INPUT OUTPUT INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

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

COMMISSION FILE NUMBER 1-13402

INPUT/OUTPUT, INC.
(Exact name of registrant as specified in its charter)

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

12300 PARC CREST DR., 77477
STAFFORD, TEXAS (Zip Code)

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

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

State the aggregate market value of the voting stock held by non-affiliates
of the registrant. Approximately $402.5 million as of June 28, 2002.

Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. Common stock, $1 par
value, 51,250,906 shares outstanding as of March 14, 2003.

Portions of the registrant's definitive proxy statement for its annual
meeting of stockholders scheduled to be held June 11, 2003 are incorporated by
reference into Part III hereof.
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PART I

PRELIMINARY NOTE: THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING
STATEMENTS AS DEFINED BY THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
FORWARD-LOOKING STATEMENTS SHOULD BE READ IN CONJUNCTION WITH THE CAUTIONARY
STATEMENTS AND OTHER IMPORTANT FACTORS INCLUDED IN THIS FORM 10-K. SEE ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION -- CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD-LOOKING STATEMENTS FOR
A DESCRIPTION OF IMPORTANT FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE CONTAINED IN THE FORWARD-LOOKING STATEMENTS.

ITEM 1. BUSINESS

INPUT/OUTPUT, INC.

Input/Output, Inc. and its wholly owned subsidiaries (collectively referred
to as the "Company" or "I/O") is a leading provider of seismic acquisition
imaging technology for land, marine, transition zone exploration, production and
reservoir monitoring. Our data acquisition products are particularly well suited
for both traditional and passive three-dimensional ("3-D") and four dimensional
("4-D") data collection techniques, as well as the newer and more advanced
multi-component ("3C") data collection techniques. Our mission is to be the
recognized leader in delivering cost-effective imaging technology that improves
exploration and production economics for the energy industry.

We offer a full suite of related products and services for seismic data
acquisition, including products incorporating traditional analog technologies
and products incorporating our proprietary VectorSeis(R), True Digital(R)
technology. Our VectorSeis platform is based on a multi-component digital sensor
incorporating a unique micro-electromechanical systems (MEMS) based
accelerometer that we design and manufacture. As compared to traditional seismic
technologies, our VectorSeis platform offers improved seismic data quality and
operational efficiency with the potential to substantially improve finding and
development economics.

Our executive headquarters are located at 12300 Parc Crest Drive, Stafford,
Texas 77477. Our telephone number is (281) 933-3339. Our home page on the
Internet is www.i-o.com. We make our website content available for information
purposes only. It should not be relied upon for investment purposes, nor is it
incorporated by reference into this Form 10-K.

Throughout this Form 10-K, we incorporate by reference information from
parts of other documents filed with the Securities and Exchange Commission
("SEC"). The SEC allows us to disclose important information by referring to it
in this manner, and you should review this information. We make our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K
and proxy statement for our annual shareholders' meeting, as well as any
amendments to those reports, available free of charge through our website as
soon as reasonably practicable after we electronically file such material with,
or furnish it to, the SEC. You can learn more about us by reviewing our SEC
filings on our website. Our SEC reports can be accessed through the investor
relations page of our website, namely www.i-o.com/htmlweb/framesetinvest.htm.
The SEC also maintains a website at www.sec.gov that contains reports, proxy
statements and other information regarding SEC registrants, including
Input/Output, Inc.

RECENT DEVELOPMENTS

Net sales of our traditional analog products have been affected by the
lower level of worldwide oil and gas exploration activity and the diminished
profitability and cash flows of oil and gas companies and seismic contractors.
These factors are affected by expectations regarding the supply and demand for
oil and natural gas, energy prices, and finding and development costs. The use
of existing seismic data, principally library data, to generate prospects rather
than new exploration activity has significantly reduced demand for our analog
products. Demand for our VectorSeis product line is primarily related to the
acceptance of new technology by oil companies and seismic contractors. While we
are seeing great interest in products incorporating VectorSeis technology,
geophysical contractors and exploration and production companies in general are
still evaluating the technology. Other factors which may limit the demand for
our products may

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include, but are not limited to, those described in Item 7. Management's
Discussion and Analysis of Results of Operations and Financial
Condition -- Cautionary Statement for Purposes of Forward Looking Statements.

In response to the continued weak seismic market fundamentals, we have
taken decisive steps in 2002 to further reduce our overall cost structure to
enable us to operate profitably at lower levels of overall seismic activity.
First, we have taken steps to significantly reduce our corporate overhead burden
by reducing the number of personnel. Second, we closed our Austin, Texas
software development facility, combined our two Colorado-based operations into
one location, and are in the process of vacating our Alvin, Texas manufacturing
facility and our Norwich, U.K. based geophone stringing facility, eliminating
approximately 270,000 square feet of space. We are outsourcing the operations in
these facilities or relocating them to other existing Company facilities. In
late 2002, we finalized an agreement with Stewart & Stevenson to manufacture our
land energy sources. Also, we are in the process of relocating our cable
operations to a contract manufacturer in Mexico and our geophone stringing
operations to a Company-leased facility in the United Arab Emirates ("UAE").
Third, we have combined certain business units in order to improve efficiency
and further reduce our administrative costs. Finally, we are carefully
evaluating our portfolio of products to eliminate those products for which the
market outlook does not justify continuing investments.

We believe demand for seismic services and equipment will be weak in the
near term. Several of our largest customers have recently announced that they
will scale back their operations in 2003. Despite current conditions, we are
cautiously optimistic that planned increases in seismic expenditures by oil
companies, especially in international areas such as China and Russia, along
with growing acceptance of our VectorSeis platform products, will result in
higher sales in 2003. Based upon long-term forecasted increases in demand for
oil and gas, as well as statements from oil companies regarding lack of
sufficient prospects, we believe long-term fundamentals for the sector remain
strong. We further believe we should be well positioned to benefit from new
product introductions and anticipated strengthening demand.

On March 31, 2003, we announced that Robert P. Peebler has been appointed
the Company's President and Chief Executive Officer. Mr. Peebler is leaving his
positions as the President and Chief Executive Officer of Energy Virtual
Partners, Inc. ("EVP"), which he founded in April, 2001. Mr. Peebler will also
become chairman of EVP. Mr. Peebler has been a director of I/O since 1999.

In addition, we will invest $3.0 million in Series B Preferred securities
of EVP. After consummation of this investment, we will own approximately 22% of
the outstanding ownership interests of EVP and 11% of the outstanding voting
interests of EVP. The closing of the investment, which is subject to customary
closing conditions, is scheduled to occur in April 2003. EVP provides asset
management services to large oil and gas companies to enhance the value of their
oil and gas properties.

Mr. Peebler has had a 30-year career in the oil and gas industry. He began
as a field engineer and spent sixteen years with Schlumberger. While at
Schlumberger he held technical, marketing and management positions, including a
five-year period as Vice President of North America Wireline Operations, and two
years as Global Vice President of Strategic Marketing for Oil Field Services.
Mr. Peebler joined Landmark as Vice President of Marketing in 1989, and later
was appointed Chief Executive Officer in 1992. Mr. Peebler continued as Chief
Executive Officer for two years after Halliburton acquired Landmark in 1996, and
later became Halliburton's Vice President of e-Business and New Ventures. Mr.
Peebler left Halliburton to start EVP in the spring of 2001.

VECTORSEIS PRODUCTS

Our VectorSeis digital platforms offer high-resolution, cost-effective
compression-wave ("P-wave") data collection as well as shear wave
multi-component acquisition. Digital sensors, when compared with traditional
analog geophones, provide increased response linearity and bandwidth and
preserve a higher degree of vector fidelity. In addition, one digital sensor can
replace a string of six or more analog geophones providing geophysical
contractors with significant operating efficiencies. These advantages bring the
promise of improved location and characterization of reservoir structure and
fluids and more accurate identification of rock properties at reduced total
costs. We are utilizing VectorSeis for new seismic data acquisition systems for
(i) land surface applications, (ii) ocean-bottom applications, and (iii) in-well
applications.
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We began VectorSeis land acquisition field tests in 1999 and we have
acquired data throughout Canada, Mexico, the United States, France, Eastern
Europe and the Commonwealth of Independent States ("CIS"). In May 2002, we
commercialized our VectorSeis System Four(TM) radio-based land acquisition
system. Our initial land system incorporates our radio telemetry system, and we
anticipate commercializing a cable-based telemetry system in the first half of
2003. In addition, we have formed a marketing alliance with Veritas DGC that has
successfully collected VectorSeis data in North America during the past two
years. Initial reports by our customers indicate that crew productivity with
VectorSeis System Four has been better than anticipated in addition to providing
superior data quality.

