Granite Construction Inc (GVA) 2013 Q3 法說會逐字稿

Good morning, my name is Sayed 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 2013 conference earnings call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (Operator Instructions) Please note we will take one question and one follow-up question from each participant. Thank you.

It is now my pleasure to turn the floor over to your host Mr. Ron Votto, Granite Construction Investor Relations Manager. Sir, the floor is yours.

Good morning. Thank you for joining our third-quarter 2013 earnings call. I'm here with our President and CEO, Jim Roberts, and our Senior Vice President and CFO, Laurel Krzeminski.

As a reminder, any forward-looking statements that are made this morning are subject to risks and uncertainties that could cause actual results to differ materially from these statements and which are further described in our most recent SEC filings. Granite assumes no obligation to update any of these forward-looking statements or other information.

With that, I will turn the call over to Jim.

Thank you, Ron, and good morning everyone. As I get started this morning, I would like to thank Jackie Fourchy for her more than a dozen years serving as the face and voice of our Investor Relations group before turning the reins over to Mr. Votto in the third quarter of this year.

Jackie has transitioned to focus on communications and still is an interval part of our granite family. So thank you very much, Jackie.

Today, I will start with a focus on our large project segment, including an update on key projects driving results and the overall bidding and building environment. Then I will spend a minute discussing our backlog trends, including the impact from new revenue synergies. I will discuss our vertically-integrated business as well as the general scope of the continued restructuring actions we are working to finalize, and then I will close with our outlook for the remainder of 2013 and a look ahead to 2014, starting with large projects.

Now, let's start with some very positive news out of New York from last week. We were extremely pleased to hear Governor Andrew Cuomo's announcement of the federal governments largest ever TIFIA loan for the Tappan Zee Bridge project of up to $1.6 billion.

At more than $3 billion this is not only Granite's largest ever project, but our portion of more than $700 million it is also the largest project in the 63-year history of the New York State Freeway Authority, and among the biggest public works projects in the history of the United States. This is great news for a great project and good overall news for our industry.

That said, this quarter's large project segment results were a disappointment. The core fundamentals in the large projects segment remained very sound with continued solid execution on mature profitable projects, including the Houston Light Rail, Queensboro Tunnels and Selmon Expressway in Tampa providing a stable foundation. But the mix of project progression in the third quarter and throughout 2013, combined with a challenging project, outweighed our core results.

We are proud of last year's third-quarter large projects performance, which included positive forecast changes of nearly $36 million reflecting, at that time, a larger stable of mature profitable projects and solid execution. It also illustrates how project progression and the mix of projects in our portfolio can cause significant profit variability on a quarter-to-quarter basis.

Three more recently awarded large projects are progressing as planned. The Tappan Zee Bridge, the IH-35E in Texas, I-40/440 in North Carolina. These projects contributed revenue this quarter but were less than 10% complete and, therefore, not yet contributing profit.

Before we update you on these projects, let me first offer an operational and financial update. This quarter, and throughout 2013, we have dealt with the ongoing negative impact from a large highway project in the state of Washington.

We are about 80% complete with the project and we expect to complete it in mid-2014. We have a talented senior team in place that is committed to completing the project expeditiously and efficiently for the owner.

During the year, and including the third quarter, we incurred significant cost overruns related to unknown conditions at bid time, design issues, schedule delays, resequencing, as well as additional costs related to scope growth. In the last 12 months we have reported approximately $50 million in negative forecast changes related to this single project. We believe we have rights for a significant cost recovery on this project, which we are pursuing diligently.

All of these items are included in an ongoing claim we have in process with the project owner. Now, please remember we do not accrue for any estimated claim recovery. We only book revenue from a claim once it has been agreed to and executed by all parties.

Onto the progress of some of our key projects. On the Tappan Zee Bridge, as I mentioned earlier, the financing news is great and the project is accelerating. The mobilization of our marine fleet continues. Dredging for 2013 season was completed.

The initial test pilot program was completed and production piling began during the quarter. The project is on schedule and is on budget.

