Granite Construction - Q2 2014
August 1, 2014
Transcript
Operator (participant)
Good morning. My name is Andrew, and I will be your conference facilitator today. At this time, I would like to introduce everyone to the Granite Construction Investor Relations Q2 2014 earnings conference call. All lines have been placed on mute to prevent any background noise, and after the speaker's remarks, there will be a question and answer period. To ask a question, please dial star, then one on your touch-tone telephone. That's star, then one. Please note, we will take one question and one follow-up question from each participant. It is now my pleasure to turn the floor over to your host, Granite Construction Director of Investor Relations, Ron Botoff. Sir, the floor is yours.
Ronald E. Botoff (Director of Investor Relations)
Thank you. Welcome to the Granite Construction Incorporated Q2 2014 earnings conference call. I'm here today with our President and CEO, Jim Roberts, and our Senior Vice President and CFO, Laurel Krzeminski. We begin today with an overview of the company's Safe Harbor language. Some of the discussion today may include forward-looking statements. Actual results could differ materially from the statements made today, so please refer to Granite's most recent 10-K and 10-Q filings for a more complete description of risk factors that could affect these projections and assumptions. The company assumes no obligation to update forward-looking statements, whether as a result of new information, future events, or otherwise. A reconciliation of non-GAAP results was included as part of our Q2 earnings press release. Certain non-GAAP measures may be discussed during the call and from time to time by the company's executives.
For more information, please visit our Investor Relations website at investor.graniteconstruction.com. Thank you. Now I'd like to turn the call over to Granite Construction Incorporated Chief Executive Officer, Jim Roberts.
James H. Roberts (President and CEO)
Thank you, Ron, and good morning, everyone. This morning, I am pleased to spend a few minutes reviewing Granite's operational performance this quarter, as well as year to date, and how it aligns to our expectations. Then Laurel will review financial results, and we, of course, will be happy to answer your questions. I begin today with a thank you to all Granite employees for their efforts to work safely during a very busy construction season. We are off to an excellent start in 2014, as our overall safety statistics are well ahead of last year. Our people are working hard and going home safely every day, and of course, that is our goal. Safety and operational excellence go hand in hand. Safety and operational excellence are reflected in a solid mix of operational performance and financial gains during the quarter. This performance was in alignment with our broad expectations.
As we execute on our strategic plan, our focus on Granite's most significant near-term opportunity centers on our ability to win additional contracts and execute at a high level on our current work. On Monday, Chris Miller will join Granite as our Chief Operating Officer to help our leaders and our teams continue to add to the momentum we are building. As part of my team, Chris will be responsible for overseeing the day-to-day operations of the company, and I'm confident he will get up to speed as quickly as possible. Chris is a proven executive and a proven leader, and we are excited to have him join us to help drive results across the company. As noted in recent quarters, we remained relentlessly focused on driving results through improved execution on our $2.6 billion backlog and on developing and implementing our stepped-up continuous improvement investments.
Our expectations for steady growth and improved execution remain on track. With that in mind, while we do not believe that the continued inaction by Congress has had strong impacts to the current environment, our partners and state departments of transportation certainly are focused on the lack of long-term funding solution from the feds. Dozens of states have taken it upon themselves to address near-term infrastructure investment opportunities by instituting a variety of transportation funding measures and emphasizing alternative procurement methods. These are short-term solutions to a long-term funding challenge. This week's congressional game of ping-pong and approval of yet another stopgap funding measure, unfortunately, comes as no surprise. We remain acutely aware and vocal in our belief that long-term funding solutions are critical for the long-term infrastructure planning of our country.
The Transportation Trust Fund insolvency, a threat for the sixth time in the past 8 years, is simply unacceptable. In fact, over the past 5 years, Congress has passed more than two dozen short-term transportation funding measures. Long-term solutions are a necessity to ensure America's infrastructure does not become a headwind to broader economic development. The Department of Transportation warned that allowing the Highway Trust Fund to become insolvent could cost the U.S. about 700,000 jobs and would mean an immediate 28% funding cut for states. Let me be clear: funding stability and financing alternatives are critical to driving progress on infrastructure investment at federal, state, and local levels. That said, let's transition to Granite's results in the Q2 and so far this year. Our vertically integrated businesses continue to perform better than in recent years, with some markets showing strong trends and others continued weakness.
