10-Q 1 h80944e10-q.txt INPUT/OUTPUT, INC. - DATED AUGUST 31, 2000 1 ================================================================================ FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2000 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 1-13402 INPUT/OUTPUT, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 22-2286646 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 12300 C. E. SELECMAN DR., STAFFORD, TEXAS 77477 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (281) 933-3339 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: [X] No: [ ] At August 31, 2000 there were 50,898,095 shares of common stock, par value $0.01 per share, outstanding. 2 INPUT/OUTPUT, INC. AND SUBSIDIARIES INDEX TO FORM 10-Q FOR THE QUARTER ENDED AUGUST 31, 2000
PART I. Financial Information. Page ---- Item 1. Financial Statements. Consolidated Balance Sheets August 31, 2000 and May 31, 2000 ............................................ 2 Consolidated Statements of Operations Three months ended August 31, 2000 and August 31, 1999 ...................... 3 Consolidated Statements of Cash Flows Three month ended August 31, 2000 and August 31, 1999 ....................... 4 Notes to Consolidated Financial Statements .................................... 5 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition ............................................................ 10 Item 3. Quantitative and Qualitative Disclosures about Market Risk ...................... 21 PART II. Other Information. Item 1. Legal Proceedings ............................................................... 21 Item 6. Exhibits and Reports on Form 8-K ................................................ 22
1 3 INPUT/OUTPUT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
ASSETS AUGUST 31, May 31, Current assets: 2000 2000 ---------- --------- Cash and cash equivalents .................................................................. $ 84,842 $ 99,210 Restricted cash ............................................................................ 1,006 1,006 Trade accounts receivable, net ............................................................. 30,875 24,944 Trade notes receivable, net ................................................................ 13,445 12,224 Inventories, net ........................................................................... 70,457 69,185 Deferred income tax asset, net ............................................................. 12,479 13,459 Prepaid expenses ........................................................................... 1,214 1,274 --------- --------- Total current assets ............................................................... 214,318 221,302 Long-term trade notes receivable, net ......................................................... 6,108 6,013 Deferred income tax asset, net ................................................................ 42,373 41,393 Property, plant and equipment, net ............................................................ 55,592 58,419 Goodwill, net ................................................................................. 48,331 49,256 Other assets, net ............................................................................. 4,427 4,681 --------- --------- Total assets ....................................................................... $ 371,149 $ 381,064 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable, principally trade ........................................................ $ 10,212 $ 8,011 Current installments of long-term debt ..................................................... 1,176 1,154 Income tax payable ......................................................................... 2,898 1,464 Accrued expenses ........................................................................... 20,365 27,261 --------- --------- Total current liabilities .......................................................... 34,651 37,890 Long-term debt ................................................................................ 7,491 7,886 Other liabilities ............................................................................. 274 273 Commitments and contingencies Stockholders' equity: Cumulative convertible preferred stock, $.01 par value; authorized 5,000,000 shares; issued and outstanding 55,000 shares at the end of both periods (liquidation value of $55.0 million) ............................................................................. 1 1 Common stock, $.01 par value; authorized 100,000,000 shares; outstanding 50,898,095 shares and 50,744,180 shares respectively ....................................... 512 510 Additional paid-in capital .................................................................... 350,485 348,743 Retained deficit .............................................................................. (13,539) (6,065) Accumulated other comprehensive loss .......................................................... (6,079) (5,427) Treasury stock, at cost, 232,500 shares at the end of both periods ........................... (1,651) (1,651) Unamortized restricted stock compensation ..................................................... (996) (1,096) --------- --------- Total stockholders' equity .............................................................. 328,733 335,015 --------- --------- Total liabilities and stockholders' equity ......................................... $ 371,149 $ 381,064 ========= =========
See accompanying notes to consolidated financial statements. 2 4 INPUT/OUTPUT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
Three months ended August 31, ------------------------------ 2000 1999 ------------ ------------ Net sales ............................................. $ 27,141 $ 29,979 Cost of sales ......................................... 20,780 23,994 ------------ ------------ Gross profit ................................. 6,361 5,985 ------------ ------------ Operating expenses: Research and development ........................... 6,463 7,203 Marketing and sales ................................ 2,453 2,881 General and administrative ......................... 3,094 6,914 Amortization and impairment of intangibles ......... 1,153 1,925 ------------ ------------ Total operating expenses ..................... 13,163 18,923 ------------ ------------ Loss from operations .................................. (6,802) (12,938) Interest income ....................................... 1,602 1,092 Interest expense ...................................... (261) (212) Other expense ......................................... (131) (58) ------------ ------------ Loss before income taxes .............................. (5,592) (12,116) Income tax expense (benefit) .......................... 667 (3,877) ------------ ------------ Net loss .............................................. (6,259) (8,239) Preferred dividend .................................... 1,215 1,081 ------------ ------------ Net loss applicable to common stock ................... $ (7,474) $ (9,320) ============ ============ Basic loss per common share ........................... $ (0.15) $ (0.18) ============ ============ Weighted average number of common shares outstanding ........................................ 50,845,070 50,667,007 Diluted loss per common share ......................... $ (0.15) $ (0.18) ============ ============ Weighted average number of diluted common shares outstanding ........................................ 50,845,070 50,667,007 ============ ============
