Granite Construction Incorporated (NYSE:GVA) Q3 2023 Earnings Call Transcript

Granite Construction Incorporated (NYSE:GVA) Q3 2023 Earnings Call Transcript October 31, 2023

Granite Construction Incorporated misses on earnings expectations. Reported EPS is $1.07 EPS, expectations were $1.41.

Operator: My name is Kate 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 2023 Conference Call. This call is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Granite Construction Inc. Vice President of Investor Relations, Mike Barker.

Mike Barker: Good morning and thank you for joining us. I am pleased to be here today with President and Chief Executive Officer, Kyle Larkin and Executive Vice President and Chief Financial Officer, Lisa Curtis. Please note that today’s earnings presentation will be available on the Events and Presentations page of our Investor Relations website. We begin today with a brief discussion regarding forward-looking statements and non-GAAP measures. Some of the discussion today may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are estimates reflecting the current expectations and best judgment of senior management regarding future events, occurrences, opportunities, targets, growth, demand, strategic plans, circumstances, activities, performance, shareholder value, outcomes, outlook, guidance, objectives, committed and awarded projects or CAP and results.

Actual results could differ materially from statements made today. Please refer to Granite’s most recent 10-K and 10-Q filings for a more complete description of risk factors that could affect these forward-looking statements. The company assumes no obligation to update forward-looking statements, except as required by law. Certain non-GAAP measures maybe 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 and adjusted earnings per share. The required disclosures regarding our non-GAAP measures are included as part of our earnings press releases and in company presentations, which are available on our website, graniteconstruction.com under Investor Relations.

Now I’d like to turn the call over to Kyle Larkin.

Kyle Larkin: Good morning and welcome to our third quarter conference call. We had a strong third quarter. Q3 marked our second consecutive quarter of top line growth we continue to grow our record cap on projects that should produce margins in line with our expectations. Just over 2 years ago, we stated that our goal was to transform Granite from what had become a volatile business into a business that earns predictable strong financial results, while also producing consistent, sustainable growth. We also shared our plan to earn adjusted EBITDA margins that Granite had not seen since the housing boom. To support this effort, we took significant actions on both the construction and material side of the business. For construction, the first step we took was to derisk our committed and awarded project portfolio or CAP.

We moved away from complex design-build projects and shifted our focus to best value and bid build projects and best value projects such as CMGC or Construction Manager General Contractor, we are better positioned to succeed as we worked collaboratively with the client to mitigate risk for the project. Although some best value projects have high total contract values, they are often separated in smaller work packages, which are then reviewed through multiple project workshops. We have constructed more than 60 best value projects, and they are generally completed quicker and with fewer claims. Our record high-quality CAP and macroeconomic construction market fueled by the federal infrastructure bill or IIJA puts Granite in the strongest position for growth and profitability in over a decade.

On the material side of the business, we said we intended to invest in our materials business and in the home markets to the banner of strength since our founding. For the past 3 years, we have invested in green field reserves, a liquid asphalt terminal, new automated aggregate plants and bolt-on materials investments. These actions have strengthened our positions in our profitable vertical integrated markets. We see further opportunities to strengthen our current home markets and to expand into new geographies. While much of the focus in the past couple of years has been on internal transformation, we are now growing and plan to pursue opportunities to drive growth and expand our footprint in both our Materials and Construction segments. Our 2024 strategic plan is designed to grow our margins.

The actions our teams have accomplished over the past 3 years gives me confidence that we are on track to achieve our 2024 financial targets. Now let’s review the performance in our segments for the quarter, starting with the Construction segment. Total CAP grew in Q3, continuing the trend over the last year. CAP increased $147 million from the second quarter and is up $1.5 billion or 37% year-over-year to $5.6 billion. This represents a second consecutive record CAP for Granite. In what is typically our largest revenue quarter of the year, growing CAP is a significant accomplishment for our teams. Robust market has produced a number of public and private opportunities that should allow us to continue to build high-quality CAP in the fourth quarter and as we move into 2024.

Further, I believe the IIJA funding will continue to expand bid opportunities in 2024 across all of our key markets, and we are well positioned to capitalize on those opportunities. Diving into our operating groups, and starting with the California Group, CAP was flat from the second quarter and increased $792 million or 51% from Q3 2022. This is a really impressive result as the group continued to win a significant amount of work, while achieving record third quarter revenue. Public spending in the state has been strong and is expected to continue. Earlier in the year, there were concerns about the state budget deficit that these concerns were resolved without impact transportation spending. During Q3, Caltrans, the State Department of Transportation, again, awarded their highest dollar value contracts at least 5 years.

