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Geospace Technologies Corp (NASDAQ:GEOS)

Q2 2014 Results Conference Call

May 08, 2014 / 10:00 A.M. E.T.

Executives

Rick Wheeler – President & CEO

Tom McEntire – VP & CFO

Analysts

Veny Aleksandrov – FIG Partners

Joe Maxa – Dougherty & Company

Georg Venturatos – Johnson Rice & Company

Joel Luton – Westlake Securities

Bill Dezellem – Tieton Capital Management

William Alpaugh – Simmons & Company

Jason Maxwell – The TCW Group

Hamed Khorsand – BWS Financial Inc.

Operator

Welcome to the Geospace Technologies Second Quarter 2014 Earnings Conference Call. Hosting the call today from Geospace is Mr. Rick Wheeler, President and Chief Executive Officer. He is joined by Tom McEntire, the Company's Vice President and Chief Financial Officer. Today's call is being recorded and will be available on 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

Rick Wheeler

Good morning, and welcome to Geospace Technologies' conference call for the second quarter of FY14, and thank you for listening in today. I am Rick Wheeler, the Company's President and Chief Executive Officer, and with me is Tom McEntire, the Company's Vice President and Chief Financial Officer.

I'll start off the prepared portion of the call with an overview of the quarter, and Tom will follow that with an in-depth review and commentary of our financial performance. I'll then close out the prepared portion of the call with some final remarks, and we will open the line for questions. Also, as a matter of convenience, we will make a replay of this conference call available in the Investor Relations section of our website at www.Geospace.com.

Let me first caution that the information we will discuss this morning is time-sensitive, and therefore may not be accurate on the date one listens to the replay. And secondly, many of the statements we will make today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. By example, this includes statements about the market of our products, revenue recognition, planned operations and capital expenditures.

These statements are based on Management's current perceptions, expectations and knowledge. Actual outcomes are influenced by uncertainties and other factors that we are unable to predict or control. These and other risks, both known and unknown, may create undesirable results or cause our performance to differ materially from what we may express or imply. These risks and uncertainties include those discussed in our SEC Form 10-K and Form 10-Q filings.

Yesterday after the market closed, the Company released its financial results for the second quarter of FY14. Revenues were $68.6 million, with net profits of $10.8 million.

For the second quarter and first six months of the fiscal year, net income as a percentage of revenues was lower when compared to the same periods last year. An unfavorable mix of lower-margin products, higher discounts on large wireless orders, as well as manufacturing inefficiencies and higher operating costs, contributed to these reductions. Even so, our performance over the first half of FY14 increased overall shareholder equity by almost 13%, to just under $326 million.

Traditional product revenues in the second quarter were slightly less than reported in the previous year. However, for the first six months of FY14, this segment is up by 20% over last year. This in part stems from central product orders companioned with large GSX orders that occurred in the first quarter. In addition, strong marine product sales in the second quarter also played an important role.

In our wireless products segment, very few channels were sold in the second quarter, with most sales made up of replacements, low-margin upgrades and components. On the other hand, the second quarter saw rental revenues and rented GSX channels at the highest levels ever seen.

Had it not been for start-up delays that effected our customers in the Canadian and South America markets, these levels would have been even higher. As we continually point out, our business experiences variations that are often unpredictable and may be impacted by seasonal, as well as cyclical events in the industry.

While our reservoir product segment made up 40% of revenues over the first six months of the fiscal year, products in this segment contributed about 56% of revenue is just the second quarter. In addition to deliveries on the Statoil contract, other products delivered in the second quarter from this segment included the first permanent land data acquisition system, to Makamin Petroleum Services in Saudi Arabia. And an extension to the world's first PRM system, installed by BP over a decade ago at the Valhall field in the North Sea.

In order to provide you with more detailed commentary and insight on the Company's second-quarter financial performance, I'll now turn the call over to Tom.