See accompanying notes to consolidated financial statements. 3 5 INPUT/OUTPUT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (UNAUDITED)
Three months ended August 31, ------------------------------ 2000 1999 -------- -------- Cash flows from operating activities: Net loss ................................................. $ (6,259) $ (8,239) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ............................ 4,971 5,332 Amortization of restricted stock compensation ............ 100 28 Loss on disposal of fixed assets ......................... 28 -- Bad debt expense and loan losses ......................... 14 -- Inventory obsolescence expense ........................... -- 340 Deferred income benefit .................................. -- (2,808) Changes in assets and liabilities, net of above provisions: Accounts and notes receivable ............................ (7,331) 6,946 Inventories .............................................. (1,387) 4,903 Accounts payable and accrued expenses .................... (4,744) (10,998) Income taxes payable/receivable .......................... 1,403 3,777 Other .................................................... 69 273 -------- -------- Net cash used in operating activities ............. (13,136) (446) -------- -------- Cash flows from investing activities: Purchase of property, plant and equipment ................ (1,006) (3,046) -------- -------- Net cash used in investing activities .............. (1,006) (3,046) -------- -------- Cash flows from financing activities: Payments on long-term debt ............................... (373) (259) Payments of preferred dividends .......................... (138) (60) Proceeds from exercise of stock options .................. 240 101 Proceeds from issuance of common stock to Employee Stock Purchase Plan ................................... 427 -- Net proceeds from preferred stock offering ............... -- 14,804 -------- -------- Net cash provided by financing activities .......... 156 14,586 -------- -------- Effect of change in foreign currency exchange rates on cash and cash equivalents ............................. (382) 6 -------- -------- Net increase (decrease) in cash and cash equivalents ..... (14,368) 11,100 Cash and cash equivalents at beginning of period ......... 99,210 75,140 -------- -------- Cash and cash equivalents at end of period ......... $ 84,842 $ 86,240 ======== ========
See accompanying notes to consolidated financial statements. 4 6 INPUT/OUTPUT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) GENERAL The accompanying unaudited consolidated financial statements were prepared using generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X. Accordingly, these financial statements do not include all information or footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with our 2000 Annual Report on Form 10-K. The financial statements reflect all adjustments 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 current year presentation. (2) SEGMENT INFORMATION Commencing in fiscal year 2000 we began reporting operating segment information by two segments: Land and Marine. During the quarter ended August 31, 2000, we added another segment called Reservoir. The Marine and Land segments are defined by the environment in which customers use our equipment and services. Our Reservoir products and technologies are used for enhanced reservoir imaging. All segments provide products and services that are used in the exploration for, and development and related production of oil and gas reserves. Customers include major, independent and national oil companies as well as seismic survey operators. Our Land segment products include vibrators, geophones, vehicles, data acquisition systems, and applications software. We also offer transition zone systems in shallow water with marine versions of our land-based recording systems. Our Marine segment provides data acquisition systems, hydrophones, airguns and marine positioning systems. Our Reservoir segment principally provides services (along with related products), including studies, analysis and management to enhance hydrocarbon recovery. We measure segment operating results based on income (loss) from operations. The following summarizes our segment information (in thousands):
Three months ended August 31, ------------------------------ 2000 1999 ------------ ------------ Net sales: Land ................ $ 20,157 $ 22,692 Marine .............. 6,963 7,287 Reservoir ........... 21 -- ------------ ------------ $ 27,141 $ 29,979 ============ ============ Gross profit: Land ................ $ 5,514 $ 4,996 Marine .............. 839 989 Reservoir ........... 8 -- ------------ ------------ $ 6,361 $ 5,985 ============ ============ Loss from operations: Land ................ $ (203) $ (2,683) Marine .............. (2,824) (4,515) Reservoir ........... (106) -- Corporate ........... (3,669) (5,740) ------------ ------------ $ (6,802) $ (12,938) ============ ============
5 7 INPUT/OUTPUT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three months ended August 31, ----------------------------- 2000 1999 ------------ ------------ Depreciation and amortization: Land .......................... $ 1,820 $ 2,141 Marine ........................ 1,060 1,943 Reservoir ..................... -- -- Corporate ..................... 2,091 1,248 ------------ ------------ $ 4,971 $ 5,332 ============ ============ Capital expenditures: Land .......................... $ 766 $ 553 Marine ........................ 193 872 Reservoir ..................... -- -- Corporate ..................... 47 1,621 ------------ ------------ $ 1,006 $ 3,046 ============ ============ AUGUST 31, May 31, Total assets: 2000 2000 ------------ ------------ Land .......................... $ 110,607 $ 106,431 Marine ........................ 73,789 77,411 Reservoir ..................... -- -- Corporate ..................... 186,753 197,222 ------------ ------------ $ 371,149 $ 381,064 ============ ============
Intersegment sales are insignificant for all periods presented. Corporate assets include all assets specifically related to corporate personnel and operations, substantially all cash and cash equivalents, all facilities and manufacturing machinery and equipment that are jointly utilized by segments and all income taxes receivable and deferred income tax assets. The depreciation expense and facility expense related to all jointly utilized facilities and machinery and equipment is allocated based on each segment's use of those assets. Revenues from two significant customers comprised 27% and 17%, respectively of Land segment net sales for the quarter ended August 31, 2000. Revenues from one customer comprised 50% of Marine segment net sales for the quarter ended August 31, 2000. (3) INVENTORIES A summary of inventories follows (in thousands):
AUGUST 31, May 31, 2000 2000 ---------- ------- Raw materials ................. $51,928 $52,451 Work-in-process ............... 7,266 7,979 Finished goods ................ 25,863 23,746 ------- ------- 85,057 84,176 Less inventory reserves ....... 14,600 14,991 ------- ------- $70,457 $69,185 ======= =======
6 8 INPUT/OUTPUT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (4) TRADE NOTES RECEIVABLE Trade notes receivable at August 31, 2000 are generally secured by seismic equipment sold by us, bearing interest at contractual rates of up to 13% per annum and are due at various dates through 2001. The recorded investment in trade notes receivable for which an impairment has been recognized was $17.7 million at August 31, 2000. The activity in the allowance for loan loss is as follows (in thousands):
