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Executives

Andrew B. Schmitt – President, Chief Executive Officer & Director

Jerry W. Fanska – Senior Vice President Finance & Treasurer

Analysts

Richard Paget – Morgan Joseph & Co., Inc.

Steve [Ferazini] – Sidoti & Company

Jonathan Ellis – Merrill Lynch

John Rogers - D.A. Davidson & Co.

Debra Coy – Janney Montgomery Scott LLC

Michael Huffman - Rock Point Advisors

Steven Fisher – UBS

Eric Stein – Northland Securities

Layne Christensen Company, Inc. (LAYN) Q1 2009 Earnings Call June 2, 2009 11:00 AM ET

Operator

At this time all participants are in a listen only mode. Later there will be an opportunity for questions. Instructions will be given at that time. (Operator Instructions) As a reminder, today’s call is being recorded. I would now like to turn the conference over to President and CEO Andrew Schmitt.

Andrew B. Schmitt

This is Andy Schmitt, President and CEO and Jerry Fanska is with me today. We’re glad to be here with you. We’d like to welcome you to Layne Christensen’s first quarter conference call. Earlier today we issued a press release outlining the results for the first quarter ended April 30, 2009. Before we discuss the financial results I’d like to remind the participants that the call my contain forward-looking statements that are subject to the Safe Harbor statement found in today’s press release.

Jerry will take you through the financial results and I’ll give you a brief overview of division operating performance and how we see things going forward.

Jerry W. Fanska

Revenues for the first quarter decreased $40.3 million or 16.5% to $204.2 million from $244.5 million in the prior year. Water infrastructure revenues decreased 6.9% for the quarter to $168.1 million, the decrease driven mainly by decreased water supply demand in the housing construction market and to municipal budget constraints. Mineral exploration revenues decreased 51.5% to $24.8 million driven by tightening credit and economic uncertainty for our customers in this sector. Layne Energy revenues decreased 13.1% to $10.3 million attributable to lower gas prices for the portion of the company’s production which was not forward sold.

Cost of revenue decreased $22.2 million to $159.9 million in the quarter of 78.3% of revenues compared to $182 million or 74.4% of revenues for the same period last year. The increase as a percentage of revenues was primarily focused in the water infrastructure division as a result of a shift in revenue mix to higher concentration and heavy construction which typically carries a lower margin. We also had difficulties on several projects and we had some pricing pressures from increased competition. Also contributing was reduced volume and pricing in the mineral exploration division.

Selling, general and administrative expenses decreased to $31.7 million in the quarter from $33 million in the prior year primarily the result of decreased compensation related expenses of $3.1 million offset by increased operating tax expense of $1.9 million, a large part of which was value added tax referrals that we determined were unrecoverable in certain foreign jurisdictions. Depreciation, depletion and amortization increased $1.9 million in the quarter to $14.3 million primarily due to higher depletion in the energy division resulting from the impact that the lower gas prices had on our estimated lives of our proven oil and gas reserves.

During the quarter the company received litigation settlements valued at $3.2 million. The settlements included receipt of land and buildings valued at $2.8 million and cash receipts of $300,000. Equity in our affiliates in Latin America decreased to $1.9 million in the quarter from $2.5 million in the prior year mainly due to the impact of softening exploration demand for commodities in South America.

Interest expense decreased $131,000 to $810,000 for the quarter as a result of scheduled debt reductions and reduced borrowing needs for working capital. The income tax rate for the quarter was 48% compared to 43% in the prior year. The increase in the effective rate is primarily attributable to the impact of non-deductable expenses as your pre-tax income declines. The net result for the quarter was $0.05 in earnings compared to $0.55 last year.

The company’s balance sheet at April 30th reflects total assets of $709.9 million, stockholders’ equity of $459.3 million, total long term debt of $26.7 million excluding current maturities and cash and cash equivalents of $62.7 million. The company provided $9.1 million in cash from operating activities in the quarter. Investing activities totaled $12.8 million in the quarter net of proceeds from equipment sales. The investing activities for the quarter included $2.8 million in unconventional gas activities and the remainder of the spending was for PP&E additions in the other divisions.

So, with that I’ll turn it back over to Andy to talk about the operations.

Andrew B. Schmitt

From an operating perspective, it was a difficult quarter. In the water infrastructure group the clear bright spot was the rentals business lines which have held up very well in this downturn. Their year-over-year revenue was up 7% with their division operating EBIT more than double prior year. We had a number of projects in which we had excellent execution, especially in two businesses that we acquired a couple of years ago, Collector Wells International and Tierdale Construction.

Rentals backlog still at a very high level, it’s around $369 million yesterday against what I think was an all time high of about $392. Quoting on work is still very active, the mix as we said before is not quite as rich and the prices remain a little more competitively light but the volume is certainly welcome in today’s marketplace. As good as rentals was our legacy water businesses had their worse quarter in many years.

Really, except for draught related work in the ag sector, we’ve had very little demand for new supplies of ground water requiring drilling wells. We also suffered, as Jerry mentioned, from some job related problems. We had some warranty expenses on treatment, projects that had been previously built that we have to circle back and fix up. On last quarter’s earnings call we had unfortunately a very accurate forecast on legacy revenue as we said, it might steer a set down as much as 20% which was exactly what it did.

Really every region in the country experienced some weakness. We’re in the process of further adjusting manning an overhead to lower volumes of work and should get a better feel for a more sustainable level of demand and margins later in the second quarter. Division operating EBIT for legacy water was about $905,000 in the quarter. That would compare to $6.7 million in a first quarter which albeit was a very strong first quarter a year ago so I think this definitely meets the definition of having the bottom drop out particular for a water related business line.

The stimulus impact from government spending so far has had somewhat unintended, though not really unexpected I’d say consequences as a lot of the municipalities are waiting to see what they get. We said last quarter that beginning to have a little bit of a paralysis of sorts and it will gradually pass as that becomes clearer to municipalities exactly what they’re going to receive and how it’s going to be spent but it has hurt in the short term. About two thirds of waste treated water is municipals and a lot of communities we serve are smaller and they’re under a lot of day-to-day pressure.

