Geospace Technologies Corp: Form 10-Q for the period ended Mar 31, 2023

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, 2022.

Forward-Looking Statements

This Quarterly Report on Form 10-Q and the documents incorporated by reference herein 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”, “could”, “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 timing, adoption, results and success of our rollout of our Aquana smart water valves and cloud-based control platform, future demand for our Quantum security solutions, the adoption and sale of our products in various geographic regions, potential tenders for permanent reservoir monitoring systems, future demand for OBX rental equipment, the adoption of Quantum's SADAR® product monitoring of subsurface reservoirs, the completion of new orders for channels of our GCL system, the fulfillment of customer payment obligations, the impact of and the recovery from the impact of the coronavirus (or COVID-19) pandemic, the impact of the current armed conflict between Russia and Ukraine, our ability to manage changes and the continued health or availability of management personnel, volatility and direction of oil prices, anticipated levels of capital expenditures and the sources of funding therefor, and our strategy for growth, product development, market position, financial results and the provision of accounting reserves. These forward-looking statements reflect our current 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, 2022, as well as other cautionary language in such Annual Report and this Quarterly Report on Form 10-Q, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Such examples include, but are not limited to, the failure of the Quantum and OptoSeis® or Aquana technology transactions to yield positive operating results, decreases in commodity price levels, the continued adverse impact of COVID-19 which could reduce demand for our products, the failure of our products to achieve market acceptance (despite substantial investment by us), our sensitivity to short term backlog, delayed or cancelled customer orders, product obsolescence resulting from poor industry conditions or new technologies, bad debt write-offs associated with customer accounts, inability to collect on promissory notes, lack of further orders for our OBX rental equipment, failure of our Quantum products to be adopted by the border and security perimeter market or a decrease in such market due to governmental changes, and infringement or failure to protect intellectual property. 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

Unless otherwise specified, the discussion in this Quarterly Report on Form 10-Q refers to Geospace Technologies Corporation and its subsidiaries. We principally design and manufacture seismic instruments and equipment. These seismic products are marketed to the oil and gas industry and used to locate, characterize and monitor hydrocarbon producing reservoirs. We also market our seismic products to other industries for vibration monitoring, border and perimeter security and various geotechnical applications. We design and manufacture other products of a non-seismic nature, including water meter products, imaging equipment, remote shutoff water valves and Internet of Things ("IoT") platform and provide contract manufacturing services. We report and categorize our customers and products into three different segments: Oil and Gas Markets, Adjacent Markets and Emerging Markets. In recent years, the revenue contribution from our Adjacent Markets segment has grown to represent nearly half of our total revenue. This revenue growth is reflective of both our diversification strategy as well as the continued downturn in the Oil and Gas Markets segment.

Demand for our seismic products targeted at customers in our Oil and Gas Markets segment 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, 2022.

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 www.sec.gov (http://www.sec.gov). Our SEC filings are also available to the public on our website at www.geospace.com (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.

Products and Product Development

Oil and Gas Markets

Our Oil and Gas Markets 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. This segment’s products include wireless seismic data acquisition systems, reservoir characterization products and services, and traditional seismic exploration products such as geophones, hydrophones, leader wire, connectors, cables, marine streamer retrieval and steering devices and various other seismic products. We believe that our Oil and Gas Markets 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 that are used to detect pressure changes. Hydrophones transmit electrical impulses back to the vessel’s data recording unit where the seismic data is stored for subsequent processing and analysis. Our marine seismic products also help steer streamers while being towed and help recover streamers if they become disconnected from the vessel.

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

Wireless Products

We have developed multiple versions of a land-based wireless (or nodal) seismic data acquisition system. Rather than utilizing interconnecting cables as required by most traditional land data acquisition systems, each of our wireless stations operate as an independent data collection system, allowing for virtually unlimited channel configurations. As a result, our wireless systems require 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. Each wireless station is available in a single-channel or three-channel configuration.

We have also developed a marine-based wireless seismic data acquisition system called the OBX. Similar to our land-based wireless systems, the marine OBX system may be deployed in virtually unlimited channel configurations and does not require interconnecting cables between each station. We have two versions of OBX nodal stations. A shallow water version that can be used in depths up to 750 meters and a deepwater version that can be deployed in depths of up to 3,450 meters. Through March 31, 2023, we have sold 13,000 OBX stations and we currently have 24,000 OBX stations in our rental fleet.

