GEOSPACE TECHNOLOGIES CORP 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following is management’s discussion and analysis of the major elements of our consolidated financial statements. You should read this discussion and analysis together with our consolidated financial statements, including the accompanying notes, and other detailed information appearing elsewhere in this Annual Report on Form 10-K, including under the heading “Risk Factors.” The discussion of our financial condition and results of operations includes various forward-looking statements about our markets, the demand for our products and services and our future plans and results. These statements are based on assumptions that we consider to be reasonable, but that could prove to be incorrect. For more information regarding our assumptions, you should refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements and Assumptions” below. Cautionary Note Regarding Forward-Looking Statements and Assumptions This Annual Report on Form 10-K and the documents incorporated by reference herein, if any, contain “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements can be identified by terminology such as “may”, “will”, “should”, “intend”, “expect”, “plan”, “budget”, “forecast”, “anticipate”, “believe”, “estimate”, “predict”, “potential”, “continue”, “evaluating” or similar words. Statements that contain these words should be read carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial position or state other forward-looking information. Examples of forward-looking statements include, among others, statements that we make regarding our expected operating results, the results and success of our transaction with Aquana, LLC, future demand for our Quantum security solutions, the adoption and sale of our products in various geographic regions, potential tenders for PRM systems, future demand for OBX systems, the completion of new orders for our 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 Company’s 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”, as well as cautionary language in this Annual Report on Form 10-K, 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 or OptoSeis ® or Aquana technology transactions to yield positive operating results, decreases in commodity price levels and 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 systems, failure of our Quantum products to be adopted by the border and perimeter security 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 Annual Report on Form 10-K 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, except as required by applicable securities laws and regulations. Background We design and manufacture seismic instruments and equipment and primarily market these products to the oil and gas industry 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, offshore cables and provide contract manufacturing services. See the information under the heading “Business” in this Annual Report on Form 10-K. Consolidated Results of Operations As we have reported in the past, our revenue and operating profits have varied significantly from quarter-to-quarter, and even year-to-year, and are expected to continue that trend in the future, especially when our quarterly or annual financial results are impacted by the presence or absence of relatively large, but somewhat erratic, sales of our oil and gas PRM systems and/or wireless seismic data acquisition systems for land and marine applications. 20 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): YEAR ENDED SEPTEMBER 30, 2021 2020 Oil and Gas Markets Traditional exploration product revenue $ 4,518 $ 6,653 Wireless exploration product revenue 45,751 54,072 Reservoir product revenue 1,983 936 Total revenue 52,252 61,661 Operating loss (16,229 ) (2,139 ) Adjacent Markets Industrial product revenue 21,335 15,622 Imaging product revenue 11,084 9,818 Total revenue 32,419 25,440 Operating income 6,423 4,017 Emerging Markets Revenue 10,193 734 Operating income (loss) 5,033 (6,064 ) Corporate Revenue — — Operating loss (12,098 ) (13,853 ) Consolidated Totals Revenue 94,864 87,835 Operating loss (16,871 ) (18,039 ) 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 and will likely continue to result in reductions in their capital spending budgets for oil and gas exploration-focused activities, including seismic data acquisition activities. Our Oil and Gas Markets segment has in recent years experienced strong demand for the rental of our marine wireless nodal products; however, this demand has significantly declined during the first half of fiscal year 2021 and could continue to decline in future years as a result of the significant uncertainty in the outlook for oil and gas exploration. Demand for new land-based seismic equipment in recent fiscal years has remained restrained due to capital limitations affecting many of our customers, along with their excess levels of underutilized equipment. As a result, revenue from the sale and rental of our land-based traditional and wireless products has remained low due to the reduced investment in exploration-focused seismic activities. Policies