The geo construction which is the soil stabilization part of our infrastructure group suffered a similar fate as legacy water this quarter. Revenue declined 36% and actually swung the business to a quarterly loss. The main issue here was really just the big cap between finishing up a strong year and then running in to delays on new projects that are starting up this year. We also wrote down some inventories real they had really gone up quite a bit in our Italian subsidiaries and so that didn’t help the financial numbers.

However, we’re really not worried about geo construction for full year. The division has about $34 million of work which really has to be finished this fiscal year. That doesn’t include the work we have in the Italian subsidiary which is probably another $15 or $18 million. So, the big unknown at this point is just when will we get the notice to proceed and then going ahead and prosecuting those jobs.

The mineral exploration business as previously discussed as been cut about in half. That’s a little bit easier on the benchmark because you’ve got Boart Longyear and Major Drilling both out with some masons of business activity or preannounced in the case of Major. Really, the only semi bright spot for us was the Latin American affiliates dropped only about half as much as our wholly owned business. Operationally, at this level about all the manning and cost reductions of any consequence have been made and we’re just going to bounce around at a real volatile bottom, or so we hope it’s a bottom. We’re operating with some seasoned experienced management and field crews so efficiency is quite high despite the low utilization.

The mix of work has shifted to about 70% gold and 30% base metals. Historically that split has been 50/50 for a long, long time so clearly we’re getting the shift towards the gold sector. Between our Latin American affiliates and the wholly owned business, even at these low levels we should be able to generate a modest profit but it’s certainly going to be bumpy as we have to deal with the shorter jobs and erratic demand for drilling services by customer and just about every country we operate.

It’s pretty amazing, we have covered the same relative decline in global exploration spending in about five months that it took to reach in the last downturn in the after math of the Asian financial crisis. Layne Energy suffered further, as Jerry said, a difficult February and March as the pricing on their 25% of production which had not been forward sold was at the lowest spot prices we’ve seen, I think Jerry, we’ve saw so far.

As of April 1st things got a little bit better as approximately 100% of production moved in to a forward sold category of about $8.70. When you take that price and April results excluding the higher depletion charge April was sort of flat with a year ago. The Layne Energy team has really done a fine job lowering their lease operating expenses, they’re spending little to no capital as we only drill enough to meet forward sales requirements.

We continue to see a lot of opportunities in the energy sector more than probably any of our business segments in terms of deal flow. At this point adding oil reserves could be attractive to us as we feel really a compelling need to diversify this portfolio but we don’t necessarily feel that the deep shales are really a good fit for our skills set at this time. I think our preference is still less exotic properties, buying existing production with some room to develop it as opposed to just outright more Greenfield exploration.

When you look at the balance of the year, a critical factor for us at this point will be finding the bottoms in the Layne legacy business and then operating as efficiently as possible. The more intensive infrastructure business rentals, water and waste water need to continue to experience the bidding activity we’re seeing today. We can deal with the mix shift and a more competitive environment as long as there is sufficient volume of work and our success rate on job awards continues.

As discussed, geo construction will have a good second half and although it’s a small part, the infrastructure group, it will provide a nice boost when they get cranked up and we should begin to see some evidence of government spending later this year or early next. The thing is I have to caution everyone, you have to put that in the proper context of size and impact. When you look at direct stimulus spending as part of the Recovery Act now, there’s plenty of detail to figure out what that is and for water and waste water it’s projected to about $6 billion. That’s about $2 billion for drinking water and about $4 billion for waste water.

This compares to annual spending in the water and waste water sector when you look at it in total of $115 to $120 billion. So, when we talk about [shovel ready pitch] made on the US rebuilding infrastructure we’re not speaking of the order of magnitude that appears to be taking shape in a place like China. So, I do think when you look at spending the brighter spot may be the reauthorization by Congress of the state revolving fund. That fund is actually larger as its currently proposed. It will be metered out on an annual basis. Municipalities are very use to working through that fund, in fact, the new stimulus will come through it as well.

On the original green water, safe water drinking act, that fund there, they can leverage that for bond issuance and it won’t have the stimulus restrictions, whatever they might be on the Recovery Act. So, on the commodity side we’re facing the classic case of too much output chasing too little demand. History has taught us that it can take a while to work off excess put in place in economic booms. In the mineral exploration we’ll just stay hunkered down and deal with the carnage.

But, we would expect to see a significant fall out amongst competition, smaller competitors, weaker competitors if this current level of activity were to take another sizeable step down from here. At this time we’re pretty much at our core level of manning and about as far as we are willing to go in lowering prices. I think we can rest assured with all the government spending around the world there will be a reinflation of the global economy and it will be a positive effect. We’re seeing some of it in early stage in commodity prices but the longer term metric for everybody to focus on and that we focus on will be the return of real demand, a reduction in inventories and not geared so much by currency swings or inflation fears.

Layne Energy will do fine the balance of the year. As we said we’d like to add our producing properties and take advantage of the downturn but it would take something that really caught our attention at a very attractive price. A looming issue for Layne Energy is our current forward sold contracts expire at the end of March, 2010. My guess is that will pass quicker, that time will, than we would like. For now, we sort of hope for a hot summer and a cold winter because the current future prices in such an oversupplied gas market in the US is not particularly attractive.

You know when you first experience that big step down in activity, particularly for a full quarter as we have and you really get pasted on earnings, the inclination is to say, “Boy this sure feels like a bottom.” Unfortunately, that is not always the case, so with that thought in mind we’ll stay in a pretty defensive conservative posture. There’s no question in Layne Christensen we’re lucky to be in industries who’s output the world has to have. But, we’re clearly experiencing a healthy reminder this year, like many others, that the world doesn’t have to have quite as much as we all thought before.

Fortunately, we had the foresight to prepare well for this eventuality and have the depth and experience in the field and in management to effectively deal with the consequences but, they’re pretty painful and can be ugly as you can see. So, now if you have any questions we’ll see if we can answer them for you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Richard Paget – Morgan Joseph & Co., Inc.

Richard Paget – Morgan Joseph & Co., Inc.

I wanted to talk a little bit more about the water business, you guys had said mix and then some lower volumes and pricing and then some problem projects all hit margins. I wondered if you could maybe quantify at least what the problem projects were so we could get a better sense going forward what margins should be based on what you’re seeing today?

