Layne Christensen Company F4Q10 (Qtr End 01/31/2010) Earnings Call Transcript

| About: Layne Christensen (LAYN)

Layne Christensen Company (NASDAQ:LAYN)

F4Q10 Earnings Call

March 30, 2010 11:00 am ET

Executives

Andrew Schmitt – President & CEO

Jerry Fanska – SVP Finance

Analysts

Richard Paget - Morgan Joseph & Co.

Jonathan Ellis – B of A/Merrill Lynch

Steve Ferazani – Sidoti & Company

John Rogers - D. A. Davidson & Co.

Michael Smith - Kansas City Capital

Deborah Coy – Janney Montgomery Scott

Operator

Welcome to the fiscal 2010 fourth quarter and year-end earnings conference call. (Operator Instructions) At this time I will turn the conference call over to your host, President and CEO, Mr. Andrew Schmitt. Please go ahead, Sir.

Andrew Schmitt

Thank you. Welcome everybody. I am here with Jerry Fanska, our Chief Financial Officer and we would like to welcome you to Layne Christensen’s fourth quarter and fiscal year-end conference call. Earlier today, we issued a press release outlining the results for the fourth quarter and the fiscal year ended January 31, 2010.

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 in the fourth quarter decreased 1% to $227.2 million from $229.4 million in the prior year. Water infrastructure revenues decreased 5.1% for the quarter to $181.9 million reflecting declines across all our major product lines except our large diameter Ranney collector wells and our specialty GeoConstruction services.

Mineral exploration revenues decreased 29.2% to $32.4 million for the quarter primarily on increased demand in Mexico and West Africa. The main energy division revenues increased for the quarter 3.1% to $11.9 million primarily due to more gas volume sold through our higher priced forward-sales contracts. There was no impairment charge recorded in the fourth quarter of fiscal 2010. In the fourth quarter of fiscal 2009 a pre-tax charge of $26.7 million was recorded. As of January 31, 2010 the remaining book value of assets subject to impairment testing is $26.7 million.

Selling, general and administrative expenses increased to $34.7 million in the quarter from $31.4 million in the prior year. The increase primarily is the result of settlement charges of $5 million due to the elimination of our hourly pension plan liability, something we have been working on for a number of years. Depreciation, depletion and amortization increased to $14.8 million in the quarter compared to $13.9 million in the prior year as a result of increased depletion in the energy division and depreciation from property additions in the other divisions.

Equity and earnings of our affiliates in Latin America decreased only slightly to $2.7 million in the quarter from $3 million in the prior year. Interest expense decreased to $528,000 in the quarter primarily a result of scheduled debt reductions. The income tax rate for the quarter was an expense of 60.2% compared to a benefit of 30.6% in the prior year as non-deductible expenses had a higher impact on the effective rate as the company earnings declined.

The fourth quarter net income was $0.12 per share in earnings compared to a net loss of $0.59 last year. Excluding the pension plan adjustments this quarter and the oil and gas impairment charge last year earnings would be $0.28 per share this year compared to $0.24 per share last year.

For the year revenues decreased $141.6 million or 14.1% to $866.4 million. Revenues were down across all divisions for the year with mineral exploration revenues down the most at 37.4%. As I previously mentioned, however, the minerals division did show substantial improvement in the fourth quarter up 29.2% from the prior year. Operating expenses including SG&A, depreciation and amortization and depletion were down 3.6% or 1.9% from the prior year mainly reflecting decreased incentive costs as earnings came down plus other cost reduction measures, offset by higher depreciation due to higher levels of capital expenditures and additional depletion in the energy division.

Equity and earnings of affiliates decreased this year to $8.2 million compared to $14.1 million last year reflecting weak demand for exploration in Latin America for most of the year. For the year the company earned $1.4 million or $0.07 per share compared to $26.5 million or $1.37 per share last year. At January 31, 2010 the company’s balance sheet reflected total assets of $731 million, stockholder equity of $466.8 million, long-term debt of $6.7 million and cash and cash equivalents of $84.5 million. Net cash from operating activities for the quarter and the year were $21.3 million and $94 million respectively.

Investing activities totaled $17.9 million for the quarter and $58.6 million for the year. These activities included $0.2 million and $4.3 million in the quarter and year respectively on unconditional gas activities and $14.6 million for the year on acquisitions with the remainder spent on property, plants and equipment. The energy division reported proved reserves as of January 31, 2010 of 16.5 BCF of natural gas and estimated future net cash flows discounted at 10% after income taxes at $23.6 million. This calculation was based on an average gas price of $3.24 per MCF.

With that I will turn it back over to Andy to talk about the operations.

Andrew Schmitt

Thanks Jerry. From an operating perspective I could best sum up the year by saying good things came in small packages. We had three business units with a combined revenue of 14% of total company revenue and produced about half of Layne Christensen’s total division operating EBIT. The business units were our Ranney large diameter collector wells, Layne GeoConstruction, our soil stabilization business and Layne Energy.

Nonetheless, fiscal 2010 was a very difficult year for most of the rest and our total net income of approximately $0.90 per share excluding write down’s represented a significant drop from prior years where we were earning in excess of $2 per share for the company on the same basis. Thanks to several small certainly over-achieving business units this past year it could have been a lot worse.

Water infrastructure group, the rental business lines including our recent acquisition of W.L. Hailey & Company the product backlog is $427 million versus $330 million in the year-ago period. Within that backlog we have seen pretty good increase in our cured and placed pipe (CIPP) activity and a trend towards improving margins in that business line as well. The Ranney Collector Well business which was such a big factor this past year will still be very profitable but not likely to repeat last year’s all-time record result.

That will also be the case for Layne GeoConstruction business as they anticipate having a decent year but it will be well below their record results last year as well. In GeoConstruction’s case we finished up the reinforcement work in New Orleans and have moved onto another significant job on the west coast but one where the soil conditions are more difficult and may dictate lower margins.

The largest business unit in our rentals product line is our pipeline and design build treatment plant construction. We have maintained the volume of work as this is the biggest part of our backlog. However, the margins are weaker in that backlog reflecting an increasingly competitive environment in the heavy civil work. Hard hit areas in the U.S. economy such as residential and more recently non-residential commercial markets have pushed a lot of general contractors into the municipal water and wastewater public bid sector. This trend is likely to continue for much of the year so we think our margins are going to remain pretty under pressure in that heavy civil work.

