Granite Construction Inc (GVA) 2018 Q3 法說會逐字稿

Good morning. My name is Phil, 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 2018 Conference Call. This call is being recorded. (Operator Instructions)

It is now my pleasure to turn the floor over to your host, Granite Construction Vice President of Investor Relations and Government Affairs, Ron Botoff.

Good morning. Welcome to the Granite Construction Incorporated Third Quarter 2018 Earnings Conference Call. I am pleased to be here today with President and Chief Executive Officer, Jim Roberts; and Senior Vice President and Chief Financial Officer, Jigisha Desai.

We begin today with an overview of the company's safe harbor language. Some of the discussion today may include forward-looking statements. These forward-looking statements are estimates reflecting the best judgment of senior management and reflect our current expectations regarding future events, occurrences, circumstances, activities, performance, outcomes and results.

Actual results could differ materially from the 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.

On October 9, the company filed an 8-K, which provides a quarterly and annual look back and mapping of our new reportable end-market focused segments. Our third quarter results reflect this new reporting structure.

Certain non-GAAP measures may be discussed during today's call and from time to time by the company's executives. These include, but are not limited to, adjusted EBITDA, adjusted EBITDA margin, adjusted net income, adjusted earnings per share and backlog. Please note that, as applicable, these metrics exclude nonrecurring acquisition-related expenses and onetime integration costs associated with the acquisition and integration of Layne Christensen Company and LiquiForce.

Reconciliations of certain non-GAAP measures are included as part of our earnings press releases as well as in company presentations, all of which are available on our Investor Relations website, investor.graniteconstruction.com. Thank you.

Now I would like to turn the call over to Granite Construction Incorporated's President and Chief Executive Officer, Jim Roberts.

Well, good morning, everyone. Thank you for joining us to discuss Granite's performance. The third quarter of 2018 marks something of a starting point for Granite.

About 2 weeks ago, we introduced end-market focused reportable segments. This follows the deliberate strategic effort we have made to diversify and to grow both organically and via acquisition-led growth over the last 5-plus years.

Our actions emphasize broadened geographic reach, new capabilities and activities that consistently enhance returns, growing opportunities for Granite's key stakeholders, from our shareholders and employees to our customers and our partners.

Granite employees have remained focused this year as we integrate new teams and as we expand the Granite brand as America's infrastructure company. We thank Granite employees for their dedication to our core values and, especially, to safety. This year's safety performance has been steady-to-improved across our business, but our focus remains on 0 injuries, ensuring everyone gets home safely every single day.

In fact, safety is one of the key initial focus areas we have reinforced with the newest members of the Granite team. On top of the obvious people benefits, working safety translates consistently into higher quality work and improved financial performance. The emphasis on improved safety highlights the focus on our people, and it aligns with our integration approach to equipment systems and process improvement.

We thought it was important to begin by highlighting some examples of our strategy in action, both in our current results and in our strategic outlook. Jigisha will provide additional detail and color on the quarter.

Performance in the third quarter and really throughout 2018 has been outstanding. Revenue, profitability and earning, all are solidly higher this year, and we expect these trends to continue for some time. Revenue increased double-digits for the quarter and for the year, even as our focus has remained on improved profitability in 2018.

From a margin perspective, acquired businesses have delivered performance in line with our expectations, as our focus on improved bidding discipline is creating solid bottom line performance. This year's work on pricing illustrates the broad leverage our business can exert to create bottom line results. Granite teams are market leaders. Recently, Engineering News-Record ranked Granite as the #1 highway contractor in America. In Water, we ranked #2 in sanitary and storm sewers; and #5 in sewage and solid waste. In mining, we ranked at #5 according to ENR, and we finished at eighth nationally in power transmission and distribution. These markets will continue to fuel our future growth and profitability.

Across these diversified end markets, our focus remains on reinforcing the value of sustained pricing discipline to deliver consistent, balanced, risk-adjusted returns. Despite healthy and growing demand in our Transportation, Water and Specialty segments, much of the work we are pursuing continues to be priced below what we believe are appropriate levels. This has impacted project win rates in 2018, most notably, for transportation projects. We are confident that our deliberate bottom line focus is sound, practical and strategic. With solid demand trends across our business, we expect our approach will create significant top and bottom line value over the next few quarters and years, especially considering healthy near and long-term public and private market demand.

Through 3 quarters this year, increased discipline has contributed to consolidated gross profit margin of 11.6%, up 180 basis points from last year. Excluding acquisition-related expenses, adjusted net income more than doubled from 2017 and adjusted EBITDA margin increased more than 200 basis points to 7.1% at the end of Q3. The business is performing well, and we continue to set the bar higher across geographies and end markets.

Now let's shift back to Granite strategy. Specifically, I want to spend a few minutes this morning discussing how these segment changes capture the well-communicated execution of our rolling 5-year strategic plan. As our industry entered its steep recession in 2009 and 2010, we recognized that Granite's public transportation and public funding reliance were limiting factors for consistent reliable growth.

In the midst of weakening public transportation and infrastructure funding trends that did not bottom until 2013, unmanageable and unprecedented political risk also took hold, impacting our industry from Washington D.C. and from the state Houses across the country.

Infrastructure, previously a nonpartisan point of general agreement, recently has been tossed around in a new game of political football. Through this period, we defined and set the path to extend Granite's reach and to broaden opportunities for long-term growth and more consistent returns. We focused on internal resource and asset optimization, and we invested in Lean Six Sigma techniques that we refer to as continuous improvement.

