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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: AUGUST 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
_____________ TO ____________
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 (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
11104 WEST AIRPORT BLVD., 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 August 31, 1999 there were 50,669,031 shares of common stock, par value $0.01
per share, outstanding.
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INPUT/OUTPUT, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED AUGUST 31, 1999
PART I. Financial Information. PAGE
----
Item 1. Financial Statements.
Consolidated Balance Sheets
August 31, 1999 and May 31, 1999................................................................. 2
Consolidated Statements of Operations
Three months ended August 31, 1999 and 1998..................................................... 3
Consolidated Statements of Cash Flows
Three months ended August 31, 1999 and 1998..................................................... 4
Notes to Consolidated Financial Statements......................................................... 5
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition..................................................................... 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................. 22
PART II. Other Information.
Item 2. Changes in Securities and Use of Proceeds................................................... 22
Item 6. Exhibits and Reports on Form 8-K............................................................ 24
1
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS AUGUST 31, MAY 31,
1999 1999
---------- --------
Current assets:
Cash and cash equivalents................................................. $ 86,240 $ 75,140
Trade accounts receivable, net............................................ 19,247 21,617
Trade notes receivable, net............................................... 20,882 21,907
Income taxes receivable................................................... 11,223 15,000
Inventories, net.......................................................... 90,582 95,825
Deferred income tax asset, net............................................ 25,751 27,568
Prepaid expenses.......................................................... 1,993 1,495
-------- --------
Total current assets.............................................. 255,918 258,552
Long-term trade notes receivable, net..................................... 14,065 17,616
Deferred income tax asset, net............................................ 23,364 18,739
Property, plant and equipment, net........................................ 62,347 62,979
Goodwill, net............................................................. 85,878 87,558
Other assets.............................................................. 5,901 6,304
-------- --------
Total assets...................................................... $447,473 $451,748
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, principally trade.......................................... $ 6,702 $ 10,526
Current installments of long-term debt....................................... 1,088 1,067
Accrued expenses ............................................................ 26,247 33,347
-------- --------
Total current liabilities........................................... 34,037 44,940
Long-term debt............................................................... 8,667 8,947
Other liabilities............................................................ 1,013 887
Commitments and contingencies
Stockholders' equity:
Cumulative convertible preferred stock, $.01 par value; authorized
5,000,000 shares, issued and outstanding 55,000 shares at August 31,
1999 and 40,000 shares at May 31, 1999 (liquidation value of
$55.1 million)......................................................... 1 --
Common stock, $.01 par value; authorized 100,000,000 shares;
issued 50,669,031 shares at August 31, 1999 and 50,663,358
shares at May 31, 1999................................................... 507 507
Additional paid-in capital................................................... 343,697 327,845
Retained earnings............................................................ 63,134 72,455
Accumulated other comprehensive loss......................................... (3,327) (3,549)
Unamortized restricted stock compensation.................................... (256) (284)
-------- --------
Total stockholders' equity........................................ 403,756 396,974
-------- --------
Total liabilities and stockholders' equity........................ $447,473 $451,748
======== ========
See accompanying notes to consolidated financial statements.
2
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
AUGUST 31,
-------------------------
1999 1998
---- ----
Net sales.......................................................................... $ 29,979 $ 66,995
Cost of sales 23,994 44,716
----------- -----------
Gross profit............................................................. 5,985 22,279
----------- -----------
Operating expenses:
Research and development........................................................ 7,203 9,242
Marketing and sales............................................................. 2,881 4,013
General and administrative...................................................... 6,914 6,419
Amortization of intangibles..................................................... 1,925 1,860
----------- -----------
Total operating expenses................................................. 18,923 21,534
----------- -----------
Earnings (loss) from operations.................................................... (12,938) 745
Interest expense................................................................... (212) (242)
Other income ...................................................................... 1,034 2,843
----------- -----------
Earnings (loss) before income taxes................................................ (12,116) 3,346
Income tax (benefit) expense....................................................... (3,877) 1,071
----------- -----------
Net (loss) earnings................................................................ (8,239) 2,275
----------- -----------
Preferred stock dividend........................................................... 1,081 --
----------- -----------
Net (loss) earnings applicable to common
stockholders....................................................................... $ (9,320) $ 2,275
=========== ===========
Basic (loss) earnings per common share............................................. $ (0.18) $ 0.05
=========== ===========
Weighted average number of common
shares outstanding................................................................. 50,667,007 44,585,501
=========== ===========
Diluted (loss) earnings per common share........................................... $ (0.18) $ 0.05
=========== ===========
Weighted average number of diluted
common shares outstanding.......................................................... 50,667,007 44,702,268
=========== ===========
See accompanying notes to consolidated financial statements.
3
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
AUGUST 31,
---------------------
1999 1998
---- ----
Cash flows from operating activities:
Net (loss) earnings ..................................................................... $ (8,239) $ 2,275
Adjustments to reconcile net (loss) earnings to net cash used in operating
activities:
Depreciation and amortization ........................................................ 5,332 4,706
Amortization of restricted stock compensation ........................................ 28 156
Deferred income tax benefit .......................................................... (2,808) (823)
Inventory obsolescense expense ....................................................... 340 415
Bad debt expense and loan losses ..................................................... -- 800
Changes in assets and liabilities, net of effect of above provisions:
Accounts and notes receivable ........................................................ 6,946 10,022
Inventories .......................................................................... 4,903 (5,597)
Leased equipment ..................................................................... -- 335
Accounts payable and accrued expenses ................................................ (10,998) (15,216)
Income taxes payable/receivable ...................................................... 3,777 (3,454)
Other ................................................................................ 273 (645)
-------- --------
Net cash used in operating activities .......................................... (446) (7,026)
Cash flows from investing activities:
Purchases of property, plant and equipment ........................................... (3,046) (5,145)
Recovery of other assets ............................................................. -- 146
-------- --------
Net cash used in investing activities .......................................... (3,046) (4,999)
Cash flows from financing activities:
Payments on long-term debt ........................................................... (259) (237)
Proceeds from exercise of stock options .............................................. 101 19
Preferred stock dividends ............................................................ (60) --
Net proceeds from preferred stock offering ........................................... 14,804 --
-------- --------
Net cash provided by (used in) financing activities ............................ 14,586 (218)
Effect of change in foreign currency exchange rates on
cash and cash equivalents ............................................................ 6 (33)
-------- --------
Net increase (decrease) in cash and cash equivalents ................................. 11,100 (12,276)
Cash and cash equivalents at beginning of period ..................................... 75,140 72,275
-------- --------
Cash and cash equivalents at end of period ..................................... $ 86,240 $ 59,999
======== ========
See accompanying notes to consolidated financial statements.
4
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) GENERAL
The consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission. The financial statements reflect
all adjustments (consisting of normal recurring accruals and the charges
described in Note 2) which are, in the opinion of management, necessary to
fairly present such information. Certain amounts previously reported in the
consolidated financial statements have been reclassified to conform to the
current year presentation. Although the Company believes that the disclosures
are adequate to make the information presented not misleading, certain
information and footnote disclosures, including significant accounting
policies, normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to
such rules and regulations. It is suggested that these financial statements
be read in conjunction with the consolidated financial statements and the
notes thereto, as well as Item 7. "Management's Discussion and Analysis of
Results of Operations and Financial Condition," included in the Company's
Annual Report on Form 10-K for the year ended May 31, 1999, as filed with the
Securities and Exchange Commission.
(2) FIRST QUARTER CHARGES
During the first quarter of fiscal 2000, the Company recorded pretax
charges totaling $4.7 million ($3.2 million after giving effect to income
taxes, or $0.06 per share), comprised of $3.3 million primarily related to
employee severance arrangements and the closing of the Company's Ireland
facility (included in general and administrative expenses) and charges of
$1.4 million for product-related warranties (included in cost of sales).