One of the water businesses in this segment where we do expect considerable improvement is our Layne legacy water well drilling and pump repair business. This division was extremely hard hit in the recession as the operating EBIT In fiscal 2010 was only about $2.7 million down from $27.9 million in fiscal 2009. The expected pickup in activity and earnings in the New Year is the result of water well drilling work in Afghanistan to supply U.S. bases there and deep disposal wells used to inject wastewater primarily by large power companies in Florida.

That latter market is being driven by tightened regulations on waste water disposal. We would logically expect in fiscal 2011 some modest improvement in municipal spending for replacement wells for water supply and improved repair and maintenance work as well. I have to say so far we haven’t seen much evidence of that. The backlog has picked up a little bit in Layne legacy but we haven’t seen much in this first couple of months in the first quarter.

So to summarize our prospects in the New Year we currently see in the total water infrastructure segment GeoConstruction and Ranney collector well business returning to earth so to speak, having sort of normal years. CIPP is going to show continued improvement and in the heavy civil work we are going to face a fair amount of margin pressure and we will look to Layne legacy to recapture a good portion of its peak earnings which we experienced in fiscal 2009.

Moving to our mineral exploration business particularly our wholly owned drilling division we are experiencing an extremely strong turnaround in activity. In fact, in April we will be very close to operating almost the same number of rigs and shifts that we were operating in the peak and early September 2008. In our last earnings call we said the major mining companies were checking on rig availability and budget quotes but we were a bit skeptical about how much increased activity would actually materialize.

Well we have gone from that mode to scrambling to get rigs in shape and locate former employees that were laid off in the downturn. So after going to the sidelines for more than a year the large and mid-sized mining companies are all finally going back to work. A combination of a need to add reserves and anticipated continued growth in China and the developing economies seem to be the main drivers. Our Latin American affiliates are also experiencing a pickup in demand but they have less room to move on the upside as their larger drilling contracts that helped cushion their decline in activity in the downturn also gives them a little less spare capacity when you see a sharp turnaround like this.

In both businesses I don’t think either will return to the glory days of 2007 and 2008 mainly due to pricing which on average for us is about 15% below peak levels. However, if this activity proves sustainable we will recapture some or all of that price in due course. But after the year we just finished we would be happy with getting half the glory back so to speak.

The third reportable business segment for our company is energy. Our Layne Energy E&P company was benefited from some opportunistic forward sales programs for several years. As of April 1 we do have a day of reckoning. At current spot prices which are about half of our forward sold price of $8.70, actually end tomorrow. We would have an operating EBIT decline of about $1.5 million per month since it is price, EBITDA will drop the same amount will drop through to EBITDA as well. EBITDA as a percent of revenue, of course revenue would be reduced accordingly, would still be around 50% but a significant decline from 2010’s 71% rate. So definitely a very tough year on Layne Energy if we don’t begin to see a decline in natural gas supplies and/or a pickup in industrial and power demand for natural gas either of which would spur a better price environment.

Our main problem on hedging is we never did see a window on natural gas pricing on the southern [shore] pipeline to which all of our natural gas flows that was really attractive enough to lock down forward sales for an extended period of time. I think on the last call we saw about the best pricing we have seen at about $5.15 on the forward contract if you locked it up for a year.

To summarize what we see as we sit today, granted very early in the new year. We have a recovery expected in Layne legacy water business, improvement in CIPP to help offset declines in our more infrastructure intensive businesses. Strong recovery in mineral exploration will help counter a decline in Layne Energy earnings until natural gas prices improve. I think on capital spending we will be in the $50 million range excluding any acquisitions compared to about $45 million this past year with acquisitions.

We might spend some of that money early seeing the price increase valet on iron ore. I just sent an email this morning to our guys to start buying up the inventory they could find in the tubular area, casing area. They have a feel for what sizes they will need because we can expect some pretty good increases down the road and the mills will look to pass that pretty quickly but I still think we will be in the $50 million range. It may just be timing. The balance sheet is going to remain strong as we continue to pile up cash. Cash remains at about $85 million at the end of February like it was in January worldwide.

We continue to look for ways to spend that cash, investigating opportunities in water, minerals and energy sectors with the latter being both on ENP and oil and gas service side as well. The oil and gas sector on the ENP side you may recall we liked early on the oil side and came close to a transaction, a fairly large one, but with $80 oil M&A prices just haven’t been that attractive to us. They moved up in a hurry. The deeper shales have turned out exactly as we expected. We have talked about it on a couple of these calls. That is being what I will call a big boy play. We always felt the large capital expenditures and steep decline curves would produce that outcome. Even the large independent oil and gas companies have reached out to partners and I think that was fairly predictable.

At this juncture it may make sense for us to go back to our roots with Layne Energy and look for some small partners with drillable acreage in cost competitive basins. I don’t think taking a more grassroots approach by growing through the drill bit, we care if it is oil or gas at this point. We don’t see gas pricing staying low forever and we think the eventual cost of producing from the shale will be higher than a lot of companies or investors realize. So one could expect a cost push to also affect prices in the future.

On the water side of our business ironically one of the best growth prospects we currently see is trying to find the optimal approach to treat Frac flow back water in the Marcellus shale. We have narrowed our discussions to fairly small company that has a process that may have potential. It would be a pretty large R&D effort initially to develop a commercial product but we have talked to a number of companies and just don’t feel the better mousetrap has been found when all the variables that need to be considered are taken into account.

On the mineral exploration side our Latin American affiliate partners in our opinion are probably the best company out there that we don’t own 100% of. They are quite happy at this time to remain in our partnership and what will be our 15th anniversary together in December. There are a few regional companies in well established markets which last year were close to coming to us with a tin cup in their hands but this recent spike in activity if sustainable may postpone that decision. However, with major drilling [inaudible] and Layne Christensen all with stellar balance sheets and good cash flows, consolidation in this mineral exploration industry is going to pick up in the future.

I think that is pretty much it. Operator, if we have any questions we will try and entertain them now.

Question and Answer Session

Operator

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

Richard Paget - Morgan Joseph & Co.

I wonder if you could talk a little bit more about the ramp up in MinEx. I know you mentioned that April was a pretty strong month. I want to try and get a sense of are we at a mid-$40 million quarterly run rate with mid to high teen margins? Are we there yet? Given some of the potential longer-term contracts you have in place now might that delay the peak level type of run rate going forward?

