Granite Construction Incorporated (GVA) Earnings Call Transcript & Summary

Good morning. My name is Chloe, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Granite 2026 Second Quarter Conference Call. This call is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Granite Vice President of Investor Relations, Mike Barker.

Good morning, and thank you for joining us. I'm pleased to be here today with President and Chief Executive Officer, Kyle Larkin; and Executive Vice President and Chief Financial Officer, Staci Woolsey. Please note that today's earnings presentation will be available on the Events and Presentations page of our Investor Relations website. We begin 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 may be 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 adjusted earnings per share, cash gross profit and cash gross profit per ton. 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.

Thanks, Mike. Let's start with the Construction segment. I'm pleased to report that cap growth continued to be strong, increasing $250 million sequentially to $7.4 billion as project wins outpaced revenue burn in what was a very strong [ growth ] quarter. The increase was driven by a healthy and active bidding environment across our markets as well as the addition of Kenny Seng Construction. This record CAP underscores the strength of our end markets, the effectiveness of our growth initiatives and provides strong visibility into future revenue. We continue to see significant opportunities to grow CAP leveraging our leadership and publicly funded transportation infrastructure, while expanding our presence across a broader set of end markets. Publicly funded work for state and local departments of transportation a cornerstone of the Granite's and continues to support both our Construction and Materials segments. Over the past several years, the IIJA has provided significant funding to transportation agencies across our footprint. With the sustainable portion of those funds still available for deployment, we continue to benefit from a strong and robust transportation market. In May, the UN House Representatives introduced the BUILD America 250 Act, or BA250. BA250 is designed to be the successor to the IIJA, which is expiring in September. While BA250 does not currently contemplate significant increases in highway funding, we view the draft positively because the shift to funding mix towards formula-based programs and bridge investments and away from larger discretionary mega projects. We believe this funding approach aligns well with Granite's geographic footprint and capabilities. While the timing and final content of the bill remain a work in progress, we expect the final bill may have a higher level of ending than the current draft, and we believe bipartisan support for infrastructure investment will sustain elevated funding levels, whether through new legislation or by way of a funding extension. Against this backdrop, we see significant opportunities for continued growth through market share gains in our home markets, increased participation and collaborative contracting delivery methods, such as construction manager, general contractor and progressive design build, and disciplined geographic expansion, both organically and through acquisitions. These collaborative contracting delivery methods foster earlier engagement with project owners, better alignment throughout project execution and more balanced risk sharing. Over time, this approach has enabled us to build a higher-quality project portfolio and reduce volatility, allowing us to deliver more predictable outcomes, including improved margins. Importantly, Granite has a much broader and more diversified growth platform than it did just a few years ago. By leveraging Granite's geographically diverse home markets, we have strategically expanded into attractive end markets to complement our traditional strengths and deepen relationships with key clients. This includes growing our federal business, increasing our participation in rail and transit infrastructure and establishing a meaningful presence in data centers like development. Within federal, we've invested for more than a decade to build our capabilities, establish customer relationships and broaden our geographic reach, from the armed forces versus to the Department of Homeland Security to the U.S. Army Corps of Engineers. We have participated in building a nation's federal infrastructure in a variety of civil projects across United States in Guam. While the recently won task infrastructure projects provide near-term revenue growth in 2026 and 2027, we believe the greater opportunity lies to long-term expansion of our federal business, leveraging the strong customer relationships, proven execution and expertise we have developed. Class 1 railroads continue to make significant investments in their infrastructure, with a particular focus on expanding intermodal capacity and increasing the movement from truck traffic to rail. Supported by a strong history of successful project execution and collaboration with these customers, Granite is well positioned to capitalize on growing opportunities within the rail market over the next several years. Mission-critical infrastructure, such as data center site development, there's another significant growth opportunity that structures across our footprint. Granite has over a decade of experience working with developers, vertical builders and hyperscalers in the civil infrastructure needs of data center construction, primarily in the Pacific Northwest and the [indiscernible]. Earlier this year, we launched a dedicated data center division with specialized leadership and resources to support these important clients across Granite's footprint. This team works alongside our regional operations to pursue, win and successfully deliver data center projects while providing a consistent best-in-class client experience. As a result, data center-related CAP is increasing from $65 million a year ago to $223 million at the end of the second quarter. Given the substantial demand driven by AI and digital infrastructure investment, we continue to see a robust pipeline of opportunities across many of our markets and expect this end market to remain an important contributor to CAP growth in 2026 and 2027. The common theme across our rail, federal and data center pursuits is our ability to leverage the capabilities of our geographically diverse home markets to serve strategic clients in attractive markets. We have the people, equipment and expertise and relationships to capitalize on these opportunities efficiently and to scale. This same platform also positions us to pursue additional end markets over time, inputting water and power infrastructure, markets that we believe are poised for meaningful long-term investment. Taken together, our record CAP and strong opportunities across public and private markets give us confidence that Granite can continue to grow while driving sustained margin expansion in both the near and long term. Turning to the Materials segment. Second quarter results underscore the strength and resilience of our Materials platform. Severe weather disrupt reduction and sales activity across the Southeast in the second half of the quarter, but our teams continue to execute well against those challenges. Overall, aggregate and asphalt volumes increased year-over-year, both from acquired companies and on an organic basis. Demand for Construction and Materials remains healthy across our footprint with orders outpacing prior year levels. This demand environment continues to support pricing, and through the second quarter, we are realizing our targeted mid-single-digit aggregate price increases. We also continue to execute on strategic capital improvement projects, including automation, planned investments, and reserves expansion. These investments align with our long-term strategy to improve production efficiency, lower operating costs and strengthen our competitive position in our home markets. Finally, we continue to closely monitor the increases in oil prices driven by geopolitical uncertainty in the Middle East. Energy prices during the second quarter were in line with our expectations, and the impact on segment performance was minimal. increases in [indiscernible] and diesel costs were largely mitigated through a combination of fixed-forward contracts, physical storage, financial hedges and energy surcharges. I am pleased with the resilient performance of our teams. Demand remains healthy. Pricing is tracking to expectations, and we continue to make investments in Materials segment that we believe will support long-term growth and margin expansion. Now I'll turn it over to Staci to review our financial performance for the quarter.

