Granite Construction - Q3 2016
October 28, 2016
Transcript
Operator (participant)
Good morning. My name is Keith, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Granite Construction Investor Relations third quarter 2016 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. To ask a question, please press star, then one. Please note, this event is being recorded. Please note we will take one question and one follow-up question from each participant. It's now my pleasure to turn the floor over to your host, Granite Construction Director of Investor Relations Ron Botoff. Sir, the floor is yours.
Ron Botoff (Director of Investor Relations)
Welcome to the Granite Construction Incorporated third quarter 2016 earnings conference call. I am pleased to be here today with President and Chief Executive Officer, Jim Roberts, and Executive Vice President and Chief Financial Officer, 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 statements made today. 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. Certain non-GAAP measures may be discussed during the call and from time to time by the company's executives.
Please note that a reconciliation of certain non-GAAP measures is included as part of our earnings press release. For more information, 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.
Jim Roberts (CEO)
Well, good morning, everyone, and thank you for joining us to discuss another quarter of solid execution. The focus on efficiency of our teams continues to grow and expand, always with an emphasis on enabling and empowering our employees to get home safely each and every single day. Today marks the end of an internal 90-day safety challenge called Lead from the Heart, which has emphasized three themes: people over projects, stories over statistics, and relationship-based safety. Daily, weekly, and monthly communications during safety meetings, inspections, and observations have engaged employees to gather and share stories and best practices across all of our businesses and projects from coast to coast. We expect teams will continue to emphasize the learnings of this program as they work to finish a very busy year safely. We believe strongly that safe work is a key component to operational and financial performance.
I personally challenge our teams to keep up the momentum and finish the year as safely as possible. Late second quarter momentum carried into the third quarter, driving strong year-over-year results. 7% revenue growth translated into our highest revenue quarter since 2008. It spurred more than 20% improvement in net income to more than $37 million, our best quarterly performance since 2012. The business has not paused. Backlog remains at an all-time high of nearly $3.8 billion, reflecting steady public market conditions, which remain positively countered by private non-residential demand. Gross profit growth, operating income expansion, and improved overall bottom line performance continues to be driven by solid execution across our business portfolio. Let's look first at the Construction segment, the driver to our year-over-year profit improvement.
Segment revenue growth of nearly 9% in the quarter helped push margins up to more than 15%. That makes it 10 consecutive quarters and 13 quarters out of the past 15, a period-over-period Construction segment margin expansion. We remain very pleased by the consistent, consistently strong mid-teens margin performance in this segment, and we remain encouraged to see the improvement in results moving in lockstep with solid booking trends, resulting in segment backlog up more than 27% from last year to $1.1 billion. This, yet again, was without a pickup in public spending trends. Public transportation spending remains steady and stable, but near-term bidding activity has yet to increase. Granite teams continue to focus on the solid stream of diverse opportunities that exist in each of our local geographies.
Whether manufacturing, automotive, logistics, data center, utility, mining, rail, or renewable energy, these end-market opportunities and others continue to provide a positive balance to our opportunity set across geographies and businesses. Our diversification efforts continue to drive growth, while we and our Department of Transportation customers await the just now arriving financial impact from the FAST Act. I remind you that the Construction segment is the part of our business where we expect the FAST Act to provide the most impact for Granite. We continue to expect heightened bidding activity at the state level, with demand accelerating in 2017 and remaining at a higher level, likely for most of the duration of the five-year highway bill. Now on to the Construction Materials segment, which again performed solidly in the third quarter. I've talked for years about Construction Materials as the leading indicator of our business.
Now in our fourth year of recovery from trough level demand, committed volumes, otherwise known as materials backlog, remain solid, which gives us confidence as we plan for the improved demand environments that we expect in 2017 and beyond. The materials business continues to deliver efficiency gains. Third quarter margin was up about 100 basis points from 2015, despite a 16% revenue decline. A volume shift from external to internal consumption accounted for the majority of revenue change from last year, with the internal volume benefiting the Construction segment. While we always experience product and demand changes from year to year by geography and by customer, we have been pleased to see overall demand in materials volume steady year-over-year, with production volume right in line with 2015 levels.
Continuous improvement efforts, a focus in the materials segment, remain in place to improve and capture greater plant efficiency gains. These activities and actions allow our businesses to operate more profitably and more nimbly in responding to challenges in local demand environments. Finally, let's move to the Large Project segment, where performance improved, but continues to lag our expectations. During the quarter, certain projects were impacted by weather, production, design, or owner-related issues. However, the segment produced solid sequential margin improvement to more than 9% on nearly 15% revenue growth from last year. During the quarter, we added our one-third portion of the Honolulu Authority for Rapid Transit Project in Hawaii, also known as HART, to backlog as expected. With this latest addition to our large, diverse project portfolio, we continue to focus on performance improvement and execution of record segment backlog of nearly $2.7 billion.
