UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

for the Quarterly Period Ended June 30, 2016

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  o

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  o

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

 

 

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

Yes  o    No  x

There were 13,328,066 shares of the Registrant’s Common Stock outstanding as of the close of business on July 31, 2016.

 

 

 

 

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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)

(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, 2015 was derived from the Company’s audited consolidated financial statements at that date.  The consolidated balance sheet at June 30, 2016 and the consolidated statements of operations and comprehensive loss for the three and nine months ended June 30, 2016 and 2015, and the consolidated statements of cash flows for the nine months ended June 30, 2016 and 2015 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, 2016 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, 2015.

Reclassifications

Certain amounts previously presented in the consolidated financial statements have been reclassified to conform to the current year presentation.  During the three months ended December 31, 2015, the Company elected to early adopt Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2015-17-Income Taxes (Topic 740) requiring all deferred tax assets and liabilities to be classified as non-current on the balance sheet.  The purpose of this adoption was to simplify the presentation of deferred income taxes.  The accompanying balance sheet as of September 30, 2015 has been retrospectively adjusted to reflect the adoption of this standard.  The effect of the adjustment at September 30, 2015 was a $6.4 million decrease in current assets, a $10,000 decrease in current liabilities, a $3.0 million increase in non-current deferred tax assets and a $3.4 million decrease in non-current deferred tax liabilities.  Such reclassification had no effect on our previously reported net loss, stockholders’ equity or cash flows.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amount of assets, liabilities, revenue and expenses 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 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, the results of which form the basis for making judgments about the carrying values of assets and liabilities which are not readily available from other sources.  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.

Short-term Investments

The Company classifies its short-term investments consisting of corporate bonds, government bonds and other such similar investments as available-for-sale securities.  Available-for-sale securities are carried at fair market value with net unrealized holding gains and losses reported each period as a component of accumulated other comprehensive loss in stockholders’ equity.  See note 2 for additional information.

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

Inventories

The Company records a write-down of its inventories when the cost basis of any manufactured product, including any estimated future costs to complete the manufacturing process, exceeds its net realizable value.  Inventories are stated at the lower of cost or market value.  Cost is determined on the first-in, first-out method, except that certain of the Company’s foreign subsidiaries use an average cost method to value their inventories.

Impairment of Long-lived Assets

The Company’s long-lived assets are reviewed for impairment whenever an event or change in circumstances indicates the carrying amount of an asset or group of assets may not be recoverable. The impairment review, if necessary, includes a comparison of expected future cash flows (undiscounted and without interest charges) to be generated by an asset group with the associated carrying value of the related assets.  If the carrying value of the asset group exceeds the expected future cash flows, an impairment loss is recognized to the extent that the carrying value of the asset group exceeds its fair value.  At June 30, 2016, management reviewed the recoverability of the carrying value of the Company’s long-lived assets based on future undiscounted cash flows and determined that the carrying value of certain rental assets exceeded the expected future cash flows.  As a result, the Company recorded an impairment charge of $1.0 million in the accompanying consolidated statements of operations for the three and nine months ended June 30, 2016.  No such impairment of remaining long-lived assets was necessary as the expected future cash flows exceeded the carrying value of the assets.

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 (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.  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.

Research and Development Costs

The Company expenses research and development costs as incurred.  Research and development costs include salaries, employee benefit costs, department supplies, direct project costs and other related costs.

Product Warranties

Most of the Company’s products do not require installation assistance or sophisticated instructions.  The Company offers a standard product warranty obligating it to repair or replace equipment with manufacturing defects.  The Company maintains a reserve for future warranty costs based on historical experience or, in the absence of historical product experience, management’s estimates.  Reserves for future warranty costs are included within accrued expenses and other current liabilities on the consolidated balance sheets.  Changes in the warranty reserve are reflected in the following table (in thousands):

 

 

Recent Accounting Pronouncements

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

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

immediate recognition of estimated credit losses expected to occur for most financial assets and certain other instruments.  For available-for-sale debt securities with unrealized losses, the losses will be recognized as allowances rather than reductions in 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 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 does not expect the adoption of this standard to have a material effect upon its consolidated financial statements.

In March 2016, the FASB issued guidance to simplify key components of employee share-based payment accounting.  The guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within that reporting period.  Several aspects of the accounting for share-based payment award transactions are simplified, including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows.  The Company does not expect the adoption of this guidance to have a material effect upon 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 as a finance or operating lease.  However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, this new guidance will require both types of leases to be recognized on the balance sheet.  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 does not expect the adoption of this guidance to have a material effect upon its consolidated financial statements.

