Layne Christensen Company F3Q10 (Qtr End 10/31/09) Earnings Call Transcript

Dec. 7.09 | About: Layne Christensen (LAYN)

Layne Christensen Company (NASDAQ:LAYN)

Q3 2010 Earnings Call

December 7, 2009 11:00 am ET

Executives

Andrew Schmitt – President & CEO

Jerry Fanska – SVP Finance

Analysts

Richard Paget - Morgan Joseph & Co.

Ryan Connors - Boenning & Scattergood Inc

Steve Ferazani – Sidoti & Company

John Rogers - D. A. Davidson & Co.

Jonathan Ellis – B of A/Merrill Lynch

Michael Smith - Kansas City Capital

Dick Kindig – Keeley Asset Management

Operator

Welcome to the fiscal 2010 third quarter earnings call. (Operator Instructions) I would now like to turn the conference over to our host, Mr. Andrew Schmitt; please go ahead.

Andrew Schmitt

Good morning everyone. My name is Andrew Schmitt, President, and Chief Executive Officer of Layne Christensen Company. I’m here with Jerry Fanska, our Chief Financial Officer and we would like to welcome you to Layne Christensen’s third quarter conference call. Earlier today, we issued a press release outlining the results for the third quarter ended October 31, 2009.

Before we discuss the financial results, I would like to remind the participants that the call may 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 will give you an overview of division operating performance and how we see things going forward.

Okay Jerry; take us through the numbers.

Jerry Fanska

Thank you Andrew, good morning everyone. Revenues for the third quarter decreased $46.7 million or 17.7% to $217.8 million from $264.5 million in the prior year. Water infrastructure revenues decreased 12.2% for the quarter to $174.3 million from $198.6 million in the prior year.

The decrease occurred across all major product lines except pipeline and water and wastewater treatment plant construction. The decrease was also a result of decreased water supply demand in the weak housing construction markets and two municipal budget constraints.

Mineral exploration revenues decreased 42.2% to $30.7 million from $53.2 million in the prior year driven by economic uncertainties in this market despite higher than historical gold prices. Layne energy revenues increased 8.1% in the third quarter to $11.7 million from $10.9 million in the prior year primarily due to a greater percentage of that division’s production being sold at higher prices based on forward sales contracts in place.

Last quarter the energy division recorded an impairment of its oil and gas properties primarily as a result of lower natural gas prices at quarter end and its effect on the evaluation of oil and gas reserves.

Because of improved pricing at October 31, 2009 no such impairment charge was required. However the current volatility in gas prices and the likely inability to replace our current attractive forward sales contracts could result in an additional impairment in the fourth quarter.

As of October 31, 2009 the remaining net book value of assets subject to this ceiling test was approximately $30 million. Selling, general and administrative expenses decreased to $31.5 million for the quarter from $35.7 million in the prior year primarily the result of decreased compensation related expenses from lower profits, as well as headcount reductions offset by increased non-income related tax expense of $2.6 million, a large part of which was value added tax in the minerals division determined unrecoverable in certain foreign jurisdictions.

Depreciation depletion and amortization increased to $14.2 million in the quarter from $13.6 million last year primarily to higher depletion in the energy division resulting from the impact of the lower gas prices on the estimated lives of our proven oil and gas reserves.

Equity and earnings of affiliates in Latin America decreased to $1.2 million for the quarter from $4.8 million in the prior year mainly due to the soft minerals exploration market in Latin America. Interest expense decreased to $584,000 for the quarter from $838,000 last year as a result of scheduled debt reductions.

Income tax expense was $4.9 million for the quarter or an effective rate of 42.7% compared to $8.6 million or 41.9% last year. The increase in the effective rate was primarily attributable to the impact of non-deductible expenses as pre-tax income declined.

The net result for the quarter was $0.34 per share in earnings compared to $0.63 per share last year. The company’s balance sheet at October 31, 2009 continues to be very sound reflecting total assets of $717 million, stockholders equity of $463.6 million, total long-term debt of $6.7 million excluding current maturities, and cash and cash equivalents of $77.5 million.

The company provided $34 million in cash from operating activities in the quarter. Investing activities totaled $16.3 million for the quarter, net of the proceeds from equipment sales. The investing activities for the quarter included $520,000 in unconventional gas activities, $6.6 million in property plant and equipment additions to other divisions, and $9.2 million for acquisition related expenditures.

The company had $6.2 million in financing activities primarily the payment of a $6.7 million principal reduction. With that I’ll turn it back over to Andrew to talk about the operations.

Andrew Schmitt

Thanks Jerry, last earnings call I believe we discussed that if the third quarter earnings were up sequentially from the second, it would likely be due to our deal construction division which is reported as part of our infrastructure group. And that definitely was the case this quarter while comprising only about 9% of infrastructural revenue, GeoConstruction was responsible for over one-third of infrastructure segment earnings.

Geo’s current mix of work is really right in their performance sweet spot as their jet grouting product line is being used on Katrina-related reinforcement work in New Orleans. This job has given Layne Christensen quite a shot in the arm for earnings.

Adding to the strong incremental earnings was our rentals infrastructure intensive business. Their revenue was essentially flat with last year but the division operating EBIT was up 24%. This combination of geoconstruction and rentals was almost sufficient to offset the continued weak performance of our Layne legacy water well, pump and treatment business.

The legacy water division has as you know been hit hard in this downturn and we certainly found no relief this quarter with revenue down 35%, earnings down 86% from a year ago. In addition to the overall US economic malaise, this division has really been doubly impacted with our heavy exposure in California, Nevada, Arizona, and Florida.

Traditionally you know those had been some of the best ground water markets certainly in the country. When we look at it and step back a little bit we don’t expect that our municipal water well drilling business will recover in the volume or price that we saw back in the 2007, 2008 timeframe for several years.

As a result we’ve taken a lot of steps to shift some of the resources to a more specialty drilling product line where we see better opportunities and we’ve reorganized the division to more of a, I’ll call it centralized commanding control type organization.

