Edgar Filing: INPUT OUTPUT INC

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FORM 10-Q/A

(Amendment No. 1)

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 1-12691

INPUT/OUTPUT, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


DELAWARE (State or other jurisdiction of incorporation or organization)		22-2286646 (I.R.S. Employer Identification No.)

12300 PARC CREST DR., STAFFORD, TEXAS (Address of principal executive offices)		77477 (Zip Code)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (281) 933-3339

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: þ No: o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

At July 28, 2005, there were 78,969,036 shares of common stock, par value $0.01 per share, outstanding.

INPUT/OUTPUT, INC. AND SUBSIDIARIES

EXPLANATORY NOTE

This Form 10-Q/A (Amendment No. 1) amends our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005, as initially filed with the Securities and Exchange Commission (the “SEC”) on August 15, 2005, and is being filed to reflect the restatement of our consolidated financial statements for the quarterly period ended June 30, 2005, as discussed in Note 1 of the Notes to Unaudited Consolidated Financial Statements contained herein. The restatements were necessitated principally due to an incorrect application of accounting principles for revenue recognition by the company’s GX Technology Corporation subsidiary in connection with license sales of its multi-client seismic survey data. On March 16, 2006, we announced that our previously reported consolidated financial statements as of and for the three and six months ended June 30, 2005 and the year ended December 31, 2004 should no longer be relied upon. Also, we included in our restated balance sheet at June 30, 2005 a deferred tax liability and a corresponding increase in goodwill related to the book and tax differences between the acquired intangible assets of Concept Systems, in addition to its deferred income tax expense impact on our results of operations for the three and six months ended June 30, 2005. The consolidated financial information contained in this Form 10-Q/A as of and for the three and six months ended June 30, 2005 reflects our restated results of operations for that three and six month period. Our consolidated balance sheet at December 31, 2004 has been updated to reflect the restatements and reclassifications as previously reported in our Annual Report on Form 10-K for the year ended December 31, 2005 as filed with the SEC on March 31, 2006. Our consolidated statement of cash flows for the six months ended June 30, 2005 has been restated resulting in changes within cash flows from operating activities, but no change to net cash used in operating activities. For additional information concerning the restatements, the accounting periods affected and the impact on the company’s results of operations and financial condition, see Note 1 of Notes to Unaudited Consolidated Financial Statements and Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this Form 10-Q/A.

As required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), new certifications of our principal executive officer and principal financial officer are being filed as exhibits to this Form 10-Q/A under Item 6 of Part II. For purposes of this Form 10-Q/A, and in accordance with Rule 12b-15 under the Exchange Act, each item in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005 that was affected by this Amendment No. 1 has been amended and replaced in its entirety. No attempt has been made in this Form 10-Q/A to modify or update other disclosures as presented in the original Form 10-Q, except as required to reflect such amendments. This Amendment No. 1 does not reflect events, other than those relating to the restatements, that have occurred after August 15, 2005, the date the Quarterly Report on Form 10-Q was originally filed, except that the information and disclosure contained in Part I, Item 4. “Controls and Procedures” has been brought current to the date of this filing. Information with respect to events occurring after August 15, 2005 has been or will be set forth, as appropriate, in our subsequent periodic filings, including our Quarterly Reports on Form 10-Q and Form 10-Q/A, and Current Reports on Form 8-K. Any reference to facts and circumstances at a “current” date refer to such facts and circumstances as of such original filing date.

TABLE OF CONTENTS FOR FORM 10-Q/A
AMENDMENT NO. 1 TO FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2005


	PAGE
PART I. Financial Information
Item 1. Unaudited Financial Statements
Consolidated Balance Sheets as of June 30, 2005 (Restated) and December 31, 2004 (Restated)		4
Consolidated Statements of Operations for the three and six months ended June 30, 2005 (Restated) and June 30, 2004		5
Consolidated Statements of Cash Flows for the six months ended June 30, 2005 (Restated) and June 30, 2004		6
Notes to Unaudited Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Restatement		17
Restatement		17
Executive Summary		18
Registered Marks		19
Results of Operations		19
Liquidity and Capital Resources		21
Inflation and Seasonality		22
Future Contractual Obligations		22
Critical Accounting Policies and Estimates		23
Credit Risk		23
Risk Factors		24
Item 4. Controls and Procedures		31

PART II. Other Information		32
Item 6. Exhibits		32
Certification of CEO and CFO Pursuant to Rule 13a-14a/15d-14a
Certification of CFO Pursuant to Rule 13a-14a/15d-14a
Certification of CEO Pursuant to Section 1350
Certification of CFO Pursuant to Section 1350

INPUT/OUTPUT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)


	June 30,			December 31,
	2005			2004
	(Restated)			(Restated)
	(In thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents	$	20,413		$	14,935
Restricted cash		1,645			1,592
Accounts receivable, net		72,816			61,598
Current portion of notes receivable, net		10,185			10,784
Unbilled revenue		9,954			7,309
Inventories		83,877			86,659
Prepaid expenses and other current assets		12,964			7,974

Total current assets		211,854			190,851
Notes receivable		2,462			4,143
Non-current deferred income tax asset		1,113			1,113
Property, plant and equipment, net		28,555			46,051
Multi-client data library, net		9,233			10,025
Investments at cost		4,000			3,500
Goodwill		154,890			152,958
Intangible and other assets, net		70,596			77,453

Total assets	$	482,703		$	486,094


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Notes payable and current maturities of long-term debt and lease obligations	$	3,648		$	6,564
Accounts payable		24,479			40,856
Accrued expenses		25,727			26,116
Deferred revenue		10,334			15,081
Deferred income tax liability		1,113			1,113

Total current liabilities		65,301			89,730
Long-term debt and lease obligations, net of current maturities		70,544			79,387
Non-current deferred income tax liability		5,078			5,529
Other long-term liabilities		4,561			2,688

Total liabilities		145,484			177,334

Cumulative convertible preferred stock		29,779			—

Stockholders’ equity:
Common stock, $0.01 par value; authorized 200,000,000 shares; outstanding 78,881,989 shares at June 30, 2005 and 78,561,675 shares at December 31, 2004, net of treasury stock		798			795
Additional paid-in capital		481,801			480,845
Accumulated deficit		(168,325	)		(167,151	)
Accumulated other comprehensive income		363			2,332
Treasury stock, at cost, 778,391 shares at June 30, 2005 and 784,009 shares at December 31, 2004		(5,777	)		(5,844	)
Unamortized restricted stock compensation		(1,420	)		(2,217	)

Total stockholders’ equity		307,440			308,760

Total liabilities and stockholders’ equity	$	482,703		$	486,094

See accompanying Notes to Unaudited Consolidated Financial Statements.

INPUT/OUTPUT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
	(Restated)						(Restated)
	(In thousands, except per share data)
Net sales	$	90,167		$	62,326		$	152,209		$	98,614
Cost of sales		62,204			41,183			113,372			65,503

Gross profit		27,963			21,143			38,837			33,111

Operating expenses (income):
Research and development		4,779			4,722			9,334			8,505
Marketing and sales		7,522			5,016			15,009			8,314
General and administrative		6,494			5,852			12,799			10,545
Loss (gain) on sale of assets		81			(47	)		76			(896	)

Total operating expenses		18,876			15,543			37,218			26,468

Income from operations		9,087			5,600			1,619			6,643
Interest expense		(1,615	)		(1,497	)		(3,359	)		(2,993	)
Interest income		193			290			264			758
Other income		24			140			65			158

Income (loss) before income taxes		7,689			4,533			(1,411	)		4,566
Income tax expense (benefit)		363			347			(852	)		938

Net income (loss)		7,326			4,186			(559	)		3,628
Preferred dividend		422			—			616			—

Net income (loss) applicable to common shares	$	6,904		$	4,186		$	(1,175	)	$	3,628

Basic net income (loss) per common share	$	0.09		$	0.07		$	(0.01	)	$	0.07

Weighted average number of common shares outstanding		78,745			57,074			78,694			54,596

Diluted net income (loss) per common share	$	0.08		$	0.07		$	(0.01	)	$	0.07

Weighted average number of diluted common shares outstanding		93,565			71,425			78,694			55,005

See accompanying Notes to Unaudited Consolidated Financial Statements.

INPUT/OUTPUT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)


	Six Months Ended
	June 30,
	2005			2004
	(Restated)
	(In thousands)
Cash flows from operating activities:
Net income (loss)	$	(559	)	$	3,628
Adjustments to reconcile net income (loss) to cash used in operating activities:
Depreciation and amortization (other than multi-client library)		13,004			5,811
Amortization of multi-client library		4,565			610
Amortization of restricted stock and other stock compensation		922			112
Reduction of tax reserves		(1,303	)		—
Deferred income taxes		(158	)		—
Bad debt expense		457			297
Loss (gain) on sale of fixed assets		76			(896	)
Change in operating assets and liabilities:
Accounts and notes receivable		(9,895	)		(18,924	)
Unbilled revenue		(2,645	)		(1,076	)
Inventories		6,722			(6,083	)
Accounts payable and accrued expenses		(17,917	)		7,148
Deferred revenue		(5,058	)		4,588
Other assets and liabilities		(5,670	)		473

Net cash used in operating activities		(17,459	)		(4,312	)


Cash flows from investing activities:
Purchase of property, plant and equipment		(2,462	)		(1,722	)
Investment in multi-client data library		(3,763	)		—
Proceeds from the sale of fixed assets		30			1,588
Proceeds from collection of long-term note receivable		—			5,800
Business acquisition		—			(174,999	)
Cash of acquired businesses		—			2,193
Investment at cost		(500	)		—
Liquidation of Energy Virtual Partners, Inc.		—			117

Net cash used in investing activities		(6,695	)		(167,023	)


Cash flows from financing activities:
Borrowings under revolving line of credit		2,057			—
Payments on notes payable, long-term debt and lease obligations		(3,965	)		(2,165	)
Net proceeds from issuance of common stock		—			150,066
Net proceeds from preferred stock offering		29,779			—
Payment of preferred dividends		(616	)		—
Return of deposit securing a letter of credit		1,500			—
Proceeds from employee stock purchases and exercise of stock options		1,148			408
Purchases of treasury stock		(81	)		(79	)

Net cash provided by financing activities		29,822			148,230


Effect of change in foreign currency exchange rates on cash and cash equivalents		(190	)		(337	)

Net increase (decrease) in cash and cash equivalents		5,478			(23,442	)
Cash and cash equivalents at beginning of period		14,935			59,507

Cash and cash equivalents at end of period	$	20,413		$	36,065

See accompanying Notes to Unaudited Consolidated Financial Statements.

