ION GEOPHYSICAL CORP - Quarter Report: 2021 September (Form 10-Q)

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

See accompanying Footnotes to Condensed Consolidated Financial Statements.

ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

See accompanying Footnotes to Condensed Consolidated Financial Statements.

ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(UNAUDITED)

See accompanying Footnotes to Condensed Consolidated Financial Statements.

ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

^(a) Represents $30.1 million in New Notes and $11.7 million of ION common stock issued in connection with the Rights Offering described in the footnotes.

^(b) Consists primarily of $17.1 million payment for the Old Notes resulting from the Exchange Offer.

^(c) Represents transaction costs incurred in connection with the Restructuring Transactions.

See accompanying Footnotes to Condensed Consolidated Financial Statements.

ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(UNAUDITED)

See accompanying Footnotes to Condensed Consolidated Financial Statements.

ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES

FOOTNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Basis of Presentation

The condensed consolidated balance sheet of ION Geophysical Corporation and its subsidiaries (collectively referred to as the “Company” or “ION,” unless the context otherwise requires) at December 31, 2020, has been derived from the Company’s audited consolidated financial statements at that date. The condensed consolidated balance sheet at September 30, 2021, and the condensed consolidated statements of operations, condensed consolidated statements of comprehensive loss, condensed consolidated statements of stockholders' deficit for the three and nine months ended September 30, 2021 and 2020 and the condensed consolidated statements of cash flows for the nine months ended September 30, 2021 and 2020, are unaudited. In the opinion of management, all adjustments of a normal recurring nature that are necessary for a fair presentation of the results of the interim period have been included. Interim results are not necessarily indicative of the operating results for a full year or of future operations. Intercompany transactions and balances have been eliminated.

The Company’s condensed consolidated financial statements reflect a non-redeemable noncontrolling interest in a majority-owned affiliate which is reported as a separate component of equity in “Noncontrolling interest” in the condensed consolidated balance sheets. Net (income) loss attributable to noncontrolling interest is stated separately in the condensed consolidated statements of operations. The activity for this noncontrolling interest relates to proprietary processing projects in Brazil.

Certain reclassifications were made to previously reported amounts in the condensed consolidated financial statements and notes thereto; particularly, the presentation of revenue by geographic area to make previously reported amounts consistent with current period presentation.

These condensed consolidated financial statements have been prepared using accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in annual financial statements presented in accordance with GAAP have been omitted. The accompanying condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.

Going Concern

On April 20, 2021, the Company completed the Restructuring Transactions (as further discussed below) that extended the maturity of the notes tendered in the Exchange Offer (as defined below) by four years to December 2025 and provided additional liquidity. While the Company completed the Restructuring Transactions and revenues in the third quarter significantly improved, the timing of the market recovery remains uncertain and overall revenues were lower than expected. Though the significant revenues generated during the third quarter are expected to have a positive impact on the Company's near-term cash collection, it may not be sufficient to fund the Company's operations and meet the Company's debt and other obligations. 

In the fourth quarter, the following amounts totaling $16.8 million will become due and payable: (i) principal and interest on the Old Notes of $7.7 million; (ii) interest on the New Notes of $4.6 million and (iii) an escrow payment of $4.5 million with respect to the India litigation described in Footnote 8 "Litigations". Based on the Company's current available liquidity, these near-term payment obligations, and its obligations from the Company's on-going operations, such as amounts due to its seismic acquisition partners and royalty obligations, there is substantial doubt about the Company's ability to continue as a going concern. Furthermore, any failure to make the above-described required payments on the Old Notes or the New Notes would likely result in a default under that indebtedness and likely cause cross-defaults under the Company's other indebtedness further limiting its ability to access capital, including under its Credit Agreement. 

As a result of these liquidity issues, the Company is considering various strategic alternatives, which include, among others, a sale or other business combination transaction, sales of assets, private or public equity transactions, debt financing, or some combination of these alternatives. This process is ongoing and there can be no assurance that the Company's efforts will be successful. If the Company is unable to significantly increase its revenues and cash collection in the fourth quarter or raise additional funds through equity issuances, further debt financing arrangements, sales of assets or through other means of preserving cash through cost reduction initiatives, the Company would be unable to continue as a going concern.

The Company is implementing a significant cost reduction program, building on the over $40 million eliminated last year, in an effort to right size its business. Approximately $16 million of additional annualized savings were identified through a combination of both short-term and long-term reductions. In addition to maintaining ongoing cost discipline, the Company will continue to identify opportunities for government relief such as employee retention credits. For further details, refer to Footnote 5, “Government Relief Funding.” This management plan reflects the Company’s continued focus on preserving cash and managing liquidity in the current uncertain macroeconomic environment. 

The condensed consolidated financial statements conform with accounting principles generally accepted in the United States of America ("GAAP") on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and satisfaction of liabilities and commitments in the normal course of business. Accordingly, the Company’s condensed consolidated financial statements exclude certain adjustments that might result if the Company is unable to continue as a going concern.

Old Notes Restructuring

On April 20, 2021, the Company successfully completed its previously announced offer to exchange (the “Exchange Offer”) the Old Notes for newly issued 8.00% Senior Secured Second Priority Notes due 2025 (the “New Notes”) and other consideration in the form of cash and ION common stock, as described in the Company's Prospectus dated March 10, 2021 and its previously announced rights offering (the "Rights Offering") to its holders of the Company's common stock, par value $0.01 per share (the "Common Stock") to purchase for (i) $2.78 principal amount of the New Notes per right, at a purchase price of 100% of the principal amount thereof or (ii) 1.08 shares of common stock per right, at a purchase price of $2.57 per whole share of common stock. The Exchange Offer and the Rights Offering are sometimes referred to herein as the "Restructuring Transactions". 

As described in more detail in Footnote 4 "Long-term Debt", the holders of the New Notes may convert all or any portion of their New Notes at their option at any time prior maturity. The initial conversion price is $3.00 per share of Common Stock and is subject to adjustment as described in the New Notes Indenture. The total number of shares of Common Stock that may be issued upon conversion of the New Notes is 38.7 million shares, which excludes an additional 6.5 million shares that may be issued upon a conversion resulting from a make-whole change of control.

In the Exchange Offer, approximately $113.5 million, or approximately 94.1%, of the $120.6 million outstanding Old Notes were accepted and exchanged for (i) $84.7 million aggregate principal amount of its New Notes, (ii) 6.1 million shares of Common Stock, including 1.5 million shares issued as the early participation payment and 4.6 million shares issued as stock consideration in lieu of the New Notes and (iii) $20.7 million paid in cash, including $3.6 million of accrued and unpaid interest that became due on the Old Notes as part of the exchange. The Company accepted for exchange all such Old Notes validly tendered and not validly withdrawn in the Exchange Offer as of the expiration time on April 12, 2021.  Pursuant to the Exchange Offer, the Company will make an offer to participants to repurchase New Notes at par for up to 50% of the proceeds raised in excess of $35.0 million from the Rights Offering valued at $3.4 million. As of September 30, 2021, the Company has yet to initiate such offer.

In the concurrent Rights Offering, an aggregate amount of $41.8 million of rights (including over-subscription) was validly exercised by the holders of Common Stock, apportioned as $30.1 million in New Notes and $11.7 million in Common Stock allocated in 4.6 million shares. All over-subscription rights were exercised without proration as the $50.0 million limit on proceeds was not exceeded. Backstop parties were paid 5% backstop fees, in kind, resulting in the issuance of an additional $1.5 million in aggregate principal amount of New Notes and 0.2 million shares of Common Stock.

In total, $116.2 million in aggregate principal amount of New Notes and 10.9 million shares of Common Stock were issued. The Company received approximately $14 million in net proceeds from the transactions after deducting noteholder obligations, estimated transaction fees and accrued and unpaid interest paid on the Old Notes. After the Restructuring Transactions, $7.1 million of Old Notes remain outstanding and are due along with unpaid interest (at a rate of 9.125% per annum) on December 15, 2021.

The Restructuring Transactions resulted in amendment to the Old Notes Indenture (as defined in Footnote 4, "Long-term Debt") effective as of April 20, 2021. The Old Notes were modified to, among other things, provide for the release of the second priority security interest in the collateral securing the Old Notes, and deleted in their entirety substantially all of the restrictive covenants and certain events of default pertaining to the Old Notes. Refer to Footnote 4 "Long-term Debt - Old Notes" for further details.