AUGUST 31, 2000 ---------------- Balance at beginning of period ................... $ 13,718 Additions charged to costs and expenses .......... 814 Recoveries reducing costs and expenses ........... (1,558) Write-downs charged against the allowance ........ (796) ---------------- Balance at end of period ......................... $ 12,178 ================
(5) LOSS PER SHARE Basic loss per share is computed by dividing net loss applicable to common stock by the weighted average number of common shares outstanding during the period. Diluted earnings per share is typically 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 our common stock using the average price of such common stock for the period. Because inclusion of these shares would reduce the loss per share amount, we have not included the effects of these dilutive equity items in our calculation of diluted loss per share. At August 31, 2000 and August 31, 1999 there were 4,588,112 and 4,588,813, respectively of common stock shares subject to stock options that were not included in the calculation of diluted loss per common share. In addition, the cumulative convertible preferred stock has also not been considered in the computation of diluted loss per common share. (6) STATEMENTS OF CASH FLOWS We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. We do not use or intend to use derivative instruments. Exchange rate fluctuations have not had a material effect on our cash balances. At August 31 and May 31, 2000 we had approximately $1.0 million of certificates of deposits that were used to secure standby and commercial letters of credits. Supplemental disclosure of cash flow information follows (in thousands):
Three months ended August 31, ----------------------------- Cash paid (refund) during the period for: 2000 1999 ---------- ---------- Interest .......................... $ 261 $ 212 ========== ========== Income taxes ...................... $ (862) $ (3,352) ========== ========== Non-cash financing activities Dividends on preferred stocks ..... $ 1,077 $ 1,021 ========== ==========
7 9 INPUT/OUTPUT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (7) LONG TERM DEBT In August 1996, we obtained, through one of our wholly-owned subsidiaries, a $12.5 million, ten-year term loan secured by certain of our land and buildings located in Stafford, Texas which then included our executive headquarters, research and development headquarters, and electronics manufacturing building. The term loan, which we have guaranteed under a limited guaranty, bears interest at a fixed rate of 7.875% per annum and is repayable in equal monthly installments of principal and interest of $151,439. We lease all of the property from our 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 pre-payment prior to maturity. (8) COMPREHENSIVE LOSS Comprehensive loss includes all changes in a company's equity (except those resulting from investments by and distributions to owners). The components of total comprehensive loss are as follows:
Three months ended August 31, ------------------------------ 2000 1999 ------------ ------------ Net loss .................................... $ (6,259) $ (8,239) Foreign currency translation adjustment ..... (652) 222 ------------ ------------ $ (6,911) $ (8,017) ============ ============
(9) STOCKHOLDERS' EQUITY In July 2000, we announced that our Board of Directors had authorized the repurchase of up to an additional 1,000,000 shares of our common stock in open market and privately negotiated transactions, with purchases to be made from time to time through May 31, 2001. Shares repurchased will be held by us as treasury stock to be available for our stock option and other equity compensation and benefits plans. As of September 30, 2000, we had not yet repurchased any shares under this program. (10) COMMITMENTS AND CONTINGENCIES In the ordinary course of our business, we have been named from time to time in various lawsuits. While the final resolution of these matters may have an impact on our consolidated financial results for a particular reporting period, we believe that the ultimate resolution of these matters will not have a material adverse impact on our financial position, results of operations or liquidity. We sell to many customers on extended-term arrangements. Moreover, in connection with certain sales of our systems and equipment, we have previously guaranteed loans from unaffiliated parties to purchasers of such systems and equipment. In addition, we have sold contracts and leases to third-party financing sources, the terms of which often obligate us to repurchase the contracts and leases in the event of a customer default or upon certain other occurrences. At August 31, 2000 and May 31, 2000, no guaranties were outstanding with regards to any of our trade notes receivable or loans from unaffiliated parties to purchasers of our seismic equipment. 8 10 INPUT/OUTPUT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Sales outside the United States have historically accounted for a significant part of our net sales. Foreign sales are subject to special risks inherent in doing business outside of the United States, including fluctuations in currency exchange rates, and the risk of war, civil disturbances, embargo and government activities, which may disrupt markets and affect operating results. Demand for our products from customers in developing countries is difficult to predict and can fluctuate significantly from year to year. We believe 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 our future operating results and financial position. In addition, sales to customers in developing countries on extended terms can present heightened credit risks for us, for the reasons discussed above. (11) SPECIAL CHARGES AND RECOVERIES Our special charges and recoveries have consisted of various transactions resulting from industry downturns and cost reduction initiatives. The table below summarizes the fiscal year 2000 pretax expenses and costs for special charges and the accrued amounts at August 31, 2000 for cash liabilities (in thousands):
Receivable Long-lived Personnel/ Inventory Related Asset Warranty Facility Related Charges/ Related Product And Other Charges Recoveries Charges Related Charges Total --------- ---------- ---------- --------- ---------- -------- Fiscal 2000 charges/recoveries to expense by business segment: Marine .............................. $ 3,607 $ 2,400 $ 25,200 $ 1,993 $ 1,700 $ 34,900 Land ................................ 8,700 3,600 7,100 -- 1,400 20,800 Corporate ........................... -- -- -- -- 7,900 7,900 -------- -------- -------- -------- -------- -------- Total .................................. 12,307 6,000 32,300 1,993 11,000 63,600 Adjustments to 1999 Charges recorded in Fiscal 2000 ..... -- (10,200) -- (2,600) -- (12,800) -------- -------- -------- -------- -------- -------- $ 12,307 $ (4,200) $ 32,300 $ (607) $ 11,000 $ 50,800 ======== ======== ======== ======== Balance at May 31, 1999 ................ 11,980 1,903 Settled in Fiscal 2000 ................. (8,079) (5,362) -------- -------- Balance at May 31, 2000 ................ $ 3,294 $ 7,541 Settled in first quarter ............... (330) (5,676) -------- -------- Balance at August 31, 2000 ............. $ 2,964 $ 1,865 ======== ========