Tom McEntire

Thanks, Rick, and good morning, everyone. I will begin by recapping our second-quarter 2014 results, and then I will discuss each of our four product segments. Finally, I will close with some information concerning our balance sheet and cash flows. We also want to remind everyone on the call today that while our discussions may include estimates of revenue recognition, cash flows and other factors, we will not provide any earnings guidance on this call.

As Rick just mentioned, for our second quarter of FY14, we reported revenues of $68.6 million, a decrease of 10% compared to revenues of $76.4 million last year. Our net income for the quarter was $10.8 million or $0.82 per diluted share, a decrease of 36% from last year's net income of $16.9 million or $1.30 per diluted share.

Revenues from our traditional seismic products for the second quarter of FY14 were $13.1 million, a decrease of 6% compared to revenues of $13.9 million last year. The decrease reflects lower demand for geophone product sales, and was partially offset by increased demand for our marine products. We believe demand for our traditional products will remain soft for the remainder of the fiscal year.

Revenues from our GSX and OBX wireless seismic products for the second quarter were $12.5 million, a decrease of 20% compared to revenues of $15.7 million last year. The decrease in revenues was primarily due to lower demand for sales of our GSX wireless products resulting from continuing industry softness in North America, and increasing competition for sales and rentals of wireless data acquisition systems.

As Rick earlier indicated, most product sales for the quarter represented replacement parts, upgrades and components having low margins. These lower product sales were partially offset by significantly higher GSX rental revenues from our customers in North America and Europe, with almost 100,000 channels rented at the end of the quarter.

With over 400,000 GSX channels deployed around the world, we believe demand for our land and marine wireless systems will continue growing as the industry transitions from less efficient cable-based systems. Although we expect this order flow to continue to be erratic from quarter to quarter. Since its inception in three – March 31, 2014, we have sold 316,000 GSX channels, and we had 133,000 GSX channels in our worldwide rental fleet.

Revenue use from our reservoir seismic products for the second quarter were $38.2 million, a decrease of 5% compared to $40.2 million last year. The current quarter includes revenues of $27 million from the Statoil order, $5 million for delivery of a land PRM system to Makamin Petroleum Services for use of in Saudi Arabia, and a $4.4 million addition to BP's PRM system or it's Valhall field in the North Sea.

Last year's quarter included revenues of $21 million from the Statoil order and $17 million of revenue from delivery of a PRM system to Shell in Brazil. With the exception of the remaining $5.3 million of revenues in the Statoil contract, the majority of which we expect to recognize in the third quarter, this marks the end of the Statoil contract. And as result, we expect revenues from our reservoir products will decline significantly for the remainder of the fiscal year.

Revenues from our non-seismic products for the second quarter were $4.8 million, a decrease of 26% compared to last year. This decrease in revenue is primarily due to lower sales of our offshore cable products due to constrained manufacturing capacity caused by the Statoil order.

Our lower gross profit margins for the second quarter were influenced by several unfavorable factors, including production cost overruns on the Statoil and other orders, manufacturing inefficiencies were right into the use of multiple facilities and outsourcing, unfavorable wireless product mix, increased inventory obsolescence expense, and of course, lower sales.

Our operating expenses for the second quarter increased by 19% to $11.9 million compared to $10 million last year. The increase in operating expenses primarily reflects higher cost for personnel, legal services, research and development investments, stock-based and incentive compensation, and other general increases associated with our business expansion.

Our effective tax rate for the second quarter of FY14 was 32.3% compared to 32.6% last year. We expect our effective tax rate for the remainder of the fiscal year to be between 32% and 33%.

We end the second quarter with $215 million of working capital, $44 million of cash and no long-term debt on our balance sheet. Our $50 million credit facility remains untapped at this time, resulting in total liquidity of $94 million at March 31, 2014.

As we look ahead, we plan to continue making investments to expand our operations. Through the first six months of this year, we've invested $18.3 million into our rental fleet, resulting in the addition of 56,000 channels to our worldwide GSX wireless rental fleet, bringing the total number of GSX rental channels to 133,000.

