Granite Construction - Q2 2015

Transcript

Operator (participant)

Good morning. My name is Hilda, and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Granite Construction Investor Relations second quarter 2015 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 press star 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 Botoff (Head of Investor Relations)

Welcome to the Granite Construction Incorporated second quarter 2015 earnings conference call. I am 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 is included as part of our second quarter 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 would like to turn the call over to Granite Construction Incorporated, Chief Executive Officer, Jim Roberts.

James H. Roberts (CEO)

Thank you, Ron, and thank you all. Thank you, Ron, and thank you all for joining us. After posting our best first quarter financial performance since 2009, I remain encouraged by the overall solid performance in our business in the second quarter, which contributed to Granite's best first half financial results since 2009, when the economic downturn was strongly in play. Quite a contrast of trends. At this point in 2009, our total company backlog was just above 50% of today's record $3 billion figure, another example of a sharp contrast of trends. I mentioned last quarter that the trends, opportunities, and challenges ahead of us had not changed for quite some time. It is how these factors interrelate that continues to feed my optimism. Let's start with some near-term trends.

Our large projects business had a challenging quarter, and frankly, it had a challenging start to 2015. We began the year with a broad book of business, reflecting consistently record or near record backlog, and correspondingly, we began the year with a number of new projects. During the quarter, there were four key factors that contributed to the variance from last year's segment results. First, last year's quarterly results included our initial profit recognition on the Tappan Zee Bridge project, which was not repeated. Second, last year's quarterly large projects results also included significant claim recovery with the state of Washington, which was not repeated. In addition, we had new projects ramp up slower than anticipated in the second quarter this year, and we typically show lower profit margins in the early stages of our projects.

Finally, this year, severe weather has managed to keep finding us right where most of our large projects are located. This was a significant impediment to progress on several projects. Laurel will help quantify the first two factors with you in a few minutes, but let me spend just a minute with you on the latter two items. We spoke last quarter about the large project segment portfolio trend, reflecting weighting toward projects early in progression. We noted that this weighting in project life cycles typically produces margins that are lower in the earlier stages of jobs than when the projects mature. For example, as new projects and new teams in Pennsylvania and Florida began to take shape, they encountered some start-up challenges, and these projects progressed more slowly than we had expected.

As our teams continue to build momentum, I'm pleased to say that progress has accelerated on both projects this quarter. And then there's Mother Nature. Our team in Dallas on the I-35 project encountered record wet weather both last winter and this spring, which hampered progress significantly. During the quarter and throughout the year in North Carolina, heavier than normal rainfall has slowed progress on our I-40/I-440 project as well. We continue to work to get back up to speed and overcome these considerable challenges. Despite these recent near-term challenges, we remain confident that we have a strong opportunity to recover lost ground the remainder of the year and over the next few years as we focus on execution of our more than $2 billion of segment backlog. The large project market continues to show strength.

We currently have teaming agreements to bid on more than $20 billion of large projects over the next couple of years, with our percentage of participation in the projects in line with recent history. Okay, next, let's explore some of the trends in our construction materials and construction businesses. As we saw in the first quarter, improved operating trends once again drove margin growth in both materials and construction in the second quarter, marking the fifth consecutive quarter of margin improvement across both segments. We continue to benefit from construction materials segment improvement in the second quarter, as both internal and external demand contributed to volume and pricing strength. This segment of our business is a great example of the overall cycle confluence of trend, challenge, and opportunity. We expect that volume and pricing trends will continue on this path of improvement.

After spending much of the past five years feeling for the bottom, we are continuing our investment in this business to drive returns, leveraging continuous improvement successes across our materials facilities, and driving ongoing efficiency and cost management gains. As I've said for many years, our construction materials business is both a leading indicator for our business, as well as a critical component of our vertically integrated business. A critical component, once again, contributing to our bottom line nicely, and that we expect will continue to deliver revenue and profit growth for the company. Moving now to another source of positive trends, our construction segment. Second quarter segment performance was driven by improvements across geographies and across end markets. Solid year-over-year improvements in power and underground fueled some of the growth, with solid contributions from our businesses across the West contributing to this trend.

Overall, the market and bidding environment remains fairly stable, but quite competitive. As we have said for some time, private market activity continues to provide solid growth and diversification opportunities. However, it is the transportation market, our largest, that is expected to fuel significant top and bottom line growth for Granite. We are well-positioned to benefit from recent state and local funding actions, coupled with the potential catalyst in the form of a long-term highway bill. So with that in mind, I'll spend just a couple moments on the funding trends, both at the state and the federal level. Trends at the state level are encouraging. So while a long-term federal highway bill certainly can be expected to unleash billions of dollars of pent-up demand, many states are beginning to take action to accelerate investment well in advance of potential help from the feds.

In response to continued federal foot-dragging on long-term transportation funding, as of July 1st, nearly a dozen states had enacted new user-based transportation funding since 2013. These states are attempting to bridge the very real infrastructure funding gaps they have been up against now for more than five years. We expect that more is on the way at the state and local level. Right now, in a special session of the California Legislature, transportation funding legislation is being debated. Over the course of the past two decades, gas tax revenue declines and increasingly more fuel-efficient cars have created an estimated annual shortfall of about $5.7 billion per year in California. The result? California's 50,000 miles of highways and nearly 13,000 bridges needs an estimated additional $59 billion worth of repairs.

