Item 1. Business
ION is an innovative, asset light global technology company that delivers powerful data-driven decision-making offerings to offshore energy, ports and defense industries. 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 to enhance decisions, gain a competitive edge and deliver superior returns.
We have been a leading technology innovator for over 50 years. While the traditional focus of our cutting-edge technology has been on the exploration and production (“E&P”) industry, we are now broadening and diversifying our business into relevant adjacent markets such as offshore logistics, ports and harbors, defense and marine robotics. Our offerings are focused on improving subsurface knowledge to enhance E&P decision-making and enhancing situational awareness to optimize offshore operations. We have approximately 600 patents and pending patent applications in various countries around the world.
The Company is publicly listed on the New York Stock Exchange under the ticker IO. ION is headquartered in Houston, Texas with regional offices around the world. The company has approximately 500 employees, about half of whom are in technical roles and a quarter have advanced degrees.
During the first quarter of 2019, we consolidated our operating segments from three into two, eliminating the separate presentation of our Ocean Bottom Integrated Technologies segment. This consolidation aligns with our asset light business model and evolved strategy to commercialize 4Sea ocean bottom technologies instead of operating a crew.
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 our INOVA Geophysical Equipment Limited (“INOVA Geophysical,” or “INOVA”), a joint venture with BGP Inc. (“BGP”), a subsidiary of China National Petroleum Corporation (“CNPC”). BGP owns the remaining 51% equity 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. While we primarily sell to service providers, we began selling existing technology to new customers in E&P, ports and harbors, scientific, defense and academic industries.
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. We wrote our investment in INOVA down to zero in 2014.
Services and Products
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 three synergistic groups: Imaging Services, E&P Advisors and Ventures.
Our Imaging Services group provides advanced data processing and imaging services designed to maximize image quality and subsurface insights, helping E&P companies reduce exploration and production risk, evaluate and develop reservoirs, and increase production. Imaging Services continually develops and applies proprietary processing algorithms via its cutting-edge imaging engine to data owned or licensed by our customers to translate raw data into subsurface images. We continually enhance our novel workflows and invest in leading-edge infrastructure to efficiently deliver the best image quality.
While our Imaging 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, keeping our toolkit sharp. We maintain approximately 19 petabytes of digital seismic data storage in four 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 E&P Advisors group partners with E&P operators, energy industry regulators and capital institutions to capture and monetize E&P opportunities worldwide. This group’s strategy is to provide technical, commercial and strategic advice across the exploration and production value chain, working at basin, prospect and field scales. E&P Advisors couples ION’s proven technical capabilities with the industry’s best commercial and strategic minds to deliver fit-for-purpose solutions, employing a variety of commercial models specific to our clients’ needs. In addition, the group drives value in our multi-client library by providing program assurance by understanding the technical, commercial, strategic and operational landscape to optimize our investments and seamlessly extends Imaging Services’ workflows into the reservoir.
Our Ventures group leverages the world-class geoscience skills of both the Imaging Services and E&P Advisors groups 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 714,000 km of 2D and over 350,000 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.
We offer our services to customers on both a proprietary and multi-client (non-exclusive) basis. In both cases, a majority of our exposure to survey costs are generally pre-funded by our customers. 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, they 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 or long-term exclusive marketing rights to the data and receive ongoing revenue from subsequent data license sales.
Operations Optimization. Our Operations Optimization segment develops mission-critical subscription offerings and provides engineering services that enable operational control and optimization offshore. Our advanced systems improve situational awareness, communication and risk management to enable rapid and informed decisions in challenging offshore environments. Our industry-leading mission management, navigation, communications and sensing technologies enable the operations of modern 3D towed streamer vessels.
This segment is comprised of our Optimization Software & Services and Devices offerings. While we primarily sell to oil and gas service providers, we began selling existing technology to new customers in E&P, ports and harbors, scientific, defense and academic industries. Service providers rely on our industry-leading marine imaging systems and services to acquire the highest quality data - safely and efficiently - in both towed streamer and seabed operations. Our integrated technology platforms combined with advanced prediction tools enable safer, more efficient operations.
We also leverage our core competencies to develop custom solutions. Our capabilities include data management, navigation, software development, acoustics, sensing, telemetry, fluid dynamics, positioning and control devices and electrical and mechanical engineering expertise.
Our Optimization Software & Services group provides survey design, command and control software systems and related services for marine towed streamer and seabed operations. Our software business commands recurring, premium subscription revenues. We are market leaders in our core business and adapted our platform to more broadly optimize operations. 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.
Command & Control System - Our command and control software for towed streamer acquisition, Orca, integrates acquisition, planning, positioning, source and quality control systems into a seamless operation. Gator is our integrated navigation and data management system for multi-vessel ocean bottom services, electromagnetic and transition zone operations. Orca and Gator both have modules that enable in-field survey optimization. These modules are designed to enable improved, safer acquisition through analysis and prediction of sea currents integrated with the operational plan.
Survey Planning and Design - We offer software and consulting services for planning and supervising complex surveys, including for 4D (time lapse) and wide-azimuth. Our acquisition expertise and MESA software platform enables clients, including both E&P companies and service providers, to optimize survey efficiency, data quality and costs.
Optimization Software - Marlin is a cloud-based software designed to maximize the safety and efficiency of complex offshore operations by automatically integrating a variety of data sources in real-time with operational plans to improve situational awareness and decision making. Akin to air traffic control systems, Marlin enables multiple stakeholders to share and visualize vessel route plans, foresee and avoid conflicts between vessels and fixed assets, optimize schedules safely within a rules-based environment, and measure and improve asset performance.
Our Devices group develops intelligent equipment controlled by our software to optimize operations. Our Devices group develops, manufactures and repairs marine towed streamer and seabed data acquisition systems, sensors and compasses which have been deployed in marine robotics, defense, scientific, E&P and other commercial applications.
Marine Positioning Systems - Our marine towed streamer positioning system includes streamer cable depth control devices, lateral control devices, compasses, acoustic positioning systems and other auxiliary sensors. This equipment is designed to control the vertical and horizontal positioning of the streamer cables and provides acoustic, compass and depth measurements to allow processors to tie navigation and location data to geophysical data to determine the location of potential hydrocarbon reserves.
Towed Streamer Data Acquisition System - DigiSTREAMER enables customers to acquire low noise, cost-effective data in an environmentally-friendly manner with solid cables.
Ocean Bottom Data Acquisition Technologies - Ocean bottom data acquisition provides higher resolution imaging typically used for development rather than exploration objectives because it provides more detailed reservoir characteristics to optimize production. ION’s 4Sea ocean bottom system is designed to deliver a step change in economics, image quality, QHSE and final data delivery time, creating more value for the customers by providing information faster for critical decisions, such as determining drilling locations, fluid injections, etc. The system’s transformational architecture enables a paradigm shift in performance by centralizing operational data to power analytics and optimize decision-making. While the technology components can be licensed separately, maximum value is derived from a complete system. The Company is offering 4Sea components more broadly to the growing number of OBS service providers under recurring revenue commercial strategies.
Marine Diverter - SailWing is an innovative foil-based marine diverter for smart and efficient source towing. SailWing consists of a series of foils over ropes strung between the head float and the first source station. The foil sizes and number are easily configurable to accommodate a wide variety of survey requirements.
Analog Geophones - Analog geophones are sensors that measure acoustic energy reflected from rock layers in the Earth’s subsurface using a mechanical, coil-spring element. We manufacture and market a full suite of geophones and geophone test equipment that operate in most environments, including land surface, transition zone and downhole. Our geophones are used in other industries as well.
INOVA Geophysical. INOVA manufactures land acquisition systems, including the G3i HD, Hawk and Quantum recording platforms, land source products, including the AHV-IV series, UNIVIB®, and UNIVIB 2 vibroseis vehicles, and source controllers and multicomponent sensors, including the VectorSeis digital 3C receivers.
ION History
Founded in 1968 as Input/Output (“I/O”), ION began as a provider of highly specialized seismic source synchronization equipment. In 1988, the company introduced its first land system, System One, capable of recording large volumes of data more quickly, which helped the industry shift from 2D to 3D data. ION became publicly traded on the NASDAQ exchange in 1991, and was listed on the New York Stock Exchange in 1994 using the trading symbol "IO". Throughout the 1990s and 2000s, ION experienced growth through a number of acquisitions. In 2002, the company’s first BasinSPAN multi-client program was introduced, paving the way for a global data library. In September 2007, Input/Output officially changed its name to "ION" as part of a re-branding to better reflect the continuing evolution of the company from an equipment manufacturer to a broad-based, technology-focused seismic solutions provider.
E&P Subsurface Data Collection and Use
Since the 1930s, oil and gas companies have sought to reduce exploration risk by using seismic data to create an image of the Earth’s subsurface. Seismic imaging plays a fundamental role in hydrocarbon exploration and reservoir development by delineating structures, rock types and fluid locations in the subsurface. Our technologies, services and solutions are used by E&P companies to generate high-resolution images of the Earth’s subsurface to identify hydrocarbons and pinpoint drilling locations for wells and to monitor production from existing wells.
Typically, an E&P company engages the services of a geophysical acquisition contractor to develop a seismic survey design, secure permits, coordinate logistics, and acquire seismic data in a selected area. The E&P company generally relies on third parties, such as ION, to provide the contractor with equipment, navigation and data management software, and field support services necessary for data acquisition. After the data is collected, the same geophysical contractor, a third-party data processing company, or the E&P company itself will process the data using proprietary algorithms and workflows to create a series of seismic images. Geoscientists then interpret the data by reviewing the images of the subsurface and integrating the geophysical data with other geological and production information such as well logs or core information.
Seismic data is recorded when listening devices placed on the Earth’s surface, ocean bottom floor, or carried within the streamer cable of a towed streamer vessel, measure how long it takes for sound vibrations to echo off rock layers underground. For seismic data acquisition onshore, the acoustic energy producing the sound vibrations is generated by large vibroseis (vibrator) vehicles. In marine acquisition, the energy is provided by a series of source arrays that deliver compressed air into the water column. The acoustic energy propagates through the subsurface as a spherical wave front, or seismic wave. Interfaces between different types of rocks will both reflect and transmit this wave front. Onshore, the reflected signals return to the surface where they are measured by sensitive receivers that are analog coil-spring geophones. Offshore, the reflected signals are recorded by either hydrophones towed in an array behind a streamer acquisition vessel or by multicomponent geophones or micro electromechanical system sensors that are placed directly on the ocean floor. Once the recorded seismic energy is processed using advanced algorithms and workflows, images of the subsurface can be created to depict the structure, lithology (rock type), fracture patterns, and fluid content of subsurface horizons, highlighting the most promising places to drill for oil and natural gas. This processing also aids in engineering decisions, such as drilling and completion methods, as well as decisions affecting overall reservoir production and economic decisions relating to infrastructure and reserves in place.
Markets and Customers
Our core E&P market is in recovery and we are diversifying our revenues in other markets to help mitigate the impact of oil and gas market cycles. Our primary customers are E&P companies to whom we market and offer services, primarily multi-client seismic data programs from our Ventures group, data processing and imaging services from our Imaging Services group, as well as consulting services from our E&P Advisors and Optimization Software & Services group. In 2019, E&P companies accounted for approximately 73% of our total consolidated net revenues. Secondarily, seismic contractors purchase our towed streamer data acquisition systems and related equipment and software to collect data in accordance with their E&P company customers’ specifications or for their own seismic data libraries.
We are actively diversifying our software and hardware into adjacent markets, primarily focused on ports and harbors and defense industries. Ports and harbors are undergoing a digital transformation that is fundamentally changing how they operate and increasing efficiency. Tier 1 ports have been leading the digital transformation, and there's an emerging need for Tier 2 ports to do so as well to compete. New disruptive technologies, such as artificial intelligence, Internet of Things and Blockchain have the potential to transform port efficiency.
The defense industry also benefits from enhanced situational awareness and advanced technologies for mission management and threat detection and mitigation. Using Marlin as the mission control and decision optimization tool in defense exercises, we were able to track hostile divers and unmanned underwater vehicles and manage real-time mitigation actions in response to operation zone incursions, such as smart nets, remote operated vehicle (“ROV”) interception and shepherding of friendly assets via unmanned service vehicles.
A significant portion of our marketing effort is focused on areas outside of the United States. Foreign sales are subject to special risks inherent in doing business outside of the United States, including the risk of political instability, armed conflict, civil disturbances, currency fluctuations, embargo and governmental activities, customer credit risks and risk of non-compliance with U.S. and foreign laws, including tariff regulations and import/export restrictions.
We sell our services and products through a direct sales force consisting of employees and international third-party sales representatives responsible for key geographic areas. The majority of our foreign sales are denominated in U.S. dollars. During 2019, 2018 and 2017, sales to destinations outside of North America accounted for approximately 73%, 75% and 76% of our consolidated net revenues, respectively. Further, systems and equipment sold to domestic customers are frequently deployed internationally and, from time to time, certain foreign sales require export licenses.
Traditionally, our business has been seasonal, with strongest demand typically in the second half of our fiscal year.
For information concerning the geographic breakdown of our consolidated net revenues, see Footnote 3 “Segment and Geographic Information of Footnotes to Consolidated Financial Statements contained elsewhere in this Annual Report on Form 10-K for additional information.
Competition
The market for seismic services and products is highly competitive and characterized by frequent changes in technology.
Our Ventures group within our E&P Technology & Services segment faces competition in creating, developing and selling multi-client data libraries from a number of companies. CGG (an integrated geophysical company) and Schlumberger (a large integrated oilfield services company) shifted to an asset light strategy, joining TGS-NOPEC Geophysical Company ASA. Petroleum GeoServices ASA, Shearwater and Polarcus run acquisition crews and also compete in multi-client data acquisition. BGP operates in this space by primarily partnering with the aforementioned competitors to develop and sell multi-client data.
Our Imaging Services group within our E&P Technology & Services segment competes with companies that provide data processing services to E&P companies. See “Services and Products - E&P Technology & Services Segment.” While the barriers to enter this market are relatively low, we believe the barriers to compete at the higher end of the market where our efforts are focused - are significantly higher. At the higher end of this market, CGG and Schlumberger are our two primary competitors for advanced imaging services. Both of these companies are significantly larger than ION in terms of revenue, processing locations and sales, marketing and financial resources.
Our principal competitor for marine equipment is Sercel (a manufacturing subsidiary of CGG). Sercel has the advantage of being able to sell its products and services to its parent company that operates both land and marine crews, providing it with a significant and stable internal market and a greater ability to test new technology in the field. We also compete with other equipment companies on a product-by-product basis. Our ability to compete effectively in the manufacture and sale of seismic instruments and data acquisition systems depends principally upon continued technological innovation, as well as pricing, system reliability, reputation for quality and ability to deliver on schedule.
Some service providers design and manufacture acquisition technology in-house (or through a network of third-party vendors) to differentiate themselves. Although this technology competes directly with ours, it is not usually made available to other seismic acquisition contractors.
In the land seismic equipment market, where INOVA competes, the principal competitors are Sercel and Geospace Technologies. INOVA is a joint venture with BGP as a majority stake owner. BGP purchases land seismic equipment from both INOVA and competing land equipment suppliers.
Outside of our core market, we compete with a number of software and hardware technology companies. The market for ports and harbors and defense technologies tends to be very fragmented and with a range of huge multi-billion dollar competitors to new startups. The closest competitor to Marlin in ports and harbors is PortMaster, software developed by the Port of Rotterdam.
Our Strategy
The key elements of our business strategy are to:
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Leverage our technologies to create value through data capture, analysis and optimization to enhance companies’ critical decision-making abilities and returns. Data, analytics and digitalization provide a step-change opportunity to translate information into insights to enhance decisions, gain a competitive edge and deliver superior returns. As a result, decision-making is shifting from what was historically an art to a science. ION offerings are focused on improving E&P decision-making and optimizing offshore operations.
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Expand our E&P Technology & Services business, focusing on delivering value closer to the reservoir. Over the last 5 years, we have made an effort to diversify our offerings within the E&P life cycle and move closer to the reservoir. Historically known for our 2D programs, we entered the 3D multi-client market in 2014 by acquiring and processing our first survey offshore Ireland. Since then, we have expanded our 3D seismic data library considerably by purchasing existing seismic data and reimaging the data using our advanced data processing techniques and algorithms, such as our new Full Waveform Inversion (“FWI”). For the foreseeable future, we expect to continue investing in research and development and computing infrastructure for our data processing business and to support our multi-client projects. We believe shifting to more reservoir-focused E&P offerings will increase earnings and position our company better for E&P cycles.
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Expand our Operations Optimization business into relevant adjacent markets. While our traditional focus for technology has been on the E&P industry, we are broadening and diversifying our software and equipment businesses into relevant adjacent markets such as offshore logistics, defense and marine robotics. Adjacent markets broaden our opportunity to better monetize our return on technology investments while reducing our susceptibility to E&P cycles. We intend to derive a significant portion of revenues from these non-E&P markets over the next 5 years.
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Continue investing in advanced software and equipment technology to provide next generation services and products. Our industry is competitive and continually evolving, so we intend to continue investing in the development of new technologies to stay on the cutting-edge of innovation. A key element of our business strategy has been to understand the challenges faced in survey planning, data acquisition, processing, and interpretation and offshore operations. We will continue to develop and offer technology and services that enable us to work with clients to solve their unique challenges around the world. In particular, we intend to focus on the development of our 4Sea next generation ocean bottom seismic (“OBS”) technology, our Marlin operations optimization software, and continued advancement of our data processing and imaging workflows, such as FWI, with the goal of obtaining technical and market leadership in what we continue to believe are important and expanding markets. In 2019, our total investment in research and development and engineering was equal to approximately 11% of our total consolidated net revenues for the year.
Our Strengths
We believe that we are solidly positioned to successfully execute the key elements of our business strategy based on the following competitive strengths:
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We develop and leverage cutting-edge technology platforms to improve decision-making and profitability. Our cutting-edge data management and analysis platforms help derive insights from data we acquire to improve E&P decision-making, enhance reservoir management and optimize offshore operations. The data can be used to decide whether and how much to bid on a block, how to maximize production from a field, or how to optimize the safety and efficiency of complex maritime projects. Our operations optimization platform and imaging engine are the core underlying technology and we continually advance our complex algorithms to improve the resulting analysis.
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We focus on higher potential return offerings and creative business models to maximize shareholder value. We streamlined our business and focused on the areas with the highest potential returns because we believe every dollar invested should go further. In addition, we try to structure both the project financing and payment in a way to maximize profit, such as sharing in the success of a project.
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Our “asset light” strategy enables us to avoid significant fixed costs and remain financially flexible. We do not own a fleet of marine vessels and do not provide our own crews to acquire seismic data. We outsource seismic data acquisition activity to third parties that operate fleets of seismic vessels and equipment. This practice enables us to avoid fixed costs associated with these assets and personnel and to manage our business in a manner designed to afford us the flexibility to quickly scale up or down our capital investments based on E&P spending levels. We actively manage the costs of developing our multi-client data library business by having our customers partially pre-fund, or underwrite, the investment for any new project. Our target goal is to have a vast majority of the total cost of each new project’s data acquisition to be underwritten by our customers. We believe this conservative approach to data library investment is the most prudent way to reduce the impact of any sudden reduction in the demand for seismic data, giving us the flexibility to aggressively reduce cash outflows as we have successfully implemented in the current industry downturn.
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Our global footprint and diversified portfolio approach enable us to offset regional downturns or local slowdowns. Conducting business around the world has been and will continue to be a key component of our strategy. This global focus and diversified portfolio approach has been helpful in minimizing the impact of any regional or country-specific slowdown for short or extended periods of time. While the traditional focus of our cutting-edge technology has been on the E&P industry, we are now broadening and diversifying our business into relevant adjacent markets such as offshore logistics, defense and marine robotics. Adjacent markets broaden our opportunity to better monetize our return on technology investments while reducing our susceptibility to E&P cycles.
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We have a diversified and blue chip customer base. We provide services and products to a diverse, global customer base that includes many of the largest oil and gas and geophysical companies in the world, including National Oil Companies (“NOCs”) and International Oil Companies (“IOCs”). Whereas almost all of our revenues in the early 2000s were derived principally from seismic service providers, in 2019, E&P companies accounted for approximately 73% of our total consolidated net revenues.
Product Research and Development
Our ability to compete effectively depends principally upon continued innovation in our underlying technologies and the value we can provide to inform decisions. As such, the overall focus of our research and development efforts has remained on improving the quality and value of the data we provide and the subsurface images we generate. In particular, we have concentrated on enhancing the quality of the information that can be extracted from the subsurface images. Research and development efforts targeted a range of new technologies.
The Imaging Services group continued to enhance its high-end workflows, such as FWI, and invest in infrastructure to efficiently deliver Tier 1 image quality.
The Optimization Software & Services group continues enhancing core survey design and command and control software while broadening Marlin’s capabilities for adjacent markets, primarily for ports and harbors.
In 2019, development within Devices group was focused on the new in-water control device, SailWing, including sea trials and integration with Orca and Gator software, as well as further development of our successful towed streamer positioning products, including the automated Streamer Recovery Device and rechargeable battery option. We continue to invest in the development of new sensors applicable within and outside our core business. In 2020, development will be primarily focused on new technologies for adjacent markets and sustaining our existing portfolio of technologies.