We see indications that market demand is continuing to increase for this important technology. We expect OBX rental demand will grow in future periods due to the short-term duration of many offshore projects, and the risk perceived by some customers of unutilized time between jobs.

If market conditions allow, we are prepared to further expand our GSX and OBX rental investments up to $30 million in FY14. As in prior years, we expect these cash investments in our rental fleet will be partially or entirely offset by cash proceeds from sales of rental equipment.

Investments in our property plant and equipment are currently planned to be about $20 million, including $7 million for in-progress construction expenditures related to the expansion of our Houston manufacturing and engineering facilities. We expect to fund these investments from our cash on hand, internal cash flows and available borrowings under our credit facility, which we believe will be sufficient to fund our capital needs through FY14 and beyond. ¶

That concludes my commentary, and I'll turn the call back over to Rick for his closing remarks.

Rick Wheeler

Thanks, Tom. As the second quarter of FY14 has come to an end, we see the Statoil contract essentially at a close. With no other similar contract eminently in hand, we've begun to make adjustments accordingly.

As we've mentioned, several of our operations have been pushed to nearby satellite facilities, bringing on higher costs and less efficiency. In addition, our research and development activities on new and existing products continue unabated.

For these reasons, we remain convinced at this time that expanding our Pinemont facilities through construction of a new building is necessary to facilitate our overall growth. And to provide us with sustainable means to take on future projects, like the recent Statoil project. As the leader in the PRM and wireless markets that we serve, this plan allows us to meet success with more success.

As this concludes our prepared remarks, I will now turn the call back to the moderator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Veny Aleksandrov from FIG Partners. Please go ahead.

Veny Aleksandrov – FIG Partners

Good morning.

Rick Wheeler

Hi, Veny.

Veny Aleksandrov – FIG Partners

My first question is the GSX, the rentals. It was 100,000 channels, but was it all in Canada, or it was a mixture? And how much was Canada and how much was South America and how much was current?

Rick Wheeler

I believe most of it was in Canada at this point. We have some equipment that is being rented in South America, but during the quarter, very little of it was actually in rent at that point.

Tom McEntire

Yes, actually the channels in South America came on to rent just immediately after the first quarter. So they were not included in the total. So it could have been even better than it was.

Veny Aleksandrov – FIG Partners

Okay. And then, looking forward, the North American seismic market is challenged. But in terms of internationally, I know you were doing the [post-to-sale] GSX internationally. How does this look for the rest of the year?

Rick Wheeler

Well, things are looking good right now. We have a system that's being used in Serbia by a Russian company. That's going well. The outlook for that system – it looks like there may be more work for it.

We have, as you mentioned, equipment in South America. That's quite a large system. As I understand it, it's the largest number of channels that have ever been deployed in South America on any survey in history. So that's going out well too, at this point in time.

Veny Aleksandrov – FIG Partners

For rentals, any indication that some of these rentals can turn into sales?

Rick Wheeler

Well, that's always a possibility. We offer very good equity incentives with respect to our rental purchase plan. We always – we don't know that typically until sometimes at the last minute, as these contractors and companies are making those sorts of decisions.

Veny Aleksandrov – FIG Partners

Right. And my next question is on the OBX side. You're saying that you're very optimistic about rentals. But I know that you were working and hoping for some potential sales. Is there any update on potential sales? Or for now, we're looking to rentals to prove the technology, and then possibly turning to sales?

Rick Wheeler

Well, we think rentals are going to be an important part of that market, quite honestly. We do have some sales. They are typically small numbers, and they are accretive, where they continue to buy channels to enlarge the systems that they have. We still have SGS out there that is trying to secure their new investor funding, at which time that sale would be able to be delivered.

So overall, the sales are going to be those things we can't predict, again. As Tom mentioned in some of his remarks, many of the contractors do perceive risks with respect to time between jobs, where the equipment may not be utilized. So many of them want to rent the equipment. But our equity program will certainly make it attractive for them to buy as those rentals progress.