During the first quarter of fiscal year 2000, we recorded pretax charges totaling $4.7 million, comprised of $3.3 million primarily related to employee severance arrangements and the closing of our 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 weak customer demand for our equipment. This weak demand 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. There were no special charges or recoveries recorded during the quarter ended August 31, 2000. 9 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS INTRODUCTION Our 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, in turn, 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 Seismic Services Industry Will Adversely Affect Results of Operations", and "- Risk from Significant Amount of Foreign Sales Could Adversely Affect Results of Operations". During fiscal years 2000 and 1999, our financial performance was adversely impacted by the deterioration in energy industry conditions and, more specifically, in the seismic service 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 and oilfield service firms. As a result of reduced exploration spending and a deterioration of energy service sector conditions beginning in 1998, demand for our products has continued to decline. Despite the recovery in commodity prices during 1999 and 2000, energy producers' continued concerns over the sustainability of higher prices for hydrocarbon production resulted in lower exploration budgets by energy companies, which primarily has resulted in continued weak demand for our seismic data acquisition equipment. Further contributing to this weak demand for new equipment has been an industry-wide oversupply of seismic equipment in the field and an excess inventory of seismic data in contractors' data libraries. This weak demand coupled with pricing pressures from competitors have in turn weakened our margins. SUMMARY REVIEW AND OUTLOOK In response to the prevailing industry conditions, we have concentrated on lowering our cost structure, consolidating our product offerings and reorganizing into a products-based divisional structure. During the first and second quarters of fiscal year 2000, we closed our cable manufacturing facility in Cork, Ireland and merged its operations into our U.K. and U.S. facilities, allowing us to address some of our excess capacity issues. We are evaluating additional restructuring and cost control solutions with the goal of returning to profitability as quickly as practicable. Implementing these solutions could result in additional charges in the near term. For the next nine months, we foresee continued equipment oversupply in the marine seismic fleets and continued weak demand in the marine seismic sector. While overall demand for new seismic work currently remains low by historical standards, demand for land seismic equipment is showing signs of improvement, which we believe will be reflected in our results of operations after January 1, 2001. We are continuing to invest resources and seek improvements in our seismic data acquisition technology. A few of the goals we are seeking to achieve during the next nine months include commercializing our VectorSeis(TM) technology in our sensor product line, further development in our land seismic ground electronics, and developing new product offerings in hydrocarbon reservoir monitoring. We recently completed a field test 10 12 for a VectorSeis(TM) system in Canada and are currently manufacturing a pilot system which we believe should be ready by May 31, 2001. Our goal is to complete as many field tests as possible by then. We continue to explore opportunities on how the product will be marketed. We are also reviewing possible alternatives to further strengthen our balance sheet, potential corporate opportunities, and alternative applications for some of our technology. No assurances can be made that we will implement any of these potential actions, and if so, whether any of them will prove successful or the degree of that success. We presently believe that industry conditions will continue to adversely impact demand for our products during the next 9 to 12 calendar months. However, we also believe that the initiatives discussed above will better position us to return to profitability as industry conditions improve. CHANGE IN FISCAL YEAR END On September 25, 2000, our Board of Directors adopted a resolution providing for the change of our fiscal year end from May 31 to December 31. We intend to file a Transition Report on Form 10-K covering the transition period from June 1, 2000 to December 31, 2000 on or before March 31, 2001. FISCAL YEAR 2000 FIRST QUARTER SPECIAL CHARGES During the first quarter of fiscal year 2000, we recorded pretax charges totaling $4.7 million, comprised of $3.3 million primarily related to employee severance arrangements and the closing of our 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 weak customer demand for our equipment. This weak demand resulted from, among other things, a widespread downturn in exploration activity due to the decline in energy prices from October 1997 through February 1999, and consolidation among energy producers. No special charges were recorded during the quarter ended August 31, 2000. NET SALES Land division net sales for the quarter ended August 31, 2000 decreased $2.5 million, or 11%, to $20.2 million as compared to the land division's net sales of $22.7 million for the prior year's first quarter. Marine division net sales for the quarter ended August 31, 2000 decreased $324,000, or 4%, to $7.0 million as compared to the marine division's net sales of $7.3 million for the prior year's first quarter. The decline in both the land and marine division net sales for the quarter ended August 31, 2000 is attributable to the deterioration in the seismic service industry over the past two years, resulting in continued weak demand for our seismic data acquisition equipment. See "Introduction" above. Reservoir services and products did not contribute significant net sales during the current quarter. GROSS PROFITS Land division gross profit and gross profit margin for the quarter ended August 31, 2000 compared to the first quarter of fiscal year 2000 increased to a gross profit of $5.5 million, or 27.3% of land net sales, from a gross profit of $5.0 million, or 22.0% of land net sales. The increase in margins reflects primarily changes in product mix. 11 13 Marine division gross profit and gross profit margin for the quarter ended August 31, 2000 compared to the first quarter in fiscal year 2000 decreased to a gross profit of $839,000, or 12.0% of marine net sales, from a gross profit of $989,000 or 13.6% of marine net sales. The marine division's gross profit margin for the first quarter in fiscal year 2000 included charges of $1.4 million for product-related warranties. Excluding these charges, the marine division's gross profit margin for the first quarter in fiscal year 2000 would have been 33.2%. This decrease in current year margin is principally the result of a $900,000 warranty charge recorded in the quarter ended August 31, 2000, partially offset by reduced manufacturing overheads. The land and marine division gross profit margins continue to be affected by pricing pressures attributable to our competitors, the weak customer demand for our products, and manufacturing under-absorption due to low production volumes as a result of the prevailing industry conditions. Our 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. RESEARCH AND DEVELOPMENT Research and development expenses for the quarter ended August 31, 2000 were $6.5 million, a decrease of $740,000, or 10%, compared to the first quarter in