Perhaps most importantly, we refined opportunities by focusing on 3 key areas, including diversifying the sources and drivers of our project funding, diversifying our customer base with private market focus and emphasizing new, but related end-market growth opportunities. New and aligned capabilities will require to meaningfully enter new end markets and geographies. The Kenny Construction addition at the end of 2012, now our Midwest operating group, was our first target for end market and geographic diversification. That move drove growth via the additions of tunnel, power, water and wastewater markets as well as new geographic markets for our Civil Construction business.

Importantly, it introduced Granite to diversification, delivering incremental growth and improved profitability at a time when our 9 decades old business remained mired in a pernicious trough. Diversification, a defined strategic driver, took hold as a key focus area across our business and it created results, emphasizing relationship and customer management teams engaged and took action to develop new end-market focused business plans. Within just 2 years across the Granite portfolio, work in new end markets with new customers began contributing significantly to backlog, revenue and profitability. We recognized then that our teams were capable of leveraging existing resources, expanding capabilities and delivering growth in a low-demand transportation market with profitability above traditional transportation profit margins. Effort toward acquisition-led expansion began to accelerate again in 2015 when we targeted Granite growth in waterpower and rail markets.

Our prudence and patience was rewarded, and we capitalized on opportunities to execute the acquisitions of Layne Christensen and LiquiForce, allowing us to deliver on the next leg of our growth and diversification strategy.

We continue to review opportunities for eastward geographic expansion of Granite's vertically integrated model. Simultaneously, we continued to target end-market expansion, whether through bolt-on opportunities or through more significant investments in our existing end markets. Granite's end-market based segments illustrate our strategy in action, highlighting significant opportunities for our growth. We believe this new presentation provides investors with an improved view into Granite with deeper visibility and insight than ever before. We also believe that our diversified end-market focus is the most appropriate way to balance growth and risk opportunities for our business.

Our growth outlook is based on today's steady private market demand across end markets along with stable and improving infrastructure funding demand trends from the public sector. Granite's key transportation and water infrastructure markets continue to improve steadily. As a result, today's healthy balance of long-term public and private demand remains the best we have seen in well over a decade. Granite is extremely well positioned to continue to flourish and to grow, delivering on our vision as America's infrastructure company.

And with that, I hand it over to Jigisha with detail on our results and our 2018 outlook. Jigisha?

Thank you, Jim, and good morning, everyone. Third quarter 2018 revenue was $1.06 billion, up 10.3% from last year with the year-to-date revenue higher by 10.9% at $2.43 billion.

Excluding the impact of acquisition-related expenses, third quarter and year-to-date 2018 adjusted net income increased nearly 47% and more than 118%, respectively, from 2017. This translated into adjusted earnings per share of $1.42 in the quarter and $1.85 on a year-to-date basis.

As was the case last quarter, adjusted EBITDA improved significantly in the third quarter, up 30.9% from 2017. On a year-to-date basis, adjusted EBITDA increased 62.5% year-over-year to $172.9 million. This figure already exceeds our full year 2017 performance and at 7.1% year-to-date, it translates into 220 basis points of EBITDA margin improvement.

Third quarter gross profit increased 26.2% year-over-year, and year-to-date gross profit increased 31.2% to $281.1 million. The year-to-date consolidated gross profit margin of 11.6% was a 100 basis point improvement from 2017.

Our scalable cost structure continues to produce results. While third quarter and year-to-date 2018 SG&A increased year-over-year, the increase was driven by acquisition-related costs, primarily acquired G&A. Excluding the impact of acquisition-related costs and overhead, our core G&A expenses declined slightly year-over-year through Q3.

As Jim noted, we began the Layne and LiquiForce integration with an emphasis on safety. Our teams are working to deliver on cost synergies and growth opportunities, while they continue to improve safety performance. Safety will remain a key focus as we work to capture and to create cost and growth synergies to drive overhead costs steadily lower over the next couple of years.

Granite's balance sheet remains strong with more than $300 million in cash and marketable securities at the end of Q3. We continue to target improved working capital trends and cash flow expectations, which are expected to further strengthen our capital structure supporting the execution of our strategic plan.

Total contract backlog was $3.24 billion, down 23.5% year-over-year. Earlier in 2018, we received notification of certain project wins that are not yet included in our backlog. These 3 projects in California, Utah and Florida total more than $825 million and are expected to enter our backlog in late 2018 and 2019.

Next, let's move to our new segments. Extending our reach to deliver end market and geographic diversification in the growing water, wastewater and mining infrastructure markets, acquisitions have led to our new segment reporting. In June, following the close of the Layne transaction, we announced the formation of the Water and Mineral Services operating group, and we announced our new reportable segments.

Granite's functional businesses continue to be managed in operating groups with our end-market based segments well aligned with the execution of our rolling 5-year strategic plan. Our M&A activity in 2018 has enabled Granite to focus and align our strategic outlook with our end-market focus on growth, profitability and risk-weighted returns. The former Kenny Underground and the LiquiForce businesses joined the Layne and Liner business to become Granite Inliner in the third quarter of 2018. This newly combined team is the largest part of the Water and Mineral Services group, which also includes our water resources and mining services division.

