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Layne Christensen (NASDAQ:LAYN)

Q3 2012 Earnings Call

December 08, 2011 11:00 am ET

Executives

Rene J. Robichaud - President, Director, Member of Compensation Committee, Member of Nominating & Corporate Governance Committee and Member of Nominating & Corporate Governance Committee

Jerry W. Fanska - Principal Financial Officer, Principal Accounting Officer, Senior Vice President Of Finance And Treasurer

Andrew B. Schmitt - Chief Executive officer and Director

Analysts

Steven Fisher - UBS Investment Bank, Research Division

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Jonathan P. Braatz - Kansas City Capital Associates

John Rogers - D.A. Davidson & Co., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Layne Christensen's Fiscal 2012 Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Andrew Schmitt, Chief Executive Officer. Sir, you may begin.

Andrew B. Schmitt

Thanks, Sam. Good morning, everyone. I'm here with Jerry Fanska, our Senior Vice President of Finance; Jeff Reynolds, our Chief Operating Officer; and Rene Robichaud, our President. 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, 2011. 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 Rene will give you an overview of division operating performance and how we see things going forward.

Okay, Jerry, want to take us away?

Jerry W. Fanska

Thank you, Andy. Good morning, everyone. Revenues for the third quarter increased $25.1 million or 9.3% to $294.9 million from $269.8 million in the prior year. Water Infrastructure revenues increased $5.4 million or 2.6% for the quarter to $215.3 million. Revenues from business acquisitions increased $18.3 million and specialty drilling operations increased $8.6 million. These increases were partially offset by decreases of $11.2 million in non-acquisition-related geoconstruction operations and $7.3 million in heavy civil construction.

Revenues from our water well drilling work in Afghanistan also decreased $4.6 million from the prior year's quarter. Mineral Exploration revenues increased 39.6% to $72.1 million, another quarterly record, with increased activity across all regions. Layne Energy revenues increased 2.8% to $5.1 million from $4.9 million in the prior year.

Cost of revenues increased $19.5 million to $229.2 million for the quarter compared to $209.7 million in the same period last year and remained flat as a percentage of revenues at 77.7%. Margin pressures, especially in the Water Infrastructure's heavy civil construction unit, were offset by other product lines and divisions.

Selling, general and administrative expenses increased to $43.7 million in the quarter from $37.9 million in the prior year, primarily the result of $3 million of increased compensation-related expenses, $2.1 million of operating tax increases, $1.6 million in legal and professional costs and $1 million in additional SG&A from acquired operations. Included in the $3 million of compensation-related expenses are $2.4 million or approximately $0.07 per share of transitional cost associated with the retirement of the CEO and changes in other executive positions.

Depreciation, depletion and amortization increased in the quarter to $15.5 million from $12.8 million, primarily due to acquisitions and property additions.

Equity and earnings of affiliates increased 51.3% to a record $6.5 million in the quarter, $1.2 million from the Water Infrastructure affiliates and the remainder from minerals. The Water Infrastructure increase comes from the results of our Costa Fortuna affiliate and infrastructure projects in Brazil, and the Mineral Exploration increase is primarily the result of continued strong metals markets in Latin America in copper and gold.

Interest expense increased $700,000 -- increased to $700,000 from $337,000 for the quarter as a result of additional working capital requirements.

The effective income tax rate for the quarter was 30.7% compared to 38.7% in the prior year. The decrease in the effective rate was primarily attributable to the tax effect of a continued increase in the forecasted equity earnings of our affiliates as a percentage of overall forecasted pretax earnings for the year. This has, obviously, an effect on our effective income tax rate. The current effective rate estimate for the entire year is 39%.

The net result for the quarter was $0.45 per diluted share in earnings compared to $0.42 per diluted share last year. The company's balance sheet at October 31, 2011, reflects total assets of $899 million; stockholders' equity of $536.9 million; total long-term debt of $65.2 million, excluding current maturities of $84,000; and cash and cash equivalents of $44.5 million.

The company generated $19.4 million in cash from operating activities in the quarter. Investing activities totaled $16.9 million net of proceeds from equipment sales.

The investing activities included $24.9 million in property, plant and equipment additions and approximately $1 million in energy expenditures, offset by a release of $9 million net in restricted cash associated with the previously disclosed Fontana, California real estate transaction.

With that, I'll turn it over to Rene to talk about the operations.

