Welcome to the Geospace Technologies' Second Quarter 2020 Earnings Conference Call. Hosting the call today from Geospace is Mr. Rick Wheeler, President and Chief Executive Officer. He is joined by Robert Curda, the company's Chief Financial Officer; and Mark Tinker, CEO of our subsidiary, Quantum Technology Sciences. Today's call is being recorded and will be available on the Geospace Technologies' Investor Relations website following the call. [Operator Instructions] It is now my pleasure to turn the floor over to Rick Wheeler. Sir, you may begin.

Thank you, Brie. Good morning. And welcome to Geospace Technologies' conference call for the second 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. In addition, as mentioned, we're pleased to have Mark Tinker, CEO of our Quantum Technology Sciences subsidiary, with us on the call today. I'll first give an overview of the second quarter, and Robert will then give some in-depth commentary on our financial performance. Following that, I'll give Mark an opportunity to discuss Quantum and our recently award contract with the U.S. Border Patrol. Finally, I'll make a few last remarks, and then we'll open the line for 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 the 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. 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. Note that the information discussed this morning is time-sensitive and may not be accurate at the time one listens to that replay. Yesterday, after the market close, we released our financial results for our second quarter of fiscal year 2020, ended March 31, 2020. As mentioned, we are very thankful that our second quarter transpired safely and with very little commercial disruption brought about by the COVID-19 pandemic, which was…

Thanks, Rick. And good morning, everyone. Before I begin, I'd like to remind everyone that we will not provide any specific revenue or earnings guidance during our call this morning. In yesterday's press release, our second quarter ended March 31, 2020, we reported revenue of $25.9 million compared to last year's revenue of $26.1 million. The net loss for the quarter was $11.8 million or $0.87 per diluted share compared to last year's net income of $700,000 or $0.05 per diluted share. For the 6 months ended March 31, 2020, we reported revenue of $51.6 million compared to revenue of $44 million last year. Our net loss for the 6-month period was $13.1 million or $0.97 per diluted share compared to last year's net loss of $5.1 million or $0.38 per diluted share. A breakdown of our oil and gas product revenue is as follows. Our traditional product revenue for the second quarter was $2 million, a decrease of 49% compared to revenue of $4 million last year. The revenue decline is attributed to lower demand for our traditional sensor products and lower demand for our marine seismic products. Traditional product revenue for the 6 months of 2020 was $4.4 million, a decrease of 35% compared to revenue of $6.8 million last year. This period's decrease is also due to lower demand for marine seismic products and traditional sensor products. Our wireless product revenue for the quarter was $16.1 million, an increase of 18% compared to revenue of $13.6 million last year. Wireless product revenue for 6 months was $33 million, an increase of 58% compared to revenue of $20.9 million for the same period last fiscal year. The increase in revenue for both periods is due to higher rental demand and utilization of our OBX marine nodal systems. Second…

Thank you, Robert. And now I'd like to introduce you to Dr. Mark Tinker, CEO of our subsidiary, Quantum Technology Sciences, and let him say a few words about Quantum and our recent contract. Go ahead, Mark.

Thank you, Rick. Thanks for the introduction. As Rick said, I am Dr. Mark Tinker, and I am the CEO of Quantum Technology Sciences. I appreciate the opportunity to address everyone on the call. It's been nearly 2 years since Geospace acquired Quantum even though it feels like only 2 minutes. Over the past 2 years, in addition to the expected business integration efforts, we have spent significant time integrating the core competencies and technologies of both organizations. This has resulted in a unified offering that can serve markets outside of oil and gas. As previously noted, Quantum generated revenue of $372,000 in the second quarter of fiscal year 2020 and $469,000 for the 6-month period ending March 31, 2020. This revenue came from the sale of perimeter security products to a commercial customer. On April 6, 2020, we were pleased to announce a $10 million contract with U.S. Customs and Border protection for the U.S. Border Patrol. I cannot stress enough how deeply honored we are to be able to provide a solution capable of satisfying a challenging mission for the U.S. Border Patrol agents in the field. It is very gratifying to contribute to reducing the trafficking of weapons, drugs and other illegal contrabands into and out of our country. And while it took longer than desired, the first Border Patrol contract validates Geospace management's strategy to acquire Quantum. In fact, we further believe the efficacy and value of our combined unique technology will allow us to pursue not only future Border Patrol contracts, but also open up other doors for additional opportunities. Back to you, Rick.