Andrew B. Schmitt

The biggest problem we had was on a project where we were doing the drilling for an eventual ground freezing of shaft but you’re using the same water well type drills and the water well business that we use and sonic type rigs. The equipment was new design and we really had mechanical problems as much as anything on the rig. We haven’t closed it out, we’re still in the process of connecting up the freeze but, by the time we got through the drilling phase of it, we had about $1 million that we were underwater on the job I think when the quarter ended.

There’s more to do but the drilling piece is pretty much over so it’s more the mechanical construction piece, maybe we’ll make up a little ground there next quarter as we get in to that phase of it. But, that was the biggest single project that we had that caused problems. I think Richard too, our weakest business, I should have said this actually, is in the western United States. California, Nevada, Colorado and Arizona are big businesses for us at Layne and our legacy water site.

So, when you look at that overall revenue decline in water of 20%, it’s down year-over-year 40% in the west. Now, this is an area that’s represented historically 50% of revenue and at times as much as 70% of the legacy profit. So, when we talk about mix I should have said that because that western part of the United States giving us the most problems. We’re seeing softening everywhere else but that clearly was an area that for many years drove a lot of organic growth, a lot of water treatment growth in Layne Legacy and that is really our most difficult business right now.

I don’t remember outside of 1995 when we had a great deal of water, a great deal of rain, reservoirs filled up and that was more California specific, I don’t think that I’ve ever seen that decline even Jerry, the last downturn, we didn’t see that kind of decline. So, that’s really one that has us on point and we’ll see if that picks up. But, the job was actually on the east coast, it was in the state of New York, our problem on the mix side is clearly more in the west than any other area and that’s a big profitable business, for Layne it has been really forever.

Richard Paget – Morgan Joseph & Co., Inc.

So backing that out, I mean is this a 4% to 5% business given pricing and mix these days going forward?

Jerry W. Fanska

If you take the $1 million to $1.5 million out in loss jobs, you never can predict obviously what’s going to happen on jobs but if you just take that $1 million to $1.5 million out in jobs you’re picking up two to three points just in losses we’ve identified.

Richard Paget – Morgan Joseph & Co., Inc.

So I guess just doing the quick math a little less than 4% but I know you said there’s some warranty and pluses and minuses so with the mix and the pricing this is now 4% to 5%?

Andrew B. Schmitt

Yeah and last year was a strong quarter and operating EBIT was 8.9%.

Richard Paget – Morgan Joseph & Co., Inc.

Then with the increased demand and maybe you could talk about the legacy business versus the rentals business, how many more people are you seeing at the bid table and how much is pricing going down?

Andrew B. Schmitt

Our pricing on the infrastructure side, pure pricing has pulled down about 2%, 2.5%. When you look at a fully loaded cost bid that might have been bid at a certain percent, it’s about 2% below that now. I think as long as the volume stays up on the rental side, we’ll continue to get our share of the work. They had a really strong quarter, the Collector Wells’ business had an excellent quarter, it’s small but it’s some of the better margin business that we have so that was clearly a favorable mix for rentals.

But, the bidding activity although it ebbs and flows, has picked back up for us on both the pipeline work and the design build work. So, I’d say the level of quotes right now is fine with us, we can live with the pricing. I think they’ll have a year that’s close to what they planned and I think when you look forward for the rentals business with the backlog they have is do we have sort of a bridge here of enough work and if the stimulus impacts anybody it will probably have a bigger impact on rentals than Layne legacy or geo construction.

Rentals will also probably be the biggest beneficiary of the state revolving fund on these larger projects that are backed by state revolving funds where the municipalities leverage that by using that in effect as their equity in a bond financing. So, if rentals can have a bridge the balance of this year and continue on this track then they might get a little bit of a bridge to maybe more normal economic growth particularly through the SRF. So, that would be our hope. Legacy is going to have to deal with a slower market. As we talked it’s more driven by – it has a bigger housing component, not that we drill residential water wells but the bigger developments, the developments with the golf course, the baby boomer’s second homes, the retirement, that piece of the business we did a pretty good job extending Layne legacy much longer than I would have thought.

Before, that business just started to chip away to the point that we had not been able to make it up with the repair work and water treatment work. I would say that if it had occurred anywhere but to the extent that it’s occurring in the western US we could have probably still have legged it out for a few more quarters and sort of hoped for whatever stimulus we get in the rural water fund. But, that west is too much of a drag so I think you have to sort of bifurcate that and say, “Look geo is actually going to make a good contribution in the second quarter, I don’t have to worry about them.”

Layne legacy is going to have to deal with this lower level of activity and replace it somehow with treatment, or replacement wells, or repair work and that’s some question if they’ll be able to do that right away. Then rentals business, we can keep steady as we go. You can probably add it up, take out the bad jobs, push it forward and say geo construction will pick up a $1 million because they did have a loss this quarter and that will disappear half in the second and completely in the third and fourth. That’s the way I’d look at those components. What do you think Jerry?

Jerry W. Fanska

That sounds fine.

Richard Paget – Morgan Joseph & Co., Inc.

Can you easily transfer your water assets between Layne legacy, rentals, east coast, west coast or if you’re going to right size the business for the near term you’ll be laying these people off or selling equipment?

Andrew B. Schmitt

We have definitely laid off people as we’ve got back. Probably the first layoffs that we saw go back six months or so now in the western US as that business got weak first. We’ll have to do a combination of both. We can move the Layne legacy rigs, we have Colorado rigs that were normally drilling coal bed methane, shallow gas for customers at one time that are drilling injection wells in Florida.

They’re bigger, deeper, heavier rigs so we pushed out. In the case of rentals they’ve had to expand their own footprint too where they’ve been bidding work. We’re clearly stretching the areas we’re covering. Layne legacy is stretching areas where they work their equipment. So, sonic rigs out of Milwaukee were working in New York, albeit had a rough go of it but they were over in New York.

So, we’re doing that, we’re going to have to adjust to the lower levels of manning. We’ve been reorganizing the business anyway and going to much more regional pod concept we call it so some of that has been underway for about a year and it’s very timely relative to accelerating that. Richard, we our quoting level of activity almost disappeared in Layne legacy, I mean by order of magnitude late in the fourth quarter.