Andrew Schmitt

The longer term contracts we have really were in the joint ventures down in Latin America. That has typically been the case for a number of years there on the larger mines and some of the larger contracts. I think I mentioned before those contracts have been renegotiated with the magnitude of this downturn, not so much on volume but the price. So those have been unfortunate.

They have room to move up capacity but not as much as we do in our wholly owned business. I think mainly you will see improvement in Latin American results year-over-year and be reflected in our interest of ownership but it might not be as sharp, in fact I wouldn’t expect it to be as sharp an improvement as we will see in the wholly owned business. We don’t have a lot of long-term contracts so the new contracts we entered into I said the last call if all the phones start ringing at once we will try to push for higher prices which we have and we have improved some of the pricing we had in the third quarter last year.

But we will work through those contracts over the next 6-9 months and the volume is a factor but we have also taken a lot of cost out of that business. If I were to look at even the EBITDA in February including our Latin American affiliates the EBITDA in the month of February compared to February a year ago went to 21% from 13%. We will really see the bigger impact of the activity we have in March and April. In April, as it stands right now unless there are changes in the forecast, we look at the number of shifts as opposed to rigs as we can run double shifts and that tends to be more meaningful for us but we would be about at the same number of shifts we were in 2008 and that was a peak. So we really had to scramble through the month of February and certainly into March.

We don’t have March’s results. We will see how they come in and then take a good look at April. That will really give us a good snapshot of current pricing and how much cost we have taken out. We will have most of the startup trying to reach the utilization levels behind this and most of the maintenance on the rig and finding the people and some quickly training in some cases. But it has been a much sharper turnaround than I would have expected.

Clearly I have information from our field people the phone was really beginning to ring from a lot of customers we had not heard from for quite awhile. I was probably more skeptical at that time saying it was more okay getting pricing from budgets and we will see [sketchy] calls for the rigs and so I had a little bit of a jaundiced view. The mining industry and the segment we haven’t seen for awhile with the exception of a couple of large contracts down in Chile that have seemed to definitely have made a turn.

We seemed to pickup in Africa. We have seen the pickup in Mexico. We have seen the pickup in North America. Australia has been a little bit slow for us but even our partners in South America quickly begin running up against the ceiling of capacity. People, as I said, they were already busy so it didn’t take much for that to happen. We are sending out an email for tubular and one of my thoughts in mind is of course is the mineral exploration business because they can burn through some pipe in a hurry. So my email went out as soon as I saw $100 per metric ton on iron ore prices.

So there is a pickup. It has clearly in my mind got to be driven by China and the emerging and developing markets that are much stronger. We don’t see that much pickup being driven by the U.S., Europe or the U.K. but in that area as well the economy is considerably better and everybody sees it than it was at this time a year ago everything just ground to a halt. It won’t take long to get up to about the second quarter we will have a pretty good feel for how much of that earnings we will recapture.

Richard Paget - Morgan Joseph & Co.

Moving onto the water business I know there are a lot of moving parts here but you mentioned you are doing some federally sponsored work in Afghanistan and I wonder if you could talk a little bit more about that and if there are other opportunities for chasing federal dollars. I know Mississippi is doing a coastal restoration plan similar to Louisiana. Then the work you are doing in California is that for levy work as well out there?

Andrew Schmitt

It is soil stabilization for an extension of the subway in the bay area. They have to stabilize the soil before they can continue to push part of the subway further along the bay. The project is almost the same size as the project was in New Orleans but much tougher soil conditions. Much more competitively bid. It will give us the volume. It will certainly pay the light bills but it won’t produce the kind of results in the soil stabilization. The work in Afghanistan is two rigs working in various parts of the country where we are drilling deep, large capacity water wells to supply potable water to U.S. troops. It could be NATO troops. I am not sure what the breakdown would be in areas where you have a considerable ramp up of contractors, etc. moving into a country.

If the contract was for six months I couldn’t imagine we could get disassembled and packaged up and shut down within the year. We will just have to see, it is totally up to the military and we are working through [Dyne Corp] as to what they need and how they need it. They are large diameter. They are expensive wells to drill. They have a fair amount of lost circulation zones. It is not easy work. We had to bring everything but the kitchen sink over there because there is no place to pick up supplies. We sent 4 million pounds of stuff so it is a significant amount of work that has to be done.

The contract is six months. I expect we couldn’t get out for a year. We don’t know. It is good work and it is expensive wells. It is at the high end of the drilling market. The other federal work is driven by regulation affecting the environment and that is the tightening of the ability of companies to dispose wastewater and push that affluent deep out into the ocean. It is going to have to be reinjected. It has always been a niche market. Very, very difficult drilling. Large diameter top holes that telescope down much like oil and gas drilling. Various sizes of casing. Specialized casing has to be set along the way.

We stayed out of that market for 20 years. The reason we left, before my time so I can say this, is because the company had some major screw ups and some really bad wells and had a belly full of it. These regulations are going to increase the size of that market. There is really only one bona fide competitor down there. They stayed when Layne left and made a good living down there but the market size is probably big enough that it will be more work than either of us can do. It is not small company work. It has a fair risk component. The rig and all the ancillary equipment that is being built to do the first job, I saw part of it under construction in Houston. It is a significant rig. It is a $7 million investment.

So this is not your typical water well you would think when you look at the size of these wells. So it is very much in this market but as the regulations change, as you know regulations can be a big driver of business for us and put us in the asbestos cleanup market. That is the case here. So these specialized drilling applications will really buffer and help make up for the lack of new water supply well drilling which as you know has virtually disappeared in the municipal market with this downturn in housing. It is not going to come back, that piece, until we get people buying homes and moving again and population growing. We will get replacement well business just as a matter of course.

Of course things are more competitive as a matter of course. The cities are looking to save money wherever they can or in deferring delayed maintenance. The municipal sector is slow to recover. There are some pretty good statistics out there that shows municipal spending deficits, state budget deficits and how much they lag a recovery. So that is to be expected but the guys have done a good job in the water business finding other work to do. Again it is going a long way in Afghanistan but it is the right thing to do certainly from a patriotic standpoint.

