Geospace Technologies Corp (GEOS) Q3 2020 Earnings Call Transcript

Good morning, and welcome to Geospace Technologies conference call for the third quarter of our 2020 fiscal year. I'm Rick Wheeler, the company's President and Chief Executive Officer, and I'm joined by Robert Curda, the company's Chief Financial Officer. We also have with us Dr. Mark Tinker, CEO of our Quantum Technology Sciences subsidiary. I'll first give an overview of the third quarter, and Robert will follow with some in-depth commentary on our financial performance. I'll then make a few last remarks before opening the line so that Robert, Mark and I can answer questions. Some of today's statements may be considered forward-looking as defined in the Private Securities Litigation Reform Act of 1995, including comments about product markets, revenue recognition, planned operations and capital expenditures. These statements are based on our present awareness, while actual outcomes are affected by uncertainties and other factors we can't control or predict. Both known and unknown risks can lead to undesirable results or performance differences from what we say or imply today and such risks and uncertainties include those discussed in our SEC Forms 10-K and 10-Q filings. For convenience, we will link a recording of this call on the Investor Relations page of our geospace.com website. However, since the information discussed this morning is time-sensitive, it may not be accurate at the time one listens to the replay. Yesterday, after the market closed, we released the financial results for our third quarter of fiscal year 2020 ended June 30, 2020. As reported, we were very pleased that the coronavirus pandemic gripping both our country and the world at large had limited impact on our third quarter performance. Even more gratifying, our employees have been minimally affected by COVID-19, and to date, our heightened and evolving safety protocols have helped us in maintaining a safe working environment. While our operations have not entirely escaped the vast negative impact of this pandemic, we were nonetheless pleased to report that total revenue of $22.7 million and $66.3 million for the respective 3- and 9-month periods ended June 30, 2020, were very similar to last year's 3- and 9-month totals. Continued strong demand for our marine ocean bottom nodal recording systems fueled both our third quarter and 9-month results. In fact, increased demand for these systems acted to counter some of the weakness we experienced in demand for other products in our oil and gas segments as well as in our adjacent markets business, both of which were negatively impacted by the effects of COVID-19. As was also mentioned, reported revenue did not include additional timely payments we received from a customer toward its promissory note to secure the purchase of a GCL land recording system, comprised of 30,000 channels. These paid-in amounts totaling $3.8 million through the end of the third quarter are included on the balance sheet as part of the noncurrent deferred revenue and are intended to be recognized as revenue at a later date when the collection of the note is determined to be likely. For the 3 months ended June 30, 2020, revenue from our combined oil and gas market products totaled $17.5 million and for the similarly ended 9-month period, revenue totaled $47.5 million. These figures reflect respective increases of 21% and 8% over last year's similar periods. In both periods, the increases are attributed to the greater demand for our OBX ocean bottom recording systems, which were partially offset by lower demand for some of our other oil and gas segment product lines. Our traditional seismic products generated $1.2 million and $5.6 million, respectively, in the 3- and 9-month periods ended June 30, 2020. Both periods reflect notable declines from last year, which we attribute to lower demand for seismic sensors as a result of fewer seismic exploration and imaging projects being performed by oil and gas companies. Moreover, due to low oil prices, oversupplies of crude and the large drop in global demand for oil and gas amidst the COVID-19 pandemic, we expect revenue from these products to remain challenged for the foreseeable future. In the 3- and 9-month periods ended June 30, 2020, revenue produced from our wireless seismic products totaled $16.1 million and $41.1 million, respectively. These reflected increases over last year's equivalent periods and are a direct result of expanded rentals of our OBX marine nodal recording systems, even though partially offset by lower sales of our wireless land products. As previously mentioned, we have not yet recorded revenue from the delivery of the aforementioned 30,000-channel GCL land system, which has a sales value of $12.5 million. The growth in demand for our OBX system derives from a renewed focus by many oil and gas companies to better leverage existing offshore resources in the recovery of discovered and nearby fields. Ocean bottom seismic surveys, which often utilize our OBX systems, increase the likelihood of success in these endeavors by producing a superior geological image over other survey methods. Note that the frequency and extent of ocean bottom surveys can fluctuate with weather and seasonal changes and are subject to being negatively impacted by the declines in global demand for oil and gas brought on by COVID-19. Our reservoir seismic products generated revenue of $271,000 and $826,000 in the 3- and 9-month periods that ended June 30, 2020. Both figures reflect reductions compared to last year's similar periods as a consequence of lower sales of borehole seismic tools and lesser demand for our performed services. We maintained that contracts for the manufacture and installation of permanent reservoir monitoring or PRM systems hold the largest opportunity for meaningful revenue from this product category. And while the COVID-19 pandemic did disrupt some of our discussions with oil and gas companies interested in such systems, most have remained ongoing or have since resumed. And based on these discussions, we currently believe a tender for our PRM system is likely to be released sometime in calendar year 2020. We further believe that our broad portfolio of PRM accomplishments and the diversity of our systems, which offer both electrical and OptoSeis fiber optic sensing technologies maximize our ability to be awarded a released PRM tender. If such a tender occurs and a contract is subsequently awarded to Geospace, we would not expect to recognize revenue related to the contract until later in the 2021 fiscal year or beyond. Our adjacent markets segment produced revenue of $5.1 million and $18.3 million in the 3- and 9-month periods ended June 30, 2020. These respective reductions of 38% and 17% compared to last year's same 3- and 9-month periods are the result of lower demand for industrial sensors and contract manufacturing services as well as lower sales of our graphic imaging products. In addition, lower demand for our water meter connectors and cables further contributed to this reduction in the recent third quarter. In all cases, we believe the lower demand for these products is primarily affiliated with the economic impact of the COVID-19 pandemic on our customers. Our emerging markets segment, which is essentially our Quantum subsidiary, generated revenue of $88,000 and $557,000 in the respective 3- and 9-month periods ended June 30, 2020. Included in these figures is early revenue recognized from site preparation and engineering activities related to the contract awarded to Quantum by the U.S. Border Patrol. Revenue in the 9-month period also includes the sale of border and perimeter security products to a commercial customer. As you may recall, Quantum was awarded a $10 million contract in April 2020 to provide a technology solution to the Department of Homeland Security for the U.S. Customs and Border Protection, U.S. Border Patrol, and current execution of the contract is progressing on schedule. However, the company does not expect significant revenue from the contract until the first quarter of fiscal year 2021, which ends December 31, 2020. Quantum remains a keystone element of our strategy to leverage our long-standing competencies in the design and manufacture of seismic acoustic technology in combination with advanced analytics to create products that expand revenue from diversified markets outside of our oil and gas segment.