Historically, high-bid opportunities are expected to continue in 2024. Moving to the Mountain Group, our most seasonal group, CAP decreased $65 million from the second quarter as the group posted year-over-year revenue growth of 12% in the third quarter. Despite the decrease in CAP during the quarter, the group ended with CAP of $1.4 billion remained significantly higher by $431 million or 43% year-over-year. Our Utah, Alaska, and Nevada regions continue to lead the group with strong CAP. With budgeted spending in each state and the group expected to increase in 2024 and the Mountain Group is poised for continued growth in the fourth quarter and 2024. Finally, in the Central Group, CAP increased in the quarter by $212 million sequentially, up $284 million year-over-year to $1.8 billion.

The increase in CAP was led by the tunnel division, which landed a $205 million tunnel project in Ohio and continued growth in the Texas region, home markets in Houston and Dallas. While the Central Group revenue was flat year-over-year in the quarter, I expect the group to return to revenue growth in 2024. The transformation of the Centural Group’s CAP has been tremendous and a key component to our expected margin expansion in 2024. Overall, the Construction segment had an outstanding quarter. We continue to build high-quality CAP, grow revenue and increase profitability in line with expectations. I believe we will continue to grow CAP and revenue in the fourth quarter and enter 2024, very well positioned to achieve our financial targets.

Moving to the Materials segment, we built on the momentum in the second quarter with another strong performance in the third quarter. As I mentioned last call, cost inflation to significantly impacted profitability last year normalized in 2023. These stabilized costs, combined with aggregate and asphalt price increases resulted in margin gains in the second and third quarters of 2023. Materials volumes and orders remained strong throughout the third quarter and going into the fourth quarter. In this market environment, I expect to realize further price increases in 2024. As we have previously reported, we’ve been investing in our materials business in numerous ways over the last 2 years. In the fourth quarter, we’re expecting the completion of major investments in two automation projects including a new fully automated aggregate plant.

These investments in our Materials segment should drive cost efficiencies and further margin expansion in 2024 in line with our gross margin expectations of 15% to 17%. Now I’ll turn it over to Lisa to review our financial performance for the quarter.

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Lisa Curtis: Thank you, Kyle. In the third quarter, revenue increased $108 million or 11% year-over-year to $1.1 billion, while gross profit increased $52 million to $167 million or gross profit margin of 15%. These results reflect a strong performance in both the Construction and Materials segments during the quarter. In the Construction segment, revenue increased $98 million or 12% year-over-year to $946 million, an outstanding result for the segment. The revenue increase was led by the California and Mountain Groups, which were up an impressive 21% and 12%, respectively, year-over-year. Entering the quarter with record CAP, the California Group’s significant year-over-year revenue increase was in line with our expectations as the group overcame a historically wet and slow start to the year.

Heading into Q4, I expect continued top line growth in the fourth quarter year-over-year and in 2024. The Mountain Group’s 12% year-over-year growth was led by construction revenue increases in the Alaska and Nevada regions, with our larger regions such as Utah and Washington also contributing meaningfully to revenue. Finally, in the Central Group, revenue in the quarter was flat year-over-year, with revenue in the growing Texas, Arizona and Illinois regions, offsetting declines in the Florida region as legacy projects rep up. Construction segment gross profit increased $44 million year-over-year to $137 million, with a gross margin impact of 14.5% up from 11% in the third quarter of the prior year. The gross profit margin includes a write-down on the I-64 high-rise bridge project of $8 million during the quarter with an impact to granted after non-controlling interest of $4 million.

The project continues to move towards completion, which is expected by the end of 2023. Despite the impact of I-64 in the quarter, Construction segment gross profit margin improved year-over-year as expected, led by our higher quality CAP compared to the prior year. Over the past year, we have one work at higher margins and we are seeing the benefits in our gross profit margin. In the Materials segment, revenue increased $10 million year-over-year to $171 million, with gross profit increasing $7 million to $29 million or a gross profit margin of 17%. The improvement in gross profit margin was primarily due to sales price increases in both asphalt and aggregates and stable oil and energy costs. The year-over-year increases in revenue and gross profit resulted in third quarter adjusted diluted earnings per share of $1.69 and adjusted EBITDA margin of 11%.

Our non-GAAP adjustments during the quarter included a litigation charge of $8 million in other costs related to the settlement of the Salesforce Tower matter. At the end of the third quarter, our cash and marketable securities totaled $329 million, up from $251 million in the second quarter. During the quarter, we also paid off our outstanding revolver draw in the amount of $55 million, resulting in a net debt reduction of $133 million. Third quarter profit and favorable movement in key working capital full accounts produced strong operating cash flow in the quarter of $153 million. We reduced net contract assets by $55 million from the second quarter as billings, cash collection and overall activity from projects ramping up in the second quarter progressed through the heart of the construction season.