It is the kind of difficult work you need a company of Layne’s size to do. That will bring us a nice recovery in Layne legacy but it won’t be driven by the municipal side. In the government work we benefited from the restoration in Louisiana. A couple of years ago some of our better years were in our Layne Baton Rouge offices. We have good group in Jackson. We are in Pensacola to the extent there is work in that part. We have done already some of the FEMA related work and the wells are drilled in that area so we are just kind of wrapping up mainly sub-contract work. I would have to see how much more work is to be done on the Mississippi restoration.

Richard Paget - Morgan Joseph & Co.

I have a quick housekeeping. I know the tax rate has been bouncing around and it has been high due to some of the write downs. What should we expect going forward?

Jerry Fanska

The main driver obviously of the effective rate going up is earnings coming down. Some of that is impacted by the impairment charge obviously. I think notwithstanding any of that happening to us it should go back to something normal. Maybe mid 40’s to upper 40’s or something like that.

Operator

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

Jonathan Ellis – B of A/Merrill Lynch

Do you have for the legacy and rentals business the year-over-year change in revenue and EBIT?

Jerry Fanska

We do. In the quarter or the year?

Jonathan Ellis – B of A/Merrill Lynch

For the quarter if you have it available.

Andrew Schmitt

On the legacy business?

Jonathan Ellis – B of A/Merrill Lynch

Legacy and rental if you have it.

Andrew Schmitt

Revenue right?

Jonathan Ellis – B of A/Merrill Lynch

Revenue and EBIT if you have that available.

Andrew Schmitt

Versus prior year of $74.6 million. EBIT was a loss of $1.6 million versus $6.6 million last year. The rentals, et al, was $102.7 million in revenue versus $103.7 million last year. EBIT of $3.8 million versus $4.5 million. GeoConstruction was a big factor because New Orleans was all in the second half so it was a good quarter so you will get that as well. So if you add our Geo business you had $19.9 million in revenue versus $13.5 million last year and $6.4 million in profit versus $1.7 million the prior year. All that adds up to obviously the infrastructure segment. That FEMA job with Katrina providing the stabilization there as they were putting in new barriers while we were working off the barges on that work.

Jonathan Ellis – B of A/Merrill Lynch

When you talk about, and I appreciate the color you gave about 2011, with respect to water infrastructure and the various moving parts and the heavy civic business being under pressure and Geo coming a little bit off the peak and then expected recovery in the legacy business on a net basis is your expectation that profitability, total EBIT dollars in the water business will be up in 2011 versus 2010 or is it at this point really too close to call?

Andrew Schmitt

It would really just be a guess at this point. We would like to say that we see enough recovery in Layne because you see how much that business came down. We clearly had more exposure to the housing sector even though we aren’t house well drillers. We had more overall exposure to that growth in calendar year 2007 and 2008 than we would have thought or historically had. So you would think there would be more recovery there or enough to offset. The rentals guys and the heavy civil side will have to have some really good execution. I mean there is not any room for slippage with the margin we have seen on the heavy civil side.

The collector well part of the business will be a good business. That will do as much work as we had done because that year was the most wells that we had seen in that particular area. Cured in place is in there and it is helpful. It is higher margin. You have seen in [inaudible] results or if you haven’t they have really done a good job and a lot of their improvement has been in the rehab side and in North America. They have gotten their situation in Europe improved. Their energy business will probably recover as energy recovers. Their industrial side with [Core Pro] is okay but really it has been the old base business for them and they have done such a good job in terms of cost reduction the pricing in that has loosened up a little bit. They had a lot to do with that because they compete in all markets and they are the largest company.

CIPP part of the business will help Layne legacy, the [randy] side will be good, it just won’t be on the moon somewhere and I think the real key will be that heavy civil. We used to get bids in that where Jonathon and there would be 5-6 bidders and we knew them all for many years and competed with them and the usual suspects we got used to seeing in rentals. Now you get a bid and there are 12-18 people and 2/3 of them you don’t know. We have probably a silver lining there in picking up the work that can’t do the work. Those are bonded jobs so we will probably have some upside in finishing up bonded jobs as we get calls from the cities but that is down the road because of the thin margin municipal work; mainly large jobs spread over a lot of time.

Many things out of your control because of the length of time it takes to do those jobs. It can be hazardous to your health so we see too many unqualified people who are doing work in sub-divisions. Not putting in a sewer line for a city. A big difference in work. We know there will be some problems there. Right now we are going to have to shoulder our way through and the guys felt like we had to be competitive and you can see from the backlog they went ahead and maintained the volume. That will be an issue for us this year and as I said the execution will have to be awfully good.

Jonathan Ellis – B of A/Merrill Lynch

Turning to the mining business you talked about the improvement geographically. In terms of project type are you seeing most of the demand coming from gold projects? Are you seeing more copper projects given the recent price increases there? Can you talk a little bit about from a metals standpoint?

Andrew Schmitt

We are seeing about 70% gold initially and glad to have the smaller mining companies that had saved some money. Our traditional balance has been 50/50. This recent push up has been more on the base metals and the iron ore side. What we are seeing now is shifting back more to base metal and not just the gold sector. It will probably move in our, we will probably be 60% gold, 40% moving to 50/50 if the work continues to be…a couple of contracts in the iron ore area for BHP in Australia and things like that probably will shift us back to our traditional mix.

Copper down in Zambia and copper in the Democratic Republic. Iron Ore in Brazil. So in our wholly owned business in Brazil iron ore is and our partners we are also down. More gold in Mexico and gold in West Africa and gold in Tanzania.

Jonathan Ellis – B of A/Merrill Lynch

In terms of the profitability contribution from the wholly owned versus affiliates business in fiscal 2011 at this point do you have a good feel for which could actually contribute more to the profitability for the overall company? The affiliates business or wholly owned?

Andrew Schmitt

Wholly owned. If what we are seeing and if our cost is truly as low as we think it is then that contribution would shift back to the larger portion being on the wholly owned side of the business. That typically is the case in the early stages of a turnaround. That is the way it generally works. We are not locked down price wise and we are not locked down contract or customer wise. Then as you get to the late stage of the next upturn by then contracts would have been renegotiated by our partners with their large mining customers and then you will see that cross over.