However, private market activity across geographies continues to provide some positive momentum in overall fairly stable markets. Once again, in the Q2, our construction materials segment produced improved results driven by increased volumes and some solid early-stage efficiency gains. These near-term results bolster our expectations for overall steady improvement in 2014. In large projects, we continue to make progress on the Tappan Zee Bridge in New York, the IH 35E project in Texas, the I-40/I-440 project in North Carolina, and the San Clemente Dam in California, among many, many other projects as well. These projects, again, made strong revenue contributions in the quarter, and we were pleased when we began recognizing profit on Tappan Zee late in the Q2. A number of projects, again, contributed substantial revenue in the Q2, but we have not yet recognized profit.
We continue to expect these projects will recognize profit in the H2 of the year. Large projects' revenue from projects that have not recognized profit has increased so far this year. These fluctuations continue to be part of our normal course of business. During the quarter, we also reached agreement for a cost recovery on a project with the owner in the state of Washington. The majority of the project is built, and we are focused now on final completion. The bidding environment throughout the company remains robust and highly competitive. In alignment with previous discussions, we expect to bid on more than $12 billion of large projects in the next 12 months, with about half of the value representing potential Granite backlog. Opportunities are emerging for Granite to drive steady growth across the business.
Ultimately, execution aligned to our strategic plan remains our focus, and I remain confident that we will continue to grow and produce significantly improved results in 2014 and beyond. With that, I will turn the call over to Laurel. Laurel?
Laurel J. Krzeminski (SVP and CFO)
Thank you, Jim. Good morning, everyone. Second quarter 2014 revenues were $586 million, a 6.5% increase from last year. Diluted earnings per share in the quarter were $0.34 compared to $0.04 last year. Gross profit margins increased to 14.1%, a more than 500 basis point improvement from the Q2 of 2013. Improvement was driven by a solid mix of operational performance gains, profit recognition, and dispute resolution during the quarter. And we continue to be pleased with the improvement in our construction materials business. In line with last quarter, total contract backlog was $2.6 billion at the end of June, and construction segment backlog, up more than 20% year over year, totaled $975 million, continuing the positive recent trend.
Large project backlog, down about $400 million year over year in June at $1.6 billion, still does not include our nearly $700 million share of the I-4 Ultimate job in Florida, which we expect to book in the Q3 once a final contract is approved and a notice to proceed is issued. With this addition, we are continuing to grow our backlog as planned. Looking at the segment detail, construction segment revenues decreased to $269 million in the Q2, down about 13% from 2013. But gross margin improved about 140 basis points to 9.2%. While construction revenue was impacted by weaker-than-expected public market conditions in the northwest, as well as a change in the mix of power projects, profit improvement was driven by improved operational performance in certain western markets.
Large project construction segment revenues increased nearly 35% in the quarter to $244 million, as growth was driven by job progression on projects from coast to coast. Gross profit margin improved to 20.8% in the Q2, driven by project profit recognition and dispute resolution coupled with improved project execution. Construction materials segment revenues increased more than 20% quarter-over-quarter in the Q2 to $72 million. In line with the Q1, volume growth was driven by both market conditions and some project-specific sales. Gross margin in the Q2 improved more than 280 basis points from 2013 to 9.4%. We certainly are pleased with the improvement, but we're still not satisfied with these returns and expect continued improvement over time. SG&A increased about 9% in the Q2 to $51 million, with increased pre-bid selling costs and substantial investment in continuous improvement.
The balance sheet remained strong, with more than $258 million in cash and marketable securities at the end of June. As a reminder, we typically use cash in the H1 of the year and build it in the back half. Notably, although profit recognition was a driver of improved Q2 performance for the H1 of 2014, more than $75 million of large project segment revenue remains related to projects that are not yet contributing profit. A similar trend has occurred in our construction business, where in the H1 of 2014, more than $46 million of revenue came from projects not yet recognizing profit. In total, revenue from projects that have not yet recognized profit totaled more than $121 million in the H1 of the year, up more than $68 million year over year. Our 2014 outlook remains unchanged.
