10-Q 1 d10q.txt FORM 10-Q FOR PERIOD ENDING JUNE 30, 2002 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 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 June 30, 2002 [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number 001-13601 OYO GEOSPACE CORPORATION (Exact Name of Registrant as Specified in Its Charter) Delaware 76-0447780 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 12750 South Kirkwood, Suite 200 Stafford, Texas 77477 (Address of Principal Executive Offices) (281) 494-8282 (Registrant's telephone number, including area code) 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 -------- -------- There were 5,546,795 shares of the Registrant's Common Stock outstanding as of the close of business on August 12, 2002. ================================================================================ Table of Contents
Page Number ------ PART I. FINANCIAL INFORMATION Item 1. Financial Statements 3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures about Market Risks 25 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 26 Informational Addendum to Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 28
2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements OYO GEOSPACE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands)
ASSETS June 30, 2002 September 30, 2001 -------------- ------------------ (unaudited) Current assets: Cash and cash equivalents ....................................... $ 1,857 $ 882 Trade accounts and notes receivable, net ........................ 13,746 11,539 Inventories ..................................................... 22,721 28,737 Deferred income tax ............................................. 1,551 1,152 Prepaid expenses and other ...................................... 1,556 1,299 ---------- ----------- Total current assets ....................................... 41,431 43,609 Rental equipment, net ............................................... 2,200 2,075 Property, plant and equipment, net .................................. 19,319 20,307 Goodwill and other intangible assets, net ........................... 6,495 4,775 Deferred income tax ................................................. 441 340 Other assets ........................................................ 172 1,982 ---------- ----------- Total assets ............................................... $ 70,058 $ 73,088 ========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and current maturities of long-term debt .......... $ 2,352 $ 1,033 Accounts payable ................................................ 2,588 4,984 Accrued expenses and other ...................................... 4,279 4,047 Deferred revenue ................................................ 720 4,859 Income tax payable .............................................. 399 235 ---------- ----------- Total current liabilities .................................. 10,338 15,158 Long-term debt ...................................................... 3,597 3,772 Deferred income tax ................................................. 956 1,367 ---------- ----------- Total liabilities .......................................... 14,891 20,297 ---------- ----------- Minority interest in consolidated subsidiary ........................ 268 -- Stockholders' equity: Preferred stock ................................................. -- -- Common stock .................................................... 55 55 Additional paid-in capital ...................................... 30,633 30,530 Retained earnings ............................................... 24,936 23,213 Accumulated other comprehensive loss ............................ (716) (865) Unearned compensation-restricted stock awards ................... (9) (142) ---------- ----------- Total stockholders' equity ................................. 54,899 52,791 ---------- ----------- Total liabilities and stockholders' equity ................. $ 70,058 $ 73,088 ========== ===========
The accompanying notes are an integral part of the consolidated financial statements. 3 OYO GEOSPACE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share amounts) (unaudited)
Three Months Ended Nine Months Ended -------------------------------- --------------------------------- June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001 ------------- ------------- ------------- ------------- Sales ....................................... $ 24,668 $ 15,810 $ 51,401 $ 47,705 Cost of sales ............................... 17,904 10,204 35,747 31,713 --------- --------- --------- --------- Gross profit ................................ 6,764 5,606 15,654 15,992 Operating expenses: Selling, general and administrative ..... 2,756 3,373 8,795 9,617 Research and development ................ 1,531 1,532 4,048 4,450 Impairment of assets .................... 1,216 -- 1,216 -- --------- --------- --------- --------- Total operating expenses ........... 5,503 4,905 14,059 14,067 --------- --------- --------- --------- Income from operations ...................... 1,261 701 1,595 1,925 Other income (expense): Interest expense ........................ (162) (93) (476) (267) Interest income ......................... 44 61 141 169 Other, net .............................. (14) (31) (290) (43) --------- --------- --------- --------- Total other expense, net ........... (132) (63) (625) (141) --------- --------- --------- --------- Income before income taxes, minority interest and extraordinary gain .. 1,129 638 970 1,784 Income tax expense (benefit) ................ (38) 10 (160) 328 --------- --------- --------- --------- Income before minority interest and extraordinary gain .................... 1,167 628 1,130 1,456 Minority interest ........................... (11) -- (93) -- --------- --------- --------- --------- Income before extraordinary gain ............ 1,156 628 1,037 1,456 Extraordinary gain, net of tax of $85 ....... -- -- 686 -- --------- --------- --------- --------- Net income .................................. $ 1,156 $ 628 $ 1,723 $ 1,456 ========= ========= ========= ========= Basic earnings per share: Income before extraordinary item ......... $ 0.21 $ 0.11 $ 0.19 $ 0.27 Extraordinary gain ....................... -- -- 0.12 -- --------- --------- --------- --------- Net income ............................... $ 0.21 $ 0.11 $ 0.31 $ 0.27 ========= ========= ========= ========= Diluted earnings per share: Income before extraordinary item ......... $ 0.21 $ 0.11 $ 0.19 $ 0.26 Extraordinary gain ....................... -- -- 0.12 -- ---------- --------- --------- --------- Net income ............................... $ 0.21 $ 0.11 $ 0.31 $ 0.26 ========= ========= ========= ========= Weighted average shares outstanding - Basic . 5,545,113 5,499,980 5,532,641 5,482,578 ========= ========= ========= ========= Weighted average shares outstanding - Diluted ................................... 5,556,853 5,639,257 5,545,323 5,610,184 ========= ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 4 OYO GEOSPACE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Nine Months Nine Months Ended Ended June 30, 2002 June 30, 2001 ------------- ------------- Cash flows from operating activities: Net income ................................................ $ 1,723 $ 1,456 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Deferred income tax expense (benefit) .................. (911) 183 Depreciation and amortization .......................... 3,612 3,014 Amortization of restricted stock awards ................ 133 344 Impairment charge ...................................... 1,216 -- Extraordinary gain, net of tax ......................... (686) -- Minority interest ...................................... 93 -- Bad debt expense ....................................... 174 280 Effects of changes in operating assets and liabilities: Trade accounts and notes receivable .................... (1,815) (3,692) Inventories ............................................ 6,702 (5,171) Prepaid expenses and other assets ...................... (30) 854 Accounts payable ....................................... (2,488) (1,155) Accrued expenses and other ............................. (4,766) 6,062 Income tax payable ..................................... 79 98 --------- --------- Net cash provided by operating activities ............ 3,036 2,273 --------- --------- Cash flows from investing activities: Capital expenditures ...................................... (2,605) (3,366) Investment in business acquisition, net of cash acquired .. 913 (1,925) Purchase of intangible assets ............................. (2,148) -- Proceeds from sale of equipment ........................... 408 246 --------- --------- Net cash used in investing activities ................ (3,432) (5,045) --------- --------- Cash flows from financing activities: Increase in notes payable ................................. 23,028 21,701 Principal payments on notes payable ....................... (21,883) (21,664) Proceeds from exercise of stock options ................... 77 360 --------- --------- Net cash provided by financing activities ............ 1,222 397 --------- --------- Effect of exchange rate changes on cash ....................... 149 (93) --------- --------- Increase (decrease) in cash and cash equivalents .............. 975 (2,468) Cash and cash equivalents, beginning of period ................ 882 3,989 --------- --------- Cash and cash equivalents, end of period ...................... $ 1,857 $ 1,521 ========== =========