In July 2015, the FASB issued guidance requiring management to measure inventory at the lower of cost or net realizable value.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  The pronouncement is effective for fiscal years beginning after December 15, 2016, including interim periods within that reporting period and should be applied retrospectively, with early application permitted.  The Company is currently evaluating the impact this guidance will have on its consolidated financial statements and related disclosures.

In August 2014, the FASB issued guidance requiring management to evaluate whether there are conditions and events that raise substantial doubt about the entity's ability to continue as a going concern and to provide disclosures in certain circumstances.  The new guidance was issued to reduce diversity in the timing and content of footnote disclosures. This guidance is effective for fiscal years, and interim reporting periods therein, beginning after December 15, 2016.  The Company does not expect the adoption of this guidance to have a material effect upon its consolidated financial statements.

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 is currently evaluating the impact this guidance will have on its consolidated financial statements.

 

 

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

2. Short-term Investments

 

 

 

 

3. Derivative Financial Instruments

At June 30, 2016 and September 30, 2015, the Company’s Canadian subsidiary had $27.5 million and $28.1 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.  Approximately $3.3 million of these Canadian dollar denominated intercompany accounts payable are considered by management to be of a short-term nature whereby the appreciation or devaluation of the Canadian dollar against the U.S. dollar will result in a gain or loss, respectively, to the consolidated statement of operations.  The Company considers the remaining $24.2 million Canadian dollar denominated intercompany accounts payable to be of a long-term nature and whereby settlement is not planned or anticipated in the foreseeable future; therefore, any resulting foreign exchange gains and losses are reported in the consolidated balance sheets as a component of other comprehensive income in accordance with ASC 830 “Foreign Currency Matters”.  In June 2016, the Company entered into a $3.0 million 90-day hedge contract with a United States bank to hedge a portion of its short-term Canadian dollar foreign exchange rate exposure.  This contract reduces 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.  At June 30, 2016, the fair value of this contract was a liability of $11,000.

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, 2016 and 2015 (in thousands):

 

 

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

 

 

4. Fair Value of Financial Instruments

At June 30, 2016, the Company’s financial instruments included cash and cash equivalents, short-term investments, foreign currency forward contract, trade and notes receivables and accounts payable.  Due to the short-term maturities of cash and cash

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

equivalents, trade and other receivables and accounts payable, the carrying amounts approximate fair value on the respective balance sheet dates.

The Company measures its short-term investments and derivative instruments at fair value on a recurring basis.  The fair value measurement of the Company’s short-term investments and derivative instruments was determined using the following inputs (in thousands):

 

 

 

The Company applies fair value techniques on a non-recurring basis in evaluating potential impairment losses related to long-lived assets.

 

 

5. Accounts and Notes Receivable

Current trade accounts 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 review of its balances.  Accounts receivable balances are charged off against the allowance whenever it is probable that the receivable will not be recoverable.  The Company does not have any off-balance-sheet credit exposure related to its customers.

Notes receivable, net are reflected in the following table (in thousands):

 

 

 

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

6. Inventories

Inventories consist of the following (in thousands):

 

 

During the nine months ended June 30, 2016 and 2015, the Company made non-cash inventory transfers of $3.0 million and $4.8 million, respectively, to its rental equipment fleet. Raw materials include semi-finished goods and component parts totaling $52.5 million and $48.4 million, respectively, at June 30, 2016 and September 30, 2015.

 

 

7. Long-Term Debt

The Company had no long-term debt outstanding at June 30, 2016 and September 30, 2015.