The IH-35E project in Texas, the owner exercised all of their options, which brings the job to over $1 billion of which our portion is more than $350 million. The startup phase of the project, including right-of-way acquisition, design, and utility relocation is progressing on schedule and field construction will begin this month.

Although it is still early, the $130 million I-40/440 project in North Carolina is also well into its start-up phase, including mobilization, design and some fieldwork. These projects represent more than $1 billion of our backlog and we currently expect all three to recognize profit in late 2014. Importantly, though, we are not simply focused on the business we already won.

The large projects business remains competitive while the near and midterm bidding pipeline remains very healthy. In the near term, through the third quarter of 2014, we expect to bid on more than $10 billion of large projects. More than half of the value of the work we are bidding in the next year represents potential Granite revenue, and beyond 2014 we are tracking an additional $20 billion in large projects.

As we have noted before, the success of many of our large projects starts with the project team. I am pleased to say that we have strong teaming partnerships already established for many of the projects in our pipeline.

Granite is dedicated to grow this segment of our business by winning our share of upcoming large project opportunities. And, as you can see, the large project market remains very robust.

While the bidding environment is currently healthy, long-term dedicated federal funding remains a concern. We have talked in detail previously about the two-year federal Highway Bill, MAP-21, which importantly increased TIFIA financing. This bill expires in September 2014 and will need strong attention from Congress in early 2014 to provide the long-term stability of a new highway bill.

Funding and financing stability ultimately remains critical to driving progress on important infrastructure investment at the federal, state and local levels. Total company backlog in the third quarter is at record levels at $2.75 billion. Large project backlog is also at record levels at $2 billion.

This quarter the composition of large projects backlog changed somewhat as we booked a milestone win by our power division in the quarter of more than $175 million. This win provides an early look at the powerful revenue synergies that our diversification strategy already is providing. We will continue to build and leverage these early successes within Kenny.

The vertically-integrated business, comprised of the construction segment and the construction materials segment, had mixed results in the quarter. I was very pleased to see nearly 200 basis points of construction segment gross margin year-over-year improvement in the third quarter.

We are seeing increasing signs of overall economic improvement in some of our markets but certainly not in all of our markets. Construction backlog at more than $700 million is up more than 30% year-over-year and it continues to trend positively, pointing to continued growth in 2014. The materials business did benefit from some pricing improvement in the quarter compared to the third quarter of 2012, but aggregate volumes remained weak in certain markets.

As noted in our press release, as well as in previous quarterly filings, we expect to finalize restructuring actions related to our 2010 better price improvement plan before the end of the year. Throughout 2013 we have focused our analytics on certain real estate assets as well as certain underperforming materials segment assets. Optimizing our business portfolio is a key tenant of Granite's strategic plan.

As previously mentioned, optimization may include divestiture, closure, impairment, or even partnering arrangements to enhance our return on assets as well as operating income in both the short and long-term. We will make final decisions on our restructuring efforts in the coming weeks and we will communicate the expected total financial impacts and the expected resulting benefits of these actions in the fourth quarter.

We cannot predict exactly when demand in both the public and private markets will recover materially to drive strong improvement in our vertically integrated business. However, some markets are showing improvement and backlog trends point to a stronger 2013, which is a nice change in this area of our business.

The private sector continues to build momentum coupled with state and local budgets showing increased revenues. Every market is unique but, overall, we are very encouraged.

The Kenny acquisition is performing as planned for 2013 and beginning to provide additional growth opportunities for 2014 and beyond. And the mix and timing of our large projects portfolio is pointing to improved revenues and profits, as well.

We are committed to drive growth at Granite by executing on our strategic plan. We are transforming growing the vertically-integrated business.

We are growing the large projects business. We are growing through diversification and we are optimizing our business portfolio. We continue to make progress on our plan and grow our business in order to drive results for our shareholders.

With that, I will turn the call over to Laurel. Laurel.

Thank you, Jim, and good morning everyone. Revenues in the third quarter were $742 million, up 1.8% from last year. Earnings per diluted share were $0.28 compared with $0.94 last year.