Thanks, Kyle. We delivered significant second quarter growth by building on the momentum generated in the first quarter and continuing to execute on our strategic priorities. Compared to the same period in the prior year, revenue increased 29% to $1.5 billion. Gross profit increased 20% to $239 million. Adjusted net income increased by $15 million to $101 million. And adjusted EBITDA increased by $34 million to arrive at $186 million. We also generated year-to-date operating cash flow of $142 million. In the Construction segment, revenue increased $270 million or 29% year-over-year to $1.2 billion. Of the growth in the quarter, $98 million, or 11%, was attributable to acquired businesses, while organic growth contributed $172 million, or 18%. Our revenue growth was driven by our record CAP and strong project execution across many of our geographic markets. Gross profit margin increased slightly year-over-year, a strong outcome given the difficult comparison against the prior year. We recognized favorable claim recoveries in both periods. However, the gross profit margin impact was less significant in the current year due to increased revenue this year. As we enter our busiest quarter, the Construction segment is performing ahead of our expectations and is well positioned to deliver strong full year results. Materials segment revenue increased [ $60 million ] year-over-year to $248 million with acquired business contributing $60 million in the quarter, led by Warren Paving. Total aggregate and asphalt revenue, prior to consolidation adjustments between our segments, increased $111 million, led by a significant increase in internal asphalt sales during the quarter of $42 million or 73%. While the majority of our volume growth was driven by the acquired businesses, we also delivered stronger-than-expected organic volume increases. With Materials orders ahead of the prior year and pricing performing in line with expectations, the Materials segment remains on track to deliver another year of profitable growth despite margin headwinds experienced in the second quarter. Gross profit margin decreased 800 basis points, and cash gross profit margin decreased 310 basis points, driven by severe weather in the Southeast as well as higher production costs associated with development activities in the quarter. Turning to cash flow. Year-to-date cash provided by operating activities was $142 million compared to [ $5 million ] in the prior year. Generating this level of operating cash flow in the first half of the year is a significant achievement and demonstrates the quality of our earnings and execution across the business. We expect our operating cash flow in the second half of the year to be consistent with our traditional seasonality. With this performance through June, we are raising our annual operating cash flow target from 10% to 11% of revenue. The second quarter marked an important step forward in strengthening Granite's capital structure. We secured inaugural credit ratings from Moody's and S&P, successfully completed a $600 million senior unsecured note offering and called our remaining 3.75% convertible notes. Together, these actions strengthened our balance sheet, enhanced financial flexibility and expanded our access to capital. The proceeds of the senior unsecured notes will mainly be utilized to settle the 3.75% convertible notes. We elected to settle the majority of our conversion obligation with cash rather than shares to minimize dilution. We expect to use approximately $570 million of cash, net of proceeds from the unwind determination of the associated CAP call transactions to settle conversions with the remainder to be settled in shares. Based on our current assumptions, this approach is expected to reduce adjusted diluted shares outstanding by approximately 2 million shares and preserves the financial flexibility to pursue our growth acquisition and capital allocation strategy. With Granite's share price increasing significantly since the 3.75% convertible notes were issued, redeeming the notes ahead of maturity reduces potential future dilution associated with the convertible notes and represents another important milestone in optimizing our long-term capital structure. During the quarter, we recorded nonoperating charges of $363 million related to our convertible notes, which were excluded from adjusted net income and adjusted EBITDA. The primary drivers were a loss on remeasurement of the conversion option derivative embedded in the 3.75% convertible notes and amortization of debt discount. The remaining debt discount of $270 million will be recognized as interest expense in the third quarter. The change in the fair value of the conversion option derivative through the settlement of the notes in the third quarter will be recognized in the income statement as a nonoperating gain or loss as applicable. Our strong cash generation and balance sheet, particularly when coupled with support from the credit market, puts us in an excellent position to continue executing on our M&A and capital allocation strategy. which includes opportunistic share repurchases. We believe we have the capital, balance sheet flexibility and organizational capacity to complete additional acquisitions this year, and we continue to see a robust pipeline of M&A opportunities. Now let's turn to an update on guidance for the year. With our performance in the first half of the year, CAP balance and project opportunities ahead of us, we are increasing our revenue guidance to a range of $5.3 billion to $5.5 billion from a range of $5.2 million to $5.4 million. This reflects annual organic growth of approximately 12% and growth of approximately 10% from acquired companies at the midpoint of the range. We are also increasing our organic revenue growth expectation for 2027 from a range of 6% to 8% to above 10%. This represents a substantial increase in our growth outlook and reflects the visibility provided by our CAP, the public infrastructure funding environment and the opportunities we continue to see across our end markets. Our annual guidance for adjusted EBITDA margin, SG&A expense as a percent of revenue, adjusted effective tax rate and CapEx is unchanged. Now I'll turn it back over to Kyle.