As many of these new services and products are under development and, as the development cycles from initial conception to commercial introduction can extend over a number of years, their commercial feasibility or degree of commercial acceptance may not yet be established. No assurance can be given concerning the successful development of any new service or product, any enhancements to them, the specific timing of their release or their level of acceptance in the marketplace.
Intellectual Property
We rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary technologies. We have approximately 600 patents and pending patent applications, including filings in international jurisdictions with respect to the same kinds of technologies. Although our portfolio of patents is considered important to our operations, and particular patents may be material to specific business lines, no one patent is considered essential to our consolidated business operations.
Our patents, copyrights and trademarks offer us only limited protection. Our competitors may attempt to copy aspects of our products despite our efforts to protect our proprietary rights, or may design around the proprietary features of our products. Policing unauthorized use of our proprietary rights is difficult, and we may be unable to determine the extent to which such use occurs. Our difficulties are compounded in certain foreign countries where the laws do not offer as much protection for proprietary rights as the laws of the United States, including the potential for adverse decisions by judicial or administrative bodies in foreign countries with unpredictable or corrupt judicial systems. From time to time, third parties inquire and claim that we have infringed upon their intellectual property rights and we make similar inquiries and claims to third parties. Material intellectual property litigation is discussed in detail in Item 3. “Legal Proceedings.”
The information contained in this Annual Report on Form 10-K 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 terms “VectorSeis,” “DigiFIN,” “Hawk,” “Orca,” “G3i,” “WiBand,”,“UNIVIB”, “MESA,” and “VectorSeis” refer to the VECTORSEIS®, DigiFIN®, HAWK®, ORCA®, G3I®, WiBand®, UNIVIB®, MESA®, and VectorSeis® registered marks owned by ION or INOVA Geophysical or their affiliates, and the terms “BasinSPAN,” “DigiBIRD II,” “Gator,” “AHV-IV,” “ResSCAN,” “SailWing,” “Marlin”, “SimSurvey” and “4Sea” refer to the BasinSPAN™, DigiBIRD II™, GATOR™, AHV-IV™, ResSCAN™, SailWing™, Marlin™, SimSurvey™, and 4Sea™ trademarks and service marks owned by ION or INOVA Geophysical or their affiliates.
Regulatory Matters
Our operations are subject to various international conventions, laws and regulations in the countries in which we operate, including laws and regulations relating to the importation of and operation of seismic equipment, currency conversions and repatriation, oil and gas exploration and development, taxation of offshore earnings and earnings of expatriate personnel, environmental protection, the use of local employees and suppliers by foreign contractors and duties on the importation and exportation of equipment. Our operations are subject to government policies and product certification requirements worldwide. Governments in some foreign countries have become increasingly active in regulating the companies holding concessions, the exploration for oil and gas and other aspects of the oil and gas industries in their countries. In some areas of the world, this governmental activity has adversely affected the amount of exploration and development work done by major oil and gas companies and may continue to do so. Operations in less developed countries can be subject to legal systems that are not as mature or predictable as those in more developed countries, which can lead to greater uncertainty in legal matters and proceedings (including the potential for adverse decisions by judicial or administrative bodies in foreign countries with unpredictable or corrupt judicial systems). We are required to consent to home country jurisdiction in many of our contracts with foreign state-owned companies, particularly those countries where our data are acquired.
Changes in these conventions, regulations, policies or requirements could affect the demand for our services and products or result in the need to modify them, which may involve substantial costs or delays in sales and could have an adverse effect on our future operating results. Our export activities are subject to extensive and evolving trade regulations. Certain countries are subject to trade restrictions, embargoes and sanctions imposed by the U.S. government. These restrictions and sanctions prohibit or limit us from participating in certain business activities in those countries.
Our operations are also subject to numerous local, state and federal laws and regulations in the United States and in foreign jurisdictions concerning the containment and disposal of hazardous materials, the remediation of contaminated properties and the protection of the environment. While the industry has experienced an increase in general environmental regulation worldwide and laws and regulations protecting the environment have generally become more stringent, we do not believe compliance with these regulations has resulted in a material adverse effect on our business or results of operations, and we do not currently foresee the need for significant expenditures in order to be able to remain compliant in all material respects with current environmental protection laws. Regulations in this area are subject to change, and there can be no assurance that future laws or regulations will not have a material adverse effect on us.
Our customers’ operations are also significantly impacted in other respects by laws and regulations concerning the protection of the environment and endangered species. To the extent that our customers’ operations are disrupted by future laws and regulations, our business and results of operations may be materially adversely affected.
Employees
As of December 31, 2019, we had 519 regular, full-time employees, 295 of whom were located in the U.S. From time to time and on an as-needed basis, we supplement our regular workforce with individuals that we hire temporarily or retain as independent contractors in order to meet certain internal manufacturing or other business needs. Our U.S. employees are not represented by any collective bargaining agreement, and we have never experienced a labor-related work stoppage. We believe that our employee relations are satisfactory.
Financial Information by Segment and Geographic Area
For a discussion of financial information by business segment and geographic area, see Footnote 3 “Segment and Geographic Information” of Footnotes to Consolidated Financial Statements.
Available Information
Our executive headquarters are located at 2105 CityWest Boulevard, Suite 100, Houston, Texas 77042-2839. Our telephone number is (281) 933-3339. Our home page on the Internet is www.iongeo.com. We make our website content available for information purposes only. Unless specifically incorporated by reference in this Annual Report on Form 10-K, information that you may find on our website is not part of this report.
In portions of this Annual Report on Form 10-K, we incorporate by reference information from parts of other documents filed with the Securities and Exchange Commission (“SEC”). The SEC allows us to disclose important information by referring to it in this manner, and you should review this information. We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, annual reports to stockholders, and proxy statements for our stockholders’ meetings, as well as any amendments, available free of charge through our website as soon as reasonably practicable after we electronically file those materials with, or furnish them to, the SEC.
You can learn more about us by reviewing our SEC filings on our website. Our SEC reports can be accessed through the Investor Relations section on our website. The SEC also maintains a website at www.sec.gov that contains reports, proxy statements, and other information regarding SEC registrants, including our company.
Item 1A.
Item 1A. Risk Factors
This report contains or incorporates by reference statements concerning our future results and performance and other matters that are “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “would,” “should,” “intend,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of such terms or other comparable terminology. Examples of other forward-looking statements contained or incorporated by reference in this report include statements regarding:
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any additional damages or adverse rulings in the WesternGeco litigation and future potential adverse effects on our financial results and liquidity;
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future levels of capital expenditures of our customers for seismic activities;
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future oil and gas commodity prices;
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the effects of current and future worldwide economic conditions (particularly in developing countries) and demand for oil and natural gas and seismic equipment and services;
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future cash needs and availability of cash to fund our operations and pay our obligations;
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the effects of current and future unrest in the Middle East, North Africa and other regions;
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the timing of anticipated revenues and the recognition of those revenues for financial accounting purposes;
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the effects of ongoing and future industry consolidation;
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the timing of future revenue realization of anticipated orders for multi-client survey projects and data processing work in our E&P Technology & Services segment;
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future levels of our capital expenditures;
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future government laws or regulations pertaining to the oil and gas industry, including trade restrictions, embargoes and sanctions imposed by the U.S. government;
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future government actions that may result in the deprivation of our contractual rights, including the potential for adverse decisions by judicial or administrative bodies in foreign countries with unpredictable or corrupt judicial systems.
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expected net revenues, income from operations and net income;
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expected gross margins for our services and products;
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future seismic industry fundamentals, including future demand for seismic services and equipment;
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future benefits to our customers to be derived from new services and products;
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future benefits to be derived from our investments in technologies, joint ventures and acquired companies;
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future growth rates for our services and products;
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the degree and rate of future market acceptance of our new services and products;
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expectations regarding E&P companies and seismic contractor end-users purchasing our more technologically-advanced services and products;
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anticipated timing and success of commercialization and capabilities of services and products under development and start-up costs associated with their development;
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future opportunities for new products and projected research and development expenses;
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expected continued compliance with our debt financial covenants;
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expectations regarding realization of deferred tax assets;
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expectations regarding the impact of the U.S. Tax Cuts and Jobs Act;
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anticipated results with respect to certain estimates we make for financial accounting purposes; and
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compliance with the U.S. Foreign Corrupt Practices Act and other applicable U.S. and foreign laws prohibiting corrupt payments to government officials and other third parties.
These forward-looking statements reflect our best judgment about future events and trends based on the information currently available to us. Our results of operations can be affected by inaccurate assumptions we make or by risks and uncertainties known or unknown to us. Therefore, we cannot guarantee the accuracy of the forward-looking statements. Actual events and results of operations may vary materially from our current expectations and assumptions. While we cannot identify all of the factors that may cause actual results to vary from our expectations, we believe the following factors should be considered carefully:
An unfavorable outcome in our pending litigation matter with WesternGeco could have a materially adverse effect on our financial results and liquidity.
In June 2009, WesternGeco L.L.C. (“WesternGeco”) filed a lawsuit against us in the United States District Court for the Southern District of Texas (the “District Court”). In the lawsuit, styled WesternGeco L.L.C. v. ION Geophysical Corporation, WesternGeco alleged that we infringed four of their patents concerning marine seismic surveys.
Trial began in July 2012, and the jury returned a verdict in August 2012. The jury found that we infringed on six “claims” contained in four of WesternGeco’s patents by supplying our DigiFIN lateral streamer control units from the United States. (In patent law, a “claim” is a technical legal term; an infringer infringes on one or more “claims” of a given patent.)
In May 2014, the District Court entered a Final Judgment against us in the amount of $123.8 million. The Final Judgment also enjoined us from supplying DigiFINs or any parts unique to DigiFINs in or from the United States. We conducted our business in compliance with the District Court’s orders, and have reorganized our operations such that we no longer supply DigiFINs or any parts unique to DigiFINs in or from the United States.
As of 2018, we paid WesternGeco the $25.8 million of the Final Judgment (the portion of the judgment representing reasonable royalty damages and enhanced damages, plus interest).
However, as further described below, the balance of the judgment against us ($98.0 million, representing lost profits from surveys performed by our customers outside of the United States, plus interest) has been vacated, and a new trial ordered, to determine what lost profit damages, if any, WesternGeco is entitled to.
The Final Judgment was vacated after it was appealed to the United States Court of Appeals for the Federal Circuit in Washington, D.C. (the “Court of Appeals”), then to the Supreme Court of the United States, which remanded the case, again, to the Court of Appeals.
On January 11, 2019, the Court of Appeals refused to disturb the award of reasonable royalties to WesternGeco (which the Company paid in 2016), but did not reinstate the lost profits award; rather, the Court of Appeals remanded the case back to the District Court to determine whether to hold a new trial as to lost profits.
On August 30, 2019, the District Court refused WesternGeco’s request to reinstate the lost profits awards against us, and instead ordered a new trial to determine what lost profits, if any, WesternGeco is entitled to from surveys performed by our customers outside of the United States.
The District Court’s basis for granting the new trial as to lost profits was that, subsequent to the jury verdict that awarded lost profits, the Patent Trial and Appeal Board (“PTAB”) of the Patent and Trademark Office, in an administrative proceeding, invalidated four of the five patent claims that formed the basis for the lost profits judgment against us (that is, the PTAB held that those four patent claims should never have been granted), and the Court of Appeals and the Supreme Court both subsequently refused to overturn that finding. A trial date for the new trial has not yet been set.
We may not ultimately prevail in the litigation and we could be required to pay lost profits if and when a new judgment issues in the new trial. Our assessment that we do not have a loss contingency may change in the future due to developments at the District Court, and other events, such as changes in applicable law, and such reassessment could lead to the determination that a significant loss contingency is probable, which could have a material adverse effect on our business, financial condition and results of operations.
Our business depends on the level of exploration and production activities by the oil and natural gas industry. If capital expenditures by E&P companies decline, typically because of lower price realizations for oil and natural gas, the demand for our services and products would decline and our results of operations would be materially adversely affected.
Demand for our services and products depends upon the level of spending by E&P companies and seismic contractors for exploration and production activities, and those activities depend in large part on oil and gas prices. Spending by our customers on services and products that we provide is highly discretionary in nature, and subject to rapid and material change. Any decline in oil and gas related spending on behalf of our customers could cause alterations in our capital spending plans, project modifications, delays or cancellations, general business disruptions or delays in payment, or non-payment of amounts that are owed to us, any one of which could have a material adverse effect on our financial condition. E&P companies’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which our management has no control, such as:
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the supply of and demand for oil and gas;
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the level of prices, and expectations about future prices, of oil and gas;
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the cost of exploring for, developing, producing and delivering oil and gas;
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the expected rates of decline for current production;
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the discovery rates of new oil and gas reserves;
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weather conditions, including hurricanes, that can affect oil and gas operations over a wide area, as well as less severe inclement weather that can preclude or delay seismic data acquisition;
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domestic and worldwide economic conditions;
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public health crises, such as the coronavirus outbreak at the beginning of 2020;
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changes in government leadership;
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political instability in oil and gas producing countries;
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technical advances affecting energy consumption;
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government policies regarding the exploration, production and development of oil and gas reserves;
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the ability of oil and gas producers to raise equity capital and debt financing;
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merger and divestiture activity among oil and gas companies and seismic contractors; and
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compliance by members of the OPEC and non-OPEC members, such as Russia, with agreements to cut oil production.
The level of oil and gas exploration and production activity has been volatile in recent years. Trends in oil and gas exploration and development activities have declined, together with demand for our services and products. Any prolonged substantial reduction in oil and gas prices would likely further affect oil and gas production levels and therefore adversely affect demand for the services we provide and products we sell.
Our operating results often fluctuate from period to period as we are subject to cyclicality and seasonality factors.
Our industry and the oil and gas industry in general are subject to cyclical fluctuations. Demand for our services and products depends upon spending levels by E&P companies for exploration and production of oil and natural gas and, in the case of new seismic data acquisition, the willingness of those companies to forgo ownership of the seismic data. Capital expenditures by E&P companies for these activities depend upon several factors, including actual and forecasted prices of oil and natural gas and those companies’ short-term and strategic plans.
Our operating results are subject to fluctuations from period to period as a result of introducing new services and products, the timing of significant expenses in connection with customer orders, unrealized sales, levels of research and development activities, the product and service mix of our revenues, the seasonality of our business (with strongest demand typically in the second half of the year) and delays caused by factors beyond our control. Because some of our products are technologically complex and tend to be relatively large investments, we generally experience long sales cycles for these types of products with a series of technical and commercial reviews by our customers and historically incur significant expense at the beginning of these cycles. Our revenues and gross margin can vary widely from period to period due to changes in customer requirements and demand as well as timing of orders and shipments and mix of services and products sold. This uneven pattern makes financial predictions for any given period difficult, increases the risk of unanticipated variations in our quarterly results and financial condition, and places challenges on our inventory management. As a result, if net revenues or gross margins fall below expectations, our results of operations and financial condition will likely be materially adversely affected.
Our indebtedness could adversely affect our liquidity, financial condition and our ability to fulfill our obligations and operate our business.
At December 31, 2019, our total outstanding indebtedness was approximately $121.5 million, consisting of approximately $120.6 million outstanding Senior Secured Second-Priority Notes (“Second Lien Notes”), $1.9 million of equipment finance lease obligations and $1.0 million of other short-term debt, partially offset by $2.0 million of debt issuance costs. At December 31, 2019, there was no outstanding indebtedness under our Credit Facility. Under our Credit Facility, the lender has committed $50.0 million of revolving credit, subject to a borrowing base. At December 31, 2019, we had $39.3 million of borrowing base availability under the Credit Facility. The amount available will increase or decrease monthly as our borrowing base changes. We may also incur additional indebtedness in the future. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
In February 2019, S&P Global Ratings (“S&P”) maintained our corporate credit rating of CCC+ and revised their outlook from a negative to stable. S&P’s outlook revision reflects our improved liquidity and expected improving financial measures due to an expected increase in international capital spending. Following the redemption of our Third Lien Notes in March 2018, Moody’s Investors Service has withdrawn all assigned public credit ratings on our Company, including the Caa2 Corporate Family Rating.
Our high level of indebtedness could have negative consequences to us, including:
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we may have difficulty satisfying our obligations with respect to our outstanding debt;
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we may have difficulty obtaining financing in the future for working capital, capital expenditures, acquisitions or other purposes;
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we may need to use all, or a substantial portion, of our available cash flow to pay interest and principal on our debt, which will reduce the amount of money available to finance our operations and other business activities;
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our vulnerability to general economic downturns and adverse industry conditions could increase;
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our flexibility in planning for, or reacting to, changes in our business and in our industry in general could be limited;
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our amount of debt and the amount we must pay to service our debt obligations could place us at a competitive disadvantage compared to our competitors that have less debt;
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our customers may react adversely to our significant debt level and seek or develop alternative licensors or suppliers;
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we may have insufficient funds, and our debt level may also restrict us from raising the funds necessary to repurchase all of the Notes, as defined below, tendered to us upon the occurrence of a change of control, which would constitute an event of default under the Notes; and
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our failure to comply with the restrictive covenants in our debt instruments which, among other things, limit our ability to incur debt and sell assets, could result in an event of default that, if not cured or waived, could have a material adverse effect on our business or prospects.
Our level of indebtedness will require that we use a substantial portion of our cash flow from operations to pay principal of, and interest on, our indebtedness, which will reduce the availability of cash to fund working capital requirements, capital expenditures, research and development and other general corporate or business activities.
If we are unable to raise additional working capital, we will be unable to fully fund our operations and to otherwise execute our strategic objectives.
At December 31, 2019, we had a negative working capital of $23.6 million. Should our costs and expenses prove to be greater than we currently anticipate, or should we change our current operating plan in a manner that will increase or accelerate our anticipated costs and expenses, the depletion of our working capital would be accelerated. In addition, if we do not generate sufficient revenues to cover our working capital requirements, our operations could be severely affected. To the extent it becomes necessary to raise additional cash in the future as s result of current cash and working capital resources being depleted, we would draw on our credit facility, of which $39.3 million was available to borrow at December 31, 2019. We may also seek to raise additional working capital through the public or private sale of assets, issuance of debt or equity securities and debt financing or short-term loans, or a combination of the foregoing. There is no assurance that we will be able to secure the additional cash or working capital we may require to continue our operations and to fully implement our operating plan.
We are subject to intense competition, which could limit our ability to maintain or increase our market share or to maintain our prices at profitable levels.
Many of our sales are obtained through a competitive bidding process, which is standard for our industry. Competitive factors in recent years have included price, technological expertise, and a reputation for quality, safety and dependability. While no single company competes with us in all of our segments, we are subject to intense competition in each of our segments. New entrants in many of the markets in which certain of our services and products are currently strong should be expected. See Item 1. “Business - Competition.” We compete with companies that are larger than we are in terms of revenues, technical personnel, number of processing locations and sales and marketing resources. A few of our competitors have a competitive advantage in being part of a large affiliated seismic contractor company. In addition, we compete with major service providers and government-sponsored enterprises and affiliates. Some of our competitors conduct seismic data acquisition operations as part of their regular business, which we have traditionally not conducted, and have greater financial and other resources than we do. These and other competitors may be better positioned to withstand and adjust more quickly to volatile market conditions, such as fluctuations in oil and natural gas prices, as well as changes in government regulations. In addition, any excess supply of services and products in the seismic services market could apply downward pressure on prices for our services and products. The negative effects of the competitive environment in which we operate could have a material adverse effect on our results of operations. In particular, the consolidation in recent years of many of our competitors in the seismic services and products markets has negatively impacted our results of operations.
There are a number of geophysical companies that create, market and license seismic data and maintain seismic libraries. Competition for acquisition of new seismic data among geophysical service providers historically has been intense and we expect this competition will continue to be intense. Larger and better-financed operators could enjoy an advantage over us in a competitive environment for new data.
The indentures governing the 9.125% Second Lien Notes due 2021 contain a number of restrictive covenants that limit our ability to finance future operations or capital needs or engage in other business activities that may be in our interest.
The indenture governing the Second Lien Notes imposes, (and the terms of any future indebtedness could impose) operating and other restrictions on us and our subsidiaries. Such restrictions affect, or will affect, and in many respects limit or prohibit, among other things, our ability and the ability of certain of our subsidiaries to:
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incur additional indebtedness;
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create liens;
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pay dividends and make other distributions in respect of our capital stock;
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redeem our capital stock;
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make investments or certain other restricted payments;
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sell certain kinds of assets;
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enter into transactions with affiliates; and
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effect mergers or consolidations.
The restrictions contained in the indenture governing the Second Lien Notes could:
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limit our ability to plan for or react to market or economic conditions or meet capital needs or otherwise restrict our activities or business plans; and
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adversely affect our ability to finance our operations, acquisitions, investments or strategic alliances or other capital needs or to engage in other business activities that would be in our interest.
A breach of any of these covenants could result in a default under the indenture governing the Second Lien Notes. If an event of default occurs, the trustee and holders of the Second Lien Notes could elect to declare all borrowings outstanding, together with accrued and unpaid interest, to be immediately due and payable. An event of default under the indenture governing the Second Lien Notes would also constitute an event of default under our Credit Facility. In addition, if we are unable to repay or extend the maturity of our Second Lien Notes prior to their scheduled maturity in December 2021, the maturity of our Credit Facility, which currently matures in August 2023, will accelerate to mature in October 2021 which may cause us to face substantial liquidity problems and may force us to reduce or delay investments, dispose of material assets or operations, or issue additional debt or equity. See Footnote 5 “Long-term Debt” of the Footnotes to Consolidated Financial Statements appearing below in this Form 10-K.