The accompanying notes are an integral part of the consolidated financial statements. 5 OYO GEOSPACE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation The consolidated balance sheet of OYO Geospace Corporation and its subsidiaries (the "Company") at September 30, 2001 has been derived from the Company's audited consolidated financial statements at that date. The consolidated balance sheet at June 30, 2002 and the consolidated statements of operations for the three months and nine months ended June 30, 2002 and 2001, and the consolidated statements of cash flows for the nine months ended June 30, 2002 and 2001, have been prepared by the Company, without audit. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the consolidated financial position, results of operations and cash flows have been made. The results of operations for the three months and nine months ended June 30, 2002 are not necessarily indicative of the operating results for a full year or of future operations. Certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America have been omitted. The accompanying consolidated financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended September 30, 2001. Revenue is primarily derived from the sale, and short-term rental under operating lease, of seismic instruments and equipment and commercial graphics products. Sales revenues are recognized when the products are shipped and title and risk of loss have passed to the customer. Rental revenues are recognized as earned over the rental period. Short-term rentals of the Company's equipment generally range from daily rentals to rental periods of up to six months. Products are generally sold without any customer acceptance provisions and the Company's standard terms of sale do not allow its customers to return products. The Company's products generally do not require installation assistance or sophisticated instruction. The Company offers a standard product warranty obligating it to repair or replace equipment with manufacturing defects. The Company maintains a reserve for future warranty costs based on historical experience. The Company expenses research and development costs as incurred. The Company records a write-down of its inventory when the cost basis of any manufactured product (including any estimated future costs to complete the manufacturing process) exceeds its net realizable value. In November 2001, the Company acquired an additional equity interest in a Russian joint venture; thereby, increasing its ownership percentage from 44% to 85%. As a result of this acquisition, the Company records expense or income of minority interests, reflecting the portion of earnings or loss, respectively, of the majority-owned operations allocated to the minority interest partners. For additional information, see Note 6 to the Consolidated Financial Statements contained in this Report on Form 10-Q. In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. The Company adopted the provisions of SFAS 141 effective October 1, 2001. Among the provisions of SFAS 141 is the requirement to record as an extraordinary gain all negative goodwill resulting from new business combinations. As a result, the Company recorded an extraordinary gain of $686,000 relating to the acquisition of the Russian joint venture in November 2001. Also in July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually for impairment; or more frequently if impairment is indicated. Intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives; however, no maximum life applies. The Company will adopt the provisions of SFAS 142 effective in its fiscal year 2003, beginning October 1, 2002. At June 30, 2002, the Company had 6 OYO GEOSPACE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) goodwill, net of accumulated amortization, of $1.9 million. Management is currently evaluating the impact of SFAS 142 on the Company's financial position and results of operations. In August 2001, the Financial Accounting Standards Board issued SFAS No. 143 - "Accounting for Asset Retirement Obligations". This statement requires the Company to recognize the fair value of a liability associated with the cost the Company would be obligated to incur in order to retire an asset at some point in the future. The liability would be recognized in the period in which it is incurred and can be reasonably estimated. The standard is effective for fiscal years beginning after June 15, 2002. The Company expects to adopt this standard at the beginning of fiscal 2003. Management is currently evaluating the impact of SFAS No. 143 on the Company's financial position and results of operations. Additionally, in October 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets". SFAS No. 144 develops an accounting model, based upon the framework established in SFAS No. 121, for long-lived assets to be disposed by sales. The accounting model applies to all long-lived assets, including discontinued operations, and it replaces the provisions of APB Opinion No. 30, "Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for disposal of segments of a business. SFAS No. 144 requires long-lived assets held for disposal to be measured at the lower of carrying amount or fair values less costs to sell, whether reported in continuing operations or in discontinued operations. The statement is effective for fiscal years beginning after December 15, 2001. The Company intends to adopt this standard at the beginning of its fiscal 2003. Management is currently evaluating the impact of SFAS No. 144 on the Company's financial position and results of operations. In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, "Recission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This statement clarifies guidance related to the reporting of gains and losses from extinguishment of debt and resolves inconsistencies related to the required accounting treatment of certain lease modifications. The provisions of this statement relating to extinguishment of debt become effective for financial statements issued for fiscal years beginning after May 15, 2002. The provisions of this statement relating to lease modification are effective for transactions occurring after May 15, 2002. The Company intends to adopt this standard at the beginning of fiscal 2003. Management is currently evaluating the impact of SFAS No. 145 on the Company's financial position and results of operations. Certain amounts previously presented in the consolidated financial statements have been reclassified to conform to the current year presentation. 7 OYO GEOSPACE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 2. Earnings Per Common Share The following table summarizes the calculation of net earnings and weighted average common shares and common equivalent shares outstanding for purposes of the computation of earnings per share (in thousands, except per share data):
Three Months Ended Nine Months Ended ----------------------------- -------------------------------- June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001 ------------- ------------- ------------- ------------- Income before extraordinary gain .............. $ 1,156 $ 628 $ 1,037 $ 1,456 Extraordinary gain ............................ -- -- 686 -- --------- --------- --------- --------- Net earnings available to common stockholders ................................ $ 1,156 $ 628 $ 1,723 $ 1,456 ========= ========= ========= ========= Weighted average common shares outstanding .... 5,545,113 5,499,980 5,532,641 5,482,578 Weighted average common share equivalents outstanding ................................. 11,740 139,277 12,682 127,606 --------- --------- --------- --------- Weighted average common shares and common share equivalents outstanding .............. 5,556,853 5,639,257 5,545,323 5,610,184 ========= ========= ========= ========= Basic earnings per share: Income before extraordinary gain .......... $ 0.21 $ 0.11 $ 0.19 $ 0.27 Extraordinary gain ........................ -- -- 0.12 -- --------- --------- --------- --------- Net income .................................... $ 0.21 $ 0.11 $ 0.31 $ 0.27 ========= ========= ========= ========= Diluted earnings per common share: Income before extraordinary gain .......... $ 0.21 $ 0.11 $ 0.19 $ 0.26 Extraordinary gain ........................ -- -- 0.12 -- --------- --------- --------- --------- Net income .................................... $ 0.21 $ 0.11 $ 0.31 $ 0.26 ========= ========= ========= =========
3. Comprehensive Income Comprehensive income includes all changes in a company's equity, except those resulting from investments by and distributions to owners. The following table summarizes the components of comprehensive income (in thousands):
Three Months Nine Months Ended Ended ------------------ ------------------ June 30, June 30, June 30, June 30, 2002 2001 2002 2001 -------- -------- -------- -------- Net income ............................. $ 1,156 $ 628 $ 1,723 $ 1,456 Foreign currency translation adjustments 270 157 149 (93) ------- ------- ------- ------- Total comprehensive income ............. $ 1,426 $ 785 $ 1,872 $ 1,363 ======= ======= ======= =======
8 OYO GEOSPACE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 4. Trade Accounts and Notes Receivable Trade accounts and notes receivable consisted of the following (in thousands):
June 30, September 30, 2002 2001 ------- ------------- Trade accounts receivable .......................... $12,842 $ 9,566 Trade notes receivable ............................. 1,462 2,443 Allowance for doubtful accounts and notes .......... (558) (470) ------- ------- $13,746 $11,539 ======= =======
5. Inventories Inventories consisted of the following (in thousands):
June 30, September 30, 2002 2001 ------- ------------- Finished goods .................................... $ 4,150 $ 3,649 Work-in-process ................................... 4,867 9,653 Raw materials ..................................... 15,678 16,524 Obsolescence reserve .............................. (1,974) (1,089) ------- ------- $22,721 $28,737 ======= =======
The Company's reserve for slow moving and obsolete inventories is analyzed and adjusted periodically to reflect the Company's best estimate of the net realizable value of such inventories. 6. Acquisition Effective November 8, 2001, the Company increased its equity ownership from 44% to 85% in a Russian joint venture formed more than ten years ago with Geophyspribor Ufa Production Association, Bank Vostock and Chori Co., Ltd. Since the increase in ownership, the operating results of the reorganized entity, now known as OYO-GEO Impulse International LLC ("OYO-GEO Impulse"), have been consolidated with those of the Company. Geophyspibor Ufa Production Association and Chori Co., Ltd. has continued as minority equity holders of OYO-GEO Impulse. The Company restructured its participation in the Russian joint venture in order to broaden production capabilities, reduce production costs and increase its market scope internationally. In exchange for the additional equity ownership, the Company forgave a debt of $1.2 million owed to it by OYO-GEO Impulse. At the time of the acquisition, the Company's basis in the receivable and related equity investment was zero as such items were written-off in 1994. In accordance with the provisions of SFAS No. 141, the Company recorded an extraordinary gain of $686,000, net of income taxes of $85,000. This extraordinary gain resulted from the write-off of negative goodwill associated with the acquisition of the additional equity interest of OYO-GEO Impulse. 9 OYO GEOSPACE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) The allocation of the purchase price and a reconciliation of the purchase price to the cash provided by business acquisitions follows:
