渥肯建材 (VMC) 2018 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Vulcan Materials Company Second Quarter 2018 Earnings Conference Call. My name is Holly, and I will be your conference call coordinator today. Please note today's conference is being recorded. (Operator Instructions)

And now I would like to turn the call over to your host, Mr. Mark Warren, Director of Investor Relations for Vulcan Materials. Mr. Warren, you may begin.

Good morning, and thank you for joining our second quarter earnings call. With me today are Tom Hill, Chairman and CEO; and John McPherson, Executive Vice President, Chief Financial and Strategy Officer.

Before we begin, I would like to call your attention to our quarterly supplemental materials posted at our website, vulcanmaterials.com. You can access this presentation from the Investor Relations homepage of the website. A recording of this call will be available for replay at our website later today. Additionally, you can sign up to receive future news releases under the e-mail alerts quick link on the Investor Relations homepage.

Please be reminded that comments regarding the company's results and projections may include forward-looking statements, which are subject to risks and uncertainties. These risks, along with the other legal disclaimers, are described in detail in the company's earnings release and in other SEC filings. Additionally, management will refer to certain non-GAAP financial measures. You can find a reconciliation of these measures and other related information in both our earnings release and at the end of the supplemental presentation.

Now I'd like to turn the call over to Tom.

Thank you, Mark, and thank you, all of you, for joining our call today. Our second quarter results are another really solid step towards our longer-term goals. We finished the first half of the year on plan and will position to stay on plan for the balance of the year. The business is running well as expected, and we're seeing good things come together. Higher public funding for transportation infrastructure is now converting into increased shipments. Pricing momentum, including our backlog work, continues to strengthen. And we've turned the corner on cost challenges we faced in 2017, with flow-throughs moving towards long-range norms. We expect each of these trends to continue through the second half of this year and into 2019. We are well positioned for continued shipment growth, compounding pricing improvements and further gains in unit profitability. Now we experienced spikes in diesel and liquid asphalt cost, but these headwinds will be offset by pricing gains over time. Diesel prices have risen 28% year-over-year and 59% since June 2016. Those increases are not yet fully reflected in our reported product pricing, but we are already pricing [were] higher. Remember, higher logistics costs widen the natural economic moat around our quarries. Also, liquid asphalt prices have risen 22% year-over-year, putting pressure on asphalt margins. But here again, these headwinds will ultimately be offset, and we're already seeing prices improve. Good things are happening as public construction demand joins a sustained private recovery. And our aggregates-focused business model positions us extremely well for this dual recovery. We are keeping our midpoint projection for full year adjusted EBITDA at $1.2 billion, and we expect to move in 2019 with very good momentum in market demand, in shipments and in pricing.

Now let me touch a bit more detail -- on a bit more detail on the trends we're seeing in our core Aggregates segment, with a focus on shipments, pricing and cost. John will then recap our full year outlook, and I'll sum up with some closing comments.

First, our strength in shipments. Public demand is kicking in. We're finally beginning to see the transportation funding increases that passed in many Vulcan-served states showing up in our shipments. And as I point out last quarter, we expect this demand to build over multiple years as state DOTs and contractors deliver on their large backlogs of bigger and more complex projects.

At the same time, private end use demand in Vulcan-served markets continues to recover steadily, growing at a rate that is significantly ahead of the rest of the country. Our local sales teams are covering our markets and serving our customers well. We've taken steps to give them more time to partner with our customers and help them grow. They are reaping the benefits of more back-office support, less paperwork and more time with our customers. And it's paying off nicely. We expect strong shipment growth at a pace similar to the second quarter for the balance of the year based on demand patterns and our booking pace. And the shipment results, we reported this quarter still yet reflect the strength we're seeing coming in California or Virginia. Those states were actually down in the quarter.

Regarding California, we're very encouraged by the letting data we're seeing and efforts to accelerate public projects. We're having success in booking key new jobs. We expect second half shipments in California to be up mid- to high single digits over the prior year, with that growth still supported by strong private demand. We continue to expect the benefit of stronger public construction activity in California to start impacting our shipments in 2019. Meanwhile, we continue to focus on longer-term materials pricing improvements in this key state. Our average selling prices for aggregates in California improved 7% compared to the second quarter of 2017.

So to recap, we're seeing real strength in shipments, 11% same-store shipment growth in the quarter as public demand joined a sustained recovery in private demand, with a similar growth rate expected for the remainder of the year.

Second, let's talk about pricing. Geographic mix impacted our total reported average selling prices in the second quarter. Excluding this mix impact, average aggregate selling prices improved 3%. Given the continuing recovery in public demand, geographic and product mix may continue to affect reported average sales prices for the next few quarters. But let me tell you, I'm not concerned about this mix effect. It's good for the business to sell a full product mix, and we're focused on driving prices higher for all product types. Please don't base fines across all geographies. We like the pricing trends we're seeing in our backlogs.

And project pricing continues to strengthen and will throughout the year. We're pressing for second half price increases in many of our markets across all customer segments. As you know, there's a natural lag between pricing and shipments. For example, we're shipping today on several large public jobs initially priced well over a year ago. Our reported pricing will benefit as we work off older jobs and ship on more recently quoted work. And of course, the shipment strength we've experienced with public demand joining what has been a private-led recovery bodes very well for pricing strength into 2019 and beyond.

Third, let's discuss how we convert that top line growth into profit growth. We're doing a good job controlling the cost that we can control, moving toward more normal flow-through rates on same-store incremental revenue. For the quarter, our unit cost of sales in aggregates on a same-store basis, freight adjusted, was essentially flat. We deliver with operating leverage and shipment strength. But this per-ton cost benefit was offset by the spike in diesel costs and also by distribution-related costs that are behind us as we move into the second half of the year. Excluding higher unit cost per diesel, our same-store flow-through rate on incremental sales for the first half was 56%, a clear move in the right direction. And we expect further improvements in the second half of the year. Diesel costs ultimately pass through in our product pricing, but despite diesel, we finished the first half essentially on plan with respect to operating cost results and total gross profit for Aggregates segment.

And following the flooding from Hurricane Harvey, we've now finished dredging our Houston port facility, and our new ships are fully operational, bringing additional cost efficiencies to the business in the second half of the year.

Our continuing world-class safety record underscores our confidence in our operating discipline and execution. Our MSHA/OSHA incident rate through the first half of the year is less than one injury for every 200,000 employee hours worked. Our people are focused on every aspect of operational excellence, and it shows.

