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ION Geophysical Corporation (NYSE:IO)

Q3 2008 Earnings Call

November 05, 2008 at 10:00 am ET

Executives

James M. Lapeyre Jr. – Chairman of the Board

Robert P. Peebler - President & Chief Executive Officer

R. Brian Hanson - Executive Vice President & Chief Financial Officer

Jack Lascar- Investor Relations - Dennard Rupp Gray & Easterly

Analysts

James West – Barclay’s Capital

Terese Fabian - Sidoti & Company

Morten Nystrom - Finley Fones

Joe Agular - Johnson Rice & Company

Operator

Welcome to the ION Geophysical third quarter earnings conference call. In today’s presentation all parties will be in a listen only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today Wednesday, November 5, 2008. I would now like to turn the conference over to Jack Lascar with DRG&E. Please go ahead sir.

Jack Lascar

Thank you, Britney and good morning. We appreciate your joining us today. Your hosts today are Bob Peebler, President and Chief Executive Officer and Brian Hanson, Executive Vice President and Chief Financial Officer.

Before I turn the call over to management I have a few items to cover.

If you would like to be on an email distribution list to receive future news releases or experience some technical problem and did not receive your release yesterday, please call DRG&E and provide us with that information. That number is 713-529-6600. If you would like to listen to a replay of today’s call, it is available by webcast by going to the investor relations section of the Company’s website at www.IONGEO.com or via recorded instant replay until November 19. The information was provided in yesterday’s earnings release.

Information reported on this call speaks only as of today, November 5, 2008 and therefore you are advised that time sensitive information may no longer be accurate as of the time of any replay. Before we begin let me remind you that certain statements made by management during this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management’s current expectations and include known and unknown risks, uncertainties and other factors, many of which the Company is unable to predict or control that may cause the Company’s actual results or performance to differ materially from any future results or performance expressed or implied by those statements.

These risks and uncertainties include the risk factors disclosed by the Company from time to time in its filings with the SEC including in its annual report on Form 10-K for the year ended December 31, 2007, and its quarterly reports on Form 10-Q. Furthermore, as we start this call please refer to the statement regarding forward-looking statements incorporated in our press release issued yesterday and please note that the contents of our conference call this morning are covered by those statements.

I will turn the call now to Bob Peebler.

Robert P. Peebler

Good morning and thanks for joining us on our third quarter conference call. We are very pleased with our record third quarter revenues and improve profitability. We had another exact quarter in Marine Imaging Systems driven by strong sales of positioning systems and DigiFIN streamer technology and the delivery of most of the remaining portion of the fifth VectorSeis Ocean System for RXT. We are also delighted by the continued record performance of our ION Solutions group including new venture sales related to our programs off the coast of Alaska, South America, and West Africa in our continued strength and data processing.

Our Land Imaging Systems gross margin continuous to improve driven by reductions in cable system and VibroSeis vehicle costs and higher margins for ARAM system sales. Even though we had a strong quarter and expect to finish the year within our original earnings guidance, we realize that along with the rest of the industry, we are likely to be affected by the current turbulence in the financial markets resulting in the ensuing slowdown of the economy and the decline of commodity prices. From a macroeconomic standpoint, we believe the size in the industry is likely to be affected by the economic slowdown which we are assuming will likely last to 2009 and may well expand into 2010. Two main areas most likely to be affected for us will be our land business in North America and Russia.

We still believe we are in a long growth phase for the oil and gas business and what we are experiencing is a temporary down cycle within the context of this long growth phase. The underlying issues of decline in reserves and the likely continued increase in energy demand over the long term will still be in the fundamental drivers of the industry. It is clear to me that investor perceptions have shifted dramatically from concern about oil supplies as recently as last summer can overwhelming concerned about demand due to the economic slowdown related to the financial crisis and a resulting impact in commodity prices.

I have most recently heard concerns that we may be entering the downturn and oil consumption similar to the 1980s where demand fell over 6 billion barrels a day, oil prices plunged has been and it took almost a decade to recover. During that period oil prices plummeted from a high of $32 barrel in 1981 to $6 of 1986 and prices languished for the rest of the decade.

I would like to point out two important differences on a consumption side in the 1980s compared to now. First in the US and Europe, there was a significant switch from oil to natural gas related to power generation that is started in 1982 and resulted in a significant and almost instant plunge in oil usage. We do not have nearly the same extent of switching to natural gas going on today. Second, in the 70s and early 80s prices were driven mainly by OPEC controlling production starting with the OPEC or the embargo in 1973.

Today, the rapid economic growth in Asia and other developing countries has significantly increase demand resulting in very little excess capacity. I still think it is reasonable to assume that future economic development will continue particularly in Asia unless the financial crisis grows beyond the recession. I would rather not speculate on the depth of that recession compared to the early 80s as they are very different animals but I would like to focus on what I think is the biggest difference related to supply of oil and the impact on price.