We continue to expect consolidated revenues of $2.4-$2.8 billion, significant gross profit improvement across segments, which remains weighted toward the H2 of the year. We continue to expect consolidated adjusted EBITDA margin of 5%-7%. Now, before we open it up for your questions, let me turn the call back to Jim.
James H. Roberts (President and CEO)
Thank you, Laurel. Certainly, we are pleased with our second consecutive quarter of improved results. But we are far from satisfied. We must continue to improve to take advantage of ongoing growth and efficiency opportunities. Our commitment to continuous improvement is unwavering, and I'm confident these investments will create long-term returns for our company, our employees, and our shareholders. We are committed to driving change and incremental improvement across all parts of the company. And with that, we'll be happy to take your questions.
Operator (participant)
Thank you. Ladies and gentlemen, if you have a question for the speakers at this time, you may dial star, then one on your touch-tone telephone. If your question has been answered, or if you wish to remove yourself from the queue, you may press the pound key. Once again, please limit yourself to one question and one follow-up, and jump back in the queue if you have additional questions. Just one moment, please, while we wait for participants to queue up. Our first question comes from the line of Jack Kasprzak from BB&T. Your line is open.
Jack F. Kasprzak (Managing Director and Senior Equity Research Analyst)
Thanks. Good morning, everyone.
James H. Roberts (President and CEO)
Good morning, Jack.
Jack F. Kasprzak (Managing Director and Senior Equity Research Analyst)
First question is, you mentioned that you reached an agreement with the state of Washington, but it wasn't clear to me whether that was part of the dispute resolution that helped the large construction margin in the quarter. Or is that still to come in terms of seeing the impact of that?
James H. Roberts (President and CEO)
The resolution that was reached in the Q2 was included in the large project results, Jack.
Jack F. Kasprzak (Managing Director and Senior Equity Research Analyst)
Okay. Can you tell us the amount of that, or will that be in the queue?
James H. Roberts (President and CEO)
Actually, yeah, I'd prefer not to, Jack. Just as always, we try not to focus financials on individual projects.
Jack F. Kasprzak (Managing Director and Senior Equity Research Analyst)
Fair enough. Is the Tappan Zee Bridge tripping in late Q2, 25% complete? Was that ahead of schedule?
James H. Roberts (President and CEO)
Well, I think it's close to being on schedule. Again, the project is making up ground rapidly from obviously a difficult winter. I think it could have tripped in the second or Q3. So we might have tripped it a little quicker than what we originally anticipated at the beginning of the year. But it's pretty much on track.
Jack F. Kasprzak (Managing Director and Senior Equity Research Analyst)
Okay. Last question is, the other large projects that you mentioned, but that aren't more than 25% complete, are there any change in the timing there when you think they will trip 25% complete late this year?
James H. Roberts (President and CEO)
No change at all, Jack. I think all of the ones that I mentioned, the IH 35E, let's see, the I-40/I-440, San Clemente Dam, all of them should reach profit recognition in the H2 of the year.
Jack F. Kasprzak (Managing Director and Senior Equity Research Analyst)
That's great. Okay. Thank you, Jim.
James H. Roberts (President and CEO)
Thank you, Jack.
Operator (participant)
Thank you. Our next question comes from the line of Nick Coppola from Thompson Research. Your line is open.
Nicholas A. Coppola (Senior Equity Research Analyst)
Hey, good morning.
James H. Roberts (President and CEO)
Morning, Nick.
Nicholas A. Coppola (Senior Equity Research Analyst)
Construction backlog was up over 20% quarter-over-quarter. Can you talk a little bit about the major drivers there? Clearly, one of the less lumpy parts of the business. I'm wondering if you can add any color that's indicative of overall improvement. Then kind of where are the projects coming from? I'm assuming that's mostly public markets, public market work.
James H. Roberts (President and CEO)
Yeah, Nick. So as we talked about in the Q1 call, we had a little slow start in Q1 in some of our work in Chicago and other places. So some of this just hasn't moved as quickly as we would have liked, so some of it stays in backlog faster. So although the overall backlog is up, we had a little slower H1 of the year in construction than maybe we had anticipated at the beginning of the year. So there'll be a very busy back half of the year. And really, across all segments, we're moving into a larger backlog and more productive environment in the bidding area, including the power, underground, and our vertically integrated businesses. So it's kind of across the board.