Shifting to segment results, we begin today in the Transportation segment. Granite is a national leader in the transportation, and these markets are stable and improving, fueled by strengthening long-term public funding trends and by private, commercial and industrial demand that remains healthy. This segment's portfolio now includes larger transportation projects that are primarily managed by our Heavy Civil operating group.

In the third quarter, Transportation segment revenue decreased 2.2% year-over-year to $610.8 million. On a year-to-date basis, segment revenue has increased 3.5% from 2017 to $1.47 billion. Quarterly gross profit increased 8.3% year-over-year with gross profit margin of 11.6%, up more than 100 basis points from last year.

Year-to-date, gross profit increased 15.4% with a resulting gross profit margin of 9.4%, up about 100 basis points from 2017.

Year-over-year profit performance continues to support our efforts to raise prices in a healthy environment for most of our geographic markets. It also reflects the impact of ongoing work on several underperforming mature projects, which, again, had a negative impact on quarterly results as we anticipated.

For context, as previously constituted, the former Larger Project Construction segment contributed a 4.3% gross profit margin performance in the third quarter, which translated into a year-to-date gross margin of 4.1%. As expected throughout the year, we continue to benefit from the positive contribution of the more recent project wins in our portfolio. We continue to expect that large legacy projects that have been a drag on results for quite some time should have a declining negative impact on segment results in 2019.

Transportation segment backlog decreased 30% year-over-year to $2.31 billion. We continue to increase our gross profit margin, operating income and cash flow expectations on all new work. Market opportunity remained robust as we patiently reshape our project portfolio, pursuing disciplined strategies that balance and limit project risk dynamics, reflected in our improved third quarter and year-to-date Transportation segment results.

We're developing the Water segment into an efficient, disciplined and growing presence in the attractive water and wastewater markets. We're particularly excited that this new significant portion of our business has delivered solid performance since entering the Granite portfolio. Here, revenue rose significantly due to the impact of acquisitions, both on a quarterly and on a year-to-date basis. But more importantly, profit and margin performance was a solid contributor to results.

Quarterly gross profit increased to $24.1 million from only $1.8 million last year with gross profit margin of 19.4%, up more than 1,400 basis points from last year.

Year-to-date gross profit increased to $41.1 million from $9.8 million last year with gross profit margin of 19%, up nearly 1,000 basis points from 2017. Year-over-year profit improvement is tied to solid execution on projects in the robust markets we target in the Water segment. Water segment backlog increased significantly year-over-year to $364.8 million with recent acquisitions providing most of the uplift. The segment's bidding environment remains healthy, mirroring steady to improving federal, state and local funding of municipal and investor-owned utilities.

The Specialty segment is comprised of diverse and highly variable projects and businesses, including tunnel, power, renewable energy and site development in addition to logistics, materials management and a broadening portfolio of mining activities and capabilities.

In the third quarter, Specialty segment revenue decreased 3.6% year-over-year to $190.8 million. On a year-to-date basis, segment revenue increased 2% to $461.1 million. Quarterly gross profit increased 1.1% year-over-year with gross profit margin up about 70 basis points to 14.7%.

Year-to-date gross profit increased 15.1% year-over-year with gross profit margin up about 170 basis points to 14.2%. This profit improvement was attributable primarily to solid execution and consistent bidding discipline, which is producing improved margins on new work. Specialty segment backlog decreased 27.6% year-over-year to $564.7 million based on steady project burn rate. The bidding environment in Granite's Specialty segment also remains healthy, supported by steady public and private market demand. The environment is expected to allow teams to continue to build backlog in order to grow this segment in 2019.

Project diversity will balance Specialty segment returns, and it will produce exciting opportunities for growth tied to future project wins across industries, geographies and across Granite's operating groups.

Over the past 3 to 5 years, our Materials segment has emphasized efficiency and relationship building to optimize asset utilization in steady and growing demand environments. In the third quarter, Materials segment revenue increased 32.1% year-over-year to $129.6 million and year-to-date revenue increased 30.4% to $276.3 million.

Quarterly gross profit improved 9.9% year-over-year to $21.3 million from the prior year period with gross profit margin of 16.4%. Year-to-date gross profit increased 30.6% year-over-year to $36.3 million from last year with gross profit margins steady at 13.1%.

The quarterly and year-to-date revenue and the profit performance was attributable primarily to improved external demand across most markets, while maintaining an expectation of overall mid-teen gross margins in this segment. We continue to emphasize operational discipline and growth strategies in both our traditional construction materials business as well as in the vertically integrated line of products business that we acquired. Over time, increased demand and volume in the Materials segment will contribute to consistent improving margin performance and steady cash generation.

With that, let's discuss our outlook and some additional metrics that are -- guide our view. Noting that we have taken on higher acquired overhead that will rationalize over the next couple of years, we expect SG&A as a percentage of revenue to finish slightly higher than last year's 7.5% level.

Our effective tax rate in the quarter was 12.8%, driven by $7.6 million benefit, a discrete item related to revaluation of deferred tax assets and liabilities. In 2018, we expect our effective tax rate to finish in the high-teens to low-20s percentage range. Longer term, we expect Granite's tax rate on a go-forward basis to settle around the mid-20s percentage level. Our full year expectation for 2018, including acquisitions are mid-teens revenue growth, which as always is subject to last year -- late-year seasonality and adjusted EBITDA margin of 7.5% to 8.5%.