fiscal year 2000, primarily due to reduced costs and expenditures for salaries and other payroll related items, contract labor, and outside services, offset in part by an increase in depreciation and amortization. MARKETING AND SALES Marketing and sales expenses for the quarter ended August 31, 2000 were $2.5 million, a decrease of $428,000, or 15%, compared to the first quarter in fiscal year 2000 primarily due to reduced costs and expenditures for salaries, commissions and other payroll related items. This decrease was principally attributable to our cost reduction program and reduced net sales. GENERAL AND ADMINISTRATIVE General and administrative expenses for the quarter ended August 31, 2000 were $3.1 million, a decrease of $3.8 million, or 55%, compared to the first quarter in fiscal year 2000. In the first quarter of fiscal year 2000, we recorded $3.3 million of charges related to employee severance arrangements and the closing of our Ireland facility. Excluding these charges for the first quarter in fiscal year 2000, general and administrative expenses for the quarter ended August 31, 2000 decreased approximately $500,000, or 14% compared to the first quarter in fiscal year 2000. The decrease was attributed to the cost reduction initiatives put in place during the past two fiscal years. AMORTIZATION AND IMPAIRMENT OF IDENTIFIED INTANGIBLES Amortization of intangibles for the quarter ended August 31, 2000 was $1.2 million, a decrease of $772,000, or 40%, compared to the first quarter in fiscal year 2000. The decrease was attributable to the intangibles that were impaired in fiscal year 2000. 12 14 OPERATING INCOME The loss from operations for the quarter ended August 31, 2000 was $6.8 million, an improvement of $6.1 million, or 47%, compared to the $12.9 million loss in the first quarter in fiscal year 2000. Excluding special charges, our loss from operations in the first quarter in fiscal year 2000 was $8.2 million. The improvement was primarily the result of improvements in gross margins and reductions in operating expenses. INTEREST EXPENSE Interest expense was $261,000 in the quarter ended August 31, 2000, an increase of $49,000, or 23% from the first quarter in fiscal year 2000. Our principal interest expense is attributed to our ten-year-term facilities financing. INTEREST INCOME Interest income for the quarter ended August 31, 2000 was $1.6 million, an increase of $510,000 or 47% compared to the first quarter in fiscal year 2000. Income from investments increased $504,000 to $1.4 million as a result of higher excess cash balances invested during the year and increases in the rates earned on invested balances. INCOME TAX EXPENSE The effective tax rate for the quarter ended August 31, 2000 was 12%, compared to (32%) for the first quarter of fiscal year 2000. Our effective tax rate for the quarter ended August 31, 2000 is reflective of current U.S. losses for which we have recorded no income tax benefit. In assessing the realizability of deferred income tax assets, we consider 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. We consider 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, we will need to generate future taxable income of approximately $165 million over the next 20 years. Although we experienced significant losses in fiscal years 2000 and 1999, our taxable income for the years 1996 through 1998 aggregated approximately $128 million. Based on the level of historical income prior to fiscal year 1999 and our 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 carry-forward, we believe it is more likely than not that we will realize the benefits of the deferred income tax assets, net of the valuation allowance at August 31, 2000. The ultimate realization of the net deferred tax assets, prior to the expiration of the net operating loss carry-forward in the next 19-20 years, will require significant improvements in our results of operations from fiscal years 1999 and 2000 levels and a return to levels of profitability that existed prior to fiscal year 1999. The amount of deferred income tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry-forward period are reduced. If a reduction in the net deferred tax assets determined to be more likely than not realizable occurs in the near term, it is likely that this adjustment will have a material adverse effect on our results of operations. Finally, we do not expect to be in a position to recognize any deferred tax benefits in the near term if we incur losses, which may result in a negative impact when comparing quarterly results for these periods. 13 15 PREFERRED STOCK DIVIDENDS Preferred stock dividends for the quarter ended August 31, 2000 are related to our outstanding Series B and Series C Preferred Stock. The dividends are recognized as a charge to retained earnings at the rate of 8% per annum, compounded quarterly (of which 7% is accounted for as accrued dividends and 1% is paid as a quarterly cash dividend). The preferred stock dividend charge for the quarter ended August 31, 2000 was $1.2 million, an increase of $134,000 over the quarter ended August 31, 2000. The increase was attributed to the compounding of interest on the accrued and unpaid dividends. LIQUIDITY AND CAPITAL RESOURCES General. In recent years we have financed our operations from internally generated cash and funds from equity financings. Our cash and cash equivalents were $84.8 million at August 31, 2000, a decrease of $14.4 million, or 14%, as compared to May 31, 2000. The decrease is due to negative cash flows from operating activities for the quarter ended August 31, 2000. Cash flow from operating activities before changes in working capital items was a negative $1.1 million for the quarter ended August 31, 2000. Cash flow from operating activities after changes in working capital items was a negative $13.1 million for the quarter ended August 31, 2000, primarily due to the operating loss, increases in accounts and notes receivables, and decreases in levels of accounts payable and accrued expenses (primarily in connection with the $5.0 million payment for the Coastline Geophysical, Inc. litigation settlement). Our various working capital accounts can vary in amount substantially from period to period depending upon our levels of sales, product mix sold, demand for our products, percentages of cash versus credit sales, collection rates, inventory levels and general economic and industry factors. Cash flow used in investing activities was $1.0 million for the quarter ended August 31, 2000. The principal investing activities were capital expenditure projects. Cash flow from financing activities was $156,000 for the quarter ended August 31, 2000. Long Term Indebtedness. In 1996, we obtained a $12.5 million ten-year term mortgage loan to finance the construction of our electronics manufacturing facility in Stafford, Texas. The loan is secured by land, buildings and improvements, including our executive and research and development headquarters as well as the adjacent manufacturing facility. The mortgage loan bears interest at the fixed rate of 7.875% per annum and is repayable in equal monthly installments of principal and interest of $151,439. The promissory note contains certain prepayment penalties. As of August 31, 2000, $8.7 million in indebtedness was outstanding under this mortgage loan. Capital Expenditures. Capital expenditures for property, plant and equipment totaled $1.0 million for the quarter ended August 31, 2000 and are expected to aggregate $8.0 million for the twelve months ending