Over the course of 2002, we increased our focus on reservoir applications
using VectorSeis. Our VectorSeis ocean-bottom product line addresses many of the
shortcomings of current multi-component ocean-bottom systems. VectorSeis modules
can operate at any angle which eliminates the need for gimbal receiver units
that distort data and add cost. In addition, our patented cable de-coupler
design further reduces data distortions and improves sea-bottom coupling. In
2002, we completed the first test of our VectorSeis ocean-bottom acquisition
system in the Ekofisk Field in the North Sea. This test was supported by
ConocoPhilips and delivered higher frequency and better vector fidelity than
previous OBC surveys. Based on this success, we are now negotiating with a
number of companies regarding the funding or purchase of both retrievable and
permanent VectorSeis ocean-bottom systems.

For in-well environments, we delivered our first mixed geophone and
VectorSeis systems last year for collecting passive, micro-seismic and 4D
reservoir data. These projects place VectorSeis sensors downhole to monitor
fluid fronts and other dynamic reservoir processes using natural formation noise
as an energy source. VectorSeis simplifies some of the complex data processing
procedures as VectorSeis sensors measure their vertical deployment angle
directly. Because VectorSeis sensors are smaller and provide much improved
vector fidelity compared to traditional analog sensors, VectorSeis sensors are
more suitable for permanently emplaced sensor arrays.

ANALOG LAND PRODUCTS

Data acquisition products for our Land Division include the following:

Data Acquisition Systems: Our Image(TM) land data acquisition system
consists of a central electronics unit and multiple remote ground equipment
modules, which are either connected by cable or utilize radio transmission and
retrievable data storage. The central electronics unit, which acts as the
control center of our data acquisition system, is typically mounted within a
vehicle or helicopter transportable enclosure. The central electronics unit
receives digitized data, stores the data on storage media for subsequent
processing and displays the data on optional monitoring devices. The central
electronics unit also provides calibration, status and test functionality. The
remote ground equipment of the I/O Image system consists of multiple remote
modules ("MRX(TM)") and line taps positioned over the survey area. Seismic
signals from geophones are collected by the MRX modules, which collect multiple
channels of analog seismic data. The MRX modules filter and digitize the data,
which is then transmitted by the MRX modules via cable to a line tap.
Alternatively, our radio telemetry system ("RSR(TM)") records data across a
variety of environments, including transition zones, swamps, mountain ranges,
jungles and other environments. RSRs are radio controlled and do not require
cables for data transmission since the information is stored at the unit source
and subsequently retrieved.

Geophones: Geophones are analog electro-mechanical seismic sensor devices
that measure acoustic energy reflected from rock layers in the earth's
subsurface. I/O markets a full suite of geophones and geophone test equipment
that operate in all environments including land, marine, ocean-bottom and
downhole. Our flagship geophone product, the SM-24, provides low distortion, and
wide bandwidth for greater realization of the potential of 24 bit seismic
recording systems.

Vibrators and Traditional Energy Sources: Vibrators are devices carried by
large vehicles and are used as energy sources for land seismic acquisition. We
market and sell the AHV-IV(TM), an articulated vibrator vehicle with simplified
hydraulics and superior maneuverability. In addition, we offer a low impact,
tracked

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vibrator, the X-Vib(TM) for use in environmentally sensitive areas like the
Arctic tundra and desert environments.

Our 2001 Pelton acquisition added energy source control and positioning
technology to the I/O suite of products. The Vib Pro(TM) control system provides
digital technology for VIBROSEIS(R) energy control, and integrates GPS
technology for navigation and positioning of vibrator vehicles. The Shot Pro(TM)
dynamite firing system is the equivalent technology for seismic operations using
dynamite energy sources. Integrated GPS technology and compatibility with the
Vib Pro control system streamline field operations and improve operational
efficiency.

Specialty Cables and Connectors: Cables and connectors are used in
conjunction with most seismic equipment. Our Tescorp(TM) cables not only offer a
replacement option to correct for ordinary wear, but also offer performance
improvement and specialization for new environments and applications.

MARINE PRODUCTS

Products for the Marine Division include the following:

Marine Positioning Systems: Our positioning systems include streamer cable
depth control devices (Model 5011 compassbird), compasses, acoustic positioning
systems (DigiRANGE(TM)), and other auxiliary sensors (velocimeters and speed
logs). Marine positioning equipment controls the depth of the streamer cables
and provides acoustic, compass and depth measurements so processors can tie
navigation and location data with geophysical data to determine the location of
potential hydrocarbon reserves for precise drilling operations.

Data Acquisition Systems: Our marine data acquisition system ("MSX(TM)")
consists primarily of towed marine streamers and shipboard electronics that
collect seismic data in marine environments below 30 meters. Marine streamers,
which contain hydrophones, electronic modules and cabling, may measure up to
12,000 meters in length and are towed behind a seismic acquisition vessel.
Seismic sensors installed in the cable (hydrophones) detect acoustical energy
transmitted through water from the earth's subsurface structure.

Airguns: Airguns are the primary seismic energy source used in marine
environments to initiate the acoustic energy transmitted through the earth's
subsurface. An airgun fires a high compression burst of air under water to
create an energy wave for seismic measurement. Additionally, we offer a digital
source control system, DigiSHOT(TM), which allows more precise and reliable
control and QC of airgun arrays.

INTERPRETATION-READY PROCESSING

In July 2002, we acquired AXIS Geophysics, Inc. ("AXIS"). AXIS is a seismic
data service company based in Denver, Colorado that provides specialized seismic
data processing and integration services to major and independent exploration
and production companies. The AXIS Interpretation-Ready Process(TM) ("IRP")
integrates seismic and subsurface geological data to provide customers more
accurate and higher quality data that can result in improved reservoir
characterizations. We combined AXIS with our geophysical software operations,
Green Mountain Geophysics ("GMG"). GMG offers a wide range of geophysical
software used in seismic survey planning and design. We are leveraging these
services to broaden and support our reservoir offerings.

APPLIED MEMS

Applied MEMS, Inc. holds our MEMS technology development and manufacturing
capabilities. In addition to producing the accelerometers for our VectorSeis
digital sensor, this business unit is also actively pursuing sales of
accelerometer products for non-seismic applications and foundry services for
third parties.

PRODUCT RESEARCH AND DEVELOPMENT

Our strategic focus for research and development is driven by our desire to
improve the quality of the subsurface image and the overall acquisition
economics of our customers. Our ability to compete effectively in

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the manufacture and sale of seismic instruments and data acquisition systems
depends upon continued technological innovation. Development cycles, from
initial conception through product introduction, may extend over several years.
Principally, research and development expenditures have related to the continued
enhancement and commercialization of our VectorSeis technology for (i) land
surface applications, (ii) ocean-bottom applications, and (iii) in-well
applications.

During 2002, our primary research and development efforts were focused on
field testing and commercialization of a land-based seismic data acquisition
recording system incorporating VectorSeis digital sensors for single and
multi-component recording. In 2003 our principal research and development goals
include the further migration of our VectorSeis platform into ocean-bottom
systems and in-well products.

We continue to develop a lightweight, cable-based land seismic system with
a view towards commercial introduction of this system during the first half of
2003 and are developing a next generation marine seismic data acquisition system
for commercial deployment in 2003. We have a number of other products under
development including reservoir monitoring applications for all acquisition
environments.

Because the new products are under development, their commercial
feasibility or degree of commercial acceptance, if any, is not yet known. No
assurance can be given concerning the successful development of any new products
or enhancements, the specific timing of their release or their level of
acceptance in the market place.

MARKETS AND CUSTOMERS

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 directly to oil and gas companies,
particularly for reservoir monitoring applications. During the year ended
December 31, 2002, two customers (Western-Geco and Laboratory of Regional Geo
Dynamics) each accounted for approximately 10% of consolidated net sales. In
recent years, our customers have been rapidly consolidating, shrinking the
demand for our products. The loss of any one of these customers could have a
material adverse effect on the results of operations and financial condition.
See Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition -- Cautionary Statement for Purposes of Forward Looking
Statements -- Further consolidation among our significant customers could
materially and adversely affect us and Note 13 of Notes to Consolidated
Financial Statements.