implemented by the Biden administration in the United States could also result in decreased demand for our products. President Biden has announced climate change as a core focus of his administration and that he intends to set the United States on a path to net-zero carbon emissions by 2050. In January of 2021, President Biden implemented a hold on issuing new drilling permits and new oil and gas leasing for federal lands and waters. The administration may also implement new or amended rules and regulations concerning hydraulic fracturing and emissions from oil and gas sector operations. Crude oil prices have recently rebounded above February 2020 levels; however, a lag in time typically occurs between higher oil prices and greater demand for our Oil and Gas Markets segment products. Lasting higher levels of oil and gas commodity pricing may not stabilize in the long term, thus continuing the challenging industry conditions we have experienced in previous fiscal years. We only expect improved market conditions when we see lasting stabilization of higher crude oil commodity prices, which should result in higher revenue from our Oil and Gas Markets segment products. In light of current market conditions, the inventory balances in our Oil and Gas Markets business segment at September 30, 2021 continued to exceed levels we consider appropriate for the current level of product demand. While we are aggressively working to reduce these legacy inventory balances, 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. If difficult market conditions continue for the products in our Oil and Gas Markets segment, we expect to record additional inventory obsolescence expense in fiscal year 2022 and beyond until product demand and/or resulting inventory turnover return to acceptable levels. 21 Coronavirus (COVID-19) The ongoing COVID-19 pandemic has spread across the globe and has negatively impacted worldwide economic activity, including the global demand for oil and natural gas, and continues to create challenges in our markets. While we continue to support our customers, there remain uncertainties regarding the duration and the 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. As of the date of this filing, 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. We have experienced a reduction in demand for the rental of our OBX marine nodal products, which we believe is primarily the result of the pandemic. Our supply chain has become increasingly strained due to increased pricing for raw material and supplies coupled with longer than expected lead times. We believe we may be entering a period of recovery from the initial effects of the COVID-19 pandemic on our business, but we continue to be cautious about the pandemic’s effect on our supply chain. As a result, we continually communicate with our suppliers and customers as information is available to best manage this difficult situation. Fiscal Year 2021 Compared to Fiscal Year 2020 Consolidated revenue for fiscal year 2021 was $94.9 million, an increase of $7.0 million, or 8.0%, from fiscal year 2020. The increase in revenue was primarily due to (i) the recognition of $12.5 million of wireless product revenue attributable to a large land-based wireless seismic product delivered in fiscal year 2020, (ii) a $9.9 million sale of used OBX rental equipment to the former lessee of the equipment, (iii) $10.1 million of revenue recognized on our contract with the CBP from our Emerging Markets business segment, which was awarded to us in fiscal year 2020, and (iv) a $7.0 million increase in both industrial and imaging product revenue from our Adjacent Markets business segment. These increases in revenue were largely offset by a $34.7 million decrease in rental revenue, primarily from our OBX marine nodal products caused by sales of rental equipment and lower utilization of our OBX rental fleet caused by the COVID-19 pandemic. Consolidated gross profit for fiscal year 2021 was $16.3 million, a decrease of $7.1 million, or 30.5%, from fiscal year 2020. The decrease in gross profit was caused by the reduction of rental revenue discussed above, and was partially offset by increased gross profits attributable to the higher revenue from other product categories discussed above. Consolidated operating expenses for fiscal year 2021 were $33.2 million, a decrease of $8.3 million, or 20.0%, from fiscal year 2020. The decrease was due to (i) a $4.6 million net non-cash decrease in the estimated fair value of contingent earn-out consideration related to our Quantum and OptoSeis ® acquisitions, (ii) a $1.5 million decrease in personnel costs primarily related to our cost reduction program initiated in the third quarter of fiscal year 2020, (iii) a $0.7 million reduction in research and development project costs, (iv) a $0.8 million reduction in other general business expenses and (v) a $0.7 million reduction in goodwill impairment charges. Consolidated other income for fiscal year 2021 was $3.4 million compared to $1.4 million from fiscal year 2020. The increase in other income was primarily caused by a gain recognized on the sale of our