Thanks, Rick, and good morning, everyone. I'd like to remind everyone that we will not provide any specific revenue or earnings guidance during our call this morning. Before I discuss our financial results for the third quarter ended June 30, 2020, I want to briefly explain our correction of the accounting error that impacted our first and second quarter financial statements. The error relates to the timing of the $8 million receivable write-off as we reported in our second quarter. We adopted a new leasing standard called ASC Topic 842 in fiscal year 2020. And in our first quarter, we properly applied the new leasing standard by transitioning to a cash basis revenue recognition for an international customer who was having difficulty paying its debt. And we've determined that collection of their future lease payments was not probable. At that time, we also determined that an $8 million receivable owed to the company by the customer was fully collectible based upon a promised security interest in a significant asset of the customer. During our second quarter as negotiations with the customer continued, the product security interest became diluted with other creditor claims, and it became unclear whether a deal will ever be concluded with the customer. As a result, we decided to write off the receivable by recording an $8 million bad debt expense in our second quarter. After filing our second quarter financial statements with the SEC, we concluded our previously issued consolidated financial statements for the first quarter ended December 2019 and the second quarter ended March 31, 2020, contained two accounting errors with respect to the application of the new leasing standard. First, ASC Topic 842 required the immediate write-off in our first quarter of the customer's accounts receivable when we determine collection of future rental billings was not probable. When management determines lease revenue collectibility is not probable, the standard limits leased revenue to the cash paid by the customer. This limit requires the write-off of all existing receivables even if the receivable is being fully collectible by management. Second, ASC Topic 842 required the receivable write-off to be recorded as a reduction of lease revenue rather than as a bad debt expense. We have revised our unaudited consolidated balance sheet at December 31, 2019, and our unaudited statements of operations for the 3 months ended December 31, 2019, and our unaudited statements of operations for the 3 and 6 months ended March 31, 2020, to correct identified errors. The correction has no impact on our operating loss or net income for the 6 months ended March 31, 2020, nor did it have a net impact on cash flow from operating activities for the 3 months ended December 31, 2019, and for the 6 months ended March 31, 2020. In yesterday's press release, our third quarter ended June 30, 2020, we reported revenue of $22.7 million compared to last year's revenue of $22.9 million. The net loss for the quarter was $2.3 million or $0.17 per diluted share compared to last year's net loss of $3.7 million or $0.27 per diluted share. For the 9 months ending June 30, 2020, we reported revenue of $66.3 million compared to revenue of $66.9 million last year. Our net loss for the 9-month period was $15.4 million or $1.14 per diluted share compared to last year's net loss of $8.8 million or $0.66 per diluted share. A breakdown of our oil and gas product revenue. Our traditional product revenue for the third quarter was $1.2 million, a decrease of 46% compared to revenue of $2.2 million last year. Traditional product revenue for the 9 months of 2020 was $5.6 million, a decrease of 38% compared to revenue of $8.9 million last year. Both periods decrease are due to lower demand for traditional sensor products. We believe revenue for these products will be challenged in the foreseeable future due to low oil prices, oversupply of crude oil and the drop in demand for oil and gas, a result of the COVID-19 pandemic. Our wireless product revenue for the quarter was $16.1 million, an increase of 36% compared to revenue of $11.9 million last year. Wireless product revenue for the 9 months was $41.1 million, an increase of 25% compared to revenue of $32.8 million for the same period of 2019. The increase in revenue for both periods is due to higher rental demand and utilization of our OBX marine nodal system. As a reminder, we have not recognized revenue since the year 2020, from a $12.5 million GCL product sale delivered in the second