INPUT/OUTPUT, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation and Restatement

The consolidated balance sheet of Input/Output, Inc. and its subsidiaries (collectively referred to as the “Company” or “I/O”) at December 31, 2004 (restated – see below) has been derived from the Company’s audited consolidated financial statements at that date. The consolidated balance sheet at June 30, 2005 (restated – see below), the consolidated statements of operations for the three and six months ended June 30, 2005 (restated – see below) and 2004, and the consolidated statements of cash flows for the six months ended June 30, 2005 (restated – see below) and 2004 have been prepared by the Company without audit. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2005 (restated – see below) are not necessarily indicative of the operating results for a full year or of future operations.

These consolidated financial statements have been prepared using accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States have been omitted. The accompanying consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, which reflects the restatement of the consolidated financial statements as of and for the year ended December 31, 2004. Certain amounts previously reported in the consolidated financial statements have been reclassified to conform to the current period’s presentation.

Restatement of Consolidated Financial Statements as of and for the Three and Six Months Ended June 30, 2005

The Company’s consolidated balance sheet at June 30, 2005 and December 31, 2004 and the consolidated statements of operations for the three and six months ended June 30, 2005 and the consolidated statement of cash flows for the six months ended June 30, 2005 have been restated as a result of incorrect application of accounting principles for revenue recognition by the Company’s subsidiary, GX Technology Corporation (GXT), in connection with license sales of GXT’s multi-client seismic survey data. The Company has included in its restated balance sheet at June 30, 2005 and December 31, 2004 a deferred tax liability and a corresponding increase in goodwill related to book and tax differences of the intangible assets of its Concept Systems Holding Limited (Concept Systems) subsidiary, which had been acquired by the Company in 2004, in addition to its deferred income tax expense impact on the Company’s results of operations for the three and six months ended June 30, 2005. Also, the Company’s balance sheet at December 31, 2004 has been updated to reflect the restatements and reclassifications as previously reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 as filed with the SEC on March 31, 2006.

GXT was acquired by the Company in June 2004; therefore, GXT’s internal control over financial reporting was excluded from management’s assessment of the Company’s internal control over financial reporting as of December 31, 2004. In the process of assessing GXT’s internal controls in connection with the preparation of the 2005 consolidated financial statements the Company determined that GXT’s policies and procedures for timing of recognizing revenue generated from licenses of multi-client seismic survey data were not in accordance with generally accepted accounting principles. The Company determined that the revenues from certain GXT multi-client data transactions in 2004 and the first three quarters of 2005 were recognized by GXT upon the signing of customer letter agreements and delivery of the multi-client data, but prior to the receipt from the customer of a signed final master geophysical data license agreement and accompanying license supplement. As there was not adequate evidence of a final license arrangement, the Company determined that the revenue from these transactions should not have been recognized by GXT until delivery of the data to the customer and the receipt from the customer of a signed final master geophysical data license agreement and accompanying license supplement.

A summary of the restatements included in this amended filing are the following:


	As Previously
	Reported			Adjustments			As Restated
	(In thousands, except share and per share data)
Balance Sheet as of June 30, 2005:
Unbilled revenue	$	12,854		$	(2,900	)	$	9,954
Total current assets		214,754			(2,900	)		211,854
Non-current deferred income tax asset		—			1,113			1,113
Multi-client data library, net		9,542			(309	)		9,233
Goodwill		148,998			5,892			154,890
Intangible and other assets, net		71,050			(454	)		70,596
Total assets		479,361			3,342			482,703
Accrued expenses		25,942			(215	)		25,727
Deferred revenue		7,924			2,410			10,334
Deferred income tax liability		—			1,113			1,113
Total current liabilities		61,993			3,308			65,301
Non-current deferred income tax liability		—			5,078			5,078
Total liabilities		137,098			8,386			145,484
Accumulated deficit		(163,081	)		(5,244	)		(168,325	)
Accumulated other comprehensive (loss) income		163			200			363
Total stockholders’ equity		312,484			(5,044	)		307,440
Total liabilities and stockholders’ equity		479,361			3,342			482,703

Statement of Operations for the three months ended June 30, 2005:
Net sales	$	84,024		$	6,143		$	90,167
Cost of sales		60,600			1,604			62,204
Gross profit		23,424			4,539			27,963
Marketing and sales		7,281			241			7,522
Total operating expenses		18,635			241			18,876
Income from operations		4,789			4,298			9,087
Income before income taxes		3,391			4,298			7,689
Income tax expense (benefit)		521			(158	)		363
Net income (loss)		2,870			4,456			7,326
Net income (loss) applicable to common shares		2,448			4,456			6,904
Basic net income (loss) per common share		0.03			0.06			0.09
Diluted net income (loss) per common share		0.03			0.05			0.08
Weighted average number of diluted common shares outstanding		79,676			13,889			93,565

Statement of Operations for the six months ended June 30, 2005:
Net sales	$	150,861		$	1,348		$	152,209
Cost of sales		112,298			1,074			113,372
Gross profit		38,563			274			38,837
Marketing and sales		14,967			42			15,009
Total operating expenses		37,176			42			37,218
Income from operations		1,387			232			1,619
Income (loss) before income taxes		(1,643	)		232			(1,411	)
Income tax expense (benefit)		(694	)		(158	)		(852	)
Net income (loss)		(949	)		390			(559	)
Net income (loss) applicable to common shares		(1,565	)		390			(1,175	)
Basic and diluted net income (loss) per common share		(0.02	)		0.01			(0.01	)

Statement of Cash Flows for the six months ended June 30, 2005:
Net income (loss)	$	(949	)	$	390		$	(559	)
Amortization of multi-client library		3,793			772			4,565
Deferred income taxes		—			(158	)		(158	)


	As Previously
	Reported			Adjustments			As Restated
	(In thousands, except share and per share data)
Unbilled revenue		(5,545	)		2,900			(2,645	)
Accounts payable and accrued expenses		(18,261	)		344			(17,917	)
Deferred revenue		(810	)		(4,248	)		(5,058	)

Balance Sheet as of December 31, 2004:
Non-current deferred income tax asset	$	480		$	633		$	1,113
Multi-client data library, net		9,572			453			10,025
Goodwill		147,066			5,892			152,958
Total assets		479,116			6,978			486,094
Accrued expenses		26,686			(570	)		26,116
Deferred revenue		8,423			6,658			15,081
Deferred income tax liability		—			1,113			1,113
Total current liabilities		82,529			7,201			89,730
Non-current deferred income tax liability		—			5,529			5,529
Total liabilities		164,604			12,730			177,334
Accumulated deficit		(161,516	)		(5,635	)		(167,151	)
Accumulated other comprehensive income (loss)		2,449			(117	)		2,332
Total stockholders’ equity		314,512			(5,752	)		308,760
Total liabilities and stockholders’ equity		479,116			6,978			486,094

(2) Summary of Significant Accounting Policies and Estimates

Refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 for a complete discussion of the Company’s significant accounting policies and estimates.

In the first quarter of 2005, the Company determined that the estimated useful economic life of its multi-client data library is four years from the date a multi-client data library becomes available for commercial sale. Prior to the first quarter of 2005, the estimated useful life of a multi-client data library once it became available for commercial sale was two years for 2-D projects and three years for 3-D projects. Therefore, the Company’s method of amortizing the costs of a multi-client data library available for commercial sale is the greater of (i) the percentage of actual revenue to the total estimated revenue multiplied by the estimated total cost of the project or (ii) the straight-line basis over a four-year period. The change in estimate was determined based upon the further historical experience of GXT in marketing and selling its multi-client data libraries, in addition to a review of industry standards regarding such useful economic lives. The change did not have a material impact to the Company’s results of operations during the six months ended June 30, 2005.

(3) Pro Forma Results of Acquisitions

In June 2004, the Company purchased all the equity interest of GXT, and in February 2004, the Company purchased all the share capital of Concept Systems. The consolidated results of operations of the Company include the results of GXT and Concept Systems from the dates of acquisition. The following summarized unaudited pro forma consolidated income statement information for the three and six months ended June 30, 2004, assumes that the GXT and Concept Systems acquisitions had occurred as of the beginning of the period presented. The Company has prepared these unaudited pro forma financial results for comparative purposes only. These unaudited pro forma financial results may not be indicative of the results that would have occurred if the Company had completed the acquisitions as of the beginning of the period presented or the results that will be attained in the future.

The Company has adjusted these pro forma income statements as a result of the final purchase price studies which were completed in the fourth quarter of 2004. In addition, during the second quarter of 2005 the Company discovered that royalty expenses incurred by GXT related to its multi-client data library had not been properly recorded in the first quarter of 2005. See Item 4. — Controls and Procedures for further discussion of the procedures implemented during the second quarter of 2005 that discovered these errors. As a result of these errors, the Company restated its financial statements for the three months ended March 31, 2005. The pro forma information for the three and six month periods ended June 30, 2004 are also being restated to give effect to a correction of the royalty expense of that pre-acquisition period. Amounts presented below are in thousands, except for the per share amounts:


	As Previously							As Previously
	Reported Pro							Reported Pro
	forma					Pro forma		forma					Pro forma
	Three Months					Three Months		Six Months					Six Months
	Ended					Ended		Ended					Ended
	June 30, 2004		Adjustment			June 30, 2004		June 30, 2004		Adjustment			June 30, 2004
Net sales	$	74,915	$	—		$	74,915	$	132,677	$	—		$	132,677
Income from operations	$	3,573	$	(401	)	$	3,172	$	5,064	$	(454	)	$	4,610
Net income applicable to common shares	$	1,979	$	(446	)	$	1,533	$	3,158	$	(2,016	)	$	1,142
Basic net income per common share	$	0.03	$	(0.01	)	$	0.02	$	0.04	$	(0.02	)	$	0.02
Diluted net income per common share	$	0.03	$	(0.01	)	$	0.02	$	0.04	$	(0.03	)	$	0.01

(4) Stock-Based Compensation

The Company has elected to continue to follow the intrinsic value method of accounting for equity-based compensation as prescribed by APB Opinion No. 25. If the Company had adopted SFAS No. 123, net income (loss) applicable to common shares, basic and diluted net income (loss) per common share for the periods presented would have changed as follows (in thousands, except per share amounts):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
	(Restated)						(Restated)
Net income (loss) applicable to common shares	$	6,904		$	4,186		$	(1,175	)	$	3,628
Add: Stock-based employee compensation expense included in reported net income (loss) applicable to common shares		486			73			922			112
Deduct: Stock-based employee compensation expense determined under fair value methods for all awards		(1,367	)		(628	)		(2,682	)		(1,222	)

Pro forma net income (loss) applicable to common shares	$	6,023		$	3,631		$	(2,935	)	$	2,518

Basic net income (loss) per common share – as reported	$	0.09		$	0.07		$	(0.01	)	$	0.07

Diluted net income (loss) per common share – as reported	$	0.08		$	0.07		$	(0.01	)	$	0.07

Pro forma basic net income (loss) per common share	$	0.08		$	0.06		$	(0.04	)	$	0.05

Pro forma diluted net income (loss) per common share	$	0.06		$	0.06		$	(0.04	)	$	0.05

The fair value of each option was determined using the Black-Scholes option valuation model. The key variables used in valuing the options were as follows: average risk-free interest rate based on 5-year Treasury bonds, an estimated option term of five years, no dividends and expected stock price volatility of 60% during the three and six months ended June 30, 2005 and 2004.