A significant part of our marketing efforts are focused on areas outside
the United States. Contractors from China and the CIS are increasingly active
not only in their own countries, but also in other international areas. Foreign
sales are subject to special risks inherent in doing business outside of the
United States, including the risk of war, civil disturbances, exchange rate
fluctuations, embargo and governmental activities, as well as risks of
non-compliance with U.S. and foreign laws, including tariff regulations and
import/export restrictions. We sell products through a direct sales force
consisting of employees and through several international third-party sales
representatives responsible for key geographic areas. During the year ended
December 31, 2002, sales to destinations outside of North America accounted for
approximately 71% of net sales. Further, systems sold to domestic customers are
frequently deployed internationally and, from time to time, certain foreign
sales require export licenses. See Item 7. Management's Discussion and Analysis
of Results of Operations and Financial Condition -- Cautionary Statement for
Purposes of Forward Looking Statements -- We derive a substantial amount of our
revenues from foreign sales, which pose additional risks and Note 13 of Notes to
Consolidated Financial Statements.

Sales to customers are normally on standard net 30-day terms. We also
provide financing arrangements to customers through long-term notes receivable.
Notes receivable, which are generally collateralized by the products sold, bear
interest at contractual rates up to 13.5% per year and are due at various dates
through 2005. The weighted average interest rate at December 31, 2002 was 8.5%.
See Notes 1 and 10 of Notes to Consolidated Financial Statements.

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SUPPLIERS

As part of our strategic direction, we are increasing our use of contract
manufacturers as an alternative to our own manufactured products. We may
experience supply interruptions, cost escalations and competitive disadvantages
if we do not monitor these relationships properly. See Item 7. Management's
Discussion and Analysis of Results of Operations and Financial
Condition -- Cautionary Statement for Purposes of Forward Looking
Statements -- We have developed outsourcing arrangements for the manufacturing
of 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, our revenues, profitability and cash flow may decline.

We and our contract manufacturers purchase a substantial portion of the
components used in our systems and products from third-party vendors. Certain
items, such as integrated circuits used in I/O systems are purchased from sole
source vendors. Although we and our contract manufacturers attempt to maintain
an adequate inventory of these single source items, the loss of ready access to
any of these items could temporarily disrupt our ability to manufacture and sell
certain products. Since our components are designed for use with these single
source items, replacing the single source items with functional equivalents
could require a redesign of our components and costly delays could result.

COMPETITION

The market for seismic data acquisition systems and seismic instrumentation
is highly competitive and is characterized by consolidation, as well as
continual and rapid changes in technology. Our principal competitor for land and
marine seismic equipment is Societe d'Etudes Recherches et Construction
Electroniques ("Sercel"), an affiliate of Compagnie General de Geophysique.
Unlike I/O, Sercel possesses an advantage of selling to an affiliated seismic
contractor. In addition, I/O competes with other companies on a product-by-
product basis.

INTELLECTUAL PROPERTY

We rely on a combination of trade secrets, patents, copyrights and
technical measures to protect our proprietary hardware and software
technologies. Although patents are considered important to our operations, no
one patent is considered essential to our success. Copyright and trade secret
protection may be unavailable in certain foreign countries in which we sell
products. In addition, we seek to protect trade secrets through confidentiality
agreements with employees and agents and through ownership of a number of
trademarks.

REGULATORY MATTERS

Our export activities are subject to extensive and evolving trade
regulations. Certain countries in which products may be utilized are subject to
trade restrictions, embargoes and sanctions imposed by the U.S. government.
These restrictions and sanctions, generally speaking, 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. We do not currently foresee the
need for significant expenditures to ensure continued compliance with current
environmental protection laws. Regulations in this area are subject to change,
and there can be no assurance that future laws or regulations will not have a
material adverse effect on us. Our customer's operations are also significantly
impacted by laws and regulations concerning the protection of the environment
and endangered species. For instance, many of our marine contractors have been
affected by new regulations protecting marine mammals in the Gulf of Mexico. 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.

EMPLOYEES

At December 31, 2002, we had 598 full-time employees worldwide, 434 of whom
were employed in the United States. Also, at December 31, 2002, we had 106
temporary employees. Our temporary employee base

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fluctuates based upon our level of manufacturing activity, as a majority of
these positions are manufacturing related. U.S. employees are not subject to any
collective bargaining agreements and we have never experienced a work stoppage.

ITEM 2. PROPERTIES

Primary manufacturing facilities at March 1, 2003 are as follows:

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* Leased

** Owned

*** Owned and in the process of vacating.

**** Leased and in the process of vacating.

In addition we lease facilities in Denver, Colorado, Norwich, England and
Beijing, China to support our processing operations and our global sales force.
Our executive headquarters (utilizing approximately 25,000 square feet) are
located at 12300 Parc Crest Drive, Stafford, Texas. The machinery, equipment,
buildings and other facilities leased are considered by management to be
sufficiently maintained and adequate for current operations.

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of business, we have been named in various lawsuits
or threatened actions. While the final resolution of these matters may have an
impact on our consolidated financial results for a particular reporting period,
we believe that the ultimate resolution of these matters will not have a
material adverse impact on our financial position, results of operations or
liquidity.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

GENERAL

Our common stock trades on the New York Stock Exchange ("NYSE") under the
symbol "IO." The following table sets forth the high and low sales prices of the
common stock for the periods indicated, as reported on the NYSE composite tape.

We have not historically paid, and do not intend to pay in the foreseeable
future, cash dividends on our common stock. We presently intend to retain cash
from operations for use in our business, with any future decision to pay cash
dividends on our common stock dependent upon our growth, profitability,
financial condition and other factors our Board of Directors consider relevant.
The $31.0 million unsecured promissory note issued in August 2002, in connection
with the repurchase of preferred stock, restricts cash dividends in excess of
$5.0 million per year while the note is outstanding. See Notes 8 and 11 of Notes
to Consolidated Financial Statements.

On December 31, 2002, there were 282 stockholders of record of common stock
outstanding.

In October 2001 our Board of Directors authorized the repurchase of up to
1,000,000 shares of our common stock in the open market and privately negotiated
transactions at such prices and at such times as management deems appropriate.
Under this repurchase program the Company has repurchased 40,000 shares of
common stock for a total purchase price of $0.2 million at an average price of
$3.97 per share for the year ended December 31, 2002 and 461,900 shares of our
common stock for a total purchase price of $3.6 million at an average price of
$7.78 per share for the year ended December 31, 2001.

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below with respect to
our consolidated statements of operations for the years ended December 31, 2002
and 2001, the seven months ended December 31, 2000 and the three fiscal years
ended May 31, 2000, 1999 and 1998, and with respect to our consolidated balance
sheets at December 31, 2002, 2001, and 2000 and May 31, 2000, 1999 and 1998 have
been derived from our audited consolidated financial statements. Our results of
operations and financial condition have been affected by acquisitions of
businesses and significant charges during certain periods presented, which may
affect the comparability of the financial information. For a discussion of
significant charges, please see Note 18 of Notes to Consolidated Financial
Statements. This information should be read in conjunction with Item 7.
Management's Discussion and Analysis of Results of Operations and Financial
Condition and the consolidated financial statements and the notes thereto
included elsewhere in this Form 10-K.

Results for each of the years ended December 31, 2002 and 2001, the seven
months ended December 31, 2000 and the year ended May 31, 2000 include specific
charges (if applicable) as discussed in Note 18 of Notes to Consolidated
Financial Statements. For the year ended May 31, 1999, charges of $77.0 million
were included in cost of sales relating to inventory write-downs of $57.0
million and warranty reserves and other product related contingencies of $20.0
million. In addition, charges of $1.1 million primarily related to prototype
development costs were included in research and development, along with charges
of $46.4 million included in general and administrative expenses related to
accounts and notes receivable allowances of $39.9 million, the early termination
of a facility lease and other restructuring costs of $2.6 million and employee
severances and other expense totaling $3.9 million. Charges of $14.5 million
were included in impairment of long-lived assets for the year ended May 31,
1999.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION

In our traditional analog business, we are committed to reducing both the
unit cost of our products and our fixed cost structure. These reductions, if
achieved, will make our products more competitive and reduce our annual
breakeven revenue level. By the end of 2003, we intend to substantially
transform our business by outsourcing most of our non-core manufacturing
processes and otherwise relocating our operations to lower cost venues. At the
same time, as we continue to transform our traditional analog business, we
intend to grow our business by aggressively marketing our VectorSeis technology
in our traditional exploration markets and also in production-related markets
where we have not historically generated significant revenue.
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RECENT EVENTS AND SIGNIFICANT 2002 CHARGES

During 2002, we recorded significant charges in connection with our
restructuring program. The related reserves reflect many estimates, including
those pertaining to severance costs of $3.5 million, facility related charges,
primarily future, non-cancelable, lease obligations of $1.3 million, and
inventory revaluation charges of $4.3 million. In addition, during 2002, we
recorded charges of $15.1 million relating to the impairment of goodwill and
$6.9 million for the impairment of long-lived assets. We will continually
reassess the requirements necessary to complete our restructuring plan, which
may result in additional charges recorded in future periods. However, we
currently do not anticipate any significant future charges or adjustments to our
restructuring accruals. See Notes 1, 3, 4, 5, 9 and 18 of Notes to Consolidated
Financial Statements for further discussion of these charges.