That’s why we said we’re probably going to see a real step down in the first quarter even going back to the prior call. I mean, literally went down to virtually a handful of quotes, two handfuls down from 30 or 40 that fly out every week. That seems to be picking back up so we very well could be we suffer another six to eight weeks and then we’ll start to see something that resembles a sustainable level of work. Where that level is, is it going to be what it has been in the prior couple of years, I don’t think for a while, I think it’s going to be less but, I don’t think we’re going to see – we should see a pick up from where we are here just from the quotes that we’re putting out now. They literally dried up, it got a little scary there for a while.

Richard Paget – Morgan Joseph & Co., Inc.

Just real quick on the housekeeping, from the water side what was organic growth?

Andrew B. Schmitt

Well, the businesses that contributed so much this time we’ve all had for well over a year, I guess Meadors would be the only one Jerry?

Jerry W. Fanska

I mean it’s kind of hard to define organic growth because obviously we have a major project in Tierdale that they wouldn’t have done without the rentals connection. So, even though that’s an acquisition that job is probably more organic than acquisition related.

Andrew B. Schmitt

Layne legacy was down 16.5%, geo plummeted 36%, I think the organic growth we probably had was in rentals. It was about 7% and how much of that was Meadors I don’t actually know, probably not too much, probably 3% to 4% where you could point and say that was real organic growth. But, it’s coming from projects that go back a ways. Now, the Tierdale project was $55 million but it was awarded some time ago they’re just executing that project now. So, it’s a tough definition right now.

Operator

Your next question comes from Steve [Ferazini] – Sidoti & Company.

Steve [Ferazini] – Sidoti & Company

I just wanted to ask a couple of questions on the energy side, due to you’ve got those excess rigs from the water segment right now and completion costs for wells would be much lower than they were six months ago, your IPs of those wells are very low, why not go ahead and drill some wells right now?

Andrew B. Schmitt

We have so few wells that we’re drilling at all and the rates are so competitive in the oil field services side that they take about in terms of the drilling of these wells about a day and a half. So, unless you had 20 or 30 wells to drill, and we don’t, it really wouldn’t make a lot of sense to put a rig out there for the occasional time you go in because of a lease commitment and have to drill a well because our first opportunity is to extend the lease and pay the land owner a bit to extend that lease as opposed to spend the capital to drill the well to bring on the production.

So, really all we’ll do is just what we need to maintain the production. Right now, they’re doing an excellent job, they’re running the gas field like a storage field and staying right at the numbers that are forward sold and then just backing off the pressure a little bit as we start to deal with the decline curve that’s inevitable. We certainly could do it but I doubt we could be as efficient as the oil and gas service companies that have [inaudible] rigs with the big air packages. They’ll knock a well down in a day.

When you get in to cold bed methane, probably 20% of the cost is in the drilling and the rest is in everything else. So, it’s not a huge backward integrated cost for us.

Steve [Ferazini] – Sidoti & Company

What do you need to see in terms of commodity pricing or storage levels that would make you decide to start being more aggressive in trying to pick up production again?

Andrew B. Schmitt

I’d like to see that storage curve if you will sort of pull back in the middle of that five year average as opposed to pushing at the top of the upper limits. We’d like to see that sort of become a little bit more centered. I think one of the issues that most gas producers that are not in the deeper shales, Fayetteville, Marcellus, Haynesville, are all paying attention to the amount of quantity of gas that comes out of those shales and how much that gas can be delivered and over what period of time. Because it’s still some impressive IPs on those wells but you just don’t know the sustainability of the production and how do you get all that gas out of there.

But it clearly has an impact on looking at your mix of business if you’re an unconventional and you’re not in the deeper shale players like we are, we would like to see gas pricing to move back in to that I’d say $6, $7, $8 would be utopia. Remember, we’re about $1 off of the NYMEX price so when I said we need to see $6, $7 then you would look at $7 or $8 on the NYMEX so we have a ways to go there. So, the focus I think is on the lease operating expenses, maintaining that production where we don’t have a molecule that’s wasted at a price that’s not forward sold if we can.

That’s a heck of a job to try and manage. Unlike conventional where you can shut the gas in, you can’t do that with cold bed methane so the guys are really doing an amazing job really tweaking with compression and pressure. [Phil Winter] and his people are doing a great job in managing that field. So, I think that’s the right course of action, give me something that starts with a $6. On Southern Star I’d probably take something that starts with a $5 and we’d start to feel comfortable. Our cash cost Jerry is what?

Jerry W. Fanska

$4 probably, $3.75.

Andrew B. Schmitt

We can generate some cash at the current forward sale prices that we could go at right now but it would be right at our fully loaded EBIT cost so we need a couple of more bucks on top of what we currently see in the futures I think Steve.

Steve [Ferazini] – Sidoti & Company

Then the last thing was just on the new Albany shale, are the economics ever going to make sense do you think to develop that? Do you need to drill any of those wells to maintain the leases?

Andrew B. Schmitt

No, we’ve got good leases there, five year leases. We’ve got lots of flexibility with the people there and at this point you’re going to have to have gas prices similar to what we’ve seen in the past in Cherokee for those types of plays.

Operator

Your next question comes from Jonathan Ellis – Merrill Lynch.

Jonathan Ellis – Merrill Lynch

I wanted to just circle back to the water business for a moment, when you talk about the pricing pressures that you’re facing on new bids, are more of those pricing pressures and as I guess you as you mentioned in the Q&A you’re seeing fewer bids in total in the legacy side but if you could just kind of compare contrast pricing in the legacy versus rentals business where are you really facing more pressure? Is it more so on the rentals side now because of more contractors?

Andrew B. Schmitt

The rental side of the business I said has pulled down about two percentage points. I think if we got back to we were dealing with comparable volumes you’d probably see about the same decline in legacy. So, I don’t know if there is that much difference, legacy has a lot of small competitors and when they are just completely out of work you’re going to really go through bouts of pricing that are very aggressive.

However, rentals has a lot of contractors that came from the residential side and they are equally as hungry so at both ends of that spectrum when levels of activity get down, you see some erratic bidding. But, we’re not even close, you know what I mean? When that happens Jonathan it just sort of look at it and shake your head and you’re the 15th highest bidder out of 20. It’s not really work that you expect to get and you just don’t react to that.