COVID-19 Business Impact and Response

The COVID-19 pandemic caused the global economy to enter a recessionary period starting in the second quarter of 2020. During 2020, the exploration and production (“E&P”) industry faced the dual impact of demand deterioration from COVID-19 and market oversupply from increased production, which caused oil and natural gas prices to decline significantly for most of 2020. The sharp commodity price decline triggered E&P companies to reduce budgets by approximately 25%.  Exploration offerings and data purchases are often discretionary and, therefore, receive disproportionately higher reductions than overall budget cuts. Consequently, there has been a material slowdown in offshore seismic spending since second quarter of 2020, and while the market remains uncertain, there are signs of sequential improvement and gradual market recovery. 

Significant Accounting Policies

The Company’s significant accounting policies are disclosed in Footnote 1 “Summary of Significant Accounting Policies” of the Annual Report on Form 10-K for the year ended December 31, 2020. There have been no changes in such policies or the application of such policies during the nine months ended September 30, 2021.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are made at discrete points in time based on relevant market information. These estimates may be subjective in nature and involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Areas involving significant estimates include, but are not limited to, collectability of accounts and unbilled receivables, inventory valuation reserves, sales forecasts related to multi-client data library, impairment of property, plant and equipment and goodwill and deferred taxes. Actual results could materially differ from those estimates.

Recent Accounting Pronouncement

In August 2020, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2020-06, “Debt — Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The new guidance eliminates two of the three models in Accounting Standards Codification ("ASC") 470-202 that require separating embedded conversion features from convertible instruments. As a result, only conversion features accounted for under the substantial premium model in ASC 470-20 and those that require bifurcation in accordance with ASC 815-153 will be accounted for separately. For contracts in an entity’s own equity, the new guidance eliminates some of the requirements in ASC 815-404 for equity classification. The guidance also addresses how convertible instruments are accounted for in the diluted earnings per share calculation and requires enhanced disclosures about the terms of convertible instruments and contracts in an entity’s own equity. For public business entities other than smaller reporting companies as defined by the SEC, the guidance is effective for annual periods beginning after December 15, 2021, and interim periods therein. For all other entities, it is effective for annual periods beginning after December 15, 2023, and interim periods therein. Early adoption is permitted in fiscal years beginning after December 15, 2020. The Company adopted the standard as of January 1, 2021. This resulted in presenting the New Notes holders' conversion option within "long-term debt, net of current maturities" account in the condensed consolidated balance sheets instead of a separate presentation in equity. See Footnote 4, "Long-term Debt - New Notes" for further details.

The Company evaluates and reviews its results of operations based on two reporting segments: E&P Technology & Services and Operations Optimization. Refer to Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for information about each business segment’s business, products and services.

The segments represent components of the Company for which separate financial information is available that is utilized on a regular basis by the Chief Operating Decision Maker in determining how to allocate resources and evaluate performance. The Company measures segment operating results based on income (loss) from operations.

A summary of segment information follows (in thousands):

Intersegment sales are insignificant for all periods presented.

The Company derives revenue from the (i) sale or license of multi-client and proprietary data, imaging and reservoir services within its E&P Technologies & Services segment; (ii) sale, license and repair of seismic data acquisition systems and other equipment; and (iii) sale or license of seismic command and control software systems and software solutions for operations management within its Operations Optimization segment. All E&P Technology & Services’ revenues and the services component of Optimization Software & Services’ revenues under Operations Optimization segment are classified as service revenues. All other revenues are classified as product revenues.    

The Company uses a five-step model to determine proper revenue recognition from customer contracts. Revenue is recognized when (i) a contract is approved by all parties; (ii) the goods or services promised in the contract are identified; (iii) the consideration the Company expects to receive in exchange for the goods or services promised is determined; (iv) the consideration is allocated to the goods and services in the contract; and (v) control of the promised goods or services is transferred to the customer. The Company is not required to disclose information about remaining contractual future performance obligations with an original term of one year or less. The Company does not have any contractual future performance obligations with an original term of over one year.

Revenues by Geographic Area

The following table is a summary of net revenues by geographic area (in thousands):

Product revenues are allocated to geographic locations on the basis of the ultimate destination of the equipment, if known. If the ultimate destination of such equipment is not known, product revenues are allocated to the geographic location of initial shipment. Service revenues, which primarily relate to the Company's E&P Technology & Services segment, are allocated based upon the billing location of the customer and the geographic location of the data.

See Footnote 2“Segment Information” for total net revenues by segment for the three and nine months ended September 30, 2021 and 2020.

Unbilled Receivables

Unbilled receivables balances relate to revenues recognized on multi-client surveys, imaging and reservoir services and devices equipment repairs on a proportionate basis, and on licensing of multi-client data for which invoices have not yet been presented to the customer. The following table is a summary of unbilled receivables (in thousands):

The changes in unbilled receivables are as follows (in thousands):

^(a) Includes all gross revenue recognition and related billing activity of the Company. As a matter of process, all net revenue recognized is initially reflected as an unbilled receivable and subsequently billed to customers, as applicable, including net revenue for all of software and a portion of devices within the Operations Optimization segment, although they are billed at the time of recognition.

Deferred Revenue

Billing practices are governed by the terms of each contract based upon achievement of milestones or pre-agreed schedules. Billing does not necessarily correlate with revenue recognized on a proportionate basis as work is performed and control is transferred to the customer. Deferred revenue represents cash received in excess of revenue not yet recognized as of the reporting period but that will be recognized in future periods. The following table is a summary of deferred revenues (in thousands):

The changes in deferred revenues were as follows (in thousands):

The Company expects to recognize a majority of deferred revenue within the next twelve months.

Credit Risks

For the nine months ended September 30, 2021 and 2020, the Company had three and two customers, respectively, with sales that each exceeded 10% of the Company’s consolidated net revenues. Revenues related to each of these customers are included within the E&P Technology & Services segment.

At  September 30, 2021 and 2020, the Company had two large multi-national and national oil company customers with balances that accounted for 53% and 39%, respectively, of the Company’s total combined accounts receivable and unbilled receivable balances.

The Company routinely evaluates the financial stability and creditworthiness of its customers. The Company has a corporate credit policy that is intended to minimize the risk of financial loss due to a customer’s inability to pay. Credit coverage decisions for customers are based on references, payment histories, financial and other data. The Company utilizes a third-party trade credit insurance policy. The Company has historically not extended long-term credit to its customers.

Concentration of Foreign Sales Risk

The majority of the Company’s foreign sales are denominated in U.S. dollars. For the nine months ended September 30, 2021 and 2020, international sales comprised 96% and 92%, respectively, of total net revenues. To the extent that world events or economic conditions negatively affect the Company’s future sales to customers in many regions of the world, as well as the collectability of the Company’s existing receivables, the Company’s future results of operations, liquidity and financial condition would be adversely affected.

The following table is a summary of long-term debt (in thousands):    

Old Notes

The Old Notes were senior secured second-priority debt obligations guaranteed by GX Technology Corporation, ION Exploration Products (U.S.A.) Inc., I/O Marine Systems Inc. and GX Geoscience Corporation, S. de R.L. de C.V. (the "Guarantors"). As a result of the Restructuring Transactions on April 20, 2021 as further discussed in Footnote 1 "Summary of Significant Accounting Policies - Old Notes Restructuring", $113.5 million in aggregate principal amount outstanding of Old Notes were tendered and exchanged for New Notes. At  September 30, 2021, $7.1 million of Old Notes remain outstanding and are due along with unpaid interest (at a rate of 9.125% per annum) on December 15, 2021.

The April 2016 indenture governing the Old Notes (the "Old Notes Indenture") contained certain covenants that, among other things, limited or prohibited ION Geophysical Corporation’s and its restricted subsidiaries from taking certain actions or permitting certain conditions to exist during the term of the Old Notes, including among other things, incurring additional indebtedness in excess of permitted indebtedness, creating liens, paying dividends and making other distributions in respect of ION Geophysical Corporation’s capital stock, redeeming ION Geophysical Corporation’s capital stock, making investments or certain other restricted payments, selling certain kinds of assets, entering into transactions with affiliates, and effecting mergers or consolidations. These and other restrictive covenants contained in the Old Notes Indenture were subject to certain exceptions and qualifications. 

On April 20, 2021, the Company, the Guarantors, Wilmington Savings Fund Society, FSB, as trustee, and collateral agent, entered into a supplemental indenture (the “Supplemental Indenture”) to the Old Notes Indenture, dated as of April 28, 2016, among the Company, the Guarantors, Wilmington Savings Fund Society, FSB (as successor to Wilmington Trust, National Association), as trustee, and U.S. Bank National Association, as collateral agent, governing the Old Notes Indenture. The Supplemental Indenture, among other things, provided for the release of the second priority security interest in the collateral securing the Old Notes, and deleted in their entirety substantially all of the restrictive covenants and certain events of default pertaining to the Old Notes. The Old Notes Indenture, as modified by the Supplemental Indenture, is materially less restrictive and affords significantly reduced protection to holders of such securities as compared to the restrictive covenants, events of default and other provisions previously contained in the Old Notes Indenture.