(5) Segment and Product Information

The Company evaluates and reviews results based on four segments (Land Imaging Systems, Marine Imaging Systems, Data Management Solutions and Seismic Imaging Solutions) to allow for increased visibility and accountability of costs and more focused customer service and product development. The Company measures segment operating results based on income (loss) from operations. Intersegment sales are insignificant for all periods presented.

A summary of segment information for the three and six months ended June 30, 2005 and 2004 is as follows (in thousands):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
	(Restated)						(Restated)
Net sales:
Land Imaging Systems	$	37,445		$	36,637		$	68,002		$	57,275
Marine Imaging Systems		16,773			13,095			27,646			24,554
Data Management Solutions		3,700			4,685			6,851			6,966
Seismic Imaging Solutions		32,249			7,672			49,710			9,179
Corporate and Other		—			237			—			640

Total	$	90,167		$	62,326		$	152,209		$	98,614


Income (loss) from operations:
Land Imaging Systems	$	4,762		$	5,948		$	7,820		$	7,608
Marine Imaging Systems		4,406			2,383			5,499			5,173
Data Management Solutions		478			1,189			354			2,110
Seismic Imaging Solutions		6,155			2,615			1,050			2,696
Corporate and Other		(6,714	)		(6,535	)		(13,104	)		(10,944	)

Total	$	9,087		$	5,600		$	1,619		$	6,643

A summary of net sales by products and services is as follows (in thousands):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2005		2004		2005		2004
	(Restated)				(Restated)
Equipment and system sales	$	51,680	$	49,002	$	91,153	$	80,148
Multi-client data library sales (including underwriting revenues)		17,122		4,383		24,854		4,383
Imaging services		15,051		3,192		24,334		4,166
Other revenues		6,314		5,749		11,868		9,917

Total	$	90,167	$	62,326	$	152,209	$	98,614

(6) Accounts and Notes Receivable

A summary of accounts receivable is as follows (in thousands):


	June 30,			December 31,
	2005			2004
Accounts receivable, principally trade	$	76,000		$	64,751
Less allowance for doubtful accounts		(3,184	)		(3,153	)

Accounts receivable, net	$	72,816		$	61,598

Notes receivable are collateralized by the products sold, bear interest at contractual rates ranging from 5.1% to 8.0% per year and are due at various dates through 2006. The weighted average interest rate at June 30, 2005 was 5.9%. A summary of notes receivable, accrued interest and allowance for doubtful notes is as follows (in thousands):


	June 30,			December 31,
	2005			2004
Notes receivable and accrued interest	$	18,609		$	20,820
Less allowance for doubtful notes		(5,962	)		(5,893	)

Notes receivable, net		12,647			14,927
Less current portion of notes receivable, net		10,185			10,784

Long-term notes receivable	$	2,462		$	4,143

In 2004, the Company sold its first VectorSeis^® Ocean system for seabed data acquisition. A portion of the purchase was financed by the Company through a series of notes receivable totaling $6.9 million at December 31, 2004. During the second quarter of 2005, the Company advanced to the customer $4.6 million on a non-interest bearing basis. The Company imputed interest on a short-term basis as expectation is the advance will be repaid over a short-term period. The combination of these

notes and other activity with this customer increased the total outstanding balance to $14.8 million at June 30, 2005. In July 2005, the Company and the customer entered into a Memorandum of Understanding (MOU) which provides for proposed terms of repayment of the outstanding balances on a secured basis. In addition to the repayment plan, the MOU provides for the Company to purchase for $1.8 million all intellectual property rights or other claims the customer may have regarding the VectorSeis Ocean system as a result of the customer’s work on enhancing the system. The Company expects to be paid in full on all of this customer’s obligations owed to it.

(7) Inventories

A summary of inventories is as follows (in thousands):


	June 30,			December 31,
	2005			2004
Raw materials and subassemblies	$	34,812		$	33,791
Work-in-process		8,176			5,737
Finished goods		50,971			57,953
Reserve for excess and obsolete inventories		(10,082	)		(10,822	)

Inventories, net	$	83,877		$	86,659

As part of the Company’s business plan, the Company uses contract manufacturers as an alternative to in-house manufacturing. Under certain of the Company’s outsourcing arrangements, its manufacturing outsourcers first utilize the Company’s on-hand inventory, then directly purchase inventory at agreed-upon quantities and lead times in order to meet the Company’s scheduled deliveries. If demand proves to be less than the Company originally forecasted and the Company cancels its committed purchase orders, its outsourcer generally has the right to require the Company to purchase inventory which it had purchased on the Company’s behalf. During the six months ended June 30, 2005, the Company purchased $2.0 million of inventory under these obligations.

(8) Non-Cash Investing and Financing Activities

In June 2005, the owner of the Company’s corporate headquarters and manufacturing facility located in Stafford, Texas, sold the facilities to two unrelated parties. See further discussion of certain effects of this transaction on the Company at Note 9 of Notes to Unaudited Consolidated Financial Statements.

In February 2004, the Company acquired all of the share capital of Concept Systems. As part of the consideration, the Company issued 1,680,000 of its common shares, valued at $10.8 million. Also, in June 2004, the Company acquired all the capital stock of GXT. As part of the purchase consideration for the GXT acquisition, the Company assumed certain outstanding GXT stock options, valued at $14.6 million.

During the six months ended June 30, 2005 and 2004, respectively, the Company transferred $1.1 million and $4.4 million, respectively, of inventory at cost, to property, plant and equipment.

(9) Notes Payable, Long Term Debt and Lease Obligations

In May 2005, the Company obtained a $25.0 million revolving line of credit with a maturity date of May 24, 2008. The outstanding balance of indebtedness under this credit facility was $2.1 million at June 30, 2005. Beginning October 1, 2005, the Company can elect to use either the lender’s Base Rate (as defined in the agreement) or the three month LIBOR rate plus 2.25% to 2.75% (depending on the Company’s Fixed Charge Coverage Ratio, as defined in the agreement) in connection with borrowings under the revolving line of credit. Prior to October 1, 2005, the lender’s Base Rate applies. The annual interest rate in effect at June 30, 2005 was 6.25%. The Company is obligated to pay a commitment fee of 0.25% per annum on the unused portion of the revolving credit facility. In addition, the Company can issue letters of credit totaling up to $5 million under this facility, which, if issued, reduces the Company’s borrowing availability under this revolving line of credit. At June 30, 2005, a $0.6 million letter of credit had been issued under this facility.

A portion of the Company’s assets are pledged as collateral for outstanding borrowings under this revolving line of credit. Total borrowings are subject to a borrowing base limitation based on a percentage of eligible accounts receivable and inventories. As of June 30, 2005, the borrowing base calculation permitted total borrowings of $25.0 million, of which $22.3 million remained available. The credit agreement prohibits the Company from paying common stock dividends and limits

certain capital expenditures (as defined), incurring additional debt, selling significant assets, acquiring other businesses, and merging with other entities without the consent of the lenders. The credit agreement requires compliance with certain financial and non-financial covenants, including quarterly requirements related to the Fixed Charge Coverage Ratio (not less than 1.25 to 1), as defined in the agreement. At June 30, 2005, the Company was in compliance with all of the covenants under the credit agreement.

In 2001, the Company sold its building that served as the corporate headquarters and manufacturing facility located in Stafford, Texas for $21.0 million. Simultaneously with the sale, the Company entered into a non-cancelable twelve-year lease with the purchaser of the property. The Company (seller-lessee) had continuing involvement in the property that precluded sale-leaseback accounting. As a result, the sale and leaseback was accounted for as a financing transaction and the Company recorded a lease obligation of $21.0 million using an implicit interest rate of 9.1% per annum.

In June 2005, the owner sold the facilities to two parties, who are unrelated to each other as well as unrelated to the seller. In conjunction with the sale of the facilities, the Company entered into two separate lease arrangements for each of the facilities with the new owner. One lease (the Operating Lease), which was classified as an operating lease, had a lease term of twelve years; while the other lease (the Lease Obligation) continued to be accounted for as a financing transaction because the continuing involvement still existed, had a lease term of ten years. Both leases have renewal options which allowed the Company to extend the leases up to an additional twenty-year term. The Company determined that the renewal options were not reasonably assured of exercise.

Because the Company subleases more than a minor portion of the property under the Lease Obligation, the Company recorded the commitment as a $6.3 million lease obligation at an implicit interest rate of 9% per annum. The Operating Lease qualified as a sale-leaseback for financial reporting purposes; as a result, in June 2005, $11.8 million under its lease obligations and $8.1 million of long-term assets (primarily fixed assets) were treated as being disposed of, with the Company recording a deferred gain of $3.7 million. The deferred gain will be recognized on the straight-line basis over the twelve-year lease term. Under the previous lease arrangements, the Company had provided a letter of credit to the previous owner, which the Company secured by depositing $1.5 million with the issuing bank. There are no similar requirements under the new lease agreements; therefore, in June 2005, the letter of credit was terminated and the Company reclassified the $1.5 million deposit to cash and cash equivalents as the deposit has a maturity of less than three months.

The Company has entered into a series of equipment loans that are due in installments for the purpose of financing the purchase of computer equipment in the form of capital leases expiring in various years through 2008. Interest charged under these loans range from 3.5% to 13.9% and the leases are collateralized by liens on the computer equipment. The assets and liabilities under these capital leases are recorded at the lower of the present value of the minimum lease payments or the fair value of the assets. The assets are depreciated over the lesser of their related lease terms or their estimated productive lives. The unpaid balance at June 30, 2005 was $5.5 million.

In December 2003, the Company issued $60.0 million of convertible senior notes, which mature on December 15, 2008. The notes bear interest at an annual rate of 5.5%, payable semi-annually. The notes, which are not redeemable prior to their maturity, are convertible into the Company’s common stock at an initial conversion rate of 231.4815 shares per $1,000 principal amount of notes (a conversion price of $4.32 per share), which represents 13,888,890 total common shares. The Company paid $3.5 million in underwriting and professional fees, which have been recorded as deferred financing costs and are being amortized over the term of the notes.

