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IO > SEC Filings for IO > Form 10-K on 24-Feb-2014All Recent SEC Filings

Show all filings for ION GEOPHYSICAL CORP

Form 10-K for ION GEOPHYSICAL CORP


24-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Note: The following should be read in conjunction with our Consolidated Financial Statements and related Notes to Consolidated Financial Statements that appear elsewhere in this Annual Report on Form 10-K. References to "Notes" in the discussion below refer to the numbered Notes to Consolidated Financial Statements.
Executive Summary
Our Business
The terms "we," "us" and similar or derivative terms refer to ION Geophysical Corporation and its consolidated subsidiaries, except where the context otherwise requires.
We are a global, technology-focused seismic solutions company. Our services and products include data processing and reservoir imaging services; planning services for survey design and optimization; navigation, command and control and data management software products; and marine and land seismic data acquisition equipment. In addition, we maintain a multi-client data library with seismic data acquired and processed from surveys of offshore and onshore regions around the world. We serve customers in all major energy producing regions of the world from strategically located offices in 21 cities on six continents. Seismic imaging plays a fundamental role in hydrocarbon exploration and reservoir development by delineating structures, rock types and fluid locations in the subsurface. Our services, technologies and products are used by oil and gas exploration and production ("E&P") companies and seismic acquisition contractors to generate high-resolution images of the Earth's subsurface in order to identify new sources of hydrocarbons and pinpoint drilling locations for wells, which can be costly and involve high risk.


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We provide our services and products through three business segments - Solutions, Systems and Software. In addition, we have a 49% ownership interest in our INOVA Geophysical joint venture and an ownership interest in our OceanGeo joint venture, which we increased from 30% to 70% in January 2014. For over 45 years we have been engaged in providing innovative seismic data acquisition technology, such as full-wave imaging capability with VectorSeis® products, cableless seismic techniques and the ability to record seismic data from basins that underlie ice fields in the Arctic region. Our advanced technologies offered include Orca®, our WiBand™ data processing technology, Calypso®, Narwhal™, INOVA Geophysical's cableless Hawk™ land system and a new cabled system (G3i) and other technologies, each designed to deliver improvements in both image quality and productivity. We have more than 550 patents and pending patent applications in various countries around the world. Approximately 51% of our employees are involved in technical roles and approximately 22% of our employees have advanced degrees.
Solutions. Our Solutions business provides advanced seismic data processing services for marine and land environments, reservoir solutions, onboard processing and quality control, seismic data libraries and services by our GeoVentures® group. We maintain approximately 10.5 petabytes of seismic data digital information storage in 12 global data centers, including our largest data center in Houston.
Our GeoVentures services are designed to manage the entire seismic process, from survey planning and design to data acquisition and management, and to final subsurface imaging and reservoir characterization. The GeoVentures group focuses on the technologically intensive components of the image development process, such as survey planning and design and data processing and interpretation, and outsources the logistics components (such as field acquisition) to experienced seismic and other geophysical contractors.
Our GXT Imaging Solutions group offers processing and imaging services designed to help our E&P customers reduce exploration and production risk, evaluate and develop reservoirs and increase production. GXT develops a series of subsurface images by applying its processing technology to data owned or licensed by its customers and also provides its customers with support services (including onboard seismic vessel services), such as data pre-conditioning for imaging and outsourced management (including quality control) of seismic data acquisition and image processing services.
The Solutions business focuses on providing services and products for challenging environments, such as the Arctic frontier; complex and hard-to-image geologies, such as deepwater subsurface salt formations in the Gulf of Mexico and offshore West Africa and Brazil; unconventional reservoirs, such as those found in shale, tight gas and oil sands formations; and offshore basin-wide seismic data and imaging programs. Since 2002, the development of our basin exploration seismic data programs has resulted in a substantial data library that covers significant portions of many of the frontier basins in the world, including offshore East and West Africa, India, South America, the Arctic, deepwater Gulf of Mexico and Australia.
Software. Our Software business provides command and control software systems and related services for navigation and data management functions involving towed marine streamer and seabed operations. Our proprietary software, with over 13 million lines of code, is installed on towed streamer marine vessels worldwide and is a component of many re-deployable and permanent seabed monitoring systems. Through our Software business, we provide marine imaging, seabed imaging and survey design, planning and optimization.
During the third quarter of 2013, we announced the launch of our Narwhal system, which enables operators to gather, monitor and analyze data from various sources, including satellite imagery, ice charts, radar, manual observations, wind and ocean currents, in order to forecast weather and predict ice movements in the harsh environments of the Arctic. We believe that this system will give operators the ability to better track, forecast and monitor potential ice threats, and thereby make informed, proactive decisions to ensure the safety of people, assets, and the environment while minimizing operational downtime. Systems. The traditional business of our Systems segment has been manufacturing marine towed streamer and re-deployable ocean-bottom cable seismic data acquisition systems, shipboard recorders, streamer positioning and control systems, energy sources and analog geophone sensors. However, in the third quarter of 2013, we determined to restructure our product offerings in our Systems segment (see "- Restructuring and Other Charges" below). Following this restructuring, our Systems business will be engaged solely in manufacturing of
(i) re-deployable ocean-bottom cable seismic data acquisition systems and shipboard recorders; (ii) towed streamer acquisition, positioning and control systems and energy sources; and (iii) analog geophone sensors.