On March 2, 2011, the Company entered into a credit agreement with Frost Bank with borrowing availability of $50.0 million (the “Credit Agreement”).  On May 4, 2015, the Company amended the Credit Agreement which reduced its borrowing availability to $30.0 million with amounts available for borrowing determined by a borrowing base.  Under the amendments to the Credit Agreement, the borrowing base is determined based upon certain of the Company’s and its U.S. subsidiaries’ assets which include (i) 80% of certain accounts receivable plus (ii) 50% of certain notes receivable (such result not to exceed $10 million) plus (iii) 25% of certain inventories (excluding work-in-process inventories).  As of June 30, 2016, the Company’s borrowing base was $35.3 million resulting in borrowing availability of $30.0 million less $0.5 million of outstanding letters of credit.  The Company’s domestic subsidiaries have guaranteed the obligations of the Company under the Credit Agreement and such subsidiaries have secured their obligations under such guarantees by the pledge of substantially all of the assets of such subsidiaries, except real property assets.  The Credit Agreement expires on May 4, 2018 and all borrowed funds are due and payable at that time.  The Company is required to make monthly interest payments on borrowed funds.  The Credit Agreement as amended limits the incurrence of additional indebtedness, requires the maintenance of a single financial ratio that compares certain of the Company’s assets to certain of its liabilities, restricts the Company and its subsidiaries’ ability to pay cash dividends and contains other covenants customary in agreements of this type.  The interest rate for borrowings under the Credit Agreement as amended is based on the Wall Street Journal prime rate, which was 3.50% at June 30, 2016.  At June 30, 2016, the Company was in compliance with all covenants under the Credit Agreement.

 

 

8. Accumulated Other Comprehensive Loss

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

 

 

 

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

9. Stock-Based Compensation

During the nine months ended June 30, 2016, the Company issued 182,400 shares of restricted stock under its 2014 Long Term Incentive Plan, as amended (the “Plan”).  The weighted average grant date fair value of the restricted stock was $14.84 per share.  The grant date fair value of these awards was $2.7 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 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.

During the nine months ended June 30, 2016, the Company also issued 69,300 nonqualified stock options under the Plan.  The options issued are based upon three tiers, each with separate market and service based vesting conditions.  Market based vesting conditions are based on achieving a specified market return on the Company’s stock price.  Compensation expense for the nonqualified stock option awards was determined based on a Monte Carlo simulation, which incorporates the possibility that the market conditions may not be satisfied.   The weighted average grant date fair value of the options issued was determined to be $5.96 per option resulting in unrecognized compensation costs of $0.4 million, which will be charged to expense over the requisite service period of the options, ranging from 18 to 36 months.  

As of June 30, 2016, the Company had unrecognized compensation expense of $8.1 million relating to restricted stock awards.  This unrecognized compensation expense is expected to be recognized over a weighted average period of 2.8 years.  In addition, the Company had $0.3 million of unrecognized compensation expense related to nonqualified stock option awards which is expected to be recognized over a weighted average period of 1.7 years.

As of June 30, 2016, a total of 276,150 shares of restricted stock and 159,000 nonqualified stock options shares were outstanding.

 

 

10. 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, 2016 and 2015, 159,000 stock options and 89,700 stock options, respectively, were excluded in the calculation of weighted average shares outstanding as a result of their impact being antidilutive.

 

 

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GEOSPACE TECHNOLOGIES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

11. Commitments and Contingencies

The Company is involved in various pending or potential legal actions in the ordinary course of our business. Management is unable to predict the ultimate outcome of these actions, because of the inherent uncertainty of litigation.  Management is not aware of any material pending or known to be contemplated legal or government proceedings against the Company.

 

 

12. 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: thermal imaging products and industrial products.

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

 

 

 

13. Income Taxes

The Company’s effective tax rates for the three months ended June 30, 2016 and 2015 were (7.7)% and (33.8)%, respectively.  The Company’s effective tax rates for the nine months ended June 30, 2016 and 2015 were (16.9)% and (34.6)%, respectively. The United States statutory tax rate for the same periods was 35%.  The lower effective tax rates resulted from (i) the provision of a valuation allowance against the Company’s U.S. and Canadian deferred tax assets of $3.4 million recorded during the fiscal quarter ended June 30, 2016, (ii) the provision of a valuation allowance against the Company’s Canadian subsidiary’s deferred tax assets of $2.5 million recorded during the fiscal quarter ended March 31, 2016, and (iii) a net expense adjustment totaling $1.0 million recorded during the fiscal quarter ended March 31, 2016 to correct the Company’s fiscal year 2015 income tax benefit. 

 

 

 

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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, 2015.

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 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, 2015, 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.  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 is a Texas corporation originally incorporated in Delaware 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 acquisition and processing of seismic data as well as in the characterization and monitoring of producing oil and gas reservoirs.  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, 2015.

We have engaged in the seismic instrument and equipment business since 1980 and market our products primarily to the oil and gas industry.  We also design, manufacture and distribute non-seismic equipment including thermal imaging equipment and industrial products.  We report and categorize our customers and products into two different segments: Seismic and Non-Seismic.