May 31, 2001. Planned expenditures include the purchase of advanced manufacturing machinery and additional equipment for our rental fleet. We believe that the combination of our existing working capital, current cash in place and access to other financing sources will be adequate to meet our anticipated capital and liquidity requirements for the foreseeable future. Credit Agreement. We terminated our outstanding credit agreement during the first quarter of fiscal year 2000. While we believe that we would be able to negotiate a credit facility 14 16 or facilities with similar lenders, we believe that the terms currently available would not be as advantageous as future terms may be when we may then require a facility. We do not anticipate the need for a credit facility at the present time, but anticipate securing a facility or facilities in the future at a time when the proposed terms are more likely to be more advantageous for us. RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), as amended by SFAS No. 137 and SFAS No. 138, 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. Based on our announced change in year end to December 31, we will adopt SFAS 133 beginning January 1, 2001. We do not expect the adoption of SFAS 133 will have a material effect on our financial condition or results of operation because we historically have not entered into derivative or other financial instruments for trading or speculative purposes nor do we use or intend to use derivative financial instruments or derivative commodity instruments. In December 1999, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB No. 101"). SAB No. 101 summarizes the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. We understand that the SEC staff is preparing a document to address significant implementation issues related to SAB No. 101. To the extent that SAB No. 101 ultimately changes our revenue recognition practices, we are required to adopt SAB No. 101 in our Transition Report on Form 10-K for the seven-month period ended December 31, 2000, with any cumulative effect adjustment computed as of June 1, 2000. We cannot determine the potential impact that SAB No. 101 may have on our consolidated financial position or results of operations at this time. OTHER FACTORS Market Conditions. Demand for our products is dependent upon the level of worldwide oil and gas exploration and development activity and the availability of seismic information in seismic libraries. Exploration and development activity is primarily dependent upon oil and gas prices, which have been subject to wide fluctuation in recent years. During fiscal years 2000 and 1999, our financial performance was adversely impacted by the deterioration in the seismic services industry. 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, consolidation among energy producers and oilfield services firms and an oversupply of speculative seismic data and current-generation seismic instrumentation in the field. Despite the recovery in commodity prices, the factors of increased competition and pricing pressures and the oversupply of seismic data and current-generation instrumentation have resulted in continued weak demand for our seismic data acquisition equipment. Credit Risk. A continuation of weak demand for the services of our customers will further strain the revenues and cash resources of our customers, thereby resulting in lower sales levels and a higher likelihood of defaults in the customers' timely payment of their obligations under our credit sales arrangements. Increased levels of payment defaults with respect to our credit sales arrangements could have a material adverse effect on our results of operations. 15 17 Our combined gross trade accounts receivable and trade notes receivable balance as of August 31, 2000 from customers in Russia and other former Soviet Union countries was approximately $15.1 million, from customers in Latin American countries was approximately $9.3 million, and from customers in China was approximately $9.4 million. As of August 31, 2000 the total allowance for doubtful accounts (foreign and US) was $1.8 million and the allowance for loan losses was $12.2 million. During the quarter ended August 31, 2000, there were approximately $2.8 million of sales to customers in Russia and other former Soviet Union countries, approximately $600,000 of sales to customers in Latin American countries and $1.2 million of sales to customers in China. All terms of sale for these foreign receivables are denominated in US dollars. Russia and certain Latin American countries have experienced economic problems and uncertainties and devaluations of their currencies in recent years. To the extent that economic conditions in the former Soviet Union, Latin America, China or elsewhere negatively affect future sales to our customers in those regions or the collectibility of our existing receivables, our future results of operations, liquidity and financial condition may be adversely affected. See Note 4 and Note 10 of the Notes to Consolidated Financial Statements and "- Cautionary Statement for Purposes of Forward-Looking Statements - Continuation of Downturn in Seismic Services Industry 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. We own facilities and manufacture components for our systems in one member country. The transition period for the introduction of the Euro is between January 1, 1999 and June 30, 2002. We continue to address the issues involved with the introduction of the Euro. The more important issues facing us include: converting information technology systems; reassessing currency risk; and processing tax and accounting records. Based on our progress to date in reviewing this matter, and the fact that our sales to customers are denominated in US dollars, we believe that the introduction of the Euro has not had and will not have a significant impact on the manner in which we conduct our business affairs and process our business and accounting records. Therefore, we anticipate that conversion to the Euro should not have a material effect on our financial condition or results of operations. CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD-LOOKING STATEMENTS Certain information contained in this Quarterly Report on Form 10-Q (including statements contained in Part I -Item #2. "Management's Discussion and Analysis of Results of Operations and Financial Condition"), as well as other written and oral statements made or incorporated by reference from time to time by us and our 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 write-downs and special charges and savings and benefits therefrom; anticipated timing of commercialization of and capabilities of products planned or under development, including products incorporating VectorSeis(TM) technology; future demand for our products; anticipated product releases and technological 16 18 advances; the future mix of business and future asset recoveries; the realization of deferred tax assets; the effect of changes in accounting standards on our results of operation and financial condition; the effect of the Euro's introduction; the Company's Year 2000 issues; the inherent unpredictability of adversarial proceedings and other contingent liabilities; future capital expenditures and our future financial condition; future 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 Form 10-Q. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we 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 our actual results and cause actual results to differ materially from those results which might be projected, forecast, estimated or budgeted by us in these forward-looking statements include, but are not limited to, the following: CONTINUATION OF DOWNTURN IN SEISMIC SERVICES INDUSTRY WILL ADVERSELY AFFECT RESULTS OF OPERATIONS AND FINANCIAL CONDITION. Demand for our 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 our control. Worldwide oil prices declined from October 1997 and remained at lower levels through February 1999. Despite the recovery in commodity prices since 1999, energy producers' continuing concerns over the sustainability of higher prices for hydrocarbon production resulted in lower exploration budgets by energy companies, which resulted in weak demand for our seismic data acquisition equipment. Other factors which have negatively impacted demand for our products have been the weakened financial condition of many of our customers, consolidations among energy producers and oilfield service and equipment providers, an oversupply in the marketplace of current-generation seismic equipment, a current industry-wide oversupply of "spec" seismic data, pricing pressures from our competitors and customers, and the destabilized economies in many developing countries. Despite higher prices for oil and natural gas since February 1999, 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 with any certainty. A further prolonged downturn in market demand for our products will have a material adverse effect on our 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 worldwide oil and gas exploration and development and their relationship(s) to the demand for our products. Additionally, no assurances can be given that our efforts to reduce and contain costs will be sufficient to offset the effect of continued lower levels of our net sales until industry conditions improve. FAILURE TO DEVELOP PRODUCTS AND KEEP PACE WITH TECHNOLOGICAL CHANGE WILL ADVERSELY AFFECT RESULTS OF OPERATIONS. The markets for our product lines are characterized by rapidly changing technology and frequent product introductions. Whether we 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 our customers, will be significant factors in our ability to compete in 17 19 the future. During the third quarter of fiscal year 2000, we recorded $8.7 million of inventory charges primarily related to our decision then to commercialize VectorSeis(TM) digital sensor products having higher technical standards than the products we had previously produced. We had previously decided to commercialize earlier-stage VectorSeis(TM) products, which subsequently were proven not to be commercially feasible based on data gathered from VectorSeis(TM) digital sensor surveys, the anticipated longer-term market recovery for new seismic instrumentation and then current and expected market conditions. There can be no assurance that we will not encounter resource constraints or technical or other difficulties that could delay introduction of new products in the future. No assurances can be given as to whether any new products incorporating the VectorSeis(TM) digital sensor (or any other of our technology product introductions or enhancements) will be commercially feasible or accepted in the marketplace by our present or future customers. If we are 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, our business and operating results will be materially and adversely affected. In addition, our continuing development of new products inherently carries the risk of inventory obsolescence with respect to our older products. Updates and upgrades in our 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 products. 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. Our 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 (Sercel), an affiliate of Compagnie General de Geophysique (CGG). Our principal marine seismic competitors are, among others, Bolt Technology Corporation; GeoScience Corporation (GSI), an affiliate of CGG; Teledyne Brown Engineering, an affiliate of Allegheny Teledyne Company; and Thomson Marconi Sonar P/L. Unlike us, Sercel and GSI possess the advantage of being able to sell to an affiliated seismic contractor. Competition in the industry is expected to intensify and could adversely affect our future results. Several of our competitors have greater name recognition, more extensive engineering, manufacturing and marketing capabilities, and greater financial, technological and personnel resources than those available to us. In addition, certain companies in the industry have expanded and improved their product lines or technologies in recent years. There can be no assurance that we 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 and lower margins for our 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 our products and services. 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 our 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, 18 20 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. U.S. technology export restrictions may affect the types and specifications of products we may export. We are, from time to time, required to obtain export licenses and there can be no assurance that we may not experience difficulty in obtaining such licenses as may be required in connection with export sales. Demand for our products from customers in developing countries (including Russia and other Former Soviet Union countries as well as certain Latin American and Asian countries, including China) is difficult to predict and can fluctuate significantly from year to year. We believe 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 our future operating results and financial position. In addition, sales to customers in developing countries on extended terms present heightened credit risks for us, for the reasons discussed above. See, in particular above, "- Other Factors" for further information concerning these risks in those countries. We are also required to convert to the Euro currency at our facility located in one of the European Union member countries and although we do not currently anticipate any problems with such conversion, there can be no assurances that the problems actually encountered by us in the Euro conversion will not be more pervasive than those anticipated by management. SIGNIFICANT PAYMENT DEFAULTS UNDER SALES ARRANGEMENTS COULD ADVERSELY AFFECT THE COMPANY. We sell to many customers on extended-term arrangements. Significant payment defaults by customers could have a material adverse effect on our financial position and results of operations. A significant portion of our trade notes and trade accounts receivable balance as of August 31, 2000 was attributable to sales made in former Soviet Union, Latin American and Asian countries. DEPENDENCE ON KEY AND TECHNICAL PERSONNEL. Our success depends upon the continued contributions of our personnel, particularly our management personnel, many of whom would be difficult to replace. Our success will depend on our abilities to attract and retain skilled employees. Changes in personnel, particularly technical personnel, therefore, could adversely affect operating results. In addition, continued changes in management personnel could have a disruptive effect on employees which could, in turn, adversely affect operating results. LOSS OF SIGNIFICANT CUSTOMERS WILL ADVERSELY AFFECT US. A relatively small number of customers have accounted for most of our net sales, although the degree of sales concentration with any one customer has varied from fiscal year to