Granite Construction Incorporated — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited results; amounts below are in millions except per-share data. Construction results are seasonal and quarterly performance may not indicate full-year results.
Financial performance
- Q3 revenue: $1,055.6, up 10.3% year over year. Gross profit was $144.5 and gross margin was 13.7%, compared with $114.5 and 12.0% in Q3 2017. Operating income was $67.4, roughly flat with $66.8; net income attributable to Granite was $55.7 versus $46.0. Diluted EPS was $1.17 versus $1.14.
- First nine months: Revenue was $2,426.1, up 10.9%; gross profit was $281.1 and gross margin 11.6%, up from $214.2 and 9.8%. Operating income declined to $48.8 from $54.3. Net income attributable to Granite was $35.9 versus $36.3; diluted EPS was $0.84 versus $0.90.
- Segment trends: Q3 Water revenue rose to $124.3 from $36.4, mainly reflecting acquired businesses. Transportation revenue declined 2.2% to $610.8; Specialty fell 3.6% to $190.8; Materials increased 32.1% to $129.6. For the nine months, all segments grew in revenue, with Water and Materials posting the largest percentage increases.
- Cash flow and investment: Nine-month operating cash flow was $14.7, down from $64.6. Investing cash outflow was $81.3, including $55.0 net cash paid for acquisitions and $86.1 of capital expenditures. Financing cash inflow was $68.7, principally reflecting borrowing. Cash, cash equivalents and restricted cash increased $2.1 to $235.9; cash and cash equivalents on the balance sheet were $230.3.
- Liquidity and debt: Cash plus marketable securities totaled $311.4, including cash held in joint ventures that is generally not available for Granite’s working capital. Cash excluding consolidated joint ventures was $105.1. Total debt was $433.7; the $500.0 credit facility had $182.4 of unused availability. Granite reported compliance with debt covenants; leverage ratio was 1.74 against a 3.00 maximum under the more restrictive applicable test.
- Margins and expenses: Q3 SG&A increased to $70.8 from $49.5, and acquisition and integration expenses were $9.3. Nine-month acquisition and integration costs were $44.0. The nine-month effective tax rate fell to 14.5% from 29.4%, primarily reflecting U.S. tax reform and adjustments to provisional tax estimates.
Material changes and business developments
- Granite acquired LiquiForce in April for $35.9 cash and Layne in June in a $349.8 stock-for-stock transaction, with $28.8 cash for certain equity awards and assumed convertible notes. Layne contributed $129.1 of Q3 revenue; its Q3 pretax income was $8.6, including acquisition-related effects. Acquisitions expanded Granite’s water, drilling and international operations.
- Reported Q3 results reflect the adoption of Topic 606. Compared with prior revenue guidance, adoption increased Q3 revenue by $6.4 and Granite-attributable net income by $6.4; for the nine months, net income increased $8.8. Adoption also reduced opening retained earnings by $15.2 and changed balance-sheet presentation of contract assets and liabilities.
- Contract backlog was $3.24 billion at September 30, down from $4.23 billion a year earlier and $3.65 billion at June 30. Management said three project wins totaling more than $825 million were expected to enter backlog in late 2018 or early 2019.
- Total debt rose from $224.5 at December 31, 2017, reflecting acquisition financing and assumed debt. The Layne 8.0% notes were partly converted into Granite shares and the remainder redeemed in cash during Q3. The assumed 4.25% convertible notes, approximately $69.9, were due November 15, 2018.
Outlook, risks and contingencies
- Management described demand as stable to improving across its markets, citing increased state and local infrastructure investment, healthy water demand and private-market opportunities. It emphasized disciplined bidding and selecting work with returns appropriate to project risk. The filing gives no formal earnings or revenue guidance.
- Full-year 2018 capital expenditures were expected to be $105–$115 million. Management said available cash, securities, borrowing capacity and expected operating cash flow should meet anticipated needs for the next 12 months, while noting financing could be needed if results change materially or the company makes a significant acquisition.
- Management identified four projects with reasonably possible additional costs above amounts in forecasts; the aggregate potential adverse gross-profit impact ranged from zero to $45 million. Q3 and nine-month gross profit also included downward project-estimate revisions of $19.3 and $57.8, respectively, primarily in Transportation, associated with costs, productivity, weather and claim recoveries.
- Unresolved claims and change orders require significant judgment. Joint-venture performance obligations can expose Granite to costs if partners fail to perform; the filing reports $3.5 billion of remaining revenue on unconsolidated and line-item JV contracts, including $1.2 billion representing Granite’s share.
- Legal proceedings and government inquiries are in the ordinary course; recorded liabilities were described as immaterial, but reasonably possible losses could materially affect results if they become probable and estimable. New risks following Layne include foreign currency exposure and potential Foreign Corrupt Practices Act liabilities. California Proposition 6, if passed, could affect growth plans from 2019 onward; management did not expect a 2018 impact.
- Granite expected adoption of lease accounting in 2019 to increase reported assets and liabilities by approximately $45–$60 million, with an immaterial income-statement impact.
Important facts for investors to verify
- Whether the announced projects totaling more than $825 million entered backlog as expected, and how backlog conversion compares with new awards.
- Performance and integration costs of Layne and LiquiForce, including acquired business profitability and the final purchase-price allocation.
- Updates to project cost forecasts, affirmative claims and the potential $0–$45 million gross-profit exposure.
- Cash generation and working-capital trends, particularly joint-venture contributions and the availability of cash held by joint ventures.
- Repayment or refinancing of the 4.25% convertible notes due November 2018, debt levels and covenant headroom.
- Final tax-reform accounting, foreign-operation risks and any material developments in legal or government matters.