Now I'll hand it off to John for a brief review of our full year outlook for profitability and cash flow. John?

Thanks, Tom. Let me begin by providing a bit more background regarding our balance of year outlook. In our core Aggregates segment, as Tom mentioned, we expect continued strength in shipments, roughly in line with the second quarter results. We now project full year same-store aggregates shipment growth of between 7% and 9% compared to our beginning-of-year expectation of 4% to 6%. We expect freight-adjusted price increases in the second half of approximately 3%, in line with our beginning-of-year projection. However, given geographic mix impacts through the first half, we now project a full year increase in reported freight-adjusted average selling prices of 2% to 3%.

Absent these mix impacts, which are largely tied to stronger-than-expected shipments in certain lower-priced markets, pricing momentum was in line with our plans through the first half and should strengthen through the second half and into 2019. Our projection for full year freight-adjusted revenues for the Aggregates segment remains in line or slightly ahead of our year-beginning plan, again as a function of stronger shipments at a marginally lower geographic price mix. As noted, diesel prices in the first half rose more than projected. We now expect full year diesel costs for the Aggregates segment to be approximately $15 million higher than our year-beginning plan. Again, higher diesel prices should support higher aggregates pricing over the longer term as, along with other logistics constraints, they serve to widen the economic moats around the better-located quarries.

Absent the short-term impact of the rise in diesel costs, Aggregates segment gross profit for the first half was in line with plan. Aggregates segment unit profitability should improve in the second half, as expected, as the business benefits from higher volumes, solid operating disciplines and the absence of certain costs tied to hurricanes and other weather events in the prior year period. In total, full year Aggregates segment gross profit should approximate beginning-of-year expectations as higher revenues offset the impact of higher diesel costs.

In contrast, first half results for the Asphalt segment trailed plan in the first half and likely will remain below plan for the second half and full year. Due primarily to the increase in liquid asphalt prices, first half results missed plan by approximately $15 million. Second half material margins, although stabilizing and improving, likely will remain below beginning-of-year projections due to higher input costs. And we expect full year segment results will miss plan by approximately $20 million.

Concrete segment results were in line for the first half and should meet plan for the full year. Management expectations for SAG expense, interest expense, taxes and operating and maintenance CapEx remain unchanged.

Taken as a whole, we continue to project full year net earnings of between $4 and $4.65 per diluted share and adjusted EBITDA of between $1.15 billion and $1.25 billion. We do note that the current year impact of higher diesel and liquid AC prices may make the higher end of this range difficult to reach despite the shipment strength we see.

As Tom referenced, our midpoint expectation for full year adjusted EBITDA, supported by our bottoms-up business unit projections, currently stands at $1.2 billion. Again, the business is generally performing as expected, with shipment growth better than planned and petroleum-related input costs worse than planned. Strengthening shipments to public end uses, plus improving pricing in unit margins, plus maturing growth investments, should position the business very well heading into 2019 and beyond. Our overall capital allocation priorities remain unchanged as does our commitment to maintaining an investment-grade credit rating.

Now I'd like to wrap up with a reminder of the fundamental strength of our franchise- and aggregates-focused business model. Ours is a business that in the last 5 years has done the following: in the Aggregates segment, using trailing 12-months figures, we had compounded shipments at a 6.5% annual rate; unit pricing has compounded at a 4.3% rate, with unit costs growing at less than 1%; unit gross profit has, as a result, compounded at nearly 13% annually; and total company-adjusted EBITDA has compounded at a 20% clip. Furthermore, ours is a business with attractive cash flow dynamics. As noted last quarter, after-tax cash flow from earnings, less adjusted EBITDA, less working capital growth of $50 million, operating and maintenance CapEx of $250 million and cash taxes of $75 million should approximate $825 million for the year. And all of this backed by an advantaged, irreplaceable essential asset base and a culture centered on taking care of each other and winning the right way.

And now this business sits at another positive inflection point, with public construction activity beginning what should be a multiyear recovery, backed by new, higher dedicated funding. But as great as Vulcan's business is, and you know it's a great business, it is an even better place to work and an even better team to be a part of. I will miss it deeply, but I have every confidence, every confidence in our direction and continued success.

Thank you, John. As you all know, this is John's last earnings call as our CFO. I want to thank John for his outstanding work as part of our senior leadership team. He has been a key player in developing and refining the fundamentals of our strategy and our business models. Working together as a closely knit team, we and our employees throughout the company are shaping a direction that has delivered and will continue to deliver great value to our shareholders, our customers and our employees. And you can continue to count on that kind of continuity and steadiness both in strategic direction and our daily operational excellence that is a hallmark for the way we do business at Vulcan. I would like to personally thank John for his friendship and partnership and all that he has done for his Vulcan family. Thank you, John. And although I'm sad to see John moving on at the end of the year, we've had an organized smooth transition underway. Suzanne Wood, who joins us as our CFO on September 1, is an outstanding talent, with deep and broad experience. She will bring her own highly regarded leadership abilities and fresh perspectives. She will be a key member of the team that is tightly focused on strategic growth and superior execution in all aspects of our business. That is of the utmost importance to us. It's how we go about making our company better every day. We know what we need to do to maximize the value of our asset base and our franchise. We are going to keep focused on that and on day-in and day-out execution. We are more than ready to meet the growing demand in public and private sectors. We are securing increasing business in projects of all sizes, from megaprojects to small construction jobs all across our footprint, with particular growth in our high-margin, high-population markets. We will continue to achieve price and volume gains that further improve our superior unit margins. And we will remain keenly focused on our operational excellence and maintaining our world-class safety performance.

And now we'll be happy to take your questions.

(Operator Instructions) Our first question today will come from Trey Grooms with Stephens.

First off, wanted to say, John, being your last call, it's been great working with you, and wish you the best.

Thanks. I appreciate it.

First off, I wanted to just talk about the kind of turning the corner on cost challenges that you guys have talked about. Really, if you could just kind of go into more detail on how to think about the flow-through and the bridge to your expectations here in the back half, understanding here some of these things are behind you. But -- and just really trying to get our head around the shift in incrementals needed to kind of get to that original aggregates kind of gross profit goals.