Rene J. Robichaud

Thanks, Jerry. Just a few comments on our consolidated results. It's interesting that all 3 of our divisions had higher revenues in the third quarter despite the economic headwinds. I also appreciate that our cost of revenues were flat at 77.7%, despite at least a couple, what I will say, short-term expenses in SG&A. One includes legal expenses and travel of $1.6 million in the quarter or $0.04 per share. Part of that, of course, has to do with our FCPA investigation. And the other is $2.4-million expense or $0.07 per share in our executive transition cost.

I'd like to walk through the divisions that we have and some facts and impressions on those divisions. The Water Infrastructure division has 5 businesses related inside of it. The first one is Layne's heavy civil construction business. That was our worst quarter ever in that business. This, of course, is the business where we have larger water-related projects, both treatment plants and water pipelines.

I would say our pricing strategy in the last 12 months was to keep busy and keep our talented people busy. We ended up lowering our pricing even on some smaller jobs. We also estimated the cost of some of our jobs probably too aggressively, so the result is losses in that segment, as some projects have not been executed as well as they could have been. So we've made some changes. We've all agreed we are raising prices, and that will result in shrinking our backlog, which has already happened. Our backlog today is roughly $250 million, and that's down from beginning of the year of -- in the area of $320 million. We expect that to increase our profitability in this business.

We will also be migrating towards more industrial and energy customer business. We continue to bid on selected very large projects with healthy margins, where smaller players are not competitive, so we continue to see continued volume of good opportunities for us. Next year, in 2012, we expect a breakeven performance or better, not the losses that we just saw in this business in the last 90 days. Notably, we are bidding on a number of large good projects, including emergency projects in drought-stricken Texas.

The other business I'd like to talk about is our geo group. It was a good quarter for the geo group, better than planned in profits, but not in the top line. This is our larger slurry wall project business that's holding the business up pretty well, and we expect the larger slurry wall projects to continue to do well for Layne going forward. Smaller jet grouting projects at fair margins are harder to come by, but we expect some improvement by the spring. Here, the growth in the international markets is more attractive to us.

The third business in Water Infrastructure we'd like to talk about is the Inliner business or the cured-in-place pipe business. Good quarter for them. Strong revenues, decent margins. The pricing, looking forward, is stable. The backlog today is stable, and we're running at full capacity.

The next business is the water supply division, our water well drilling, our repair and installation business. The R&I business is a little less than half the total water supply division today, and that's the biggest portion -- proportion that we can remember. So the R&I business is actually where we get very good strength in this division. The R&I business had roughly 9% better margins than the water drilling business in the last 90 days. Overall, water supply had a decent quarter with higher revenues than our plan but somewhat lower profits.

After our very successful project in Afghanistan, we are entering several new and large international markets.

And in our water technology business -- I'd say the smallest and newest of our Water Infrastructure-related businesses -- we completed our new technology center in Phoenix and had a very successful grand opening with many new customers visiting. This business is not yet profitable, but it is the foundation for a differentiated strategy in our water and our new energy services initiative. We expect this to be profitable next year.

In our Energy division, revenues were on plan. EBITDA was 35% of revenues. This is a well-managed business, but we have changed our strategy here. Layne will not be investing new capital in the upstream business. Rather, we will build our energy services business during 2012, focusing on Layne's unique strengths to solve the E&P industry's toughest water problems. We're developing our plans to build a substantial and highly focused oilfield services business by 2016 based on our strengths in water supply, water transfer, water treatment and water disposal and reuse.

And now I'd like to talk a little bit about our Mineral Exploration business, which is performing as well as it ever has been. As you know, we explore for copper and gold around the world. We also own about 45% of our Latin American affiliates that dominate this business in Chile and Peru. Both these businesses are running flat out and producing record revenues and profits. Based on our customers' discussions of their expected exploration budgets for next year, we should have another terrific performance in 2012. Our new global MinEx President has done a great job integrating our worldwide operations. Our last 9 months of revenues and profits would be a record year for us if we stopped exploring right now.

I'd like to give you a little historical perspective. Today, our MinEx business is doing very well and parts of our Water Infrastructure business are not. Two years ago, it was the exact opposite.

Okay. A little bit on fourth quarter outlook, which for us, of course, includes January. Our Water Infrastructure group will have somewhat softer revenues, say, 5% to 10%, due to the holidays and colder weather, but we expect better profitability. Our Mineral Exploration group should see softer revenues and profits of around 20%, due solely to the holidays and poor weather. Unless something material changes, we expect another record year in 2012. Our E&P division will likely show a small loss due to low natural gas prices.

