GEOSPACE TECHNOLOGIES CORP - Quarter Report: 2003 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the Quarterly Period Ended June 30, 2003 OR

¨    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 001-13601

OYO GEOSPACE CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

12750 South Kirkwood, Suite 200

Stafford, Texas 77477

(Address of Principal Executive Offices)

(281) 494-8282

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

There were 5,554,674 shares of the Registrant’s Common Stock outstanding as of the close of business on August 11, 2003.

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PART I—FINANCIAL INFORMATION

Item 1.    Financial Statements

OYO GEOSPACE CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

(unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1.    Significant Accounting Policies

Basis of Presentation

The consolidated balance sheet of OYO Geospace Corporation and its subsidiaries (the “Company”) at September 30, 2002 was derived from the Company’s audited consolidated financial statements at that date. The consolidated balance sheet at June 30, 2003 and the consolidated statements of operations for the nine months ended June 30, 2003 and 2002, and the consolidated statements of cash flows for the nine months ended June 30, 2003 and 2002, were prepared by the Company, without audit. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the consolidated financial position, results of operations and cash flows were made. The results of operations for the nine months ended June 30, 2003 are not necessarily indicative of the operating results for a full year or of future operations.

Certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America were omitted. The accompanying consolidated financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on
Form 10-K for the year ended September 30, 2002.

Revenue Recognition

Revenue is primarily derived from the sale, and short-term rental under operating leases, of seismic instruments and equipment and commercial graphics products. Sales revenues are recognized when title and risk of loss have passed to the customer, which generally occurs when such products are shipped (when the revenue cycle is completed). The Company’s products generally do not require installation assistance or sophisticated instruction. Products are generally sold without any customer acceptance provisions and the Company’s standard terms of sale do not allow its customers to return products except for manufacturing defects. The Company offers a standard product warranty obligating it to repair or replace equipment with manufacturing defects. The Company maintains a reserve for future warranty costs based on historical experience. Rental revenues are recognized on a straight-line basis as earned over the rental period. Rentals of the Company’s equipment are short term and generally range from daily rentals to rental periods of up to six months.

Research and Development Costs

The Company expenses research and development costs as incurred.

Inventories

The Company records a write-down of its inventory when the cost basis of any product (including any estimated future costs to complete the manufacturing process) exceeds its net realizable value.

Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement revises the accounting and reporting for costs associated with exit or disposal activities so as to provide recognition of such costs when a liability is incurred rather than when the entity commits to an exit plan. SFAS No. 146 is effective for exit or disposal activities initiated after June 30, 2003. Management does not believe the adoption of SFAS No. 146 will have a material effect on the Company’s financial position and results of operations.

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation and Disclosure—an amendment of FASB Statement

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

No. 123”. This statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative transition methods for a voluntary change to the fair value of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FASB Statement No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. At June 30, 2003, the Company had two stock-based employee compensation plans. The Company accounts for the plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

For a further discussion of the Company’s stock-based employee compensation plans, see Note 11 to the audited Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the year ended September 30, 2002.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” Statement 149 amends and clarifies financial accounting and reporting of derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003, except for certain hedging relationships designated after June 30, 2003. Management does not believe the adoption of SFAS No. 149 will have a material effect on the Company’s financial position and results of operations.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 specifies that freestanding financial instruments within its scope constitute obligations of the issuer and that, therefore, the issuer must classify them as liabilities. Such freestanding financial instruments include mandatory redeemable financial instruments, obligations to repurchase the issuer’s equity shares by transferring assets, and certain obligations to issue a variable number of

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

shares. SFAS No. 150 is effective immediately for all financial instruments entered into or modified after May 31, 2003. For all other instruments, SFAS No. 150 is effective at the beginning of the third quarter of 2003. Management does not believe the adoption of SFAS No. 150 will have a material effect on the Company’s financial position and results of operations.

2.    Earnings Per Common Share

The following table summarizes the calculation of net earnings and weighted average common shares and common equivalent shares outstanding for purposes of the computation of earnings per share (in thousands, except per share data):

No common share equivalents have been included in the diluted earnings per share calculations because of the potential antidilutive effect as a result of the Company’s net loss for the three months and nine months ended June 30, 2003. Options totaling 141,703 and 93,467 equivalent shares for the three months ended June 30, 2003 and 2002, and 194,051 and 82,732 for the nine months ended June 30, 2003 and 2002, respectively, were not included in the computation of weighted average shares because the impact to these options were antidilutive.

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

3.    Comprehensive Income

Comprehensive income includes all changes in a company’s equity, except those resulting from investments by and distributions to stockholders. The following table summarizes the components of comprehensive income (in thousands):

4.    Trade Accounts and Notes Receivable

Trade accounts and notes receivable consisted of the following (in thousands):

5.    Inventories

Inventories consisted of the following (in thousands):

The Company’s reserve for slow moving and obsolete inventories is analyzed and adjusted periodically to reflect the Company’s best estimate of the net realizable value of such inventories.

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

6.    Segment and Geographic Information

The Company evaluates financial performance based on two business segments: Seismic and Commercial Graphics. The seismic product lines currently consist of geophones and hydrophones, including multi-component geophones and hydrophones, seismic leader wire, geophone string connectors, seismic telemetry cable, high definition reservoir characterization products and services, marine seismic cable retrieval devices and small data acquisition systems targeted at niche markets. Commercial graphics products include thermal imaging equipment and dry thermal film.