Gross profit margin for the quarter was 7.3% down from 13.9% last year driven by weaker-than-expected large project segment profitability. Total contract backlog at the end of the third quarter was $2.8 billion compared with $1.6 billion last year. As Jim mentioned, this includes the booking of our power division win worth more than $175 million; however, it does not include our city of Chicago Underground contract valued at more than $140 million, which are booked into backlog as tax orders are executed.

Looking at segment detail, construction segment revenues were $471 million compared with $386 million last year, and gross margin improved to 10.5% in the third quarter from 8.6% last year. Large project construction segment revenues were $188 million in the third quarter compared with $256 million last year. The segment posted a loss of $2.5 million in the third quarter compared with gross profit of $57.8 million last year.

As mentioned, the unfavorable year-over-year variance was driven by forecast changes and by strong 2012 comparisons related to project timing. Please note it's our policy to recognize additional costs when known, and future claims and change order revenue is recognized only when signed contract changes are executed.

On a longer-term basis, we continue to expect average gross margins in the mid-teens in the large project segment. Annual segment gross margin performance from 2010 through 2012 in large projects averaged more than 14%. We will continue to grow this business with a keen eye on risk and associated returns expectations.

Revenues for the construction materials segment decreased 4% to $83 million. Materials gross margin in the third quarter of 8.8% reflects a decline from 11.5% last year.

Third-quarter SG&A was $46.6 million compared with $41.3 million a year ago with the increase associated with Kenny. We remain focused on continued opportunities to reduce, or at least maintain, costs as we look ahead to 2014.

This year's operating cash flow performance is well below expectations and a definite part of my focus. Despite this, Granite continues to have a strong balance sheet as cash and marketable securities totaled nearly $300 million at quarter end including consolidated construction joint ventures.

Before I talk about our fourth-quarter expectations, let's spend just a couple of moments on our outlook and our guidance policies. Over the past six months, we've spoken with Granite shareholders, analysts and investors about guidance practices and metrics. We welcome continued input on the topic and the metrics you would like to see most.

Early feedback, both internal and external, has focused on consolidated revenue earnings-per-share and a number of non-GAAP metrics. We'll provide you with additional updates as we finalize our plans.

In terms of guidance for the fourth quarter, we currently expect between breakeven net income to a small loss before the impact of anticipated restructuring charges. Our guidance for 2013 is as follows.

Construction segment revenues are expected to total $1.2 billion to $1.3 billion with a corresponding gross profit margin of 8.5% to 9.5%. Large project construction segment revenues are expected to be in the range of $750 million to $800 million with a corresponding gross profit margin of 8.5% to 9.5%.

Construction materials revenues are expected to be $220 million to $230 million with a corresponding gross profit margin of 2% to 3%. Selling, general, and administrative expenses are expected to be $205 million to $210 million for the year.

2013 has, in many ways, been the transition year we anticipated with the Kenny acquisition, the ramp up of new large projects, and the continued slow road to recovery in our vertically-integrated regions. Unfortunately, we could not anticipate the additional impact from the large project in the Northwest.

Though it is still too early to offer details, Jim and I both fully expect 2014 to leverage the strides made in this year's transition and to provide a clear pathway to long-term profitable growth. Thank you. Now before we begin Q&A, I'll turn the call back to Jim.

Thank you, Laurel. I want to reiterate that although our quarter had a significant negative impact with a large project writedown, our backlog is strong, our strategic plan is on target, overall our markets are improving, and our diversification efforts are working very nicely.

With that, we look forward to a strong 2014. And now, let's open it up for your questions.

Thank you. (Operator Instructions) John Rogers, D.A. Davidson.

Couple of things. First of all, in terms of the revenue ramp that you've seen on the large project side of the business -- sequentially, we've seen the higher quarters and setting aside margins for a second -- based on your schedule, does that continue now for the next five or six quarters, Jim?

Okay, first of all, John, nice to hear from you. With the backlog, it really depends on the ramp up of the projects and the answer is, in general, yes.