In August 2022, we announced the release of a new seismic acquisition product known as Mariner™, a continuous, cable-free, four channel autonomous, shallow water ocean bottom recorder. Mariner is the next generation node designed for extended duration seabed ocean bottom seismic data acquisition. The slim profile nodes, which are part of our shallow water stations, are ideally deployed as deep as 750 meters. The device continuously records for up to 70 days and offers more rapid recharging times. Its slim profile creates space savings on seismic survey vessels, allowing contractors to fit up to 25% more nodes into a download/charge container.

Reservoir Products

Seismic surveys repeated over selected time intervals show dynamic changes within a producing oil and gas reservoir, and operators can use these surveys to monitor the effects of oil and gas development and production. This type of 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. Utilizing these reservoir monitoring tools, producers can enhance the recovery of oil and gas deposits over the life of a reservoir.

We have developed permanently installed high-definition reservoir monitoring systems for land and ocean-bottom applications in producing oil and gas fields. Our electrical reservoir monitoring systems are currently installed on numerous offshore reservoirs in the North Sea and elsewhere. Through our acquisition of the OptoSeis® fiber optic sensing technology, we now offer both electrical and fiber optic reservoir monitoring systems. These high-definition seismic data acquisition systems have a flexible architecture allowing them to be configured as a subsurface system for both land and marine reservoir-monitoring projects. The scalable architecture of these systems enables custom designed configuration for applications ranging from low-channel engineering and environmental-scale surveys requiring a minimum number of recording channels to high-channel surveys required to efficiently conduct permanent reservoir monitoring (“PRM”). The modular architecture of these products allows virtually unlimited channel expansion for these systems.

In addition, we produce seismic borehole acquisition systems that 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 hydraulic fracturing operations.

We believe our reservoir characterization products make seismic acquisition a cost-effective and reliable process for reservoir monitoring. Our multi-component seismic product developments also 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.

During 2022, we have maintained active discussions with potential clients for future PRM systems. In coordination with a potential client, we concluded a successful demonstration of our OptoSeis® fiber optic PRM technology in real-world field conditions. This demonstration was a pre-requisite step toward future contract consideration. If we are awarded a PRM contract in fiscal year 2023, revenue will most likely not be recognized until fiscal year 2024. We have also held discussions and received requests for information from other major oil and gas producers regarding PRM systems. We have not received any orders for a large-scale seabed PRM system since November 2012.

Adjacent Markets

Our Adjacent Markets businesses leverage upon existing manufacturing facilities and engineering capabilities utilized by our Oil and Gas Markets businesses. Many of the seismic products in our Oil and Gas Markets segment, with little or no modification, have direct application to other industries.

Our business diversification strategy has centered largely on translating expertise in ruggedized engineering and manufacturing into expanded customer markets. To bolster the solid market share we have established in the water utility market for water meter cables, in fiscal year 2021, we acquired the smart water IoT company, Aquana, LLC ("Aquana").

Industrial Products

Our industrial products include water meter products, remote shut-off water valves and IoT Platform, contract manufacturing services and seismic sensors used for vibration monitoring.

Our water meter products support the global smart meter connectivity water utility market. Our products provide our customers with highly reliable automated meter-reading and automated meter infrastructure with our robust water-proof connectors. Our field splice kits allow for accelerated repairs once identified.

Our water IoT platform and remote-shut off valve allows customers that manage multi-family and commercial properties to monitor their properties for leak and burst events, with real-time notifications, complimented with our remote-shut off to stop water damage. These products also allow water utilities to control and monitor water use remotely, discontinue or limit service without placing its employees in potential harm or danger.

Our robust manufacturing capabilities have allowed us to provide specialized contract manufacturing services for printed circuit board manufacturing, cabling and harnesses, machining, injection molding and electronic system assembly.

Our seismic sensors provide unique high definition, low frequency sensing that allows for vibration monitoring in industrial machinery, mine safety and earthquake detection.