Veny Aleksandrov – FIG Partners

Thank you

Operator

Our next question comes from Joe Maxa, Dougherty & Company.

Joe Maxa – Dougherty & Company

Good morning.

Rick Wheeler

Hi, Joe.

Tom McEntire

Hi, Joe.

Joe Maxa – Dougherty & Company

On this OBX, as far as additional potential large orders out there, I just want to get your sense. It sounds like some of these orders are shifting to be more rental in focus. Or are there still some of these big ones out there that you've been in talks with, and we could see in addition – or to replace SGS, if that doesn't happen?

Rick Wheeler

Well, there are other orders out there, potentially, that are being discussed. But they are not secure enough to where we can actually say they would transpire. And that's because they're still working on potential jobs where they would use those.

But we do see the rental activity and particular quotes on rental activities significantly higher as time continually goes on. So that's why we say that we believe that is going to be a fundamental increase in the OBX demand.

Joe Maxa

I see. Let's talk a little bit about the PRM business. Statoil winding down, no big orders expected the rest of the year. What about discussions with Statoil and others for next year? Are you at that level where they're giving some indications there might be some interest to place orders for 2015?

Rick Wheeler

We are certainly in discussion with Statoil and others. These discussions are of the type where we discuss feasibilities and other aspects of what opportunities may exist. But there's – the discussions do not lead themselves to – as qualifying a particular time where a tender might be offered. And to try to speculate on that probably would just be the wrong thing to do. But we definitely are in discussions with them on other activities, you bet.

Joe Maxa – Dougherty & Company

Tom, how much cash do you think you will generate the rest of the year? You have a big inventory balance. How much of that can you work off? I know SGS will play a role in that. But what do you think the outlook would be on cash generation?

Tom McEntire

Yes, that's a good question, Joe. When we hit slow times like this in the cycle, we generally generate a nice amount of cash. So don't want to speculate on the amount. But right now with the outlook that we have, it looks like Q3 and perhaps even into Q4, we could generate some nice cash.

Joe Maxa – Dougherty & Company

Okay. And the headcounts let go – is that primarily temps? Or – well give me that answer.

And then also, how should we be thinking about your overall OpEx? You did have a big R&D quarter in Q2. Does that come back down on lower revenues in Q3 and Q4? Or do we see that stick at that $5 million level? And then, same with the SG&A.

Rick Wheeler

Well, as far as the personnel reductions, many were temps. Others were here for short durations. As far as expenses go, R&D is something that we do here; its fundamental to our business. And their were other increases, as Tom mentioned. I'll let him elaborate on those.

Tom McEntire

Yes, Joe, one of the main things – and it's kind of a fixed cost as we're going forward – is the stock-based compensation related to some grants that we issued back in November. That's about $1 million, or $1.1 million a quarter is what that cost is. And so we will see that going forward. We've had some higher bonus expenses or incentive compensation expenses the first half of this year. We try to match our incentive compensation with the earnings that we generate, and we would expect to see lower levels of that, perhaps, for the rest of the year.

Joe Maxa – Dougherty & Company

Okay. So kind of a base-level, no real changes, a few headcounts, the way it sounds. And then really, dependent on how profitable you are?

Tom McEntire

That's right.

Joe Maxa – Dougherty & Company

Okay, all right. I'll jump back in queue. Thanks

Operator

And our next question will come from Georg Venturatos from Johnson Rice. Please go ahead.

Georg Venturatos – Johnson Rice & Company

Good morning, guys

Rick Wheeler

Good morning

Georg Venturatos – Johnson Rice & Company

Wanted to touch on the SGS order – obviously still remains uncertain. But just wanted to get a sense of what your plans may be. Would you anticipate providing detail intra-quarter in terms of any update positively with that respect?

Rick Wheeler

You bet. If we learn anything positive with respect to the SGS, I'm sure we will make that information known at that time.