Mineral exploration as you see in the segment reporting is still bouncing along the bottom. Both our wholly owned minerals division and our joint venture with our Latin America affiliates contributed roughly equal amounts to the quarterly earnings you see reported. That was up from the first quarter and was also up from the second quarter.

Most our third quarter work continues to be from small, mid-sized mining companies with the notable exception being major mining work on a couple of projects in Chile. We did hire back another 70-plus employees in the third quarter with this gradual pick up in activity.

We hired about 70 more people as you’ll recall in the second quarter from the first so we’re moving up gradually and in just about equal increments at this point. When you look at Layne energy its essentially flat with last year if you add back the non-cash write-down we took in our Chilean energy assets about a year ago.

We’ve been holding production steady at about 15 million cubic feet a day, enough to fill our forward sold contracts which were about $8.70. Since contracts cover 100% of Layne’s net production we’ve experienced very little variation in our quarterly results. We expect that to be the case in the fourth quarter, sans of ceiling test, non-cash impairment charge that Jerry alluded to.

As is usually the case with these SEC mark-to-market rules for long-lived assets, you know, the accounting treatment can be pretty meaningless. If we are fortunate the ceiling test will eliminate at least on paper, all the reserves, and depletion charges that go with them.

I know investors these days are very focused on what companies anticipate going forward and we are getting more clarity in that regard then we had earlier in the year. Our water infrastructure group, the rentals portion of that backlog moved up to over $400 million at the end of November.

That’s equal to last year’s revenue and about what we expect to do this year. The margins are weaker by a couple of percentage points but the pipeline CIPP design build work volume continues to be there.

GeoConstruction’s current backlog is also at historical highs. They exceed the normal year’s revenue but again the mix is less profitable going forward particularly compared to the work that we’re doing in New Orleans right now and that should finish up most of it by the end of fourth quarter. A little bit may go into the first quarter next year.

Finally believe it or not, Layne legacy’s backlog also moved up in the October, November timeframe. Its really only about 10% below the calendar year 2007 and 2008 average backlog. However as with rentals and geocontruction, the margins are quite weaker as well.

Despite the very recent upturn in Layne legacy water backlog this business we think is going to remain challenged. We’re very determined to get back on a growth track. For instance we recently signed an agreement to drill water wells in Afghanistan for the US bases. Equipment and people are currently in route.

I’m not allowed to furnish much details but this could be a fairly good sized contract if its extended. Also at our last Board meeting a week ago approval was given for the capital necessary to purchase a new large drilling rig for deep wastewater injection wells in Florida.

In addition on the treatment side we have a major effort underway to evaluate a number of technologies to treat the flow backwater on site for oil and gas companies operating in the Marcella Shale. It’s a treatment market we feel has enormous potential as environmental regulations for water get tightened which we suspect they will.

Layne legacy will also be entering the [DNI’s] water market in the Western US. We’re looking to close a small acquisition in Arizona. Competition in this market and throughout the US has been primarily GE an Siemens and those are two companies we’ve taken share from in other treatment markets in the past.

So I guess to know we’re certainly not sitting on our hands waiting for the water market related to new housing development or urban sprawl to come back. However when it does we will spread into many more product lines in Layne legacy, hopefully better anchoring our revenue base in that segment.

In the mineral exploration division we are finally, and I say finally hearing from our traditional large major mining customers. They certainly appear as they’re going to return to the exploration market next year. We have moved from supply and budgetary quotes to serious discussions about their expected drilling programs.

In fact we’re trying to move up pricing as we submit from quotes of new work as prices have fallen about 10% to 15% over the past year. As I had mentioned previously with the exception of a handful of projects in Chili, the large mining companies both for gold and base metal have really been missing in action since about the middle of last December.

Although we hardly expect a boom and we would expect to have the usual extended year-end shut down at the mines, it would appear that better times may be ahead in metal exploration. I think by the second quarter next year, we’ll be in a position to gauge the strength of the recovery and determine how much volume pricing we can regain.

We’ve also seen a modest pick up recently as folks would have noticed in spot natural gas prices. We’re forward sold through for all of Layne energy’s production till April 1 next year but we welcome any improvement in natural gas future’s pricing.

We’re in a range of $5.50 per Mcf for natural gas hedges, if you look at an April 1, 2000 through March 31, 2011 timeframe but that’s close to break-even for Layne energy. And given the earnings contribution this division after you add back the non-cash impairment charge, its pretty clear we could not make up that reduction in earnings if we were to go to break-even next year and I think that’s true even with the expected improvement in our water related businesses and mineral exploration.

Granted we have a cash cost of the $260 range and spending a little to no capital so the cash contributions for Layne energy can remain fairly positive at low pricing but earnings would be an issue in fiscal 2011.

As far our current view for natural gas, for whatever its worth, the three factors contributing to the surplus you see in the storage levels, the weak economy’s impact on industrial demand. The very cool moderate weather in the summer, fall sessions and the unusually large addition to natural gas production brought on stream by really all operators not just the shale operators in 2008, early 2009.

So I think one could logically conclude that a recovering economy, a return to we’ll call it normal weather patterns and with the natural gas rig count having been at 50% of last year’s levels for so long that natural gas excess supplies could go down and that the low prices we see today may gradually improve over the course of next year.

At this point I think we’ll take a wait and see approach before we look to forward selling any production. From a strategic perspective we announced as you may have seen this quarter the acquisition of W.L. Hailey. So the rentals bolt on strategy continues and will continue as we look to stretch that rentals infrastructure intensive footprint.

Layne legacy’s water focus will remain on more advanced treatment and shift to specialized drilling situations. As far as energy anyone in the M&A space knows Layne Christensen has been pretty active in the $100, $200 million price range for acquisitions with a bias towards oil at this point and certainly a bias towards proved developing producing reserves.