Thanks, Staci. I'll close with the following points. I am confident that the strength of our public and private end markets, combined with the strategic actions we have taken, Granite is well positioned to continue growing revenue across our footprint, whether serving clients and data center in Granite, intermodal rail infrastructure, federal projects for our core transportation markets, our teams have the capabilities to deliver. I believe we have the teams, capabilities and expertise necessary to capitalize on the opportunities ahead of us and continue to grow our record CAP. In the Materials segment, we are encouraged by the strength of demand across our markets and the level of orders entering the third quarter. Our teams are resilient to the second quarter, and I believe we remain on track to achieve our margin targets both in 2026 and 2027. Given our strong first half performance, record CAP and opportunities ahead, we raised our 2026 revenue guidance and increased our expectation for organic growth in 2027. Finally, M&A pursuits are very active. We closed on the Kenny Seng Construction acquisition this quarter and believe we will close on additional transactions in 2026. Disciplined M&A remains an important component of our long-term growth strategy. We continue to evaluate opportunities to strengthen our market position, expand our geographic footprint and create long-term shareholder value. Operator, I will now turn it back to you for questions.

[Operator Instructions] Our first question is from Brent Thielman with Oppenheimer.

Yes, I guess, just first question on the thoughts on Materials in the second half. Kind of margin recovery opportunity, obviously, some nuances here in the quarter with adverse weather and some other factors, but maybe you could just talk about your sort of cash, gross profit margin, expectations for the year for that business group as you move into the second half.

Yes, yes. Thanks, Brent. First, I'll start with some things I think are really positive. In the quarter, demand was strong, as we mentioned, both internal and external, which is good both in the external market. Obviously, we're still seeing a lot of public infrastructure demand data centers in certain markets, manufacturing. And our teams are executing well on the pull-through strategy. So I think that's -- I'm really pleased in the quarter. Our pricing is still at mid-single digits on the ag, so that's holding. So from a pricing/demand perspective, we feel really good. It is unfortunate we did have -- we also [indiscernible] weather in the Southeast. We'll put in the ballpark of around $10 million in the quarter. So that obviously has a drag on our margins. But we feel good about the outlook for the full year. Those tons will shift to the right, and we expect to be where we want to be by the time that we wrap up 2026.