You will see the Latin American affiliate contributions starting to grow and we will start beginning to run out of steam a bit. It actually is a pretty good barometer for us when we were looking for the downturn really sooner than it happened in 2008 I would say because we were beginning to see too many things that we sort of knew how this went both in customer spending patterns and it got us pretty nervous. In early 2008 we continued to underestimate earnings in the first couple of quarters in 2008. Even the third quarter. I am talking about calendar year 2008.

It looked a bit overly conservative but our view is we were reaching a top there in a saturation point. It took awhile for it to happen and we certainly didn’t anticipate it happening quite like it did or even to the extent it did. It has us a little bit nervous at that time. Anyway we are in the early stages and you should see wholly owned if they can maintain this volume. Is this sustainable? I tell you I don’t know. At this point we can’t figure that out. We just know it is a sharp turnaround that caught us with very low cost structure which will help us be more profitable than otherwise if we are going to run at these prices. A 15% price doesn’t sound like a whole lot but on $200 million in wholly owned business it is about $30 million in profit.

You can say Geez, you are not going to be that profitable until you recapture that. Well, like every company late stage in the boom you are patting yourself on the back and thinking you are going a great job but you are not very efficient and you find that out and your costs have ballooned as well and you find that out when you go through a significant downturn and you sort of reset and start over. Our cost structure will go a pretty good ways to make up for the fact prices won’t spring back immediately. We won’t be able to gobble through that. We will get a couple of quarters under our belt and if the phone keeps ringing we obviously will be tougher negotiators and our customers would expect that. In the short term we are going to be running where we are and the proven results will be more utilization and a lower cost structure.

Jonathan Ellis – B of A/Merrill Lynch

In terms of the profitability in the mining business in terms of the cost savings you achieved how much of that is really structural? I ask the question in the context as you look at the margins you achieved in fiscal 2008 at the peak is there a reason to think over a period of time where your margins can be higher than that because of your more downsized cost structure or will cost really start to scale up with volume and therefore it will be hard to exceed prior peak margins?

Andrew Schmitt

If you look at the peak year and you sort of strip it back about all of our improvement was coming from pricing. The cost structure had ballooned and it was that cost push that kept the margins actually peaking in calendar 2008 but not too bad in 2007. It sort of ebbed and flowed with volume. Overall those were the peaks. We can certainly reach those again. Can we exceed them before that cost structure catches up? For a period of time and then costs will start to balloon. Prices for consumables, prices for people, benefit costs. We ended up not being able to get the folks to stay out of country and away from home as long. Rotations get shortened because people have more negotiating…drillers start having options to leave. That typically takes about…you get midway through and you will be sort of humming along at a more balanced cost versus price.

Then you have a year where you just start to kill it and then your cost starts to become a problem for you. That is generally when the thing is about to end quite honestly or slow down considerably. Customers start pushing back and you are not as efficient as you think. That is typically the way that works. We will get it for about a year and then over the next year we will eat into it but it is certainly possible to go back to where we were peak wise. More because the costs won’t move up as quickly.

Operator

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

Steve Ferazani – Sidoti & Company

I wanted to touch briefly on the energy segment. I want to be clear. You are going to be 100% spot now starting in Q2 and also if you have expectations of production level? I know the CDM wells the decline rates aren’t steep but I am assuming you are not going to maintain the same production levels without the hedges in place. Is that fair?

Andrew Schmitt

We may stay close to the current volumes just because of an unwillingness to push down more. We will ride that decline curve a little bit but we haven’t seen much decline curve in those wells. In fact if you look at the proved BCF when you see the 10-K filed it is almost flat with a year ago even though we produced 4 BCF of gas. So it is a bit of a head scratcher. Those wells have held up better than we thought. I am not sure other than the natural curve which we expected more of that to occur this year and it did not. It shows up in those reserves. You will see the PV10 value come down even at the same pricing and that is more of a reflection of the hedge lines running out.

You will see the BCF flat. The guys did a good job on dealing with the compression. I think we will stay fairly close. I am not sure how much more tinkering we want to do. We will let Mother Nature tinker. We thought that would happen this year and it didn’t. So if you look at those year-over-year proved reserves believe me you will scratch your head. It looks like, hmmm, this is a divine field or something here. The question is were they right in the prior year. I don’t know one could conclude…they probably were greater the prior year but we have had the same people doing the reserves ever since we started drilling this property. The same individuals.

So I think the databank is pretty good at this point. We will probably stay closer to flat and just ride the normal curve but it probably won’t artificially push that volume down. Our cash costs of what is already drilled and produced, currently running is about 260-270 cash cost. Once it is drilled and in place particularly with such a low decline it is not the end of the world relative to the return there. The more difficult question is how much new investment do you put in if the spot parks in the $4 range. That is a more difficult question.

We will look to Mother Nature to do her job declining but we haven’t seen much. You see it in the production ad we would be reluctant to force it much more although response has been pretty good when we have checked to make sure we are not screwing up the wells. Pretty good equilibrium right now. We might be a little…we would be a little reluctant.

Steve Ferazani – Sidoti & Company

Difficult weather conditions around the country. Late winter. Should we consider any of that affecting your water business in Q1?

Andrew Schmitt

It probably has. I mean, I think February we don’t have audited numbers for February at this point, but it didn’t seem to be…I don’t recall it being that big an issue in February. Legacy for the month of February compared to year-ago which was a lousy, easy comparison, well I guess it wasn’t that bad. It was flat. Rentals business, total rentals was down about $4 million. They might have had weather related issues compared to a year ago. GeoConstruction in February was actually better than a year-ago February but that was pre-job with Katrina. So when you look at the whole infrastructure group February was $48.4 million and last year was $52 million. So there is probably some weather in there and the profit would be affected accordingly.

The big changes are in minerals which was $14 million in February just wholly owned versus $8 million. That is why I say when I say a strong ramp up you can see that come piling through and we were scrambling in February so I am sure we weren’t as efficient as we will be in March or as efficient as we will be in April. I think April will probably give us a pretty good view of pricing/cost conversation we had prior with Jonathon and what kind of profit we can recapture that is lower cost driven at these prices.

Steve Ferazani – Sidoti & Company

When do you think you can get really aggressive on pricing again? If you get all of your rigs back to work what are you seeing industry wide if there is just a lack of supply out there? Is it just we are not sure at this point if this is going to be a temporary bounce or you need to see the sustainable growth before you can get aggressive?

