e10vq
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 |
COMMISSION FILE NUMBER 1-12691
INPUT/OUTPUT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE |
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(State or other jurisdiction of
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22-2286646 |
incorporation or organization)
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(I.R.S. Employer Identification No.) |
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12300 PARC CREST DR., |
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STAFFORD, TEXAS
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77477 |
(Address of principal executive offices)
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(Zip Code) |
REGISTRANTS 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: þ No: o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (check one):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the
Exchange Act). Yes: o No: þ
At October 30, 2006, there were 79,891,211 shares of common stock, par value $0.01 per share,
outstanding.
INPUT/OUTPUT, INC. AND SUBSIDIARIES
TABLE OF CONTENTS FOR FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2006
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
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September 30, |
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December 31, |
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2006 |
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2005 |
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(In thousands, except share data) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
43,130 |
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$ |
15,853 |
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Restricted cash |
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1,559 |
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1,532 |
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Accounts receivable, net |
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114,508 |
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120,880 |
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Current portion of notes receivable, net |
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6,030 |
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8,372 |
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Unbilled receivables |
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23,668 |
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15,070 |
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Inventories |
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104,079 |
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81,428 |
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Prepaid expenses and other current assets |
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12,824 |
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10,919 |
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Total current assets |
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305,798 |
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254,054 |
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Notes receivable |
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5,617 |
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6,508 |
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Non-current deferred income tax asset |
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3,183 |
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3,183 |
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Property, plant and equipment, net |
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33,773 |
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28,997 |
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Multi-client data library, net |
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31,862 |
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18,996 |
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Investments at cost |
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4,254 |
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4,000 |
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Goodwill |
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155,016 |
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154,794 |
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Intangible and other assets, net |
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63,151 |
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67,329 |
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Total assets |
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$ |
602,654 |
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$ |
537,861 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Notes payable and current maturities of long-term debt |
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$ |
7,150 |
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$ |
4,405 |
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Accounts payable |
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35,903 |
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31,938 |
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Accrued expenses |
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42,138 |
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29,867 |
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Accrued multi-client data library royalties |
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24,867 |
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18,961 |
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Deferred revenue |
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29,015 |
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11,939 |
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Deferred income tax liability |
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3,183 |
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3,183 |
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Total current liabilities |
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142,256 |
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100,293 |
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Long-term debt, net of current maturities |
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71,868 |
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71,541 |
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Non-current deferred income tax liability |
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4,138 |
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4,304 |
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Other long-term liabilities |
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4,405 |
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4,340 |
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Total liabilities |
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222,667 |
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180,478 |
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Cumulative convertible preferred stock |
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29,950 |
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29,838 |
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Stockholders equity: |
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Common stock, $0.01 par value; authorized 200,000,000
shares; outstanding 79,825,278 shares at September 30, 2006, and
79,764,338 shares at December 31, 2005, net of
treasury stock |
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808 |
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|
807 |
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Additional paid-in capital |
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489,800 |
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487,232 |
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Accumulated deficit |
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(136,124 |
) |
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(150,007 |
) |
Accumulated other comprehensive gain (loss) |
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2,057 |
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(728 |
) |
Treasury stock, at cost, 850,455 shares at September
30, 2006 and 801,558 at December 31, 2005 |
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(6,504 |
) |
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(5,968 |
) |
Unamortized restricted stock compensation |
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(3,791 |
) |
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Total stockholders equity |
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350,037 |
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327,545 |
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Total liabilities and stockholders equity |
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$ |
602,654 |
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$ |
537,861 |
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See accompanying Condensed Notes to Unaudited Consolidated Financial Statements.
3
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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(In thousands, except per share amounts) |
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Product revenues |
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$ |
77,608 |
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$ |
59,862 |
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$ |
237,620 |
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$ |
162,361 |
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Service revenues |
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32,365 |
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19,646 |
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99,693 |
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69,356 |
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Total net revenues |
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109,973 |
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79,508 |
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337,313 |
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231,717 |
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Cost of products |
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56,113 |
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42,681 |
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170,236 |
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116,086 |
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Cost of services |
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20,847 |
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13,002 |
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63,344 |
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52,967 |
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Total cost of sales |
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76,960 |
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55,683 |
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233,580 |
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169,053 |
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Gross profit |
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33,013 |
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23,825 |
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103,733 |
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62,664 |
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Operating expenses (income): |
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Research and development |
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7,762 |
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4,814 |
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23,032 |
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14,148 |
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Marketing and sales |
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9,813 |
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7,565 |
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28,458 |
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22,575 |
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General and administrative |
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8,994 |
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6,429 |
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29,557 |
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19,227 |
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(Gain) loss on sale of assets |
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(9 |
) |
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(1 |
) |
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(33 |
) |
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75 |
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Total operating expenses |
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26,560 |
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18,807 |
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|
81,014 |
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56,025 |
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Income from operations |
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6,453 |
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|
5,018 |
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22,719 |
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6,639 |
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Interest expense |
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(1,484 |
) |
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(1,367 |
) |
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(4,309 |
) |
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(4,726 |
) |
Interest income |
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630 |
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218 |
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1,517 |
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|
482 |
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Other income (expense) |
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(687 |
) |
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(4 |
) |
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(1,309 |
) |
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61 |
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Income before income taxes and change in
accounting principle |
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4,912 |
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3,865 |
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18,618 |
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2,456 |
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Income tax expense (benefit) |
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|
1,419 |
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|
650 |
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3,332 |
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(202 |
) |
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Net income before change in accounting principle |
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3,493 |
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3,215 |
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15,286 |
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|
2,658 |
|
Cumulative effect of change in accounting principle |
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|
398 |
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Net income |
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3,493 |
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|
3,215 |
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|
15,684 |
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2,658 |
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Preferred stock dividends and accretion |
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636 |
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|
488 |
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1,801 |
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1,104 |
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Net income applicable to common shares |
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$ |
2,857 |
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$ |
2,727 |
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$ |
13,883 |
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$ |
1,554 |
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Basic and diluted income per share: |
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Net income per basic and diluted share before
change in accounting principle |
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$ |
0.04 |
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$ |
0.03 |
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$ |
0.17 |
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$ |
0.02 |
|
Cumulative effect of change in accounting principle |
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Net income per basic and diluted share |
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$ |
0.04 |
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$ |
0.03 |
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|
$ |
0.17 |
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$ |
0.02 |
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Weighted average number of common shares outstanding: |
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Basic |
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|
79,575 |
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|
79,313 |
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|
79,344 |
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|
78,903 |
|
Diluted |
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|
81,354 |
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|
80,646 |
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|
80,976 |
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|
79,957 |
|
See accompanying Condensed Notes to Unaudited Consolidated Financial Statements.
4
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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Nine Months Ended |
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September 30, |
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2006 |
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2005 |
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(In thousands) |
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Cash flows from operating activities: |
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Net income |
|
$ |
15,684 |
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|
$ |
2,658 |
|
Adjustments to reconcile net income to cash provided by (used in) operating
activities: |
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|
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Cumulative effect of change in accounting principle |
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(398 |
) |
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Depreciation and amortization (other than multi-client library) |
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|
16,243 |
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|
18,292 |
|
Amortization of multi-client library |
|
|
16,573 |
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|
5,521 |
|
Stock based compensation expense related to stock options, nonvested stock and
employee stock purchases |
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|
4,220 |
|
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|
1,707 |
|
Reduction of tax reserves |
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|
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(1,393 |
) |
Deferred income tax |
|
|
(542 |
) |
|
|
(544 |
) |
Bad debt expense |
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|
298 |
|
|
|
473 |
|
(Gain) loss on sale of fixed assets |
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|
(33 |
) |
|
|
75 |
|
Change in operating assets and liabilities: |
|
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|
|
|
|
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|
Accounts and notes receivable |
|
|
8,037 |
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|
(31,964 |
) |
Unbilled receivables |
|
|
(8,598 |
) |
|
|
(6,191 |
) |
Inventories |
|
|
(21,717 |
) |
|
|
10,885 |
|
Accounts payable, accrued expenses and accrued royalties |
|
|
21,375 |
|
|
|
(15,086 |
) |
Deferred revenue |
|
|
16,993 |
|
|
|
7,281 |
|
Other assets and liabilities |
|
|
(847 |
) |
|
|
(2,980 |
) |
|
|
|
|
|
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|
Net cash provided by (used in) operating activities |
|
|
67,288 |
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|
|
(11,266 |
) |
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|
|
|
|
|
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|
|
|
|
|
|
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|
Cash flows from investing activities: |
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|
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|
|
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|
Purchase of property, plant and equipment |
|
|
(5,837 |
) |
|
|
(4,233 |
) |
Investment in multi-client data library |
|
|
(29,439 |
) |
|
|
(11,431 |
) |
Proceeds from the sale of fixed assets |
|
|
241 |
|
|
|
37 |
|
Proceeds from collection of note receivable associated with the sale of a facility |
|
|
2,000 |
|
|
|
|
|
Increase in investments |
|
|
(254 |
) |
|
|
(500 |
) |
Acquisition of intellectual property rights |
|
|
|
|
|
|
(1,850 |
) |
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(33,289 |
) |
|
|
(17,977 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Net (repayments) borrowings under revolving line of credit |
|
|
(2,977 |
) |
|
|
3,585 |
|
Payments on notes payable and long-term debt |
|
|
(4,932 |
) |
|
|
(5,483 |
) |
Net proceeds from preferred stock offering |
|
|
|
|
|
|
29,800 |
|
Payment of preferred dividends |
|
|
(1,689 |
) |
|
|
(1,104 |
) |
Return of deposit securing a letter of credit |
|
|
|
|
|
|
1,500 |
|
Proceeds from employee stock purchases and exercise of stock options |
|
|
2,609 |
|
|
|
2,314 |
|
Purchases of treasury stock |
|
|
(607 |
) |
|
|
(224 |
) |
|
|
|
|
|
|
|
Net cash (used in) provided by financing activities |
|
|
(7,596 |
) |
|
|
30,388 |
|
|
|
|
|
|
|
|
Effect of change in foreign currency exchange rates on cash and cash equivalents |
|
|
874 |
|
|
|
(398 |
) |
|
|
|
|
|
|
|
Net increase in cash and cash equivalents |
|
|
27,277 |
|
|
|
747 |
|
Cash and cash equivalents at beginning of period |
|
|
15,853 |
|
|
|
14,935 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
43,130 |
|
|
$ |
15,682 |
|
|
|
|
|
|
|
|
See accompanying Condensed Notes to Unaudited Consolidated Financial Statements.
5
INPUT/OUTPUT, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
The consolidated balance sheet of Input/Output, Inc. and its subsidiaries (collectively
referred to as the Company or I/O, unless the context otherwise requires) at December 31, 2005
has been derived from the Companys audited consolidated financial statements at that date. The
consolidated balance sheet at September 30, 2006, the consolidated statements of operations for the
three and nine months ended September 30, 2006 and 2005, and the consolidated statements of cash
flows for the nine months ended September 30, 2006 and 2005 have been prepared by the Company
without audit. In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. The results of
operations for the three and nine months ended September 30, 2006 are not necessarily indicative of
the operating results for a full year or of future operations.
These consolidated financial statements have been prepared using accounting principles
generally accepted in the United States for interim financial information and the instructions to
Form 10-Q and applicable rules of Regulation S-X of the Securities and Exchange Commission (SEC).
Certain information and footnote disclosures normally included in financial statements presented in
accordance with accounting principles generally accepted in the United States have been omitted.
The accompanying consolidated financial statements should be read in conjunction with the Companys
Annual Report on Form 10-K for the year ended December 31, 2005.
Net revenues and cost of sales have been presented to reflect the total of product and service
revenues and their related costs. The net revenues and cost of sales for the three and nine months
ended September 30, 2005, and other certain amounts previously reported have been reclassified to
conform to the current year presentation.
(2) Summary of Significant Accounting Policies and Estimates
Refer to the Companys Annual Report on Form 10-K for the year ended December 31, 2005 for a
complete discussion of the Companys significant accounting policies and estimates.
Stock-Based Compensation. On January 1, 2006, the Company adopted Financial Accounting
Standards (FAS) No. 123 (revised 2004), Share-Based Payment (FAS 123R), that addresses the
accounting for share-based payment transactions in which an enterprise receives employee services
in exchange for either equity instruments of the enterprise or liabilities that are based on the
fair value of the enterprises equity instruments or that may be settled by the issuance of such
equity instruments. The statement requires that such transactions be accounted for using a
fair-value-based method and recognized as expense in the Companys consolidated statement of
operations. Prior to the adoption of FAS 123R, the Company used the intrinsic value method as
prescribed by Accounting Principles Board (APB), Opinion No. 25, Accounting for Stock Issued to
Employees.