In the late 70s and early 80s OPEC had significant excess capacity and new non-OPEC capacity including the North Sea and Alaska were hitting in the market as a result of the drilling boom that started in the early 70s. The combination of the excess capacity and the decline in consumption created industry overhang of over 12 million barrels a day against 60 million barrels per day of production. In the 70s and 80s it took more than a decade to work to that surplus production. The biggest difference today and what I believe is one of the most significant factors to consider related to commodity prices and drilling activity is peak production by country.

In 1980, there were only six countries that had reached peak production including the Lower 48 and Indonesia. The other four peak production countries were minor players such as Germany and Romania. Starting in 1990, 18 more production areas have reached peak production including Alaska and the North Sea that were just come in to production back in the 1970s. Peak production is caused by the aggregate natural production decline of older fields and that decline is accelerating around the world. A recently released IEA report which is the first in-depth study of oil field declines around the world estimates that the 500 largest fields in the world have a natural decline rate of 9.1%. This decline rate is much larger than previously believed. The report estimates that it will take $360 billion of industry investment per year through 2030 to meet the world hydrocarbon demand and even at this rate of investment the oil field decline will still reduce to 6.8%.

At today’s estimated production of 87 million barrels per day, the industry has to find nearly 6 billion barrels per day just to keep even. With these facts, we believe that is reasonable to assume that any activity decline due to the recession in lower commodity prices will quickly aggravate the long term supply problem and a result will likely be the prospect of even greater shortages down the road. It is this problem combined with the fact that easy oil has been found that causes us to be bullish on both expiration and exploitation activities and the needed geophysical technology both new measurements and process and interpretation that reduce risk and increase productivity. We frankly disagree with the assertion by some that we are approaching the end of the geophysical cycle and we would argue that we are closer to the beginning of a long, higher end technology cycle. We do expect some cutback in spending due to 2009, during 2009 due to the debt crunch and other short term adjustments being made due to short term commodity prices that we believe that a longer term up cycle is still intact likely starting again sometime in 2010 assuming by then that the end is in sight for any global recession. What will be different is the gross cycle has lasted long enough that significant new capacity is coming into the market in all areas of the business and we expect price deflation for the companies and earnings growth has mainly been dependent on high activity and price inflation.

It is more of this commodity end of the business where we believe all companies will likely be working to reduce their cost through more competition and contractors will have to compete more on efficiency and high-end technology to grow profitably. We also believe that the stronger contractors will be upgrading their fleets and land crews to better compete and will be retiring equipment that was put into service to meet the demand and take advantage of the oil rise high prices.

We strongly believe that in an environment of lower commodity prices technology becomes even more relevant to all companies as they need to be even more efficient in finding and developing oil and gas reservoirs. The declining commodity price does not mean that the E&P challenge has gotten easier.

Oil companies will continue to look for ways to reduce the number of dry holes and to get more out of existing reservoirs more cost effectively. We believe that we are clearly moving from the pricing leverage due to capacity constraints to technology differentiation. That being said, we are mindful of the fact that in the short term both domestic and international oil companies are becoming more cautious and cost-conscious as a result of the recent turmoil and commodities and credit markets and we will have to work harder to prove our technology and services are even more important to both contractors and oil companies.

ION is very well positioned for this new environment as we have invested over $160 million in R&D over the last five years aimed at resolving tough imaging problems and significantly improving productivity and field operations for both marine and land. We also have chosen to be asset light, meaning that we are not in the seismic contracting business and do not own crews in the associated equipment but rather have invested in technology in both acquiring and processing for the most difficult imaging challenges. Since we are not in the contracting business our multi-client business should also benefit if boats and land crews become more available at lower costs.

As to our market presence with the exception of our recently acquired ARAM business, the majority of our businesses are international markets and the deep water Gulf of Mexico. We believe ARAM sales are likely to be impacted the North America for the balance of the year and 2009 due to the weakness in gas markets but we plan to mitigate that problem as much as possible by pushing more their product through our international channels and consolidating the ARAM business with our Scorpion cable system business, which we believe our result and significant cost reductions.

I am optimistic about our improved competitive position with the acquisition of ARAM and feel confident that the combination gives us an improved ability to navigate through this land down cycle. Although we are very aware of the challenges facing us and are preparing for some impact on our business, our visibility in the future business is currently difficult due to the high level of uncertainty with both our oil company and contract to customers.

As a result in the short term, we are tightening our earnings guidance for 2008 which will be covered in more detail by Brian. As far as 2009 is concerned, we are in the middle of our budgeting cycle and while we expect softness in some of our markets and are tightening up appropriately, we also believe our portfolio high technology and the complex challenges and a strong mix of international business should provide us with the opportunity to have a solid year. We will update you on our 2009 annual guidance call sometime in mid-December.

