Granite Construction Incorporated — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Unaudited results; dollar amounts below are in millions unless noted. Granite operates Construction, Large Project Construction, and Construction Materials businesses.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $957.1 | $803.9 | $2,188.4 | $1,847.9 |
| Gross profit | $114.5 | $107.7 | $214.2 | $220.1 |
| Gross margin | 12.0% | 13.4% | 9.8% | 11.9% |
| Operating income | $66.8 | $53.9 | $54.3 | $63.5 |
| Net income attributable to Granite | $46.0 | $37.2 | $36.3 | $40.9 |
| Diluted EPS | $1.14 | $0.92 | $0.90 | $1.02 |
| Operating cash flow | Not separately presented | $64.6 | $(19.4) |
Revenue, margins, and segment developments
- Q3 revenue increased 19.1% year over year; nine-month revenue increased 18.4%. Growth reflected higher construction activity and materials sales.
- Construction segment revenue rose 24.6% in Q3 and 22.9% year to date. Construction gross profit increased, primarily with higher volume.
- Large Project Construction revenue grew 12.2% in Q3 and 15.5% year to date, but its gross margin fell to 2.3% and 1.3%, respectively, from 9.4% and 7.9%. Management attributed the deterioration chiefly to unfavorable project estimate revisions.
- Construction Materials revenue rose 9.1% in Q3 and 5.7% year to date, primarily on higher sales volume. Q3 gross profit also benefited from improved production volume and fixed-cost absorption.
- Despite higher Q3 gross profit, consolidated gross margin declined. Nine-month gross profit and Granite-attributable income were below 2016 levels.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $64.6 million, an $84.0 million improvement from 2016, mainly from increased joint-venture distributions and working-capital cash flow. Investing cash use was $39.1 million and financing cash use was $29.3 million.
- Cash and cash equivalents were $185.5 million and marketable securities were $117.8 million at September 30, 2017; combined total was $303.3 million. Some joint-venture cash is generally unavailable to Granite until distributed.
- Total current assets were $1,286.0 million and current liabilities were $717.2 million. Balance-sheet debt was $240.7 million, including $14.8 million of current maturities. The credit facility had $161.7 million of unused availability.
- Granite reported compliance with its debt covenants. Its 2019 Notes carry a 6.11% interest rate, with installments remaining through 2019; the credit agreement term loan matures in October 2020.
- Nine-month capital expenditures were $56.8 million. The company expected 2017 capital expenditures of $75–$85 million.
Material changes versus prior comparable periods
- Revenue expanded in both the quarter and year-to-date period, while nine-month gross profit, operating income, and Granite-attributable net income declined.
- The principal margin pressure was in Large Project Construction, where estimate revisions reduced gross profit by $19.3 million in Q3 and $58.1 million for the first nine months, on projects with individual estimate changes of at least $1 million.
- Backlog reached $4.2 billion at September 30, up 12.5% from a year earlier. Large Project Construction backlog rose to $3.1 billion; Construction backlog was $1.1 billion.
- Operating cash flow improved substantially from the prior-year period, when it was negative.
Outlook, risks, contingencies, and unusual items
- Management described public and private markets as highly competitive and cited modest economic growth, record backlog, and potential multi-year public infrastructure demand. It viewed the FAST Act as stabilizing funding visibility through 2020 and expected California’s 2017 infrastructure legislation to accelerate investment in 2018 and beyond. No specific revenue or earnings guidance was provided.
- Management emphasized selective pursuit of large projects based on risk and expected returns. Backlog may include awarded work whose funding is considered probable, and substantially all contracts may be canceled or modified by customers.
- Large-project cost estimates, productivity, design, weather, owner-related costs, claims, and back charges can change; the company disclosed reasonably possible additional costs, including liquidated damages, for which a range could not be estimated. Such changes could materially affect future results or cash flows.
- Customer affirmative-claim estimate revisions increased revenue by $11.5 million in Q3 and $25.5 million year to date. These are estimates and recoveries may vary. A review also identified a prior-period error: a $4.9 million reduction to Q3 2016 Large Project Construction revenue and gross profit and a $1.6 million increase in Granite’s net loss; management said the correction was not material.
- Adoption of revenue standard Topic 606 was expected in Q1 2018. Granite estimated a cumulative retained-earnings decrease of $11–$19 million at adoption, subject to change, and identified potential effects on performance obligations, contract accounting, and loss provisions.
- Recorded liabilities for legal proceedings and government inquiries were approximately $1.7 million. The filing states that reasonably possible losses above accrued amounts, including liquidated damages, could be material if they become probable and estimable.
- Granite noted seasonal weather effects and variability in project timing, collections, claims, and joint-venture cash flows. It said existing liquidity was expected to meet needs for the next 12 months, while warning that prolonged operating changes or significant acquisitions could require additional financing.
Important facts for investors to verify
- Whether Large Project Construction estimate revisions, claim recoveries, and potential liquidated damages lead to further margin changes or cash costs.
- How the $4.2 billion backlog converts into funded, executable revenue, particularly the large-project portion and customer cancellation or modification exposure.
- Collections and working-capital trends, including the rise in receivables and the availability of joint-venture cash.
- The final Topic 606 transition adjustment and related effects on reported revenue, contract assets and liabilities, and retained earnings.
- Capital spending against the $75–$85 million 2017 expectation, debt installments through 2019, and continued covenant compliance.
- Developments in legal proceedings, government inquiries, and unquantified project contingencies.