The Company adopted FAS 123R using the modified prospective method which requires the
application of the accounting standard as of January 1, 2006. The consolidated financial statements
as of and for the three and nine months ended September 30, 2006 reflect the impact of adopting FAS
123R. In accordance with the modified prospective method, the consolidated financial statements for
prior periods have not been restated to reflect, and do not include, the impact of FAS 123R. See
Note 8 Stock-Based Compensation for further details.
Stock-based compensation expense recognized during the period is based on the value of the
portion of stock-based payment awards that is ultimately expected to vest. Stock-based compensation
expense recognized in the consolidated statement of operations during the three and nine months
ended September 30, 2006 includes compensation expense for stock-based payment awards granted prior
to, but not yet vested, as of December 31, 2005 based on the grant date fair value estimated in
accordance with the pro forma provisions of FAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure an amendment of FASB Statement No. 123 (issued 12/02) (FAS 148), and
compensation expense for the stock-based payment awards granted subsequent to December 31, 2005,
based on the grant date fair value estimated in accordance with FAS 123R. As stock-based
compensation expense recognized in the consolidated statement of operations for the three and nine
months ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced
for estimated forfeitures.
6
FAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary,
in subsequent periods if actual forfeitures differ from those estimates. In the pro forma
information required under FAS 148 for the periods prior to 2006, the Company accounted for
forfeitures as they occurred. Also, prior to adoption to FAS 123R, the Company accounted for
forfeitures of its restricted stock and restricted stock units as the forfeitures occurred. The
Company has estimated forfeitures on its unvested restricted stock and restricted stock units
outstanding as of January 1, 2006, and recorded a $0.4 million cumulative effect of a change in
accounting principle to reflect the compensation cost that would not have been recognized in prior
periods had forfeitures been estimated during these periods.
Effective January 1, 2006, the Company recognizes stock-based compensation on the
straight-line basis over the service period of each award (generally the awards vesting period).
The Company had recognized compensation expense in its pro forma disclosures under FAS 123 on the
straight-line basis related to its stock options. Prior to the adoption of FAS 123R, the Company
recognized compensation expense related to its restricted stock and restricted stock unit awards
using the accelerated method of amortization and will continue to apply the accelerated method to
all outstanding restricted stock and restricted stock unit awards granted prior to January 1, 2006.
Recent Accounting Pronouncements. In June 2006, the Financial Accounting Standards Board
(FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty
in income taxes recognized in accordance with FAS No. 109, Accounting for Income Taxes (FAS 109).
FIN 48 clarifies the application of FAS 109 by defining criteria that an individual tax position
must meet for any part of the benefit of that position to be recognized in the financial
statements. Additionally, FIN 48 provides guidance on the measurement, derecognition,
classification and disclosure of tax positions, along with accounting for the related interest and
penalties. The provisions of FIN 48 are effective for fiscal years beginning after December 15,
2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to
beginning retained earnings. The Company is currently evaluating the impact the adoption of FIN 48
will have on its financial position, results of operations and cash flows.
(3) Segment and Product Information
The Company evaluates and reviews results based on four segments (Land Imaging Systems, Marine
Imaging Systems, Seismic Imaging Solutions and Data Management Solutions) to allow for increased
visibility and accountability of costs and more focused customer service and product development.
The Company measures segment operating results based on income from operations. Intersegment sales
are insignificant for all periods presented.
A summary of segment information for the three and nine months ended September 30, 2006 and
2005 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Imaging Systems |
|
$ |
46,082 |
|
|
$ |
38,809 |
|
|
$ |
130,837 |
|
|
$ |
106,811 |
|
Marine Imaging Systems |
|
|
24,864 |
|
|
|
16,338 |
|
|
|
89,990 |
|
|
|
43,984 |
|
Seismic Imaging Solutions |
|
|
32,365 |
|
|
|
19,646 |
|
|
|
99,693 |
|
|
|
69,356 |
|
Data Management Solutions |
|
|
6,662 |
|
|
|
4,715 |
|
|
|
16,793 |
|
|
|
11,566 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
109,973 |
|
|
$ |
79,508 |
|
|
$ |
337,313 |
|
|
$ |
231,717 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Imaging Systems |
|
$ |
1,874 |
|
|
$ |
4,257 |
|
|
$ |
6,467 |
|
|
$ |
12,077 |
|
Marine Imaging Systems |
|
|
5,792 |
|
|
|
4,090 |
|
|
|
22,310 |
|
|
|
9,588 |
|
Seismic Imaging Solutions |
|
|
5,123 |
|
|
|
1,613 |
|
|
|
17,176 |
|
|
|
2,663 |
|
Data Management Solutions |
|
|
2,423 |
|
|
|
1,470 |
|
|
|
5,389 |
|
|
|
1,824 |
|
Corporate and Other |
|
|
(8,759 |
) |
|
|
(6,412 |
) |
|
|
(28,623 |
) |
|
|
(19,513 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
6,453 |
|
|
$ |
5,018 |
|
|
$ |
22,719 |
|
|
$ |
6,639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7
(4) Inventories
A summary of inventories is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Raw materials and subassemblies |
|
$ |
47,150 |
|
|
$ |
45,661 |
|
Work-in-process |
|
|
15,631 |
|
|
|
9,047 |
|
Finished goods |
|
|
51,289 |
|
|
|
37,031 |
|
Reserve for excess and obsolete inventories |
|
|
(9,991 |
) |
|
|
(10,311 |
) |
|
|
|
|
|
|
|
Inventories, net |
|
$ |
104,079 |
|
|
$ |
81,428 |
|
|
|
|
|
|
|
|
The Company has increased its use of contract manufacturers as an alternative to in-house
manufacturing. Under some of the Companys outsourcing arrangements, its manufacturing outsourcers
first utilize the Companys on-hand inventory, then directly purchase inventory at agreed-upon
quantities and lead times in order to meet the Companys scheduled deliveries. If demand proves to
be less than the Company originally forecasted (thereby allowing the Company to cancel its
committed purchase orders with its manufacturing outsourcer), its outsourcer generally has the
right to require the Company to purchase inventory which it had purchased on the Companys behalf.
(5) Net Income per Common Share
Basic net income per common share is computed by dividing net income applicable to common
shares by the weighted average number of common shares outstanding during the period. Diluted net
income per common share is determined based on the assumption that dilutive restricted stock and
restricted stock unit awards have vested and outstanding dilutive stock options have been exercised
and the aggregate proceeds were used to reacquire common stock using the average price of such
common stock for the period. See Note 8 Stock-Based Compensation for further details of the
Companys stock based awards.
The Company has outstanding $60.0 million of convertible senior notes, for which 13,888,890
common shares may currently be acquired upon their full conversion. In 2005, the Company issued
30,000 shares of Series D-1 Cumulative Convertible Preferred Stock (Preferred Stock), which may
presently be converted, at the holders election, into up to 3,812,428 shares of common stock. The
convertible senior notes and Preferred Stock are anti-dilutive for all periods presented and
therefore have been excluded from the computation of diluted net income per share.
The following table summarizes the computation of basic and diluted net income per common
share (in thousands, except per share amounts):
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net income before change in
accounting principle |
|
$ |
2,857 |
|
|
$ |
2,727 |
|
|
$ |
13,485 |
|
|
$ |
1,554 |
|
Cumulative effect of change in
accounting principle |
|
|
|
|
|
|
|
|
|
|
398 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income applicable to common shares |
|
$ |
2,857 |
|
|
$ |
2,727 |
|
|
$ |
13,883 |
|
|
$ |
1,554 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common
shares outstanding |
|
|
79,575 |
|
|
|
79,313 |
|
|
|
79,344 |
|
|
|
78,903 |
|
Effect of dilutive stock awards |
|
|
1,779 |
|
|
|
1,333 |
|
|
|
1,632 |
|
|
|
1,054 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of diluted
common shares outstanding |
|
|
81,354 |
|
|
|
80,646 |
|
|
|
80,976 |
|
|
|
79,957 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per basic and diluted
share before change in accounting
principle |
|
$ |
0.04 |
|
|
$ |
0.03 |
|
|
$ |
0.17 |
|
|
$ |
0.02 |
|
Cumulative effect of change in
accounting principle |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per basic and diluted share |
|
$ |
0.04 |
|
|
$ |
0.03 |
|
|
$ |
0.17 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6) Income Taxes
In 2002, the Company established a valuation allowance for substantially all of its domestic
deferred tax assets including its net operating loss carryforward. Since that time, the Company has
continued to record a valuation allowance. The valuation allowance was calculated in accordance
with the provisions of FAS 109, which require that a valuation allowance be established or
maintained when it is more likely than not that all or a portion of deferred tax assets will not
be realized. The Company will continue to reserve for substantially all net deferred tax assets
until there is sufficient evidence to warrant reversal. The Companys effective tax rate for the
three and nine months ended September 30, 2006 was 28.9% and 17.9%. The increased effective tax
rate for the three months ended September 30, 2006 relates to improved results of operations of
foreign operations. The effective tax rate for the nine months ended September 30, 2006 is lower
than the statutory rate due to the utilization of previously reserved domestic deferred tax assets.
(7) Comprehensive Net Income (Loss)
The components of comprehensive net income (loss) are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net income applicable to common shares |
|
$ |
2,857 |
|
|
$ |
2,727 |
|
|
$ |
13,883 |
|
|
$ |
1,554 |
|
Foreign currency translation adjustment |
|
|
2,129 |
|
|
|
(512 |
) |
|
|
2,785 |
|
|
|
(2,481 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive net income (loss) |
|
$ |
4,986 |
|
|
$ |
2,215 |
|
|
$ |
16,668 |
|
|
$ |
(927 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(8) Stock-Based Compensation
Stock Option Plans
The Company has adopted stock option plans for eligible employees, directors and consultants,
which provide for the granting of options to purchase shares of common stock. As of September 30,
2006, there were 7,120,519 shares issued or committed for issuance under outstanding options under
the Companys stock option plans, and 987,495 shares available for future grant and issuance, of
which, 947,495 shares may also be issued as other stock-based awards such as restricted stock or
restricted stock units.
9
The options under these plans generally vest in equal annual installments over a four-year
period and have a term of ten years. These options are typically granted with an exercise price per
share equal to or greater than the current market price and, upon exercise, are issued from the
Companys unissued common shares. On August 16, 2006, the Compensation Committee of the Board of
Directors of the Company approved fixed pre-established quarterly grant dates for all future grants
of options.
Effective March 31, 2003, the Company granted its President and Chief Executive Officer stock
options to purchase 1,325,000 shares of common stock of the Company at an exercise price of $6.00
per share. The market price of the Companys common stock at the close of business on March 31,
2003 was $3.60 per share. The options vest in equal monthly installments over a three-year period
beginning on the first anniversary of the date of grant and have a term of ten years.
Additional information related to the Companys stock options is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
Remaining |
|
Aggregate |
|
|
|
|
|
|
Weighted Average |
|
Grant Date Fair |
|
Contractual Life in |
|
Intrinsic |
|
|
Number of Shares |
|
Exercise Price |
|
Value |
|
Years |
|
Value (000s) |
Total outstanding at January 1, 2006 |
|
|
7,047,127 |
|
|
$ |
7.41 |
|
|
|
|
|
|
|
6.3 |
|
|
|
|
|
Options granted |
|
|
1,085,000 |
|
|
$ |
9.69 |
|
|
$ |
4.40 |
|
|
|
|
|
|
|
|
|
Options exercised |
|
|
(477,101 |
) |
|
$ |
4.12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Options expired |
|
|
(130,000 |
) |
|
$ |
11.84 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Options forfeited |
|
|
(404,507 |
) |
|
$ |
7.49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total outstanding at September 30, 2006 |
|
|
7,120,519 |
|
|
$ |
7.90 |
|
|
|
|
|
|
|
6.6 |
|
|
$ |
14,425 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable and vested at
September 30, 2006 |
|
|
4,570,790 |
|
|
$ |
7.75 |
|
|
|
|
|
|
|
5.3 |
|
|
$ |
9,962 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of options exercised during the three and nine months ended
September 30, 2006 was $1.2 million and $2.5 million, respectively. Cash received from option
exercises under all share-based payment arrangements for the three and nine months ended September
30, 2006 was approximately $0.8 million and $2.0 million, respectively.