Democratic proposals would contribute at least $2 billion-$3 billion per year to transportation projects, each over a 5-year period. A competing Republican alternative provides $6 billion in incremental annual funding for transportation in California. It's too soon to say which of the bills has the best chance of success, but it is encouraging to see potential progress is being made in Sacramento from both sides of the aisle. Now, if only our representatives in D.C. could follow suit. In another key Granite market, the state of Washington, legislators recently passed, and the governor signed into law, a 16-year, $16.1 billion transportation revenue bill that commits more than half of the funds, $8.8 billion, to new road projects. Certainly, we feel well-positioned to be a significant beneficiary of this important legislation and the opportunities it creates in the state of Washington.

But let's not lose sight of a simple fact: the United States needs a highway bill that resolves current and future funding gaps, grows the annual investment, and enables a long-term planning environment, period. Anything less is unacceptable. I was among a group of construction industry leaders who walked the halls of Congress about a month ago. Unfortunately, our call to action for long-term investment with both Senate and House leaders remains unheeded, with Congress expected once again to only kick the can down the road before they recess. We are hopeful that they will take proper action on this critical issue and pass a long-term highway bill later this year. Make no mistake, though, we are not sitting idle waiting for Congress to help. Despite federal investment stalled for more than six years, we have made significant investments in our business.

We have invested in modernizing our business systems, upgrading our plant facilities, and purchasing state-of-the-art rolling stock equipment. But the most important investments we have made in recent years have been in our people and in our processes. We have doubled our expenditures in training and development over the last three years, and we have advanced a very progressive Lean Six Sigma approach to process improvement that we term continuous improvement. It has taken a lot of hard work, and it is now paying off as we continue to develop into a better, stronger, more efficient company. Our vertically integrated business is beginning to gain some of the momentum I have spoken about for years.

We will continue to update you regularly on the progress of our currently early-stage large projects portfolio, but our medium and long-term perspective gives us confidence in our expectations and in execution of our overall strategic plan. So having produced our best first half overall financial performance since 2009, we are focused on capitalizing and building upon our current momentum. And finally, I am confident that we are building a strong team to lead our company through this next phase of growth and prosperity. Recently, Rob Beekhuizen, a former Fluor senior leader, joined the Granite team to help guide the growth of our vertically integrated business. Focused on accelerating diversification efforts and developing stronger client relationships, Rich Rantala joined the Granite team from Balfour Beatty to oversee all business development endeavors.

And Rick Dennis is now our supply chain leader, coming to us from Great Lakes Dredge & Dock. Rick and his team are building a company-wide approach to leverage the buying power of a $2 billion company. I'm confident that these additions, coupled with our strong incumbent Granite team, are preparing the company for our next phase of growth and leadership. So with that, I will turn the call over to Laurel to discuss results and our 2015 outlook. Laurel?

Laurel J. Krzeminski (CFO)

Thank you, Jim, and good morning, everyone. Second quarter 2015 revenues were $569.2 million, down 2.8% from last year. Earnings per share in the quarter were $0.24, compared with $0.34 in 2014. As Jim mentioned, despite a challenging first half for our Large Projects business, we produced our best midyear financial results in 2015 since 2009. On a year-to-date basis, revenues increased 2.5% from 2014. Total company gross profit margin decreased about 250 basis points year-over-year in the second quarter to 11.6%. Importantly, the trend of improved quarterly performance in the construction materials segments continued in the second quarter.

This marked the fifth consecutive quarter of gross profit margin improvement across both segments of our vertically integrated business, one of the key trends that Jim mentioned. Following a similar year-to-date trend at the top line, gross profit margin totaled 10.7% in the first half of 2015, in line with last year. Driven by a reduction in selling expenses, second quarter SG&A expenses decreased 4% year-over-year to $49.1 million, with SG&A about flat year-to-date. We continue to maintain and manage a strong balance sheet, with more than $276 million in cash and marketable securities at quarter end. As a reminder, we typically use cash in the first half of the year and build it in the back half.

Total contract backlog at the end of the second quarter was $3 billion, up more than 17% from last year. Backlog improvement was fueled by strong growth in Large Project Construction segment backlog of nearly 37% to $2.2 billion, which outweighed a construction segment backlog decline of about 15% year-over-year to $831 million. Let's take a look at segment results. Second quarter construction segment revenues increased 13.5%, with gross profit margin of 13.1%, up nearly 390 basis points from 9.2% last year. Segment revenue and profit improvement was driven by performance across geographies and across end markets. Large Project segment revenues decreased 25.1% in the quarter, with gross profit margin of 8.1%, down from 20.8% last year.

Remember, though, that last year's second quarter performance was driven primarily by initial profit recognition on the Tappan Zee Bridge project and dispute resolution income from the State of Washington. The total of these two milestone recognitions last year added about $40 million in both revenue and gross profit in the quarter. We believe it's important that our stakeholders understand our approach and our expectations for the Large Projects portfolio, so I'll repeat what I mentioned just last quarter. Our Large Projects portfolio is currently weighted toward projects still earlier in progression, so as is typical, we expect reported margins to remain lower in the earlier stages of jobs than when the projects mature through the project life cycle. This does not change our expectations for projects or for segment performance. We continue to expect mid-teens margins over the life of projects.