When we look at it, it looks a lot more like master limited partner type assets as opposed to any type of aggressive exploration assets. Finally on a very, very important note on safety, as any long-term investor knows we view safety as the most important part of Layne Christensen’s job.

You’ve seen a very good track record performance by the company through the years. We don’t report our Latin American affiliate results in safety. We monitor them but they’re not included in our numbers. However the safety culture there is every bit as pronounced. Last week our Chilean company Geotech reached four million man-hours without a lost time accident. Really a remarkable achievement and one which as best we can tell has never been approached by a mineral exploration company.

Probably helps explain one of the key reasons that our Latin American affiliates have had the largest mineral exploration contract in the world for 16 of the last 17 years. So quite an achievement from really an excellent, excellent group of managers and we’ve enjoyed that relationship now for 14 years.

So with that we’ll wrap it up on a very positive note and if you have any questions Jerry and I will try to answer.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Richard Paget - Morgan Joseph & Co.

Richard Paget - Morgan Joseph & Co.

I wondered if you could talk a little bit more about the water margins, just based on what you said back of the envelope, it seems like some of those geoconstruction margins were around 25%.

Andrew Schmitt

Why don’t I give you a breakdown of the EBITDA margins for Layne legacy for the quarter versus last year, geo, and rentals. If you look at the EBITDA margins in Layne legacy they’re about 7.1%, a year ago they were 12.7% at third quarter to third quarter year over year.

When I look at geoconstruction, they’re 29.2%, a year ago that was 5%. Look at the rentals businesses, both rentals we bought, CIPP, pipeline, and the design build piece, the group we call rental, its 9%, 8.9% versus 7.8% last year.

Okay so if you were to look at it all added together with the mix, infrastructure is 10.3%, last year it was 9.6. So that sort of gives you the breakdown. We might as well finish it up, if you go to minerals for the quarter its 16.7%, that would include our share of the Latin American affiliates net after-tax income, not their EBITDA but we roll those together and call them EBITDA, and a year ago it was abo0ut 28.8% in the third quarter.

As I recall that was a pretty peaky quarter for us last year as well for both companies. So energy 74.6, last year 76. So, just a little bit different of mix there. So that’s sort of the breakdown for those products and I think EBITDA when you get through impairments tests and so on and so forth is probably a better way to look at it in terms of gauging that pure margin difference.

Richard Paget - Morgan Joseph & Co.

So based on those numbers what exactly was it in those Louisiana projects that you were able to achieve such high profitability, was it just great execution on fixed price contracts.

Andrew Schmitt

The execution was excellent and we were working off in this case mostly marine barges but we’ve said in the past that we would get into, our geoconstruction business is probably the best jet grouting business in the world. So when you cross over into these projects, where there is a heavy, heavy mix of jet grouting you’re going to see that margin performance move up. It’s a very specialized part of what we do in the soil stabilization market as opposed to just say a normal grouting project.

And that gives you quite a mix shift. So the performance was very good. We had built a new dual jetting machine which had never been done before that was also on the project and it worked extremely well. So you’re going to get that and I can almost name through the years and the quarters from time to time when that has happened.

There was IBM job, there was a Merc job, there was a Mercedes job and when that mix shifts that way you get some very, very good results. Not a lot of people can do that type of work at that performance level. I said I think with a lot of the clients around the US we probably have the best reputation you can find.

So that’s very helpful for us when it happens. Its nice. We actually have a job that’s, is large in that backlog next year as this one in New Orleans, but it’s a different type of grouting and so its got a little bit of jetting in it but the combination is not going to be as lucrative.

So I think the volume will be there and geoconstruction certainly looks like it entered into the year but I don’t think we’ll see these oversized margins. There is more work in New Orleans but for the real specialized piece in this particular case we may get some more work. I don’t think it will be at this level but it will be okay. It won’t have quite this impact where it drives infrastructure earnings for a quarter.

My guess is it will drive them in the fourth quarter as well because where we are right now the mix is if anything its identical in our performance as we’ve gained experience with the machines and working off the barges is even better. That should be a big bump in the fourth quarter. But again we’ll have the mineral exploration year-end slowdown as well.

We’ll have to gauge it against that.

Richard Paget - Morgan Joseph & Co.

So just longer-term, are there a lot more levy projects that could possibly be needed over the next call it five years where you could, maybe you don’t have any near-term bidding for this type of work but longer-term, is this a bigger program that might be a good earnings driver.

Andrew Schmitt

They would have to shift to more jetting and less soil mixing which a lot of the work is spec now. Okay so they would literally have to change some of the design parameters. At this point I don’t necessarily know that that would be the case. And so as we move this, there’s more work to be done, but as we move out of the reinforcement segment we’re in, it may keep it as soil mixing. If that’s the case that unlikely would involve us.

So I think for looking at your models going forward purposes I would assume that you know, we picked up an awfully good job that gave us some real solid report in the third and fourth quarter but it will fade a little bit for first and second, we’ll be out without that type of work.

If it changes we’ll let you know but like I say, the design parameters right now haven’t changed.

Richard Paget - Morgan Joseph & Co.

And then looking at the rentals margins it looks year over year that the EBITDA margins were up which seems a little bit counter to some of your commentary that it got more competitive. There’s going to be margin pressure, is that just you still have some legacy projects that were still bid in good days. I’m just trying to get a sense of what the trend should be going forward.

Andrew Schmitt

I think the project really, the secured in place business had picked up, CIPP. And so if you were to look at their EBITDA margins in that quarter its more than double what it was last year. Its 10.3% so as you know that’s a, between our rentals business and the UIG business we bought, and that market is definitely picked up, probably seen a little bit more stimulus activity then we would have thought but the market is busier.

And I think you probably saw that in North America CIPP results [for 54] last quarter. I don’t exactly recall but my expectation is that you would have because they would have been out earlier than we are. So the backlog in the rentals infrastructure businesses too, we’re coming in with in liner backlogs that CIPP backlogs, I think higher than we’ve seen it. Haven’t we Jerry?

Jerry Fanska

For a while, yes.