Trey, I'll start and just with a view of the quarter and the first half, and I think Tom will comment on the full year. And we'll kind of clarify as best we can. First thing we would say, as we said in the prepared remarks and the releases, we are on plan. For the Aggregates segment, we are on our plan for the first half of the year, albeit driven a little bit by stronger shipments than originally projected, offsetting the higher diesel cost than we'd expected. But we are on our plan for the first half of the year. In terms of flow-throughs and just the way we look at it as a management team internally: one, I was trying to take a little bit longer-term view at that number. But as we look at the first half, first, you got to look at it on a same-store basis, I'll just remind everybody. The flow-through on acquired revenue, particularly Agg USA, is always going to distort those numbers. You got to look at it on a same-store basis. As we look at same-store flow-through the first half, we see 43%, absent the year-over-year impact in diesel, which we will overcome as we move forward and put in their own pricing. That's 56%. I noted in the release -- I don't want to distract anybody, but if you look at the pensionary class and what that did, absent that, it's 59% to 60%. So our main message on flow-through and on the business as a whole for the first half is that we are on plan. We also expect those flow-throughs, as we've said I think all year long, to improve meaningfully in the second half, such that the full year number is basically in line with what you'd expect from our beginning-of-year guidance, of course, and at or slightly above that 60% long-term number.

Yes. Trey, the second half, we will definitely see flow-through improvement, and it's really driven by 3 things. Number one, prices will continue to rise. Our backlog pricing is much higher. We've got fuel offset in that. And you also, we're just simply working off all work. We've got some work we're working off right now. It's more than 2-years old and is priced that long ago. Then second, we'll see significant cost improvements. First piece of that, as we move past the old storm-related and some of the transportation cost that we saw last year, and we saw in the first half of the year. The second piece of that is we'll reap the benefit and not the cost of the first half improvements we did in some big plants, we took down in preparation for the season. And the third thing is you're just going to see that volume growth continue, and it's really driven by the big jump in public demand. So I think we're confident in how we did in the first half and how it sets itself in the second half.

And then, Trey, if you wanted to square -- and others -- if you want to square the guidance for the year and just taking a look at the total business and kind of how we get there, again, this is all consistent with our plan. We're looking for about $160 million profit improvement in the second half year-over-year. And again, if the question is how do you get there? Here is the way we look at it. We've got significant benefit in the second half from acquisitions, about $30 million year-over-year. That's mostly Agg USA. We've got, as you know, significant operating cost and margin improvement in the Aggregates segment in the second half. Again, we're comping over a bunch of storm-related costs in the second half that shouldn't repeat. That's about another $30 million to $35 million. We've got approximately 10 million more tons in the second half of this year on a same-store basis than we had in the second half of last year. That's up its own benefit at a strong flow-through rate. As Tom mentioned, we've got higher pricing in the second half than a year ago. That's probably another $40 million of benefit year-over-year in the second half. We'll have a little bit of contribution from the downstream businesses, not a lot year-over-year, given the headwinds in our Asphalt segment. And SAG, that's slightly up in the second half over the prior year, maybe $5 million, but largely flat. So look, our plan is basically intact. We're kind of following the exact plan we had at the beginning of the year. Only difference is really being higher aggregates shipments driven by stronger public shipments, which is fantastic, offsetting higher-than-anticipated diesel costs and helping offset what will be a full year miss in our Asphalt segment.

All right. That's super helpful. And then second one for me is just around a lot of the noise out there around SB 1. Obviously, a lot of chatter, possibility for repeal obviously on the ballot for November. Just trying to get maybe your updated thoughts around how we should be thinking about that or how that could shake out? I mean, understanding you guys don't have a crystal ball either, but some of the polls we see look like could be pretty much a coin toss at this point. But as you guys know, these polls can sometimes be a little bit deceiving depending on sample size and the population there. So really just trying to get any updated thoughts you guys might have around SB 1 from where you sit today.

Yes, I think your opening comment about SB 1 was completely accurate. There is a lot of noise and there will continue to be noise for the next 4 months about it. But let's kind of step back on and look at the facts as we know it in California. And I would point out 4 things: Number one, remember, California is the fifth largest economy in the world, and it's also got some of the country's worst roads. Number two, California voters understand how bad the roads are, and they've already supported 20 local initiatives that increased transportation funding. We saw that 1.5 years ago. And fact number three, as you know, SB 1 was firewalled for transportation uses only in June, which is very good for us and it also removes the biggest argument for repeal. And fact four, SB -- you got to remember, SB 1 has incredibly broad and deep support in the state. So those are facts if we go on California. And I'll explain, don't forget 3 other points. Remember, Caltrans is already moving, so by November, they will have already collected an additional $4.7 billion for highway construction. And those local initiatives that I mentioned earlier, they will raise $50 billion over the life of the initiatives. Fact number three, remember, Vulcan shipments and prices to the public market in California are going to be higher than second half of this year. They'll be higher than that in '19, and they'll be higher than that in '20, given our current pipeline of backlogs. So our success in California is enhanced by SB 1, but it's not dependent on SB 1. But we have a fantastic position in the fifth largest economy in the world. Our backlogs are higher. The pricing of those backlogs is higher than they've been in years and they're accelerating. And that price momentum, which was very good and first half of the year will continue to grow balance of this year and then the next year and into '20. So again, our success -- we're going to be successful in California. SB 1 will only enhance that.

Our next question today will come from Jerry Revich with Goldman Sachs.

This is Ben Burud on for Jerry. Just wanted to start and get some more color on pricing in light of such strong shipment growth. So double-digit volume growth in the quarter. Can you kind of help reconcile that strength with 3% clean pricing?

Yes. So pricing momentum is good, improving. If you take a closer look at our individual markets, we're actually where we thought we'd be. It's really 3% to 4%. 80% of our markets that we're in had prices in the 3% to 4% range. And we've been raising prices all along. So as we work our whole work, we'll see replaced with higher-price jobs. Some of that -- as I mentioned already, some of the prices that we're working on today are priced 1 or 2 years ago. As we always say, rising transportation cost is good for pricing in our economic moat. Same thing for diesel. We're reporting higher prices over because of those things right now. And this will keep building the second half of the year. Our booking and backlogs are at higher prices. Remember, accelerating volumes are very good for pricing. Public work is driving improved volumes and prices. And I'll give you a couple examples like this. So in the first half of this year, we've seen California, Virginia and Georgia up mid- to high single digits. So the pricing is coming, and you see it across the vast majority of our markets.

