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GEOS > SEC Filings for GEOS > Form 10-K on 22-Nov-2013All Recent SEC Filings

Show all filings for GEOSPACE TECHNOLOGIES CORP

Form 10-K for GEOSPACE TECHNOLOGIES CORP


22-Nov-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is management's discussion and analysis of the major elements of our consolidated financial statements. You should read this discussion and analysis together with our consolidated financial statements, including the accompanying notes, and other detailed information appearing elsewhere in this Annual Report on Form 10-K, including under the heading "Risk Factors". The discussion of our financial condition and results of operations includes various forward-looking statements about our markets, the demand for our products and services and our future plans and results. These statements are based on assumptions that we consider to be reasonable, but that could prove to be incorrect. For more information regarding our assumptions, you should refer to the section entitled "Forward-Looking Statements and Assumptions" contained in this Item 7 in this Annual Report on Form 10-K.

Background

We design and manufacture instruments and equipment used by the oil and gas industry to acquire seismic data in order to locate, characterize and monitor hydrocarbon producing reservoirs. The company also designs and manufactures non-seismic products, including industrial products, offshore cables, thermal printing equipment and film. See the information under the heading "Business" in this Annual Report on Form 10-K.

Consolidated Results of Operations

As we have reported in the past, our sales and operating profits have varied significantly from quarter-to-quarter, and even year-to-year, and are expected to continue that trend in the future, especially when our quarterly or annual financial results are impacted by the presence or absence of relatively large, but somewhat erratic, shipments of permanent seabed reservoir monitoring systems and/or wireless data acquisition systems for land and marine applications.

We report and evaluate financial information for two segments: Seismic and Non-Seismic. Summary financial data by business segment follows (in thousands):

                                                    Year Ended September 30,
                                             2013             2012             2011
 Seismic
 Traditional exploration product revenues $   49,781       $   66,849       $   67,862
 Wireless exploration product revenues        87,316           82,646           63,753
 Reservoir product revenues                  138,103           15,426           15,998
 Total sales                                 275,200          164,921          147,613
 Operating income                            110,118           55,990           49,486
 Non-Seismic
 Sales                                        24,578           25,942           24,559
 Operating income                              3,344            4,479            3,954
 Corporate
 Sales                                           829              801              798
 Operating loss                              (12,235 )         (9,604 )         (9,035 )
 Consolidated Totals
 Sales                                       300,607          191,664          172,970
 Operating income                            101,227           50,865           44,405

Overview

Fiscal Year 2013 Compared to Fiscal Year 2012

Consolidated sales for fiscal year 2013 increased $108.9 million, or 56.8%, from fiscal year 2012. This increase in sales reflects greater demand for our seismic permanent reservoir monitoring products.


Consolidated gross profit for fiscal year 2013 increased by $57.7 million, or 70.3%, from fiscal year 2012. The increase in gross profit resulted from increased sales of our permanent reservoir monitoring products.

Consolidated operating expenses for fiscal year 2013 increased $7.3 million, or 23.5%, from fiscal year 2012. The increase in operating expenses reflects higher personnel costs and other general expense increases associated with our sales growth and asset expansion.

The U.S. statutory tax rate applicable to us for fiscal years 2013 and 2012 was 35.0%; however, our effective tax rate was 31.2% and 32.3% for fiscal years 2013 and 2012, respectively. The lower effective tax rate for both fiscal years resulted from (i) the impact of the manufacturers'/producers' deduction available in the United States, and (ii) research and experimentation tax credits.

Fiscal Year 2012 Compared to Fiscal Year 2011

Consolidated sales for fiscal year 2012 increased $18.7 million, or 10.8%, from fiscal year 2011. The higher level of sales resulted from increased customer demand for our seismic products and particularly robust demand for sales and rentals of our land-based wireless (or nodal) data acquisition systems. The increased demand for our seismic products is being driven by strong oil and gas exploration activities throughout the world.

Consolidated gross profit for fiscal year 2012 increased by $8.0 million, or 10.7%, from fiscal year 2011. The increase in gross profits resulted from increased sales and rentals of our seismic products.

Consolidated operating expenses for fiscal year 2012 increased $1.5 million, or 5.0%, from fiscal year 2011. The increase in operating expenses resulted from expanded activities associated with our sales growth, and from increased incentive compensation expenses.

