Granite Construction Incorporated (NYSE: GVA) — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Financial statements are unaudited. Amounts below are in millions except per-share data.
Business context and outlook
Granite provides infrastructure construction and construction materials, with operations grouped into California, Central and Mountain and reportable segments of Construction and Materials. Most Construction revenue is from public-sector work. Management cited inflation, supply-chain and labor constraints, alongside strong state and local funding. It expects the Infrastructure Investment and Jobs Act to support project lettings beginning in 2023, with more meaningful impact in 2024 and beyond.
Committed and Awarded Projects (CAP) was $4.08 billion at quarter-end, down from $4.33 billion a year earlier. Management said market conditions in key markets remain strong. CAP includes executed, funded work and certain other awards; it is not equivalent to revenue guidance.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $1,009.8 | $1,062.1 | $2,514.2 | $2,696.2 |
| Gross profit | $120.4 | $119.9 | $278.0 | $300.2 |
| Gross margin | 11.9% | 11.3% | 11.1% | 11.1% |
| Operating income | $60.0 | $43.7 | $77.0 | $26.6 |
| Net income attributable to Granite | $73.4 | $35.0 | $77.6 | $23.3 |
| Diluted EPS | $1.44 | $0.73 | $1.56 | $0.49 |
- Q3 revenue fell 4.9% year over year, mainly as large Central projects wound down and following the Inliner sale. Construction revenue declined 8.2%; Materials revenue rose 17.3%, reflecting higher prices, energy surcharges and aggregate demand.
- For the nine months, revenue fell 6.7%. Construction revenue declined 9.7%, while Materials revenue rose 14.3%.
- Q3 gross profit was nearly flat; nine-month gross profit declined 7.4%. Construction profitability was affected by adverse project estimate revisions, while Materials margins faced higher energy, fuel and liquid asphalt costs.
- Operating income improved despite lower revenue, supported by lower selling, general and administrative expenses and substantially lower other costs than in 2021.
Cash flow, liquidity and debt
- Operating cash flow was negative $14.6 million for the first nine months, versus positive $59.9 million in 2021. Management attributed the deterioration primarily to working-capital timing; net cash used in working capital increased $85.7 million.
- Investing activities provided $13.9 million, including $142.6 million of proceeds from the Inliner sale, partly offset by capital spending and purchases of marketable securities. Financing activities used $157.8 million, including term-loan repayment, share repurchases and dividends.
- Cash and cash equivalents were $255.1 million and marketable securities were $61.4 million at September 30. Cash includes $112.5 million held by consolidated construction joint ventures; joint-venture funds may not be available for Granite’s general working-capital needs.
- Total debt was $288.3 million, comprising $230.0 million of 2.75% convertible notes and $50.0 million drawn on the revolver, net of debt issuance costs and other items. The notes mature November 2024. The $350 million revolving credit facility matures June 2027; unused availability was $267.0 million after borrowings and letters of credit.
- Granite reported covenant ratios within requirements: leverage ratio 1.89 versus a maximum 3.25; interest coverage 10.15 versus a minimum 3.00.
- Capital expenditures were $97.8 million for the nine months. Management expected full-year 2022 capital expenditures of approximately $120–$130 million.
Material changes and unusual items
- Granite sold Inliner in March for a stated purchase price of $159.7 million, subject to adjustments; it received $142.6 million in cash and recorded a $6.2 million gain. In September it chose to retain Water Resources and Mineral Services because market conditions did not support an appropriate sale value. Those businesses returned to continuing operations, with prior periods conformed; Q3 included $8.2 million of catch-up depreciation and amortization.
- Q3 and nine-month 2022 income taxes included benefits associated with reversing deferred tax liabilities after the retention decision and releasing valuation allowances on capital-loss carryforwards. Effective tax rates were negative 10.3% for Q3 and negative 1.0% for the nine months.
- Construction contract estimate revisions included a Q3 net $15.2 million reduction in gross profit from one project, driven by extended duration, higher labor and materials costs, and disputed work. For the nine months, six projects had downward revisions totaling $63.2 million. One claim-related upward revision added $8.0 million to Q3 gross profit.
- The company completed an SEC settlement without admitting or denying allegations, agreed to a $12 million civil penalty, and paid it in September 2022. It also received $5.0 million, net of fees, from a shareholder derivative settlement, recorded as income.
- In a Salesforce Tower foundation dispute involving subsidiary Layne, plaintiffs seek approximately $70 million and $30 million in claims, later consolidated. Granite said a material loss was not probable, but estimated the reasonably possible loss could be up to approximately $100 million if unsuccessful.
- The 2021 securities class-action settlement totaled $129 million, funded with $66 million from Granite and $63 million from insurance; final approval was granted in March 2022. The filing reports the settlement liability and escrow arrangements.
Risks and investor verification points
- Verify the sustainability of improved earnings, given lower revenue, project estimate volatility, the Q3 tax benefit and other nonrecurring legal items.
- Track operating cash conversion and working-capital requirements, including contract assets, receivables, retention balances and joint-venture funding needs.
- Review CAP composition, conversion timing and the six loss-forecast contracts; approximately $2.2 billion of unearned revenue was expected to be recognized within 12 months.
- Monitor inflation, supply-chain and labor effects, materials margins, and the timing and scale of expected IIJA-funded work.
- Assess exposure from the Salesforce Tower litigation and other legal proceedings; outcomes and potential losses may change.
- Consider dilution and refinancing implications of the $230 million convertible notes, including their November 2024 maturity and conversion terms.
- Management stated that liquidity was expected to meet requirements for the next 12 months and long term, but this depends on operating cash generation and continued access to capital. Results are seasonal and the filing cautions that interim results are not necessarily indicative of full-year performance.