year. During fiscal years 2000, 1999 and 1998 the three largest customers in each of those years accounted for 41%, 52% and 43%, respectively, of our net sales. The loss of these customers or a significant reduction in their equipment needs could have a material adverse effect on our net sales and results of operations. RISKS RELATED TO GROSS MARGIN. Our gross margin percentage is a function of pricing pressures from our customers and our competitors and 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 heightened price competition, unit volumes, inventory obsolescence, increased warranty costs and other product related contingencies, changes in sales and distribution channels, shortages in components due to untimely supplies or 19 21 inability to obtain items at reasonable prices, unavailability of skilled labor and manufacturing under-absorption due to low production volumes, may also continue to affect the cost of sales and the fluctuation of gross margin percentages in future periods and results of operations. FAILURE TO PROTECT INTELLECTUAL PROPERTY WILL ADVERSELY AFFECT OUR OPERATIONS. We believe that technology is a primary basis of competition in the industry. Although we currently hold certain intellectual property rights relating to our product lines, there can be no assurance that these rights will not be challenged by third parties or that we will obtain additional patents or other intellectual property rights in the future. Additionally, there can be no assurance that our efforts to protect our trade secrets will be successful or that others will not independently develop products similar to our products or design around any of the intellectual property rights owned by us, or that we will be precluded by others' patent claims. DISRUPTION IN VENDOR SUPPLIES WILL AFFECT FINANCIAL RESULTS. Our manufacturing process requires a high volume of quality components. Certain components used by us are currently provided by only one supplier. In the future, we may, from time to time, experience supply or quality control problems with our suppliers, and such problems could significantly affect our ability to meet production and sales commitments. Our 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 our future financial results. RISKS RELATED TO GOVERNMENT REGULATIONS AND PRODUCT CERTIFICATION. Our 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 our products or result in the need to modify products, which may involve substantial costs or delays in sales and could have an adverse effect on our future operating results. Certain countries are subject to restrictions, sanctions and embargoes imposed by the US Government. These restrictions, sanctions and embargoes prohibit or limit us and our domestic subsidiaries from participating in certain business activities in those countries. These constraints may adversely affect our 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 our 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 our operating results from time to time, is that a substantial portion of our net sales in any period may result from shipments during the latter part of a period. Because we establish our sales and operating expense levels based on our operational goals, if shipments in any period do not meet goals, net sales and net earnings may be adversely affected. STOCK VOLATILITY AND ABSENCE OF DIVIDENDS MAY ADVERSELY AFFECT OUR STOCK PRICE. In recent years, the stock market in general and the market for energy and technology stocks in particular, including our common stock, have experienced extreme price fluctuations. There is a risk that future stock price fluctuations could impact our operations. Continued depressed prices for our common stock (and further price declines) could affect our ability to successfully attract and retain qualified personnel, complete desirable business combinations or accomplish financing or similar transactions in the future. We have historically not paid, and do not intend to pay in the foreseeable future, cash dividends on our common stock. 20 22 RISKS RELATED TO ACQUISITIONS. We 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 our operations. Our operating results could be adversely affected if we are unable to successfully integrate these new companies into our operations. Structural changes in our 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 us could also result in issuance of equity securities or the rights associated with the equity securities, which could potentially dilute our 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 our 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, WE WISH TO REFER READERS TO OTHER FACTORS DISCUSSED ELSEWHERE IN THIS REPORT AS WELL AS OUR OTHER FILINGS AND REPORTS WITH THE SECURITIES AND EXCHANGE COMMISSION FOR A FURTHER DISCUSSION OF RISKS AND UNCERTAINTIES WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE CONTAINED IN FORWARD-LOOKING STATEMENTS. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE THE RESULT OF ANY REVISIONS TO ANY SUCH FORWARD-LOOKING STATEMENTS, WHICH MAY BE MADE TO REFLECT THE EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We may be, from time to time, exposed to market risk, which is the potential loss arising from adverse changes in market prices and rates. We traditionally have not entered into derivative or other financial instruments for trading or speculative purposes nor do we use or intend to use derivative financial instruments or derivative commodity instruments. We are not currently a borrower under any material credit arrangements which feature fluctuating interest rates. Our market risk could arise from changes in foreign currency exchange rates. Our sales and financial instruments are principally denominated in US dollars. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We were named, along with a former employee, as defendants in an action filed on May 21, 1999, in State District Court in Harris County, Texas styled Coastline Geophysical, Inc. v. Input/Output, Inc. et al. The plaintiffs' petition alleged a number of claims arising out of a purchase of a marine seismic system manufactured by us. While believing we had meritorious defenses to this action, we settled this lawsuit in July 2000 for $5.0 million, after giving consideration to the cost and distraction of protracted litigation. As a result of the settlement, we recorded a $5.0 million charge to general and administrative expense in the fourth quarter and year ended May 31, 2000. See Part I - Item 2. "Management's Discussion and Analysis of Results of Operations and Financial Condition - Liquidity and Capital Resources." 21 23 In the ordinary course of business, we have been named in other various lawsuits or threatened actions. While the final resolution of these matters may have an impact on our consolidated financial results for a particular reporting period, we believe that the ultimate resolution of these matters will not have a material adverse impact on our financial position, results of operations or liquidity. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) List of Documents Filed. 3.1 Bylaws of the Company, as amended as of September 25, 2000 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 quarter ended August 31, 2000 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED IN THE CITY OF STAFFORD, STATE OF TEXAS, ON OCTOBER 16, 2000. Input/Output, Inc. By /s/ C. Robert Bunch ------------------------------------------------------ C. ROBERT BUNCH VICE PRESIDENT AND CHIEF ADMINISTRATIVE OFFICER 22