Thanks, Mark. The challenges thrust upon virtually all facets of industry by the COVID-19 pandemic, combined with initial disputes between Saudi Arabia and Russia, are really unprecedented. And each has contributed to the historic drop in worldwide oil prices seen in recent months. Despite this adversity, we are confident that all the steps we have taken, both now and in the past, to expand into new markets, diversify our revenue streams and steadfastly maintain our commitment to strong financial discipline have helped us navigate these trouble times. And the recent $10 million contract awarded to our Quantum subsidiary by the Department of U.S. Homeland Security is just one example highlighting our ability to successfully execute our strategy of diversifying our innovative technology products and the revenue we can generate from them. Lastly, I'd like to sincerely thank all of our hard-working employees, valued clients and loyal shareholders for their support through these very difficult and uncertain times. We've made good progress on a strategic course of action, and I feel confident that our decisions have and will continue to position us favorably for the future. With that, this concludes our prepared remarks, and I'll now turn the call back over to Brie for questions.

[Operator Instructions] And we'll go first to Bill Dezellem with Tieton Capital.

Mark, since you're on the line, I'll -- I'm going to take advantage of this and ask a few Quantum questions. First of all, you referenced the $372,000 of revenue in the quarter. Would you talk to what that revenue was, whether it was U.S. or outside of the country? Whether it was to a government type agency or private? And any additional detail would be helpful.

Yes, sir. And nice to talk to you, Bill. Part of the challenges of being in the security and surveillance market is, as you might expect, some of my answers won't feel very gratifying because we have to preserve some of the -- not only the anonymity of our customers but also the fact that our technologies are being used for their security purposes. And we don't want to give any adversary an undue advantage. But still, to that end, this particular customer was a commercial entity, a large system integrator within the United States who is -- has their own purposes and own mission for which we are becoming an integrated component of an overall security system that they are providing to their customer.

And their customer would be a government or a private business?

Their customer ranges, but in this particular example, it's for a U.S. government end user.

And what additional information can you share about that end user?

I can't. We're under a pretty strict nondisclosure with them.

Understood. And then are you anticipating any further border security, I guess, final purchase decisions, for a lack of a better phrase, this year? Mark, maybe I should qualify that in meaningful size because $370,000 of revenues is nice, but it certainly isn't a needle mover. So really something more meaningful like the Homeland Security?

Yes. Well, let me kind of hit both of those actually. While it's not meaningful, and I completely agree with you, it's somewhat analogous to what we're doing in border security. Both of these are contracts that are building towards something that we see to be of a more substantial nature. It can take a while to not only get on contracts but to get deployed and get integrated. And then the system starts to roll for larger integration efforts, larger deployment efforts. But to answer your question specifically, absolutely, it is our desire and intent to continue to support the Border Patrol with upcoming efforts in the future.

So you're thinking that you do have a reasonable opportunity to have an additional meaningful business announced this year?

This year is likely -- I don't want to go that far. I'll say probably not announced. What's happened is, and I can't say the name, but there is a -- the Border Patrol is able to stand up a nice program of record. This is a big win for everybody involved, not just us. A program of record is a nice thing to have because it is a line item within the United States' budget for that particular department. And we are happy to see that stood up because it shows everybody's intent and purpose to march forward and continue to work towards that common goal. So that is optimistic for us to see because it means we can keep driving and working hard to meet their needs. And so when we always see a customer who has a need and a desire, it's always nice when we're able to see that, that customer also has an ability and a program of record kind of goals towards that. So this program of record is going to extend for many years into the future. And so we have every intention of doing everything we can to continue to serve them in the upcoming years, but that would likely not occur until starting next fiscal year.