All of the projects that I mentioned -- Tappan Zee, IH-35E, I-40/440 plus several others, San Clemente Dam, we just got a job in Florida this last week -- they're all starting to accelerate. And what happened during the second and third quarter was there was a slow start up.

Some of them got delayed. So, in general, John, the answer is yes, there should be a ramp up a revenue production on our large projects going forward.

Okay. And then my second question is just in terms of the restructuring that you're referring to here, and I know it's probably not complete yet, but are you looking at writing assets down?

Try that again John.

Sorry, are you looking at writing assets down to market, or I'm a little confused on what the restructuring would be because I already thought you'd taken your organizational changes.

Okay, so if you remember back in 2010, our enterprise improvement plan was the beginning of what we said was a three-year plan to look at our assets both in our real estate portfolio and in some other underperforming assets. The majority of what we've been working on over the last three years has been to divest of assets that we thought were underperforming in the real estate segment.

We still have some of those and the intent of the restructuring, which we've been communicating to our investors, is to focus on impairing some of those assets down to market if we believe market is lower than where we're at today and conclude that by the end of 2013. And that has been a three-year project that we've been working on and stating so in our filings.

In addition, we have underperforming assets in our material segment, that are mostly from the quarry side, that we are looking at writing down also because they have no future benefit to the Company. So it's a combination of those two, John, which has previously been discussed and this would be the tail end of our three-year plan. Laurel?

And John, I just wanted to add something on the real estate divestiture plans. In some of the cases we thought we were going to stay in some of these investments and develop them. And the biggest thing we're looking at now is we're to the end of the three years, it's taken a lot longer for the market to recover than we had anticipated or hoped, and so now we're looking at our plans and saying do we want to not develop them and instead accelerate the sales, which is what results in an impairment.

Okay. All right. That helps. I'll get back in queue, thanks.

Jerry Revich, Goldman Sachs.

Jim, can you talk about the competitive bid environment that you're seeing today? Obviously, a healthy dose of activity.

Are you seeing that translate into the industry being more disciplined on the types of bids that you are seeing from competitors? Also, can you provide some more context on what the broad areas of disagreement are on the Northwest project and whether, I guess, there's a systematic element of the disagreement there.

Sure. Let me focus on the market first and then I'll discuss, Jerry, the large project in the Northwest.

As we look at our markets we definitely look at large projects as an individual market and we look at the construction and materials market as a second market. Large projects I mentioned, Jerry, is very healthy.

The bid list continues just to be robust. And we are entering a phase, I think in the entire market, which we like, where they are shortlisting teams on projects before we bid them, which means that now there are three or four competitors, typically, on these large projects, which gives us a much better opportunity of winning these projects.

So large projects, the competition is very sophisticated, has high expectations of return per associated risk. And so I think that market, and I'm very comfortable that market will continue to perform very well, again, with quarter-to-quarter volatility based on the way that we account for a certain profitability thresholds and claim recovery.

The I business, or the construction segment, like I mentioned in my discussion points, Jerry, it is actually becoming better as well. We are starting to see increased margin opportunities, and we are starting to see shorter bid lists.

So that is really nice and that really stems from the private sector starting to see some signs of vitality along with, really nicely, seeing state and local budgets coming back. And those have really been hidden over the last three or four years or they've been really struggling on the revenue side and we are starting to see revenue pickup on the local and state levels, which is really making those programs stronger as well.

So I think that market's getting better. And that's really indicated by the gross margins you see in the third quarter up almost 2 points in the construction segment.

Okay, let me talk a little bit about the large projects in the Northwest because we have talked about it several times not only in our press release but in our discussions earlier. This is a large project that we've had ongoing now for about three years. We have a dispute with the owner, which is really a formal process of a claim.

We have filed a large claim on the job. We have been through a dispute review board process already. We have a good owner, an owner that we work with a lot in the Northwest, and we are following the contractual requirements of the contract, which requires us to file a claim if we have a dispute in what we expect to receive in terms of revenue.