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INOVA Geophysical. We conduct our land seismic equipment business through INOVA Geophysical Equipment Limited ("INOVA Geophysical" or "INOVA"), which is a joint venture with BGP Inc. ("BGP"). BGP is a subsidiary of China National Petroleum Corporation, and is generally regarded as the world's largest land geophysical service contractor. BGP owns a 51% equity interest in INOVA Geophysical, and we own the remaining 49% interest. INOVA manufactures cable-based, cableless and radio-controlled seismic data acquisition systems, digital sensors, vibroseis vehicles (i.e., vibrator trucks) and source controllers for detonator and energy sources business lines. INOVA's research and development centers are located primarily in the U.S. and Canada, although the joint venture intends to evaluate lower-cost manufacturing opportunities in China. In addition, we and BGP often field-test, and we expect to field-test further, INOVA's new technologies and related equipment for operational feedback and quality improvements. During the third quarter of 2013, INOVA Geophysical restructured its business and related product lines in order to reduce costs in light of current market fundamentals and competitive pressures. See "- Restructuring and Other Charges" below.
Investment in OceanGeo
In February 2013, we purchased from Reservoir Exploration Technology ASA for $1.5 million its 30% interest in OceanGeo B.V. (formerly known as GeoRXT B.V.). OceanGeo is headquartered in Rio de Janeiro, Brazil, and specializes in seismic acquisition operations using ocean-bottom cables deployed from vessels leased by OceanGeo. We were originally granted an option, exercisable at any time on or before May 15, 2013, to increase our ownership percentage to 50% by making additional capital contributions to OceanGeo. We also at that time provided OceanGeo with an $8.0 million working capital loan, the repayment of which was guaranteed by our majority joint venture partner in OceanGeo, Georadar Levantamentos Geofisicos S/A ("Georadar"). No repayments were made under the loan, and the full $8.0 million indebtedness under the loan remained outstanding as of December 31, 2013. In addition, during 2013 we sold certain seismic equipment to OceanGeo, and Georadar guaranteed the payment of the equipment purchase price. As of December 31, 2013, OceanGeo owed $7.0 million to us for the equipment.
During 2013, OceanGeo experienced a sharp pull-back in business in its home market of Brazil, which resulted in its anticipated backlog being reduced to zero. We assisted OceanGeo with its move into the international market, in meeting prequalification requirements in order to obtain work from international E&P companies through the tender cycle, and with bid preparation. Although we had expected to increase our ownership interest in OceanGeo from our 30% level, we delayed doing so to give the joint venture an opportunity to secure backlog within Brazil and beyond. We remained fully committed to putting our Calypso seabed acquisition technology to work in a service model to meet the growing demand for seabed seismic.
In October 2013, we reached agreement with Georadar, which gave us the option to increase our ownership percentage in OceanGeo to 70% in lieu of the earlier option granted to us. To further assist OceanGeo in acquiring backlog, in October 2013 we agreed to loan OceanGeo additional funds for working capital, subject to our agreement on the necessity and purpose for each advance and certain other conditions, up to a maximum of $25.0 million. As of December 31, 2013, we had advanced an additional $15.3 million to OceanGeo under this additional loan.
In November 2013, OceanGeo was awarded a new seismic acquisition project by a customer, but OceanGeo and the customer did not complete the project contract and all prerequisites to commence the project until late December 2013. In January 2014, we exercised our option to increase our ownership interest in OceanGeo to 70%, with Georadar owning the remaining 30%. In connection with our increase in ownership, we converted into additional equity interests of OceanGeo the indebtedness owed to us under the $8.0 million working capital loan and approximately $3.0 million of the original $7.0 million owed to us for the purchase of equipment by OceanGeo. The guaranties provided to us by Georadar with regard to the loan and the equipment purchase obligations were also terminated.
Restructuring and Other Charges
Geophysical contractors have traditionally been significant customers of our products and services. However, due to current marketplace pressures that have resulted principally from further consolidation in the geophysical contractor industry in recent years, we initiated a restructuring of our Systems business and related product lines so that we could be more oriented toward providing services and selling directly to E&P customers. We anticipate that for the foreseeable future, our Systems business will focus all of its development efforts on ocean-bottom cable systems. We plan to continue to manufacture towed streamer systems, but will no longer invest in the development of a next-generation towed streamer system. Through this restructuring, we are closing certain manufacturing facilities and have reduced headcount in Systems personnel by approximately 31%, reducing their costs by approximately $12 million per year.