I will now turn the call over to Brian.

R. Brian Hanson

Thank you, Bob. Good morning everyone.

As Bob mentioned, we had a robust third quarter. We generated $219 million compared to $174 million during the third quarter of 2007, an increase of almost 25%. Our year-to-date revenues increased seven percentage points or $36 million to $539 million. Our 2007 sales include revenue associated with sale for FireFly version one system for $21 million and $58 million associated with the delivery of a 14 Land Seismic acquisition systems to ONGC.

Sales from the remaining non-Land division product and service offerings including our marine imaging systems and ION solution segments have continued to grow in revenues and income from operation compared a year ago. We continue to see improvement in our gross margin in the third quarter as compared to 2007 with third quarter gross margins of 33%. A year-to-date gross margin rate of 33% is six percentage points better than the same period in the prior year. This increase is reflected across from the majority of our segments but most notably in our ION solutions and land businesses. In our ION solutions division is strong multi-client data library sales including recently completed programs combined with robust new venture multi-client surveys off the coast of South America, Africa and the Arctic led to significant margin increases compared to 2007.

In our land imaging system segment, we continue to benefit from margin improvements related the cost reduction programs around our Scorpion cable system and with our VibroSeis vehicle sales. We also had additional system sales of ARAMs land systems after acquisition date.

In the land imaging system segment revenues increased to $82 million compared to $79 million in 2007. Year-to-date revenues of $177 million decreased $66 million from the same period in 2007. As I mentioned earlier, 2007 included $21 million in revenue associated with sale of the first FireFly system and $58 million associated with the delivery of the systems to ONGC. In a land business, we are starting to see indications of slowing the demand for land seismic acquisition systems across to North America and Russian markets. We believe the slowdown is a direct result of current economic conditions and that demand for our Land products will increase again with the recovery of the economy in late 2009 or early 2010.

However, as Bob mentioned, this economic recession also provides opportunity with the addition of ARAM, we are in the strong strategic position to further penetrate international markets with the lower cost yet highly reliable system. In addition, it provides further opportunities to strengthen our position in the North American market to ARAM’s current rental business in these capital challenged times. ARAM is proven Aries land system eventually combined with our digital VectorSeis technology will provide an even better product offering to meet the needs of our customers.

Currently, we are working on the consolidation of our land business and expect to achieve significant cost reductions for 2009. We would expect to book a restructuring charge associated with this integration in the fourth quarter of this year but do not have it finalized as we are still working through this specific details.

As we move in the 2009, we believe that we are positioning our land imaging systems business to meet and exceed our customers’ needs both now and in the future.

Gross margins in our land business grew during the third quarter to 26% compared to 17% in 2007. This increase was driven by continued focus on cost reductions in our Scorpion system and in our VibroSeis vehicle sales as well as higher margin Aries system sales in the mix.

Marine imaging systems finished another strong quarter with approximately $49 million in revenue as compared to $37 million in revenues for 2007. Year-to-date revenues of $134 million increased $17 million in the comparable period of 2007. The third quarter of 2008 included the delivery of the majority of our fifth VectorSeis ocean system to RXT. Additionally, demand for our streamer positioning and control systems remains strong which include increased sales of our new DigiFIN system with the continued strength shown in the sales of DigiBIRD, DigiFIN and now DigiSTREAMER, our marine business is experiencing another solid year in 2008.

Third quarter gross margin in the marine group declined to 41% compared to 44% in the third quarter of 2007. Year-to-date gross margin in the marine group decreased four percentage points to 39%. These decreases are primarily a result to product mix.

Our third quarter data management solutions segment revenues remain consistent at $10 million compared to $11 million in the third quarter of 2007. Year-to-date revenues of $29 million were up $1 million over the comparable period in the prior year with the mix shifting to more recurring revenue on the software side of the product line as ORCA gains traction and less one-time hardware sales that we saw in 2007 as clients upgraded their systems in anticipation of upgrading to ORCA.

In our ION solutions division net revenues grew 67% to $78 million in the third quarter of 2008. Year-to-date revenues grew to $199 million, a 72% increase from the $116 million generated in the same period of 2007. This growth is primarily driven by increased multi-client data library and new venture sales including new programs off the coast of South America and Alaska.

Third quarter gross margin in the solutions division slightly decreased two points to 31% due to the product mix. Year-to-date gross margin showed a significant improvement by six percentage points to 32% due to strong data library and new venture multi-client surveys.

Overall, consolidated operating expenses for the third quarter of 2008, as a percentage of revenue decreased two percentage points to 19% compared to 21% for the third quarter of 2007. As discussed previously, we expect operating expenses as a percentage of net revenues to remain consistent or even improve over the 2007 levels on a full year basis.