Fair values of assets and liabilities Accounts receivable ................................ $ 185 Inventories ........................................ 686 Prepaid expenses and other ......................... 263 Accounts payable ................................... (92) Accrued expenses ................................... (1,009) Income taxes payable ............................... (85) Minority interest .................................. (175) Negative goodwill .................................. (686) ------ Total allocated purchase price ..................... (913) Less consideration paid ............................ -- ------- Cash provided by business acquisition .............. $ (913) =======
7. Segment and Geographic Information The Company evaluates financial performance based on two business segments: Seismic and Commercial Graphics. The seismic product lines currently consist of geophones and hydrophones, including multi-component geophones and hydrophones, seismic leader wire, geophone string connectors, seismic telemetry cable, high definition reservoir characterization products and services, marine seismic cable retrieval devices and small data acquisition systems targeted at niche markets. Commercial graphic products include thermal imaging equipment and dry thermal film. The following tables summarize the Company's segment information:
Three Months Ended Nine Months Ended -------------------- --------------------- June 30, June 30, June 30, June 30, 2002 2001 2002 2001 --------- -------- --------- --------- Net sales: Seismic .................. $ 20,997 $ 12,184 $ 41,106 $ 37,630 Commercial graphics ...... 3,765 3,641 10,476 10,137 Eliminations ............. (94) (15) (181) (62) -------- -------- -------- -------- Total .................... $ 24,668 $ 15,810 $ 51,401 $ 47,705 ======== ======== ======== ======== Income (loss) from operations: Seismic .................. $ 3,095 $ 1,606 $ 4,382 $ 4,845 Commercial graphics ...... (999) (1) -- (112) Corporate ................ (835) (904) (2,787) (2,808) -------- -------- -------- -------- Total .................... $ 1,261 $ 701 $ 1,595 $ 1,925 ======== ======== ======== ======== June 30, September 30, 2002 2001 --------- ------------- Total assets: Seismic ................. $ 54,500 $ 56,968 Commercial graphics ..... 11,987 11,059 Corporate ............... 3,571 5,061 -------- -------- $ 70,058 $ 73,088 ======== ========
10 OYO GEOSPACE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 8. Credit Agreement The Company has a working capital line of credit pursuant to which it can borrow up to $10.0 million secured by its accounts receivable and inventories (the "Credit Agreement"). The Credit Agreement, as amended, expires in January 2003. Borrowings under the Credit Agreement are subject to borrowing base restrictions based on (i) consolidated net income plus consolidated interest expense, income taxes, depreciation and amortization and (ii) levels of eligible accounts receivable and inventories. The Credit Agreement limits the incurrence of additional indebtedness, requires the maintenance of certain financial amounts and contains other covenants customary in agreements of this type. As of June 30, 2002, there were borrowings of $2.1 million outstanding under the Credit Agreement. Based on the levels of eligible accounts receivable and inventories, the Company had additional borrowings available under the Credit Agreement of $5.5 million. The borrowing interest rate at June 30, 2002 was 5.0%. In January 2002, the Company amended its Credit Agreement to expire in January 2003. In connection with this amendment, the Company's borrowing interest rate became the bank's prime rate with a minimum rate of 5.0%. In addition, the Company arranged for an additional promissory note of $2.5 million ("Additional Note") to assist the Company with the funding of several long-term projects. As of June 30, 2002 there were no borrowings outstanding under the Additional Note, and additional borrowings available under the Additional Note of $2.5 million. The Additional Note had a fixed borrowing rate of 8.0% and matured on July 15, 2002. 9. Purchase of Intangible Assets A private corporation headquartered in New York State is currently the primary supplier of dry thermal film used by the Company's customers in the thermal imaging equipment that the Company manufactures (the "Primary Film Supplier"). In April 2002, the Company purchased certain intellectual property rights from its Primary Film Supplier for a total purchase price inclusive of professional fees of $2.1 million. As a result of this purchase, the Company has exclusive ownership of all technology used by the Primary Film Supplier to manufacture dry thermal film used in the thermal imaging equipment the Company manufactures. Such purchase includes technology currently existing and any dry thermal film technology later developed by the Primary Film Supplier for use in the Company's equipment. In connection with the purchase, the Company licensed the technology to the Primary Film Supplier on a perpetual basis so long as it can meet predefined quality and delivery requirements. The Company and the Primary Film Supplier also entered into an amended supply agreement pursuant to which the Primary Film Supplier provides the Company with the dry thermal film. Should the Primary Film Supplier not meet such requirements, the Company has the right to license to any third party the right to manufacture dry thermal film. 10. Subsequent Events On July 3, 2002, the Primary Film Supplier filed a Chapter 11 reorganization petition in Federal Bankruptcy Court for the Western District of New York. At June 30, 2002 and at the date of such bankruptcy filing, the Company had $3.3 million of long-term assets carried on its balance sheet (including the $2.1 million investment in certain intellectual property acquired from such Primary Film Supplier described in Note 9), as a result of the prior transactions with the Primary Film Supplier. The Primary Film Supplier has advised the Company that, in connection with its bankruptcy filing, it is seeking a buyer for its assets that would assume its relationship and contracts with the Company, and the Company intends to cooperate in such efforts to the extent its on-going interest can be served thereby. At this time, the Company is not able to determine whether a buyer can be found to operate the Primary Film Supplier's business or, if a buyer is found, that it will agree to perform the Primary Film Supplier's obligations under the agreements entered into between the Company and the Primary Film Supplier in accordance with the terms thereof, or whether any such buyer would be capable of carrying out such obligations. Should such efforts not be successful, the Company intends to use the intellectual property to manufacture the film internally or establish a relationship with another vendor as a source of supply for the film used in connection with the thermal imaging equipment that the Company manufactures. 11 OYO GEOSPACE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) As a result of such bankruptcy filing by the Primary Film Supplier and in accordance with the provisions of Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," the Company has provided an impairment charge of approximately $1.2 million due to the ultimate uncertainty of its ability to realize the value of certain assets, particularly certain prepaid purchase benefits and similar benefits under the supply contract with the Primary Film Supplier. The Company does not believe there has been any impairment in the value of the intellectual property acquired from the Primary Film Supplier in the April 2002 transaction described above because of its ability to utilize the intellectual property to have thermal film manufactured elsewhere. No claims have been made against the Company or by the Company at present in connection with the Supplier's bankruptcy proceeding. The Company is at present unable to predict whether any claims will be made by or against the Company in connection with the Primary Film Supplier's bankruptcy proceeding as to any aspect of the Company's relationship with such Primary Film Supplier and is otherwise unable to predict the outcome of this developing situation. 11. Tax Footnote The United States statutory tax rate for the current year and prior year periods was 34%. The difference between the Company's effective tax rate and the statutory tax rate resulted from adjustments due to the resolution of contingent tax matters and a change in estimates used to calculate the Company's year-end tax accrual upon the subsequent filing of the previous year's United States tax return. For the three months and nine months ended June 30, 2002, such adjustments were $422,000 and $489,000, respectively. For the three months and nine months ended June 30, 2001, such adjustments were $188,000 and $264,000, respectively. In addition, the Company recorded a tax expense of $85,000 related to an extraordinary gain that occurred in the first quarter of 2002. 