FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

OR

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

COMMISSION FILE NUMBER 1-12691

INPUT/OUTPUT, INC.

     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: [X] No: [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes: [X] No: [ ]

At April 30, 2004, there were 53,126,054 shares of common stock, par value $0.01 per share, outstanding.

INPUT/OUTPUT, INC. AND SUBSIDIARIES

TABLE OF CONTENTS FOR FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2004

INPUT/OUTPUT, INC. AND SUBSIDIARIES

See accompanying Notes to Unaudited Consolidated Financial Statements.

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INPUT/OUTPUT, INC. AND SUBSIDIARIES

See accompanying Notes to Unaudited Consolidated Financial Statements.

4

INPUT/OUTPUT, INC. AND SUBSIDIARIES

See accompanying Notes to Unaudited Consolidated Financial Statements.

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INPUT/OUTPUT, INC. AND SUBSIDIARIES

(1)

Basis of Presentation

     The consolidated balance sheet of Input/Output, Inc. and its subsidiaries (collectively referred to as the “Company” or “I/O”) at December 31, 2003 has been derived from the Company’s audited consolidated financial statements at that date. The consolidated balance sheet at March 31, 2004, the consolidated statements of operations for the three months ended March 31, 2004 and 2003, and the consolidated statements of cash flows for the three months ended March 31, 2004 and 2003, 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 months ended March 31, 2004 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, 2003 (as amended by Forms 10-K/A). Certain amounts previously reported in the consolidated financial statements have been reclassified to conform to the current period’s presentation.

(2)

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 Statement of Accounting Standards (SFAS) No. 123, net loss, basic loss per share and diluted loss per share for the periods presented would have been increased as follows (in thousands, except per share amounts):

     The above amounts are based on Black-Scholes’ 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 months ended March 31, 2004 and 2003.

(3)

Segment and Geographic Information

     The Company evaluates and reviews results based on three segments (Land Imaging, Marine Imaging, and Processing and Software) 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.

     Prior to December 31, 2003, the Company included Processing and Software (formerly referred to as Processing) within the Land Imaging segment due to its relatively low contribution to the Company’s operations. However, during 2003, as the Company re-evaluated its business strategies, concluding that Processing and Software will be an increasing portion of its business and should be reported as a separate segment. In February 2004, the Company purchased Concept Systems Holdings Limited (Concept) and has included Concept within the Processing and Software segment. See further discussion of the Concept acquisition at Note 14 of Notes to Unaudited Consolidated Financial Statements.

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     A summary of segment information for the three months ended March 31, 2004 and 2003, restated for three months ended March 31, 2003 to reflect the Processing and Software segment, is as follows (in thousands):

     Intersegment sales are insignificant for all periods presented. Corporate assets include all assets specifically related to corporate personnel and operations, a majority of cash and cash equivalents and all facilities that are jointly utilized by segments. Depreciation and amortization expense is allocated to segments based upon use of the underlying assets.

     A summary of net sales by geographic area is as follows (in thousands):

     Net sales are attributed to individual countries on the basis of the ultimate destination of the equipment, if known. If the ultimate

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destination of such equipment is not known, net sales are attributed to the geographical location of initial shipment.

(4)

Accounts and Notes Receivable

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

     Approximately $4.5 million of the Company’s total accounts receivable at March 31, 2004 related to a July 2003 sale of an Image™ land data acquisition system to a customer located in China. This customer had experienced certain reliability issues with the system that the Company is currently working to resolve. The Company expects to be paid in full once all reliability issues have been resolved. Therefore, no allowance has been established for this receivable.

     Notes receivable are collateralized by the products sold, bear interest at contractual rates of up to 12.7% per year and are due at various dates through 2006. The weighted average interest rate at March 31, 2004 was 7.7%. A summary of notes receivable, accrued interest and allowance for loan-loss is as follows (in thousands):

     Approximately $10.6 million of the Company’s total notes receivable at March 31, 2004 related to one customer, a subsidiary of a major Russian energy company. During 2003, this customer became delinquent on approximately $0.8 million of its scheduled principal and interest payments, in addition to becoming delinquent on $1.8 million of its trade receivables. In January 2004, the Company refinanced the delinquent portion of its notes and trade receivables into a new note totaling $2.6 million, with payments due in equal installments over a twelve-month period. Based on the Company’s internal credit review and meetings with the customer and its parent company, the Company expects the customer will pay all of its obligations in full and, therefore, no allowance has been established for these receivables.

(5)

Inventories

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

     For the three months ended March 31, 2003, inventory of approximately $0.2 million was written off and included within research and development expenses. This write-off relates to the cancellation of the solid streamer project within the Marine Imaging segment. See further discussion at Note 10 of Notes to Unaudited Consolidated Financial Statements. In addition, an unrelated inventory obsolescence charge of $0.3 million was reflected in cost of sales related to the closure of the Company’s Alvin, Texas manufacturing facility.

     In October 2003, the Company purchased certain marine equipment for $3.2 million for an anticipated sale to one customer. However, this potential customer ceased negotiations after it failed to be awarded an expected survey. For the three months ended March 31, 2004, the Company entered into a lease agreement for approximately $0.6 million of costs for this equipment. As of March

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31, 2004, approximately $1.8 million of this equipment remained available for sale by the Company, and the Company expects to sell the equipment in 2004.

     As part of the Company’s business plan, the Company is increasing the use of contract manufacturers as an alternative to in-house manufacturing. Under a few 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, the Company’s outsourcer has the right to require the Company to purchase inventory which the outsourcer had purchased on the Company’s behalf. However, since the Company now typically issues purchase orders to the Company’s outsourcers based upon its short-term forecast (usually three months or less), the Company has reduced the risk that it may be required to purchase inventory that it may never utilize.

(6)

Net Assets Held For Sale

     In July 2003, the Company completed the closure of its Alvin, Texas manufacturing facility and is currently marketing the facility for sale. At March 31, 2004, the facility and related land had a net carrying value of $2.4 million and has been reclassified as “Held for Sale” under the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. In January 2004, the Company completed the sale of 16.75 acres of land owned by it located across from its headquarters in Stafford, Texas, receiving net proceeds of $1.5 million, resulting in a gain on the sale of $0.6 million.

(7)

Non-Cash Activity

     During the first quarter of 2004, the Company acquired Concept. As part of the consideration, the Company issued 1,680,000 of its common shares. See further discussion at Note 14 of Notes to Unaudited Consolidated Financial Statements. During the three months ended March 31, 2004 and 2003, the Company transferred $2.6 million and $1.9 million, respectively, of inventory at cost to rental equipment in connection with certain leasing arrangements.