Now before we take your questions, let me turn the call back to Jim.

Thank you, Jigisha. Growth is here for our business across the end markets and geographies that we serve. We have planned for it, and we have broadened the reach of our portfolio. Optimism is growing as the long-awaited federal infrastructure action in Washington appears finally to be on the horizon. We hope that the recently passed Water Resources Development Act of 2018 is an example of the improved emphasis on infrastructure investment ahead.

The new water resource bill authorizes $3.7 billion for new Army Corps of Engineers civil works projects and $4.4 billion for the Environmental Protection Agency drinking water program. While extension of previous legislation, this reauthorization marks a step up in funding from previous bills.

Of course, through November 6, the key focus remains on the upper -- to defeat Proposition 6 right here in California. To all in California, we strongly recommend you vote no. We remain optimistic that this shortsighted, purely political, anti-transportation measure will be defeated. We believe the tide has changed where citizens committed to vote for investment in their communities in ever larger numbers. Proposition 6 is one of more than 300 state and local transportation funding measures on voter's ballots on November 6.

Today, Granite is extremely well positioned to feed our strengths, sharpen our capabilities and grow in all parts of our business. Our Transportation segment, the largest both by revenue and profit today, will continue to be a source of significant growth and opportunity for Granite's teams across the country. Chronic underinvestment and stepped-up spending trends fuel our growth expectation in water infrastructure, whether for wastewater, dams, inland waterways, levees or drinking water systems. Our strategy was developed to capture the benefit of improving secular demand trends across transportation, water and other infrastructure markets.

Across the infrastructure solutions, the roads and the pipes and the wires our grandparents and parents built continue to carry the weight of decades of underinvestment, and they continue to crumble at scale. Our businesses are positioned to create significant long-term benefits from investment to reduce chronic pent-up demand. Even in established mature markets, we continue to emphasize discipline, we're still very early cycle growth and investment opportunities. This effort is expected to fuel improved financial performance and a strengthening balance sheet to deliver on our growth plan through diversification and geographic expansion, providing significant incremental economic value for Granite stakeholders.

And with that, everyone, we will be happy to take your questions.

(Operator Instructions) Our first question comes from Jerry Revich with Goldman Sachs.

I'm wondering if you could talk about what level of decline you saw in your win rates as a result of the change in the pricing focus. In other words, is the overall bid environment -- or is the overall opportunity set intact? Or are you seeing the cadence of opportunities slowing?

Okay, well, that's really important, Jerry. Because, as mentioned, as we continue to raise our prices, our win rates do tend in the short run to drop slightly. And I say that, we've been normally in the 25% to 30% hit rate. And I would suggest today, we're down probably in the 20% hit rate. So yes, there is a slight reduction there. But I do think that, as you can see what it's doing, it's allowing us to create a more healthy bottom line, which what we believe is by far the more important dynamic of our business. There is no slowdown in the overall market. The market is healthy. We're bidding more work today in our Transportation segment than we have bid in recent times, probably in the last 10 years. So it's not an issue relative to the market. It's our opportunity to really focus on higher margins on bid day and then that will equalize itself as we believe the continued solid market will continue through the next several years and we believe that we'll be able to go back and capture higher win rates over time.

Okay. And then, in terms of the prior segment reporting, obviously, we've had a change here, but can you talk about what Large Construction margins would have looked like under the prior segment reporting, just so we can make an assessment of your progress on the remaining projects that you're working to roll off the book?

Okay, Jerry. So I believe that Jigisha addressed that briefly in her comments, that in Q3, Large Projects under the old segment reporting would have had a margin of about 4.3%, and -- which brings the year-to-date margin in the Large Projects at about -- to about 4.1%. So as we mentioned, that, that now rolls into the Transportation segment, but we did tell the investor base that we certainly would relay that information in this call.

The next question comes from Michael Dudas with Vertical Research Partners.

Jim, following up on Transportation segment and dynamic with regard to your discipline on bidding and backlog, characterize some of the revenue growth we've seen this year? And looking forward, how quickly is some of the excess capacity going to get mopped up relative to the demand trends in your important markets? And how we should think about as we're going into '19 that we should anticipate better margins when the revenue growth will be commensurate with the overall macro trends that we're seeing, especially throughout the West?

Sure. I think though that maybe the way to look at it is that, as the markets continue to gain momentum, a reminder that and certainly we'll -- probably somebody will ask a question about SB 1 today, as SB 1 has started to gain traction in California, it was slower than anticipated. So the back half of 2018 has seen some additional bidding opportunities. And I think what needs to happen to match our revenue growth with the bidding opportunities out there in the environment is going to be a kind of a projection that, that market is going to stay steady in the long run. So people get nervous as do investors and as do contractors that this is a short-term issue relative to the demand. We believe, and based on what we've seen in most of our markets, this is not a short-term issue. So as soon as the construction contractor base understands that, I think you'll see markets, the pricing start moving up and our hit rate will probably start moving up by the middle of next year.

And the follow-up may be further on SB 1 or Prop 6. Maybe elaborate on some of the optimism or some of the concrete, I guess, it's not -- no pun intended there, issues regarding the advertisements and the focus from both sides on getting the message out and it was leading to the increased confidence that investor -- the voters will repeat -- not choose to repeal SB 1?