Imaging Products

Our imaging products include electronic pre-press products that employ direct thermal imaging, direct-to-screen printing systems, and digital inkjet printing technologies targeted at the commercial graphics, industrial graphics, textile and flexographic printing industries.

Emerging Markets

Our Emerging Markets business segment consists entirely of our Quantum business. Quantum’s product line includes a proprietary detection system called SADAR®, which detects, locates and tracks items of interest in real-time. Using the SADAR® technology, Quantum designs and sells products used for border and perimeter security surveillance, cross-border tunneling detection and other products targeted at movement monitoring, intrusion detection and situational awareness. SADAR's technology also provides passive seismic real-time monitoring in emerging energy applications such as Carbon Capture and Storage (CCS) and geothermal energy. Quantum's customers include various agencies of the U.S. government including the Department of Defense, Department of Energy, Department of Homeland Security and other agencies as well as energy companies needing real-time monitoring of seismic data.

Consolidated Results of Operations

We report and evaluate financial information for three segments: Oil and Gas Markets, Adjacent Markets and Emerging Markets. Summary financial data by business segment follows (in thousands):

Overview

Although in an already depressed oil and gas industry, demand further decreased in February 2020 because of the oversupply of crude oil due to failed OPEC negotiations that led to a dramatic drop in crude oil prices when combined with the impact of the COVID-19 pandemic. These declines in the demand for oil and gas have caused oil and gas exploration and production companies to experience a significant reduction in cash flows, which have resulted in reductions in their capital spending budgets for oil and gas exploration-focused activities, including seismic data acquisition activities. Crude oil prices held above $70 per barrel throughout 2022 and through March 2023; however, a lag in time typically occurs between higher oil prices and greater demand for our Oil and Gas Markets segment products. We believe this lag is the result of exploration and production (“E&P”) companies allocating their cash flow towards shareholder reward initiatives, such as stock buy-back programs and dividend payments, or in debt reduction. We believe this lag is a short-term trend that will continue until E&P companies decide to reinvest capital into exploration activities. As this lag persists, we expect the reduced levels of demand for our Oil and Gas Markets segment products and our rental marine wireless nodal products to continue. We also expect our land-based traditional and wireless products will continue to experience low levels of product demand until our customers consume their excess levels of underutilized equipment. During the third quarter of fiscal year 2022, we began to experience an increase in rental demand for our marine nodal products in the form of additional rental contracts and requests for quotes from existing and new customers. The increase in demand has led to near full utilization of our marine wireless rental fleet, yet we continue to experience low levels of demand for our land-based wireless products.

During the first quarter of fiscal year 2023, we implemented a plan to discontinue the manufacture of certain low margin, low revenue products and reconfigure our production facilities to lower our costs and raise efficiencies. As part of the plan, reductions were made to our workforce which are expected to yield an annual savings of more than $2 million. In connection with the plan, we incurred costs of $0.6 million in the first quarter of fiscal year 2023, primarily termination costs related to the workforce reduction. The costs were recorded both to cost of revenue and operating expenses in the consolidated statement of operations. No significant future costs are expected.

In light of current market conditions, the inventory balances in our Oil and Gas Markets business segment at March 31, 2023 continued to exceed levels we consider appropriate for the current level of product demand. We are continuing to work aggressively to reduce these legacy inventory balances; however, we are also adding new inventories for new wireless product developments and for other product demand in our Adjacent Markets segment. During periods of excessive inventory levels, our policy has been, and will continue to be, to record obsolescence expense as we experience reduced product demand and as our inventories continue to age. As difficult market conditions continue for the products in our Oil and Gas Markets segment, we are recording additional expenses for inventory obsolescence and will continue to do so in the future until product demand and/or resulting inventory turnover return to acceptable levels.

Armed Conflict Between Russia and Ukraine

A portion of our oil and gas product manufacturing is conducted by Geospace Technologies Eurasia LLC, our wholly-owned subsidiary based in the Russian Federation. Consequently, our oil and gas business could be directly affected by the current war between Russia and Ukraine. See Note 16 in this Quarterly Report on Form 10-Q for more information.

Coronavirus (COVID-19)

The ongoing COVID-19 pandemic has negatively impacted worldwide economic activity and continues to create challenges in our markets, such as uncertainties regarding the duration and extent to which the COVID-19 pandemic will ultimately have a negative impact on the demand for our products and services or on our supply chain. We continue to closely monitor the situation as information becomes readily available.

