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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 MARCH 31, 2003
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: [ ]
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act). Yes: [X] No: [ ]
At May 8, 2003 there were 51,247,776 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 MARCH 31, 2003
<Table>
<Caption>
PAGE
PART I. Financial Information.
Item 1. Financial Statements.
Consolidated Balance Sheets
March 31, 2003 (unaudited) and December 31, 2002......... 3
Consolidated Statements of Operations
Three months ended March 31, 2003 (unaudited) and
March 31, 2002 (unaudited)............................... 4
Consolidated Statements of Cash Flows
Three months ended March 31, 2003 (unaudited) and
March 31, 2002 (unaudited)............................... 5
Notes to Unaudited Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition....................... 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk.. 20
Item 4. Controls and Procedures..................................... 21
PART II. Other Information.
Item 6. Exhibits and Reports on Form 8-K............................ 21
Certifications.............................................. 23
</Table>
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<Table>
<Caption>
MARCH 31,
2003 DECEMBER 31,
(UNAUDITED) 2002
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 56,317 $ 77,144
Restricted cash ................................................. 252 247
Accounts receivable, net ........................................ 30,560 18,745
Current portion notes receivable, net ........................... 12,483 6,137
Inventories ..................................................... 47,561 50,010
Prepaid expenses and other current assets ....................... 2,030 3,136
------------ ------------
Total current assets .................................... 149,203 155,419
Notes receivable ................................................... 6,131 12,057
Property, plant and equipment, net ................................. 38,764 39,255
Goodwill, net ...................................................... 33,758 33,758
Other assets, net .................................................. 6,966 7,956
------------ ------------
Total assets ............................................ $ 234,822 $ 248,445
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt ............................ $ 1,787 $ 2,142
Accounts payable ................................................ 13,387 18,927
Accrued expenses ................................................ 17,898 19,410
------------ ------------
Total current liabilities ............................... 33,072 40,479
Long-term debt, net of current maturities .......................... 50,979 51,430
Other long-term liabilities ........................................ 4,934 5,199
Stockholders' equity:
Common stock, $0.01 par value; authorized 100,000,000 shares;
outstanding 51,250,906 shares at March 31, 2003 and
51,078,939 shares at December 31, 2002, net of treasury
stock ......................................................... 521 519
Additional paid-in capital ...................................... 296,267 296,002
Accumulated deficit ............................................. (141,813) (136,534)
Accumulated other comprehensive loss ............................ (2,536) (2,380)
Treasury stock, at cost, 774,651 shares at March 31, 2003 and
783,298 shares at December 31, 2002 ........................... (5,859) (5,929)
Unamortized restricted stock compensation ....................... (743) (341)
------------ ------------
Total stockholders' equity ................................... 145,837 151,337
------------ ------------
Total liabilities and stockholders' equity ................... $ 234,822 $ 248,445
============ ============
</Table>
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)
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
------------ ------------
Net sales ..................................... $ 41,177 $ 30,213
Cost of sales ................................. 32,416 23,252
------------ ------------
Gross profit ......................... 8,761 6,961
------------ ------------
Operating expenses:
Research and development ................... 5,518 7,021
Marketing and sales ........................ 2,811 2,530
General and administrative ................. 4,065 4,627
Amortization of intangibles ................ 304 316
Impairment of long-lived assets ............ 1,120 --
------------ ------------
Total operating expenses ............ 13,818 14,494
------------ ------------
Loss from operations .......................... (5,057) (7,533)
Interest expense .............................. (1,345) (35)
Interest income ............................... 591 491
Fair value adjustment of warrant obligation ... 871 --
Other income (expense) ........................ 249 (136)
------------ ------------
Loss before income taxes ...................... (4,691) (7,213)
Income tax expense (benefit) .................. 588 (2,671)
------------ ------------
Net loss ...................................... (5,279) (4,542)
Preferred dividend ............................ -- 1,455
------------ ------------
Net loss applicable to common shares .......... $ (5,279) $ (5,997)
============ ============
Basic loss per common share ................... $ (0.10) $ (0.12)
============ ============
Weighted average number of
common shares outstanding .................. 51,194,690 50,890,836
============ ============
Diluted loss per common share ................. $ (0.10) $ (0.12)
============ ============
Weighted average number of diluted
common shares outstanding .................. 51,194,690 50,890,836
============ ============
</Table>
See accompanying Notes to Unaudited Consolidated Financial Statements.