The following tables summarize the Company’s segment information:

Net sales for the periods ended June 30, 2002 include the sale of a $15.8 million reservoir characterization and monitoring system.

7.    Line of Credit

The Company has entered into a credit agreement pursuant to which it can borrow up to $10.0 million secured by its accounts receivable and inventory (the “Credit Agreement”). The Credit Agreement, as amended, expires in January 2004. Borrowings under the Credit Agreement are subject to borrowing base restrictions based on (i) consolidated net income plus consolidated interest expense, income taxes, depreciation and amortization and (ii) levels of eligible accounts receivable and inventories. The Credit Agreement limits the incurrence of additional indebtedness, requires the maintenance of certain financial amounts and contains other covenants customary in agreements of this type. As a result of operating losses through June 30, 2003, the Company failed to meet certain of its covenants for the quarter ended June 30, 2003 relating to the maintenance of specified ratios of EBITDA to

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

interest expense and senior debt to EBITDA. The Company received a waiver of these covenants from the bank as of such date in consideration for a fee of $10,000 and increased borrowing rates for future borrowings. As of June 30, 2003 there were borrowings of $4.6 million outstanding under the Credit Agreement, and additional borrowings available under the Credit Agreement of $5.4 million.

The Company recently amended its Credit Agreement to expire in January 2004. In connection with this amendment, the Company’s borrowing interest rate has become, at the Company’s option, the bank’s prime rate or a LIBOR based rate. In addition, the borrowing base restrictions were modified so the Company could incur additional borrowings up to the maximum limit of $10.0 million. The Company’s borrowing interest rate at June 30, 2003 was 3.8% for its LIBOR-based borrowings and 4.3% for its prime-based borrowings.

8.    Adoption of Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed for impairment. Intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives; however, no maximum life applies. The Company adopted the provisions of SFAS 142 effective October 1, 2002. At June 30, 2003, the Company had goodwill, net of accumulated amortization, of $1.8 million. Adoption of SFAS No. 142 resulted in a reduction of amortization expense for the three and nine months ended June 30, 2003 of $41,000 and $124,000, respectively.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 143 – “Accounting for Asset Retirement Obligations”. This statement requires the Company to recognize the fair value of a liability associated with the cost the Company would be obligated to incur in order to retire an asset at some point in the future. The liability would be recognized in the period in which it is incurred and can be reasonably estimated. The standard is effective for fiscal years beginning after June 15, 2002. The Company adopted this standard effective October 1, 2002. The adoption of SFAS No. 143 did not have a material effect on the Company’s financial position or results of operations.

In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets”. SFAS No. 144 develops an accounting model, based upon the framework established in SFAS No. 121, for long-lived assets to be disposed of by sales. The accounting model applies to all long-lived assets, including discontinued operations, and it replaces the provisions of APB Opinion No. 30, “Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, for disposal of segments of a business. SFAS No. 144 requires long-lived assets held for disposal to be measured at the lower of carrying amount or fair values less costs to sell, whether reported in continuing operations or in discontinued operations. The statement is effective for fiscal years beginning after December 15, 2001. The Company adopted this standard effective October 1, 2002. The adoption of SFAS No. 144 did not have a material effect on the Company’s financial position or results of operations.

In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, “Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. This statement clarified guidance related to the reporting of gains and losses from extinguishment of debt and resolves inconsistencies related to the required accounting treatment of certain lease modifications. The provisions of this statement relating to extinguishment of debt became effective for financial statements issued for fiscal years beginning after May 15, 2002. The provisions of this statement relating to lease modification are effective for transactions occurring after May 15, 2002. The Company adopted this standard effective October 1, 2002. The adoption of SFAS No. 145 did not have a material effect on the Company’s financial position or results of operations.

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

On November 25, 2002, the Financial Accounting Standards Board (“FASB”) issued FASB interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies (FAS 5), relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. The Company is implementing the disclosure requirements of this standard this year and will disclose the measurement and other provisions of FIN 45 in its 2004 fiscal year financial statements. The Company offers a standard product warranty obligating it to repair or replace equipment with manufacturing defects. The Company maintains a reserve for future warranty costs based on historical experience. Changes in the warranty reserve are contained in the following table (in thousands):

The FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which the Company adopted effective January 31, 2003. This statement addresses the consolidation of variable interest entities (“VIEs”) by business enterprises that are primary beneficiaries. A VIE is an entity that does not have sufficient equity investment at risk to permit it to finance its activities without additional subordinated financial support, or whose equity investors lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the enterprise that has the majority of the risks or rewards associated with the VIE. The Company believes it has no material interests in VIEs that will require disclosure or consolidation under FIN 46.

9.    Film Supplier Developments

In April 2002, the Company purchased certain intellectual property rights from its then primary supplier of dry thermal film (the “Former Primary Film Supplier”) for $2.3 million. Such purchase gave the Company exclusive ownership of all technology used by the Former Primary Film Supplier to manufacture dry thermal film used in the thermal imaging equipment the Company manufactures. Such purchase included technology then existing and any dry thermal film technology thereafter developed by the Former Primary Film Supplier for use in the Company’s equipment. The Company also entered into an amended supply agreement pursuant to which the Former Primary Film Supplier agreed to provide the Company with the dry thermal film. In connection with the purchase, the Company agreed to license the technology to the Former Primary Film Supplier on a perpetual basis so long as it could meet predefined quality and delivery requirements. If the Former Primary Film Supplier could not meet such requirements, the Company has the right to use the technology itself or to license the technology to any third party to manufacture dry thermal film.