Today, I finish our segment discussion with our construction materials business, where revenues in the segment increased almost 12% year-over-year in the second quarter, with gross profit margin improving more than 410 basis points. Last quarter, we were encouraged after generating modest first quarter profitability in this segment for the first time since 2008. Our enthusiasm is growing. In the second quarter, the 13.5% gross margin represents our best margin performance in this business on a quarterly basis since 2009. This trend of improvement continues to revalidate our optimism that the overall economy, economy is improving and demand for our products is improving. Finally, as we noted in our earnings release this morning, we are maintaining the guidance we provided to you in February and kept in May. We continue to expect mid-single digit consolidated revenue growth in 2015, with EBITDA margin in a range of 6%-8%. Now, before we take your questions, let me turn the call back to Jim.

James H. Roberts (CEO)

Thank you, Laurel. We are well positioned to continue to grow both the top and bottom line of our business, as well as diversify into new end markets. The quality of our team, the overall economy, the improvements that we have made and continue to make are providing the foundation for both our short- and long-term success. With that, we'll be happy to take your questions.

Operator (participant)

To ask a question, please press star one. Please limit yourself to one question and one follow-up, and jump back in the queue if you have additional questions....Our first question comes from Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich (Senior investment leader)

Good morning, everyone.

James H. Roberts (CEO)

Good morning, Jerry.

Jerry Revich (Senior investment leader)

I'm wondering if you could just give us an update on the bid pipeline, as you do from time to time, or Ron, just to give us a sense for projects within the next 12-18 months that you're bidding on, how that's evolved versus your last update a quarter ago.

James H. Roberts (CEO)

Sure, Jerry. It's actually really an interesting question because I wanna talk not just about large projects, but I think it's important to also talk about our construction business as well. And it's, when you look at the construction business, it doesn't necessarily make the highlights, and that's been averaging somewhere on our bidding horizon here around somewhere from $250 million-$450 million worth of work every single month that we're bidding in the construction segment. And that's one of the things that we highlighted here in our discussion and in our press release, was that that market's changing. It's getting to be more robust, and that's a good sign. So that's one thing, and those, we bid hundreds of projects, and I think everybody knows that.

But to see the consistent amount of work out in front of us bidding in the construction segment is really a nice sign. We go back to the large project segment, and we noted that we've got about $20 billion over the next couple years we're teamed up on. Currently, we've got about $6 billion that we will bid between now and year-end, and they range from large projects, large tunneling projects. We're seeing more tunnel projects come out, which is really nice. We're seeing still some very large light rail projects that are still on the docket. We're actually seeing some nice freeway, highway expansion projects coming on the docket, too.

So there's a huge amount of diversification in the large projects business, which is really nice because we've got highways, we've got tunnels, we've got some work in the greater New York City area. Really just a nice amount of work. We're actually, again, being very picky, Jerry, as to what we team up with and what we bid. We have more coming in than we can actually bid, so we wanna pick the jobs we have the best shot of obtaining.

Jerry Revich (Senior investment leader)

Jim, can you just put the $250 million-$400 million of bid work per month, just to give us a rough sense, where was that number a year ago? And any change in mix within that compared to a year ago?

James H. Roberts (CEO)

Yeah. You know, so, the best way to put it really is that I think the opportunities that we've got today are slightly greater than they were a year ago, but the key is that we're seeing less competitors on the work, and we're seeing more visibility, months ahead, that there is still more work out there. So it's a stronger market. I wouldn't say it's substantially bigger, Jerry, but I would say it's a stronger market, and we're seeing different types of work come into play. I'll give you an example. We're seeing DOT work is probably just the same. That probably has not been a big, increase because obviously, with the highway bill, lack of, visibility down the road, the DOTs have been stalling.

So the nice part is that at least as much of that stalled work has been made up in other types of work, and I'll give you an example. Solar work. We do a lot of solar work in the West and in the Southwest, and that has actually picked up this year. So again, working with private companies, doing solar work is something that wasn't on the horizon a year ago. We're also seeing more commercial work that is out there today. We're seeing more industrial work that is out there today. The one thing we're not seeing is more residential work. It, it's interesting, the residential market has just kind of slowed and then picked up and slowed. But the nice part about what we've seen is that the remainder of the private sector is more than offsetting a sluggish residential and a sluggish DOT market. So when the DOT market comes back, and if the residential market comes back, I think you're gonna see this really jump to another level.

Jerry Revich (Senior investment leader)

Jim, you gave some helpful color on the state of Washington. So the $1 billion per year funding increase, can you just put that into context for us? What's the current total, federal and state highway, spending there? So how big of an increase is that, versus current budget? And then, you know, out of the 12 states that you mentioned, what have you seen has been the general increase in highway spending, for the states that have supplemented with their own use-based fees?