(8)

Loss per Common Share

     Basic loss per common share is computed by dividing net loss applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted 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 March 31, 2004 and 2003 were 5,719,131 and 4,488,325, respectively. In December 2003, the Company issued $60.0 million of notes convertible into its common stock at a conversion rate 231.4815 shares per $1,000 principal amount of notes (a conversion price of $4.32), which represents 13,888,888 total common shares. Basic and diluted loss per share are the same for the three months ended March 31, 2004 and 2003, as all potential common shares were anti-dilutive.

(9)

Notes Payable, Long Term Debt and Lease Obligations

     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 per annum 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), which represents 13,888,888 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.

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     In May 2003, the Company financed $0.5 million of insurance costs through the execution of a short-term note payable. The principal and interest on the note were due on a monthly basis and bore interest at a rate of 5.75% per annum with final payment made in February 2004. In August 2003, the Company financed an additional $1.4 million of insurance costs with similar terms except final payment is due in May 2004. The unpaid balance under this note payable at March 31, 2004 was $0.3 million.

      In August 2002, in connection with the repurchase of its Series B Preferred Stock, the Company issued a $31.0 million unsecured promissory note due May 7, 2004, which bore interest at 8% per year until May 7, 2003, at which time the interest rate increased to 13% per annum. Interest was payable in quarterly payments, with all principal and unpaid interest due on May 7, 2004. The Company recorded interest on this note at an effective rate of approximately 11% per year over the life of the note. In May 2003, the Company repaid $15.0 million of the note and in December 2003, the Company repaid, in full, the remaining outstanding principal balance of $16.0 million plus accrued interest. The note terms had restricted cash dividends on shares of Company common stock in excess of $5.0 million per year while the note was outstanding.

     In July 2002, in connection with the acquisition of AXIS, the Company entered into a $2.5 million three-year unsecured promissory note payable to the former shareholders of AXIS, bearing interest at 4.34% per year. Principal was payable in quarterly payments of $0.2 million plus interest, with final payment due in July 2005. The unpaid balance at March 31, 2004 was $1.3 million.

     In August 2001, the Company sold its corporate headquarters and manufacturing facility located in Stafford, Texas for $21.0 million. Simultaneously with the sale, the Company entered into a non-cancelable lease with the purchaser of the property. The lease has a twelve-year term with three consecutive options to extend the lease for five years each. The Company has no purchase option under the lease. As a result of the lease terms, the commitment was recorded as a twelve-year, $21.0 million lease obligation with an implicit interest rate of 9.1% per annum. The unpaid balance at March 31, 2004 was $18.6 million. The Company paid $1.7 million in commissions and professional fees, which have been recorded as deferred financing costs and are being amortized over the twelve-year term of the lease obligation. At June 30, 2003, the Company failed to meet the tangible net worth requirement under this lease. Therefore, in the third quarter of 2003, the Company provided a letter of credit to the landlord of the property in the amount of $1.5 million. To secure the issuance of the letter of credit, the Company was required to deposit $1.5 million with the issuing bank. This letter of credit will remain outstanding until the Company is back in compliance with the tangible net worth requirement for eight consecutive quarters, or until the expiration of the eighth year of the lease in 2009. The deposit has been classified as a long-term other asset.

     A summary of future principal obligations under the notes payable and lease obligations is as follows (in thousands):

(10)

Impairment of Long-Lived Assets

     During the first quarter of 2003, the Company initiated an evaluation of its solid streamer project and concluded it would no longer internally pursue this product for commercial development. In conjunction with this evaluation, certain fixed assets and patented technology within the Marine Imaging segment were deemed impaired in accordance with SFAS No. 144. As a result, fixed assets of $0.5 million and intangible assets of $0.6 million were considered impaired and written off as a charge against earnings. In addition, inventory associated with this project of approximately $0.2 million was written off and included within research and development expenses at March 31, 2003.

(11)

Investment in Energy Virtual Partners, Inc.

     In April 2003, the Company invested $3.0 million in Series B Preferred securities of Energy Virtual Partners, Inc. (EVP) for 22% of the outstanding ownership interests and 12% of the outstanding voting interests. EVP provided asset management services to large oil and gas companies to enhance the value of their oil and gas properties. This investment was accounted for under the cost method for

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investment accounting. Robert P. Peebler, the Company’s President and Chief Executive Officer, founded EVP in April 2001 and served as EVP’s President and Chief Executive Officer until joining I/O in March 2003.

     During the second quarter of 2003, EVP failed to close two anticipated asset management agreements, which resulted in EVP’s management re-evaluating its business model and adequacy of capital. During August 2003, the board of directors of EVP voted to liquidate EVP. For that reason, in the second quarter of 2003, the Company wrote its investment down to its approximate liquidation value of $1.0 million. Mr. Peebler offered, and the Company agreed, that all proceeds Mr. Peebler received from the liquidation of EVP were to be paid to the Company. In December 2003, the Company received a portion of its final liquidation payment of $0.7 million from EVP and $0.1 million from Mr. Peebler. In March 2004, the Company received final liquidation payments of $0.1 million from EVP and $0.01 million from Mr. Peebler.

(12)

Deferred Income Tax

     In 2002, the Company established an additional valuation allowance to reserve for substantially all of its net deferred tax assets. Subsequent to that date the Company has continued to record a valuation allowance for its net deferred assets, which are primarily net operating loss carryforwards. 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. At March 31, 2004 and 2003, the unreserved deferred income tax asset of $1.1 million represents the Company’s prior alternative minimum tax payments that are recoverable through the carryback of net operating losses. Income tax expense of $0.6 million and $0.6 million for the three months ended March 31, 2004 and 2003, respectively, reflects state and foreign taxes.

     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 substantially all of its net deferred tax assets and will continue until there is sufficient positive evidence to warrant reversal.

(13)

Comprehensive Loss

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

(14)

Acquisitions

     In February 2004, the Company purchased all the share capital of Concept. Concept is a provider of software, systems and services for towed streamer, seabed and land seismic operations based in Edinburgh, Scotland. The purchase price was approximately $38.4 million in cash, including acquisition costs, and 1,680,000 shares of the Company’s common stock, valued at $10.8 million. The Company issued to certain key employees options to purchase up to 365,000 shares of its common stock for an exercise price of $6.42 per share. The options vest over a four-year period. The Company acquired Concept as part of its strategy to develop solutions that integrate complex data streams from multiple seismic sub-systems, including source, source control, positioning, and recording in all environments, including land, towed streamer, and seabed acquisition.