Okay. We'll just remind a number of you that it's not atypical at all for us to have a 6-month lag on average between when we close something and when we ship it. It obviously varies by job type. But 6 months on average isn't way off. So lot of what we shipped in the second quarter this year, we quoted and booked in Q3 and Q4 of last year. So when we referenced improving pricing in our backlog, I mean, you've heard us talk in Q1, I think, pretty clearly and, obviously, in this call pretty clearly about the direction we have as a company on pricing and the fact that that's only reinforced by a strengthened public. You're going to see that come with a lag. So what you're seeing is good for pricing in the second half, but it is equally good for pricing in '19. And look, this is a business that's compounded pricing to the recovery so far. Our business had almost 4.5%. Pricing climate is probably only improving in total. Some peer is higher, some peer is lower. Mix is going to affect it in a given quarter, but don't lose sight of the power of the business model. None of that has changed and really has a whole another push from these higher logistics costs, which widen the economic moats around our quarry. So I hope you can tell, it's not something that we're overly concerned with on this, and we see it as something that should be quite positive for the business moving forward.

Got it. And then in California, you gave us pricing up 7% year-over-year. Could you help give us an idea of how shipments were in the quarter? And then related to that, if you think of SB 1 as we head into the end of the year and maybe people, who knows, maybe some people get cold feet. Is there any pull forward into late 2018 in what was supposed to be beginning in 2019?

Yes. So I mean, if you look at the shipments for the year, we're just a little ahead of where we were prior year in the quarter, they were down. All of that is timing of how we work in California. As we said, we had a strong first quarter. The private demand in California continues to be solid. Second half, the growth is some private, but a lot of that is public flow-through. If you look at our backlogs, both in volume and price, in California, we're up where we should be. We don't see a lot of SB 1 in '19. It will really be in '20 and beyond. But in spite of that, in '19, our backlogs will support the volumes that we project in the second half. So -- and as I said in my comment about SB 1, remember, Caltrans will have already collected $4.7 billion -- additional $4.7 billion by November. And you've got the impact of the locals funding an additional $1.35 billion. So there's a lot of increased funding in California. And I think we feel good about it. As I said about -- on the last call about SB 1, told that the second half of this year, we feel good about '19 and that'll grow into '20.

And again, just to be clear. I mean, we're super excited about what Caltrans is doing. It's just -- we don't expect it to show up in our shipments in '18. And that's always been our view. That's not changed. So anything that happens there is effectively upside, but very good for '19.

Yes.

The shipment strength we saw in the quarter, just as a reminder, came without help from California, without help from Virginia, without help from Georgia. Many of our higher-priced markets. All those markets are super healthy long term. Just some timing issues there in the quarter, and you're going to see good growth in all those areas in the second half.

Yes. Full flavor on Caltrans. So they've really done -- so they've done a good job. We've already backlogged 1 million tons of aggregate off of SB 1 funding and about 300,000 tons of asphalt. This is really early in the game, I would not expect to see much of that in 2018. It will be '19 and '20.

Next, we'll hear from Kathryn Thompson with Thompson Research Group.

Still on the policy vein, wanted to shift coast and go to Georgia, Texas, Florida, Tennessee and North Carolina, which we in our work have seen some better lettings in the first half of '18. Given strong lettings, obviously, there can be a delay between the dollars in lettings, which we saw last year, but also possibly wanted to get a little bit more color of now that we've seen good lettings numbers out of those key states. Can you talk about what you're seeing in terms of real work flow-through? And also what you're seeing in lettings going into '19 based on early reads from this year?

Yes. I think that we're seeing a turn in a lot of markets. When I say a turn, it is in really turning profitability driven by volume and price and that turn is also -- the catalyst for that turn is the turn in public work. And I'll talk about 3 markets where we've seen a big turn there. The first one would be coastal Texas. And we saw a big turn in coastal Texas, probably, in the last 6, 8 months. We had a downturn there. It's recovered, the private size recovering. It's good highway work. Our volumes are dramatically up. You're seeing prices -- actually, prices in the second quarter rose over prices in the first quarter, and they'll continue to rise through the year. And all of that's driving market -- improving profitability in coastal Texas. And that's without the impact of energy work that -- out there. There's dozens of energy jobs and billions of dollars that are in the planning stages. We don't think we expect to see that till '19 and '20. And then behind that, you're going to see in '19 and '20, you'll start to see nonhighway infrastructure pull-through with Harvey projects that are in the design stages right now. Those -- I think there's 30 of those in preplanning process, so very exciting in coastal Texas. Turning now from there to Tennessee, particularly Nashville is a great example. Kathryn, we're -- that has been a very healthy state for a long time. But we actually, the Tennessee DOT has done an excellent job, already pulling through improved back projects. That's a state where some of those projects will hit this year. And with that turn in public, you've also, again, you got the price and the volume flowing through in Tennessee. The last one I've mentioned is a state that has been hot for a while, Florida DOT. Really solid private, really solid public. You're starting to see infrastructure -- nonhighway infrastructure flow-through in Florida, but with the big public work maturing in Florida, you get a better mix. So actually our overall profitability and our unit profitability is getting better with the volume and mix. So -- and you could go on and on and on across the country wherever the funding is -- has started to mature. And as we always talk about, you'll see a layering effect of that over the next 3 to 4 years.

And Kathryn, just a wonky add. I mean, I know you understand all this actually quite well. But from inside our shop, in each of those markets and others, there's a turn not just in volume, but also in profitability, as Tom said, and in pricing. So if you take coastal Texas, I mean, we've talked a lot about that over the last year, given the hurricane impacts and those kind of things, again, that's turning in volume, and you know very well, the DOT outlook, the Harvey relief fund outlook, the recovery in private, you know the energy projects, all of which give great visibility. That's a market where in the first half we would have had the way we measure it on a freight-adjusted basis down pricing. That freight headwinds, the way we report pricing is going to reverse. And on top of that, our overall pricing is moving up. So if you look to kind of down pricing first half, you'd see up pricing in the last month, to give you a feel. So that's a really good story moving forward. Same kind of dynamic of the places. You'd asked about Georgia in your question, we really like what we see in Georgia. Of course, still some issues with capacity constraints, really logistics constraints, I should say, not ours, but the markets, in particular, some rail issues there. That's one place that's been affecting us. But the outlook on public and just the backlog of work to be done bodes, again, really well for the second half. Continued pricing that market has been very strong. And again, strength into '19.