The U.S. statutory tax rate applicable to us for fiscal years 2012 and 2011 was 35.0%; however, our effective tax rate was 32.3% and 33.4% for fiscal years 2012 and 2011, respectively. The lower effective tax rate for both fiscal years resulted from (i) the impact of the manufacturers'/producers' deduction available in the United States, (ii) lower tax rates applicable to income earned in foreign tax jurisdictions and (iii) research and experimentation tax credits.

Segment Results of Operations

Seismic Products

Fiscal Year 2013 Compared to Fiscal Year 2012

Sales

Sales of our seismic products for the fiscal year ended September 30, 2013 increased by $110.3 million, or 66.9%, from the prior fiscal year. The components of this increase include the following:

ˇ Traditional Product Sales and Rentals - For the fiscal year ended September 30, 2013, revenues from our traditional products decreased $17.1 million, or 25.5%, from the corresponding period of the prior fiscal year. The decline in revenues resulted from lower demand for our geophone products, marine products and connector products. We believe this decline in sales of our traditional products is partially due to a general decline in seismic exploration activities in North America caused by producers focusing investment activities on oil and gas distribution infrastructure during 2013. With increasing production and declining demand for crude oil in North America, we believe the market for many of our traditional seismic products could remain challenged in future periods.

ˇ Wireless Product Sales and Rentals - For the fiscal year ended September 30, 2013, sales and rental revenues from our land and marine wireless products increased by $4.7 million, or 5.7%, from the prior fiscal year. During fiscal year 2013, we sold approximately 81,000 channels of land wireless systems, including the sale of 33,000 channels of used wireless equipment from our rental fleet which generated revenues of $22.9 million. We believe demand for land and marine wireless channel sales and rentals, although erratic from quarter-to-quarter, will continue into the future and reflects the


seismic industry's acceptance of our wireless systems in lieu of less efficient legacy cable-based systems. This product line represents a significant part of our revenues and quarterly fluctuations can significantly impact our operating income.

ˇ Reservoir Product Sales, Rentals and Services - For the fiscal year ended September 30, 2013, revenues from our reservoir products increased $122.7 million, or 795.3%, from the prior fiscal year. During the year ended September 30, 2013, we recorded revenues of approximately $18.0 million for delivery of a reservoir characterization system to Shell Brasil Petróleo Ltda and we recognized revenues under the percentage of completion method of approximately $109.6 million from production of the Statoil order. Revenues from our reservoir products, which in recent years primarily reflected sales of our seismic borehole tools, have historically been erratic.

The rate of new customer orders for our seismic products, especially large orders for our wireless, marine, borehole and subsea reservoir products, generally occur irregularly thereby making it difficult for us to predict our sales and production levels each quarter. Furthermore, product shipping dates are generally determined by our customers and are not at our discretion. As a result, these factors have caused past sales of our seismic products to be unpredictable and we expect this trend to continue into the future.

Operating Income.

Operating income for fiscal year 2013 increased $54.1 million, or 96.7%, from fiscal year 2012. The higher level of operating income resulted primarily from the recognition of revenues from our permanent reservoir monitoring systems.

Fiscal Year 2012 Compared to Fiscal Year 2011

Sales

Sales of our seismic products for the fiscal year ended September 30, 2012 increased by $17.3 million, or 11.7%, from the prior fiscal year. The components of this increase include the following:

ˇ Traditional Product Sales and Rentals - For the fiscal year ended September 30, 2012, revenues from our traditional products decreased $1.0 million, or 1.5%, from the corresponding period of the prior fiscal year. This decline in revenues primarily resulted from reduced shipments of marine products and was partially offset by increased sales of geophones and connectors.

ˇ Wireless Product Sales and Rentals - For the fiscal year ended September 30, 2012, revenues from our wireless products increased by $18.9 million, or 29.6%, from the prior fiscal year. During fiscal year 2012, we sold approximately 73,000 channels of land wireless systems, including the sale of 29,000 channels of used wireless equipment from our rental fleet which generated revenues of $19.0 million. The increase in revenues resulted from the continued industry acceptance of our wireless systems in lieu of less efficient legacy cable-based systems.

ˇ Reservoir Product Sales, Rentals and Services - For the fiscal year ended September 30, 2012, revenues from our reservoir products decreased $0.6 million, or 3.6%, from the prior fiscal year. Revenues from these products, which in recent years primarily include our seismic borehole tools, have historically been erratic. Due to the recent receipt of large orders for our permanent seabed reservoir monitoring systems, we expect revenues for our reservoir products to increase significantly in future years.