But again, a little slower start at the H1 of the year creates more backlog at this time, which will create a stronger H2 of the year.
Nicholas A. Coppola (Senior Equity Research Analyst)
Right. Okay. That makes sense in the interplay there. And then in the projects you're looking at in construction, is there any change in the competitive environment there? Are you seeing margins on new awards changing or bid lists getting any shorter? Any commentary around that?
James H. Roberts (President and CEO)
Sure, Nick. We're trying at every chance to work into a stronger market position. We're probably seeing a slight reduction in the number of bidders. Our teams are working very hard to get more margin on jobs every single day. But again, I think it's pretty similar to what we had talked about the last couple of quarters. It's an incremental improvement day after day after day. It's getting better, but there's no inflection point relative to the results.
Nicholas A. Coppola (Senior Equity Research Analyst)
Okay. Okay. All right. Thanks for your questions.
James H. Roberts (President and CEO)
Thank you, Nick.
Operator (participant)
Thank you. Our next question comes from the line of Jerry Revich from Goldman Sachs. Your line is open.
Jerry Revich (Equity Research Analyst)
Good morning.
James H. Roberts (President and CEO)
Good morning, Jerry.
Jerry Revich (Equity Research Analyst)
Jim, on the last calls, you mentioned that you had some better visibility on out-year projects than you have in the past. I'm wondering if you'd give us an update for the activity levels on projects that might be awarded in 2015 and whether there's been any slippage at all as we've waited and, I guess, finally got the resolution through Congress on the Highway Trust Fund.
James H. Roberts (President and CEO)
Well, let me address that, Jerry, kind of in two areas of emphasis then. First, the Highway Trust Fund shoring up and the Highway Bill extension a little bit. That would mostly focus on, I would call it, our day-to-day work out of the DOTs. And I really didn't see a significant delay in the work there. Certainly, there were nervous DOTs across the country, and they were threatening to slow down work if something had not occurred. So that was a good deal to get that extension relative to that. On the other side of the program is our large projects, and they are less influenced by the Highway Bill itself. And they are very, very strong in the pipeline. And maybe some slight delays in individual projects. But overall, like I mentioned, there's $12 billion on the list between now and a year, 12 months from now.
That really hasn't changed. That has stayed robust. Those projects are bidding. I'm very excited about those staying in line with our original timing.
Jerry Revich (Equity Research Analyst)
Jim, Jerry can you just quantify that for us, just provide an update relative to the numbers you laid out on last quarter's call? How much work are you evaluating for the 2015 award? How does that compare to the $12 billion of projects that you expect to be awarded over the next 12 months? Can you just provide some more detail there for us?
James H. Roberts (President and CEO)
Yeah. So what we try to do is give some insight as to where we're at in the next 12 months. Certainly, we look way out. We look out 2-3 years for teaming arrangements. And there's well in excess of $20 billion of projects that we're actually pursuing. They move, Jerry. They tend to move forward and backwards up to maybe 3-6 months even. And so we try to stay really focused on the next 12 months, which is around $12 billion. But our agreements, our teaming agreements, and our teams are focused on upwards of $20 billion over the next probably 2 years.
Jerry Revich (Equity Research Analyst)
And Jim, in terms of just the timing out of the $12 billion projects over the next 12 months, can you talk about when you expect the key investment decision to be made for some of the bigger projects within that mix? What's that cadence look like, 3Q, 4Q versus early part of 2015?
James H. Roberts (President and CEO)
Well, first of all, we ought to chat a little bit about the I-4 job, which we'll anticipate an award hopefully at the end of this quarter, sometime in September is what we're anticipating. And so that job, when every job, every one of these large jobs does kick off, certainly we have an investment that we make into the job from an equity infusion relative to the joint venture partnership. So that job will kick in in the Q3 or maybe the fourth quarter from that perspective. And then the other jobs, even as we bid them in the H2 of this year, most of those larger projects probably would not have a notice to proceed until the beginning of next year, probably at the earliest. So you'll probably see some investment in those projects in the first or Q2 of next year.
Jerry Revich (Equity Research Analyst)
Jim, in terms of just the smaller projects within construction, I know that can be lumpy, but can you just give us a sense for how you expect the cadence of orders to play out there?