However, there is work in rentals that is right up our alley, some that have water well drilling that picks up the legacy piece as well, some that we’re very competitive on. We’ve got a good track record with the municipality, the city, whoever, the engineer that’s handling the job. Those you interest is way up. On the others, when you’re out you’re so far out, I get an email that says, “Here look at this list.” You sort of look at it and shake your head. Those we’re not going to be competitive with anyway so on average we’re seeing about 2% price both places.

With the mineral side we’re seeing 10% declines. So, order of magnitude difference in the 10%, 12% to 15% declines where you see more modest declines in the overall water sector in total. And, as I said, the geo construction piece, they’ll make up theirs in a hurry when they get the volume because work they have is work that is a very good mix for them. The work is related, a big chunk of it is related to work for Katrina on the jetting that has to be done for the supports for the reconstruction of the levies. So, that’s been in process for a long time and it’s really unaffected by the current economic situation.

Jonathan Ellis – Merrill Lynch

Is that why that work – I think you mentioned it has to be done by the end of this year?

Andrew B. Schmitt

It is the schedule to be met and we really need to get a notice to proceed. There’s a specialized piece of equipment that’s headed towards New Orleans, it should be there pretty soon. When that equipment gets there and gets fired up and we go through a shakeout period, we’ve got to get moving.

Jonathan Ellis – Merrill Lynch

Then just within the rentals business, you didn’t mention at all the CIPP business and I’m wondering usually in the past you’ve given some update on revenue and EBIT trends, year-over-year trends in the CIPP part of the rentals business. Can you update us on what happened in the first quarter there?

Andrew B. Schmitt

Sure, the in liner piece of that was about $25.2 million the first quarter, it was $29.3 in the prior year. The division EBIT was $1.4 million and a year ago it was $1.5 million. So, not a lot of change. We’ve got backlog in that business not as long as the rentals or infrastructure design build pipeline backlog so we’ve probably got about four to five months of backlog as we start to chew through that we’re going to have to pick up some work in the second half of the year to sort of stay on that plane.

But, I think it’s sort of flat, it’s competitive but not unreasonably so given where we stand today. Now, I don’t think you’ll see a lot of stimulus money go that way in CIPP. [Inaudible] may have a different view or maybe even a better view. We may pick up some projects there but I don’t think too much based on how we see the allocation on the Recovery Act spend.

Jonathan Ellis – Merrill Lynch

Since you touched on the backlog and I think you gave an absolute dollar figure for rentals backlog but, it may be helpful, do you have available the year-over-year change in the rentals backlog or sequential change if that’s more readily available rentals versus legacy for backlog?

Jerry W. Fanska

I mean basically the rentals business last year was $242 million at the end of April, it’s actually $369 million at the end of April this year and it was $330 million at the end of January. The legacy business was $115 million last year and was $99 million, basically $100 million at the end of April this year, up from $86 million at the end of January. So, as Andy mentioned obviously the quoting is getting a little bit stronger and their backlog is kind of up.

Andrew B. Schmitt

It stepped up sort of in February, March and April and just sort of went through this paralysis of freezing so it’s the releasing of that work, a little bit like our notice to proceed on geo construction out of [inaudible] strong right now. This waiting to see what we get, I know we can’t be the only company that’s experienced that but that is surprisingly as I said sort of not unexpected when you think about it but sort of an unintended consequence of stimulus money coming out to these cities because so much of our business on legacy outside the industrial and ag areas is clearly tied to just towns, cities.

We don’t do a lot for states, we don’t do that much, occasionally we do for counties but I mean in terms of the direct funding it really comes from the City of Houston, the City of Wichita, the city of whoever. So, it is waiting to see what we get has been a little frustrating for some of our guys. I just say, “Hey it will pass.” Sooner or later you know what you’re getting or not getting so we’re looking forward to that phase of the stimulus to move pass us I guess.

Jonathan Ellis – Merrill Lynch

As you talked about the backlog, I appreciate those numbers those were helpful, any sense, you may not have this at your fingertips but any sense for the average margins in that backlog? Is the profitability profile in your backlog much different than it was a year ago?

Andrew B. Schmitt

Actually I might be able to reach out somewhere in this mound of paper. Rentals business, the shift would be more on the pipeline transmission side because a lot of the bigger projects that we have are there. Jerry could probably tell you that mix it’s been worth a couple of percentage points down for us here I think. I thought I had the Layne legacy but I don’t seem to. I thought I did but I don’t. I can circle back and give it to you. It’s a more detailed backlog and they give it to me by month and it actually parallels what Jerry gave but they have the margins on the work that’s been bid but, it would probably be a job margin number so it would probably be revenue versus direct cost so it might not be as meaningful for you not knowing what the field expense is, the breakdown on what the gross profit would be on that. But, I can’t put my hand on it right now so I’m sorry.

Jonathan Ellis – Merrill Lynch

Just two quick questions on the mining business and then I’ll get back in the queue, just you mentioned in the press release that you were actually running at a loss in Africa and Australia and a slight profit in North America. I guess as you look at towards the remainder of the year, do you anticipate the losses to continue in Africa and Australia assuming no real pickup in activity levels? Also, why has the North American business remained profitable?

Andrew B. Schmitt

The North American business has picked up in Mexico which is primarily gold and silver is a big byproduct of that market. The business that we’ve had in Arizona and Nevada has held up pretty well. Grayson Kentucky and the coals, zinc and lead or the Alabama Appalachian area has not been as affected. North America has hung on pretty well but primarily the pickup in Mexico has been helpful there.

Africa, our biggest problem is going to be in East Africa, particularly Tanzania and the Democratic Republic. One of our largest contracts was Freeport and our last rig was shut down in the Democratic Republic of Congo and I think we had nine drills running there coming in through the years. So, that’s been a bit of a setback I think probably Boart Longyear got clipped as well because they had 11 rigs as well so that pull back in the DRC affects us both.

We’ve got some work in Zambia, Tanzania is very slow despite being a gold market. It is very slow, I think we’re just down to one rig. I know this will sound amazing but if you go back about 12 to 15 months ago we had 31 rigs in Tanzania. So, that will give you an order of magnitude when you talk about falling off a cliff. The West African business is gold, it virtually shut down in the last six weeks of the last quarter and it stayed slow this quarter but it’s coming back to life.