We recorded a net charge of $60.0 million to income tax expense to
establish an additional valuation allowance for our net deferred tax assets. We
will continue to reserve all of our net deferred tax assets until we have
sufficient evidence to warrant reversal. See Note 14 of Notes to Consolidated
Financial Statements.

FISCAL YEAR CHANGE

In September 2000, our Board of Directors approved changing our fiscal
year-end to December 31 of each year. The consolidated statements of operations,
stockholders' equity and comprehensive loss and cash flows for the period from
June 1, 2000 to December 31, 2000 represent a transition period of seven months.
The following is a comparative summary of the operating results for the years
ended December 31, 2002, 2001 and 2000 and the seven month periods ended
December 31, 2000 and 1999 (in thousands, except per share amounts).

11

COMPARABILITY OF PERIODS

Results of operations and financial condition have been affected by
acquisitions of businesses and pre-tax charges during certain periods discussed
which may affect the comparability of the financial information. See Notes 12
and 18 of Notes to Consolidated Financial Statements. Additionally, during 2000
we changed our year end from May 31 to December 31. As a result, we have
presented our historical results on an unaudited basis for the twelve months
ended December 31, 2000 for comparative purposes within Management's Discussion
and Analysis of Results of Operations and Financial Condition.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

Net Sales: Net sales of $118.6 million for the year ended December 31,
2002 decreased $93.5 million, or 44%, compared to the prior year. Our Land
Division's net sales decreased $97.1 million, or 60%, to $65.2 million,
primarily as a result of declining industry conditions and a loss of market
share to our principal competitor. Our Marine Division's net sales increased
$3.6 million or 7%, to $53.4 million, compared to the prior year, primarily due
to an increase in demand from Russian contractors.

Cost of Sales: Cost of sales of $99.6 million for the year ended December
31, 2002 decreased $38.8 million, or 28%, compared to the prior year. The
decrease results from a decrease in revenues, partially offset by lower gross
profit on those revenues and severance for work force reductions totaling $1.9
million. Cost of sales was negatively affected by $4.3 million of inventory
related charges. Cost of sales of our Land Division was $65.8 million and cost
of sales of our Marine Division was $33.8 million.

Gross Profit and Gross Profit Percentage: Gross profit of $19.0 million
for the year ended December 31, 2002 decreased $54.7 million, or 74%, compared
to the prior year. Gross profit percentage for the year ended December 31, 2002
was 16% compared to 35% in the prior year. The decline in gross profit
percentage is primarily due to under-absorbed manufacturing overhead, inventory
revaluations of $4.3 million, and to a lesser degree, severance for work force
reductions totaling $1.9 million. Excluding inventory revaluations and severance
expense, our gross profit percentage for the year ended December 31, 2002 was
21%.

Research and Development: Research and development expense of $28.8
million for the year ended December 31, 2002 decreased $0.7 million, or 2%,
compared to the prior year. Research and development expense remained at high
levels as we completed the final stages of VectorSeis commercialization and
continue to develop a solid marine streamer, a lightweight ground electronics
system and an ocean bottom system that exploits our VectorSeis technology. Also,
research and development expenses included significant charges of $2.1 million
for severance expenses of $0.8 million and charges related to the closure of our
Austin, Texas software development facility of $1.3 million. After completion of
our lightweight, cable-based VectorSeis ground system, we expect a significant
reduction in our research and development expense.

Marketing and Sales: Marketing and sales expense of $11.2 million for the
year ended December 31, 2002 decreased $0.4 million, or 4%, compared to the
prior year. The decrease is primarily related to lower payroll costs and
commissions on sales, partially offset by severance for work force reductions of
$0.3 million.

General and Administrative: General and administrative expense of $19.2
million for the year ended December 31, 2002 decreased $0.5 million, or 3%,
compared to the prior year. The decrease in general and administrative expense
is primarily due to decreases in payroll, profit-based bonuses and facility
related costs, partially offset by an increase in bad debt expense (net of
recoveries) of $0.5 million and severance for workforce reductions of $0.5
million.

Amortization of Intangibles and Goodwill: Amortization of intangibles of
$1.4 million for the year ended December 31, 2002 decreased $3.5 million, or
72%, compared to the prior year. The decrease in amortization of intangibles and
goodwill relates to the implementation of Statement of Financial Accounting
Standards ("SFAS") No. 142 "Goodwill and Other Intangible Assets" in the current
year, which, among other things, eliminates the amortization of goodwill.
Goodwill amortization for 2001 was $3.9 million.

12

Impairment of Long-Lived Assets: Impairment of long-lived assets of $6.9
million for the year ended December 31, 2002 primarily relates to the impairment
of our Alvin, Texas manufacturing facility, the impairment of the leasehold
improvements of our Norwich, U.K. geophone stringing facility and certain
related manufacturing equipment of both facilities. The impairments were
triggered by the announced closures of facilities. There was no corresponding
charge during the year ended December 31, 2001. See Note 4 of Notes to
Consolidated Financial Statements.

Goodwill Impairment: Goodwill impairment of $15.1 million for the year
ended December 31, 2002 relates to the impairment of goodwill of our analog land
products reporting unit. There was no corresponding charge during the year ended
December 31, 2001. See Note 5 of Notes to Consolidated Financial Statements.

Net Interest and Other Income: Total net interest and other income of $1.6
million for the year ended December 31, 2002 decreased $6.2 million compared to
the prior year. The decrease is primarily due to falling interest rates on cash
balances, as well as increased interest expense on new debt, compared to the
prior year.

Fair Value Adjustment of Warrant Obligation: The fair value adjustment of
the warrant obligation totaling $3.3 million is due to a change in the fair
value between August 6, 2002 (the issuance date) and December 31, 2002 of the
common stock warrants, as further discussed below in "Repurchase of Series B and
Series C Preferred Stock" and Note 11 of Notes to Consolidated Financial
Statements.

Income Tax Expense: Income tax expense of $57.9 million for the year ended
December 31, 2002 increased $54.8 million compared to the year ended December
31, 2001 due to a charge of $60.0 million in 2002 to establish an additional
valuation allowance for our net deferred tax assets. Although management's plans
include generating sufficient taxable income in future years to fully utilize
our net operating losses, such expectation is subject to a significant amount of
risk and uncertainty. In accordance with SFAS No. 109 "Accounting for Income
Taxes," we established an additional valuation allowance for our net deferred
tax assets based on our cumulative operating results in the most recent
three-year period. Our results in this period were heavily affected not only by
industry conditions, but also by 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 of our
VectorSeis technology. Nevertheless, recent losses represented sufficient
negative evidence to establish an additional valuation allowance. We have
continued to reserve all of our net deferred tax assets and will continue until
we have sufficient evidence to warrant reversal. This valuation allowance does
not affect our ability to reduce future tax expense through utilization of net
operating losses.

Preferred Stock Dividends: Preferred stock dividends for the years ended
December 31, 2002 and 2001 are related to previously outstanding Series B and
Series C Preferred Stock (the "Preferred Stock"). We recognized the dividends as
a charge to retained earnings at a stated rate of 8% per year, compounded
quarterly (of which 7% was accounted for as a non-cash event recorded to
additional paid-in capital so as to reflect potential dilution upon preferred
stock conversion and 1% was paid as a quarterly cash dividend). The preferred
stock dividend charge for the year ended December 31, 2002 was $0.9 million,
compared to $5.6 million for the year ended December 31, 2001. As discussed
below in "Repurchase of Series B and Series C Preferred Stock" and Note 11 of
Notes to Consolidated Financial Statements, we repurchased the Preferred Stock
on August 6, 2002. The decrease in preferred dividends is due to a preferred
stock dividend credit of approximately $2.5 million, which represents the
difference in the fair value of the consideration granted to the holders of the
Preferred Stock and our carrying value of the Preferred Stock at the time of the
repurchase and less than a full year of dividends in 2002.