Georg Venturatos – Johnson Rice & Company

Okay, great. And you talked about the strong rental demand you're seeing both for GSX and OBX. I wondered if you could just describe how those customer conversations are going with regard to their willingness to deploy the capital to purchase equipment down the line, as we have seen in the past?

Do you see more reluctance there, given where we are today? Or do you think that's still a matter of the economics are in their favor, given the way the rental program is set up?

Rick Wheeler

I think the economics are always in their favor to do that. I think some might be a little hesitant because of some market softness we see in the seismic industry in general. But we've got some potential customers out there that have some pretty big campaigns they are trying to march on right now, so we'll just have to see how that goes.

Georg Venturatos – Johnson Rice & Company

Okay. And then last one for me. Nice to see the delivery on the permanent land reservoir monitoring system. I think we had talked about this a couple of times. But how should we think about that? Is that kind of – do you see that as more of a one-off type opportunity? Or do you think that there is some potential to have some further smaller tack-on, land-type orders over the next 12 months or so?

Rick Wheeler

Well, there always has to be a first one, and this is the first one. So we can't conclude from that what demand may turn into. This is a special project that's taking place, and it may not fit every circumstance on land. But it certainly fits this one. Permanent reservoir monitoring is something that, in our belief, is something that is going to continue to increase in the course of time. And certainly land will present its own set of opportunities for that, and this is the first system that is doing that.

Georg Venturatos – Johnson Rice & Company

Okay. Appreciate the answers, Rick.

Operator

Our next question comes from Joel Luton with Westlake Securities. Please go ahead.

Joel Luton – Westlake Securities

Hi, Rick and Tom. Most of my questions have been answered, but a little color on your inventory. What essentially does the inventory consist of? Is it OBX or the GSX?

Tom McEntire

Hi, Joel. Well, it consists of a lot more than that. But yes, there is, of course, a nice chunk of OBX, especially with the SGS order being deferred. We're still sitting on that inventory, as well as we're making – and have mostly made – a fair amount of OBX nodes to be used on what we perceive as this rental demand that's marching towards us right now. So yes, we have a big chunk of OBX and GSX inventory, as well as inventory for our other product lines.

Joel Luton – Westlake Securities

Okay. And also, you know, your stock is getting pretty smacked today, which – it's a little bit of a surprise, because I don't think all of this was unexpected. But would you consider buying back your stock at these levels?

Tom McEntire

That's certainly a consideration that's on the table. I don't have an official answer for you, but that's something that's come to our minds. So we will have to discuss that with our Board, and if we decide to do that, we will let the market know.

Joel Luton – Westlake Securities

Okay. Thank you.

Operator

(Operator Instructions) And our next question will come from Bill Dezellem from Tieton Capital. Please go ahead.

Bill Dezellem – Tieton Capital Management

Thank you. I'd actually like to follow up on an earlier question relative to GSX. Would you discuss the large rental channel activity, and how there may be a correlation with the lower sales activity? Or whether those really are very independent issues?

Rick Wheeler

I don't know if there's a correlation. There certainly could be a correlation of higher rentals to lower sales. But these large rentals took place in Canada. And as we said, we had some that really didn't show themselves on the quarter, that are in South America, but that are ongoing now in large numbers. Now, the Russian rental is one that did impact our quarter and was part of those channels. International events typically have been rentals, until such time as they believe that it's the right thing to do to purchase these. But as we mentioned before, it's always in one's best interest to own this equipment.

Bill Dezellem – Tieton Capital Management

That's helpful. And then secondarily, would you discuss the comment in the press release about new customers that are anticipated in South America and Eastern Europe?

Rick Wheeler

Well, that has to do with many of these rentals that we're talking about. There is potential demand on this system that's currently in Serbia, for more work over there in Eastern Europe. And then the South American market has some other potential opportunities that may open up.

Bill Dezellem – Tieton Capital Management

Great, thank you.

Operator

And we'll take our next question from Veny Aleksandrov. Please go ahead. Your line is open.

