Granite Construction Incorporated (NYSE: GVA) — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; filed February 16, 2018. Granite is a U.S. heavy-civil contractor and construction-materials producer, reporting Construction, Large Project Construction, and Construction Materials segments.
Financial results and liquidity
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Revenue | $2,989.7 million | $2,514.6 million | +18.9% |
| Gross profit / margin | $314.9 million / 10.5% | $301.4 million / 12.0% | Margin down 1.5 percentage points |
| Operating income | $98.7 million | $92.4 million | +6.9% |
| Net income attributable to Granite | $69.1 million; $1.71 diluted EPS | $57.1 million; $1.42 diluted EPS | +21.0% |
| Cash from operating activities | $146.2 million | $73.1 million | Up $73.0 million |
| Cash, cash equivalents and marketable securities | $366.5 million | $317.1 million | +$49.4 million |
| Total debt | $224.5 million | $244.3 million | Down $19.8 million |
| Working capital | $576.8 million | $559.1 million | +$17.7 million |
Revenue rose across all three segments: Construction increased 21.9% to $1.665 billion, Large Project Construction increased 16.2% to $1.032 billion, and Construction Materials increased 12.1% to $292.8 million. Segment profitability diverged: Construction gross margin was 14.8% versus 15.3%; Large Project Construction margin fell to 2.9% from 7.2%; Construction Materials margin improved to 13.0% from 10.7%.
Operating cash flow improved principally with higher earnings, joint-venture distributions and working-capital changes. Capital expenditures were $67.7 million, down from $91.0 million; management anticipated $100–$105 million for 2018. Year-end DSO was 48 days versus 50 in 2016. Reported cash includes $94.4 million held by consolidated construction joint ventures, and joint-venture funds are generally not freely available for Granite’s working-capital needs.
Debt included $80 million of 6.11% senior notes, a $90 million term loan and $55 million drawn on the revolving facility. The company reported $136.7 million of unused credit availability and compliance with debt covenants at year-end. The board’s $200 million share-repurchase authorization remained unused; the annual dividend was $0.52 per share.
Material changes and unusual items
- Backlog reached a record $3.718 billion, up from $3.484 billion. Large Project Construction backlog increased 15.0% to $2.821 billion, while Construction backlog declined 13.0% to $897.0 million. Approximately $2.0 billion of year-end backlog was expected to be completed in 2018.
- Large Project Construction gross profit fell $34.3 million, primarily reflecting adverse project-estimate revisions. Net downward revisions of at least $1 million per project were $66.6 million in this segment. Three projects had reasonably possible additional costs that could adversely affect 2018 gross profit by $0–$44 million; one loss-making project represented $106.2 million of remaining backlog.
- Granite identified and corrected amounts associated with 2016 estimates: the filing reports a $4.9 million reduction to revenue and gross profit and a $1.6 million reduction to Granite-attributable net income in 2017, which management concluded was not material to the periods presented.
- The 2017 effective tax rate was 27.4%, down from 31.3%. Tax reform produced a provisional $3.7 million tax benefit; the final accounting remained subject to completion of analysis and the 2017 tax return.
- After year-end, Granite agreed to acquire Layne Christensen Company, subject to shareholder approval and other closing conditions. The announced transaction’s estimated stock-and-cash purchase price was approximately $360 million, excluding approximately $209 million of assumed debt. Granite obtained a commitment for a $370 million backstop facility if required lender consents or waivers are not obtained.
Outlook, management commentary and risks
Management described demand across markets and geographies as steady to improving, citing increased state and local infrastructure commitments and anticipated acceleration of California’s SB1 transportation spending in 2018 and beyond. It characterized the large-project market as robust, while emphasizing disciplined bidding and appropriate returns for project risk. No quantitative revenue or earnings guidance was provided. The company expected any incremental federal infrastructure program to have limited business impact before 2019 or 2020.
Key risks include lower-than-estimated project profitability, especially on fixed-price and fixed-unit-price work; delays, weather, design issues, labor and materials costs, subcontractor or joint-venture partner failures, and difficulties recovering claims. Backlog may be canceled or modified and is not a guarantee of profitable revenue. Other risks include dependence on government funding and contracting, competition, bonding and insurance availability, environmental and aggregate-permitting requirements, safety, pension-plan exposure, and interest-rate and commodity-price volatility. Caltrans represented 9.4% of 2017 revenue; approximately 81.8% of Construction and Large Project Construction revenue came from government-funded contracts.
Revenue and profit depend on estimates of costs to complete construction contracts, with changes recognized using the cumulative catch-up method. The company planned to adopt Topic 606 in 2018 and estimated a $15–$18 million cumulative decrease to retained earnings on adoption as of January 1, 2018. Auditors gave unqualified opinions on the financial statements and internal control over financial reporting.
Investor verification priorities
- Track Large Project Construction cost forecasts, estimate revisions, and the disclosed potential $0–$44 million adverse 2018 gross-profit exposure.
- Verify the quality, funding status, cancellation risk and expected conversion timing of the $3.718 billion backlog, including the concentration in large projects.
- Assess cash generation and usable liquidity separately from cash held in joint ventures, and monitor the 2018–2020 debt maturities and covenant headroom.
- Review the final tax-reform accounting and the actual retained-earnings impact of Topic 606 adoption.
- Confirm Layne transaction approvals, closing terms, assumed obligations, lender consents and financing needs.
- Monitor public infrastructure funding, project pricing and execution, claims recoveries, and government-contract concentration.