investment in a debt security. Consolidated income tax expense for fiscal year 2021 was $0.6 million compared to $2.6 million from fiscal year 2020. This decrease in income tax expense was primarily the result of a decrease in rental revenue earned in foreign jurisdictions requiring tax withholding. We are currently unable to record any tax benefits from the tax losses we incur in the U.S., Canada and Russian Federation due to the uncertainty surrounding our ability to utilize such losses in the future to offset taxable income. Segment Results of Operations Oil and Gas Markets Fiscal Year 2021 Compared to Fiscal Year 2020 Revenue Revenue from our Oil and Gas Markets products for fiscal year 2021 decreased $9.4 million, or 15.3%, from fiscal year 2020. Our product and rental revenue in this segment was negatively impacted by the COVID-19 pandemic and its impact on worldwide demand for crude oil. The components of this decrease included the following: • Traditional Exploration Product Revenue – Revenue from our traditional products decreased $2.1 million, or 32.1% from the prior fiscal year. The decrease primarily reflects lower demand for our marine products and lower rental utilization of our traditional products. The decrease was partially offset by an increase in demand for our sensor products. • Wireless Exploration Product Revenue – Revenue from our wireless exploration products decreased $8.3 million, or 15.4%, from the prior fiscal year. The decrease was primarily due to a $35.5 million decrease in rental revenue from our OBX marine nodal products due to lower utilization of our OBX rental fleet caused by the COVID-19 pandemic. This 22 decrease was partially offset by (i) the recognition of $12.5 million of revenue related to the sale of land-based wireless seismic products delivered to a customer in the prior year, (ii) a $9.9 million sale of used OBX rental equipment to the former lessee of the equipment and (iii) a $ 2.9 million third q uarter sale of land-based wireless seismic products . Operating Loss Operating loss from our Oil and Gas Markets products for fiscal year 2021 was $(16.2) million, an increase of $(14.1) million from the prior fiscal year. The increase in operating loss was primarily due to lower wireless rental revenue and related gross profits from the rental of our OBX systems driven by the continued depreciation of our rental fleet. The increase in operating loss was partially offset by (i) the sale of the OBX rental equipment to the former lessee of the equipment, (ii) the recognition of revenue on the land-based wireless system delivered in the prior year, and (iii) lower operating expenses resulting from our fiscal year 2020 cost reduction program and other related cost reductions. The decrease was also attributable to net non-cash adjustments of $0.9 million related to the decrease in the estimated fair value of contingent earn-out consideration related to our OptoSeis ® acquisition and a $0.7 million reduction in goodwill impairment expense related to an impairment charge recorded in fiscal year 2020. Adjacent Markets Fiscal Year 2021 Compared to Fiscal Year 2020 Revenue Revenue from our Adjacent Markets products for fiscal year 2021 increased $7.0 million, or 27.4%, from the prior fiscal year. While we experienced an increase in the demand for our Adjacent Markets products and services during fiscal year 2021 despite the current COVID-19 pandemic, we cannot reasonably determine if this marks the beginning of a lasting recovery from the impact of the COVID-19 pandemic for this operating segment. As a result, we are unable to determine the lasting effect the COVID-19 pandemic will have on the future demand and the supply chain for our Adjacent Markets products and services. The components of this increase included the following: • Industrial Product Revenue and Services – Revenue from our industrial products increased $5.7 million, or 36.6%, from the prior fiscal year. The increase was primarily due to higher demand for water meter products and contract manufacturing services. • Imaging Product Revenue – Revenue from our imaging products increased $1.3 million, or 12.9%, from the prior fiscal year. The increase was primarily due to higher demand for our equipment products and consumable film products. Operating Income Operating income from our Adjacent Markets products for fiscal year 2021 was $6.4 million, an increase of $2.4 million, or 59.9%, from the prior fiscal year. The increase was primarily due an increase in both industrial and imaging product revenue and related gross profits. Emerging Markets Fiscal Year 2021 Compared to Fiscal Year 2020 Revenue Revenue from our Emerging Markets products for fiscal year 2021 was $10.2 million, compared to $0.7 million from the prior fiscal year. The increase was primarily attributable to the recognition of revenue related to our contract with the CBP. Quantum was awarded this contract during fiscal year 2020 to provide a technology solution to the Department of Homeland Security. As of September 30, 2021, unrecognized revenue related to this contract was approximately $0.1 million, which