Veny Aleksandrov – FIG Partners

So my next question is again on OBX. You used to be in discussions with a number of clients about a number of big systems. Now we are talking a lot about rentals. Are you still in discussions with clients about sales?

Rick Wheeler

We are still are in discussions on sales. Some of those sales are contingent on things that keep getting pushed back. So they themselves would come at a later time, if they come at all.

But what we're really saying is that there have been significant recent additions to these discussions for rentals. Poised to go out almost imminently is a 3,300 station rental of OBX equipment, and there are others on the horizon.

Veny Aleksandrov – FIG Partners

So in addition to what's out, the 3,300 [rental] system is going out soon?

Rick Wheeler

I'm sorry?

Veny Aleksandrov – FIG Partners

Is this correct? In addition of what's out, a 3,300 rental system is going out soon. That's what you just said?

Rick Wheeler

That is correct.

Veny Aleksandrov – FIG Partners

Okay, thank you. And then on the PRM – and I'm sorry, I had to jump off the call for a second and I might have missed it. But I know it's not going to be a 2014 event, but again, are you still in discussions about potential sales and potential systems?

Rick Wheeler

We're definitely in discussions, but there's really no way to predict when they would bring those to an official tender.

Veny Aleksandrov – FIG Partners

Thank you so much.

Operator

Your next question comes from William Alpaugh with Simmons. Please go ahead.

William Alpaugh – Simmons & Company

Hey. Good morning, guys.

Rick Wheeler

Good morning.

William Alpaugh – Simmons & Company

I had a question on margins. Q2 saw a considerable drop. Can you give us a little more color on how margins shaked out – how they did? And can you walk us – give a little more detail to some of the measures you're taking to bring that back up?

Tom McEntire

Yes. William, the gross profit margins are lower for several reasons. And as we were getting through this Statoil project, we found out that we were going to need to incur some addition costs to finish some things off. And we also had another product line that got smacked pretty hard with some cost overruns. So we're always attacking those things.

In terms of the manufacturing inefficiencies with our satellite facilities, we're planning to consolidate, and build a new factory, try to pull that work in, as well as pull in the outsourced manufacturing that's going on right now. So yes, we do have plans to try to make the shop more efficient, and we're always working on that.

William Alpaugh – Simmons & Company

All right. Another question on the reservoir products. What is the lead time between the orders and delivery typically?

Rick Wheeler

The lead time between when the orders are placed and delivery takes place?

William Alpaugh – Simmons & Company

Right.

Rick Wheeler

That varies all over the place. It's always an issue that we have to face. And that's why we have to balance inventory with our build-out capabilities. We do stock inventory of various products, simply because many of these sales are opportunistic. They come in – if you can't supply the equipment within two or three weeks, then they're going to go find some other kind of equipment somewhere else to use. So it's a balancing act that we continually fight. But fundamentally, there is no real answer to that, that's quantitative.

William Alpaugh – Simmons & Company

Okay. Just last one, a question on SGS and OBX. Do you all have any more color on the problems they are having finding financing? And how is the marketing effort for the product as a whole?

Rick Wheeler

We have spoken to them recently, and they are very confident. But then again, we can't establish their successor; that's up to them. But from what they report to us, things are looking very good for them. So that's why we still have great encouragement that this order is simply a matter of being deferred

William Alpaugh – Simmons & Company

Okay. Well, thank you very much.

Rick Wheeler

You bet.

Operator

Our next question comes from Jason Maxwell with TCW. Please go ahead. Your line is open.

Jason Maxwell – The TCW Group

Hello, thanks. I just had a few questions on some of your earlier comments. You mentioned inventory obsolescence is hitting the cost of goods sold this quarter. Can you quantify that and compare it to last quarter and year?

Tom McEntire

Yes. I believe our 10-Q is out now, but it's in there. And for the first six months of the year, it's $1.7 million. And last year, it was actually a negative number or favorable number, because we were able to draw down a significant amount of inventory in connection with the production of the Statoil order. So the delta is close to about $2 million.