Design and owner-related issues remain focus areas for improved project productivity and efficiency. These efforts are expected to provide benefits to some existing projects as they get closer to completion. But importantly, we also believe these efforts will provide benefits and new opportunities in much of our recent work as well. And of course, these areas of focus help guide us in prioritizing risk and appropriate project returns, as well as allowing us to be more selective on the future projects we bid. Finally, today, let's talk politics, the politics of infrastructure investment. While the presidential election has captivated us with talks of hundreds of billions of incremental infrastructure investment, know that I use the term captivated quite loosely, and I also remind you that it took Congress nearly a decade to pass a long-term transportation bill.
That bill, the FAST Act, I also will remind you, is just now beginning to disburse funds to state departments of transportation following congressional budget delays. Should the feds actually give or get their act together, whether at the behest of Donald or Hillary, then this certainly would have a large impact on demand. We are enthusiastically listening to their promises of increased infrastructure investment, but we also are cautiously aware of how slowly Congress actually works. In fact, it is chronic federal inaction that spurred nearly half of the states in our country to make some type of adjustment to their transportation program in the past few years. The positive action remains at the state and at the local level. In many states, notably for Granite, Washington, and Utah, these changes enacted in 2015 just now have begun to impact infrastructure investment.
In Texas, voters have repeatedly approved measures to expand and protect the transportation infrastructure funding. On November 8, in Illinois, voters will decide on a constitutional amendment to protect transportation funds for transportation purposes. Meanwhile, here in the Golden State, California voters will weigh in on more than a dozen local transportation funding measures on Election Day, representing more than $3 billion of potential incremental infrastructure spending per year. That figure does not include L.A.'s Measure M, which itself would create an additional $3 billion a year. Of course, while these measures are an important potential source of funding for future projects around the state, they also are a distinct reflection and a result of state funding levels that remain significantly and woefully below demand.
These voter measures, of which Granite is a large supporter, are important, but the bigger needle to move resides in Sacramento, where state-level capital spending has declined for five consecutive years. A unified industry in California continues to press elected officials for action on desperately needed long-term incremental transportation investment by the end of this year. Now, I hand it to Laurel with some more detail on our results and an update of our 2016 outlook. Laurel?
Laurel Krzeminski (EVP and CFO)
Thank you, Jim, and good morning, everyone. Third quarter 2016 revenues were $803.9 million, up 7% from last year. Net income improved 20.6% year-over-year, with diluted earnings per share of $0.92, up from $0.77 last year. Gross profit increased 12.1% year-over-year to $107.7 million, with gross profit margin up about 60 basis points to 13.4%, as a strong Construction segment and steady Construction Materials segment once again more than offset a weaker Large Project segment contribution. SG&A expenses increased year-over-year in the quarter to $54.2 million, driven primarily by compensation expenses. Our balance sheet remains strong, with $258 million in cash and marketable securities at the end of September.
Cash and working capital trends have been impacted this year primarily by increased CapEx investment, as well as the addition of two new consolidated joint venture tunnel projects. We've invested more in CapEx to support efficient project starts and execution on our growing backlogs, with year-to-date investment increasing to $67.9 million, up about $41 million year-over-year. Total contract backlog at the end of the third quarter finished at a record of nearly $3.8 billion, up 21.9% from last year. Large Project construction backlog increased 19.8% year-over-year to nearly $2.7 billion, and it now includes our one-third portion of the $874 million HART project. In the Construction segment, backlog grew 27.2% from last year to more than $1.1 billion.
As we have seen each quarter this year, third quarter bookings were broad-based across end markets and geographies, continuing to highlight the diversification benefits and the broadening of opportunities for our business. Looking at the segment detail. Third quarter Construction segment revenues increased 8.8% to $464.6 million, with gross profit margin of 15.4%, up more than 120 basis points from last year. Solid execution across the West and the benefits of diversification helped drive the segment's 10th consecutive quarter of margin improvement. In the Large Project segment, revenues increased nearly 15% in the third quarter to $249.3 million. Segment margin declined about 50 basis points year-over-year to 9.4%, as certain projects were impacted by the issues Jim mentioned.
In Construction Materials, segment revenues decreased about 16% in the third quarter to $89.9 million, as results reflected a year-over-year mix shift from external to internal consumption. The business continued its efficient performance, delivering segment margin up about 100 basis points year over year to 14%. Before I discuss our guidance, a couple housekeeping items on tax rate, CapEx, and SG&A. With the ramp-up of our new consolidated tunnel jobs, non-controlling interest has increased, especially compared to the past few years. This increase has moved our tax rate lower, and as a result, we currently expect our 2016 tax rate in the low 30s. As we've discussed, both project and market demand have driven our increased CapEx investment in 2016. We currently anticipate 2016 capital expenditures of $80 million-$90 million.
We also have experienced growth in SG&A this year, both as a result of rewarding our people for improved performance and by investing this year in growing capabilities, some inward-facing and some customer-facing. With that, I finish with our outlook for 2016. We continue to expect mid-single-digit consolidated revenue growth in 2016, with EBITDA margin in a range of 6%-8%. Now, before we take your questions, let me turn the call back to Jim.