These charges resulted from continued reduced customer demand for the
Company's equipment due to the deterioration in energy industry conditions
over the past 12 months and, more specifically, in the seismic services
sector. This deterioration resulted from, among other things, a widespread
downturn in exploration activity due to a decline in energy prices from
October 1997 through February 1999, and consolidation among energy producers.
Despite a recent recovery in commodity prices, energy producers' concerns
over the sustainability of higher prices for hydrocarbon production resulted
in lower exploration budgets by energy companies, which has resulted in
reduced demand for the Company's seismic data acquisition equipment. As of
August 31, 1999 there was approximately $1.1 million of accrued severance
costs, all of which will be paid by the end of December 2000.
(3) INVENTORIES
Inventories are stated at the lower of cost (primarily first-in,
first-out) or market. A summary of inventories follows (in thousands):
AUGUST 31, May 31,
1999 1999
---------- -------
Raw materials.................................. $53,442 $54,731
Work-in-process................................ 12,252 8,717
Finished goods................................. 39,329 48,624
------ ------
105,023 112,072
Less inventory reserves........................ 14,441 16,247
------ -------
$90,582 $95,825
======= =======
5
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- CONTINUED -
(4) EARNINGS PER SHARE
Basic (loss) earnings per common share is computed by dividing net
(loss) earnings applicable to common stockholders by the weighted average
number of common shares outstanding during the period. Diluted (loss)
earnings per common share is determined on the assumption that outstanding
dilutive stock options and other common stock equivalents have been exercised
and the aggregate proceeds as defined were used to reacquire Company common
stock using the average price of such common stock for the period.
The following table summarizes the calculation of net (loss) earnings
applicable to common stockholders, weighted average number of common shares
outstanding and weighted average number of diluted common shares outstanding
for purposes of the computation of basic (loss) earnings per common share and
diluted (loss) earnings per common share (in thousands, except share and per
share amounts):
FOR THE THREE MONTHS ENDED
AUGUST 31,
--------------------------
1999 1998
---- ----
Net (loss) earnings........................................... $(8,239) $2,275
Preferred stock dividend...................................... 1,081 --
------- ------
Net (loss) earnings applicable to common stockholders......... $(9,320) $2,275
======= ======
Weighted average number of common shares outstanding.......... 50,667,007 44,585,501
Stock options................................................. -- 116,767
Weighted average number of diluted
common shares outstanding..................................... 50,667,007 44,702,268
========== ==========
Basic (loss) earnings per common share........................ $(0.18) $0.05
======= =====
Diluted (loss) earnings per common share...................... $(0.18) $0.05
======= =====
At August 31, 1999 and 1998, there were 4,588,813 and 3,558,393,
respectively, of shares subject to stock options that were not included in the
calculation of diluted (loss) earnings per common share, because to do so would
have been antidilutive. In addition, the cumulative convertible preferred stock
has not been considered in the computation of diluted (loss) earnings per common
share because the effect would be antidilutive.
6
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- CONTINUED -
(5) STATEMENTS OF CASH FLOWS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. The Company
does not use or intend to use derivative instruments. Exchange rate fluctuations
have not had a material effect on the Company's Consolidated Statements of Cash
Flows. As of August 31, 1999 and May 31, 1999, the Company had approximately
$8.2 million and $2.3 million, respectively, of certificates of deposit with one
month original maturities that were used to secure standby and commercial
letters of credit.
Supplemental disclosures of cash flow information for the three months
ended August 31, 1999 and 1998 follow (in thousands):
1999 1998
---- ----
Cash paid (received) during the periods for:
Interest..................................... $ 212 $ 242
========= ======
Income taxes................................. $ (3,352) $5,313
========= ======
Non-cash financing activities:
Dividends on preferred stock................. $ 1,021 $ --
========= ======
(6) LONG TERM DEBT
A Company subsidiary has a $12.6 million original principal amount,
ten-year term loan secured by certain of its land and buildings located in
Stafford, Texas which includes the Company's executive offices, research and
development headquarters, and electronics manufacturing facility. The term loan,
which the Company has guaranteed under a Limited Guaranty, bears interest at a
fixed rate of 7.875% per annum. The Company leases all of the property from its
subsidiary under a master lease, which lease has been collaterally assigned to
the lender as security for the term loan. The term loan provides for penalties
for prepayment prior to maturity.
(7) COMPREHENSIVE EARNINGS
Comprehensive (loss) earnings includes all changes in a company's
equity (except those resulting from investments by and distributions to owners).
With respect to the Company, comprehensive (loss) earnings includes net (loss)
earnings, foreign currency translation adjustments and minimum pension
liabilities. Total comprehensive (loss) earnings for the three months ended
August 31, 1999 and 1998 follow (in thousands):
1999 1998
---- ----
Net (loss) earnings................................ $(8,239) $2,275
Foreign currency translation adjustments........... 222 (118)
------- ------
Total comprehensive (loss) earnings................ $(8,017) $2,157
======= ======
7
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
-CONTINUED-
(8) SEGMENT AND GEOGRAPHIC INFORMATION
Late in fiscal 1999, the Company initiated a fundamental reorganization
of its internal structure. As a result of this reorganization, the Company's
management now evaluates and reviews results based on two segments, Land and
Marine. This segment structure permits increased visibility and accountability
of costs and more focused customer service and product development. Prior to
such time, the Company's management made business decisions using consolidated
financial information. The Company has determined that it is impracticable to
obtain all of the applicable information for the first quarter of fiscal year
1999 to report its operating segments for that period in accordance with the new
internal reporting structure. However, in order to provide meaningful
information available for the first quarter of fiscal 1999, the Company is able
to disclose a measure of results of operations utilizing a gross profit measure
based on its current land and marine segments. Commencing in the first quarter
of fiscal year 2000, the Company is reporting operating segment information by
the Land and Marine segments, and is measuring the operating results of these
segments based on a measure of earnings (loss) from operations excluding
unallocated corporate expenses and is able to provide asset information at
August 31, 1999 and May 31, 1999 based on the current land and marine segments.
The following summarizes this information (in thousands):
THREE MONTHS ENDED
AUGUST 31,
----------------------------
1999 1998
--------- ----------
Net sales:
Land................................................................. $ 22,692 $ 41,203
Marine............................................................... 7,287 25,792
--------- ----------
$ 29,979 $ 66,995
========= ==========
Gross profit:
Land................................................................. $ 4,996 $ 15,428
Marine............................................................... 989 6,851
--------- ----------
$ 5,985 $ 22,279
========= ==========
Loss from operations:
Land................................................................. $ (2,683)
Marine............................................................... (4,515)
Corporate expenses................................................... (5,740)
---------
$ (12,938)
=========
AUGUST 31, May 31,
1999 1999
---------- --------
Total assets:
Land................................................................. $ 133,131 $141,510
Marine............................................................... 115,822 116,203
Corporate............................................................ 198,520 194,035
---------- --------
$ 447,473 $451,748
========== ========
8
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
-CONTINUED-
Intersegment revenues are insignificant for all periods presented.
Corporate expenses not allocated to the operating segments include costs
related to corporate general and administrative personnel and activities and
costs related to certain research and development personnel and activities
not specifically identified with land or marine products. 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. The
depreciation expense and facility expense related to all jointly utilized
facilities and machinery and equipment are allocated based on each segment's
use of those assets.
(9) CHANGES IN CAPITAL STRUCTURE
On August 17, 1999, SCF-IV, L.P., a Delaware limited partnership
("SCF-IV"), exercised its option to purchase 15,000 shares of Series C Preferred
Stock, par value $0.01 per share (the "Series C Preferred Stock"), under the
option granted to SCF-IV by the Company in connection with SCF-IV's purchase of
40,000 shares of Series B Preferred Stock in a privately negotiated transaction
in May 1999. The purchase price paid for the Series C Preferred Stock was $1,000
per share, resulting in net proceeds of approximately $14.8 million. The net
cash proceeds are to be used to fund the Company's research and development
projects, to provide additional working capital and for general corporate
purposes. The issuance of the Series C Preferred Stock and the underlying shares
of Common Stock were exempt from the registration requirements of Section 5 of
the Securities Act of 1933 in accordance with Section 4(2) of that Act. The
Series C Preferred Stock has substantially the same terms and conditions as the
Series B Preferred Stock, except that the fixed conversion price for the Series
C Preferred Stock is $8.50 per share, compared to $8.00 per share for the Series
B Preferred Stock.