Andrew Schmitt

I think there is more supply capacity still out there. If you look at Layne Christensen and our Latin American affiliate partners we have between the two of us 250 rigs. 300. But you look at Major they have 500. They have more underground than we do. It is not a market we compete it. There is more capacity out there. We took an add a rig strategy approach in the ramp up. We figured we would really get tighter quicker than buy companies. But a lot of the major players bought companies and they picked up, you can imagine you pick up everybody else’s rigs and their utilization and sort through them and by and large they spend more capital than we did. There is not a rig that was bought or major bought and they bought companies.

So there is more capacity out there but we get tighter quicker and we do look at pricing. That is where we typically have an edge. We can move that needle quicker as our capacity gets tighter. We tend to look at the high end of the market which is typically not very big with junior mining companies so we are generally looking at the larger customers and the requirements on safety and environmental compliance and things like that are pretty demanding. We said last quarter we went 5 million man hours without a lost time accident. In Chile that is our mark. I am not sure anybody in the industry could ever do that again and we still haven’t had an accident. So that record is running. A little bit different model. We don’t have quite the spare capacity that everybody does and we tend to cream it a little bit more at the top.

Operator

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

John Rogers - D. A. Davidson & Co.

I apologize, earlier in the call you mentioned some backlog numbers. $427 million versus $330 million. Was that for the legacy business? I just want to make sure I have the numbers right.

Andrew Schmitt

No the numbers that are in the press release in your total water infrastructure group, I just gave the rentals number.

John Rogers - D. A. Davidson & Co.

That is just rentals.

Andrew Schmitt

That is just rentals and includes the acquisition we made of W.L. Hailey so you are looking at Hailey being in and they weren’t last year. I don’t know that number. Overall it is up with or without Hailey. That is the volume. In that is CIPP which is better. Collector wells that were so important last year is probably lower but the heavy civil business is higher with weaker margins.

That didn’t have the GeoConstruction backlog in it nor did it have Layne legacy. So if you subtract my numbers from Jerry’s, sorry that is a bit confusing, but subtract my numbers from Jerry’s and you get rentals only and then the balance would be Layne legacy and the GeoConstruction piece.

John Rogers - D. A. Davidson & Co.

As far as the $27 million in potential write down in the gas business for the impairment, when would you have to take that charge? I know it is a non-cash charge.

Andrew Schmitt

Hopefully never. We survived a ceiling test at $3.00 plus some pricing with the hedges running out. So we sort of surprised ourselves. If you look at the fact that there are 16 BCF’s of reserves and it is the same as last year the reserves stood up a lot better, I would say last quarter we will probably write the investment to zero which is a little bit ridiculous with these SEC rules. I was surprised as anybody when Jerry said the proved reserves didn’t drop. I said how could they not drop? We pumped out 4 BCF of gas. What do you mean they didn’t drop?

I am looking at the independent analysis here from Gillespie but it didn’t drop. Remember we pressured up, pushed that gas volume down and we probably messed up the decline curves when you go to stick them into any kind of computer model with the way we ran the business. I don’t know. After surviving $3.31 gas and having reserves stay flat year-over-year and produced what would be…the reserve report will tell you only 3-4 years worth of life left but if they don’t go down…

John Rogers - D. A. Davidson & Co.

Then there is no charge.

Andrew Schmitt

That is exactly right. At this point I would hope we wouldn’t be at gas prices much below $3.31 or whatever it was. Maybe there is nothing there. I guess it is probably just stay in that level. Again it will depend on the decline curves in the wells but they sure flattened out this year. We shall see. We were quite prepared to do some drilling to maintain production. Some required drilling for leases we don’t want to expire and actually go prospecting again with the guys and we look at different basins and probably go back to how we started the company with partners. That works pretty good.

We started with partners in the business. We eventually bought those partners out as our willingness to drill and expend capital typically would exceed their ability to do so. So we were able to negotiate a decent agreement with them and one of the reasons CBM for us is as low cost as it has been. That is not a bad model. We started last time when gas prices were absolutely horrible and had a nice 5-year run. We will probably take that approach again. There may not be any write down. We also look back in the oil and gas service sector it is more like our minerals business probably even more than the water business even though the rigs look similar. There are still some pretty good values in the oil and gas sector.

My view is I am not sure I would spend the money in the shales that are being spent but if somebody is going to spend it then it will be drilled. That is the only way to put down proved reserves, to it with a drill bit. SO one thing you know is if there are that many people interested and we are seeing a lot of oil being drilled horizontally and using techniques like they use in the shale with the multi-stage frac, would clearly when you look at the rig count it has picked up on the oil side. I mean if you look year-over-year at [Baker Hughes] gas rigs they are up 16%. Most of it is horizontal. When we look at oil rigs they are up 125%. We may see some resurgence in drilling on the shallow oil and oil field people have left. So the drilling is going to occur in either side we are a drilling company. Our thoughts do go a little bit to the shallow oil and gas drilling or the horizontal drilling or the under-balance drilling, air drilling, so it would not be a bad piece to hook up on our energy business and probably from an investors standpoint they understand the service side, most of our investors, better than they do the ENP side.

Right now we have an oil field that has no decline curve. That’s the good news in a low price environment.

John Rogers - D. A. Davidson & Co.

You touched on the minerals business and the gas business but in terms of acquisition opportunities in the water side of your business, how aggressive do you expect to get just given the market environment? Have you been pretty good in the past at buying on lows?

Andrew Schmitt

On the bolt-on type acquisitions for rentals as that market gets tougher and tougher and more and more competitive we will probably still have opportunities we can pursue and there are certain geographies we would like to be more prominent in anticipating a recovery over time. I think those opportunities at good values like we saw with [Tierdale] and like we saw with [Methers] and like we have seen with W.L. Hailey. I think those opportunities will still be there for us and some of them are quite sizeable.

On the cured in place side it would be more the fragmented part of the industry and I would say that for us would clearly be geography we are not represented in. We have looked but we have really not found willing sellers at this point in cured and place but that would also be driven by geography. In the Layne legacy business because of the municipal market tied to the housing was such a prominent part of not just our business but a lot of traditional water well drillers we were going to circle back and look at the people in the base water well drilling business and see if we shouldn’t revisit that.