During the fiscal year 2022, our operations have, for the most part, remained open globally and the impact of the effects of COVID-19 to our personnel and operations has been limited. Our supply chain has become increasingly strained due to increased pricing for raw material and supplies coupled with longer than expected lead times. We initially experienced a reduction in demand for the rental of our OBX marine nodal products, which we believed was primarily the result of the pandemic; however, demand has increased over the past twelve months. We also believe our Adjacent Markets business segment has entered into a period of recovery from the initial effects of the COVID-19 pandemic, but we continue to be cautious about the pandemic’s effect on our other business segments and our supply chain. As a result, we continually communicate with our suppliers and customers as information is available to best manage this difficult situation

Three and six months ended March 31, 2023 compared to the three and six months ended March 31, 2022

Consolidated revenue for the three months ended March 31, 2023 was $31.4 million, an increase of $6.7 million, or 27.0%, from the corresponding period of the prior fiscal year. Consolidated revenue for the six months ended March 31, 2023 was $62.5 million, an increase of $19.8 million, or 46.4%, from the corresponding period of the prior fiscal year. The increase for both periods was largely due to higher rental revenue from our Oil and Gas Markets segment due to increased utilization of our OBX rental fleet, partially offset by a decrease in sales of wireless exploration products. The increase in consolidated revenue for both periods was also attributable to an increase in demand for our industrial products from our Adjacent Markets segment. Wireless exploration product revenue for the six months ended March 31, 2023 included $4.0 million from a rental customer as compensation for lost OBX nodes.

Consolidated gross profit for the three months ended March 31, 2023 was $$12.9 million, an increase of $6.1 million, or 90.1% from the corresponding period of the prior fiscal year. Consolidated gross profit for the six months ended March 31, 2023 was $23.5 million, an increase of $15.0 million, or 175.9% from the corresponding period of the prior fiscal year. The increase was primarily due to higher gross profits from the increased utilization of our OBX rental fleet, partially offset by the decrease in wireless exploration product revenue and related gross profits. The increase was also attributable to the increase in industrial product revenue and related gross profits.

Consolidated operating expenses for the three months ended March 31, 2023 were $9.9 million, an increase of $1.4 million, or 16.9%, from the corresponding period of the prior fiscal year. The increase was due to (i) a $2.2 million favorable non-cash adjustment reported in the prior year period resulting from a change in the estimated fair value of contingent consideration related to our Quantum and OptoSeis® acquisitions and (ii) a $0.4 million increase in selling, general and administrative expenses, resulting from increased revenue. These increased operating expenses were partially offset by a $1.2 million decrease in research and development expense, primarily personnel costs attributable to our workforce reduction in the first quarter of fiscal year 2023. Consolidated operating expenses for the six months ended March 31, 2023 were $20.7 million, an increase of $3.7 million, or 21.4%, from the corresponding period of the prior fiscal year. The increase was due to (i) a $4.7 million favorable non-cash adjustment reported in the prior year period resulting from a change in the estimated fair value of contingent consideration related to our Quantum and OptoSeis® acquisitions, (ii) a $1.1 million increase in selling, general and administrative expenses resulting from increased revenue, inclusive of $0.3 million in employee termination costs and (iii) a $0.1 million increase in bad debt expense. These increased operating expenses were partially offset by a $2.2 million decrease in research and development expense attributable to lower project expenditures and the decrease in personnel costs.

In February 2023, we sold our real property located at 7310 Langfield Road in Houston, Texas for a cash sales price of $3.7 million, net of closing costs of $0.3 million. We recognized a gain of $1.3 million from the sale of this property in the second quarter of fiscal year 2023. The sale was part of our plan to streamline operations and reduce costs.

Consolidated other income for the three months ended March 31, 2023 was $0.3 million, compared to $0.2 million from the corresponding period of the prior year. Consolidated other income for the six months ended March 31, 2023 was $0.5 million, compared to $0.4 million from the corresponding period of the prior year. The increase for both periods was primarily due to an increase in net foreign exchange gains.