Tell Georgia -- a little bit of good news in Georgia over top of all the DOT funding that has been growing in the state, we also see -- started to see some local initiatives, particularly in South Georgia, right in the middle of where all the Agg USA rail yards are. It's about $0.5 billion that will flow through. Now that's going to -- again, that'll take a while, but pleased -- we're very pleased with that in light of what's going on with Agg USA.

That's helpful. Tagging on to your commentary on pricing, for the second half, you've already commented a bit in the Q&A just about to flow through of pricing and how it takes time. But just to be really clear on that 2% to 3% guide for the year, is that on a freight-adjusted or non-freight-adjusted basis? Because one would imply an acceleration of pricing trends in the second half, while the other would imply a deceleration of trends just a quick clarification on that point. Then also -- go ahead.

First of all -- no, first of all that would be -- I'm sorry to interrupt you. That is freight-adjusted, and we would tell you that will accelerate not just in the second half, but through the second half and into '19.

Perfect. And then finally, and the -- you might have already answered this in terms of the incremental margin question, but just to be clear, following up on a question we've had for the past few quarters on incremental margins, any impact on how Aggregates USA impacted the incremental margin calculation? And are there any other items that we should take into consideration that won't happen in the second half of the year, like the Houston dredging cost, like the Panamax ship and like the weather concept perhaps wasn't outlined earlier?

Yes. I think John covered that a little in his first remark on pricing or on flow-throughs. But we won't face a lot of the storm challenges that we faced in 2018 -- excuse me, 2017. And we said that it would take us through the second quarter to get those behind us. That includes dredging, that includes some of the other transportation costs we had. And on top of that, our new ships are now in place and shipping.

Kathryn, in the quarter the -- again, we had, as you know, we called it out, $7-plus million of diesel headwind. Again, we'll catch-up on that, and our own pricing helps our pricing. We have a little bit less than $10 million of elevated distribution costs that should not repeat in the second half that hit the quarter. But again, as we get into the second half, and I know you're all familiar, but we're comping over in terms of the difficulties we had with last year's storms. But we should have $30 million to $35 million of cost improvement year-over-year in the second half. Some of that is costs from last year second half not repeating. Some of that is the fact our own internal plans had some costs front-loaded in the first half. We called that out in Q1, for example. And then of course, as Tom mentioned, we get a benefit of higher operating leverage and stronger volumes in the second half. So despite the diesel headwind, we should see our unit cost improve markedly, our flow-throughs improve markedly in the second half, all in the same-store basis, is really the way to look at it.

Our next question will come from Garik Shmois with Longbow Research.

John, best of luck. It was a pleasure working with you the last several years. First question was on follow-up on incremental margin outlook and the discussion around 60% in long term, and I think coming into the year was an expectation of 65% to 70%, because of some of these onetime items. Then you talked about that occurred last year that's not occurring this year. Just wanted to be clear on the incremental, though. Does the view of improving incremental margins factor in the rising diesel costs? Or should we expect that 60% to, I guess, 70% incremental moving forward to be, if you stripped out diesel?

I think that the second half incremental takes into account the increase in diesel cost. I think that's built in. What we've told you is it is a headwind, but it continues to be less and less of a headwind as the year goes along.

Garik, in the second half, we're probably expecting diesel of around -- it varies by market, but around [$2.60]. So obviously there is some uncertainty around that. We'll kind of see how it plays out. But keep in mind, we've got basically stronger volumes offsetting diesel impact in the Aggregates segment. So full year, our expectation for the Aggregates segment is darn close to what it was in the beginning of the year, slightly different way of getting there. We do expect to have a headwind from our Asphalt segment due to liquid AC costs relative to our beginning-of-the-year expectations. But when we sit at the end of the year and look backwards, we expect a flow-through rate in our Aggregates segment that's really not that different than what we've expected at the beginning of the year. And again, I just caution anybody, you get looking at just flow-throughs on a quarterly basis, they swing a lot. So you got to take a bit of a longer-term view. And I would remind -- by the time we finish this year, we're going to look back over the previous 5 years, and we're going to find out that our flow-through rate for 5 years has been about 62% or something. So pretty much in line with long-term expectation.

Okay. Got it. And then just follow-up question on volumes. You called out California and Virginia later in the quarter should rebound due to timing, but these are also markets that saw stronger price growth. And conversely, you had stronger volume growth in some of the lower price markets. So just it begs the question around market share, some of these higher pricing markets. Have you seen any share shift? And how should we expect or contemplate market share over the next several quarters in some of the stronger markets?

I don't know that we would -- I would call that a share shift based on that. It was really where those shipments were. For example, in Alabama and Arizona, those are driven by very large highway projects that we booked sometime back. And so I think the impact is really -- of those 2 is timing of big projects, same thing was impacting in California, and Virginia was weather.

Garik, and I know what you're -- exactly what you're asking, but the kind of mix impact we had on reported average stock prices this quarter, we would expect to be fairly transitory. I mean, you know this, that our higher-price markets are the ones that have higher long-term growth. So longer term, if anything, mix should probably help us a teeny bit. But in the quarter, we had a set of markets, by the way, they all grew. So 80% of our markets that had growth around it, pricing growth around 4%, they grew 9%. We just had some of the lower priced markets like Illinois, Alabama, Arizona grow at a higher rate. They all grew, but we just had a little bit more growth in markets that on average have prices $5 -- $4, $5 below the higher-priced markets.

Our next question today will come from Rohit Seth with SunTrust.

Question is on transportation costs. I mean, how much of a headwind was the distribution costs in the quarter? And I heard you say that the headwind was behind us. Can you just provide some color on some of the basis for that?

Yes. It was 2 things. We had talked about the port in Houston that was silted in from the hurricanes. We suffered from that second half of last year. We got that dredged in the first quarter. Did 2 things, you got the cost of -- excuse me, got dredged in the second quarter. There were 2 pieces of that cost. Number one, you got the cost of dredging. Number two, in the first and second quarter, you're still going in the light loads and partial ships, which is very inefficient. And then we had some -- still had some barge costs go up and down the Mississippi that we were fighting. I would tell you that, as we said, those costs are behind us, and we feel really good, really confident about how we enter third quarter.

I'm talking more about the trucking-related costs at your distribution yards -- sales yard, sorry.