Jim Roberts (CEO)
Thank you very much, Laurel. We remain encouraged by the progress our teams around the country are making. We are focused on execution of our strategic plan, looking to capitalize on a strong construction market, a Large Project segment with strong demand and performance that is stabilizing, and solid demand for our materials businesses across the West. In California, we are confident that significant long-term transportation funding solutions are achievable either in 2016, after Election Day, or early in 2017. Our focus on California's elected leaders in this area is unrelenting. We continue to focus on opportunities to drive improved operational and financial performance, both through execution on our record $3.8 billion of backlog and from solid demand trends in 2017 and beyond. And with that, we'll be happy to take your questions.
Operator (participant)
Thank you. To ask a question, please press star, then one. Please limit yourself to one question and one follow-up, and jump back in the question queue if you have additional questions. Our first question is from John Rogers from D.A. Davidson.
John Rogers (Analyst)
Good morning.
Jim Roberts (CEO)
Morning, John.
John Rogers (Analyst)
I guess the first thing is, I mean, you mentioned the shift in some of the Construction Materials work for internal use. And can you give us a sense of how much of your operating income, if it's possible, was transitioned between the Construction Materials and the Construction segment?
Jim Roberts (CEO)
Well, I'm not sure I understand the question. I mean, if the operating income adjustment overall probably didn't adjust itself, it just went from one segment to the other, John. It actually moved from the materials segment to the Construction segment. Overall, it would be the same at the end of the day.
John Rogers (Analyst)
Sure. I'm just trying to understand how much moved. So as we think about looking forward, how to think about margins in each of those segments.
Jim Roberts (CEO)
Well, okay. So just as a reminder to, and John, you know our business quite well, as we bid work, sometimes we'll bid as a materials supplier, and we'll bid it as a contractor. And in some cases, you know, we'll be competing as a contractor on jobs where we'll actually be supplying the materials to our competitors. And in that case, it just depends on who gets the job at that time. You get a very large project, and we'll call it with hundreds of thousands of tons of asphalt on it, and in the swipe of a pen on bid day, depending on who is the low bidder, it could be internal consumption or external consumption.
So this last quarter, we have seen more work going to Granite than to the external customer, but it could change back next quarter and the following quarter. I think the key for us is the overall volume that we produce through our materials facilities. And then whether it goes one direction or or the other, really is not overly important to us. And as we said, the materials volume, in general, has kept at the same levels as 2015.
John Rogers (Analyst)
So thank you for that. I'm just trying to understand, I mean, is this $1 million that shifted between those or orders of magnitude?
Jim Roberts (CEO)
No, I think it's substantially more than that, but I don't know if I can detail that out for you as to what the difference is. And maybe we can talk offline later, John, if there's more details that we're not properly relaying to you as to how much the shift was. Maybe another way to look at it is this: When you look at our materials business over the years, it's fluctuated anywhere from 50/50, 50% internal sales, 50% external sales, all the way to 70% external to 30% internal. Right now, it's shifting more of a 60/40. It's more 60 external, 40. So it's shifting more towards internal from last year, but it's not that far out of alignment with the historicals. Oh, that's John? Yeah.
Laurel Krzeminski (EVP and CFO)
Yeah, and the 10-Q will be out shortly, where we show the intersegment transfers in the segment footnote, and I believe it's around $73 million in total revenue, just to give you some basis versus the external revenue of $39, so.
Jim Roberts (CEO)
John, I think the key is, how is it different from previous quarters or previous years? And I think that that's also available in the Q as well.
John Rogers (Analyst)
Great, thanks. It's just that you had mentioned it in the press release. I just wanted to understand a little how significant-
Jim Roberts (CEO)
Yeah, it's a mix. It's more of a quarter-over-quarter and a year-over-year discussion point for right now.
John Rogers (Analyst)
Okay. My follow-up question would just be, Jim, in terms of, especially in the Construction segment, the smaller project work, You talked about the politics of it, but are we starting to see that FAST Act money show up in bid activity at the end of 2016? I mean, are you starting to see those bids come out now? I mean, when it was passed, you know, a year ago, you'd indicate we wouldn't see it till the second half of it, of this year at the earliest. And is that starting to show up now?
Jim Roberts (CEO)
Yes, it is, John, and as expected. And that's why I really wanted to make sure that as it passed last December, that everybody understood that a federal bill takes longer to enact than a state bill, than a local bill. So yeah, we're starting to see it happen. September was actually a pretty good bidding month. October's a pretty healthy bidding month. November is a very healthy bidding month, and we'll start seeing that play in the fourth quarter and the first half of next year, we'll start seeing it ramp up. And that's what we've talked about all along, and it's happening.
John Rogers (Analyst)
Okay, great. Thank you. I'll get back in queue.
Jim Roberts (CEO)
Okay, John. Thanks.
Operator (participant)
Thank you. The next question comes from Daniel Scott with MKM Partners.
Daniel Scott (Analyst)
Hey, good morning, guys. How are you?