A summary of future principal obligations under the notes payable, long-term debt and capital lease obligations as of June 30, 2005, is as follows (in thousands):


	Notes Payable
	and Long-term		Capital Lease
Years Ended December 31,	Debt		Obligations
2005	$	379	$	2,016
2006		348		2,580
2007		405		1,185
2008		62,527		219
2009		541		—
2010 and thereafter		4,448		—

Total	$	68,648		6,000

Imputed Interest				(456	)

Net present value of capital lease obligations				5,544
Current portion of capital lease obligations				3,101

Long-term portion of capital lease obligations			$	2,443

(10) Cumulative Convertible Preferred Stock

In February 2005, the Company issued 30,000 shares of a newly designated Series D-1 Cumulative Convertible Preferred Stock (Series D-1 Preferred Stock) in a privately-negotiated transaction, at a purchase price of $1,000 per share, for an aggregate of $29.8 million in net proceeds. Dividends, which are contractually obligated to be paid quarterly, may be paid, at the option of the Company, either in cash or by the issuance of the Company’s common stock. Dividends are paid at a rate equal to the greater of (i) five percent per annum or (ii) the three month LIBOR rate on the last day of the immediately preceding calendar quarter plus two and one-half percent per annum.

The Series D-1 Preferred Stock may be converted, at the holder’s election, into 3,812,428 shares of the Company’s common stock, subject to adjustment, at an initial conversion price of $7.869 per share, also subject to adjustment in certain events. Also, commencing on February 17, 2007, the holder has the right to redeem all or part of the Series D-1 Preferred Stock. The Company may satisfy its redemption obligations either in cash or by the issuance of the Company’s common stock, calculated based upon the prevailing market price, but not less than $4.45, of the Company’s common stock at the time of redemption.

The Company also granted the holder the right, commencing on August 16, 2005 and expiring on February 16, 2008 (subject to extension), to purchase up to an additional 40,000 shares of Series D-1 Preferred Stock, having similar terms and conditions as the Series D-1 Preferred Stock, and having a conversion price equal to 122% of the then-prevailing market price of the Company’s common stock at the time of its issuance, but not less than $6.31 per share (subject to adjustment in certain events).

(11) Net Income (Loss) per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is determined on the assumption that 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 options outstanding at June 30, 2005 and 2004 were 7,093,876 and 9,013,446, respectively. The Company has outstanding $60.0 million of convertible senior notes, for which 13,888,890 common shares may be acquired upon their full conversion. The convertible notes are dilutive for the three months ended June 30, 2005 and June 30, 2004, and therefore are included in the diluted net income per common share for those periods. However, the convertible notes are anti-dilutive for the six months ended June 30, 2005 and the six months ended June 30, 2004 and have been excluded from the diluted net income per common share for those periods. In February 2005, the Company issued the Series D-1 Preferred Stock, which may be converted, at the holder’s election, into 3,812,428 total common shares. The Series D-1 Preferred Stock is anti-dilutive for the periods outstanding and has been excluded from the diluted net income per common share.

The following table summarizes the calculation of the net income impact from the assumed convertible debt conversion and the calculation of the weighted average number of common shares and weighted average number of diluted common shares

outstanding for purposes of the computation of basic net income (loss) per common share and diluted net income (loss) per common share (in thousands, except share and per share amounts):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2005		2004		2005			2004
	(Restated)				(Restated)

Net income (loss) applicable to common shares	$	6,904	$	4,186	$	(1,175	)	$	3,628
Income impact of assumed convertible debt conversion		654		648		—			—

Net income (loss) after impact of assumed convertible debt conversion	$	7,558	$	4,834	$	(1,175	)	$	3,628


Weighted average number of common shares outstanding		78,744,692		57,073,916		78,694,481			54,596,409
Effect of convertible debt conversion		13,888,890		13,888,890		—			—
Effect of dilutive stock options		931,481		462,282		—			408,168

Weighted average number of diluted common shares outstanding		93,565,063		71,425,088		78,694,481			55,004,577

Basic net income (loss) per common share	$	0.09	$	0.07	$	(0.01	)	$	0.07

Diluted net income (loss) per common share	$	0.08	$	0.07	$	(0.01	)	$	0.07

(12) Deferred Income Tax

The Company records a valuation allowance for substantially all of its net deferred tax assets, which are primarily net operating loss carryforwards. The Company currently does not recognize a benefit from net operating losses. The establishment of this valuation allowance does not affect the Company’s ability to reduce future tax expense through utilization of prior years’ net operating losses. Income tax expense for the three months ended June 30, 2005 and 2004, and the six months ended June 30, 2004 reflects state and foreign taxes. Included in the income tax benefit for the six months ended June 30, 2005, is a $1.3 million credit due to the resolution of a foreign tax matter for an amount less than the Company’s reserve for that potential liability.

The valuation allowance was calculated in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes,” which places primary importance on the Company’s cumulative operating results in the most recent three-year period when assessing the need for a valuation allowance. The Company’s results for those periods were heavily affected by industry conditions, and deliberate and planned business restructuring activities in response to the prolonged downturn in the seismic equipment market, as well as heavy expenditures on research and development. Nevertheless, recent losses represented sufficient negative evidence to establish an additional valuation allowance. The Company has continued to reserve for substantially all of its net deferred tax assets and will continue until there is sufficient positive evidence to warrant reversal.

(13) Comprehensive Net Income (Loss)

The components of comprehensive net income (loss) are as follows (in thousands):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
	(Restated)						(Restated)
Net income (loss) applicable to common shares	$	6,904		$	4,186		$	(1,175	)	$	3,628
Foreign currency translation adjustment		(1,160	)		(330	)		(1,969	)		(713	)

Comprehensive net income (loss)	$	5,744		$	3,856		$	(3,144	)	$	2,915

(14) Commitments and Contingencies

Legal Matters: On January 12, 2005, a putative class action lawsuit was filed against I/O, its chief executive officer, its chief financial officer and the president of GXT in the U.S. District Court for the Southern District of Texas, Houston Division. The action, styled Harold Read, individually and on behalf of all others similarly situated v. Input/Output, Inc, Robert P. Peebler, J. Michael Kirksey, and Michael K. Lambert, alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. The action was filed purportedly on behalf of purchasers of I/O’s common stock who purchased shares during the period from May 10, 2004 through January 4, 2005. The complaint seeks damages in an unspecified amount plus costs and attorneys’ fees. The complaint alleges misrepresentations and omissions in public

announcements and filings concerning the Company’s business, sales and products. On February 4 and 10, 2005, and March 15, 2005, three similar lawsuits were filed in the U.S. District Court for the Southern District of Texas, Houston Division. The three complaints, styled (i) Matt Brody, individually and on behalf of all others similarly situated v. Input/Output, Inc, Robert P. Peebler and J. Michael Kirksey, (ii) Giovanni Arca vs. Input/Output, Inc., Robert P. Peebler, J. Michael Kirksey, and Michael K. Lambert, and (iii) Schneur Grossberger, individually and on behalf of all others similarly situated v. Input/Output, Inc., Robert P. Peebler, J. Michael Kirksey, and Michael K. Lambert, contain factual allegations similar to those in the Read complaint.

The Brody complaint was voluntarily dismissed by the plaintiff in that case on April 28, 2005. On May 13, 2005, the court ordered the three remaining cases to be consolidated into one case, styled Harold Read, individually and on behalf of all others similarly situated v. Input/Output, Inc, Robert P. Peebler, J. Michael Kirksey, and Michael K. Lambert. The plaintiffs in the consolidated case then filed a Motion for Appointment as Lead Plaintiff and for Approval of Plaintiff’s Choice of Lead Counsel. On June 22, 2005, the court denied the Plaintiff’s motion on the basis that the particular plaintiff and lawyers seeking lead plaintiff and lead counsel status in the case did not meet the requirements under the Federal Rules of Civil Procedure. The court ordered the plaintiff in the case to publish a public notice to find an adequate plaintiff to be designated as lead plaintiff in the case within the following 30 days. The plaintiff published the new notice on June 22, 2005, but did not file a new motion with the court within the required 30-day time period.

No discovery has been conducted by the parties in the case, and discovery will be stayed should the defendants file a motion to dismiss until there is a ruling on that motion. Based on the Company’s review of the complaints, management believes the lawsuit is without merit and intends to defend the Company and its officers named as parties vigorously. However, management is unable to determine whether the ultimate resolution of the case will have a material adverse impact on the Company’s financial condition, results of operations or liquidity.

A shareholder derivative lawsuit (Kovalsky v. Robert P. Peebler, et al., No. 2005-17565) was filed on March 16, 2005 in the District Court of Harris County, Texas, 189th Judicial District, against certain of the Company’s officers and all of the members of its board of directors as defendants, and against the Company as a nominal defendant. The complaint alleges breach of the officers’ and directors’ fiduciary duties by failing to correct publicly reported financial results and guidance, abuse of control, gross mismanagement, unjust enrichment and corporate waste. The plaintiff seeks judgment against the defendants for unspecified damages sustained by the Company, restitution, disgorgement of profits, benefits and compensation allegedly obtained by the defendants and attorneys’ and experts’ fees and costs. No discovery has been conducted by the parties in the case. Based on the Company’s review of the Kovalsky complaint, management believes that the derivative suit is without merit and intends to defend vigorously the Company and its officers and directors named as parties in this action. However, management is unable to determine whether the ultimate resolution of this case will have a material adverse impact on the Company’s financial condition, results of operations or liquidity.

In October 2002, the Company filed a lawsuit against Paulsson Geophysical Services, Inc. (PGSI) and its owner in the 286th District Court for Fort Bend County, Texas, seeking recovery of approximately $0.7 million that was unpaid and due to the Company resulting from the sale of a custom product that PGSI asked the Company to construct in 2001. In 2002, the Company fully reserved for all amounts due from PGSI with regard to this sale. After the Company filed suit to recover the PGSI receivable, PGSI alleged that the delivered custom product was defective and counter-claimed against the Company, asserting breach of contract, breach of warranty and other related causes of action. The case was tried to a jury during May 2004. The jury returned a verdict in June 2004, the results of which would not have supported a judgment awarding damages to either the Company or the defendants. In August 2004, the presiding judge overruled the jury verdict and ordered a new trial. A new trial has been scheduled for November 2005. Company management continues to believe that the ultimate resolution of the case will not have a material adverse impact on the financial condition or liquidity of the Company.

The Company has been named in various lawsuits or threatened actions that are incidental to its ordinary business. Such lawsuits and actions could increase in number as the Company’s business expands and the Company grows larger. 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 believes that the ultimate resolution of these matters will not have a material adverse impact on the financial condition or liquidity of the Company.