Restricted Stock and Restricted Stock Unit Plans
The Company has adopted restricted stock plans which provide for the award of up to 300,000
shares of common stock to key employees. In addition, the Company has issued restricted stock and
restricted stock units under the Companys 2004 Long-Term Incentive Plan (the Plan). The Plan
provides for the award of stock options, share appreciation rights, deferred shares, restricted
stock and restricted stock units. Restricted stock units are awards that obligate the Company to
issue a specific number of shares of common stock in the future if continued service vesting
requirements are met. Non-forfeitable ownership of the common stock will vest over a period as
determined by the Company in its sole discretion, which is generally in equal annual installments
over a three-year period. Shares of restricted stock awarded may not be sold, assigned,
transferred, pledged or otherwise encumbered by the grantee during the vesting period. Except for
these restrictions, the grantee of an award of shares of restricted stock has all the rights of a
common stockholder, including the right to receive dividends on and the right to vote such shares.
The status of the Companys restricted stock and restricted stock unit awards for the nine
months ended September 30, 2006 is as follows:
|
|
|
|
|
|
|
Number of Shares/Units |
Total nonvested at January 1, 2006 |
|
|
777,236 |
|
Granted |
|
|
585,000 |
|
Vested |
|
|
(262,785 |
) |
Forfeited |
|
|
(92,750 |
) |
|
|
|
|
|
Total nonvested at September 30, 2006 |
|
|
1,006,701 |
|
|
|
|
|
|
At September 30, 2006, the intrinsic value of restricted stock and restricted stock unit
awards is approximately $10.0 million. The weighted average grant date fair value for restricted
stock and restricted stock unit awards granted during the nine months ended September 30, 2006 was
$9.63 per share. The total fair value of shares vested during the nine months ended September 30,
2006 was $2.6 million.
10
Employee Stock Purchase Plan
In April 1997, the Company adopted its Employee Stock Purchase Plan (ESPP), which allows all
eligible employees to authorize payroll deductions at a rate of 1% to 15% of base compensation for
the purchase of the Companys common stock. The purchase price of the common stock will be the
lesser of 85% of the closing price on the first day of the applicable offering period (or most
recently preceding trading day) and 85% of the closing price on the last day of the offering period
(or most recently preceding trading day). Each offering period is six months in duration and
commences on January 1 and July 1 of each year. The ESPP is considered a compensatory plan under
FAS 123R. Therefore, the Company recorded compensation expense of approximately $0.2 million during
the nine months ended September 30, 2006. The expense represents the estimated fair value of the
look-back purchase option. The fair value was determined using the Black-Scholes option pricing
model and is recognized over the purchase period.
Impact of the Adoption of FAS 123R
Beginning January 1, 2006, the Company adopted FAS 123R using the modified prospective method.
Accordingly, during the three and nine months ended September 30, 2006, the Company recorded
stock-based compensation expense for awards granted prior to, but not yet vested, as of January 1,
2006, as if the fair value method required for pro forma disclosure under FAS 123 were in effect
for expense recognition purposes, adjusted for estimated forfeitures. For stock-based awards
granted after January 1, 2006, the Company recognized compensation expense based on the estimated
grant date fair value method using the Black-Scholes valuation model. Effective January 1, 2006,
the Company began to recognize stock-based compensation for all awards on the straight-line basis
over the service period of each award (generally the awards vesting period). Prior to the adoption
of FAS 123R, the Company had recognized compensation expense related to its restricted stock and
restricted stock unit awards using the accelerated method and will continue to apply the
accelerated method to all outstanding restricted stock and restricted stock unit awards granted
prior to January 1, 2006.
FAS 123R requires that stock-based compensation expense be based on awards that are expected
to ultimately vest. Accordingly, stock-based compensation for the three and nine months ended
September 30, 2006 has been reduced for estimated forfeitures. When estimating forfeitures, the
Company considers voluntary termination experience as well as trends of actual forfeitures.
Stock-based compensation expense for the three and nine months ended September 30, 2006 was as
follows (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, 2006 |
|
|
September 30, 2006 |
|
Total cost of sales |
|
$ |
334 |
|
|
$ |
921 |
|
Research and development |
|
|
164 |
|
|
|
575 |
|
Marketing and sales |
|
|
334 |
|
|
|
968 |
|
General and administrative |
|
|
520 |
|
|
|
1,756 |
|
|
|
|
|
|
|
|
Income before income taxes and change in accounting principle |
|
|
1,352 |
|
|
|
4,220 |
|
Cumulative effect of change in accounting principle |
|
|
|
|
|
|
398 |
|
|
|
|
|
|
|
|
Net income |
|
$ |
1,352 |
|
|
$ |
3,822 |
|
|
|
|
|
|
|
|
Basic and diluted income per share |
|
$ |
0.02 |
|
|
$ |
0.05 |
|
|
|
|
|
|
|
|
FAS 123R requires tax benefits relating to excess stock based compensation deductions to be
prospectively presented in the Companys consolidated statement of cash flows as financing cash
inflows. As the Company has net operating loss carryforwards available to be utilized to reduce its
income taxes payable, no benefit has been realized from any excess tax deductions during the three
and nine months ended September 30, 2006.
As of September 30, 2006, there was approximately $10.2 million of unrecognized compensation
cost related to all nonvested stock options, nonvested restricted stock and restricted stock units
issued subsequent to December 31, 2005. These costs will be recognized on a straight-line basis
over a weighted-average vesting period of 2.8 years. Unrecognized compensation cost at September
30, 2006 of $1.4 million relating to nonvested restricted stock and restricted stock units granted
prior to January 1, 2006 will continue to be amortized using the accelerated method, over a
weighted-average vesting period of 1.7 years.
11
Prior to the adoption of FAS 123R, the intrinsic value of restricted stock was recorded as
unamortized restricted stock compensation. Upon the adoption of FAS 123R, the unamortized
restricted stock compensation balance of approximately $3.8 million was reclassified to additional
paid-in capital.
Valuation Assumptions
The Company calculated the fair value of each option award on the date of grant using the
Black-Scholes option pricing model. The following assumptions were used for each respective period:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
September 30, |
|
|
2006 |
|
2005 |
Risk-free interest rates |
|
|
4.44% 5.15 |
% |
|
|
3.63% 4.33 |
% |
Expected lives (in years) |
|
|
4.5 |
|
|
|
5.0 |
|
Expected dividend yield |
|
|
0% |
|
|
|
0% |
|
Expected volatility |
|
|
47.5% 53.8 |
% |
|
|
60% |
|
The computation of expected volatility during the three and nine months ended September 30,
2006 was based on an equally weighted combination of historical volatility and market-based implied
volatility. Historical volatility was calculated from historical data for a period of time
approximately equal to the expected term of the option award, starting from the date of grant.
Market-based implied volatility was derived from traded options on the Companys common stock
having a term of six months. Prior to 2006, the Companys computation of expected volatility was
based on historical volatility. The Companys computation of expected life in 2006 was determined
based on historical experience of similar awards, giving consideration to the contractual terms of
the stock-based awards, vesting schedules and expectations of future employee behavior. The
risk-free interest rate assumption is based upon the U.S. Treasury yield curve in effect at the
time of grant for periods corresponding with the expected life of the option.
Pro Forma Information for Periods Prior to the Adoption of FAS 123R
Prior to January 1, 2006, the Company accounted for equity-based compensation using the
intrinsic method prescribed in APB Opinion No. 25. As required by FAS 123R, the effect on net
income and earnings per share of stock-based employee compensation, including stock options, that
would have been recorded using the fair value based method for the three and nine months ended
September 30, 2005, is as follows (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, 2005 |
|
|
September 30, 2005 |
|
Net income applicable to common shares |
|
$ |
2,727 |
|
|
$ |
1,554 |
|
Add: Stock-based employee compensation expense included in
reported net income applicable to common shares |
|
|
785 |
|
|
|
1,707 |
|
Deduct: Stock-based employee compensation expense determined
under fair value methods for all awards |
|
|
(1,746 |
) |
|
|
(4,589 |
) |
|
|
|
|
|
|
|
Pro forma net income (loss) applicable to common shares |
|
$ |
1,766 |
|
|
$ |
(1,328 |
) |
|
|
|
|
|
|
|
Basic and diluted net income per common share as reported |
|
$ |
0.03 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
Pro forma basic and diluted net income (loss) per common share |
|
$ |
0.02 |
|
|
$ |
(0.02 |
) |
|
|
|
|
|
|
|
(9) Commitments and Contingencies
Legal Matters: In October 2002, the Company filed a lawsuit against Paulsson Geophysical
Services, Inc. (PGSI) and its owner in the 286th District Court for Fort Bend County, Texas,
seeking recovery of approximately $0.7 million that was unpaid and due to the Company resulting
from the sale of a custom-built product that PGSI had asked the Company to construct in 2001. After
the Company filed suit to recover the PGSI receivable, PGSI alleged that the delivered custom
product was defective and counter-claimed against the Company, asserting breach of contract, breach
of warranty and other related causes of action. The case was initially tried to a jury during May
2004. The jury returned a verdict in June 2004, the results of which would not have supported a
judgment awarding
12
damages to either the Company or the defendants. In August 2004, the presiding judge overruled
the jury verdict and ordered a new trial. The new trial commenced in March 2006 and the jury in the
new trial returned a verdict on April 13, 2006 finding that both parties had breached their
contract but that PGSI did not suffer any damages in connection with the Companys breach. On July
5, 2006, the Court issued a judgment awarding the Company $732,074 in damages on its breach of
contract claim and $156,563 in prejudgment interest, while issuing a take-nothing judgment against
PGSI. The Company is also entitled to recover post-judgment interest and its legal costs and
attorneys fees. At a hearing held on August 11, 2006, the judge determined that the Company was
entitled to recover $365,000 in attorneys fees, thereby bringing the total award to the Company to
$1,259,294, plus post-judgment interest and recoverable legal costs. The Company will not
recognize this gain until the judgment is final and nonappealable and its collectibility is
reasonably assured.
The Company has been named in various lawsuits or threatened actions that are incidental to
its ordinary business. Such lawsuits and actions could increase in number as the Companys business
expands and the Company grows larger. Litigation is inherently unpredictable. Any claims against
the Company, whether meritorious or not, could be time consuming, cause the Company to incur costs
and expenses, require significant amounts of management time and result in the diversion of
significant operational resources. The results of these lawsuits and actions cannot be predicted
with certainty. Management currently believes that the ultimate resolution of these matters will
not have a material adverse impact on the Companys financial condition, results of operations or
liquidity.
Warranties: The Company generally warrants that all manufactured equipment will be free from
defects in workmanship, materials and parts. Warranty periods generally range from 90 days to three
years from the date of original purchase, depending on the product. The Company provides for
estimated warranty as a charge to cost of sales at time of sale, which is when estimated future
expenditures associated with such contingencies become probable and reasonably estimated. However,
new information may become available, or circumstances (such as applicable laws and regulations)
may change, thereby resulting in an increase or decrease in the amount required to be accrued for
such matters (and therefore a decrease or increase in reported net income in the period of such
change). A summary of warranty activity is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Balance at beginning of period |
|
$ |
4,877 |
|
|
$ |
3,568 |
|
|
$ |
3,896 |
|
|
$ |
3,832 |
|
Accruals for warranties issued during the period |
|
|
1,501 |
|
|
|
1,817 |
|
|
|
5,030 |
|
|
|
4,149 |
|
Settlements made (in cash or in kind) during the period |
|
|
(992 |
) |
|
|
(520 |
) |
|
|
(3,540 |
) |
|
|
(3,116 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period |
|
$ |
5,386 |
|
|
$ |
4,865 |
|
|
$ |
5,386 |
|
|
$ |
4,865 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10) Concentration of Credit and Foreign Sales Risks
For the nine months ended September 30, 2006 and for all of 2005, approximately 9% of the
Companys consolidated net revenues were attributable to land equipment sales to one customer
headquartered in China. Approximately $14.7 million, or 13%, of the Companys total accounts
receivable at September 30, 2006 related to this same customer. For the nine months ended September
30, 2006, $25.5 million, or 8% of consolidated net revenues, were attributable to marine equipment
sales to a single customer. At September 30, 2006, $5.3 million, or 5% of the Companys total
accounts receivable and $7.0 million of the Companys total notes receivable, related to this same
customer. The loss of these customers or a deterioration in the Companys relationship with either
customer could have a material adverse effect on the Companys results of operations and financial
condition.
For the nine months ended September 30, 2006, the Company recognized $93.8 million of sales to
customers in Europe, $72.4 million of sales to customers in Asia Pacific, $27.7 million of sales to
customers in Africa, $30.5 million of sales to customers in the Middle East, $14.6 million of sales
to customers in Latin American countries, and $11.9 million of sales to customers in the
Commonwealth of Independent States, or former Soviet Union (CIS). The majority of the Companys
foreign sales are denominated in U.S. dollars. In recent years, the CIS and certain Latin American
countries have experienced economic problems and uncertainties. To the extent that world events or
economic conditions negatively affect the Companys future sales to customers in these and other
regions of the
13
world or the collectibility of the Companys existing receivables, the Companys future
results of operations, liquidity and financial condition may be adversely affected.