Andrew Schmitt

Yes, I don’t think we’ve seen backlogs that strong for some time. So that’s the richer part of that work within those rental businesses so that helped in the third quarter to sort of push things up.

Richard Paget - Morgan Joseph & Co.

Anything else besides potential stimulus related funding that’s helping that market.

Andrew Schmitt

I think the big plus is that we’ve gotten past the waiting to see what we’re going to get in stimulus money. So things are starting to flow a little bit more normally. They’re going to push what money there is in stimulus through state revolving funds which is a good means to do it because we’re all used to working with that mechanism in the municipal water, wastewater sector.

So that probably helps both Layne legacy and probably puts a little bit of solid foundation on rentals related businesses. I was worried since they have a longer lead-time that we would start running into problems, 18 to 24 months, and we had said we hoped maybe the stimulus SRF, state revolving funds would be able to bridge.

It seems that, there’s more reason to be a little more optimistic now that that might happen when early in the year we were really, didn’t have a lot of clarity about much of anything and somewhat unsure as to how that would unfold so, better clarity and I think return to a little bit more normal bidding and awarding and notice to proceed activities.

We get a little bit of hot dry water that, our weather, that would help as well.

Richard Paget - Morgan Joseph & Co.

And then finally, you already touched a little bit on this new orders were pretty strong and you already mentioned that CIPP has picked up, any large waste water treatment projects that might have bumped the backlog up a bit more or was this business is still—

Andrew Schmitt

There wasn’t one that sticks out that was huge or anything like we have with Tierdael last year on the underground utility work. Its been pretty steady.

Jerry Fanska

Its pretty much across the board. Some locations better than others but—

Andrew Schmitt

That’s oversized projects that jumps out at me. We’ve seen a pretty steady range of projects in rentals in the $10 to $25, $35 million range and we’ve been a little bit more aggressive bidding them but just a couple of percentage points and we seem to be winning our share in a still a very disciplined fashion.

Operator

Your next question comes from the line of Ryan Connors - Boenning & Scattergood Inc

Ryan Connors - Boenning & Scattergood Inc

I want to first touch on energy, you mentioned that you’re at 15 Mcf per day right now, I remember previously that you mentioned that you had capped some wells. Can you give an update on your production estimate for 2010.

Andrew Schmitt

I can tell you that if you look at our gross production in that field right now, third quarter it was about 1642 million cubic feet per day, or a million cubic feet. Last year it was 1884 so we’re down about 13% so if you can say we’ve pressured up that much but we can’t really go much beyond that so that’s about down about 13% from the third quarter a year ago which was similar to the second quarter a year ago which was similar to the first quarter.

So that’s the differential you’re looking at there.

Ryan Connors - Boenning & Scattergood Inc

And you’re not locking in at 550 is that correct?

Andrew Schmitt

No we’re not at this point. We get an update on a year and two years on a fairly regular basis from the traders. At this point in time we’ve sort of pulled back and taken a little bit of a wait and see approach. Spot price picked up a while, its comes back a little bit. I don’t know what it was this morning but on our particular pipeline, but overall at this point if we do much we might not do a year, maybe just some little shorter-term forward sale, for some of it, part of it, all of it.

But not locking up for a year because its just too hard to make that call. There may be more upset than we thought, I think the rig count is the one thing that we would look at most being down so long and then a lot of small producers like ourselves, hedges expire in 2009 and if they’re conventional they can take more gas offline easier then the coal bed methane unconventional people will.

So I think that’s something we’ll turn our attention too as well, is there any way to gauge how much gas is taken offline in a reluctance to sell at the lower prices. Obviously that only happens with companies like Layne that has such a strong balance sheet that you have that type of luxury.

Ryan Connors - Boenning & Scattergood Inc

And you did mention that you were looking at opportunities and kind of expanding your mid stream presence in terms of gathering infrastructure and I’m wondering are you focused solely on the Cherokee and New Albany plays for, in terms of that or are you looking outside of this core area.

Andrew Schmitt

No, they’ve been outside of the Kansas area, most have been, we’ll call them fairly mundane with an oil producing, Permian basin, some of the more recent acquisition we looked at in California, it was not heavy crude, it was conventional oil. So a lot of the projects coming to market, we haven’t seen the package from ConocoPhillips they announced $10 billion.

You’re seeing a changeover not only a shift like you saw with range resources and the shale producers but just that normal shift to companies high grading their both oil and natural gas assets and so you can see a lot of deal flow coming in the market. Most of the assets we look at is I call them MLP type assets that don’t look real exciting from an exploration standpoint.

But still have a fair amount of useful life and good return. We like more steady reliable predictable energy projects and you might say Layne’s view of the world is sort of like an MLP, like a [inaudible] energy except we don’t pay a dividend. And I doubt we would so we’d be more focused on assets that can produce earnings in a stable environment. We’ve looked at a lot. We’ve been on a couple but we’ve been the bridesmaid more often than not so we’ll find something probably.

Ryan Connors - Boenning & Scattergood Inc

You mentioned a little bit about the frac waste water treatment I’m just wondering if you could give us a first a broader review of that market, how big you think it can be, how long it would take to ramp that business up and secondly give us an update on do you have any facilities currently on the field in the Marcellus or any of the other plays that are out there.

Andrew Schmitt

First let me say on the Marcellus its our view that all of the different technologies that are being tried, all of the R&D that’s going in, no one really at this point has a guaranteed acceptable owned site treatment of that flow back water from what we can tell. And we’ve looked at about four or five different companies with technologies and still sort of scratch our head and try to evaluate them as well.

I’d say on site, because we don’t think with the truck traffic from just pumping the flow back water into frac tanks and hauling them off to disposal wells, most of the disposal wells are located outside of Pennsylvania, West Virginia, and New York, we just don’t think that that’s going to be allowed as that play develops over time.