James H. Roberts (CEO)

Well, okay, in general, I can't give you all the details of the states. I can't give you the details, Jerry, on this call relative to what the increase or what the current rate is in the state of Washington. Again, I know that there's about $8.8 billion of additional roadwork. It equates to about $1 billion of additional overall infrastructure work on an annualized basis. But I can't go back and give you the details relative to what's currently being spent there. I don't have that in front of me. But I will tell you this, that whether it is the state of Washington, other big states we work in, Utah has just increased last March their gas taxes by $0.05 a gallon.

They've actually added a 12% tax on the wholesale price of gasoline. So that's gonna be a nice increase. I don't have the dollar value of that increase as well. North Dakota, South Dakota, Ohio, Idaho, a state we do work in, had a $0.07 increase in the fuel tax. So that's been nice. Well, the key ingredient here for us, and I can go down the whole list here, Texas has obviously done a lot of work. They measure, they've actually added about $2.5 billion of their general sales tax and a portion of their future motor vehicle sales tax to the highway fund. Oregon has got some voluntary road usage charge program that they've actually increased their overall program.

I think the point here, really, Jerry, is across the board, all of the states are starting to, you know, just, they've convinced themselves they're not gonna wait for the feds, and they are focusing on what they can do to take care of themselves. The big one is California. The governor has a special session in place today that is debating, and I said I mentioned it, you know, some alternatives here. But I believe the state of California is very well committed to increasing its transportation funding somewhere from, I'm gonna say, $3 billion to $6 billion per year, and I think we're gonna see that implemented in the state of California in the very near future. If they could, there's a potential that it will get done in this special session before the end of August.

If that takes place, California is really on a whole different playing field than where it has been historically. So it's good news. I will say, on the same side, I am disappointed that the feds haven't done a better job, Jerry, than I was hoping they could. My expectation was that they will pass a highway bill by the end of the year. I did expect them to kick the can down the road prior to their break in August. I think they're going to do that. The House has already passed a 3-month extension, but it's really just some same old stuff in D.C. right now. That's why I think the states are really stepping up to the game and doing a nice job.

Operator (participant)

Our next question comes from Michael Dudas with Sterne Agee. Please go ahead.

Michael Dudas (Managing Director)

Good morning, gentlemen. How are you today?

James H. Roberts (CEO)

Mike, how are you?

Michael Dudas (Managing Director)

Wonderful. Thank you, Jim. Two questions. For a short-term sense of how weather is so far currently in, you know, through the first month of the third quarter, and, off that, on your comment about on the construction material side, internal and external demand both growing pretty nicely. Is there a sense of one growing better than the other? Do you get a predictive sense that, with more external demand, that could lead to a lot more, you know, less competition, better bidding opportunities on the construction side?

James H. Roberts (CEO)

Okay. So let's talk about weather first. And I am happy to say, Mike, that we have got some change in the weather patterns where our large projects exist. We did have a good July, and we're starting. We're back on track. You can just imagine in Dallas what the effect of was on our I-35 job there, when basically, the I-35 project was almost flooded. So and then, same thing back in North Carolina, we're seeing that weather subside, so we're able to do a lot of paving. We have a huge paving job back there in North Carolina. And then on our other jobs, you know, they really weren't weather-induced issues, they were really just startup issues, and we're getting over the hurdle on those down in Florida and Pennsylvania. So certainly, we expect to see a significant improvement in the second quarter on those large projects.

Also, let's talk about materials. Pretty interesting. So right now, we run about 60% of our material sales are external, and only about 40% of them are internal. And, you know, we've we fluctuate with those percentages. And certainly, as we migrate more towards the higher percentage of external sales, you'll see more better results, probably on the overall materials business. But the nice part here is that both internal and external are growing. And what that does for us, Mike, is it gives us a overall stronger volume with to amortize some of our fixed costs over, and that gives us a lower cost basis for our entire materials facilities, and that's a big deal for us.

So we're seeing the construction business is healthy, which means the internal sales is healthy, and we're seeing a ramp up on the external sales. It's interesting, on the external sales, what we're starting to see is back where we were, you know, 10 years ago. We're starting to see the external customers buying the higher quality products, and that's a really important change. When they buy concrete aggregates, when they buy the products that are of a higher quality, it creates more opportunity for us. The other thing we're seeing in the materials business is we've got a nice amount of committed volume between now and the end of the year. We don't call it backlog, we don't report backlog in our materials business. Internally, we call it committed volume. We've got nice, consistent customer base, we've got dedicated expectations of volume through the end of the year. Very nice, consistent run rate out in front of us in that business.

Michael Dudas (Managing Director)

I appreciate it. That sounds very helpful, Jim, and my follow-up question would be: So as you look at what's going on in Washington, you know, there's been some creative ways that the Senate and the House have come up to try to help bridge the funding gaps here. But is it really gonna be tied towards this repatriation issue, or is it gonna be just the issue on gasoline taxes? Is there something you can point towards that could smooth the way for something to happen in 2016, and are those the two key determinants before we get more clarity on that?