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In addition, during the third quarter of 2013, INOVA Geophysical initiated a restructuring of its product lines in response to continued softness in the land seismic equipment market and competition among the land equipment providers for both cabled and cableless acquisition systems. The restructuring within INOVA Geophysical was intended to enable the business to operate profitably at lower revenue levels. The restructuring primarily involves reducing headcount in order to reduce INOVA Geophysical's cost structure; since the third quarter of 2013, INOVA Geophysical has reduced its employee headcount by approximately 20%. As a result of INOVA Geophysical's restructuring, INOVA Geophysical has reduced its annual operating costs by approximately $12 million, and we will share in 49% of those savings.
See Note 17 "Restructuring Activities" of Notes to Consolidated Financial Statements.
Senior Secured Second-Priority Notes
In May 2013, we sold $175 million aggregate principal amount of 8.125% Senior Secured Second-Priority Notes due 2018 (the "Notes") in a private offering. The Notes represent senior secured second-priority obligations guaranteed by our material U.S. subsidiaries, and mature on May 15, 2018. Interest on the Notes accrues at the rate of 8.125% per annum and is payable semiannually on May 15 and November 15 of each year during their term. The first interest payment on the Notes was made on November 15, 2013. We used the net proceeds from the offering to repay outstanding indebtedness under our senior secured credit facility with China Merchants Bank Co., Ltd., New York Branch, as administrative agent and lender ("CMB"), and for general corporate purposes. For further information regarding these Notes and our Credit Facility, see Note 4 "Long-term Debt and Lease Obligations" of Notes to Consolidated Financial Statements. WesternGeco Legal Proceedings
As described above in Part I, Item 3. "Legal Proceedings," an August 2012 jury verdict in the WesternGeco L.L.C. v. ION Geophysical Corporation lawsuit found that we had willfully infringed claims contained in four patents and awarded WesternGeco the sum of $105.9 million in damages, consisting of $12.5 million in reasonable royalty and $93.4 million in lost profits.
In June 2013, the presiding judge in the WesternGeco lawsuit entered a Memorandum and Order rejecting the jury's finding of willfulness and denying WesternGeco's motions for willfulness and enhanced damages, but also denying our post-verdict motions that challenged the jury's infringement findings and the damages amount. Based on our analysis after the trial court's Memorandum and Order, we increased our loss contingency accrual related to this case from $10.0 million to $120.0 million as of June 30, 2013. The loss contingency accrual amount consisted of jury verdict damages, court costs and estimates of prejudgment interest and supplemental damages.
On October 24, 2013, the judge entered another Memorandum and Order, ruling on the number of DigiFIN® units that are subject to supplemental damages and also ruling that the supplemental damages applicable to the additional units should be calculated by adding together the jury's previous reasonable royalty and lost profits damages awards per unit, resulting in supplemental damages of $73.1 million. The total damages award in the case now consists of the jury award of $105.9 million and the supplemental damages award of $73.1 million, plus prejudgment interest and court costs. The October 2013 Memorandum and Order also concluded that our infringement involving the supplemental units was not willful and that WesternGeco was not entitled to receive enhanced damages.
Based on our analysis of the trial court's October 2013 Memorandum and Order, we concluded that we should increase our loss contingency accrual related to this case. At December 31, 2013, our loss contingency accrual totaled $193.3 million, which consists of jury verdict damages, supplemental damages, court costs and estimates of prejudgment interest.
Upon any further rulings or developments in the case, we will evaluate whether the accrual should be further adjusted. See further discussion at Part I, Item
3. "Legal Proceedings." Estimated amounts of loss contingency accruals disclosed in this Annual Report on Form 10-K or elsewhere are based on currently available information and involve elements of judgment and significant uncertainties. Actual losses may exceed or be less than these accrual amounts. Economic Conditions
Demand for our seismic data acquisition services and products has traditionally been cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers' willingness and ability to expend their capital for oil and natural gas exploration and development projects. This demand is sensitive to current and expected future crude oil and natural gas prices. In 2013, WTI spot crude oil prices remained in a range of approximately $90 to $110 per barrel, finishing the year near $95 per barrel. Brent crude oil prices remained in a range of $97 to $118 per barrel, finishing the year near $110 per barrel.
Energy price forecasts are by their nature highly uncertain, but external reports indicate that WTI crude oil prices and Brent crude oil prices are expected to remain in price ranges of $80 to $110 and $100 to $130 per barrel, respectively, for 2014.