4
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Adjustments to reconcile net loss to cash used in
operating activities:
Net loss ................................................. $ (5,279) $ (4,542)
Depreciation and amortization ............................ 3,574 2,992
Fair value adjustment of warrant obligation .............. (871) --
Impairment of long-lived assets .......................... 1,120 --
Amortization of restricted stock and other
stock compensation ...................................... (312) 56
Loss on disposal of fixed assets ......................... 45 47
Bad debt collections ..................................... (37) (54)
Change in operating assets and liabilities:
Accounts and notes receivable ............................ (12,213) 9,775
Inventories .............................................. 493 16
Accounts payable and accrued expenses .................... (6,276) (11,569)
Other assets and liabilities ............................. 993 987
------------ ------------
Net cash used in operating activities .............. (18,763) (2,292)
------------ ------------
Cash flows from investing activities:
Purchase of property, plant and equipment ................ (1,395) (1,054)
------------ ------------
Cash flows from financing activities:
Payments on long-term debt ............................... (806) (571)
Payments of preferred dividends .......................... -- (136)
Proceeds from exercise of stock options .................. -- 164
Proceeds from issuance of common stock ................... 248 457
------------ ------------
Net cash used in financing activities .............. (558) (86)
------------ ------------
Effect of change in foreign currency exchange rates on
cash and cash equivalents ............................. (111) (458)
------------ ------------
Net decrease in cash and cash equivalents ................ (20,827) (3,890)
Cash and cash equivalents at beginning of period ......... 77,144 101,681
------------ ------------
Cash and cash equivalents at end of period ............... $ 56,317 $ 97,791
============ ============
</Table>
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, 2002 has
been derived from the Company's audited consolidated financial statements at
that date. The consolidated balance sheet at March 31, 2003, the consolidated
statements of operations for the three months ended March 31, 2003 and 2002, and
the consolidated statements of cash flows for the three months ended March 31,
2003 and 2002 have been prepared by the Company without audit. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. The results of operations
for the three months ended March 31, 2003 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, 2002. Certain amounts previously reported in the consolidated
financial statements have been reclassified to conform to the current period's
presentation.
(2) RESTRUCTURING ACTIVITIES
In 2002, the Company initiated a restructuring program which included
reducing its full-time headcount by approximately 300 positions and closing
certain of its facilities and relocating those operations to other existing
Company facilities or outsourcing those operations to contract manufacturers. As
of March 31, 2003, the Company had eliminated approximately 250 of the estimated
300 full-time positions. As the Company completes its move out of its Alvin,
Texas and Norwich, U.K. facilities, an additional reduction of approximately 50
full-time employees is anticipated. As of March 31, 2003, the Company had
relocated a majority of its geophone stringing operations to a Company-leased
facility in the United Arab Emirates and anticipates to have completed the move
by the end of May. The Company anticipates to vacate its Alvin, Texas facility
by the end of this second quarter. Also in 2002, the Company combined its two
Colorado-based operations into one location, abandoning its non-cancelable lease
of its Louisville, Colorado operation. During the first quarter of 2003, the
Company reduced its accrual for the non-cancelable lease obligation by $0.1
million due to more favorable terms than anticipated for the sublease of the
facility. For the three months ended March 31, 2003, the Company paid $0.3
million, net of sublease income, related to all abandoned non-cancelable lease
obligations. The accrual for these obligations was $1.1 million at March 31,
2003 and $1.5 million at December 31, 2002.
As of December 31, 2002, the Company had accrued approximately $1.2 million
for its planned reduction in headcount. During the first quarter of 2003, the
Company incurred $0.5 million of additional severance expenses ($0.4 million
included in cost of sales and $0.1 million in general and administrative
expenses) for further reductions in headcount, which were unplanned as of
December 31, 2002. Total payments for severance during the period were $0.6
million, resulting in a $1.1 million severance accrual at March 31, 2003.
In May 2003, the Company determined that it would no longer continue the
internal development of the solid streamer project within the Marine segment. As
such, certain assets were considered impaired and other assets related to the
project were written off as of March 31, 2003. See further discussion of this
impairment at Note 3 of Notes to Unaudited Consolidated Financial Statements.
(3) IMPAIRMENT OF MARINE ASSETS
During the first quarter of 2003, the Company initiated an evaluation of its
solid streamer project and in May concluded it would no longer internally pursue
this product for commercial development. In conjunction with this evaluation,
certain fixed assets and patented technology within the Marine segment were
deemed impaired in accordance with Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets". As a result of the impairment test, fixed assets of approximately $0.5
million and intangible assets totaling approximately $0.6 million were
considered impaired and written off as a charge against earnings in the first
quarter of 2003. In addition, inventory associated with this project of
approximately $0.2 million was written off and included within research and
development expenses at March 31, 2003.
6
(4) STOCK-BASED COMPENSATION
If the Company had elected to recognize compensation expense using a fair
value approach, net loss, basic loss per share and diluted loss per share for
the periods presented would have been reduced as follows (in thousands, except
per share amounts):
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
-------- --------
Net loss applicable to common shares....... $(5,279) $(5,997)
Deduct: Stock-based employee compensation
expense determined under fair value
methods for all awards.................. $ (641) $ (779)
Pro forma net loss......................... $(5,920) $(6,776)
Basic and diluted loss per common
share - as reported .................... $ (0.10) $ (0.12)
Pro forma basis and diluted
loss per common share................... $ (0.12) $ (0.13)
</Table>
Effective March 31, 2003 the Company granted its President and Chief
Executive Officer stock options to purchase 1,325,000 shares of common stock of
the Company at an exercise price of $6.00 per share under the Company's proposed
2003 Stock Option Plan (the "Plan"). The options will vest in equal monthly
installments over a three-year period beginning on the anniversary of the date
of grant and have a term of ten years. The granting of the options is subject to
the approval of the Plan by the Company's stockholders at the Company's 2003
annual meeting of Shareholders.