James H. Roberts (CEO)

Okay. So, Mike, today, those are the two key issues. You know, first of all, the repatriation money has just been a long talk, but when you listen to certain members, they'll tell you that they won't discuss the repatriation monies until we do overall tax reform. So that's potentially a problem. And at the same time, you have certain really focused members who say they will not allow a gas tax to pass. So I think what's gonna probably end up happening between, and I'm gonna say somewhere in October through December, which hasn't changed, you're gonna see some innovative funding mechanisms come into play. And I wouldn't be surprised at all, Mike, if they come up with a totally different alternative to fund a long-term highway bill.

The Senate has really already, I think today, they'll probably approve their 6-year bill, knowing that the House already passed over a 3-month extension to them. But I think you're gonna see some real innovation over the next 6 months on alternative funding mechanisms, because there are people that will not touch repatriation because of overall tax reform, and there are people that won't touch gas taxes just because it's political suicide in their opinion. But I do think they're gonna come up with some numbers, and the Senate has already come up with a reasonable 6-year bill, financial, the financial aspects of it. And I think what they're gonna focus on are some really alternative ways of funding the whole deal. Today, I can't tell you what that's gonna be, but I think the innovative part of it's gonna start hitting the street here, probably when they get back from recess.

Alex Rygiel (Senior Managing Director)

Jim, excellent call. Thank you very much. Good luck.

James H. Roberts (CEO)

Thanks, Mike.

Operator (participant)

The next question comes from Daniel Scott with Cowen and Company. Please go ahead.

Daniel Scott (Managing Director)

Hey, thanks for taking my question, guys. You did give a lot of cover on large projects and weather impacts and how that was probably a drag on the quarter. As we look at guidance being maintained for the full year, does that imply that there's gonna be a catch-up contribution on the large project side, or is it gonna be that the vertically integrated continues to carry the day through the end of the year?

James H. Roberts (CEO)

I think it's both. I think, Dan, that as you look at it, we know we lost some time on large projects. We have accelerated those projects, so we will make up as much as we possibly can. I also think, Dan, that you're gonna see that the construction and the construction materials business are in a stronger environment than they've been in a while, so that performance will help bridge the gap as well. So I think both.

Daniel Scott (Managing Director)

Okay, great. And piggybacking off of Mike's question there on the construction materials, clearly, it sounds like volumes are working. Are you getting pricing as well?

James H. Roberts (CEO)

Yeah, that's the key, Dan, right there. That's the key question. The volumes are up and pricing is up. We started off with some modest price increases at the first of the year, and we just met with some of our teams yesterday, this last couple of weeks as well, and they're actually implementing more price increases midway through the year. So both volume and pricing increases, which is exactly what needs to happen. The pricing has stayed fairly static over several years now, and now that the volumes are raising up, the demand is raising up, and the pricing is moving nicely.

Daniel Scott (Managing Director)

Okay, great. And last question, you've talked in the past a little bit about targeted growth into new areas, I think water infrastructure, those sorts of things. Is there any change in that mentality, any new opportunities that we should be aware of?

James H. Roberts (CEO)

Well, no, there's nothing new except that we continue to explore expansion into water, industrial, rail. We've been talking about that for quite some time, and we're certainly working on it. The other thing that we're doing is we're increasing our expansion into our power business, into the underground business, the rehabilitation of pipeline business. So we're starting to expand some of the work also into the federal market, that are the latest kind of expansions of the business that we wanna grow while we look and work on getting into the new markets as well. But nothing's really changed except that we're growing the current markets as well.

Operator (participant)

Our next question comes from Alex Rygiel with FBR Capital Markets. Please go ahead.

Alex Rygiel (Senior Managing Director)

Thanks. Good morning, Jim and Laurel.

Laurel J. Krzeminski (CFO)

Good morning.

James H. Roberts (CEO)

Good morning, Alex.

Alex Rygiel (Senior Managing Director)

Jim, in the past, you've kind of addressed how many competitors show up at certain bids, whether or not it's in the construction segment in California or it's on some large projects. Can you talk about, you know, sort of how many competitors you're seeing today in those two different environments and how it compared maybe six, 12 months ago?

James H. Roberts (CEO)

You bet, Alex. First of all, let's talk about large projects. That's an interesting environment. Almost most of the projects that we're bidding today do have a short list approach to them. In other words, where we will put our qualifications into an owner, and an owner will shortlist three or four bidders. I will tell you that it's interesting that even if they shortlist four bidders for a large project, we would think twice about whether or not that's the kind of a project we would want to literally compete on because of the cost of putting together a large project bid. So three competitors on large projects, maybe four, is the sweet spot today, and that's about where we see that part of the business.

The kind of wild card is over on the construction side, where the markets are all different. You can have a market in one part of California, substantially different than another. But in general, we're seeing somewhere between 3-5 bidders on our projects. There are times where we'll see more than 5 bidders, and I think sometimes we look in the mirror after that and ask ourselves, "Why did we bid that job?" But literally speaking, it's staying pretty consistent, somewhere around 3-5 bidders, which is a healthy market. That works for our construction business. So overall, our intention on the construction side of the business is to literally focus more, kind of like large projects, on where we have potential high percentage of win rate and increase our hit rate on the work that we actually bid, instead of just bidding everything. So we're starting to be much more selective on the work that we bid, and our overall hit rate is actually going up.

Alex Rygiel (Senior Managing Director)

How far into the cycle would you hope that you could actually see a little bit of pricing power develop in the construction markets where there's, you know, three to five bidders?