(11) Non-Cash Investing and Financing Activities
During the nine months ended September 30, 2006 and 2005, the Company entered into various
capital leases for the purchase of computer equipment totaling $9.3 million and $1.2 million,
respectfully.
In June 2005, the owner of the Companys facilities located in Stafford, Texas sold the
facilities. The facilities were originally sold by the Company and leased-back from the owner in
2001. As a result of the owners sale, a portion of the facilities qualified as a sale-leaseback
for financial reporting purposes. Therefore, in June 2005, $11.8 million of lease obligations and
$8.1 million of long-term assets (primarily fixed assets) were treated as a sale, with the Company
recording a deferred gain of $3.7 million. See further discussion of this transaction in Note 11
of the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
We are a leading seismic solutions company, providing the global oil and natural gas industry
with a variety of seismic products and services, including seismic data acquisition equipment,
survey design planning services, software products, seismic data libraries, and seismic data
processing services. In recent years, we have transformed our business from being solely a seismic
equipment manufacturer to being a provider of a full range of seismic imaging products and services
including designing and planning a seismic survey, overseeing the acquisition of seismic data by
experienced contractors, and processing the acquired seismic data using advanced algorithms and
modem workflows. During 2004, we completed two acquisitions as part of our strategy to expand the
range of products and services we provide. This expanded offering, including seismic data
management software and advanced imaging services, has enabled us to broaden our customer base
beyond seismic acquisition contractors to also include oil and natural gas exploration and
production companies.
Our current growth strategy is focused on the following key areas:
|
|
|
Continuing to emphasize GXTs Integrated Seismic Solutions (ISS) offering, where we
obtain and process seismic data and license data library rights to multiple customers; |
|
|
|
|
Expanding the coverage of our geophysical data libraries to more major land and marine
oil and gas basins on a worldwide basis; |
|
|
|
|
Continuing development and commercialization of our next-generation marine streamer and
seabed acquisition systems and services; |
|
|
|
|
Developing more competitive and cost-efficient land data acquisition systems; and |
|
|
|
|
Continuing development and commercialization for our new FireFly cableless full-wave
land data acquisition systems. |
Despite the decline in commodity prices, the trends that we experienced in the first half of
fiscal 2006 continued into the third quarter. We believe that this strengthening in our seismic
equipment sales and processing services has resulted from the energy industry refocusing on
exploration activities.
As anticipated, both our product revenues and services revenues for the three month period
ended September 30, 2006, were below the comparable amounts for the three months ended June 30,
2006. This decrease was due in part to a seasonal slowdown that we typically experience in the
third quarter of each year. The second quarter of 2006 was unusually strong due in part to certain
sales that had been expected to close in the first quarter but that slipped into the second
quarter, including deliveries of our VectorSeis Ocean seabed acquisition system equipment, as well
as seismic data library sales which were originally expected to close in the third and fourth
quarters, but closed in the second quarter of this year.
14
For both the three and nine month periods ended September 30, 2006, our equipment and systems
sales revenues and our services revenues increased significantly over that for the comparable
periods in 2005. Each of our four operating business segments experienced strong percentage
increases in their revenues compared to their revenues for the comparable nine months in 2005.
Income from operations for the nine months ended September 30, 2006 was significantly higher in our
Marine Imaging Systems, Seismic Imaging Solutions and Data Management Solutions business segments,
compared to income from operations for those segments in the comparable periods of 2005. Income
from operations for our Land Imaging Systems segment declined for both the three and nine month
periods ended September 30, 2006 compared to those for the comparable periods in 2005, primarily
because of increased research and development expenses associated with FireFly and competitive
pricing pressures.
Cash flows provided by our operating activities for the nine months ended September 30, 2006
were $67.3 million, due principally to increases in net income for that nine month period and
increases in our accrued liabilities and deferred revenue, partially offset by an increase in our
inventory primarily in our Marine Imaging Systems segment. The increase in our deferred revenue
was the result of increased underwriting commitments to our GXT new venture programs for which we
have not yet recognized the related revenue and advanced payments for our new FireFly cableless
full-wave land seismic data acquisition system (see below for further discussion of FireFly). At
September 30, 2006, we had $43.1 million in cash and cash equivalents, and there were no
outstanding borrowings under our revolving line of credit.
During the quarter ended September 30, 2006, we continued to see increasing interest in our
new technologies. During the fourth quarter of 2006, we expect to complete final engineering and
begin deployment and field testing of our new FireFly cableless full-wave land seismic data
acquisition system for a project in the Wamsutter gas fields in Wyoming. During August 2006, we
announced the receipt of an order for approximately $29 million from Reservoir Exploration
Technology, a marine seismic contractor headquartered in Oslo, Norway, for a third VectorSeis®
Ocean redeployable ocean-bottom cable system. This system is scheduled for delivery in the fourth
quarter of 2006 and the first quarter of 2007. In October 2006, we announced the release and first
commercial sale of our Scorpion® system for cable-based, land seismic data acquisition. The
Scorpion system builds upon our traditional System Four® land acquisition system platform and
incorporates several new features designed to improve the systems recording capacity, reliability,
productivity, and ease of use.
We operate our company through four business segments: Land Imaging Systems, Marine Imaging
Systems, Seismic Imaging Solutions and Data Management Solutions. The following table provides an
overview of key financial metrics for our company as a whole and our four business segments during
the three and nine months ended September 30, 2006 compared to those periods one year ago (in
thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Imaging Systems |
|
$ |
46,082 |
|
|
$ |
38,809 |
|
|
$ |
130,837 |
|
|
$ |
106,811 |
|
Marine Imaging Systems |
|
|
24,864 |
|
|
|
16,338 |
|
|
|
89,990 |
|
|
|
43,984 |
|
Seismic Imaging Solutions |
|
|
32,365 |
|
|
|
19,646 |
|
|
|
99,693 |
|
|
|
69,356 |
|
Data Management Solutions |
|
|
6,662 |
|
|
|
4,715 |
|
|
|
16,793 |
|
|
|
11,566 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
109,973 |
|
|
$ |
79,508 |
|
|
$ |
337,313 |
|
|
$ |
231,717 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Imaging Systems |
|
$ |
1,874 |
|
|
$ |
4,257 |
|
|
$ |
6,467 |
|
|
$ |
12,077 |
|
Marine Imaging Systems |
|
|
5,792 |
|
|
|
4,090 |
|
|
|
22,310 |
|
|
|
9,588 |
|
Seismic Imaging Solutions |
|
|
5,123 |
|
|
|
1,613 |
|
|
|
17,176 |
|
|
|
2,663 |
|
Data Management Solutions |
|
|
2,423 |
|
|
|
1,470 |
|
|
|
5,389 |
|
|
|
1,824 |
|
Corporate and Other |
|
|
(8,759 |
) |
|
|
(6,412 |
) |
|
|
(28,623 |
) |
|
|
(19,513 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
6,453 |
|
|
$ |
5,018 |
|
|
$ |
22,719 |
|
|
$ |
6,639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income applicable to common shares |
|
$ |
2,857 |
|
|
$ |
2,727 |
|
|
$ |
13,883 |
|
|
$ |
1,554 |
|
Basic and diluted net income per common share |
|
$ |
0.04 |
|
|
$ |
0.03 |
|
|
$ |
0.17 |
|
|
$ |
0.02 |
|
15
We intend that the discussion of our financial condition and results of operations that
follows will provide information that will assist in understanding our consolidated financial
statements, the changes in certain key items in those financial statements from quarter to quarter,
and the primary factors that accounted for those changes.
For a discussion of factors that could impact our future operating results and financial
condition, see Part II, Item 1A Risk Factors below.
The information contained in this Quarterly Report on Form 10-Q contains references to our
trademarks, service marks and registered marks, as indicated. Except where stated otherwise or
unless the context otherwise requires, the terms VectorSeis and VectorSeis System Four refer to
our VectorSeis® and VectorSeis System Four® registered marks, the term FireFly refers to our
FireFly mark (registration pending), and the term Orca refers to our Orca mark.
Stock-Based Compensation
On January 1, 2006, we adopted Financial Accounting Standards (FAS) No. 123 (revised 2004),
Share-Based Payment (FAS 123R), that addresses the accounting for share-based payment
transactions in which an enterprise receives employee services in exchange for either equity
instruments of the enterprise or liabilities that are based on the fair value of the enterprises
equity instruments or that may be settled by the issuance of such equity instruments. The statement
requires that such transactions be accounted for using a fair-value-based method and recognized as
expense in our consolidated statement of income. Prior to the adoption of FAS 123R, we used the
intrinsic value method as prescribed by Accounting Principles Board (APB), Opinion No. 25,
Accounting for Stock Issued to Employees.
We adopted FAS 123R using the modified prospective method which requires the application of
the accounting standard as of January 1, 2006. The consolidated financial statements as of and for
the three and nine months ended September 30, 2006 reflect the impact of adopting FAS 123R. In
accordance with the modified prospective method, the consolidated financial statements for prior
periods have not been restated to reflect, and do not include, the impact of FAS 123R.
During the three and nine months ended September 30, 2006, we recorded a total of $1.4 million
and $4.2 million, respectively, of stock-based compensation expense associated with our stock
options, restricted stock, restricted stock units and our ESPP. Also, upon our adoption of FAS
123R, we recorded a $0.4 million cumulative effect of change in accounting principle to reflect the
compensation costs that would have not been recognized in the periods prior to adoption had
forfeitures been estimated on the unvested restricted stock and restricted stock units outstanding
at January 1, 2006. During the three and nine months ended September 30, 2005, we recorded total
stock-based compensation expense associated with our restricted stock and restricted stock units of
$0.8 million and $1.7 million, respectively. See Note 8 Stock-Based Compensation of Condensed
Notes to Unaudited Consolidated Financial Statements.
Results of Operations
Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005
Net Revenues: Net revenues of $110.0 million for the three months ended September 30, 2006
increased $30.5 million, compared to the corresponding period last year. Land Imaging Systems net
revenues increased by $7.3 million, to $46.1 million compared to $38.8 million in the corresponding
period of last year. This increase was due primarily to an increase in our Sensor geophone sales
and vibrator truck sales. Our land acquisition system sales for the third quarter of 2006 remained
consistent with our 2005 sales levels for the quarter. Marine Imaging Systems net revenues
increased $8.6 million to $24.9 million compared to $16.3 million in the corresponding period of
last year mainly due to an increase in sales of our towed streamer positioning and control product
line resulting from the significant upturn in demand for marine seismic equipment as well as
delivery of approximately $3.4 million of VectorSeis Ocean systems equipment to our customer,
Reservoir Exploration Technology.
16
Seismic Imaging Solutions net revenues increased $12.7 million, to $32.4 million for the
three months ended September 30, 2006 compared to $19.6 million in the corresponding period last
year. This increase is related to higher proprietary processing revenues and pre-funded
multi-client surveys primarily off the coast of India and in the Arctic. The increase was
partially offset by a decline in sales of off-the-shelf seismic data. Our Data Management Solutions
segment (Concept Systems) contributed $6.7 million to our net revenues for the third quarter,
compared to $4.7 million in the corresponding period of last year, also reflecting the increased
demand for marine seismic work.
Gross Profit and Gross Profit Percentage: Gross profit of $33.0 million for the three months
ended September 30, 2006 increased $9.2 million, compared to the corresponding period last year.
Gross profit percentages for both the three months ended September 30, 2006 and 2005 were 30.0%.
Gross margin percentages remained flat primarily due to a favorable mix of sales of our higher
margin Seismic Imaging Solutions segment, offset by lower margins in our Land Imaging Systems and
Marine Imaging Systems segments. Competitive pricing pressures continue to affect margins in our
Land Imaging Systems segment, although we are beginning to see the positive impact of cost control
initiatives developed over the last several months.
Research and Development: Research and development expense of $7.8 million (approximately 7%
of net revenues) for the three months ended September 30, 2006 increased $3.0 million compared to
the corresponding period last year. We expect to continue to incur significant research and
development expenses as we continue to invest heavily in the next generation of our seismic
acquisition products and services, such as FireFly and the next generation of marine products. The
impact of the adoption of FAS 123R resulted in the recognition of $0.2 million in our research and
development expenses related to those employees compensation expense associated with outstanding
employee stock awards.
Marketing and Sales: Marketing and sales expense of $9.8 million for the three months ended
September 30, 2006 increased $2.2 million compared to the corresponding period last year. The
increase of our sales and marketing expenses reflects additional sales personnel, an increase in
business development personnel within our product groups and an increase in corporate marketing and
advertising expenses. We intend to continue investing significant sums in our marketing efforts as
we further penetrate markets for our new products. The impact of the adoption of FAS 123R resulted
in the recognition of $0.3 million in our marketing and sales expenses related to those employees
compensation expense associated with outstanding employee stock awards.