Sure. Well, Proposition 6, as most of our investor base understands, if there was a yes vote, it would repeal the SB 1 additional investments that were put into place of April 2017. But what we see today in the surveys we've done that although it will be close, in almost every credible survey that we're seen, it is being defeated. Some have a wider spread than others. So based on the direction, based on where we see it going, with the feedback we've got, we've still got 1.5 weeks here to get this thing to conclusion, we believe it will be defeated, although I will tell you, Mike, as we all know that surveys are one thing and reality when people go to vote are maybe possibly a different thing. So we will be keeping our pedal to the metal all the way until November 6.

And there has been support from the Governor and other officials to get this thing to vote no?

Absolutely. The Governor has -- is a very strong proponent of SB 1. In fact, he was probably the one individual who put it into play with a legislature in '17, and he is out campaigning heavily to defeat Proposition 6.

The next question comes from Kathryn Thompson with Thompson Research Group.

This is Steven Ramsey on for Kathryn. Can you maybe talk about the nuances of staying disciplined in bidding in the water market versus some of your more traditional larger businesses that you play in? And kind of thinking about how you guys plan to run the Water unit, if there are differences in how Layne approached the market?

Well, that's -- Steve, so part of what we're doing today is integrating the business into the Granite system. And I mentioned it a little bit previously, but probably the biggest dynamic and the biggest change in the way that Layne did around the Water business versus Granite is that what we try to do is let them operate strictly as operating units and not worry about any corporate issues. Example, all the insurance and the bonding, all of the banking and the cash metrics and everything are all done away from the operating unit, so they can focus strictly on the bidding and building of their work. Now there is no doubt that as Granite moves in and has a larger oversight of the water business that we do have reasonable expectations in terms of margins. But I would suggest to you that in the water market, as you've seen in the results in the third quarter, their margins are pretty healthy right now and they have been. The issue that was -- that needs to be dealt with is basically the SG&A attached to that business, more so than the operational function of bidding and building. So what we're really focusing on are the synergies, as we talked during the acquisition time frame that we're talking about synergistically creating a more efficient overhead to help build their business. And we're seeing that today in the changing of the corporate structure with the Layne acquisition, where a lot of those folks already are no longer in place because the Granite folks are already here to handle those corporate functions. But operationally, we are using the same systems for bidding. We are bringing the bidding systems in alignment with Granite today so that if you bid a job in the Inliner and we bid a job, let's say, up in the state of Washington or Utah or in Florida, they're all using the same system today. So we will continue to do that. But overall, the water business, the operating basis for it is very strong, the margins are strong. The key now is to integrate the 2 structural components together and reduce the overall size of the overhead.

I was going to also add that with the combination of Kenny Underground and LiquiForce, now we are a very meaningful player in the water market and that is going to be able to capitalize on some of the services, cross-selling services that wasn't available previously to Layne, and now we have ability to do that.

And maybe the other thing I'll add here, Steve, for you is that as we saw the Layne business when we were looking into the diligence on it, it had been undercapitalized for quite some time. And so what we have been through is a cycle now. Since the acquisition in June, our CapEx cycle runs during the late summer months and they will be receiving additional monies to help stabilize and create a stronger asset base in their business, which we believe will create immediate value for them. So they've just been undercapitalized in not only repairs, but in acquisitions of new equipment to really optimize their business. And we're going to -- as we mentioned, from day 1, we are in the middle of making sure they get what they need.

Excellent. And then this may be kind of more of a stepping back or elementary question, thinking about the Materials segment. But could you remind us of your pricing strategy in internal versus external sales channels? And is there anything on the pricing front that you would call out that -- would you raise prices enough that maybe the capacity doesn't get used up as much, but you still get solid revenue because of your pricing?

Okay. Steve, so a couple of things. And I think it's really good, I'm glad you brought up Materials. A lot of time, as one of the smaller segments, it doesn't get really the discussion that it deserves. I've always said that as our Materials segment maneuvers, it is the guiding light of what's going on in the marketplace. And as you can see, with significant revenue increase, the Materials business is starting to really show that the demand is increasing in the marketplace. We price inside versus outside very similarly. Unless there is a specific job that may create, I'll call it a real value to the company, we might change the internal pricing, but on a day-to-day basing, the pricing of internal versus external is very, very similar. And as a reminder, that we have a huge fixed asset base of equipment and land reserves attached to that Materials business. And what we've said is that as we create incremental value and incremental demand, there was a very large, and we suggested it's somewhere in the 40%, incremental additional margin as we increase the overall amount of material coming through our products. So volume alone will help the bottom line. And simultaneously, we have raised prices, and we are continuing to raise prices. So the combination of all of those will create a substantially healthier market as we go into 2019 and beyond. And I always go back and make it clear to people that back in '05 -- '04, '05 and '06, when you look at our Materials business, our margins were substantially higher than they are today, were at about 13% for the year, which in itself is substantially higher than it was a few years back, it was as low as 3% during the downturn. So we've gone from 3% to 13%. I believe it needs to get up into the high-teens, low 20s in order to be really the business we're looking at.

The next question comes from Brent Thielman with D.A. Davidson.

Jim, on the Transportation backlog, appreciate the comments about the wins not included, 3 for $825 million. Last quarter, you talked about 4 jobs for $875 million you are waiting to book. So...

Right.

Did you book 1 or 2 of those since last quarter's call and you had some new one -- wins pending award since then?