quarter, secured by a $10 million promissory note. As of June 30, 2020, we have received $3.8 million in cash by way of the deposit and monthly note payments from our customer. I am pleased to note to date the customer is current on all payment obligations. The cash payments received and the cost of revenue associated with the sale have been recorded on our balance sheet as part of long-term deferred revenue and long-term deferred cost of revenue. We plan to recognize the revenue and cost of revenue on this transaction when we determine the collection of the promissory note is probable. Our reservoir product revenue for the third quarter was $271,000, a decrease of 39% compared to revenue of $447,000 last year. Reservoir product revenue for 9 months was $826,000, a decrease of 66% compared to revenue of $2.4 million last year. The decrease for the 3- and 9-month periods reflect reduced sales and service of our borehole tools. We do not expect meaningful revenue from these products unless and until we are engaged in a contract for the delivery of a permanent reservoir monitoring system. We believe a tender for a PRM system could be released in calendar year 2020 or soon after. Should we be awarded a tender, we do not expect to recognize any PRM-related revenue until later in fiscal year 2021 or beyond. Moving on to our adjacent markets product segment. Our industrial product revenue for the third quarter of fiscal year 2020 was $3.4 million, a decrease of 37% over the third quarter of 2019. The industrial products' 9 months revenue for fiscal year 2020 is $11.2 million, a decrease over the same period in 2019 of 14%. The decrease in revenue in both periods is due to lower demand for our industrial sensors and contract manufacturing services. The decrease in the 3-month period is due to lower demand for our water meter cable and connector products. We believe the lower demand for these products is primarily due to the economic impact of the COVID-19 pandemic on our customers. Imaging product revenue for the third quarter was $1.7 million, a decrease of 41% compared to last year's revenue of $2.9 million. This decrease is due to reduced demand for graphic imaging film products. The 9-month revenue for imaging products for fiscal year 2020 is $7.1 million, a 22% decrease when compared to the same period in 2019. In both periods, we believe the lower demand for these products is primarily due to the economic impact of the COVID-19 pandemic on our customers. Finally, revenue from our emerging markets segment totaled $88,000 for the 3 months and $557,000 for the 9-month period ending June 30, 2020. The prior year revenue was $11,000 for the third quarter and $145,000 for the 9-month period ending June 30, 2019. While we do not anticipate significant revenue contributions from Quantum in fiscal year 2020, we do expect to record most of the revenue from our $10 million contract with the U.S. Customs and Border Protection in our first quarter of fiscal year 2021. Our third quarter of fiscal year 2020 operating expenses decreased by $297,000 or 3% compared to the third quarter of 2019. The 9-month operating expenses increased by $2.9 million or 10% when compared to the same period of fiscal year 2019. The increase in operating expenses for the 9-month period is mostly due to $1.6 million in changes to the estimated fair value of the contingent consideration and higher engineering project costs. In July of 2020, we took actions to reduce operating costs as a result of decreased demand for our products. The cost-saving measures include workforce reductions of approximately 100 employees from our company's workforce and a reduction in cash compensation of named executives and company directors. We will incur $800,000 in termination costs in our fourth quarter of fiscal year 2020. We expect we will realize annual savings of $2 million or more as a result of these cost-cutting measures. Our 9-month cash investment into our rental fleet and property, plant and equipment are $5.4 million and $2.6 million, respectively. We do not expect any significant additional cash investments into our rental fleet or into our property plant equipment for the remaining of fiscal year 2020. Our balance sheet at the end of the third quarter reflected $26.7 million of cash. We have no long-term debt outstanding and the available borrowings under our credit agreement is $17.9 million. In addition, we own numerous real estate holdings in Houston and around the world that are owned free and clear without any leverage.