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 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. Sales result 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 marine 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.

Our wholly-owned subsidiary in the Russian Federation manufactures international standard geophones, sensors, seismic leader wire, seismic telemetry cables and related seismic products for customers in the Russian Federation and other international seismic marketplaces. We have a branch office in Colombia that primarily rents seismic equipment to our customers in the South American market.

Wireless Products

We have developed a land-based wireless (or nodal) seismic data acquisition system called the GSX.  Each GSX station operates independently and therefore can be deployed in virtually unlimited channel configurations.  Rather than utilizing interconnecting cables as required by most traditional land data acquisition systems, each GSX station operates as an independent data collection system.  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, 2016, we have sold 335,000 GSX channels and we have 127,000 GSX channels in our rental fleet.  Due to depressed seismic industry conditions, we do not expect to expand our GSX rental fleet in the foreseeable future.

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, 2016, we have sold 460 OBX stations and we have 5,700 OBX stations in our rental fleet.

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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 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.

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 imaging and monitoring. 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 delivered nor did we receive orders for any permanent reservoir monitoring systems during fiscal year 2015 or during the first nine months of fiscal year 2016.

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 seismic borehole tools to monitor subsurface carbon dioxide injections and for mine safety applications.

Our non-seismic products include thermal imaging products targeted at the commercial graphics industry as well as various industrial products including (i) sensors and tools for vibration monitoring, mine safety application and earthquake detection, (ii) cables for power and communication for the offshore oil and gas and offshore construction industries, and (iii) water meter cables and other specialty 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 began to experience 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 $40 in July 2016.  With the 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.  In addition, we have not received any orders for permanent reservoir monitoring systems since the Statoil order was completed in April 2014.  We expect sales of our seismic products, and in particular our traditional and wireless products, to remain low until crude oil prices stabilize at higher levels and exploration-focused industry conditions improve.  We expect these challenging industry conditions to negatively impact the demand for our seismic products throughout fiscal year 2016 and beyond.

In January 2016, in light of the decrease in demand for our seismic products, we initiated a program to further reduce our operating costs.  The program is expected to produce approximately $7 million of annualized cash savings in addition to savings from other cost-saving measures implemented in the first fiscal quarter ended December 31, 2015.  The majority of savings was realized through a reduction of over 150 employees from our Houston-area workforce.  In connection with the workforce reduction, the Company incurred $1.0 million of termination costs in its second fiscal quarter ended March 31, 2016, which are recorded to both cost of goods sold and to operating expenses.  The remaining cost savings were realized through a facility consolidation as well as expense reductions in other areas.

Three and nine months ended June 30, 2016 compared to the three and nine months ended June 30, 2015

Consolidated revenue for the three months ended June 30, 2016 decreased $2.1 million, or 10.5%, from the corresponding period of the prior fiscal year.  Consolidated revenue for the nine months ended June 30, 2016 decreased $23.1 million, or 33.6%, from the corresponding period of the prior fiscal year. The decrease in revenue for the three and nine months ended June 30, 2016 was primarily attributable to substantially lower product demand in our seismic business segment driven by the low level of crude oil prices.  While crude oil prices have recently rebounded to approximately $45/barrel, market conditions in the seismic industry continue to remain depressed due to reduced capital spending for seismic exploration-focused activities.

Consolidated gross profit (loss) for the three months ended June 30, 2016 was ($2.9) million, compared to ($3.3) million for the corresponding period of prior fiscal year.  The improvement in gross profit (loss) for the three months ended June 30, 2016 was primarily caused by (i) a decrease in unabsorbed fixed manufacturing costs resulting from the Company’s workforce reduction in the second fiscal quarter of 2016, (ii) a decrease in warranty expense due to a decline in product defects and (iii) increased rental revenue.  

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These improvements were partially offset by an increase in inventory obsolescence expenses related to our seismic products.  Consolidated gross profit (loss) for the nine months ended June 30, 2016 was ($13.9) million, compared to ($1.9) million for the corresponding period of prior fiscal year.  The change in gross profit (loss) for the nine months ended June 30, 2016 was caused by a number of factors, including (i) a substantial reduction in seismic product revenue, (ii) fixed depreciation expenses from our rental equipment during periods of low utilization, (iii) unabsorbed fixed manufacturing costs due to lower factory utilization caused by reduced demand for our seismic products and (iv) increased inventory obsolescence expenses due to higher levels of slow-moving inventories.  We expect our seismic product gross margins to be lower throughout fiscal year 2016 due to expected lower manufacturing activity caused by reduced seismic product demand.