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U.S. Henry Hub natural gas prices traded in a range of $3.15 to $4.50 per MMBtu, ending the year at approximately $4.30 per MMBtu. We believe demand for natural gas will continue to grow because it is increasingly being used to supplant coal as the preferred fuel for the generation of U.S. electric power. For 2013, our Solutions segment revenues increased over 2012 results, due to significantly higher data library sales and modest growth in new ventures and data processing. In the fourth quarter, revenues from data library sales more than doubled due to sales of data sets with respect to offshore East and West Africa, East and West India and the Gulf of Mexico. However, there continues to be a softening multi-client data market. There currently appears to be an over-supply of marine proprietary seismic data acquisition capacity, which creates opportunities for geophysical contractors to increase participation in the multi-client market. As a result of this excess supply driving lower than expected customer underwriting levels in our multi-client business, we have delayed certain of our planned investments in new multi-client programs until we see more appropriate underwriting levels return. We invested approximately $30 million less in our seismic data library during 2013, compared to prior years. Our data processing revenues grew by 4% in 2013 due to (i) further international penetration driven by stronger demand in Europe and the Middle East, (ii) increased demand in the Gulf of Mexico, and (iii) continued demand for our broadband processing solution, WiBand. However, second-half 2013 revenues for data processing were negatively impacted by approximately $14.0-16.0 million of unrecorded revenues tied to a customer contract pending final execution. That contract was executed in February 2014. At December 31, 2013, our Solutions segment backlog, which consists of commitments for (i) data processing work and
(ii) both multi-client new venture and proprietary projects by our GeoVentures group that have been underwritten, was $84.4 million compared with $151.3 million at December 31, 2012. The data processing contract that was executed in February 2014 adds an additional $20-$30 million to our backlog balance that existed at December 31, 2013. We anticipate that the majority of our backlog at December 31, 2013 will be recognized as revenue over the first half of 2014. Our Software segment revenues decreased for 2013 compared to 2012, primarily due to the impact of recent consolidation in marine geophysical contractors, causing decreased revenues from our Gator® seabed software and our Orca towed streamer software. Revenues for our Systems segment decreased in 2013 compared to 2012. Sales of our towed marine streamer products have decreased primarily due to reduced demand from the shrinking marketplace as the industry continues to work through spare capacity resulting from the recent consolidation of marine geophysical contractors. INOVA Geophysical reported a slight decrease in revenues for 2013, compared to 2012. This decrease in revenues was principally due to decreased sales in all major product categories, including rentals, except for sales of its G3i cable-based land data acquisition system, which experienced increased sales, partially offsetting the decreases in sales for its other products. Gross profits and gross margin decreased for 2013 to 2012 primarily due to the decrease in revenues from rental equipment. OceanGeo reported significant losses in 2013 due to OceanGeo's vessels and crew being idle for approximately five months during 2013. In late December 2013, OceanGeo commenced seismic acquisition operations in Trinidad related to its recently awarded contract. It is our view that technologies that add a competitive advantage through improved imaging, cost reductions or improvements in well productivity will continue to be valued in our marketplace. We believe that our newest technologies, such as Calypso, our next-generation VSO ocean-bottom cable system, WiBand broadband data processing technology, Orca, Narwhal and INOVA Geophysical's newest technologies, will continue to attract customer interest, because those technologies are designed to deliver improvements in image quality within more productive delivery systems. We remain confident that, despite current marketplace issues that we describe above, the long-term growth in demand for seismic services worldwide will continue. We expect growth in demand for seismic services to continue to remain positive for the foreseeable future, and we remain positioned to achieve year-over-year improvement in both our revenue and profitability for 2014 as compared to 2013. However, in stating these expectations, we are assuming that
(i) the global and U.S. economies will not slip back into a recession, (ii) the prices of WTI and Brent crude oil will remain predominantly above $80 and $100 per barrel, respectively, and (iii) there will be increasing demand for seismic services in the Middle East and North Africa resulting from improved geopolitical stability in those areas. Key Financial Metrics
Our results of operations have been materially affected by the restructuring within our Systems segment and our INOVA Geophysical joint venture, and by other charges, which affect the comparability of certain of the financial information contained in this Form 10-K. In order to assist with the comparability to our historical results of operations, certain of the financial metrics tables and the discussion below exclude charges related to the restructuring and other write-downs. The gross profit (loss), income (loss) from operations, costs and expenses below that are identified as "As Adjusted" reflect the exclusion of the restructuring and other charges shown and described in the tables below.