     The acquisition was accounted for by the purchase method, with the purchase price allocated to the fair value of assets purchased and liabilities assumed. As of March 31, 2004, the allocation of the purchase price was based upon a preliminary fair value study, which will be finalized in the second quarter of 2004. The allocation of the purchase price, including related direct costs, for the acquisition of Concept is as follows (in thousands):

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     The consolidated results of operations of the Company include the results of Concept from the date of acquisition. Pro forma results prior to the acquisition date were not material to the Company’s consolidated results of operations.

(15)

Restructuring Activities

     A summary of the Company’s restructuring programs is as follows (in thousands):

     In January 2004, the Company announced the consolidation of three operating units with its Land Imaging segment into one division and in April 2004, consolidated two operating units of its Marine Imaging segment into one division. These consolidations are expected to eliminate approximately twenty full-time positions resulting in approximate severance charges of $0.4 million in the second and third quarter of 2004.

(16)

Commitments and Contingencies

     Legal Matters: The Company has been named in various lawsuits or threatened actions that are incidental to its ordinary business. While the final resolution of these matters may have an impact on its consolidated financial results for a particular reporting period, the Company believes that the ultimate resolution of these matters will not have a material adverse impact on its financial position or liquidity.

     Product Warranty Liabilities: The Company warrants that all manufactured equipment will be free from defects in workmanship, materials and parts. Warranty periods range from 90 days to three years from the date of original purchase, depending on the product. The Company provides for estimated warranty 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). A summary of warranty activity is as follows (in thousands):

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(17)

Recent Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board (FASB) issued FIN No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”. The primary objective of the interpretation is to provide guidance on the identification of and financial reporting for entities over which control is achieved through means other than voting rights; such entities are known as variable-interest entities (VIEs). FIN No. 46 provides guidance that determines (a) whether consolidation is required under the “controlling financial interest” model of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” or other existing authoritative guidance, or, alternatively, (b) whether the variable-interest model under FIN No. 46 should be used to account for existing and new entities. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (FIN 46-R) resulting in multiple effective dates based on the nature as well as creation date of the VIE. FIN No. 46, as revised, did not have an impact on the Company’s results of operations or financial position.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this statement had no initial impact on the Company’s results of operations or financial position.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires a financial instrument within its scope to be classified as a liability. It is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. These effective dates are not applicable to the provisions of paragraphs 9 and 10 of SFAS 150 as they apply to mandatorily redeemable non-controlling interests, as the FASB has delayed these provisions indefinitely. The adoption of this statement had no initial impact on the Company’s results of operations or financial position.

     In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition”, which supersedes SAB No. 101, “Revenue Recognition in Financial Statements.” SAB No. 104’s primary purpose is to rescind accounting guidance contained in SAB No. 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” While the wording of SAB No. 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB No. 101 remain largely unchanged by the issuance of SAB No. 104. The impact of SAB No. 104 did not have a material effect on the Company’s results of operations or financial position.

(18)  Subsequent Event

     The Company has entered into a stock purchase agreement with GX Technology Corporation (GXT) and its shareholders to acquire all of the equity interest of GXT for approximately $150 million. The Company has agreed to pay the purchase price through a combination of cash and stock option value to acquire GXT. The $150 million purchase price includes the assumption of $4.5 million in debt and the delivery of I/O stock options with a value of approximately $15.5 million. The transaction contemplates the completion of an offering of I/O common stock and a new senior bank facility, all expected to be completed within the next 45 to 60 days. Refer to the Company’s Registration Statement on Form S-3 filed with the SEC on May 10, 2004.

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

Executive Summary

     Our traditional business segments have involved the manufacture and sale of land, marine and transition zone seismic instrumentation for oil and gas exploration and production. In recent years, we have changed our overall focus toward being a provider of seismic acquisition imaging technology for exploration, production and reservoir monitoring in land and marine, including shallow water and marsh, environments. The relatively low level of traditional seismic activity has presented for the past number of years, and continues to present, a challenging environment for companies involved in the seismic industry. This environment, along with product life cycle developments affecting our traditional product lines, have been the principal factors affecting our results of operations in recent years.

     However, positive trends for our business include:

	•		The increasing worldwide demand for hydrocarbons,
	•		The increasing use of seismic products by oil companies to enhance production from their existing reserves,
	•		The increasing needs of exploration and production companies for seismic surveys that are custom-designed to meet particular geological formation characteristics, and
	•		The increasing need for more sophisticated information tools to monitor and assess new and producing oil and gas reservoirs.

     Our strategy involves repositioning our company as a seismic imaging company, providing both equipment and services across a broader spectrum of the seismic technology industry than merely an equipment manufacture and sales company. The advantages of our products and services that incorporate full-wave digital imaging capabilities will, we believe, ultimately drive the demand for new survey designs and associated processing and interpretive skills. We believe that our products that digitally monitor seismic characteristics of reservoirs will reduce the costs of performing multiple seismic surveys over the same areas, thereby reducing overall seismic costs for operators and owners of the reserves.

     However, executing our strategic plan is not without risk. Industry fundamentals, while improving, remain weak by historical standards. In December 2003, we successfully refinanced substantially all of our existing short-term indebtedness with the proceeds from our convertible notes offering. As of March 31, 2004, our total outstanding indebtedness was $80.2 million.

     Our cash needs are anticipated to increase in 2004. We have typically financed our operations from internally generated cash and funds from equity and debt financings. With our higher debt burden, our interest expense increased for the three months ended March 31, 2004 compared to the three months ended March 31, 2003. We will continue to need funds to complete the research, development and testing of our products and services. During the three months ended March 31, 2004, net cash used in operations was $1.7 million.

     Our ability to produce positive operating cash flows, return to consistent profitability, grow our business and service and retire our debt (in addition to our other obligations) will depend on the success of our efforts in increasing our revenues from sales of our seismic imaging systems and equipment and our processing services, successfully introducing and continuing to technologically enhance our product line and service offerings, penetrating new markets for our seismic products and services, achieving more consistency in our period-to-period results of operations, improving margins on our sales and reducing our overall costs.