On July 3, 2002, the Former Primary Film Supplier filed a Chapter 11 reorganization petition in Federal Bankruptcy Court for the Western District of New York. At the date of such bankruptcy filing, the Company had $3.4 million of long-term assets carried on its balance sheet as a result of the Company’s prior transactions with the Former Primary Film Supplier (including the $2.3 million investment in intellectual property acquired from the Former Primary Film Supplier described above). Around that time, the Former Primary Film Supplier advised the Company that, in connection with its bankruptcy filing, it was seeking a buyer for its business that would assume its relationship and contracts with the Company, and it was the Company’s intention to cooperate in such efforts to the extent its on-going interest could be served thereby. The Company no longer believes that a buyer can be found to operate the Former Primary Film Supplier’s business.

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OYO GEOSPACE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

During the Company’s current fiscal year, the Former Primary Film Supplier has failed to meet substantially all of the Company’s purchase orders and has ceased providing the Company with dry thermal film. As a result, the Company is currently purchasing a large quantity of dry thermal film from its alternate supplier of dry thermal film (the “Other Film Supplier”) and the Company is using the technology it purchased from the Former Primary Film Supplier to manufacture dry thermal film internally.

As a result of the bankruptcy filing by the Former Primary Film Supplier, the Company recorded a $1.2 million charge in its third quarter of fiscal year 2002 due to the ultimate uncertainty of realization of value on certain assets, particularly certain prepaid purchase benefits and similar benefits under the amended supply agreement with the Former Primary Film Supplier. The Company does not believe there has been any impairment in the value of the intellectual property it acquired from the Former Primary Film Supplier because of its ability to utilize the intellectual property to have dry thermal film manufactured internally or possibly elsewhere.

No claims have been made against the Company or by the Company at present in connection with the Former Primary Film Supplier’s bankruptcy, except that on December 10, 2002, the Company received a notice of claim for alleged preferential payments made by the Former Primary Film Supplier to the Company in the period before filing of the bankruptcy proceeding in the approximate amount of $260,000. The Company intends to vigorously defend against such claim under the overall circumstances of its relationship with the Former Primary Film Supplier. At present, the Company does not know whether it will make any claims against the Former Primary Film Supplier and it is unable to predict whether any additional claims will be made against the Company in connection with the Former Primary Film Supplier’s bankruptcy proceeding as to any aspect of its relationship with the Former Primary Film Supplier. The Company is unable at this time to predict the outcome and effects of this situation. The Company has, nevertheless, made provision for existing claims that it believes are adequate at this time, although it is unable to make such predictions with any certainty.

10.    Income Taxes

The United States statutory tax rate for the periods reported was 34%. The effective tax rate for the three months and nine months ended June 30, 2003 was 34.8% and 33.1%, respectively. The effective tax rate for the three months and nine months ended June 30, 2002 was 3.4% and 16.5%, respectively. During the third quarter of 2003, the Company filed amended tax returns for prior years and completed its 2002 federal tax filing. Upon completion of such filings, the Company identified $0.8 million of additional tax benefits that are available for potential use in future periods. The additional benefits are related to foreign tax credits and extraterritorial income deductions. Based upon the current industry environment and projections of future taxable income, the Company has reviewed its deferred tax assets and recorded a valuation allowance of approximately $0.8 million. Including the valuation allowance, the Company has net deferred tax assets of $3.0 million at June 30, 2003. The Company will continue to evaluate its deferred tax position on a regular basis to determine whether additions to or reversal of a valuation is needed. Further operating losses could result in additional valuation allowances being recorded in future periods.

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following analysis of the financial condition and results of operations of OYO Geospace Corporation should be read in conjunction with the Consolidated Financial Statements and Notes related thereto which are included elsewhere in this Form 10-Q.

Industry Overview

We design and manufacture instruments and equipment used in the acquisition and processing of seismic data. We have been in the seismic instrument and equipment business since 1980, marketing our products primarily to the oil and gas industry worldwide. We also design and manufacture thermal imaging equipment and distribute dry thermal film products to the commercial graphics industry. We have been serving the commercial graphics industry since 1995.

Seismic Industry

Geoscientists use seismic data to map potential or existing oil and gas bearing formations and the geologic structures that surround them. Seismic data is used primarily in connection with the exploration, development and production of oil and gas.

Seismic data acquisition is conducted on land by combining a seismic energy source and a data recording system. The energy source imparts seismic waves into the earth, reflections of which are received and measured by geophones and hydrophones. Electrical signals generated by the geophones and hydrophones are simultaneously transmitted through leader wire, geophone and hydrophone string connectors and telemetric cable to data collection units, which store information for processing and analysis. Seismic thermal imaging output devices are used in the field or office to create a graphic representation of the seismic data after it has been acquired.

Marine seismic data acquisition is conducted primarily by large ocean-going vessels that tow long seismic cables known as “streamers”. Usually, the energy source in marine seismic data acquisition is an airgun, and the reflected seismic waves are received and measured by hydrophones, which are an integral part of the streamers. The streamers simultaneously transmit the electrical impulses back to the vessel via telemetric cable included within the streamers, and the seismic data is recorded and processed in much the same manner as it is on land.