Its just too much truck traffic in an area that is not quite the same with its oil and gas I’ll say friendliness as you find in the Barnett Shale and East Texas for instance, has a different terrain. We think regulations will be tightened. They also might not let that frac flow backwater go to any of the wastewater treatment plants right now.

We know the total dissolved solids are rising in the rivers and streams. We think that becomes a bigger issue in this part so when you look at the market for treatment, I guess we’d say that that’s a $3 to $500 million market with nobody having a clear idea of exactly how to do it. There are systems out there that are used in various parts of the country for big frac that will handle flow backwater, but footprint is an issue as well.

So we’re looking for one that size wise you can put together. You can treat the water. You can pick it up and to move to the next location, in the least disruptive way and clean down those total dissolved solids. So we’re very much in an early evaluation stage. This is not technology that Layne will develop. This is technology that Layne will either license or buy.

Being in the energy business and being in the unconventional side, combined with our own water production that we have to dispose of in Kansas, being a water and waster water treatment company, being geographically dispersed and used to handling big equipment, there are a lot of things that line up well for us to be one of the companies that can handle this type of project.

The key is we still have to have the right technology. Its got to clean down to limit which might be pretty tight depending on what the environmental EPAs in West Virginia, New York, and Pennsylvania come up with, but it’s a big enough gas market, its going to go forward with the caveat, its probably not going to go forward with 100’s of trucks hauling frac flow back water up and down over hill and dale, throughout that part of the country.

Common sense would just tell you that that’s probably not going to happen. Its supplying a lot of jobs so you will have the normal fight between the number of jobs its supplies and the environmental consequences so it will become a little bit of a political and regulatory football. In the meantime the [best] answer in our view is treated on site. Come up with a good technology. That tends to be right up our alley for a number of businesses so our level is quite high.

Whether we’ll be able to penetrate that, find the right technology. I know we can handle it if we had the right technology because that’s the kind of work we do every day. So sort of a lengthy explanation but that’s our early view of the Marcellus shale. We’re not interested as an oil and gas ENP company. That hardly, that doesn’t fit the type of oil and gas assets I described earlier for Layne energy.

Operator

Your next question comes from the line of Steve Ferazani – Sidoti & Company

Steve Ferazani – Sidoti & Company

Looks like revenue held up pretty well Q2 to Q3 on the min ex side, but saw some margin erosion, can you give us a sense, I’m assuming that wasn’t seasonality.

Andrew Schmitt

No it wouldn’t be because typically these are pretty good quarters. And then last year, I’m not sure it wasn’t our best quarter in mineral exploration. So whatever you’ve seen there in terms of margin wise, is not seasonal. A little bit more weakness maybe in our Latin American affiliate income that it held up pretty strongly for the first two quarters. So maybe a little slowdown there.

Steve Ferazani – Sidoti & Company

Given where we are with gold prices, copper prices, rallied back up here. I would assume you’re having more contact with customers and seeing some pick up activity into the first part of next year, is that a reasonable characterization of what you’re seeing.

Andrew Schmitt

Yes that would be a reasonable expectation. I’d say we might have the year-end slowdown, starts about the middle of December. Generally it lasts through January then we cross our fingers and see if we put any, how many rigs we put together, back to work in February. So you’d expect that, that’s why I said second quarter we’ll probably get a clearer view but I think our expectation is that first quarter, second quarter should be better than what we saw in our wholly owned business for sure.

Then this year our Latin American affiliates had not seen a lot of disruption because of the projects in Chile or as much as we’ve seen. So they may have less upside relative to their contribution but we’ll just see. We’ll see but clearly much more positive than what we had seen in any of the previous two quarters.

Steve Ferazani – Sidoti & Company

What do you think you need to see to see a much more dramatic pick up, do you think its more US European demand for copper, clearer economic activity recovery, what should we look for for signs.

Andrew Schmitt

I think a broadening of the recovery would definitely help. We’ve always said that if you want to know where the mineral exploration business is going, look at Asia. That’s probably still true. I think anyone that saw the quarterly numbers for instance that India put up, had to be pretty impressed. There’s not been a huge amount of stimulus spent by India and the quarterly numbers were pretty good.

They’re still the largest purchaser of gold in the world. So I mean its still a look at Asia with the faucet, it would be helpful if the US and the EU and the United Kingdom could pick up a little bit. So I think you’re next buffer up is to see how the more western countries recover. Looks like the emerging markets, India, China, are doing fine. I think in South America, Brazil, obviously has done quite well as well. So we’ll likely see a little bit. That would probably be the next step up. We’ll bounce up as we said next year compared to where we were the first two quarters in our wholly owned business this year and then we’ll see if we move up the next leg.

Operator

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

John Rogers - D. A. Davidson & Co.

I just wanted to follow-up on the gas business, as it stands right now what are you seeing in terms of offers for your gas now if you were to hedge it out.

Andrew Schmitt

About, if we went out a year say, April 1 of this year to say March of 2011, we’re seeing about 535, 550 range, bounces around a little bit. That’s going to move closer to that spot price, about 450. The longer we wait so there clearly is a penalty for waiting as opposed to doing something now for, and say okay, next year we’ll take a break-even but at $2.60 cash cost we’d make a pretty good return particularly when we’re not spending a lot of money for drilling.

So that’s sort of where we are a little bit there and that pricing has sort of hung in there a little bit. We were concerned the 550 may drop sooner than we like but then the spot price picked up a little bit, probably gave you a little bit of buffering.

So that’s where we’re, we sit today.

John Rogers - D. A. Davidson & Co.

And what are you, the hedges that run out through April 1 what’s the average price there.

Andrew Schmitt

Its 870.

John Rogers - D. A. Davidson & Co.

Okay I just wanted to understand the difference.

Andrew Schmitt

And so if you look at the quarterly earnings in that segment earning in Layne energy, you got a pretty good number there that you could probably annualize. Then you tax effect that at about say about 60% after-tax, divide by 19.5 million shares, you’d note it wouldn’t be insignificant when we talk about earnings next year. It generates a lot of cash because that kind of EBITDA number we see, not spending any CapEx, it generates a lot of cash as well.