Jim Roberts (CEO)
Good.
Jerry Revich (Analyst)
Morning.
Daniel Scott (Analyst)
So Jim, you've talked about the California bill over the past several quarters, and the way I hear your words, it sounds like the momentum has been building. The anticipation, maybe being able to pass something in the lame duck session next month, seems to be improving. Maybe you could talk to handicapping that a little bit. Does that presume that the Democrats have to get the supermajority, or has your, you know, kind of team been able to push some Republicans?
Jim Roberts (CEO)
Well, first of all, I'm not a betting man, Dan, to begin with. So, but we have worked very hard with the California legislature to talk about opportunities. And I do think that, after election day, there is a very strong opportunity to bring the legislators back to session to discuss and hopefully vote on a transportation bill. I don't think it is a huge issue relative to whether you get a Democratic super majority or not. I think that whether it is the Republicans or the Democrats, they've all kind of come to an agreement that the infrastructure investment in California is suffering. They understand that. They're all willing to do something.
It's more a matter of getting the fine print and everything done relative to reform of environmental issues, reform of the way the DOT operates, and some adjustments to the size of the bill. I think we've got a pretty good agreement from both sides of the aisle for a transportation bill. It's more about the, the details than anything. So I don't think it's a huge issue relative to being a Democratic supermajority or not.
Daniel Scott (Analyst)
Okay, great. And could you maybe give us some color on what the polls might be saying about the Los Angeles and the Santa Clara initiatives?
Jim Roberts (CEO)
Well, there's... And without diving into detail on any of them individually, they're just all over the state of California. There's, like, a dozen measures, ranging everywhere from Northern California, around the Sacramento area, to the Bay Area. There's actually a big one right here in our backyard, in Monterey County. L.A.'s Measure M is huge. That's, I think it's a $120 billion long-term infrastructure investment bill.
And when you look at, when you look at what's happening, and this is what I was trying to articulate in the script, Dan, was that people are at the local level fed up, and they're not getting what they need, and their quality of life is being affected by being stuck in traffic, trying to get from point A to point B every single day. So that group of people are starting to vote at the local level to pass all these measures. So whether it's $6 billion a year total, including Measure M, and, you know, I'm sure a chunk of those will pass, and some of them probably won't, 'cause they, most of them will need a super majority to pass in the state of California.
And then you couple that with a transportation bill for the entire state, for the highway system. There's a big movement underway right now to get the infrastructure investment in the state of California back where it belongs. So, we'll see. We got a couple weeks, Dan.
Daniel Scott (Analyst)
And just to echo what you said earlier, I think you would expect the pace of anything state or local to be faster than what we're seeing in the FAST Act?
Jim Roberts (CEO)
Oh, absolutely. Yeah, the FAST Act, we knew it would take a year to get that money into the system, and then we had the congressional budget delays that delayed it actually a couple more months. But at the state and local level, those monies get collected and distributed much quicker.
Daniel Scott (Analyst)
All right. Thanks very much, Jim.
Jim Roberts (CEO)
Thank you, Dan.
Operator (participant)
Thank you. And the next question comes from Jerry Revich with Goldman Sachs.
Jerry Revich (Analyst)
Hi, good morning, everyone.
Jim Roberts (CEO)
Hey, good morning, Jerry.
Jerry Revich (Analyst)
Jim, can you talk about your risk metrics on the large construction side at this point? You and Laurel have spoken about, you know, practical limits of how big the large construction business can be as part of your overall mix. Can you just update us?
... where you stand on that? And then also, can you talk about the, how to think about the margin trajectory into 2017 and 2018? I guess, typically at this point in the cycle, we get improving margins on new bids as the work gets let. So I'm wondering, at which point do the project issues that you alluded to earlier get ironed out, and we transition to improving margins in large construction broadly?
Jim Roberts (CEO)
Okay. So, just maybe Large Projects in general, Jerry, because I think you've got several questions in there. First of all, Large Projects has always been a very strong part of our company, and I continue to feel and know that we are an excellent builder of Large Projects. And historically, Large Projects has been about a third of our company, and we like that balance of somewhere from 25%-33% is fine relative to the size of our business and where the large project sits in that overall portfolio. As far as our ability to operate it at a level back up into the mid-teens and how long that's gonna take, I think it's gonna take through 2017 to get there.
We certainly did improve slightly quarter over quarter in the last quarter. We still have some of these older jobs to burn off. We have a host of nice new jobs that are absolutely bid at higher margins, and we also have a host of owner-related and design-related issues that we're attempting to resolve right now. And as those resolutions take place, which they typically take place at the end of the projects, we'll start seeing a nice opportunity for some margin adjustments at that point in time as well. But most of those Large Projects won't be ending for probably the, let's say, 2-3 years from now. And so we're working hard to try to get those cleaned up as quickly as possible.