James H. Roberts (President and CEO)
Can you be a little more specific on that, Jerry?
Jerry Revich (Equity Research Analyst)
Yeah, sure. So within the construction segment where you have smaller projects than these multi-billion-dollar bids, can you just talk about what inquiry levels are, what you expect the order cadence to look like in the back half of the year?
James H. Roberts (President and CEO)
Well, as I mentioned, Jerry, we've got a very strong backlog. We're up, let's say, $170 million over the previous time this last year. So we're going to have a very, very robust H2 of this year in terms of building the work. In terms of bidding, just in this month alone, we're bidding $500 million worth of construction work. So there's no slowdown at all relative to the amount of work bidding. Certainly, the ingredient there is our hit rate and then when the projects start. So we're going to have a very busy H2 of the year, both in the building and the bidding. The bidding is not slowing down either.
Jerry Revich (Equity Research Analyst)
Okay. And lastly, Jim, can you talk about how the costs are tracking on the projects that are under 25% completion? I know you mentioned Tappan Zee timing is on track. Can you touch on the cost structure on that and other projects? Is that generally in line ahead of schedule, or are there any bumps along the way?
James H. Roberts (President and CEO)
What I probably ought to do is go back to what our expectations in large projects are, which we have consistently said, Jerry, is that we expect mid-teen margins in our large projects. Although we don't discuss any individual project, we still believe that our large projects' overall return should consistently be in the mid-teen margin area. That's what we're tracking.
Jerry Revich (Equity Research Analyst)
Okay. Thank you.
James H. Roberts (President and CEO)
Okay. You bet, Jerry.
Operator (participant)
Thank you. Our next question comes from a line of Allie Hemmings from D.A. Davidson. Your line is open.
Alli Heckmann (Equity Research Associate)
Hi. Good morning.
James H. Roberts (President and CEO)
Good morning, Allie.
Alli Heckmann (Equity Research Associate)
I was wondering, you spoke a little bit at the beginning of the call about what you're seeing in terms of government funding for infrastructure. I was wondering if you could provide a little bit more detail about what you're seeing on the state level for that, particularly in California?
James H. Roberts (President and CEO)
So certainly, the states are somewhat dependent in a lot of respects. Depending on the state, they're dependent on the federal side of their funding levels. But the individual states that we work in, the majority of those states are strengthening their own programs, Alli. So we've seen them divert some monies from their general funds back into their transportation funds. We've seen them with some individual referendums for gas tax overrides. California is probably one that is still struggling a little bit with their transportation funding. Their capital outlay for the 2014-2015 year has been reduced from $4.8 billion to $4 billion. And the overall transportation budget, I think, was reduced to about $1.7 billion out of about $12 billion overall. That was anticipated.
One of the good things in California is that over the very difficult years during the California budget times, they borrowed money from the transportation fund, and they are now starting to repay that. I think the first year is about $350 million. So they're starting to repay that. So that's a good thing. But across most of the country, the states have quickly determined over the last several years that they really have to become more independent and more self-sufficient in their funding mechanisms. And we're starting to see that occur now. So that's a good thing. And then if we can get a Highway Bill to shore it up that has some type of incremental indexing to it, I think that'll create a very strong program going forward. And as you know, they passed a patchwork funding mechanism through May of next year yesterday.
We'll have to work on a long-term bill between now and next May.
Alli Heckmann (Equity Research Associate)
Great. Thank you so much.
James H. Roberts (President and CEO)
Thank you, Alli.
Operator (participant)
Thank you. Our next question comes from a line of Sameer Rathod from Macquarie. Your line is open.
Sameer Rathod (Equity Research Analyst)
Hi. Good morning. A couple of quick questions here. First, can you comment at all on the pricing on the aggregates business that you've seen continue the incremental pricing there?
James H. Roberts (President and CEO)
Yeah. Good morning, Samir. Yes. Overall, we mentioned in the last call that we were looking at 3%-5% increases in materials. We're seeing that stick pretty well across the board. Certain markets are stronger than others, obviously. But it is our intention to continue with those kinds of increases. And so far, so good.