An estimated one to two-thirds of the reserves found with every oil and gas discovery will be left behind in the reservoir, not recoverable economically or at times even identified. Reservoir characterization and management programs, in which the reservoir is carefully imaged and monitored throughout its economic life by seismic instruments and equipment, are now seen as vital tools for improving production recovery rates. Seismic surveys repeated over selected time intervals show dynamic changes within the reservoir and can be used to monitor the effects of production. We now provide products and services for use in the reservoir monitoring and characterization marketplace, and expect to incur significant future research and development expenditures aimed at the development of additional seismic acquisition products and services used for high definition reservoir characterization in both land and marine environments.

Orders for our products can vary substantially from quarter to quarter. Reservoir characterization projects, especially large-scale deepwater projects, require the use of more equipment over a longer period of time than is required by conventional surface seismic systems. Revenue recognition in accordance with generally accepted accounting principles for these large-scale projects has the potential to result in substantial fluctuations in our quarterly performance. These variations may impact our operating results and cash flow, manufacturing capability and expense levels in any given quarter. Furthermore, because of the scale and nature of large-scale deepwater reservoir characterization projects, there may be delays in their implementation and uncertainties about their final course.

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Commercial Graphics Industry

Our entry into the commercial graphics business segment occurred in 1995 as we leveraged our thermal imaging equipment technology, originally designed for seismic data processing applications, into new markets. With minor product modifications, we were successful in adapting these products for use in the commercial graphics industry.

Our commercial graphics business segment manufactures and sells thermal imaging equipment and dry thermal film primarily to the screen print, point of sale, signage and textile market sectors. Our thermal imaging equipment is capable of producing data images ranging in size from 12 to 54 inches wide, with resolution ranging from 400 to 1,200 dpi (dots per inch). This business segment has some sales to customers in the seismic industry.

In April 2002, we purchased certain intellectual property rights from our then primary supplier of dry thermal film (the “Former Primary Film Supplier”) for $2.3 million. Such purchase gave us exclusive ownership of all technology used by the Former Primary Film Supplier to manufacture dry thermal film used in the thermal imaging equipment we manufacture. Such purchase included technology then existing and any dry thermal film technology thereafter developed by the Former Primary Film Supplier for use in our equipment. We also entered into an amended supply agreement pursuant to which the Former Primary Film Supplier agreed to provide us with the dry thermal film. In connection with the purchase, we agreed to license the technology to the Former Primary Film Supplier on a perpetual basis so long as it could meet predefined quality and delivery requirements. If the Former Primary Film Supplier could not meet such requirements, the agreement provides us with the right to use the technology ourselves or to license the technology to any third party to manufacture dry thermal film.

On July 3, 2002, the Former Primary Film Supplier filed a Chapter 11 reorganization petition in Federal Bankruptcy Court for the Western District of New York. At the date of such bankruptcy filing, we had $3.4 million of long-term assets carried on our balance sheet as a result of the prior transactions with the Former Primary Film Supplier (including the $2.3 million investment in intellectual property acquired from the Former Primary Film Supplier described above). Around that time, the Former Primary Film Supplier advised us that, in connection with its bankruptcy filing, it was seeking a buyer for its business that would assume its relationship and contracts with us, and it was our intention to cooperate in such efforts to the extent our on-going interest could be served thereby. We no longer believe that a buyer can be found to operate the Former Primary Film Supplier’s business.

During our current fiscal year, the Former Primary Film Supplier has failed to meet substantially all of our purchase orders and has ceased providing us with dry thermal film. As a result, we are currently purchasing a large quantity of dry thermal film from our alternate film supplier (the “Other Film Supplier”) and we are using the technology we purchased from the Former Primary Film Supplier to manufacture dry thermal film internally.

As a result of the bankruptcy filing by the Former Primary Film Supplier, we recorded a $1.2 million charge in our third quarter of fiscal year 2002 due to the ultimate uncertainty of realization of value on certain assets, particularly certain prepaid purchase benefits and similar benefits under the amended supply agreement with the Former Primary Film Supplier. We do not believe there has been any impairment in the value of the intellectual property we acquired from the Former Primary Film Supplier because of our ability to utilize the intellectual property to have dry thermal film manufactured internally or possibly elsewhere.

No claims have been made against us or by us at present in connection with the Former Primary Film Supplier’s bankruptcy, except that on December 10, 2002, we received a notice of claim for alleged preferential payments made by the Former Primary Film Supplier to us in the period before filing of the bankruptcy proceeding in the approximate amount of $260,000. We intend to vigorously defend against such claim under the overall circumstances of our relationship with the Former Primary Film Supplier. At present we do not know whether we will make any claims against the Former Primary Film Supplier and we are unable to predict whether any additional claims will be made against us in connection with the Former Primary Film Supplier’s bankruptcy proceeding as to any aspect of our relationship with such Former Primary Film Supplier. We are unable at this time to predict the outcome and effects of this situation. We have, nevertheless, made provision for existing claims that we believe are adequate at this time, although we are unable to make such predictions with any certainty.

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Results of Operations

We report and evaluate financial information for two segments: Seismic and Commercial Graphics. Summary financial data by business segment follows:

Overview

Three and nine months ended June 30, 2003 compared to three and nine months ended June 30, 2002.