That process will most likely take through the first quarter of next year and hopefully we will be seeing some settlement. Or if we do not get settlement certainly we go through additional processes as well. We think we have a very strong case. It has been a significant write-down over the last 12 months, as I mentioned.

A very strong portion of that write-down has been submitted in our claim recovery, and we are following the process with the owner. Again, it takes time, but due to our policies and procedures, we will not recognize any revenue on that until we actually settle with the owner.

Thank you for the context. Jim, as a follow-up, you mentioned that the large construction projects are now being run with three to four teams. Is that a recent development or does that reflect the fact that you just have much bigger jobs moving forward then you did maybe a year or two ago?

Well, I think it's actually becoming a requirement from most of the competitive bidding environments. The amount of monies that we spend upfront, Jerry, in the process is pretty significant and I think the industry has really worked nicely to tell the owners that if you're going to want some strong teams bidding your work that we're going to have less people shortlisted because of the size of the upfront monies.

And we have excellent partners that we've already teamed with on these jobs. We agree in advance to only look at jobs that we believe we have a strong chance of obtaining, which means we really enjoy the SOQ process, we call it statement of qualifications, where they shortlist the teams, which gives us the higher opportunities.

So I think it's heading that direction on the larger projects. And I think the industry, as well as the owners, have agreed that that's the right path for the projects.

Thank you.

(Operator Instructions) Nick Coppola, Thompson Research.

So with MAP-21 expiring in less than a year now, what are your thoughts on the next highway bill? And it might be a bit early, but what are you hearing in terms of early indication from DC and what do you think it could look like?

Well, I tell you, I've been back in DC and actually testified in front of the Senate EPW Committee, and there's a strong sense that there are certain things in the current bill that are working well and certain things that aren't. And let me just talk briefly about what's working well.

Transportation Infrastructure Finance and Innovation Act is working well, and I know the Senate side would love to really enhance that portion of the upcoming bill. We've increased it to a $1.75 billion leverage ratio over the next year, which creates upward of potentially $50 billion of additional work, and it's working. You saw that in the New York State Freeway Authority receiving the TIFIA loan just last week. So I think that's going to get enhanced as we go forward.

I do think there is a fundamental issue in the Highway Bill funding that is a problem and that is the Gas Tax Program. And there are people on the Hill today that are believing that a Gas Tax adjustment is appropriate.

It is not politically positive. It's not politically popular to increase the Gas Tax, but even indexing it would make a huge change.

So with that, the good and the bad, we're going to have a difficult time probably getting a robust bill done by September. If you listen to some the discussions on the Hill there's a chance for a continuation of the current bill with similar funding the way it is. And if that happened there might be an opportunity to increase the TIFIA size of the program.

And really, I think, it's going to depend on how much other activity is going on in Congress during the first half of the year to see if they can actually focus on the Highway Bill. It's been a secondary effort for the last couple of years and it is starting to gain momentum. Whether or not it will be completed before 2014 is questionable.

Right. That's helpful color.

Switching gears a bit, can you talk a little bit about Kenny's performance in the quarter and what kind of revenue synergies you are seeing? I heard you talking about that $175 million project. Any kind of qualitative color they are about what kind of revenues synergies you are seeing?

Yes, I think the Kenny business is working well. We've got the majority of integration and transition processes behind us.

We are seeing some of the synergies in, that's a power division win, that's a large materials management contract, that's in the US. We are also seeing some opportunities up above in Canada as well. We've got new projects going on there.

Also, the Kenny business is teaming up with our large projects team to bid some tunnel work, which is really nice to see. I would say the Kenny integration and transition has gone very well, and the power division win we mentioned was trying to just show that these were the kind of things that a larger company can bring to the table to help the Kenny team in growing their business, and it's working very nicely.

Okay. What kind of margins are they posting in the construction segment? And just thinking about the year-over-year improvement in construction margin, should we be thinking that Kenny is being one of the drivers there?

