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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-13402
INPUT/OUTPUT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 22-2286646
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
12300 PARC CREST DR., STAFFORD, TEXAS 77477
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (281) 933-3339
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes: [X] No: [ ]
At November 8, 2002 there were 51,118,939 shares of common stock, par value
$0.01 per share, outstanding.
INPUT/OUTPUT, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
Page
PART I. Financial Information.
Item 1. Financial Statements.
Consolidated Balance Sheets
September 30, 2002 (unaudited) and December 31, 2001......... 3
Consolidated Statements of Operations
Three and nine months ended September 30, 2002 (unaudited)
and September 30, 2001 (unaudited)........................... 4
Consolidated Statements of Cash Flows
Nine months ended September 30, 2002 (unaudited) and
September 30, 2001 (unaudited)............................... 5
Notes to Unaudited Consolidated Financial Statements............ 6
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition........................... 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk...... 20
Item 4. Controls and Procedures......................................... 20
PART II. Other Information. 21
Item 2. Changes in Securities and Use of Proceeds....................... 21
Item 6. Exhibits and Reports on Form 8-K................................ 21
Certifications.................................................. 24
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents...................................... $ 73,330 $ 101,681
Restricted cash................................................ 148 221
Accounts receivable, net....................................... 21,716 46,434
Current portion notes receivable, net.......................... 3,293 1,078
Inventories.................................................... 55,778 68,283
Deferred income tax asset...................................... -- 15,083
Prepaid expenses............................................... 2,738 3,115
------------- ------------
Total current assets................................... 157,003 235,895
Notes receivable.................................................. 6,393 5,800
Deferred income tax asset......................................... -- 40,745
Property, plant and equipment, net................................ 38,881 47,538
Goodwill, net..................................................... 33,731 45,584
Other assets, net................................................. 8,344 7,609
------------- ------------
Total assets........................................... $ 244,352 $ 383,171
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt........................... $ 2,496 $ 2,312
Accounts payable............................................... 9,426 10,169
Accrued expenses............................................... 24,001 18,814
------------- ------------
Total current liabilities.............................. 35,923 31,295
Long-term debt, net of current maturities......................... 51,883 20,088
Other long-term liabilities....................................... 833 751
Stockholders' equity:
Cumulative convertible preferred stock, $0.01 par value;
authorized 5,000,000 shares; issued and outstanding 55,000
shares at December 31, 2001 (liquidation value of $55
million at December 31, 2001). Shares were repurchased on
August 6, 2002............................................... -- 1
Common stock, $0.01 par value; authorized 100,000,000 shares;
outstanding 51,118,939 shares at September 30, 2002 and
50,865,729 shares at December 31, 2001....................... 519 516
Additional paid-in capital..................................... 295,731 360,147
Accumulated deficit............................................ (130,015) (15,713)
Accumulated other comprehensive loss........................... (4,434) (7,499)
Treasury stock, at cost, 743,298 shares at September 30, 2002
and at December 31, 2001..................................... (5,769) (5,769)
Unamortized restricted stock compensation...................... (319) (646)
------------- ------------
Total stockholders' equity................................... 155,713 331,037
------------- ------------
Total liabilities and stockholders' equity............. $ 244,352 $ 383,171
============= ============
See accompanying notes to unaudited consolidated financial statements.
3
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ----------------------------------
2002 2001 2002 2001
-------------- -------------- -------------- --------------
Net sales...................................... $ 28,539 $ 58,647 $ 81,602 $ 160,924
Cost of sales.................................. 24,767 41,123 68,384 106,912
-------------- -------------- -------------- --------------
Gross profit.......................... 3,772 17,524 13,218 54,012
-------------- -------------- -------------- --------------
Operating expenses:
Research and development.................... 6,750 6,699 22,438 21,895
Marketing and sales......................... 2,625 2,857 7,930 8,444
General and administrative.................. 5,366 4,491 14,702 14,101
Amortization of intangibles................. 370 1,225 1,007 3,546
Impairment of goodwill and long-lived assets 20,992 -- 20,992 --
-------------- -------------- -------------- --------------
Total operating expenses.............. 36,103 15,272 67,069 47,986
-------------- -------------- -------------- --------------
Earnings (loss) from operations................ (32,331) 2,252 (53,851) 6,026
Interest expense............................... (1,247) (55) (1,743) (645)
Interest income................................ 511 1,388 1,755 3,874
Other income................................... 1,824 158 1,481 58
-------------- -------------- -------------- --------------
Income (loss) before income taxes.............. (31,243) 3,743 (52,358) 9,313
Income tax expense (benefit)................... 157 (352) 60,997 2,044
-------------- -------------- -------------- --------------
Net earnings (loss)............................ (31,400) 4,095 (113,355) 7,269
Preferred dividend............................. (1,987) 1,416 947 4,201
-------------- -------------- -------------- --------------
Net earnings (loss) applicable to
common shares............................... $ (29,413) $ 2,679 $ (114,302) $ 3,068
============== ============== ============== ==============
Basic earnings (loss) per common share......... $ (0.58) $ 0.05 $ (2.24) $ 0.06
============== ============== ============== ==============
Weighted average number of
common shares outstanding................... 51,090,776 51,319,419 50,985,098 51,179,516
============== ============== ============== ==============
Diluted earnings (loss) per common share....... $ (0.58) $ 0.05 $ (2.24) $ 0.06
============== ============== ============== ==============
Weighted average number of diluted
common shares outstanding................... 51,090,776 52,413,427 50,985,098 52,444,450
============== ============== ============== ==============
See accompanying notes to unaudited consolidated financial statements.
4
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2002 2001
----------- ----------
Cash flows from operating activities:
Net earnings (loss).................................. $(113,355) $ 7,269
Depreciation and amortization........................ 9,424 13,123
Impairment of goodwill and long-lived assets......... 20,992 --
Fair value adjustment of warrant obligation.......... (2,345) --
Amortization of restricted stock and other stock
compensation........................................ 169 177
Loss on disposal of fixed assets..................... 762 --
Bad debt expense (collections)....................... 242 (514)
Deferred income tax.................................. 59,992 (385)
Accounts and notes receivable........................ 22,437 (18,682)
Inventories.......................................... 13,253 (1,383)
Accounts payable and accrued expenses................ (6,411) 3,493
Income taxes payable/receivable...................... 423 (1,842)
Other assets and liabilities......................... 1,520 351
--------- --------
Net cash provided by operating activities...... 7,103 1,607
--------- --------
Cash flows from investing activities:
Purchase of property, plant and equipment............ (4,183) (4,646)
Business acquisitions................................ (3,129) (7,223)
Cash of acquired businesses.......................... 501 2,032
--------- --------
Net cash used in investing activities.......... (6,811) (9,837)
--------- --------
Cash flows from financing activities:
Proceeds from issuance of debt....................... -- 18,837
Payments on long-term debt........................... (1,743) (8,842)
Payments of preferred dividends...................... (411) (413)
Proceeds from exercise of stock options.............. 989 1,956
Proceeds from issuance of common stock............... 825 768
Repurchase of preferred stock........................ (30,000) --
Purchase of treasury stock........................... -- (425)
--------- --------
Net cash (used in) provided by financing
activities.................................... (30,340) 11,881
--------- --------
Effect of change in foreign currency exchange rates
on cash and cash equivalents........................ 1,697 33
--------- --------
Net (decrease) increase in cash and cash equivalents. (28,351) 3,684
Cash and cash equivalents at beginning of period..... 101,681 92,376
--------- --------
Cash and cash equivalents at end of period..... $ 73,330 $ 96,060
========= ========
See accompanying notes to unaudited consolidated financial statements.
5
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The consolidated balance sheet of Input/Output, Inc. and its subsidiaries
(collectively referred to as the "Company" or "I/O") at December 31, 2001 has
been derived from the Company's audited consolidated financial statements at
that date. The consolidated balance sheet at September 30, 2002, the
consolidated statements of operations for the three and nine months ended
September 30, 2002 and 2001, and the consolidated statements of cash flows for
the nine months ended September 30, 2002 and 2001 have been prepared by the
Company without audit. In the opinion of management, all adjustments,
consisting only of normal and recurring adjustments, which are necessary to
present fairly the consolidated financial position, results of operations and
cash flows have been made. The results of operations for the three and nine
months ended September 30, 2002 are not necessarily indicative of the operating
results for a full year or of future operations.