Ideally, we work with owners on these issues continually, and ideally, in many cases, we settle them before the end of the jobs. But I will say this: one thing that we've done, and is, that is significantly different than historically that we've done, we are now working at the beginning of these projects, and I mentioned this over the last several quarters, to really fine-tune the design of these projects in advance of any construction and fine-tune our relationships with the owners. So that we know we are in a better position to know exactly where those projects are going before you put a shovel in the ground. And that's really the key, and I mentioned that earlier when I was chatting. It's really the key. Get these projects started off correctly, and they typically end up being very nice jobs.
I'm not sure, Jerry, if I answered every question of yours there, but certainly, if there's anything else I can... that you need, just let me know.
Jerry Revich (Analyst)
That's really good context. In terms of the Caltrans budget is down about 5% this year. You folks have posted really good top line and order performance. Despite that, can you just talk about did you folks have a higher win rate, or was it a mix of work that was more favorable to you within the overall budget? Can you just give us some more context there?
Jim Roberts (CEO)
Well, again, Caltrans has been one of our biggest customers, almost every year in the company. But I would say that, yes, our win rate is absolutely higher. The projects that we have with Caltrans are bigger. We've got a very large project down in the Palm Springs area, very Large Projects down the Highway 99 corridor. But the key to our California success has actually been our diversification efforts. It has been moving away from just large, listed numbers of bidders on projects for DOT work, to a lot of the renewable energy work, a lot of industrial and commercial work, and so we're starting to see a better mix in our overall portfolio. But what I will say is that if we can get a transportation bill passed, it will dramatically change that Caltrans program.
The Caltrans program, as you mentioned, is pretty dismal today. It's down in the $2 billion level and substantially lower where than it has been historically, and it will change the dynamics of the bidding environment on Caltrans work if a bill is passed. But for us, we have a higher win rate, and we've diversified into other areas in California, and that's been our success story.
Jerry Revich (Analyst)
Okay, thank you very much.
Jim Roberts (CEO)
Thanks, Jerry.
Operator (participant)
Thank you. The next question comes from Nick Coppola with Thompson Research Group.
Nick Coppola (Analyst)
Hi, good morning.
Jim Roberts (CEO)
Morning, Nick.
Nick Coppola (Analyst)
Wanted to follow up on your large project pipeline. I know in the past, you talked about kind of the size of that and expectations there. So any color around projects you're looking at, bidding on here in the near future?
Jim Roberts (CEO)
Sure. In fact, I, I pulled the list out and put it in front of me in case that question got asked. And I... You know, one of the things, Nick, that always tends to continually surprise me with Large Projects is there's just no shortage of opportunities, and they just keep coming, they keep coming, keep coming. So our job today is to try to pick and choose and be very selective on which projects we bid. But I'm looking at a list here in front of me, $20 billion that we're teamed up with on projects for the next couple of years. And, and it doesn't even include a whole bunch of projects that we're in discussion with right now.
So anywhere from all the way from out in Guam to Washington, D.C., L.A., Boston, more Hawaii work, lots of New York, New York work, Florida work. I'd be happy to discuss any project, but they're just continuing to come. And it's a nice position to be in when you have $2.7 billion of backlog, and you have some really nice new projects starting... and you have a robust pipeline behind you. So our job now is to be very selective, focus on the projects that we believe can get us into the margin range that works acceptable to us, and obviously, we have a good chance of winning. So it's not slowing down at all, Nick.
Nick Coppola (Analyst)
Okay, that's good to hear. And then moving over to construction, margins there continue to be up nicely, and I know you've talked about your diversification efforts. What's going on in terms of margins in core public infrastructure type work? Any comments on the competitive environment?
Jim Roberts (CEO)
Yeah, I go back and look at that core public work as being kind of the foundation of what we do. But honestly, it's the lowest margin work that we have. And the problem with that is, and the reason behind it, is that it's been underfunded for quite some time, and a lot of companies, these regional companies, have built their businesses around having to obtain a certain percentage or a certain amount of that local public works. And with very little public works spending going on, that obviously creates a very competitive environment. So where I see it going is that with the FAST Act kicking in, which will help the DOT side, with these measures that we see coming up, and we see, you know, transportation bills at the state level, that's gonna change those dynamics.
So we've been able to capitalize on diversification efforts and raise our, our margin profile because of diversifying outside of the solid, standard public projects. But now that those projects have the ability to start increasing the demand side over there, I think those margins are gonna change and come back to where they're gonna be back up to the same area of where our, our private sector margins are. But historically, they've been, they've been the lowest margins in the business.
Nick Coppola (Analyst)
It's positively here going forward. Thanks for taking my questions.
Jim Roberts (CEO)
Absolutely. Thank you.
Operator (participant)
Thank you. And the next question comes from Ryan Cassil with Seaport Global.
Ryan Cassil (Analyst)
Hey, how's it going?
Jim Roberts (CEO)
Good, Ryan.
Ryan Cassil (Analyst)
Just following on that last question, you know, the proliferation of work going on in construction right now, do you see your more prominent competitors, you know, thinking about higher margins as bidding activity picks up? Or do you have any sense there that there's gonna be a, you know, sort of more rational approach to these bids? Any color you can give there?