We incurred an income tax expense of approximately $4 million in the third quarter of 2008. Year-to-date income tax expense increased $4 million to $9 million compared to $5 million for the same period of 2007. The income tax expense represents from effective tax rate of 13% for third quarter of 2008 compared to 9% in the third quarter of 2007 driven primarily by the tax jurisdictions for sales occurred around the world. For year-to-date 2008 and 2007 our effective tax rate remains stable at approximately 16%. We nearly doubled our third quarter net income of $25 million compared to the $13 million earned in the third quarter of 2007. For the third quarter of 2008 diluted EPS increased 79% to $0.25 compared to $0.14 in the third quarter of 2007. The third quarter results included several special items. The first item relates to the fair value adjustment of our preferred stock redemption features. Every quarter these features must be valued at fair market value, which caused the non-cash loss of approximately $1.1 million for the third quarter or an impact of $0.01 to our diluted earnings per share.

Additionally, we are charges related to our ARAM acquisition of approximately $900,000 which another $0.01 impact to our diluted earnings per share. The final special item relates to Hurricane Ike, which directly hit the Houston area in September and caused extensive power outages and other infrastructural damage across the region. The impact of this natural disaster was approximately $500,000 or approximately $0.05 impact to our diluted earnings per share.

As a result of this Hurricane, we were forced to shutdown operations in our Texas locations for several days and shipping to the Gulf of Mexico for a New Orleans location was also interrupted. The total impact of these special items is approximately $2.6 million or $2.05 per diluted share. Excluding these special items diluted earnings per share nearly doubled to more than $0.27 in the third quarter of 2008 compared to $0.14 for 2007.

Turning to the balance sheet, inventories rose by $126 million. The increase was primarily due to the acquisition of ARAM as we invest in our new product lines such as DigiFIN, DigiSTREAMER and the commercial version of FireFly. The building of the remaining portion of the fifth VSO system for RXT and building up of Scorpion and VibroSeis vehicle inventory levels in anticipation of fourth quarter demand. Accounts receivable decreased by $8 million from year end 2007. Overall, our working capital decreased 14% over prior year.

CapEx, excluding the investment in our multi-client data library for the first three quarters of 2008 was $11 million. Year-to-date investment in the multi-client library totaled $88 million which continues to be exceptionally as compared to last year. However, we expect the capital demand of our multi-client business for the last quarter of 2008 to be lower than the average spent in the first three quarters of the year as much of the expensive activity shooting seismic was in the spring and through early fall.

As I mentioned earlier, we have entered into several new financing arrangements in order to purchase ARAM. While these agreements and the respective criteria are listed in detail in our 8-K filed in September after the ARAM closing and we will also be described the detail in our third quarter 10-Q, I wanted to give you a brief overviewed this time.

As of September 30, 2008, we had total indebtedness of $315 million of which a $191 million is current. In the late September, we entered into an amendment and restated our credit facility. Part of this amendment included adding a 5 year, $125 million term loan of which $19 million is due within a year. This term loan matures in September 2013 and carries an interest rate of 6.3% at September 30, 2008. We also have $78 million outstanding on a revolving line of credit as of September 30, 2008. Since $72 million of the revolver we used to purchase ARAM, we are required under the amended credit facility to repay it prior to year end and have re-classed the full $72 million to current maturities of long term debt.

Additionally, we entered into a short term bridge loan with Jefferies Finance CP Funding LLC, with a principal amount of $40.8 million and a discount of 2%. This note matures on December 31, 2008. The fees associated with this note and the expense of the 2% discount of approximately $800,000 are being amortize through year end. Again, this note is classified as short term.

We issued one of the sellers of ARAM, a Senior Seller Note in the principal amount of $35 million due upon the earlier September 18, 2009 or the day we replace the bridge facility with other permanent instrument or draw down on the commitment I will describe in a minute.

This debt is an increasing rate debt with the interest rate increasing at marked intervals from 9% to 15% by maturity. This note is short term. Finally, we issued one of the sellers of ARAM a subordinated seller note in the principal amount of $10 million due one day after the senior seller note. Like the senior seller note, this debt has an increasing interest rate in marked intervals from 10% to 16% by maturity. This note is also short term. Therefore in total, we have entered into four new debt agreements for a total of $288 million, a new debt financing for $176 million classified as short term.

The original purpose of issuing these short term debt instruments and bridge financing facility was to close the transaction as quickly as possible as we were concerned that any delay of closing after the announcement of the deal in July would time out both companies with purchases by land contractors until they understood how the surviving entity would go to market. It is our intent to pay down the $72 million on the revolver both sellers’ notes and the bridge facility with a high yield bond.