I'd like to talk to you a little bit about Layne's internal investigation regarding foreign corrupt practices. Layne has aggressively managed this issue in my opinion. Jeff Reynolds, our COO, who's with us today, and I each purchased over $1 million in Layne stock recently, in part because we want to send a message to our employees that we believe in them. In the last 15 months, Layne has taken many strong actions, including strengthening our internal controls, replacing key employees, training hundreds of employees and third-party agents to ensure that our policies and procedures are followed. Investigation is still ongoing, and we are working diligently to conclude as quickly as we can and reach a resolution with the SEC and the DOJ.

I'm hopeful that we can reach a settlement with these agencies quickly, so we can put this sad episode behind us and build on Layne's long and proud history of being a global leader in providing and protecting the world's essential natural resources: water, minerals and energy.

Regarding Andy Schmitt, I'd like to tell you that he's been a true partner and mentor to me in the last 4 months. He's guided Layne well for 18 years, and we wish him the best in his future endeavors. Andy?

Andrew B. Schmitt

Thanks, Rene. Folks, it's been a real pleasure, and I'm confident this company will continue to show improvement for many, many years to come. Our track record of year-over-year revenue and earnings growth is mighty good, and that was achieved again this quarter despite a lot of headwinds, and I see no reason for that to change. We have a very strong management team; great employees; and in Latin America, the best business partners anyone could ask for.

So with that, Sam, I think we'll take any questions you may have for Rene and Jerry and Jeff. They're ready and waiting.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from John Rogers of D.A. Davidson.

John Rogers - D.A. Davidson & Co., Research Division

A couple of questions I had -- Rene, I wasn't quite sure -- in terms of the Energy business, you're trying to redirecting it towards water-related work. I assume that's related to shale, but that will be included in the Energy segment. Could you talk a little bit more about that and the opportunity there?

Rene J. Robichaud

Sure. It's really a brand-new initiative for Layne, but we found that many of our E&P customers who would come to us for water well drilling and selected other problems, had come to us really looking for overall solutions to their very significant water sourcing and water management problems, particularly with respect to unconventional natural wells -- natural gas wells and oil wells throughout the Marcellus Shale, the Bakken, the Eagle Ford. And we know that there's no company on the planet that has drilled more water wells than us and managed water for the last 129 years. What we haven't done in the past is focus the team to solve the oil and gas industry's toughest problems there, and we've agreed that's really necessary for that industry to perform well.

John Rogers - D.A. Davidson & Co., Research Division

And I mean, how big an opportunity is this for Layne?

Rene J. Robichaud

My board is asking that question every day. It's a huge opportunity for Layne. It's a huge problem for the oil and gas industry. I guess it was just yesterday, the front page on the Wall Street Journal, another article on the water challenges for the oil and gas industry and how they have such tremendous needs that they're taking it away from farmers and other users, and that is a call to action for Layne.

John Rogers - D.A. Davidson & Co., Research Division

Okay. And I guess my other question was in terms of the comments you made relative to the fourth quarter for the Water Infrastructure business and the minerals -- MinEx business, when you say down 5% to 10% for Water Infrastructure and down 20% for Minerals Exploration, you're talking sequentially.

Rene J. Robichaud

Yes, Q3 versus Q4.

John Rogers - D.A. Davidson & Co., Research Division

Okay. And in terms of pricing on the minerals, the drilling or the exploration -- Minerals Exploration business, have you gotten through the process of negotiating pricing for 2012?

Rene J. Robichaud

We're still in the middle of it, but we've done a lot of that, and I will say that we expect much better pricing in 2012 overall, than -- in calendar 2012, pardon me, than this year.

John Rogers - D.A. Davidson & Co., Research Division

Okay. So that means on the same levels of activity, that would imply better margins in calendar 2012. Is that fair?

Rene J. Robichaud

We are planning on that. We're not giving you specific numbers because we don't think that's the right thing to do, but I would say that our plan is to have another record year coming up for Mineral Exploration. I would say the largest component of the change in margin will be pricing, but we'll also get more volume, both because we'll have more rigs being used, and we feel we'll have better capacity utilization over the course of the year as well.

Operator

Our next question or comment comes from Steven Fisher of UBS.

Steven Fisher - UBS Investment Bank, Research Division

I think you just basically answered this on that last question, but maybe to clarify a little bit: as it relates specifically to the Latin affiliates, just wondering what the expected trend in income would be in -- for the next upcoming fiscal year versus what we saw in this fiscal year. I noticed the income came down in the quarter sequentially, so I don't know if that was some type of special, unique quarterly situation or what that was.