Sameer Rathod (Equity Research Analyst)
Okay. Great. And then could you comment anything on the non-residential construction side? I know that's a smaller part of your business, but any of the competitive dynamics working now that the non-res cycle seems like it has some legs to it?
James H. Roberts (President and CEO)
Okay. So when you say non-res, I mean, maybe are you talking about the private sector in general, or are you talking about?
Sameer Rathod (Equity Research Analyst)
Yeah. The private sector in general versus the public non-res.
James H. Roberts (President and CEO)
Yeah. Sure. You bet, Samir. So when we look at it, we've made a very strong effort over the last couple of years to diversify into several areas of the private sector. And certainly, I think it is bearing fruits now, and it's doing quite well. Our power sector is strong, and we're starting to see more transmission and distribution work across North America because that's a very healthy non-governmental funded environment. We're in the mining business. We've actually transitioned with some very strong efforts in the mining business, which is strengthening. The oil and gas business is getting stronger. We're increasing our investments there as well. Solar market actually is continuing. We're starting to see some efforts again in the solar market. And actually, on top of that, we got a few commercial buildings that we're doing some very, very large site work for.
So those are all good signs. I would say that out of all of the private sector, the residential is probably the one part that hasn't moved up as quickly as the rest of it.
Sameer Rathod (Equity Research Analyst)
Okay. Interesting. I guess my last question is more broad. We did pass this patchwork highway funding yesterday. When do you think we'll have an earnest discussion on longer-term funding needs? It seems like we've kind of been stuck in this temporary patchwork for several years now. Do you have any views on when we might have a real discussion on longer-term funding? And that's a similar question.
James H. Roberts (President and CEO)
Oh, Sameer, I have lots of views, but I will be very short with my view here. I think that the intention originally from the Senate was to put a shorter extension out there to curtail the extension at the end of the year to force a lame duck session into focusing on a Highway Bill between now and the end of the year. But what got passed was an extension through May of next year. So I would be hopeful that there would be some very strong discussions between now and the changing of the congressional members, but I would not bank on that. Because I would imagine if history plays out correctly, they'll work all the way up until May of next year before they enact any type of a longer-term Highway Bill.
I'm going to keep my fingers crossed, Samir, because I would really love to see something done between now and the end of the year.
Sameer Rathod (Equity Research Analyst)
Okay. Thank you.
James H. Roberts (President and CEO)
Thank you.
Operator (participant)
Thank you. Ladies and gentlemen, as a brief reminder, you can queue up for a question with star one on your touch-tone telephone. If your question has been answered, or if you wish to remove yourself from the queue, you may press the pound key. Our next question comes from a line of Brian Rafn from Morgan Dempsey Capital Management. Your line is open.
Brian G. Rafn (Director of Research)
Good morning, everybody.
James H. Roberts (President and CEO)
Morning, Brian.
Brian G. Rafn (Director of Research)
Give me a sense, Jim. Talk a little bit. You talked about the $12 billion that you guys were kind of bidding on in the next 12 months on the heavy civil side. How much of that, and I imagine most of it's design-build, but I'll ask the question. And then could you give us a little sense of projects and maybe geographic, kind of what you're looking at, what projects are available in the universe?
James H. Roberts (President and CEO)
You bet. In fact, Brian, there are all types of different projects. Interestingly enough, the environment with TIFIA, the Transportation Infrastructure Finance and Innovation Act, tied in with the last Highway Bill, allows us to do a lot of different things relative to the type of procurement. So we've got our standard bid build is where you turn a bid in, and they read them at that point in time. Certainly, a big chunk of the big ones are still design-build, Brian. And then we've got design-build and P3s where there's a public-private partnership relative to the financing mechanisms. And there's operation and maintenance of these projects going on today. There's even CMGC jobs where they choose somebody upfront and negotiate contracts with them. So the environment is becoming a lot more complex relative to the different kinds of procurement.
We're bidding work, and I'm looking down the list here, Brian, all the way from, well, we're actually starting to bid work again in Guam, which is nice. Seeing that program come back. New York is healthy. We've got a lot of projects bidding in New York. We've got certainly some work bidding, additional work in the Northeast up in Pennsylvania. We are bidding work in Canada, continuing to bid work through the Kenny organization up in the Canadian market. There's work in Washington, D.C., Chicago, California, the Carolinas, quite a bit of work in Texas, some work in Florida on the list here, South Carolina, Arizona, you name it. It's all across the country, Brian. So as I think Laurel mentioned, from coast to coast, our large projects have now expanded and up into the Canadian market.