Ideally, we would have liked to raise the bond funds prior to year end but given the current credit markets that goal maybe unlikely. In anticipation of difficulties in the credit markets and prior to closing, we entered into a bridge long commitment with Jefferies Financial LLC for a one year $150 million bridge loan which can be drawn on between December 15th and December 31st, 2008 if we are not able to raise the desired funds through the high yield bond. We are currently working with our advisors at Jefferies to evaluate the feasibility of marketing the high yield bond in 2008 or deferring it into 2009 and drawing on the commitment to ION.

For 2008, we are reducing the top end of our earnings guidance from $0.85 per diluted share to $0.80 per diluted share. The tightening of our earnings guidance mainly assume that we were not likely see the normal high level of year end spending due to both oil and gas companies and our contractor customers taking the more conservative approach in the current economic climate. We therefore expect 2008 consolidated revenues to be between $780 million and $830 million and earnings to be between $0.70 and $0.80 per diluted share.

As we have done in prior years we will hold a 2009 guidance call in December upon the completion of our 2009 plan to discuss our views on how we see next year’s expected performance unfold.

With that I will turn the call back over to Bob.

Robert Peebler

Thanks Brian. I would like to wrap up with a few specific comments on our new technology and our acquisition of ARAM. As you know, we are in the process of commercializing FireFly but have made a mid-course correction in strategy due to the current credit crunch and the impact on our North American customers.

We expect some rough sledding for our North American contractor customers and expect the significant pull back in their capital spend. For the first time in a long while we are seeing some contractors tacking crews and we expect this may get worse before it gets better.

Our short term dilemma is that all company interest in FireFly has grown significantly since our success at Durham Ranch and we expect that interest level to continue to grow as again further exposure to our marketing efforts. We believe that in the short term the most important thing we can do to get FireFly in the field and we will be looking for some creative business models that assure we can cover short term oil company demand while be in realistic that our North American contractors likely cannot make large capital commitments due to the combination of the debt markets and the current slowdown. In addition the continued to focus on North America, we have also accelerated our international efforts with FireFly. It is more difficult to support early stage technology further from our home based that we believe that the economic climate is better where some of our international customers and the interest is high so by necessity, we have broadened our marketing scope.

We also believe that even though ARAM has seen softening to the Aries product in North America due to the turndown, we are well positioned to aggressively push ARAM into the international markets. We are very close to releasing Aries II, which has significant new capabilities including much higher density shooting. This combined with much lower cost in our Scorpion analog system gives us more flexibility to gain share internationally. Also a big technical push with ARAM will be the integration of VectorSeis into Aries II offering, so we can sell full wave back into Aries or ARAM’s install base.

The ARAM is a bit of a hedge against the diffusion rate of FireFly since we have room to grow from a market share perspective and it is a lower cost to offering for the mainstream market which is still growing internationally.

In marine, we are making great progress with Orca sales and growing interest and demand for DigiFIN. The combination of DigiFIN, DigiBIRD, and DigiSTREAMER are all aimed and not only an approved image but much more productive operations. The cost to DigiFIN can easily be justified by the productivity gains related to more efficient operations, so the value proposition is a perfect fit if contractors are looking for ways to save money while still offering a customer better data.

In summary, I would also like to make a comment on our asset light strategy. We chose not to get into the contracting business as we prefer investing our capital mainly in R&D and to maintain a low fix cost overhead. Our short term goal is to leverage our built-in strengths and navigate through these choppy waters so we can take full advantage of our portfolio technology when more certainty returns to the market.

Operator, we will not take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from James West – Barclay’s Capital.

James West – Barclay’s Capital

Bob, clearly 2009 is going to be more challenging than we thought couple of months back, North America is going to be certainly difficult and definitely under pressure and so I would say your customer base likely to be able to spend less next year. But on the international side, I think the only country or customer base you have mentioned where you see a downturn is Russia at this point. So I wondered if you could talk a little bit more about the international business in this environment. Do you think that your international operations can continue to grow next year?

Robert P. Peebler

With respect to the environment, Russia is the only place today that we have seen issues and frankly, Russia is a bit of puzzle for us. We do not know exactly how event will turnout as we ended 2009. What we are seeing as you would expect is at the lower commodity prices certainly have put pressure on the government and what we do not know is how it is going to find its way into the NOCs which are a dominant part of the Russian market. The Russian dilemma is that about the time this happened, their production has peak in fact, speculated now to production is now in decline and there is pretty good evidence of that. So, I think to have a real dilemma and it is going to be curious to see how that plays out work. We are assuming and we certainly have seen that in the short term, we are assuming that Russia is not going to be as good a robust market as it was in the last couple of years, and we will just have to sort of play that one as it unfolds in 2009 and a remainder of the international markets we really have not seen much effect at all. In fact, as much as we can tell most of the companies we are talking to whether it is NOCs or the large IOCs that are major players are all pretty much seem to be holding to their capital spend. There is a little bit of wait and see attitude but as you know, many of those projects are already locked-in and fairly significant. And then you have countries like China and India that very much have an energy policy that is driving a lot of their activity and we just have not seen any signs of reduction in those markets. So, less Russia, we are still looking at our 2009 plan. We will speak more of that in December but at the moment I would still expect that we will see some growth in international markets.