At September 30, 2021, the Company was in compliance with all of the covenants under the Old Notes.

Each guarantee of the New Notes are senior obligations of each Guarantor; secured on a second-priority basis, equally and ratably with all obligations of that Guarantor under any other future Parity Lien Debt, by Liens on all of the assets of that Guarantor other than the Excluded Assets, subject to the Liens securing that Guarantor’s guarantee of the Credit Agreement obligations and any other Priority Lien Debt and other Permitted Prior Liens; are effectively junior, to the extent of the value of the Collateral (as defined in the New Notes Indenture), to that Guarantor’s guarantee of the Credit Agreement and any other Priority Lien Debt, which are secured on a first-priority basis by the same assets of that Guarantor that secure the New Notes; are effectively junior to any Permitted Prior Liens, to the extent of the value of the assets of that Guarantor subject to those Permitted Prior Liens; and are senior in right of payment to any future subordinated Indebtedness of that Guarantor, if any.

The New Notes Indenture contains covenants that, among other things, limit the Company's ability, and the ability of ION's restricted subsidiaries (all of ION Geophysical Corporation’s subsidiaries are currently restricted subsidiaries) to incur additional debt or issue certain preferred stock; make certain investments or pay dividends or distributions on ION's capital stock, purchase or redeem or retire capital stock, or make other restricted payments; sell assets, including capital stock of ION's restricted subsidiaries; restrict dividends or other payments by restricted subsidiaries; create liens; create unrestricted subsidiaries; enter into transactions with affiliates; and merge or consolidate with another company. These covenants are subject to a number of important limitations and exceptions that are described in the New Notes Indenture.   

At September 30, 2021, the Company was in compliance with all of the covenants under the New Notes.

Holders of New Notes may convert all or any portion of their New Notes at their option at any time prior to the close of business on the business day immediately preceding the maturity date.  The conversion rate will initially be 333 shares of Common Stock per $1,000 principal amount of New Notes (equivalent to an initial conversion price of approximately $3.00 per share of Common Stock) and is subject to adjustment as described in the New Notes Indenture. Upon conversion of a New Note, ION will satisfy its conversion obligation by paying or delivering, as the case may be, cash, shares of its Common Stock or a combination of cash and Common Stock, at ION’s election. If ION satisfies its conversion obligation solely in cash or through payment and delivery, as the case may be, of a combination of cash and shares of its Common Stock, the amount of cash and shares of Common Stock, if any, due upon conversion will be based on a daily conversion value calculated on a proportionate basis for each trading day in a 30 trading day observation period. The total number of shares of Common Stock that may be issued upon conversion of the New Notes is 38.7 million shares, which excludes an additional 6.5 million shares that may be issued upon a conversion resulting from a make-whole change of control.

On or after the day that is the eighteen (18) month anniversary of the issue date of the New Notes (the “Issue Date”), ION may require the conversion of all or part of the New Notes, at its option, if Common Stock, as determined by ION, has a 20-day volume weighted average price of at least 175% of the conversion price then in effect ending on, and including, the trading day immediately preceding the date on which ION provides notice of conversion (an “Optional Conversion”). If ION undergoes an Optional Conversion prior to the third anniversary of the Issue Date, holders of New Notes will be entitled to a make-whole premium payment in cash equal to the applicable premium amount.

The New Notes will be redeemable, in whole or in part, at ION's option at any time prior to December 15, 2023, at a cash redemption price equal to 100.0% of the principal amount of New Notes to be redeemed plus a make-whole premium and accrued and unpaid interest. The New Notes will also be redeemable, in whole or in part, at the Company's option at any time on or after December 15, 2023, at a cash redemption price equal to 100.0% of the principal amount of New Notes to be redeemed plus accrued and unpaid interest.

If a Change of Control (as described in the New Notes Indenture) occurs, holders of the New Notes may require the Company to repurchase their New Notes at a cash repurchase price equal to 101% of the principal amount of the New Notes to be repurchased, plus accrued and unpaid interest. 

Upon certain asset sales, the Company  may be required to use the net proceeds therefrom to purchase New Notes at an offer price in cash equal to 100% of the aggregate principal amount thereof, plus accrued and unpaid interest.

The Company issued one (1) shares of Series A Preferred Stock (the “Series A Preferred Stock”) to the New Notes Trustee to (i) provide certain rights and protections to holders of the New Notes and (ii) allow, under certain circumstances, the holders of New Notes to vote on an as-converted basis. The New Notes Trustee shall take direction from holders of 50.1% of the New Notes for any action requiring the consent of the holder of the Series A Preferred Stock or each act on which the holder of the Series A Preferred Stock is entitled to vote.

Following a default or event of default under the New Notes Indenture, the Series A Preferred Stock will be entitled to vote with the Common Stock of the Company as a single class and having voting power equal to the number of shares of Common Stock issuable upon the conversion of the New Notes. In addition, at all times when the Common Stock is entitled to vote, the Series A Preferred Stock will be entitled to vote with the Common Stock as a single class and having voting powers equal to the number of shares of Common Stock issuable upon the conversion of the New Notes for any transaction (a) modifying, amending, supplementing, or waiving any provision of ION’s organizational documents or (b) entering into any merger, consolidation, sale of all or substantially all of ION’s assets, or other business combination transactions. The holder of the Series A Preferred Stock has the right to appoint two (2) directors to ION’s board of directors, both of whom must be independent. This holder exercised this right in June 2021.

The one share of Series A Preferred Stock (i) ranks pari passu in respect of voting rights with respect to Common Stock, (ii) has a liquidation preference equal to $1.00, (iii) will not produce preferred dividends or ordinary dividends, (iv) is not transferable, except to a successor New Notes Trustee under the terms of the New Notes Indenture, (v) is not convertible into any other class of equity of ION, and (vi) will not be granted registration rights.  The Series A Preferred Stock may be redeemed by the Company upon the conversion into Common Stock, in the aggregate, of 75% or more of the New Notes. The redemption price will be $1.00.

On April 20, 2021, the Company and the Guarantors acknowledged and agreed to an intercreditor agreement (the “Intercreditor Agreement”) by and among PNC Bank, National Association ("PNC"), as first lien representative and collateral agent for the first lien secured parties, and UMB Bank, National Association, as second lien representative and collateral agent for the second lien secured parties. The Intercreditor Agreement, among other things, defines the relative priorities of the respective security interests in the collateral securing the New Notes and the obligations under the Company’s senior secured credit facility and certain other matters relating to the administration of security interests, exercise of remedies, certain bankruptcy-related provisions and other intercreditor matters.

The Intercreditor Agreement superseded and replaced the second lien intercreditor agreement, dated as of April 28, 2016, by and among PNC Bank, National Association, as first lien representative for the first lien secured parties and collateral agent for the first lien secured parties, and Wilmington Savings Fund Society, FSB, as second lien representative and collateral agent for the second lien secured parties and third lien representative for the third lien secured parties and U.S. Bank National Association, as collateral agent for the third lien secured parties.

Derivative Liabilities Associated with the New Notes

On April 20, 2021, the Company issued New Notes in exchange for Old Notes (see detailed discussion above on both the New Notes and the Old Notes). Due to the interest make-whole premium payable in cash associated with the Optional Conversion Feature of the New Notes (as described above in more details), the Company has determined that the Optional Conversion Feature is a derivative liability. Further, the interest make-whole premium is not clearly and closely related to the New Notes and is therefore considered a derivative liability (the Optional Conversion Feature and interest make-whole premium are referenced herein as "derivative financial instruments" or "derivatives"). The accounting treatment for derivative financial instruments requires that the Company record the fair value of the derivatives at inception and is adjusted for fair value changes at each reporting date. Considering the impact of other features in the New Notes, the fair value of these derivative instruments using the "with or without" scenario under a lattice option pricing model was determined to be zero over the life of the derivative financial instruments.

Loss on Extinguishment of Old Notes

As discussed in more detail in Footnote 1 "Summary of Significant Accounting Policies - Old Notes Restructuring", on April 20, 2021, the Company successfully completed its offer to exchange the Old Notes for New Notes. As a result of these transactions, the Old Notes with a carrying value of $113.5 million were replaced with $84.7 million of New Notes issued at par and other consideration in the form of cash of $17.1 million and ION common stock of $15.7 million, including the early participation payment. 