(5) 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 months ended March 31, 2003 and 2002 is as follows (in
thousands):
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
------------ ------------
Net sales:
Land .......................... $ 32,596 $ 17,611
Marine ........................ 8,581 12,602
------------ ------------
Total ......................... $ 41,177 $ 30,213
============ ============
Depreciation and amortization:
Land .......................... $ 1,362 $ 1,498
Marine ........................ 912 434
Corporate ..................... 1,300 1,060
------------ ------------
Total ......................... $ 3,574 $ 2,992
============ ============
Loss from operations:
Land ......................... $ 1,395 $ (6,626)
Marine ....................... (1,876) 2,506
Corporate .................... (4,576) (3,413)
------------ ------------
Total ........................ $ (5,057) $ (7,533)
============ ============
</Table>
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Total assets:
Land ......................... $ 108,588 $ 102,064
Marine ....................... 64,155 62,020
Corporate .................... 62,079 84,361
------------ ------------
Total ........................ $ 234,822 $ 248,445
============ ============
</Table>
7
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Total assets by geographic area:
North America ................ $ 196,412 $ 205,640
Europe ....................... 37,392 41,679
United Arab Emirates ......... 1,018 1,126
------------ ------------
Total ........................ $ 234,822 $ 248,445
============ ============
</Table>
Intersegment sales are insignificant for all periods presented. Corporate
assets include all assets specifically related to corporate personnel and
operations and all facilities and manufacturing machinery and equipment that are
jointly utilized by segments. 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):
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
------------ ------------
2003 2002
------------ ------------
Asia ................................ $ 13,662 1,444
North America ....................... 10,274 11,064
Europe .............................. 5,760 7,958
Latin America ....................... 4,488 2,367
Commonwealth of Independent States .. 3,580 6,081
Africa .............................. 3,034 939
Middle East ......................... 373 360
Other ............................... 6 --
------------ ------------
$ 41,177 $ 30,213
============ ============
</Table>
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.
(6) INVENTORIES
A summary of inventories, net of reserves, is as follows (in thousands):
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Raw materials ..................... $ 26,369 $ 31,447
Work-in-process ................... 5,927 5,781
Finished goods .................... 15,265 12,782
------------ ------------
$ 47,561 $ 50,010
============ ============
</Table>
During the first quarter of 2003, inventory of approximately $0.2 million
was written off and included within research and development expenses. This
write-off relates to the cancellation of the solid streamer project within the
Marine segment. See further discussion at Note 3 of Notes to Unaudited
Consolidated Financial Statements. In addition, an unrelated inventory
obsolescence charge of $0.3 million was reflected in cost of sales related to
the closure of the Company's Alvin, Texas manufacturing facility.
The Company has developed a program to reduce its inventory to a level which
does not exceed the Company's near-term requirements. Based upon this program,
the Company believes upon disposition of this inventory no significant
losses will be incurred in excess of its current reserve estimates.
As part of the Company's strategic direction, the Company is increasing the
use of contract manufacturers as an alternative to their own manufactured
products. Under many of the Company's outsourcing arrangements, its
manufacturing partners first utilize the Company's on-hand inventory, then
directly purchase inventory at agreed-upon levels to meet the Company's
forecasted demand. If demand proves to be less than the Company originally
forecasted, its manufacturing partners have the right to require the Company to
purchase any excess or obsolete inventory that its partners purchased on their
behalf. Should the Company be required to purchase inventory pursuant to these
provisions, the Company may be required to expend large sums of cash for
inventory that it may never utilize. Such purchases could materially and
adversely effect the Company's financial position and results of operations. The
8
Company's outsourcing activity increases the risk that they might be required to
purchase excess or obsolete inventory. Historically, the Company has not been
required to purchase any excess or obsolete inventory under their outsourcing
arrangements.
(7) ACCOUNTS AND NOTES RECEIVABLE
A summary of accounts receivable is as follows (in thousands):
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Accounts receivable, principally trade .... $ 32,100 $ 20,420
Allowance for doubtful accounts ........... (1,540) (1,675)
------------ ------------
Accounts receivable, net .................. $ 30,560 $ 18,745
============ ============
</Table>
The original recorded investment in notes receivable, excluding accrued
interest, for which a reserve has been recorded was $24.1 million at March 31,
2003. A summary of notes receivable, accrued interest and allowance for loan
loss is as follows (in thousands):
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Notes receivable and accrued interest ........ $ 28,403 $ 28,422
Less allowance for loan loss ................. (9,789) (10,228)
------------ ------------
Notes receivable, net ........................ 18,614 18,194
Less current portion notes receivable, net ... 12,483 6,137
------------ ------------
Long-term notes receivable ................... $ 6,131 $ 12,057
============ ============
</Table>
(8) NON-CASH ACTIVITY
During the first quarter of 2003, the Company transferred $1.9 million of
inventory at cost to rental equipment in connection with leasing arrangements
with marine customers.
(9) LOSS PER COMMON SHARE
Basic loss per common share is computed by dividing net loss applicable to
common shares by the weighted average number of common shares outstanding during
the period. Diluted loss per common share is determined on 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. Basic and diluted loss per share are the same for
the quarters ended March 31, 2003 and 2002, as all potential common shares were
anti-dilutive. 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"). 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 loss per common share.
(10) LONG TERM DEBT AND LEASE OBLIGATIONS
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.
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 March 31,
2003 was $2.1 million.
9
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 a former shareholder of Pelton, bearing interest at
8.5% per year. The note was paid in full in February 2003.
In August 2001, the Company sold its corporate headquarters and
manufacturing facility located in Stafford, Texas for $21.0 million.