So Mark, I'm going to have to expose my ignorance here. The program of record concept that you just identified is not something that I am familiar with. Would you please walk through the significance of that for those of us who are not intimately understanding how the government works?

Yes. Absolutely. So from Congress all the way down into every department within the United States government, whether it's DoD to, you name it, housing and development, the budgets are established. And as those trickle down, they fall into specific lines, and a program of record can have what are called program element line numbers within the United States budget. And so it's a specific place with a specific definition for Congress to both authorize an appropriate funding to be used. When you see that there's a program of record as a federal government contractor, it's encouraging because you can see a commitment from the United States to be behind something that they're intending to go complete and go satisfied. So that was encouraging for us to see that Border Patrol says, hey -- as you might imagine, there's a big push to put the wall into the ground. There's -- they have line elements for physical things such as ports of entry. They have to support their agents. They have a massive amount of logistics they have to deal with. All these things fall into a specific budget within the Border Patrol, for which they move and assign their funds to then go meet those specific needs and missions. And so the one that we're satisfying to provide our technology into has now been established. That was a big win for us, and it occurred within the last 12 months. And so to see that happen -- that was part of the reason it took us a little longer to get our contract to is because of their intent to do that. The program of record, I want to be crystal clear, it's not all about fund. It's about a mission that they're going to go satisfy, and we're going to go compete for those funds along others for that portion of that mission that may apply to us.

And so I'm actually going to use that as a great segue, and I apologize for taking up lots of time here, but I'm going to use that as a segue to an RFI that we understand was due, at least this is what we read, was due February 25 where the Border Patrol was looking for a solution to address waterways in particular. It didn't appear that it was open water or like the Rio Grande, for example. And when looking at the criteria, it looked as though much of that criteria fit you all. Would you please talk to that opportunity? Number one. And then number two, because you were granted the SBIR Phase 3, does -- if you do fit the requirements, does -- are we understanding correctly that this obligates the government to buy from you because you do have that Phase 3 status?

Bill, that's a really good question. And I -- let me do my best to address that in sequence. We are intimately familiar with the RFI coming out. An RFI for everybody else in the call is request for information. It's a completely noncommittal request from the government to gather information from industry for them to ascertain what solutions might be available and for them to then formulate a procurement strategy and set requirements according to what they learned from industry. But again, I stress it's noncommittal. The waterways RFI, we are intimately familiar with and did respond to. When you get into SBIR status, what that means is the government's not obligated to buy from us. But what it does mean is if a particular aspect of our technology which aligns with that SBIR serves the requirement, they are then able to award us a sole source contract. That can make them very happy because it means they get to avoid a complete competition, which both costs them money and can delay a procurement. So we do everything in our power to make sure that they are aware that we might fit that particular requirement with our capability. And if we don't, we get out of the way. But we've had a good deal of success with this in the past with leveraging this in our distant past with both Air Force Research Labs and the Air Force Nuclear Weapons Center. And as you guys read in the press release, we were able to do it for this current contract with the Border Patrol. Waterways is something that we are very excited to further engage the Border Patrol on and make sure they're aware of how we would approach solving that particular requirement.

Okay. And then I'm going to take one more question, if I may, and then I'll turn it over to someone else to ask about oil and gas. But relative to the original question about the $370,000 of revenue this quarter and your description of a commercial systems integrator. Would this be an example, I'm just going to use an example in pulling this out of the air, where, say, Raytheon would be the systems integrator who is working to secure military installations. And so you'd be selling to Raytheon, who would then be selling to the military. Is that an example of what you were referring to there?

Yes. That's an exact example of what I'm referring to.

[Operator Instructions] We'll go next to Chris Sansone with Sansone Advisors.

Okay. So I did have one question on the Quantum side. What's the revenue model for that business?

It's a good $10 million.

Is it? Okay. So it's a onetime sale? Is there a recurring nature to any of that?

Well, there are possible extensions to the contract as far as that goes. But as far as the part that's, for sure, established, it's what was mentioned in the press release.

Okay. Right. So there's no ongoing service -- servicing revenue stream that we could expect from those orders?

Well, there might be some. Mark can address that, if he'd like, but it's not going to be a huge amount going forward.