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The tables below provide (i) a summary of our net revenues for our company as a whole, and by segment, for 2013, 2012 and 2011, and (ii) an overview of other certain key financial metrics for our company as a whole and our three business segments on a comparative basis (a) for 2013 and 2012, as reported and as adjusted in both years for the restructuring and other charges recorded for those years, and (b) for 2012 as reported and as adjusted, and 2011 on an as reported, unadjusted basis.
For certain tabular information on the operating results of our INOVA Geophysical joint venture and our OceanGeo joint venture, see "- Other Items - Equity in Earnings (Losses) of Investments."

                                  Years Ended December 31,
                               2013         2012         2011
                                       (In thousands)
Net revenues:
Solutions:
New Venture                 $ 154,578    $ 147,346    $  98,335
Data Library                  111,998       88,085       76,332
Total multi-client revenues   266,576      235,431      174,667
Data Processing               120,808      115,834       88,783
Total                       $ 387,384    $ 351,265    $ 263,450
Systems:
Towed Streamer              $  66,991    $  77,769    $ 111,453
Ocean bottom                    7,307       14,823          960
Other                          48,134       39,404       40,591
Total                       $ 122,432    $ 131,996    $ 153,004
Software:
Software Systems            $  35,418    $  39,738    $  36,031
Services                        3,933        3,318        2,136
Total                       $  39,351    $  43,056    $  38,167
Total                       $ 549,167    $ 526,317    $ 454,621


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                             Year Ended December 31, 2013                                  Year Ended December 31, 2012
                                 Restructuring and                                             Restructuring and                          Year Ended December
               As Reported         Other Charges            As Adjusted       As Reported        Other Charges            As Adjusted           31, 2011
                                                        (In thousands, except per share data)
Gross profit:
Solutions     $   111,108      $          5,461      (a)  $    116,569      $    132,950      $             -           $    132,950      $      84,647
Systems            19,999                25,688      (b)        45,687            50,790                1,280      (d)        52,070             61,109
Software           28,206                     -                 28,206            32,061                    -                 32,061             27,689
Total         $   159,313      $         31,149           $    190,462      $    215,801      $         1,280           $    217,081      $     173,445
Gross margin:
Solutions              29  %                  1 %                   30  %             38  %                 - %                   38  %              32  %
Systems                16  %                 21 %                   37  %             38  %                 1 %                   39  %              40  %
Software               72  %                  - %                   72  %             74  %                 - %                   74  %              73  %
Total                  29  %                  6 %                   35  %             41  %                 - %                   41  %              38  %
Income from
operations:
Solutions     $    61,146      $          5,461      (a)  $     66,607      $     88,589      $             -           $     88,589      $      50,620
Systems            (9,957 )              28,050      (b)        18,093            10,132               12,848      (d)        22,980             33,034
Software           23,602                     -                 23,602            28,129                    -                 28,129             24,463
. . .
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