James H. Roberts (CEO)

Well, that is another good question, because I think when you look at it, Alex, I think you're starting to see the pricing move already. And I think that what will happen is as people, and I mentioned this earlier, if you go forward-looking, and you see the workload out there, and you see the competitors of Granite have a limited capacity in most of our markets, they will start changing their pricing. We have already increased our expectations on bid day in our construction market. So I think what you're gonna see is it'll take some time. It's already moving there. Unfortunately, the prices never move up as fast as they move down in a down market. But I think from last year to this year, there has been a positive movement.

If we can continue to see the states focus on these DOT trends and get more of that DOT work out on the street, that's gonna suck up a lot of capacity. If that happens, I think you're gonna see much more of a step jump in the overall pricing. And I think that's exactly what needs to happen. But right now, it's methodical, and it is getting better every month because of the continued strong bid list.

Alex Rygiel (Senior Managing Director)

That's helpful. Thank you very much.

James H. Roberts (CEO)

Thanks, Alex.

Operator (participant)

The next question comes from John Rogers with D.A. Davidson. Please go ahead.

John Rogers (Managing Director)

Hi, good morning.

James H. Roberts (CEO)

Morning, John.

John Rogers (Managing Director)

If we could just go back to the construction segment for a second. I just want to understand a little bit more about the margins that you're seeing in that business now, and the improvement, especially year-over-year, that you've been trending at. How much of that, Jim, is related to the private work versus public work?

James H. Roberts (CEO)

I think, John, that's probably the biggest driver of the positive trend. Historically, we have always had a higher margin expectation on the private side than in the public side. The public side seems to be just a low-cost mentality, and really a very competitive environment on bid day. But our increase definitely comes from the private side, and I think that it will continue to move up as the overall public side gets stronger and the bid list gets shorter, and some of those individuals go back to the private side. But today, our highest margins are still on the private side.

John Rogers (Managing Director)

So it's a and I guess that's why I'm wondering, so as the public side of it comes back, does that, I realize it would add a lot to revenue, but does it keep the margins from further improvement?

James H. Roberts (CEO)

It doesn't keep, no, because what happens is that, is that historically, when you come back up out of a downturn, there's a very limited capacity with our competitors. So, if we can get the states to do what we say they're doing here, and/or what we think they're gonna do, especially like California, and that, that alone, I think, would change the pricing on the transportation work in California. But I do think they have limited capacity, and I also think as the private sector gets healthier, John, what you're seeing is that people are migrating back towards the private sector, which is reducing the competition in the public sector, and that will change the pricing there as well.

John Rogers (Managing Director)

Okay. So still expectation for longer-term that like the large project work that can get up into those mid-teens margins?

James H. Roberts (CEO)

Well, we've said that historically, our construction, except for probably the mid-2000s, where we were up in the, the high teens, mid to high teens, we've always said that we would expect construction to be in the low teens, on a typical basis. Now, certainly, if the market improves beyond that, we're gonna be very happy, but I would not expect the construction segment to on average, move itself into the mid-teens. We've been saying the low teens.

John Rogers (Managing Director)

Okay. And then one other just point of clarification. In terms of the transmission market, how active are you in that business now? A couple of references to it, but I just want to understand what you're seeing in that market.

James H. Roberts (CEO)

Okay. So remember what our transmission, our T&D business is. We are focused heavily in the staff augmentation, construction management, and working with the providers themselves to manage their projects. We have ramped up significantly in the last six months in that part of our business. It's a very strong component, and I mentioned that in my discussion at the beginning. That power, the power part of our business is one of the fastest-growing parts of our construction segment. And really, we've staffed up with over 100 additional people for staff augmentation. So we're continuing to see an expansion in transmission, in fact, in all parts of the country, and we're ramping up even more with more people.

John Rogers (Managing Director)

Okay, great. Thank you.

James H. Roberts (CEO)

Okay, John.

Operator (participant)

Once again, to ask a question, please press star one. Please limit yourself to one question and one follow-up only. Thank you. Our next question comes from Nick Coppola with Thompson Research Group. Please go ahead.

Nicholas Coppola (Senior Equity Analyst)

Good morning.

James H. Roberts (CEO)

Morning, Nick.

Nicholas Coppola (Senior Equity Analyst)

In terms of operational improvements and lean initiatives, can you talk a little bit more about what work's being done there and what kind of benefits you expect?

James H. Roberts (CEO)

You bet. You bet. So, I don't know how much, Nick, that you've followed some of the discussions I've had previously. So when we started CI, we started with 10 Black Belts back in 2014 training. We're now up to 17 Black Belts that have been trained and are in play, working on individual projects across the country, inside the company. And every Black Belt is expected to be working approximately 3 projects at a time. And most of those projects need to be somewhere between, have a financial benefit of somewhere between $250,000-$1 million for the individual project. We're closing out projects, starting to close out projects now, and I'll give you an example of a couple types of projects.