The holders of Series C Preferred Stock are entitled to receive
cumulative cash dividends of $10.00 per share, per annum (1% of the liquidation
preference) for each share of Series C Preferred Stock. Each share of Series C
Preferred Stock is entitled to a liquidation preference of $1,000 per share,
plus all accrued and unpaid dividends.
The Series C Preferred Stock is convertible at the holder's option after
the first to occur of any of the following (the "Initial Conversion Date"): (i)
May 7, 2002, (ii) the approval by the Board of Directors of the Company of an
agreement relating to a Business Combination (as defined) or the consummation of
a Business Combination, (iii) a tender offer for Common Stock is approved or
recommended by the Board of Directors of the Company or (iv) the redemption,
repurchase or reacquisition by the Company of rights issued pursuant to the
Company's Stockholder Rights Plan or any waiver of the application of the
Company's Stockholder Rights Plan to any beneficial owner other than SCF-IV or
its affiliates (except as approved by SCF-IV's representative on the Board of
Directors of the Company). After the Initial Conversion Date and prior to the
Mandatory Conversion Date (defined below), the holders of Series C Preferred
Stock will be entitled to convert their shares into a number of fully paid and
nonassessable shares of Common Stock per share equal to, at the option of the
holder, one of, or if not specified by the holder, at the greater of, the
following (such amount being referred to as the "Conversion Ratio Amount"): (a)
the quotient of $1,000 (plus any accrued and unpaid dividends through the record
date for determining stockholders entitled to vote) divided by the fixed
conversion price of $8.50 (as adjusted from time to time in accordance with
certain anti-dilution provisions) or (b) the quotient of $1,000 increased at a
rate of eight percent per annum from August 17, 1999, compounded quarterly, less
the amount of cash dividends
9
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
-CONTINUED-
actually paid through the applicable conversion date (the "Adjusted Stated
Value"), divided by the average market price for the Common Stock during the
ten trading day period prior to the date of conversion.
On May 7, 2004 (the "Mandatory Conversion Date"), each outstanding
share of Series C Preferred Stock shall, without any action on the part of the
holder, be converted automatically into a number of fully paid and nonassessable
shares of Common Stock equal to the Conversion Ratio Amount, provided that a
shelf registration statement to be filed with the Securities and Exchange
Commission ("SEC") covering those shares of Common Stock has been declared
effective.
In the event of a conversion of Series C Preferred Stock pursuant to
which the Conversion Ratio Amount is determined using clause (b) above, then,
provided that full cumulative dividends have been paid or declared and set apart
for payment upon all outstanding shares of Series C Preferred Stock for all past
dividend periods, the Company may redeem for cash up to 50% (or such greater
percentage as the holders shall agree) of the shares of Series C Preferred Stock
surrendered for conversion at a redemption price per share equal to the Adjusted
Stated Value , in lieu of conversion.
For financial accounting purposes, based on the terms of the Series C
Preferred Stock, dividends will be recognized as a charge to retained earnings
at the rate of 8% per annum, compounded quarterly. Such preferred dividends will
reduce net earnings applicable to common stockholders accordingly. The Company
is permitted to pay dividends on Common Stock as long as the Series B and C
Preferred Stock dividends are current.
(10) COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS. The Company, along with one of its subsidiaries, a
current executive officer and a former executive officer, has been named a
defendant in an action filed on December 28, 1998, in State District Court in
Fort Bend County, Texas styled Geoview, Inc., Geoview Services, Inc. and Ralph
E. Clements vs. Input/Output, Inc., et al. The plaintiffs' petition alleges a
number of causes of action in tort and contract arising out of a purchase of
certain assets by a subsidiary of the Company in 1996. The plaintiffs have
claimed actual damages of $60 million and exemplary damages of $180 million. The
Company plans to vigorously defend against the plaintiffs' claims.
In the ordinary course of business, the Company has been named in
other various lawsuits. While the final resolution of these matters may have an
impact on the Company's consolidated financial results for a particular
reporting period, management believes that the ultimate resolution of these
matters will not have a material adverse impact on the Company's financial
position, results of operations or liquidity.
CREDIT RISK. The Company sells to many customers on extended-term
arrangements. In connection with certain sales of its systems and equipment, the
Company has also guaranteed loans from unaffiliated parties to purchasers of
such systems and equipment. In addition, the Company has sold contracts and
leases to third party financing sources, the terms of which often obligate the
Company to repurchase the contracts and leases in the event of a customer
default or upon certain other occurrences. At August 31, 1999 and May 31, 1999,
the Company had guaranteed approximately $813,000 and $948,000, respectively, of
trade notes receivable sold with recourse and loans from unaffiliated parties to
purchasers of the Company's seismic equipment. Continued depressed seismic
market demand could accelerate the
10
INPUT/OUTPUT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
-CONTINUED-
deterioration of the financial condition of certain customers. A number of
significant payment defaults by customers could have an adverse effect on the
Company's financial position and results of operations. All loans guaranteed
are collateralized by the seismic equipment. Due to the inherent
uncertainties of guaranty agreements, the Company cannot estimate the fair
value of the guaranties as of August 31, 1999.
Sales outside the United States have historically accounted for a
significant part of the Company's net sales. Foreign sales are subject to
special risks inherent in doing business outside of the United States, including
the risk of war, civil disturbances, embargo, and government activities, which
may disrupt markets and affect operating results.
Demand for the Company's products from customers in developing
countries is difficult to predict and can fluctuate significantly from year to
year. The Company believes that these changes in demand result primarily from
the instability of economies and governments in certain developing countries,
changes in internal laws and policies affecting trade and investment, and
because those markets are only beginning to adopt new technologies and establish
purchasing practices. These risks may adversely affect the Company's future
operating results and financial position. In addition, sales to customers in
developing countries on extended terms can present heightened credit risks for
the Company, for the reasons discussed above.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RESULTS OF OPERATIONS
INTRODUCTION. The Company's net sales are directly related to the level
of worldwide oil and gas exploration activity and the profitability and cash
flows of oil and gas companies and seismic contractors, which in turn are
affected by expectations regarding the supply and demand for oil and natural
gas, energy prices and finding and development costs. Oil and gas supply and
demand and pricing are influenced by numerous factors including, but not limited
to those described in "Cautionary Statement for Purposes of Forward-Looking
Statements" - "Continuation in Downturn in Energy Industry and Seismic Services
Industry Conditions Will Adversely Affect Results of Operations and Financial
Condition", "Significant Payment Defaults under Sales Arrangements Could
Adversely Affect the Company" and "Risk from Significant Amount of Foreign Sales
Could Adversely Affect Results of Operations". During fiscal 1999 and the first
quarter of fiscal 2000, our financial performance was adversely impacted by the
deterioration in energy industry conditions over the past 12 months and, more
specifically, in the seismic services sector. This deterioration resulted from,
among other things, a widespread downturn in exploration activity due to a
decline in energy prices from October 1997 to February 1999 and consolidation
among energy producers. Despite a recent recovery in commodity prices, energy
producers' continued concerns over the sustainability of higher prices for
hydrocarbon production resulted in lower exploration budgets by energy
companies, which has resulted in reduced demand for the Company's seismic data
acquisition equipment. As a result of these continuing prevailing conditions, we
recorded operating losses and pre-tax charges totaling $4.7 million ($3.2
million after giving effect to income taxes, or $0.06 per share) during the
first quarter of fiscal 2000.