Amidst all the ramifications of COVID-19, demand for certain products in our oil and gas and adjacent markets segment will undoubtedly continue to be negatively impacted. Large curtailments of travel and social activities, combined with lower factory outputs, will continue to hold global energy demands well below normal levels. Thus, resulting supply balancing acts and pricing volatility will pose ongoing challenges to oil and gas companies and energy service providers who are our major customers. However, we believe our available products in this market stand out as the preferred instruments of choice within a recovering energy market. In addition, we believe our executed diversification strategy is already demonstrating successful mitigation of the volatility in our oil and gas market segment, as evidenced by our contract with the U.S. Border Patrol. Furthermore, we believe our recent cost reduction efforts and our long-standing financial discipline keeps us optimally positioned to thrive in the post-COVID-19 world ahead. In closing, we heartily thank our hardworking workforce who provide the lifeblood support for our operations and our valued customers. And we very much appreciate our loyal shareholders for trusting our vision and values to consequently emerge from the challenge of these uncertain times. That concludes our prepared remarks, and I'll now turn the call back over to Keith for questions.

I have a group of questions relative to the Quantum business since Mark is on the line. First of all, Mark, apparently, there is a binational industrial research and development proposal request tied to border protection, and I believe the executive summary is due on the 13th of this month and then final proposals are due next month. Would you talk a little bit about that and the degree to which Quantum is or it is not participating?

Sure, Bill. We're familiar with that. If I understand the proposal request to which you are referring and we're talking about the same one, it's a joint effort that comes out of Congress. It's very R&D based, which means you submit proposals to advance something in an R&D profile. So it's a kind of a service-based effort, which is where Quantum earned its chops many years ago doing R&D. It's not in the direction that we're going now, which is significantly past the R&D stage and selling product into those same border security markets. They can have a tunnel focus, but I think it's important for you and everyone on the call to understand that the complete tunnel challenge is not simply one of technological detection. It has other aspects for which we do not participate, which includes investigation, includes remediation where you fill the tunnels full of cement and how you do that. There's a lot of other technologies associated with — as members on the hill will say, solving the tunnel challenge. So we're a component of that. So when you think of a $30 million, $40 million bill, it's not all aligned to something for which we would be applicable. So those are the 2 key points. There's routine collaboration between our U.S. and, for example, Israel on some of these challenges. And we track them very, very closely. We are known — we've worked with members of Congress as appropriate. So it's a great question. I'm pleased you're keeping apprised of it. And rest assured, so are we.

Great. And that's actually a really nice segue, Mark, into my next question, which was, I guess, pure coincidence, but I was listening to a report on the BBC where they were in Israel on the northern border, and they were referencing the Hezbollah tunnels that had been built between Lebanon and Israel. And I believe that the person that was being interviewed was referencing the tunnel problem was considered a strategic issue for the Israeli military and Israeli border protection. Would you please talk through kind of your understanding of that northern border and importantly, how Quantum may or may not be able to participate in that? And if you are able to participate, how quickly you could see commercial activity develop there?

That's a big question. We tracked the Israeli environment closely. We've been in-country before. We've deployed our technology in the past. They are well aware of what we are capable of. I have to be mindful as to how much I am able to disclose on this call, so please understand that. The competitive environment over there is indeed competitive. They have a lot of talent within their country as well. We do know that they've had, like the rest of the world, some economic impact with their military due to COVID. We understand the northern environment and what differs between it and the southern environment on a tunnel detection standpoint. And what I can say is that we are very intimately tracking where they are on that — their northern border strategy to the best of our abilities. I'm not sure what that will look like in the next 6 to 12 months. The big thing to remember about Israel versus our country is that, in our country, all sorts of bad things come through tunnels — a tunnel. Nothing good comes through a tunnel. But in their country, they have an additional challenge, which is people come through tunnels with the intent to do physical harm to their citizens. And so they do track that and take those tunnel threats very seriously, but they have other ways of also mitigating them through other means that they try to stay in front of. But yes, I'm sure you're aware, in the last year, how many tunnels they found due to Hezbollah. And there are pictures on the Internet there that everyone can go look at. And those had — were very mature tunnels and have been developed over a period of years. So I hope I'm kind of giving you a little bit more insight. I'm sorry, I can't get too much more specific than that. But just rest assured that we're doing everything we can to remain aware of that.