In light of current market conditions, we have evaluated the level of our seismic product inventories at June 30, 2016 and we continue to believe that those inventory balances far exceed levels considered appropriate for the current level of product demand, although we do expect our seismic product inventory levels to continue to decline slowly throughout fiscal year 2016 and beyond.  During such periods of excessive inventory levels, our policy has been, and will continue to be, to record higher obsolescence expense in our consolidated income statement as we experience reduced levels of inventory turnover and as our inventories continue to age.  Due to weak seismic product demand which is expected to continue into the foreseeable future, we expect significantly higher levels of inventory obsolescence expense during fiscal year 2016 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, 2016 decreased $30,000, or 0.3%, from the corresponding period of the prior fiscal year.  The decrease in operating expenses for the three months ended June 30, 2016 was attributable to the Company’s cost reduction program implemented during the second fiscal quarter of 2016, partially offset by a $0.4 million increase in bad debt expense.  Consolidated operating expenses for the nine months ended June 30, 2016 decreased $2.2 million, or 7.5%, from the corresponding period of the prior fiscal year.  The decrease in operating expenses was attributable to the cost reduction program, and such reductions were partially offset by $0.5 million of termination costs associated with the program.  The decrease in operating expenses also reflects the collection of past due accounts receivable from a seismic customer, which contributed to a net bad debt recovery of $0.1 million for the nine months ended June 30, 2016 compared to a bad debt expense of $1.1 million for the corresponding period of the prior year.

Consolidated other loss for the three months ended June 30, 2016 increased $0.1 or 26.2%, from the corresponding period of the prior fiscal year.  The increase in other loss primarily resulted from an increase in foreign exchange losses attributable to U.S. dollar deposits held by our Russian subsidiary.  Consolidated other income for the nine months ended June 30, 2016 decreased $1.4 million, or 88.6%, from the corresponding period of the prior fiscal year.  The decrease in other income primarily resulted from a decrease in foreign exchange gains attributable to U.S. dollar deposits held by our Russian subsidiary.

Our effective tax rates for the three months ended June 30, 2016 and 2015 were (7.7)% and (33.8)%, respectively.  Our effective tax rates for the nine months ended June 30, 2016 and 2015 were (16.9)% and (34.6)%, respectively. The United States statutory tax rate for the same periods was 35%.  The lower effective tax rates resulted from (i) the provision of a valuation allowance against the Company’s U.S. and Canadian deferred tax assets of $3.4 million recorded during the fiscal quarter ended June 30, 2016, (ii) the provision of a valuation allowance against our Canadian subsidiary’s deferred tax assets of $2.5 million recorded during the fiscal quarter ended March 31, 2016, and (iii) a net expense adjustment totaling $1.0 million recorded during the fiscal quarter ended March 31, 2016 to correct our fiscal year 2015 income tax benefit. 

Seismic Products

Revenue

Revenue from our seismic products for the three months ended June 31, 2016 decreased $4.0 million, or 29.3%, from the corresponding period of the prior fiscal year.  Revenue from our seismic products for the nine months ended June 31, 2016 decreased $26.3 million, or 50.6%, from the corresponding period of the prior fiscal year.  In each of the product groups below, the decline in revenue resulted from lower demand for our seismic products due to the deterioration of industry conditions brought about by the substantial decline in oil and gas prices which began in 2014.  While crude oil prices have recently rebounded to approximately $45/barrel, market conditions in the seismic industry continue to remain depressed due to reduced capital spending for seismic exploration-focused activities.  The components of this decrease include the following:

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During the nine months ended June 30, 2016, demand for our seismic products has fallen to historic lows.  In past periods when customer demand for our seismic products was greater, especially demand for large orders for our GSX wireless systems and our seabed permanent reservoir monitoring systems, orders for such products would generally occur irregularly making it difficult for us to predict our sales and production levels each quarter.  Furthermore, product shipping dates are generally determined by our customers and are not at our discretion.  As a result, these factors have caused past sales of our seismic products to be unpredictable, or “lumpy,” and if demand were to resume to historical levels, we would expect this trend to continue.