Rene J. Robichaud

I'm not sure I understand...

Jerry W. Fanska

I'm not [indiscernible]. What's the last piece?

Rene J. Robichaud

The income didn't come down in the quarter. It was a record quarter.

Steven Fisher - UBS Investment Bank, Research Division

The affiliate piece?

Jerry W. Fanska

Mineral Exploration for the Latin American?

Steven Fisher - UBS Investment Bank, Research Division

Yes.

Jerry W. Fanska

Yes, it was up quarter-to-quarter. Oh, I know what you're saying, because in the overall $6.5 million, we have also -- if you recall my piece was we have Costa Fortuna in there for about $2.1 million, $2.3 million. That's Water Infrastructure.

Steven Fisher - UBS Investment Bank, Research Division

Right. I'm just seeing the MinEx piece going from about $7 million to just over $5 million from July to October.

Jerry W. Fanska

Oh, you're talking about sequentially.

Steven Fisher - UBS Investment Bank, Research Division

Yes, yes. Yes, that's true. And so what was the reason for that sequential decline?

Jerry W. Fanska

Not sure. Third quarter would be...

Andrew B. Schmitt

Didn't think of that month of July, which includes the weather problem we had in Chile and the strike. And the lag. We had the lag.

Rene J. Robichaud

After effects of the strike that they had in Chile. He's right. And I have to tell you if anybody thinks that, that is a precursor to a softer next 12 months of our affiliates, I would want to clear that up. It is absolutely not. I mean, we can't -- if they do have a strike in the future, we can't predict that. But I can tell you that they are also running flat out, and they are growing their rig count, and their profitability is very good.

Steven Fisher - UBS Investment Bank, Research Division

Okay. So your fiscal, I guess, 2013, you'd expect to be at a better run rate than the $5.3 million that we had in this quarter.

Rene J. Robichaud

Yes, sir, that's our expectation.

Steven Fisher - UBS Investment Bank, Research Division

Okay. And related to this, are you doing any work on the Newmont Conga project?

Rene J. Robichaud

I can't say that we are.

Steven Fisher - UBS Investment Bank, Research Division

Okay. I was just curious if you had any view on the pace of that project. I guess the next question, on the water side of things, I know you mentioned the heavy civil backlog is coming down, but it looks like the overall backlog was up. What part of the business did the backlog grow in?

Rene J. Robichaud

We have even more business in our CIPP business, and we expect that to stay stable with more business. We -- in the -- for example, in the heavy civil business, Steven, we are bidding today on almost $300 million worth of projects in the heavy civil business. There are lots of projects for us to bid on. If we want a bigger backlog, we can get you that next week. We absolutely will be picking and choosing more carefully how we manage the backlog so that we end up being profitable, certainly not losing money like we did in heavy civil the last 90 days.

Steven Fisher - UBS Investment Bank, Research Division

Okay. And just, sorry, one numbers clarification. I'm sorry if I missed it or if it's in the release, but can you give us what the total debt and the total cash balance is at the end of the quarter?

Jerry W. Fanska

Yes. I think the total debt was $65.2 million, if I recall, and the total cash was $44 million.

Operator

[Operator Instructions] And we do have a question from Gerard Sweeney of Boenning.

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Question on the heavy civil. Obviously, you're most likely unhappy with the quarter, and taking a look back earlier this year in the Water Infrastructure group, you've broken everything out into about 4 or 5 categories. Would there be any chance that you broke that out -- maybe that was a precursor to just looking at each of those separate categories from maybe a strategic standpoint. I know Rene mentioned that the profitability has flipped in the last couple of years in the heavy civil and some of those areas, but looking forward, looking at the municipal budgets, they don't look too good going forward. There's maybe some constraints in construction. I mean, would you ever maybe look at a strategic alternative to any of those groups, like specifically the heavy construction side?

Rene J. Robichaud

There's never anything that's off the table, but I can tell you that the heavy civil business, the water resources business, the Inliner business, the water technology business, they work together very well, and they help each other. More importantly, they help our clients with their water infrastructure needs, their growing water infrastructure needs. So even though we talk about a top line and sometimes an IBT [ph] for any one of those businesses, they are very well linked. And so the answer is I would not support that today.