General and Administrative: General and administrative expenses of $9.0 million for the three
months ended September 30, 2006 increased $2.6 million over third quarter 2005 general and
administrative expenses. General and administrative expenses as a percentage of net revenues for
the three months ended September 30, 2006 and 2005 were both approximately 8.1%. This increase in
expenses is related to higher professional and accounting fees, as well as an increase in expected
bonuses for 2006 related to our improved results of operations. The impact of the adoption of FAS
123R resulted in the recognition of $0.5 million in our general and administrative expenses related
to those employees compensation expense associated with outstanding employee stock awards.
Income Tax Expense: Income tax expense for the three months ended September 30, 2006 was $1.4
million compared to $0.7 million for the three months ended September 30, 2005. Income tax expense
consists mainly of foreign taxes, since we continue to maintain a valuation allowance for
substantially all of our domestic net deferred tax assets. The increase in tax expense relates to
improved results of operations of our foreign divisions. The Companys effective tax rate for the
three months ended September 30, 2006 was 28.9% as compared to 16.8% for the similar period during
2005. The increased effective tax rate for the current year relates to improved results of
operations of our foreign divisions during the current year. The effective tax rate is lower than
the statutory rate due to the utilization of previously reserved domestic deferred tax assets.
Preferred Dividend: The preferred dividend relates to our Series D-1 Preferred Stock we issued
in February 2005. Quarterly dividends may be paid, at the option of the Company, either in cash or
by the issuance of the Companys common stock. Dividends are paid at a rate equal to the greater of
(i) five percent per annum or (ii) the three month LIBOR rate on the last day of the immediately
preceding calendar quarter plus two and one-half percent per annum. All dividends paid on the
Series D-1 Preferred Stock have been paid in cash. The Preferred Stock dividend rate was 8.0% at
September 30, 2006.
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Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
Net Revenues: Net revenues of $337.3 million for the nine months ended September 30, 2006
increased $105.6 million, compared to the corresponding period last year. Land Imaging Systems
net revenues increased by $24.0 million, to $130.8 million compared to $106.8 million in the
corresponding period of last year. This increase was due to increases in our Sensor geophone sales
and vibrator truck sales. Land acquisition system sales remained consistent for the nine-month
period. Marine Imaging Systems net revenues increased $46.0 million to $90.0 million compared to
$44.0 million in the corresponding period of last year due to delivery of approximately $24 million
under our VectorSeis Ocean systems contract with Reservoir Exploration Technology, as well as an
increase in sales from our towed streamer position and control product line due to the significant
upturn in demand for marine seismic equipment.
Seismic Imaging Solutions net revenues increased $30.3 million to $99.7 million for the nine
months ended September 30, 2006, compared to $69.4 million in the corresponding period last year.
This increase is related to higher proprietary processing revenues, sales of off-the-shelf seismic
data and pre-funded multi-client surveys. Concept Systems contributed $16.8 million to our net
revenues for the first nine months of 2006, compared to $11.6 million in the corresponding period
of last year.
Gross Profit and Gross Profit Percentage: Gross profit of $103.7 million for the nine months
ended September 30, 2006 increased $41.1 million, compared to the corresponding period last year.
Gross profit percentage for the nine months ended September 30, 2006 was 30.8% compared to 27.0% in
the prior year. The improvement in our gross margin percentages was primarily due to increased
sales of higher margin marine positioning and data acquisition system electronics by Marine Imaging
Systems, an increase in sales of GXTs off-the-shelf seismic data library and pre-funded
multi-client surveys, and an increase in higher margin sales at Concept Systems. This increase was
partially offset by continuing pricing pressures on our land acquisition systems and vibrator
trucks. We are currently engaged in various engineering projects to reduce the cost of our
products.
Research and Development: Research and development expense of $23.0 million (approximately 7%
of net revenues) for the nine months ended September 30, 2006 increased $8.9 million compared to
the corresponding period last year. We incurred significant research and development expenses
during the nine months ended September 30, 2006 and expect to continue to incur significant
research and development expenses as we continue to invest heavily in the next generation of our
seismic acquisition products and services, such as FireFly and the next generation of marine
products. The impact of the adoption of FAS 123R resulted in the recognition of $0.6 million in
our research and development expense related to those employees compensation expense associated
with their outstanding employee stock awards.
Marketing and Sales: Marketing and sales expense of $28.5 million for the nine months ended
September 30, 2006 increased $5.9 million compared to the corresponding period last year. The
increase of our sales and marketing expenses reflect additional sales personnel, an increase in
business development personnel within our product groups and an increase in corporate marketing and
advertising expenses. We intend to continue investing significant sums in our marketing efforts as
we further penetrate markets for our new products. The impact of the adoption of FAS 123R resulted
in the recognition of $1.0 million in our marketing and sales expenses related to those employees
compensation expense associated with their outstanding employee stock awards.
General and Administrative: General and administrative expenses of $29.6 million for the nine
months ended September 30, 2006 increased $10.4 million over the corresponding period last year.
General and administrative expenses as a percentage of net revenues for the nine months ended
September 30, 2006 was 8.8% compared to 8.3% in the prior year. This increase is related to higher
professional fees associated with the on-going integrated audit of our 2006 results and our
assessment of the effectiveness of our internal control over financial reporting as well as an
increase in expected bonuses for 2006 relating to our improved results of operations. Also
contributing to the increase in general and administrative expenses were legal fees associated with
our lawsuit against Paulsson Geophysical Services. The impact of the adoption of FAS 123R resulted
in the recognition of $1.8 million in our general and administrative expenses related to those
employees compensation expense associated with their outstanding employee stock awards.
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Income Tax Expense (Benefit): Income tax expense for the nine months ended September 30, 2006
was $3.3 million compared to an income tax benefit of $0.2 million for the nine months ended
September 30, 2005. During the first quarter of 2005, we reduced our tax reserves by $1.3 million
due to the successful closure of a certain foreign tax matter. Income tax expense reflects mainly
foreign taxes, since we continue to maintain a valuation allowance for substantially all of our
domestic net deferred tax assets. After excluding the reduction of tax reserves, the increase in
tax expense during 2006 primarily relates to improved results of our foreign operations. The
Companys effective tax rate for the nine months ended September 30, 2006 was 17.9% as compared to
the tax benefit for the similar period during 2005. The increased effective tax rate for the
current year relates to improved results of operations of our foreign divisions and the release of
tax reserves during the prior year. The year-to-date effective tax rate is lower than the
statutory rate due to the utilization of previously reserved domestic deferred tax assets.
Liquidity and Capital Resources
Sources of Capital
In May 2005, we obtained a $25.0 million revolving line of credit facility having a maturity
date of May 24, 2008; there were no outstanding borrowings under this line of credit at September
30, 2006. We can periodically elect to use either the lenders Base Rate (as defined in the credit
agreement) or the three-month LIBOR Rate plus 2.25% to 2.75% (depending on our Fixed Charge
Coverage Ratio, as defined in the credit agreement) in connection with borrowings under the
revolving line of credit. In addition, we can issue letters of credit totaling up to $5 million
under this facility, which, if issued, reduces our borrowing availability under the line of credit.
A portion of our assets are pledged as collateral for outstanding borrowings under the line of
credit. Total borrowings are subject to a borrowing base limitation based on a percentage of
eligible accounts receivable and inventories. As of September 30, 2006, the borrowing base
calculation permitted total available borrowings of $25 million. Our borrowing base could
decrease if our Eligible Collateral (as defined in the credit agreement) falls below $25 million.
In February 2005, we issued 30,000 shares of a newly-designated Series D-1 Cumulative
Convertible Preferred Stock (Series D-1 Preferred Stock) in a privately-negotiated transaction, and
received $29.8 million in net proceeds. We also granted to the Series D-1 Preferred Stock purchaser
the right, expiring on February 16, 2008, to purchase up to an additional 40,000 shares of Series
D-1 Preferred Stock, having a conversion price equal to 122% of the then-prevailing market price of
our common stock at the time of issuance, but not less than $6.31 per share.
Based on our forecasts and our liquidity requirements for the near term future, we believe
that the combination of our projected internally generated cash, the borrowing availability under
our revolving line of credit and our working capital (including our cash and cash equivalents on
hand), will be sufficient to fund our operational needs and liquidity requirements for at least the
next twelve months.
Cash Flow from Operations
We have historically financed operations from internally generated cash and funds from equity
and debt financings. Cash and cash equivalents were $43.1 million at September 30, 2006, an
increase of $27.3 million from December 31, 2005. Net cash provided by operating activities was
$67.3 million for the nine months ended September 30, 2006, compared to a use of net cash in
operating activities of $11.3 million for the nine months ended September 30, 2005. The increase in
net cash provided by our operating activities was primarily due to our increase in net income
earned for the nine months ended September 30, 2006 plus increases for that period in our accrued
expenses, accrued royalties and cash received for deferred revenue in our Seismic Imaging Solutions
and Land Imaging Systems segments, partially offset by an increase in inventories in our Marine
Imaging Systems segment. The increase in our deferred revenue was the result of increased
underwriting commitments to our GXT new venture programs for which we have not yet recognized the
related revenue and advanced payments for our new FireFly cableless full-wave land seismic data
acquisition system. Offsetting these increases in part were higher levels of unbilled receivables
outstanding as of September 30, 2006 compared to those items outstanding at December 31, 2005.
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Cash Flow from Investing Activities
Net cash flow used in investing activities was $33.3 million for the nine months ended
September 30, 2006, compared to $18.0 million for the nine months ended September 30, 2005. The
principal uses of cash for our investing activities during the nine months ended September 30, 2006
were $5.8 million for equipment purchases and $29.4 million for investments in our multi-client
data library. Cash used in investing activities was partially offset by the collection of $2.0
million in proceeds from the note receivable associated with our prior sale of a facility in Alvin,
Texas. We expect to spend an additional $10 million to $15 million for equipment purchases and
investments in our multi-client data library during the remainder of 2006. The range of
expenditures for the remainder of the year could vary depending on the level of multi-client
seismic data acquisition projects that are initiated in the last three months of 2006.
Cash Flow from Financing Activities
Net cash flow used by financing activities was $7.6 million for the nine months ended
September 30, 2006, compared to $30.4 million of cash provided by financing activities for the nine
months ended September 30, 2005. The net cash flow used during the nine months ended September 30,
2006 was primarily related to scheduled principal payments of $4.9 million on our notes payable and
capital lease obligations, $3.0 million to pay off all outstanding borrowings under our revolving
line of credit and $1.7 million in cash dividends paid on our outstanding Series D-1 Preferred
Stock. These cash payments were partially offset by $2.6 million in proceeds related to the
exercise of stock options and stock purchases by our employees under the ESPP during the nine
months ended September 30, 2006. The net cash provided by financing activities during the nine
months ended September 30, 2005 was primarily related to the sale of our Series D-1 Preferred
Stock, on which we paid $1.1 million in cash dividends during that period.
Inflation and Seasonality
Inflation in recent years has not had a material effect on our costs of goods or labor, or the
prices for our products or services. Traditionally, our business has been seasonal, with strongest
demand in the fourth quarter of our fiscal year.
Critical Accounting Policies and Estimates
General. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2005
for a complete discussion of our other significant accounting policies and estimates.
Share-Based Payments. Prior to January 1, 2006, our equity compensation plans were accounted
for under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees and related Interpretations, as permitted by FAS 123, Accounting for
Stock-Based Compensation. We did not recognize stock-based compensation expense associated with
our stock options in our statement of operations for periods prior to January 1, 2006 because all
of our stock options granted had an exercise price equal to or in excess of the market value of the
underlying common stock on the date of grant.
On January 1, 2006, we adopted the fair value recognition provisions of FAS No. 123 (Revised
2004), Share-Based Payment, (FAS 123R), using the modified prospective method. Under this
transition method, stock-based compensation cost recognized in the nine months ended September 30,
2006 includes: (a) compensation cost for all unvested stock-based awards as of January 1, 2006 that
had been granted prior to January 1, 2006, based on the grant date fair value estimated in
accordance with the original provisions of FAS 123, and (b) compensation cost for all stock-based
awards granted after January 1, 2006, based on the grant-date fair value estimated in accordance
with the provisions of FAS 123(R).
Under our equity compensation plans, we have granted (i) stock options to purchase our common
stock to our employees and directors, and (ii) restricted stock and restricted stock unit awards to
our employees. Eligible employees can also participate under our ESPP where, through payroll
deductions, they can purchase shares of our common stock for a purchase price equal to 85% of the
lower of the closing price per share on the New York Stock Exchange on the first and the last day
of each six-month offering period. The benefits provided under these plans are
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share-based payments subject to FAS 123R. Under the modified prospective method, prior
periods are not restated for comparative purposes. Share-based compensation expense recognized
under FAS 123R for the first nine months of fiscal 2006 was $4.2 million. As of September 30, 2006,
there was approximately $10.2 million of unrecognized compensation cost related to all nonvested
stock options and nonvested restricted stock issued subsequent to December 31, 2005. These costs
will be recognized on a straight-line basis over a weighted-average vesting period of 2.8 years.