No. That's helpful, Mark. And the tunnels that I have seen do appear to be quite sophisticated and don't look like they were put together by a bunch of 10-year-old boys in the afternoon. So the question is, given the talent that you referenced that's already in Israel, do you see where there is a real probability for Quantum to be able to participate and have meaningful business? Or is that going to be a bigger challenge because of the expertise that they have in-country?

There's always a possibility. But at this time, I don't want to really dive deeper in answering that question. I just don't feel comfortable doing that right now.

Okay. And then I'm going to ask a couple of additional questions here. First of all, if I hear correctly in the opening remarks that you expect most of the $10 million in U.S. Customs and Border revenue with that first contract to happen in the December quarter?

Yes. So the significant amount of revenue will come in the first quarter of next fiscal year. So the October to December quarter.

And so what's going to happen between December and April when the next renewal is potentially available or the remainder of the contract term if you're doing most of the business in that 3-month period of your first fiscal quarter?

Understood. Payment doesn't correlate with effort. I think that's a big point. It's a product sale. And so there's still — that's still equal. It's a level-loaded contract from an effort standpoint. Our effort remains constant over the 12 months. But the payment and the revenue that we're recognizing doesn't correlate to that effort because it is a product sale.

Great. Okay. And then what additional opportunities do you have with contractors? You referenced the contractor last quarter. Could you talk to that market or that opportunity a bit further in terms of that singular contractor and that piece of business that you are working with them on, but also with other contractors and how you're viewing that position?

That might take a few hours. We're always on the hunt, and we're maintaining our relationship with other contractors. There's a couple of paths to market, of course. Do we go in directly to government customers through large system integrators? Or do we go direct ourselves as they're doing with Border Patrol? Large system integrators have need of our better unique talents and products on occasion. And our relationships with them remain on point. We've — since we've been in the business for a couple of decades now, we work very hard to be top of mind with them for certain types of applications. It's a bit more of a wildcard with COVID right now on where funds are landing, what's going to come out of the budget, we're in an election year. So everybody is kind of sitting back a little bit and holding their breath, staying true to the contracts that we have. But from a business development standpoint, seeing what's going to come out of Congress for fiscal year '21. And when that budget might close, we can expect probably a continued resolution until the election is passed. So it's a bit of a multivariate issue right now that we're tracking. But to the heart of your question, a key strategy for us is maintaining those relationships with those large system integrators to provide the security and surveillance component of any particular large contract they may be performing to or pursuing.

Great. And then I'm going to shift to PRM real quickly here. The tender that you have referenced that may be released later this calendar year, given what you know about that piece of business. How would you anticipate the revenue would be recognized over the life of the contract or upfront?

Well, Bill, I think that, that would end up being a little bit further down the road. So that revenue might start be recognized — being recognized in fiscal year 2021. But the installations are not going to be until after our fiscal year 2021, at least under the current discussions as they are now. So with the way the revenue recognition rules run these days, they change on a daily basis. But I think that would likely — there would be some, obviously, that occur as that contract would develop. But I think a good portion and perhaps the majority would come later.

Yes. To be specific, Bill, we would expect to recognize that revenue over time using some metric to give us a view to how far along we are in the production of that contract.

Now. That doesn't particularly have anything to do with how cash payments may come in because there are milestone arrangements and that sort of thing. As those contracts are negotiated, that with respect to how cash flows are executed over the contract, but the revenue recognition follows different rules.

And it will be very specifically based upon the terms of the contract.

Right. Okay. So in the past, when you've had smaller PRM contracts, you have recognized the revenue kind of in one shot deal. That's the time of delivery. But with a larger contract, that was done over time. So it's — would it be appropriate to infer from your comments that this PRM discussion, if it comes to fruition, would be quite large in size?

Frankly, Bill, from an accounting guidance point of view, the way we recognize revenue in the past related to PRM contracts, those rules have considerably changed. So I'm not quite sure the size of the contract really will have anything to do with how we decide to recognize revenue on time. And you certainly can't draw reference from the past to what we'll do in the future.