We had a huge project in play to minimize the non-value added steps of our P2P process, or Procure-to-Pay process. That will be rolled out at the end of the year here, and that's a big deal. It's not hard dollars, it's soft dollar savings, but it will be able to redirect a lot of the efforts of our people that have been focusing on many non-value added steps. We've been out in our asphalt plants, and really found some real cost savings in our asphalt plants. We started down in Southern California, and now we're working through the rest of the company, to put some of those things into play in other asphalt plants around the company as well.

So there's a combination of hard dollar events that are occurring out in the field, and there are a combination of soft dollar, we call them type one and type two benefits, that are behind the scenes. And right now, we're tracking towards about somewhere between, I'd say, $10 million-$20 million of overall annualized benefits, by the end of the year here, that will allow us to, you know, increase our efficiencies, our bottom line, over the next several years. So it's progressing really nicely. It's something that I wish we had done a long time ago. Although a very expensive investment, it's teaching our company how to improve our processes and make those processes stick for a long time.

Nicholas Coppola (Senior Equity Analyst)

Okay, that's certainly helpful. And then, can you add any more color on your acquisition strategy and whether or not the number of opportunities you're looking at has changed at all?

James H. Roberts (CEO)

No, it hasn't changed. Actually, we're looking at a combination of acquisition opportunities. First of all, and we've been discussing this, the diversification opportunities to move into the markets of oil and gas, water, rail, those were the focused areas that we've had. The other thing that we've been focusing on also is geographic diversity. We're looking at moving, I'd really like to move our vertically integrated business further to the east. It's a strong business. We're starting to see it come back again, where we know it can operate at, and we'd like to geographically diversify that as well. So we're looking at all those options right now.

Nicholas Coppola (Senior Equity Analyst)

Okay. That's pretty much my questions.

James H. Roberts (CEO)

Thanks, Nick.

Operator (participant)

The next question comes from c. Please go ahead.

Brian Rafn (Principal and Director of Research)

Good morning, Jim.

James H. Roberts (CEO)

Morning, Brian.

Brian Rafn (Principal and Director of Research)

Hi. Give me a sense, you talked about the low-cost mentality on the kind of the big public, heavy civil side. If by chance, by miracle, we get a six-year highway bill, it's kind of like building the border fence. Is that going to impact in just a complete release of more federal DOT work? Will that bring margins and pricing up on some of that, what you call low-cost mentality, heavy civil work?

James H. Roberts (CEO)

So Brian, you know, I think there's even a bigger question, than I'm gonna add on to that one, that if we can get a federal highway bill, which I agree with you, I'm not gonna make it a miracle work, but I'm gonna say that, you know, there's a 50/50 chance, maybe even better than that, we'll get something by the end of the year. Some of the work that's been done over the last couple of weeks is fairly encouraging, especially on the Senate side, and then the House side is now saying, "You give us a three-month extension, and we'll work with you on something for the back half of the year." So that's good news, but that's one thing, the federal highway bill.

I think what you're gonna see, and I think that all by itself would have an slight upward tick in the pricing. But I think the bigger deal is if you couple that, Brian, with what these states are doing themselves, I think you're gonna start seeing the combination of those two is going to increase the overall volume of work bidding at the DOT level and change pricing even more. And so I think you're gonna see a combination of events there. And I think, maybe even late this year and into 2016, it's gonna have a nice effect on the rip and read market, which is the lowest priced market in the industry today, is the standard DOT rip and read is the most competitive part of the business. The other thing that happens is as we continue to see the private sector, commercial, industrial, and again, we haven't seen the residential side yet. As we see those other sides grow, what we're gonna end up seeing is people migrating back towards the private sector, and that's gonna, once again, create less competition on the public sector, and that pricing will change as well.

Brian Rafn (Principal and Director of Research)

Okay. From the standpoint of, you know, kind of back, you talked about the heyday of some of those upper teens in the construction side on the EBIT side. If you look on the materials and quarry side, as you recover, do you see that external to internal mix shifting as you continue to fund more of your own internal, you know, backlog jobs, or is that 60/40 kind of, you know, what we're gonna see?

James H. Roberts (CEO)

Well, I think that it probably isn't gonna change dramatically because what we're really looking at is the combination of both internal and external growing like we've seen so far this year. And I think what you're gonna see is, you're gonna see the internal part grow, along with the external part. So I don't think the actual ratios are gonna change dramatically. And I'm kind of hoping they don't. I'd always like to see the external part grow, but it's also very healthy to have that internal work in there at the same time. And I think you're gonna continue to see that part grow. So I don't think it's gonna change dramatically, Brian.

Brian Rafn (Principal and Director of Research)

Yeah. Jim, if you see on the construction side, going back to that, again, that heyday of the mid-2000s, in the turn business today, is there any difference in the type of work, the number of jobs? You talked a little bit about the residential, like that would be a difference. You know, the dollar volume, the duration of the work, you know, local streets versus industrial parks. Any different in the mix of the construction business today versus where it was, say, the margins that we talked about?

James H. Roberts (CEO)

Not really, except that I still think the private sector has a lot more growth opportunity because of the residential. I also think, and I mentioned this before, that, you know, things that are hot, like, the renewable energy market right now, is a nice amount of work. We're also seeing more of a regional transportation or really quasi-municipal setup programs that are bigger than they used to be, because the DOTs are actually smaller overall. But this public work, when they have specialized groups to go focus on individual projects, those are starting to increase. So I think you're seeing less DOT, more quasi-municipal, and then a shift in the private sector towards industrial and commercial.