     We have traditionally relied on a relatively small number of significant customers; consequently, our business is exposed to risks related to customer concentration. In recent years, our traditional customers have been rapidly consolidating, shrinking the demand for our products. The loss of any of our significant customers or deterioration in our relations with any of them could materially and

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adversely affect our results of operations and financial condition. The fact that such a high percentage of our sales currently are made to foreign destinations and customers presents additional issues for our revenues and cash flows. We continue to see expansion from Chinese and Eastern European seismic contractors, and we plan to expand our presence internationally. As a result of these factors, the collections cycle for our sales in 2004 may be longer than it has traditionally been, which would thereby increase our working capital funding needs.

     While we anticipate an increase in worldwide seismic activity in 2004, this anticipated increase may not materialize. As a result, our internal revenue forecast may not be realized, resulting in lower cash flows available for our future capital and operational needs. In order to meet our future capital requirements, we may need to issue additional debt or equity securities. We cannot assure you that we would be able to issue additional debt or equity securities in the future on terms that would be acceptable to us, or at all.

     Through our manufacturing outsourcing activities, we have sought to reduce both the unit cost of our products and our fixed cost structure, as well as to accelerate our research and development cycle for non-core technologies. For example, in July 2003, we closed our Alvin, Texas manufacturing facility. Additionally, we closed our Norwich, U.K. geophone stringing operation in the first quarter of 2003, and moved its operations to our leased facility in Dubai, as well as outsourced other manufacturing activities to various partners. In January 2004, we consolidated three operating units of our Land Imaging segment into one division and in April 2004, we consolidated two operating units of our Marine Imaging segment into one division. We will continue to work to reduce the unit costs of our products.

Acquisition of Concept

     In February 2004, we purchased all of the share capital of Concept Systems Holdings Limited (Concept), a provider of software, systems and services for towed streamer, seabed and land seismic operations based in Edinburgh, Scotland, in a privately negotiated transaction. The purchase price was approximately $38.4 million cash, including acquisition costs, and 1,680,000 shares of our common stock. The source of the cash component of the consideration paid was from the December 2003 sale of our convertible senior notes and from general corporate funds. Under a registration rights agreement, we granted certain demand and piggyback registration rights for the shares of stock issued in the acquisition transaction.

Planned Acquisition of GXT Technology Corporation

     We have entered into a stock purchase agreement with GX Technology Corporation (GXT) and its shareholders to acquire all of the equity interest of GXT for approximately $150 million. We have agreed to pay the purchase price through a combination of cash and stock option value to acquire GXT. The $150 million purchase price includes the assumption of $4.5 million in debt and the delivery of I/O stock options with a value of approximately $15.5 million. The transaction contemplates the completion of an offering of I/O common stock and a new senior bank facility, all expected to be completed within the next 45 to 60 days. Refer to our Registration Statement on Form S-3 filed with the SEC on May 10, 2004.

Results of Operations

     Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

     Net Sales: Net sales of $36.3 million for the three months ended March 31, 2004 decreased $4.9 million, or 12%, compared to the corresponding period last year. Land Imaging’s net sales decreased $10.1 million, or 32%, to $21.0 million compared to $31.1 million in the corresponding period of last year. The decrease was mainly due to vibrator vehicle sales being shifted out of the first quarter of 2004 into the second and third quarter of 2004 because of supply chain management issues and product transition from our mature Image land data acquisition to our new System Four Analog Cable system, which is scheduled for introduction in the second quarter of 2004. Marine Imaging’s net sales increased $2.9 million, or 34%, to $11.5 million compared to $8.6 million in the corresponding period last year. The increase was due to the first sale of our VectorSeis® Ocean-Bottom acquisition system of $3.1 million, which represents a new technology for seismic imaging directly from the seabed floor. The Processing and Software (formerly referred to as Processing) segment’s net sales increased $2.3 million to $3.8 million compared to $1.5 million in the corresponding period last year. The increase is due to the acquisition of Concept (acquired in February 2004), which contributed $2.3 million to our net sales. See further discussion of the acquisition of Concept at Note 14 of Notes to Unaudited Consolidated Financial Statements.

     Cost of Sales: Cost of sales of $24.0 million for the three months ended March 31, 2004 decreased $8.7 million, or 27%, compared to the corresponding period last year. Cost of sales for Land Imaging, Marine Imaging and Processing and Software was $16.0 million, $6.7 million and $1.3 million, respectively. Costs of sales decreased primarily as a result of a decrease in sales activity in Land Imaging. Included in costs of sales for the three months ended March 31, 2003 was $0.3 million of severance costs; there was no corresponding charge for the three months ended March 31, 2004.

     Gross Profit and Gross Profit Percentage: Gross profit of $12.3 million for the three months ended March 31, 2004 increased $3.8 million, or 45%, compared to the corresponding period last year. Gross profit percentage for the three months ended March 31, 2004 was 34% compared to 21% in the prior year. The improvement in gross profit was driven mainly by the contribution from Concept, the sale of new products within our Marine Imaging segment, such as our VectorSeis Ocean-Bottom system, in addition to follow-on sales of VectorSeis System Four® land acquisition systems by our Land Imaging segment. Also, the decrease in sale volumes of our lower

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margin vibrator vehicles had a positive impact to our total gross margin percentage. In the first quarter of 2003, we delivered our first VectorSeis System Four acquisition radio-based system, which resulted in lower margins primarily because of a low introductory price.

     Research and Development: Research and development expense of $4.1 million for the three months ended March 31, 2004 decreased $1.4 million, or 26%, compared to the corresponding period last year. This decrease primarily reflects lower prototype expenses and the cancellation of our solid streamer project. In the second quarter of 2003, we entered into the commercial phase of our VectorSeis System Four land acquisition cable-based system project; this reduced our prototype expenses for the quarter ended March 31, 2004 compared to the quarter ended March 31, 2003. Also, as discussed further at Note 10 of Notes to Unaudited Consolidated Financial Statements, we incurred a charge of $0.2 million during the three months ended March 31, 2003 related to the write-down of inventory associated with our cancelled solid streamer project; there was no corresponding charge for the three months ended March 31, 2004.

     Marketing and Sales: Marketing and sales expense of $3.3 million for the three months ended March 31, 2004 increased $0.5 million, or 17%, compared to the corresponding period last year. The increase is primarily related to expanding our sales force within China and Russia. In 2002, we opened our sales representative office in Beijing, China, and we further expanded our personnel and travel to the region throughout 2003 and the first quarter of 2004. In addition, in the first quarter of 2004, we opened a new sales representative office in Moscow, Russia.