is expected to be recognized during the first quarter of 2022. On January 20, 2021, President Biden ordered a pause on construction of the wall at the U.S. – Mexico border to assess the legality of the funding, contracting methods, as well as the consequences of stopping the construction. It remains uncertain at this time whether the executive order will result in a temporary halt or permanent cessation of the construction. The new Biden administration may implement new or different policies or take further executive action regarding border security that could change the demand for our perimeter and security products. Operating Income (Loss) Operating income (loss) from our Emerging Markets products for fiscal year 2021 was $5.0 million, an increase of $11.1 million from the prior fiscal year. The increase in operating income for fiscal year 2021 was primarily due to revenue and gross profits recognized on our contract with the CBP. The increase was also due to net non-cash adjustments of $3.7 million related to the 23 decrease in the estimated fair value of contingent earn-out consideration related to the Quantum acquisition . Since its acquisition in July 2018, Quantum has primarily focused on product development activities, and the marketing of its technologies to government agencies and other end users. Liquidity and Capital Resources Fiscal Year 2021 At September 30, 2021, we had approximately $23.6 million in cash and cash equivalents and short-term investments. For fiscal year 2021, we used $7.2 million of cash from operating activities. Our net loss of $14.1 million was offset by net non-cash charges of $22.2 million resulting from deferred income taxes, depreciation, amortization, accretion, inventory obsolescence, stock-based compensation, bad debt expense and changes in the estimated fair value of contingent consideration. Other uses of cash in our operations included (i) the removal of $6.7 million gross profit from the sale of used rental equipment and the removal of a $2.0 million gain resulting from the sale of our investment in a debt security since the proceeds related to both of these transactions are included in investing activities, (ii) a $7.7 million increase in inventories primarily for the maintenance and upgrade of OBX rental products and components, (iii) a $4.0 million increase in trade accounts and notes receivable primarily due to a trade note receivable recognized on a land-based wireless product sale that was delivered in the prior fiscal year, (iv) a $1.1 million increase in unbilled receivables related to our contract with the CBP and (v) a $5.1 million decrease in deferred revenue and other liabilities primarily due to revenue recognized on a land-based wireless product. Offsetting these uses of cash were (i) a $4.7 million increase in accounts payable due to the increase in inventories and the timing of payments to suppliers and (ii) a $5.4 million increase in deferred cost of revenue and other assets primarily due to recognition of cost of revenue on the land-based wireless product sale and the prepayment of insurance premiums. For fiscal year 2021, we used cash of $3.3 million in investing activities. Uses of cash included (i) net disbursements of $9.4 million for purchases of short-term investments, (ii) $3.2 million for additions to our property, plant and equipment and (iii) $2.1 million for additions to our equipment rental fleet. Sources of cash included (i) $10.6 million of proceeds from the sale of used rental equipment and (ii) $2.1 million of proceeds from the sale of our investment in a debt security. We expect our cash investments in property, plant and equipment during fiscal year 2022 to be approximately $4 million. Depending on demand for our OBX marine rental equipment, we expect fiscal year 2021 cash investments into our rental fleet to be approximately $3 million. 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 a potential new credit facility arrangement, if any. For fiscal year 2021, we used $6.8 million from financing activities for the purchase of treasury stock pursuant to a stock buy-back program authorized by our board of directors. The program authorizes us to repurchase up to $7.5 million of our common stock in open market transactions. At September 30, 2021, approximately $0.7 million of our common stock remains available for repurchases under the program. On July 13, 2020, we received an interest in a senior secured bond from an international seismic marine customer. Our interest in the bond, which had a face value of $13.0 million, was received in exchange for $13.0 million of unpaid invoices and late fees owed by the customer. The bond was secured by a third in line lien on the assets owned by the customer and had an 8% interest rate with bi-annual interest and possible principal payments based on excess available cash flow. Interest payments could be made either in cash or in-kind payments in the form of additional debt security. In-kind interest payments required an 8.8% interest rate. The bond’s scheduled maturity date was July 13, 2022. The bond was listed on the Oslo Alternative Bond