These consolidated financial statements have been prepared using
accounting principles generally accepted in the United States for interim
financial information and the instructions to Form 10-Q and applicable rules of
Regulation S-X of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in financial statements presented in
accordance with accounting principles generally accepted in the United States
have been omitted. The accompanying consolidated financial statements should be
read in conjunction with the Company's Annual Report on Form 10-K for the year
ended December 31, 2001. Certain amounts previously reported in the
consolidated financial statements have been reclassified to conform to the
current period's presentation.
(2) SEGMENT INFORMATION
The Company evaluates and reviews results based on two segments, Land and
Marine, to allow for increased visibility and accountability of costs and more
focused customer service and product development. The Company measures segment
operating results based on earnings (loss) from operations. A summary of
segment information for the three and nine months ended September 30, 2002 and
2001 is as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- --------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net sales:
Land......................... $ 16,435 $48,063 $ 44,869 $120,104
Marine....................... 12,104 10,584 36,733 40,820
-------- ------- -------- --------
Total........................ $ 28,539 $58,647 $ 81,602 $160,924
======== ======= ======== ========
Depreciation and amortization:
Land......................... $ 1,898 $ 2,309 $ 5,118 $ 6,416
Marine....................... 346 846 1,126 2,598
Corporate.................... 1,162 1,074 3,180 4,109
-------- ------- -------- --------
Total........................ $ 3,406 $ 4,229 $ 9,424 $ 13,123
======== ======= ======== ========
Earnings (loss) from
operations:
Land........................ $(26,534) $ 5,564 $(42,187) $ 11,545
Marine...................... 296 1,603 5,917 8,587
Corporate................... (6,093) (4,915) (17,581) (14,106)
-------- ------- -------- --------
Total....................... $(32,331) $ 2,252 $(53,851) $ 6,026
======== ======= ======== ========
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Total assets:
Land......................... $ 96,949 $139,978
Marine....................... 61,525 62,422
Corporate.................... 85,878 180,771
-------- --------
Total........................ $244,352 $383,171
======== ========
6
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Total assets by geographic area:
North America................ $205,128 $340,375
Europe....................... 39,224 42,796
-------- --------
Total........................ $244,352 $383,171
======== ========
Intersegment sales are insignificant for all periods presented. Corporate
assets include all assets specifically related to corporate personnel and
operations, substantially all cash and cash equivalents, all facilities and
manufacturing machinery and equipment that are jointly utilized by segments and
all income taxes receivable and deferred income tax assets. Depreciation and
amortization expense is allocated to segments based upon use of the underlying
assets.
A summary of net sales by geographic area is as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
2002 2001 2002 2001
------- ------- ------- --------
North America........................... $10,503 $18,228 $29,188 $ 66,067
Middle East............................. 385 12,154 1,232 33,329
Europe.................................. 8,617 9,020 24,930 20,136
Asia.................................... 5,217 8,515 8,808 14,491
Former Soviet Union..................... 690 5,376 7,574 16,156
Other................................... 3,127 5,354 9,870 10,745
------- ------- ------- --------
$28,539 $58,647 $81,602 $160,924
======= ======= ======= ========
Net sales are attributed to individual countries on the basis of the
ultimate destination of the equipment, if known; if the ultimate destination is
not known, it is based on the geographical location of initial shipment.
(3) INVENTORIES
A summary of inventories is as follows (in thousands):
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------- ------------
Raw materials......................... $38,602 $46,729
Work-in-process....................... 2,603 4,191
Finished goods........................ 14,573 17,363
------- -------
$55,778 $68,283
======= =======
During the third quarter of 2002, the Company recorded an inventory
obsolescence charge of approximately $3.8 million. This charge was primarily
related to the discontinuance of certain analog land seismic and marine
positioning products, and to a lesser extent, inventory determined to be in
excess of the Company's near-term requirements. For the year ended December 31,
2001, the Company recorded total inventory obsolescence charges of
approximately $3.6 million.
(4) ACCOUNTS AND NOTES RECEIVABLE
A summary of accounts receivable is as follows (in thousands):
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Accounts receivable, principally trade....... $23,306 $48,186
Allowance for doubtful accounts.............. (1,590) (1,752)
------- -------
Accounts receivable, net..................... $21,716 $46,434
======= =======
The original recorded investment in notes receivable, excluding accrued
interest, for which a reserve has been recorded was $13.6 million at September
30, 2002. A summary of notes receivable, accrued interest and allowance for
loan loss is as follows (in
7
thousands):
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Notes receivable and accrued interest......... $ 20,144 $ 17,613
Less allowance for loan loss.................. (10,458) (10,735)
-------- --------
Notes receivable, net......................... 9,686 6,878
Less current portion notes receivable, net.... 3,293 1,078
-------- --------
Long-term notes receivable.................... $ 6,393 $ 5,800
======== ========
(5) GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets". Under SFAS
No. 142, existing goodwill will no longer be amortized, but will be tested for
impairment using a fair value approach. SFAS No. 142 requires goodwill to be
tested for impairment at a level referred to as a reporting unit, generally one
level lower than reportable segments. SFAS No. 142 required the Company to
perform the first goodwill impairment test on all reporting units within six
months of adoption. The first step was to compare the fair value with the book
value of a reporting unit. If the fair value of the reporting unit was less
than its book value, the second step was to calculate the impairment loss, if
any. The Company will test goodwill for impairment on an annual basis.
Goodwill will be tested for impairment between annual tests if an event occurs
or circumstances change that would more likely than not reduce the fair value
of a reporting unit below its carrying amount. The Company completed its
initial periodic tests for impairment during the second quarter of 2002, which
did not indicate any impairment of goodwill.
During the third quarter of 2002, the Company performed an interim
impairment test on the Company's analog land seismic reporting unit. This
reporting unit represents our traditional analog geophones, vehicles and
vibrators, cables and connectors. The need for an interim impairment test was
predicated upon the success of new our VectorSeis(R) digital sensor technology,
the continuing weakness in the traditional analog land seismic markets and the
precarious financial condition of many of the North American land seismic
contractors. The results of the impairment test indicated that all of the
goodwill associated with the Company's analog land seismic reporting unit was
impaired. Therefore an impairment charge of $15.1 million was recorded in the
third quarter of 2002. The Company determined the fair value of the reporting
unit using a discounted future returns valuation method.
The following is a reconciliation of reported net income to adjusted net
income subsequent to the adoption of SFAS No. 142 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
2002 2001 2002 2001
--------- --------- ---------- ---------
Reported net earnings (loss) applicable to
common shares................................ $(29,413) $2,679 $(114,302) $3,068
Elimination of goodwill amortization............ -- 972 -- 2,868
-------- ------ --------- ------
Adjusted net earnings (loss) applicable to
common shares................................ $(29,413) $3,651 $(114,302) $5,936
======== ====== ========= ======
(6) IMPAIRMENT OF FACILITIES
In the third quarter of 2002, the Company continued to take steps to
reduce the Company's overall cost structure. As part of these steps the Company
will combine its two Colorado-based operations into one location and will close
its Alvin, Texas manufacturing facility. Due to the planned closure of the
Alvin, Texas manufacturing facility, the Company performed an impairment test
in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets". As a result of the impairment test, the facility and
certain related manufacturing equipment was considered impaired and the Company
recorded an impairment charge of approximately $5.3 million in the third
quarter of 2002. The method of determining fair value was primarily based upon
quoted market prices for the facility and forecasted negative cash flows during
the interim period prior to closure. In addition, the Company recorded a charge
of $0.6 million for the closure of its Louisville, Colorado facility, which
primarily relates to the future non-cancelable lease obligation.
8
(7) NON-CASH ACTIVITY
In August 2002, the Company repurchased all of the 40,000 outstanding
shares of its Series B Convertible Preferred Stock and all of the 15,000
outstanding shares of its Series C Convertible Preferred Stock (the "Preferred
Stock"). In exchange for the Preferred Stock, the Company paid $30.0 million in
cash at closing, issued a $31.0 million unsecured promissory note due May 7,
2004 (the "Note") and granted warrants to purchase 2,673,517 shares of the
Company's common stock at $8.00 per share through August 5, 2005. See Note 14.