Operating Income.

Operating income for fiscal year 2012 increased $6.5 million, or 13.1%, from fiscal year 2011. The higher level of operating income resulted from increased wireless product sales and the recognition of revenues from our reservoir products.

Non-Seismic Products

Fiscal Year 2013 Compared to Fiscal Year 2012

Sales.

Sales of our non-seismic products for the year ended September 30, 2013 decreased by $1.4 million, or 5.3%, from fiscal year 2012. This decrease is primarily due to lower sales of our thermal solutions and industrial sensor products to our European customers


which appear to have been impacted by the region's economic crisis. We expect the European market for sales of our non-seismic products to remain challenging during fiscal year 2014.

Operating Income.

Our operating income associated with sales of our non-seismic products for the year ended September 30, 2013 decreased $1.1 million, or 25.3%, from the corresponding period of the prior fiscal year. The decrease in operating income resulted from lower sales levels, and lower profit margins due to less favorable sales mix and higher operating expenses.

Fiscal Year 2012 Compared to Fiscal Year 2011

Sales.

Sales of our non-seismic products for fiscal year 2012 increased $1.4 million, or 5.6%, from fiscal year 2011. This increase resulted from higher sales of our offshore cable products, and was partially offset by a decrease in sales of our thermal imaging products.

Operating Income.

Our operating income from our non-seismic products for fiscal year 2012 increased $0.5 million, or 13.3%, from fiscal year 2011. The increase in operating income resulted from increased product sales.

Incentive Compensation Program

We adopted an incentive compensation program for fiscal year 2013 whereby most employees will be eligible to begin earning incentive compensation if the Company reaches a five percent pretax return on stockholders' equity, determined as of September 30, 2012. To be eligible to participate in this incentive compensation program, employees must participate in our Core Values Program. Based on our experience in prior years, we expect one hundred percent of our eligible employees to participate in the Core Values Program. The incentive compensation program does not apply to the employees of our subsidiary in the Russian Federation since such employees participate in a locally administered bonus program. Certain non-executive employees are required to achieve specific goals to earn a significant portion of their total incentive compensation award. Any bonus awards earned under this program in fiscal year 2013 will be paid out to eligible employees after the end of the fiscal year.

Upon reaching the five percent threshold under this proposed program, an incentive compensation accrual will be established equal to 16.7 percent of the amount of any consolidated pretax profits above the five percent pretax return threshold. The maximum aggregate bonus available under the program for fiscal year 2013 was $6.5 million. For the fiscal years ended September 30, 2013 and 2012, we had accrued $6.5 million and $5.7 million, respectively, of incentive compensation expense.

Liquidity and Capital Resources

Fiscal Year 2013

At September 30, 2013, we had $2.7 million in cash and cash equivalents. For fiscal year 2013, we used approximately $57.2 million of cash from operating activities. Sources of cash generated in our operating activities included our net income of $69.6 million. Additional sources of cash included net non-cash charges of $13.1 million for deferred income taxes, depreciation, amortization, accretion, stock-based compensation, inventory obsolescence and bad debts and a $3.3 million increase accrued expenses and other. These sources of cash were offset by uses of cash which included (i) a $73.4 million increase in inventories due to current and expected future production for the Statoil order and for production of marine and land wireless products in anticipation of future orders, (ii) a $33.7 million increase in trade accounts and notes receivable primarily resulting from increased sales and the timing of cash collections, (iii) a $13.6 million adjustment to transfer gross profits from rental equipment sales to investing activities since such transactions involve the sale of long-lived assets, (iv) a $12.4 million increase in costs and estimated earnings in excess of billings for the Statoil order, (v) a $7.5 million decrease in deferred revenue primarily due to the revenue recognition of advance payments received from Shell Brasil Petróleo Ltda, (vi) a $1.1 million decrease in income tax payable resulting from the timing of our


income tax payments, (vii) a $0.7 million increase in prepaid income taxes related to intercompany product sales, (viii) a $0.5 million increase in prepaid expenses and other current assets due to vendor prepayment requirements and tax deposits and (iv) a $0.4 million decrease in accounts payable due to the timing of payments to our vendors.