As a technology-focused company, we are continually exposed to risks related to complex, highly technical services and products that are sometimes operated in dangerous marine environments.
We make strategic decisions from time to time as to the technologies in which we invest. Our operating results are dependent upon our ability to improve and refine our seismic imaging and data processing services and to successfully develop, manufacture and market our products and services. New technologies generally require a substantial investment before any assurance is available as to their commercial viability. If we choose the wrong technology, or if our competitors develop or select a superior technology, we could lose our existing customers and be unable to attract new customers, which would harm our business and operations.
The markets for our services and products are characterized by changing technology and new product introductions. We must invest substantial capital to develop and maintain a leading edge in technology, with no assurance that we will receive an adequate rate of return on those investments. If we are unable to develop and produce successfully and timely new or enhanced services and products, we will be unable to compete in the future and our business, our results of operations and our financial condition will be materially and adversely affected. Our business could suffer from unexpected developments in technology, or from our failure to adapt to these changes. In addition, the preferences and requirements of customers can change rapidly.
The businesses of our E&P Technology & Services segment and Optimization Software & Services group within our Operations Optimization segment, being more concentrated in software, processing services and proprietary technologies, have also exposed us to various risks that these technologies typically encounter, including the following:
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future competition from more established companies entering the market;
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technology obsolescence;
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dependence upon continued growth of the market for seismic data processing;
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the rate of change in the markets for these segments’ technology and services;
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further consolidation of the participants within this market;
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research and development efforts not proving sufficient to keep up with changing market demands;
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dependence on third-party software for inclusion in these segments’ services and products;
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misappropriation of these segments’ technology by other companies;
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alleged or actual infringement of intellectual property rights that could result in substantial additional costs;
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difficulties inherent in forecasting sales for newly developed technologies or advancements in technologies;
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recruiting, training and retaining technically skilled, experienced personnel that could increase the costs for these segments, or limit their growth; and
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the ability to maintain traditional margins for certain of their technology or services.
Seismic data acquisition and data processing technologies historically have progressed rather rapidly and we expect this progression to continue. In order to remain competitive, we must continue to invest additional capital to maintain, upgrade and expand our seismic data acquisition and processing capabilities. However, due to potential advances in technology and the related costs associated with such technological advances, we may not be able to fulfill this strategy, thus possibly affecting our ability to compete. New data acquisition or processing technologies may be developed. New and enhanced services and products introduced by one of our competitors may gain market acceptance and, if not available to us, may adversely affect us.
Our customers often require demanding specifications for performance and reliability of our services and products. Because many of our products are complex and often use unique advanced components, processes, technologies and techniques, undetected errors and design and manufacturing flaws may occur. Even though we attempt to assure that our systems are always reliable in the field, the many technical variables related to their operations can cause a combination of factors that can, and have from time to time, caused performance and service issues with certain of our products. Product defects result in higher product service, warranty and replacement costs and may affect our customer relationships and industry reputation, all of which may adversely impact our results of operations. Despite our testing and quality assurance programs, undetected errors may not be discovered until the product is purchased and used by a customer in a variety of field conditions. If our customers deploy our new products and they do not work correctly, our relationship with our customers may be materially and adversely affected.
As a result of our systems’ advanced and complex nature, we expect to experience occasional operational issues from time to time. Generally, until our products have been tested in the field under a wide variety of operational conditions, we cannot be certain that performance and service problems will not arise. In that case, market acceptance of our new products could be delayed and our results of operations and financial condition could be adversely affected.
We also face exposure to product liability claims in the event that certain of our products, or certain components manufactured by others that are incorporated into our products, fail to perform to specification, which failure results, or is alleged to result, in property damage, bodily injury and/or death. Marine exploration in particular can present dangerous conditions to those conducting it. Any product liability claims decided adversely against us may have a material adverse effect on our results of operations and cash flows. While we maintain insurance coverage with respect to certain product liability claims, we may not be able to obtain such insurance on acceptable terms in the future, if at all, and any such insurance may not provide adequate coverage against product liability claims. In addition, product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant periods of time, regardless of the ultimate outcome. Furthermore, even if we are successful in defending against a claim relating to our products, claims of this nature could cause our customers to lose confidence in our products and us.
We have invested, and expect to continue to invest, significant sums of money in acquiring and processing seismic data for our E&P Technology & Services’ multi-client data library, without knowing precisely how much of this seismic data we will be able to license or when and at what price we will be able to license the data sets. Our business could be adversely affected by the failure of our customers to fulfill their obligations to reimburse us for the underwritten portion of our seismic data acquisition costs for our multi-client library.
We invest significant amounts in acquiring and processing new seismic data to add to our E&P Technology & Services’ multi-client data library. The costs of most of these investments are funded by our customers, with the remainder generally being recovered through future data licensing fees. In 2019, we invested approximately $28.8 million in our multi-client data library. Our customers generally commit to licensing the data prior to our initiating a new data library acquisition program. However, the aggregate amounts of future licensing fees for this data are uncertain and depend on a variety of factors, including the market prices of oil and gas, customer demand for seismic data in the library, and the availability of similar data from competitors.
By making these investments in acquiring and processing new seismic data for our E&P Technology & Services’ multi-client library, we are exposed to the following risks:
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We may not fully recover our costs of acquiring and processing seismic data through future sales. The ultimate amounts involved in these data sales are uncertain and depend on a variety of factors, many of which are beyond our control.
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The timing of these sales is unpredictable and can vary greatly from period to period. The costs of each survey are capitalized and then amortized as a percentage of sales and/or on a straight-line basis over the expected useful life of the data. This amortization will affect our earnings and, when combined with the sporadic nature of sales, will result in increased earnings volatility.
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Regulatory changes that affect companies’ ability to drill, either generally or in a specific location where we have acquired seismic data, could materially adversely affect the value of the seismic data contained in our library. Technology changes could also make existing data sets obsolete. Additionally, each of our individual surveys has a limited book life based on its location and oil and gas companies’ interest in prospecting for reserves in such location, so a particular survey may be subject to a significant decline in value beyond our initial estimates.
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The value of our multi-client data could be significantly adversely affected if any material adverse change occurs in the general prospects for oil and gas exploration, development and production activities.
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The cost estimates upon which we base our pre-commitments of funding could be wrong. The result could be losses that have a material adverse effect on our financial condition and results of operations. These pre-commitments of funding are subject to the creditworthiness of our customers. In the event that a client refuses or is unable to pay its commitment, we could incur a substantial loss on that project.
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As part of our asset-light strategy, we routinely charter vessels from third-party vendors to acquire seismic data for our multi-client business. As a result, our cost to acquire our multi-client data could significantly increase if vessel charter prices rise materially.
Reductions in demand for our seismic data, or lower revenues of or cash flows from our seismic data, may result in a requirement to increase amortization rates or record impairment charges in order to reduce the carrying value of our data library. These increases or charges, if required, could be material to our operating results for the periods in which they are recorded.
A substantial portion of our seismic acquisition project costs (including third-party project costs) are underwritten by our customers. In the event that underwriters for such projects fail to fulfill their obligations with respect to such underwriting commitments, we would continue to be obligated to satisfy our payment obligations to third-party contractors.
We derive a substantial amount of our revenues from foreign operations and sales, which pose additional risks.
The majority of our foreign sales are denominated in U.S. dollars. Sales to customer destinations outside of North America represented 73%, 75% and 76% of our consolidated net revenues for 2019, 2018 and 2017, respectively. We believe that export sales will remain a significant percentage of our revenues. U.S. export restrictions affect the types and specifications of products we can export. Additionally, in order to complete certain sales, U.S. laws may require us to obtain export licenses, and we cannot assure you that we will not experience difficulty in obtaining these licenses.
Like many energy services companies, we have operations in and sales into certain international areas, including parts of the Middle East, West Africa, Latin America, India, Asia Pacific and Russia, that are subject to risks of war, political disruption, civil disturbance, political corruption, public health crises, possible economic and legal sanctions (such as possible restrictions against countries that the U.S. government may in the future consider to be state sponsors of terrorism) and changes in global trade policies. Our sales or operations may become restricted or prohibited in any country in which the foregoing risks occur. In particular, the occurrence of any of these risks could result in the following events, which in turn, could materially and adversely impact our results of operations:
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disruption of E&P activities;
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restriction on the movement and exchange of funds;
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inhibition of our ability to collect advances and receivables;
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enactment of additional or stricter U.S. government or international sanctions;
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limitation of our access to markets for periods of time;
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expropriation and nationalization of assets of our company or those of our customers;
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political and economic instability, which may include armed conflict and civil disturbance;
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currency fluctuations, devaluations and conversion restrictions;
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confiscatory taxation or other adverse tax policies; and
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governmental actions that may result in the deprivation of our contractual rights, including the potential for adverse decisions by judicial or administrative bodies in foreign countries with unpredictable or corrupt judicial systems.
Our international operations and sales increase our exposure to other countries’ restrictive tariff regulations, other import/export restrictions and customer credit risk.
In addition, we are subject to taxation in many jurisdictions and the final determination of our tax liabilities involves the interpretation of the statutes and requirements of taxing authorities worldwide. Our tax returns are subject to routine examination by taxing authorities, and these examinations may result in assessments of additional taxes, penalties and/or interest.
We may be unable to obtain broad intellectual property protection for our current and future products and we may become involved in intellectual property disputes; we rely on developing and acquiring proprietary data which we keep confidential.
We rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary technologies. We believe that the technological and creative skill of our employees, new product developments, frequent product enhancements, name recognition and reliable product maintenance are the foundations of our competitive advantage. Although we have a considerable portfolio of patents, copyrights and trademarks, these property rights offer us only limited protection. Our competitors may attempt to copy aspects of our products despite our efforts to protect our proprietary rights, or may design around the proprietary features of our products. Policing unauthorized use of our proprietary rights is difficult, and we are unable to determine the extent to which such use occurs. Our difficulties are compounded in certain foreign countries where the laws do not offer as much protection for proprietary rights as the laws of the United States.
Third parties inquire and claim from time to time that we have infringed upon their intellectual property rights. Many of our competitors own their own extensive global portfolio of patents, copyrights, trademarks, trade secrets and other intellectual property to protect their proprietary technologies. We believe that we have in place appropriate procedures and safeguards to help ensure that we do not violate a third party’s intellectual property rights. However, no set of procedures and safeguards is infallible. We may unknowingly and inadvertently take action that is inconsistent with a third party’s intellectual property rights, despite our efforts to do otherwise. Any such claims from third parties, with or without merit, could be time consuming, result in costly litigation, result in injunctions, require product modifications, cause product shipment delays or require us to enter into royalty or licensing arrangements. Such claims could have a material adverse effect on our results of operations and financial condition.
Much of our litigation in recent years have involved disputes over ours and others’ rights to technology. See Item 3. “Legal Proceedings.”
To protect the confidentiality of our proprietary and trade secret information, we require employees, consultants, contractors, advisors and collaborators to enter into confidentiality agreements. Our customer data license and acquisition agreements also identify our proprietary, confidential information and require that such proprietary information be kept confidential. While these steps are taken to strictly maintain the confidentiality of our proprietary and trade secret information, it is difficult to ensure that unauthorized use, misappropriation or disclosure will not occur. If we are unable to maintain the secrecy of our proprietary, confidential information, we could be materially adversely affected.
If we do not effectively manage our transition into new services, products and adjacent markets, our revenues may suffer.
Services and products for our business are characterized by rapid technological advances and innovation in hardware performance, software functionality and features, frequent introduction of new services and products, and improvement in price characteristics relative to product and service performance. Among the risks associated with the introduction of new services and products and diversification to new markets are delays in development or manufacturing, variations in costs, customer acceptance, delays in customer purchases, reductions in price or replacing sales of existing products in anticipation of new offerings, write-offs or write-downs of the carrying costs of materials associated with prior generation products, difficulty in predicting customer demand due to competition, risks associated with customer qualification, evaluation of new products, quality issues or other defects that may not be adequately supported by application software and untimely commercialization. In addition, it may be difficult to ensure performance of new services and products in accordance with our revenue, margin and cost estimations and to achieve operational efficiencies embedded in our estimates. If any of these risks materializes or if we do not make an effective transition, our revenues and results of operations, may suffer.
Global economic conditions and credit market uncertainties could have an adverse effect on customer demand for certain of our services and products, which in turn would adversely affect our results of operations, our cash flows, our financial condition and our stock price.
Historically, demand for our services and products has been sensitive to the level of exploration spending by E&P companies and geophysical contractors. The demand for our services and products will be lessened if exploration expenditures by E&P companies are reduced. During periods of reduced levels of exploration for oil and natural gas, there have been oversupplies of seismic data and downward pricing pressures on our seismic services and products, which, in turn, have limited our ability to meet sales objectives and maintain profit margins for our services and products. In the past, these then-prevailing industry conditions have had the effect of reducing our revenues and operating margins. The markets for oil and gas historically have been volatile and may continue to be so in the future.
Turmoil or uncertainty in the credit markets and its potential impact on the liquidity of major financial institutions may have an adverse effect on our ability to fund our business strategy through borrowings under either existing or new debt facilities in the public or private markets and on terms we believe to be reasonable. Likewise, there can be no assurance that our customers will be able to borrow money for their working capital or capital expenditures on a timely basis or on reasonable terms, which could have a negative impact on their demand for our services and products and impair their ability to pay us for our services and products on a timely basis, or at all.
Our sales have historically been affected by interest rate fluctuations and the availability of liquidity, and we and our customers would be adversely affected by increases in interest rates or liquidity constraints. This could have a material adverse effect on our business, results of operations, financial condition and cash flows.
The loss of any significant customer or the inability of our customers to meet their payment obligations to us could materially and adversely affect our results of operations and financial condition.
Our business is exposed to risks related to customer concentration. In 2019, we had one multinational oil customer with sales that exceeded 10% of our consolidated net revenues. In 2018, we had two customers with sales that each exceeded 10% of our consolidated net revenues and we had one customer with sales that exceeded 10% of our consolidated net revenues for 2017. Our top five customers together accounted for approximately 40%, 39% and 34% of our consolidated net revenues during 2019, 2018 and 2017. The loss of any of our significant customers or deterioration in our relations with any of them could materially and adversely affect our results of operations and financial condition.
Any consolidation or strategic change made by our customers may impact the demand for our services and products. The loss of any of our significant customers could materially and adversely affect our results of operations and financial condition.
Our business is exposed to risks of loss resulting from nonpayment by our customers. Many of our customers finance their activities through cash flow from operations, the incurrence of debt or the issuance of equity. Declines in commodity prices, and the credit markets could cause the availability of credit to be constrained. The combination of lower cash flow due to commodity prices, a reduction in borrowing bases under reserve-based credit facilities and the lack of available debt or equity
financing may result in a significant reduction in our customers’ liquidity and ability to pay their obligations to us. Furthermore, some of our customers may be highly leveraged and subject to their own operating and regulatory risks, which increases the risk that they may default on their obligations to us. The inability or failure of our significant customers to meet their obligations to us or their insolvency or liquidity may adversely affect our financial results.
Our stock price has been volatile, declining and increasing from time to time.
The securities markets in general and our common stock in particular have experienced significant price and volume volatility in recent years. The market price and trading volume of our common stock may continue to experience significant fluctuations due not only to general stock market conditions (such as changes in interest rates, commodity and equity prices and the value of financial assets) but also to a change in sentiment in the market regarding our operations or business prospects or those of companies in our industry. In addition to the other risk factors discussed in this section, the price and volume volatility of our common stock may be affected by:
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the inherent lumpiness and volatility of our customers’ spending cycles;
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operating results that vary from the expectations of securities analysts and investors;
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factors influencing the levels of global oil and natural gas exploration and exploitation activities, such as the decline in crude oil prices and changes in oil and gas supply and demand;
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the operating and securities price performance of companies that investors or analysts consider comparable to us;
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actions by rating agencies related to the Notes; and
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announcements of strategic developments, acquisitions and other material events by us or our competitors.
If the price of our common stock declines, our ability to raise funds through the issuance of equity or otherwise use our common stock as consideration will be reduced. A low price for our equity may negatively impact our ability to access additional debt capital. These factors may limit our ability to implement our operating and growth plans. In addition, the volatility in the market price of our common stock affects the value of our stock appreciation rights (“SARs”). To the extent that the price of our common stock increases, the value of our SARs will increase and could have a negative impact on our earnings and cash flows.
Goodwill and other long-lived assets (multi-client data library and property, plant and equipment) that we have recorded are subject to impairment evaluations. In addition, our product inventory may become obsolete or excessive due to future changes in technology, changes in market demand, or changes in market expectations. Write-downs of these assets may adversely affect our financial condition and results of operations.
Reductions in or an impairment of the value of our goodwill and other long-lived assets would result in additional charges against our earnings, which could have a material adverse effect on our reported results of operations and financial position in future periods. At December 31, 2019, our remaining goodwill, multi-client data library and property, plant and equipment balances were $23.6 million, $60.4 million and $13.2 million, respectively. For 2019, we wrote down our multi-client data library by $9.1 million resulting from our annual impairment review. For 2018, we recognized an impairment of $36.6 million in property, plant and equipment for our cable-based ocean bottom acquisition technologies.
Our services and products’ technologies often change relatively quickly. Phasing out of old products involves estimating the amounts of inventories we need to hold to satisfy demand for those products and satisfy future repair part needs. Based on changing technologies and customer demand, we may find that we have either obsolete or excess inventory on hand. Because of unforeseen future changes in technology, market demand or competition, we might have to write off unusable inventory, which would adversely affect our results of operations.
Due to the international scope of our business activities, our results of operations may be significantly affected by currency fluctuations.
We derived approximately 73% of our 2019 consolidated net revenues from international sales, subjecting us to risks relating to fluctuations in currency exchange rates. Currency variations can adversely affect margins on sales of our products in countries outside of the United States and margins on sales of products that include components obtained from suppliers located outside of the United States. We operate in a wide variety of jurisdictions, including the United Kingdom, Brazil, Mexico, China, Canada, Russia, the United Arab Emirates, Egypt and other countries. Certain of these countries have experienced geopolitical instability, economic problems and other uncertainties from time to time. To the extent that world events or economic conditions negatively affect our future sales to customers in these and other regions of the world, or the collectability of receivables, our future results of operations, liquidity and financial condition may be adversely affected.
We currently require customers in certain higher risk countries to provide their own financing. We do not currently extend long-term credit through notes to companies in countries where we perceive excessive credit risk.
Our foreign subsidiaries receive their income and pay their expenses primarily in their local currencies. To the extent that transactions of these subsidiaries are settled in their local currencies, a devaluation of those currencies versus the U.S. dollar could reduce the contribution from these subsidiaries to our consolidated results of operations as reported in U.S. dollars. For financial reporting purposes, such depreciation will negatively affect our reported results of operations since earnings denominated in foreign currencies would be converted to U.S. dollars at a decreased value. In addition, since we participate in competitive bids for sales of certain of our services and products that are denominated in U.S. dollars, a depreciation of the U.S. dollar against other currencies could harm our competitive position relative to other companies. While we periodically employ economic cash flow and fair value hedges to minimize the risks associated with these exchange rate fluctuations, the hedging activities may be ineffective or may not offset more than a portion of the adverse financial impact resulting from currency variations. Accordingly, we cannot provide assurance that fluctuations in the values of the currencies of countries in which we operate will not materially adversely affect our future results of operations.
We rely on highly skilled personnel in our businesses, and if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to effectively operate our business.
Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain skilled personnel for all areas of our organization. We require highly skilled personnel to operate and provide technical services and support for our businesses. Competition for qualified personnel required for our data processing operations and our other businesses has intensified recently. Our growth has presented challenges to us to recruit, train and retain our employees while managing the impact of potential wage inflation and the lack of available qualified labor in some markets where we operate. A well-trained, motivated and adequately-staffed work force has a positive impact on our ability to attract and retain business. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.
Certain of our facilities could be damaged by hurricanes and other natural disasters, which could have an adverse effect on our results of operations and financial condition.
Certain of our facilities are located in regions of the United States that are susceptible to damage from hurricanes and other weather events.
Future hurricanes or similar natural disasters that impact our facilities may negatively affect our financial position and operating results for those periods. These negative effects may include reduced production, product sales and data processing revenues; costs associated with resuming production; reduced orders for our services and products from customers that were similarly affected by these events; lost market share; late deliveries; additional costs to purchase materials and supplies from outside suppliers; uninsured property losses; inadequate business interruption insurance and an inability to retain necessary staff. To the extent that climate change increases the severity of hurricanes and other weather events, as some have suggested, it could worsen the severity of these negative effects on our financial position and operating results.
Our operations, and the operations of our customers, are subject to numerous government regulations, which could adversely limit our operating flexibility. Regulatory initiatives undertaken from time to time, such as restrictions, sanctions and embargoes, can adversely affect, and have adversely affected, our customers and our business.