Simultaneous to the sale, 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 was recorded as a twelve-year $21.0 million lease obligation with an
implicit interest rate of 9.1%. The unpaid balance at March 31, 2003 was $19.5
million. 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. If the Company fails to meet the
tangible net worth requirements of this lease for any four consecutive quarters
during the first five years of the lease, the Company is required to provide a
letter of credit to the landlord of the property in the amount of $1.5 million.
The Company has not met this requirement for the past three consecutive quarters
and does not expect to meet this requirement at the end of the second quarter of
2003. In addition to the above lease agreement, the Company has other capital
leases totaling $0.2 million at March 31, 2003.
A summary of future principal obligations under the notes payable and lease
obligations is as follows (in thousands):
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2003......................................... $ 1,336
2004......................................... 32,864
2005......................................... 1,883
2006......................................... 1,489
2007......................................... 1,610
2008 and thereafter.......................... 13,584
----------
Total........................................ $ 52,766
==========
</Table>
(11) DEFERRED INCOME TAX
In the second quarter of 2002, the Company established an additional
valuation allowance to fully reserve for its net deferred tax assets and has
continued to maintain a full valuation allowance. The Company's net deferred
assets are primarily net operating loss carryforwards. The establishment of this
valuation allowance does not affect the Company's ability to reduce future tax
expense through utilization of prior years net operating losses. Income tax
expense of $0.6 million for the three months ended March 31, 2003 reflects only
state and foreign taxes.
The valuation allowance was calculated in accordance with the provisions of
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 not only by
industry conditions, but also 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 technology,
the Company's cumulative loss in the most recent three-year period, including
the net loss reported in 2002 and the first quarter of 2003, represented
sufficient negative evidence to establish an additional valuation allowance
under the provisions of SFAS No. 109. The Company will 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.
(12) COMPREHENSIVE LOSS
The components of comprehensive loss are as follows (in thousands):
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
------------ ------------
Net loss .................................... $ (5,279) $ (4,542)
Foreign currency translation adjustment ..... (156) (754)
------------ ------------
Comprehensive loss .......................... $ (5,435) $ (5,296)
============ ============
</Table>
10
(13) ACQUISITIONS
In July 2002, the Company acquired all of the outstanding capital stock of
AXIS Geophysics, Inc. ("AXIS") for $2.5 million of cash and issued a $2.5
million three-year unsecured promissory note. The Company is obligated to 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 geological data to provide customers more accurate and higher
quality data that can result in improved reservoir characterizations.
In May 2002, the Company acquired certain assets of S/N Technologies
("S/N") for $0.7 million of cash. The assets acquired from S/N included
proprietary technology applicable to solid streamer products used to acquire 2D,
3D and high-resolution marine seismic data. However, in May 2003 the Company
determined that it would no longer continue the internal development of the
solid streamer project. As such, the acquired assets of S/N were impaired and
other assets associated with this project were written off as of March 31, 2003.
See further discussion of this impairment at Note 3 of Notes to Unaudited
Consolidated Financial Statements.
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 and S/N are as follows (in thousands):
<Table>
<Caption>
AXIS S/N
------------ ------------
Fair values of assets and liabilities
Net current assets ................................ $ 395 $ --
Property, plant and equipment ..................... 354 85
Intangible assets ................................. 1,142 603
Goodwill .......................................... 3,296 --
Long-term liabilities ............................. (224) --
------------ ------------
Total allocated purchase price ............ 4,963 688
Less non-cash consideration -- note payable ......... 2,500 --
Less cash of acquired business ...................... 501 --
------------ ------------
Cash paid for acquisition, net of cash acquired ..... $ 1,962 $ 688
============ ============
</Table>
The consolidated results of operations of the Company include the results of
AXIS and S/N from the date of acquisition. Pro-forma results prior to the
acquisition date were not material to the Company's consolidated results of
operations.
The intangible asset of AXIS relates to proprietary technology, which is
being amortized over a 4-year period. The goodwill of AXIS was assigned to the
digital land products reporting unit, a reporting unit within the Company's Land
division.
(14) COMMITMENTS AND CONTINGENCIES
Legal Matters. 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.
Product Warranty Liabilities. The Company warrants that all manufactured
equipment will be free from defects in workmanship, materials and parts.
Warranty periods typically range from 90 days to three years from the date of
original purchase, depending on the product. The Company provides for estimated
warranty as a charge to cost of sales at time of sale, which is when estimated
future expenditures associated with such contingency becomes probable and
reasonably estimated. However, new information may become available, or
circumstances (such as applicable laws and regulations) may change, thereby
resulting in an increase or decrease in the amount required to be accrued for
such matters (and therefore a decrease or increase in reported net income in the
period of such change). A summary of warranty activity is as follows (in
thousands):
11
<Table>
Balance at December 31, 2002 ................................. $ 2,914
Accruals for warranties issued during the period ............. 248
Settlements made (in cash or in kind) during the period ...... (216)
------------
Balance at March 31, 2003 .................................... $ 2,946
============
</Table>
(15) REPURCHASE OF SERIES B AND SERIES C PREFERRED STOCK
In August 2002, the Company repurchased all the outstanding shares of
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%.
The Company records interest on this note at an effective rate of approximately
11% per year.