So but when you run the numbers that’s why I say that clearly it’s an earnings issue for us. Its going to be a tough call either way. But that will give you the delta. I wouldn’t worry about any G&A allocation or anything like that. That’ll give you a pretty good view I think.

John Rogers - D. A. Davidson & Co.

Okay but so all the earnings, I mean, the cash will still be there, but—

Andrew Schmitt

Yes, it still has pretty good cash flow and like I say normally you spend a lot of capital in a business like that. That’s typically a third of Layne Christensen’s capital expenditures when we’re at a peak. There was $75 million at our peak for Layne Christensen its probably $25 million was Layne energy.

Now we have this thing where the cash flow and the return is pretty good, I don’t think we expect to get the return on energy quite this way, but its been pretty good for the last 18 months.

John Rogers - D. A. Davidson & Co.

And then on the water infrastructure business, you gave us a breakdown but what was if we ex out the acquisitions, what was the organic, I guess decline in the quarter.

Andrew Schmitt

Organic decline in the quarter without the acquisitions, let me see, let me look at that segment, we were at $174 million, let me just think of the acquisition that would be in there. And I’m talking about from, you’re talking about from the beginning at which time we bought Reynolds, fair enough.

John Rogers - D. A. Davidson & Co.

Yes that’s fair enough.

Andrew Schmitt

And we’ve, do you want me to include the CIPP business because that was about $45 million.

John Rogers - D. A. Davidson & Co.

Okay.

Andrew Schmitt

Well let’s look year over year so, l’m not going to take you back to the beginning of time. Let’s say this year, Jerry what did we have in there, you look at the detail and tell us.

Jerry Fanska

Really we just really had the Florida acquisition that wasn’t necessarily in there in the third quarter last year and that’s about $5 or $6 million in revenue.

John Rogers - D. A. Davidson & Co.

For the quarter or annually.

Jerry Fanska

For the quarter, so you’re talking about $20 million that would be annually for just the Florida piece.

Andrew Schmitt

We don’t have W.L. Hailey in there at this point, so Jerry’s right the CIPP has been in there for a couple of years. [Collector Wells] has been there for a couple of years. Tierdael for a couple of years. So that’s about it.

John Rogers - D. A. Davidson & Co.

And then if we look at the mining business, the price increases that you’re trying to get imposed there, would those become effective really out into the second quarter when we start to see the seasonal rebound.

Andrew Schmitt

Right they would be. We’re getting more calls and I think when you look at the mineral exploration business I think historically that our mineral exploration businesses tend to be the ones that are very slow to reduce pricing. And we tend to be the one that move the quickest in raising prices. So I think historically you’ve seen that a number of times with Layne Christensen.

And one of the reasons for that if you think about it, is we have a more diversified business than most, almost any of the mineral explorations companies. So if you think about it, we’re more inclined because we typically don’t fall as far or see the deterioration so there’s less panic on the decline and there’s a little more backbone on the recovery.

Because we tend to get buffered as we have versus the other companies. So its not, our nature is to go ahead and move that price component up quickly but we have more flexibility to do that and more willingness to maybe not go for the market share but go for the price and have that staying power to do it.

So that’s been discussed in prior years on these calls and that typically is the case when you look at the balance and the diversity we have in the product line it gives us a little more backbone when it comes to saying, okay its been tough but we’re not locking ourselves up at these prices if we don’t have to.

John Rogers - D. A. Davidson & Co.

And if we really are hopefully moving into some sort of sustained recovery in that business, you’ve also talked about in the past that you’d look at expanding the business as well, opportunistic acquisitions, is the time right for that.

Andrew Schmitt

Well if you saw we were at or near our bottom I would say yes. I would say yes and really there’s not that many smaller deals that we look at that would make a lot of sense so its not what I’d call small rollup strategy for us, its probably more interest in the bigger chunks of business that have more meaningful consolidation impact with the recognition that even if we’re at or near the bottom its probably not going back to that rarified air that we saw in late 2007 and three quarters of 2008.

So if you can take a view that some consolidation even of the larger companies might make sense, if you want to get back to that level, its going to take some cost savings, its going to take some pricing power. It’ll take some economy to scale that may be difficult to achieve otherwise you just wait and take your share of the pick up as it comes around.

Because as you know that industry is fairly concentrated between our Latin American partners, ourselves, major drilling [inaudible] we have a fairly good chunk of the, certainly the major company and in the important mining regions of the world.

Operator

Your next question comes from the line of Jonathan Ellis – B of A/Merrill Lynch

Jonathan Ellis – B of A/Merrill Lynch

Just wanted to, you mentioned something in your prepared remarks that caught my ear and I think if I understood correctly that given where natural gas prices are right now that the energy business may be break-even in fiscal 2011 and assuming that you had to take impairments which if I remember correctly I think there’s about $30 million of assets that would potentially be impaired so that implies that the loss in the energy business could be $30 million including the impairments, and I think you had said that the water and the mining business may not be sufficient to offset that in terms of total company profitability. So just to make sure I’m clear does that imply that the combined earnings in 2011 from the water and mining businesses may not reach that $30 million threshold to offset what the profitability of the energy business would be post impairments.

Andrew Schmitt

Yes, when you look at taking any impairment charge and look at the segment income that you see there with Layne energy if you zero that out okay, it would be hard to make that up in minerals and the water infrastructure businesses. And I’d say that with the comment that although we are seeing a recovery or a sustainability in the case of rentals businesses, we’re not looking for a return to the economic kind of run rate we were at 2007 calendar year 2008, so my view is the pick up is going to be welcomed but wouldn’t expect it to be so dramatic that we’d be off to the races again.

Because offset those type of earnings you have to have it occur in mineral exploration. And even though it may pick up, I don’t expect we’re going back to a boom. So it would be with that qualifier so you take that Layne energy earnings out completely and say, okay you guys go ahead and forward sell, and they basically next year EBIT for Layne energy is break-even, will we make that up in the improvement we see in the general economy in mineral exploration, I think it would be tough to make up.