We talked briefly about it at our board meeting last week because there is a consolidation strategy that we sort of pulled away when the water well drilling business got to be so good because those are generally businesses you don’t buy. Fairly low multiples of EBITDA or traditionally have. Those multiples moved up for everybody. Obviously that part of our business helped our multiple as well. So we will go back and revisit that. That is not a strategy we have talked about for a long time but if you want to look at a market that is fairly depressed and again most of our pickup’s coming from specialty work either in Afghanistan or very large, deep injection wells.

That is not opportunities that are small, municipal water well, regional drilling companies can take advantage of. We also have a fairly good size water treatment business. They are not in that market either. I think strategically it makes sense for us to go back and look at a consolidation strategy we looked at years ago. The question is really when you look at we are not talking about house well drillers or wells for homes but when you look at the larger capacity municipal and industrial water wells there is a question of why couldn’t you buy all of them? There are none that rise to the level that there would really be Justice Department issues that would be concerns. The modification to all of that would be the municipalities would have to have competitive bids. They would reach out to people and it would become more of an endless supply you would think. It is always a fairly intriguing strategic question.

When I look and count noses there are not as many noses out there as one would think at the higher end of the more difficult water well drilling; large capacity wells. So it is always an interesting strategic issue and one we are going to revisit in this downturn and there may be better values. I know the owners have all gotten older during this downturn because I have as well. Anyway that is my strategic thought of the day.

Operator

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

Michael Smith - Kansas City Capital

Most of my questions are about natural gas and I think you put those to bed but you said something about the Marcellus shale in your presentation. It kind of woke me up a little bit and I didn’t totally understand what you were saying. That was water when you were talking about that right?

Andrew Schmitt

Ironically one of the better growth opportunities we see and others see as well is coming up with a means to handle the flow back water from the large hydraulic fracs that are being put in the wells in the Marcellus shale. Primarily in this case in West Virginia and Pennsylvania. The water both volumes and total dissolved solids in the water is a concentration that is much higher [PDF] than you find in the Barnett shale or in Haynesville. In both Barnett and Haynesville you can take that water fairly easy to injection wells. You have to go a lot further to get that water out of Pennsylvania and West Virginia.

The aquifers in those parts where they are drilling the shale don’t accept the water back very easily so you are trucking it in many cases to Ohio. That drives up the cost. The trucking is a problem in that area. The terrain is different than North Louisiana or East Texas. The county roads get torn up easy. The states are probably not as oil and gas friendly as Texas and Louisiana. So you might look for tougher department of environmental quality issues. We have looked at and talked to a number of companies and there are a lot of different ideas about how best to treat that water. We don’t think anybody has a best mouse trap and there may not be a best mousetrap. There may be several.

We have narrowed our discussions down to really just one technology which is more of an RND effort but it met our criteria of a smaller footprint on the drill site, being able to recycle and reuse part of the water, being able to take some of the water that is treated to the next drilling location, being able to assemble the plant, disassemble it and move with the drilling rig or move to the next location, reducing the amount of trucking required in terms of the overall water that has to be moved in and out of locations.

So we are sort of trying to check off all of the boxes and the process we think will be more efficient than certain processes we see. It is more of an R&D effort. That area will develop more slowly than people think anyway because of environmental regulations and because of EPA reviews which are going to occur. Money has already been budgeted for that. There really isn’t any alternative but to deal with the water in a responsible way.

All the oil and gas companies know that. They are looking for more environmentally friendly FRAC fluid but that is not going to solve the total dissolved solids problem. There are going to be a multitude of answers but we as opposed to being people that would lease land and drill the Marcellus Shale we feel like that is a real big company play. We were involved in it. We would be in the New York, very shallow part of that play, not the deeper, longer reach on the horizontal arm part of the play. Interestingly enough the water side is probably more appealing to us. We have been more engaged on the water side than the oil and gas side. We wouldn’t mind drilling it if we had the rigs to drill it but we would also like to treat the water. If you could do both of those you would have a pretty good package to offer operators but there won’t be one answer. Dick [Heckman] has a view and has been out touting that. There is a GE sponsored company that has a process that works that is used in Wyoming in the Pinedale. It is a fairly large footprint.

It is hard to move in and out. The Marcellus is just more restrictive in where you can move the type of equipment you need to treat the water just given the terrain. It is not as friendly as north Louisiana, east Texas or certainly in Wyoming. So that mystery hasn’t been totally solved. The Regulations haven’t been totally written. Hopefully we will be able to come up to some agreement with the company we are having discussions with and begin the R&D effort which really involves upscale process that appears to have merit on we will call it a pilot or a test run.

Operator

The next question comes from the line of Deborah Coy – Janney Montgomery Scott.

Deborah Coy – Janney Montgomery Scott

I wanted to just kind of, we have had a lot of discussion to wrap up how you are thinking about the outlook for next year. I don’t have the exact EBITDA break down by segment but I can sort of roughly back into it. It looks like we ended up with energy contributing somewhere around $30-32 million in EBITDA for the year just completed?

Jerry Fanska

That is about right I think.

Deborah Coy – Janney Montgomery Scott

From what you are saying that EBITDA margin is obviously we hang in but if we assume for the moment that gas prices stay where they are we will cut that about in half or a little more in half?

Andrew Schmitt

I think if they stay where they are today. We are probably in the shoulder month a little bit right now in spring anyway. It will probably move up in the summer. Assuming we get a hot summer. Last year it didn’t move it was so cool everywhere. If we get a more normal summer we will call it we expect those to move up and then it just depends on how much is in storage as to how that last 1/3 of the year really looks, probably the last quarter.

Deborah Coy – Janney Montgomery Scott

Heaven forbid they should go down any more. We didn’t think they would go as low as they have gone. Then on that gas side in terms of how we think about the modeling you talked about your cash costs. Obviously below where you can still sell gas for but your all-in gas cost…

Andrew Schmitt

We have moved right at or above the spot if you look at new investments. Like all the oil and gas statistics when you break them down when you look at the leased operating expense, finding and developing costs, you add all that stuff together and your cost of capital. That is why I said I think it is higher cost in the shales too because one thing about the oil and gas industry they give you about three different ways to look at costs. All of them use a little different way of measuring it. But we look at all-in costs so we won’t spend a lot of new investment if we didn’t have to at these prices.