In addition to the specific regulatory risks discussed elsewhere in this Item 1A. “Risk Factors” section, our operations are subject to other laws, regulations, government policies and product certification requirements worldwide. Changes in such laws, regulations, policies or requirements could affect the demand for our products or services or result in the need to modify our services and products, which may involve substantial costs or delays in sales and could have an adverse effect on our future operating results. Our export activities in particular are subject to extensive and evolving trade regulations. . We have multiple product lines and services that are sold in many countries throughout the world. Certain countries are subject to restrictions, sanctions and embargoes imposed by the United States government. These restrictions, sanctions and embargoes also prohibit or limit us from participating in certain business activities in those countries. Violation of these rules could result in significant penalties. In addition, our operations are subject to numerous local, state and federal laws and regulations in the United States and in foreign jurisdictions concerning the containment and disposal of hazardous materials, the remediation of contaminated properties, and the protection of the environment. These laws have been changed frequently in the past, and there can be no assurance that future changes will not have a material adverse effect on us. In addition, our customers’ operations are also significantly impacted by laws and regulations concerning the protection of the environment and endangered species. Consequently, changes in governmental regulations applicable to our customers may reduce demand for our services and products. To the extent that our customers’ operations are disrupted by future laws and regulations, our business and results of operations may be materially and adversely affected.
Offshore oil and gas exploration and development recently has been a regulatory focus. Future changes in laws or regulations regarding such activities, and decisions by customers, governmental agencies or other industry participants in response, could reduce demand for our services and products, which could have a negative impact on our financial position,
results of operations or cash flows. We cannot reasonably or reliably estimate that such changes will occur, when they will occur, or whether they will impact us. Such changes can occur quickly within a region, which may impact both the affected region and global exploration and production, and we may not be able to respond quickly, or at all, to mitigate these changes. In addition, these future laws and regulations could result in increased compliance costs or additional operating restrictions that may adversely affect the financial health of our customers and decrease the demand for our services and products.
Existing or future laws and regulations related to greenhouse gases and climate change could have a material adverse effect on our business, results of operations, and financial condition.
Changes in environmental requirements related to greenhouse gases and climate change may negatively impact demand for our services. For example, oil and natural gas exploration and production may decline as a result of environmental requirements. Local, state, and federal agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of greenhouse gases in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to greenhouse gases and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas.
We have outsourcing arrangements with third parties to manufacture some of our products. If these third party suppliers fail to deliver quality products or components at reasonable prices on a timely basis, we may alienate some of our customers and our revenues, profitability and cash flow may decline. Additionally, current global economic conditions could have a negative impact on our suppliers, causing a disruption in our vendor supplies. A disruption in vendor supplies may adversely affect our results of operations.
Our manufacturing processes require us to purchase quality components. In addition, we use contract manufacturers as an alternative to our own manufacturing of products. We have outsourced the manufacturing of our products, including our towed marine streamers, geophone manufacturing. Certain components used in our towed marine manufacturing operations are currently provided by a single supplier. Without these sole suppliers, we would be required to find other suppliers who could build these components for us, or set up to make these parts internally. If, in implementing any outsource initiative, we are unable to identify contract manufacturers willing to contract with us on competitive terms and to devote adequate resources to fulfill their obligations to us or if we do not properly manage these relationships, our existing customer relationships may suffer. In addition, by undertaking these activities, we run the risk that the reputation and competitiveness of our services and products may deteriorate as a result of the reduction of our control over quality and delivery schedules. We also may experience supply interruptions, cost escalations and competitive disadvantages if our contract manufacturers fail to develop, implement, or maintain manufacturing methods appropriate for our products and customers.
Reliance on certain suppliers, as well as industry supply conditions, generally involves several risks, including the possibility of a shortage or a lack of availability of key components, increases in component costs and reduced control over delivery schedules. If any of these risks are realized, our revenues, profitability and cash flows may decline. In addition, the more we come to rely on contract manufacturers, we may have fewer personnel resources with expertise to manage problems that may arise from these third-party arrangements.
Additionally, our suppliers could be negatively impacted by current global economic conditions. If certain of our suppliers were to experience significant cash flow issues or become insolvent as a result of such conditions, it could result in a reduction or interruption in supplies to us or a significant increase in the price of such supplies and adversely impact our results of operations and cash flows.
Our business is subject to cybersecurity risks and threats.
Threats to our information technology systems associated with cybersecurity risk and cyber incidents or attacks continue to grow. It is also possible that breaches to our systems could go unnoticed for some period of time. Risks associated with these threats include, among other things, loss of intellectual property, disseminating of highly confidential information, impairment of our ability to conduct our operations, disruption of our customers’ operations, loss or damage to our customer data delivery systems, and increased costs to prevent, respond to or mitigate cybersecurity events.
Our certificate of incorporation and bylaws, Delaware law and certain contractual obligations under our agreement with BGP contain provisions that could discourage another company from acquiring us.
Provisions of our certificate of incorporation and bylaws, Delaware law and the terms of our investor rights agreement with BGP may have the effect of discouraging, delaying or preventing a merger or acquisition that our stockholders may consider favorable, including transactions in which you might otherwise receive a premium for shares of our common stock. These provisions include:
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authorizing the issuance of “blank check” preferred stock without any need for action by stockholders;
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providing for a classified board of directors with staggered terms;
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requiring supermajority stockholder voting to effect certain amendments to our certificate of incorporation and bylaws;
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eliminating the ability of stockholders to call special meetings of stockholders;
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prohibiting stockholder action by written consent; and
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establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
In addition, the terms of our INOVA Geophysical joint venture with BGP and BGP’s investment in our company contain a number of provisions, such as certain pre-emptive rights granted to BGP with respect to certain future issuances of our stock, that could have the effect of discouraging, delaying or preventing a merger or acquisition of our company that our stockholders may otherwise consider to be favorable.
Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our stock price.
If, in the future, we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal control environment could have a material adverse effect on the price of our common stock.
Note: The foregoing factors pursuant to the Private Securities Litigation Reform Act of 1995 should not be construed as exhaustive. In addition to the foregoing, we wish to refer readers to other factors discussed elsewhere in this report as well as other filings and reports with the SEC for a further discussion of risks and uncertainties that could cause actual results to differ materially from those contained in forward-looking statements. We undertake no obligation to publicly release the result of any revisions to any such forward-looking statements, which may be made to reflect the events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our principal operating facilities at December 31, 2019 were as follows:
Each of these operating facilities is leased by us under long-term lease agreements. These lease agreements have terms that expire ranging from 2020 to 2026. See Footnote 14 “Lease Obligations” of Footnotes to Consolidated Financial Statements.
In addition, we lease offices in Dubai, UAE; Beijing, China; Rio de Janeiro, Brazil; and Moscow, Russia to support our global sales force. We lease offices for our seismic data processing centers in Port Harcourt, Nigeria; Luanda, Angola; Cairo, Egypt; Villahermosa, Mexico; and Rio de Janeiro, Brazil. Our executive headquarters is located at 2105 CityWest Boulevard, Suite 100, Houston, Texas. The machinery, equipment, buildings and other facilities owned and leased by us are considered by our management to be sufficiently maintained and adequate for our current operations.
Item 3.
Item 3. Legal Proceedings
WesternGeco
In June 2009, WesternGeco L.L.C. (“WesternGeco”) filed a lawsuit against us in the United States District Court for the Southern District of Texas (the “District Court”). In the lawsuit, styled WesternGeco L.L.C. v. ION Geophysical Corporation, WesternGeco alleged that we infringed four of their patents concerning marine seismic surveys.
Trial began in July 2012, and the jury returned a verdict in August 2012. The jury found that we infringed on six “claims” contained in four of WesternGeco’s patents by supplying our DigiFIN lateral streamer control units from the United States. (In patent law, a “claim” is a technical legal term; an infringer infringes on one or more “claims” of a given patent.)
In May 2014, the District Court entered a Final Judgment against us in the amount of $123.8 million. The Final Judgment also enjoined us from supplying DigiFINs or any parts unique to DigiFINs in or from the United States. We conducted our business in compliance with the District Court’s orders, and have reorganized our operations such that we no longer supply DigiFINs or any parts unique to DigiFINs in or from the United States.
As of 2018, we paid WesternGeco the $25.8 million of the Final Judgment (the portion of the judgment representing reasonable royalty damages and enhanced damages, plus interest).
However, as further described below, the balance of the judgment against us ($98.0 million, representing lost profits from surveys performed by our customers outside of the United States, plus interest) has been vacated, and a new trial ordered, to determine what lost profit damages, if any, WesternGeco is entitled to.
The Final Judgment was vacated after it was appealed to the United States Court of Appeals for the Federal Circuit in Washington, D.C. (the “Court of Appeals”), then to the Supreme Court of the United States, which remanded the case, again, to the Court of Appeals.
On January 11, 2019, the Court of Appeals refused to disturb the award of reasonable royalties to WesternGeco (which the Company paid in 2016), but did not reinstate the lost profits award; rather, the Court of Appeals remanded the case back to the District Court to determine whether to hold a new trial as to lost profits.
On August 30, 2019, the District Court refused WesternGeco’s request to reinstate the lost profits awards against us, and instead ordered a new trial to determine what lost profits, if any, WesternGeco is entitled to from surveys performed by our customers outside of the United States.
The District Court’s basis for granting the new trial as to lost profits was that, subsequent to the jury verdict that awarded lost profits, the Patent Trial and Appeal Board (“PTAB”) of the Patent and Trademark Office, in an administrative proceeding, invalidated four of the five patent claims that formed the basis for the lost profits judgment against us (that is, the PTAB held that those four patent claims should never have been granted), and the Court of Appeals and the Supreme Court both subsequently refused to overturn that finding. A trial date for the new trial has not yet been set.
We may not ultimately prevail in the litigation and we could be required to pay lost profits if and when a new judgment issues in the new trial. Our assessment that we do not have a loss contingency may change in the future due to developments at the District Court, and other events, such as changes in applicable law, and such reassessment could lead to the determination that a significant loss contingency is probable, which could have a material adverse effect on our business, financial condition and results of operations.
Other Litigation
In July 2018, we prevailed in an arbitration that we initiated against the Indian Directorate General of Hydrocarbons (“DGH”) relating to our ability to continue to license data under our IndiaSPAN program. The DGH filed a lawsuit in court in India to vacate the arbitration award; in connection with that lawsuit, we were ordered to escrow approximately $4.5 million in sales proceeds that we had received in respect of sales from our IndiaSPAN program, pending the outcome of the DGH’s challenge to the arbitration award. We challenged the escrow order, but on December 9, 2019, the Supreme Court of India ordered us to comply with it which will require us to deposit approximately $4.5 million in escrow in late February 2020. We prevailed on the merits in the arbitration and expect to have that award upheld in Indian court, which would result in release of our portion of the escrowed money.
We have been named in various other lawsuits or threatened actions that are incidental to our ordinary business. Litigation is inherently unpredictable. Any claims against us, whether meritorious or not, could be time-consuming, cause us to incur costs and expenses, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits and actions cannot be predicted with certainty. We currently believe that the ultimate resolution of these matters will not have a material adverse effect on our financial condition or results of operations.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock trades on the New York Stock Exchange (“NYSE”) under the symbol “IO.”
We have not historically paid, and do not intend to pay in the foreseeable future, cash dividends on our common stock. We presently intend to retain cash from operations for use in our business, with any future decision to pay cash dividends on our common stock dependent upon our growth, profitability, financial condition and other factors our board of directors consider relevant.
The terms of our Credit Facility contain covenants that restrict us from paying cash dividends on our common stock, or repurchasing or acquiring shares of our common stock, unless (i) there is no event of default under the Credit Facility, (ii) there is excess availability under the Credit Facility greater than $20.0 million (or, at the time that the borrowing base formula amount is less than $20.0 million, the borrowers’ level of liquidity (as defined in the Credit Facility) is greater than $20.0 million) and (iii) the agent receives satisfactory projections showing that excess availability under the Credit Facility for the immediately following period of ninety (90) consecutive days will not be less than $20.0 million (or, at the time that the borrowing base formula amount is less than $20.0 million, the borrowers’ level of liquidity is greater than $20.0 million). The aggregate amount of permitted cash dividends and stock repurchases may not exceed $10.0 million in any fiscal year or $40.0 million in the aggregate from and after the closing date of the Credit Facility.
The indenture governing the Second Lien Notes contains certain covenants that, among other things, limit our ability to pay certain dividends or distributions on our common stock or purchase, redeem or retire shares of our common stock, unless (i) no default under the indenture has occurred or would occur as a result of that payment, (ii) we would have, after giving pro forma effect to the payment, been permitted to incur at least $1.00 of additional indebtedness under a fixed charge coverage ratio test under the indenture, and (iii) the total cumulative amount of all such payments would not exceed a sum calculated by reference to, among other items, our consolidated net income, proceeds from certain sales of equity or assets, certain conversions or exchanges of debt for equity and certain other reductions in our indebtedness and in aggregate not to exceed at any one time $25.0 million.
On December 31, 2019, there were 547 holders of record of our common stock.
During the three months ended December 31, 2019, in connection with the vesting of (or lapse of restrictions on) shares of our restricted stock held by certain employees, we acquired shares of our common stock in satisfaction of tax withholding obligations that were incurred on the vesting date. The date of acquisition, number of shares and average effective acquisition price per share were as follows:
On November 30, 2018, the Company’s stockholders approved certain amendments to the Company’s Second Amended and Restated 2013 Long-term Incentive Plan (the “2013 LTIP”) including increasing the total number of shares of common stock available for issuance under the 2013 LTIP by 1.2 million shares, for a total of approximately 1.7 million shares, eliminating the restriction on the number of shares in the 2013 LTIP that can be issued as full value awards and certain other technical updates and clarifications related to Section 162(m) of the internal revenue code, as amended.
On February 21, 2018, in connection with the Public Equity Offering (as described in Footnote 12 “Stockholders' Equity and Stock-based Compensation” of Footnotes to the Consolidated Financial Statements), we issued and sold 1,820,000 shares of common stock at a public offering price of $27.50 per share, and warrants to purchase an additional 1,820,000 shares of the Company’s common stock. The net proceeds from this offering were $47.0 million, including transaction expenses. A portion of the net proceeds were used to retire the Company’s $28.5 million Third Lien Notes in March 2018. The warrants have an exercise price of $33.60 per share, are immediately exercisable and were to expire on March 21, 2019. On February 4, 2019, the Company extended expiration of the warrants to March 21, 2020.
Item 6.
Item 6. Selected Financial Data
Special Items Affecting Comparability
The selected consolidated financial data set forth below under “Historical Selected Financial Data” with respect to our consolidated statements of operations for 2019, 2018, 2017, 2016 and 2015, and with respect to our consolidated balance sheets at December 31, 2019, 2018, 2017, 2016 and 2015, have been derived from our audited consolidated financial statements.
Our results of operations and financial condition have been affected by restructuring activities, legal contingencies, dispositions, debt refinancing and impairments and write-downs of assets during the periods presented, which affect the comparability of the financial information shown. In particular, our results of operations for the fiscal years ended December 31, 2015 - 2019 time period were impacted by the following items (before tax):
The historical selected financial data shown below should not be considered as being indicative of future operations, and should be read in conjunction with Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Note: The following should be read in conjunction with our Consolidated Financial Statements and related Footnotes to Consolidated Financial Statements that appear elsewhere in this Annual Report on Form 10-K. References to “Footnotes” in the discussion below refer to the numbered Footnotes to Consolidated Financial Statements.
Executive Summary
Our Business
The terms “we,” “us” and similar or derivative terms refer to ION Geophysical Corporation and its consolidated subsidiaries, except where the context otherwise requires or as otherwise indicated.
We have been a leading technology innovator for over 50 years. While the traditional focus of our cutting-edge technology has been on the exploration and production (“E&P”) industry, we are now broadening and diversifying our business into relevant adjacent markets such as offshore logistics, ports and harbors, defense and marine robotics.
Our offerings are focused on improving subsurface knowledge to enhance E&P decision-making and enhancing situational awareness to optimize offshore operations. We serve customers in most major energy producing regions of the world from strategically located offices.
The Company is publicly listed on the New York Stock Exchange under the ticker IO. ION is headquartered in Houston, Texas with regional offices around the world.
During the first quarter of 2019, we consolidated our operating segments from three into two, eliminating the separate presentation of our Ocean Bottom Integrated Technologies segment. This consolidation aligns with our asset light business model and evolved strategy to commercialize 4Sea ocean bottom technologies instead of operating a crew. Revenues from 4Sea are being recognized through the relevant segment, either E&P Technology & Services or Operations Optimization.
We provide our services and products through two business segments - E&P Technology & Services and Operations Optimization.
For a full discussion of our business, see Part I, Item 1. “Business.”
Macroeconomic Conditions
Demand for our services and products is cyclical and dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to invest capital in the exploration for oil and natural gas. Our customers’ capital spending programs are generally based on their outlook for near-term and long-term economic growth, resource supply and demand, and commodity prices. Oil and gas projections suggest continued demand growth may create a supply gap in the middle of the next decade that production from US shale developments may be unable to meet, necessitating offshore exploration and development. The annual decline rate in existing oil fields is about 10%, which can be reduced to about 5% per year with infill and other enhanced recovery techniques. Due to the time it takes to develop and start producing oil and gas from new discoveries offshore, there’s an increasing need to reinvest in conventional resources offshore to meet demand in the middle of the next decade. We’re starting to see increasing pressure for a resumption in offshore investment and exploration activity to replace reserves and existing production.
The following is a summary of recent oil and gas pricing trends:
Crude oil prices traded within relatively narrow price ranges in 2019. Brent prices reached an annual daily low of $55 per barrel in early January 2019 and a daily high of $75 per barrel in late April 2019, resulting in a range of $20 per barrel, the narrowest Brent price range since 2003. These narrower trading ranges occurred as a result of OPEC and others actively managing supply to offset upward and downward price pressures. The U.S. Energy Information Administration (“EIA”) estimates that global oil markets were roughly balanced in 2019, as global oil supply declined slightly and global oil consumption grew at its slowest pace since 2011. In 2019, several factors provided downward pressure on crude oil prices including the growth in US production and lower global demand growth. These were offset by the September attacks on Saudi Arabia’s crude oil processing facilities, OPEC and non-OPEC continued production cut and U.S sanctions on Venezuela and Iran. The EIA forecasts the Brent crude oil spot price will average $65 per barrel in 2020, which is relatively consistent with 2019.
Given the historical volatility of crude prices, there is a continued risk that if commodity prices start to deteriorate again, demand for our services and products could decline.
Impact to Our Business
Our portfolio of E&P offerings is aligned with market trends and targets all aspects of spending across the E&P life cycle. For example, current E&P focus areas include higher return infrastructure-led exploration, emerging basins, lower breakeven opportunities and targeted frontier basins.
In 2019, our total net revenues decreased by $5.3 million, or 3%, to $174.7 million for 2019 from $180.0 million for 2018. This decrease is primarily attributable to decline in our New Venture revenues resulting from the scale and timing of our multi-client programs.
Investments in our multi-client data library are dependent upon the timing of our new venture projects and the availability of underwriting by our customers. We continue to maintain high standards for underwriting new projects. Our asset light strategy enables us to scale our business to market conditions avoiding significant fixed costs and maintaining flexibility to manage the timing and amount of our capital expenditures.
In our E&P Technology & Services segment, our New Venture revenues decreased compared to 2018 due to scale and timing of our new programs. Delays in license round announcements can materially impact the timing of sales in areas where
our New Venture programs are underway. Our Data Library sales increased in 2019 compared to 2018 due to sales of South American data. Imaging Services revenues increased due to modest market improvement and the successful execution of our strategy to focus on key clients, applications and basins that benefit from and enable us to continue enhancing our advanced technologies. We invested $28.8 million in our multi-client data library during 2019, approximately $0.5 million and $5.1 million more compared to 2018 and 2017, respectively.
At December 31, 2019, our E&P Technology & Services segment backlog, which consists of commitments for (i) data processing work, (ii) New Venture projects (both multi-client and proprietary) by our Ventures group underwritten by our customers and (iii) E&P Advisors projects, decreased 14% to $18.9 million, compared with $21.9 million at December 31, 2018. The majority of our backlog relates to our multi-client seismic programs and our proprietary Imaging Services and E&P Advisors work. We anticipate that the majority of our backlog will be recognized as revenue over the first half of 2020.
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 more consistent. Our Imaging Services team has largely worked in the high-end 3D market for the last decade. In the multi-client market, we were historically known for our 2D programs and entered the 3D market in 2014. Since then, we have rapidly expanded our 3D seismic data library by purchasing existing seismic data and reimaging the data using our advanced data processing techniques and algorithms. The 350,000 sq km of multi-client reimaging programs has given us credibility and experience in the space, leading to a pipeline of opportunities for new 3D towed streamer or seabed programs that offer larger scale revenue and profit potential.
Within the Operations Optimization segment, the increase in Optimization Software & Services revenues was due to an increase in deployments of and associated engineering services related to our Marlin offshore operations optimization software. Devices revenues increased due to an increase in sales of replacement marine equipment and repairs.
It is our view that technologies that add a competitive advantage through improved imaging, lower costs, higher productivity, or enhanced safety will continue to be valued in our marketplace. We believe that our newest technologies, such as Marlin and 4Sea, will continue to attract customer interest, because these technologies are designed to deliver those desirable attributes.
The sustained E&P shift to maintain capital discipline and deliver shareholder value has resulted in a leaner, more profitable environment. E&P management focus is now much more closely aligned with investor interests where emphasis is on value metrics such as return on investment and cash generation as opposed to volume metrics such as production or reserves growth.