I don't think that's what we were referring to when we talked about that. We were really referring to more of the Bluewater than trucking costs.

The biggest place we had elevated distribution costs were related to our businesses, and this is in the quarter, related to our businesses -- this is in the quarter, related to our businesses in the Gulf Coast of Texas, so think Houston and along the rest of the Gulf Coast. That's really where we saw most of our elevated distribution costs in the quarter. We have higher trucking costs. But again, given that we report freight-adjusted pricing and other factors, that's less of an issue in the numbers that you see. I would note, it's a little bit of a different topic, but just on the Agg USA outlook and what I mentioned on rail there in terms of distribution headwinds and logistics headwinds, for that business, we still see a $50 million EBITDA contribution for the year, but that would have been higher if we had the kind of rail service we'd like to see. We're probably full year looking at being nearly 500,000 tons below what we would have otherwise been in that business. So if anyone's wondering why we're not raising our outlook for Agg USA like you might expect, that's really the issue. We're super happy with the acquisition, still going to contribute $50 million, as we laid out. But going to take slightly longer to capture some of the synergies that we would have hoped to have captured this year due to the challenges we're facing in rail service. Now we think those are getting worked out, but still a bit of a challenge.

To your point on trucking, usually that adjusts very fast.

Okay. And then on your guidance, you said in the full year guidance, you think the top end is less achievable. Can you just maybe provide some direction whether you're tracking towards the low end or the midpoint?

We would say we're tracking to the midpoint. And again, not trying to set off any alarm bells or anything, just trying to be realistic. We've got a $20 million hold in our Asphalt segment relative to our beginning-of-year expectations. We've got diesel headwinds, relative to beginning-of-year expectations of, let's call it, $15 million. And to reach the equivalent of what would have been [1 2 7 5] even with stronger shipments, it's just tough. So it's not that it's impossible given the shipment strength we see. We just wanted to be realistic and tell you that the high end of our range, the [1 2 50] given those headwinds in diesel and in our asphalt segment economics, it does get a little bit tougher. And so to be clear, we really didn't want you all to take the strength in our shipments, which is very real and powerful, and just move right in the high end of our range. Because those headwinds we have seen in diesel and liquid asphalt so far are a real thing.

Okay. And then are you seeing any project delays in any of your key markets?

Every one of them is different. I think with California, we saw some that may be a little bit delayed, but they'll come on this year. We've seen -- continue to see some, they're not delayed, but they're a little slower shipping on the I-85, 400 job in Georgia. But actually they've gotten approval and that has cranked back up. So for the most part, we're where we thought we'd be as far as timing of jobs. And in some places, probably a little ahead with people trying to push new funding through.

So no project delays and no trucking logistics headwinds, that's what I'm hearing?

With the exception of California, and we talked about that moving from Q2 into Q3 and Q4, I think that's probably accurate. Now I'm sure there's some projects out there where we'll -- I don't know what goes on in every one of them, but for the most part, I think that's an accurate statement.

Okay. And your capital allocation?

(inaudible) we had some delays in the first half like 285, 400, but I wouldn't let that be too big a distraction. When you get back to guidance range, I would remind you and everybody, we're shipping more than 900,000 tons a day right now. So it doesn't take a lot to shift a couple million dollars from one quarter to another, and that's just something we should all be aware of, just so we don't mistake short-term stuff for the underlying health of the business. Just you can think about that math. But if you were asking the question why our range is still as wide as it is, that's really a big driver of it. And where we would, we are able to get the work done as evidenced by our shipment growth rate in the second quarter. But if we had a big major disruption like another hurricane event, it does take longer to catch up. That's really where we're seeing some of these trucking constraints and logistic constraints come into play. If you get a big, massive disruption, it does take a little bit longer to catch up.

Okay. And then final question, your capital allocation priorities, and is there any potential here for a share buyback?

I think those -- our priorities really haven't changed. And we've talked about those a lot, but that's -- we'll always look at that.

I think, obviously, we take a lot of factors into consideration, and certainly share price is one. But as we've been doing, we will make those decisions and report them out in the following quarter. We remain very committed to our investment-grade credit rating. We would expect to finish this year in a leverage ratio within our 2 to 2.5 range. So I'm not telling you what we'll do or not do, but there are multiple factors of which the share price is one.

Moving along, we'll take our next question from Mike Dahl with RBC Capital Markets.

I wanted to follow up on -- just 2-part question around just some of the diesel issues and just, a, is just a little more clarity around timing of what the guide assumes for new diesel surcharges or other price hikes. And second, I guess, related to your comment about the implied economic moat. What are you seeing around -- like are you guys tightening up your shipping radiuses? Are you seeing competitors tightening up shipping radiuses as a way of combating the diesel? And how's that kind of affecting the local market dynamics, if at all?

Yes, let me take the diesel first. And as I said earlier, pricing, we're already pricing up to offset diesel costs. And those are our production costs and how it affects the [cords] themselves. So that's already happening. It will take a little while to flow through. As John said, a lot of times that takes 6 months, for work to -- once you book it, for it to ship. As far as the moats are concerned, what drives the moats is just increased freight cost, because some want to come closer to you. And it just allows you to -- as when you price, let's say, 5 miles away 2 years ago versus today, that moat got wider and your prices go up. So it's kind of as simple as that.

Right. And I guess, just relating to that, though, more specifically if you have seen kind of competitive activity already be affected by that in some of your key markets? Is that enabling some of the stronger growth that you're seeing, just effectively less competition in certain markets?

No. I think there's plenty of competition in all of our markets. The moat really affects price. And I think that -- but also you got to remember, and this kind of goes back to the fundamentals of price increases is visibility to coming work is really underscores and underpins price increases. And that's just not in that Aggregates business. That's for Contracting, Asphalt, Concrete, across the whole construction chains. That's what really drives the price. And as those -- as that public demand has joined in, that is very clear, there's no question that that's coming, and it allows people to -- more confidence in raising prices.

Got it. And my second question just relates -- and sorry to harp on prices a bit here, but just trying to understand the second half guide. And you guys talked about it a couple different ways as far as the, what the true like-for-like pricing is. And so I think throughout that, it was 3% to 4% in 80% of your markets. So when we're looking at the price guide for the second half, what would you say as far as the mix impact in the -- the geographic mix impact in your second half pricing commentary? Is it the same? Has that -- is it diminishing as some of those, like the California markets come back? Just trying to get at really what the underlying change is there.