Consolidated sales for the three months and nine months ended June 30, 2003 decreased $11.8 million, or 47.9%, and $12.0 million, or 23.3%, respectively from the corresponding periods of the prior fiscal year. Sales for the corresponding periods of the prior fiscal year included a $15.8 million sale of a reservoir characterization and monitoring system. Excluding the impact of the $15.8 million sale in the prior year periods and similar sales of reservoir characterization products in the current year periods, consolidated sales for the three months and nine months ended June 30, 2003 increased $2.3 million, or 25.8%, and decreased $0.8 million, or 2.1%, respectively. The sales increase for the three months ended June 30, 2003 include increased rental revenues from our land-based seismic equipment, as well as sales of our new offshore cable products. These sales increases were partially offset by a decline in sales of our marine-based seismic equipment products. For the nine months ended June 30, 2003, the sales decrease is primarily attributed to a decline in marine-based seismic equipment sales, offset by improved product sales and rentals of our land-based seismic equipment in the Canadian marketplace. Due to the soft demand for traditional seismic equipment, we expect these sales to remain weak in the near term. However, we also expect continued growth and acceptance of our new deepwater reservoir characterization and our offshore cable products, although we cannot predict the exact timing thereof or the periods in which we will specifically see growth and acceptance of these products.

Consolidated gross profits for the three and nine months ended June 30, 2003 decreased by $4.1 million, or 60.0% and $6.0 million, or 38.6%, respectively, from the corresponding periods of the prior year. The lower gross profits correspond with the lower level of sales during the fiscal 2003 periods. In addition, we recorded charges of $0.6 million in the current year periods to write-off defective dry thermal film inventories and obsolete borehole seismic assets. Competitive pricing pressures in the seismic industry resulting from manufacturing over-capacity and the under-absorption of fixed manufacturing costs are expected to continue to have an unfavorable impact upon the gross profit margins we realize from sales of our traditional seismic products. In light of the current environment, we are initiating steps to reorganize our manufacturing operations in order to improve our gross profit margins.

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Consolidated operating expenses for the three months and nine months ended June 30, 2003 decreased $1.4 million, or 25.4%, and $1.3 million, or 9.2%, respectively from the corresponding periods of the prior fiscal year. The prior year periods include a $1.2 million asset impairment charge relating to the bankruptcy of the former supplier of our dry thermal film. Excluding the $1.2 million asset impairment charge, our operating expenses for the three months and nine months ended June 30, 2003 decreased $0.2 million and $0.1 million, respectively. The decrease in operating expenses is due to the lower level of sales and actions taken to reduce operating costs in response to current market conditions. We intend to undertake additional cost-cutting actions in the near future to reorganize our business operations in an effort to increase efficiency.

The United States statutory tax rate for the periods reported was 34%. The effective tax rate for the three months and nine months ended June 30, 2003 was 34.8% and 33.1%, respectively. The effective tax rate for the three months and nine months ended June 30, 2002 was 3.4% and 16.5%, respectively. During the third quarter of 2003, we filed amended tax returns for certain prior year periods and completed our fiscal 2002 federal tax filing. Upon completion of such filings, we identified $0.8 million of additional tax benefits that are available for potential use in future periods. These additional benefits are related to foreign tax credits and extraterritorial income deductions. Based upon the current industry environment and our projections of future taxable income, we have reviewed our deferred tax assets and recorded a valuation allowance of approximately $0.8 million. Including the valuation allowance, we have net deferred tax assets of $3.0 million at June 30, 2003. We will continue to evaluate our deferred tax position on a regular basis to determine whether additions to or reversal of a valuation is needed. Further operating losses could result in additional valuation allowances being recorded in future periods.

Seismic

Our seismic product lines currently consist of geophones and hydrophones, including multi-component geophones and hydrophones, seismic leader wire, geophone string connectors, seismic telemetry cable, high definition reservoir characterization products and services, marine seismic cable retrieval devices and small data acquisition systems targeted at niche markets.

Net Sales

Sales of our seismic products for the three months and nine months ended June 30, 2003 decreased $11.9 million, or 56.6%, and $11.3 million, or 27.5%, respectively, from the corresponding periods of the prior fiscal year. The large decline in sales is due to the $15.8 million sale of a large deepwater reservoir characterization system reflected in the prior year periods. Excluding the impact of the $15.8 million sale in the prior year periods and similar sales of reservoir characterization products in the current year periods, consolidated sales for the three months ended June 30, 2003 increased $2.3 million, or 44.0%. This sales increase resulted from increased rentals of our traditional land-based seismic products and sales of our new offshore cable products, partially offset by a decline in our marine-based product sales. Under this same basis, consolidated sales for the nine months ended June 30, 2003 decreased $0.1 million, or 0.4%.

Operating Income (Loss)

Operating income (loss) for the three months and nine months ended June 30, 2003 decreased $3.6 million, or 117.0%, and $4.6 million, or 105.8%, respectively, from the corresponding periods of the previous fiscal year. The decrease is primarily attributable to the gross profit associated with the $15.8 million sale of the deepwater reservoir characterization and monitoring system in the third quarter of the prior fiscal year. In addition, the decline in gross profits from sales of our marine-based seismic products has unfavorably impacted our operating income (loss) for the current year periods.

Commercial Graphics

Our commercial graphics business segment manufactures and sells thermal imaging equipment and dry thermal film primarily to the screen print, point of sale, signage and textile market sectors. This business segment has some sales to customers in the seismic industry.