International activity has been picking up while North America has slowed down. Sustainable structural changes have made offshore increasingly cost-competitive with shale, with improved payback timeframes. As a result, we are seeing investment start to flow offshore again, which aligns more favorably with ION’s strategy and portfolio. In addition, exploration returns have rebounded back to healthier levels, with frontier areas demonstrating the most attractive returns, which will likely encourage future investment.
Historically, our revenue and EBITDA generation is lower in the first part of the year as customers tend to set budgets in the first quarter, then picks up as they firm up plans throughout the year. The last few years, E&P companies have remained focused on generating cash and shareholders return prioritizing value over volume.
We expect continued activity to rationalize and high grade portfolios to maximize return on investment, and related data sales opportunities to fill knowledge gaps. With a strong focus on value generation, exploration spending remains very focused on specific geographic areas.
As a result, we are focusing to align our organization structure with our strategy as well as rightsizing our costs relative to our revenues. We are cutting our costs by reducing our use of contractors and vendors and eliminating certain discretionary spending, reducing our facilities and reducing our headcount by approximately 11%. We expect that these efforts will result in annualized savings of over $20.0 million.
Key Financial Metrics
The tables below provide (i) a summary of our net revenues for our company as a whole, and by segment, for 2019, 2018 and 2017, and (ii) an overview of other certain key financial metrics for our company as a whole and our two business segments on a comparative basis for 2019, 2018 and 2017, as reported and as adjusted in all three years for the special items recorded for those years.
(a)
Includes net revenues generated by our E&P Advisors group.
(b)
Excluding item (a) above, this represents net revenues generated our Ventures group.
We intend that the following discussion of our financial condition and results of operations will provide information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes. The financial results are reported in accordance with Generally Accepted Accounting Principles (“GAAP”). However, management believes that certain non-GAAP performance measures may provide users of this financial information, additional meaningful comparisons between current results and results in prior operating periods. One such non-GAAP financial measure is net income (loss) applicable to common shares as adjusted or adjusted net income (loss), which excludes certain charges or amounts. This adjusted net income (loss) is not a measure of financial performance under GAAP. Accordingly, it should not be considered as a substitute for income (loss) from operations, net loss or other income data prepared in accordance with GAAP.
For a discussion of factors that could impact our future operating results and financial condition, see Item 1A. “Risk Factors” above.
Results of Operations
Year Ended December 31, 2019 (As Adjusted) Compared to Year Ended December 31, 2018 (As Adjusted)
Our total net revenues of $174.7 million for 2019 decreased $5.3 million, or 3%, compared to total net revenues of $180.0 million for 2018. Our overall gross profit percentage, as adjusted, for 2019 was 40%, compared to a gross profit percentage of 33% for 2018. Total operating expenses as a percentage of total net revenues for 2019 and 2018 were 45% and 42%, as adjusted, respectively. During 2019, our loss from operations as adjusted, was $9.7 million, compared to a loss of $15.6 million for 2018.
Our net loss as adjusted, for 2019 was $33.9 million, or a loss of $2.40 per share, compared to net loss of $32.5 million or a loss of $2.37 per share for 2018. As noted above, our net loss for 2019 and 2018 included other special items totaling $14.3 million and $38.7 million, respectively, impacting our loss per share by $1.01 and $2.83, respectively.
Net Revenues, Gross Profits and Gross Margins
E&P Technology & Services - Net revenues for 2019 decreased by $10.9 million, or 8%, to $125.6 million, compared to $136.5 million for 2018. Within the E&P Technology & Services segment, total multi-client revenues were $103.0 million, a decrease of 12%, with New Venture revenues experiencing significant declines during 2019 resulting from timing and scale of new multi-client programs. Partially offsetting the overall decline in New Venture revenues was an increase in Data Library revenues of $24.8 million, or 53%, attributable to sales of South American data. Imaging Services revenues were $22.5 million, a 14% increase, attributable to modest market improvement and the successful execution of our strategy to focus on key clients, applications and basins that benefit from and enable us to continue enhancing our advanced technologies.
Gross profit as adjusted, increased by $1.4 million to $44.8 million, representing a 36% gross margin, compared to $43.4 million, or 32% gross margin, for 2018. The increase in gross profit and margin were due to increases in Data Library and Imaging Services revenues, as noted above.
Operations Optimization - Net revenues for 2019 increased by $5.6 million, or 13%, to $49.1 million, compared to $43.5 million for 2018. Optimization Software & Services net revenues increased by $2.0 million, or 10%, to $23.1 million, compared to $21.1 million for 2018 due to an increase in deployments of and associated engineering services related to our Marlin offshore optimization software. Devices revenues for 2019 increased by $3.6 million, or 16%, to $26.0 million, compared to $22.4 million for 2018. This increase was due to an increase in sales of marine equipment replacement and repairs. Operations Optimization gross profit for 2019 increased by $2.0 million to $24.3 million, in 2019, compared to $22.3 million, for 2018. Gross margin were consistent for both 2019 and 2018.
Operating Expenses (As Adjusted)
The following table presents the “As Adjusted” in both 2019 and 2018, excluding other special items (in thousands):
(a)
Represents severance expense of $2.8 million and stock appreciation right awards expense of $2.9 million.
(b)
Represents stock appreciation rights awards and related expenses for 2018.
(c)
Represents a write-down of the cable-based ocean bottom acquisition technologies.
Research, Development and Engineering - Research, development and engineering expense increased $0.8 million, or 5%, to $19.0 million, for 2019, compared to $18.2 million, for 2018. Increase is primarily driven by higher spend in developing imaging algorithms and infrastructure, devices and software. We see significant long-term potential in offerings that are designed to improve image quality, safety and productivity, which drives our investment decisions.
Marketing and Sales - Marketing and sales expense increased $1.4 million, or 6%, to $23.2 million, for 2019, compared to $21.8 million, for 2018. This increase was primarily due to increased commission expenses driven by increased data library sales within the E&P Technology and Services segment.
General, Administrative and Other Operating Expenses - General, administrative and other operating expenses increased $1.3 million, or 4%, to $36.5 million, as adjusted, for 2019 compared to $35.3 million, as adjusted, for 2018. The increase was related to compensation expense.
Other Items
Interest Expense, net - Interest expense, net, of $13.1 million for 2019 compared to $13.0 million for 2018. For additional information, please refer to “- Liquidity and Capital Resources - Sources of Capital” below.
Other Expense - Other expense for 2019 was $1.6 million compared to $0.4 million for 2018. Increase primarily relates to foreign exchange loss from our operations in Brazil.
Income Tax Expense - Income tax expense for 2019 was $8.1 million compared to $2.7 million for 2018. Our effective tax rates for 2019 and 2018 were 20.6% and 4.0%, respectively. The income tax expense for 2019 and 2018 primarily relates to profits generated by our non-U.S. businesses. Tax expense for 2019 and 2018 includes zero and $0.3 million, respectively, of tax benefit for the release of the valuation allowance against refundable U.S. alternative minimum tax (“AMT”) credits. Tax expense has not been offset by the tax benefits on losses within the U.S. and other jurisdictions, from which we cannot currently benefit. Our effective tax rate for 2019 was negatively impacted by the change in valuation allowance related to U.S. operating losses for which we cannot currently recognize a tax benefit. See further discussion of establishment of the deferred tax valuation allowance at Footnote 7 “Income Taxes” of Footnotes to Consolidated Financial Statements.
Results of Operations
Year Ended December 31, 2018 (As Adjusted) Compared to Year Ended December 31, 2017 (As Adjusted)
Our total net revenues of $180.0 million for 2018 decreased $17.6 million, or 9%, compared to total net revenues of $197.6 million for 2017. Our overall gross profit percentage for 2018 was 33%, compared to a gross profit percentage of 38% for 2017. Total operating expenses as a percentage of total net revenues for 2018 and 2017 were 42% and 40%, as adjusted, respectively. During 2018, our loss from operations was $15.6 million, as adjusted, compared to a loss of $2.6 million, as adjusted, for 2017.
Our net loss for 2018 was $32.5 million, as adjusted, or a loss of $2.37 per share, compared to net loss of $19.1 million, as adjusted, or a loss of $1.61 per share for 2017. As noted above, our net loss for 2018 and 2017 included other special items totaling $38.7 million and $11.1 million, respectively, impacting our loss per share by $2.83 and $0.94, respectively.
Net Revenues, Gross Profits and Gross Margins
E&P Technology & Services - Net revenues for 2018 decreased by $20.7 million, or 13%, to $136.5 million, compared to $157.2 million for 2017. Within the E&P Technology & Services segment, total multi-client revenues were $116.8 million, a decrease of 17%, with New Venture revenues experiencing significant declines during 2018. Partially offsetting the overall decline in New Venture revenues was an increase in Data Library revenues, attributable to sales of the recently completed phases of the Brazil and Mexico reimaging programs, along with sales of 2D data libraries in Libya. The decrease in multi-client revenues was driven by the continued delay of the Panama license round announcement, the deferment of new E&P investments in Mexico and the continued focus on cash preservation within E&P companies restricting exploration spending. Imaging Services revenues were $19.7 million, a 20% increase, due to an increase in proprietary ocean bottom nodal imaging projects.
Gross profit decreased by $21.8 million to $43.4 million, representing a 32% gross margin, compared to $65.2 million, or 41% gross margin, for 2017. The decline in gross profit and margin were due to the decrease in New Venture revenues partly offset by the increases in Data Library and Imaging Services revenues, as noted above.
Operations Optimization - Net revenues for 2018 increased by $3.2 million, or 8%, to $43.5 million, compared to $40.3 million for 2017. Optimization Software & Services net revenues increased by $4.4 million, or 26%, to $21.1 million, compared to $16.7 million for 2017 due to increase in sales of our Gator ocean bottom command and control system. Devices revenues for 2018 decreased by $1.2 million, or 5%, to $22.4 million, compared to $23.6 million for 2017. This decrease was due to a decline in our repairs business due to seismic contractors focus on cash preservation and decrease in sales of our various product offerings. Operations Optimization gross profit for 2018 increased by $2.2 million to $22.3 million, in 2018, compared to $20.1 million, for 2017. Gross margin increased to 51% in 2018 from 50% in 2017.
Operating Expenses (As Adjusted)
The following table presents the “As Adjusted” in both 2018 and 2017, excluding other special items (in thousands):
(a)
Represents stock appreciation rights awards and related expenses for 2018 and 2017.
(b)
Represents a write-down of the cable-based ocean bottom acquisition technologies.
Research, Development and Engineering - Research, development and engineering expense increased $1.8 million, or 11%, to $18.2 million, for 2018, compared to $16.4 million, for 2017. Increase is primarily driven by increased employment costs as 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 expense increased $1.0 million, or 5%, to $21.8 million, for 2018, compared to $20.8 million, for 2017. This increase was primarily due to increased marketing expenses to broaden and diversify our offerings into adjacent markets including consulting fees, partly offset by decrease in commission expense.
General, Administrative and Other Operating Expenses - General, administrative and other operating expenses decreased $5.7 million, or 14%, to $35.3 million, as adjusted, for 2018 compared to $41.0 million, as adjusted, for 2017. The decrease was driven by reductions in bonus expense due to current operating results.
Other Items
Interest Expense, net - Interest expense, net, of $13.0 million for 2018 compared to $16.7 million for 2017. The decrease in interest expense was a result of lower outstanding debt during 2018. For additional information, please refer to “- Liquidity and Capital Resources - Sources of Capital” below.
Other Expense - Other expense for 2018 was $0.4 million compared to other expense of $3.9 million for 2017. The difference primarily relates to changes in our accrual for loss contingency related to the WesternGeco legal proceedings. See further discussion at Footnote 8 “Legal Matters” and in Part 1, Item 3, “Legal Proceedings.”
The following table reflects the significant items of other income (in thousands):
Income Tax Expense - Income tax expense for 2018 was $2.7 million compared to less than $0.1 million for 2017. Our effective tax rates for 2018 and 2017 were 4.0% and 0.1%, respectively. The income tax expense for 2018 and 2017 primarily relates to profits generated by our non-U.S. businesses. Tax expense for 2018 and 2017 includes a $0.3 million and $1.3 million, respectively tax benefit for the release of the valuation allowance against refundable U.S. alternative minimum tax (“AMT”) credits. Tax expense has not been offset by the tax benefits on losses within the U.S. and other jurisdictions, from which we cannot currently benefit. Our effective tax rate for 2018 was negatively impacted by the change in valuation allowance related to U.S. operating losses for which we cannot currently recognize a tax benefit. See further discussion of establishment of the deferred tax valuation allowance at Footnote 7 “Income Taxes” of Footnotes to Consolidated Financial Statements.
Liquidity and Capital Resources
Sources of Capital
At December 31, 2019, we had total liquidity of $72.4 million, consisting of $33.1 million in cash on hand and $39.3 million of available borrowing capacity under the Credit Facility. Our cash requirements include working capital requirements and cash required for our debt service payments, multi-client seismic data acquisition activities and capital expenditures. At December 31, 2019, we had negative working capital of $23.6 million. Excluding current maturities of operating lease liabilities, our working capital would have been negative $12.5 million. Working capital requirements are primarily driven by our investment in our (i) multi-client data library ($28.8 million in 2019) and royalty payments for multi-client sales. Also, our headcount has traditionally been a significant driver of our working capital needs. As a significant portion of our business is involved in the planning, processing and interpretation of seismic data services, one of our largest investments is in our employees, which involves cash expenditures for their salaries, bonuses, payroll taxes and related compensation expenses, typically in advance of related revenue billings and collections.
Our working capital requirements may change from time to time depending upon many factors, including our operating results and adjustments in our operating plan in response to industry conditions, competition and unexpected events. In recent years, our primary sources of funds have been cash flows generated from operations, existing cash balances, debt and equity issuances and borrowings under our Credit Facility.
Revolving Credit Facility
On August 16, 2018, we and our 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 Bank, National Association (“PNC”), as agent for the lenders, entered into that certain Third Amendment and Joinder to Revolving Credit and Security Agreement (the “Third 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 and the Second Amendment to Revolving Credit and Security Agreement, dated as of April 28, 2016, the “Credit Agreement”). The Credit Agreement, as amended by the First Amendment, the Second Amendment and the Third Amendment is herein called, the “Credit Facility”). The Third Amendment amended the Credit Agreement to, among other things:
•
extend the maturity date of the Credit Facility by approximately four years (from August 22, 2019 to August 16, 2023), subject to the retirement or extension of the maturity date of the Second Lien Notes, as defined below, which mature on December 15, 2021;
•
increase the maximum revolver amount by $10.0 million (from $40.0 million to $50.0 million);
•
increase the borrowing base percentage of the net orderly liquidation value as it relates to the multi-client data library (not to exceed $28.5 million, up from the previous maximum of $15.0 million for the multi-client data library component);
•
include the eligible billed receivables of the Mexican Subsidiary up to a maximum of $5.0 million in the borrowing base calculation and joins the Mexican Subsidiary as a borrower thereunder (with a maximum exposure of $5.0 million) and require the equity and assets of the Mexican Subsidiary to be pledged to secure obligations under the facility;
•
modify the interest rate such that the maximum interest rate remains consistent with the fixed interest rate prior to the Third Amendment (that is, 3.00% per annum for domestic rate loans and 4.00% per annum for LIBOR rate loans), but lowers the range down to a minimum interest rate of 2.00% for domestic rate loans and 3.00% for LIBOR rate loans based on a leverage ratio for the preceding four-quarter period;
•
decrease the minimum excess borrowing availability threshold 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; and
•
modify the trigger required to test for compliance with the fixed charge coverage ratio.
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 our multi-client data library. At December 31, 2019, the undrawn borrowing base availability under the Credit Facility was $39.3 million, and there was no outstanding indebtedness under the Credit Facility. The maturity of the Credit Facility will accelerate to October 31, 2021 if we are unable to repay or extend the maturity of the Second Lien Notes.
The Credit Facility requires us to maintain compliance with various covenants. At December 31, 2019, we are in compliance with all of the covenants under the Credit Facility. For further information regarding our Credit Facility see Footnote 5 “Long-term Debt” of Footnotes to Consolidated Financial Statements.
Senior Secured Notes
At December 31, 2019, ION Geophysical Corporation’s 9.125% Senior Secured Second Priority Notes due December 2021 (the “Second Lien Notes”) had an outstanding principal amount of $120.6 million and are senior secured second-priority obligations guaranteed by the Material U.S. Subsidiaries and the Mexican Subsidiary. Interest on the Second Lien Notes is payable semiannually in arrears on June 15 and December 15 of each year during their term, except that the interest payment otherwise payable on June 15, 2021 will be payable on December 15, 2021.
The April 2016 indenture governing the Second Lien Notes contains certain covenants that, among other things, limits or prohibits our ability and the ability of our restricted subsidiaries to take certain actions or permit certain conditions to exist during the term of the Second Lien Notes, including among other things, incurring additional indebtedness in excess of permitted indebtedness, creating liens, paying dividends and making other distributions in respect of our capital stock, redeeming our 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 Second Lien Notes Indenture are subject to certain exceptions and qualifications. All of our subsidiaries are currently restricted subsidiaries.
At December 31, 2019, we are in compliance with all of the covenants under the Second Lien Notes.
On or after December 15, 2019, we may on one or more occasions redeem all or a part of the Second Lien Notes at the redemption prices set forth below, plus accrued and unpaid interest and special interest, if any, on the Second Lien Notes redeemed during the twelve-month period beginning on December 15th of the years indicated below:
Meeting our Liquidity Requirements
At December 31, 2019, our total outstanding indebtedness was approximately $121.5 million, consisting primarily of approximately $120.6 million outstanding Second Lien Notes, $1.9 million of equipment finance leases and $1.0 million of other short-term debt, partially offset by $2.0 million of debt issuance costs. At December 31, 2019, there was no outstanding indebtedness under our Credit Facility.
For the Current Period, total capital expenditures, including investments in our multi-client data library, were $31.2 million. We currently expect that our capital expenditures related to investments in our multi-client data library will be in the range of $30.0 million to $40.0 million in 2020, a portion of which will be pre-funded by our customers. Investments in our multi-client data library are dependent upon the timing of our New Venture projects and the availability of underwriting by our customers. We currently expect capital expenditures related to property, plant and equipment to be in the range of $5.0 million to $10.0 million in 2020.
We believe that our existing cash balance, cash from operations and undrawn availability under our Credit Facility will be sufficient to meet our anticipated cash needs for at least the next twelve months. However, should our costs and expenses prove to be greater than we currently anticipate or if we do not generate sufficient revenues to cover our working capital requirements, our operations will be severely affected. In addition, as described at Part I, Item 3. “Legal Proceedings,” there are possible scenarios involving an outcome in the WesternGeco lawsuit that could materially and adversely affect our liquidity, financial condition and results of operations.
Cash Flow from Operations
Net cash provided by operating activities was $34.2 million for 2019, compared to $7.1 million for 2018. The increase was primarily driven by collections of our combined accounts and unbilled receivable balance.
Net cash provided by operating activities was $7.1 million for 2018, compared to $27.6 million for 2017. The decrease was driven by lower revenue activity compared to 2017, payment of $3.8 million damages for the WesternGeco lawsuit, reductions in accounts payable and accrued expenses and increase in our combined accounts and unbilled receivable balance.
Cash Flow Used In Investing Activities
Net cash flow used in investing activities was $31.2 million for 2019, compared to $29.8 million for 2018. The principal uses of cash in our investing activities during 2019 were $28.8 million of investments in our multi-client data library and $2.4 million of investments in property, plant and equipment.
Net cash flow used in investing activities was $29.8 million for 2018, compared to $24.8 million for 2017. The principal uses of cash in our investing activities during 2018 were $28.3 million of investments in our multi-client data library and $1.5 million of investments in property, plant and equipment.
Cash Flow Used in Financing Activities
Net cash flow used in financing activities was $3.5 million for 2019, compared to $3.8 millionnet cash flow provided by financing activities in 2018. The net cash used in financing activities was primarily related to $2.6 million of payments on long-term debt, including equipment finance leases during 2019.
Net cash flow provided by financing activities was $3.8 million for 2018, compared to $3.6 million of net cash flow used in financing activities for 2017. The net cash flow provided by financing activities during 2018 was primarily related to $47.0 million of net cash received from our public equity offering, partially offset by $30.8 million of payments on long-term debt including equipment capital leases and a $10.0 million repayment of our Credit Facility.
Inflation and Seasonality
Inflation in recent years has not had a material effect on our costs of goods or labor, or the prices for our products or services. Traditionally, our business has been seasonal, with strongest demand typically in the second half of our fiscal year.
Future Contractual Obligations
The following table sets forth estimates of future payments of our consolidated contractual obligations, as of December 31, 2019 (in thousands):
The long-term and short-term debt at December 31, 2019 included $120.6 million of principal indebtedness outstanding under our Second Lien Notes that will mature in December 2021. The $2.0 million of equipment finance leases relates to Imaging Services’ financing of computer and other equipment purchases.
The operating lease commitments at December 31, 2019 relate to our leases for certain equipment, offices, processing centers, and warehouse space. Our purchase obligations primarily relate to our committed inventory purchase orders under which deliveries of inventory are scheduled to be made in 2020.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make choices between acceptable methods of accounting and to use judgment in making estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenue and expenses. The following accounting policies are based on, among other things, judgments and assumptions made by management that include inherent risk and uncertainties. Management’s estimates are based on the relevant information available at the end of each period. We believe that all of the judgments and estimates used to prepare our financial statements were reasonable at the time we made them, but circumstances may change requiring us to revise our estimates in ways that could be materially adverse to our results of operations and financial condition. We describe our significant accounting policies more fully in Footnote 1 “Summary of Significant Accounting Policies” of Footnotes to Consolidated Financial Statements.