If there’s any green shoots there, they happen to be gold shoots and you see the shift in our mix. In fact, we in our wholly owned business had dropped as low as about 40 rigs running in February of this year as best I can recall. We probably have moved up to 60 rigs, 65 rigs running. That would have been higher but the DRC just happened a couple of weeks ago so we were probably moving closer to 70 rigs and then you drop nine and maybe we’re at 61. So, we’ve gotten off the bottom there and our partners, Latin American affiliates as we said would hold up better because of the big contracts at [Chuquecomada], Escondida, [inaudible] and [Yanachocha] and that’s been the case, that’s the main stay for them.

Once you pull away from those contracts it looks just as volatile as it does for everybody else that’s dealing with these shorter contracts. So we’re going to bounce along at this bottom and it’s going to have a range, it might vary from 40 to 70 type rigs over the course of this year and until we start seeing I think some real demand that’s driven by clearly economic activity and that may take a while. We said if we made any money this year it would probably be in the Latin American affiliates and we’ll probably make money in our wholly owned business but it will come and go.

One quarter will be good for a couple of months and then it will be lousy, it’s just that situation that you have when you hit these commodity type cycles and they step down this far. But, really we’ve come down as I said in five months in relative spending the same decline that it took five years to accomplish. So, you’d hardly look at that as silver lining but I have to tell you, getting there in one swoop if this is the bottom will be much easier for us to deal with than that stair stepping that we went through last time because every year was worse than the prior year.

If we were to move down from this level for whatever reason as an industry where exploration to spending would decline much from this point then you’d see major stress enter the system for a lot of weaker competitors. It would rough everyone up, ourselves, Boart Longyear, Major Drilling but when you look at it right now, like I said maybe it’s wishful thinking but it feels a bit like a bottom. We can’t tell you how long we’ll be there but we cross our fingers and hope that it wouldn’t take a step down.

That’s really about all I can give at this point because it’s one week you get a forecast and there’s a few bright spots and the next one they all disappear. It’s that type of operation right now. We are losing some competitors and we continue to because that’s inevitable at these levels of activity. These clients are going to use the most efficient companies and it doesn’t do them any good to get a real cheap price and then not get the meters or to have problems on the rig, or to have a safety issue particularly for the majors.

So, that sorts itself out going forward. I always find bad things happen at these lower levels of activities, it’s Murphy’s Law. It effects smaller people bigger than it does companies that have the capacity to absorb it.

Operator

Your next question comes from John Rogers - D.A. Davidson & Co.

John Rogers - D.A. Davidson & Co.

Andy you talked a little bit in your prepared remarks about acquisitions looking on the oil side for your energy business and I know in the past you’ve talked about acquisition opportunities on the water infrastructure side. Could you give us a sense of what does that market look like in terms of opportunities? How big of a target would you potentially pursue?

Andrew B. Schmitt

On the energy side?

John Rogers - D.A. Davidson & Co.

Or both, on the water side as well?

Andrew B. Schmitt

Well, if we’re buying, presumably you would be buying on the oil side the criteria for us is we would have to be buying at a decent price whether it’s per MCF or per barrel of oil current production. I don’t think we’d feel comfortable going out and buying just property to develop which probably tells you even if prices come down in the Marcellus, Haynesville or Fayetteville you’re not going to find Layne going in and making a big acquisition maybe even of a distressed company or distressed property in those areas.

I think the first criteria for us is we’ve got to have some proven production and then an ability just to stretch out like we do in the coal bed methane area. There are a fair amount of older oil properties that I’ve used the word mundane but I think our comfort level is higher with the oil business being driven by more global economics than a more narrowly focused US natural gas market particularly when we can’t get a view of just how much gas-on-gas competition we might see from these deeper, richer shales.

So, that’s put a degree of uncertainty so when you start looking at properties like our Cherokee basin property which is fairly project intensive. Initial IPs are not that great it sort of fits Layne’s banging and clanging type of style. When you look for those properties in a little bit more safer environment or one of higher comfort it tends to lend itself more towards west Texas Permian Basin. Again, not exactly exciting but for us if we do it right, we’ve demonstrated an ability to produce some pretty good returns.

We also like the ability to forward sell so anything we would purchase we would forward sell a certain portion on the strip just to lock in the initial returns, make sure that we’re not overly exposed. So it would be fairly cautious. On the water infrastructure piece one of the issues we have to ask ourselves in the water strategy is actually in two areas, is the rentals [inaudible] strategy, this really works well for us including picking up rentals itself. It really is standing tall it’s done exactly what we said.

It’s provided an infrastructure component and really quite an anchor for the company in general which was our thought when we did it, our expressed strategy and it’s nice to see something work for a change. But, the question is does that work as well going forward? We’re in the process of sorting stress testing that ourselves. But, it would appear to still be a good place to be given the age of the infrastructure and we would think that values would be better and a lot of the properties that we picked up after Reynolds were properties that were good businesses but for whatever reason the ownership even in the case of American Water and UIG on the management of Tierdale and Meadors we just decided it’s time to retire, it’s time to move on.

We’re not willing to go through another cycle. So, that’s worked out pretty well for us in terms of a value proposition and we think that will probably continue. We’re in the process of doing that. When you look at the size of an acquisition, depending on the amount of EBITDA we bought, we wouldn’t have a problem. Well, we have right now currently what Jerry said $55 million in really free cash not counting cash in a lot of these bank accounts around the world.

We have $200 million in the revolver and about $50 million in cash so it wouldn’t bother me to pull down half of what’s available, a little bit more depending on if you picked up a lot of EBITDA. We looked at an acquisition, I can’t go in to any specifics, we were picking up about $40 to $50 million in EBTIDA. We made the final round and weren’t the annotated ones obviously. It was in the range of $190 so you pick up $50, probably net out at $140. It would have been a good value if we were able to do it but it just wasn’t to be.

I think with the caveat we have to get a little bit more of a bottom and a little bit clearer view and clearly we’d like to see where the longer term US growth prospects are going to be, I’ll say absent the amount of money that’s coming in to the economy. On the Layne legacy side, one of the issues that’s clearly jumped up in front of us is given those US growth prospects, is the organic treatment going to be sufficient?

We’ve always said there’s plenty of business in the USA. The bigger boys, the GE, the Siemens, are looking overseas, that leaves opportunities for us we’ve taken advantage of to basically build a water treatment business from scratch a few years ago to $67 million in revenue last year, not too bad. We’ve always made the case, at least internally and for our strategy that that’s not a bad way to go and it was hard to find water treatment opportunities. We’ve not looked internationally, that’s one of the questions as we stress test our strategy that comes forward, is it a domestic only strategy?