But that’s just my view. Until I see what this economy looks like a little bit better next year, I think conservative view is the right one to take.

Jonathan Ellis – B of A/Merrill Lynch

And to be clear just to make sure I understand it—

Andrew Schmitt

--without the impairment. Just taken those numbers out completely.

Jonathan Ellis – B of A/Merrill Lynch

But when you say excluding the impairment then you mean that if the energy business is operating at break-even excluding an impairment that you think that the total company is still going to be able to produce some earnings from the water and mining businesses but I guess to make sure I understand what you meant by the total company being at break-even was that including the impairments in the energy business next year.

Andrew Schmitt

No not including the impairments.

Jonathan Ellis – B of A/Merrill Lynch

On the impairments for one moment to make sure we all understand assuming that natural gas prices stay at their current level both in terms of spot and on a foreign basis and obviously we know that the forward contracts are rolling off beginning of April, would you expect that the remaining $30 million of assets that potentially be impaired would be impaired at this point based on what we know today.

Jerry Fanska

In the fourth quarter we have a number of things going on there but no the new SEC rules basically go back to an averaging of gas prices for the calculation of the impairment. So that’s one factor for the full year. You do 12 months rolling basically. Instead of a point in time price which has been the case for each quarter end this year, you go back to a 12-month rolling which kind of has a negative impact. I think the thought was it would have a more leveling impact but its going to be a negative impact because the prices were so low for most of the months this year.

So that will have an impact on January 31. The hedges that we have for the forward sales contracts I should say that we have in place, at an average price of $8.70 will be rolling down to where we’re only going to have three months left at January 31 or actually February, March so we just have two months left.

And so most of your reserve calculation will be based on assuming we don’t put any forward sales contracts in place between now and then, they’ll be based on that average price that you calculate for the last 12 months.

Andrew Schmitt

Which for you, what do you think its going to be.

Jerry Fanska

So today it would be $325 to $350, so versus the $407 or $410 that it was at the end of October. So those factors in combination could very possibly end up having some impact on the reserve, obviously they’re going to have a lot of impact on the reserves that we at January 31 which will impact the calculation of the net present value of those assets which in essence you compare it to what you have on the books and could very possibly be a write-off.

Jonathan Ellis – B of A/Merrill Lynch

The mining business, you talked about potentially some price increases in the coming year, any way at least based on preliminary discussions to quantify what those price increases may be.

Andrew Schmitt

Not at this point, its just a general feeling that as we get more calls and more interest and more definition to programs, when we’re quoting the work, we’re going to move these prices up period. Whether that’s enough to, whether they push back and we end up having to back up or the work goes to someone else, we won’t know but we get into early next year we’ll find out just how much room is there.

But you have to start. Nobody in the mineral exploration business is happy with these current prices that’s for sure.

Jonathan Ellis – B of A/Merrill Lynch

The other question I had was in the water business, in terms of the stimulus spending, what’s your sense as to whether the stimulus capital is really been directed towards existing projects that need additional funding as opposed to actually new projects that had not been brought online previously.

Andrew Schmitt

I think its more projects that additional funding. It makes up the difference I think whether these projects get moved along in a timely fashion. What we have seen, its not been that we have seen a project that I recall that someone says, 100% of their funding is from the stimulus. That’s not been the case. It was the fact the project is going forward, is they’ve got some stimulus money and some of that is going to be directed and so this project will probably be done. Which I think really is sort of our preference.

It has a smoothing effect and it will roll over and really and I’d like to see the stimulus and we will see it, next year and even the following year see that state revolving fund get reauthorized at the levels that have been discussed in addition to the stimulus. That could give us some nice fairly steady more predictable rollout of work that could be done in a, what I’ll call under normal circumstances as opposed to some mad dash to spend which doesn’t make much sense for anybody.

Poorly designed projects, a pricing environment, you do it today its more aggressive then it needs to be. So I’d rather see it slower and continue to provide that little bit of a bridge to more long-term recovery in the economy in general and my expectation is just given the bureaucracy as you know, that’s probably the way its going to roll out.

So from the water and wastewater side we’re probably better than the highway money that went out and everybody finished their potholes and now there’s no money. So I think if you look at the road construction versus the water I prefer the way the water is going to roll out but again we’re a company with a lot of diversity, multiple businesses, ability to redirect work as you’ve seen on the specialized drilling side so we can handle that type of rollout.

I recognize other companies that are more narrowly functions need it now. But that’s not my preference. I just assume it roll out in an organized fashion.

Jonathan Ellis – B of A/Merrill Lynch

Just turning back to the energy business for a moment, is there a price point on forward contracts where you’d be willing to lock in a full year’s worth of production at this point. Is there a threshold that you’re looking at.

Andrew Schmitt

We like to generate some earnings next year in Layne energy so when we move about $550 and start generating some earnings that becomes more attractive to us and a year can be an awfully long time. And we’ve been, as we look at industrial demand, look at coal prices right now, clearly that is the power supplier when you look at the coal prices whether its Appalachia, whether its [Powder] Rive, they stink.

So you know power demand is down and not everybody has been able to cut their thermostat up or down so we know the weather was not conducive to burn a lot of power. We know that the industrial demand is very, very weak, and we also know that there was lots of supply brought on and we’re looking at half the rig count.

So when you start adding up those type of factors, and you don’t get in a real eager mode to go out and say, okay we’re going to lock in for a full year even with the consequences that we could be at a spot price that I’m looking at right now on our pipeline is $480. Okay, as of today. And March, April through March price forward price is $544, I’m looking at it on [Main power] right now.

But you don’t have a perfect view but you see a lot of factors that could take supply off the market and where is our interest in the Marcellus shale, well as much as everybody talks about it and it’s the largest reserves clearly unconventional reserves in the United States, huge reserves, what are we looking at as a water company.