Revenue Recognition
We derive revenue from the (i) sale or license of multi-client and proprietary data, imaging services and E&P Advisors consulting services within our E&P Technology & Services segment; (ii) sale, license or 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 our 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 services revenues. All other revenues are classified as product revenues.
We use 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 we expect 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. We apply the practical expedient in Accounting Standards Codification Topic 606 (“ASC 606”) and do not disclose the value of contractual future performance obligations such as backlog with an original expected length of one year or less.
Multi-client and Proprietary Surveys, Imaging Services and E&P Advisors Services - As multi-client seismic surveys are being designed, acquired or processed (the “New Venture” phase), we enter into non-exclusive licensing arrangements with our customers, who pre-fund or underwrite these acquisition programs in part. License revenues from these surveys are recognized during the New Venture phase as the seismic data is acquired and/or processed on a proportionate basis as work is performed and control is transferred to the customer. Under this method, we recognize revenue based upon quantifiable measures of progress, such as kilometers acquired or surveys of performance completed to date. Upon completion of a multi-client seismic survey, it is considered “on-the-shelf,” and licenses to the survey data are granted to customers on a non-exclusive basis.
We also perform seismic surveys, imaging and other services under contracts to specific customers, whereby the seismic data is owned by those customers. We recognize revenue as the seismic data is acquired and/or processed on a proportionate basis as work is performed. We use quantifiable measures of progress consistent with our multi-client seismic surveys.
Acquisition Systems and Other Equipment - For sales of seismic data acquisition systems and other equipment, we recognize revenue when control of the goods has transferred to the customer. Transfer of control generally occurs when (i) we have a present right to payment; (ii) the customer has legal title to the asset; (iii) we have transferred physical possession of the asset; and (iv) the customer has significant rewards of ownership; or (v) the customer has accepted the asset.
Software - Licenses for our navigation, survey design and quality control software systems provide the customer with a right to use the software. We offer usage-based licenses under which we receive a monthly fee based on the number of vessels and licenses used. For these usage-based licenses, revenue is recognized as the performance obligations are performed over the contract term, which is generally two to five years. In addition to usage-based licenses, we offer perpetual software licenses as it exists when made available to the customer. Revenue from these licenses is recognized upfront at the point in time when the software is made available to the customer.
These arrangements generally include us providing related services, such as training courses, engineering services and annual software maintenance. We allocate consideration to each element of the arrangement based upon directly observable or estimated standalone selling prices. Revenue is recognized for these services as control transfers to the customer over time.
Multi-client Data Library
Our multi-client data library consists of seismic surveys that are offered for licensing to customers on a non-exclusive basis. The capitalized costs include the costs paid to third parties for the acquisition of data and related activities associated with the data creation activity and direct internal processing costs, such as salaries, benefits, computer-related expenses and other costs incurred for seismic data project design and management. For 2019, 2018 and 2017, we capitalized, as part of our multi-client data library, $9.3 million, $11.9 million and $12.7 million, respectively, of direct internal processing costs.
Our method of amortizing the costs of an in-process multi-client survey (the period during which the seismic data is being acquired or processed, the New Venture phase) consists of determining the percentage of actual revenue recognized to the total estimated revenues (which includes both revenues estimated to be realized during the New Venture phase and estimated revenues from the licensing of the resulting “on-the-shelf” survey data) and multiplying that percentage by the total cost of the project (the sales forecast method). We consider a multi-client survey to be complete when all work on the creation of the seismic data is finished and that survey is available for licensing.
Once a multi-client data survey is completed, the data survey is considered “on-the-shelf” and our method of amortization is then the greater of (i) the sales forecast method or (ii) the straight-line basis over a four-year period. The greater amount of amortization resulting from the sales forecast method or the straight-line amortization policy is applied on a cumulative basis at the individual survey level. Under this policy, we first record amortization using the sales forecast method. The cumulative amortization recorded for each survey is then compared with the cumulative straight-line amortization. The four-year period utilized in this cumulative comparison commences when the data survey is determined to be complete. If the cumulative straight-line amortization is higher for any specific survey, additional amortization expense is recorded, resulting in the accumulated amortization being equal to the cumulative straight-line amortization for that survey. We have determined the amortization period to be four years based upon our historical experience that indicates that the majority of our revenues from multi-client surveys are derived during the acquisition and processing phases and during the four years subsequent to survey completion.
Estimated sales are determined based upon discussions with our customers, our experience and our knowledge of industry trends. Changes in sales estimates may have the effect of changing the percentage relationship of cost of services to revenue. In applying the sales forecast method, an increase in the projected sales of a survey will result in lower cost of services as a percentage of revenue and higher earnings when revenue associated with that particular survey is recognized, while a decrease in projected sales will have the opposite effect. Assuming that the overall volume of sales mix of surveys generating revenue in the period was held constant in 2019, an increase of 10% in the sales forecasts of all surveys would have increased our amortization expense by approximately $0.9 million.
We estimate the ultimate revenue expected to be derived from a particular seismic data survey over its estimated useful economic life to determine the costs to amortize, if greater than straight-line amortization. That estimate is made by us at the project’s initiation. For a completed multi-client survey, we review the estimate quarterly. If during any such review, we determine that the ultimate revenue for a survey is expected to be materially more or less than the original estimate of total revenue for such survey, we decrease or increase (as the case may be) the amortization rate attributable to the future revenue from such survey. In addition, in connection with such reviews, we evaluate the recoverability of the multi-client data library, and, if required, record an impairment charge with respect to such data. For 2019, we wrote down our multi-client data library by $9.1 million for programs with capitalized costs exceeding the remaining sales forecast.
Reserve for Excess and Obsolete Inventories
Our reserve for excess and obsolete inventories is based on historical sales trends and various other assumptions and judgments, including future demand for our inventory, the timing of market acceptance of our new products and the risk of obsolescence driven by new product introductions. When we record a charge for excess and obsolete inventories, the amount is applied as a reduction in the cost basis of the specific inventory item for which the charge was recorded. Should these assumptions and judgments not be realized for these or for other reasons, our reserve would be adjusted to reflect actual results. Our industry is subject to technological change and new product development that could result in obsolete inventory. Our reserve for inventory at December 31, 2019 and 2018 was $13.3 million and $15.0 million, respectively.
Goodwill
Goodwill is allocated to our reporting units, which is either the operating segment or one reporting level below the operating segment, which includes E&P Technology & Services, Optimization Software & Services and Devices. Goodwill is not amortized, but rather tested and assessed for impairment at least annually on December 31, or more frequently, if facts and circumstances indicate that the carrying amount may exceed fair value. We first perform a qualitative assessment by evaluating relevant events or circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we are unable to conclude qualitatively that it is more likely than not that a reporting unit’s fair value exceeds its carrying value, then we will use a two-step quantitative assessment of the fair value of a reporting unit. If the carrying value of a reporting unit of an entity that includes goodwill is determined to be more than the fair value of the reporting unit, there exists the possibility of impairment of goodwill. An impairment loss of goodwill is measured in two steps by first allocating the fair value of the reporting unit to net assets and liabilities including recorded and unrecorded other intangible assets to determine the implied carrying value of goodwill. The next step is to measure the difference between the carrying value of goodwill and the implied carrying value of goodwill, and, if the implied carrying value of goodwill is less than the carrying value of goodwill, an impairment loss is recorded equal to the difference.
The goodwill balance at December 31, 2019 was comprised of $20.6 million in our Optimization Software & Services and $2.9 million in our E&P Technology & Services reporting units. Based on our qualitative assessment performed as of December 31, 2019, we concluded it was more likely than not that the fair values of our E&P Technology & Services and Optimization Software & Services reporting units exceeded their carrying values. Accordingly, no further testing was required and no impairment was recognized. However, if the market value of our shares declines for a prolonged period, and if management's judgments and assumptions regarding future industry conditions and operations diminish, it is reasonably possible that our expectations of future cash flows may decline and ultimately result in a goodwill impairment for our E&P Technology & Services and Optimization Software & Services reporting units.
Long-lived Asset Impairment
We evaluate the recoverability of our property, plant and equipment, when indicators of impairment exist, relying on a number of factors including operating results, business plans, economic projections and anticipated future cash flows. Impairment in the carrying value of an asset held for use is recognized whenever anticipated future undiscounted cash flows from an asset are estimated to be less than its carrying value. The amount of the impairment recognized is the difference between the carrying value of the asset and its fair value. No indicators of impairment were noted for 2019 and as such, no impairment charge was recognized. For 2018, we identified an indicator of impairment related to our cable-based ocean bottom acquisition technologies and recognized an impairment charge of $36.6 million.
Deferred Tax Assets
We established a valuation allowance on a substantial majority of our U.S. net 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. We will continue to record a valuation allowance for the substantial majority of all of our deferred tax assets until there is sufficient evidence to warrant reversal. In the event our expectations of future operating results change, an additional valuation allowance may be required to be established on our existing unreserved net U.S. deferred tax assets.
Stock-Based Compensation
We estimate the value of stock-based payment awards on the date of grant using an option pricing model such as Black-Scholes or Monte Carlo simulation. The determination of the fair value of stock-based payment awards is affected by our stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to, expected stock price volatility over the term of the awards, actual and projected stock-based instrument exercise behaviors, risk-free interest rate and expected dividends. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We recognize stock-based compensation expense on the straight-line basis over the requisite service period of each award that are ultimately expected to vest. For our stock appreciation rights, in the event that the market price of our common stock increases, our expectation of participants’ expected exercise behavior and risk free interest rate change in the future, we may have to recognize additional SARs expense that could ultimately affect our operating results and cash flows.
Foreign Sales Risks
The majority of our foreign sales are denominated in U.S. dollars. Product revenues are allocated to geographical 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 geographical location of initial shipment. Service revenues, which primarily relate to our E&P Technology & Services segment, are allocated based upon the billing location of the customer. For 2019, 2018 and 2017, international sales comprised 73%, 75% and 76%, respectively, of total net revenues.
Off-Balance Sheet Arrangements
Variable interest entities. At December 31, 2019, our investment in INOVA Geophysical constitutes an investment in a variable interest entity, as that term is defined in Accounting Standards Codification Topic 810-10 “Consolidation - Overall” and as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. See Footnote 1 “Summary of Significant Accounting Policies-Equity Method Investments” of Footnotes to Consolidated Financial Statements included elsewhere in this Form 10-K for additional information.
Indemnification
In the ordinary course of our business, we enter into contractual arrangements with our customers, suppliers and other parties under which we may agree to indemnify the other party to such arrangement from certain losses it incurs relating to our products or services or for losses arising from certain events as defined within the particular contract. Some of these indemnification obligations may not be subject to maximum loss limitations. Historically, payments we have made related to these indemnification obligations have been immaterial.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. Our primary market risks include risks related to interest rates and foreign currency exchange rates.
Interest Rate Risk
At December 31, 2019, we had outstanding total indebtedness of approximately $121.5 million. At December 31, 2019, all of this indebtedness, other than borrowings under our Credit Facility (described below) accrues interest at fixed interest rates.
As our borrowings under the Credit Facility are subject to variable interest rates, we are subject to interest rate risk to the extent we have outstanding balances under the Credit Facility. We are therefore impacted by changes in LIBOR and/or our bank's base rates. We may, from time to time, use derivative financial instruments to help mitigate rising interest rates under our Credit Facility. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors.
Foreign Currency Exchange Rate Risk
Our operations are conducted in various countries around the world, and we receive revenue from these operations in a number of different currencies with the most significant of our international operations using British Pounds Sterling. As such, our earnings are subject to movements in foreign currency exchange rates when transactions are denominated in currencies other than the U.S. dollar, which is our functional currency, or the functional currency of many of our subsidiaries, which is not necessarily the U.S. dollar. To the extent that transactions of these subsidiaries are settled in currencies other than the U.S. dollar, a devaluation of these currencies versus the U.S. dollar could reduce the contribution from these subsidiaries to our consolidated results of operations as reported in U.S. dollars.
Through our subsidiaries, we operate in a wide variety of jurisdictions, including the United Kingdom, Brazil, Mexico, China, Canada, Russia, the United Arab Emirates, Egypt and other countries. Our financial results may be affected by changes in foreign currency exchange rates. Our consolidated balance sheets at December 31, 2019 reflected approximately $9.7 million of net working capital related to our foreign subsidiaries, a majority of which is within the United Kingdom and Brazil. Our foreign subsidiaries receive their income and pay their expenses primarily in their local currencies. To the extent that transactions of these subsidiaries are settled in the local currencies, a devaluation of these currencies versus the U.S. dollar could reduce the contribution from these subsidiaries to our consolidated results of operations as reported in U.S. dollars. In 2019, we recorded net foreign currency losses of approximately $1.3 million in other expense, a majority of these losses are due to currency fluctuations related to our operations in Brazil.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and related notes thereto required by this item begin at page hereof.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file with or submit to the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms. Disclosure controls and procedures are defined in Rule 13a-15(e) under the Exchange Act, and they include, without limitation, controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to management, including the principal executive officer and the principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Our management carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2019. Based upon that evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective as of December 31, 2019.
(b) Management’s Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
(i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of our company;
(ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of our company are being made only in accordance with authorizations of our management and directors; and
(iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we assessed the effectiveness of our internal control over financial reporting as of December 31, 2019 based upon criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based upon their assessment, management concluded that the internal control over financial reporting was effective as of December 31, 2019.
The independent registered public accounting firm that has also audited our consolidated financial statements included in this Annual Report on Form 10-K has issued an audit report on our internal control over financial reporting. This report appears below.
(c) Changes in Internal Control over Financial Reporting. There was not any change in our internal control over financial reporting that occurred during the three months ended December 31, 2019, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
ION Geophysical Corporation
Opinion on internal control over financial reporting
We have audited the internal control over financial reporting of ION Geophysical Corporation (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2019, and our report dated February 6, 2020 expressed an unqualified opinion on those financial statements.
Basis for opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and limitations of internal control over financial reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ GRANT THORNTON LLP
Houston, Texas
February 6, 2020
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Reference is made to the information appearing in the definitive proxy statement, under “Item 1 - Election of Directors,” for our annual meeting of stockholders to be held on May 13, 2020 (the “2020 Proxy Statement”) to be filed with the SEC with respect to Directors, Executive Officers and Corporate Governance, which is incorporated herein by reference and made a part hereof in response to the information required by Item 10.
Item 11.
Item 11. Executive Compensation
Reference is made to the information appearing in the 2020 Proxy Statement, under “Executive Compensation,” to be filed with the SEC with respect to Executive Compensation, which is incorporated herein by reference and made a part hereof in response to the information required by Item 11.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Reference is made to the information appearing in the 2020 Proxy Statement, under “Item 1 - Ownership of Equity Securities of ION” and “Equity Compensation Plan Information,” to be filed with the SEC with respect to Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, which is incorporated herein by reference and made a part hereof in response to the information required by Item 12.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Reference is made to the information appearing in the 2020 Proxy Statement, under “Item 1 - Certain Transactions and Relationships,” to be filed with the SEC with respect to Certain Relationships and Related Transactions and Director Independence, which is incorporated herein by reference and made a part hereof in response to the information required by Item 13.
Item 14.
Item 14. Principal Accounting Fees and Services
Reference is made to the information appearing in the 2020 Proxy Statement, under “Principal Auditor Fees and Services,” to be filed with the SEC with respect to Principal Accountant Fees and Services, which is incorporated herein by reference and made a part hereof in response to the information required by Item 14.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) List of Documents Filed
(1) Financial Statements
The financial statements filed as part of this report are listed in the “Index to Consolidated Financial Statements” on page hereof.
(2) Financial Statement Schedules
The following financial statement schedule is listed in the “Index to Consolidated Financial Statements” on page hereof, and is included as part of this Annual Report on Form 10-K:
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the requested information is shown in the financial statements or noted therein.
(3) Exhibits
(b)
Exhibits required by Item 601 of Regulation S-K.
Reference is made to subparagraph (a) (3) of this Item 15, which is incorporated herein by reference.
(c)
Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Houston, State of Texas, on February 6, 2020.
ION GEOPHYSICAL CORPORATION
By
/s/ Christopher Usher
Christopher Usher
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Christopher Usher and Matthew Powers and each of them, as his or her true and lawful attorneys-in-fact and agents with full power of substitution and re-substitution for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all documents relating to the Annual Report on Form 10-K for the year ended December 31, 2019, including any and all amendments and supplements thereto, and to file the same with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully as to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or their or his or her substitute or substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
ION Geophysical Corporation
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of ION Geophysical Corporation (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and schedule included under Item 15(a) (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 6, 2020 expressed an unqualified opinion.
Change in accounting principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases on January 1, 2019 using the modified retrospective method due to the adoption of Accounting Standards Codification 842, “Leases”.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2014.
Houston, Texas
February 6, 2020
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying Footnotes to Consolidated Financial Statements.
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying Footnotes to Consolidated Financial Statements.
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
See accompanying Footnotes to Consolidated Financial Statements.
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The following table is a reconciliation of cash, cash equivalents and restricted cash:
See accompanying Footnotes to Consolidated Financial Statements.
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIT) EQUITY
See accompanying Footnotes to Consolidated Financial Statements.
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
FOOTNOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
General Description and Principles of Consolidation
ION Geophysical Corporation and its subsidiaries offer a full suite of services and products for seismic data acquisition and processing. The consolidated financial statements include the accounts of ION Geophysical Corporation and its majority-owned subsidiaries (collectively referred to as the “Company” or “ION”). Intercompany balances and transactions have been eliminated.
Certain reclassifications were made to previously reported amounts in the consolidated financial statements and notes thereto to make them consistent with the current period presentation, including the change in reportable segments presentation which had no impact on the consolidated financial statements and the recognition of right-of-use (“ROU”) assets and operating lease liabilities on the consolidated balance sheets as a result of the adoption of the new lease standard. See Footnote 2 “Recent Accounting Pronouncements.” and Footnote 3 “Segment and Geographic Information.”
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the 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 libraries, impairment of property, plant and equipment and goodwill and deferred taxes. Actual results could materially differ from those estimates.
Foreign Currency Transactions
Assets and liabilities of the Company’s subsidiaries operating outside the United States that have a functional currency other than the U.S. dollar have been translated to U.S. dollars using the exchange rate in effect at the balance sheet date. Results of foreign operations have been translated using the average exchange rate during the periods of operation. Resulting translation adjustments have been recorded as a component of accumulated other comprehensive loss. Foreign currency transaction gains and losses, as they occur, are included in “Other expense, net” on the consolidated statements of operations. Total foreign currency transaction losses were $1.3 million, $0.4 million and $1.6 million for 2019, 2018 and 2017, respectively. The foreign currency transaction losses are primarily due to the currency rate fluctuations between the US dollar and the Brazilian real related to the Company’s operations in Brazil.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company places its temporary cash investments with high credit quality financial institutions. At times such investments may be in excess of the Federal Deposit Insurance Corporation insurance limit. At December 31, 2019 and 2018, there was $0.1 million and $0.3 million, respectively, of long-term and short-term restricted cash used to secure standby and commercial letters of credit, which is included within “Other assets” and “Prepaid expenses and other current assets” in the consolidated balance sheets.
Accounts and Unbilled Receivables
Accounts and unbilled receivables are recorded at cost, less the related allowance for doubtful accounts. The Company considers current information and events regarding the customers’ ability to repay their obligations, such as the length of time the receivable balance is outstanding, the customers’ credit worthiness and historical experience. Unbilled receivables relate to revenues recognized on multi-client surveys, imaging services and devices equipment repairs on a proportionate basis, and on licensing of multi-client data libraries for which invoices have not yet been presented to the customer.
Inventories
Inventories are stated at the lower of cost (primarily first-in, first-out method) or net realizable value. The Company provides reserves for estimated obsolescence or excess inventory equal to the difference between cost of inventory and its estimated net realizable value based upon assumptions about future demand for the Company’s products, market conditions and the risk of obsolescence driven by new product introductions.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation expense is provided straight-line over the following estimated useful lives:
Expenditures for major renewals and betterments, that increase the value or extend the economic useful life of the asset, are capitalized and depreciated. Repairs and maintenance are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the accounts and any gain or loss is reflected in “Other expense, net” in the consolidated statements of operations.
Long-lived Asset Impairment
The Company evaluates the recoverability of long-lived assets, including property, plant and equipment, when indicators of impairment exist, relying on a number of factors including operating results, business plans, economic projections and anticipated future cash flows. Impairment is recognized whenever anticipated future undiscounted cash flows the assets are expected to generate are estimated to be less than its carrying value. The amount of the impairment recognized is the difference between the carrying value of the asset and its fair value. No indicators of impairment were noted for 2019 and as such no impairment charge was recognized. For 2018, the Company identified an indicator of impairment as it relates to its cable-based ocean bottom acquisition technologies and recognized an impairment charge of $36.6 million.