Jim Roberts (CEO)
Well, Ryan, first of all, I wouldn't know what my competitors are doing inside of their own businesses. But I would imagine that good businesspeople, as they see the market starting to adjust positively, would sort of do the same thing that we are and raising their expectations on margins. But obviously, I have no idea what the other companies' individual expectations are. But in general, what happens is as the bid lists get shorter, the margin opportunities increase, and that's historically been the trend.
Ryan Cassil (Analyst)
Okay, sure. That's what I was getting at. And then in terms of the SG&A line, you guys mentioned some investments you were making there and some compensation expenses going up. Obviously, there's a variable component to that, but do you feel like, you know, you're making these investments, and next year you can begin to lever that line more significantly?
Laurel Krzeminski (EVP and CFO)
Yes. We do. As we make more money, though, obviously, compensation, some elements of compensation will go up because that portion is variable. We are investing in selling expenses as well. You'll see that when the 10-Q comes out, and there's the breakout. But we would expect to grow the top line faster than we grow our SG&A.
Ryan Cassil (Analyst)
Okay. Is that, like, in the nature of 2 to 1, or do you have any sense there you could give us?
Laurel Krzeminski (EVP and CFO)
It depends, I think. You know, for instance, there's one thing that's in our third quarter this year, our non-qualified deferred compensation plan had a mark-to-market fair market value adjustment that just happened to show a negative comparison year-over-year of $2 million. It has no impact on our bottom line because it's offset in other income, but all of those details are in the 10-Q. So once you take a look at it, if you have some further questions, then we can get together and talk about it.
Jim Roberts (CEO)
Well, and also, just as another thing of the investment, I think you made some great comments during the discussion earlier, Laurel, about the inward-facing and the customer-facing SG&A, which the customer-facing would be the selling of the SG&A, and we have invested heavily into our business development program at Granite. And we've actually gone throughout the entire nation to try to get our business units to be more focused on customer relationships, and we're actually spending quite a bit of money there. So I do think that one is at least a 2-to-1, even higher, of a 3-to-1 to 4-to-1 ratio, leveraging our selling expenses to our revenue side and actually to our income side.
So we call it a return on investment, and when we look at a capital or a SG&A investment like that, our business development group actually has metrics that they expect to provide back to the company relative to what they're spending on really educating the entire company on business development. So that's a change. You know, this industry has been more I call it engineers and accountants, where we focus on numbers, where our business today, we're starting to focus on customers, what they need. And I think it's gonna change the. It might change our selling costs slightly, but it's gonna create a much better environment for us to deal with the customers that we want to deal with.
Ryan Cassil (Analyst)
Great. All right. Thank you.
Jim Roberts (CEO)
Thank you.
Operator (participant)
...Thank you. The next question comes from Min Cho with FBR & Company.
Min Cho (Analyst)
Great, thank you. Good morning.
Jim Roberts (CEO)
Good morning, Min.
Min Cho (Analyst)
So in terms of the California transportation bill, it sounds like this definitely should pass, and it's really more of a timing issue, and obviously, your backlog is pretty strong now. So even if it's not until 2017, seems like it should be fine. But can you talk a little bit about potential labor issues? I mean, it sounds like a substantial increase in infrastructure spending in California.
Jim Roberts (CEO)
Okay, Min. So let me clarify one thing first. I'm very confident we're going to get a bill. I hope I don't suggest that it's done, because it's not. There is a lot of work to do, and our legislators, our governor, industry associations are working very hard to cooperatively bring everybody together. So, I mean, there is light at the end of the tunnel, and that is a really good progress. And it is big, and you're right, Min, this is a big deal to the state of California. And also a $5 billion a year number on the table above where we're at today, adding $5 billion to a $2 billion program, is going to upset the equilibrium of the labor force, no doubt about it.
But what I will say in the state of California is, and this is why I'm ecstatic about the potential opportunity, is that we have a long history of relationships in the state of California, and we have a tremendous reputation, and we also have wages that we pay that are at the very high end of the spectrum. So for Granite, I'm actually pretty comfortable saying that we will be able to expand our business to accept those challenges, probably better than most any other company in the state.
Min Cho (Analyst)
Okay. Well, that makes sense, and it's probably a good problem to have to deal with at some point. Also, if you could just talk a little bit about your M&A pipeline. I know you've talked in the past about kind of a focus on water. If you can just talk, you know, about timing or just, again, what the pipeline looks like right now.
Jim Roberts (CEO)
Okay. So yes, it's, we're focused on... Our strategic plan has a very focused organic growth environment and a very focused M&A environment for growth. We do believe that there are opportunities both in the water sector and in, I'll call it, our vertically integrated business sector. And as a reminder, the timing is very difficult to determine because really it's a matter of when the right deal comes along and getting it completed at the right time. But we are actively in the process of searching and discussing opportunities in both water and the vertically integrated business. As a reminder, water, we are looking at both the combination of the water wastewater, transmission of water, the redoing, rehabilitation of pipelines, the heavy civil side of water.