Under the terms of a registration rights agreement, SCF has the right to
demand that the Company 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 shares of Common Stock in the
public market could adversely affect the market price for Common Stock. If the
Company is acquired in a business combination pursuant to which the 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 the Company may be required to repurchase the warrants in
these limited circumstances, the warrants are classified as a current liability
on the balance sheet and the Company records any change in value as a credit or
charge to the consolidated statement of operations. The change in the fair value
of the warrants between January 1, 2003 and March 31, 2003 resulted in other
income of approximately $0.9 million. The fair value of the warrants was $1.3
million at March 31, 2003. Fair value was determined using the Black-Scholes
valuation model. The key variables used in valuing the warrants were
contractually specified and 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%.
(16) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations". This Statement addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. The provisions of this Statement are effective for fiscal years beginning
after June 15, 2002. The Company adopted SFAS No. 143 on January 1, 2003 and its
adoption did not have a significant impact on our reported results of operations
and financial condition.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity is
recognized when the liability is incurred. Under EITF Issue 94-3, a liability
for an exit cost was recognized at the date of an entity's commitment to an exit
plan. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. For all exit and disposal
activities initiated on or before December 31, 2002, the Company continued to
follow EITF No. 94-3.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - and Amendment of FASB No. 123." SFAS
No. 148 amends FASB No. 123, "Accounting for Stock-Based Compensation", to
provide alternative methods of transition for a voluntary change in fair value
based method of accounting for stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company has elected to continue to follow
the intrinsic value method of accounting prescribed by Accounting Principal
Board Opinion No. 25. See Note 4 of Notes to Unaudited Consolidated Financial
Statements for the pro forma results if the Company had adopted SFAS No. 123.
12
In November 2002, the FASB issued Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others: an Interpretation of FASB
Statements No. 5, 67, and 107 and Rescission of FASB Interpretation No. 34". FIN
No. 45 clarifies the requirements of FASB No. 5, "Accounting for Contingencies",
relating to the guarantor's accounting for, and disclosure of, the issuance of
certain types of guarantees. The initial recognition and measurement provisions
of FIN No. 45 are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The Company does not expect the requirements
of FIN No. 45 to have a material impact on our results of operations or
financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities", which amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under SFAS No. 133. This statement is
effective for contracts entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. The adoption of this
statement is not expected to have a significant impact on the Company's results
of operations and financial position.
(17) SUBSEQUENT EVENTS
On April 3, 2003, the Company invested approximately $3.0 million in Series
B Preferred Securities of Energy Virtual Partners, Inc. ("EVP"). Upon
consummation of this investment, the Company owns approximately 22% of the
outstanding ownership interests of EVP and 11% of the outstanding voting
interests of EVP. EVP provides asset management services to large oil and gas
companies to enhance the value of their oil and gas properties. Robert P.
Peebler, the Company's President and Chief Executive Officer, founded EVP in
April 2001, and served as EVP's President and Chief Executive Officer until
joining I/O in March 2003. Mr. Peebler has become the Chairman of EVP. This
investment will be accounted for under the cost method basis for investment
accounting.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
ANNOUNCEMENT OF PRESIDENT AND CHIEF EXECUTIVE OFFICER AND CHIEF OPERATING
OFFICER
Effective March 31, 2003, we named Robert P. Peebler as our President and
Chief Executive Officer. Mr. Peebler has been one of our directors since 1999.
Mr. Peebler has had a 30-year career in the oil and gas industry. He began as a
field engineer and spent sixteen years with Schlumberger. While at Schlumberger,
he held technical, marketing and management positions, including five years as
Vice President of North America Wireline Operations, and two years as Global
Vice President of Strategic Marketing for Oil Field Services. Mr. Peebler joined
Landmark Graphics as Vice President of Marketing in 1989, and was appointed
Chief Executive Officer in 1992. He continued as Chief Executive Officer for two
years after Halliburton acquired Landmark in 1996, and later became
Halliburton's Vice President of e-Business and New Ventures. Mr. Peebler left
Halliburton to start EVP in the spring of 2001.
On May 1, 2003, we named Jorge Machnizh as our Executive Vice President and
Chief Operating Officer, effective May 12, 2003. Mr. Machnizh brings significant
seismic industry experience to I/O, including senior executive positions with
large seismic acquisition contractors. Most recently, Mr. Machnizh served as
Vice President - Operations for North and South America for Landmark Graphics.
SUMMARY REVIEW AND OUTLOOK
Seismic activity continues to reflect a challenging exploration environment,
as most of our seismic contractor customers are still cutting back their
operations and consolidating their businesses. Despite this trend, oil companies
have stated that they lack an inventory of new drilling prospects. As a result,
we are beginning to see several oil companies increasing their planned 2003
drilling budgets, some of which should result in increases in geophysical
spending, but not likely until the second half of 2003 at the earliest. We are
however seeing some expansion from Chinese and Eastern European seismic
contractors. In particular, Chinese seismic contractors are increasingly active
not only within their own country, but also in other international areas. BGP,
an international seismic contractor headquartered in China, purchased our first
VectorSeis(R) System Four(TM) acquisition system which we delivered in the first
quarter of 2003.
Our strategy in response to the current prevailing industry conditions
remains three-fold. We seek to lower costs, increase flexibility, and decrease
research and development cycle time via outsourcing. Second, we plan to continue
to focus on accelerating the adoption rate of VectorSeis technology in markets,
including exploring new potential business models to capture additional value.