Yes. That -- there's the potential for follow-on maintenance and service in any contract, of course, and there's the potential for that one. But nothing in case of this moment.

Okay. And do we have any sense for what the market opportunity would be for our Quantum's products? Not -- what the total addressable market might be?

Well, I think we think it's easily as large as what our oil and gas business has been in the past. This is a very fertile industry that doesn't have products like that we have innovated and come out with and it solves some very serious problems. So we expect it -- I mean, it's hard to measure something that -- of this size, but we have every anticipation that it can grow into -- at least as big as our oil and gas market has been in our past.

Okay, great. And then -- so when you put the Quantum stations in place, how long do they last for? Was there some period of time where you have to go back and replace them?

Mark, do you want to answer that?

Sure. So one of the things I mentioned, Chris, about what we've been working on now intimately with Geospace and bringing our capabilities together is what they were able to do and what we desperately needed as Quantum prior to being acquired, was that really deep maturity of hardened geophysical data acquisition systems. So when you consider Geospace's depth here, they have put literally 80,700 miles of PRM systems on the ocean bottom that have been in place and operational for 10 years. That gives me such a degree of confidence now, as it does our customers, that we can deploy systems that will get deployed and operate with a mean time to failure that's very impressive. So I fully anticipate that our systems will be in place and be operational for 5, 10, 15 years. And the parts that might -- that are in the most hazardous conditions are actually the more disposable, less expensive part of the system. So I anticipate our systems are going to serve a mission for an extremely long time.

Okay. And then switching to oil and gas. I guess I'm curious about the excluded revenue of $3.6 million. How much more potential excluded revenue should we expect to see in the coming quarters?

We're working with that customer on an ongoing basis. So I'm not sure I can really answer that completely at this point because our negotiations are happening every couple of days with this customer.

Okay. So if we look at -- there's 2 numbers, there is $8 million that was written off versus $14 million of -- was it total deferred revenue. So is it safe to say if we're not successful on any of it, it's potentially another $6 million of revenue that could be excluded. Is that...

No, that's incorrect. That's incorrect. Our exposure was $8 million. And it doesn't expand because we stopped recognizing revenue on this customer back in November. So that differential is unrecognized revenue and late fees and penalties we've charged the customer on late payment.

Okay. How many stations did we exit the quarter with, OBX stations?

34,000 stations, I believe.

Okay. And like you guys said, the investment in stations for the balance of the year is not going to -- there's not going to be much more of that?

No. And in fact, what we reported, Chris, even within this first 6 months, most of that was spent in the first quarter of the year. But we don't anticipate any significant expenses going forward. We did, as you know, upgrade -- and mentioned that in our press release, that we did upgrade some of that fleet to current technologies. Have we not done that, it would not have qualified for some of the work that we're getting with that equipment right now. As you know, some of this equipment has been around for a while and technology changes pretty rapidly. So these upgrades were sort of a onetime event to bring them up to higher qualification levels, allowing them to be utilized in some of these upcoming jobs. But short of that, we're not planning on any new investments and increasing the rental fleet at this time. I mean if some magic happens and all this blows open, of course, we'll take that into consideration.

Right. Okay. And then you mentioned utilization. What visibility do you have into utilization or utilization rates for the balance of the year?

Well, I would say, given the disruption we've had in commerce, based on the pandemic and the instability in the oil and gas prices, we don't have a live. But as we've said, we've only had, thus far, one contract -- or a small contract that's been canceled, and we're putting out quotes for new contracts as we speak.

Yes, that's a very good question, Chris, but it's not one that we can give you a really accurate answer on because of so many balls that are being juggled in the air right now with -- out of our control. But I mean all we can tell you is that, at least from what we can see at this point in time, we might have anticipated there would be more disruption, but there hasn't been. And I think the reason being is that the OBX use is for much longer-term elements within the oil companies' plans as far as that goes. So to that extent, to what extent they're looking towards their longer-term aspects of their future, I think that mitigates some of -- even though it's huge, some of the elements that in our immediacy have occurred.