Market; however, the actual marketability was unknown. Based on the distressed financial condition of the customer, we believed the fair value of the bond was nominal. In January 2021, we transferred our interest in the bond pursuant to a purchase agreement (the “Agreement”) entered into with a third party (the “Buyer”). Pursuant to the Agreement, we transferred the bond to the Buyer in exchange for non-refundable consideration of $0.3 million and were entitled to receive additional cash compensation of $2.4 million from the Buyer if certain terms and conditions between the Buyer and our customer were met by December 31, 2021. In the event these terms and conditions were not met, we had the option to reacquire the bond from the Buyer for one US dollar ($1.00). During the third quarter of fiscal year 2021, we agreed to a reduction to the additional cash compensation required from the Buyer to obtain full rights to the bond from $2.4 million to $1.8 million. In June 2021, we received the $1.8 million from the Buyer and relinquished all rights to the bond. Our available cash, cash equivalents and short-term investments totaled $23.6 million at September 30, 2021, which included $5.2 million of cash and cash equivalents held by our foreign subsidiaries and branch offices. The 2017 Tax Act creates new taxes on certain foreign earnings and also requires companies to pay a one-time transition tax on undistributed earnings of their foreign subsidiaries which were previously tax deferred. We have determined that we are not required to pay any transition tax on the undistributed earnings of our foreign subsidiaries since we had no accumulated foreign earnings on a consolidated basis. Our credit agreement with Frost Bank allows for borrowings of up to $20.0 million with such amounts available for borrowing determined by a borrowing base. In November 2019, the credit agreement was amended to (i) extend the maturity date from April 2020 to April 2022, (ii) increase the unencumbered liquid assets covenant threshold from $5 million to $10 million commencing with the fiscal quarter ending December 31, 2020 and for each fiscal quarter thereafter, (iii) increase the tangible net worth requirement from $140 million to $145 million commencing with the fiscal quarter ending December 31, 2020 and for each 24 fiscal quarter thereafter and (iv) remove the requirement that we obtain the consent of Frost Bank prior to paying dividends or repurchasing stock so long as we are in compliance with the covenants of the credit agreement. In March 2021, we amended the credit agreement to reduce the maximum amount available for borrowing from $30 million to $20 million. The March 2021 amendment also altered the tangible net worth requirement to decrease the minimum threshold from $145 million to $132 million commencing with the fiscal quarter ending March 31, 2021 and for each fiscal quarter thereafter. Additionally, the March 2021 amendment added a funded debt to EBITDA ratio financial covenant which requires us to maintain, for a twelve-month period ending on the last day of each fiscal quarter commencing with the fiscal quarter ended March 31, 2021, and for each fiscal quarter thereafter, a ratio of funded debt to EBITDA not exceeding 1.50 to 1.00. The March 2021 amendment also amended the definition of “Eligible Accounts” to include certain unbilled receivables, and reduced the limit on the amount of “Eligible Inventory” that may be included in the borrowing base from $20 million to $15 million. At September 30, 2021, we had no outstanding borrowings under our credit agreement. In October 2021, Frost Bank notified us that they will not be extending our credit agreement upon its expiration in April 2022, and in November 2021 we elected to cancel the agreement. We are currently in negotiations with multiple lenders for a new credit facility arrangement; however, we may not be successful in obtaining a credit facility on terms that are favorable to us. The lack of a credit facility could negatively impact our liquidity and could have a material adverse impact on our future operations, financial condition, growth, and other aspects of our business. However, currently we believe that our cash, cash equivalents and short-term investments will be sufficient to finance any future operating losses and planned capital expenditures through the next twelve months. 