In response to these industry conditions, we have concentrated on
lowering our cost structure, consolidating our product offerings and
reorganizing into a divisional structure to allow increased visibility and
accountability of costs and more focused customer service and product
development. We have also revised our credit policies and are implementing other
processes to better position the Company to manage through the downturn and
minimize the effects of future industry volatility on our business.
We currently believe that industry conditions will continue to
adversely impact demand for our products during the next 12 months. However, we
also believe that the initiatives discussed above will better position the
Company to return to profitability once industry conditions improve.
NET SALES. The Company's first quarter fiscal 2000 land division net
sales decreased $18.5 million, or 44.9%, to $22.7 million as compared to the
prior year's first quarter land division net sales of $41.2 million. The
Company's first quarter fiscal 2000 marine division net sales decreased $18.5
million, or 71.7%, to $7.3 million as compared to the prior year's first
quarter marine division net sales of $25.8 million. The decline in both the
land and marine division net sales is primarily attributable to the
deterioration in the seismic service industry over the past 12 months,
resulting in reduced demand for the Company's seismic data acquisition
equipment. See "Introduction" above.
GROSS PROFIT MARGIN. The Company's land division gross profit margin
decreased for the first quarter of fiscal 2000 compared to the prior year's
first quarter, from 37.4% in 1999 to 22.0% in 2000. The Company's marine
division gross profit margin decreased for the first quarter of fiscal 2000
compared to the prior year's first quarter, from 26.6% in 1999 to 13.6% in
2000. The decrease in both the land and marine division gross profit margin
was primarily due to reduced customer demand for the Company's products as a
result of prevailing industry conditions; the marine division gross profit
margin decrease also reflected charges of $1.4 million for product-related
warranties incurred during the first quarter of fiscal 2000. The marine
division gross profit margin for the first quarter of fiscal 2000 excluding
these special
12
charges would have been 33.2% as compared to 26.6% in the prior year; this
increase is due to higher margins from sales of products manufactured by
DigiCourse, Inc., which was acquired during the second quarter of fiscal
1999. The Company's gross profit margin for any particular reporting period
is dependent on the product mix sold and the pricing scheme for the products
sold for that period, and may vary materially from period to period.
OPERATING EXPENSES. Operating expenses decreased $2.6 million, or
12.1%, for the first quarter of fiscal 2000 over the prior year's first quarter
operating expenses. Research and development expenses decreased $2.0 million, or
22.1%, compared to the prior year's first quarter, primarily due to reduced
salaries and other payroll related expenses, reduced contract labor and reduced
product development expenses attributable to the Company's efforts to lower its
cost structure. Marketing and sales expenses decreased $1.1 million, or 28.2%,
compared to the prior year's first quarter, primarily due to reduced salaries,
employee commissions and other payroll related expenses; reduced advertising
expenditures; and reduced convention and exhibit expenses. General and
administrative expenses increased $495,000, or 7.7%, compared to the prior
year's first quarter, primarily due to $3.3 million of charges related to
employee severance arrangements and the closing of the Company's Ireland
facility; these charges were offset in part by reduced bad debt expense and loan
losses, reduced insurance costs and reduced state and local taxes. Amortization
of intangibles increased $65,000, or 3.5%, compared to the prior year's first
quarter.
INTEREST EXPENSE. Interest expense for the first quarter of fiscal 2000
(related to the ten-year term facilities financing) was $212,000. See "Note (6)
- - Long Term Debt" of the Notes to Consolidated Financial Statements. Interest
expense for the prior year's first quarter was $242,000, also representing
interest on this facility.
INCOME TAXES. The Company's effective income tax rate was approximately
32%, for both the first quarter of fiscal 2000 and fiscal 1999.
In assessing the realizability of deferred income tax assets,
management considers whether it is more likely than not that some portion or all
of the deferred income tax assets will be realized. The ultimate realization of
deferred income tax assets is dependent upon the generation of future taxable
income during the periods in which those deferred income tax assets become
deductible. Management considers the scheduled reversal of deferred income tax
liabilities and projected future taxable income in making this assessment. In
order to fully realize the deferred income tax assets, the Company will need to
generate future taxable income of approximately $153 million over the next 20
years. Although the Company experienced a significant loss in fiscal 1999 and
the first quarter of fiscal 2000, the Company's taxable income for the fiscal
years 1996 through 1998 aggregated approximately $128 million. Based on the
level of historical income prior to fiscal 1999 and the Company's projections of
future taxable income over the periods that the deferred income tax assets are
deductible and the expiration date of the net operating loss carryforward,
management believes it is more likely than not that the Company will realize the
benefits of the deferred income tax assets, net of the valuation allowance at
August 31, 1999. The amount of deferred income tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable income
during the carryforward period are reduced.
PREFERRED STOCK DIVIDENDS. Preferred stock dividends for the first
quarter of fiscal 2000 are related to the Series B and C Preferred Stock. Based
on the terms of the Series B and C Preferred Stock, the dividends are recognized
as a charge to retained earnings at the rate of 8% per annum, compounded
quarterly. The preferred stock dividend charge for the first quarter of fiscal
2000 was $1.1 million. There were no preferred stock dividends for fiscal 1999.
See "Note (9) - Changes in Capital Structure" of the Notes to Consolidated
Financial Statements.
13
LIQUIDITY AND CAPITAL RESOURCES
GENERAL. The Company has traditionally financed its operations from
internally generated cash flows, funds from equity financings and its credit
facilities. The Company's cash and cash equivalents were $86.2 million at
August 31, 1999, an increase of $11.1 million, or 14.8%, as compared to May
31, 1999. The increase is primarily due to the August 1999 sale of 15,000
shares of Series C Preferred Stock in a privately negotiated transaction to
SCF-IV LP, for which the Company received net proceeds of approximately $14.8
million. The increase in cash attributable to the preferred stock offering
was offset in part by the purchase of property, plant and equipment and the
first quarter 2000 operating losses.
Cash flows used in operating activities were $446,000 for the first
quarter ended August 31, 1999, primarily due to decreases in accounts payable
and accrued expenses and first quarter 2000 operating losses, offset in part
by decreased accounts and notes receivable, decreased inventories and income
tax refunds.
The Company had outstanding indebtedness of $9.8 million as of
August 31, 1999 under a mortgage loan secured by the land, buildings and
improvements housing the Company's executive offices, research and
development headquarters and electronics manufacturing facility in Stafford,
Texas. The loan bears interest at the rate of 7.875% per annum and is
repayable in equal monthly installments of principal and interest of
$151,439. The promissory note, which matures on September 1, 2006, contains
prepayment penalties. See "Note (6) -Long-term Debt" of the Notes to
Consolidated Financial Statements.
Capital expenditures for property, plant and equipment totaled $3.0
million for the first quarter of fiscal 2000. Total capital expenditures are
currently expected to aggregate $29.5 million for fiscal 2000, which includes
an estimated $23.7 million of additions to the Company's rental equipment
fleet, a portion of which will come from on-hand inventories. The Company
believes that the combination of its existing working capital, current cash
balances and access to other financing sources will be adequate to meet its
anticipated capital and liquidity requirements for the foreseeable future.
See however "-Cautionary Statement for Purposes of Forward-Looking
Statements" - "Continuation in Downturn in Energy Industry and Seismic
Services Industry Conditions Will Adversely Affect Results of Operations and
Financial Condition".
CREDIT AGREEMENT. The Company terminated its credit facility during
the first quarter of fiscal 2000. While the Company believes that it would be
able to negotiate a credit facility or facilities with similar lenders, the
Company believes that the terms currently available would not be as
advantageous as future terms may be when the Company may require a credit
facility. The Company does not anticipate the need for a credit facility at
the present time, but anticipates securing a facility or facilities in the
future at a time when the proposed terms are more likely to be more
advantageous for the Company.