The way I think about it, is just try and cut to the chase, is we obviously build this bottom up as we look at it. So I don't know that you'll see exactly the same kind of mix impact that you saw in the second quarter over time, but we'll continue at this rate of growth. And we're growing shipments 10-plus percent as we did in the second quarter. When you have that kind of rate of growth, you're a little bit, just mathematical definition, a little more prone to mix shifts. So it's good, bad, sideways. So I wouldn't try and read too much into that. To help you, we're expecting in the second half year-over-year price improvements in that 3% to 4% range, in that range of about $0.40 a ton on a same-store basis, just to give you a rough ballpark. And what I'd really underscore is continued further improvement in our quoted pricing, which will further benefit late this year and into '19. So there will be more momentum probably in our quoted work than you see in our shipped work, per Tom's comments. But think something on the order of $0.40, 3-ish percent, 3%, 4%. And the mix is going to be what it is. We don't try and -- the last thing in the world you'd ever want us to try and do is to avoid shipments in order to improve the average selling price. So I hope that helps. But it's a positive story, and it's an acceleration, not a deceleration.

Yes, I think, important to note, we're pushing prices across all geographies, across all product lines. And so John said, when you talk about a mix effect, what happened in the second quarter, there's nothing bad with that. In fact, it's healthy and good. We simply sold more product in markets like Alabama, Arizona than we expected. That's a really good thing. And as you look at it, we're always going to maximize all the products in all geographies at the best price and margin possibly.

We don't mind you asking questions. You're not going to ask any question any harder than Tom is asking the operator, so.

That's helpful, yes. It's certainly clear in terms of your conviction moving forward.

No worries.

Our next question today will come from Adam Thalhimer with Thompson Davis.

One more on price. I'm sorry, but are you -- would you say you're the pricing leader out in the market? Or are you seeing others push mid-year prices also?

I said this to [Laurie], I think that what you're seeing with pricing is pretty widespread. That's what we're talking about. So -- and again, I'll go back. That volume confidence and the visibility to, particularly to the public work coming in, is very good for pricing. And that's good for pricing across the construction material segment, whether that's contracting, asphalt, concrete and all aggregate product lines. So it's pretty widespread, and that is really healthy. And it's pretty consistently moving up in the vast majority of our markets.

And the dynamics vary a lot market by market. I think people would tell you we typically play a price and value leadership role over time.

Okay. And then I wanted to ask about, we've seen a lot of -- year-to-date, we've seen a lot of multiple compression for these aggregates names, maybe people worrying about the cycle getting long in the tooth. I mean, are you guys seeing any signs that we're late cycle instead of something else?

I think if you look at where we are normalized demand across most of our markets, we're still well below it. If you look at the underpinning drivers of demand, the private side, both res and non-res continues to be healthy. What we had suffered with in last year was the lack of flow-through of highway work as we talked a lot about. That's really pulling through. The thing that we've yet to see is the flow-through of non-highway infrastructure. I would tell you, we're on the cusp of that. We're starting to see that today in places like Florida, and it catches up to what's going on the growth in res and nonres. And that will be exciting to see. So it's a much smaller segment of ours. But -- so at this point, in the vast majority of our markets, we see steady continued growth, particularly with the onset of public demand.

We're well more than 50 million tons short, good bit more than that, of where we would expect to be mid-cycle. Our views on that have not changed. The numbers I gave earlier about just the amazing performance in this businesses, this franchise through the recovery so far, is about halfway through the recovery in terms of tonnage in our agg segment. And again, I think most people on this call understand that, that's still more than another 50 million tons below peak volumes from the asset base we have today. So we, like others in the industry, would still see a multiple year recovery ahead and one that allows for really a good compounding EBITDA margin improvements through time, which I think certainly we, but I think many others in our marketplace are very, very focused on.

Our next question will come from Phil Ng with Jefferies.

You're expecting double digit volume growth in the second half, which is certainly a nice acceleration. It sounds like you're expecting good momentum heading into next year. So just curious, how should we think about the growth trajectory going into '19? And is this pace sustainable?

I'd look at it this way. I think going into '19, and we've talked a lot about this, the private side continues to be healthy, particularly in our markets. The -- what -- and we've talked about this a lot, I think what you're going to see is that compounding effect on the highway demand as funds mature. And that's compounding within a state like Georgia as the DOTs mature and able to get work out and they're not going to wait on one job to finish to put another one out. And then you'll see the compounding effect between states. So a place like Georgia or Texas or Florida, which have very, very good growing highway programs, will be complemented with the onset of maturing DOTs and the money flowing through the shipments in places like South Carolina, Tennessee and California.

And while it's too early for us to give any specific numbers on '19, in our markets, we like the steady growth we see in residential. As we all know, that's -- there's plenty of demand. That's really still a supply-constrained marketplace. For our markets in our business, we still like what we see in private non-res, just what we're booking in our backlogs. We always keep an eye on that marketplace. It's got the benefit of some of those energy projects that Tom mentioned as we look to '19. The highway transportation Tom just talked about, that's a really good outlook for multiple years. And we've actually just recently begun to see, and it's very early, but the first signs, really the first signs of some improvement in what we call non-transportation public infrastructure, water systems, airport systems, schools, other things like that, and so it would be very encouraging if we see that continue. That's really been a laggard in the recovery so far. So very positive outlook. Again, we don't think we're running into capacity constraints relative to our shipment plans for this year. We'll need to keep an eye on that. Could we sustain growth at this quarter's 11% all the way through the recovery? Somewhere in some markets, we'll run into capacity constraints. But again, as others have said, our hours that just relate to largely logistics or our contracting customers, we've been very encouraged. And you've heard Tom say and we've pointed out what's been happening with construction deployment. So I would say keep in mind, at least as it relates to Vulcan markets that for this last 2-year period where we had disappointing public shipments relative to expectations, everybody fell within expectations, and they continued with construction hiring in our markets. So that's some of that capacity issue is a little bit alleviated right now because of the hiring pattern we've seen in our markets over the last 2 years.

We'll take our next question in the queue from Stanley Elliott with Stifel.

Quick question. All else being equal, when you think about kind of the mix impacts thus far this year, looking into next year, given what you've seen in your backlogs and the quoting activity, is regional mix a positive or a negative? Kind of thinking about those expectations.