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, borrowings under a potential new credit facility arrangement, if any, leveraging or sales of real estate assets, sales of rental assets and other liquidity sources which may be available to us. Fiscal Year 2020 At September 30, 2020, we had approximately $32.7 million in cash and cash equivalents. For fiscal year 2020, we generated $18.1 million of cash from operating activities. Our net loss of $19.2 million was offset by net non-cash charges of $40.7 million resulting from deferred income taxes, depreciation, amortization, inventory obsolescence, goodwill impairment, stock-based compensation, bad debt expense, change in estimate of collectability of rental revenue and changes in the estimated fair value of contingent consideration. Other sources of cash included (i) a $5.2 million increase in deferred revenue and other liabilities primarily due to the deferral of revenue on a significant product sale occurring in our second fiscal quarter and partially offset by a decrease in customer deposits and (ii) a $2.5 million decrease in trade and other receivables resulting from the timing of collections from customers. Offsetting these sources of cash were (i) a $2.5 million decrease in accounts payable resulting from the timing of payments to our suppliers, (ii) an $7.8 million increase in deferred cost of revenue and other assets primarily due to the deferral of cost on a product sale and an increase in the prepayment of certain expenses and (iii) the removal of a $0.7 million gross profit from the sale of used rental equipment since such gross profit is reflected in the proceeds from the sale of used rental equipment under investing activities. For fiscal year 2020, we used cash of $4.1 million in investing activities. Uses of cash included (i) a $5.5 million investment in our rental equipment primarily to expand our OBX rental fleet and (ii) $2.9 million for additions to our property, plant and equipment. These uses of cash were partially offset by (i) $4.1 million of proceeds from the sale of rental equipment and (ii) $0.2 million of proceeds from the sale of equipment. For fiscal year 2020 we used $0.1 million from financing activities for the payment of contingent consideration related to our acquisition of Quantum in 2018. 25 Contractual Obligations Contingent Consideration We recorded an initial contingent earn-out liability of $7.7 million in connection with our July 2018 acquisition of Quantum. Subsequent to the acquisition, we have reduced the estimated contingent earn-out liability to $0.8 million as of September 30, 2021 as a result of $1.5 million of earn-out payments made through September 2021 (with an additional $0.8 million payable) and $4.6 million of reductions in the value of expected future earn-out payments. Contingent payments, if any, may be paid in the form of cash or Company stock and will be derived from eligible revenue generated during the four-year post-acquisition period ending in July 2022. We made cash earn-out payments of $1.4 million and $0.1 million in fiscal year 2021 and 2020, respectively, to the former shareholders of Quantum. The Company made an additional earn-out payment of $0.8 million in October 2021. The maximum amount of contingent payments is $23.5 million. We recorded an initial contingent earn-out liability of $4.3 million in connection with our November 2018 acquisition of all the intellectual property and related assets of the OptoSeis ® fiber optic sensing technology. Subsequent to the acquisition, we have increased the estimated contingent earn-out liability to $4.4 million at September 30, 2021 as a result of a $0.1 million net increase in the value of the expected future earn-out payments. Contingent cash payments, if any, will be derived from eligible revenue generated during a five-and-a-half year post-acquisition earn-out period ending in May 2024. In order for revenue to be considered eligible, sales contracts must be entered into during the first four years of the earn-out period ending in November 2022. No payments have been made to date related to the continent earn-out liability. The maximum amount of contingent payments is $23.2 million. We will reassess the earn-out calculations related to this contingent consideration in future periods. 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, LLC. 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, LLC for the first four years of the six year earn-out period in order for any of Aquana’s former members to be eligible to any earn-out payments. As discussed in Note 3 of the accompanying consolidated financial statements, 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. Critical Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We consider many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the estimates and assumptions that are used in the preparation of these financial statements. We continually evaluate our estimates, including those related to revenue recognition, bad debt reserves, inventory obsolescence reserves, goodwill and long-lived asset impairment and contingent consideration. We base our estimates on historical experience and various other factors, including the impact from the current economic conditions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different conditions or assumptions. Our normal credit terms for trade receivables are 30 days. In certain situations, credit terms for trade receivables may be extended to 60 days or longer and such receivables generally do not require collateral. Additionally, we provide long-term financing in the form of promissory notes and sales-type leases when competitive conditions require such financing and, in such cases, we may require collateral. We perform ongoing credit evaluations of our accounts and financing receivables, and allowances are recognized for potential credit