Operating Loss

Our operating loss associated with revenue from our seismic products for the three months ended June 30, 2016 increased $10,000, or 0.1%, from the corresponding period of the prior year.  The increase in operating loss was primarily due to an increase in inventory obsolescence expense.  This increase was partially offset by (i) workforce reductions, (ii) lower warranty expenses and (iii) increased rental revenues.  Our operating loss associated with revenue from our seismic products for the nine months ended June 30, 2016 increased $10.9 million, or 46.4%, from the corresponding period of the prior year.  The increase in operating loss for the nine months ended June 30, 2016 was due to the substantial decline in our product revenue combined with a high level of fixed manufacturing costs and rental equipment depreciation expenses.

Non-Seismic Products

Revenue

Revenue from our non-seismic products for the three months ended June 30, 2016 increased $1.9 million, or 30.6%, from the corresponding period of the prior fiscal year.  Revenue from our non-seismic products for the nine months ended June 30, 2016 increased $3.1 million, or 19.0%, from the corresponding period of the prior fiscal year.  The increase in revenue for both periods was primarily attributable to higher demand for our industrial products.  The revenue increase for the both periods was partially offset by lower sales of our offshore cable products.

Operating Income

Our operating income associated with sales of our non-seismic products for the three months ended June 30, 2016 increased by $0.2 million, or 23.0%, 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, 2016 increased by $0.3 million, or 11.8%, from the corresponding period of the prior fiscal year.  The increase in operating income for the three and nine months ended June 30, 2016 was primarily the result of increased sales of our industrial products.

Liquidity and Capital Resources

At June 30, 2016, we had approximately $11.5 million in cash and cash equivalents and $27.3 million in short-term investments.  For the nine months ended June 30, 2016, we used $1.1 million of cash in operating activities.  These uses of cash included (i) our net loss of $33.7 million, (ii)  a $1.8 million decrease in accounts payable primarily due to declining inventory purchases resulting from

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reduced product demand, (ii) a $2.1 million decrease in accrued and other expenses primarily due to the payment of calendar year 2015 property taxes, (iii) a $4.4 million increase in prepaid and other current assets primarily attributable to straight-line rent receivable associated with an OBX rental contract and  (iv) $1.4 million in excess tax expense associated with the vesting of restricted stock.  These uses of cash were partially offset by (i) net non-cash charges of $31.4 million from deferred income taxes, depreciation, accretion, stock-based compensation, inventory obsolescence, write-down of inventories and bad debts, (ii) a $6.9 million decrease in income tax receivable primarily resulting from an $18.3 million income tax refund received in our second quarter, (ii) a $3.1 million decrease in inventories caused by a drawdown of our excess levels of finished goods.

For the nine months ended June 30, 2016, we used cash of $9.6 million from investing activities.  These uses of cash included (i) net disbursements of $9.1 million from the purchase and sale of short-term investments, (ii) $1.2 million for additions to our property, plant and equipment and (iii) $0.5 million to expand our rental equipment fleet primarily for the addition of OBX nodes (this amount excludes approximately $3.0 million of non-cash transfers of inventories to our rental fleet). . These uses of cash were partially offset by $1.3 million in proceeds from the sale of used rental equipment.  We periodically respond to various customer inquiries for additional OBX rental systems.  If our customers order additional OBX rental systems, we may need to execute a non-cash transfer of additional OBX nodes and related equipment from our inventories to our rental fleet.  In addition, we may need to partially or completely manufacture additional OBX nodes and related equipment if our finished goods inventories do not contain sufficient quantities of completed OBX products to meet customer demand.  In the absence of additional customer orders for OBX systems, we expect fiscal year 2016 cash investments in our rental fleet to be approximately $0.5 million and additional non-cash transfers from our inventory account of up to $3.5 million.  We estimate total fiscal year 2016 cash investments in property, plant and equipment will be approximately $2.0 million.  We expect these capital expenditures 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, 2016 and June 30, 2015, we had no cash flows from financing activities.

With the decline in oil and natural gas prices which have occurred since July 2014, exploration and production companies have experienced a significant reduction in cash flows resulting in sharp reductions in their capital spending budgets for exploration-focused activities, including seismic activities.  As a result, our seismic business segment has experienced a significant decline in product orders and associated revenue, resulting in substantial operating losses and the continued depletion of our cash balances.  Due to the uncertainty concerning a recovery of crude oil prices to levels capable of sustaining increased seismic exploration activities, we expect these depressed market conditions to continue through fiscal year 2016 and beyond.