For fiscal year 2013, we generated approximately $3.4 million of cash from investing activities. We generated $25.5 million of cash proceeds from the sale of used rental equipment and we generated $19.6 million of cash proceeds from the sale of short-term investments. These cash proceeds were offset by an investment of $22.3 million to expand our rental equipment fleet to meet customer demand, and a $19.4 million investment in other property and equipment, including $8.5 million of real property acquisitions in Houston and Bogotá. We estimate that our capital expenditures for rental equipment in fiscal year 2014 could be approximately $30 million or more, excluding non-cash transfers from our inventory account. In addition, we estimate that other capital expenditures for property and equipment could be approximately $30 million, including approximately $13 million for the in-process construction expenditures relating to the expansion of our Houston manufacturing and engineering facilities. We expect these capital expenditures will be financed from our cash on hand, internal cash flow, rental equipment sales proceeds and/or from borrowings under our Credit Agreement.

For fiscal year 2013, we generated approximately $5.8 million of cash from financing activities. We generated $4.8 million from the exercise of stock options and related tax benefits and we borrowed $0.9 million under our Credit Facility for working capital purposes. Such borrowings were subsequently repaid during October 2013.

Fiscal Year 2012

At September 30, 2012, we had $50.8 million in cash and cash equivalents. In addition, we had $20.0 million of short-term investments at September 30, 2012. For fiscal year 2012, we generated approximately $43.2 million of cash from operating activities. The primary sources of cash generated in our operating activities resulted from net income of $35.1 million. Additional sources of cash included net non-cash charges of $13.3 million for deferred income tax expense, depreciation, amortization, stock-based compensation, inventory obsolescence and bad debts. Other sources of cash from operating activities included (i) a $12.2 million increase in accounts payable due to increased purchases of raw materials, (ii) a $7.9 million increase in deferred revenue resulting from an increase in the amount of advanced payments received from our customers, (iii) a $3.8 million decrease in trade accounts and notes receivable primarily resulting from improved cash receipts from customers during fiscal year 2012, and (iv) a $0.6 million increase in accrued expenses and other, including a $1.6 million increase in incentive compensation expenses due to increased consolidated pretax earnings. These sources of cash were offset by (i) a $15.6 million increase in inventories due to increasing levels of work-in-process resulting from known and anticipated product orders, rental equipment demands and the production of a permanent seabed acquisition for Shell Brasil Petróleo Ltda , (ii) a $10.0 million adjustment to transfer gross profits from rental equipment sales to investing activities since such transactions involve the sale of long-lived assets, and (iii) a $4.5 million increase in prepaid income taxes related to intercompany sales.

For fiscal year 2012, we used approximately $26.3 million of cash in investing activities. The uses of cash primarily resulted from (i) our investment of $31.7 million for rental equipment, (ii) $4.0 million of capital expenditures for property and equipment, and (iii) a $14.8 million net increase in our short-term investments. In addition, we transferred $2.0 million of inventories to our rental equipment during fiscal year 2011 which had a non-cash impact. The uses of cash outlined above were partially offset by $24.2 million of proceeds from the sale of used rental equipment.

For fiscal year 2012, we generated approximately $2.5 million of cash in the financing activities from the exercise of stock options and related tax benefits.

Fiscal Year 2011

At September 30, 2011, we had $31.4 million in cash and cash equivalents. For fiscal year 2011, we generated approximately $1.1 million of cash in operating activities. Sources of cash generated in our operating activities resulted from net income of $29.7 million. Additional sources of cash included net non-cash charges of $11.8 million for deferred income tax benefit, depreciation, amortization, stock-based compensation, inventory obsolescence and bad debts. Other sources of cash included (i) a $2.0 million decrease in trade accounts and notes receivable primarily resulting from improved cash receipts from customers during fiscal year


2011, (ii) a $1.8 million increase in accrued expenses and other, primarily resulting from an increase of $0.8 million for incentive compensation expenses due to increased consolidated pretax earnings, and a $0.7 million increase in warranty accruals due to increased potential warranty exposure resulting from increased product sales, and (iii) a $1.2 million increase in accounts payable due to increased purchases of raw materials. These sources of cash were offset by (i) a $29.5 million increase in inventories due to the replenishment of low levels of our wireless data acquisition system inventories, and increasing levels of work-in-process resulting from product orders and anticipated demand for wireless data acquisition system sales and rentals, (ii) a $11.2 million adjustment to transfer gross profits from rental equipment sales to investing activities since such transactions involve the sale of long-lived assets,
(iii) a $2.5 million increase in other current assets resulting from the advanced payment of income taxes in certain tax jurisdictions, (iv) a $1.7 million decrease in income tax payable resulting from the payment of income taxes owed on our pretax profits, and (v) a $0.6 million decrease in deferred revenue resulting from a reduction in the amount of advanced payments received from our customers.