losses. Our long-lived assets are reviewed for impairment whenever an event or change in circumstances indicates the carrying amount of an asset or group of assets may not be recoverable. The impairment review, if necessary, includes a comparison of expected future cash flows (undiscounted and without interest charges) to be generated by an asset group with the associated carrying value of the related assets. If the carrying value of the asset group exceeds the expected future cash flows, an impairment loss is recognized to the extent that the carrying value of the asset group exceeds its fair value. We conduct our evaluation of goodwill at the reporting unit level on an annual basis as of September 30 and more frequently if events or circumstances indicate that the carrying value of a reporting unit exceeds its fair value. The guidance on the testing of goodwill for impairment provides the option to first assess qualitative factors to determine if the fair value of a reporting unit exceeds its carrying amount. If, based on the qualitative assessment of events or circumstances, an entity determines it is more likely than not that the fair value of a reporting unit is more than its carrying amount then it is not necessary to perform a quantitative assessment. However, if an entity concludes otherwise, then a quantitative assessment must be performed. If, based on the quantitative 26 assessment, we determine that the fair value of a reporting unit is less that its carrying amount, a goodwill impairment is recognized equal to the difference between the carrying amount of the reporting unit and its fair value, not to exceed the carrying amount of the goodwill. We record a write-down of our inventories when the cost basis of any manufactured product, including any estimated future costs to complete the manufacturing process, exceeds its net realizable value. Inventories are stated at the lower of cost or net realizable value. Cost is determined on a first-in, first-out method, except that our subsidiaries in the Russian Federation and the United Kingdom use an average cost method to value their inventories. We periodically review the composition of our inventories to determine if market demand, product modifications, technology changes, excessive quantities on-hand and other factors hinder our ability to recover our investment in such inventories. Management’s assessment is based upon historical product demand, estimated future product demand and various other judgments and estimates. Inventory obsolescence reserves are recorded when such assessments reveal that portions or components of our inventory investment will not be realized in our operating activities. The value of our inventories not expected to be realized in cash, sold or consumed during our next operating cycle are classified as non-current assets in our consolidated balance sheets. We established contingent earn-out liabilities in connection with its acquisition of Quantum in fiscal year 2018 and the OptoSeis ® fiber optic sensing technology business fiscal year 2019. The estimated earn-outs payments are remeasured to fair value on a quarterly basis. We utilize the services of an independent valuation consultant to assist with the remeasurement of our contingent consideration, which includes estimates and projections of future revenue, including the size, length, and timing of future contracts. Adjustments to the liabilities are included as a component of earnings. We recognize revenue from product sales and services in accordance with ASC Topic 606, Revenue from Contracts with Customers . This standard applies to contracts for the sale of products and services and does not apply to contracts for the rental or lease of products. Under this standard, we recognize revenue when performance of contractual obligations are satisfied, generally when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled in exchange for those goods or services. Revenue from product sales is recognized when obligations under the terms of a contract are satisfied, control is transferred and collectability of the sales price is reasonably assured. Transfer of control generally occurs with shipment or delivery, depending on the terms of the underlying contract. Our products are generally sold without any customer acceptance provisions, and our standard terms of sale do not allow customers to return products for credit. Most of our products do not require installation assistance or sophisticated instruction. We offer a standard product warranty, which obligates us to repair or replace our products having manufacturing defects. We maintain a reserve for future warranty costs based on historical experience or, in the absence of historical experience, management estimates. Revenue from engineering services is recognized as services are rendered over the duration of a project or as billed on a per hour basis. Field service revenue is recognized when services are rendered and is generally priced on a per day rate. We recognize rental revenue as earned over the rental period. Rentals of our equipment generally range from daily rentals to