In accordance with ASC Topic No. 470, “Debt – Modifications and Extinguishments” (Topic 470), the transactions noted above were determined to be an extinguishment of the existing debt and an issuance of new debt. As a result, the Company recorded a loss on the extinguishment of debt in the amount of $4.7 million presented in "Other income (expense)" account in the Condensed Consolidated Statements of Operations. Of the $4.7 million loss on the extinguishment of debt, $4.0 million represents the 1.5 million shares the Company issued to the holders of the Old Notes as the early participation payment. The remaining $0.7 million represents the write-off of the remaining debt issuance costs related to the Old Notes.

Revolving Credit Facility

On April 20, 2021, ION and its material U.S. subsidiaries — GX Technology Corporation, ION Exploration Products (U.S.A.) Inc. and I/O Marine Systems Inc. (the “Material U.S. Subsidiaries”) — along with GX Geoscience Corporation, S. de R.L. de C.V., a limited liability company (Sociedad de Responsibilidad Limitada de Capital Variable) organized under the laws of Mexico, and a subsidiary of the Company (the “Mexican Subsidiary”), (the Material U.S. Subsidiaries and the Mexican Subsidiary are collectively, the “Subsidiary Borrowers”, together with ION Geophysical Corporation are the “Borrowers”) — the financial institutions party thereto, as lenders, and PNC, as agent for the lenders, entered into that certain Fourth Amendment and Joinder to Revolving Credit and Security Agreement (the “Fourth Amendment”), amending the Revolving Credit and Security Agreement, dated as of August 22, 2014 (as previously amended by the First Amendment to Revolving Credit and Security Agreement, dated as of  August 4, 2015, the Second Amendment to Revolving Credit and Security Agreement, dated as of April 28, 2016 and the Third Amendment to Revolving Credit and Security Agreement, dated as of August 16, 2018, the “Credit Agreement”). The Credit Agreement, as amended by the First Amendment, the Second Amendment, the Third Amendment and the Fourth Amendment is herein called the “Credit Facility”). The Credit Agreement, as amended by the Fourth Amendment, among other things, permitted the consummation of the Restructuring Transactions, including the issuance of the New Notes and certain cash payments to the Company's noteholders in connection with the Exchange Offer and the Rights Offering, and made certain other changes to the Credit Agreement’s definitions and other provisions, including with respect to LIBOR, where the successor LIBOR rate index will be the benchmark replacement determined by PNC. The Credit Facility is available to provide for the Borrowers’ general corporate needs, including working capital requirements, capital expenditures, surety deposits and acquisition financing.

The maximum interest rate in the Credit Facility is 3% per annum for domestic rate loans and 4% per annum for LIBOR rate loans with a minimum interest rate of 2% for domestic rate loans and 3% for LIBOR rate loans based on a leverage ratio for the preceding four-quarter period. The Credit Facility matures on August 16, 2023. The terms include a minimum excess borrowing availability threshold (excess borrowing availability less than $6.25 million for five consecutive days or $5.0 million on any given day), which (if the Borrowers have minimum excess borrowing availability below any such threshold) triggers the agent’s right to exercise dominion over cash and deposit accounts.

The maximum amount available under the Credit Facility is the lesser of $50.0 million or a monthly borrowing base. The borrowing base under the Credit Facility will increase or decrease monthly using a formula based on certain eligible receivables, eligible inventory and other amounts, including a percentage of the net orderly liquidation value of the Borrowers’ multi-client data library (not to exceed $28.5 million for the multi-client data library component). The borrowing base calculation includes the eligible billed receivables of the Mexican Subsidiary up to a maximum of $5.0 million. At September 30, 2021, there was $19.4 million outstanding indebtedness under the Credit Facility which was presented as a current liability in the Condensed Consolidated Balance Sheets due to the lockbox requirement within the terms of the Credit Facility with PNC. The undrawn remaining borrowing base capacity was $10.9 million.

The obligations of Borrowers under the Credit Facility are secured by a first-priority security interest in 100% of the stock of the Subsidiary Borrowers and 65% of the equity interest in ION International Holdings L.P., and by substantially all other assets of the Borrowers. However, the first-priority security interest in the other assets of the Mexican Subsidiary is capped to a maximum exposure of $5.0 million.

The Credit Facility contains covenants that, among other things, limit or prohibit the Borrowers, subject to certain exceptions and qualifications, from incurring additional indebtedness in excess of permitted indebtedness (including finance lease obligations), repurchasing equity, paying dividends or distributions, granting or incurring additional liens on the Borrowers’ properties, pledging shares of the Borrowers’ subsidiaries, entering into certain merger transactions, entering into transactions with the Company’s affiliates, making certain sales or other dispositions of the Borrowers’ assets, making certain investments, acquiring other businesses and entering into sale-leaseback transactions with respect to the Borrowers’ property. The Credit Facility contains customary event of default provisions (including a “change of control” event affecting ION Geophysical Corporation), the occurrence of which could lead to an acceleration of the Company's obligations under the Credit Facility.

The Credit Facility requires that the Borrowers maintain a minimum fixed charge coverage ratio of 1.1 to 1.0 as of the end of each fiscal quarter during the existence of a covenant testing trigger event. The fixed charge coverage ratio is defined as the ratio of (i) ION’s earnings before interest, taxes, depreciation and amortization (“EBITDA”), minus unfunded capital expenditures made during the relevant period, minus distributions (including tax distributions) and dividends made during the relevant period, minus cash taxes paid during the relevant period, to (ii) certain debt payments made during the relevant period. A covenant testing trigger event occurs upon (a) the occurrence and continuance of an event of default under the Credit Facility or (b) by a two-step process based on (i) a minimum excess borrowing availability threshold (excess borrowing availability less than $6.25 million for five consecutive business days or $5.0 million on any given business day), and (ii) the Borrowers’ unencumbered cash maintained in a PNC deposit account is less than the Borrowers’ then outstanding obligations. 

At September 30, 2021, the Company was in compliance with all of the covenants under the Credit Facility.

A summary of future principal obligations under long-term debt and equipment capital lease obligations follows (in thousands):

⁽¹⁾ While the outstanding balance of $19.4 million under the Credit Facility is shown as a current liability, the Credit Facility matures on August 16, 2023. 

Paycheck Protection Program

On April 11, 2020, the Company entered into a Note Agreement (“Note”) with PNC amounting to $6.9 million pursuant to the Coronavirus Aid, Relief, and Economic Security Act’s (“CARES Act”) Paycheck Protection Program (“PPP”). Amounts outstanding under this Note bore interest at 1% per annum as of the date of disbursement. The Note was scheduled to mature in two years after the receipt of the loan proceeds. On June 16, 2021, the Company received the notice of forgiveness from the Small Business Administration for the full amount of the Note including all accrued interest.

The Company recognized the Note of $6.9 million as a deferred income liability during 2020 and fully amortized to other income in the condensed consolidated income statements for the nine months ended September 30, 2020, as the related expenses it was intended to offset were incurred from April 2020 to June 2020.

Employee Retention Credit

The Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted December 27, 2020, made a number of changes to the employee retention tax credits previously made available under the CARES Act, including modifying and extending the Employee Retention Credit ("ERC") through December 31, 2021. As a result of the new legislation, eligible employers can now claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees after December 31, 2020 through December 31, 2021. This resulted in an ERC of $4.8 million for the nine months ended September 30, 2021, $3.2 million of which has been received as of the third quarter 2021 and the remaining $1.6 million is expected to be received during the fourth quarter 2021. The Company will continue to monitor the availability of the ERC for the fourth quarter of 2021 which, if available, would be received during the first quarter of 2022.

Basic net loss per share is computed by dividing net loss attributable to ION by the weighted average number of common shares outstanding during the period. In computing diluted net income per share, basic net income per share is adjusted based on the assumption that dilutive restricted stock and restricted stock unit awards have vested and outstanding dilutive stock options have been exercised and the aggregate proceeds were used to reacquire common stock using the average price of such common stock for the period. The total number of shares issuable pursuant to outstanding stock options at  September 30, 2021 and 2020 of 405,070 and 569,673, respectively, were excluded as their inclusion would have an anti-dilutive effect. The total number of shares issuable pursuant to restricted stock unit awards outstanding at September 30, 2021 and 2020 of 1,134,617 and 762,277, respectively, were excluded as their inclusion would have an anti-dilutive effect.

The Company maintains a valuation allowance for substantially all of its deferred tax assets. A valuation allowance is established or maintained when it is “more likely than not” that all or a portion of deferred tax assets will not be realized. Based on all available positive and negative evidence, the Company believed that it is more likely than not that the Company's deferred tax assets will not be realized. A significant item of objectively verifiable negative evidence is the substantial doubt that the Company will continue as a going concern within the next twelve months. The Company will continue to record a valuation allowance until there is sufficient evidence to warrant reversal, including the removal of the substantial doubt that the Company will continue as a going concern.