Deborah Coy – Janney Montgomery Scott

But at these prices once the hedges roll off if we look at the all-in costs including what is left on depletion charges will this come through at a GAAP loss on the income statement?

Jerry Fanska

At today’s price, yes. I haven’t worked out what it is. But we know with the lower reserve amounts obviously your depletion is going to be higher as well. So the depletion number is going to be $2-3 on MCF.

Deborah Coy – Janney Montgomery Scott

So at least for the near-term it will be a negative drag on earnings?

Andrew Schmitt

Right if we don’t see a pickup in gas.

Deborah Coy – Janney Montgomery Scott

Then on the MinEx side my back of the envelope is you did somewhere around $25 million in EBITDA in that business this year, down from $53 million or so? Somewhere around that.

Jerry Fanska

Including the Latin America share of that it is around $25 million.

Deborah Coy – Janney Montgomery Scott

It sounds like if I am adding up everything you are saying that we could actually hit fairly close to the fiscal 2009 level? In other words, I think what I am parsing through what you said earlier is that you are getting hurt obviously on the lower price but you are largely right now making up for that at least how you are running right this minute you are largely making up for that in lower cost and that should be able to continue for the next several quarters so that you are not really losing on margin relative to where you were previously?

Andrew Schmitt

That will be the issue for us and that will be the big question mark. How low is our cost compared to that point in time when you look at that EBITDA. That will be the tradeoff because I can do the math on pricing and say well a big chunk of that $52 million was in the peak and was coming from prices we don’t have now.

Deborah Coy – Janney Montgomery Scott

But you don’t have the costs now either.

Andrew Schmitt

No and that will be the key. So take your 52 and subtract 30. So you have that you would cover. It doesn’t work out exactly because of the Latin America affiliates. But just to start and then I say we will see. April should give us a pretty good idea how low your cost really is and at these prices how much of that do you recapture. I am not sure.

Deborah Coy – Janney Montgomery Scott

You do not feel like you are sure yet. I guess at the end of the day…

Andrew Schmitt

That is your question mark. When you say if energy prices went up I can tell you what I can’t tell you is easy with 125 rigs scattered around the world that that will look like. When you are up and running and at the lower price.

Deborah Coy – Janney Montgomery Scott

Chances are your costs start to creep up?

Andrew Schmitt

Our cost is definitely lower.

Deborah Coy – Janney Montgomery Scott

So some sort of jump in between there. Then finally on the water side…

Andrew Schmitt

I said I would take half the glory.

Deborah Coy – Janney Montgomery Scott

I can do that math too. On the water side, it has as you said the small pieces in GeoCon and the collector wells have been a tough year. So backing up number there is we went from a little over $70 million in EBITDA to a little under $60 million and with the biggest part of your business being under cost pressure it seems to me we probably stay all-in with legacy recovering some and CIPP helping you are still not going to get back to fiscal 2009 EBITDA levels?

Andrew Schmitt

No I don’t think so. You would if you have the small pieces contributing at the kind of levels they did this past year. That would be an ingredient there you won’t recapture. That piece is not going to occur so we have collectors wells, we have GeoConstruction coming back to earth, CIPP will move up and that will certainly help Layne legacy so that is the tug of war there as you move through the recovery. I wouldn’t think just off the top of my head I wouldn’t think that would be possible.

Deborah Coy – Janney Montgomery Scott

My last question is related to what you said previously in terms of coming back to look at a water well driller strategy and perhaps some additional consolidation opportunities there. What is your market share in the large capacity well drilling business currently?

Andrew Schmitt

I think we say 25%. It is a tough one to measure because there is so much variability in the work. We do repair work and not everybody does repair work. That is our best estimate we could come up with to finding wells 6” in diameter completed diameter and larger. I doubt that has changed much because share doesn’t change much in that market as a rule. Somebody drops out it typically has gotten fairly evenly distributed between Layne and the regional competitors. We will back out of a market for awhile if prices get too lousy. We will tend to be the one that will push price as capacity gets a little bit tight. That is about where it is. On a regional basis market share could move around quite a bit but I think that is the way it works in the country.

Deborah Coy – Janney Montgomery Scott

That is by far bigger than anybody else to my knowledge?

Jerry Fanska

No question.

Andrew Schmitt

Again you are buying smaller companies and really the barriers to entry one would make with the costs of the rigs are fairly low. You never felt like you had small competitors that occasionally will come in and put in bids for the municipalities. Whether they get them or not. Some are qualified and some aren’t. It is not a case where you worry about accumulating too much concentration but there is sort of an intriguing play there we have looked at through the years. Layne is typically the logical consolidator whenever anyone wants to sell. That has generally been the companies we have picked up they said we are retiring. The kids don’t want to be in the business and you have been good competitors for years. That is where I would like to see my employees end up. The market has been good for the last several years and that opportunity kind of went away as the water industry recovered.

If you think about it recession wise going back to 2001 and 2002 with the peak because we lagged the recession. 2003, 2004 and 2005 was the bottom. 2006, 2007 and 2008 was the next peak. We stopped hearing from a lot of people in 2006, 2007 and 2008 because business was good. Really it is certainly worth reviewing because it could be more attractive than we have seen in years.

Deborah Coy – Janney Montgomery Scott

It is kind of interesting because that is obviously your history and your background and clear leadership position and the little niche wastewater disposal market is kind of interesting and I am wondering if there are other industrial opportunities both on the wastewater and on the supply side? It just seems that over whatever next economic cycle that water supply issues for industrial customers may be a pressure point as well.

Andrew Schmitt

I think it would be on the wastewater side with niche opportunities. There are and we have been in discussions with one we particularly like. They particularly like their business too. That is definitely an area. You are right on the niche wastewater side is attractive as well.

Operator

You have no additional questions, Sir.

Andrew Schmitt

Thanks everybody. Thanks for all your time and attention. We will look forward to visiting with you next quarter and hopefully be able to fine tune a bit our view at that point in some of the questions that are still out there. Hopefully we will start to see an improvement in the natural gas pricing as well. That would be certainly an encouraging sign. Thanks again. We appreciate it.

Operator

Ladies and gentlemen this conference call will be available for replay after 1 p.m. CT today through April 6, 2010 at midnight. You may access the AT&T teleconference replay system at any time by dialing 800-475-6701 and entering the access code of 148149. International parties may dial 320-365-3844. This does conclude your conference for today. We do thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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