That gives a nice diversification play to the overall geographic environment of our bidding.
Brian G. Rafn (Director of Research)
Yeah. Jim, would the core of that still be primarily highway and bridge work, or are you seeing canals, dams, levees? Because what you are doing is you are seeing a different diversity given power transmission in that. Is still the transit stuff mostly highway and bridge?
James H. Roberts (President and CEO)
Well, I would say it's interesting because there's some rail work as well. There's quite a bit of underground tunnel work. But yes, I would say a lot of it is in transit light rail. It has a large portion of this. Some large sewer work is involved in it. Bridge replacements. You're starting to see the infrastructure bridge replacement take off again. So I would say yes, a lot of it is in the transportation segment, but we're, as you know, Brian, diversifying into the water, the sewer, and other areas simultaneously, as well as obviously the power.
Brian G. Rafn (Director of Research)
Yeah. Okay. Let me ask you, and you've commented this in the past on some of the highway transit stuff. We all follow certainly the residential peaking at 2.2 million. U.S. housing starts falling to 310,000, climbing back to 1 million. What, from the standpoint of some of that fast turn business in the road building, the local highway, the county highways, kind of that $30 million, $40 million, $50 million to a couple hundred million, how is that midterm segment relative to bidding projects?
James H. Roberts (President and CEO)
Well, I think it's starting to gain some momentum, Brian. I think that what they've done, and I mentioned it briefly, was they've come to the realization that they're going to have to find their own local funding mechanism to get that work done. And they've actually been doing that. So I think it's actually starting to strengthen again, but I think it's a very methodical process right now. And they're actually looking at their own ways to partner to create more opportunities for funding mechanisms as well. It's starting to move up again. I think it's really important though that as we look at this, all of these entities are determining that they're not going to go have somebody writing them checks anymore. So they're going to have to figure out how to do it themselves. And that's actually a good thing.
We're starting to get more diversification in the funding mechanisms themselves. I don't think it's going to be an inflection point, as I mentioned, Brian, but I do think that they've all come to the conclusion they've got to fix their infrastructure, and they're starting to do it.
Brian G. Rafn (Director of Research)
Yeah. Okay. And then one, just on, Jim, on the materials quarry side, kind of give me a sense of range, kind of what maybe your capacity utilization might be in broad terms? And then how much would you be seeing on internal use versus external sales?
James H. Roberts (President and CEO)
Well, first of all, capacity-wise, we've got lots of capacity. That is not an issue at all. Remembering, our business was substantially bigger six or seven years ago, Brian. You followed us for quite a while. So that materials business has a long way to go to get back up to any, using that C word of capacity, long, long way to go. And the mix is today we're focusing heavily on third-party sales. We believe that for that business to go to the next level, we have got to continue to be a better retail seller of product. And there is a very strong sales effort inside of our materials business to focus on third-party customers.
Operator (participant)
Thank you. Our next question comes from a line of Jerry Revich from Goldman Sachs. Your line is open.
Jerry Revich (Equity Research Analyst)
Yes. Hello again. Thank you for taking the follow-up. Jim, can you talk about and say more of the operating profit improvement we saw in the construction materials business? How much of that came from aggregates versus asphalt? And are you planning any mid-year price increases? I'm wondering if you could flesh that out for us.
James H. Roberts (President and CEO)
Well, we don't break it out to aggregate and asphalt, but I would suggest, Jerry, that across the board, we're seeing increased margins. So I would put it in both categories. And I would say that they're a little bit different than just giving price increases at the beginning of the year. A lot of this stuff is project-specific pricing. And certainly, we're attempting to increase our pricing on all of our individual projects, internal and external, as we go forward mid-year.
Jerry Revich (Equity Research Analyst)
Just the magnitude of those price increases, I guess we've heard from some of the European-based contractors who have significant aggregates exposure in the U.S. They're pushing pricing by 5%-10% and 10%+ in some areas. Is that the magnitude of price increases that you're pushing through on projects?