I am pleased with our progress in the quarter and expect the trend of strong cash generation to continue in the fourth quarter as seasonally high receivable balances are collected. I believe as we settle older outstanding claims in conjunction with our derisked business model, our cash flow will continue to significantly improve. Our third quarter performance was directly in line with our 2023 guidance expectations, and we are not changing our guidance. I believe we could achieve the higher end of our revenue and adjusted EBITDA margin ranges, if we continue to have favorable weather conditions in the fourth quarter, and we continue to execute across our portfolio. We are also maintaining our 2024 financial targets of $3.6 billion to $3.9 billion in revenue and adjusted EBITDA margin of 9% to 11%.

We believe we have the market opportunities and the CAP to reach our 2024 targets that will then lead to even further gains beyond 2024. Now I’ll turn it back over to Kyle.

Kyle Larkin: Thanks, Lisa. I’ll close with the following points. Although we grew our top and bottom lines in the quarter in alignment with our guidance for 2023 and 2024 financial targets, our results were impacted again by I-64, while less impactful than prior quarters, we can’t finish this job soon enough. Fortunately, we expect to complete the project this year. Revenue growth during the quarter was consistent with the strong CAP position our teams had when heading into the quarter. I’m impressed that even though the third quarter was our busiest quarter, we were still able to continue to build CAP as we have done in each quarter over the last year. We ended the third quarter with another record CAP in a great position for the fourth quarter and 2024.

I believe we will continue to build CAP over the next year as we are still in the early stages of projects going out for bid funded by the IIJA. We’re being selective in the projects that we bid that are winning or better margins year-over-year. That is really a good sign for Granite and the industry. Lastly, the Materials segment is performing very well. We continue to invest in the Materials segment, and I believe we will see top line growth and bottom line expansion as those investments come online. Operator, I will now turn it back to you for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Steven Ramsey with Thompson Research Group. Please go ahead.

Brian Biros: Hi, good morning. This is actually Brian Biros on for Steven. Thank you for taking my questions.

Kyle Larkin: Hi, good morning.

Brian Biros: First of all, the CAP growth in the Central region was very strong. Can you guys just talk more to the project set that you fill the CAP with there? I think you mentioned a few projects in the prepared remarks. Are there any other specific types of projects you’re targeting? And just how does the margin profile on those compared to the other Mountain California regions?

Kyle Larkin: Yes, so good question. Our business down in Texas and our Texas region. That was one of our initiatives a couple of years ago to really shift back to that home market strategy, specifically within our Texas region. And they’ve been focused on two primary markets today: Dallas-Fort Worth, which we’ve been in the market for a long time and also in the Houston market. And so we’re seeing that home market strategy pay off for that team. Historically, we’ve been pursuing large projects and mega projects out of that office across the country. So this home market strategy for them is really focusing on smaller DOT jobs, projects that are fully designed, the bid build type projects that they can execute on and perform at a high level.

And that’s really what their portion of the CAP is. It’s – the average job size now for them is probably pretty close to $50 million, maybe $75 million, which is a lot different than historically the type of work that they would have on the book. So that’s just a great example of how we shifted away from really risky projects and asked our teams to focus on a home market strategy, and they’ve done a really nice job of executing on that. From a margin profile perspective, it’s right in line with the rest of the company and where we expect to be directionally as an organization moving in 2024.

Brian Biros: Got it. Thank you. And then a follow-up, maybe as the construction gross margins overall, looks like it might have been above 15% if you exclude the I-64. Is that the right way to think about the gross margins there? And if you can just put kind of the year-to-date gross margins of that segment ex the oldest projects in the perspective kind of seems like you’re maybe already within the targeted zone for next year. So just thinking about how to reach the high end of that in ‘24?

Kyle Larkin: Yes, we’re pretty close. I think if you adjust out I-64, we’re just below the kind of the range that we put out there of 14% to 16% for 2024. We have a few other things going for us. Certainly, we’ve been focusing on execution as a company for a while. We put in place our construction playbook across the company, and that’s been moving forward, and the team have been adopting the playbook and implementing it across the organization. And so we expect to see further margin expansion and construction through our efforts on that front. And then the other thing to think about is our CAP. So our CAP has gotten stronger. As we’ve talked in the last few quarters now, we’re picking up more work with higher margins.

And so we’ve seen that trend continue through Q3. And so as projects get burned through in construction. We bring new CAP into construction, we expect margin expansion on that end. So that gives us with the confidence that we’re going to be well within that range of 14% to 16% as we get into 2024.

Brian Biros: Okay, thank you.

Kyle Larkin: Thank you.

Lisa Curtis: Thank you.

Operator: The next question is from Brent Thielman of D.A. Davidson. Please go ahead.