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Net Sales

Sales of our commercial graphics products for the three months and nine months ended June 30, 2003 decreased $19,000, or 0.5% and $0.8 million or 7.3%, respectively, from the corresponding period of the prior year. The decrease in sales primarily resulted from a decline in sales of parts and accessories, partially offset by increasing sales of dry thermal film.

Operating Income (Loss)

Our operating income for the three months and nine months ended June 30, 2003 increased $1.0 million and decreased $0.3 million, respectively, from the corresponding periods of the prior fiscal year. The prior year periods include a $1.2 million asset impairment charge relating to the bankruptcy of the former supplier of our dry thermal film. Excluding the $1.2 million asset impairment charge, our operating income for the three months and nine months ended June 30, 2003 decreased $0.2 million and $1.2 million, respectively. This reduction in operating income primarily resulted from (i) increased manufacturing and operating costs associated with the self-manufacture of dry thermal film, including the write-off of $0.4 million of defective dry thermal film inventories (ii) increased research and development expenses associated with a newly introduced 1200 dpi thermal imaging device, and (iii) increased amortization expenses resulting from the $2.3 million purchase of intellectual property in April 2002 (being amortized on a straight basis over five years).

Liquidity and Capital Resources

At June 30, 2003, we had $1.1 million in cash and cash equivalents. For the nine months ended June 30, 2003, we used approximately $1.5 million of cash in operating activities. The cash used in operating activities resulted from a combination of our net loss of $2.0 million, which included a $0.9 million non-cash deferred tax benefit. In addition, we increased our inventories by $1.6 million in order to build orders awaiting shipment and to build ample stocks of dry thermal film; we decreased our accounts payable by $1.6 million as a result of a recent decline in purchases of raw materials; we increased our prepaid expenses by $1.4 million primarily to reflect an outstanding insurance claim for goods damaged in transit; and we reduced our income taxes payable by $1.0 million primarily related to the payment of foreign income taxes. Such uses of cash were offset by a $3.2 million non-cash charge for depreciation and amortization, a $3.3 million decrease in accounts and notes receivable due to a decline in sales, and a $0.5 million increase in accrued expenses and other items.

For the nine months ended June 30, 2003, we used approximately $2.0 million of cash in investing activities relating to capital expenditures.

For the nine months ended June 30, 2003, cash from financing activities increased approximately $2.9 million primarily due to borrowings under our credit facility.

We have entered into a credit agreement pursuant to which we can borrow up to $10.0 million secured by our accounts receivable and inventory (the “Credit Agreement”). The Credit Agreement, as amended, expires in January 2004. Borrowings under the Credit Agreement are subject to borrowing base restrictions based on (i) consolidated net income plus consolidated interest expense, income taxes, depreciation and amortization and (ii) levels of eligible accounts receivable and inventories. The Credit Agreement limits the incurrence of additional indebtedness, requires the maintenance of certain financial amounts and contains other covenants customary in agreements of this type. As a result of operating losses through June 30, 2003, we failed to meet certain covenants for the quarter ended June 30, 2003, relating to the maintenance of specified ratios of EBITDA to interest expense and senior debt to EBITDA. We received a waiver of these covenants from the bank as of such date in consideration for a fee of $10,000 and increase in borrowing rates for future borrowings. As of June 30, 2003 there were borrowings of $4.6 million outstanding under the Credit Agreement, and additional borrowings available under the Credit Agreement of $5.4 million. As of September 30, 2002 there were borrowings of $0.5 million outstanding under the Credit Agreement.

We recently amended our Credit Agreement to expire in January 2004. In connection with this amendment, our borrowing interest rate has become, at our option, the bank’s prime rate or a LIBOR based rate. In addition, the

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borrowing base restrictions were modified so that we could incur additional borrowings up to the maximum limit of $10.0 million. Our borrowing interest rate at June 30, 2003 was 3.8% for our LIBOR-based borrowings and 4.3% for our prime-based borrowings.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We consider many factors in selecting appropriate operational and financial accounting policies and controls and in developing the estimates and assumptions that are used in the preparation of these financial statements. We continually evaluate our estimates, including those related to bad debts reserves, inventory obsolescence reserves, self-insurance reserves, product warranty reserves, intangible assets and deferred income tax assets. We base our estimates on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different conditions or assumptions.

Revenue is primarily derived from the sale, and short-term rental under operating leases, of seismic instruments and equipment and commercial graphics products. Sales revenues are generally recognized when our products are shipped and title and risk of loss have passed to the customer. Rental revenues are recognized as earned over the rental period. Rentals of our equipment are short term and generally range from daily rentals to rental periods of up to six months. Products are generally sold without any customer acceptance provisions and our standard terms of sale do not allow customers to return products for credit. Our products generally do not require installation assistance or sophisticated instruction. We offer a standard product warranty obligating us to repair or replace equipment with manufacturing defects. We maintain a reserve for future warranty costs based on historical experience. We record a write-down of inventory when the cost basis of any manufactured product (including any estimated future costs to complete the manufacturing process) exceeds its net realizable value.

New Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed for impairment. Intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives; however, no maximum life applies. We adopted the provisions of SFAS 142 effective October 1, 2002. At June 30, 2003, we had goodwill, net of accumulated amortization, of $1.8 million. Adoption of SFAS No. 142 resulted in a reduction of amortization expense for the three and nine months ended June 30, 2003 of $41,000 and $124,000, respectively.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 143—“Accounting for Asset Retirement Obligations”. This statement requires us to recognize the fair value of a liability associated with the cost we would be obligated to incur in order to retire an asset at some point in the future. The liability would be recognized in the period in which it is incurred and can be reasonably estimated. The standard is effective for fiscal years beginning after June 15, 2002. We adopted this standard effective October 1, 2002. The adoption of SFAS No. 143 did not have a material effect on our financial position or results of operations.

In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets”. SFAS No. 144 develops an accounting model, based upon the framework established in SFAS No. 121, for long-lived assets to be disposed of by sales. The accounting model applies to all long-lived assets, including discontinued operations, and it replaces the provisions of APB Opinion No. 30, “Reporting Results of Operations—Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, for disposal of segments of a business. SFAS No. 144 requires long-lived assets held for disposal to be measured at the lower of carrying amount or fair values less costs to sell, whether reported in continuing operations or in discontinued operations.

The statement is effective for fiscal years beginning after December 15, 2001. We adopted this standard effective October 1, 2002. The adoption of SFAS No. 144 did not have a material effect on our financial position or results of operations.

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In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, “Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. This statement clarified guidance related to the reporting of gains and losses from extinguishment of debt and resolves inconsistencies related to the required accounting treatment of certain lease modifications. The provisions of this statement relating to extinguishment of debt became effective for financial statements issued for fiscal years beginning after May 15, 2002. The provisions of this statement relating to lease modification are effective for transactions occurring after May 15, 2002. We adopted this standard effective October 1, 2002. The adoption of SFAS No. 145 did not have a material effect on our financial position or results of operations.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement revises the accounting and reporting for costs associated with exit or disposal activities so as to provide recognition of such costs when a liability is incurred rather than when the entity commits to an exit plan. SFAS No. 146 is effective for exit or disposal activities initiated after June 30, 2003. We do not believe the adoption of SFAS No. 146 will have a material effect on our financial position or results of operations.

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation and Disclosure—an amendment of FASB Statement No. 123”. This statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative transition methods for a voluntary change to the fair value of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FASB Statement No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. See Note 1 to the Consolidated Financial Statements for additional disclosures under SFAS No. 148. The FASB is currently discussing new standards for expensing all stock options, which, if enacted, could materially affect future earnings.

On November 25, 2002, the Financial Accounting Standards Board (“FASB”) issued FASB interpretation No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies (FAS 5), relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. We are implementing the disclosure requirements of this standard this year and will disclose the measurement and other provisions of FIN 45 in its 2004 fiscal year financial statements; this disclosure has been included in Note 9 to the Consolidated Financial Statements. We offer a standard product warranty obligating us to repair or replace equipment with manufacturing defects. We maintain a reserve for future warranty costs based on historical experience.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” Statement 149 amends and clarifies financial accounting and reporting of derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003, except for certain hedging relationships designated after June 30, 2003. We do not believe the adoption of SFAS No. 149 will have a material effect on our financial position and results of operations.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 specifies that freestanding financial instruments within its scope constitute obligations of the issuer and that, therefore, the issuer must classify them as liabilities. Such freestanding financial instruments include mandatory redeemable financial instruments, obligations to repurchase the issuer’s equity shares by transferring assets, and certain obligations to issue a variable number of shares. SFAS No. 150 is effective immediately for all financial instruments entered into or modified after May 31, 2003. For all other instruments, SFAS No. 150 is effective at the beginning of the third quarter of 2003. We do not believe the adoption of SFAS No. 150 will have a material effect on our financial position and results of operations.

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The FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which we adopted effective January 31, 2003. This statement addresses the consolidation of variable interest entities (“VIEs”) by business enterprises that are primary beneficiaries. A VIE is an entity that does not have sufficient equity investment at risk to permit it to finance its activities without additional subordinated financial support, or whose equity investors lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the enterprise that has the majority of the risks or rewards associated with the VIE. We believe it has no material interests in VIEs that will require disclosure or consolidation under FIN 46.

Forward Looking Statements and Risks

Certain of the statements we make in this document and in documents incorporated by reference herein, including those made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are, or may be, forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934. Such statements include projections of our expectations regarding our future capital expenditures, research and development expenses, expansion of product lines, growth of product markets and other statements that relate to future events or circumstances. These statements are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to differ materially from the future results, performance or achievements expressed or implied by such forward-looking statements, including the risks and factors described below. You are cautioned to consider the following factors and risks in connection with evaluating any such forward-looking statements or otherwise evaluating an investment in our company.

Management’s Current Outlook.

Our estimates as to future results and industry trends, to the extent described in this document, are generally based on assumptions regarding the future level of seismic exploration activity and seismic reservoir monitoring projects and, in turn, their effect on the demand and pricing of our products and services. In analyzing the market and its impact on us, we have the following outlook for fiscal year 2003:

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Our outlook is based on various macro-economic factors, and our internal assessments, and actual market conditions could vary materially from those assumed.

Our New Products May Not Achieve Market Acceptance.

In recent years, we have incurred significant expenditures to fund our research and development efforts and we intend to continue those expenditures in the future. However, research and development is by its nature speculative, and we cannot assure you that these expenditures will result in the development of new products or services or that any new products and services we have developed recently or may develop in the future will be commercially marketable or profitable to us.

In particular, we have incurred substantial expenditures to develop our recently introduced HDSeis^™ product line for borehole and reservoir characterization applications. We cannot assure you that we will realize our expectations regarding market acceptance and revenues from these products and services.