Jason Maxwell – The TCW Group

Thanks. And then, you made a comment about not only slow sales in North America – South America and North America demand. But also that you're seeing increasing competition. Can you give me some more color around that?

Tom McEntire

Well, there's of course – we have competition in the wireless market, and we face that on every transaction that we enter, just about, especially on rentals. And so, we want to make sure we win our fair share, but we don't win every order, and the competition is tough.

Jason Maxwell – The TCW Group

I understand that. I'm just – why you felt the need to say that it was increasing, as opposed to just – it's always tough.

Rick Wheeler

Well, it is increasing. I think that our success is just – with our wireless products, just have stimulated basically a more competitive market for those that want to get out there. It is – as Tom says, it's always a pressure. But I think as time goes on, we're clearly a target that's more readily visible.

Jason Maxwell – The TCW Group

Okay. You talked about some success you had in the rental fleet in the quarter. In particular there were some large rentals in Canada. I imagine that is probably set to decline here in the current quarter, given the typical break-up season. Is that a fair assumption?

Rick Wheeler

Yes, that's a fair assumption.

Jason Maxwell – The TCW Group

Okay. And then, last question is on the inventory build rate. Obviously, your inventories are quite a bit higher over the last few years. Are you slowing your build rate? Do you really have enough inventory on hand to satisfy the call-up orders that you get at this point time? And what would that mean if you slow down your build rate, in terms of the facilities management you're trying to do and so forth, that you've talked about in the last couple of quarters?

Tom McEntire

Yes, we are substantially slowing the build rate. So we are still building components and products that we need. But we are reducing overtime; we have reduced headcount in the factory, especially in connection with the Statoil order. And so, yes, it is slowing significantly.

Jason Maxwell – The TCW Group

Does that mean that we should – and I know there was some talk about a lot of cash generation. But just ask directly – should we then see inventory start to decline as we go through the year?

Tom McEntire

Yes, that's the plan.

Jason Maxwell – The TCW Group

Okay, thank you very much.

Operator

Our next question comes from William Oakland [ph] with Geospace Technologies. Please go ahead.

Unidentified Speaker

Would you give us some guidance on sales and earnings for the current quarter and the full year?

Rick Wheeler

No, we don't really give out guidance on earnings for the full year, in that regard.

Unidentified Speaker

Okay.

Operator

Our next question comes from Joe Maxa from Dougherty & Company. Please go ahead.

Joe Maxa – Dougherty & Company

Two things. With the inventory conditions and utilizing that, do you expect to have much of an impact beyond normal in your gross margins, with production being lower?

Tom McEntire

Joe, certainly with lower production, you have fixed costs that now are not spread across as many units. So yes, that's going to have pressure on our product margins.

Joe Maxa – Dougherty & Company

Right, great. And then I just wanted to ask – Statoil, the feedback you've been getting so far from the product that's in the field, and just want to get an overall sense of what you're hearing about that project.

Rick Wheeler

Well, the project is going well. It's under installation. They are, if not shooting, about to shoot, some the first data on the Sonora field. That field is not fully installed, so this would be a partial – part of the field that they would be examining with this first shoot, and just seeing some first data. But the projects are going well. They are busy deploying this stuff.

Joe Maxa – Dougherty & Company

The data that are getting, are they happy with it?

Rick Wheeler

Well, there is not enough data to answer that question. They are just now beginning to shoot. But there's no reason they wouldn't be happy with the data. The system is fully tested, has been tested every way from Sunday during its construction and, in fact, during its installation. So the system is clearly known to work. It's just a matter of getting some initial baselines on the geophysics of it.

Joe Maxa – Dougherty & Company

Right. Okay, thank you.

Operator

(Operator Instructions) We'll go next to Jeffrey Mills. Please go ahead. Your line is open.

Unidentified Speaker

Yes, good morning, gentlemen. I'm just wondering. You make the statement that low-product demand in traditional markets – land seismic market, mainly, in North America. I'm just wondering to what you attribute this weakness?