The tax provision for the nine months ended September 30, 2021 has been calculated based on actual tax expense incurred during the period. Given the current uncertainty in expected income generated in various foreign jurisdictions, where tax rates can vary greatly, the Company’s actual tax rate is the best estimate of the year-to-date tax expense. The Company’s effective tax rates for the three and nine months ended September 30, 2021 and 2020 were negatively impacted by the change in valuation allowance related to U.S. operating losses for which the Company cannot currently recognize a tax benefit. The Company’s income tax expense for the nine months ended September 30, 2021 and 2020 of $5.6 million and $10.0 million primarily relates to results from the Company’s non-U.S. businesses, including $2.2 million of valuation allowance for the nine months ended September 30, 2020.

In response to the global pandemic related to COVID-19, the President of the United States signed into law the CARES Act on March 27, 2020. The CARES Act provides numerous relief provisions for corporate taxpayers, including modifications of the utilization limitations on net operating losses, favorable expansions of the deduction for business interest expense under Internal Revenue Code Section 163(j), and the ability to accelerate timing of refundable AMT credits. For the nine months ended September 30, 2021 and 2020, there were no material tax impacts to the Company's condensed consolidated financial statements as it relates to COVID-19 measures. The Company continues to monitor additional guidance issued by the U.S. Treasury Department, the Internal Revenue Services ("IRS") and others.

At September 30, 2021, the Company has approximately $0.4 million of unrecognized tax benefits and does not expect to recognize significant increases in unrecognized tax benefits during the next twelve-month period. Interest and penalties, if any, related to unrecognized tax benefits are recorded in income tax expense.

At September 30, 2021, the Company’s U.S. federal tax returns for 2017 and subsequent years remain subject to examination by tax authorities. In the Company’s foreign tax jurisdictions, tax returns for 2016 and subsequent years generally remain open to examination.

In July 2018, the Company prevailed in an arbitration that it initiated against the Indian Directorate General of Hydrocarbons (“DGH”) relating to the Company’s ability to continue to license data under the Company’s IndiaSPAN program. The DGH filed a lawsuit in court in India to vacate the arbitration award; in connection with that lawsuit, the Company was ordered to escrow approximately $4.5 million in sales proceeds that it had received in respect of sales from the IndiaSPAN program, pending the outcome of the DGH’s challenge to the arbitration award. The Company challenged the escrow order, but on December 9, 2019, the Supreme Court of India ordered the Company to comply with it. The Company prepared a petition to file with the court to request that a March 2020 deadline to deposit approximately $4.5 million in escrow in early 2020 be extended due to the changes to the Company’s business, and to the markets, that have been spurred by the COVID-19 pandemic. The Company was unable to file the application because the courts in India were closed due to the pandemic (other than for emergencies), and were not accepting filings at that time. The Company served a copy of its draft petition on the DGH’s counsel on March 26, 2020 and intends to address the escrow issue in advance of the next hearing, which has been repeatedly delayed due to the COVID-19 pandemic. The Company prevailed on the merits in the arbitration and expects to have that award upheld in Indian court, which would result in release of the portion of any money escrowed by the Company. The DGH’s request to vacate the arbitration award is currently scheduled to be heard by the court in India on December 1, 2021. The Company has not escrowed the money as of  November 3, 2021.

The Company has been named in various other lawsuits or threatened actions that are incidental to its ordinary business. Litigation is inherently unpredictable. Any claims against the Company, whether meritorious or not, could be time-consuming, cause the Company to incur costs and expenses, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits and actions cannot be predicted with certainty. The Company currently believes that the ultimate resolution of these matters will not have a material adverse effect on its financial condition or results of operations.

Accounts Receivable

A summary of accounts receivable follows (in thousands):

Inventories

A summary of inventories follows (in thousands):

The Company's inventories relate to its Operations Optimization segment. No significant provision for excess and obsolete inventories was recognized during the nine months ended September 30, 2021 and 2020.  

Property, Plant and Equipment

^(a) Consists primarily of cable-based ocean bottom acquisition technologies that were fully impaired.

Total depreciation expense, including amortization of assets recorded under equipment finance leases, for the nine months ended September 30, 2021 and 2020 was $3.3 million and $2.9 million, respectively. No impairment charge was recognized during the nine months ended September 30, 2021 and 2020.

Multi-client Data Library

Total amortization expense for the nine months ended September 30, 2021 and 2020 was $22.0 million and $16.7 million, respectively. For the nine months ended September 30, 2021 and 2020, the Company recognized an impairment to multi-client data library of zero and $1.2 million, respectively, for programs with capitalized costs exceeding the remaining sales forecasts. 

Goodwill

The Company, following the qualitative consideration, assessed the relevant events and circumstances in evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. During the first quarter 2020, markets for oil and gas, as well as other commodities and equities, experienced significant volatility and price declines amid concerns over the economic effects of the COVID-19 pandemic. As a result, the Company’s stock price experienced a significant decline. Based on these facts, the Company performed a goodwill impairment test at March 31, 2020 to determine if it was more likely than not that the fair value of certain reporting units was less than their carrying value.

The Company, following the quantitative consideration, compared the fair value of each reporting unit against its carrying value. If the carrying value of the reporting unit exceeds the fair value, an impairment loss shall be recognized in an amount equal to that excess. The fair value of each reporting unit at March 31, 2020 was determined using a discounted cash flow model. The Company utilized a discount rate of 19% for both reporting units. The Company used reasonable assumptions based on historical data supplemented by anticipated market conditions and estimated growth rates. However, given the uncertainty in determining the assumptions underlying a discounted cash flow analysis, actual results may differ which could result in additional impairment charges in the future.

As a result of this assessment, the Company recorded an impairment charge of $4.2 million for the nine months ended September 30, 2020 related to its Optimization Software & Services reporting unit, which is included within the Operations Optimization segment. No impairment charge was recognized for the Optimization Software & Services reporting unit for the nine months ended September 30, 2021. No impairment charge was recognized for the E&P Technology Services reporting unit for the nine months ended September 30, 2021 and 2020.

Accrued Expenses

A summary of accrued expenses follows (in thousands):

Registered Direct Offering

On February 16, 2021, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) which provided for the sale and issuance by the Company of an aggregate of 2,990,001 shares (the “Shares”) of the Company’s common stock, $0.01 par value per share (the “Common Stock”) at an offering price of $3.50 per share for gross proceeds of approximately $10.5 million before deducting the placement agent’s fees and related offering expenses. The Securities Purchase Agreement contained customary representations, warranties and agreements by the Company, customary conditions to closing, indemnification obligations of the Company, other obligations of the parties and termination provisions. The Company used the net proceeds for working capital and general corporate purposes.

The Registered Direct Offering was made pursuant to a Registration Statement (No. 333-234606) on Form S-3, which was filed by the Company with the SEC on November 8, 2019, as amended on December 19, 2019, and declared effective on December 23, 2019.

Stock-Based Compensation

The total number of shares issued or reserved for future issuance under outstanding stock options at September 30, 2021 and 2020 was 405,070 and 569,673, respectively, and the total number of shares of restricted stock and shares reserved for restricted stock units outstanding at September 30, 2021 and 2020 was 1,134,617 and 762,277, respectively. The total number of stock appreciation rights (“SARs”) awards outstanding at September 30, 2021 and 2020 was 659,257 and 811,415, respectively. The following table presents a summary of the activity related to stock options, restricted stock, restricted stock unit awards and SARs awards for the nine months ended September 30, 2021:

Stock-based compensation expense recognized for the nine months ended September 30, 2021 and 2020, totaled $1.3 million and $1.6 million, respectively. SARs expense (credit) recognized for the nine months ended September 30, 2021 and 2020, totaled zero and $(1.0) million, respectively. 

SARs awards are considered liability awards as they are ultimately settled in cash. As such, these amounts are incrementally accrued in the liability section of the condensed consolidated balance sheets over the service period. All of the Company’s currently outstanding SARs awards achieve vesting through both a market condition and a service condition. SARs awards that are fully vested under both conditions are measured at intrinsic value (i.e. the difference between the market price on the last day of the quarter and the strike price of the awards times the number of awards vested and outstanding) and marked to market each quarter until settled. SARs awards that are not fully vested are incrementally accrued over the service period and adjusted to their fair value each quarter until settled based on a valuation model. As of September 30, 2021, all of the outstanding SARs awards are fully vested as a result of the Restructuring Transactions (as further discussed in Footnote 1, "Summary of Significant Account Policies - Old Notes Restructuring") and are measured at intrinsic value. Previously, the Company has calculated the fair value of each award using a Monte Carlo simulation model. The following assumptions were used as of December 31, 2020:

At-The-Market Equity Offering Program

On April 26, 2021, the Company filed a prospectus supplement under which it may sell up to $10.0 million of its common stock through an "at-the-market" equity offering program (the "ATM Program"). The Company is currently subject to baby-shelf rule limitation, which as of September 30, 2021, only $1.6 million of the ATM Program would have been available. The Company intends to use the net proceeds from sales under the ATM Program for working capital and general corporate purposes. The timing of any sales will depend on a variety of factors to be determined by the Company.