James West – Barclay’s Capital

Okay. And then just on FireFly quickly with respect to the international, the shift towards the more international markets. Were your customers internationally fairly well aware of FireFly before this or is just going to be a significant marketing effort over the next couple of years?

R. Brian Hanson

No, no. They are very much aware. We have kept them educated and obviously we have been so visible that it would be hard for them not to be aware and so, there is an awareness and we have been in discussions with more than one for sometime but it is still on a different timeframe and so we are just looking at possibilities of going faster than we have originally planned. That has even altered to a certain extent on our own testing programs and thinking about training up some of our international folks who can handle it. So, we have the sort of adjust to that. But I think there is good chance we will end up with some kind of program internationally next year so that is sort of our timeframe that we are working on.

James West – Barclay’s Capital

Bob, do you have to reengineer the product for it to work internationally?

Robert P. Peebler

No. The only thing we have to do is there are some firmware changes, for example, it depends on the radio frequencies but that is a firmware change. I mean basically it is a quite a robust system, so we have to make software tweaks but basically that is the beauty in FireFly that it is the box is a box and the sensor is a sensor and mainly if you make changes, probably the bigger changes are just adapting to their operational practices and the value proposition changes a bit, for example, just to give you some data in China, a crew that you had have a 150 people in the US, you might have 1500. And so the value proposition in saving people is not exactly the main value prop. But they have great interest in some of their areas where you have difficult terrains, same thing in India. I mean there are a lot of places where the value prop is different but there are some very significant value propositions. The other fact in the international market is actually in favor of FireFly is with the exception of the Middle East. Much of those markets are dynamite which really placed the current versions strengths.

James West – Barclay’s Capital

In BP and Apache have time on the original FireFly version 1 system, are they back out in the field or do they have plan to go back out in the field with that product?

Robert P. Peebler

It will be actually with version 2, we have work out a way of getting them or the service can be provided on with version 2 and we are talking to both of them, they each have their own individual plans. I am still guessing and if I had to guess between the two we will probably see something going on with BP before Apache. BP is quite, quite still excited about FireFly and one of the main customers out there that we think is going to create some opportunities for the market.

James West – Barclay’s Capital

Okay. Thanks Bob.

Operator

(Operator Instructions). Your next question comes from Terese Fabian – Sidoti & Company. Please go ahead.

Terese Fabian - Sidoti & Company

Thank you. Good morning, I have a question on the RXT contract; you have in place three more system sales for the Ocean bottom cabling system. Are those firms or are those negotiable?

R. Brian Hanson

No Terese, the RXT contract, it was a contract as you know, it goes up multiple years and it has a minimum purchase requirement per year. So, that is not negotiable. That was in consideration to the exclusivity we extended to them.

Terese Fabian - Sidoti & Company

Okay. So that, and then I have a question on your land system sales number, it seems pretty high in the third quarter. What went into that?

Robert P. Peebler

You are talking about the total system?

Terese Fabian - Sidoti & Company

Right, the land imaging systems, the $82 million.

R. Brian Hanson

Actually, I am not sure how to answer that. Can you be more specific with the question?

Terese Fabian - Sidoti & Company

Sure. Well, there are $45 million in the second quarter and you had that $30 million ONGC sale in both quarters, so I am wondering why the pop?

Robert P. Peebler

Part of the pop is we had a small part of the, we picked up some ARAM business and because we closed it before the end of the quarter. So it is a little bit of boost because of ARAM and then we normally have, I mean as you know it is a lumpy business. So, I think actually I would have to go back and look at the detail. I suspect that I do not know if that was Vibes or that was a land system, I am not sure. But I think part of that outlook was probably the ARAM addition.

Terese Fabian - Sidoti & Company

I mean, I know the quarters are lumpy and you may have taken some in the fourth quarter in the…?

Robert P. Peebler

Yes, we look at quarter-to-quarter…

Terese Fabian - Sidoti & Company

But I am just wondering in terms of modeling, how to look at that.

R. Brian Hanson

Yes, it is just really, Terese, it is just a function of just the lumpiness of the business. I was really hard to say what happened, how you can compare Q3 to Q2.

Terese Fabian - Sidoti & Company

Okay. Can I ask you another question? The ARAM rental business, is that a very large portion of last year’s revenue stream, is that something that you might be building on, is that a market you see?