Product Warranty Liabilities: The Company generally warrants that all manufactured equipment will be free from defects in workmanship, materials and parts. Warranty periods generally range from 90 days to three years from the date of original purchase, depending on the product and equipment. The Company provides for estimated warranty costs as a charge to cost of sales at time of sale, which is when estimated future expenditures associated with such contingencies become probable and reasonably estimated. However, new information may become available, or circumstances (such as applicable laws and regulations) may change, thereby resulting in an increase or decrease in the amount required to be accrued for such matters (and therefore a decrease or increase in reported net income in the period of such change). The Company generally receives warranty support from its suppliers regarding equipment which the outsourcer manufactures. A summary of warranty activity is as follows (in thousands):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
Balance at beginning of period	$	3,781		$	3,150		$	3,832		$	3,433
Accruals for warranties issued during the period		1,061			1,156			2,332			1,377
Settlements made (in cash or in kind) during the period		(1,274	)		(745	)		(2,596	)		(1,249	)

Balance at end of period	$	3,568		$	3,561		$	3,568		$	3,561

(15) Recent Accounting Pronouncements

In March 2004, the FASB issued EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” which provides new guidance for assessing impairment losses on debt and equity investments. Additionally, EITF Issue No. 03-1 included new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF Issue No. 03-1; however, the disclosure requirements remain effective and have been adopted for the Company’s year ended December 31, 2004. The Company will evaluate the effect, if any, of EITF Issue No. 03-1 when final guidance is released.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4,” which requires that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead, and that allocation of fixed production overheads to conversion costs should be based on normal capacity of the production facilities. The provisions in SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe that the adoption of SFAS No. 151 will have a significant impact on the Company’s financial statements.

In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share-Based Payment” (SFAS 123R), which replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. Currently, the Company will be required to adopt SFAS 123R effective as of January 1, 2006. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is evaluating the requirements of SFAS 123R and expects that the adoption of SFAS 123R will have a material impact on its consolidated results of operations and earnings per share. However, the Company has not yet determined the method of adoption or the actual effects of adopting SFAS 123R, and has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.

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

Restatement

See Note 1 to Unaudited Consolidated Financial Statements for explanation regarding the restatement of our consolidated financial statements as of and for the three and six months ended June 30, 2005.

The restatement was necessitated principally due to the incorrect application of accounting principles for revenue recognition by our subsidiary, GX Technology Corporation (GXT), in connection with license sales of GXT’s multi-client seismic survey data. The principal effects of the restatement on our historical results of operations for the accounting periods affected have been to shift amounts of revenue and associated costs and expenses recognized from these multi-client license transactions to subsequent accounting periods. For the three months ended June 30, 2005, the restatement increased our consolidated net sales from $84.0 million to $90.2 million, increased our gross profit from $23.4 million to $28.0 million and increased our net income applicable to common shares from $2.4 million ($0.03 per common share (diluted)) to $6.9 million ($0.08 per common share (diluted)). For the six months ended June 30, 2005, the restatement increased our consolidated net sales from $150.9 million to $152.2 million, increased our gross profit from $38.6 million to $38.8 million and decreased our net loss applicable to common shares from ($1.6) million ($0.02 loss per common share (diluted)) to ($1.2) million ($0.01 per common share (diluted)). Our consolidated statement of cash flows for the six months ended June 30, 2005 has been restated resulting in changes within cash flows from operating activities, but no change to net cash used in operating activities. Also, our consolidated balance sheets at June 30, 2005 and December 31, 2004 have been restated to include a deferred tax liability and a corresponding increase in goodwill related to book and tax differences between the intangible assets of our Concept Systems Holding Limited (Concept Systems) subsidiary, which we had acquired in 2004.

Executive Summary

We are a leading seismic services company, providing seismic data acquisition equipment, software and planning and seismic processing services to the global oil and gas industry. During 2004, we accomplished a major repositioning of our business. Formerly, we were primarily an equipment and technology provider; now we offer our customers full-seismic imaging solutions. In February 2004, we acquired Concept Systems, an Edinburgh, Scotland-based provider of software, systems and services for towed streamer, seabed and land seismic operations. In June 2004, we acquired GX Technology Corporation (GXT), a leading provider of seismic imaging technology, data processing and subsurface imaging services to oil and gas companies. Both acquisitions were completed as part of our strategy to expand the range of products and services we can provide to our existing customers and new end-user customers.

After several years of decreased levels of seismic activity, we are seeing the businesses of our oil company and seismic contractor customers improve as they have increased their capital spending. We would expect this trend to escalate as they become more confident in the strength of the market, primarily driven by rapidly escalating oil and gas prices. The increase in levels of seismic spending has been primarily evidenced by the increase in sales within our Marine Imaging Systems segment and increased sales of our vibrator trucks within our Land Imaging Systems segment, which reflects the growing international land market. Also, during the second quarter of 2005, GXT returned to profitability due to improving results within their processing business.

In February 2005, we issued 30,000 shares of a newly designated Series D-1 Cumulative Convertible Preferred Stock (Series D-1 Preferred Stock) in a privately-negotiated transaction and received $29.8 million in net proceeds. Also, in May 2005, we obtained a $25.0 million revolving line of credit which has a maturity date in May 2008. We believe, based upon our forecasts and our liquidity requirements for the near term, that the combination of our projected internally generated cash, the availability of this revolving line of credit and our working capital (including cash and cash equivalents on hand) will provide further flexibility in meeting our growth plans and liquidity requirements for the next twelve months.

We operate our company through four business segments: Land Imaging Systems, Marine Imaging Systems, Data Management Solutions and Seismic Imaging Solutions. The following table provides an overview of key financial metrics for our company as a whole and our four business segments during the three and six months ended June 30, 2005 compared to those periods one year ago (in thousands):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
	(Restated)						(Restated)
Net sales:
Land Imaging Systems	$	37,445		$	36,637		$	68,002		$	57,275
Marine Imaging Systems		16,773			13,095			27,646			24,554
Data Management Solutions		3,700			4,685			6,851			6,966
Seismic Imaging Solutions		32,249			7,672			49,710			9,179
Corporate and Other		—			237			—			640

Total	$	90,167		$	62,326		$	152,209		$	98,614

Income (loss) from operations:
Land Imaging Systems	$	4,762		$	5,948		$	7,820		$	7,608
Marine Imaging Systems		4,406			2,383			5,499			5,173
Data Management Solutions		478			1,189			354			2,110
Seismic Imaging Solutions		6,155			2,615			1,050			2,696
Corporate and Other		(6,714	)*		(6,535	)*		(13,104	)*		(10,944	)*

Total	$	9,087		$	5,600		$	1,619		$	6,643


Net income (loss) applicable to common shares	$	6,904		$	4,186		$	(1,175	)	$	3,628
Basic net income (loss) per common share	$	0.09		$	0.07		$	(0.01	)	$	0.07
Diluted net income (loss) per common share	$	0.08		$	0.07		$	(0.01	)	$	0.07


*		Represents corporate general and administrative expenses not allocated to any segment.

We intend that the discussion of our financial condition and results of operations that follows will provide information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from quarter to quarter, and the primary factors that accounted for those changes.

For a discussion of factors that could impact our future operating results and financial condition, see the section entitled “ — Risk Factors” below.

Registered Marks

The information contained in this Quarterly Report on Form 10-Q contains references to our trademarks, service marks and registered marks, as indicated. Except where stated otherwise or unless the context otherwise requires, the terms “VectorSeis,” “VectorSeis System Four” and “DigiCourse” refer to our VectorSeis^®, VectorSeis System Four^®, and DigiCourse^® registered marks.

Results of Operations

The following descriptions of our results of operations for the three and six month periods ended June 30, 2005 reflect the restated financial data for those periods.

Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004

Net Sales: Net sales of $90.2 million for the three months ended June 30, 2005 increased $27.8 million, compared to the corresponding period in 2004, due principally to the acquisition of GXT. Land Imaging Systems’ net sales increased slightly, by $0.8 million, to $37.4 million compared to $36.6 million in the corresponding period in 2004. This increase was due to an increase in our land acquisition system and vibrator truck sales, partially offset by a decline in our Sensor geophone sales. Due to a strong marine seismic market, Marine Imaging System’s net sales increased $3.7 million to $16.8 million compared to $13.1 million in the corresponding period in 2004.

Seismic Imaging Solutions’ net sales increased $24.5 million, to $32.2 million compared to $7.7 million in the corresponding period in 2004, due to our acquisition of GXT in June 2004. GXT contributed $30.3 million to our net sales for the three months ending June 30, 2005, compared to $5.6 million in the corresponding period in 2004. GXT’s backlog of processing projects has improved significantly since the end of 2004. Concept Systems contributed $3.7 million to our net sales for the second quarter, compared to $4.7 million in the corresponding period in 2004. The decrease in net sales of Concept Systems is the result of one contract to a Chinese customer delivered during the three months ended March 31, 2004, that had a greater than normal amount of software and hardware.

Gross Profit and Gross Profit Percentage: Gross profit of $28 million for the three months ended June 30, 2005 increased $6.8 million, compared to the corresponding period in 2004. Gross profit percentage for the three months ended June 30, 2005 was 31% compared to 34% in 2004. The decline in our gross margin percentages was primarily due to pricing pressures on our land acquisition systems related to entering new markets and low processing margins at GXT due to their excess processing capacity during the quarter.

Marketing and Sales: Marketing and sales expense of $7.5 million for the three months ended June 30, 2005 increased $2.5 million, compared to the corresponding period in 2004. The increase is primarily a result of the acquisition of GXT in June 2004, which added $2.3 million to our marketing and sales expense compared to $0.7 million for the same period in 2004. Excluding the expenses of GXT, our sales and marketing expenses increased primarily related to an increase in sales personnel, an increase in business development personnel within our product groups, an increase in corporate marketing and advertising expenses and expenses related to our sales representative offices in Moscow and Beijing. We intend to continue investing significant sums in our marketing efforts as we penetrate markets for our new products.

Income Tax Expense: Income tax expense for the three months ended June 30, 2005 was $0.4 million compared to an income tax expense of $0.3 million for the three months ended June 30, 2004. Income tax expense reflected only state and foreign taxes, since we continue to maintain a valuation allowance for substantially all of our net deferred tax assets.

Preferred Dividend: The preferred dividend is a result of our issuance of Series D-1 Preferred Stock in February 2005, which resulted in $29.8 million of net proceeds. Dividends, which are contractually obligated to be paid quarterly, may be paid, at the option of the Company, either in cash or by the issuance of the Company’s common stock. Dividends are paid at a rate equal to the greater of (i) five percent per annum or (ii) the three month LIBOR rate on the last day of the immediately preceding calendar quarter plus two and one-half percent per annum. The preferred dividend rate was 5.62% at June 30, 2005.

Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004

Net Sales: Net sales of $152.2 million for the six months ended June 30, 2005 increased $53.6 million, compared to the corresponding period in 2004 due principally to the acquisition of GXT. Land Imaging Systems’ net sales increased by $10.7 million, to $68.0 million compared to $57.3 million in the corresponding period in 2004. This increase was due to an increase in our land acquisition system and vibrator truck sales, partially offset by the decline in our Sensor geophone sales. Marine Imaging System’s net sales increased $3.1 million to $27.6 million, compared to $24.5 million in the corresponding period in 2004 due to a strong marine seismic market.

Seismic Imaging Solutions’ net sales increased $40.5 million, to $49.7 million compared to $9.2 million in the corresponding period in 2004, due to our acquisition of GXT in June 2004. GXT contributed $46.2 million to our net sales for the six months ended June 30, 2005, compared to $5.6 million in the corresponding period in 2004. Concept Systems, which we acquired in February 2004, contributed $6.9 million to our net sales for the six months ended June 30, 2005, compared to $7.0 million in the corresponding period in 2004.

Gross Profit and Gross Profit Percentage: Gross profit of $38.8 million for the six months ended June 30, 2005 increased $5.7 million above the gross profit for the corresponding period in 2004. Gross profit percentage for the six months ended June 30, 2005 was 26% compared to 34% in 2004. The decline in our gross margin percentages is primarily due to pricing pressures on land acquisition systems related to entering new markets and low processing margins at GXT due to their excess processing capacity during the period. A higher mix of lower margin vibrator truck sales during the periods of comparison also lowered the gross profit percentage.

Marketing and Sales: Marketing and sales expense of $15.0 million for the six months ended June 30, 2005 increased $6.7 million compared to the corresponding period in 2004. The increase is primarily a result of the acquisition of GXT in June 2004. Excluding the expenses of GXT, our sales and marketing expenses reflect additional sales personnel, an increase in

business development personnel within our product groups, an increase in corporate marketing and advertising expenses and expenses related to our sales representative offices in Moscow and Beijing. We intend to continue investing significant sums in our marketing efforts as we penetrate markets for our new products.

General and Administrative: General and administrative expense of $12.8 million for the six months ended June 30, 2005 increased $2.3 million compared to the corresponding period in 2004. The increase in general and administrative expense is partially a result of the acquisition of GXT in June 2004, which added $1.1 million to our general and administrative expenses compared to $0.1 million to the corresponding period in 2004. The remainder of the increase was primarily related to fees associated with the implementation of requirements under Section 404 of the Sarbanes-Oxley Act of 2002.

Income Tax (Benefit) Expense: Income tax benefit for the six months ended June 30, 2005 was $0.9 million compared to an income tax expense of $0.9 million for the six months ended June 30, 2004. This benefit was primarily due to the closure of a foreign tax matter, which resulted in a $1.3 million reduction in our reserve for that matter. Excluding this tax benefit, income tax expense for the six months ended June 30, 2005 and 2004 reflected only state and foreign taxes, since we continue to maintain a valuation allowance for substantially all of our net deferred tax assets.

Liquidity and Capital Resources

The cash flow information described below reflects the restatement of our consolidated financial statements for the six months ended June 30, 2005.

New Sources of Capital

In February 2005, we issued 30,000 shares of a newly designated Series D-1 Cumulative Convertible Preferred Stock (Series D-1 Preferred Stock) in a privately-negotiated transaction and received $29.8 million in net proceeds. We have no present commitment or ongoing negotiations with respect to any potential acquisition. The Series D-1 Preferred Stock may be converted, at the holder’s election, into 3,812,428 shares of our common stock, subject to adjustment, at an initial conversion price of $7.869 per share, also subject to adjustment in certain events.

We also granted the holder the right, commencing on August 16, 2005 and expiring on February 16, 2008 (subject to extension), to purchase up to an additional 40,000 shares of one or more additional series of Series D-1 Preferred Stock, having similar terms and conditions as the Series D-1 Preferred Stock, and having a conversion price equal to 122% of the prevailing market price of our common stock at the time of its issuance, but not less than $6.31 per share (subject to adjustment in certain events).

In May 2005, we obtained a $25.0 million revolving line of credit with a maturity date of May 24, 2008. The outstanding balance of indebtedness under this credit facility was $2.1 million at June 30, 2005. We can periodically elect to use either the lender’s Base Rate (as defined in the credit agreement) or the three-month LIBOR Rate plus 2.25% to 2.75% (depending on our Fixed Charge Coverage Ratio, as defined in the credit agreement) in connection with borrowings under the revolving line of credit. In addition, we can issue letters of credit totaling up to $5 million under this facility, which, if issued, reduces our borrowing availability under this revolving line of credit. At June 30, 2005, a $0.6 million letter of credit had been issued under this facility.

A portion of our assets are pledged as collateral for outstanding borrowings under the line of credit. Total borrowings are subject to a borrowing base limitation based on a percentage of eligible accounts receivable and inventories. As of June 30, 2005, the borrowing base calculation permitted total borrowings of $25.0 million, of which $22.3 million remained available. Our borrowing base will decrease if our Eligible Collateral (as defined in the credit agreement) falls below $25.0 million. The credit agreement prohibits us from paying dividends on common stock and limits certain capital expenditures (as defined), incurring additional debt, selling significant assets, acquiring other businesses, and merging with other entities without the consent of the lenders. The credit agreement requires compliance with certain financial and non-financial covenants, including quarterly requirements related to Fixed Charge Coverage Ratio (not less than 1.25 to 1), as defined in the agreement. We were in compliance with all of the covenants under the credit agreement as of June 30, 2005.

The issuance of the Series D-1 Preferred Stock and our obtaining a revolving line of credit resulted from our evaluation that began in late 2004 of our long-term and short-term capital needs. In connection with our assessment of 2004’s results of operations, we evaluated the amount of working capital required to manufacture certain of our sophisticated VectorSeis

systems, the projections of our short-term and long-term working capital requirements, the potential for unanticipated delays in the adoption of new technologies, certain research and development opportunities and market trends in the seismic industry, and determined that an infusion of additional long-term capital and having the availability of a revolving line of credit were desirable. We believe, based upon our forecasts and our liquidity requirements for the near term, that the combination of our projected internally generated cash, the availability of this revolving line of credit and our working capital (including cash and cash equivalents on hand), will provide further flexibility in meeting our growth plans and liquidity requirements for the next twelve months.

Cash Flow from Operations

We have historically financed operations from internally generated cash and funds from equity and debt financings. Cash and cash equivalents were $20.4 million at June 30, 2005, an increase of $5.5 million, compared to December 31, 2004, primarily as a result of the issuance of $30 million of our Series D-1 Preferred Stock, partially offset by payments on our accounts payable. Net cash used in operating activities was $17.5 million for the six months ended June 30, 2005, compared to cash used in operating activities of $4.3 million for the six months ended June 30, 2004. The increase in net cash used in our operating activities for the six months ended June 30, 2005 was primarily due to decreases in our payables and accrued expenses, which resulted from our payments to vendors for inventory received near the end of 2004, and an increase in our unbilled revenues and accounts receivable due to our higher sales levels.

Cash Flow from Investing Activities

Net cash flow used in investing activities was $6.7 million for the six months ended June 30, 2005, compared to $167.0 million for the six months ended June 30, 2004. During the six months ended June 30, 2004, we acquired Concept Systems and GXT. The principal uses of our investing activities during the six months ended June 30, 2005 were $2.5 million of equipment purchases and a $3.8 million investment in our multi-client data library. We expect to expend an additional $10 million to $20 million for equipment purchases and investments in our multi-client data library during the remaining six months of 2005. The range of expenditures for the remainder of the year could vary substantially depending on the level of multi-client projects that are completed in the last half of 2005.

Cash Flow from Financing Activities

Net cash flow provided by financing activities was $29.8 million for the six months ended June 30, 2005, compared to $148.2 million of cash provided by financing activities for the six months ended June 30, 2004. The net cash flow provided during the six months ended June 30, 2005 was primarily related to the sale of our Series D-1 Preferred Stock, on which we paid $0.6 million of cash dividends during the period. During the period we made scheduled payments of $4.0 million on our notes payable, long-term debt and lease obligations. Our employees exercised stock options, resulting in proceeds to us of $1.1 million during the period. In addition, we borrowed $2.1 million under our revolving line of credit and reclassified a $1.5 million deposit to cash and cash equivalents as the letter of credit the deposit was securing was terminated during the period.

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 in the first and fourth quarters of our fiscal year.

Future Contractual Obligations

The following table sets forth estimates of future payments for the remainder of 2005, and for 2006 through 2010 and thereafter, of our consolidated contractual obligations, as of June 30, 2005 (in thousands):


	Payments Due by Fiscal Year
													2010 and
Contractual Obligations	Total		2005		2006		2007		2008		2009		Thereafter
Long-term debt obligations	$	68,648	$	379	$	348	$	405	$	62,527	$	541	$	4,448
Interest on long-term debt obligations		16,705		3,589		3,848		3,815		3,775		430		1,248
Capital lease obligations		6,000		2,016		2,580		1,185		219		—		—
Operating leases		46,839		3,223		6,446		5,000		4,315		4,160		23,695
Product warranty		3,568		1,784		1,784		—		—		—		—
Purchase obligations		69,461		39,328		7,385		7,958		7,395		7,395		—

Total	$	211,221	$	50,319	$	22,391	$	18,363	$	78,231	$	12,526	$	29,391

The long-term debt and lease obligations at June 30, 2005 included $60.0 million in indebtedness under our convertible senior notes that mature in December 2008. The remaining amount of these obligations consist of (i) $2.1 million under our revolving line of credit, (ii) $6.3 million related to our sale-leaseback arrangement, and (iii) $0.2 million in unsecured promissory notes related to our acquisition of AXIS in 2002. The $6.0 million of capital lease obligations relates to GXT’s financing of equipment purchases. For further discussion of our notes payable, long-term debt and lease obligations, see Note 9 of Notes to Unaudited Consolidated Financial Statements.

The operating lease commitments at June 30, 2005 relate to our leases for certain equipment, offices, and warehouse space under non-cancelable operating leases.

The liability for product warranties at June 30, 2005 relate to the estimated future warranty expenditures associated with our products. Our warranty periods generally range from 90 days to three years from the date of original purchase, depending on the product. We record an accrual for product warranties and other contingencies at the time of sale, which is when the estimated future expenditures associated with those contingencies become probable and the amounts can be reasonably estimated. We generally receive warranty support from our suppliers regarding equipment they manufactured.

Our purchase obligations primarily relate to our committed inventory purchase orders for which deliveries are scheduled to be made in 2005 and 2006. In December 2004, we entered into a five-year supply agreement with Colibrys Ltd. for the purchase of MEMS accelerometers. The five-year minimum commitment ranges between $7 million to $8 million per year through 2009.