I kind of go a little bit back to mix, as long as you're selling increased volumes, in any market is always good, because just, you're just adding more margin to the bottom line. So and as always, we do those from the bottom up. It's way too early for us to tell where we are. If you look at what's gone on with highway programs in markets like I mentioned Texas, Florida, South Carolina, Georgia, California, those are all very good-margin markets and play into our strength. So I think it really boils down to margins. And so you see the volumes going up. That can only help cost, particularly on the private -- in the public side because it's a better mix of how -- you have a better sales mix with that, and it matches your production mix better. So that helps price, as does the -- helps cost, as does the volume. We've talked a lot about price. You put all that together, and it's really why we're so excited for the second half of this year and '19 because those margins will just grow.

And so I think that Tom's point is really the main one, which is it doesn't really matter economically. That's, by far, the most important point. But from a headline reported number, as we get into next year, and we put a slide in here in the stuff that you can see, Stanley. But you know that Alabama and Illinois, which grew 14% in the quarter and are lower-price markets, those are not our fastest-growing markets long term. We've called that out over and over again. Our teams are -- they are doing a fantastic job running those businesses, but they don't have the same long-term visibility that almost the rest of our footprint has, at least not yet. So and the distribution costs that affected pricing in place like coastal Texas, you heard Tom say coastal Texas is rapidly turning in those dimensions. So in total, we'd expect what you got next year is an easier comp in the second quarter, if you will.

Yes. No, I think that's fair. I think that, that was the kind of line of questioning. I think there's a lot of momentum in some of these other states that should help from a mix perspective.

Absolutely.

And thinking about next year, right, I mean so if you guys are down to 2, 2.5x by the end of this year, you'd have some of your growth CapEx rolling off in addition to what should be very strong earnings, has that -- is M&A still kind of at the forefront? And/or maybe what are you seeing in terms of opportunities out there? And then part of it, too, kind of goes back to the repurchase piece, right? Because I think that there's a disconnect seemingly with the stock with the visibility that I think you all have and kind of what's been happening here as of late.

I would sum up M&A right now as I usually do with discipline, but a little bit different twist. We're going to remain incredibly disciplined when it comes to M&A. I think our focus right now is capturing the synergies of acquisitions that we've made. As always, we'll be very, very selective, but we're working real hard to make sure that throughout this year and '19 we capture the synergies of the very strategic growth projects that we've entered into and make sure that we capture -- have that going into '19.

And I think you're kind of getting more to the core of the issue, but -- so thanks for the question. You're right. Growth capital -- internal growth capital should be a lower number next year. We had a bump up this year, really again, as you've heard me say before, just because some projects would have been 10-plus years in the making, it made sense to turn on right now. The quarry in California, new quarry in Texas, for example. So our cash flow profile should continue to improve quite significantly, and it creates a lot of flexibility. So we wouldn't expect that our capital allocation priorities change at all, but there's a lot of flexibility, particularly as we get into next year. And it's something that you can tell we're very focused on as a management team. We've often laughed, this is a good problem to have, and we're going to work hard every single day to keep making it a bigger problem to have. So -- but our cash flow profile has benefited a lot from tax reform. It's benefited a lot from the embedded leverage in the business. You're going to continue to see some of the really good growth investments we've made over a number of years mature. So they're not done with their contribution. They're continuing to improve. And so again, a lot of flexibility in '19.

Perfect, guys. And John, best wishes to you. I'll be looking for you in 5 years, if we get off the 62% incremental. I'm just kidding. Take care.

All right. Thank you.

And ladies and gentlemen, our final question today will come from Scott Schrier with Citi.

I was wondering if you could talk a little bit about how much of your backlog might be comprised of these delayed projects that were priced a long time ago and how long we might see that for? And then I guess, as you think about right now, we might have the propensity with labor for some more project delays, what kind of measures do you take to account for the potential for delays and pricing mechanisms for the future in your current bidding?

I would point out, we've got a number of very long projects that we're shipping. I don't know if they've been delayed now. At this point we're shipping most of those. They'll ship throughout this year, maybe a little bit go into '19. But what's really important is the work you're bringing on is at much higher prices. And so that mix will flow out over time, it will take balance of this year, probably a little bit into '19 to do that. But everything you're adding on is at higher prices. And we like the way that flow is going. You can see it in our backlogs, and you can -- it supports our plan for the second half of 2018. As far as labor constraints, we don't have any labor constraints. John talked a little bit about this year, about this earlier, where we saw our customers with volumes basically flat grow their labor over the last 2 years, and they're reaping the benefit of that. If I had to weigh that, I would say the private, which is more labor-intensive, could have some constraints. The public shipments, which are coming on strong, I don't see those constraints. Not that they're not there to catch up, but on a day-to-day basis unless you have, as John said, a big event. John also mentioned logistics with some headwinds with rail and potentially some trucking at times. But we think those are guinea pigs. We got to work through them. But -- so pricing, as we've talked about, continues to flow through at higher levels. And I don't see a big impact on labor, unless, as John said, we have an event and you're playing catch up.

Got it. And then last question, on Illinois, which obviously has been a challenging market, and it looks like you lumped it together with Alabama on that slide to show pretty significant year-on-year growth. And to John's point that you don't think that maybe that's going to be sustained, I'm just curious, was this quarter an anomaly? Or are you seeing some better growth or just the demand environment in Illinois?

I think we're just seeing Illinois' big project work really driven by airport and tollways. We've had some good backlogs of that. We'll see some continue with that. The problem with Illinois is the DOT is obviously grossly underfunded and has issues and state budgeting has funding and -- has funding issues. So with the exception of big projects, which I think our folks have done a good job, and is right in our wheelhouse, the fundamentals there are tough.

And ladies and gentlemen, this does conclude our question-and-answer session for today. I would like to turn the conference back over to Tom for any additional or closing remarks.

Yes. Thank you all for joining us today. As you can tell, we're very pleased to see public demand kick in and the highway really kick off. We're seeing the benefit of that, and we'll see it for years to come. We've talked a lot about pricing, that jump in demand is driving price increases. And as time goes on, we'll continue to see that. All of this, coupled with really disciplined cost disciplines and enhancements, will drive margins. We're exactly where we thought we'd be right now in the year, and we're on track for our full year guidance. And we look forward to talking to you throughout the third quarter. Thanks.

Thank you. And again, ladies and gentlemen, that does conclude our conference for today. We thank you for your participation.