditions or changes in the political climate.  Our consolidated balance sheet at June 30, 2018 reflected approximately USD $5.1 million and USD $0.2 million of foreign currency denominated net working capital related to our Russian and Colombian operations, respectively.  Both of these entities receive a portion of their revenue and pay a majority of their expenses primarily in their local currency.  To the extent that transactions of these entities are settled in their local currency, a devaluation of these currencies versus the U.S. dollar could reduce any contribution from these entities to our consolidated results of operations and total comprehensive income as reported in U.S. dollars.  We do not hedge the market risk with respect to our operations in these countries; therefore, such risk is a general and unpredictable risk of future disruptions in the valuation of such currencies versus U.S. dollars to the extent such disruptions result in any reduced valuation of these foreign entities’ net working capital or future contributions to our consolidated results of operations.  At June 30, 2018, the foreign exchange rate for $1.00 (one U.S. dollar) was equal to approximately 62.75 Russian Rubles and 2,939 Colombian Pesos.  If the value of the U.S. dollar were to strengthen by ten percent against these foreign currencies, our working capital in the Russian Federation and in Colombia would decline by USD $0.5 million and USD $18,000, respectively.

Foreign Currency Intercompany Accounts and Notes Receivable

We sell products to our foreign subsidiaries on trade credit terms in both U.S. dollars and in the subsidiary’s local currency.  At June 30, 2018, we had outstanding Canadian-dollar denominated intercompany accounts receivable of CAN $38.9 million, which we consider to be of a short-term nature.  The appreciation or devaluation of the Canadian dollar against the U.S. dollar will result in a gain or loss, respectively, to our consolidated statement of operations.  At June 30, 2018, the foreign exchange rate for USD $1.00 was equal to approximately CAN $1.31.  On June 29, 2018 we entered into a CAN $30.0 million short-term hedge contract with a United States bank to hedge a portion of our Canadian dollar foreign exchange rate exposure, resulting in an under-hedged position of approximately CAN $8.9 million.  At June 30, 2018, if the U.S. dollar exchange rate were to strengthen by ten percent against the Canadian dollar, we would recognize a foreign exchange loss of USD $0.7 million in our consolidated financial statements.

Floating Interest Rate Risk

Our credit agreement contains a floating interest rate which subjects us to the risk of increased interest costs associated with any upward movements in bank market interest rates.  Under our credit agreement our borrowing interest rate is the Wall Street Journal prime rate, which was 5.0% at June 30, 2018.  As of June 30, 2018 and September 30, 2017, there were no borrowings outstanding under our credit agreement.

Item 4.   Controls and Procedures

Our management is responsible for establishing and maintaining a system of disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified under the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”).  

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Notwithstanding the foregoing, there can be no assurance that our disclosure controls and procedures will detect or uncover all failures of persons within our company and consolidated subsidiaries to report material information otherwise required to be set forth in our reports.

In connection with the preparation of this Quarterly Report on Form 10-Q, we carried out an evaluation under the supervision and with the participation of our management, including the CEO and CFO, as of June 30, 2018, of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act.  Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures were effective as of June 30, 2018.

Changes in Internal Control over Financial Reporting

We previously reported a material weakness in our internal control over financial reporting.  As of September 30, 2017, we did not maintain effective controls concerning our classification of current assets with respect to inventories.  We determined that a portion of our inventories should have been classified as noncurrent assets, as all inventories were not reasonably expected to be realized in cash, sold or consumed during our next operating cycle.  

This error was subsequently identified and corrected, and resulted in a restatement to the consolidated balance sheets as of September 30, 2016 and 2015 and as of December 31, 2016, March 31, 2017 and June 30, 2017, which was included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017.  The error had no impact upon previously reported total assets, total liabilities, revenue, net loss, net loss per share, or cash flows.

To remediate the material weakness described above, we have designed and implemented a quarterly control to determine the value of inventories expected to be realized in cash, sold or consumed during the next operating cycle.  This control, which encompasses a review by senior management, utilizes a combination of forecasts and historical trends to determine our future expected inventory utilization.  

We believe that this measure remediates the material weakness identified and strengthens our internal controls over financial reporting.

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PART II - OTHER INFORMATION

Item 6.   Exhibits

The following exhibits are filed with this Report on Form 10-Q or are incorporated by reference

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SIGNATURES

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

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