Well, the answer is yes and no. We did book the $50 million into the Transportation segment in the quarter, and the other 3 are still hanging out there, which we expect to be booked in late 2018 and '19 as planned. Nothing's changed from our discussion last quarter.

Okay. I mean, I guess, if that's the case, Jim, and this is -- if you booked fairly sizable $50 million job in the backlog, I mean, that would still suggest the small project or other project work in Transportation bookings were really low this quarter. I'm just trying to understand why the market is as strong as it is?

Well, I think that maybe another way to look at it is this, that remember we set our hit rates down a little bit from what it was in previous years. We're burning a lot of it faster too. So what you're going to see, I think, and I try to relay this to everybody about 2 quarters ago, you guys started seeing more of the smaller work and you're going to start seeing that, that revenue will pick up and it will not be indicative of an [equivalent] amount of backlog buildup. And because you're going to bid, you're going to burn it in the same quarter. And so with margins coming up, which they are, we anticipated the revenue we're at today, we anticipated the backlog in most respects where we're at today. I think, Brent, what will happen is that you're going to see a steady increase in our revenue and our backlog in Transportation as the strength of the market continues to put into play. So I don't think there is anything going on today in the Transportation segment that is a surprise to us, and I think that it is just more of a steady demand and allowing the market to absorb our higher margins, in which we will begin to get a higher percentage of the win rate. And it's -- as I tell the Granite people, it is patience. This is a very good market. And to capitalize on it, we need to be patient. And if you look at the margins that we're getting out of the business today, they're as healthy as we've seen in many, many years. So we're going -- we're focusing on bottom line right now, for the next several quarters we will as well, and then I believe we're going to see the big revenue uptick.

Okay. And -- sorry, if I could, real quick on CapEx. I mean, it's a big step up this quarter. I understand what you said about Layne and some investments there. Where should we be thinking about the sort of recurring CapEx for the business going forward?

Yes, so historically, we've been in the mid-2% of revenue range. And I'm going to say that with where we are today, we're probably going to be in the 3% plus or minus range on revenue. So if somebody was the model that, I think you'd be very safe.

(Operator Instructions) The next question comes from Sameer Rathod with Macquarie.

Just going back to backlog. So I guess, I understand the strategy. I think that makes a lot of sense. But when do you expect the backlog to bottom then?

Well, okay. So I think it will depend, Sameer. It's going to depend on when we actually received the awards on those $825 million of outstanding. So that -- and that's where it's really important that we're transparent and we talk about what is in the backlog. Is it large project backlog, is it in the older discussion points, construction, transportation or water. So most of our backlog today, outside of the larger work, that $825 million, is smaller day-to-day work. I think that has pretty much, and I'm going to say, bottomed out, but it will probably stay very steady for the next couple of quarters. You're going to see an increase in the actual backlog because we will layer in this $800 million. But from that point forward, I think it's going to be a steady demand increase going forward. So if you want to say, has it bottomed out, it could have bottomed out where it is today, but I say that with making sure that our investor base focuses on large project, the moment you put one into play, you're going to get that blip. And we will make sure that everybody understands that when we put 1 or 2 big ones in there, that there's a couple of big ones in there, because I think the more important backlog, not to take away from the large work, is the size and the amount of all of the work going on in the smaller transportation and water segments across the country. So backlog, I think, is kind of where you -- I don't think it's going to get any lower unless there is delays in awards because the market is pretty healthy right now in the bidding environment, Sameer.

The next question comes from Alex Rygiel with B. Riley FBR.

This is actually Min Cho for Alex. Quick question about Prop 6. So if it passes, can you talk about how it really impacts your business? I mean, it sounds like you have so many other opportunities outside of SB 1. Could you maybe change your pricing strategy in California? Or just any updates there would be helpful.

You bet, Min, and all of the above. You are right. Strategically, we have diversified the company significantly over the last couple of years for exactly this reason, not because of this issue, but for this reason, is that so that one event doesn't have an overly sizable impact on the company. So we would need to probably adjust our pricing in California, if SB 1 was defeated or Prop 6 got passed. But California in itself is a healthy market. And I think people may be missing the fact that a lot of the local environments are very healthy. The state is still healthy with a very -- with a balanced budget. We also look into the private sector. The private sector is very strong in California. So a big chunk of our work in California is coming from the private sector. We would most likely need to go ahead and have a little adjustment in our margins, but I don't think it's going to be a huge impact. There would be no impact in 2018. And we're trying to figure out what it would be in 2019. But I don't think it's that big of an issue in 2019 because I think that a lot of the contractors in the state already today have been quite aggressive in building their backlog because they're not sure what's going to happen to Prop 6. So they already have a lot of work on their books, but I think that you're exactly correct. It is such a healthy market in California that it will have a slight impact, but it's not going to be substantial.

Yes. In fact, we will be meeting with our leadership team in a couple of weeks to review our 2019 budget, and our California group will be coming with, kind of, before and after on with the SB 1 implications. So we will know more, obviously.

And Min, as a reminder, we firmly believe that Proposition 6 will be defeated. And with that said, it would be foolish not to figure out what the opportunities that would be coming our way if it did pass. But we -- based on where we are today, it's full steam ahead with the anticipation that Prop 6 will be defeated.