Finally, we intend to broaden the VectorSeis product and service offering to
include all phases of the oil field lifecycle, including production via
permanent down-hole sensors.
13
Through our outsourcing strategy, we seek to reduce both the unit cost of
our products and our fixed cost structure, as well as to speed our research and
development cycle for non-core technologies. Substantial cost savings are
expected once we have completely exited our Alvin, Texas manufacturing facility,
which is currently scheduled for the end of the second quarter of this year.
Additionally, we have closed our Norwich, U.K. geophone stringing operation,
with operations moved to our leased facility in Jebel Ali and outsourced to
various partners. We continue to work with all of our outsourced manufacturing
suppliers to reduce the unit costs of our products, and have made substantial
progress on that front with the providers of our land acquisition system
products.
Additionally, during the first quarter of 2003 we initiated an evaluation of
the solid streamer project. Upon completion of our review in May, we determined
that we would no longer internally pursue this product for commercial
development. The presence of established product competition and an increased
timeline related to the anticipated release of our version of the solid streamer
were contributing factors in our decision to discontinue this project. Total
charges related to discontinuing this project are approximately $1.3 million
($1.1 million included in impairment of long-lived assets and $0.2 million in
research and development expenses) for the first quarter of 2003.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002
Net Sales: Net sales of $41.2 million for the three months ended March 31,
2003 increased $11.0 million, or 36%, compared to the corresponding period last
year. The increase is due to an increase in land seismic activity with our
non-Western contractors, especially in China. Our Land Division's net sales
increased $15.0 million, or 85%, to $32.6 million and our Marine Division's net
sales decreased $4.0 million to $8.6 million, or 32%, compared to the prior
year.
Cost of Sales: Cost of sales of $32.4 million for the three months ended
March 31, 2003 increased $9.2 million, or 39%, compared to the corresponding
period last year. Cost of sales of our Land Division was $26.0 million and cost
of sales of our Marine Division was $6.4 million. Cost of sales in the current
quarter increased as a result of the increase in revenues.
Gross Profit and Gross Profit Percentage: Gross profit of $8.8 million for
the three months ended March 31, 2003 increased $1.8 million, or 26%, compared
to the corresponding period last year. Gross profit percentage for the three
months ended March 31, 2003 was 21% compared to 23% in the prior year. The
decline in our gross margin percentage is primarily due to four reasons: first,
during this transition period as we transform our business by outsourcing most
of our non-core manufacturing, we continue to experience the unabsorbed burden
of our fixed and semi-fixed overhead, primarily associated with our Alvin, Texas
facility; second, we had a decline in our Marine sales, which historically
contributed a higher gross margin percentage of our overall product mix; third,
in the first quarter of 2003, we delivered our first VectorSeis System Four
acquisition system which resulted in a discounted margin primarily from the
introductory price necessary to penetrate the market with our first system; and
fourth, severance expenses for workforce reductions of $0.4 million.
Research and Development: Research and development expense of $5.5 million
for the three months ended March 31, 2003 decreased $1.5 million, or 21%,
compared to the corresponding period last year. This decrease primarily reflects
reduced staffing levels and lower prototype expenses resulting from the
completion of the final stages of VectorSeis commercialization in the fourth
quarter of 2002. This decrease was partially offset by $0.2 million in expenses
related to the cancellation of our solid streamer project within the Marine
segment. See further discussion at Note 3 of Notes to Unaudited Consolidated
Financial Statements. After completion of our lightweight, cable-based
VectorSeis ground system in the second quarter of 2003, we expect a further
significant reduction in our research and development expense.
Marketing and Sales: Marketing and sales expense of $2.8 million for the
three months ended March 31, 2003 increased $0.3 million, or 11%, compared to
the corresponding period last year. The increase is primarily related to higher
sales and commissions on those sales.
General and Administrative: General and administrative expense of $4.1
million for the three months ended March 31, 2003 decreased $0.6 million, or
12%, compared to the corresponding period last year. The decrease in general and
administrative expense is primarily attributable to lower compensation expense
due to reductions in personnel, partially offset by the inclusion of AXIS, which
was acquired in July 2002, and severance expenses for workforce reductions of
$0.1 million.
14
Amortization of Intangibles: Amortization of intangibles of $0.3 million for
the three months ended March 31, 2003 remained constant compared to the
corresponding period last year.
Impairment of Long-Lived Assets: Impairment of long-lived assets of $1.1
million was recorded in the first quarter of 2003 related to the cancellation of
our solid streamer project within the Marine segment. As such, certain assets
were impaired and other related assets and costs were written off. See further
discussion of this impairment at Note 3 of Notes to Unaudited Consolidated
Financial Statements.
Net Interest and Other Expense: Total net interest and other expense of $0.5
million for the three months ended March 31, 2003 increased $0.8 million
compared to the corresponding period last year. The increase is primarily due to
increased interest expense from the issuance of the SCF promissory note,
partially offset by fluctuations in exchange rates and increased interest income
resulting from an increase in notes receivable.
Fair Value Adjustment of Warrant Obligation: The fair value adjustment of
the warrant obligation totaling $0.9 million is due to a change in the fair
value between January 1, 2003 and March 31, 2003 of the common stock warrants,
as previously discussed in Note 15 of Notes to Unaudited Consolidated Financial
Statements. No comparable adjustment was recorded in the first quarter of 2002
as the warrants were granted in August 2002.