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following analysis of the financial condition and results of operations of OYO Geospace Corporation should be read in conjunction with the Consolidated Financial Statements and Notes related thereto included elsewhere in this Form 10-Q. Industry Overview We design and manufacture instruments and equipment used in the acquisition and processing of seismic data. We have been in the seismic instrument and equipment business since 1980, marketing our products primarily to the oil and gas industry worldwide. We also design and manufacture thermal imaging equipment and distribute dry thermal film products to the commercial graphics industry. We have been serving the commercial graphics industry since 1995. Seismic Industry Geoscientists use seismic data to map potential or existing oil and gas bearing formations and the geologic structures that surround them. Seismic data is used primarily in connection with the exploration, development and production of oil and gas. Seismic data acquisition is conducted on land by combining a seismic energy source and a data recording system. The energy source imparts seismic waves into the earth, reflections of which are received and measured by geophones and hydrophones. Electrical signals generated by the geophones and hydrophones are simultaneously transmitted through leader wire, geophone and hydrophone string connectors and telemetric cable to data collection units, which store information for processing and analysis. Seismic thermal imaging products are output devices used in the field or office to create a graphic representation of the seismic data after it has been acquired. Marine seismic data acquisition is conducted primarily by large ocean-going vessels that tow long seismic cables known as "streamers". Usually, the energy source in marine seismic data acquisition is an airgun, and the reflected seismic waves are received and measured by hydrophones, which are an integral part of the streamers. The streamers simultaneously transmit the electrical impulses back to the vessel via telemetric cable included within the streamers, and the seismic data is recorded in much the same manner as it is on land. An estimated one to two-thirds of the reserves found with every oil and gas discovery will be left behind in the reservoir, not recoverable economically or at times even identified. Reservoir characterization and management programs, in which the reservoir is carefully imaged and monitored throughout the life of the field by seismic instruments and equipment, are now seen as vital tools for improving production recovery rates. Seismic surveys repeated over selected time intervals show dynamic changes within the reservoir and can be used to monitor the effects of production. We expect to incur significant future research and development expenditures aimed at the development of additional seismic acquisition products and services used for high definition reservoir characterization for use in both land and marine environments. While orders for our products can vary substantially from quarter to quarter, reservoir characterization projects, especially deepwater projects, require the use of more equipment over a longer period of time than is required by conventional surface seismic systems. Revenue recognition in accordance with generally accepted accounting principles for these large-scale projects has the potential to result in substantial fluctuations in quarterly performance. These variations may impact our operating results and cash flow, manufacturing capability and expense levels in any given quarter. Furthermore, because of the scale and nature of reservoir characterization projects, there may be delays in their implementation and uncertainties about their final course. As a result, we are unable at present to predict the impact of all such projects on our business and financial results and condition. 13 During our third quarter ended June 30, 2002, we delivered a reservoir characterization and monitoring system to a major oil company. In accordance with the terms of the contract, we recognized $15.8 million of revenues in our third quarter ended June 30, 2002. The contract provides for additional revenue of $3.2 million based upon the system's performance, and we expect to recognize such revenue in the last calendar quarter of 2003. All costs related to this sale, including estimated costs for warranty and delivery, have been recorded in the third quarter ended June 30, 2002. Commercial Graphics Industry We developed our commercial graphics business segment over time as we leveraged our thermal imaging product technology, originally designed for seismic data processing applications, into new markets. With minor product modifications, we were successful in adapting these products for use in the commercial graphics industry. Our commercial graphics business segment manufactures and sells thermal imaging equipment and distributes dry thermal film primarily to the screen print, point of sale, signage and textile market sectors. Our thermal imaging equipment is capable of producing data images ranging in size from 12 to 54 inches wide. This business segment has some sales to customers in the seismic industry. A private corporation headquartered in New York State is currently the primary supplier of dry thermal film used by our customers in the thermal imaging equipment we manufacture (the "Primary Film Supplier"). We also have a secondary supplier of dry thermal film headquartered in Europe. We are not aware of other suppliers of dry thermal film for our thermal imaging equipment. While alternate suppliers might be able to provide dry thermal film, such film has not historically performed as well in our thermal imaging equipment. In April 2002, we purchased certain intellectual property rights from our Primary Film Supplier for $2.1 million. Such purchase gives us exclusive ownership of all technology used by the Primary Film Supplier to manufacture dry thermal film used in the thermal imaging equipment we manufacture. Such purchase includes technology currently existing and any dry thermal film technology hereinafter developed by the Primary Film Supplier for use in our equipment. We have also entered into an amended supply agreement pursuant to which the Primary Film Supplier provides us with the dry thermal film. In connection with the purchase, we licensed the technology to the Primary Film Supplier on a perpetual basis, so long as it can meet predefined quality and delivery requirements. Should the Primary Film Supplier not meet such requirements, we have the right to license any third party to manufacture dry thermal film. On July 3, 2002, the Primary Film Supplier filed a Chapter 11 reorganization petition in Federal Bankruptcy Court for the Western District of New York. At June 30, 2002 and at the date of such bankruptcy filing, we had $3.3 million of long-term assets carried on our balance sheet (including the $2.1 million investment in certain intellectual property acquired from such Primary Film Supplier described above and in Note 9 to Consolidated Financial Statements), as a result of the prior transactions with the Primary Film Supplier. The Primary Film Supplier has advised us that, in connection with its bankruptcy filing, it is seeking a buyer for its assets that would assume its relationship and contracts with us, and we intend to cooperate in such efforts to the extent our on-going interest can be served thereby. At this time, we are not able to determine whether a buyer can be found to operate the Primary Film Supplier's business or, if a buyer is found, that it will agree to perform the Primary Film Supplier's obligations under the agreements entered into between us and the Primary Film Supplier in accordance with the terms thereof, or whether any such buyer would be capable of carrying out such obligations. Should such efforts not be successful, we intend to use the intellectual property to manufacture the film internally or establish a relationship with another vendor as a source of supply for the film used in connection with the thermal imaging equipment that we manufacture. As a result of the bankruptcy filing by the Primary Film Supplier, we have provided an impairment charge of approximately $1.2 million due to the ultimate uncertainty of realization of value on certain assets, particularly certain prepaid purchase benefits and similar benefits under the supply contract with the Primary Film Supplier. We do not believe there has been any impairment in the value of the intellectual property we acquired from the Primary Film Supplier in the April 2002 transaction described above because of our ability to utilize the intellectual property to have thermal film manufactured internally or elsewhere. No claims have been made against us or by us at present in connection 14 with the Primary Film Supplier's bankruptcy proceeding. We are at present unable to predict whether any claims will be made by or against us in connection with the Primary Film Supplier's bankruptcy proceeding as to any aspect of our relationship with such Primary Film Supplier and are otherwise unable to predict the outcome of this developing situation. Results of Operations We report and evaluate financial information for two segments: Seismic and Commercial Graphics. Summary financial data by business segment follows:
Three Months Ended Nine Months Ended ---------------------------- ---------------------------- June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001 ------------- ------------- ------------- ------------- Seismic Revenue ....................... $ 20,997 $ 12,184 $ 41,106 $ 37,630 Operating income .............. 3,095 1,606 4,382 4,845 Commercial Graphics Revenue ....................... 3,765 3,641 10,476 10,137 Operating income (loss) ....... (999) (1) -- (112) Corporate Revenue ....................... -- -- -- -- Operating loss ................ (835) (904) (2,787) (2,808) -- Eliminations Revenue ....................... (94) (15) (181) (62) Operating income .............. -- -- -- -- Consolidated Totals Revenue ....................... 24,668 15,810 51,401 47,705 Operating income .............. 1,261 701 1,595 1,925
Overview Third Quarter of Fiscal Year 2002 Compared to Third Quarter of Fiscal Year 2001. Consolidated sales for the three months and nine months ended June 30, 2002 increased $8.9 million, or 56.0% and $3.7 million, or 7.7%, respectively, from the corresponding periods of the prior fiscal year. The increase in sales in both periods was primarily due to (i) a $15.8 million sale of a reservoir characterization and monitoring system to a major oil company, (ii) the acquisition and consolidation of OYO GEO Impulse, and (iii) an increase of sales by our commercial graphics segment. Such increases were partially offset by a significant decrease in sales of our traditional land-based seismic products. Such decrease in sales resulted from a softening in the demand for seismic equipment along with significant competitive pricing pressures due to excess manufacturing capacity in the seismic business segment. Consolidated gross profits for the three months ended June 30, 2002 increased by $1.2 million, or 20.6% from the corresponding period of the prior year. Consolidated gross profits for the nine months ended June 30, 2002 decreased by $0.3 million, or 2.1% from the corresponding period of the prior year. While the sale of the reservoir characterization system had a favorable impact on our consolidated gross profits and gross profit margins, the continued depressed state of the seismic industry adversely affected gross profit margins for our land-based seismic products. In response to these market conditions, we recorded a charge of $0.9 million in the quarter ended June 30, 2002 to reflect the impairment of slow moving inventories and the underutilization of certain manufacturing plant assets. 