Right. Right. Before I switch over to CapEx, just one comment on the issues that we're having with some of the bad debt or the uncollected receivables. You would think that with the end user or the end customer being a major offshore exploration production company, I'm sure they're paying the bills. So I'm just curious if you have a blue chip customer who's paying their bills, why is it that our customer isn't paying us?

Well, in some cases, those blue chip customers aren't paying their bills. And that has a downhill flow to some extent with respect to particularly those companies that are more cash flow restricted than others. So you're right, you would believe in that circumstance that, that would be more the case. But there has been a considerable squeeze that has occurred from parties that you wouldn't necessarily think that would be the case.

Right. And what control do we have to prevent that from happening again?

Near 0. I mean part of the problem is that there is a certain amount of disarray within the industry and the way it's organized and the independence of all the contractors. So there's really no consistency that exists necessarily. And the way these contracts come about, the different oil companies have their own issues, the library houses have yet another set of issues. It would be great if there was just more consistency that one could point their finger at and then get better assurances, but it just has not been the case over the years for that to be true.

Okay. And then my last question is the $5 million of non-sensor CapEx. Can you talk about what that's geared towards?

I think you're speaking about improvements to plant, property and equipment in non-sensor CapEx, right?

Yes.

Yes. We're just updating, adding additional equipment to our manufacturing facilities and research and development and things of the like, things that we've decided to do this year as part of our initiatives to improve our efficiency.

But it wasn't $5 million, I don't believe.

Yes. We spent $2.8 million, but we expect we could spend up to $5 million this year.

Yes, that is right. Our current spend is $2.8 million.

We will take a follow-up from Bill Dezellem with Tieton Capital.

I'll actually take the bait on that last question. So given how the oil and gas business is under pressure. What is it that you would need to upgrade your plant for that's leading to that difference between $2.8 million and $5 million as opposed to just shutting CapEx down to 0?

Well, in many cases, Bill, it has to do with bringing the machinery up-to-date in certain cases for the manufacturing. We certainly have the products with Quantum that we need to get out and put together. We're consistently trying to improve our processes through various means of automation to bring our costs even further down than what they have been as far as that goes. That certainly helps with margins on products, even in lower volumes. So it's not that we will necessarily spend that, but those are elements that as we examine the future under reasonably cautious and examined circumstances that we could spend up to that much towards those purposes.

Yes. Bill, we'll certainly watch our cash flow going forward. We've always watched cash flow, and we certainly won't expend any money on improvements that won't have any incoming cash to support that.

Right.

That's part of why I was asking the question is it seems that you have done a good job managing your cash historically, and it seems a bit out of character that you would be spending cash now. So I read between the lines that there is some interesting business that may be associated with this CapEx and hoping you could shed some light on that.

Well, I mean, there's always interesting business in this stuff. But we look very seriously at the return on that investment, the time frames based on commitments with our customers that those improvements would span over and examining the pertinence of those expenditures. I mean, quite honestly, that's how we've operated forever and a day, and so we're not really changing any of that. The one outcome would be that we don't spend another dime. The other outcome would depend on some of these discussions we're having with various customers. And even in our adjacent markets, this is not just oil and gas. But certainly, there are other potentials within our emerging markets, our Quantum segment, within our adjacent markets, those lists of customers. So those are just things that we want to make sure you're aware of.

And then how much of this is potentially tied to Quantum and some of the business that Mark spoke of earlier in the call?

Well, I think probably not the majority of it, maybe even just a smaller portion of it. We're pretty well set up. As Mark indicated, we're already well versed in producing extremely reliable bulletproof seismic acquisition, hardware and sensors and that sort of thing, and those are crucial and critical to what Quantum needs in its product. Other aspects aren't going to necessarily require that much capital expenditure. But certainly, there will be some machinery with respect to making these sensors and cables and all that, that if it became necessary, we could upgrade. But I think for the most part, it would be other areas.

That is helpful. And then the prior questioner was asking a bit about how big the Border Patrol could be and -- if I understood part of where he was going. So I'm going to ask that question slightly different. The $10 million would be for how much distance? There's a couple of thousand miles of border, but not all of that is densely populated border where maybe tunnels might be important. So how much distance are we talking about for $10 million?