Well, it's part of it, but it's not a majority driver. They have strong margins in the construction segment as well as but a much smaller revenue size, so it doesn't have a huge impact on the overall granite margins.

I would say this in the construction segment that those 2 points increase in GPM in the third quarter is indicative of all parts of our business, so that's really a good sign. But the Kenny business, again, the construction segment is somewhere in the 10% to 15% range of the overall volume, so it doesn't have an overall effect on the GPM, but it is operating at a strong level.

Okay. That makes sense. Thanks for taking my questions.

Alex Rygiel, FBR Capital Markets.

Couple quick questions. First, Jim, could you talk a little bit about sort of the award opportunities out there in the marketplace right now, what you're bidding on and more importantly, focus on sort of what you think the award timeline could look like over the next three to six months?

Should we expect a number of large projects to be awarded by year end? Or should we be thinking more first half of 2014?

Large projects, again, is been over the past couple of years, Alex, a very solid player for us. But I would say one of the things I saw occur in 2013, which was a surprise in some respects, was projects being delayed and pushed out towards the tail end of 2013 in the early part of 2014.

So I would not expect a significant amount of awards in the fourth quarter, although we have several projects that we are bidding and we just actually were apparent low bidder on a nice job in Florida last week. So some of those jobs are going to hit, but I think you're going to see the big influx in the first and second quarter of 2015.

I'm showing on my list about $6 billion bidding between just now and the end of the first quarter. So it's a huge amount of work to get those projects in place. But what happens is that a lot of times the owner takes their time to review the bids and come back with an award that could take a month or two or even longer after the submittal.

So my suggestion, Alex, is first quarter we should hear some hopefully some nice awards; second quarter even stronger. Fourth quarter, this year, is probably questionable.

That's helpful. Also, as it relates to the four or five large projects that you're working on right now, will any of them hit the profit thresholds in 2Q of 2014?

No. I think the ones that I mentioned, the Tappan Zee, the IH-35E, the I-40/440, and even there's a dam project that we're building in California, all of them are looking in the later part of the year of next year.

That's very helpful. Thank you very much.

And that's, again, based on our 25% threshold.

Sure. Thank you very much.

John Rogers, D.A. Davidson.

I just wanted to follow up. First of all, on the Highway 520 project, the one in Washington state, the original claims on that, didn't you have some claims back a year or so ago and have those been settled?

Yes, there are some minor ones, John, that we worked at that were like, were not the major redesign issues. They were just individual components of the projects that, yes, they've been ongoing, and some of the smaller ones have been settled.

Okay. In terms of what's in your backlog now, Jim, on the large projects side, how much of that backlog are you the lead on the project versus minority partner? (multiple speakers)

I'd have to see that calculation. I can't tell you off the top of my head, John. I'd certainly be able to work on that and let you know.

It varies as project by project, but we can certainly they tell you. I don't have that off the top of my head.

Okay. I'd appreciate it. And then one other if I just could. On the power line project that Kenny was awarded, the $175 million, are you self performing that entire project?

No. The Kenny power division does a lot of what I will call materials management logistics and construction management, so they'll be doing a really majority of the work is going to be doing managing the job itself.

Okay. That helps. So the margin opportunities on that, are they comparable to, are they less than your regular construction business?

Well, I think the way that I would put it, John, is that some of those projects have lower margins. Others of our projects have margins that are well in excess of mid-teens. So as we continue to mold some of the power division wins in with the other large projects, we're still looking at mid-teens across the board. So I would not like to talk about individual margins on individual projects.

Okay. Fair enough. Thanks, Jim, appreciate it.

Thank you. And this ends our Q&A session for today. I would like to hand the conference back over to our host for any closing remarks.

Well, thank you everybody for your questions. I want to close by thanking our employees across the country. They are the primary reason we have been successful in the past and they continue to be the key to our future.

We look forward to seeing some of you next Wednesday in Boston at the Goldman Sachs Industrials Conference and on Thursday in New York. And Laurel, Ron and I, of course, are always available for follow-up if you have any further questions. Thank you everyone.

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