(8) EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is computed by dividing net
earnings (loss) applicable to common stock by the weighted average number of
common shares outstanding during the period. Diluted earnings (loss) per common
share is determined based upon the assumption that outstanding dilutive stock
options have been exercised and the aggregate proceeds were used to reacquire
common stock using the average price of such common stock for the period. The
following table summarizes the calculation of weighted average number of common
shares outstanding and weighted average number of diluted common shares
outstanding for purposes of the computation of basic earnings (loss) per common
share and diluted earnings (loss) per common share (in thousands, except share
and per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- --------------------------------
2002 2001 2002 2001
------------ ----------- ------------ -----------
Net earnings (loss) applicable to common shares........ $ (29,413) $ 2,679 $ (114,302) $ 3,068
Weighted average number of common shares
outstanding......................................... 51,090,776 51,319,419 50,985,098 51,179,516
Stock options and other common stock equivalents....... -- 1,094,008 -- 1,264,934
----------- ----------- ----------- -----------
Weighted average number of diluted common shares
outstanding......................................... 51,090,776 52,413,427 50,985,098 52,444,450
=========== =========== =========== ===========
Basic earnings (loss) per common share................. $ (0.58) $ 0.05 $ (2.24) $ 0.06
=========== =========== =========== ===========
Diluted earnings (loss) per common share: $ (0.58) $ 0.05 $ (2.24) $ 0.06
=========== =========== =========== ===========
At September 30, 2002, and 2001, 5,502,343 and 4,971,315 respectively, of
common shares subject to stock options were considered anti-dilutive and not
included in the calculation of diluted earnings (loss) per common share. In
August 2002, the Company repurchased all outstanding shares of its Series B and
Series C Convertible Preferred Stock (the "Preferred Stock"). As part of the
repurchase the Company granted warrants to purchase 2,673,517 shares of the
Company's common stock at $8.00 per share through August 5, 2005. The Preferred
Stock and warrants are considered anti-dilutive for all periods outstanding and
are not included in the calculation of diluted earnings (loss) per common share.
(9) LONG TERM DEBT
In August 2002 in connection with the repurchase of Preferred Stock, the
Company issued a $31.0 million unsecured promissory note due May 7, 2004,
bearing interest at 8% per year until May 7, 2003, at which time the interest
rate will increase to 13%. Interest is payable in quarterly payments, with all
principal and unpaid interest due on May 7, 2004. The Company records interest
on this note at an effective rate of approximately 11% per year over the life
of the note. Should the Company redeem the note early, any excess accrued
interest would be recorded as an adjustment of interest expense during the
period the note is redeemed. The note restricts cash dividends in excess of
$5.0 million per year while the note is outstanding.
9
In July 2002, in connection with the acquisition of AXIS Geophysics, Inc.
("AXIS"), the Company entered into a $2.5 million three year unsecured
promissory note payable to the former shareholders of AXIS, bearing interest at
4.34% per year. Principal is payable in quarterly payments of $0.2 million plus
interest, with final payment due in July 2005. The unpaid balance at September
30, 2002 was $2.5 million.
In January 2001, in connection with the acquisition of Pelton Company,
Inc. ("Pelton"), the Company entered into a $3.0 million two-year unsecured
promissory note payable to the former shareholder of Pelton, bearing interest
at 8.5% per year. Principal is payable in quarterly payments of $0.4 million
plus interest, with final payment due in February 2003. The unpaid balance at
September 30, 2002 was $0.8 million.
In August 1996, the Company obtained a $12.5 million, ten-year term loan
collateralized by certain land and buildings. The term loan bore interest at a
fixed rate of 7.875% per year and was repayable in equal monthly installments
of principal and interest of $151,439. On August 20, 2001, the Company sold the
same land and buildings for $21 million. As part of the transaction, the
Company repaid the ten-year term loan. Simultaneous to the sale and loan
repayment, the Company entered into a non-cancelable lease with the purchaser
of the property. The lease has a twelve-year term with three consecutive
options to extend the lease for five years each. The Company has no purchase
option pursuant to the lease. As a result of the lease terms, the commitment is
recorded as a twelve year $21 million lease obligation with an implicit
interest rate of 9.1%. The Company paid $1.7 million in commissions and
professional fees which have been recorded as deferred financing costs and are
being amortized over the twelve year term of the obligation.
A summary of future principal obligations under the notes payable and
lease obligation is as follows (in thousands):
YEARS ENDED DECEMBER 31,
- ------------------------
2002......................................... $ 804
2003......................................... 2,142
2004......................................... 32,864
2005......................................... 1,883
2006......................................... 1,489
2007 and thereafter.......................... 15,197
----------
Total........................................ $ 54,379
==========
(10) DEFERRED INCOME TAX
In June 2002, the Company recorded a $68.4 million charge to establish an
additional valuation allowance for its net deferred tax assets, which are
primarily net operating loss carryforwards. In the third quarter of 2002, the
Company increased the valuation allowance by $11.8 million recognizing no
current benefit from additional net operating losses. The establishment of this
valuation allowance in no way affects the Company's ability to reduce future
tax expense through utilization of prior years net operating losses.
The valuation allowance was calculated in accordance with the provisions
of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for
Income Taxes", which places primary importance on the Company's cumulative
operating results in the most recent three-year period when assessing the need
for a valuation allowance. Although management believes the Company's results
for those periods were heavily affected by deliberate and planned business
restructuring activities in response to the prolonged downturn in the seismic
equipment market, as well as heavy expenditures on research and development
primarily relating to the development of the Company's new VectorSeis
technology, the Company's cumulative loss in the most recent three-year period,
including the net loss reported in the first nine months of 2002 represented
sufficient negative evidence to establish an additional valuation allowance
under the provisions of SFAS No. 109. The Company intends to maintain a full
valuation allowance for its net deferred tax assets and net operating loss
carryforwards until sufficient positive evidence exists to support reversal of
the allowance.
(11) COMPREHENSIVE EARNINGS (LOSS)
The components of comprehensive earnings (loss) are as follows (in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ----------------------------------
2002 2001 2002 2001
--------------- --------------- --------------- ---------------
Net earnings (loss)........................ $ (31,400) $ 4,095 $ (113,355) $ 7,269
Foreign currency translation adjustment.... (580) 2,310 3,065 (575)
----------- ----------- ----------- -----------
Comprehensive earnings (loss).............. $ (31,980) $ 6,405 $ (110,290) $ 6,694
=========== =========== =========== ===========
10
(12) ACQUISITIONS
In July 2002, the Company acquired all of the outstanding capital stock
of AXIS Geophysics, Inc. ("AXIS") for $2.4 million of cash and issued a $2.5
million three-year unsecured promissory note. The Company will pay additional
consideration to the former shareholders of AXIS at an amount equal to 33.33%
of AXIS' EBITDA (as adjusted by the terms of the Earn-Out Agreement), for the
years ended December 31, 2003, 2004 and 2005, exceeding a minimum threshold of
$1.0 million. AXIS is a seismic data service company based in Denver, Colorado,
which provides specialized seismic data processing and integration services to
major and independent exploration and production companies. The AXIS
Interpretation-Ready Process(TM) ("IRP") integrates seismic and subsurface data
to provide customers more accurate and higher quality data that can result in
improved reservoir characterization.
In May 2002, the Company acquired certain of the assets of S/N
Technologies ("S/N") for $0.6 million of cash. In addition, the Company will
pay consideration up to a maximum of $5 million if certain revenue and sales
thresholds are met. The assets acquired from S/N include proprietary technology
applicable to solid streamer products used to acquire 2D, 3D and high
resolution marine seismic data.