Rick Wheeler

Well, our weakness is, our customers are seeing weakness from the E&P companies. So there is the belief that there's a lot of focus on the E&P companies on the production side, and actually getting the oil and infrastructure out of these finds that they have. So they're not doing as much seismic work. And that certainly is a sensible determination, as far as I can see.

Unidentified Speaker

So it's mostly a business cycle thing, and how long would you see this lasting?

Rick Wheeler

It's exactly a business cycle thing, is what it appears to be. Typically, the duration is not that predictable. But from what many of our customers are saying, they are starting to see some backlog come up. They do see some initial challenge here in the near future, but have better long-term outlooks. So it looks like things will pick up.

Unidentified Speaker

Thank you.

Operator

And we'll next to Bill Dezellem. Please go ahead. Your line is open.

Bill Dezellem – Tieton Capital Management

Thank you. I would actually like to the follow up on your comment about Statoil doing their first shoot. To what degree is that one of the important next steps before they make any decisions on additional fields and deploying them?

Rick Wheeler

I don't really believe it's much of a condition at all. Fundamentally, this system is – they know what to expect from the system. They understand the science of the permanent reservoir monitoring. And quite honestly, have put quite an investment in this system, not based on speculation, and therefore having to see if it might work. In reality, they know what to expect. So I don't think there is really a correlation there with respect having to wait and see some sort of data before they would continue with their plans on doing other permanent reservoir monitoring.

Bill Dezellem – Tieton Capital Management

Thank you, Rick.

Operator

Our next question comes from Hamed Khorsand from BWS Financial. Please go ahead.

Hamed Khorsand – BWS Financial Inc.

Hi. One of my questions I had was, when you were talking about competition and having to face pricing pressure. Do you think that the pricing pressure you face is going to be permanent?

Rick Wheeler

That's hard to say. Our product has many features that definitely differentiate it. And so no, I don't think that some of these systems will necessarily survive the market. But nonetheless, we have to deal with that at present.

Hamed Khorsand – BWS Financial Inc.

Okay. And is competition the reason why you saw a slowdown this past quarter? Or is there really just more about weather and delays?

Rick Wheeler

No, not really I don't think.

Tom McEntire

Hamed, I believe it's just general softness – that we just talked about with the previous caller – in the industry. We're lumpy. We just have an order flow that's erratic and we just had one of the soft quarters. And we think it's going to come and go, and come and go, and it's just part of a cycle.

Hamed Khorsand – BWS Financial Inc.

Yes, I get that. But I'm just trying to gauge as to when can we see a recovery, as far as the order flow goes. Because I thought the colder months were usually your better months, as far as sales performance goes.

Rick Wheeler

It's circumstantial. We have other things going on now, and clearly, we're entering into the warmer seasons. So I don't know that, that's exactly true. It is for Canada obviously.

Tom McEntire

Yes, certainly, Hamed, for the rental part of our business, it's highly focused in the winter months, and there's higher utilization then than there is in the summer months. So we'll see utilization go down in Q3 and Q4 in the Canadian market.

Hamed Khorsand – BWS Financial Inc.

Okay. And my last question is, can you give some insight as to what you think your sales pipeline is, in terms of a channel opportunity right now?

Rick Wheeler

Opportunities for channels?

Hamed Khorsand – BWS Financial Inc.

Yes.

Rick Wheeler

Well, the market itself has probably 2 million channels out there, of which we've got about 300,000 installed. So those are…

Hamed Khorsand – BWS Financial Inc.

I was referring to just this coming quarter.

Rick Wheeler

Oh, this quarter? No, we don't really have a way of giving you that forecast.

Hamed Khorsand – BWS Financial Inc.

Okay. Thank you.

Operator

This does conclude today's Q&A session. Do we have any further closing remarks from our speakers?

Rick Wheeler

No. With that in mind, I appreciate everyone listening, and I appreciate all the questions that everyone asked.

Operator

We would like to thank everybody for their participation in today's conference call. And please feel free to disconnect at any time.

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