A Decline in Industry Conditions Could Affect our Projected Results.

Any unexpected material changes in oil and gas prices or other market trends that would impact seismic exploration activity would likely affect the forward-looking information contained in this document. In addition, the oil and gas industry is extremely volatile and seismic activity is subject to change based on political and economic factors outside of our control. In fact, our results for fiscal year 2002, as well as for our current fiscal year, and results from our land-based seismic activity in particular, were materially and adversely affected by the downturn in the industry particularly as the industry has continued to limit exploration activities and to be cautious in spending notwithstanding some improvements in oil and gas prices.

We May Experience Fluctuations in Quarterly Results of Operations.

Historically, the rate of new orders for our products has varied substantially from quarter to quarter. Moreover, we typically operate, and expect to continue to operate, on the basis of orders in hand for our products before we commence substantial manufacturing “runs” hence, the completion of orders, particularly large orders for deepwater reservoir characterization projects, can significantly impact the operating results and cash flow for any quarter, and results of operations for any one quarter may not be indicative of results of operations for future quarters.

Our Credit Risks Could Increase as our Customers Continue to Face Difficult Economic Circumstances.

We believe and have assumed that our allowance for bad debts at June 30, 2003 is adequate in light of known circumstances. However, we cannot assure you that additional amounts attributable to uncollectible receivables and bad debt write-offs will not have a material adverse effect on our future results of operations. Many of our customers, particularly seismic contractors, have suffered from lower revenues and experienced liquidity challenges resulting from the economic difficulties throughout our industry. We have in the past incurred significant write-offs in our accounts and notes receivable due to customer credit problems. We have found it necessary from time to time to extend trade credit to long-term customers and others where risks of non-payment or late payment exist. Given recent industry conditions, some of our customers are experiencing liquidity difficulties, which increases those credit risks.

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Demand for Our Products is Volatile.

Demand for our products depends primarily on the level of worldwide oil and gas exploration activity. That activity, in turn, depends primarily on prevailing oil and gas prices and availability of seismic data. Historically, the markets for oil and gas have been volatile, and those markets are likely to continue to be volatile. Oil and gas prices are subject to wide fluctuation in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty and a variety of additional factors that are beyond our control. These factors include the level of consumer demand, weather conditions, domestic and foreign governmental regulations, price and availability of alternative fuels, political conditions and hostilities in the Middle East and other significant oil-producing regions, foreign supply of oil and gas, price of foreign imports and overall economic conditions. Continued low demand for our products could materially and adversely affect our results of operations and liquidity.

We Have a Relatively Small Public Float, and Our Stock Price May be Volatile.

We have approximately 2.4 million shares outstanding held by non-affiliates. This small float results in a relatively illiquid market for our common stock. Our average daily trading volume during fiscal year 2002 was approximately 4,000 shares. Our small float and daily trading volumes may have in the past caused, and may in the future result in, greater volatility of our stock price.

Our Industry is Characterized by Rapid Technological Development and Product Obsolescence.

Our instruments and equipment are constantly undergoing rapid technological improvement. Our future success depends on our ability to continue to:

Current competitors or new market entrants may develop new technologies, products or standards that could render our products obsolete. We cannot assure you that we will be successful in developing and marketing, on a timely and cost effective basis, product enhancements or new products that respond to technological developments, that are accepted in the marketplace or that comply with industry standards.

We Operate in Highly Competitive Markets.

The markets for our products are highly competitive. Many of our existing and potential competitors have substantially greater marketing, financial and technical resources than we do. Additionally, two competitors in our seismic business segment currently offer a broader range of instruments and equipment for sale and market this equipment as “packaged” data acquisition systems. We do not now offer for sale such a complete “packaged” data acquisition system. Further, certain of our competitors offer financing arrangements to customers on terms that we may not be able to match. In addition, new competitors may enter the market and competition could intensify.

We cannot assure you that sales of our products will continue at current volumes or prices if current competitors or new market entrants introduce new products with better features, performance, price or other characteristics than our products. Competitive pressures or other factors also may result in significant price competition that could have a material adverse effect on our results of operations.

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We Have a Limited Market.

In our seismic business segment, we market our products to contractors and large, independent and government-owned oil and gas companies. We estimate that, based on published industry sources, fewer than 30 seismic contracting companies are currently operating worldwide (excluding those operating in Russia and the former Soviet Union, India, the People’s Republic of China and certain Eastern European countries, where seismic data acquisition activity is difficult to verify). We estimate that fewer than ten seismic contractors are engaged in marine seismic exploration. Due to these market factors, a relatively small number of customers, some of whom are experiencing financial difficulties, have accounted for most of our sales. From time to time these seismic contractors have sought to vertically integrate and acquire our competitors, which has influenced their supplier decisions before and after such transactions. The loss of a small number of these customers for whatever reason could materially and adversely impact our sales.

We Cannot Be Certain of Patent Protection of Our Products.

We have applied for and hold certain patents relating to our seismic data acquisition and other products. We also acquired several patents which relate to the development of dry thermal film from our Former Primary Film Supplier. We cannot assure you that our patents will prove enforceable, that any patents will be issued for which we have applied or that competitors will not develop functionally similar technology outside the protection of any patents we have or may obtain.

Our Foreign Marketing Efforts Face Additional Risks and Difficulties.