Critical Accounting Policies and Estimates

Refer to our Annual Report on Form 10-K for the year ended December 31, 2004 for a complete discussion of our significant accounting policies and estimates. Since the Form 10-K filing, we have changed our methodology for estimates regarding the useful economic life of our multi-client data library.

In the first quarter of 2005, we determined that the estimated useful economic life of our multi-client data library is four years from the date a multi-client data library becomes available for commercial sale. Prior to the first quarter of 2005, the estimated useful life of a multi-client data library once it became available for commercial sale was two years for 2-D projects and three years for 3-D projects. Therefore, our method of amortizing the costs of a multi-client data library available for commercial sale is the greater of (i) the percentage of actual revenue to the total estimated revenue multiplied by the estimated total cost of the project or (ii) the straight-line basis over a four-year period. The change in estimate was determined based upon GXT’s further historical experience in marketing and selling its multi-client data libraries, in addition to a review of industry standards regarding such useful economic lives. Therefore, it can be expected that the overall average amortization rate for the costs of an available-for-sale multi-client data library for future periods will decrease when compared to prior periods. This change did not have a material impact to our results of operations during the first six months of 2005.

Credit Risk

Historically, our principal customers have been seismic contractors that operate seismic data acquisition systems and related equipment to collect data in accordance with their customers’ specifications or for their own seismic data libraries. However, through the acquisition of GXT, we have diversified our customer base to include major integrated and independent oil and gas companies.

For the six months ended June 30, 2005 and for all of 2004, approximately 9% and 15%, respectively, of our consolidated net sales were equipment sales to one Chinese customer. Approximately $12.0 million, or 16%, of our total accounts receivable at June 30, 2005 related to this same customer. The loss of this customer or deterioration in our relationship with it could have a material adverse effect on our results of operations and financial condition.

In 2004, we sold our first VectorSeis Ocean system for seabed data acquisition. A portion of the purchase price was financed by us through a series of notes receivable totaling $6.9 million at December 31, 2004. During the second quarter of 2005, we advanced to the customer $4.6 million on a short-term non-interest bearing basis. The combination of these notes and other activity with this customer increased the total outstanding balance to $14.8 million at June 30, 2005. In July 2005, we and the customer entered into a Memorandum of Understanding (MOU) which provides for proposed terms of repayment of the outstanding balances on a secured basis. We expect to be paid in full on all of this customer’s obligations.

For the six months ended June 30, 2005, we recognized $6.9 million of sales to customers in the Commonwealth of Independent States, or former Soviet Union (CIS), $5.3 million of sales to customers in Latin American countries, $36.9 million of sales to customers in Europe, $15.4 million of sales to customers in the Middle East, $10.9 million of sales to customers in Asia Pacific and $20.3 million of sales to customers in Africa. The majority of our foreign sales are denominated in U.S. dollars. In recent years, the CIS and certain Latin American countries have experienced economic problems and uncertainties. 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 collectibility of our existing receivables, our future results of operations, liquidity and financial condition may be adversely affected. We currently require customers in these higher risk countries to provide their own financing and in some cases assist the customer in organizing international financing and Export-Import credit guarantees provided by the United States government. We do not currently extend long-term credit through notes or otherwise to companies in countries we consider to be inappropriate for credit risk purposes.

Risk Factors

This report (as well as certain oral statements made from time to time by authorized representatives on behalf of our company) contain 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 (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the 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,” “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 in this report include statements regarding:

•		expected revenues, operating profit and net income;

•		expected gross margins for our products and services;

•		future growth rates for certain of our products and services;

•		expectations of successfully marketing our products and services to oil and gas company end-users;

•		the degree and rate of future market acceptance of our new products;

•		the timing of anticipated sales;

•		anticipated timing and success of commercialization and capabilities of products and services under development, and start-up costs associated therewith;

•		potential future acquisitions;

•		success in integrating our acquired businesses;

•		our expectations regarding future mix of business and future asset recoveries;

•		future levels of capital expenditures;

•		future cash needs and future sources of cash, including availability under our revolving line of credit facility;

•		the outcome of pending or threatened disputes and other contingencies;

•		the adequacy of our future liquidity and capital resources;

•		future demand for seismic equipment and services;

•		future seismic industry fundamentals;

•		future oil and gas commodity prices;

•		future opportunities for new products and projected research and development expenses;

•		future worldwide economic conditions;

•		our expectations regarding realization of deferred tax assets;

•		our beliefs regarding accounting estimates we make; and

•		results from strategic alliances with 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:

Our operating results may fluctuate from period to period and we are subject to seasonality factors.

Our operating results are subject to fluctuations from period to period, as a result of new product or service introductions, the timing of significant expenses in connection with customer orders, unrealized sales, the product mix sold and the seasonality of our business. Because many of our products feature a high sales price and are technologically complex, we generally have experienced long sales cycles for these products and historically incur significant expense at the beginning of these cycles for component parts and other inventory necessary to manufacture a product in anticipation of a future sale, which may not ultimately occur. In addition, the revenues from our sales can vary widely from period to period due to changes in customer requirements. These factors can create fluctuations in our net sales and results of operations from period to period. Variability in our overall gross margins for any quarter, which depend on the percentages of higher-margin and lower-margin products and services sold in that quarter, compounds these uncertainties. As a result, if net sales or gross margins fall below expectations, our operating results and financial condition will likely be adversely affected. Additionally, our business can be seasonal in nature, with strongest demand typically in the first and fourth calendar quarters of each year.

Due to the relatively high sales price of many of our products and data libraries and relatively low unit sales volume, our quarterly operating results have historically fluctuated from period to period due to the timing of orders and shipments and the mix of products and services sold. This uneven pattern has made 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. Delays caused by factors beyond our control, such as the granting of permits for seismic surveys by third parties and the availability and equipping of marine vessels, can affect GXT’s revenues from its processing services from period to period. Also, delays in ordering products or in shipping or delivering products in a given quarter could significantly affect our results of operations for that quarter. Fluctuations in our quarterly operating results may cause greater volatility in the price of our common stock and convertible notes.

We may not gain rapid market acceptance for our VectorSeis products, which could materially and adversely affect our results of operations and financial condition.

We have spent considerable time and capital developing our VectorSeis product lines. Because VectorSeis products rely on a new digital sensor, our ability to sell our VectorSeis products will depend on acceptance of our digital sensor and technology solutions by geophysical contractors and exploration and production companies. If our customers do not believe that our digital sensor delivers higher quality data with greater operational efficiency, our results of operations and financial condition will be materially and adversely affected.

We are exposed to risks related to complex, highly technical products.

System reliability is an important competitive consideration for seismic data acquisition systems. Our customers often require demanding specifications for product performance and reliability. 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 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.

We derive a substantial amount of our revenues from foreign sales, which pose additional risks.

Sales to customers outside of North America accounted for approximately 63% of our consolidated net sales for the six months ended June 30, 2005, and we believe that export sales will remain a significant percentage of our revenue. United States export restrictions affect the types and specifications of products we can export. Additionally, to complete certain sales, United States laws may require us to obtain export licenses, and we cannot assure you that we will not experience difficulty in obtaining these licenses. Operations and sales in countries other than the United States are subject to various risks peculiar to each country. With respect to any particular country, these risks may include:

•		expropriation and nationalization;

•		political and economic instability;

•		armed conflict and civil disturbance;

•		currency fluctuations, devaluations and conversion restrictions;

•		confiscatory taxation or other adverse tax policies;

•		tariff regulations and import/export restrictions;

•		customer credit risk;

•		governmental activities that limit or disrupt markets, or restrict payments or the movement of funds; and

•		governmental activities that may result in the deprivation of contractual rights.

There is a risk that our collections cycle will lengthen due to the increased level of our sales to foreign customers, particularly those in China and the CIS.

The majority of our foreign sales are denominated in United States dollars. An increase in the value of the dollar relative to other currencies will make our products more expensive, and therefore less competitive, in foreign markets.

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.

The loss of any significant customer could materially and adversely affect our results of operations and financial condition.

We have traditionally relied on a relatively small number of significant customers. Consequently, our business is exposed to the risks related to customer concentration. For the six months ended June 30, 2005 and for the entire year of 2004,

approximately 9% and 15%, respectively, of our consolidated net sales related to one Chinese customer. 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.

GXT and Concept Systems increase our exposure to the risks experienced by more technology-intensive companies.

The businesses of GXT and Concept Systems, being more concentrated in software, processing services and proprietary technologies than our traditional business, have exposed us to the risks typically encountered by smaller technology companies that are more dependent on proprietary technology protection and research and development. These risks include:

•		future competition from more established companies entering the market;

•		product obsolescence;

•		dependence upon continued growth of the market for seismic data processing;

•		the rate of change in the markets for GXT’s and Concept Systems’ technology and services;

•		research and development efforts not proving sufficient to keep up with changing market demands;

•		dependence on third-party software for inclusion in GXT’s and Concept Systems’ products and services;

•		misappropriation of GXT’s or Concept Systems’ technology by other companies;

•		alleged or actual infringement of intellectual property rights that could result in substantial additional costs;

•		difficulties inherent in forecasting sales for newly developed technologies or advancements in technologies;

•		recruiting, training, and retaining technically skilled personnel that could increase the costs for GXT or Concept Systems, or limit their growth; and

•		the ability to maintain traditional margins for certain of their technology or services.

We may not realize the anticipated benefits of our acquisitions of GXT or Concept Systems or be successful in integrating their operations, personnel or technology.

There can be no assurance that the anticipated benefits of our acquisitions of GXT or Concept Systems will be realized or that our integration of their operations, personnel and technology will be successful. Likewise, no assurances can be given that our business plan with respect to GXT’s or Concept Systems’ services and products will prove successful. The integration of these companies into our operations will require the experience and expertise of managers and key employees of GXT and Concept Systems who are expected to be retained by us. There can be no assurance that these managers and key employees of GXT and Concept Systems retained by us will remain with us for the time period necessary to successfully integrate their companies into our operations.

Future technologies and businesses that we may acquire may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention.

An important aspect of our current business strategy is to seek new technologies, products and businesses to broaden the scope of our existing and planned product lines and technologies. While we believe that these acquisitions complement our technologies and our general business strategy, there can be no assurance that we will achieve the expected benefit of these acquisitions. In addition, these acquisitions may result in unexpected costs, expenses and liabilities.

Acquisitions expose us to:

•

increased costs associated with the acquisition and operation of the new businesses or technologies and the management of geographically dispersed operations;

•		risks associated with the assimilation of new technologies, operations, sites and personnel;

•		the possible loss of key employees and costs associated with their loss;

•		risks that any technology we acquire may not perform as well as we had anticipated;

•		the diversion of management’s attention and other resources from existing business concerns;

•		the potential inability to replicate operating efficiencies in the acquired company’s operations;

•		potential impairments of goodwill and intangible assets;

•		the inability to generate revenues to offset associated acquisition costs;

•		the requirement to maintain uniform standards, controls, and procedures;

•		the impairment of relationships with employees and customers as a result of any integration of new and inexperienced management personnel; and

•		the risk that acquired technologies do not provide us with the benefits we anticipated.