Our available cash, cash equivalents and short-term investments totaled $38.8 million at June 30, 2016, including $6.6 million of cash and cash equivalents held by our foreign subsidiaries and branch offices.  We intend to permanently reinvest the undistributed earnings of our foreign subsidiaries.  If we were to repatriate the cash held by our foreign subsidiaries, we would be required to accrue and pay income taxes in the United States.

Our credit agreement allows for borrowings of up to $30.0 million with such amounts available for borrowing determined by a borrowing base.  At June 30, 2016, we had no outstanding borrowings under the credit agreement and our borrowing availability under the credit facility was $29.5 million due to outstanding letters of credit.  At June 30, 2016, we were in compliance with all covenants under the credit agreement and we expect to remain in compliance with all covenants throughout fiscal year 2016.  We currently do not anticipate the need to borrow from the credit agreement during fiscal year 2016 and for the foreseeable future; however, we can make no assurance that we will not do so.

In March 2016, we received an $18.3 million income tax refund from the U.S. Department of Treasury.  The refund was a result of the significant tax losses we experienced in fiscal year 2015 which we elected to carryback to our fiscal year 2013 U.S. tax return to recoup taxes previously paid.  In addition, should we continue to incur significant pretax losses in fiscal year 2016, we will be eligible for a maximum tax refund of up to approximately $13 million upon the filing of our fiscal year 2016 U.S. tax return.  We believe the combination of our existing cash balances, expected cash proceeds from executed rental contracts, short-term investments, future tax refunds and available borrowings under the credit agreement will be sufficient to finance our operating losses and planned capital expenditures for the next twelve months.

Critical Accounting Policies

During the nine months ended June 30, 2016, 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, 2015.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

We have market risk relative to our short-term investments as described below.  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, 2016 reflected approximately $3.0 million and $0.1 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, 2016, the foreign exchange rate for $1.00 (one U.S. dollar) was equal to 64.0 Russian Rubles and 3,033 Colombian Pesos, respectively.  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 $0.3 million and $6 thousand U.S. dollars, respectively.

Foreign Currency Intercompany Accounts and Notes Receivable

From time to time, we provide access to capital to our foreign subsidiaries through U.S. dollar denominated interest bearing promissory notes.  Such funds are generally used by our foreign subsidiaries to purchase capital assets and for general working capital needs. In addition, 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, 2016, we had outstanding Canadian-dollar denominated intercompany accounts receivable of CAN$27.5 million.  Approximately CAN$3.3 million of these intercompany receivables are considered by management to be of a short-term nature whereby 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.  The Company considers approximately CAN$24.2 million of the intercompany receivable to be of a long-term nature whereby settlement is not planned or anticipated in the foreseeable future; therefore, any resulting foreign exchange gains and losses are reported in the consolidated balance sheets as a component of other comprehensive income in accordance with ASC 830 “Foreign Currency Matters”.  In June 2016, we entered into a CAN$3.0 million 90-day hedge agreement with a United States bank to hedge a portion of our short-term Canadian dollar foreign exchange rate exposure, resulting in an under-hedged position of approximately $0.4 million Canadian dollars. To the extent our under-hedged position remains, 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 $40 thousand U.S. dollars 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 3.50% at June 30, 2016.  As of June 30, 2016 and September 30, 2015, 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”). Notwithstanding the foregoing, there can be no assurance that the Company’s disclosure controls and procedures will detect or uncover all failures of persons within the Company and its consolidated subsidiaries to report material information otherwise required to be set forth in the Company’s reports.

In connection with the preparation of this Quarterly Report on Form 10-Q, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the CEO and CFO, as of June 30, 2016, of the

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effectiveness of the Company’s 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, 2016.

Changes in Internal Control over Financial Reporting

We previously reported a material weakness in our internal control over financial reporting.   As of September 30, 2015, we did not maintain effective monitoring and oversight controls over income taxes.  Additionally, as disclosed in Note 13 – Income Taxes, during our fiscal quarter ended March 31, 2016, we identified an error relating to income taxes which impacted our September 30, 2015 consolidated financial statements.

Beginning with our fiscal quarter ended December 31, 2015, we engaged RSM US LLP (“RSM”), a third-party public accounting firm with global tax expertise and experience, to review our quarterly federal, state, and foreign tax positions to ensure that we are in compliance with the guidance of ASC 740.

We believe that this measure remediates the material weakness and, therefore 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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