Segment Results of Operations

Oil and Gas Markets

Revenue

Revenue from our Oil and Gas Markets products for the three months ended March 31, 2023 increased $3.3 million, or 21.6%, from the corresponding period of the prior fiscal year. Revenue from our Oil and Gas Markets products for the six months ended March 31, 2023 increased $13.8 million, or 55.6%, from the corresponding period of the prior fiscal year. The components of these increases were as follows:

• Traditional Exploration Product Revenue – For the three months ended March 31, 2023, revenue from our traditional products was $3.4 million, an increase of $2.1 million from the corresponding period of the prior fiscal year. For the six months ended March 31, 2023, revenue from our traditional products was $6.1 million, an increase of $4.3 million from the corresponding period of the prior fiscal year. The increase was primarily due to higher demand for our sensor products.
• Wireless Exploration Product Revenue – For the three months ended March 31, 2023, revenue from our wireless exploration products increased $1.4 million, or 10.3%, from the corresponding period of the prior fiscal year. For the six months ended March 31, 2023, revenue from our wireless exploration products increased $9.9 million, or 44.5%, from the corresponding period of the prior fiscal year. Wireless product revenue for the six months ended March 31, 2023 included $4.0 million from a rental equipment customer as compensation for lost OBX nodes. The increase for both periods was primarily due to increased rental revenue attributable to higher utilization of our OBX rental fleet, partially offset by a decrease in wireless product sales.

Operating Income (Loss)

Operating income associated with our Oil and Gas Markets products for the three months ended March 31, 2023 was $4.2 million, an increase of $2.5 million from the corresponding period of the prior fiscal year. Operating income associated with our Oil and Gas Markets products for the six months ended March 31, 2023 was $6.6 million, compared to an operating loss of $(2.5) million from the corresponding period of the prior fiscal year. The increase in operating income was primarily due to (i) higher wireless rental revenue and related gross profits due to improved utilization of our OBX rental fleet and (ii) a decrease in research and development expense attributable to our workforce reduction in the first quarter of fiscal year 2023 and lower project expenditures. The increase in operating income was partially offset by (i) a decrease in wireless product revenue and related gross profits and (ii) favorable non-cash adjustments reported of $2.9 million and $4.0 million for the three and six month periods of the prior year, respectively, resulting from changes in the estimated fair value of contingent consideration related to our OptoSeis® acquisition.

Adjacent Markets

Revenue

Revenue from our Adjacent Markets products for the three months ended March 31, 2023 increased $3.5 million, or 38.1%, from the corresponding period of the prior fiscal year. Revenue from our Adjacent Markets products for the six months ended March 31, 2023 increased $6.2 million, or 35.4%, from the corresponding period of the prior fiscal year. The components of these increases were as follows:

• Industrial Product Revenue and Services – For the three months ended March 31, 2023, revenue from our industrial products increased $3.6 million, or 60.9%, from the corresponding period of the prior fiscal year. For the six months ended March 31, 2023, revenue from our industrial products increased $6.6 million, or 59.7%, from the corresponding period of the prior fiscal year. The increase in revenue for both periods was primarily due to higher demand for our water meter products.
• Imaging Product Revenue – For the three months ended March 31, 2023, revenue from our imaging products decreased $0.1 million, or 4.5%, from the corresponding period of the prior fiscal year. For the six months ended March 31, 2023, revenue from our imaging products decreased $0.4 million, or 6.4%, from the corresponding period of the prior fiscal year. The decrease for both periods was primarily due to lower demand for our consumable film products.

Operating Income

Operating income from our Adjacent Markets products for the three months ended March 31, 2023 was $3.1 million, an increase of $1.8 million, or 136.5%, from the corresponding period of the prior fiscal year. Operating income from our Adjacent Markets products for the six months ended March 31, 2023 was $4.8 million, an increase of $2.3 million, or 92.1%, from the corresponding period of the prior fiscal year. The increase in operating income for both periods was primarily due to the increase in revenue and related gross profits. The increase in operating income was partially offset by an increase in operating expenses, mostly caused by (i) higher selling, general and administrative resulting from the increased revenue and (ii) an increase in research and development project costs.