In January 2001, the Company acquired all of the outstanding capital
stock of Pelton for approximately $6.0 million in cash and a $3.0 million
two-year unsecured promissory note. Pelton is based in Ponca City, Oklahoma and
designs, manufactures and sells seismic vibrator control systems, vibrator
positioning systems and explosive energy control systems
The acquisitions were accounted for by the purchase method, with the
purchase price allocated to the fair value of assets purchased and liabilities
assumed. The allocation of the purchase price, including related direct costs,
for the acquisition of AXIS, S/N and Pelton (Pelton represents the final
purchase price at December 31, 2001) are as follows (in thousands):
AXIS S/N Pelton
------------- ------ -------
Fair values of assets and liabilities
Net current assets....................................... $ 395 $ - $ 5,266
Property, plant and equipment............................ 354 85 373
Intangible assets........................................ 4,415 603 4,969
Long-term liabilities.................................... (223) - -
------------ ------ -------
Total allocated purchase price................... 4,941 688 10,608
Less non-cash consideration -- note payable................ 2,500 - 3,000
Less cash of acquired business............................. 501 - 2,032
------------ ------ -------
Cash paid for acquisition, net of cash acquired............ $ 1,940 $ 688 $ 5,576
============ ====== =======
The consolidated results of operations of the Company include the
results of AXIS, S/N and Pelton from the date of acquisition. Pro-forma results
prior to the acquisition date were not material to the Company's consolidated
results of operations.
(13) COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has been named in
various lawsuits or threatened actions. While the final resolution of these
matters may have an impact on its consolidated financial results for a
particular reporting period, the Company believes that the ultimate resolution
of these matters will not have a material adverse impact on its financial
position, results of operations or liquidity.
(14) REPURCHASE OF SERIES B AND SERIES C PREFERRED STOCK
In August 2002, the Company repurchased all of the 40,000 outstanding
shares of its Series B Convertible Preferred Stock and all of the 15,000
outstanding shares of its Series C Convertible Preferred Stock (the "Preferred
Stock") from the holder, SCF-IV, L.P. ("SCF"), a Houston-based private equity
fund specializing in oil service investments. In exchange for the Preferred
Stock, the Company paid SCF $30.0 million in cash at closing, issued SCF a
$31.0 million unsecured promissory note due May 7, 2004 (the "Note") and
granted SCF warrants to purchase 2,673,517 shares of the Company's common stock
at $8.00 per share through August 5, 2005. The Note bears interest at 8% per
year until May 7, 2003, at which time the interest rate will increase to 13%.
Immediately
11
preceding the closing of this transaction, David C. Baldwin, the elected
representative of the holder of the Preferred Stock, resigned from the
Company's board of directors.
The difference in the fair value of the consideration granted to SCF
and our carrying value of the preferred stock resulted in a credit to preferred
dividends of approximately $2.5 million. In the event the Company is acquired
and the total consideration paid is more than 60% cash, the Company may be
required to repurchase the warrants at their fair value. Therefore, the
warrants are accounted for as current liabilities and are reflected at their
fair value. The change in the fair value of the warrants between August 6,
2002 and September 30, 2002 resulted in other income of approximately $2.3
million. The fair value of the warrants was determined using the Black-Scholes
valuation model. The key variables used in valuing the warrants were as
follows: risk-free rate of return of Treasury notes having an approximate
duration of the remaining term of the warrants and expected stock price
volatility of 60%.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
SUMMARY REVIEW AND OUTLOOK
In response to the continued weak seismic market fundamentals, we have
taken decisive steps to further reduce our overall cost structure to enable us
to operate profitably at lower levels of overall seismic activity. First, we
have taken steps to significantly reduce our corporate overhead burden by
reducing the number of corporate personnel. Second, we will combine our two
Colorado-based operations into one location and close our Alvin, Texas
manufacturing facility. We also have initiated the statutorily-mandated steps
leading to the possible closure of our Norwich, U.K. based geophone stringing
facility. Existing operations in these facilities will either be relocated to
other existing Company facilities or outsourced to contract manufacturers with
a preference to lower cost environments. Third, we have combined certain
business units in order to create critical mass and further reduce our
administrative costs. Finally, we are carefully evaluating the portfolio of
products we currently support and will eliminate those products for which the
market outlook does not justify continuing investments. These actions resulted
in charges to earnings in the third quarter of 2002 of approximately $9.8
million. It is anticipated that these actions will result in additional charges
next quarter in the range of $2.5 to $3.5 million, relating principally to
costs associated with staff reductions. We expect these steps will reduce our
annual consolidated operating expenses by about $10.5 million, moving us
substantially towards our breakeven annual revenue target of $140 million.
We believe demand for seismic services and equipment will be weak in the
near term. Several of our largest customers have recently announced that they
will scale back their operations in 2003. Despite current conditions, we
believe that revenue and operating profits for the fourth quarter of 2002 will
modestly improve compared to the first three quarters of 2002. Based upon
long-term forecasted increases in demand for oil and gas as well as oil company
statements regarding lack of sufficient prospects, we believe long-term
fundamentals for the sector remain strong. We further believe we should be
well-positioned to benefit from new product introductions and anticipated
strengthening sector fundamentals as demand rebounds from current conditions.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2002 Compared to Three Months Ended September
30, 2001
Net Sales: Net sales of $28.5 million for the three months ended
September 30, 2002 decreased $30.1 million, or 51%, compared to the
corresponding period last year. The decrease is primarily due to decreased
demand for products produced by our Land Division. Our Land Division's net
sales decreased $31.6 million, or 66%, to $16.4 million primarily as a result
of declining industry conditions. Our Marine Division's net sales increased
$1.5 million to $12.1 million, or 14%, compared to the corresponding period
last year. We have seen some increase in demand for marine seismic equipment,
particularly from non-Western contractors.
Cost of Sales: Cost of sales of $24.8 million for the three months ended
September 30, 2002 decreased $16.4 million, or 40%, compared to the
corresponding period last year. Cost of sales of our Land Division was $17.1
million and cost of sales of our Marine Division was $7.7 million. Cost of
sales in the current quarter decreased as a result of the decrease in revenues.
Gross Profit and Gross Profit Percentage: Gross profit of $3.8 million
for the three months ended September 30, 2002 decreased $13.8 million, or 78%,
compared to the corresponding period last year. Gross profit percentage for the
three months ended September 30, 2002 was 13% compared to 30% in the
corresponding period last year. The decline in gross profit percentage is
primarily due to under-absorbed manufacturing overhead.
Research and Development: Research and development expense of $6.8
million for the three months ended September 30, 2002
12
remained relatively constant, increasing $0.1 million or 1% compared to the
corresponding period last year. Research and development expense remained at
high levels as we develop a next generation solid marine streamer and
lightweight ground electronics system and ocean bottom system that exploits our
VectorSeis technology.
Marketing and Sales: Marketing and sales expense of $2.6 million for the
three months ended September 30, 2002 decreased $0.2 million, or 8%, compared
to the corresponding period last year due to lower payroll and commission
expenses, partially offset by an increase in expenditures for conventions and
exhibits in the current period.
General and Administrative: General and administrative expense of $5.4
million for the three months ended September 30, 2002 increased $0.8 million,
or 19%, compared to the corresponding period last year. This is primarily
attributable to an increase in bad debt expense principally related to the
non-payment of certain invoices by one of our in-well reservoir customers,
partially offset by decreases in payroll and facility related costs.
Amortization of Intangibles: Amortization of intangibles of $0.4 million
for the three months ended September 30, 2002 decreased $0.9 million, or 70%,
compared to the corresponding period last year. The decrease in amortization
of intangibles primarily relates to the implementation of SFAS No. 142 in the
current year, which among other things eliminates the amortization of goodwill.
Impairment of Goodwill and Long-Lived Assets: Impairment of goodwill and
long-lived assets for the three months ended September 30, 2002, includes a
$15.1 million charge for the impairment of goodwill related to our analog land
seismic operations and $5.9 million for the closure of our Alvin, Texas and
Louisville, Colorado facilities. See Note 5 - Goodwill and Other Intangibles
and Note 6 - Impairment of Facilities.
Total Other Income: Total net interest and other income of $1.1 million
for the three months ended September 30, 2002 decreased $0.4 million or 27%,
compared to the corresponding period last year. This is primarily due to
interest expense on new debt as well as falling interest rates on cash
balances, partially offset by the change in the fair value of the warrants
between August 6, 2002 and September 20, 2002.