All right. Well, let me just ask the question directly then. Would you — from what you know today, does this contract appear to be larger in nature if it does come to fruition or smaller in nature?

The scope of work being discussed, if there's more than one contracted oil company that we're talking to, but I think the one of nearest vicinity here is a large — the discussions have been pointing to a large deployment.

My question is directly related to Mark. So Mark, there's a gentleman by the name of Palmer Luckey. He created Oculus, sold it to Facebook, got fired and now has created a company called Anduril. And team — this company was awarded a 5-year contract to deploy portable surveillance towers, I believe 60 were part of a pilot program 1.5 years ago, and now it exceeds 140 towers. They also are part of the program of record. Anyways, some of the discussion appears to imply that this is a $200 million or $300 million contract so money is being dispersed, and I believe the contract was awarded around early July. So my question, Mark, to you is what differentiates what you guys are doing versus what Anduril is doing? And I do understand that the tower projects are going to be used in open desert as opposed to what you are doing, but I'm just curious about if there's an overlap? Or are they different markets or your thoughts on that?

Sure. There's a number of tower solutions on the border today. Palmer took a specific approach to get there. There were 2 other procurements that hit the street that allowed 2 primes, again, what I call LSIs, large system integrators. They each won those 2 other procurements. One was called integrated fixed towers and the other was a remote surveillance contract. All of those employ line-of-sight technologies, so they have to see the area of regard in order to understand and have situational awareness within that area of regard. So it's electro optics. It could be visual. It could be radar, anything like that. The Geospace Quantum value to market is that we are a nonline-of-sight technology. We are a seismic acoustic technology. We're not just limited to the seismic space. Our sensors are capable of detecting signals that propagate through the earth, the air or the water. And so nonline-of-sight technologies are an essential element of a complete security posture. Very similar to what you're doing as we speak, and everybody on this call is doing because you're probably looking at your computer, you're probably reading you all at the same time, they're listening to me. You're employing the visual, the line-of-sight and the nonline-of-sight. And believe it or not, our ears are what keep us alive, far more than our eyes do. We're just used to it. And we don't really take that knowledge because it's background processing that we're looking in all directions all the time with our ears. We don't step off of the street corner by looking first. Your ears have already told you where to look and what you're about to see. That is the value that the seismic acoustics bring to any security challenge. So when you think of that and you say, well, where are the nonline-of-sight challenges? Well, it's where the towers can't see. So there's terrain in the southern border. There's force in the northern border. There's submarine vehicles that approach our borders. There's aerial targets that radar can't see because they're either small or they're too close to the ground. But most of these things, if not all of these things, emit a significant amount of acoustic energy. And acoustic energy goes hum in to air, earth, water, and we sit there and we see it. And then we do everything within our power and our analytics to automatically determine what that source of energy is, where that source of energy is, the direction of that source of energy. And that can feed into a larger system that can queue Palmer Luckey's towers. We can tell them about stuff coming before he even knows it's in his screen, and vice versa. Now what are our weaknesses? Our weaknesses are we can't tell you the license plate on a car. It's hard for us to say there's 3 people and one of them is holding a baby. We don't know that. It's hard for him to do that, too, by the way, not so close. So that's kind of a 101 on the distinction between the value that we provide and the value, the very necessary value that those towers provide. Is that helpful?

It is. So when I think about the addressable market and the fact that he received an award approaching what appears to be a couple of hundred million dollars, are we in that same category?

No. We're solving a different challenge. And from a security standpoint — and again, it's a nonline-of-sight challenge. So no, we're not in that same category. We're not in the same budget line completely. It's both a security surveillance counter for the — challenge for the border, but ours is one that's more for — of a different specificity.

So I don't think I asked my question correctly. So last time when you chatted, you stated that the system that you were deploying would represent something like 1% or 2% of the addressable market, which implies a fairly significant market. And so when I think about what Palmer is doing and the potential size of that addressable market and what you guys are doing, we're from the outside trying to figure out what that potential addressable market is? And so relative to what Palmer is doing, are you guys in the same ballpark in terms of addressable market or half of the market or more than the market? I'm not sure you can even answer the question.

The addressable market is, I would say, roughly the same, whether or not it will all be addressed is a function of both budgets and our ability to perform. Now our ability to perform right now has been pretty well established, and we're pretty excited about that. But I imagine the Border Patrol standing back and wondering if they have a one-hit wonder with us? Or if we — if they really do have a — and so we're excited. We're excited to be able to go forward on our efforts and get after more of what the requirement is. And that's what we expect to do in the next — in the upcoming years. But again, we know budgets change. We know pandemics occur, and there's a number of things that can get in the way of that, that have nothing to do with us or our performance, but there is a requirement. And we're right now, again, excited to get in the ground and do our job.