Emerging Markets

Revenue

Revenue from our Emerging Markets products was $0.2 million for the three months ended March 31, 2023 compared to $0.3 million from the corresponding period of the prior fiscal year. Revenue from our Emerging Markets products was $0.3 million for the six months ended March 31, 2023 compared to $0.4 million from the corresponding period of the prior fiscal year. The revenue for each period primarily consisted of on-going service and maintenance related to our completed contract with the U.S. Customs and Border Protection.

Operating Loss

Operating loss from our Emerging Markets products for the three months ended March 31, 2023 was $1.0 million, a decrease of $0.4 million, or 27.2%, from the corresponding period in the prior fiscal year. The decrease in operating loss for the three months ended March 31, 2023 was attributable to lower personnel costs attributable to our workforce reduction in the first quarter of fiscal year 2023. The decrease in operating loss was partially offset by a favorable non-cash adjustment reported for the three month period of the prior year of $0.1 million, resulting from a change in the estimated fair value of contingent consideration related to our Quantum acquisition. Operating loss from our Emerging Markets products for each of the six months ended March 31, 2023 and 2022 was $2.2 million. A decrease in personnel costs for the six months ended March 31, 2023 as a result of the workforce reduction were offset by a favorable non-cash adjustment reported for the three month period of the prior year of $0.7 million, resulting from a change in the estimated fair value of contingent consideration related to our Quantum acquisition.

Liquidity and Capital Resources

At March 31, 2023, we had approximately $22.8 million in cash and cash equivalents. For the six months ended March 31, 2023, we used $5.1 million of cash from operating activities. Uses of cash in our operations primarily included (i) a $8.4 million increase in trade accounts and notes receivable primarily due to our increase in revenue and the timing of collections from customers, (ii) a $7.9 million increase in inventories to meet an increase in demand for our products, (iii) the removal of $3.9 million gross profit from the sale of used rental equipment and $1.8 million of gain from the sale of property and equipment since they are included in investing activities and (iv) a $0.6 million decrease in accounts payable primarily due to the timing of payments to our suppliers. These uses of cash were primarily offset by (i) our net income of $4.5 million and net non-cash charges of $11.4 million resulting from deferred income taxes, depreciation, amortization, accretion, inventory obsolescence, stock-based compensation and bad debt expense. Other sources of cash included a $1.7 million decrease in other assets primarily due to a decrease in prepaid product purchases and prepaid insurance.

For the six months ended March 31, 2023, we generated cash of $12.2 million in investing activities. Sources of cash primarily consisted of (i) proceeds of $8.8 million from the sale of used rental equipment, (ii) proceeds of $4.2 million from the sale of property and equipment and (iii) proceeds of $0.9 million from the sale of short-term investments. Offsetting this source of cash were (i) $1.1 million for additions to our property, plant and equipment and (ii) $0.6 million for additions to our equipment rental fleet. We do not expect to make any significant cash investments into our rental fleet for the remainder of fiscal year 2023 unless changing in market conditions makes the investment necessary. We expect our cash investments in our property, plant and equipment will be approximately $2.0 million in fiscal year 2023. Our capital expenditures are expected to be funded from our cash on hand, internal cash flows, cash flows from our rental contracts or, if necessary, borrowings under our new credit agreement.

For the six months ended March 31, 2023 we used $0.2 million from financing activities for our final contingent consideration payments to the former shareholders of Quantum.

Our available cash and cash equivalents was $22.8 million at March 31, 2023, which included $4.5 million of cash and cash equivalents held by our foreign subsidiaries and branch offices, of which $3.2 million was held by our subsidiary in the Russian Federation. In response to sanctions imposed by the U.S. and others on Russia, the Russian government has imposed restrictions on companies' abilities to repatriate or otherwise remit cash from their Russian-based operations to locations outside of Russia. As a result, this cash can be used in our Russian operations, but we may be unable to transfer it out of Russia without incurring substantial costs, if at all. In addition, if we were to repatriate the cash held by our Russian subsidiary, we would be required to accrue and pay taxes on any amount repatriated. During the second quarter of fiscal year 2023, in light of recent volatility in the financial markets, we entered into an IntraFi Cash Service ("ICS") Deposit Placement Agreement with IntraFi Network LLC through our primary bank, Woodforest National Bank. The ICS program offers us access to unlimited Federal Deposit Insurance Corporation ("FDIC') insurance on domestically held cash in excess of $5.0 million, thereby mitigating our risk of falling outside of FDIC coverage limits.