The Company leases offices, processing centers, warehouse spaces and, to a lesser extent, certain equipment. These leases have remaining terms of 1 year to 10 years, some of which have options to extend for up to 10 years and/or options to terminate within 1 year. The options to renew are not recognized as part of the Company’s right-of-use assets and operating lease liabilities as the Company is not reasonably certain that it will exercise these options.

In January 2020, the Company amended its existing Houston, Texas headquarters lease agreement by extending the lease term from September 30, 2023 to June 30, 2029 and surrendering back to the landlord floors for which the Company had previously vacated. In July 2020, the Company re-negotiated the above-mentioned lease agreement to modify the rent abatement period from October 2023 through February 2024 to July 2020 through March 2021.

In May 2020, the Company amended its Houston data center lease agreement to reflect changes in the monthly base rent throughout the term of the lease and extend the lease term three months to December 2025. The execution of this amendment and the amendment to the Houston, Texas headquarters lease resulted in the Company obtaining rent relief of approximately $4.0 million.

Total operating lease expense, including short-term lease expense was $6.9 million and $8.1 million for the nine months ended September 30, 2021 and 2020, respectively.

Equipment Finance Leases

The Company has entered into equipment finance leases that are due in installments for the purpose of financing the purchase of computer equipment. As of September 30, 2021, there were no outstanding balance related to the equipment finance leases. Interest under these leases was at a rate of 8.7% per annum, and the leases were collateralized by liens on the computer equipment. The assets are amortized over the lesser of their related lease terms or their estimated productive lives and such charges are reflected within depreciation expense.

Supplemental disclosure of cash flow information follows (in thousands):

The following table is a reconciliation of cash, cash equivalents, and restricted cash to the condensed consolidated balance sheets:

Authoritative guidance on fair value measurements defines fair value, establishes a framework for measuring fair value and stipulates the related disclosure requirements. The Company follows a three-level hierarchy, under which the fair value hierarchy prioritizes the inputs used to measure fair value. The three-tiered hierarchy is summarized as follows:

Level 1—Quoted prices in active markets for identical assets and liabilities.

Level 2—Other significant observable inputs including quoted prices or other market data for similar assets and liabilities in active markets or quoted prices for identical or similar assets and liabilities in less active markets.

Level 3—Significant unobservable inputs that require significant judgment for which there is little or no market data.

Due to their highly liquid nature, the amount of the Company’s other financial instruments, including cash and cash equivalents, restricted cash, accounts and unbilled receivables, accounts payable and accrued multi-client data library royalties, represent their approximate fair value.

The carrying amounts of the Company’s Old Notes at September 30, 2021 and December 31, 2020 were $7.1 million and $120.6 million, respectively, compared to its fair values of $7.2 million and $87.9 million at September 30, 2021 and December 31, 2020, respectively. The carrying amounts of the Company’s New Notes at September 30, 2021 were $116.2 compared to its fair values of $93.0 million at  September 30, 2021. Market conditions could cause an instrument to be reclassified from Level 1 to Level 2, or Level 2 to Level 3. The fair value of the Old Notes and New Notes was calculated using Level 2 inputs using significant observable data points for similar liabilities where estimated values are determined from observable transactions.

The carrying amount of any borrowings outstanding under the Credit Facility approximate fair value, as the interest rate is variable and reflective of market rates.

Fair value measurements are applied with respect to non-financial assets and liabilities on a non-recurring basis (e.g. when possible indicators of impairment exist), which would consist of measurements of goodwill, multi-client data library and property, plant and equipment. The fair value of these assets is determined based on valuation techniques using the best information available and may include comparable market data and discounted cash flow projections.

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

In this Form 10-Q, “ION Geophysical,” “ION,” “the company” (or, “the Company”), “we,” “our,” “ours” and “us” refer to ION Geophysical Corporation and its consolidated subsidiaries, except where the context otherwise requires or as otherwise indicated.

The information contained in this Quarterly Report on Form 10-Q contains references to trademarks, service marks and registered marks of ION and our subsidiaries, as indicated. Except where stated otherwise or unless the context otherwise requires, the term “DigiFIN” refers to DigiFIN®, a registered mark owned by ION or its affiliates, and the terms “Gemini”, “WellAlert”, “Marlin SmartPort” and “SailWing” refers to the Gemini™, WellAlert™, Marlin SmartPort™ and SailWing™ trademarks and service marks owned by ION.

Going Concern

On April 20, 2021, we completed the Restructuring Transactions (as further discussed below) that extended the maturity of the notes tendered in the Exchange Offer (as defined below) by four years to December 2025 and provided additional liquidity. While we completed the Restructuring Transactions and revenues in the third quarter significantly improved, the timing of the market recovery remains uncertain and overall revenues were lower than expected. Though the significant revenues generated during the third quarter are expected to have a positive impact on our near-term cash collection, it may not be sufficient to fund our operations and meet our debt and other obligations. This has raised substantial doubt about our ability to continue as a going concern. For further discussion regarding our fourth quarter cash requirements, refer to Liquidity and Capital Resources below. The condensed consolidated financial statements conform with accounting principles generally accepted in the United States of America ("GAAP") on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and satisfaction of liabilities and commitments in the normal course of business. Accordingly, our condensed consolidated financial statements exclude certain adjustments that might result if we are unable to continue as a going concern.

We will continue to explore additional funding opportunities through private or public equity transactions, debt financing or other capital sources such as the sale of non-strategic assets to meet our ongoing cash needs. In addition, we are implementing a significant cost reduction program, building on the over $40 million eliminated last year, in an effort to right size our business. Approximately $16 million of additional annualized savings were identified through a combination of both short-term and long-term reductions. In addition to maintaining our ongoing cost discipline, we will continue to identify opportunities for government relief such as employee retention credits. For further details, refer to Footnote 5, “Government Relief Funding” of Footnotes to Condensed Consolidated Financial Statements. This management plan reflects our continued focus on preserving cash and managing liquidity in the current uncertain macroeconomic environment.

On September 15, 2021, we announced that our Board of Directors initiated a process to evaluate a range of strategic alternatives to strengthen our financial position and maximize stakeholder value as we continue to assess conditions in the capital markets and right size the business. These strategic alternatives include, among others, a sale or other business combination transaction, sales of assets, private or public equity transactions, debt financing, or some combination of these alternatives.

This process is ongoing and there can be no assurance that our efforts will be successful. If we are unable to significantly increase our revenues and cash collections in the fourth quarter or raise additional funds through equity issuances, further debt financing arrangements, sales of assets or through other means of preserving cash through cost reduction initiatives, we would be unable to continue as a going concern. For further discussion regarding our near-term cash requirements, refer to Liquidity and Capital Resources below.

Old Notes Restructuring

COVID-19 Business Impact and Response

The COVID-19 pandemic caused the global economy to enter a recessionary period starting in the second quarter of 2020. During 2020, the exploration and production (“E&P”) industry faced the dual impact of demand deterioration from COVID-19 and market oversupply from increased production, which caused oil and natural gas prices to decline significantly for most of 2020. The sharp commodity price decline triggered E&P companies to reduce budgets by approximately 25%. Exploration offerings and data purchases are often discretionary and, therefore, receive disproportionately higher reductions than overall budget cuts. Consequently, there has been a material slowdown in offshore seismic spending since second quarter of 2020, and while the market remains uncertain, there are signs of sequential improvement and gradual market recovery. 

In January 2021, the Biden Administration ordered an indefinite moratorium on new U.S. oil and gas leasing and drilling permits on federal lands onshore and offshore waters. Management believes this will have a negligible impact on our business given ION's diversified global footprint and international offshore focus. Should the moratorium result in longer-term change, this could drive large scale E&P company portfolio investment more towards international offshore, which would be well aligned with our offerings.

Our management expects continued portfolio rationalization and high grading as E&P companies seek to find the best return on investment opportunities to meet oil and gas demand in the next decade. Near-term, due to the impact of the COVID-19 pandemic, project high grading will likely be more acute due to budget reductions. Over the last several years, we strategically shifted our portfolio closer to the reservoir, where revenue tends to be higher and more consistent. New Venture data acquisition offshore and Software and related personnel-based offshore services are expected to continue to be most impacted by COVID-19 travel restrictions. While offshore operations have been temporarily impacted by travel restrictions, we believe the demand for digitalization technologies will remain strong. In some cases, ION technology is expected to be more relevant and valuable in the current environment, such as offerings that facilitate remote working.