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
(UNAUDITED)

Net Sales: Net sales of $212.1 million for the year ended December 31,
2001 increased $74.7 million, or 54%, compared to the prior year. The increase
was primarily due to increased demand for products produced by our Land
Division. Our Land Division's net sales increased $70.5 million, or 77%, to
$162.3 million, primarily as a result of improved industry conditions and the
introduction of new products. Our Marine Division's net sales increased $4.2
million or 9%, to $49.8 million, compared to the prior year. Marine sales
remained lackluster primarily due to over capacity in the sector and an
abundance of marine library data.
13

Cost of Sales: Cost of sales of $138.4 million for the year ended December
31, 2001 increased $19.2 million, or 16%, compared to the prior year. Cost of
sales of our Land Division was $109.1 million and cost of sales of our Marine
Division was $29.3 million. Results for the year ended December 31, 2000
included $10.6 million, net, in pre-tax charges for inventory write-downs
partially offset by favorable legal settlements.

Gross Profit and Gross Profit Percentage: Gross profit of $73.6 million
for the year ended December 31, 2001 increased $55.5 million, or 305%, compared
to the prior year. Results for the year ended December 31, 2000 included $10.6
million, net, in pre-tax charges for inventory write-downs partially offset by
favorable legal settlements. Gross profit percentage for the year ended December
31, 2001 was 35% compared to 13% in the prior year (21% excluding pre-tax
charges). A return to a more normal pricing regime, success in reducing costs,
improved absorption of fixed and semi-fixed overhead, as well as the continued
elimination from the sales mix of products that had been highly discounted
during prior periods of weaker demand contributed to the higher 2001 gross
profit percentage.

Research and Development: Research and development expense of $29.4
million for the year ended December 31, 2001 increased $1.4 million, or 5%,
compared to the prior year. Research and development expense remained relatively
constant due to ongoing VectorSeis development efforts.

Marketing and Sales: Marketing and sales expense of $11.7 million for the
year ended December 31, 2001 increased $2.9 million, or 33%, compared to the
prior year. Compensation expense to our in-house sales force increased because
of the higher net sales and gross profit percentage compared to the prior year.
Marketing and sales expense as a percentage of revenues remained relatively
constant in both years.

General and Administrative: General and administrative expense of $19.7
million for the year ended December 31, 2001 increased $2.1 million, or 12%,
compared to the prior year. The increase in general and administrative expense
was primarily attributable to increased compensation expense, reflecting
profit-based bonuses in 2001, and the inclusion of Pelton in the year ended
December 31, 2001 results.

Amortization of Intangibles and Goodwill: Amortization of intangibles of
$4.9 million for the year ended December 31, 2001 decreased $1.2 million, or
20%, compared to the prior year. The decrease was due to the impairment of
goodwill during the year ended December 31, 2000, for which there was no
amortization expense recorded in the current year.

Goodwill Impairment: The decrease in goodwill impairment is due to the
impairment of goodwill of $31.6 million in the year ended December 31, 2000, for
which there was no corresponding charge during the year ended December 31, 2001.

Net Interest and Other Income: Total net interest and other income of $4.6
million for the year ended December 31, 2001 decreased $2.7 million, or 37%,
compared to the prior year, primarily due to fluctuations in exchange rates and
falling interest rates.

Income Tax Expense: Income tax expense of $3.1 million for the year ended
December 31, 2001 decreased $2.2 million from the prior year. Income tax expense
decreased from the prior period despite higher earnings before income taxes
because: (i) we returned to profitability and were recording an income tax
provision that reflected a year-end effective tax rate of 38% before resolution
of certain tax issues, (ii) during the prior period we were profitable in
certain foreign tax jurisdictions but recognized no offsetting benefit from
domestic net operating losses, and (iii) we resolved certain tax issues in 2001
and received a $1.6 million cash benefit.

Preferred Stock Dividends: Preferred stock dividends for the year ended
December 31, 2001 and 2000 were related to outstanding Preferred Stock. We
recognized the dividends as a charge to retained earnings at a stated rate of 8%
per year, compounded quarterly (of which 7% is accounted for as a non-cash event
recorded to additional paid-in capital so as to reflect potential dilution upon
preferred stock conversion and 1% was paid as a quarterly cash dividend.) As
discussed below in "Repurchase of Series B and Series C Preferred Stock" and
Note 11 of Notes to Consolidated Financial Statements, we repurchased the
preferred stock on August 6, 2002. The preferred stock dividend charge for the
year ended December 31, 2001 was $5.6 million, compared to $5.0 million for the
prior year.

14

LIQUIDITY AND CAPITAL RESOURCES

We have typically financed operations from internally generated cash and
funds from equity financings. Cash and cash equivalents were $77.1 million at
December 31, 2002, a decrease of $24.5 million, or 24%, compared to December 31,
2001. The decrease is primarily due to the repurchase of preferred stock and
cash used in investing activities, partially offset by a decrease in working
capital. Net cash provided by operating activities was $14.3 million for the
year ended December 31, 2002, compared to $17.5 million for the year ended
December 31, 2001. This decrease in cash flow from operations is generally a
result of lower operating levels in 2002 with smaller gross margins, as
discussed in Management's Discussion and Analysis of Results of Operations and
Financial Condition -- Results of Operations.

Net cash flow used in investing activities was $10.9 million for the year
ended December 31, 2002, a decrease of $3.9 million compared to the year ended
December 31, 2001. The principal investing activities were $8.2 million relating
to capital expenditure projects and $2.7 million, net of cash acquired, relating
to the acquisition of AXIS and S/N Technologies ("S/N"). Included in capital
expenditures is $2.9 million of rental equipment, which has been leased to two
marine customers. Planned capital expenditures for 2003 are approximately $7.6
million.

Cash flow used in financing activities was $31.3 million for the year ended
December 31, 2002, a decrease of $38.9 million compared to the year ended
December 31, 2001. The principal use of cash was $30.0 million relating to the
repurchase of preferred stock and $2.6 million on the repayment of long-term
debt, partially offset by proceeds of $0.8 million from the issuance of common
stock under our Employee Stock Purchase Plan and $1.0 million from the exercise
of stock options.

We believe the combination of existing working capital of $114.9 million as
of December 31, 2002, including current cash on hand of $77.1 million at
year-end, will be adequate to meet anticipated capital and liquidity
requirements for the foreseeable future even if the prolonged downturn in the
seismic equipment market continues. The most significant use of cash over the
next two-year period will be the requirement to repay the $31.0 million
unsecured promissory note due in May 2004. Based on our current cash levels and
estimated uses of cash over this period, we believe we will be able to
sufficiently fund our planned operations. However, there can be no assurance
that our sources of cash will be able to support our capital requirements in the
long-term, and we may be required to issue additional debt or equity securities
in the future to meet our capital requirements. There can be no assurance we
would be able to issue additional equity or debt securities in the future on
terms that are acceptable to us or at all.

FUTURE CONTRACTUAL OBLIGATIONS

The following table sets forth estimates of future payments for 2003
through 2008 and thereafter of our consolidated contractual obligations as of
December 31, 2002 (in thousands):

The debt and lease obligations at December 31, 2002 consist of a $31.0
million unsecured promissory note issued in connection with the repurchase of
Preferred Stock during 2002, along with $2.7 million in additional unsecured
promissory notes related to acquisitions made during 2002 and 2001. The
remaining amount of the obligation (approximately $19.9 million) relates to
lease arrangements primarily involving the Company's use of certain land and
buildings. Under this lease arrangement, the Company has not met the tangible
net worth test for the third and fourth quarters of 2002. If the Company fails
to meet the requirements

15

of this test for any four consecutive quarters during the first five years of
the lease, the Company is required to provide a letter of credit in the amount
of $1.5 million. For further discussion of Long-Term Debt and Lease Obligations,
see Note 8 of Notes to Consolidated Financial Statements.

The operating lease commitments at December 31, 2002 relate to the
Company's lease of certain equipment, offices, and warehouse space under
non-cancelable operating leases. For further discussion of operating leases, see
Note 15 of Notes to Consolidated Financial Statements.

The liability for product warranties at December 31, 2002 relates to the
estimated future expenditures associated with the Company's guarantee that all
manufactured equipment is free from defects in workmanship, materials, and
parts. For further discussion of product warranty, see Note 7 of Notes to
Consolidated Financial Statements.