Multi-Client Data Library
The multi-client data library consists of seismic surveys that are offered for licensing to customers on a non-exclusive basis. The capitalized costs include costs paid to third parties for the acquisition of data and related activities associated with the data creation activity and direct internal processing costs, such as salaries, benefits, computer-related expenses and other costs incurred for seismic data project design and management. For 2019, 2018 and 2017, the Company capitalized, as part of its multi-client data library, $9.3 million, $11.9 million and $12.7 million, respectively, of direct internal processing costs.
The Company’s method of amortizing the costs of an in-process multi-client data library (the period during which the seismic data is being acquired and/or processed, referred to as the “New Venture” phase) consists of determining the percentage of actual revenue recognized to the total estimated revenues (which includes both revenues estimated to be realized during the New Venture phase and estimated revenues from the licensing of the resulting “on-the-shelf” data survey) and multiplying that percentage by the total cost of the project (the sales forecast method). The Company considers a multi-client data survey to be complete when all work on the creation of the seismic data is finished and that data survey is available for licensing. Once a multi-client data survey is complete, the data survey is considered “on-the-shelf” and the Company’s method of amortization is then the greater of (i) the sales forecast method or (ii) the straight-line basis over a four-year period, applied on a cumulative basis at the individual survey level. Under this policy, the Company first records amortization using the sales forecast method. The cumulative amortization recorded for each survey is then compared with the cumulative straight-line amortization. The four-year period utilized in this cumulative comparison commences when the data survey is determined to be complete. If the cumulative straight-line amortization is higher for any specific survey, additional amortization expense is recorded, resulting in accumulated amortization being equal to the cumulative straight-line amortization for such survey. The Company has determined the amortization period of four years based upon its historical experience indicating that the majority of its revenues from multi-client surveys are derived during the acquisition and processing phases and during four years subsequent to survey completion.
The Company estimates the ultimate revenue expected to be derived from a particular seismic data survey over its estimated useful economic life to determine the costs to amortize, if greater than straight-line amortization. That estimate is made by the Company at the project’s initiation. For a completed multi-client survey, the Company reviews the estimate quarterly. If during any such review, the Company determines that the ultimate revenue for a survey is expected to be materially more or less than the original estimate of ultimate revenue for such survey, the Company decreases or increases (as the case may be) the amortization rate attributable to the future revenue from such survey. In addition, in connection with such reviews, the Company evaluates the recoverability of the multi-client data library, and, if required, records an impairment charge with respect to such data. For 2019, the Company wrote down its multi-client data library by $9.1 million for programs with capitalized costs exceeding the remaining sales forecast.
.
Goodwill
Goodwill represents the excess of costs over the fair value of the net assets acquired in connection with a business combination. Goodwill is allocated to reporting units, which are either the operating segment or one reporting level below the operating segment, which includes E&P Technology & Services, Optimization Software & Services and Devices. Goodwill is not amortized, but rather tested and assessed for impairment at least annually on December 31, or more frequently, if facts and circumstances indicate that the carrying amount may exceed fair value. The Company begins with a qualitative assessment by evaluating relevant events or circumstances to determine whether it is more likely than not that the fair value of a reporting unit exceeds its carrying amount. If the Company is unable to conclude qualitatively that it is more likely than not that a reporting unit’s fair value exceeds its carrying value, then it will use a two-step quantitative assessment of the fair value of a reporting unit. To determine the fair value of these reporting units, the Company uses a discounted future returns valuation model, which includes a variety of level 3 inputs, as defined in Footnote 15 “Fair Value of Financial Instruments.” The key inputs for the model include the operational three-year forecast for the Company and the then-current market discount factor. Additionally, the Company compares the sum of the estimated fair values of the individual reporting units less consolidated debt to the Company’s overall market capitalization as reflected by the Company’s stock price. If the carrying value of a reporting unit that includes goodwill is determined to be more than the fair value of the reporting unit, there exists the possibility of goodwill impairment. An impairment loss is measured in two steps by first allocating the fair value of the reporting unit to net assets and liabilities including recorded and unrecorded intangible assets to determine the implied carrying value of goodwill. The next step is to measure the difference between the carrying value of goodwill and the implied carrying value of goodwill, and, if the implied carrying value of goodwill is less than the carrying value of goodwill, an impairment loss is recorded equal to the difference. The goodwill balance at December 31, 2019 was comprised of $20.6 million in the Optimization Software & Services and $2.9 million in the E&P Technology & Services reporting units. See further discussion below at Footnote 11 “Goodwill.”
Equity Method Investment
The Company determined that INOVA Geophysical is a variable interest entity because the Company’s voting rights with respect to INOVA Geophysical are not proportionate to its ownership interest and substantially all of INOVA Geophysical’s activities are conducted on behalf of the Company and BGP Inc. (“BGP”), a subsidiary of China National Petroleum Corporation and a related party to the Company. The Company is not the primary beneficiary of INOVA Geophysical because it does not have the power to direct the activities of INOVA Geophysical that most significantly impact its economic performance. Accordingly, the Company does not consolidate INOVA Geophysical, but instead accounts for INOVA Geophysical using the equity method of accounting. Under this method, an investment is carried at the acquisition cost, plus the Company’s equity in undistributed earnings or losses since acquisition, less distributions received.
In 2014, the Company fully impaired its investment in INOVA reducing its equity investment in INOVA and its share of INOVA’s accumulated other comprehensive loss, both to zero. At December 31, 2019, the carrying value of this investment remains zero. The Company no longer records its equity in losses or earnings and has no obligation, implicit or explicit, to fund any expenses of INOVA Geophysical.
Noncontrolling Interests
The Company has non-redeemable noncontrolling interests. Non-redeemable noncontrolling interests in majority-owned affiliates are reported as a separate component of equity in “Noncontrolling interests” in the consolidated balance sheets. Net income attributable to noncontrolling interests is stated separately in the consolidated statements of operations. The activity for this noncontrolling interest relates to proprietary processing projects in Brazil.
Revenue From Contracts With Customers
The Company derives revenue from the sale or license of (i) multi-client and proprietary data, imaging services and E&P Advisors consulting services within its E&P Technology & 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 services 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 does not disclose the value of contractual future performance obligations such as backlog with an original expected length of one year or less within the footnotes. See further discussion below at Footnote 4 “Revenue from Contracts with Customers.”
Research, Development and Engineering
Research, development and engineering costs primarily relate to activities that are designed to improve the quality of the subsurface image and overall acquisition economics of the Company’s customers. The costs associated with these activities are expensed as incurred. These costs include prototype material and field testing expenses, along with the related salaries and stock-based compensation, facility costs, consulting fees, tools and equipment usage and other miscellaneous expenses associated with these activities.
Stock-Based Compensation
The Company issues stock-based payment awards to employees and directors, including employee stock options, restricted stock units, restricted stocks and stock appreciation rights. The Company estimates the value of stock-based payment awards on the date of grant using an option pricing model such as Black-Scholes or Monte Carlo simulation. The determination of the fair value of stock-based payment awards is affected by the Company’s stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to, expected stock price volatility over the term of the awards, actual and projected stock-based instrument exercise behaviors, risk-free interest rate and expected dividends. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company recognizes stock-based compensation expense on the straight-line basis over the requisite service period of each award that are ultimately expected to vest.
Income Taxes
Income taxes are accounted for under the liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, including operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The Company records a valuation allowance when it is more likely than not that all or a portion of deferred tax assets will not be realized (see Footnote 7 “Income Taxes”). The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(2) Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
On January 1, 2019, the Company adopted Accounting Standards Update (“ASU”) 2016-2, “Leases (Topic 842)” using the modified retrospective method. This ASU requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under the previous guidance. The Company used January 1, 2018, the beginning of the earliest comparative period presented in its consolidated financial statements, as the date of initial application. The Company elected the practical expedients upon transition which will retain the lease classification for leases and any unamortized initial direct costs that existed prior to the adoption of the standard.
The adoption of the standard resulted in ROU assets of $59.5 million and operating lease liabilities of $70.6 million on the consolidated balance sheets as of January 1, 2018. The difference between the ROU assets and operating lease liabilities is due to the derecognition of $11.1 million in deferred rent recorded within other long-term liabilities. There was no impact on the consolidated statements of operations and cash flows. The adoption of the standard had no impact on the debt covenant compliance under existing agreements. The Company elected the practical expedient related to short-term leases, which are leases with a duration of twelve months or less, and as such, they have not been recorded in the consolidated balance sheets. See Footnote 14 “Lease Obligations.” for further discussion.
Accounting Pronouncements Not Yet Adopted
In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, “Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments.” The guidance will replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The guidance is
effective for public companies for interim and annual periods beginning after December 15, 2019, with early adoption permitted for interim and annual periods beginning after December 15, 2018. The Company does not currently expect the adoption of this standard to have a material impact on the consolidated financial statements.
On January 26, 2017, the FASB issued ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This guidance simplifies the accounting for goodwill impairment by eliminating step 2 from the goodwill impairment test. Entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. The ASU is effective for annual and interim impairment tests performed in periods beginning after December 15, 2019. The ASU is not expected to have a material impact on the consolidated financial statements as it relates to how the Company tests goodwill for impairment.
(3) Segment and Geographic Information
During the first quarter of 2019, the Company consolidated its operating segments from three into two, eliminating the separate presentation of its Ocean Bottom Integrated Technologies segment. This consolidation aligns with the Company’s asset light business model and evolved strategy to commercialize components of the Company’s next generation ocean bottom nodal system, 4Sea, instead of operating a crew. The Company is offering 4Sea components more broadly to the growing number of OBS service providers under recurring revenue commercial strategies. The Company may also license the right to manufacture and use the 4Sea nodal technology to a service provider on a value-based pricing model, such as a royalty stream. Revenues from 4Sea are being recognized through the relevant segment, either E&P Technology & Services or Operations Optimization.
Accordingly, as of first quarter 2019, the Company evaluates and reviews its results based on two reporting segments: E&P Technology & Services and Operations Optimization.
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.
Previously reported segment information has been retrospectively revised throughout the consolidated financial statements, as applicable, for all periods presented to reflect the changes in the Company’s reporting segments. These changes did not have an impact on the Company’s consolidated financial statements. These changes did not affect the Company’s reporting units used for allocating and testing goodwill for impairment.
A summary of segment information follows (in thousands):
(a) Includes net revenues generated by the E&P Advisors group.
(b) Excluding item (a) above, this represents net revenues generated by the Ventures group.
(c) Relates to gross loss primarily related to depreciation expense of previously reported Ocean Bottom Integrated Technologies segment.
(d) Includes loss from operations of previously reported Ocean Bottom Integrated Technologies segment of $1.7 million, $11.1 million and $16.3 million for 2019, 2018 and 2017, respectively, which includes item (b) above, operating expenses of $1.7 million, $5.1 million and $6.7 million for 2019, 2018 and 2017 and includes a charge of $36.6 million to write-down the cable-based ocean bottom acquisition technologies associated with the previously reported Ocean Bottom Integrated Technologies segment. Remaining balance primarily relates to operating expenses.
Intersegment sales are insignificant for all periods presented.
(a) Includes depreciation and amortization of previously reported Ocean Bottom Integrated Technologies segment of zero, $4.2 million and $7.0 million for 2019, 2018 and 2017, respectively.
Depreciation and amortization expense recorded within cost of services and operating expenses in the consolidated statements of operations is allocated to segments based upon use of the underlying assets.
(a) Support and other assets include all assets specifically related to support personnel and operations and the majority of cash and cash equivalents.
A summary of total assets by geographic area follows (in thousands):
A summary of property, plant and equipment and multi-client data library, net of accumulated depreciation, amortization and impairment, by geographic area follows (in thousands):
A summary of net revenues by geographic area follows (in thousands):
Net revenues are attributed to geographic areas on the basis of the ultimate destination of the equipment or service, if known, or the geographic area imaging services are provided. If the ultimate destination of such equipment is not known, net revenues are attributed to the geographic area of initial shipment.
(4) Revenue from Contracts with Customers
Multi-client and Proprietary Surveys, Imaging Services and E&P Advisors Services - As multi-client seismic surveys are being designed, acquired or processed (the “New Venture” phase), the Company enters into non-exclusive licensing arrangements with its customers, who pre-fund or underwrite these acquisition programs in part. License revenues from these surveys are recognized during the New Venture phase as the seismic data is acquired and/or processed on a proportionate basis as work is performed and control is transferred to the customer. Under this method, the Company recognizes revenue based upon quantifiable measures of progress, such as kilometers acquired or surveys of performance completed to date. Upon completion of a multi-client seismic survey, it is considered “on-the-shelf,” and licenses to the survey data are granted to customers on a non-exclusive basis.
The Company also performs seismic surveys, imaging and other services under contracts with specific customers, whereby the seismic data is owned by those customers. The Company recognizes revenue as the seismic data is acquired and/or processed on a proportionate basis as work is performed. The Company uses quantifiable measures of progress consistent with its multi-client seismic surveys.
Acquisition Systems and Other Seismic Equipment - For sales of seismic data acquisition systems and other seismic equipment, the Company recognizes revenue when control of the goods has transferred to the customer. Transfer of control generally occurs when (i) the Company has a present right to payment; (ii) the customer has legal title to the asset; (iii) the Company has transferred physical possession of the asset; and (iv) the customer has significant rewards of ownership; or (v) the customer has accepted the asset.
Software - Licenses for the Company’s navigation, survey design, quality control and offshore operations optimization software systems provide the customer with a right to use the software. The Company offers usage-based licenses under which it receives a monthly fee based on the number of vessels and licenses used. For these usage-based licenses, revenue is recognized as the performance obligations are performed over the contract term, which is generally two to five years. In addition to usage-based licenses, the Company offers perpetual software licenses as it exists when made available to the customer. Revenue from these licenses is recognized upfront at the point in time when the software is made available to the customer.
These arrangements generally include the Company providing related services, such as training courses, engineering services and annual software maintenance. The Company allocates consideration to each element of the arrangement based upon directly observable or estimated standalone selling prices. Revenue is recognized for these services as control transfers to the customer over time. The Company does not have any contractual future performance obligations with an original term of over one year.
Revenue by Segment and Geographic Area
See Footnote 3 “Segment Information” of Footnotes to Consolidated Financial Statements for revenue by segment and revenue by geographic area for 2019, 2018 and 2017.
Unbilled Receivables
Unbilled receivables relate to revenues recognized on multi-client surveys, imaging services and devices equipment repairs on a proportionate basis, and on licensing of multi-client data libraries 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 were as follows (in thousands):
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 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):
(a) The majority of deferred revenue recognized relates to Company’s Ventures group.
The Company expects to recognize a majority of deferred revenue within the next twelve months.
Credit Risks
In 2019, the Company had one customer with sales that exceeded 10% of the consolidated net revenues. Revenues related to this customer are included within the E&P Technology & Services segment. In 2018, the Company had two customers with sales that each exceeded 10% of the consolidated net revenues. In 2017, the Company had one customer with sales that exceeded 10% of the consolidated net revenues. Revenues related to this customer are included within the E&P Technology & Services segment.
At December 31, 2019, the Company had two customers with balances that, combined, accounted for 29% of the Company’s total combined accounts receivable and unbilled receivable balances. At December 31, 2018, the Company had one customer with a balance that accounted for 23% of the Company’s total combined accounts receivable and unbilled receivable balances.
Concentration of Foreign Sales Risk
The majority of the Company’s foreign sales are denominated in U.S. dollars. For 2019, 2018 and 2017, international sales comprised 73%, 75% and 76%, respectively, of total net revenues. The volatility in oil prices have continued to impact the global market throughout 2019. 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.
(5) Long-term Debt
The following is a summary of long-term debt and lease obligation (in thousands):
(a) The maturity of the revolving credit facility will accelerate to October 31, 2021 if the Company is unable to repay or extend the maturity of the Second Lien Notes.
Revolving Credit Facility
On August 16, 2018, 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 Bank, National Association (“PNC”), as agent for the lenders, entered into that certain Third Amendment and Joinder to Revolving Credit and Security Agreement (the “Third 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 and the Second Amendment to Revolving Credit and Security Agreement, dated as of April 28, 2016, the “Credit Agreement”). The Credit Agreement, as amended by the First Amendment, the Second Amendment and the Third Amendment is herein called, the “Credit Facility”).
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 Third Amendment amended the Credit Agreement to, among other things:
•
extend the maturity date of the Credit Facility by approximately four years (from August 22, 2019 to August 16, 2023), subject to the retirement or extension of the maturity date of the Second Lien Notes, as defined below, which mature on December 15, 2021;
•
increase the maximum revolver amount by $10.0 million (from $40.0 million to $50.0 million);
•
increase the borrowing base percentage of the net orderly liquidation value as it relates to the multi-client data library (not to exceed $28.5 million, up from the previous maximum of $15.0 million for the multi-client data library component);
•
include the eligible billed receivables of the Mexican Subsidiary up to a maximum of $5.0 million in the borrowing base calculation and joins the Mexican Subsidiary as a borrower thereunder (with a maximum exposure of $5.0 million) and require the equity and assets of the Mexican Subsidiary to be pledged to secure obligations under the facility;
•
modify the interest rate such that the maximum interest rate remains consistent with the fixed interest rate prior to the Third Amendment (that is, 3.00% per annum for domestic rate loans and 4.00% per annum for LIBOR rate loans), but lowers the range down to a minimum interest rate of 2.00% for domestic rate loans and 3.00% for LIBOR rate loans based on a leverage ratio for the preceding four-quarter period;
•
decrease the minimum excess borrowing availability threshold 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; and
•
modify the trigger required to test for compliance with the fixed charge coverage ratio, which is further described below.
The maximum amount 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. At December 31, 2019, the borrowing base under the Credit Facility was $39.3 million and there was no outstanding indebtedness under the Credit Facility.
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, 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 December 31, 2019, the Company was in compliance with all of the covenants under the Credit Facility.
The Credit Facility contains customary event of default provisions (including a “change of control” event affecting ION), the occurrence of which could lead to an acceleration of the Company’s obligations under the Credit Facility.
Senior Secured Notes
ION Geophysical Corporation’s 9.125% Senior Secured Second Priority Notes due December 2021 (the “Second Lien Notes”) are senior secured second-priority obligations guaranteed by the Material U.S Subsidiaries and the Mexican Subsidiary (each as defined above and herein below, with the reference to the Second Lien Notes, the “Guarantors”). Interest on the Second Lien Notes is payable semiannually in arrears on June 15 and December 15 of each year during their term, except that the interest payment otherwise payable on June 15, 2021 will be payable on December 15, 2021.
The April 2016 indenture governing the Second Lien Notes contains certain covenants that, among other things, limits or prohibits ION Geophysical Corporation’s ability and the ability of its restricted subsidiaries to take certain actions or permit certain conditions to exist during the term of the Second Lien Notes, including among other things, incurring additional 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 Second Lien Notes Indenture are subject to certain exceptions and qualifications. All of ION Geophysical Corporation’s subsidiaries are currently restricted subsidiaries.
At December 31, 2019, the Company was in compliance with all of the covenants under the Second Lien Notes.
On or after December 15, 2019, the Company may, on one or more occasions, redeem all or a part of the Second Lien Notes at the redemption prices set forth below, plus accrued and unpaid interest and special interest, if any, on the Second Lien Notes redeemed during the twelve-month period beginning on December 15th of the years indicated below:
A summary of future principal obligations under long-term debt follows (in thousands):
(6) Net Loss per Common Share
Basic net loss per common share is computed by dividing net loss applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted net income per common share is determined based on the assumption that dilutive restricted stock and restricted stock unit awards have vested and outstanding dilutive stock options have been exercised and the aggregate proceeds were used to reacquire common stock using the average price of such common stock for the period. The total number of shares issuable pursuant to outstanding stock options at December 31, 2019, 2018 and 2017 were 689,209, 785,890 and 890,341, respectively, were excluded as their inclusion would have an anti-dilutive effect. The total number of shares issuable pursuant to restricted stock units awards outstanding at December 31, 2019, 2018 and 2017 were 908,754, 1,044,125 and 201,702, respectively, were excluded as their inclusion would have an anti-dilutive effect.
(7) Income Taxes
The sources of income (loss) before income taxes are as follows (in thousands):
Components of income taxes are as follows (in thousands):
A reconciliation of the expected income tax expense on income (loss) before income taxes using the statutory federal income tax rate of 21% for 2019 and 2018 and 35% for 2017 to income tax expense follows (in thousands):
As a result of the passage of the Tax Cut and Jobs Act (the “Act”) in December 2017, the Company’s U.S. deferred tax assets, liabilities, and associated valuation allowance at December 31, 2017 have been re-measured at the new U.S. federal tax rate of 21%
The tax effects of the cumulative temporary differences resulting in the net deferred income tax asset (liability) are as follows (in thousands):
At December 31, 2019, the Company has a valuation allowance on substantially all net U.S. deferred tax assets. The valuation allowance was released in 2017 with respect to refundable U.S. alternative minimum tax (“AMT”) credits that will be realized as a result of provisions in the Act. 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. The Company will continue to record a valuation allowance for the substantial majority of its deferred tax assets until there is sufficient evidence to warrant reversal.
At December 31, 2019, the Company had U.S. net operating loss carryforwards of approximately $311.8 million, expiring in 2034 and beyond, and net operating loss carryforwards outside of the U.S. of approximately $159.7 million, the majority of which expires beyond 2025.