And then on the vertically integrated side, our game plan there is to take our business model further to the east. And we believe that there are some tremendous opportunities as this transportation sector starts to get stronger, that those opportunities in the east will be really good opportunities for us. I also think that the combination of water and transportation are the key drivers, what I would say is the future infrastructure of the country. So for us, those are the two areas that we're gonna continue to develop our expansion plans in, and I think the timing is gonna be pretty good for things to continue to happen in both of those areas.
Min Cho (Analyst)
Okay, great. Thanks a lot.
Jim Roberts (CEO)
Thank you.
Operator (participant)
Thank you. Excuse me, the next question is a follow-up from John Rogers with D.A. Davidson.
John Rogers (Analyst)
Hi, thanks for taking the question. And maybe for Laurel or Jim, in terms of your cash flow, seasonally, it's typical that it picks up quite a bit at the end of the year. Is that the same expectation this year? And as the business ramps, especially into 2017, can you give us a sense of what you're expecting to have to invest in working capital to support that growth?
Laurel Krzeminski (EVP and CFO)
Sure. So to answer your first question, we do expect operating cash flow to move, in the normal seasonal trend this year. So on those days-
John Rogers (Analyst)
Be positive for the whole year, right?
Laurel Krzeminski (EVP and CFO)
Right. The-
John Rogers (Analyst)
Yeah.
Laurel Krzeminski (EVP and CFO)
The sort of wild card at this point is what jobs we're gonna win on the large project side, whether they'll be sponsored or non-sponsored. You know, we picked up 2 new sponsored jobs this year, and so what happens is our working capital and our CapEx and all of those things go up associated with us having our partners' portion on our books. In the case of the non-sponsored joint ventures, it's different, but we give the cash out to our partners. So, it's going to depend what, you know, what our portfolio looks like next year, so can't really provide you any guidance relative to that. But, you know, we have a strong balance sheet and capital structure, and we're very confident that it will maintain that.
John Rogers (Analyst)
Okay. And in terms of capital expenditures, they've ramped up, and I think you've talked in the past about $70-$75 million for a range. Is that still a good expectation?
Laurel Krzeminski (EVP and CFO)
You know, this year, we expect to spend between $80 million and $90 million. We have two new tunnel, large project joint ventures, and sometimes when you have a tunnel joint venture, you have to purchase a tunnel boring machine, and those are relatively expensive. So, you know, it depends entirely on what the needs are, but we'll provide you as much information as we can as we go along, so.
John Rogers (Analyst)
Thank you.
Jim Roberts (CEO)
I think the good part, the good part here, John, is that our businesses are feeling as though they're those capital expenditures are needed to be able to prepare themselves for what the upcoming workload is, too. Which is a good sign, because I will tell you, over the last six or seven years, and John, you know this as well as anybody, you know, there just hasn't been that demand out there for those products. And as our business units start feeling more bullish about what's going on in their local environments, they're starting to ask for more CapEx, which is a good sign.
John Rogers (Analyst)
Great. Thank you.
Jim Roberts (CEO)
Thanks, John.
Operator (participant)
Thank you. And the next question comes from Joe Giordano with Cowen and Company.
Speaker 11
Hey, guys, this is, Tristan for Joe, today. Thanks for taking the question. I was wondering if you expect to get any benefits from the New Jersey gas tax increase?
Jim Roberts (CEO)
Yeah, I saw that, and I followed that a little bit, but I really don't think that's gonna have a large effect on Granite. We've done some transportation work in New Jersey, not a lot. So I would say if there's a large project that might help infuse some monies over into that might help, but I haven't followed it that closely. It would be more of a transportation issue, I think, than most of the work that we're actually focused on in New York. But it's a good deal. I was happy to see that pass. I think those are the kind of things that the individual states are working on, that they understand now that they're in charge of their own destiny, and they are focused on getting their infrastructure investments ramped up.
So it was a good thing to see. And I think nationally, it helped highlight what other states should be doing as well.
Speaker 11
Okay, thanks. I've read about some project delays in the press, and I was wondering if that affects you, if you have any comments on that, if you see anything like this?
Jim Roberts (CEO)
Project delays. Well, okay, in general, there's always project delays.
Speaker 11
Yeah.
Jim Roberts (CEO)
To me, there's always project delays or milestones or issues. But I would suggest to you that, with all of our projects, that our job is to try to, work with the owner, satisfy the owner's expectations on schedules. And some delays are because the owner had a delay, because they couldn't contractually meet certain, requirements for environmental or permits or things like that. And some of them are our own delays relative to productivity. But I don't think there's anything significant that's gonna have, a positive or a negative.
Speaker 11
Okay, thanks, guys, and congrats on the great quarter.
Jim Roberts (CEO)
Thank you very much.
Operator (participant)
Thank you. The next question comes from Brian Rafn with Morgan Dempsey.
Brian Rafn (Analyst)
Morning, guys.
Jim Roberts (CEO)
Hi, Brian.