The warrant obligation at December 31, 2002 represents the fair value of
warrants which were issued by the Company in connection with the August 2002
repurchase of Preferred Stock. If the Company is acquired in a business
combination pursuant to which the stockholders receive less than 60% of the
aggregate consideration in the form of publicly traded common equity, then the
holder of the warrants has the option to require the Company to acquire the
warrants at their fair value as determined by the Black-Scholes valuation model
as further refined by the terms of the warrant agreement. Because the Company
may be required to repurchase the warrants in these limited circumstances, the
warrants are classified as a current liability on our balance sheet and we
record any change in value as a credit or charge to the consolidated statement
of operations. For further discussion of the warrant obligation, see Note 11 of
Notes to Consolidated Financial Statements.

As part of the acquisition of AXIS, the Company could be required to pay
additional consideration to the former shareholders of AXIS at an amount equal
to 33.33% of AXIS' EBITDA (as adjusted by the terms of the Earn-out Agreement),
for the years ended December 31, 2003, 2004, and 2005, exceeding a minimum
threshold of $1.0 million.. Also, as part of the S/N acquisition, the Company
could be required to pay additional consideration up to a maximum of $5.0
million if certain revenue and sales thresholds are met.

Under many of our outsourcing arrangements, our manufacturing partners
first utilize our on-hand inventory, then directly purchase inventory at
agreed-upon levels to meet our forecasted demand. If demand proves to be less
than we originally forecasted, our manufacturing partners have the right to
require us to purchase any excess or obsolete inventory that our partners
purchased on our behalf. Should we be required to purchase inventory pursuant to
these provisions, we may be required to expend large sums of cash for inventory
that we may never utilize. Such purchases could materially and adversely effect
our financial position and our results of operations. As our outsourcing
activity increases the risk will increase that we might be required to purchase
excess or obsolete inventory. Historically, we have not been required to
purchase any excess or obsolete inventory under our outsourcing arrangements.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations". This Statement addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. The provisions of this Statement are effective for fiscal years beginning
after June 15, 2002. Due to the nature of our business, this Statement is not
expected to have a significant impact on our reported results of operations and
financial condition.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Correction." SFAS No. 145 allows classification of gains and losses from the
extinguishment of debt as extraordinary items in the income statement only if
they are deemed to be unusual and infrequent. In addition, SFAS No. 145 also
requires that capital leases that are modified so that the resulting lease
agreement is classified as an operating lease be accounted for as a sale-
leaseback transaction. SFAS No. 145 is effective for fiscal years beginning
after May 15, 2002. We do not

16

expect the provisions of this Statement to have a significant impact on our
reported results of operations and financial condition.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue No.
94-3, a liability for an exit cost was recognized at the date of an entity's
commitment to an exit plan. The provisions of this Statement are effective for
exit or disposal activities that are initiated after December 31, 2002. We have
continued to follow EITF No. 94-3 for our exit and disposal activities, which
were initiated prior to December 31, 2002.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure -- and amendment of FASB No. 123."
This Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation,"
to provide alternative methods of transition for a voluntary change in fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require more prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. The provisions of this
Statement are effective for fiscal years ending after December 15, 2002. We have
elected to continue to follow the intrinsic value method of accounting
prescribed by Accounting Principal Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees." See Critical Accounting Policies and Estimates and
Note 1 of Notes to Consolidated Financial Statements for the proforma results if
we had adopted SFAS No. 123.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others: an Interpretation of FASB Statements No.
5, 67, and 107 and Rescission of FASB Interpretation No. 34." Interpretation No.
45 clarifies the requirements of FASB Statement No. 5, "Accounting for
Contingencies," relating to the guarantor's accounting for, and disclosure of,
the issuance of certain types of guarantees. The initial recognition and
measurement provisions of this Interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. The disclosure
provisions of the Interpretation are effective for financial statements ending
after December 15, 2002. We have adopted the provisions related to the
disclosure requirements of this Interpretation effective for the year ended
December 31, 2002. We do not expect the provisions of this Interpretation to
have a significant impact on our reported results of operations and financial
condition.

REPURCHASE OF SERIES B AND SERIES C PREFERRED STOCK

On August 6, 2002, we repurchased all of the 40,000 outstanding shares of
our Series B Convertible Preferred Stock and all of the 15,000 outstanding
shares of our Series C Convertible Preferred Stock from SCF-IV, LP ("SCF"), a
Houston-based private equity fund specializing in oil service investments. In
exchange for the Preferred Stock, we paid SCF $30.0 million in cash at closing,
issued SCF a $31.0 million unsecured promissory note due May 7, 2004 and granted
SCF warrants to purchase 2,673,517 shares of our common stock at $8.00 per share
through August 5, 2005. The Note bears interest at 8% per annum until May 7,
2003, at which time the interest rate will increase to 13%. We record interest
on this note at an effective rate of approximately 11% per year. Should we
redeem the note early, any excess interest accrued would be recorded as an
adjustment of interest expense during the period the note is redeemed.
Immediately preceding the closing of this transaction, David C. Baldwin, the
elected representative of the holder of the Preferred Stock, resigned from our
Board of Directors.

We issued the Preferred Stock in 1999, at a purchase price of $1,000 per
share (the "Stated Value"), for an aggregate of $55.0 million. Since that time,
the Preferred Stock has earned an 8% dividend, of which we paid 1% quarterly in
cash and we accrued the balance to increase the Adjusted Stated Value ($1,000
per share

17

Stated Value plus accrued and unpaid dividends) of the Preferred Stock. The
Adjusted Stated Value of the Preferred Stock as of August 6, 2002, was $68.8
million.

The Preferred Stock became convertible at the option of SCF on May 7, 2002.
Under its terms, the number of shares into which the Preferred Stock would have
been convertible is the greater of (i) Stated Value divided by approximately
$8.14 per share or (ii) Adjusted Stated Value divided by the average market
price of our common stock during the ten-day trading period immediately prior to
conversion. We had the right, without the holder's consent, to redeem for cash
up to one-half of any Preferred Stock tendered for conversion based on the
Adjusted Stated Value of such Preferred Stock on the conversion date. If SCF had
converted all of the Preferred Stock on August 6, 2002, and we had declined to
exercise our redemption rights, SCF would have received approximately 9.2
million shares of our common stock, representing 15.3% of the total outstanding
common stock of the Company after giving effect to the conversion.

Under the terms of a registration rights agreement, SCF has the right to
demand that we file a registration statement for the resale of the shares of
Common Stock SCF acquires upon exercise of the warrants. Sales or the
availability for sale of a substantial number of our shares of Common Stock in
the public market could adversely affect the market price for our Common Stock.
If we are acquired in a business combination pursuant to which our stockholders
receive less than 60% of the aggregate consideration in the form of publicly
traded common equity, then the holder of the warrants has the option to require
the Company to acquire the warrants at their fair value as determined by the
Black-Scholes valuation model as further refined by the terms of the warrant
agreement. Because we may be required to repurchase the warrants in these
limited circumstances, we classify the warrants as a current liability on our
consolidated balance sheet. Every quarter the warrants are revalued and any
change in value is recorded as a credit or charge to our consolidated statement
of operations.

CREDIT RISK

A continuation of weak demand for the services of certain of our customers
will further strain their revenues and cash resources, thereby resulting in
lower sales levels and a higher likelihood of defaults in the timely payment of
their obligations under credit sales arrangements. Increased levels of payment
defaults with respect to our credit sales arrangements could have a material
adverse effect on our results of operations.

Our principal customers are seismic contractors, which 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 to oil and gas companies. During the year
ended December 31, 2002, two customers (Western-Geco and Laboratory of Regional
Geo Dynamics) each accounted for approximately 10% of consolidated net sales.
The loss of either of these customers could have a material adverse effect on
our results of operations and financial condition. In recent years, our
customers have been rapidly consolidating, shrinking the demand for our
products. See Management's Discussion and Analysis of Results of Operations and
Financial Condition -- Cautionary Statement for Purposes of Forward Looking
Statements -- Further consolidation among our significant customers could
materially and adversely affect us and Note 13 of Notes to Consolidated
Financial Statements.