15 Consolidated operating expenses for the three months and nine months ended June 30, 2002 increased by $0.6 million, or 12.2%, and decreased $9,000, or 0.1%, respectively, from the corresponding periods of the prior fiscal year. Reflected in each period's operating expenses is a $1.2 million impairment charge related to the Chapter 11 reorganization petition filed by the Primary Film Supplier. In this regard, see the discussion in Notes 9 and 10 to Consolidated Financial Statements included in this Report on Form 10-Q and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Industry Overview--Commercial Graphics Industry". Excluding the impact of the impairment charge, consolidated operating expenses for this three month and nine month period decreased by $0.6 million, or 12.6%, and $1.2 million, or 8.7%, respectively, from the corresponding period of the prior fiscal year. The lower expenses are a result of our effort to reduce expenses in our land-based seismic business segment. In the past year, we have significantly reduced the workforce in our land-based seismic manufacturing operations. The effective tax rate for the three months and nine months ended June 30, 2002 was (3.4)% and (16.5)%, respectively. The effective tax rate for the three months and nine months ended June 30, 2001 was 1.6% and 18.4%, respectively. The United States statutory tax rate for each of these periods was 34%. For each of the current year and prior year periods, the difference between our effective tax rate and the statutory tax rate resulted from the recording of tax benefits related to the resolution of contingent tax matters from prior years, as well as a change in the estimates used to calculate our year-end tax accrual to the subsequently filed United States tax return. In addition, we recorded a tax expense of $85,000 related to an extraordinary gain that occurred in the first quarter of 2002. Seismic Our seismic product lines currently consist of high definition reservoir characterization products and services, geophones and hydrophones, including multi-component geophones and hydrophones, seismic leader wire, geophone string connectors, seismic telemetry cable, marine seismic cable retrieval devices and small data acquisition systems targeted at niche markets. Revenue Sales of our seismic products for the three months and nine months ended June 30, 2002 increased $8.8 million, or 72.3%, and $3.5 million or 9.2% respectively from the corresponding periods of the prior year. The increase in seismic product sales resulted from (i) the sale of a $15.8 million reservoir characterization system and (ii) the acquisition of an increased interest in, and consolidation of, OYO-GEO Impulse discussed hereinafter under "--International Business Development Initiative". These increases in sales were significantly offset by a decrease in sales of our traditional land-based seismic products. This sales decline resulted from a softening in the demand for seismic equipment along with significant competitive pricing pressures due to excess manufacturing capacity. Operating Income Operating income for the three months and nine months ended June 30, 2002 increased $1.5 million, or 92.7%, and decreased $0.5 million, or 9.6%, respectively, from the corresponding periods of the prior year. For each period, operating income was favorably impacted by the sale of a reservoir characterization and monitoring system. However, operating income was unfavorably impacted by lower sales levels of our land-based seismic products, which yielded significantly lower gross profit margins due to unabsorbed fixed manufacturing costs. Furthermore, we recorded a charge of $0.9 million in the quarter ended June 30, 2002 to reflect the impairment of slow moving inventories and the underutilization of certain manufacturing plant assets. 16 International Business Development Initiative Effective November 8, 2001, the Company increased its equity ownership from 44% to 85% in a Russian joint venture formed more than ten years ago with Geophyspribor Ufa Production Association, Bank Vostock and Chori Co., Ltd. Since the increase in ownership, the operating results of the reorganized entity, now known as OYO-GEO Impulse International LLC ("OYO-GEO Impulse"), have been consolidated with those of the Company. Geophyspibor Ufa Production Association and Chori Co., Ltd. have continued as minority equity holders of OYO-GEO Impulse. In exchange for the additional equity ownership, we forgave a debt of $1.2 million owed to us by OYO-GEO Impulse. At the time of the acquisition, our basis in the receivable and related equity investment was zero as such items were written-off in 1994. In connection with this acquisition, we recorded an extraordinary gain of $686,000, net of income taxes of $85,000. This extraordinary gain resulted from the write-off of negative goodwill associated with the acquisition of the additional equity interest of OYO-GEO Impulse. Commercial Graphics Our commercial graphics business segment manufactures and sells thermal imaging equipment and distributes dry thermal film primarily to the screen print, point of sale, signage and textile market sectors. This business segment has some sales to customers in the seismic industry. Revenue Sales of our commercial graphics products for the three months and nine months ended June 30, 2002 increased $0.1 million, or 3.4% and $0.3 million, or 3.3%, respectively, from the corresponding periods of the prior year. Such increase in the three months ended June 30, 2002 reflects increases in the sale of dry thermal film. The increase in the nine months ended June 30, 2002 primarily reflects the impact of our acquisition of the business and assets of EcoPRO Imaging Corporation in February 2001. Operating Income Operating income for the three months and nine months ended June 30, 2002 decreased $1.0 million and increased $0.1 million, respectively, from the corresponding periods of the prior fiscal year. Both periods reflect the impact of a $1.2 million impairment charge. In this regard, see the discussion in Notes 9 and 10 to Consolidated Financial Statements included in this Report on Form 10-Q and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Industry Overview--Commercial Graphics Industry". Excluding the $1.2 million impairment charge, operating income for the three months and nine months ended June 30, 2002 would have increased $0.2 million and $1.3 million, respectively, from the corresponding periods of the prior fiscal year. The increase in operating income is due to increased sales of dry thermal film products, and the year-to-date impact of the EcoPRO acquisition. Liquidity and Capital Resources At June 30, 2002, we had $1.9 million in cash and cash equivalents. For the nine months ended June 30, 2002, we generated approximately $3.0 million of cash in operating activities principally resulting from our net income after adding back $3.6 million of net non-cash charges. In addition, our inventories decreased $6.7 million principally as a result of the sale of a reservoir characterization and monitoring system to a major oil company. Such cash flows were offset by increases in accounts receivable and decreases in account payable and accrued expenses. Accounts receivable increased $1.8 million as a result of higher sales, principally the sale of the reservoir characterization and monitoring system. Accounts payable decreased $2.5 million primarily due to decreased purchases of raw materials, resulting from lower sales of our land-based seismic equipment. The decrease in accrued expenses resulted from the revenue recognition of $4.9 million of deferred revenues in connection with the sale of the reservoir characterization and monitoring system. 17 For the nine months ended June 30, 2002, we used approximately $3.4 million of cash in investing activities primarily resulting from $2.6 million of capital expenditures and our $2.1 million purchase of intangible assets from our Primary Film Supplier. Such amount was offset by $0.9 million of cash we received through the acquisition of an additional interest in, and consolidation of, OYO-GEO Impulse. We estimate that our capital expenditures for fiscal year 2002 will range between $4.0 to $5.0 million, which we expect to fund through operating cash flows and borrowings under our credit facility. For the nine months ended June 30, 2002, we generated approximately $1.2 million of cash from financing activities primarily resulting from borrowings under our credit facility. We have a working capital line of credit pursuant to which we can borrow up to $10.0 million secured by our accounts receivable and inventory (the "Credit Agreement"). The Credit Agreement, as amended, expires in January 2003. Borrowings under the Credit Agreement are subject to borrowing base restrictions based on (i) consolidated net income plus consolidated interest expense, income taxes, depreciation and amortization and (ii) levels of eligible accounts receivable and inventories. The Credit Agreement limits the incurrence of additional indebtedness, requires the maintenance of certain financial amounts and contains other covenants customary in agreements of this type. As of June 30, 2002 there were borrowings of $2.1 million outstanding under the Credit Agreement. Based on the levels of eligible accounts receivable and inventories, the Company had additional borrowings available under the Credit Agreement of $5.5 million. The borrowing interest rate at June 30, 2002 was 5.0%. In January 2002, we amended our Credit Agreement to expire in January 2003. In connection with this amendment, our borrowing interest rate became the bank's prime rate with a minimum rate of 5.0%. In addition, we arranged for an additional promissory note of $2.5 million ("Additional Note") to assist the Company with the funding of several long-term projects. As of June 30, 2002 there were no borrowings under the Additional Note and additional borrowings available under the Additional Note of $2.5 million. The Additional Note had a fixed borrowing rate of 8.0% and matured on July 15, 2002. We believe that the combination of existing cash reserves, cash flows from operations and borrowing availability under our existing credit facility should provide us sufficient capital resources and liquidity to fund our planned operations through fiscal year 2003. However, there can be no assurance that such sources of capital will be sufficient 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. Contractual Obligations and Commercial Commitments A summary of future payments owed for contractual obligations and commercial commitments as of June 30, 2002 are shown in the table below (in thousands).