Brian Rafn (Analyst)
Hey, when you look going forward, you kind of gave us a strategic look. You've got a sizable backlog, you've got a robust pipeline accelerating, you got the FAST money potentially coming through. Is your thought process going forward the next three, four years, that we're gonna have to build up some unit volume capacity? Or are you gonna stay at the kind of the current capacity and say, "Hey, we're gonna be much more looking at leveraging accretive margin. We're gonna be much more selective. We're not as much worried about getting our unit volume capacity on," you know, with, I think you said, $20 billion in potential pipeline?
Jim Roberts (CEO)
Okay. So I wanna make sure that it's not an either/or question. Because I think for us, Brian, it's a combination of both. And when we talk about increasing our margin expectations, I think that's across all segments. Large Projects has been lagging, obviously, that's very notable. But still, even with our Construction segment at mid-teen margins today, that can work its way up higher. Our materials margins can work their way up higher. But simultaneously, I think that we are ready for a volume, a growth spurt as well. And so I see a combination of both. And that's the idea, to do a methodical growth over the next five years, with the anticipated stronger investment in infrastructure.
Remember, one of the things that we've been working on is our continuous improvement program, which we're starting to see that take nice effect into our Construction Materials business with higher margins there. I wouldn't say it's one or the other, Brian. I'd say it's both, and that's where we expect our business to go.
Brian Rafn (Analyst)
Okay. And from the standpoint of that, metered, very, you know, graduated capacity expansion, is that... Historically, you guys have talked about bench strength with, you know, employees with knowledge base, versus, say, just bulldozers and tunnel boring machinery. Is it more on the people side in capacity, or is it more on the machinery side?
Jim Roberts (CEO)
I would suggest this, that's a very right-on observation, Brian. It is about people in this business. It is all about people. And we do build our bench length accordingly. We've actually got people on projects today in number two positions, so that they can be in number one position in the next two years. And that's why methodical growth is so important, because if you outpace, your growth outpaces your people's capabilities, you will get yourself in trouble. And we are working very hard. We've been focusing on talent development in Granite. We've been focusing on significant recruitment in Granite. Yes, we have a little higher SG&A today. It's anticipation of growing the company.
Brian Rafn (Analyst)
Let me ask, relative to the materials side, when you start shifting from external to internal usage, does that shift in sourcing internally your own materials, does that give you a bid day cost leverage? How much would that be, or is it just really kind of the strategic availability of those materials and timing and delivery?
Jim Roberts (CEO)
... Yeah, I would say there's a slight cost advantage. I don't think it's huge. It's absolutely strategic. That is, by far, the biggest advantage you have. When you know that you are gonna put down 3,000, 4,000, 5,000 tons of asphalt a day, and you know that that asphalt plant is dedicated to your job, and you know what's going on in advance relative to that plant's the facility's capabilities, it gives you a very strong strategic advantage on bid day. So, and we do try to price to ourselves very close to market, if at all possible. There are some tax advantages that we certainly take into consideration, but it's a strategic advantage more than a pricing advantage.
Brian Rafn (Analyst)
Okay, and let me ask from the standpoint, you talked, and you've done a very good job kind of articulating over the years, the political side. Do you see kind of a shift in the infrastructure spending, a migration from the federal to more of a state and local level? I mean, we used to put people on the moon, built, you know, Hoover Dam, fought two major world wars, and these guys in Washington can't put a stamp on an envelope. Is that really the new reality, that you're really gonna look at more local funding and more state DOT funding, even though you've got the highway bill umbrella?
Jim Roberts (CEO)
Okay. So, again, Brian, you know the business, you know what's going on, and I should have said that earlier. But here's the deal. I think that in this interim environment, while the feds are basically inactive, the states and the local communities have taken the infrastructure investment into their own hands. But I think what we're gonna see is that the feds have realized that they've fallen down, and they haven't done their job. They've been relying on what their forefathers built in the '50s, '60s, and '70s, and I think you're gonna see congressional action in the next several years that's gonna suggest that they are gonna take a new look on investments in our infrastructure as well. So short term, absolutely, states and local communities are gonna step up and fill the void.
I actually have confidence that over a period of time here, in the next year or two... And remember, every time you have a presidential election, it's in the second year of the election cycle, after the new president comes on board, that is where they start making major investments into the infrastructure of our country. So it could be all three lining up here, all the stars aligning properly, with the feds chiming back in in the next year.
Brian Rafn (Analyst)
Okay, thanks, guys. Great quarter.
Jim Roberts (CEO)
Okay, Brian.
Operator (participant)
This is the end of our Q&A, and now I'd like to turn the call back over to our host.
Jim Roberts (CEO)
Well, everybody, thank you for your questions. I offer my personal thank you to our employees for their efforts and performance. To Granite teams across the country, please focus on finishing the year safely, as well as beginning 2017, with a commitment that every employee goes home safely each and every day. To the Granite investment community, especially our shareholders, we greatly appreciate your support and your feedback. As always, Laurel, Ron, and I are available for follow-up if you have any questions.
Operator (participant)
Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.