YEAR 2000
Many currently installed computer systems and software products are
coded to accept only two-digit entries in the date code field and cannot
distinguish 21st century dates from 20th century dates. These date code
fields will need to distinguish 21st century dates from 20th century dates
and, as a result, many companies' software and computer systems may need to
be upgraded or replaced in order to comply with such "Year 2000"
requirements. The Company is currently working to resolve the potential
impact of the Year 2000 issue on the computerized systems it utilizes
internally, and with regard to its products, suppliers and customers. The
Company has adopted the British Standards Institute "Definition of the Year
2000 Requirements." BSI DISC PD 2000-1 states the following: "Year 2000
conformity shall mean that neither performance or functionality is affected
by dates prior to, during, and after the Year 2000." The Company
14
has developed two levels of readiness for its equipment. The Company's "Year
2000 Compliant" products will perform as per the British Standards
Guidelines. The Company's "Year 2000 Assessed" products have been assessed in
the same manner as "Year 2000 Compliant" products and issues found and
determined by the Company to be detrimental to the function of recording
seismic data have been addressed so that the Company believes that these
products will function in Year 2000 and after. As used herein, the terms
"Year 2000 Compliant" or "Year 2000 Compliance" shall mean either "Year 2000
Compliant" and/or "Year 2000 Assessed", each as defined above.
STATE OF READINESS. The Company continues to carry out its Year 2000
compliance program for the hardware and software products sold by it, the
information technology systems used in its operations ("IT Systems"), and its
non-IT Systems or embedded technology, such as building security, voice mail
and other systems. The Company's Year 2000 compliance program covers the
following phases: (i) inventory of all products, IT Systems and non-IT
Systems; (ii) assessment of repair or replacement requirements; (iii)
planning and remediation; (iv) testing; and (v) implementation. The Company
has completed the inventory and assessment phases for its products, IT
systems and non-IT systems and is in the final stages of remediation, testing
and implementation on the IT and non-IT systems and on those products
identified for remediation. The Company's program calls for completion of all
phases by the end of October 1999.
As a result of its planned component testing, the Company decided
that some of its older products in the field, which it no longer manufactures
or sells, will not be made Year 2000 compliant and the Company will not offer
Year 2000 support for these products. These products are no longer covered by
the Company's product warranties. Other Company products in the field, some
of which supersede or replace the discontinued products, are already Year
2000 Compliant, or will be made Year 2000 Compliant via remedial patches.
These patches will be made available at no charge for those products under
warranty coverage and for sale for those products that are no longer under
warranty. The Company is in the process of contacting its customers to inform
them of the availability of the Year 2000 remedial patches and encouraging
them to upgrade. All products manufactured for sale by the Company since
January 1, 1999 has been tested to be Year 2000 Compliant.
The Company relies, both domestically and internationally, upon
various vendors, governmental agencies, utility companies, telecommunications
service companies, delivery service companies and other service providers,
the operations of which are outside of the Company's control. There is no
assurance that such parties will not suffer a Year 2000 business disruption,
which could have a material adverse effect on the Company's financial
condition and results of operations.
COSTS. To date, the Company has not incurred any material
expenditures in connection with identifying, evaluating or remediating Year
2000 compliance issues. The Company has not retained an outside consultant to
assist it in its review and assessment of its Year 2000 issues. Most of its
expenditures to date have related to the opportunity cost of time spent by
employees of the Company in evaluating and remediating the Company's Year
2000 issues for its products, IT Systems and its non-IT Systems. Management
currently believes that Year 2000 expenditures will not have a material
adverse effect on the Company's operations, results of operations or
financial condition.
A portion of the Company's Year 2000 compliance expenditures that
may ultimately be incurred relate to the Company's limited warranty coverage.
As of August 31, 1999, no specific amounts had been accrued to the warranty
reserve for such costs, as the Company had not been able to make a firm
estimate of such costs. However, the Company currently estimates that based
on its assessments to date, the Company's total estimated Year 2000
compliance-related expenses will be less than $500,000. This estimate
consists of estimated costs of bringing the Company's European IT systems
into Year 2000 Compliance, and possible product warranty expense.
15
RISKS. A survey was sent in November 1998 to customers, various
vendors, governmental agencies, utility companies, telecommunication service
companies, delivery service and other service companies concerning their Year
2000 compliance. Approximately 50% of the surveys sent were returned and all
of the surveys received indicated the recipient was already Year 2000
compliant or was currently carrying out a Year 2000 compliance program and
would be Year 2000 compliant by August 1999. In August 1999 a survey was sent
to the parties that had not responded to the previous survey sent in November
1998. Approximately 30% of the surveys sent in August 1999 have been returned
and all of the surveys received have indicated the recipient was already Year
2000 compliant or was currently carrying out a Year 2000 compliance program
and would be Year 2000 compliant by October 1999.
CONTINGENCY PLAN. The Company has completed its Year 2000
contingency plan for its products, IT systems and non-IT systems. The
Company's contingency plan consists of policies and procedures for addressing
any higher-risk compliance issues discovered and written communication
instructions if compliance problems are actually encountered. Also, starting
in December 1999 the Company will have a 24-hour hotline to assist in
addressing Year 2000 compliance issues that the Company's customers, vendors
or personnel may encounter. In addition, if further Year 2000 compliance
issues are discovered, the Company then will evaluate the need for one or
more contingency plans relating to those particular issues.
Due to the highly technical nature of the equipment manufactured and
sold by the Company, it is difficult to predict a "worst case" scenario if
the products provided by the Company experience a pervasive Year 2000
problem. The Company believes that if a pervasive Year 2000 product problem
did occur, it could result in a significant negative impact on the Company's
business reputation and future sales opportunities, which in turn would have
a material adverse effect on the Company's operations, results of operations
and financial position.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS 133"), was issued by the
Financial Accounting Standards Board in June 1998. SFAS 133 standardizes the
accounting for derivative instruments, including certain derivative
instruments embedded in other contracts. Under the standard, entities are
required to carry all derivative instruments in the statement of financial
position at fair value. The Company will adopt SFAS 133 beginning in fiscal
year 2002. The Company does not expect the adoption of SFAS 133 to have a
material effect on its financial condition or results of operation because
the Company does not enter into derivative or other financial instruments for
trading or speculative purposes nor does the Company use or intend to use
derivative financial instruments or derivative commodity instruments.
OTHER CONSIDERATIONS
Demand for the Company's products is dependent upon the level of
worldwide oil and gas exploration and development activity. This activity in
turn is primarily dependent upon oil and gas prices, which have been subject
to wide fluctuation in recent years. During the first quarter of fiscal 2000,
our financial performance was adversely impacted by the deterioration in
energy industry conditions over the past 12 months and, more specifically, in
the seismic services sector. This deterioration resulted from, among other
things, a widespread downturn in exploration activity due to a decline in
energy prices from October 1997 to February 1999 and consolidation among
energy producers. Despite a recent recovery in commodity prices, energy
producers' continuing concerns over the sustainability of higher prices for
hydrocarbon production resulted in lower exploration budgets by energy
companies, which has resulted in reduced demand for the Company's seismic
data acquisition equipment.
16
CREDIT RISK. A continuation of reduced demand for the services of
the Company's customers will further strain the revenues and cash resources
of customers of the Company, thereby resulting in a higher likelihood of
defaults in the customers' timely payment of their obligations under the
Company's credit sales arrangements. Increased levels of payment defaults
with respect to the Company's credit sales arrangements could have a material
adverse effect on the Company's results of operations.
During fiscal 1999 and the first quarter of fiscal 2000 there was
considerable turmoil and uncertainty in foreign financial markets. The
Russian ruble has been under significant pressure, requiring the Russian
government to raise interest rates substantially, and to seek special
assistance from the International Monetary Fund in order to defend its
currency. At the present time, it is not possible to predict whether the
Russian government will be successful in avoiding another devaluation of the
ruble, or when stability will return to its financial markets. Any further
devaluation of the ruble could exacerbate existing economic problems in
Russia. In addition, the Company sells its products to customers in Latin
American countries, which have also experienced economic problems and the
effects of devaluations.