Got it. Appreciate that, Kyle. Yes, I guess, and just in terms of the kind of improved organic growth outlook for 2027 from 6% to 8% to now plus. And Kyle, I mean, in light of not having a highway reauthorization and waste and seemingly that getting pushed out, what else kind of -- I guess, what gives you the confidence around that improved profile? If you could just unpack some of the different factors that led you to increase that would be helpful here.

Yes. I think there's probably 2 things that we point to. First is our strong CAP balance. Obviously, it's another record-level and highest quality CAP in our opinion in the company history, which is something we've been able to say now for a few years. That CAP gives us a lot of visibility. So today, we have a lot of visibility being halfway through 2026. We raised our guidance for the remainder of this year based on that visibility and maybe a lot more visibility into 2027. And I think that's really combined what we believe is still a healthy market, both in the public and the private sectors. . So the bid opportunities are really strong, continue to be strong, and our teams continue to demonstrate the fact that they can execute within the environment. So we feel very confident in 2026 and 2027.

The next question comes from Kevin Gainey with Thompson, Davis.

I was hoping that maybe we could dive into the comments you made around data centers. You said the backlog up from $60 million to $250 million, I think. Maybe you could talk about the success that your teams have in there and then maybe what that can also grow to over time?

Yes. So last year, at this time, we had a CAP of around $65 million within the data center space. Today, it's around $225 million. And as I mentioned on the last call, we have dedicated leadership within that part of our business today and leading that effort. And really, their job is to help [indiscernible] and support all the local business we have within our home markets, to support these clients and what they're trying to build. So we've made a lot of strides in a very short amount of time, which we're encouraged by. I think the fact that we've had so much success really just in the last 6 months or so, just [indiscernible], we have a great service office offering for these clients, we can deliver these contracts safely, at speed and quality. So we expect to see it grow, as we mentioned before. We want it to be around 10% or better of our annual revenue, and I think we're on track to doing that relatively quickly.

Appreciate the color there. And then maybe as well, if we could touch on, I know, Brent talked about margin recovery, but maybe if we could talk about if there's going to be further costs associated with quarry development activities that would also kind of hold margins down? Or is that just a onetime or the first half kind of environment?

Yes, I look at it more at the first half environment. And I would say the kind of plant set up for redevelopment was the ballpark about a $5 million impact in the quarter. So yes, we wouldn't expect to see that similar drag in Q3 or Q4.

The next question is from Michael Dudas with Vertical Research Partners. Michael, your line may be muted. Okay. Our next question comes from Trey Grooms Stephens.

So maybe if we could talk about the kind of preliminary DOT budgets for '27 that are out there. It seems like funding levels look pretty good in Granite state. California budget is above national average. Texas looks down, but I think that's more optical given that they have a biannual budget. But combined with also the where we are with reauthorization of IIJA, likelihood of CR, how are you thinking about the infrastructure demand backdrop kind of looking into the fiscal '27 outlook?

Yes. I think from an overall market perspective, we still feel like the book market is healthy. We're bidding more. We're -- today, we're adopting more work as well. So that's kind of the first driver that tells us we're improving and you can see it in our CAP. I think that, from an IA perspective, we're about 50% spent. So I think they obviously don't get allocated. It expires in September but continue in '27, '28 and '29, '30 likely. So it's not like the funds just turn off. We think that there likely will be some sort of funding extension while they still sort out what BA250 will look like. I think there's 3 things that we look at in BA250 that are positive. First is, it looks like it will maintain a high level of public infrastructure investments, so that's good. The second is it's more formulaic than brand-based. And that really means that the spend will be more directly focused on the types of work that we do and the size of projects that we perform very well. And at these levels, combined with our market strategies, we feel very confident that we can grow our business over the long haul. So I think today, it's just to be determined on what this [indiscernible] like ultimately, but what we've seen so far, will still allow us to do what we want to do as a company.

Got it. Okay. And then maybe just more for housekeeping. Could you -- any details you could share on the Kenny Seng acquisition? Maybe how much it added to CAP or any details around that, please?

Yes. Kenny Seng, almost a full quarter with Kenny Seng in Q2, and that business continues to perform very well. Integration has gone very well. Their CAP for the quarter is about $150 million. .