For water in general is that going to produce the kind of growth rates we think particularly as the US slows and the stimulus is withdrawn and we see levels of growth which are not as robust as we’ve seen the previous decade. That’s the thought process we’re going through right now. Hopefully that sort of paints a little bit of a landscape for you but you know, it’s in the range in terms of appetite.

Operator

Your next question comes from Debra Coy – Janney Montgomery Scott LLC.

Debra Coy – Janney Montgomery Scott LLC

Just a couple of questions to wrap up, you’ve given us a lot of information but just to understand on the mining business you’ve mentioned the expectation that you bump along the bottom here for the remainder of the year meanwhile certainly copper prices have rebounded. What’s the sense of the lag? How do you separate out copper prices as they trade on the London Exchange versus real underlying demand? How would we expect to see that?

Andrew B. Schmitt

When we start seeing shortages. When you start seeing shortages for metal on the London Metal Exchange. When you actually see that inventory really goes down, it’s not being replenished. I think that the customers get a lot more confident when they see that. I know that if I was in their place I would too. No different Deborah than if natural gas in the US, which it’s not, but if it were susceptible currency swings or the expectation of inflation, as a producer of natural gas our eyes would be focused on those storage levels and we’d be focused on that industrial demand indices.

There clearly are some signs in China and some of the early stages even in manufacturing in the US that there is certainly movement in that area. But, it’s too early a call we think for our customers and even in the gold sector, although the work we’ve seen has picked up in gold it’s mainly smaller junior to small size midsized mining companies. It’s not the major mining companies so far. So, we’ll take our queue when we see Barrick or Newmont start spending more money because they get more encouraged about gold real demand which still close to three quarters is still tied to the consumption be it the electronics, medical or primarily jewelry.

So, we’re going to look at those indices and that’s why is say bump along at the bottom, I’ll change my tune when I see inventories declining because then we’ll know that they’ll start firing up exploration programs and we start seeing some real demand. China is awfully encouraging in their big factory in those markets, their stimulus spending is a whole lot more infrastructure intensive and base metals intensive than anything we’ve seen from the US infrastructure spending or stimulus.

That’s pretty encouraging because they are such a big factor. But, a periodic refurbishing of their lower levels of inventory, spot buys to take care of prices, currency swings, inflation fears, that’s not real demand. So, our view will change when we see real solid growth, because automobile sales go up, because new homes are being built, those types of things, durable goods orders sustainably go up. That will be our key.

Debra Coy – Janney Montgomery Scott LLC

So current economic activities leaves at current production levels there’s still inventory building up or starting to decline?

Andrew B. Schmitt

Starting the early, early stages of a decline and whether it’s natural gas with the amount of rigs that have come down or it’s the amount of exploration spending that’s not been done, a little bit of demand and a major decline in output capacity makes for a pretty good mix down the road. So, you have both sides of that equation being worked. That’s helpful.

Debra Coy – Janney Montgomery Scott LLC

On the gas business, as you said, the time between now and the end of March 2010 will go fairly quickly, if the economy stays relatively weak, gas prices stay relatively low, it doesn’t get as hot or cold as it should, how will you be thinking about strategy come say this time next fall? Will you go ahead and find places where you can forward sell gas?

Andrew B. Schmitt

Yes, we will forward sell. At some point in time our hand to poker here to forward selling we’re going to have to start playing part of the cards whether we feel that strongly about the cards in our hands or not. We probably will turn the taps down just so again you’re not burning reserves at a level that you don’t think is a good return on the capital you’ve invested. So, yes it’s interesting when you look at the first quarter results in profits as bad as they were we were still 50% commodity and 50% water and infrastructure.

So the mix, sort of amazingly to me didn’t even change what we’re seeing. So clearly, that commodity part of our earnings is still an important piece and Layne Energy and our ability to forward sell is important in terms of earnings too. We wouldn’t want to recover in other areas and then step down because the amount of earnings from Layne Energy went down. But, that may be the case, we’ve got to see more demand for natural gas and we’ve got to see storage levels top out and actually begin to decline a bit.

But, it will go quick. We’ve been there before, we didn’t have hedges in place when we rolled in to April a year ago and saw prices July 3rd of last year that Jerry and I were shaking our head when we saw them. That’s obviously why we forward sold but, it seems like it was forever ago but the reality is it was less than a year ago so it changes over the course of that. We’ll see.

Debra Coy – Janney Montgomery Scott LLC

You said basically if you were in the market doing that now it’s forward sale prices are about in line with your cash cost?

Andrew B. Schmitt

It’s about $5, $5.50 something like that. We need to add a couple of bucks to that price before it gets interesting.

Debra Coy – Janney Montgomery Scott LLC

Then finally just circling back to the water business that you’ve come at this a couple of ways with earlier questions but, what I’m taking away from it is if we back out the issues in the first quarter related to geo construction, related to the big drilling project, adding in the competitive mix that we should be back in to the latter half of the year operating margins in that business at least back in to the 5% to 5.5% range it sounds to me like, not back to the 6.5% we were last year but certainly substantially above where we are now?

Andrew B. Schmitt

I would think so, at 5% I’d just say 5% and say if we get in to that in the second half that’s fair. That’s definitely fair I think.

Operator

Your next question comes from Michael Huffman - Rock Point Advisors.

Michael Huffman - Rock Point Advisors

This question has been asked a few different ways and I apologize for asking it one more time so you can give me a short answer. You talked about the demand for CIPP and the price competition in that sector and we’re looking at I guess there’s something still in committee in Congress and the Senate, maybe something like $37 billion in additional spending in water over the next five years. How do you see this playing out, the competitive landscape and where do you think this money would go if you try to look forward just to speculate on it?

Andrew B. Schmitt

Transmission and distribution would clearly – which is about 70% of the spending would pick up a good chunk of that. The need for new water and waste water treatment plants, there’s probably some limited need for that but less so in terms of the structural replacing pipes transmission and distribution I’d say. So, I think 70% would go there, 20% might go to the water treatment side of the equation and the balance would be in recycled water, those types of efforts, water desalination, things like that maybe.