Income Tax Expense: Income tax expense of $0.2 million for the three
months ended September 30, 2002 increased $0.5 million compared to the
corresponding period last year. Income tax expense in the third quarter
reflects only state and foreign taxes as the Company is continuing to maintain
a full valuation allowance for its net deferred tax assets which are primarily
net operating loss carry-forwards. See "Nine Months Ended September 30, 2002
Compared to Nine Months Ended September 30, 2001 - Income Tax Expense".
Preferred Stock Dividends: Preferred stock dividends for the three months
ended September 30, 2002 and 2001 are related to outstanding Series B and
Series C Preferred Stock. We recognized the dividends as a charge to retained
earnings at a stated rate of 8% per year, compounded quarterly (of which 7% was
accounted for as a non-cash event recorded to additional paid-in capital so as
to reflect potential dilution upon preferred stock conversion and 1% was paid
as a quarterly cash dividend). The preferred stock dividend credit for the
three months ended September 30, 2002 was $2.0 million, compared to $1.4
million charge for the corresponding period last year. As discussed below in
"Repurchase of Series B and Series C Preferred Stock" and Note 14, we
repurchased the preferred stock on August 6, 2002. The preferred stock dividend
credit for the three months ended September 30, 2002, is due to the difference
in the fair value of the consideration granted to SCF and our carrying value of
the preferred stock at the time of the repurchase, partially offset by dividend
payments made prior to the repurchase.
Nine Months Ended September 30, 2002 Compared to Nine Months Ended September
30, 2001
Net Sales: Net sales of $81.6 million for the nine months ended September
30, 2002 decreased $79.3 million, or 49%, compared to the corresponding period
last year. The decrease is primarily due to decreased demand for products
produced by our Land Division. Our Land Division's net sales decreased $75.2
million, or 63%, to $44.9 million primarily as a result of declining industry
conditions. Our Marine Division's net sales decreased $4.1 million to $36.7
million, or 10%, compared to the prior year. Recently we have seen some
increase in demand for marine seismic equipment particularly from non-Western
contractors.
Cost of Sales: Cost of sales of $68.4 million for the nine months ended
September 30, 2002 decreased $38.5 million, or 36%, compared to the
corresponding period last year. Cost of sales of our Land Division was $47.9
million and cost of sales of our Marine Division was $20.5 million. Cost of
sales in the current period decreased as a result of the decrease in revenues,
partially offset by lower gross profit percentage on those revenues.
13
Gross Profit and Gross Profit Percentage: Gross profit of $13.2 million
for the nine months ended September 30, 2002 decreased $40.8 million, or 76%,
compared to the corresponding period last year. Gross profit percentage for the
nine months ended September 30, 2002 was 16% compared to 34% in the prior year.
The decline in gross profit percentage is primarily due to under-absorbed
manufacturing overhead, and to a lesser degree, severance for work force
reductions.
Research and Development: Research and development expense of $22.4
million for the nine months ended September 30, 2002 increased $0.5 million, or
2%, compared to the corresponding period last year. Research and development
expense remained at high levels as we completed the final stages of VectorSeis
commercialization and continue to develop a next generation solid marine
streamer, a lightweight ground electronics system and ocean bottom system that
exploits our VectorSeis and due to severance expenses and charges relating to
the closure of our Austin, Texas software development facility in the second
quarter of 2002.
Marketing and Sales: Marketing and sales expense of $7.9 million for the
nine months ended September 30, 2002 decreased $0.5 million, or 6%, compared to
the corresponding period last year. The decrease is primarily related to lower
payroll costs and commission on sales partially offset by severance expenses in
the second quarter of 2002.
General and Administrative: General and administrative expense of $14.7
million for the nine months ended September 30, 2002 increased $0.6 million, or
4%, compared to the corresponding period last year. The increase in general and
administrative expense is primarily attributable to an increase in bad debt
expense, partially offset by decreases in payroll, profit-based bonuses and
facility related costs.
Amortization of Intangibles: Amortization of intangibles of $1.0 million
for the nine months ended September 30, 2002 decreased $2.5 million, or 72%,
compared to the corresponding period last year. The decrease in amortization of
intangibles primarily relates to the implementation of SFAS No. 142 in the
current year, which among other things, eliminates the amortization of goodwill.
Impairment of Goodwill and Long-Lived Assets: Impairment of goodwill and
long-lived assets for the nine months ended September 30, 2002, includes a
$15.1 million charge for the impairment of goodwill related to our analog land
seismic operations and $5.9 million for the closure of our Alvin, Texas and
Louisville, Colorado facilities. See Note 5 - Goodwill and Other Intangibles
and Note 6 - Impairment of Facilities.
Total Other Income: Total net interest and other income of $1.5 million
for the nine months ended September 30, 2002 decreased $1.8 million, or 55%,
compared to the corresponding period last year. The decrease is primarily due
to interest expense on new debt as well as falling interest rates on cash
balances, partially offset by the change in the fair value of the warrants
between August 6, 2002 and September 30, 2002.
Income Tax Expense: Income tax expense of $61.0 million for the nine
months ended September 30, 2002 increased $59.0 million compared to the
corresponding period last year. The increase is due to a charge of $68.4
million in the second quarter of 2002 to establish an additional valuation
allowance for deferred tax assets. Although management's plans include
generating sufficient taxable income in future years to fully utilize our net
operating losses, such expectation is subject to a significant amount of risk
and uncertainty. In accordance with SFAS No. 109, we established an additional
valuation allowance for our net deferred tax assets based on our cumulative
operating results in the most recent three-year period. Our results in this
period were heavily affected by deliberate and planned business restructuring
activities in response to the prolonged downturn in the seismic equipment
market, as well as heavy expenditures on research and development of our
VectorSeis technology. Nevertheless, recent losses represented sufficient
negative evidence to establish an additional valuation allowance. We have
continued to reserve all of our net deferred tax assets and will continue until
we have sufficient evidence to warrant reversal. This valuation allowance in no
way affects our ability to reduce future tax expense through utilization of net
operating losses.
Preferred Stock Dividends: Preferred stock dividends for the nine months
ended September 30, 2002 and 2001 are related to previously outstanding Series
B and Series C Preferred Stock. We recognized the dividends as a charge to
retained earnings at a stated rate of 8% per year, compounded quarterly (of
which 7% was accounted for as a non-cash event recorded to additional paid-in
capital so as to reflect potential dilution upon preferred stock conversion and
1% was paid as a quarterly cash dividend). The preferred stock dividend charge
for the nine months ended September 30, 2002 was $0.9 million, compared to $4.2
million for the corresponding period last year. As discussed below in
"Repurchase of Series B and Series C Preferred Stock" and Note 14, we
repurchased the preferred stock on August 6, 2002. The decrease in preferred
dividends is due to a preferred stock dividend credit of approximately $2.5
million which represents the difference in the fair value of the consideration
granted to SCF and our carrying value of the preferred stock at the time of the
repurchase.
14
LIQUIDITY AND CAPITAL RESOURCES
We have typically financed operations from internally generated cash and
funds from equity financings. Cash and cash equivalents were $73.3 million at
September 30, 2002, a decrease of $28.4 million, or 28%, compared to December
31, 2001. The decrease is primarily due to the repurchase of preferred stock,
partially offset by changes in foreign currency exchange rates. Net cash
provided by operating activities was $7.1 million for the nine months ended
September 30, 2002 compared to the net cash provided by operating activities of
$1.6 million for the corresponding period last year. Positive operating cash
flows were primarily due to a decrease in accounts receivable and inventories,
partially offset by decreases in accounts payable.
Net cash used in investing activities was $6.8 million for the nine
months ended September 30, 2002 compared to net cash used in investing
activities of $9.8 million for the corresponding period last year. The
principal investing activities in 2002 were capital expenditure projects and
the acquisition of AXIS. Planned capital expenditures for the fourth quarter of
2002 are approximately $1.0 million.
Net cash used in financing activities was $30.3 million for the nine
months ended September 30, 2002 compared to net cash provided by financing
activities of $11.9 million for the corresponding period last year. The
principal use of cash in 2002 was the repurchase of Preferred Stock and the
repayment of long-term debt offset by proceeds from issuance of common stock
upon exercise of stock options.