Less Than 1 - 3 4 -5 After Total 1 Year Years Years 5 Years ----- ------ ----- ----- ------- Contractual Obligations: Long-term debt ........................ $ 3,826 $ 224 $ 498 $ 574 $ 2,530 Operating leases ...................... 730 518 212 -- -- -------- --------- -------- -------- -------- Total contractual obligations ......... 4,556 742 710 574 2,530 Commercial Commitments: Lines of credit ....................... 2,128 2,128 -- -- -- -------- --------- -------- -------- -------- Total contractual obligations and commercial commitments .............. $ 6,684 $ 2,870 $ 710 $ 574 $ 2,530 ======== ========= ======== ======== ========
18 Accounting Pronouncements In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. We adopted the provisions of SFAS 141 effective October 1, 2001. Among the provisions of SFAS 141 is the requirement to record as an extraordinary gain all negative goodwill resulting from new business combinations. As a result, we recorded an extraordinary gain of $686,000 relating to the acquisition of the additional interest in the Russian joint venture in November 2001. Also in July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually for impairment; or more frequently if impairment is indicated. Intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives; however, no maximum life applies. We will adopt the provisions of SFAS 142 effective in our fiscal year 2003, beginning October 1, 2002. At June 30, 2002, we had goodwill, net of accumulated amortization, of $1.9 million. Management is currently evaluating the impact of SFAS 142 on the Company's financial position and results of operations. In August 2001, the Financial Accounting Standards Board issued SFAS No. 143 - "Accounting for Asset Retirement Obligations". This statement requires us to recognize the fair value of a liability associated with the cost we would be obligated to incur in order to retire an asset at some point in the future. The liability would be recognized in the period in which it is incurred and can be reasonably estimated. The standard is effective for fiscal years beginning after June 15, 2002. We expect to adopt this standard at the beginning of our fiscal 2003. Management is currently evaluating the impact of SFAS No. 143 on our financial position and results of operations. Additionally, in October 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets". SFAS No. 144 develops an accounting model, based upon the framework established in SFAS No. 121, for long-lived assets to be disposed by sales. The accounting model applies to all long-lived assets, including discontinued operations, and it replaces the provisions of APB Opinion No. 30, "Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for disposal of segments of a business. SFAS No. 144 requires long-lived assets held for disposal to be measured at the lower of carrying amount or fair values less costs to sell, whether reported in continuing operations or in discontinued operations. The statement is effective for fiscal years beginning after December 15, 2001. We intend to adopt this standard at the beginning of our fiscal 2003. Management is currently evaluating the impact of SFAS No. 144 on our financial position and results of operations. In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, "Recission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This statement clarifies guidance related to the reporting of gains and losses from extinguishment of debt and resolves inconsistencies related to the required accounting treatment of certain lease modifications. The provisions of this statement relating to extinguishment of debt become effective for financial statements issued for fiscal years beginning after May 15, 2002. The provisions of this statement relating to lease modification are effective for transactions occurring after May 15, 2002. We intend to adopt this standard at the beginning of fiscal 2003. Management is currently evaluating the impact of SFAS No. 145 on our financial position and results of operations. Forward Looking Statements and Risks Certain of the statements we make in this document and in documents incorporated by reference herein, including those made under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," are forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934. Such statements include projections of our expectations regarding our future capital expenditures, product lines, growth of product markets and other statements that relate to future events or circumstances. These statements are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to differ materially from the future results, performance or achievements expressed or 19 implied by such forward-looking statements, including the risks and factors described below. You are cautioned to consider the following factors and risks in connection with evaluating any such forward-looking statements or otherwise evaluating an investment in our company. Our New Products May Not Achieve Market Acceptance. In recent years, we have incurred significant expenditures to fund our research and development efforts and we intend to continue those expenditures in the future. However, research and development is by its nature speculative, and we cannot assure you that these expenditures will result in the development of new products or services or that any new products and services we have developed recently or may develop in the future will be commercially marketable or profitable to us. In particular, we have incurred substantial expenditures to develop our recently introduced HDSeis(TM) product line for borehole and reservoir characterization applications. For a discussion of particular factors and risks relating to projects in the reservoir characterization area, see the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations--Industry Overview" in this Report on Form 10-Q. We cannot assure you that we will realize our expectations regarding market acceptance and revenues from these products and services. A Decline in Industry Conditions Could Affect our Projected Results. Any unexpected material changes in oil and gas prices or other market trends that would impact seismic exploration activity would likely affect the forward-looking information contained in this document. Our results for fiscal year 2000 were materially and adversely affected by the downturn in the industry that began in fiscal year 1999. Although our results for fiscal year 2001 showed an improvement over fiscal year 2000 due to increases in oil and gas prices, the oil and gas industry is extremely volatile and subject to change based on political and economic factors outside our control as evidenced by recent decreases in oil and gas prices. Our estimates as to future results and industry trends described in this document are based on assumptions regarding the future level of seismic exploration activity and its effect on the demand and pricing of our products and services. In analyzing the market and its impact on us, we have made the following assumptions for fiscal year 2002: o Oil and gas prices will, on average, be weaker than fiscal year 2001. As a result, seismic exploration activity will decrease. o Demand for seismic instruments and equipment will decline from fiscal year 2001 levels. o Demand for our new high definition reservoir characterization products and services will increase as those products and services become known to the industry and as the need for reservoir characterization technology increases. o Deep-water marine seismic activity will remain constrained. o Demand for our products used in the commercial graphics industry will increase with continued market acceptance and new product introductions. o Pricing for many of our products will continue to be subject to pressures due to seismic industry customer consolidations and competition as the seismic industry enters another economic downturn. We have based these assumptions on various macro-economic factors, and actual market conditions could vary materially from those assumed. 20 We May Experience Fluctuations in Quarterly Results of Operations. Historically, the rate of new orders for our products has varied substantially from quarter to quarter. Moreover, we typically operate, and expect to continue to operate, on the basis of orders in hand for our products before we commence substantial manufacturing "runs"; hence, the completion of orders, particularly large orders for deepwater reservoir characterization projects, can significantly impact the operating results and cash flow for any quarter, and results of operations for any one quarter may not be indicative of results of operations for future quarters. Our Credit Risks Could Increase as our Customers Continue to Face Difficult Economic Circumstances. We believe and have assumed that our allowance for bad debts at June 30, 2002 is adequate in light of known circumstances. However, we cannot assure you that sufficient aggregate amounts of uncollectible receivables and bad debt write-offs will not have a material adverse effect on our future results of operations. Many of our customers have suffered from lower revenues and experienced liquidity challenges resulting from the economic difficulties throughout our industry. We have in the past incurred significant write-offs in our accounts receivable due to customer credit problems. We have found it necessary from time to time to extend trade credit to long-term customers and others where some risks of nonpayment or late payment exist. Given recent industry conditions, some of our customers have experienced a liquidity difficulty, which increases those credit risks. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources", contained in this Report on Form 10-Q. Demand for Our Products is Volatile. Demand for our products depends primarily on the level of worldwide oil and gas exploration activity. That activity, in turn, depends primarily on prevailing oil and gas prices. Historically, the markets for oil and gas have been volatile, and those markets are likely to continue to be volatile. Oil and gas prices are subject to wide fluctuation in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty and a variety of additional factors that are beyond our control. These factors include the level of consumer demand, weather conditions, domestic and foreign governmental regulations, price and availability of alternative fuels, political conditions in the Middle East and other significant oil-producing regions, foreign supply of oil and gas, price of foreign imports and overall economic conditions. Continued low demand for our products could materially and adversely affect our results of operations and liquidity. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Industry Overview" contained in this Report on Form 10-Q. We Have a Relatively Small Public Float, and Our Stock Price May be Volatile. We have approximately 2.4 million shares outstanding held by nonaffiliates. This small float results in a relatively illiquid market for our common stock. Our average daily trading volume during fiscal year 2001 was approximately 5,000 shares. Our small float and daily trading volumes may result in greater volatility of our stock price. Our Industry is Characterized by Rapid Technological Evolution and Product Obsolescence. Our instruments and equipment are constantly undergoing rapid technological improvement. Our future success depends on our ability to continue to: o improve our existing product lines; o address the increasingly sophisticated needs of our customers; o maintain a reputation for technological leadership; o maintain market acceptance; o anticipate changes in technology and industry standards; and o respond to technological developments on a timely basis. Current competitors or new market entrants may develop new technologies, products or standards that could render our products obsolete. We cannot assure you that we will be successful in developing and marketing, on a 21 timely and cost effective basis, product enhancements or new products that respond to technological developments, that are accepted in the marketplace or that comply with industry standards. We Operate in Highly Competitive Markets. The markets for our products are highly competitive. Many of our existing and potential competitors have substantially greater marketing, financial and technical resources than we do. Additionally, two competitors in our seismic business segment currently offer a broader range of instruments and equipment for sale and market this equipment as a "packaged" data acquisition system. We do not now offer for sale such a complete "packaged" data acquisition system. Further, certain of our competitors offer financing arrangements to customers on terms that we may not be able to match. In addition, new competitors may enter the market and competition could intensify. We cannot assure you that sales of our products will continue at current volumes or prices if current competitors or new market entrants introduce new products with better features, performance, price or other characteristics than our products. Competitive pressures or other factors also may result in significant price competition that could have a material adverse effect on our results of operations. We Have a Limited Market. In our seismic business segment, we market our products to contractors and large independent and government-owned oil and gas companies. We estimate that, based on published industry sources, fewer than 100 seismic contracting companies are currently operating worldwide (excluding those operating in Russia and the former Soviet Union, India, the People's Republic of China and certain Eastern European countries, where seismic data acquisition activity is difficult to verify). We estimate that fewer than ten seismic contractors are engaged in marine seismic exploration. Due to these market factors, a relatively small number of customers have accounted for most of our sales. The loss of a small number of these customers could materially and adversely impact our sales. We Cannot Be Certain of Patent Protection of Our Products. We have applied for and hold certain patents relating to our seismic data acquisition and other products. We cannot assure you that our patents will prove enforceable, that any patents will be issued for which we have applied or that competitors will not develop functionally similar technology outside the protection of any patents we have or may obtain. Our Foreign Marketing Efforts Face Additional Risks and Difficulties. Net sales outside the United States accounted for approximately 14.6% of our net sales during fiscal year 2001. Additionally, our United States subsidiaries engage in significant export sales. Substantially all of our sales from the United States are made in U.S. dollars, but from time to time we may make sales in foreign currencies and may, therefore, be subject to foreign currency fluctuations on our sales. In addition, net assets reflected on the balance sheet of our Russian, Canadian and U.K. subsidiaries are subject to currency fluctuations. Significant foreign currency fluctuations could adversely impact our results of operations. See also our discussion in "Quantitative and Qualitative Disclosures About Market Risk" contained in this Report on Form 10-Q. Foreign sales are subject to special risks inherent in doing business outside of the United States, including the risk of war, terrorist activities, civil disturbances, embargo and government activities, all of which may disrupt markets. Foreign sales are also generally subject to the risk of compliance with additional laws, including tariff regulations and import and export restrictions. Sales in certain foreign countries require prior United States government approval in the form of an export license. We cannot assure you that we will not experience difficulties in connection with future foreign sales. 22 We Rely on Key Suppliers for Significant Product Components. A Japanese manufacturer unaffiliated with us is currently the only supplier of wide format thermal printheads that we use to manufacture our wide format thermal imager equipment. We often return significant quantities of these products to the manufacturer for repair, testing and quality assurance review. We believe we maintain an adequate inventory of these printheads to continue production for two to three months. A private corporation headquartered in New York State is currently the primary supplier of dry thermal film used by our customers in the thermal imaging equipment we manufacture (the "Primary Film Supplier"). We also have a secondary supplier of dry thermal film headquartered in Europe. We know of no other supplier of dry thermal film for our thermal imaging equipment. While alternate suppliers might be able to provide dry thermal film, such film has not historically performed as well in our thermal imaging equipment. In April 2002, we purchased certain intellectual property rights from our Primary Film Supplier for $2.1 million. Such purchase gives us exclusive ownership of all technology used by the Primary Film Supplier to manufacture dry thermal film used in the thermal imaging equipment we manufacture. Such purchase included technology then existing and any dry thermal film technology subsequently developed by the Primary Film Supplier for use in our equipment. We have also entered into an amended supply agreement pursuant to which the Primary Film Supplier provides us with the dry thermal film. In connection with the purchase, we licensed the technology to the Primary Film Supplier on a perpetual basis, so long as it can meet predefined quality and delivery requirements. Should the Primary Film Supplier not meet such requirements, we have the right to license any third party to manufacture dry thermal film. In connection with the purchase of this technology, we received favorable price concessions from the Primary Film Supplier. We have no assurance that the Primary Film Supplier will be able to provide us a continued supply of dry thermal film for the foreseeable future. Further, we are unable to predict at this time what affect the bankruptcy of the Primary Film Supplier will have on our business. In this regard see the discussion in Notes 9 and 10 to Consolidated Financial Statements included in this Report on Form 10-Q and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Industry Overview--Commercial Graphics Industry". If the Japanese manufacturer were to discontinue supplying these printheads or was unable or unwilling to supply printheads in sufficient quantities to meet our requirements, if our Primary Film Supplier were to discontinue supplying dry thermal film, were unable or unwilling to supply dry thermal film in sufficient quantities to meet our requirements or if we were unable to replace such supplier, our ability to compete in the thermal imaging marketplace could be severely damaged, which could adversely affect our financial performance. We Are Subject to Control by a Principal Stockholder. OYO Corporation, a Japanese corporation, owns indirectly in the aggregate approximately 51.7% of our common stock. Accordingly, OYO Corporation, through its wholly owned subsidiary OYO Corporation U.S.A, is able to elect all of our directors and to control our management, operations and affairs. We currently have, and may continue to have, a variety of contractual relationships with OYO Corporation and its affiliates. Our Success Depends Upon A Limited Number of Key Personnel. Our success depends on attracting and retaining highly skilled professionals. A number of our employees are highly skilled engineers and other professionals. If we fail to continue to attract and retain such professionals, our ability to compete in the industry could be adversely effected. In addition, our success depends to a significant extent upon the abilities and efforts of several members of our senior management. Terrorist Attacks in 2001 on the U.S. Together With the Downturn in the U.S. Economy in 2001 May Adversely Affect our Business. While we are not yet able to evaluate fully the effect of the recent terrorist attacks on the U.S., which appear to have coincided with or contributed to a general downturn in the U.S. economy, both such matters could adversely 23 affect our business in ways that we cannot yet identify. However, both may adversely affect the demand for oil and gas generally and therefore, the demand for our services to the oil and gas industry and related service industry. They could also affect adversely the demand for consumer products, which could in turn adversely affect our commercial graphics business. To the extent these factors adversely affect other seismic companies in the industry, we could see an oversupply of products and services and downward pressure on pricing for seismic products and services that would affect us adversely. Critical Accounting Policies. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We consider many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the estimates and assumptions that are used in the preparation of these financial statements. We continually evaluate our estimates, including those related to bad debts, inventory obsolescence, product warranty, intangible assets and deferred income taxes. We base our estimates on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different conditions or assumptions. Revenue is primarily derived from the sale, and short-term rental under operating lease, of seismic instruments and equipment and commercial graphics products. Sales revenues are recognized when our products are shipped and title and risk of loss have passed to the customer. Rental revenues are recognized as earned over the rental period. Short-term rentals of our equipment generally range from daily rentals to rental periods of up to six months. Products are generally sold without any customer acceptance provisions and our standard terms of sale do not allow customers to return products. Our products generally do not require installation assistance or sophisticated instruction. We offer a standard product warranty obligating us to repair or replace equipment with manufacturing defects. We maintain a reserve for future warranty costs based on historical experience. We record a write-down of inventory when the cost basis of any manufactured product (including any estimated future costs to complete the manufacturing process) exceeds its net realizable value. Goodwill, representing the excess of purchase price over the fair value of net assets acquired and other intangible assets are amortized on a straight-line basis over the period of expected benefit, not exceeding 40 years. Goodwill is a residual amount and is determined after numerous estimates are made regarding the fair values of assets and liabilities included in a business combination. At June 30, 2002, the Company had goodwill, net of accumulated amortization, of $1.9 million. The carrying value of long-lived assets, including goodwill, is reviewed periodically for impairment. Substantial judgment is necessary in the determination as to whether an event or circumstances have occurred that may trigger impairment. For information regarding our current and future accounting policies regarding goodwill amortization, see Note 1 to the Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations - Accounting Pronouncements. 24 Item 3. Quantitative and Qualitative Disclosures about Market Risk The following discussion of our exposure to various market risks contains "forward looking statements" that involve risks and uncertainties. These projected results have been prepared utilizing certain assumptions considered reasonable in light of information currently available to us. Nevertheless, because of the inherent unpredictability of foreign currency rates, as well as other factors, actual results could differ materially from those projected in this forward looking information. We do not have any market risk as to market risk sensitive instruments entered into for trading purposes and have only very limited risk as to arrangements entered into other than for trading purposes. Further, we do not engage in commodity or commodity derivative instrument purchasing or selling transactions. Foreign Currency Exchange Rate Risk We purchase printheads from OYO Corporation pursuant to terms under which such purchases are denominated in Japanese Yen. We routinely attempt to hedge our currency exposure on these purchases by entering into foreign currency forward contracts with a bank. The purpose of entering into these forward hedge contracts is to eliminate variability of cash flows associated with foreign currency exposure risk on amounts payable in Japanese Yen. Under SFAS No. 133 and related interpretations, our forward contracts with the bank are considered derivatives. SFAS No. 133, which was effective for our fiscal year 2001, requires that we record these foreign currency forward contracts on the balance sheet and mark them to fair value at each reporting date. Our aggregate dollar exposure to forward yen contracts has never exceeded $0.4 million and such contracts ordinarily are settled within 10 months. Resulting gains and losses are reflected in income and were not material for our fiscal quarter ended June 30, 2002. At June 30, 2002, we had no exposure to yen denominated foreign currency forward contracts, and we had $59,000 of yen denominated accounts payable. Foreign Currency and Operations Risk We have a subsidiary located in Russia. Therefore, our financial results may be affected by factors such as changes in foreign currency exchange risks, weak economic conditions, or changes in Russia's political climate. Our consolidated balance sheet at June 30, 2002 reflected approximately $2.7 million of net working capital related to our Russian subsidiary. This subsidiary both receives its income and pays its expenses primarily in roubles. To the extent that transactions of this subsidiary are settled in roubles, a devaluation of the rouble versus the U.S. dollar could reduce any contribution from our Russian subsidiary to our consolidated results of operations as reported in U.S. dollars. We do not hedge the market risk with respect to our operations in Russia; therefore, such risk is a general and unpredictable risk of future disruptions in the valuation of Russian roubles versus U.S. dollars to the extent such disruptions result in any reduced valuation of the Russian subsidiary's net working capital or future contributions to our consolidated results of operations. Interest Rate Risk We have a revolving line of credit with a bank which subjects us to the risk of increased interest costs associated with any upward movements in bank market interest rates. Our borrowing interest rate is the bank's prime rate (4.75% at June 30, 2002) with a minimum rate of 5.0%. Further, amounts payable under the line of credit are due in full in January 2003. As of June 30, 2002, we had borrowed $2.1 million under this line of credit at a borrowing rate of 5.0%. Due to the small amount of borrowings under this credit facility and its short term, we anticipate that any increased interest costs associated with movements in market interest rates will not be material to our financial condition, results of operation or cash flow. Similarly, we have a fixed rate 8.0% loan in the amount of $2,500,000 from the same bank payable in July 2002. At June 30, 2002 there were no borrowings under this loan facility. Because of the short-term maturity of this loan and the fixed rate, and because we had no outstanding borrowings under this note, we do not have any material market risk attributable thereto. 25 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) The Company did not file any exhibits with this Quarterly Report. (b) The Company did not file any reports on Form 8-K during the quarter for which this report is filed. 26 SIGNATURES 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. OYO GEOSPACE CORPORATION Date: August 12, 2002 By: /s/ Gary D. Owens --------------------------------------- Gary D. Owens, Chairman of the Board President and Chief Executive Officer (duly authorized officer) Date: August 12, 2002 By: /s/ Thomas T. McEntire --------------------------------------- Thomas T. McEntire Chief Financial Officer (principal financial officer) 27 Informational Addendum to Report on Form 10-Q Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Not Filed Pursuant to the Securities Exchange Act of 1934 The undersigned Chief Executive Officer and Chief Financial Officer of OYO Geospace Corporation do hereby certify as follows: Solely for the purpose of meeting the apparent requirements of Section 906 of the Sarbanes-Oxley Act of 2002, and solely to the extent this certification may be applicable to this Report on Form 10-Q, the undersigned hereby certify that this Report on Form 10-Q fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and the information contained in this Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of OYO Geospace Corporation. /s/ Gary D. Owens ----------------------------------------------- Name: Gary D. Owens Title: Chief Executive Officer /s/ Thomas T. McEntire ----------------------------------------------- Name: Thomas T. McEntire Title: Chief Financial Officer 28