The Company's combined gross trade accounts receivable and trade
notes receivable balance as of August 31, 1999 from customers in Russia and
other Former Soviet Union countries was approximately $22.7 million and was
approximately $10.3 million from customers in Latin American countries. As of
August 31, 1999 the total allowance for doubtful accounts (foreign and US)
was $7.8 million and the allowance for loan loss was $41.3 million. During
the first quarter of fiscal 2000, there were $9.3 million of sales to
customers in Russia and other Former Soviet Union countries (essentially all
based on cash sales backed by letters of credit) and $39,000 of sales to
customers in Latin American countries. All terms of sale for these foreign
receivables are denominated in US dollars. To the extent that economic
conditions in the Former Soviet Union, Latin America or elsewhere negatively
affect future sales to the Company's customers in those regions or the
collectibility of the Company's existing receivables, the Company's future
results of operations, liquidity and financial condition may be adversely
affected.
See "Note 10 - Commitments and Contingencies" of Notes to
Consolidated Financial Statements and "- Cautionary Statement for Purposes of
Forward-Looking Statements - Continuation in Downturn in Energy Industry and
Seismic Services Industry Conditions Will Adversely Affect Results of
Operations and Financial Condition," "- Significant Payment Defaults Under
Sales Arrangements Could Adversely Affect the Company" and "- Risk from
Significant Amount of Foreign Sales Could Adversely Affect Results of
Operations".
CONVERSION TO THE EURO CURRENCY. On January 1, 1999, certain members
of the European Union established fixed conversion rates between their
existing currencies and the European Union's common currency, the euro. The
Company owns facilities and manufactures components for its systems in two
member countries. The transition period for the introduction of the euro is
between January 1, 1999 and June 30, 2002. The Company is addressing the
issues involved with the introduction of the euro. The more important issues
facing the Company include: converting information technology systems;
reassessing currency risk and processing tax and accounting records.
Based on its progress to date in reviewing this matter, the Company
believes that the introduction of the euro will not have a significant impact
on the manner in which it conducts its business affairs and processes its
business and accounting records. Therefore, conversion to the euro should not
have a material effect on the Company's financial condition or results of
operations.
17
CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD-LOOKING STATEMENTS
Certain information contained in this Quarterly Report on Form 10-Q
as well as other written and oral statements made or incorporated by
reference from time to time by the Company and its representatives in other
reports, filings with the Securities and Exchange Commission, press releases,
conferences, or otherwise, may be deemed to be forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934 and
are subject to the "Safe Harbor" provisions of that section. This information
includes, without limitation, statements concerning future results of
operation, future revenues, future costs and expenses, future margins and
future writedowns and special charges; the length of the period of the
downturn in demand for the Company's products; anticipated product releases
and technological advances; the future mix of business and future asset
recoveries; the realization of deferred tax assets; the resolution of
contingent liabilities; the Company's Year 2000 issues and their resolution;
the inherent unpredictability of adversarial proceedings; demand for the
Company's products; future capital expenditures and future financial
condition of the Company; energy industry and seismic services industry
conditions; and world economic conditions, including that in Former Soviet
Union, Latin American and Asian countries. These statements are based on
current expectations and involve a number of risks and uncertainties,
including those set forth below and elsewhere in this Quarterly Report on
Form 10-Q. Although the Company believes that the expectations reflected in
such forward-looking statements are reasonable, it can give no assurance that
such expectations will prove to be correct.
When used in this report, the words "anticipate," "estimate,"
"expect," "may," "project" and similar expressions are intended to be among
the statements that identify forward-looking statements. Important factors
which could affect the Company's actual results and cause actual results to
differ materially from those results which might be projected, forecast,
estimated or budgeted by the Company in such forward-looking statements
include, but are not limited to, the following:
CONTINUATION IN DOWNTURN IN ENERGY INDUSTRY AND SEISMIC SERVICES
INDUSTRY CONDITIONS WILL ADVERSELY AFFECT RESULTS OF OPERATIONS AND FINANCIAL
CONDITION. Demand for the Company's products is dependent upon the level of
worldwide oil and gas exploration and development activity. This activity in
turn is primarily dependent upon oil and gas prices, which have been subject
to wide fluctuation in recent years in response to changes in the supply and
demand for oil and natural gas, market uncertainty and a variety of
additional factors that are beyond the control of the Company. Worldwide oil
prices declined from October 1997 and remained at lower levels through
February 1999. Despite a recent recovery in commodity prices, energy
producers' continuing concerns over the sustainability of higher prices for
hydrocarbon production resulted in lower exploration budgets by energy
companies, which has resulted in reduced demand for the Company's seismic
data acquisition equipment. Other factors which have negatively impacted
demand for Company products have been the weakened financial condition of
many of the Company's customers, consolidations among energy producers, an
over-supply of current-generation seismic equipment and the destabilized
economies in many developing countries. Despite relatively higher prices for
oil and natural gas in recent months, it is expected that any turnaround for
the seismic equipment market will occur later than for other sectors of the
energy services industry. It is impossible to predict the length of the
downturn for the seismic equipment market or future oil and natural gas
prices with any certainty. A further prolonged downturn in market demand for
the Company's products will have a material adverse effect on the Company's
results of operation and financial condition. No assurances can be given as
to future levels of worldwide oil and natural gas prices, the future level of
activity in the oil and gas exploration and development industry and their
relationship(s) to the demand for the Company's products. Additionally, no
assurances can be given that the Company's efforts to reduce and contain
costs will be sufficient to offset the effect of the expected continued lower
levels of Company net sales until industry conditions improve.
18
FAILURE TO DEVELOP PRODUCTS AND KEEP PACE WITH TECHNOLOGICAL CHANGE
WILL ADVERSELY AFFECT RESULTS OF OPERATIONS. The markets for the Company's
product lines are characterized by rapidly changing technology and frequent
product introductions. Whether the Company can develop and produce
successfully, on a timely basis, new and enhanced products that embody new
technology, meet evolving industry standards and practice, and achieve levels
of capability and price that are acceptable to its customers, will be
significant factors in the Company's ability to compete in the future. The
Company has completed six field tests of its new VectorSeis-TM-,
multi-component digital sensor. Further tests are planned and may
increasingly involve potential customers. There can be no assurance that the
Company will not encounter resource constraints or technical or other
difficulties that could delay introduction of this new product or other new
products in the future. No assurances can be given as to whether any products
incorporating the VectorSeis-TM- digital sensor will be commercially feasible
or accepted in the marketplace by the Company's present or future customers.
If the Company is unable, for technological or other reasons, to develop
competitive products in a timely manner in response to changes in the seismic
data acquisition industry or other technological changes, its business and
operating results will be materially and adversely affected. In addition, the
Company's continuing development of new products inherently carries the risk
of inventory obsolescence with respect to its older products. Changes in the
Company's product offerings through newly introduced products and product
lines, whether internally developed or obtained through acquisitions, carry
with them the potential for customer concerns of product reliability, which
may have the effect of lessening customer demand for those changed products.
SIGNIFICANT PAYMENT DEFAULTS UNDER SALES ARRANGEMENTS COULD
ADVERSELY AFFECT THE COMPANY. The Company sells to many customers on
extended-term arrangements. Significant payment defaults by customers could
have a material adverse effect on the Company's financial position and
results of operations.
RISK FROM SIGNIFICANT AMOUNT OF FOREIGN SALES COULD ADVERSELY AFFECT
RESULTS OF OPERATIONS. Sales outside the United States have historically
accounted for a significant part of the Company's net sales. Foreign sales
are subject to special risks inherent in doing business outside of the United
States, including the risk of war, civil disturbances, embargo, and
government activities, which may disrupt markets and affect operating
results. Foreign sales are also generally subject to the risks of compliance
with additional laws, including tariff regulations and import/export
restrictions. The Company is, from time to time, required to obtain export
licenses and there can be no assurance that it may not experience difficulty
in obtaining such licenses as may be required in connection with export sales.