     General and Administrative: General and administrative expense of $4.7 million for the three months ended March 31, 2004 increased $0.6 million, or 15%, compared to the corresponding period last year. The increase in general and administrative expense is primarily attributable to an increase in professional fees associated with the Company’s continued implementation efforts to comply with the new rules and regulations of Sarbanes-Oxley, in addition to an increase in legal fees associated with various on-going legal matters in our ordinary course of business. Also, a portion of this increase is due to the acquisition of Concept in February 2004.

     Gain on Sale of Assets: Gain on sale of assets of $0.9 million for the three months ended March 31, 2004 primarily related to the sale of land across from our headquarters in Stafford, Texas.

     Impairment of Long-Lived Assets: Impairment of long-lived assets of $1.1 million for the three months ended March 31, 2003 related to the cancellation of our solid streamer project within Marine Imaging. There was no corresponding charge during the three months ended March 31, 2004. See further discussion of this impairment at Note 10 of Notes to Unaudited Consolidated Financial Statements.

     Net Interest and Other Expense: Total net interest and other expense of $1.0 million for the three months ended March 31, 2004 increased $0.5 million compared to the corresponding period last year. The increase is primarily due to an increase in interest expense of $0.2 million, largely because of the issuance of $60.0 million of our convertible senior notes, which was partially offset by the payment of our debt owed to SCF-IV L.P. These convertible notes were issued in December 2003 and bear interest at an annual rate of 5.5%, payable semi-annually.

     Fair Value Adjustment of Warrant Obligation: The fair value adjustment of warrant obligation totaling $0.9 million was due to a change in the fair value between January 1, 2003 and March 31, 2003 of our previously outstanding common stock warrant. No comparable adjustment was recorded in the first quarter of 2004 because this warrant was exchanged for 125,000 shares of our common stock in December 2003.

     Income Tax Expense: Income tax expense for the three months ended March 31, 2004 was $0.6 million compared to $0.6 million for three months ended March 31, 2003. Income tax expense for the three months ended March 31, 2004 and 2003, reflected state and foreign taxes, as we continue to maintain a valuation allowance for substantially all of our net deferred tax assets.

Liquidity and Capital Resources

     In December 2003, we issued $60.0 million of 5.5% convertible senior notes due in 2008. A majority of the proceeds was used to pay the $16.0 million remaining outstanding debt owed to SCF-IV L.P. in December 2003 and to acquire Concept for $38.4 million in cash, including acquisition costs, in February 2004. See “Acquisition of Concept” above. We became significantly more leveraged after the consummation of the offering. As a result, our interest expense increased during the three months ended March 31, 2004, compared to the corresponding period last year. Our ability to make scheduled payments of principal or interest on, or to refinance, our indebtedness will depend on our future business performance, which is subject to many economic, financial, competitive and other factors beyond our control.

     We plan to seek a revolving line of credit to support our working capital requirements. We can give no assurances as to whether a line of credit will be obtained, and if so, whether the terms of such a line of credit will be advantageous to us, or if the amounts available for borrowing will be sufficient for our purposes.

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     Based upon our management’s internal revenue forecast, our liquidity requirements in the near term and our projected increase in seismic activity (primarily outside of North America), we believe that the combination of our projected internally generated cash and our working capital (including cash and cash equivalents on hand) will be adequate to meet our anticipated capital and liquidity requirements for the next twelve months. We also anticipate that a larger percentage of our future sales for 2004 and beyond will be to foreign customers, particularly those in China and the Commonwealth of Independent States (CIS). As a result of this change in customer mix, our collections cycle may be longer than we have traditionally experienced.

Cash Flow from Operations

     We have traditionally financed operations from internally generated cash and funds from equity and debt financings. Cash and cash equivalents were $25.0 million at March 31, 2004, a decrease of $34.5 million, or 58%, compared to December 31, 2003. Net cash used in operating activities was $1.7 million for the three months ended March 31, 2004, compared to cash used in operating activities of $18.7 million for the three months ended March 31, 2003. The amount of net cash used in our operating activities for the three months ended March 31, 2004 was due to an increase in data acquisition systems inventory within our Land Imaging segment that is scheduled to be delivered to customers in the second quarter of 2004.

Cash Flow from Investing Activities

     Net cash flow used in investing activities was $31.7 million for the three months ended March 31, 2004, compared to $1.3 million for the three months ended March 31, 2003. The principal investing activity was related to our purchase of Concept in February 2004 for $38.4 million of cash, including acquisition costs, and 1,680,000 of our common shares. See further discussion of the Concept acquisition at Note 14 of Notes to Unaudited Consolidated Financial Statements. During the three months ended March 31, 2004, we sold excess property and equipment for net proceeds of $1.5 million, a majority of which related to land located across from our headquarters in Stafford, Texas, and we received full payment on a $5.8 million note receivable that related to the sale of a subsidiary in 1999. We purchased $0.7 million of equipment during the three months ended March 31, 2004 and expect to spend an additional $5.0 million for equipment and other capital expenditures through the remainder of 2004.

Cash Flow from Financing Activities

     Net cash flow used in financing activities was $0.9 million for the three months ended March 31, 2004, compared to $0.6 million of cash used in financing activities for the three months ended March 31, 2003. The cash flow used in financing activities primarily related to scheduled payments of $1.0 million on our notes payable.

Critical Accounting Policies

     Please refer to the Company’s Annual Report on Form 10-K (as amended by Forms 10-K/A) for the year ended December 31, 2003 for a complete discussion of the Company’s critical accounting policies and estimates. There have been no material changes in the current period regarding these critical accounting policies and estimates.

Credit Risk

     Currently, our principal customers are 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. In addition, we market and sell products and services to oil and gas companies. For the three months ended March 31, 2004, BGP, an international seismic contractor and subsidiary of the China Petroleum Corporation, accounted for approximately 13% of our consolidated net sales,

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compared to 28% for the entire year of 2003. The loss of BGP as a customer or deterioration in our relationship with them could have a material adverse effect on our results of operations and financial condition.

     Approximately $10.6 million of our total notes receivable at March 31, 2004 related to one customer, a subsidiary of a major Russian energy company. During 2003, this customer became delinquent on approximately $0.8 million of its scheduled principal and interest payments, in addition to becoming delinquent on $1.8 million of its trade receivables. In January 2004, we refinanced the delinquent portion of its notes and trade receivables into a new note totaling $2.6 million, with payments due in equal installments over a twelve-month period. Based on our internal credit review and meetings with the customer and its parent company, we expect the customer will pay all of its obligations in full and, therefore, no allowance has been established for these receivables.