On August 6, 2002, we repurchased all of the outstanding shares of Series
B Preferred Stock and Series C Preferred Stock from the holder thereof for $30
million in cash, a $31 million unsecured promissory note due May 7, 2004 and
warrants to purchase 2,673,517 shares of our common stock at $8.00 per share
through August 5, 2005. The note bears interest at 8% per annum until May 7,
2003, at which time the interest rate will increase to 13%. See "Repurchase of
Series B and Series C Preferred Stock".
We believe the combination of existing working capital, current cash on
hand and access to other financing sources will be adequate to meet anticipated
capital and liquidity requirements for the foreseeable future.
REPURCHASE OF SERIES B AND SERIES C PREFERRED STOCK
On August 6, 2002, we repurchased all of the 40,000 outstanding shares of
our Series B Convertible Preferred Stock and all of the 15,000 outstanding
shares of our Series C Convertible Preferred Stock (the "Preferred Stock") from
SCF-IV, L.P. ("SCF"), a Houston-based private equity fund specializing in oil
service investments. In exchange for the Preferred Stock, we paid SCF $30.0
million in cash at closing, issued SCF a $31.0 million unsecured promissory
note due May 7, 2004 and granted SCF warrants to purchase 2,673,517 shares of
our common stock at $8.00 per share through August 5, 2005. The Note bears
interest at 8% per annum until May 7, 2003, at which time the interest rate
will increase to 13%. The Company records interest on this note at an effective
rate of approximately 11% per year. Should the Company redeem the note early,
any excess interest accrued would be recorded as an adjustment of interest
expense during the period the note is redeemed. Immediately preceding the
closing of this transaction, David C. Baldwin, the elected representative of
the holder of the Preferred Stock, resigned from our board of directors.
The Preferred Stock was issued in 1999, at a purchase price of $1,000 per
share (the "Stated Value"), for an aggregate of $55 million. Since that time,
the Preferred Stock has earned an 8% dividend, of which we paid 1% quarterly in
cash and we accrued the balance to increase the Adjusted Stated Value ($1,000
per share Stated Value plus accrued and unpaid dividends) of the Preferred
Stock. The Adjusted Stated Value of the Preferred Stock as of August 6, 2002,
was $68.8 million.
The Preferred Stock became convertible at the option of SCF on May 7,
2002. Under its terms, the number of shares into which the Preferred Stock
would have been convertible is the greater of (i) Stated Value divided by
approximately $8.14 per share or (ii) Adjusted Stated Value divided by the
average market price of our common stock during the ten-day trading period
immediately prior to conversion. We had the right, without the holder's
consent, to redeem for cash up to one-half of any Preferred Stock tendered for
conversion based on the Adjusted Stated Value of such Preferred Stock on the
conversion date. If SCF had converted all of the Preferred Stock on August 6,
2002, and we had declined to exercise our redemption rights, SCF would have
received about 9.2 million shares of our common stock, representing 15.3% of
the total outstanding common stock of the Company after giving effect to the
conversion.
Under the terms of a registration rights agreement, SCF has the right to
demand that we file a registration statement for the resale of the shares of
Common Stock SCF acquires upon exercise of the warrants. Sales or the
availability for sale of a substantial number of our shares of Common Stock in
the public market could adversely affect the market price for our Common Stock.
If we are
15
acquired in a business combination pursuant to which our stockholders receive
less than 60% of the aggregate consideration in the form of publicly traded
common equity, then the holder of the warrants has the option to require the
Company to acquire the warrants at their fair value as determined by the
Black-Scholes valuation model as further refined by the terms of the warrant
agreement. Because we may be required to repurchase the warrants in these
limited circumstances, we classify the warrants as a current liability on our
balance sheet. Every quarter we will revalue the warrants and record any change
in value as a credit or charge to our statement of operations.
CREDIT RISK
A continuation of weak demand for the services of certain of our
customers will further strain their revenues and cash resources, thereby
resulting in lower sales levels and a higher likelihood of defaults in timely
payment of their obligations under credit sales arrangements. Increased levels
of payment defaults with respect to credit sales arrangements could have a
material adverse effect on our results of operations.
Our principal customers are seismic contractors, which operate seismic
data acquisition systems and related equipment to collect data in accordance
with their customers' specifications or for their own seismic data libraries.
In addition, we market and sell products to oil and gas companies. The loss of
any one of these customers could have a material adverse effect on our results
of operations and financial condition. See - Cautionary Statement for Purposes
of Forward Looking Statements - Further consolidation among our significant
customers could materially and adversely affect us.
CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD-LOOKING STATEMENTS
We have made statements in this report which constitute forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934. Examples of forward-looking statements in this report include statements
regarding:
- our expected revenues, operating profit and net income for 2002 or the
three months ended December 31, 2002;
- our plans for facilities closures and other future business
reorganizations;
- charges we expect to take for future reorganization activities;
- savings we expect to achieve from our restructuring activities;
- future demand for seismic equipment and services;
- future commodity prices;
- future economic conditions;
- anticipated timing of commercialization and capabilities of products
under development;
- our expectations regarding future mix of business and future asset
recoveries;
- our expectations regarding realization of deferred tax assets;
- our beliefs regarding accounting estimates we make;
- the result of pending or threatened disputes and other
contingencies; and
- our future levels of capital expenditures.
You can identify these forward-looking statements by forward-looking
words such as "believe," "may," "could," "will," "estimate," "continue,"
"anticipate," "intend," "seek," "plan," "expect," "should," "would" and similar
expressions. These forward-looking statements reflect our best judgment about
future events and trends based on the information currently available to us.
Our results of operations can be affected by inaccurate assumptions we make or
by risks and uncertainties known or unknown to us. Therefore, we cannot
guarantee the accuracy of the forward-looking statements. Actual events and
results of operations may vary materially from
16
our current expectations. While we cannot identify all of the factors that may
cause actual events to vary from our expectations, we believe the following
factors should be considered carefully:
Recent announcements by geophysical contractors indicate that demand for
our products will continue to be weak in the near term. Western-Geco, our
largest customer, recently announced that it was ceasing land seismic
operations in Canada and the Continental United States. Veritas DGC, our second
largest customer, recently announced that it was reducing its capital
expenditures by more than $30 million in its current fiscal year. These and
other announcements by geophysical contractors indicate that demand for our
products will continue to be weak in the near term which will have a material
adverse effect on our results of operations and financial condition.
Our business reorganization and facilities closure plans may not yield
the benefits we expect and could even harm our financial condition, reputation
and prospects. We intend to significantly reduce our corporate and operational
headcount, close certain manufacturing facilities and combine certain of our
business units. These activities may not yield the benefits we expect, and may
raise product costs, delay product production, result in or exacerbate labor
disruptions and labor-related legal actions against us, and create
inefficiencies in our business.
Our strategic direction and restructuring program also may give rise to
unforeseen costs, which could wholly or partially offset any expense reductions
or other financial benefits we attain as a result of the changes to our
business. In addition, if the markets for our products do not improve, we will
take additional restructuring actions to address these market conditions. Any
such additional actions could result in additional restructuring charges.
We have developed outsourcing arrangements for the manufacture of some of
our products. If these third parties fail to deliver quality products or
components at reasonable prices on a timely basis, we may alienate some of our
customers, and our revenues, profitability and cash flow may decline. As part
of our strategic direction, we are increasing our use of contract manufacturers
as an alternative to our own manufacture of products. If, in implementing this
initiative, we are unable to identify contract manufacturers willing to
contract with us on competitive terms and to devote adequate resources to
fulfill their obligations to us, or if we do not properly manage these
relationships, our existing customer relationships my suffer. In addition, by
undertaking these activities, we run the risk that the reputations and
competivness of our products and services may deteriorate as a result of the
reduction of our control over quality and delivery schedules. We also may
experience supply interruptions, cost escalations and competitive disadvantages
if our contract manufacturers fail to develop, implement, or maintain
manufacturing methods appropriate for our products and customers.
If any of these risks is realized, our revenues, profitability and cash
flow may decline. In addition, as we come to rely more heavily contract
manufacturers, we may have fewer personnel resources with expertise to manage
problems that may arise from these third-party arrangements.