Unrecognized compensation cost at September 30, 2006 of $1.4 million relating to nonvested
restricted stock and restricted stock units granted prior to January 1, 2006 will continue to be
amortized using the accelerated method, over a weighted-average vesting period of 1.7 years.
With our adoption of FAS 123R, we began estimating the value of stock option awards on the
date of grant using the Black-Scholes option pricing model. Prior to the adoption of FAS 123R, the
values of our stock-based awards were estimated as of the date of grant using the Black-Scholes
model for the pro forma information required to be disclosed under FAS 123. The determination of
the fair value of stock-based payment awards on the date of grant using an option-pricing model is
affected by our stock price as well as assumptions regarding a number of complex and subjective
variables. These variables include, but are not limited to, our expected stock price volatility
over the term of the awards, actual and projected employee stock option exercise behaviors,
risk-free interest rate and expected dividends. On August 16, 2006, the Compensation Committee of
our Board of Directors approved pre-established fixed quarterly grant dates for all future grants
of our stock options.
Our estimates of expected volatility for our stock price used in calculating fair value of our
share-based compensation under FAS 123R for the nine months ended September 30, 2006 were based on
assumptions involving a combination of historical volatility and market-based implied volatility
derived from traded options on our common stock. Prior to 2006, our calculation of expected
volatility was based solely on historical volatility. See Note 8 Stock-Based Compensation of
Condensed Notes to Unaudited Consolidated Financial Statements.
We currently recognize share-based compensation expense on the straight-line basis over the
service period of each award (generally the vesting period of the award). We had recognized
compensation expense in our pro forma disclosures under FAS 123 on the straight-line basis for our
stock options. Prior to the adoption of FAS 123R, we recognized compensation expense related to our
restricted stock and restricted stock unit awards using the accelerated method of amortization and
will continue to apply the accelerated method to all outstanding restricted stock and restricted
stock units awards granted prior to January 1, 2006. Also, prior to our adoption to FAS 123R, we
accounted for forfeitures of our restricted stock and restricted stock unit grants as the
forfeitures actually occurred. We estimated forfeitures on our unvested restricted stock
outstanding as of January 1, 2006, and recorded a $0.4 million cumulative effect of change in
accounting principle to reflect the compensation cost that would not have been recognized in prior
periods had forfeitures been estimated during these periods.
If factors change and we employ different assumptions in the application of FAS 123R in future
periods, the compensation expense that we recognize may differ significantly from what we have
recorded in the current period. Investors should be aware of the high degree of subjectivity
involved when using option pricing models to estimate share-based compensation under FAS 123R.
Option-pricing models were developed for use in estimating the value of traded options that have no
vesting restrictions, are freely transferable and do not cause dilution. Because our share-based
payments have characteristics significantly different from those of freely-traded options, and
because changes in the subjective input assumptions can materially affect our estimates of fair
values, in our opinion, existing valuation models, including the Black-Scholes model, may not
provide reliable measures of the fair values of our share-based compensation. Consequently, there
is a risk that our estimates of the fair values of our share-based compensation awards on the grant
dates may bear little resemblance to the actual values realized upon the exercise, expiration,
early termination or forfeiture of those awards in the future. Certain share-based payments, such
as stock options, may expire worthless or otherwise result in zero intrinsic value as compared to
the fair values originally estimated on the grant date and reported in our consolidated financial
statements. Alternatively, value may be realized from these instruments that is significantly in
excess of the fair values originally estimated on the grant date and reported in our consolidated
financial statements. There is currently no market-based mechanism or other practical application
to verify the reliability and accuracy of the estimates stemming from these valuation models, nor
is there a means to compare and adjust the estimates to actual values. Although the fair value of
employee share-based awards is determined in accordance with FAS 123R and the SECs Staff
Accounting Bulletin No. 107 (SAB 107) using an option-pricing model, that value may not be
indicative of the fair value observed in a transaction involving a willing buyer and a willing
seller.
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Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.
48, Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109 (FIN
48), which clarifies the accounting for uncertainty in income taxes recognized in accordance with
FAS No. 109, Accounting for Income Taxes (FAS 109). FIN 48 clarifies the application of FAS 109
by defining criteria that an individual tax position must meet for any part of the benefit of that
position to be recognized in the financial statements. Additionally, FIN 48 provides guidance on
the measurement, derecognition, classification and disclosure of tax positions, along with
accounting for the related interest and penalties. The provisions of FIN 48 are effective for
fiscal years beginning after December 15, 2006, with the cumulative effect of the change in
accounting principle recorded as an adjustment to beginning retained earnings. We are currently
evaluating the impact the adoption of FIN 48 will have on our financial position, results of
operations and cash flows.
Credit and Sales Risks
Historically, our principal customers have been seismic contractors that operate seismic data
acquisition systems and related equipment to collect data in accordance with their customers
specifications or for their own seismic data libraries. However, through the acquisition of GXT, we
have diversified our customer base to include major integrated and independent oil and gas
companies.
For the nine months ended September 30, 2006 and for all of 2005, approximately 9% of our
consolidated net revenues were attributable to land equipment sales to one customer headquartered
in China. Approximately $14.7 million, or 13%, of our total accounts receivable at September 30,
2006 related to this same customer. For the nine months ended September 30, 2006, $25.5 million, or
8% of consolidated net revenues, were attributable to marine equipment sales to a single customer.
At September 30, 2006, $5.3 million, or 5% of our total accounts receivable and $7.0 million of our
total notes receivable, related to this same customer. The loss of these customers or a
deterioration in our relationship with either customer could have a material adverse effect on our
results of operations and financial condition.
For the nine months ended September 30, 2006, we recognized $93.8 million of sales to
customers in Europe, $72.4 million of sales to customers in Asia Pacific, $27.7 million of sales to
customers in Africa, $30.5 million of sales to customers in the Middle East, $14.6 million of sales
to customers in Latin American countries, and $11.9 million of sales to customers in the
Commonwealth of Independent States, or former Soviet Union (CIS). The majority of our foreign sales
are denominated in U.S. dollars. In recent years, the CIS and certain Latin American countries have
experienced economic problems and uncertainties. To the extent that world events or economic
conditions negatively affect our future sales to customers in these and other regions of the world
or the collectibility of our existing receivables, our future results of operations, liquidity and
financial condition may be adversely affected. We currently require customers in these higher risk
countries to provide their own financing and in some cases assist the customer in organizing
international financing and Export-Import credit guarantees provided by the United States
government. We do not currently extend long-term credit through notes or otherwise to companies in
countries we consider to be inappropriate for credit risk purposes.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Please refer to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2005
for a discussion regarding the Companys quantitative and qualitative disclosures about market
risk. There have been no material changes to those disclosures during the nine months ended
September 30, 2006.
Item 4. Controls and Procedures
Disclosure Controls and Procedures. As described in Item 9A of our Annual Report on Form 10-K
for the year ended December 31, 2005, we assessed the effectiveness of our internal control over
financial reporting as of December 31, 2005. The assessment was carried out under the supervision
and with the participation of our management, including our principal executive and financial
officer, and was based on criteria established in Internal Control Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
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Commission (COSO). This assessment resulted in our managements identification of three
material weaknesses in our internal control over financial reporting:
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Weakness in the design and operation of internal controls relating to monitoring the
timing of revenue recognition for license sales of multi-client seismic survey data; |
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Weakness in the design and operation of controls to prevent unauthorized purchases by
members of our senior management (due to certain fraudulent activities conducted by our
former chief information officer); and |
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Weakness in our oversight and monitoring controls over financial reporting that
resulted from the limited number of experienced personnel on our accounting staff,
including the absence of a chief financial officer following the resignation of our prior
chief financial officer in December 2005. |
Because of these material weaknesses, our management concluded that as of December 31, 2005,
we did not maintain effective internal control over financial reporting based on the COSO criteria.
In addition, because of these material weaknesses, our management, in evaluating our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act), concluded that our
disclosure controls and procedures were also not effective as of December 31, 2005.
In connection with the preparation of our consolidated financial statements at and for the
three and nine months ended September 30, 2006, our management carried out an evaluation of the
effectiveness of the design and operation of our disclosure controls and procedures as of September
30, 2006. Based upon that evaluation and because either (i) the material weaknesses identified
above (other than the material weakness that was associated with the limited number of experienced
personnel on our accounting staff) had not been remediated at that time, or (ii) the Company has
not completed its testing to assess the effectiveness of its remediated controls, our principal
executive officer and our principal financial officer concluded that our disclosure controls and
procedures were not effective as of September 30, 2006 to ensure that the information required to
be disclosed by us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in SEC rules and forms at the
reasonable assurance level.
Changes in Internal Control over Financial Reporting. As described in our Quarterly Report on
Form 10-Q for the six months ended June 30, 2006, we have hired a chief financial officer, a
treasurer and director of tax, an assistant controller, a director of corporate finance, a director
of finance to oversee our foreign operations, and a director of information technology. Since the
second quarter of 2006, we have hired a manager of tax, a manager of treasury, a manager of
financial reporting and a senior financial analyst. We believe these actions and the resulting
improvement in controls have strengthened our disclosure controls and procedures and our internal
control over financial reporting. As of September 30, 2006, the previously disclosed material
weakness in our oversight and monitoring controls over financial reporting that resulted from the
limited number of experienced personnel on our accounting staff no longer exists as a material
weakness.
We continue to undertake remedial actions related to the other two previously disclosed
material weaknesses, including those actions described in our Annual Report on Form 10-K for the
year ended December 31, 2005, and Quarterly Reports on Form 10-Q for the three months ended March
31, 2006 and the six months ended June 30, 2006. We believe that these actions and the resulting
improvement in controls will, over time, remediate the remaining material weaknesses and will
strengthen our disclosure controls and procedures and our internal control over financial
reporting.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings.
In October 2002, we filed a lawsuit against Paulsson Geophysical Services, Inc. (PGSI) and its
owner in the 286th District Court for Fort Bend County, Texas, seeking recovery of approximately
$0.7 million that was unpaid and due to us resulting from the sale of a custom-built product that
PGSI had asked us to construct in 2001. After we filed suit to recover the PGSI receivable, PGSI
alleged that the delivered custom product was defective and counter-claimed against us, asserting
breach of contract, breach of warranty and other related causes of action. The case was initially
tried to a jury during May 2004. The jury returned a verdict in June 2004, the results of which
would not have supported a judgment awarding damages to either us or the defendants. In August
2004, the presiding judge overruled the jury verdict and ordered a new trial. The new trial
commenced in March 2006 and the jury in the new trial returned a verdict on April 13, 2006 finding
that both parties had breached their contract but that PGSI did not suffer any damages in
connection with our breach. On July 5, 2006, the Court issued a judgment awarding us $732,074 in
damages on our breach of contract claim and $156,563 in prejudgment interest, while issuing a
take-nothing judgment against PGSI. We are also entitled to recover post-judgment interest and our
legal costs and attorneys fees. At a hearing held on August 11, 2006 the judge determined that we
are entitled to recover $365,000 in attorneys fees, thereby bringing our total award to $1,259,294,
plus post-judgment interest and recoverable legal costs.
We have been named in various lawsuits or threatened actions that are incidental to our
ordinary business. Such lawsuits and actions could increase in number as our business expands and
we grow larger. Litigation is inherently unpredictable. Any claims against us, whether meritorious
or not, could be time consuming, cause us to incur costs and expenses, require significant amounts
of management time and result in the diversion of significant operational resources. The results of
these lawsuits and actions cannot be predicted with certainty. We currently believe that the
ultimate resolution of these matters will not have a material adverse impact on our financial
condition, results of operations or liquidity.
Item 1A. Risk Factors.
This report (as well as certain oral statements made from time to time by authorized
representatives on behalf of our company) contain statements concerning our future results and
performance and other matters that are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the
Securities Exchange Act of 1934, as amended (the Exchange Act). These statements involve known and
unknown risks, uncertainties, and other factors that may cause our or our industrys results,
levels of activity, performance, or achievements to be materially different from any future
results, levels of activity, performance, or achievements expressed or implied by such
forward-looking statements. In some cases, you can identify forward-looking statements by
terminology such as may, will, should, intend, expect, plan, anticipate, believe,
estimate, predict, potential, or continue or the negative of such terms or other comparable
terminology.