     During the three months ended March 31, 2004, we recognized $3.4 million of sales to customers in the CIS, $0.9 million of sales to customers in Latin American countries, $12.0 million of sales to customers in Europe and $8.0 million of sales to customers in Asia. 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, as well as devaluations of their currencies. A continuation of weak demand for the services provided by certain of our customers will further strain their revenues and cash resources, thereby resulting in a higher likelihood of defaults in the timely payment of their obligations to us under our credit sales arrangements. Increased levels of payment defaults by our customers with respect to our credit sales arrangements could have a material adverse effect on our results of operations. 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. See “ — Risk Factors — Significant payment defaults under extended financing arrangements could adversely affect us.”

Risk Factors

     This report contains 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:

	•		our expected revenues, operating profit and net income;
	•		future growth rates and margins for certain of our products and services;
	•		our future acquisitions and levels of capital expenditures;
	•		the adequacy of our future liquidity and capital resources;
	•		anticipated timing and success of commercialization and capabilities of products and services under development;
	•		savings we expect to achieve from our restructuring activities;
	•		future demand for seismic equipment and services;
	•		future seismic industry fundamentals;
	•		future oil and gas commodity prices;
	•		future worldwide economic conditions;
	•		our expectations regarding future mix of business and future asset recoveries;
	•		our expectations regarding realization of deferred tax assets;
	•		our beliefs regarding accounting estimates we make;
	•		the result of pending or threatened disputes and other contingencies; and

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•

our proposed strategic alliances.

     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:

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.

     System reliability is an important competitive consideration for seismic data acquisition systems. Even though we attempt to assure that our systems are always reliable in the field, the many technical variables related to operations can cause a combination of factors that can and have, from time to time, caused service issues with our analog products. If our customers believe that our analog products have reliability issues, then those customers may delay acceptance of our new products and reduce demand for our analog products. Our business, our results of operations and our financial condition, therefore, may be materially and adversely affected.

     While we believe that our new VectorSeis System Four land data acquisition system has made significant improvements in both field troubleshooting and reliability compared to our legacy systems, products as complex as this system, however, sometimes contain undetected errors or bugs when first introduced. Despite our testing program, these undetected errors may not be discovered until the product is purchased and used by a customer. If our customers deploy our new products and they do not work correctly, our relationship with our customers may be materially and adversely affected. Errors may be found in future releases of our products, and these errors could impair the market acceptance of our products. If our customers do not accept our new products as rapidly as we anticipate, our business, our results of operations and our financial condition may be materially and adversely affected.

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

     We rely on a relatively small number of significant customers. Consequently, our business is exposed to the risks related to customer concentration. For the three months ended March 31, 2004, BGP accounted for approximately 13% of our consolidated net sales compared to 28% for the entire year of 2003. The loss of any of our significant customers or a deterioration in our relations with any of them could materially and adversely affect our results of operations and financial condition.

Our past business reorganization and facilities closure actions may not yield the benefits we expect and could harm our financial condition, reputation and prospects.

     We have significantly reduced our corporate and operational headcount, closed certain manufacturing facilities and combined certain of our business units. These activities may not yield the benefits we expect, and may raise product costs, delay product production, result in labor disruptions and labor-related legal actions against us, or create inefficiencies in our business. In addition, if the markets for our products do not improve, we will take additional restructuring actions to address these market conditions. Any such additional actions could result in additional restructuring charges.

If we fail to implement our business strategy, our financial condition and results of operations could be materially and adversely affected.

     Our future financial performance and success are dependent in large part upon our ability to successfully implement our business strategy to introduce new seismic technologies, and to reduce costs through outsourcing manufacturing and certain research and development activities. We cannot assure you that we will be able to successfully implement our business strategy or be able to improve our operating results. In particular, we cannot assure you that we will be able to stimulate sufficient demand for our VectorSeis products, our AZIM processing services or our traditional analog product line, to execute our growth strategy (including acquisitions) or to sufficiently reduce our costs to achieve required efficiencies. Our strategic direction also may give rise to

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unforeseen costs, which could wholly or partially offset any expense reductions or other financial benefits we attain as a result of the changes to our business.

     We are in the process of evaluating and may, from time to time in the future, evaluate the acquisition of assets or operations that complement our existing businesses. We cannot estimate what impact, if any, our acquisition of these assets or operations may have on our business.

     Furthermore, we cannot assure you that we will be successful in our acquisition efforts or that we will be able to effectively manage expanded or acquired operations. Our ability to achieve our acquisition or expansion objectives and to effectively manage our growth depends on a number of factors, including:

	•		our ability to identify appropriate acquisition targets and to negotiate acceptable terms for their acquisition;
	•		our ability to integrate new businesses into our operations; and
	•		the availability of capital on acceptable terms.

     Our business strategy may require additional funding, which may be provided in the form of additional debt, equity financing or a combination thereof. We cannot assure you that we will be able to obtain this financing, and if so, on advantageous terms and conditions.

     Implementation of our business strategy could be affected by a number of factors beyond our control, such as increased competition, general economic conditions or increased operating costs. Any failure to successfully implement our business strategy could materially and adversely affect our financial condition and results of operations. We may, in addition, decide to alter or discontinue certain aspects of our business strategy at any time.

Technologies and businesses that we 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 intend to focus on acquisitions that complement our technologies and our general business strategy, there can be no assurance that we will be successful in locating such acquisitions or that any completed acquisition will achieve the expected benefit.

     In addition, an acquisition may result in unexpected costs, expenses and liabilities. For example, during 2002, we acquired certain assets of S/N Technologies and, in April 2003, we invested $3.0 million in EVP. These transactions were not successful, therefore in 2002, we completely wrote down the costs of the assets we purchased from S/N Technologies and wrote down our investment in Energy Virtual Partners to its liquidation value of $1.0 million.

     Our ability to achieve our expansion and acquisition objectives will also depend on the availability of capital on acceptable terms. Our combined businesses resulting from any acquisitions may not be able to generate sufficient operating cash flows in order for us to obtain additional financing or fund our acquisition strategy.

     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;
	•		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;

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

     The identification of suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be able to successfully complete identified potential acquisitions. Integration of acquired businesses require 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, including Concept, our future results will be negatively impacted.