rental periods of up to six months or longer. We recognize rental revenue in accordance with ASC Topic 842, Leases . In the event collectability of lease payments is not probable at the lease commencement date, we recognize revenue when payments are received. We regularly evaluate the collectability of our lease receivables on a lease by lease basis. The evaluation primarily consists of reviewing past due account balances and other factors such as the credit quality of the customer, historical trends of the customer and current economic conditions. We suspend the recognition of rental revenue when the collectability of amounts due are no longer probable and record a direct write-off of the lease receivable to rental revenue. Recent Accounting Pronouncements Please refer to Note 1 to our consolidated financial statements contained in this Annual Report for a discussion of recent accounting pronouncements. Management’s Current Outlook and Assumptions As further discussed above, there remains uncertainties regarding the duration and to what extent the COVID-19 pandemic will ultimately impact the demand for our products and services or with our supply chain. Regarding our Oil and Gas Markets business segment, demand for our products are subject to volatile fluctuations in crude oil prices. As a result of substantial declines in crude oil prices in recent years combined with the recent reduced global demand for oil and gas as a result of the COVID-19 pandemic, oil and gas exploration and production companies experienced a significant reduction in cash flows resulting in sharp reductions in their capital spending budgets for oil and gas exploration-focused activities including seismic data acquisition activities. While we have experienced strong marine nodal rental activity in recent years including fiscal year 2020, the need for new seismic equipment, particularly land-based equipment, remains restrained due to our customers’ (i) limited capital resources, (ii) lack of visibility into future demand for their seismic services and (iii) in some cases, under-utilized 27 legacy equipment. Crude oil prices have recently rebounded; however, lasting higher levels of oil and gas commodity pricing may not stabilize in the long term, thus continuing the challenging industry conditions we have experienced in previous fiscal years. Many of our land-based traditional seismic products can be damaged, destroyed or otherwise consumed during our customer’s field operations. We expect fiscal year 2022 demand for our land-based traditional seismic products may increase slightly over fiscal year 2021 levels. We believe our “GCL”, which is a new version of our land-based wireless data recorder, will be a market leader similar to our GSX wireless unit. It is uncertain what revenue impact the GCL will have during fiscal year 2022 in light of the tepid market demand for oil and gas seismic services and equipment. We do not expect our land-based wireless product revenue to exceed the levels achieved in fiscal year 2021. The vast majority of our oil and gas rental revenue in fiscal year 2021 was derived from short-term rentals of our OBX ocean-bottom recorder. We believe our OBX rental revenue will increase substantially in fiscal year 2022 as a result of rental contracts executed during fiscal year 2021 and anticipated new rental contracts, but we can make no assurance in this regard. We believe that fiscal year 2022 revenue from our oil and gas reservoir products, and principally our borehole tools and services, to increase slightly over fiscal year 2021 levels. In September 2020, we received a request from a major oil and gas producer for a proposal to manufacture a large-scale seabed PRM system. Under the offered terms and conditions as initially presented, we decided not to provide a bid. In August 2021, we received a revised request from the producer and are in the process of responding to this request. We believe the potential customer may grant the award in the second quarter of fiscal year 2022. If we are awarded the contract, revenue from this contract will most likely not be recognized until the latter part of fiscal year 2022, if any; fiscal year 2023 and 2024. We expect fiscal year 2022 revenue from our Adjacent Markets products to increase over fiscal year 2021 levels largely due to our acquisition of Aquana. We are optimistic that demand for our industrial, imaging products and contract manufacturing services will increase in fiscal year 2022. We expect fiscal year 2022 revenue from our Emerging Markets products to match fiscal year 2021 levels. We are optimistic that Quantum we will be awarded a second contract from the U.S. Customs and Border Protection U.S. Border Patrol to provide a technology solution to the Department of Homeland Security. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Not required. Item 8. Financial Statements and Supplementary Data Our consolidated financial statements, including the reports thereon, the notes thereto and supplementary data begin at page F-1 of this Annual Report on Form 10-K and are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.