So the value of this deployment in your first fiscal quarter is important for people to understand what you guys can do. Is that fair?

Yes, it is important. It's very important. We've had — some of the challenges we are addressing have not been able to be tackled to, I think, a sufficient level of performance. And so we've been given the opportunity to continue to demonstrate just how effective we are, similar to what Palmer is doing, containing and said in this particular market, I think I can do it better. And he's getting in there and stirring things up, which is good for him. And I don't want to say we're the same, but it might be an analog to what we are doing as well.

We'll take our first question from Bill Dezellem with Tieton Capital.

I'm glad everyone is doing well. I noticed on July 9 that Halliburton and TechnipFMC launched a joint reservoir monitoring suite. Given the size of those companies, do you have any initial thoughts on the collaboration or on Geospace's competitive advantage in that partnership?

Yes, Roger, I believe that the reservoir monitoring that's going on there is basically in well sort of monitoring, and that's quite a bit different than the overall spatial monitoring that happens with the seismic type equipment that is deployed in our PRM systems. So they're very limited opportunities in terms of what you can see from in-well monitoring. They're useful, but they're not nearly the scope or magnitude from an imaging point of view that you can get with our types of systems.

Great job once again on prudent conservative cash management. It looks like cash and equivalents are trending up, $10.1 million end of last year, $18.9 million first quarter this year. $26.7 million end of this quarter. So again, great job. Appreciate the thumbnail sketch you gave in the prepared comments about where the Q1 to 2Q increase came from. But could you give us a little more color on this? And do you see this trend continuing in the future quarters? Or is this Q-to-Q increase due more to like lumpier onetime events and transactions?

Well, from the oil and gas point of view, what has been driving our revenues, as we mentioned, is the demand for renting our OBX equipment. That has been just an ongoing trend. And as I mentioned in our comments, it's highly related to the fact that few oil and gas companies are trying to conserve costs on their own side by examining the fields and nearby areas to their already existing infrastructure. Now keep in mind that these projects, as you can well see here have gone on despite the fact that COVID-19 has just had a devastating effect over every economy on the globe. Most of these types of projects are ones that have inertia once they're planned, once they're underway. Capital has been allocated, and these goals are held up then they proceed. I can only expect that as this pandemic continues and more specifically, as the demand for oil and gas remains depressed, that's likely going to have an impact simply just from a capital point of view. So there are some probabilities that there will be a reduction in demand for these ocean bottom surveys, even though that is the preferential method of increasing production and managing existing production by the oil companies great.

Mark, I’d like to ask you again. You mentioned that you’re eager to demonstrate that you’re not a one-hit wonder. Are you feeling that the location for your upcoming deployment in the next few months is one where you have a high chance of achieving success, or how do you view the significance of these areas chosen for the initial deployment?

Bill, I always like answering your questions even though I probably shouldn't. The Border Patrol is very good at making sure they get best value out of their money for us. Like all government customers, good government customers want the companies that they invest in to succeed on their behalf. So I have a large degree of confidence in our collective team, in the mission that we are collectively serving that we will be doing our fair part and adding significant value to their mission.

Well, we look for — well, actually, how long — when would you expect that you would have the system deployed and operational? I guess the question is, when would you expect it to be operational? And therefore, I'm just trying to figure out how quickly we should be watching the newspapers for potential consignment...

I really wish I could answer that for you. I can't go into those details.

All right. So my next question is not meant to sound like complaining. I genuinely want to understand why Oculus has a contract worth potentially a couple of hundred million dollars, while Quantum has a $10 million contract. I can't help but feel a bit overlooked in this situation.

That is a good question. That's a really good question. They are an integrator deploying known technologies. Everybody is familiar with the camera. There's nothing new to what they're doing. I am unaware how much of their press releases are somewhat promotional compared to the other integrators that are also doing the exact same thing they are. And I do not know the procurement strategy of the government for all towers everywhere. I just don't know. Those systems leverage a tremendous amount of expensive components. And if you want to outfit every tower with all components, they can get expensive in a hurry. And because they are line of sight based, you might have a lot of towers everywhere. But again, I'm just speculating now. I don't know, again, the procurement strategy or where they're getting coverage. Press releases are an interesting thing when you are promoting something that everybody already knows about. We're not able to do that.