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Examples of other forward-looking statements contained in this report (or in such oral
statements) include statements regarding:
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expected revenues, operating profit and net income; |
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expected gross margins for our products and services; |
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future benefits to our customers to be derived from new products and services, such as FireFly and Orca; |
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future growth rates for certain of our products and services; |
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expectations of oil and gas company and contractor end-users purchasing our more
expensive, more technologically advanced products and services; |
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the degree and rate of future market acceptance of our new products; |
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the timing of anticipated sales; |
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anticipated timing and success of commercialization and capabilities of products and
services under development, and start-up costs associated with their development; |
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expected improved operational efficiencies from our Full-Wave Digital products and services; |
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success in integrating our acquired businesses; |
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expectations regarding future mix of business and future asset recoveries; |
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potential future acquisitions; |
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future levels of capital expenditures; |
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future cash needs and future sources of cash, including availability under our
revolving line of credit facility; |
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the outcome of pending or threatened disputes and other contingencies; |
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future demand for seismic equipment and services; |
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future seismic industry fundamentals; |
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the adequacy of our future liquidity and capital resources; |
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future oil and gas commodity prices; |
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future opportunities for new products and projected research and development expenses; |
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future worldwide economic conditions; |
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expectations regarding realization of deferred tax assets; |
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anticipated results regarding accounting estimates we make; and |
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results from strategic alliances with third parties. |
These forward-looking statements reflect our best judgment about future events and trends
based on the information currently available to us. Our results of operations can be affected by
inaccurate assumptions we make or by risks and uncertainties known or unknown to us. Therefore, we
cannot guarantee the accuracy of the forward-
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looking statements. Actual events and results of operations may vary materially from our
current expectations and assumptions. While we cannot identify all of the factors that may cause
actual results to vary from our expectations, we believe the following factors should be considered
carefully:
We may not gain rapid market acceptance for our full-wave digital products, which could materially
and adversely affect our results of operations and financial condition.
We have spent considerable time and capital developing our full-wave equipment product lines
that incorporate our VectorSeis and associated technologies. Because these products rely on a new
digital sensor, our ability to sell these products will depend on acceptance of our digital sensor
and technology solutions by geophysical contractors and exploration and production companies. If
our customers do not believe that our digital sensor delivers higher quality data with greater
operational efficiency, our results of operations and financial condition will be materially and
adversely affected.
The introduction of new seismic technologies and products has traditionally involved long
development cycles. Because our full-wave digital products incorporate new technologies, we have
experienced slow market acceptance and market penetration for these products. For these reasons,
and despite the fact that industry-wide demand for seismic services and equipment has increased in
recent years, we have continued to be unable to foresee and predict from period to period with the
certainty we have desired, estimated future sales volumes, revenues and margins for these new
products.
We are exposed to risks related to complex, highly technical products.
Our customers often require demanding specifications for product performance and reliability.
Because many of our products are complex and often use unique advanced components, processes,
technologies and techniques, undetected errors and design and manufacturing flaws may occur. Even
though we attempt to assure that our systems are always reliable in the field, the many technical
variables related to their operations can cause a combination of factors that can, and has, from
time to time, caused performance and service issues with certain of our products. Product defects
result in higher product service, warranty and replacement costs and may affect our customer
relationships and industry reputation, all of which may adversely impact our results of operations.
Despite our testing and quality assurance programs, undetected errors may not be discovered until
the product is purchased and used by a customer in a variety of field conditions. If our customers
deploy our new products and they do not work correctly, our relationship with our customers may be
materially and adversely affected.
Our VectorSeis System Four Digital-Analog land data acquisition system, introduced in 2004,
initially experienced operational problems in the field. During 2004, we introduced our VectorSeis
Ocean system for seismic data acquisition using redeployable ocean bottom cable. The system was put
into operation that year, but experienced a number of start-up functionality issues. As a result of
our systems advanced and complex nature, we expect to experience occasional operational issues
from time to time. Generally, until our products have been tested in the field under a wide variety
of operational conditions, we cannot be certain that performance and service problems will not
arise. Customers do occasionally experience issues and therefore there is a possibility that our
new products may also suffer from similar issues. In that case, market acceptance of our new
products could be delayed and our results of operations and financial condition could be adversely
affected.
Our operating results may fluctuate from period to period and we are subject to seasonality
factors.
Our operating results are subject to fluctuations from period to period, as a result of new
product or service introductions, the timing of significant expenses in connection with customer
orders, unrealized sales, levels of research and development activities in different periods, the
product mix sold and the seasonality of our business. Because many of our products feature a high
sales price and are technologically complex, we generally have experienced long sales cycles for
these products and historically incur significant expense at the beginning of these cycles for
component parts and other inventory necessary to manufacture a product in anticipation of a future
sale, which may not ultimately occur. In addition, the revenues from our sales can vary widely from
period to period due to changes in customer requirements. These factors can create fluctuations in
our net revenues and results of operations from period to period. Variability in our overall gross
margins for any quarter, which depend on the percentages of higher-margin and lower-margin products
and services sold in that quarter, compounds these uncertainties. As a result, if net revenues or
gross margins fall below expectations, our operating results and
26
financial condition will likely be adversely affected. Additionally, our business can be
seasonal in nature, with strongest demand typically in the fourth calendar quarter of each year.
Due to the relatively high sales price of many of our products and data libraries and
relatively low unit sales volume, our quarterly operating results have historically fluctuated from
period to period due to the timing of orders and shipments and the mix of products and services
sold. This uneven pattern has made financial predictions for any given period difficult, increases
the risk of unanticipated variations in our quarterly results and financial condition and places
challenges on our inventory management. Delays caused by factors beyond our control, such as the
granting of permits for seismic surveys by third parties and the availability and equipping of
marine vessels, can affect GXTs revenues from its processing services from period to period. Also,
delays in ordering products or in shipping or delivering products in a given quarter could
significantly affect our results of operations for that quarter. Fluctuations in our quarterly
operating results may cause greater volatility in the price of our common stock and convertible
notes.
We rely on highly skilled personnel in our businesses, and if we are unable to retain or motivate
key personnel or hire qualified personnel, we may not be able to grow effectively.
Our performance is largely dependent on the talents and efforts of highly skilled individuals.
Our future success depends on our continuing ability to identify, hire, develop, motivate and
retain skilled personnel for all areas of our organization. We require highly skilled personnel to
operate and provide technical services and support for our businesses. Competition for qualified
personnel required for GXTs data processing operations and our other segments businesses has
intensified as worldwide seismic activity and oil and natural gas exploration and development have
increased. Rapid growth presents a challenge to us and our industry to recruit, train and retain
our employees while managing the impact of potential wage inflation and the potential lack of
available qualified labor in some markets where we operate. In recent periods, the demand from E&P
companies for GXTs services has increased dramatically, putting pressures on GXTs workforce to
meet this demand. A well-trained, motivated, adequately-staffed work force has a positive impact on
our ability to attract and retain business. Our continued ability to compete effectively depends on
our ability to attract new employees and to retain and motivate our existing employees.
The loss of any significant customer could materially and adversely affect our results of
operations and financial condition.
We have traditionally relied on a relatively small number of significant customers.
Consequently, our business is exposed to the risks related to customer concentration. For the nine
months ended September 30, 2006 and for all of 2005, approximately 9% of our consolidated net
revenues related to one Chinese customer. For the nine months ended September 30, 2006, $25.5
million, or 8% of consolidated net revenues, were to a single customer. The loss of any of our
significant customers or deterioration in our relations with any of them could materially and
adversely affect our results of operations and financial condition.
Historically, a relatively small number of customers has accounted for the majority of our net
revenues in any period. During the last ten years, our traditional seismic contractor customers
have been rapidly consolidating, thereby consolidating the demand for our products. On September 5,
2006, the French seismic contractor, Compagnie General de Geophysique (CGG) announced it was
acquiring Veritas DGC, Inc. a large U.S. seismic contractor. CGG is the owner of our principal
competitor for land and marine seismic equipment, Societe dEtudes Recherches et Construction
Eletroniques (Sercel). While we do not believe the CGG acquisition will have a material impact on
us, the loss of any of our significant customers to further consolidation could materially and
adversely affect our results of operations and financial condition.
We derive a substantial amount of our revenues from foreign sales, which pose additional risks.
Sales to customers outside of North America accounted for 74% of our consolidated net revenues
for the nine months ended September 30, 2006, and we believe that export sales will remain a
significant percentage of our revenue. United States export restrictions affect the types and
specifications of products we can export. Additionally, to complete certain sales, United States
laws may require us to obtain export licenses, and we cannot assure you that we will not experience
difficulty in obtaining these licenses. Operations and sales in countries other than the United
27
States are subject to various risks peculiar to each country. With respect to any particular
country, these risks may include:
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expropriation and nationalization; |
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political and economic instability; |
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terrorist activities; |
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armed conflict and civil disturbance; |
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currency fluctuations, devaluations and conversion restrictions; |
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confiscatory taxation or other adverse tax policies; |
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tariff regulations and import/export restrictions; |
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customer credit risk; |
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governmental activities that limit or disrupt markets, or restrict payments or the movement of funds; and |
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governmental activities that may result in the deprivation of contractual rights. |
The majority of our foreign sales are denominated in United States dollars. An increase in the
value of the dollar relative to other currencies will make our products more expensive, and
therefore less competitive, in foreign markets.
In addition, we are subject to taxation in many jurisdictions and the final determination of
our tax liabilities involves the interpretation of the statutes and requirements of taxing
authorities worldwide. Our tax returns are subject to routine examination by taxing authorities,
and these examinations may result in assessments of additional taxes, penalties and/or interest.
We invest significant sums of money in acquiring and processing seismic data for GXTs multi-client
seismic data library.
We invest significant amounts in acquiring and processing new seismic data to add to our GXT
multi-client data library, which we seek to recover through future data licensing fees. For the
first nine months of 2006, we invested $29.4 million in this library. Our customers generally
commit to licensing the data prior to our initiating a new data library acquisition program.
However, the aggregate amounts of future licensing fees for this data are sometimes uncertain and
depend on a variety of factors, including the market prices of oil and gas, customer demand for
seismic data in the library and the availability of similar data from competitors. We may not be
able to recover all of the costs of or earn any return on these investments. In periods in which
sales do not meet original expectations, we may be required to record additional amortization
and/or impairment charges to reduce the carrying value of our data library, which charges may be
material to our operating results in any period.
Weak demand or technological obsolescence could impair the value of our multi-client data library.
We have invested significant amounts in acquiring and processing multi-client seismic survey
data and expect to continue to do so for the foreseeable future. There is no assurance that we will
recover all the costs of such surveys. Technological, regulatory or other industry or general
economic developments could render all or portions of our multi-client data library obsolete or
reduce its value. Additionally, our individual surveys have a book life of four years, so
particular surveys may be subject to significant amortization even through sales of licenses
associated with that survey are weak or non-existent, thus reducing our profits.
GXT and Concept Systems increase our exposure to the risks experienced by more technology-intensive
companies.
28
The businesses of GXT and Concept Systems, being more concentrated in software, processing
services and proprietary technologies than our traditional business, have exposed us to the risks
typically encountered by smaller technology companies that are more dependent on proprietary
technology protection and research and development. These risks include:
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future competition from more established companies entering the market; |
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product obsolescence; |
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dependence upon continued growth of the market for seismic data processing; |
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the rate of change in the markets for GXTs and Concept Systems technology and services; |
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research and development efforts not proving sufficient to keep up with changing market demands; |
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dependence on third-party software for inclusion in GXTs and Concept Systems products and services; |
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misappropriation of GXTs or Concept Systems technology by other companies; |
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alleged or actual infringement of intellectual property rights that could result in
substantial additional costs; |
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difficulties inherent in forecasting sales for newly developed technologies or
advancements in technologies; |
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recruiting, training, and retaining technically skilled personnel that could increase
the costs for GXT or Concept Systems, or limit their growth; and |
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the ability to maintain traditional margins for certain of their technology or
services. |
We are exposed to risks relating to the effectiveness of our internal controls and disclosure
controls and procedures.
Since our management has been required to report on the evaluation and assessment of our
internal control over financial reporting (beginning with our Form 10-K for the fiscal year ended
December 31, 2004), we have reported a number of material weaknesses in our internal control over
financial reporting. Because of these material weaknesses, our management has concluded that as of
December 31, 2004 and 2005, we did not maintain effective internal control over financial reporting
based on the criteria established in Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The existence of these material weaknesses as of the end of certain fiscal quarters also
caused our management to determine that we did not have at such dates effective disclosure controls
and procedures in place to ensure that the information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in SEC rules and forms at a reasonable assurance level.
For further information regarding these material weaknesses identified in our internal control over
financial reporting as of specified dates, see Item 9A. Controls and Procedures contained in our
Annual Report on Form 10-K for the year ended December 31, 2005, and Part I., Item 4. Controls
and Procedures of this Form 10-Q.