Brian Rafn (Principal and Director of Research)

Thanks, Jim.

James H. Roberts (CEO)

You bet.

Operator (participant)

The next question comes from Adam Thalhimer. I'm sorry, I can't pronounce your name, with BB&T Capital Markets. Please go ahead.

Adam Thalhimer (Senior Research Analyst)

No worries. Thanks. Good morning.

James H. Roberts (CEO)

Morning, Adam.

Adam Thalhimer (Senior Research Analyst)

Jim, you ran through some numbers on the potential additional funding from California. Can you go over those numbers again?

James H. Roberts (CEO)

You bet. You bet. So, they. The governor called for. First of all, it's interesting when you look at California as a economy in itself. I mean, it's got somewhere close to about a $115 billion budget they just passed. And two things occurred when they passed their annual budget in the state of California. The governor came out and said that, "You know, there are two things that need to be addressed outside of the normal budget. And I want you, the legislature, to get into a special session and focus on these two issues. They need to be resolved." One of them was healthcare, and the other was infrastructure and transportation improvements.

So this special session that's put into play to date had previously had some of the overall the legislature looking at prior to the special session. Several of the senators and assemblymen, or assembly people, had actually had put forth some bills in the general session that got kicked out to the special session. On the Democratic side, they put together a couple of bills in the $2 billion-$3 billion annual range, addition to the current $2.5 billion program. And they put those out, and they have reenacted those in the special session. On the other side, the Republicans have now come out with upwards of a $6 billion program, because the overall review of the condition of the highway program alone in the state of California had a $59 billion deficit.

So the Republicans want to attack it all right now and say, "Over the next 10 years, $6 billion a year, we need to get our state back up to speed where it deserves and should be." I don't think the Democratic group is really denying that. They're actually working quite well together. And I think that what you're gonna see over the next, and I'm gonna call it 30-45 days, Adam, is you're gonna see somewhere probably in a $3 billion-$6 billion range, somewhere between five to 10 years of additional funding being put into place in the state of California, which is a huge play for this state. And if you've been to this state recently, you know it needs it.

Now, one thing they're able to do here, they're looking at a host of funding mechanisms to fund these additional issues. They've got licensing fees, registration fees. They're looking at electric car fees, they're looking at gas tax increases, and they're looking at diesel tax increases. So they are actually attacking the problem with a very focused financing and funding approach to it, and literally, both sides of the aisle are working real well together. And kind of in conclusion, $3 billion-$6 billion, somewhere in that range.

Adam Thalhimer (Senior Research Analyst)

Wow! Okay, so you said, for the federal highway bill, probably 50/50 shot, maybe a little better. What would be your, your ratio for California?

James H. Roberts (CEO)

Oh, I think something's gonna happen in California. I, I'm actually quite confident. I haven't heard of anybody really fighting the idea of infrastructure improvements in the state of California. They know, you know, with the health of the state today, a balanced budget, some surplus, the existence of a rainy day fund now, they know, this entire legislature knows, and the private sector knows that if we're gonna create an economy in California that can last a lifetime, we've got to reinvest in the infrastructure program. So I don't. I think this is well above 70% chance we're gonna get something in this special session. Now, the question, I think, is gonna be: What size is this gonna be? We're gonna get something, but, you know, obviously, I'm hoping we get up closer to the $6 billion, Adam, but there are people that it may end up down at the $3 billion, but it's gonna be somewhere in that range.

Adam Thalhimer (Senior Research Analyst)

Well, I'm gonna buy, so I'm hoping $6 billion, too.

James H. Roberts (CEO)

Yeah, there you go.

Adam Thalhimer (Senior Research Analyst)

Then, lastly, on residential, is it fair to say you're seeing green shoots there? I mean, you said it was choppy. Is that how it normally looks before it recovers, or is that just wishful thinking?

James H. Roberts (CEO)

Yeah, I haven't seen the green shoots pop up yet. You know, the backbone that was there seven or eight years ago is starting to be built out, and that's a good sign. So you want. You got to do the, you know, you got to do the infill, and you got to get the backbone built out. It just hasn't come our way yet. You know, I'm gonna tell you that, I think it's still a ways down the road before the infrastructure development of residential comes back again, and I don't see it happening in the second half of this year. So I'm gonna kick the can on that one down the road to 2016.

Adam Thalhimer (Senior Research Analyst)

Okay, perfect. Thank you very much.

James H. Roberts (CEO)

Okay, Adam.

Operator (participant)

This is the end of Q&A, and now I'd like to turn the call back over to our host.

James H. Roberts (CEO)

Okay, everybody. Well, thank you for your questions. To our employees, thank you for what you do every day. I can't tell you how proud I am of you for the hard work that you perform every day, but more importantly, in the way you conduct yourself each and every day at Granite. Thank you for who you are. To all of our investors, please do not hesitate to reach out to see if we will be able to make it your way soon. Finally, Ron, Laurel, and I are available for follow-up if you have any further questions. Thank you, everybody, for your time.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.