Right. Okay. And then I do want to jump back to a couple of oil and gas-related questions. The customer with the OBX note payable, are they paying as agreed? And secondarily, what does their go-forward work schedule look like?

They are up-to-date on their payments. There is a seasonal lag in some of that ocean bottom work that is going on as we speak not just because of where some of the areas are where all this is taking place. So they as well as others are likely going to experience some lags in that activity. But it does look like that there are significant plans for ocean bottom surveys. In fact, many in deepwater for next year. So we'll have to see how all that plays out. Again, COVID-19 is going to eventually have some effect on the inertia that these sorts of products have enjoyed in times past.

Great. So kind of the implication of your comments that they're paying has agreed that the challenge is when this first came up maybe 9 months or so ago, that they seem to have prioritized their payments to you and it looks like we're on track.

That is correct.

Are we still not recognizing revenue from that note? What is the current status of revenue recognition with that customer?

Yes. We have not recognized the revenue or the cost of revenue associated with that sale. We're very closely following the SEC filings and public — news releases from the customer to see if there's any change in their financial outlook. But to date, there's still not good news out there related to them being a going concern going forward. So until their — that outlook changes or we've collected a very significant portion of that note receivable, we'll continue not to recognize the revenue.

And what would the incremental earnings have been this quarter had you recognized the revenue and the correlated expense?

Yes, I don't think I can tell you that, Bill.

Well, I mean, the sale was a $12.5 million sale and the paid-in amounts to date, I think we've revealed are $3.8 million. So it'd be somewhere between those two numbers.

Thanks for bracketing it. Let me switch then to the GCL, $3.8 million revenue that you...

Yes. We're — that customer, we're still continuing to only recognize revenue on a cash basis. In our third quarter, we received payments from the customer. I think it was like $3.6 million, and we recognized that as total revenue. And going forward, as they make payments to us, we'll recognize revenue as paid.

Okay. That is helpful. And then switching to the $3.8 million that was not recognized as revenue in this quarter, if I'm understanding this correctly, since that was a GCL, not a rental, but a purchase, there would not be any expenses associated with that. Therefore, we would see that flow right to the bottom line. Is that...

No. No, that's not correct, Bill. We're deferring all of the revenue and all the cost of revenue associated with that transaction until we deem collection is probable. And that determination is related to the entire sales amount, not some insignificant portion of it.

Understood. So basically, instead of going down the income path with this, we really ought to be thinking about it from a cash flow perspective. But if we wanted to just rough it out, we could say, well, if your gross margin was approximately 50% just because that's easy math to do, you could do that, tax-effect it and find that you probably would have made money this quarter had you recognized that revenue?

Yes. The thing is, it's not going to go on the income statement as it is now. So you've got to examine the balance sheet and those other lines. I mean it's sad, but the accounting has somewhat made a lot of this a little bit more complicated than what it would otherwise be.

Very messy.

And that's why you see your cash growing whereas your earnings may continue to be in a loss position from a net income perspective?

It is a part of why our cash is growing, yes, absolutely.

Can you explain the company's capital allocation strategy in relation to cost-cutting measures? Specifically, what is the plan for assets that are either underutilized or not utilized at all in a market where exploration activity appears to be declining for the foreseeable future?

Yes, Chris, the majority of our assets are associated with our manufacturing operations. And one of the things that we're currently doing is we're in the process of manufacturing equipment that's going to be used in this Border Patrol contract. In addition, we're in discussions on some of these PRM systems, which require significant manufacturing resources to put forward. So it's a constant examination of those assets and those that aren't performing. Some we get rid of and have in recent quarters here. You can well imagine, that's just an ongoing day-to-day activity that we have to go through in making those examinations. But it's very important to protect those elements that have potential for generating revenue for us. And that is largely why we have such a conservative view in the way we manage our finances and our operations so that we can preserve those opportunities.

Okay. And could you talk about the areas where you reduced headcounts?

Sure. Largely, again, that had to do with the fact that there wasn't as much manufacturing operations taking place. So that represented a significant portion of what those reductions were. But again, we've made sure that we protected our skill sets and our core competencies within the organization. And we're also working to maximize the flexibility, we'll say, of our workforce where there are not siloed skill sets that exist except as necessary into where those people can move more appropriately into other areas of need within the manufacturing space. In addition, reductions occur with respect to — we're examining our properties and other things as time goes on, and certainly the salaries of executives and all that. We're a part of that consideration as well.