James H. Roberts (President and CEO)
Okay. So depending on the type of product, Jerry, the answer is yes, but it is not an across-the-board type of increase. So again, people that have followed our business and followed the materials business closely know that higher quality products will demand a higher increase in pricing sooner than lower quality products. And so what I mean by that is the concrete aggregates and the more dense rock that's used in concrete and asphalt. That will demand increases faster than a low-quality sub-based type material. So different products will have different rates of increases.
Jerry Revich (Equity Research Analyst)
So when you roll all that together into your business, can you just give us a rough sense of what that means for you?
James H. Roberts (President and CEO)
Well, like I mentioned, the 3%-5% increase at the beginning of the year is sticking. I'm going to probably say that's probably where is a comfortable level for this year. Although I will say that if things continue, we'll look for more increases in the fall.
Jerry Revich (Equity Research Analyst)
Jim, in the past, when we've seen your construction materials price increases go through, we've seen margins improve in your construction segment as well on the vertically integrated projects. Can you just orient us when should we start to see a tailwind from that dynamic based on the pricing environment that you're seeing today?
James H. Roberts (President and CEO)
Well, I think you saw some of that in the Q2, actually, Jerry. You saw the margin increases in the construction work move up nicely in the Q2. And again, it could be I would expect it to continue to stay, as we mentioned at the beginning of the year, in the high single digits to the low double digits. And right now, you saw the high single digits in the Q2. So that's a good sign. It's moving up. I mean, again, I'm not going to suggest there's a specific timing relative going to the next level, but the trend is definitely positive.
Jerry Revich (Equity Research Analyst)
Okay. Thank you very much for taking the follow-up.
James H. Roberts (President and CEO)
Okay. Thank you, Jerry.
Operator (participant)
Thank you. Our next question comes from a line of John Rogers from D.A. Davidson. Your line is open.
John B. Rogers (Director of Institutional Research and Analyst)
Hi. Good morning.
James H. Roberts (President and CEO)
Hey. Good morning.
John B. Rogers (Director of Institutional Research and Analyst)
How's it going?
Jim, just following up a little bit on the margin questions and your earlier comments. On the large project work and the target of them, mid-high teens, is that what you're comfortable is in your backlog now?
James H. Roberts (President and CEO)
Well, okay. So mid-teens is kind of the consistent message, John. And yes, yes, that's exactly what our expectations are out of our backlog. And again, quarter to quarter, it's going to fluctuate up and down and up and down. But yes, that is the expectation out of, on average, the large project backlog.
John B. Rogers (Director of Institutional Research and Analyst)
Okay. But I just want to make sure, I mean, because I think I don't think you have much left in terms of low margin work there. But depending on what happens going forward, I mean, that's reasonable to expect that to continue. Setting aside that $25,000 hurdles.
James H. Roberts (President and CEO)
Yeah. John. So the pluses and minuses tend to weigh themselves out. You tend to have some good projects and then some not-so-good projects. And certainly, we're happy to have the project in Washington just about behind us. And certainly, we do not anticipate bad jobs going forward. But at the same time, we try to create an environment in our large projects where the mid-teens is the expectation. And we consistently bid our work there and consistently have expectations that's where we're going to end up.
Laurel J. Krzeminski (SVP and CFO)
Yeah. And John, depending on the type of work as well and the associated risk, if it's a large highway project with not as much complexity as something like Tappan Zee or whatever, it might have lower margins. So it just depends entirely on the mix.
John B. Rogers (Director of Institutional Research and Analyst)
Right. So you have the stuff that's actually higher than the average and stuff that's lower than the average.
Operator (participant)
Thank you. That is all the time we have for questions today. I'd like to turn the call back over to the speakers for closing remarks.
James H. Roberts (President and CEO)
Okay. Well, thank you, everyone, for your questions. And again, I want to thank the Granite Team for their focus on safety and operational excellence throughout the height of our construction season. We, again, will be on the road this quarter end with a planned attendance at a conference or two, as well as some long-overdue Midwest travel. And as always, Laurel, Ron and I are available for any follow-up if you have any further questions. Thank you all.
Operator (participant)
Ladies and gentlemen, thank you for your participation in Granite Construction Incorporated's Q2 2014 earnings conference call. This now.