Regulatory requirements that slow down the production or drive up the cost of producing the gas. And so I think at Layne we have a mindset that’s pretty rare when you look at our exposure and understanding of water regulations and being a gas producer and running a service company that drills so we might be people that have a pretty good view in terms of determining how that equation actually works.

Operator

Your next question comes from the line of Michael Smith - Kansas City Capital

In the press release you do refer to in the water segment a couple of problem contracts that you had, could you give us a little bit more color there.

Andrew Schmitt

The biggest problem that we had was on the, a ground freezing project in New York City and that’s been plaguing us for a number of quarters and if you bare with me a minute, I’ll give you how big it has been. If you were to look at the impact on EBIT and that project, the division EBIT, that segment earnings is about $2 million that we’ve eaten trying to finish up and get that construction project on line year to date.

So there’s a good chance it better not repeat again. But that’s the project that’s probably most consequential that plagued us for a couple of quarters now as we’ve tried to wrap up that work. We had mechanical problems, we had project management problems, you name it we had it.

Jerry Fanska

That and we had one project in Florida that obviously is done now.

Andrew Schmitt

I think the ground freeze is probably the biggest one.

Operator

Your next question is a follow-up from the line of Richard Paget - Morgan Joseph & Co.

Richard Paget - Morgan Joseph & Co.

Just a clarification on what you were talking about with Jonathan and just to be clear, so if gas stays at around this level you don’t expect the other businesses to ramp up earnings to replace those lost earnings of the energy segment next year as compared to last year which I guess, the net of that being if things don’t really change its going to be tough for you to grow earnings next year, is that fair to say.

Andrew Schmitt

I think if you look at that, I’m looking at the energy piece now, if you look at that energy earnings without the impairment charge for energy, if you were to take the year to date three quarters’ earnings without impairment it would be $11,416,000. So add a quarter like this quarter on to that. And then zero it out, tax effect it, divide it by the number of shares outstanding and you’d be able to just, you’d be able to work your model and say, here’s what you come up with and that’s what you have to make up.

If I knew we were just going to explode on the upside completely turn things around, I might be able to say, yes we probably could make that up, but it really would take quite a push in infrastructure in Layne legacy and I just think that expectation of a tough one to come, conclusion to come through at this early stage.

We typically don’t give forecast but I mean I can certainly forecast the difference between 87 and 550 on the amount of gas we’re selling. If you want to run it that way and look at it a draw your conclusions. As we get into next year we’ll know for sure so we’ll be able to let you know probably by the time we report second quarter earnings.

Operator

Your final question comes from the line of Dick Kindig – Keeley Asset Management

Dick Kindig – Keeley Asset Management

Does the technology that exists to date treat that Marcellus water on site.

Andrew Schmitt

Yes it does. Its, there is technology that used in the oil and gas industry, in fact there are a variety of techniques that are used that can treat the water, treat it on site in the current regulatory environment. Tightened regulations might present a problem and the footprint in the Marcellus is, you need to be smaller.

You need to treat it but in our view the equipment, the ability to set it up, take it down, move it needs to be more mobile. It needs to be a smaller print, it needs to be quicker, it needs to be more efficient, and so that, there’s going to be a trade off between the volume that you can handle and the size of what you handle it with and in our view although we’re not the only company looking at this and looking hard, nobody really has come up with that right combination yet.

As I said, we will probably do something in the licensing or purchasing of the technology if we get a view that we think we know how to do that. The technology there, it’s a question of size, volume that you could handle and how tight would those regulations get on total dissolved solids.

Dick Kindig – Keeley Asset Management

You periodically consider separating some of the businesses, do you go through that exercise periodically and if you do what do you think about, what do you consider.

Andrew Schmitt

Well when we look at the one that’s probably the easiest to separate is Layne energy. And if you were to make an acquisition of size probably becomes even easier to separate that. Our view is that if you did something in that range you more likely tend to look at a spin off to your existing shareholders in that regard.

We’ve looked at from time to time and discussed mineral exploration business. I’d say that that becomes fairly viable if you were to do a large acquisition of one of the consequential players with the same thought, its big enough size wise that it can carry its own weight to finance what it needs to finance going forward and that so, it wouldn’t be inconceivable if we did something sizable in mineral exploration over time, that might make a very good standalone company.

Particularly I think if you thought you were going to move up in that very aggressive rate of growth that we’ve seen in past years. It might be good timing to think about that. I think the water business has so much diversity in it now, in a much bigger infrastructure component that you’d have to be a little bit concerned about separating any of those businesses from the water business if the water business paid you a high PE but the earnings were lumpy.

And the margins can be skinnier than the other two. So that’s why we always go through the exercise but for the most part when we’ve looked at it and the company, the combination of these businesses have served us pretty well and Wall Street always seems to be willing to apply a PE that represents that combination and that moves more towards the larger revenue component which tends to be water related infrastructure.

So it’s a tough call to make because you’re not always sure that the incremental value you’re creating would necessarily accrue to the shareholders. So that’s been our discussion in the past and its always an interesting one both at a Board level and Jerry and I have looked at it individually but you look at historically in the company, when we’re at a $1.00 a share in earnings, the PE is in that 17, I’m talking about under normal historical, 17 to 22 range and as you move towards $2.00 a share it starts to move in that 25 to 28 range.

And its done it consistently through the years so its hard to have this what I’ll call somewhat investment banking mindset when you look at history. And that’s where we end up sort of sitting the way we have but you’re right, we’ve looked at it. We’ll continue. Timing would make a big difference and critical mass and the ability to finance it would make a big difference.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Andrew Schmitt

Thanks for your time and attention and I don’t know if they call it green shoots but certainly on the water infrastructure and mineral side, we’ll call it a green shoot with the caveat that we’ve talked about the Layne energy issue, maybe we’ll get something moving down the road on the gas side as well, hopefully.

In any event, we’ll do our best to keep managing this company the best way we know how and we appreciate your time and support.

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