I hope that is the case. On the Materials business, I know it's kind of a new Materials group. But what percentage of that is the Layne Liner Product right now? And I guess, what I'm trying to get to is kind of what your organic revenue growth is in the quarter? It seems like it was probably pretty flattish on a year-over-year basis?

So I would put Liner Products at about 10% of the Granite Materials business.

Okay. So you did see an increase in the Construction -- the old Construction Materials business in the quarter?

Well, absolutely. Yes, and I would suggest also, Min, that the Materials business is, as I have always mentioned, it's healthy, and it is a leading indicator of what's to come as well.

The next question comes from Joe Giordano with Cowen.

So I guess, we've kind of been talking about this throughout the call here. But Jim, what I think is critical is understanding how your business is operating today relative to, like, what changes on November 7 one way or another. Like, if SB 1 is repealed, what kind of change are we talking about, like order patterns? And if it remains, do we see this influx? I think that's like where people are struggling a little bit to just gauge what your current order -- like, what your current operating environment is like relative to the continued reality or not reality of SB 1?

Okay. So to kind of maybe put it into a little more granular. Nothing is going to change in 2018. The way we see the events of election day are that it will slow down work that would have been put out in 2019. We know that. The work that has been put out and kind of a misnomer is that it will still be put out if it has been funded, which the majority of it has been funded. And it won't change the way we do business in California. It may make a slight adjustment in the margins as they go forward. But as you can tell from where we are today in California, without picking up a lot of work, our business is very healthy. And it's because of the different types of work that we're doing in California, not just DoT transportation type work. So we're really kind of saying to ourselves that it's business as usual. It will be an emotional letdown if Proposition 6 was to pass. It will not have an immediate effect on the California business. And I'm comfortable our business units will maneuver around it very quickly in 2019, if it passes. So I don't think there is -- I do think that a lot of people are talking about this significant binary opportunity that occurs on election day, and I understand why. But if we had been reliant on SB 1 monies since April '17 to be where we are in California, it would be much more of a binary event than it is, but we have not...

So fair to say what we're seeing now from your operations does not really reflect some massive uptick from SB 1 related spending anyway. So it's kind of...

That is absolutely correct, Joe. It has not -- and I said -- and as I have said, Joe, it has not kicked in as quickly for Granite as it may have for other competitors in the market strictly because of our pricing mechanism. So -- and it was somewhat anticipated and talked about a year ago. And so no, we have not seen the big uptick due to SB 1.

Okay. And then my related question there. And we talk a lot about the pricing mechanisms in California, how you guys have been more vigilant there. Now a lot of times in the past, we've talked about when the private market is really strong, it really helps your ability to push price in your public markets. And your comment that the private markets are still really strong seems to be a little bit of a dislocation to what you're -- we are talking about with the ability to get pricing and on the win rate. So can we talk about how that dynamic has maybe changed a little bit or people are just, like you said, building backlog because they're nervous and being more aggressive now than they normally would be in a strong private-sector environment?

Well, I think what's happened, Joe, is that as the markets have strengthened, you start seeing competitors migrate into one camp or the other. And Granite's large enough where we always migrate into both camps. But what you've seen is the maneuverability of certain companies going over to the private sector, other companies going to the public sector. The public sector, that group has been competitive, as we anticipated. The private sector is pretty much -- the sector that we deal in on the private side is the larger private sector we talk about following certain industrial and technology companies that we have a very close relationship with. That part has been very healthy and is staying very healthy. So our bookings are very steady year-over-year on the private sector, in fact increasing. And you got to look at them in 2 separate camps right now. And when I say competitive, it's been very competitive on the public side because a lot of people are strictly playing in the public side today because there's enough work there for them to not migrate back into the private side.

The next question comes from Jerry Revich with Goldman Sachs.

Joe, I'm wondering if you could talk about the guidance revision this year. So nice to see margins moving up, but the top line expectations came down. Can you just talk about whether that was driven by Layne or the base business, weather, et cetera? Can you just give us some context in terms of the moving pieces around the negative revision to top line in the guide?

I spend more energy on the positive revision on the percentage of EBITDA margin than the negative perspective on the revenue, Jerry. So let's look at the glass half full here.

Great to see the margins, absolutely.

There you go, Jerry. So yes, I believe that -- what we're trying to suggest there is that our plan is exactly working. We have had a slight reduction in revenue and a refocus on the bottom line. And it's working with an expectation that our EBITDA margins are moving up and we're not as aggressive on the revenue side as we could be if we wanted to be. And I told some investors that we probably could have optimized a little bit better. We could have been more aggressive and seen that we've gotten that revenue back up to maybe the high-teens, low-20s, but we don't think that's the best thing for the company in the long run. We think that what we're doing today is creating another level of margin expectations that will stick with the company for quite some time. So I believe it is a please be patient. It is an environment where bottom line is more important than top line, and top line is going to come. The markets are plenty strong enough for us to get that top line at any point in time, that is not an issue. The issue is to try to get that top line up, while retaining the bottom line margins. And to do that, we have to mandate a certain type of margin on the bottom line in the short run and then the top line will come with it.

And in terms of the length of that transition, how should we be thinking about that playing out? Clearly, big step change this quarter. So should we think about comps from the top line standpoint being pretty tough through the first half of '19 for top line, but hopefully improving for margins? Is that the way to think about it?