Robert P. Peebler

No, it is not a very large number historically, but the nice thing about it is that they have built out a really great infrastructure a way to manage the assets, a way to maintain the integrity of the assets, so they have got a great platform and they demonstrated that platform works very well in Canada. So, we look upon it as an opportunity to be able to take that platform and take it out to other places around the world, so we look at it as a growth opportunity.

Terese Fabian - Sidoti & Company

And do you think that that business that would withstand the market trend down, I mean would people rent rather than buy or is the business just…?

Robert P. Peebler

It is an obvious one solution that people have some business they need and they do not have the right equipments set or whatever and they do not want to make capital investments. So it is really a nice, if you think about why they put it together, it was really at the beginning they have to do it at Canada where you have this very cyclic business and it was a good way for people to manage the highs and the lows and also it allows people to get into this technology and ultimately they can purchase the technology. So it is just really nice add-on to your business offering.

R. Brian Hanson

Yes, one comment, Terese, that is that our current information on the ARAM rental business is pretty much the entire rental fleet has been committed too for the winter shooting season in Canada and we are also hearing a little bit about contractors sort of forming around and seeing if they can rent equipment from each other versus buying it.

Terese Fabian - Sidoti & Company

Okay, I have some other questions. Let me queue as there are others in front.

Operator

(Operator's instruction) You have a follow up question on the line of Terese Fabian - Sidoti & Company.

Terese Fabian - Sidoti & Company

One really simple question I am sure is outstanding, what was the count at the end of this quarter?

R. Brian Hanson

You know, Terese, I do not have the exact count sitting in front of me at the end of the quarter but we will have our queue out here tomorrow.

Terese Fabian - Sidoti & Company

Right, okay. Then a more complicated question that probably you do have an answer for. When you are looking at creative business model for FireFly rollout, what would they entail? I mean possibly could you be acting as a contractor of this type of an environment just to get the said amount?

Robert P. Peebler

We are looking at different, obviously we have some inventory so we are looking at different proposal but I do not really want to get into the detail. It is just really competitive. That would be the information I just want to share. When we have it out there, we will be able to talk about it but I am just not going to talk about that right now.

Terese Fabian - Sidoti & Company

Okay, do you expect something to develop from this within the next quarter’s period or are we looking at '09 now?

R. Brian Hanson

Terese, it is very difficult for us to comment on the current deals that we are negotiating so…

Robert P. Peebler

Yes, I think we have to, we have candid out in time. We have competitors on the line so we are just not going to talk about that.

Operator

Your next question comes from the line of Morten Nystrom - Finley Fones.

Morten Nystrom - Finley Fones

Yes, just a follow up on the RXT contract. Could you say anything regarding [Inaudible] RXT needs to do to buy from you guys per year?

R. Brian Hanson

I am sorry, we did not quite…was the question what is the…

Morten Nystrom - Finley Fones

How much does RXT needs to buy from your equipment every year in order to keep the exclusivity?

R. Brian Hanson

Yes, I believe as a minimum, there is a couple of different ways the formula works but it is approximately $40 million a year I believe.

Morten Nystrom - Finley Fones

How much was it in the third quarter?

R. Brian Hanson

We do not breakout the DSO numbers as a specific number so I cannot necessarily answer that. We do not segment our business like that. That is suffice to say I cannot tell you RXT has met the contractual obligations for 2008.

Operator

Your next question comes from the line of Joe Agular - Johnson Rice & Company.

Joe Agular - Johnson Rice & Company

We were dropped off the call for a short while there. I am not sure if this has been asked yet or not but on the Q4 comments regarding the softness that you are seeing from your customers, I think you mentioned primarily was on the land side, correct?

Robert P. Peebler

Correct, yes. Land US and land Russia.

Joe Agular - Johnson Rice & Company

Okay and I guess what I am trying to find out more on is whether or not this would be both system sales and parts and supplies or is it mainly kind of the parts and the supply side of business.

Robert P. Peebler

No, it is system sales.

Joe Agular - Johnson Rice & Company

Just system sales, you did the customer, I mean is it basically the situated customers have deferred?

Robert P. Peebler

Well, yes but I think, Joe to be frank, if you think about the value chain, they are also being cautious. Now if you look at Russia and North America is two different stories. If you look at North America, you have companies like Chesapeake and some major players that were very big consumers and major customers of some of the contractors who really slow way down or even stop or sold off piece of their business so there is a lot of uncertainty currently in the market so I think part of it is people are not sure but next year is going to look like, there is going to be some assets changing and what the gas price is going to be. So I think part of it is just right now, our own customers until they get more clarity from their customers, they are not going to know and as we would all bid, therefore has been a big conservative than you do have because of fairly significant slowdowns in the resource plays. You do have some contractors that have some cruise that are not working right now. So obviously if you have a crew that is got stocked, your appetite for buying more, I would say that it is mainly been the sales that we have seen probably just slip out. Our appetite for high density shooting upgrades the things like ARAM 2 which you know is going to happen. It is just like they are going to have to slip to see their own, have their own market sort of firm up.