During the year ended December 31, 2002, we recognized $21.2 million of
sales to customers in Russia and other former Soviet Union countries, $7.2
million of sales to customers in Latin American countries and $15.7 million of
sales to customers in Asia. The majority of our foreign sales are denominated in
U.S. dollars. In recent years, Russia and certain Latin American countries have
experienced economic problems and uncertainties as well as devaluations of their
currencies. To the extent that economic conditions negatively affect our future
sales to customers in those regions or the collectibility of our existing
receivables, our future results of operations, liquidity and financial condition
may be adversely affected.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of consolidated financial statements in conformity with
generally accepted accounting principles in the United States of America
requires management to make choices between acceptable methods of accounting and
to use judgment in making estimates and assumptions that affect the reported
18

amounts of assets and liabilities, disclosure of contingent assets and
liabilities and the reported amounts of revenue and expenses. The following
accounting policies are based on, among other things, judgments and assumptions
made by management that include inherent risk and uncertainties. Management's
estimates are based on the relevant information available at the end of each
period.

- Our revenue is primarily derived from the sale of data acquisition
systems and related equipment. We typically recognize revenue when we
ship products and risk of ownership has passed to the customer. We
warrant that all manufactured equipment will be free from defects in
workmanship, material and parts. Warranty periods typically range from 90
days to three years from the date of original purchase, depending on the
product. We record an accrual for product warranty and other
contingencies when estimated future expenditures associated with such
contingencies become probable, and the amounts can be 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).

- We periodically evaluate the net realizable value of long-lived assets,
including property, plant and equipment, relying on a number of factors
including operating results, business plans, economic projections and
anticipated future cash flows. We recognize impairment in the carrying
value of an asset whenever we estimate that anticipated future cash flows
(undiscounted) from an asset are less than its carrying value. We
recognize the difference between the carrying value of the asset and its
fair value as the amount of the impairment. Since we must exercise
judgment in determining the fair value of long-lived assets, the carrying
value of our long-lived assets may be overstated or understated.

In 2002, we announced plans to close our Alvin, Texas and Norwich, U.K.
manufacturing facilities and combined our two Colorado-based operations
into one location. Applicable accounting rules required us to perform an
impairment analysis as a result of the announced closures. As a result,
we recorded an impairment charge of $6.9 million in 2002. We primarily
relied upon quoted market prices for the facilities and forecasted
negative cash flows during the interim period prior to their closure to
determine the amount of the impairment.

- On January 1, 2002, we adopted SFAS No. 142 "Goodwill and Other
Intangible Assets." Since adoption of SFAS No. 142 we no longer amortize
goodwill, but instead test for impairment at least annually and as
triggering events occur. In making this assessment we rely on a number of
factors including operating results, business plans, economic
projections, anticipated future cash flows and market place data. There
are inherent uncertainties related to these factors and our judgment in
applying them to the analysis of goodwill impairment. Since our judgment
is involved in performing goodwill valuation analyses, the carrying value
of our goodwill may be overstated or understated.

In the third quarter of 2002, we recorded an impairment charge of $15.1
million, which related to all the goodwill of our land analog reporting
unit, a reporting unit within our Land division. The continuing weakness
in the traditional analog land seismic markets and the precarious
financial condition of many of the seismic contractors, coupled with an
anticipated decrease in demand for analog products due to the success of
our new VectorSeis digital sensor technology, precipitated the need for
this interim impairment. We determined the fair value of the reporting
units using a discounted future returns valuation method.

- When we consider an account or note is impaired, we measure the amount of
the impairment based on the present value of expected future cash flows
or the fair value of collateral. We include impairment losses
(recoveries) in our allowance for doubtful accounts and for loan loss
through an increase (decrease) in bad debt expense. Notes receivable are
generally collateralized by the products sold, bear interest at
contractual rates up to 13.5% per year and are due at various dates
through 2005. The weighted average interest rate at December 31, 2002 for
our notes receivable was 8.5%. We first apply cash receipts on impaired
notes to reduce the principal amount of such notes until the principal
has been recovered and then we recognize additional cash receipts as
interest income thereafter.

19

- We provide reserves for estimated obsolescence or excess inventory equal
to the difference between cost of inventory and estimated market value
based upon assumptions about future demand for our products and market
conditions. In 2002 and 2001, we recorded inventory obsolescence charges
of approximately $4.3 million and $3.6 million, respectively, which
primarily related to the discontinuance of certain analog land seismic
and marine positioning products, and to a lesser extent, inventory
determined to be in excess of our near-term requirements.

- In 2002, we established an additional valuation allowance to reserve all
of our net deferred tax assets. Although our plans include generating
sufficient taxable income in future years to fully utilize our net
operating losses, such expectation is subject to significant amount of
risk and uncertainty. In accordance with SFAS No. 109 we established an
additional valuation allowance for our net deferred tax assets based on
our cumulative operating results in the most recent three-year period.
Our results in this period were heavily affected not only by industry
conditions, but also by 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 of our
VectorSeis technology. Nevertheless, recent losses represented sufficient
negative evidence to establish an additional valuation allowance. We will
continue to reserve all of our net deferred tax assets until we have
sufficient evidence to warrant reversal. This valuation allowance in no
way affects our ability to reduce future tax expense through utilization
of net operating losses.

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

We believe that all of the estimates used to prepare our financial
statements were reasonable at the time we made them, but circumstances may
change requiring us to revise our estimates in ways that could be materially
adverse.

RELATED PARTIES

In connection with the acquisition of DigiCourse, Inc. in November 1998, we
entered into a service agreement under which a predecessor to Laitram, L.L.C.
("Laitram") agreed to provide accounting, software, manufacturing and
maintenance services. The service agreement expired September 30, 2001 and
Laitram now charges us on an invoice basis for facility rental and maintenance
as well as manufacturing services. Our chairman of the board is the chairman and
a principal stockholder of Laitram. For the year ended December 31, 2002, we
paid Laitram a total of $1.9 million, which consisted of $1.2 million for
manufacturing services, $0.6 million for rent and other facility related
services and $0.1 million for other services. Manufacturing services consisted
primarily of machining of parts for our marine positioning systems. For the year
ended December 31, 2001, seven months ended December 31, 2000 and year ended May
31, 2000, we paid Laitram an aggregate $1.4 million, $0.8 million and $1.5
million, respectively. In the opinion of management, the terms of such services
are fair and reasonable, and as favorable to I/O as those which could have been
obtained from unrelated third parties at the time of their performance.

20

In 2000, a former director and former officer assisted in the collection
efforts of certain accounts and notes receivable. In return, we paid him a
commission on actual amounts collected. Commissions earned amounted to $0.1
million and $0.5 million, for the seven months ended December 31, 2000 and year
ended May 31, 2000, respectively.

We have guaranteed $0.2 million of bank indebtedness for one officer
related to the open market purchases of our common stock. The share purchases
were made in conjunction with shares issued in May 2000 under the Input/Output,
Inc. 2000 Restricted Stock Plan. The outstanding loan balance at December 31,
2002 was $0.2 million. Our guarantee expired in March 2003.

CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD-LOOKING STATEMENTS

We have made statements in this report which constitute forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934. Examples of forward-looking statements in this report include statements
regarding:

- our expected revenues, operating profit and net income for 2003 or the
three months ended March 31, 2003;

- our plans for facility closures and other future business
reorganizations;

- charges we expect to take for future reorganization activities;

- savings we expect to achieve from our restructuring activities;

- future demand for seismic equipment and services;

- future commodity prices;

- future economic conditions;

- anticipated timing of commercialization and capabilities of products
under development;

- 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

- our future levels of capital expenditures.

You can identify these forward-looking statements by forward-looking words
such as "believe," "may," "could," "will," "estimate," "continue," "anticipate,"
"intend," "seek," "plan," "expect," "should," "would" and similar expressions.
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. While we cannot
identify all of the factors that may cause actual events to vary from our
expectations, we believe the following factors should be considered carefully:

Recent announcements by geophysical contractors indicate that demand for
our products will continue to be weak in the near term. Western-Geco, our
largest customer, recently announced that it was ceasing land seismic operations
in Canada and the Continental United States. Veritas DGC, another large
customer, recently announced that it was reducing its capital expenditures by
more than $30 million in its current fiscal year. These and other announcements
by geophysical contractors indicate that demand for our products will continue
to be weak in the near term which will have a material adverse effect on our
results of operations and financial condition.

We may not gain rapid market acceptance for VectorSeis products, which
could materially and adversely affect our results of operations and financial
condition. We have spent considerable time and capital
21

developing our VectorSeis products line. Because our VectorSeis products rely on
a new digital sensor, our ability to sell our VectorSeis products will depend on
acceptance of digital sensor by geophysical contractors and exploration and
production companies. If our customers do not believe that our digital seismic
sensors deliver higher quality data with greater operational efficiency, our
results of operations and financial condition will be adversely affected.