We believe that the existing internal control weaknesses will be remediated during 2006.
However, we may continue to experience controls deficiencies or material weaknesses in the future,
which could adversely impact the accuracy and timeliness of our future financial reporting and
reports and filings that we make with the SEC.
Certain of our facilities could be damaged by hurricanes and other natural disasters, which could
have an adverse effect on our results of operations and financial condition.
Certain of our facilities are located in regions of the United States that are susceptible to
damage from hurricanes and other weather events, and, during 2005, were impacted by hurricanes or
weather events. Our Marine Imaging
29
Systems segment leases a 40,000-square foot facility located in Harahan, Louisiana, in the
greater New Orleans metropolitan area. On August 27, 2005, we suspended operations at this facility
and evacuated and locked down the facility in preparation for Hurricane Katrina. This facility did
not experience flooding or significant damage during or after the hurricane. However, because of
employee evacuations, power failures and lack of related support services, utilities and
infrastructure in the New Orleans area, we were unable to resume full operations at the facility
until late September 2005.
Future hurricanes or similar natural disasters that impact our facilities may negatively
affect our financial position and operating results for those periods. These negative effects may
include reduced production and product sales; costs associated with resuming production; reduced
orders for our products from customers that were similarly affected by these events; lost market
share; late deliveries; additional costs to purchase materials and supplies from outside suppliers;
uninsured property losses; inadequate business interruption insurance and an inability to retain
necessary staff.
Disruption in vendor supplies may adversely affect our results of operations.
Our manufacturing processes require a high volume of quality components. Certain components
used by us are currently provided by only one supplier. We may, from time to time, experience
supply or quality control problems with suppliers, and these problems could significantly affect
our ability to meet production and sales commitments. Reliance on certain suppliers, as well as
industry supply conditions, generally involve several risks, including the possibility of a
shortage or a lack of availability of key components and increases in component costs and reduced
control over delivery schedules; any of these could adversely affect our future results of
operations.
We have outsourcing arrangements with third parties to manufacture some of our products. If these
third parties fail to deliver quality products or components at reasonable prices on a timely
basis, we may alienate some of our customers and our revenues, profitability and cash flow may
decline.
We have increased our use of contract manufacturers as an alternative to our own manufacturing
of products. We have outsourced the manufacturing of our vibrator vehicles, our towed marine
streamers, our redeployable ocean bottom cables, our Applied MEMS components, various components of
VectorSeis Ocean and certain electronic and ground components of our land acquisition systems. If,
in implementing any outsource initiative, we are unable to identify contract manufacturers willing
to contract with us on competitive terms and to devote adequate resources to fulfill their
obligations to us or if we do not properly manage these relationships, our existing customer
relationships may suffer. In addition, by undertaking these activities, we run the risk that the
reputation and competitiveness of our products and services may deteriorate as a result of the
reduction of our control over quality and delivery schedules. We also may experience supply
interruptions, cost escalations and competitive disadvantages if our contract manufacturers fail to
develop, implement, or maintain manufacturing methods appropriate for our products and customers.
If any of these risks are realized, our revenues, profitability and cash flow may decline. In
addition, as we come to rely more heavily on contract manufacturers, we may have fewer personnel
resources with expertise to manage problems that may arise from these third-party arrangements.
Technological change in the seismic industry requires us to make substantial research and
development expenditures.
The markets for our products are characterized by changing technology and new product
introductions. We must invest substantial capital to maintain a leading edge in technology, with no
assurance that we will receive an adequate rate of return on those investments. If we are unable to
develop and produce successfully and timely new and enhanced products and services, we will be
unable to compete in the future and our business, our results of operations and financial condition
will be materially and adversely affected.
Our outsourcing relationships may require us to purchase inventory when demand for products
produced by third-party manufacturers is low.
Under a few of our outsourcing arrangements, our manufacturing outsourcers purchase
agreed-upon inventory levels to meet our forecasted demand. Since we typically operate without a
significant backlog of orders for our
30
products, our manufacturing plans and inventory levels are principally based on sales
forecasts. If demand proves to be less than we originally forecasted and we cancel our committed
purchase orders, our outsourcers generally have the right to require us to purchase inventory which
they had purchased on our behalf. Should we be required to purchase inventory under these
provisions, we may be required to hold inventory that we may never utilize.
Under our five-year supply agreement with Colibrys Ltd., we have committed to purchase a
minimum number of MEMS accelerometers with an agreed upon cost of between $7.0 million to $8.0
million per year through 2009. If demand for our VectorSeis products, which MEMS accelerometers are
a component of, prove to be less than we originally forecasted, we could be required to purchase
MEMS accelerometers that we may never utilize.
We may be unable to obtain broad intellectual property protection for our current and future
products and we may become involved in intellectual property disputes.
We rely on a combination of patent, copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary technologies. We
believe that the technological and creative skill of our employees, new product developments,
frequent product enhancements, name recognition and reliable product maintenance are the
foundations of our competitive advantage. Although we have a considerable portfolio of patents,
copyrights and trademarks, these property rights offer us only limited protection. Our competitors
may attempt to copy aspects of our products despite our efforts to protect our proprietary rights,
or may design around the proprietary features of our products. Policing unauthorized use of our
proprietary rights is difficult, and we are unable to determine the extent to which such use
occurs. Our difficulties are compounded in certain foreign countries where the laws do not offer as
much protection for proprietary rights as the laws of the United States.
Third parties inquire and claim from time to time that we have infringed upon their
intellectual property rights. Any such claims, with or without merit, could be time consuming,
result in costly litigation, result in injunctions, require product modifications, cause product
shipment delays or require us to enter into royalty or licensing arrangements. Such claims could
have a material adverse affect on our results of operations and financial condition.
Future technologies and businesses that we may acquire may be difficult to integrate, disrupt our
business, dilute stockholder value or divert management attention.
An important aspect of our current business strategy is to seek new technologies, products and
businesses to broaden the scope of our existing and planned product lines and technologies. While
we believe that these acquisitions complement our technologies and our general business strategy,
there can be no assurance that we will achieve the expected benefit of these acquisitions. In
addition, these acquisitions may result in unexpected costs, expenses and liabilities.
Acquisitions expose us to:
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increased costs associated with the acquisition and operation of the new businesses or
technologies and the management of geographically dispersed operations; |
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risks associated with the assimilation of new technologies, operations, sites and personnel; |
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the possible loss of key employees and costs associated with their loss; |
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risks that any technology we acquire may not perform as well as we had anticipated; |
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the diversion of managements attention and other resources from existing business concerns; |
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the potential inability to replicate operating efficiencies in the acquired companys operations; |
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potential impairments of goodwill and intangible assets; |
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the inability to generate revenues to offset associated acquisition costs; |
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the requirement to maintain uniform standards, controls, and procedures; |
31
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the impairment of relationships with employees and customers as a result of any
integration of new and inexperienced management personnel; and |
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the risk that acquired technologies do not provide us with the benefits we anticipated. |
Integration of the acquired businesses requires significant efforts from each entity,
including coordinating existing business plans and research and development efforts. Integrating
operations may distract managements attention from the day-to-day operation of the combined
companies. If we are unable to successfully integrate the operations of acquired businesses, our
future results will be negatively impacted.
Our operations, and the operations of our customers, are subject to numerous government
regulations, which could adversely limit our operating flexibility.
Our operations are subject to laws, regulations, government policies and product certification
requirements worldwide. Changes in such laws, regulations, policies or requirements could affect
the demand for our products or result in the need to modify products, which may involve substantial
costs or delays in sales and could have an adverse effect on our future operating results. Our
export activities are also subject to extensive and evolving trade regulations. Certain countries
are subject to restrictions, sanctions and embargoes imposed by the United States government. These
restrictions, sanctions and embargoes also prohibit or limit us from participating in certain
business activities in those countries. Our operations are subject to numerous local, state and
federal laws and regulations in the United States and in foreign jurisdictions concerning the
containment and disposal of hazardous materials, the remediation of contaminated properties and the
protection of the environment. These laws have been changed frequently in the past, and there can
be no assurance that future changes will not have a material adverse effect on us. In addition, our
customers operations are also significantly impacted by laws and regulations concerning the
protection of the environment and endangered species. Consequently, changes in governmental
regulations applicable to our customers may reduce demand for our products. For instance,
regulations regarding the protection of marine mammals in the Gulf of Mexico may reduce demand for
our airguns and other marine products. To the extent that our customers operations are disrupted
by future laws and regulations, our business and results of operations may be materially and
adversely affected.
We may not be able to generate sufficient cash flows to meet our operational, growth and debt
service needs.
Our ability to fund our operations, grow our business and make payments on our indebtedness
and our other obligations will depend on our financial and operating performance, which in turn
will be affected by general economic conditions in the energy industry and by many financial,
competitive, regulatory and other factors beyond our control. We cannot assure you that our
business will generate sufficient cash flow from operations or that future sources of capital will
be available to us in an amount sufficient to enable us to service our indebtedness or to fund our
other liquidity needs.
If we are unable to generate sufficient cash flows to fund our operations, grow our business
and satisfy our debt obligations, we may have to undertake additional or alternative financing
plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital
investments or seeking to raise additional capital. We cannot assure you that any refinancing would
be possible, that any assets could be sold, or, if sold, of the timing of the sales and the amount
of proceeds that may be realized from those sales, or that additional financing could be obtained
on acceptable terms, if at all. Our inability to generate sufficient cash flows to satisfy debt
obligations, or to refinance our indebtedness on commercially reasonable terms, would materially
and adversely affect our financial condition and results of operations and our ability to satisfy
our obligations under the notes.
The business of GXT may alienate a number of our traditional seismic contractor customers with whom
GXT competes and adversely affect sales to and revenues from those customers.
GXTs business in processing seismic data competes with a number of our traditional customers
that are seismic contractors. Many of these companies not only offer their customers generally
major, independent and national oil companies the traditional services of conducting seismic
surveys, but also the processing and interpretation of the data acquired from those seismic
surveys. In that regard, GXTs processing services directly compete with these
32
contractors service offerings and may adversely affect our relationships with them, which
could result in reduced sales and revenues from these seismic contractor customers.
Note: The foregoing factors pursuant to the Private Securities Litigation Reform Act of 1995
should not be construed as exhaustive. In addition to the foregoing, we wish to refer readers to
other factors discussed elsewhere in this report as well as other filings and reports with the SEC
for a further discussion of risks and uncertainties that 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 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(c) During the three months ended September 30, 2006, in connection with the lapse of
restrictions on shares of our restricted stock held by certain employees, we acquired shares of our
common stock in satisfaction of tax withholding obligations that were incurred on the vesting date.
The date of acquisition, number of shares and average effective acquisition price per share, were
as follows:
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(d) Maximum Number |
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(or Approximate |
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Dollar |
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(c) Total Number of |
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Value) of Shares |
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Shares Purchased as |
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That |
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(a) |
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(b) |
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Part of Publicly |
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May Yet Be Purchased |
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Total Number of |
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Average Price |
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Announced Plans or |
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Under the Plans or |
Period |
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Shares Acquired |
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Paid Per Share |
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Program |
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Program |
July 1, 2006 to July 31, 2006 |
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Not applicable |
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Not applicable |
August 1, 2006 to August 31, 2006 |
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34,462 |
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$ |
9.63 |
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Not applicable |
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Not applicable |
September 1, 2006 to September 30, 2006 |
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25,688 |
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$ |
9.96 |
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Not applicable |
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Not applicable |
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Total |
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60,150 |
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$ |
9.77 |
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33
Item 6. Exhibits
31.1 |
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Certification of President and Chief Executive Officer Pursuant to Rule 13a-14(a). |
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31.2 |
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Certification of Executive Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a). |
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32.1 |
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Certification of President and Chief Executive Officer Pursuant to 18 U.S.C. §1350. |
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32.2 |
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Certification of Executive Vice President and Chief Financial Officer Pursuant to 18 U.S.C. §1350. |
34
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.
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INPUT/OUTPUT, INC. |
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By
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/s/ R. Brian Hanson
R. Brian Hanson
Executive Vice President and
Chief Financial Officer
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Date: November 9, 2006
35
EXHIBIT INDEX
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Exhibit No. |
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Description |
31.1
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Certification of President and Chief Executive Officer Pursuant to Rule 13a-14(a). |
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31.2
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Certification of Executive Vice President and Chief Financial Officer Pursuant to
Rule 13a-14(a). |
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32.1
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Certification of President and Chief Executive Officer Pursuant to 18 U.S.C. §1350. |
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32.2
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Certification of Executive Vice President and Chief Financial Officer Pursuant to
18 U.S.C. §1350. |
36