Demand for our products will be materially and adversely affected if
there is further reduction in the level of exploration expenditures by oil and
gas companies and geophysical contractors. Demand for our products is
particularly sensitive to the level of exploration spending by oil and gas
companies and geophysical contractors. Exploration expenditures have tended in
the past to follow trends in the price of oil and gas, which have fluctuated
widely in recent years in response to relatively minor changes in supply and
demand for oil and gas, market uncertainty and a variety of other factors
beyond our control. Any prolonged reduction in oil and gas prices will depress
the level of exploration activity and correspondingly depress demand for our
products. A prolonged downturn in market demand for our products will have a
material adverse effect on our results of operations and financial condition.
We derive a substantial amount of our net sales from foreign sales which
pose additional risks. Sales to customers outside of the United States and
Canada accounted for approximately 64% of our consolidated net sales for the
nine months ended September 30, 2002. As Western contractors have announced
plans to curtail operations, we believe that export sales will grow as a
percentage of our revenue. United States export restrictions affect the types
and specifications of products we can export. Additionally, to complete certain
sales, United States laws may require us to obtain export licenses and there
can be no assurance that we will not experience difficulty in obtaining such
licenses. Operations and sales in countries other than the United States are
subject to various risks peculiar to each country. With respect to any
particular country, these risks may include:
- expropriation and nationalization;
- political and economic instability;
17
- armed conflict and civil disturbance;
- currency fluctuations, devaluations and conversion restrictions;
- confiscatory taxation or other adverse tax policies;
- governmental activities that limit or disrupt markets, restrict
payments or the movement of funds; and
- governmental activities that may result in the deprivation of
contractual rights.
The majority of our foreign sales are denominated in United States
dollars. While this practice protects the value of our assets as reported on
our consolidated financial statements, an increase in the value of the dollar
relative to other currencies will make our products more expensive, and
therefore less competitive, in foreign markets.
In addition, we are subject to taxation in many jurisdictions and the
final determination of our tax liabilities involves the interpretation of the
statutes and requirements of taxing authorities worldwide. Our tax returns are
subject to routine examination by taxing authorities, and these examinations
may result in assessments of additional taxes, penalties and/or interest.
We may not gain rapid market acceptance for our new products which could
materially and adversely affect our results of operations and financial
condition. Seismic exploration requires sensitive scientific instruments
capable of withstanding harsh operating environments. In addition, our
customers demand broad functionality from our products. We require long
development and testing periods before releasing major new product enhancements
and new products. We currently intend to release for commercial use our next
generation cable-based land seismic data acquisition system and our next
generation marine solid streamer. If our anticipated product introductions are
delayed, our customers may turn to alternate suppliers and our results of
operations and financial condition will be adversely affected. We have on
occasion experienced delays in the scheduled introduction of new and enhanced
products. In addition, products as complex as those we offer sometimes contain
undetected errors or bugs when first introduced that, despite our rigorous
testing program, are not discovered until the product is purchased and used by
a customer. If our customers deploy our new products and they do not work
correctly, our relationship with our customers may be materially and adversely
affected. We cannot assure you that errors will not be found in future releases
of our products, or that these errors will not impair the market acceptance of
our products. If our new products are not accepted by our customers as rapidly
as we anticipate, our business and results of operations may be materially and
adversely affected.
The rapid pace of technological change in the seismic industry requires
us to make substantial capital expenditures and could make our products
obsolete. The markets for our products are characterized by rapidly changing
technology and frequent product introductions. We must invest substantial
capital to maintain our leading edge in technology with no assurance that we
will receive an adequate rate of return on such investments. If we are unable
to develop and produce successfully and timely new and enhanced products, we
will be unable to compete in the future and our business and results of
operations will be materially and adversely affected.
Competition for sellers of seismic data acquisition systems and equipment
is intensifying and could adversely affect our results of operations. Our
industry is highly competitive. Our competitors have been consolidating into
better-financed companies with broader product lines. Several of our
competitors are affiliated with seismic contractors, which forecloses a portion
of the market to us. Some of our competitors have greater name recognition,
more extensive engineering, manufacturing and marketing capabilities, and
greater financial, technical and personnel resources than those available to us.
In recent years our competitors have expanded or improved their product
lines, which has adversely affected our results of operations. For instance,
one competitor recently introduced a lightweight land seismic system which we
believe has made our current land system more difficult to sell at acceptable
margins. In addition, one of our competitors has introduced a marine solid
streamer product that competes with our oil-filled product. Our net sales of
marine streamers have been, and will continue to be, adversely affected by
customer preferences for solid products. We currently intend to commercially
release a marine solid streamer in the first half of 2003. We can not assure
you, however, that we will find a cost-effective way to market a solid streamer
product or that we will be able to compete effectively in the future for sales
of marine streamers.
Further consolidation among our significant customers could materially
and adversely affect us. A relatively small number of customers account for the
majority of our net sales in any period. During the prior year ended December
31, 2001, three customers (WesternGeco, Veritas and PGS) accounted for
approximately 51% of our net sales. In recent years, our customers have been
rapidly
18
consolidating, shrinking the demand for our products. The loss of any of our
significant customers to further consolidation or otherwise could materially
and adversely affect our results of operations and financial condition.
Large fluctuations in our sales and gross margin can result in operating
losses. Because, our products have a high sales price and are technologically
complex, we experience a very long sales cycle. In addition, the revenues from
any particular sale can vary greatly from our expectations due to changes in
customer requirements. These factors create substantial fluctuations in our net
sales from period to period. Variability in our gross margins compounds the
uncertainty associated with our sales cycle. Our gross margins are affected by
the following factors:
- pricing pressures from our customers and competitors;
- product mix sold in a period;
- inventory obsolescence;
- unpredictability of warranty costs;
- changes in sales and distribution channels;
- availability and pricing of raw materials and purchased components;
and
- absorption of manufacturing costs through volume production.
We must establish our expenditure levels for product development, sales
and marketing and other operating expenses based, in large part, on our
forecasted net sales and gross margin. As a result, if net sales or gross
margins fall below our forecasted expectations, our operating results and
financial condition are likely to be adversely affected because only a
relatively small portion of our expenses vary with our revenues.
We may be unable to obtain broad intellectual property protection for our
current and future products which may significantly erode our competitive
advantages. We rely on a combination of patent, copyright and trademark laws,
trade secrets, confidentiality procedures and contractual provisions to protect
our proprietary technologies. We believe that the technological and creative
skill of our employees, new product developments, frequent product
enhancements, name recognition and reliable product maintenance are the
foundations of our competitive advantage. Although we have a considerable
portfolio of patents, copyrights and trademarks, these property rights offer us
only limited protection. Our competitors may attempt to copy aspects of our
products despite our efforts to protect our proprietary rights, or may design
around the proprietary features of our products. Policing unauthorized use of
our proprietary rights is difficult and we are unable to determine the extent
to which such use occurs. Our difficulties are compounded in certain foreign
countries where the laws do not offer as much protection for proprietary rights
as the laws of the United States.
We are not aware that our products infringe upon the proprietary rights
of others. However, third parties may claim that we have infringed their
intellectual property rights. Any such claims, with or without merit, could be
time consuming, result in costly litigation, cause product shipment delays or
require us to enter into royalty or licensing arrangements. Such claims could
have a material adverse affect on our results of operations and financial
condition.
Significant payment defaults under extended financing arrangements could
adversely affect us. We often sell to customers on extended-term arrangements.
Significant payment defaults by customers could have a material adverse effect
on our financial position and results of operations.
We are highly dependent on certain key personnel. Our future success
depends upon the continued contributions of personnel, particularly management
personnel, many of whom would be difficult to replace. Our success will also
depend on our ability to attract and retain skilled employees. Changes in
personnel, particularly technical personnel, could adversely affect operating
results and continued changes in management personnel could have a disruptive
effect on employees which could, in turn, adversely affect operating results.
Our strategy of pursuing acquisitions and alliances has risks that can
materially and adversely affect our business, results of operations and
financial condition. One of our business strategies is to acquire operations
and assets that are complementary to our existing business, or to enter
strategic alliances that will extend our existing business. Acquisitions and
alliances involve financial,
19
operational and legal risks, including:
- increased levels of goodwill subject to potential impairment;
- increased interest expense or increased dilution from issuance of
equity;
- disruption of existing and acquired business from our integration
efforts; and
- loss of uniformity in standards, controls, procedures and policies.