For fiscal year 2011, we used approximately $5.2 million of cash in investing activities. The uses of cash primarily resulted from (i) our investment of $15.4 million for rental equipment, (ii) $4.7 million of capital expenditures for property and equipment, and (iii) a $4.9 million investment in short-term investments. In addition, we transferred $0.2 million of inventories to our rental equipment during fiscal year 2011 which had a non-cash impact. The uses of cash outlined above were partially offset by $19.9 million of proceeds from the sale of used rental equipment.

For fiscal year 2011, we generated approximately $2.0 million of cash in the financing activities of our operations. During fiscal year 2011, we generated $9.7 million of proceeds from the exercise of stock options and related tax benefits. Partially offsetting these proceeds was a $7.7 million cash payment to pay off a mortgage loan obligation.

On March 2, 2011, we entered into a credit agreement with a bank. On September 27, 2013, we amended the credit agreement and increased the borrowing availability to $50.0 million (as amended, the "Credit Agreement"). Our borrowings are principally secured by our accounts receivable, inventories and equipment. In addition, certain of our domestic subsidiaries have guaranteed our obligations under the Credit Agreement and such subsidiaries have secured the obligations by the pledge of certain of the assets of such subsidiaries. The Credit Agreement expires on April 27, 2016 and all borrowed funds are due and payable at that time. We are required to make quarterly interest payments on borrowed funds. The Credit Agreement limits the incurrence of additional indebtedness, requires the maintenance of certain financial ratios, restricts us and our subsidiaries' ability to pay cash dividends and contains other covenants customary in agreements of this type. The interest rate for borrowings under the Credit Agreement is a LIBOR based rate with a margin spread of 250-325 basis points depending upon the maintenance of certain ratios. At September 30, 2013, we were in compliance with all covenants. At September 30, 2013 and 2012, there were borrowings of $0.9 million and zero, respectively, outstanding under the Credit Agreement. There were standby letters of credit outstanding in the amount of $42,000 and additional borrowings available were $49.1 million. Please see "Risk Factors" for more information about the restrictive covenants imposed on us by the Credit Agreement.

Off-Balance Sheet Arrangements

We do not have any obligations which meet the definition of an off-balance sheet arrangement and which have or are reasonably likely to have a current or future effect on our financial statements or the items contained therein that are material to investors.

Contractual Obligations

For information regarding our contractual obligations over the course of the next five years, please refer to Note 10 and Note 17 to our consolidated financial statements contained in this Annual Report, which provide detailed information regarding repayment of our Credit Agreement and an operating lease.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We consider many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the


estimates and assumptions that are used in the preparation of these financial statements. We continually evaluate our estimates, including those related to percentage of completion revenue recognition, bad debt reserves, inventory obsolescence reserves, self-insurance reserves for medical expenses, product warranty reserves, intangible assets, stock-based compensation and deferred income tax assets. We base our estimates on historical experience and various other factors, including the impact from the current economic conditions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different conditions or assumptions.

Our normal credit terms for trade receivables are 30 days. In certain situations, credit terms for trade receivables may be extended to 60 days or longer and such receivables generally do not require collateral. Additionally, we provide long-term financing in the form of promissory notes when competitive conditions require such financing and, in such cases, we may require collateral. We perform ongoing credit evaluations of our customers' accounts and notes receivable and allowances are recognized for potential credit losses.

Our long-lived assets are reviewed for impairment whenever an event or change in circumstances indicates the carrying amount of an asset or group of assets may not be recoverable. The impairment review, if necessary, includes a comparison of expected future cash flows (undiscounted and without interest charges) to be generated by an asset group with the associated carrying value of the related assets. If the carrying value of the asset group exceeds the expected future cash flows, an impairment loss is recognized to the extent that the carrying value of the asset group exceeds its fair value.

Management makes judgments regarding the interpretation of tax laws that might be challenged upon an audit and causes changes to previous estimates of tax liability. In addition, we operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions as well as by the Internal Revenue . . .

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