Mark, is that something you're at liberty to discuss?

I'm at liberty to completely not answer Bill's question. But I do want to do my best, Bill. Yes, there's thousand miles of border. And yes, our contract is for supplying our technology for a particular application for which we have not disclosed. And so because of that, it's frustrating for me not to be able to go into some more specifics. So I cannot tell you exactly by decree the distance for which we are going to go secure. And because I can't get into the specifics of the application, I can't then talk to you about the total addressable market there for that particular threat. What I will tell you is that we have every intention of taking this technology and its initial deployment further for the Border Patrol. This is, I'm hoping, the tip of the iceberg with them, and I'm looking forward to continuing to go into the upcoming fiscal years.

So Mark, I'm going to have a little fun with you here.

Okay.

So for this undisclosed application, are you addressing a small amount of the total distance that this application will be addressing with the $10 million or a really large portion of it? And so we shouldn't expect a lot more follow-on for this application, but hope for future applications.

I understand, and I'm going to give you an exact answer, but I'm having to think first to make sure I do this properly. We are addressing 2% of the total available market. What we are actually going to be able to serve for Border Patrol and become -- and our share of that market is currently unknown, and we're going to compete for.

And is that the 2% of the available market? Is the available market this application -- this undisclosed application? Or is that for the total U.S.-Mexican border?

This application.

So if you were to add an additional application for other miles of the border, that would be a whole another 100% pie that we would then get to discuss?

That's exactly correct. And the example that you already mentioned earlier was waterways.

And that would be a different application, a different pie?

Yes, sir.

That's extraordinarily exciting. So -- and how long for this current application -- if the Border Patrol were to have their wish, how many years would it take for them to fulfill this application?

Oh, boy. If I had that crystal ball, I'd be really, really happy. As I mentioned before, they are -- this program of record that's been stood up was a giant leap forward in facilitating their ability to meet it. To the degree that they will go and meet it is what I don't have the crystal ball for. But you don't stand up a program of record if you don't have the intention to go significantly forward in meeting this particular mission.

That is helpful. And then I'd like to actually switch to one more question circling back to the systems integrator for an end customer application. The implication of your comments was that this is a test that is being done. And then if the test goes well, then there would be some bigger piece of business. How long would you anticipate this test? And how large could that business be?

I'm going to take a little bit of a twist on the definition of test. Test doesn't mean test failure in or out, per se. Test means we're mutually engineering together. They are the prime. They have the overall integration effort. We are a component of an overall security system that they are establishing. And we could get in there and completely fail, but we would not have made it this far if anybody had the expectation that, that was the case. So it's more of the test and engineering of completing this on behalf of their customer, the overall system. And where that can go? It's going to be a long, long haul. I kind of have a reasonable understanding of the future for them. So it's going to stretch out well beyond -- into and beyond the 5-year horizon for us here, but with slowly increasing revenue towards that end goal. If you would ask me this question a year ago, I would have said don't even worry about it for 5 years. But unexpectedly and unusually, this slid significantly to the left [ arms ]. So it's still slow. I mean I don't want anybody to go nuts about what I'm saying right now. But the fact that we're integrating with them and we're positioning with them and they are doing what they need to do now and not 3 or 4 years from now is very positive progress.

Does this imply that the integrator has a contract that they have won? Or are they preparing for a hoped-for future win?

It's a highly likely win for them.

And so once this becomes an actual win, assuming that it does, does that lead to a burst of business for Quantum? Or how will that end up unfolding?

It won't change what we're predicting today because we're all operating under the mindset of win.

And there are no further questions in queue at this time. I'll turn it back to the speakers for any closing remarks.

All right. Well, thank you, Brie, and thanks to everyone that joined our call today. We look forward to speaking with you again on our conference call for the third quarter of fiscal year 2020, which will be in August. So thank you again, and goodbye.

This does conclude today's Geospace Technologies' Second Quarter 2020 Earnings Conference Call. Please disconnect your lines at this time, and have a wonderful day.