     Acquisitions may also result in the issuance of dilutive equity securities, the incurrence or assumption of debt and additional expenses associated with the amortization of acquired intangible assets. There is no assurance that past or future acquisitions will generate additional income, cash flows or provide any benefit to our business.

We have developed 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. If, in implementing this 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.

The current oversupply of seismic data and downward pricing pressures has adversely affected our operations and significantly reduced our operating margins and income and may continue to do so in the future.

     The current industry-wide oversupply of speculative surveys conducted and collected by geophysical contractors, and their practice of lowering prices to their customers for these surveys in order to recover investments in assets used to conduct 3-D surveys, have in recent years adversely affected our results of operations and financial condition. Particularly during periods of reduced levels of exploration for oil and gas, the oversupply of seismic data and downward pricing pressures limit our ability to meet sales objectives and maintain profit margins for our products and sustain growth of our business. These industry conditions have reduced, and if continued into the future, will reduce, our revenues and operating margins.

Oil and gas companies and geophysical contractors will reduce demand for our products and services if the level of exploration expenditures continues to remain relatively low.

     Historically, demand for our products has been sensitive to the level of exploration spending by oil and gas companies and geophysical contractors. Exploration expenditures have tended in the past to follow trends in the price of oil and gas, which have fluctuated widely in recent years in response to relatively minor changes in supply and demand for oil and gas, market uncertainty and a variety of other factors beyond our control. Prolonged reductions in oil and gas prices will generally depress the level of exploration activity and correspondingly depress demand for our products and services. A prolonged downturn in market demand for our products or services will have a material adverse effect on our results of operations and financial condition. Additionally, we cannot assure you

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that increases in oil and gas prices will increase demand for our products and services or otherwise have a positive effect on our results of operations or financial condition.

     Factors affecting the prices of oil and gas include:

	•		level of demand for oil and gas;
	•		worldwide political, military and economic conditions, including the ability of the Organization of Petroleum Exporting Countries (OPEC) to set and maintain production levels and prices for oil;
	•		level of oil and gas production;
	•		government policies regarding the exploration for, and production and development of, oil and gas reserves in their jurisdictions; and
	•		global weather conditions.

     The markets for oil and gas historically have been volatile and are likely to continue to be so in the future.

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 80% of our consolidated net sales for the three months ended March 31, 2004, 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;
	•		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 increasing risk that our collections cycle will further lengthen as we anticipate a larger percentage of our sales will be 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.

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The rapid pace of technological change in the seismic industry requires us to make substantial research and development expenditures and could make our products obsolete.

     The markets for our products are characterized by rapidly changing technology and frequent 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, 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.

Competition from sellers of seismic data acquisition systems and equipment is intensifying and could adversely affect our results of operations and financial condition.

     Our industry is highly competitive. Our competitors have been consolidating into better-financed companies with broader product lines. Certain of our competitors are affiliated with seismic contractors, which forecloses a portion of the market to us. Some of our competitors have greater name recognition, more extensive engineering, manufacturing and marketing capabilities, and greater financial, technical and personnel resources than those available to us. Our ability to compete effectively in the manufacture and sale of seismic instruments and data acquisition systems depends principally upon continued technological innovation, as well as our reputation for quality, our ability to deliver on schedule and price.

     Our competitors have expanded or improved their product lines, which has adversely affected our results of operations. One competitor has introduced a lightweight land seismic system that we believe has made our current land system more difficult to sell at acceptable margins. In addition, another competitor introduced a marine solid streamer product that competes with our oil-filled towed streamer product. Streamers are towed behind marine vessels to acquire seismic data in marine environments and can either be solid or oil-filled. Our net sales of marine streamers have been, and will continue to be, adversely affected by customer preferences for solid products. In May 2003, we decided to cancel our internal project to develop a solid streamer product.

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 customers have been rapidly consolidating, shrinking 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.

Large fluctuations in our sales and gross margins can result in operating losses.

     As our products are technologically complex, we experience a very long sales cycle. In addition, the revenues from any particular sale can vary greatly from our expectations due to changes in customer requirements. These factors create substantial fluctuations in our net sales from period to period. Variability in our gross margins compound the uncertainty associated with our sales cycle. Our gross margins are affected by the following factors:

	•		pricing pressures from our customers and competitors;
	•		product mix sold in a period;
	•		inventory obsolescence;
	•		unpredictability of warranty costs;
	•		changes in sales and distribution channels;
	•		availability and pricing of raw materials and purchased components; and
	•		absorption of manufacturing costs through volume production.

     We must establish our expenditure levels for product development, sales and marketing and other operating expenses based, in large part, on our forecasted net sales and gross margins. As a result, if net sales or gross margins fall below our forecasted expectations, our operating results and financial condition are likely to be adversely affected because not all of our expenses vary with our revenues.

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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.

     To date, we have not been required to purchase any fixed amounts of excess inventory under our outsourcing arrangements, and we have no existing obligation to purchase any such fixed amount of excess inventory. We are in the process of revising our sales forecasting techniques with our outsourcers, providing short-term forecasts (usually less than three months) rather than long-term forecasts, which should assist with mitigating the risk that we will significantly overestimate our inventory needs from these outsourcers.

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.

     We are not currently aware of any parties that intend to pursue intellectual property claims against us.

Significant payment defaults under extended financing arrangements could adversely affect us.

     We often sell to customers on payment terms other than cash on delivery. We allow many of our customers to finance substantial purchases of our products through the issuance to us of promissory notes. The terms of these promissory notes initially range from eight months to five years. As of March 31, 2004, we had accounts receivable, net, of approximately $33.9 million and notes receivable, net, of approximately $17.9 million. Significant payment defaults by customers could have a material adverse effect on our results of operations and financial condition.

     Approximately $10.6 million of our total notes receivable at March 31, 2004 related to one customer, a subsidiary of a major Russian energy company. During 2003, this customer became delinquent on approximately $0.8 million of its scheduled principal and interest payments, in addition to becoming delinquent on $1.8 million of its trade receivables. In January 2004, we refinanced the delinquent portion of its notes and trade receivables into a new note totaling $2.6 million, with payments due in equal installments over a twelve-month period. Based on our internal credit review and meetings with the customer and its parent company, we expect that the customer will pay all of its obligations in full and, therefore, no allowance has been established for these receivables.

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

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     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 will 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.