Demand for the Company's products from customers in developing
countries (including Russia and other Former Soviet Union countries as well
as certain Latin American and Asian countries) is difficult to predict and
can fluctuate significantly from year to year. The Company believes that
these changes in demand result primarily from the instability of economies
and governments in certain developing countries, changes in internal laws and
policies affecting trade and investment, and because those markets are only
beginning to adopt new technologies and establish purchasing practices. These
risks may adversely affect the Company's future operating results and
financial position. In addition, sales to customers in developing countries
on extended terms present heightened credit risks for the Company, for the
reasons discussed above. See, in particular above, "Other Factors" for
further information concerning these risks in those countries.
LOSS OF SIGNIFICANT CUSTOMERS WILL ADVERSELY AFFECT THE COMPANY. A
relatively small number of customers have accounted for most of the Company's
net sales, although the degree of sales concentration with any one customer
has varied from fiscal year to year. During fiscal 1999, 1998 and 1997 the
three largest customers in each of those years accounted for 52%, 43% and
50%, respectively, of
19
the Company's net sales. The loss of these customers or a significant
reduction in their equipment needs could have a material adverse effect on
the Company's net sales.
PRESSURE FROM COMPETITORS COULD ADVERSELY AFFECT RESULTS OF
OPERATIONS. The market for seismic data acquisition systems and seismic
instrumentation is highly competitive and is characterized by continual and
rapid changes in technology. The Company's principal competitors for land
seismic equipment are, among others, Fairfield Industries; Geo-X Systems,
Limited; JGI, Incorporated; OYO Geospace Corporation; and Societe d'etudes
Recherches et Construction Electroniques, an affiliate of Compagnie General
de Geophysique (Sercel). Unlike the Company, Sercel possesses the advantage
of being able to sell to an affiliated seismic contractor. The Company's
principal marine seismic competitors are, among others, Bolt Technology
Corporation, GeoScience Corporation, an affiliate of Tech-Sym Corporation;
Teledyne Brown Engineering, an affiliate of Allegheny Teledyne Company; and
Thomson Marconi Sonar P/L.
Competition in the industry is expected to intensify and could
adversely affect the Company's future results. Several of the Company's
competitors have greater name recognition, more extensive engineering,
manufacturing and marketing capabilities, and greater financial,
technological and personnel resources than those available to the Company. In
addition, certain companies in the industry have expanded their product lines
or technologies in recent years. There can be no assurance that the Company
will be able to compete successfully in the future with existing or new
competitors. Pressures from competitors offering lower-priced products or
products employing new technologies could result in future price reductions
for the Company's products.
A continuing trend toward consolidation, concentrating buying power
in the oil field services industry, will have the effect of adversely
affecting the demand for the Company's products and services.
RISKS RELATED TO YEAR 2000 ISSUES. The problems actually encountered
by the Company in addressing its Year 2000 issues may be more pervasive than
anticipated by management, and if so, could have adverse effects on the
Company's operations, results of operations or financial condition. See "-
Year 2000."
FAILURE TO PROTECT INTELLECTUAL PROPERTY WILL ADVERSELY AFFECT THE
COMPANY's Operations. The Company believes that technology is the primary
basis of competition in the industry. Although the Company currently holds
certain intellectual property rights relating to its product lines, there can
be no assurance that these rights will not be challenged by third parties or
that the Company will obtain additional patents or other intellectual
property rights in the future. Additionally, there can be no assurance that
the Company's efforts to protect its trade secrets will be successful or that
others will not independently develop products similar to the Company's
products or design around any of the intellectual property rights owned by
the Company, or that the Company will be precluded by others' patent claims.
DISRUPTION IN VENDOR SUPPLIES WILL AFFECT FINANCIAL RESULTS. The
Company's manufacturing process requires a high volume of quality components.
Certain components used by the Company are currently provided by only one
supplier. In the future, the Company may, from time to time, experience
supply or quality control problems with its suppliers, and such problems
could significantly affect its ability to meet production and sales
commitments. The Company's 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, suppliers' Year
2000 non-compliance, increases in component costs and reduced control over
delivery schedules, any of which could adversely affect the Company's future
financial results.
20
DEPENDENCE ON PERSONNEL. The Company's success depends upon the
continued contributions of its personnel, many of whom would be difficult to
replace. The success of the Company will depend on the ability of the Company
to attract and retain skilled employees. Changes in personnel, therefore,
could adversely affect operating results.
RISKS RELATED TO GROSS MARGIN. The Company's gross margin percentage
is a function of the product mix sold in any period. Increased sales of lower
margin equipment and related components in the overall sales mix may result
in lower gross margins. Other factors, such as unit volumes, inventory
obsolescence, increased warranty costs and other product related
contingencies, heightened price competition, changes in sales and
distribution channels, shortages in components due to untimely supplies or
inability to obtain items at reasonable prices, and unavailability of skilled
labor, may also continue to affect the cost of sales and the fluctuation of
gross margin percentages in future periods.
RISKS RELATED TO GOVERNMENT REGULATIONS AND PRODUCT CERTIFICATION.
The Company's operations are also subject to laws, regulations, government
policies, and product certification requirements worldwide. Changes in such
laws, regulations, policies, or requirements could affect the demand for the
Company's 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 the Company's future operating results. Certain countries are subject to
restrictions, sanctions and embargoes imposed by the US Government. These
restrictions, sanctions and embargoes prohibit or limit the Company and its
domestic subsidiaries from participating in certain business activities in
those countries. These constraints may adversely affect the Company's
opportunities for business in those countries.
RISKS RELATED TO TIMING OF PRODUCT SHIPMENTS COULD RESULT IN
SIGNIFICANT QUARTERLY FLUCTUATIONS. Due to the relatively high sales price of
many of the Company's products and relatively low unit sales volume, the
timing in the shipment of systems and the mix of products sold can produce
fluctuations in quarter-to-quarter financial performance. One of the factors,
which may affect the Company's operating results from time to time, is that a
substantial portion of its net sales in any period may result from shipments
during the latter part of a period. Because the Company establishes its sales
and operating expense levels based on its operational goals, if shipments in
any period do not meet goals, net sales and net earnings may be adversely
affected. In addition, because the Company typically operates, and expects to
continue to operate, without a significant backlog of orders for its
products, the Company's manufacturing plans and expenditure levels are based
principally on sales forecasts, which result in inventory excesses and
imbalances from time to time.
STOCK VOLATILITY AND ABSENCE OF DIVIDENDS MAY ADVERSELY AFFECT THE
COMPANY's Stock Price. In recent years, the stock market in general and the
market for energy and technology stocks in particular, including the
Company's Common Stock, have experienced extreme price fluctuations. The
sales price for the Company's Common Stock has declined from $22 per share at
May 29, 1998 to $7 3/8 per share at August 31, 1999 (based on New York Stock
Exchange composite tape closing sales prices). There is a risk that stock
price fluctuation could impact the Company's operations. Changes in the price
of the Company's Common Stock could affect the Company's ability to
successfully attract and retain qualified personnel, complete desirable
business combinations or accomplish financing or similar transactions in the
future. The Company has historically not paid, and does not intend to pay in
the foreseeable future, cash dividends on its Common Stock.
RISKS RELATED TO ACQUISITIONS. The Company may make further
acquisitions in the future. Acquisitions require significant financial and
management resources both at the time of the transaction and during the
process of integrating the newly acquired business into the Company's
operations. The Company's operating results could be adversely affected if it
is unable to successfully integrate these new
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companies into its operations. Structural changes in the Company's internal
organization, which may result from acquisitions, may not always produce the
desired financial or operational results.
Certain acquisitions or strategic transactions may be subject to
approval by the other party's shareholders, United States or foreign
governmental agencies, or other third parties. Accordingly, there is a risk
that important acquisitions or transactions could fail to be concluded as
planned. Future acquisitions by the Company could also result in issuances of
equity securities or the rights associated with the equity securities, which
could potentially dilute earnings per share. In addition, future acquisitions
could result in the incurrence of additional debt, taxes, or contingent
liabilities, and amortization expenses related to goodwill and other
intangible assets. These factors could adversely affect the Company's future
operating results and financial position.