At December 31, 2019, the Company has approximately $0.4 million of unrecognized tax benefits and does not expect to recognize any 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. During 2019, 2018 and 2017, the aggregate changes in the Company’s total gross amount of unrecognized tax benefits are summarized as follows (in thousands):
The Company’s U.S. federal tax returns for 2016 and subsequent years remain subject to examination by tax authorities. The Company is no longer subject to Internal Revenue Service (“IRS”) examination for periods prior to 2015, although carryforward attributes that were generated prior to 2015 may still be adjusted upon examination by the IRS if they either have been or will be used in a future period. In the Company’s foreign tax jurisdictions, tax returns for 2012 and subsequent years generally remain open to examination.
At December 31, 2019, the Company considered the outside book-over-tax basis difference in its foreign subsidiaries to be in the amount of approximately $45.2 million. United States income taxes have not been provided on this basis difference as it is the Company’s intention to reinvest the undistributed earnings of its foreign subsidiaries to the extent they cannot be remitted to the United States without incurring incremental tax as provided in the Act.
(8) Legal Matters
WesternGeco
In June 2009, WesternGeco L.L.C. (“WesternGeco”) filed a lawsuit against the Company in the United States District Court for the Southern District of Texas (the “District Court”). In the lawsuit, styled WesternGeco L.L.C. v. ION Geophysical Corporation, WesternGeco alleged that the Company had infringed four of their patents concerning marine seismic surveys.
Trial began in July 2012, and the jury returned a verdict in August 2012. The jury found that the Company infringed on six “claims” contained in four of WesternGeco’s patents by supplying the Company’s DigiFIN® lateral streamer control units from the United States. (In patent law, a “claim” is a technical legal term; an infringer infringes on one or more “claims” of a given patent.)
In May 2014, the District Court entered a Final Judgment against the Company in the amount of $123.8 million. The Final Judgment also enjoined the Company from supplying DigiFINs or any parts unique to DigiFINs in or from the United States. The Company has conducted its business in compliance with the District Court’s orders, and has reorganized its operations such that it no longer supplies DigiFINs or any parts unique to DigiFINs in or from the United States.
As of 2018, the Company has paid WesternGeco the $25.8 million of the Final Judgment (the portion of the judgment representing reasonable royalty damages and enhanced damages, plus interest).
However, as further described below, the balance of the judgment against the Company ($98.0 million, representing lost profits from surveys performed by the Company’s customers outside of the United State, plus interest) has been vacated, and a new trial ordered, to determine what lost profit damages, if any, WesternGeco is entitled to.
The Final Judgment was vacated after it was appealed to the United States Court of Appeals for the Federal Circuit in Washington, D.C. (the “Court of Appeals”), then to the Supreme Court of the United States, which remanded the case, again, to the Court of Appeals.
On January 11, 2019, the Court of Appeals refused to disturb the award of reasonable royalties to WesternGeco (which the Company paid in 2016), but did not reinstate the lost profits award; rather, the Court of Appeals remanded the case back to the District Court to determine whether to hold a new trial as to lost profits.
On August 30, 2019, the District Court refused WesternGeco’s request to reinstate the lost profits awards against the Company, and instead ordered a new trial to determine what lost profits, if any, WesternGeco is entitled to from surveys performed by the Company’s customers outside of the United States.
The District Court’s basis for granting the new trial as to lost profits was that, subsequent to the jury verdict that awarded lost profits, the Patent Trial and Appeal Board (“PTAB”) of the Patent and Trademark Office, in an administrative proceeding, invalidated four of the six patent claims patent claims that formed the basis for the lost profits judgment against the Company (that is, the PTAB held that those four patent claims should never have been granted), and the Court of Appeals and the Supreme Court both subsequently refused to overturn that finding. A trial date for the new trial has not yet been set.
The Company may not ultimately prevail in the litigation and it could be required to pay lost profits if and when a new judgment issues in the new trial. The Company’s assessment that it does not have a loss contingency may change in the future due to developments at the District Court, and other events, such as changes in applicable law, and such reassessment could lead to the determination that a significant loss contingency is probable, which could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s assessments disclosed in this Annual Report on Form 10-K or elsewhere are based on currently available information and involve elements of judgment and significant uncertainties.
Other
In July 2018, the Company prevailed in an arbitration that it initiated against the Indian Directorate General of Hydrocarbons (“DGH”) relating to its ability to continue to license data under the 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 the Company had received in respect of sales from the IndiaSPAN program, pending the outcome of the DGH’s challenge to the arbitration award. We challenged the escrow order, but on December 9, 2019, the Supreme Court of India ordered the Company to comply with it which will require the Company to deposit approximately $4.5 million in escrow in late February 2020. The Company prevailed on the merits in the arbitration and expect to have that award upheld in Indian court, which would result in release of its portion of the escrowed money.
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. Management currently believes that the ultimate resolution of these matters will not have a material adverse impact on the financial condition, results of operations or liquidity of the Company.
(9) Other Expense
A summary of other expense follows (in thousands):
(10) Details of Selected Balance Sheet Accounts
Accounts Receivable
Inventories
Total excess and obsolete inventory expense for 2019, 2018 and 2017 was $0.5 million, $0.7 million and $0.4 million, respectively.
Property, Plant and Equipment
A summary of property, plant and equipment follows (in thousands):
Total depreciation expense, including amortization of assets recorded under equipment finance leases, for 2019, 2018 and 2017 was $3.1 million, $7.6 million and $15.2 million, respectively.
For 2019, the Company did not recognized any impairment. For 2018, the Company identified an indicator of impairment as it relates to its cable-based ocean bottom acquisition technologies and recognized an impairment charge of $36.6 million.
Multi-Client Data Library
At December 31, 2019 and 2018, multi-client data library costs and accumulated amortization consisted of the following (in thousands):
Total amortization expense for 2019, 2018 and 2017 was $39.5 million, $49.0 million and $47.1 million, respectively.
For 2019, the Company wrote down its multi-client data library by $9.1 million for programs with capitalized costs exceeding the remaining sales forecast.
Accrued Expenses
(11) Goodwill
Changes in the carrying amount of goodwill for 2019 and 2018 are as follows (in thousands):
At December 31, 2019 and 2018, zero provision for impairment of goodwill is required.
(12) Stockholders' Equity and Stock-based Compensation
Public Equity Offering
On February 21, 2018, the Company completed the public equity offering (the “Offering”) of its 1,820,000 shares of common stock at a public offering price of $27.50 per share, and warrants to purchase an additional 1,820,000 shares of the Company’s common stock pursuant to the Registration Statement on Form S-3 (No. 33-213769) filed with the Securities and Exchange Commission under the Securities Act of 1933 and declared effective on December 2, 2016. The net proceeds from this Offering were $47.0 million, including transaction expenses. A portion of the net proceeds were used to retire the Company’s $28.5 million Third Lien Notes in March 2018. The warrants have an exercise price of $33.60 per share, are immediately exercisable and were to expire on March 21, 2019. On February 4, 2019, the Company extended expiration of the warrants to March 21, 2020.
Stock Option Plans
The Company has adopted stock option plans for eligible employees, directors and consultants, which provide for the granting of options to purchase shares of common stock. The options under these plans generally vest in equal annual installments over a four-year period and have a term of ten years. These options are typically granted at pre-established quarterly grant dates with an exercise price per share equal to or greater than the current market price and, upon exercise, are issued from the Company’s unissued common shares.
Transactions under the stock option plans are summarized as follows:
Stock options outstanding at December 31, 2019 are summarized as follows:
Additional information related to the Company’s stock options follows:
The total intrinsic value of options exercised during 2019, 2018 and 2017 was $0.6 million, $1.4 million and less than $0.1 million, respectively. Cash received from option exercises under all share-based payment arrangements for 2019, 2018 and 2017 was $0.1 million, $0.2 million, and less than $0.1 million, respectively. The weighted average grant date fair value for stock option awards granted during 2019, 2018 and 2017 was $4.91, $15.23 and $8.10 per share, respectively.
The Company calculated the fair value of each stock option on the date of grant using the Black-Scholes option pricing model. The following assumptions were used for each respective period:
The computation of expected volatility during 2019, 2018 and 2017 was based on an equally weighted combination of historical volatility and market-based implied volatility. Historical volatility was calculated from historical data for a period of time approximately equal to the expected term of the option award, starting from the date of grant. Market-based implied volatility was derived from traded options on the Company’s common stock having a term of six months. The Company’s computation of expected life in 2019, 2018 and 2017 was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The risk-free interest rate assumption is based upon the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option.
Restricted Stock and Restricted Stock Unit Plans
On November 30, 2018, the Company’s stockholders approved certain amendments to the Company’s Second Amended and Restated 2013 Long-term Incentive Plan (the “2013 LTIP”) including increasing the total number of shares of common stock available for issuance under the 2013 LTIP by 1.2 million shares, for a total of approximately 1.7 million shares, eliminating the restriction on the number of shares in the 2013 LTIP that can be issued as full value awards and certain other technical updates and clarifications related to Section 162(m) of the internal revenue code, as amended.
The Company has issued restricted stock and restricted stock units under the Company’s 2013 LTIP, as amended and other applicable plans. Restricted stock units are awards that obligate the Company to issue a specific number of shares of common stock in the future if continued service vesting requirements are met. Non-forfeitable ownership of the common stock will vest over a period as determined by the Company in its sole discretion, generally in equal annual installments over a three-year period. Shares of restricted stock awarded may not be sold, assigned, transferred, pledged or otherwise encumbered by the grantee during the vesting period.
On December 1, 2018, the Company issued 900,002 restricted stocks to selected employees with a grant date fair value $7.19, $6.51 and $5.89 for each of the tranches. The vesting of these restricted stocks is achieved through both a market condition and a service condition. The market condition is achieved, in part or in full, in the event that during the three-year period beginning on the date of grant the 20-day trailing volume-weighted average price of a share of common stock reaches or exceeds (i) $17.50 for the first 1/3 of the awards, (ii) $22.50 for the second 1/3 of the awards, and (iii) $27.50 for the final 1/3 of the awards. The service condition restricts the ability of the holders to exercise awards until certain service milestones have been reached such that (i) no more than 1/3 of the awards may be exercised, if vested, on and after the first anniversary of the date of grant, (ii) no more than 2/3 of the awards may be exercised, if vested, on and after the second anniversary of the date of grant and (iii) all of the awards may be exercised, if vested, on and after the third anniversary of the date of grant.
The status of the Company’s restricted stock and restricted stock unit awards for 2019 follows:
At December 31, 2019, 2018 and 2017, the intrinsic value of restricted stock and restricted stock unit awards was approximately $7.9 million, $5.4 million and $4.0 million, respectively. The weighted average grant date fair value for restricted stock and restricted stock unit awards granted during 2019, 2018 and 2017 was $7.98, $10.60 and $11.36 per share, respectively. The total fair value of shares vested during 2019, 2018 and 2017 was $2.1 million, $3.8 million and $0.6 million, respectively.
Stock Appreciation Rights Plan
The Company has adopted a stock appreciation rights plan which provides for the award of stock appreciation rights (“SARs”) to directors and selected key employees and consultants. The awards under this plan are subject to the terms and conditions set forth in agreements between the Company and the holders. The exercise price per SAR is not to be less than one hundred percent of the fair market value of a share of common stock on the date of grant of the SAR. The term of each SAR shall not exceed ten years from the grant date. Upon exercise of a SAR, the holder shall receive a cash payment in an amount equal to the spread specified in the SAR agreement for which the SAR is being exercised. In no event will any shares of common stock be issued, transferred or otherwise distributed under the plan.
On December 1, 2018, the Company issued 960,009 SARs awards to selected employees with an exercise price of $8.85 (“2018 SARs”). None of these 2018 SARs were awarded to non-employee directors. The 2018 SARs have the same service and market vesting conditions as the restricted stocks issued on December 1, 2018, as described above. The maximum value of each 2018 SARs is capped at $18.65 (the spread between the share price cap of $27.50 and the $8.85 per award price). At December 31, 2019, there were 768,009 2018 SARs outstanding and unvested.
The 2018 SARs are considered liability awards and as such, these amounts are incrementally accrued in the liability section of the consolidated balance sheets. The Company calculated the fair value of each 2018 SARs award using the following assumptions:
On March 1, 2016, the Company issued 1,210,000 SARs awards to 15 selected key employees with an exercise price of $3.10 (“2016 SARs”). None of these 2016 SARs were awarded to non-employee directors. The vesting of these 2016 SARs is achieved through both a market condition and a service condition. The market condition is achieved, in part or in full, in the event that during the four-year period beginning on the date of grant the 20-day trailing volume-weighted average price of a share of common stock is (i) greater than 120% of the exercise price for the first 1/3 of the awards, (ii) greater than 125% of the exercise price for the second 1/3 of the awards and (iii) greater than 130% of the exercise price for the final 1/3 of the awards. The service condition restricts the ability of the holders to exercise awards until certain service milestones have been reached such that (i) no more than 1/3 of the awards may be exercised, if vested, on and after the first anniversary of the date of grant, (ii) no more than 2/3 of the awards may be exercised, if vested, on and after the second anniversary of the date of grant and (iii) all of the awards may be exercised, if vested, on and after the third anniversary of the date of grant. The maximum value of each 2016 SARs is capped at $19.40 (the spread between the share price cap of $22.50 and the $3.10 per award price). At December 31, 2019, there were 186,670 2016 SARs outstanding and vested.
On December 13, 2017, the Compensation Committee (the “Committee”) of the Board of Directors (the “Board”) of the Company authorized and approved the acceleration of the vesting date to December 13, 2017 for the second tranche of the Company’s outstanding 2016 SARs. The second tranche of the 2016 SARs awards was originally scheduled to vest on March 1, 2018. The vesting of the second tranche of the 2016 SARs awards was accelerated to facilitate the exercise by the 2016 SARs participants, if they so choose, of a larger portion of the 2016 SARs awards prior to year-end, as such an exercise would minimize the potential cash flow impact of any such exercise in the first quarter of 2018, would mitigate the ongoing mark to market accounting requirements for cash-settled 2016 SARs, and would afford the 2016 SARs participants liquidity to invest in common stock of the Company to further align their interests with those of the Company’s stockholders. Participants exercised 663,330 SARs awards at a $9.95 gain per share.
The 2016 SARs are considered liability awards and as such, these amounts are incrementally accrued in the liability section of the consolidated balance sheets. The Company calculated the fair value of each 2016 SARs award on the date of grant and remeasured at each reporting period. The 2016 SARs awards 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 multiply by the number of awards vested) and marked to market each quarter until settled.
Additional information related to the Company's SARs follows:
Stock-based Compensation Expense
The following tables summarizes stock-based compensation expense for 2019, 2018 and 2017 as follows (in thousands):
(13) Supplemental Cash Flow Information and Non-Cash Activity
Supplemental disclosure of cash flow information follows (in thousands):
(14) Lease Obligations
The Company determines if an arrangement is a lease at inception by considering whether (1) explicitly or implicitly identified assets have been deployed in the agreement and (2) the Company obtains substantially all of the economic benefits from the use of that underlying asset and directs how and for what purpose the asset is used during the term of the agreement. Amounts related to operating leases are included in “Right-of-use assets”, “Current maturities of operating lease liabilities” and “Operating lease liabilities, net of current maturities” in the consolidated balance sheets. Amounts related to finance leases are included in “Property, plant and equipment, net”, “Current maturities of long-term debt”, and “Long-term debt, net of current maturities” in the consolidated balance sheets.
ROU assets represent the Company’s right to use an underlying asset for the lease term and operating lease liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets are recognized at the commencement date and consist of the present value of remaining lease payments over the lease term, initial direct costs and prepaid lease payments less any lease incentives. Operating lease liabilities are recognized at commencement date based on the present value of remaining lease payments over the lease term. The Company uses the implicit rate, when readily determinable or the incremental borrowing rate based on the information available at commencement date to determine the present value of lease payments. The lease terms may include options to extend or terminate the lease which are recorded in the financial statements if it is reasonably certain that the Company will exercise such options. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Lease agreements with lease and non-lease components are accounted for separately. The Company does not recognize leases with terms of less than twelve months in the consolidated balance sheets and will recognize those lease payments in the consolidated statements of operations on a straight-line basis over the lease term.
The Company leases offices, processing centers, warehouse spaces and, to a lesser extent, certain equipment. These leases have remaining terms of 1 year to 6 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 ROU assets and operating lease liabilities as the Company is not reasonably certain that it will exercise these options.
Total operating lease expense, including short-term lease expense was $11.6 million, $12.3 million and $12.3 million for 2019, 2018 and 2017, respectively.
Future maturities of lease obligations follows (in thousands):
The weighted average remaining lease term at December 31, 2019 and 2018 was 4.71 years and 5.26 years, respectively. The weighted average discount rate used to determine the operating lease liability at December 31, 2019 and 2018 was 6.47% and 6.25%, respectively.
Supplemental cash flow information related to leases follows:
Equipment Finance Leases
The Company has entered into capital leases that are due in installments for the purpose of financing the purchase of computer equipment through 2021. Interest accrues under these leases at rates from 4.3% to 8.7% per annum, and the leases are 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.
(15) Fair Value of Financial Instruments
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, prioritizing and defining the types of 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.
Level 3-Significant unobservable inputs.
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, short term investments, accounts payable and accrued multi-client data library royalties, represent their approximate fair value.
The carrying amounts of the Company’s long-term debt at December 31, 2019 and 2018 were $123.4 million and $124.7 million, respectively, compared to its fair values of $116.6 million and $120.7 million at December 31, 2019 and 2018, respectively. The fair value of the Second Lien Notes was calculated using Level 1 inputs, including an active market price.
Fair value measurements are applied with respect to non-financial assets and liabilities measured on a non-recurring basis, which would consist of measurements primarily of goodwill, multi-client data library and property, plant and equipment.
(16) Benefit Plans
The Company has a 401(k) retirement savings plan, which covers employees at least 18 years of age. Employees may voluntarily contribute up to 90% of their compensation, as defined, to the plan. The Company matched the employee contribution at a rate of 50% of the first 6% of compensation contributed to the plan subject to a maximum of 3% of eligible compensation. Company contributions to the plans were $0.9 million, $0.9 million and $0.8 million for 2019, 2018 and 2017, respectively.
(17) Selected Quarterly Information - (Unaudited)
A summary of selected quarterly information follows (in thousands, except per share amounts):
The sum of the quarterly per share information may not tie to per share information in the Consolidated Statements of Operations due to rounding.
(18) Certain Relationships and Related Party Transactions
For 2019, 2018 and 2017, the Company recorded revenues from BGP of $2.2 million, $4.9 million and $4.4 million, respectively. Receivables due from BGP were $1.5 million and $1.6 million at December 31, 2019 and 2018, respectively. BGP owned approximately 10.5% of the Company’s outstanding common stock at December 31, 2019.
Mr. James M. Lapeyre, Jr. is the Chairman of the Board on ION’s board of directors and a significant equity owner of Laitram, L.L.C. (Laitram), and he has served as president of Laitram and its predecessors since 1989. Laitram is a privately-owned, New Orleans-based manufacturer of food processing equipment and modular conveyor belts. Mr. Lapeyre and Laitram together owned approximately 9.1% of the Company’s outstanding common stock at December 31, 2019.
The Company acquired DigiCourse, Inc., the Company’s marine positioning products business, from Laitram in 1998. In connection with that acquisition, the Company entered into a Continued Services Agreement with Laitram under which Laitram agreed to provide the Company certain bookkeeping, software, manufacturing and maintenance services. Manufacturing services consist primarily of machining of parts for the Company’s marine positioning systems. The term of this agreement expired in September 2001, but the Company continues to operate under its terms. In addition, from time to time, when the Company has requested, the legal staff of Laitram has advised the Company on certain intellectual property matters with regard to the Company’s marine positioning systems. During 2019, 2018 and 2017, the Company paid Laitram and its affiliates $0.7 million, $0.4 million and $0.2 million, respectively, which consisted of manufacturing services and reimbursement of costs. In addition, the Company is currently subleasing approximately 47,800 square feet of office and warehouse space to Laitram. In the opinion of the Company’s management, the terms of these services are fair and reasonable and as favorable to the Company as those that could have been obtained from unrelated third parties at the time of their performance.
For 2019, the Company recorded revenues from sales to INOVA of $0.5 million related to geophones sold by our Devices group. No revenues were recorded from sales to INOVA for 2018 and 2017.
(19) Condensed Consolidating Financial Information
The Second Lien Notes were issued by ION Geophysical Corporation and are guaranteed by Guarantors, all of which are wholly-owned subsidiaries. The Guarantors have fully and unconditionally guaranteed the payment obligations of ION Geophysical Corporation with respect to the Second Lien Notes. The following condensed consolidating financial information presents the results of operations, financial position and cash flows for:
•
ION Geophysical Corporation and the Guarantors (in each case, reflecting investments in subsidiaries utilizing the equity method of accounting).
•
All other subsidiaries of ION Geophysical Corporation that are not Guarantors.
•
The consolidating adjustments necessary to present ION Geophysical Corporation’s results on a consolidated basis.
This condensed consolidating financial information should be read in conjunction with the accompanying consolidated financial statements and footnotes. For additional information pertaining to the Notes, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of this Form 10-K.
The following table is a reconciliation of cash, cash equivalents and restricted cash:
The following table is a reconciliation of cash, cash equivalents and restricted cash:
The following table is a reconciliation of cash, cash equivalents and restricted cash:
SCHEDULE II
ION GEOPHYSICAL CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
S-1