In May 2022, we entered into a credit agreement (the “Agreement”) with Amerisource Funding, Inc., as administrative agent and as a lender, and Woodforest National Bank, as a lender. Available borrowings under the Agreement are determined by a borrowing base with a maximum availability of $10 million. The borrowing base is determined based upon certain of our domestic assets which include (i) 70% loan to value of our property located at 6410 Langfield Road in Houston, Texas (the “Property”), (ii) 50% of forced liquidation value of equipment, (iii) 80% of certain accounts receivable and (iv) 50% of forced liquidation value of certain inventory (inventory borrowing base limited to 100% of borrowing base credit given toward accounts receivable). The Agreement is for a two-year term with all funds borrowed due at the expiration of the term. The interest rate on borrowed funds is the Wall Street prime rate (with a minimum of 3.25%) plus 4.00%. We are required to make monthly interest payments on borrowed funds. Borrowings under the Agreement will be principally secured by the Property and our domestic equipment, inventory and accounts receivables. In addition, certain of our domestic subsidiaries have guaranteed our obligations under the Agreement and such subsidiaries have secured the obligations by pledging certain assets. The Agreement requires us to maintain a minimum consolidated tangible net worth of $100 million. We expect to remain in compliance with this requirement in fiscal year 2023.

The Property was sold in February 2023. The sale reduced the Company's borrowing availability under the Agreement to $5.5 million at March 31, 2023. The Company is currently in discussions with one of the lenders on a new credit facility which would be secured by other alternative domestic assets.

At March 31, 2023, we had no borrowings outstanding and were compliant with all covenants under the Agreement. We do not currently anticipate the need to borrow under the Agreement, however, we may decide to do so in the future, if needed.

Our available cash and cash equivalents increased $6.7 million during the six months ended March 31, 2023. In the absence of future profitable results of operations, we may need to rely on other sources of liquidity to fund our future operations, including executed rental contracts, available borrowings under our Agreement through its expiration in May 2024, leveraging or sales of real estate assets, sales of rental assets and other liquidity sources which may be available to us. We currently believe that our cash and cash equivalents will be sufficient to finance any future operating losses and planned capital expenditures through the next twelve months.

We do not have any obligations which meet the definition of an off-balance sheet arrangement and which have or are reasonably likely to have a current or future effect on our financial statements or the items contained therein that are material to investors.

Contractual Obligations

Contingent Compensation Costs

In connection with the acquisition of Aquana in July 2021, we are subject to additional contingent cash payments to the former members of Aquana over a six-year earn-out period. The contingent payments, if any, will be derived from certain eligible revenue generated during the earn-out period from products and services sold by Aquana. There is no maximum limit to the contingent cash payments that could be made. The merger agreement with Aquana requires the continued employment of a certain key employee and former member of Aquana for the first four years of the six year earn-out period for any of Aquana’s former members to be eligible to any earn-out payments. In accordance with ASC 805, Business Combinations, due to the continued employment requirement, no liability has been recorded for the estimated fair value of contingent earn-out payments for this transaction. Earn-outs achieved, if any, will be recorded as compensation expense when incurred.

See Note 13 to our consolidated financial statements in this Quarterly Report on Form 10-Q for more information on our contractual contingencies.

Critical Accounting Estimates

During the six months ended March 31, 2023, there has been no material change to our critical accounting estimates discussed in Item 7 of our Annual Report on Form 10-K for the fiscal year ended September 30, 2022.

Recent Accounting Pronouncements

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

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information under this item, in accordance with Item 305(e) of Regulation S-K.

Evaluation of Disclosure 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 our disclosure controls and procedures will detect or uncover all failures of persons within our Company and consolidated subsidiaries to report material information otherwise required to be set forth in our reports.

In connection with the preparation of this Quarterly Report on Form 10-Q, we carried out an evaluation under the supervision and with the participation of our management, including the CEO and CFO, as of March 31, 2023, of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures were effective as of March 31, 2023.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the fiscal quarter ended March 31, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.