We continue to work closely with our clients to understand their budgets and spending priorities and to scale our business appropriately. We partially mitigated the impact of the current macroeconomic environment by fully benefiting from the structural changes and associated cost reductions through salary cuts of approximately $40 million, reduced capital expenditures, renegotiation of our leases and application for various government assistance programs, among others. In addition, we are implementing a further cost reduction program of approximately $16 million of annualized savings identified through a combination of both short-term and long-term reductions in an effort to right size our business. The management plan reflects our continued focus on preserving cash and managing liquidity in the current uncertain macroeconomic environment.

Our Business

ION is an innovative, asset light global technology company that delivers powerful data-driven decision-making offerings to offshore energy and maritime operations markets. We are entering a fourth industrial revolution where technology is fundamentally changing how decisions are made. Decision-making is shifting from what was historically an art to a science. Data, analytics and digitalization provide a step-change opportunity to translate information into insights, enabling our clients to enhance decisions and returns.

We have been a leading technology innovator for over 50 years. While the traditional focus of our technology has been on the E&P industry, we are now diversifying our business into new markets such as energy logistics, port management and maritime monitoring. Our offerings are focused on improving subsurface knowledge to enhance E&P decision-making and improving situational awareness to optimize offshore operations. We serve customers in most major energy producing regions of the world from strategically located offices. Our businesses are influenced by global spending primarily driven by our customers near and long-term commodity demand forecast and outlook for crude oil prices. The global economy is improving and commodity prices have rebounded above pre-pandemic levels, averaging over $80 per barrel during October 2021. However, energy companies’ capital discipline remains firmly in place and management expects the seismic market to continue gradually improving yet remain challenging in the near-term.

The Company is publicly listed on the New York Stock Exchange under the ticker IO. We are headquartered in Houston, Texas with regional offices around the world. We have approximately 360 employees, 44% of whom are in technical roles and 22% have advanced degrees.

We provide our services and products through two business segments: E&P Technology & Services and Operations Optimization. In addition, we have a 49% ownership interest in INOVA Geophysical Equipment Limited (“INOVA Geophysical” or “INOVA”), a joint venture with BGP Inc. (“BGP”), a subsidiary of China National Petroleum Corporation. BGP owns the remaining 51% equity interest in INOVA. We wrote our investment in INOVA down to zero in 2014. See further discussion below on our agreement to sell our interest in INOVA.

Our E&P Technology & Services segment creates digital data assets and delivers services to help E&P companies improve decision-making, reduce risk and maximize value. Across the E&P lifecycle, our E&P offerings focus on driving customer decisions, such as which blocks to bid on and for how much, how to maximize portfolio value, where to drill wells or how to optimize production.

Our Operations Optimization segment develops mission-critical subscription offerings and provides engineering services that enable operational control and optimization offshore. This segment is comprised of our Optimization Software & Services and Devices offerings. Our hardware and software offerings facilitate some of the largest man-made mobile operations and in some of the harshest conditions.

We historically conducted our land seismic equipment business through INOVA, which manufactures land seismic data acquisition systems, digital sensors, vibroseis vehicles (i.e., vibrator trucks), and energy source controllers. Since March 2020, we have entertained discussions with various parties to sell our 49% ownership interest in our INOVA joint venture.

E&P Technology & Services. Our offerings are designed to help E&P companies improve decision-making, reduce risk and maximize value. Within our E&P Technology and Services segment, there are two synergistic groups: Imaging and Reservoir Services and Ventures.

While our Imaging and Reservoir Services group processes and images data for customers on a proprietary basis, the majority of these resources support our higher potential return multi-client business. The proprietary work we take on is complex, where our advanced technology is valued and where we closely collaborate with our customers to solve their toughest challenges. We maintain approximately 19 petabytes of digital seismic data storage through our global data centers, including a core data center located in Houston. We utilize a globally distributed network of Linux-cluster processing centers in combination with our major hubs in Houston and London to process seismic data using advanced, proprietary algorithms and workflows.

Our Ventures group leverages the geoscience skills of the Imaging and Reservoir Services group to create global digital data assets that are licensed to multiple E&P companies to optimize their investment decisions. Our global data library consists of over 745,000 km of 2D and over 410,000 sq km of 3D multi-client seismic data in virtually all major offshore petroleum provinces. Ventures provides services to manage multi-client or proprietary surveys, from survey planning and design to data acquisition and management, to final subsurface imaging and reservoir characterization. We focus on the technologically intensive components of the image development process, such as survey planning and design, and data processing and interpretation, while outsourcing asset-intensive components (such as field acquisition) to experienced contractors.

Occasionally we develop proprietary technology solutions that fill a gap we have identified in the market and support our multi-client program development efforts.  For example, previously we created an under-ice acquisition solution to collect data in the Arctic and Marlin™ was initially developed to help manage our own complex survey operations. In 2020, we commercialized Gemini™ extended frequency source technology. Gemini’s unique design efficiently supports substantially improved data quality and lower environmental impact desired by the industry. This important ingredient to enhancing subsurface knowledge differentiates ION as we expand into the larger 3D multi-client new acquisition market while maintaining our asset light approach.

We offer our services to customers on both a proprietary and multi-client (non-exclusive) basis. In both cases, a majority of our survey costs are generally pre-funded by our customers, limiting our cost exposure. The period during which our multi-client surveys are being designed, acquired or processed is referred to as the “New Venture” phase. Once the New Venture phase is completed, the surveys become part of our Data Library. For proprietary services, the customer has exclusive ownership of the data. For multi-client surveys, we generally retain ownership of our long-term exclusive marketing rights to the data and receive ongoing revenue from subsequent data license sales.

We invested $22.3 million in our multi-client data library during the first nine months of 2021 and we expect investments in our multi-client data library to be in the range of $30.0 million to $35.0 million for 2021 (dependent upon the level of pre-funding or underwriting by our customers) compared to the $27.2 million invested in 2020. Whether remaining planned expenditures will be spent in 2021 depends on industry conditions, project approvals and schedules, and careful monitoring of our liquidity.

At September 30, 2021, our E&P Technology & Services segment backlog, which consists of commitments for (i) imaging and reservoir services work and (ii) new venture projects (both multi-client and proprietary) by our Ventures group underwritten by our customers, was $12.0 million compared to $19.7 million at December 31, 2020 and $17.7 million at September 30, 2020. The decline in our backlog resulted from revenues recognized as the second phase of our Mid North Sea High 3D multi-client program in the North Sea wrapped up this quarter. We anticipate that most of our backlog will be recognized as revenue during the next two quarters, providing momentum heading into the fourth quarter of 2021. 

Over the last five years, we have made an effort to diversify our offerings across the E&P life cycle and move closer to the reservoir, where capital investment tends to be higher and more consistent. Historically, our data library was largely 2D and exploration focused, which limited our revenues to approximately 3% of a $2.0 to $3.0 billion-dollar offshore multi-client market. In 2020, we entered the 3D multi-client new acquisition market, where revenue and earnings potential are at least five times a typical new 2D exploration program. This strategy shift builds on our 3D multi-client reimaging success and leverages our tier 1 imaging and new Gemini seismic source technology.

Operations Optimization. Our Operations Optimization segment develops mission-critical software and technology that enable operational control and optimization offshore. Our advanced systems improve situational awareness, communication and risk management to enable rapid, informed decisions in challenging offshore environments. Our industry-leading mission management, navigation, communications and sensing technologies enable safer, more efficient operations. While we have been focused on diversifying our offerings outside our core market for some time, it has become increasingly important given the slowdown in seismic vessel activity offshore. We are leveraging our technologies and core competencies across Software and Devices to optimize decision-making in new maritime markets, such as port operations, energy logistics and real-time infrastructure monitoring.

This segment is comprised of our Optimization Software & Services and Devices offerings. 

Our Optimization Software & Services group provides survey design, command and control software systems and related services for marine towed streamer and seabed operations. We are market leaders in our core business and adapted our platform to more broadly optimize operations beyond our core market. Our software offerings leverage a leading data integration platform to control and optimize operations. Engineering services experts deliver in-field optimization services, equipment maintenance and training to maximize value from our offerings.

Our software is focused on creating high value information that drives efficiency and related resource utilization, and reductions in HSE exposure and greenhouse gas emissions. We are expanding our Marlin software to optimize maritime detection, port management, and energy logistics markets. Marlin is the only system that links vessel plans and schedules to live offshore activities, providing greater control and transparency in the management of offshore operations. By monitoring plans and providing feedback in real time, clients can minimize fuel consumption, decrease emissions and operate with just-in-time efficiency.