In addition, products as complex as those we offer sometimes contain
undetected errors or bugs when first introduced that, despite our rigorous
testing program, are not 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. We cannot assure you that errors will not be found in future releases
of our products, or that these errors will not impair the market acceptance of
our products. If our customers do not accept our new products as rapidly as we
anticipate, our business and results of operations may be materially and
adversely affected.

Our business reorganization and facilities closure plans may not yield the
benefits we expect and could even harm our financial condition, reputation and
prospects. We intend to significantly reduce our corporate and operational
headcount, close certain manufacturing facilities and combine certain of our
business units. These activities may not yield the benefits we expect, and may
raise product costs, delay product production, result in or exacerbate labor
disruptions and labor-related legal actions against us, and create
inefficiencies in our business.

Our strategic direction and restructuring program also may give rise to
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. 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.

We have developed outsourcing arrangements for the manufacturing of 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, 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 reputations 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.

Our outsourcing relationships may require us to purchase inventory when
demand for products produced by third-party manufacturers is low. Under many of
our outsourcing arrangements, our manufacturing partners purchase agreed upon
inventory levels to meet our forecasted demand. If demand proves to be less than
we originally forecasted, our manufacturing partners have the right to require
us to purchase any excess or obsolete inventory. Should we be required to
purchase inventory pursuant to these provisions, we may be required to expend
large sums of cash for inventory that we may never utilize. Such purchases could
materially and adversely effect our financial position and our results of
operations.

Recent resignations by our executives may require a change in strategy
which may materially and adversely affect our business and results of
operations. Since the beginning of this year, our former Chief Executive
Officer and our Vice President-Marketing & Sales have resigned and our Chief
Operating Officer has announced his intention to resign shortly after the
appointment of a new Chief Executive Officer. We

22

recently hired a new Chief Executive Officer and may recruit other senior
managers. It will take some time for our new Chief Executive Officer to learn
about our various businesses and to develop strong working relationships with
our operating managers. To the extent we decide to change our strategy as a
result of these hires or to the extent such hires are delayed, our business and
results of operations may be materially and adversely affected, particularly in
the near-term.

Oil and gas companies and geophysical contractors will reduce demand for
our products if there is further reduction in the level of exploration
expenditures. Demand for our products is particularly 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. Any prolonged
reduction in oil and gas prices will depress the level of exploration activity
and correspondingly depress demand for our products. A prolonged downturn in
market demand for our products will have a material adverse effect on our
results of operations and financial condition.

We derive a substantial amount of our revenues from foreign sales, which
pose additional risks. Sales to customers outside of the United States and
Canada accounted for approximately 71% of our consolidated net sales for the
year ended December 31, 2002. As Western contractors have announced plans to
curtail operations, we believe that export sales will grow as a 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 there can
be no assurance that we will not experience difficulty in obtaining such
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;

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

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

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

In addition, we are subject to taxation in many jurisdictions and the final
determination of our tax liabilities involves the interpretation of the statutes
and requirements of taxing authorities worldwide. Our tax returns are subject to
routine examination by taxing authorities, and these examinations may result in
assessments of additional taxes, penalties and/or interest.

The on-going conflict with Iraq could materially and adversely affect
future sales of our geophone strings. We have relocated some of our geophone
stringing operations to a Company-leased facility in the UAE. The on-going war
with Iraq has resulted in the Company placing restrictions on travel to and from
the UAE. The war has raised the likelihood that we may need to curtail
operations at the UAE facility, causing us to experience significant costs
associated with temporarily relocating the manufacturing of geophone strings. If
we are unable to quickly relocate our UAE operations, we may be unable to
fulfill current orders or accept future orders and our results of operations and
financial condition will be materially and adversely affected.

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

23

characterized by rapidly changing technology and frequent product introductions.
We must invest substantial capital to maintain our 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 and results of operations 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. Our
industry is highly competitive. Our competitors have been consolidating into
better-financed companies with broader product lines. Several 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 competitors have expanded or improved their product lines, which has
adversely affected our results of operations. For instance, one competitor
introduced a lightweight land seismic system that we believe has made our
current land system more difficult to sell at acceptable margins. In addition,
one of our competitors introduced a marine solid streamer product that competes
with our oil-filled product. Our net sales of marine streamers have been, and
will continue to be, adversely affected by customer preferences for solid
products. We cannot assure you that we will find a cost-effective way to market
a solid streamer product or that we will be able to compete effectively in the
future for sales of marine streamers.

Further consolidation among our significant customers could materially and
adversely affect us. Historically, a relatively small number of customers have
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
or otherwise could materially and adversely affect our results of operations and
financial condition.

Large fluctuations in our sales and gross margin can result in operating
losses. Because our products have a high sales price and 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 margin. 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.

We may be unable to obtain broad intellectual property protection for our
current and future products, which may significantly erode our competitive
advantages. 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

24

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.

We are not aware that our products infringe upon the proprietary rights of
others. However, third parties may claim that we have infringed upon their
intellectual property rights. Any such claims, with or without merit, could be
time consuming, result in costly litigation, 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.

Significant payment defaults under extended financing arrangements could
adversely affect us. We often sell to customers on extended-term arrangements.
Significant payment defaults by customers could have a material adverse effect
on our financial position and results of operations.

Our operations are subject to numerous government regulations, which could
adversely limit our operating flexibility. Our operations are subject to laws,
regulations, government policies and product certification requirements
worldwide. Changes in such laws, regulations, policies or requirements could
affect the demand for our products or result in the need to modify products,
which may involve substantial costs or delays in sales and could have an adverse
effect on our future operating results. Certain countries are subject to
restrictions, sanctions and embargoes imposed by the United States government.
These restrictions, sanctions and embargoes prohibit or limit us from
participating in certain business activities in those countries. In addition,
changes in governmental regulations applicable to our customers may reduce
demand for our products. For instance, recent regulations regarding the
protection of marine mammals in the Gulf of Mexico may reduce demand for our
airguns and other marine products.

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.

NOTE: THE FOREGOING REVIEW OF 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 WHICH 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 7A. 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 and rates. The
Company traditionally has not entered into significant derivative or other
financial instruments other than as described below. The Company is not
currently a borrower under any material credit arrangements, which feature
fluctuating interest rates. The Company is subject to exposure from fluctuations
in foreign currencies.

As discussed in "Item 7 -- Managements Discussion and Analysis of Results
of Operations -- Repurchase of Series B and Series C Preferred Stock" and Note
11 of Notes to Consolidated Financial Statements, we repurchased all outstanding
shares of our Preferred Stock. As part of the repurchase we granted warrants to
purchase 2,673,517 shares of the Company's common stock at $8.00 per share
through August 5, 2005.

25

Because in certain circumstances upon a change in control we may be required to
redeem the warrants for cash, we record changes in the fair value of the
warrants as a credit to income or as an expense. A $1 increase in our common
stock price at December 31, 2002, would have increased the fair value of
warrants resulting in an increase to our net loss of approximately $1.3 million
or $(.02) per common share. A $1 decrease in our common stock price at December
31, 2002, would have decreased the fair value of warrants resulting in a
decrease to our net loss of approximately $1.0 million or $.02 per common share.
The fair value of the warrants was $2.2 million at December 31, 2002. We
determined fair value using the Black-Scholes valuation model as further refined
by the terms of the warrant agreement. The key variables we used in valuing the
warrants were contractually specified and were as follows: risk-free rate of
return of Treasury notes having an approximate duration of the remaining term of
the warrants and expected stock price volatility of 60%.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements required by this item begin at page F-1 hereof.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 is included in our definitive proxy
statement for our 2003 Annual Meeting of Stockholders under the headings
"Election of Directors" and "Executive Officers."

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is included in our definitive proxy
statement for our 2003 Annual Meeting of Stockholders under the heading
"Executive Compensation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The information required by Item 12 is included in our definitive proxy
statement for our 2003 Annual Meeting of Stockholders under the heading
"Ownership of Equity Securities in I/O.".

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is included in our definitive proxy
statement for our 2003 Annual Meeting of Stockholders under the heading "Certain
Transactions and Relationships."

ITEM 14. CONTROLS AND PROCEDURES

Our President and Chief Operating Officer and our Chief Administrative
Officer (the "Certifying Officers") have evaluated the Company's disclosure