Integration of the acquired businesses requires significant efforts from each entity, including coordinating existing business plans and research and development efforts. Integrating operations may distract management’s attention from the day-to-day operation of the combined companies. If we are unable to successfully integrate the operations of acquired businesses, our future results will be negatively impacted.

We have outsourcing arrangements with third parties to manufacture some of our products. If these third parties 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.

As part of our strategic direction, we are increasing our use of contract manufacturers as an alternative to our own manufacture of products. As an example, in December 2004, we sold to another company our Applied MEMS business that manufactures MEMS products that are a necessary component in many of our products. 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 products and services 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.

If any of these risks are realized, our revenues, profitability and cash flow may decline. In addition, as we come to rely more heavily on contract manufacturers, we may have fewer personnel resources with expertise to manage problems that may arise from these third-party arrangements.

Technological change in the seismic industry requires us to make substantial research and development expenditures.

The markets for our products are characterized by changing technology and new product introductions. We must invest substantial capital to maintain a leading edge in technology, with no assurance that we will receive an adequate rate of return on such investments. If we are unable to develop and produce successfully and timely new and enhanced products and services, we will be unable to compete in the future and our business, our results of operations and financial condition will be materially and adversely affected.

Our outsourcing relationships may require us to purchase inventory when demand for products produced by third-party manufacturers is low.

Under a few of our outsourcing arrangements, our manufacturing outsourcers purchase agreed-upon inventory levels to meet our forecasted demand. Since we typically operate without a significant backlog of orders for our products, our manufacturing plans and inventory levels are principally based on sales forecasts. If demand proves to be less than we originally forecasted, these manufacturing outsourcers have the right to require us to purchase any excess or obsolete inventory. Should we be required to purchase inventory under these provisions, we may be required to hold inventory that we may never utilize.

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 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. Any such claims, 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 affect on our results of operations and financial condition.

Further consolidation among our significant customers could materially and adversely affect us.

Historically, a relatively small number of customers has accounted for the majority of our net sales in any period. In recent years, our traditional seismic contractor customers have been rapidly consolidating, thereby consolidating the demand for our products. The loss of any of our significant customers to further consolidation could materially and adversely affect our results of operations and financial condition.

Our operations, and the operations of our customers, are subject to numerous government regulations, which could adversely limit our operating flexibility.

Our operations are subject to 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 result in the need to modify products, which may involve substantial costs or delays in sales and could have an adverse effect on our future operating results. Our export activities are also subject to extensive and evolving trade regulations. 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. 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 products. For instance, regulations regarding the protection of marine mammals in the Gulf of Mexico may reduce demand for our airguns and other marine products. To the extent that our customer’s operations are disrupted by future laws and regulations, our business and results of operations may be materially and adversely affected.

Disruption in vendor supplies may adversely affect our results of operations.

Our manufacturing processes require a high volume of quality components. Certain components used by us are currently provided by only one supplier. We may, from time to time, experience supply or quality control problems with suppliers, and these problems could significantly affect our ability to meet production and sales commitments. Reliance on certain suppliers, as well as industry supply conditions, generally involve several risks, including the possibility of a shortage or a lack of availability of key components and increases in component costs and reduced control over delivery schedules; any of these could adversely affect our future results of operations.

We may not be able to generate sufficient cash flows to meet our operational, growth and debt service needs.

Our ability to fund our operations, grow our business and make payments on our indebtedness and our other obligations will depend on our financial and operating performance, which in turn will be affected by general economic conditions in the energy industry and by many financial, competitive, regulatory and other factors beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future sources of capital will be available to us in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs.

If we are unable to generate sufficient cash flows to fund our operations, grow our business and satisfy our debt obligations, we may have to undertake additional or alternative financing plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital investments or seeking to raise additional capital. We cannot assure you that any refinancing would be possible, that any assets could be sold, or, if sold, of the timing of the sales and the amount of proceeds that may be realized from those sales, or that additional financing could be obtained on acceptable terms, if at all. Our inability to generate sufficient cash flows to satisfy debt obligations, or to refinance our indebtedness on commercially reasonable terms, would materially and adversely affect our financial condition and results of operations and our ability to satisfy our obligations under the notes.

We are exposed to risks relating to the effectiveness of our internal controls.

During 2004, we implemented a number of procedures to strengthen our internal controls, including procedures to comply with the annual internal controls assessment and attestation requirements under Section 404 of the Sarbanes-Oxley Act of 2002 and the related SEC rules. During the second quarter of 2005, we implemented and enhanced certain internal control procedures regarding GXT’s royalty expenses related to its multi-client data library. As a result of these procedures, we discovered errors in the calculation of royalty expenses for the three months ended March 31, 2005. In August 2005, we announced that for the three months ended March 31, 2005 we had understated our royalty expenses and liabilities by $795,000 and therefore restated the results of operations for that period. These errors in the calculation of GXT royalty expenses did not have a material impact upon our reported results for the year ended December 31, 2004, any interim periods in 2004, or any prior period.

We announced in March 2006 that we were restating our consolidated financial statements for the year ended December 31, 2004 and those for the quarterly periods ended September 30, 2004, December 31, 2004, March 31, 2005 June 30, 2005 and September 30, 2005, as a result of incorrect application of accounting principles for revenue recognition by GXT in connection with licenses of its multi-client seismic survey data. We determined that the revenues from certain GXT multi- client data transactions in 2004 and the first three quarters of 2005 were recognized by GXT upon the signing of customer letter agreements and delivery of the multi-client data, but prior to the receipt from the customer of a signed final master geophysical data license agreement and accompanying license supplement. This accounting error had a material impact on the timing of recognition of reported revenues from certain multi-client data license transactions during 2004 and the first three quarters of 2005. The impact of the financial restatement of 2004’s results of operations reduced revenues and net income for 2004 by approximately $6.7 million and $5.6 million, respectively, and increased our basic and diluted net loss per share by approximately $0.08. For a description of material weakness in our internal control over financial reporting identified at December 31, 2005 and determined to have existed at June 30, 2005, see Item 4. “Controls and Procedures.”

We may experience controls deficiencies or material weakness in the future which could adversely impact the accuracy and timeliness of our future reporting and reports and filings we make with the SEC.

The addition of the GXT business may alienate a number of our traditional seismic contractor customers with whom GXT competes and adversely affect sales to and revenues from those customers.

GXT’s business in processing seismic data competes with a number of our traditional customers that are seismic contractors. Many of these companies not only offer their customers — generally major, independent and national oil companies — the traditional services of conducting seismic surveys, but also the processing and interpretation of the data acquired from those seismic surveys. In that regard, GXT’s processing services directly compete with these contractors’ service offerings and may adversely affect our relationships with them, which could result in reduced sales and revenues from these seismic contractor customers.

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 results 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 4. Controls and Procedures

Disclosure Controls and Procedures. As described in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2005, we assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. The assessment was carried out under the supervision and with the participation of our management, including our principal executive and financial officer, and was based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). This assessment resulted in our management’s identification of three material weaknesses in our internal control over financial reporting:

• Weakness in the design and operation of internal controls relating to monitoring the timing of revenue recognition for license sales of multi-client seismic survey data;

• Weakness in the design and operation of controls to prevent unauthorized purchases by members of our senior management (due to certain fraudulent activities conducted by our former chief information officer); and

• Weakness in our oversight and monitoring controls over financial reporting that resulted from the limited number of experienced personnel on our accounting staff, including the continuing absence of a chief financial officer following the resignation of our prior chief financial officer in December 2005.

Because of these material weaknesses, our management concluded that as of December 31, 2005, we did not maintain effective internal control over financial reporting based on the COSO criteria. In addition, because these material weaknesses were also determined to have existed as of June 30, 2005, our principal executive and principal financial officer, in re-evaluating our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act), as they existed at that date, concluded that our disclosure controls and procedures were not effective as of June 30, 2005 to ensure that the information required to be disclosed by our company in the reports that it files or submits under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

Changes in Internal Control Over Financial Reporting. Since our acquisition of GXT in June 2004, we have made numerous changes to GXT’s internal controls over financial reporting in addition to making changes to certain key finance and accounting personnel at GXT.

As part of our continuous process of reviewing and improving internal control procedures, during the second quarter of 2005 we implemented and enhanced certain internal control procedures regarding GXT’s royalty expense calculations related to its multi-client data library, designed to provide reasonable assurance against any miscalculations of GXT royalty expenses. We replaced two financial and accounting positions at GXT with a new Vice President of Finance and a new Financial Controller at the GXT level. We also enhanced procedures for better segregation and identification of information regarding multi-client survey projects and other projects. In addition, we implemented or enhanced processes for assigning specific responsibilities for the regular review of project terms and management review procedures of the calculations and conclusions made by accounting personnel and modifying and confirming the relevant reports for these projects and preparation of the reports.

As a result of these procedures implemented at GXT during the second quarter of 2005, we identified and determined that $795,000 of GXT royalty expense should have been recorded in the first quarter of 2005 instead of in the second quarter of

2005. However, because the controls in effect at GXT at March 31, 2005 regarding the calculation and recording of GXT royalty expenses did not effectively and timely confirm the accuracy of GXT’s royalty expense calculations, we determined that there was a material weakness in our internal control over financial reporting as of March 31, 2005 regarding the calculation and recording of GXT royalty expenses, as currently defined by the Public Company Accounting Oversight Board. In August 2005, we restated the financial statements included in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005 by filing a Form 10-Q/A Amendment No. 1 to such Form 10-Q to reflect the correction of these errors.

We believe that as a result of certain procedures implemented during the second quarter of 2005 and the hiring of additional accounting personnel as discussed above, the control weakness at GXT related to calculation and recording of its royalty expenses had been remediated by June 30, 2005.

Except for the changes made to GXT’s internal controls and processes as a result of our evaluations of GXT’s internal controls, there were no changes in our internal control over financial reporting during the quarterly period ended June 30, 2005 that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting at the reasonable assurance level.

PART II — OTHER INFORMATION

Item 6. Exhibits

*3.1		Certificate of Amendment to Certificate of Incorporation.

31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a).

31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a).

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. §1350.

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. §1350.

*Previously filed with original report

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	INPUT/OUTPUT, INC.
	By:	/s/ Robert P. Peebler
		Robert P. Peebler
		President and Chief Executive Officer
Date: June 5, 2006

EXHIBIT INDEX


Exhibit No.		Description

*3.1		Certificate of Amendment to Certificate of Incorporation.

31.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a).

31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a).

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. §1350.

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. §1350.


* Previously filed with original report.

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