In addition, other potential buyers could compete with us for
acquisitions and strategic alliances. Competition could cause us to pay a
higher price for an acquisition than we otherwise might have to pay or reduce
the available strategic alternatives. We might be unsuccessful in identifying
attractive acquisition candidates, completing and financing additional
acquisitions on favorable terms or integrating the acquired businesses or
assets into our operations.
Our operations are subject to numerous government regulations which could
adversely limit our operating flexibility. Our operations are subject to laws,
regulations, government policies and product certification requirements
worldwide. Changes in such laws, regulations, policies or requirements could
affect the demand for our products or result in the need to modify products,
which may involve substantial costs or delays in sales and could have an
adverse effect on our future operating results. Certain countries are subject
to restrictions, sanctions and embargoes imposed by the United States
government. These restrictions, sanctions and embargoes prohibit or limit us
from participating in certain business activities in those countries.
Disruption in vendor supplies will adversely affect our results of
operations. Our manufacturing processes require a high volume of quality
components. Certain components used by us are currently provided by only one
supplier. We may, from time to time, experience supply or quality control
problems with suppliers, and these problems could significantly affect our
ability to meet production and sales commitments. Reliance on certain
suppliers, as well as industry supply conditions generally involve several
risks, including the possibility of a shortage or a lack of availability of key
components and increases in component costs and reduced control over delivery
schedules; any of these could adversely affect our future results of operations.
NOTE: THE FOREGOING REVIEW OF FACTORS PURSUANT TO THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995 SHOULD NOT BE CONSTRUED AS EXHAUSTIVE. IN
ADDITION TO THE FOREGOING, WE WISH TO REFER READERS TO OTHER FACTORS DISCUSSED
ELSEWHERE IN THIS REPORT AS WELL AS OTHER FILINGS AND REPORTS WITH THE SEC FOR
A FURTHER DISCUSSION OF RISKS AND UNCERTAINTIES WHICH COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE CONTAINED IN FORWARD-LOOKING
STATEMENTS. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE THE RESULT OF ANY
REVISIONS TO ANY SUCH FORWARD-LOOKING STATEMENTS, WHICH MAY BE MADE TO REFLECT
THE EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE
OF UNANTICIPATED EVENTS.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We may, from time to time, be exposed to market risk, which is the
potential loss arising from adverse changes in market prices and rates. The
Company traditionally has not entered into significant derivative or other
financial instruments other than as described below. We are not currently a
borrower under any material credit arrangements which feature fluctuating
interest rates. Market risk could arise from changes in foreign currency
exchange rates.
As discussed in "Repurchase of Series B and Series C Preferred Stock" and
Note 14, the Company repurchased all outstanding shares of its Preferred Stock.
As part of the repurchase the Company granted warrants to purchase 2,673,517
shares of the Company's common stock at $8.00 per share through August 5, 2005.
A $1 increase in the Company's common stock price at September 30, 2002, would
have increased the fair value of warrants resulting in an increase to the
Company's net loss of approximately $1.4 million or $(.03) per common share. A
$1 decrease in the Company's common stock price at September 30, 2002, would
have decreased the fair value of warrants resulting in a decrease to the
Company's net loss of approximately $1.2 million or $.02 per common share. The
fair value of the warrants was determined using the Black-Scholes valuation
model. The key variables used in valuing the warrants were as follows:
risk-free rate of return of Treasury notes having an approximate duration of
the remaining term of the warrants and expected stock price volatility of 60%.
20
ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Administrative Officer (the "Certifying
Officers") have evaluated the Company's disclosure controls and procedures (as
defined in Rule 13a-14(c) and Rule 15d-14(c) under the Exchange Act) as of
November 12, 2002 and concluded that those disclosures controls and procedures
are effective.
The Certifying Officers have indicated that there has been no significant
changes in our internal controls or in other factors know to us that could
significantly affect these controls subsequent to their evaluation, nor any
corrective actions with regard to significant deficiencies and material
weaknesses.
While we believe that our existing disclosure controls and procedures have been
effective to accomplish these objectives, we intend to continue to examine,
refine and formalize our disclosure controls and procedures and to monitor
ongoing developments in this area.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 6, 2002, the Company repurchased all of the 40,000 outstanding
shares of its Series B Convertible Preferred Stock and all of the 15,000
outstanding shares of its Series C Convertible Preferred Stock (the "Preferred
Stock") from SCF-IV, L.P. ("SCF"), a Houston-based private equity fund
specializing in oil service investments. We relied on Section 4(2) of the
Securities Act of 1933 as an exemption from registration of the transaction
because we only negotiated with one sophisticated party. In exchange for the
Preferred Stock, we paid SCF $30.0 million in cash at closing, issued SCF a
$31.0 million unsecured promissory note due May 7, 2004 and granted SCF
warrants to purchase 2,673,517 shares of our common stock at $8.00 per share
through August 5, 2005. The Note bears interest at 8% per annum until May 7,
2003, at which time the interest rate will increase to 13%. The note restricts
cash dividends in excess of $5.0 million per year while the note is
outstanding. Immediately preceding the closing of this transaction, David C.
Baldwin, the elected representative of the holder of the Preferred Stock,
resigned from our board of directors.
The Preferred Stock was issued in 1999 at a purchase price of $1,000 per
share (the "Stated Value"), for an aggregate of $55 million. Since that time,
the Preferred Stock has earned an 8% dividend, of which we paid 1% quarterly in
cash and we accrued the balance to increase the Adjusted Stated Value ($1,000
per share Stated Value plus accrued and unpaid dividends) of the Preferred
Stock. The Adjusted Stated Value of the Preferred Stock as of August 6, 2002,
was $68.8 million.
The Preferred Stock became convertible at the option of SCF on May 7,
2002. Under the terms, the number of shares into which the Preferred Stock
would have been convertible is the greater of (i) Stated Value divided by
approximately $8.14 per share or (ii) Adjusted Stated Value divided by the
average market price of our common stock during the ten-day trading period
immediately prior to conversion. We had the right, without the holder's
consent, to redeem for cash up to one-half of any Preferred Stock tendered for
conversion based on the Adjusted Stated Value of such Preferred Stock on the
conversion date. If SCF had converted all of the Preferred Stock on August 6,
2002, and we had declined to exercise our redemption rights, SCF would have
received about 9.2 million shares of our common stock, representing 15.3% of
the total outstanding common stock of the Company after giving effect to the
conversion.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit
Number Description
- ------ -----------
99.1 Certification of Timothy J. Probert, Chief Executive Officer,
Pursuant to 18 U.S.C. Section 1350.
99.2 Certification of C. Robert Bunch, Chief Administrative Officer,
Pursuant to 18 U.S.C. Section 1350.
21
(b) Reports on Form 8-K.
On August 13, 2002, we filed a Current Report on Form 8-K reporting under
Item 5. Other Events the repurchase of our Series B and Series C Preferred
Stock.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized in the City of
Stafford, State of Texas, on November 13, 2002.
INPUT/OUTPUT, INC.
By /s/ C. ROBERT BUNCH
-----------------------------------
Chief Administrative Officer
23
CERTIFICATIONS
I, Timothy J. Probert, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Input/Output,
Inc.
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
fulfilling the equivalent function);
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
vealuation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Timothy J. Probert
---------------------------------------
Timothy J. Probert
President and Chief Executive Officer
Date: November 13, 2002
24
CERTIFICATIONS
I, C. Robert Bunch, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Input/Output,
Inc.
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
fulfilling the equivalent function);
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ C. Robert Bunch
----------------------------
C. Robert Bunch
Chief Administrative Officer
Date: November 13, 2002
25
EXHIBIT INDEX
(a) Exhibits.
Exhibit
Number Description
- ------ -----------
99.1 Certification of Timothy J. Probert, Chief Executive Officer,
Pursuant to 18 U.S.C. Section 1350.
99.2 Certification of C. Robert Bunch, Chief Administrative Officer,
Pursuant to 18 U.S.C. Section 1350.
(b) Reports on Form 8-K.
On August 13, 2002, we filed a Current Report on Form 8-K reporting
under Item 5. Other Events the repurchase of our Series B and Series C
Preferred Stock.