Income Tax Expense (Benefit): Income tax expense of $0.6 million for the
three months ended March 31, 2003 increased $3.3 million compared to the
corresponding period last year. Income tax expense in the first quarter of 2003
reflects only state and foreign taxes as the Company continues to maintain a
full valuation allowance for its net deferred tax assets. In the first quarter
of 2002 we recognized an income tax benefit of $2.7 million from our net
operating losses. As discussed further in Note 11 of Notes to Unaudited
Consolidated Financial Statements, in the second quarter of 2002 we began to
fully reserve for our net deferred tax assets.
Preferred Stock Dividends: Preferred stock dividends for the three months
ended March 31, 2002 are related to previously outstanding Series B and Series C
Preferred Stock (the "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). As discussed in Note 15 of Notes to
Unaudited Consolidated Financial Statements, we repurchased the Preferred Stock
on August 6, 2002. As a result, there were no preferred stock dividends for the
three months ended March 31, 2003.
LIQUIDITY AND CAPITAL RESOURCES
We have typically financed operations from internally generated cash and
funds from equity financings. Cash and cash equivalents were $56.3 million at
March 31, 2003, a decrease of $20.8 million, or 27%, compared to December 31,
2002. This decrease is primarily due to net cash used in operating activities of
$18.8 million. The net cash used in operating activities is mainly due to an
increase in accounts and notes receivables, resulting from sales that were
realized but not yet collected by the end of the first quarter of 2003, and a
decrease in our accounts payable and accrued expenses.
Cash used in investing activities was $1.4 million for the three months
ended March 31, 2003, an increase of $0.3 million compared to the year ended
March 31, 2002. The principal investing activities were $1.4 million relating to
capital expenditure projects, of which $0.4 million related to rental equipment
which has been leased to a marine customer. Planned capital expenditures for the
remainder of 2003 are approximately $4.6 million.
Cash used in financing activities was $0.6 million for the three months
ended March 31, 2003, an increase of $0.5 million compared to the three months
ended March 31, 2002. The principal use of cash was $0.8 million on the
repayment of long-term debt, partially offset by proceeds of $0.2 million from
the issuance of common stock under our Employee Stock Purchase Plan.
We believe the combination of existing working capital of $116.1 million as
of March 31, 2003, including current cash on hand of $56.3 million, will be
adequate to meet anticipated capital and liquidity requirements for the
foreseeable future even if the prolonged downturn in the seismic equipment
market continues. The most significant use of cash over the next two-year period
will be the requirement to repay the $31.0 million unsecured promissory note due
in May 2004. In May 2003, the interest rate related to this note increases from
8% to 13%. We are currently evaluating our alternatives regarding this note
which may include its refinancing or paying down the note through use of our
existing cash balances or a combination of both. Other significant uses of cash
in the near term relate to our $3.0 million investment in EVP, which was paid in
April 2003. See further discussion in Note 17 of Notes to Unaudited Consolidated
Financial Statements.
15
As discussed in Note 10 of Notes to Unaudited Consolidated Financial
Statements, we have not met the tangible net worth test of our twelve-year lease
obligation for the past three consecutive quarters and we currently do not
expect to meet this test at the end of the second quarter of 2003. Therefore, we
will be required to provide a letter of credit in the amount of $1.5 million to
the landlord of the property.
Based on our current cash levels and estimated uses of cash over the near
term, we believe we will be able to sufficiently fund our planned operations.
However, there can be no assurance that our sources of cash will be able to
support our capital requirements in the long-term, and we may be required to
issue additional debt or equity securities in the future to meet our capital
requirements. There can be no assurance we would be able to issue additional
equity or debt securities in the future on terms that are acceptable to us or at
all.
CRITICAL ACCOUNTING POLICIES
Refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 for a complete discussion of the Company's critical accounting
policies. There have been no material changes in the current period regarding
these critical accounting policies.
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 their 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 the results of
operations and financial condition. See Management's Discussion and Analysis of
Results of Operations and Financial Condition - 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:
o our expected revenues, operating profit and net income for 2003 or the
nine months ended December 31, 2003;
o our plans for facility closures and other future business
reorganizations;
o the adequacy of our liquidity and capital resources;
o charges we expect to take for future reorganization activities;
o savings we expect to achieve from our restructuring activities;
o future demand for seismic equipment and services;
o future commodity prices;
o future economic conditions;
o anticipated timing of commercialization and capabilities of products
under development;
o our expectations regarding future mix of business and future asset
recoveries;
16
o our expectations regarding realization of deferred tax assets;
o our beliefs regarding accounting estimates we make;
o the result of pending or threatened disputes and other contingencies;
and
o 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 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, another large 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.
We may not gain rapid market acceptance for VectorSeis products, which could
materially and adversely affect our results of operations and financial
condition. We have spent considerable time and capital developing our VectorSeis
products line. Because our VectorSeis products rely on a new digital sensor, our
ability to sell our VectorSeis products will depend on acceptance of digital
sensor by geophysical contractors and exploration and production companies. If
our customers do not believe that our digital seismic sensors deliver higher
quality data with greater operational efficiency, our results of operations and
financial condition will be adversely affected.