Yes, I would actually suggest to you that I think there's going to be a very methodical steady healthy growth over the next 3 years. And we talked a little bit about this, Jerry, that if you wanted to just be, from a modeling standpoint, just straight line it with a really nice growth over the next 3 to 5 years, I think that's very important. We try not to blow it out in one quarter or another quarter. We're trying to create a long-term methodical revenue stream, and our growth on the overall business is very healthy. It's an exciting time to be able to now take these acquisitions and build those businesses into healthier businesses. So I would just suggest that the growth -- the revenue side will grow steadily in 2019.

Even though backlog is down entering the year and even though we're pushing pricing more and as a result the win rates are down, you're still comfortable with organic top line growth through '19?

Absolutely. In fact, Jerry, I think that's exactly what I've been trying to say, maybe not saying it well enough, is that the market is strong enough, is very -- is strong enough to be able to support nice revenue growth in 2019 and beyond while maintaining margin expectations. And it's just a matter of which one you do first. And we've decided over the last 12 months to focus on margin improvement first, revenue improvement will come along, and the market is plenty strong enough to drive those revenue expectations.

The next question comes from Michael Dudas with Vertical Research Partners.

Jim, just wanted to touch base on, couple of things. One, maybe you can review for us or Jigisha, your thoughts on the balance sheet and target ratios, how comfortable you are with your debt -- net debt and some of the things you're working towards improving the cash flow moving into 2019? And then Jim, maybe if you could review how you're thinking about what you've acquired, say the Permian business, the international business. I know you said you'd be looking all different opportunities, you've had the company here for several months. Maybe you could give us your thoughts on how that -- you're thinking about that relative to positioning Granite?

So let me address the balance sheet question first. Very comfortable with our strong balance sheet. We had the 2 tranches that we had assumed from Layne. One has already been converted, partially converted, which was about the $100 million tranche. We have one that's outstanding, $70 million, that we will take it out in November, and we'll replace it with our revolving facility. And even with that additional debt, our leverage is going to be significantly below than want we typically expect. And so -- and from a liquidity perspective, it's pretty strong as of third quarter. The Large Projects' cash contributions are what has driven the variability in the cash flow for the year. And with the addition of Layne, that changes our, kind of, risk profile because these are small duration jobs, which means that the cash generation is much more predictable. So I mean, from a balance sheet perspective, I'm very comfortable.

Yes, maybe -- and then, if that satisfies the balance sheet discussion there, Mike, before we move on to some of the other businesses.

Yes, Jim.

Okay, Mike. So certainly, we have with the acquisition of Layne, brought in several businesses what we call midstream and certainly the international businesses. Relative to that, we've actually, as discussed in previous calls, have considered divesting on some of the businesses, considered enhancing others and considered strengthening some. So we are still in the play potentially divesting of one or more of the businesses, and some of those plays are in action as we speak, and we'll be able to give further notice on it in the very near future.

The next question comes from Brent Thielman with D.A. Davidson.

Jigisha, the $63 million in assets held-for-sale, does that pertain to what you were just discussing, Jim, on the midstream side? Or is that something else?

It is.

Yes. I think that when you look into the queue, you will see that we do have certain amount of value set aside for assets for sale.

Got it. Okay. And then I don't think we dove into it, but could you just update us exactly where the problem Large Projects are? I know you want to put these behind us, but they're still in front of us to some extent. What's left on these? And I guess, should we see a similar situation as we did in the last 12 months, where if we go into fourth quarter, first quarter maybe slow these things down, expedite the good jobs such that the margins could actually increase further from here because of that? Just a little more help there.

Yes, Brent, I think that is absolutely the -- what we intend to have happen. We've mentioned several times before we made the change -- the segment change that on the Large Project segment previously, we have 3 jobs that were still on play, that were slow, mature projects that were certainly slowing down the bottom line. Two of them will be essentially completed in 2018. One of them has a longer tail attached to it. And if we were to be -- go back and talk about Large Projects in itself, what we've suggested is that taking our current numbers, and it was in the 4% range, we do believe that it is a mid-teen margin business, and that we've anticipated that would take through 2020 to get it back there because of some of that lag that will just unfortunately still be there, but a very simple way to look at that portion of the Transportation segment is somewhat of a straight line between now and the end of 2020, getting it back to the mid-teen margins.

Okay. So Jim, it was just one carrying into 2019. I don't know particularly how much is left. Is it large enough that it could prevent you from getting to a 10-plus percent EBITDA margin next year?

I don't have that answer in front of me. But in the bigger scheme of Granite, it will have a play in the Transportation segment, but the remainder of our business will have a much larger offset to it. So it will have substantially less of an impact on the business in 2019 than the top Large Projects did in 2018.

Plus, Brent, we will be updating our guidance in February when we announce our fourth quarter results too.

The final question comes from Brian Rafn with Morgan Dempsey. Okay. Brian has dropped off the Q&A session. This is the end of Q&A. And now I would like to turn the call back over to our hosts.

Okay, well, everybody, thank you, as always, for your questions. A quick note for our shareholders and investors. Jigisha, Ron and I will be on the road and in conferences visiting our operations and investors around the country in the fourth quarter. So please reach out to Ron, and we will look forward to speaking with all of you and meeting with you whenever possible. And as always, thank you to all of our employees for keeping your fellow workers safe and for exhibiting Granite's core values every single day. As always, Jigisha, Ron and I are available for follow up if you have any further questions, and thank you for joining us today everybody.

Thank you.