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Okay. So there's definitely some synergies there that don't come back -- don't necessarily shine through when you're looking at them just on a pure -- looking at the P&L side from our standpoint.

Rene J. Robichaud

Absolutely. Gerard, I'll also say that we're going and renewing a one Layne concept worldwide, where our officers, our top 20 leaders have gotten together several times in the last quarter, really to look at all of the opportunities that we have working together even more closely than we do so that when we approach a client with a solution, they get the best of Layne from everywhere.

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Got it. Okay. And then also one question on the MinEx side. I was slicing the -- I'm not sure if I got this right, but if you x out the affiliates and you look at the margins on the, we'll call the wholly-owned business on the MinEx side, did margins tick down sequentially in that business?

Rene J. Robichaud

The only reason they would have done that is not because the business got softer. It's because we've moved 10 rigs from a market where we were not making as much money as we should to a market where we plan to make even more money.

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Okay. Yes, either that or -- I mean, what about cost inflation or price inflation, wage, labor, things like that? Wasn't sure if that was -- then, you're getting later in the cycle of those contracts as well, so I was curious if that would have played any part in it.

Rene J. Robichaud

Yes. We will see certain cost inflation. We don't see that as an issue that we would highlight, because we think our pricing inflation will more than overcome that, and we also think our growth in average number of rigs utilized next year will make a big difference next year, and we also think the capacity utilization of each of those average number of rigs will be higher. They'll be achieved.

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

And then when you're talking about rigs next year, I guess in the past, you've always said -- well, not always, but maybe one of the key points was add-a-rig strategy. Is that changing? Or are you going to be a little bit more aggressive in adding rigs? Or is it still, we'll call, like opportunistic?

Rene J. Robichaud

Like our competitors, we have a people problem as well. I wouldn't call our strategy an add-a-rig. Really, it is going to be exploiting where we have a significant market share in any given geography or with any given client. And I could see us growing our average number of rigs next year 5%, plus or minus, over the number of rigs we had on average this year, and I hope to have our utilization up higher next year than we had this year. Now there are 2 ways that we measure utilization. One is, what percentage of all of our fleet is actively working for our client today? And that number is over 80%, and it's hard to get much over 85%, given the amount of time that you need to mobilize, to demobilize and to maintain your fleet. And the other capacity utilization number that we have internally is, of all of those rigs, how many of them are working around the clock versus one shift? We're working on that too.

Andrew B. Schmitt

Gerard, one thing on your question about the Mineral Exploration piece, we'll have the margins, but clearly, year-over-year margins are up on the business quite a bit. We have about 25% actually year-over-year, so pretty big delta there.

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Okay. Yes, I was just curious if that was -- the contracts, I believe, were a year in length and maybe some of the margins, if I'm doing it correctly, were coming down just because it's a little later in the contract and they might have seen some wage inflation that obviously you pick up when the new contracts come along. That's all, so...

Rene J. Robichaud

No, the third quarter only adds -- where we shut down one geographic area, we had 10 rigs in that area that weren't not making money, and we decided to bite the bullet, take the cost in the third quarter and move those rigs to a better geographic area. And that will pay off for next year.

Operator

Our next question comes from Jon Braatz of Kansas City Capital.

Jonathan P. Braatz - Kansas City Capital Associates

Jerry, can you talk a little bit about the operating tax expense of $2 million the MinEx division had? And secondly, are the -- is that cost and the severance costs and FCPA cost, are they included in your wholly owned or affiliate -- or equity and affiliate operations?

Jerry W. Fanska

Those would be in the wholly owned. All the expenses would be in the wholly owned. The operating taxes actually is an assessment that we received in one of our African countries that we are protesting currently, that we felt like we should book it, and we did. It's related more to TVA, value-added tax than -- not related to income tax at all.

Jonathan P. Braatz - Kansas City Capital Associates

Okay. Do you think that there could be a resolution of that in 2013 -- fiscal 2013?

Jerry W. Fanska

Yes, definitely. Definitely within the next year. I'm hoping even sooner than that.

Operator

At this time, I'm not showing any further questions. I'd like to turn the call back to our speakers for any further remarks.

Andrew B. Schmitt

Okay, guys. We appreciate it. Again, I thank you for all your support for me for all of these 18 years. It's been a really great run, and for me and my family, have been a great opportunity to work with so many good, fine people in Layne and all of you, the shareholders, too. And the support you've shown through the years, we really appreciate it. And I look forward next quarter to listening on the call like all of you. Thanks, Sam. I think we're through.

Operator

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.

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