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, the Company wishes to refer readers to other
factors discussed elsewhere in this report as well as the Company's other
filings and reports with the Securities and Exchange Commission, including
its most recent annual report on Form 10-K, for a further discussion of risks
and uncertainties which could cause actual results to differ materially from
those contained in forward-looking statements. The Company undertakes 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
The Company is exposed to market risk, which is the potential loss
arising from adverse changes in market prices and rates. The Company does not
enter into derivative or other financial instruments for trading or
speculative purposes nor does the Company use or intend to use derivative
financial instruments or derivative commodity instruments. The Company's
market risk could arise from changes in foreign currency exchange rates. The
Company's sales and financial instruments are principally denominated in US
dollars.
PART II - OTHER INFORMATION.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ISSUANCE OF PREFERRED STOCK. On August 17, 1999, SCF-IV, L.P., a
Delaware limited partnership ("SCF-IV), exercised its option to purchase
15,000 shares of Series C Preferred Stock, par value $0.01 per share (the
"Series C Preferred Stock"), under the option granted to SCF-IV by the
Company in connection with SCF-IV's purchase of 40,000 shares of Series B
Preferred Stock in a privately negotiated transaction in May 1999. The
purchase price paid for the Series C Preferred Stock was $1,000 per share,
resulting in net proceeds of approximately $14.8 million. The net cash
proceeds are to be used to fund the Company's research and development
projects, to provide additional working capital and for general corporate
purposes. On or before November 7, 2000, the Company may issue up to 20,000
additional shares of preferred stock ranking in parity to the Series B and
Series C Preferred Stock to other investors at a purchase price of $1,000 per
share ("Permitted Parity Securities"). The Series C Preferred Stock has
substantially the same terms and conditions as the Series B Preferred Stock,
except that the fixed conversion price for the Series C Preferred Stock is
$8.50 per share, compared to $8.00 per share for the Series B Preferred
Stock. The issuance of the Series C Preferred Stock and the underlying shares
of Common Stock were exempt from the registration requirements of Section 5
of the Securities Act of 1933 in accordance with Section 4(2) of that Act.
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VOTING OF PREFERRED STOCK. Holders of the Series B Preferred Stock
and the Series C Preferred Stock, voting together with any Permitted Parity
Securities, are entitled to elect one member to the Company's Board of
Directors, and have elected David C. Baldwin as their designee. In addition,
the holders of the Series B Preferred Stock and the Series C Preferred Stock
are entitled to vote upon all matters upon which the holders of Common Stock
are entitled to vote. The holders of Series B and Series C Preferred Stock,
when voting together with the holders of Common Stock as a single class, are
entitled to cast a number of votes equal to $1,000 (plus any accrued and
unpaid dividends through the record date for determining shareholders
entitled to vote) divided by the fixed conversion price of $8.00 for the
Series B Preferred Stock and $8.50 for the Series C Preferred Stock (as
adjusted from time to time in accordance with the Certificate of Designation).
Accordingly, SCF-IV may be deemed to beneficially own 6,764,705
shares of Common Stock based on its ownership of 40,000 shares of Series B
Preferred Stock and 15,000 shares of Series C Preferred Stock. The 6,764,705
shares of Common Stock represent shares issuable to SCF-IV upon conversion of
(i) the Series B Preferred Stock based on an $8.00 fixed conversion price and
(ii) the Series C Preferred Stock based on an $8.50 fixed conversion price.
Such 6,764,705 shares of Common Stock would constitute approximately 11.8% of
the issued and outstanding Common Stock of the Company. This amount excludes
an indeterminate number of additional shares of Common Stock that may be
acquired by SCF-IV upon conversion of the Shares pursuant to market price
based conversions, or in respect of accrued and unpaid dividends.
TERMS OF SERIES C PREFERRED STOCK. The holders of Series C Preferred
Stock are entitled to receive cumulative cash dividends of $10.00 per share,
per annum (1% of the liquidation preference) for each share of Series C
Preferred Stock. Each share of Series C Preferred Stock is entitled to a
liquidation preference of $1,000 per share, plus all accrued and unpaid
dividends.
The Series C Preferred Stock is convertible at the holder's option
after the first to occur of any of the following (the "Initial Conversion
Date"): (i) May 7, 2002, (ii) the approval by the Board of Directors of the
Company of an agreement relating to a Business Combination (as defined) or
the consummation of a Business Combination, (iii) a tender offer for Common
Stock is approved or recommended by the Board of Directors of the Company or
(iv) the redemption, repurchase or reacquisition by the Company of rights
issued pursuant to the Company's Stockholder Rights Plan or any waiver of the
application of the Company's Stockholder Rights Plan to any beneficial owner
other than SCF-IV or its affiliates (except as approved by SCF-IV's
representative on the Board of Directors of the Company). After the Initial
Conversion Date and prior to the Mandatory Conversion Date (defined below),
the holders of Series C Preferred Stock will be entitled to convert their
shares into a number of fully paid and nonassessable shares of Common Stock
per share equal to, at the option of the holder, one of, or if not specified
by the holder, at the greater of, the following (such amount being referred
to as the "Conversion Ratio Amount"): (a) the quotient of $1,000 (plus any
accrued and unpaid dividends through the record date for determining
stockholders entitled to vote) divided by the fixed conversion price of $8.50
(as adjusted from time to time in accordance with certain anti-dilution
provisions) or (b) the quotient of $1,000 increased at a rate of eight
percent per annum from August 17, 1999, compounded quarterly, less the amount
of cash dividends actually paid through the applicable conversion date (the
"Adjusted Stated Value"), divided by the average market price for the Common
Stock during the ten trading day period prior to the date of conversion.
On May 7, 2004 (the "Mandatory Conversion Date"), each outstanding
share of Series C Preferred Stock shall, without any action on the part of
the holder, be converted automatically into a number of fully paid and
nonassessable shares of Common Stock equal to the Conversion Ratio Amount,
provided that a
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shelf registration statement to be filed with the SEC covering those shares
of Common Stock has been declared effective.
In the event of a conversion of Series C Preferred Stock pursuant to
which the Conversion Ratio Amount is determined using clause (b) above, then,
provided that full cumulative dividends have been paid or declared and set
apart for payment upon all outstanding shares of Series C Preferred Stock for
all past dividend periods, the Company may redeem for cash up to 50% (or such
greater percentage as the holders shall agree) of the shares of Series C
Preferred Stock surrendered for conversion at a redemption price per share
equal to the Adjusted Stated Value , in lieu of conversion.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of documents filed as Exhibits.
3.1 - Amendment No. 1 to the Amended and Restated Bylaws
of the Company, dated September 13, 1999.
10.1 - Employee Agreement by and between the Company and
Axel M. Sigmar, dated August 17, 1999.
10.2 - Amendment No. 3 to the Input/Output, Inc.
Supplemental Executive Retirement Plan, dated
August 23, 1999.
10.3 - Amendment No. 2 to the Input/Output, Inc. Amended
and Restated 1991 Directors Stock Option Plan,
dated September 13, 1999.
10.4 - Amendment No. 1 to the Input/Output, Inc. Amended
and Restated 1996 Non-Employee Director Stock
Option Plan, dated September 13, 1999.
10.5 - Consulting and Collection Agreement by and
between the Company and Robert P. Brindley, dated
October 7, 1999.
10.6 - Consulting Agreement by and between the Company
and Sam K. Smith, dated August 10, 1999.
27.1 - Financial Data Schedule (included in EDGAR copy
only)
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed during the
three-month period ended August 31, 1999.
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SIGNATURE
PURSUANT TO THE REQUIREMENTS 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.
INPUT/OUTPUT, INC.
By: /s/ Sam K. Smith
------------------------------------
Sam K. Smith
Director and Chief Executive Officer
Dated: October 14, 1999
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