Michael Huffman - Rock Point Advisors

So the mix could change and perhaps favor the CIPP going forward?

Andrew B. Schmitt

I think once you get through the $6 billion in the original stimulus, the state revolving fund probably more transmission, distribution and design build treatment then you sort of shift in to the CIPP funds, if there’s more of that available. One of the issues is it’s always tough for the underground part of the funds, there’s no visibility politically for things that are underground. Now, you can at least see them out there with trenchers digging up pipe and sewer lines and you can see that work going on. You can certainly see the construction of a new treatment facility, water or waste water treatment but when you come in there and you run basically a tube through sewer pipe coming off a real it’s definitely one of the more efficient processes that’s ever been invented and it deserves more attention and there’s miles and miles of the stuff to be done but it does not seem to get quite the traction that one would think.

So, I don’t know if it is just the cities would rather just repair on a one off basis as opposed to actually going and realign miles. Maybe if we get a little bit more forward thinking and longer term thinking we’ll see that. But, it’s hard to zero in that right now in the absence of that becoming a more prominently discussed issue. It’s a little bit like trying to say there should be a lot more money going in to the natural gas in terms of if you’re not going to invest in coal and you can’t say clean coal, you know, at these shales are really correct that kind of production.

You clearly would look at natural gas as firing a lot of the power generation needed. Yet, most of the focus is on renewables wind and solar particularly and some biomass. So, I mean it’s very hard to make a case that natural gas should do better than coal but it’s hard to say that the stimulus will be directed in that area although there’s not a better job creator than putting in a natural gas well in terms of the amount of service people, machine shops, welders, pipelines, migration, it’s very energy intensive.

No question, we’re a little bit disappointed in how the infrastructure was sold as [shovel ready] and where it’s been directed but maybe that’s sour grapes but I would have rather taking on the shape more of what we’ve seen in China. That’s the way it was sold but the amount of money in that regard didn’t quite work out that way. So, we’ll take what we get but my guess is 70% would go in transmission and distribution.

Operator

Your next question comes from Steven Fisher – UBS.

Steven Fisher – UBS

Just a few quick housekeeping items, on the energy side, can you give us what the gross production was in the quarter?

Andrew B. Schmitt

It was probably gross first quarter – well, Jerry you’re going to have to give it because I see here that you’ve got it I don’t.

Jerry W. Fanska

It’s 1839.40 MMFC gross, net 1208.43.

Steven Fisher – UBS

And it sounds like that’s kind of what we’re going to see the next few quarters?

Jerry W. Fanska

I would say yes.

Andrew B. Schmitt

We’ve got 15 million cubic feet a day forward sold so that’s out of our target and they’ve got to have a little bit of cushion so I’d say approximately 100%, probably 93%, probably about 7% cushion that we’ve got that we’re putting out on the spot of the net gas.

Steven Fisher – UBS

Then on the water side, the warranty issue is that resolved in the first quarter or does that carry out in to the second or beyond?

Andrew B. Schmitt

I think we’ve accrued for the warranty claims that we’re aware of. It involves sludge removing systems and some undersized tanks. When we initially built the arsenic treatment plant, that removal system was fine. We didn’t realize that as the plants got a little bit bigger that it would start to arch over on capacity wise. As we’ve discovered that we’ve gone back and made the repairs and we think this is sufficient, don’t you Jerry, in terms of what we’ve been notified of at this point where they’re having trouble moving the residuals as quick as they should be able to.

So, it’s design at this point. It’s on our nickel and as we become aware of it we’ve dealt with them. So, we think we know all them so that should be behind us and should have been accrued because that work is ongoing.

Jerry W. Fanska

Unless it’s something that we don’t see at this point it’s been accrued for.

Steven Fisher – UBS

Then lastly, the tax rate going forward, do you think that would be back down to the low 40s?

Jerry W. Fanska

At this point that’s pretty difficult to predict but at these low levels it’s not going to be in the low 40s probably any time soon. It’s probably going to be closer to mid 40s just because when you get a reduction in your pre-tax income all the non-deductable items that you have, have such a bigger effect on the effective rate. Although, our goal is still obviously to get that down it’s difficult in this environment.

Operator

Your final question comes from Eric Stein – Northland Securities.

Eric Stein – Northland Securities

I did jump on a little late so forgive me if I cover something you already talked about so just in the sewer rehab business can you just talk about the backlog a little bit, maybe the level where it is now and what that looks like versus last year?

Andrew B. Schmitt

It’s flat with last year. I think we probably have a $50 million backlog and we’ve probably got backlog that’s not met the official definition in terms of our signed contract of probably another $20 million which would be fairly consistent with last year. As you can see from the quarterly numbers it’s sort of holding with last year. But, as I said that will carry us for a pretty good while but you’ve got to stay ahead.

We’ve bid on a lot of work, our rate of being awarded that work – I talked to the guys yesterday is down from where we’d like it but it’s just still pretty pricy and so we sort of drawn a line in the sand. But, I’d say four months down the road we’re going to certainly have to fill it up a bit. But, no panic at this point, it’s pretty consistent with what it has been historically really in the last couple of years.

In fact, going back two years ago overall profitability level has moved up a little bit. If you were to look at the individual business plan for that CIPP business compared to what we planned, their EBIT was actually up about 30% above what the plan we had put together at that time so I would say that’s a little bit brighter prospects than we thought back in late December when we put these business plans together.

Eric Stein – Northland Securities

So basically not a whole lot of change from last year and outlook for the business basically flat?

Jerry W. Fanska

I think flat.

Andrew B. Schmitt

I think flat. I don’t remember [inaudible] comments last quarter but my guess is they’re US they talk about North America and they pick up Canada so it’s a little bit different but my recollection is I think was pretty consistent with them. They were seeing pretty much a flat market but not declining market at this point, competitive but not declining.

Operator

There are no additional questions at this time.

Andrew B. Schmitt

I appreciate everybody’s time and attention and appreciate you being on. Sorry it’s such a rough quarter and hopefully things will get a little bit brighter as we move forward and we’ll get a little bit more clarity and be able to give you some better views as we get them as well with a little bit more specificity. So, we appreciate it all and thank you much and we look forward to visiting with you next quarter.

Operator

This does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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Source: Layne Christensen Company Q1 2009 Earnings Call Transcript
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