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 customers do not accept our new products as rapidly as we
anticipate, our business and results of operations may be materially and
adversely affected.
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 have significantly reduced our corporate and operational
headcount, closed certain manufacturing facilities and combined 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 manufacturing 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 may suffer. In addition, by undertaking these
activities, we run the risk that the reputations and competitiveness of our
products and services may deteriorate as a result of the reduction of our
17
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 are realized, our revenues, profitability and cash
flow may decline. In addition, as we come to rely more heavily on contract
manufacturers, we may have fewer personnel resources with expertise to manage
problems that may arise from these third-party arrangements.
Our outsourcing relationships may require us to purchase inventory when
demand for products produced by third-party manufacturers is low. Under many of
our outsourcing arrangements, our manufacturing partners purchase agreed upon
inventory levels to meet our forecasted demand. If demand proves to be less than
we originally forecasted, our manufacturing partners have the right to require
us to purchase any excess or obsolete inventory. Should we be required to
purchase inventory pursuant to these provisions, we may be required to expend
large sums of cash for inventory that we may never utilize. Such purchases could
materially and adversely effect our financial position and our results of
operations.
Our recent hire of a new Chief Executive Officer and Chief Operating Officer
may result in a change in strategy which may materially and adversely affect our
business and results of operations, particularly in the near-term. We recently
hired a new Chief Executive Officer in March 2003 and a new Chief Operating
Officer in May 2003 and may recruit other senior managers. It will take some
time for our new executives to learn about our various businesses and to develop
strong working relationships with our operating managers. To the extent we
decide to change our strategy as a result of these hires, our business and
results of operations may be materially and adversely affected, particularly in
the near-term.
Oil and gas companies and geophysical contractors will reduce demand for our
products if there is further reduction in the level of exploration expenditures.
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 revenues from foreign sales, which
pose additional risks. Sales to customers outside of North America accounted for
approximately 75% of our consolidated net sales for the three months ended March
31, 2003. 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:
o expropriation and nationalization;
o political and economic instability;
o armed conflict and civil disturbance;
o currency fluctuations, devaluations and conversion restrictions;
o confiscatory taxation or other adverse tax policies;
o governmental activities that limit or disrupt markets, restrict payments
or the movement of funds; and
o governmental activities that may result in the deprivation of
contractual rights.
The majority of our foreign sales are denominated in United States dollars.
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.
18
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.
The rapid pace of technological change in the seismic industry requires us
to make substantial research and development 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 from 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.
Our competitors have expanded or improved their product lines, which has
adversely affected our results of operations. For instance, one competitor
introduced a lightweight land seismic system that we believe has made our
current land system more difficult to sell at acceptable margins. In addition,
one of our competitors 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.
Further consolidation among our significant customers could materially and
adversely affect us. Historically, a relatively small number of customers have
accounted for the majority of our net sales in any period. In recent years, our
customers have been rapidly 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 compound the
uncertainty associated with our sales cycle. Our gross margins are affected by
the following factors:
o pricing pressures from our customers and competitors;
o product mix sold in a period;
o inventory obsolescence;
o unpredictability of warranty costs;
o changes in sales and distribution channels;
o availability and pricing of raw materials and purchased components; and
o 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 not all 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
19
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 upon 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.
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. In addition,
changes in governmental regulations applicable to our customers may reduce
demand for our products. For instance, recent regulations regarding the
protection of marine mammals in the Gulf of Mexico may reduce demand for our
airguns and other marine products.
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. 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 part of the repurchase of the Company's outstanding Preferred Stock, 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 March 31, 2003, would have increased the fair value of
warrants resulting in an increase to the Company's net loss of approximately
$1.0 million or $(.02) per common share. A $1 decrease in the Company's common
stock price at March 31, 2003, would have decreased the fair value of warrants
resulting in a decrease to the Company's net loss of approximately $0.8 million
or $.01 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 May 9, 2003 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 known 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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
99.1 Certification of Robert P. Peebler, President and Chief Executive Officer,
Pursuant to 18 U.S.C. Section 1350.
99.2 Certification of Brad Eastman, Vice President, Chief Administrative Officer
and Secretary, Pursuant to 18 U.S.C. Section 1350.
</Table>
(b) Reports on Form 8-K.
On March 31, 2003, we filed a Current Report on Form 8-K reporting
under Item 5. Other Events and Regulation FD Disclosure the appointment of
Robert P. Peebler as the Company's President and Chief Executive Officer.
21
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 May 15, 2003.
INPUT/OUTPUT, INC.
By /s/ ROBERT P. PEEBLER
--------------------------------------
President and Chief Executive Officer
22
CERTIFICATIONS
I, Robert P. Peebler, 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 functions):
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 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/ Robert P. Peebler
-------------------------------------
Robert P. Peebler
President and Chief Executive Officer
Date: May 15, 2003
23
CERTIFICATIONS
I, Brad Eastman, 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 functions):
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
annual report whether 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/ Brad Eastman
------------------------------------
Brad Eastman
Vice President, Chief Administrative
Officer and Secretary
Date: May 15, 2003
24
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
99.1 Certification of Robert P. Peebler, President and Chief Executive Officer,
Pursuant to 18 U.S.C. Section 1350.
99.2 Certification of Brad Eastman, Vice President, Chief Administrative Officer
and Secretary, Pursuant to 18 U.S.C. Section 1350.
</Table>