The loss of certain members of our senior management team (many of whom have only recently joined our company) could have a material adverse effect on our financial condition and results of operations.

     Our success depends, in part, on the efforts of our senior management and other key employees. These individuals possess sales, marketing, technical, engineering, manufacturing and processing skills that are critical to executing our business strategy. If we lose or suffer an extended interruption in the services of one or more of our senior officers, our financial condition and results of operations may be adversely affected. Moreover, the market for qualified individuals may be highly competitive, and we may not be able to attract and retain qualified personnel to replace or succeed members of our senior management or other key employees, should the need arise.

     While many members of our current senior management team have significant experience working at various large corporations, with some of them working together at those corporations, our senior management has had limited experience working together at our company and implementing our current business strategy. In April 2003, Robert P. Peebler became our Chief Executive Officer after serving as a member of our Board of Directors since 1999. To help lead the implementation of our seismic imaging-based strategy, Mr. Peebler has recruited several new senior executives to augment our management team, including Jorge Machnizh, Executive Vice President and Chief Operating Officer, J. Michael Kirksey, Executive Vice President and Chief Financial Officer, Chris Friedemann, Vice President — Commercial Development, and Jim Hollis, Vice President — Land Imaging Systems.

Our significant debt obligations could limit our flexibility in managing our business and expose us to certain risks.

     As of March 31, 2004, we had $80.2 million of indebtedness outstanding (including our lease obligations under our facilities sale-leaseback arrangements). As a result, our interest expense has increased during the three months ended March 31, 2004, and will continued to increase in the foreseeable future when compared to 2003. Our ability to make scheduled payments of principal or interest on, or to refinance, our indebtedness depends on our future business performance, which is subject to many economic, financial, competitive and other factors beyond our control. We do not have a working capital or other senior credit facility in place to finance our working capital needs. Our degree of leverage may have important consequences to our operations, including the following:

•

we may have difficulty satisfying our obligations under the notes or other indebtedness and, if we fail to comply with these requirements, an event of default could result;

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	•		we may be required to dedicate a substantial portion of our cash flow from operations to required payments on indebtedness, thereby reducing the availability of cash flow for working capital, capital expenditures and other general corporate activities;
	•		covenants relating to future debt may limit our ability to obtain additional financing for working capital, capital expenditures and other general corporate activities;
	•		covenants relating to future debt may limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
	•		we may be more vulnerable to the impact of economic downturns and adverse developments in our business; and
	•		we may be placed at a competitive disadvantage against any less leveraged competitors.

     The occurrence of any one of these events could have a material adverse effect on our business, financial condition, results of operations, prospects and ability to satisfy our obligations under the notes.

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

     Our cash and cash equivalents have declined from $59.5 million at December 31, 2003 to $25.0 million at March 31, 2004, a decrease of $34.5 million, primarily related to our acquisition of Concept in February 2004. Our ability to fund our operations, grow our business and to make scheduled 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, including the notes, 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.

     NOTE: The foregoing factors pursuant to the Private Securities Litigation Reform Act of 1995 should not be construed as exhaustive. In addition to the foregoing, we wish to refer readers to other factors discussed elsewhere in this report as well as other filings and reports with the SEC for a further discussion of risks and uncertainties that could cause actual results to differ materially from those contained in forward-looking statements. We undertake no obligation to publicly release the result of any revisions to any such forward-looking statements, which may be made to reflect the events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     We may, from time to time, be exposed to market risk, which is the potential loss arising from adverse changes in market prices, interest rates and foreign currency exchange rates. We traditionally have not entered into significant derivative or other financial instruments other than the warrant granted to SCF, which was terminated in December 2003. We are not currently a borrower under any material credit arrangements that feature fluctuating interest rates, but we have $78.0 million of long-term fixed rate debt outstanding at March 31, 2004. As a result, we are subject to the risk of higher interest costs if this debt is refinanced. If rates are 1% higher at the time of refinancing, our interest costs would increase by approximately $0.8 million annually.

     We have subsidiaries in the Netherlands, United Kingdom, Norway and the United Arab Emirates. Therefore, our financial results may be affected by changes in foreign currency exchange rates. Our consolidated balance sheet at March 31, 2004 reflected approximately $15.5 million of net working capital related to our foreign subsidiaries. A majority of our foreign net working capital is within the Netherlands and United Kingdom. The subsidiaries receive their income and pay their expenses primarily in Euros and British pounds (GBP), respectively. To the extent that transactions of these subsidiaries are settled in Euros or GBP, a devaluation of

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Item 4. Controls and Procedures

     We maintain disclosure controls and procedures that are intended to ensure that the information required to be disclosed in our Exchange Act filings is properly and timely recorded and reported. Management of the Company, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) under the Exchange Act) as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Exchange Act. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, the information relating to the Company (including its consolidated subsidiaries) required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.

     There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds.

     In February 2004, we issued 1,680,000 shares of our common stock to certain former securityholders of Concept in privately negotiated transactions. These shares were issued in connection with our acquisition of Concept as partial consideration for our acquiring Concept’s outstanding securities. On February 23, 2004, the closing date, the closing price per share of our common stock on the New York Stock Exchange was $6.41.

     We also entered into employment stock option agreements with certain key employees of Concept as material inducements to their joining our company, under which options to purchase up to 365,000 shares of our common stock for an exercise price of $6.42 per share were granted.

     The shares of our common stock issued in connection with the acquisition of the shares of Concept, and the inducement options and shares of common stock issuable upon exercise of the inducement options, were not registered under the Securities Act pursuant to exemptions from registration under that Act. We also granted the Concept securityholders acquiring our common stock certain demand and piggyback registration rights to register the shares acquired by them under a registration rights agreement entered into between IO and those securityholders dated February 23, 2004.

     During the three months ended March 31, 2004, in connection with the lapse of restrictions on shares of our restricted stock held by certain of our employees, we acquired shares of our restricted stock in satisfaction of tax withholding obligations that were incurred on the vesting dates. The dates of acquisition, number of shares and average effective acquisition prices per share, were as follows:

Item 6. Exhibits and Reports On Form 8-K

(a)

Exhibits

(b)		Reports on Form 8-K
		On March 5, 2004, we filed a Current Report on Form 8-K reporting under Item 2. “Acquisition or Disposition of Assets” and Item 7. “Financial Statements and Exhibits” in connection with our acquisition of Concept Holdings Systems Limited.

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) 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.

Date: May 10, 2004

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EXHIBIT INDEX