Joe Agular - Johnson Rice & Company

Okay. Bob could you give us also some comment maybe on data sales, how would the outlook be for that side of the business? It seems like that would be an area that has a little bit more discretionary aspect too as well but it sounds like it is holding up for you.

Robert P. Peebler

Yes, one thing that we have is that we are right in the sweet spot with our multi-client data sales. We are not, if you look at where our stands are, the majority of them are in exploration areas that have high levels of interest so for example, Arctic span, West Africa, Brazil, all those different places are places where people are not backing down and so if anything was intriguing to me is that I think there will also be trying to get ahead of the drill bed a bit and so I think that people slowdown in drilling some activities that do not necessarily mean they are going to cutback on the geo-science work. What we have done and as Brian said, we tightened up our range because historically, we have seen some we call it bluebirds but it is that year end that data sell or whatever so we have some budget and we are just sort of assuming that is just not going to happen as much as we have seen in the past. We do not know because at this point in the quarter, we do not know until we end the quarter anyway but we are sort of assuming that that is just not going to be the same.

But I think for a normal business model with that multi-client business even looking out next year, we are just in the right place. I think the libraries we have and the projects we are working on are still very, very important areas for exploration and I just do not see those did not cutback to much to get them all.

Joe Agular - Johnson Rice & Company

And also in your comments, introductory comments, you mentioned that given some of the overcapacity that maybe developing here in the short run basis on the sort of the crew side, the acquisition side, it sounds like you may take advantage of that. Are you not changing any plans in your investment in new data?

Robert P. Peebler

Well, obviously for us one of the challenges you have if you are collecting data is through availability and so we have several ideas for different kinds of stands on land we are in and so if the cost of the crew goes down, that is good for us.

R. Brian Hanson

Maybe one other comment I would make is we have talked a lot about sort of what is going on in the land business in North America and Russia a little bit on the multi-client side but we have really thought a lot about this the fact that the marine business is strong. We are not seeing softness there at all, quite a bit of visibility in the next year and the data processing business is actually trying to get a battle there. They have got great background and they are actually still struggling with expense initiatives.

Robert P. Peebler

Yes, that is what I am saying that we have not really seen any occasion of major slowdown on what you think at the geoscience process. I do think that even on land, all companies have problems if they have actually have not been able to get ahead of the drill back. Things have slowed down so I think the design of the strength of the processing business is good and also we will talk about this a lot more in December but we are entering a year with a hell of portfolio partner, a big portfolio technology that is very relevant to the market even in the, particularly in the marine.

Operator

You have a follow up question from the line of Terese Fabian - Sidoti & Company.

Terese Fabian - Sidoti & Company

Again, first let me say I do appreciate your review of the energy cycle back then from the 80s and the press release now I think that is very helpful to help package and I do have a question following up on the marine side of the business. You announced last year that you have a joint venture agreements set up to do some permanent type of system or permanency seabed monitoring, reservoir monitoring, is there any advance on that? I mean are you still doing work on that towards where it is going?

Robert P. Peebler

Yes, it is pretty much a program, we are in a venture I think the big step in our venture would be actually a pilot project which standalone is still committed to do and so we are just really going, still going down the path of being participants in that venture. There is really no news one way or the other on the venture.

R. Brian Hanson

Under that, the venture has been set up. The organization has been set up and we have contributed to the venture and we have a seat on the Board of it…

Robert P. Peebler

Yes, continuous on.

Terese Fabian - Sidoti & Company

Do you think that the permanence of seabed monitoring or permanent reservoir monitoring of some kind is a direction of seismic that is going to be going more into?

Robert P. Peebler

Well, while we are in the venture is that we want to keep our toe in the water. Yes I think there is going to be a permanent installation that is already send out and which form it takes is still I think in peoples' minds also the retrievable, the do it with notes. They do it with towed streamer. They built with permanent and the market is a little bit all over the place on that. If you look at the majority of 40 monitoring, it is still being done with towed streamer and so how much is ultimately going to be permitted. I think the jury is still allowed. It is a market that has been really big in hope and slow in diffusion and that is why we have not really, we just cannot; we have tried to be there with our technology to a venture versus kind of tackle it by ourselves.

Operator

Thank you and there are no further questions. At this time, I would turn it back to management for any closing remarks.

Robert P. Peebler

Well we thank you for taking the time to attend the conference call and we look forward to talking to you in December when we give you our guidance for 2009.

Operator

Thank you, ladies and gentlemen. That would be ION Geophysical third quarter earnings conference call. Thank you for your participation. You may now disconnect.

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Source: ION Geophysical Corporation Q3 2008 Earnings Call Transcript
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