ION continued to advance its diversification strategy in new maritime markets, most recently securing a competitive tender to supply Marlin SmartPort to 17 of CalMac Ferries' ports and ferry terminals in December 2020.

Our Devices group develops intelligent hardware and devices integrated with our software to optimize operations. Our Devices group develops, manufactures and repairs marine towed streamer and seabed data acquisition technology, sensors and compasses that have been deployed in marine robotics, defense, E&P and other commercial applications.

Our Devices diversification strategy is to develop real-time monitoring solutions that improve the safety and environmental compliance of offshore oil and gas operations. WellAlert™ leverages our core competencies, targets a growing market associated with sustainability and aligns with our strategy to provide decision support data and analytics. Clients are seeking advancements in technology to cost-effectively shift from reactive to proactive systems that provide more frequent, accurate measurements to assure safe operating environments. Our solution integrates sensing and communications technologies to monitor temporarily plugged and abandoned wells. 

It is our view that technologies that provide a competitive advantage through improved imaging, lower costs, higher productivity, or enhanced safety will continue to be valued in the market. We believe our newest technologies will continue to attract customer interest because these technologies are designed to deliver those desirable attributes.

INOVA Geophysical. INOVA manufactures land acquisition systems, land source products, vibroseis vehicles, and source controllers and multicomponent sensors.

Key Financial Metrics

The table below provides an overview of key financial metrics for our company as a whole and our two business segments for the three and nine months ended September 30, 2021, compared to the same period of 2020. 

For a discussion of factors that could impact our future operating results and financial condition, see (i) Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2020, and (ii) Item 1A. “Risk Factors” in Part II of this Form 10-Q.

Results of Operations

Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020

Our consolidated net revenues of $44.4 million for the three months ended September 30, 2021 (the “Current Quarter”) increased by $28.2 million, or 173%, compared to consolidated net revenues of $16.2 million for the three months ended September 30, 2020 (the “Comparable Quarter”). Our total gross margin was 50% in the Current Quarter, as compared to 8% in the Comparable Quarter. For the Current Quarter, our income from operations was $6.8 million, compared to a loss from operations of $11.2 million for the Comparable Quarter.

Net loss attributable to ION for the Current Quarter was $0.5 million, or $0.02 loss per share, compared to $16.6 million, or $1.16 loss per share, for the Comparable Quarter.

Net Revenues, Gross Profits and Gross Margins

E&P Technology & Services — Net revenues for the Current Quarter increased by $25.7 million, or 255%, to $35.8 million, compared to $10.1 million for the Comparable Quarter. Within the E&P Technology & Services segment, total multi-client net revenues were $32.5 million, an over 400% increase primarily due to sales of newly reimaged 3D data offshore Brazil and our new 3D programs in the North Sea. Imaging and Reservoir Services net revenues were $3.3 million, a decrease of $0.5 million compared to the Comparable Quarter due to lower proprietary activity. The Current Quarter reflects a gross profit of $17.9 million, representing a 50% gross margin, compared to a gross loss of $1.1 million, or (11)% gross margin, in the Comparable Quarter. Changes in gross profit and margin were due to the increase in our net revenues as discussed above.

Operations Optimization — Net revenues for the Current Quarter increased by $2.5 million, or 41% to $8.6 million, compared to $6.1 million for the Comparable Quarter. Optimization Software & Services net revenues for the Current Quarter increased by $0.8 million, or 27% to $3.8 million due to increased seismic vessel activity offshore. Devices net revenues for the Current Quarter increased by $1.7 million, or 55%, to $4.8 million, compared to $3.1 million for the Comparable Quarter primarily due to higher sales of towed streamer equipment spares. The Current Quarter reflects a gross profit of $4.3 million, representing a 50% gross margin compared to a gross profit of $2.4 million, representing a 39% gross margin for the Comparable Quarter. 

Operating Expenses

Research, Development and Engineering — Research, development and engineering expenses were $3.2 million for the Current Quarter, an increase of $0.3 million, or 9% compared to $2.9 million for the Comparable Quarter. We continue to invest in imaging algorithms and infrastructure, devices and software. We see significant long-term potential for investing in technologies that improve image quality, safety and productivity.

Marketing and Sales — Marketing and sales expenses were $3.1 million for the Current Quarter, an increase of $0.3 million, or 12% compared to $2.8 million for the Comparable Quarter primarily due to increase in commission expense during the Current Quarter.

General, Administrative and Other Operating Expenses — General, administrative and other operating expenses were $9.2 million for the Current Quarter, an increase of $2.5 million, or 37% compared to $6.7 million for the Comparable Quarter primarily due to an increase in severance expense of $1.9 million as well as higher professional fees relates to our evaluation of strategic alternatives during the Current Quarter.

Other Items

Interest Expense, Net — Interest expense, net, was $2.7 million for the Current Quarter compared to $3.7 million for the Comparable Quarter. The Current Quarter includes a credit of $1.0 million of previously fully reserved interest income received from INOVA. For additional information, please refer to “Liquidity and Capital Resources — Sources of Capital” below.

Income Tax Expense — Income tax expense for the Current Quarter was $3.6 million compared to $1.1 million for the Comparable Quarter. The income tax expense for the Current Quarter and Comparable Quarter primarily relates to results by our non-U.S. business in certain foreign subsidiaries. Our effective tax rates for the Current Quarter and Comparable Quarter were impacted by the change in valuation allowances related to U.S and certain foreign operating losses. Due to the impact of the valuation allowances on tax expense, our effective tax rates are not meaningful for all periods presented. See further discussion of establishment of the deferred tax valuation allowance at Footnote 7 “Income Taxes” of Footnotes to Condensed Consolidated Financial Statements.

Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020

Our consolidated net revenues of $78.1 million for the nine months ended September 30, 2021 (the “Current Period”) decreased by $17.3 million, or 18%, compared to consolidated net revenues of $95.4 million for the nine months ended September 30, 2020 (the “Comparable Period”). While the revenues generated during the Current Quarter significantly increased compared to the Comparable Quarter, the increase was not enough to offset a one-time significant data library sale during the first quarter of 2020. Our total gross margin was 34% in the Current Period, as compared to 36% in the Comparable Period. For the Current Period, our loss from operations was $10.8 million, compared to $10.3 million for the Comparable Period.

Net loss attributable to ION for the Current Period was $31.2 million, or $1.33 loss per share, compared to $24.1 million, or $1.69 loss per share, for the Comparable Period.

Net Revenues, Gross Profits and Gross Margins

E&P Technology & Services — Net revenues for the Current Period decreased by $17.0 million, or 24%, to $54.8 million, compared to $71.8 million for the Comparable Period primarily due to lower volume of data library sales, including a significant 2D data library that closed in the Comparable Period and was not repeated during the Current Period. Within the E&P Technology & Services segment, total multi-client net revenues were $45.4 million, a decrease of 24% primarily due to a lower volume of data library sales, including a significant 2D data library deal that was closed in the Comparable Period that was not repeated during the Current Period. Imaging and Reservoir Services net revenues were $9.4 million, a decrease of $3.0 million compared to the Comparable Period due to lower proprietary activity. The Current Period reflects a gross income of $17.3 million, representing a 32% gross margin, compared to $24.9 million, or 35% gross margin, in the Comparable Period. Changes in gross profit and margin were due to decrease in our net revenues as discussed above.

Operations Optimization — Net revenues for the Current Period of $23.4 million were flat compared to the Comparable Period. Optimization Software & Services net revenues for the Current Period decreased by $0.8 million, or 7% to $10.0 million, compared to $10.8 million for the Comparable Period due to new sales and leases of Gator command and control system that did not repeat during the Current Period. Devices net revenues for the Current Period increased by $0.7 million, or 6%, to $13.4 million, compared to $12.7 million for the Comparable Period primarily due to higher sales of towed streamer equipment spares. The Current Period reflects a gross profit of $9.4 million, representing a 40% gross margin compared to a gross profit of $9.3 million, representing a 40% gross margin for the Comparable Period. 

Operating Expenses

Research, Development and Engineering — Research, development and engineering expenses were $9.5 million for the Current Period, a decrease of $0.4 million, or 4% compared to $9.9 million for the Comparable Period. We continue to invest in imaging algorithms and infrastructure, devices and software. We see significant long-term potential for investing in technologies that improve sustainability, image quality, safety and productivity.

Marketing and Sales — Marketing and sales expenses were $9.1 million for the Current Period, an increase of $0.2 million, or 2% compared to $8.9 million for the Comparable Period.