Granite Construction Incorporated
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Good morning. My name is Laura, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Granite Construction Investor Relations Second Quarter 2017 Earnings Conference Call. Please note this event is being recorded. All lines have been placed on mute to prevent any background noise, and after the speakers' remarks, there will be a question-and-answer session. Please note we will take one question and one follow-up question from each participant. It is now my pleasure to turn the floor over to your host, Granite Construction Vice President of Investor Relations and Government Affairs, Ron Botoff. Sir, the floor is yours.

[Ronald Botoff:]

Thank you. Good morning. Welcome to the Granite Construction Incorporated's second quarter 2017 earnings conference call. I am pleased to be here today with President and Chief Executive Officer, Jim Roberts; and Executive Vice President and Chief Financial Officer, Laurel Krzeminski. We begin today with an overview of the company's Safe Harbor language. Some of the discussion today may include forward-looking statements. Actual results could differ materially from the 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 projections and assumptions. The company assumes no obligation to update forward-looking statements whether as a result of new information, future events, or otherwise. Certain non-GAAP measures may be discussed during the call and from time to time by the company's executives. And please note that a reconciliation of certain non-GAAP measures is included as part of our earnings press release. For more information, please visit our Investor Relations website at investor.graniteconstruction.com. Thank you. Now, I would like to turn the call over to Granite Construction, Incorporated Chief Executive Officer, Jim Roberts.

[James Roberts:]

Well, good morning, everyone, and thank you for joining us to discuss our second quarter results. I spoke today thanking Granite employees and teams who navigated safely out of a muddy gate in the second quarter, helping to deliver strong growth. Granite team's safety performance started solidly in 2017, and we remain on track to the safest year in our company's history. We expected it was going to be a busy year, and we expected strong growth in 2017, and we have not been disappointed. The business environment continues to trend positively, providing our businesses with private and public market opportunities balanced across geographies. Our teams are responding to these increased revenue opportunities reflected in an all-time record company backlog which crossed the $4 billion mark for the first time in Granite's more than 95-year history. Before I hand the call to Laurel to discuss our results and guidance, let me spend a few minutes with you on our operational performance and on our encouraging outlook for growth. Let's begin with the Large Projects Construction segment. Second quarter performance again was impacted by accelerated work toward completion on a number of challenging projects that represented a significant amount of segment revenue in the quarter. We continue to take action to incorporate what we have learned into existing and future projects to better anticipate challenges, to price this complex work appropriately, and to improve our overall job performance, both financial and operational. Our focus remains on increased pricing which will allow the project portfolio to again produce results in line with our mid-teens gross margin project return expectations over the next few years. Acceleration of the mature projects in the quarter and year-to-date increased their drag on segment quarter results so we are working to finish these projects as quickly as possible in 2017 and in 2018. We are proud to be playing a key role in building some of America's greatest transportation and infrastructure projects today. But as we work to complete great civil public works projects and look ahead at future bidding and building opportunities, we recognize that we, as a company and as an industry, must be compensated much more appropriately for the significant shift in risk that owners have passed on to builders in recent years. With an expectation for significantly higher returns, we continue to focus on project selection, partner selection, project duration, and owner dynamics. Looking ahead, today's solid performance across the newer projects in our Large Projects portfolio combined with recent project wins provides our teams with excellent opportunities to bolster overall segment results. We are pleased to add three new projects to segment backlog in the quarter

[Laurel Krzeminski:]

Thank you, Jim, and good morning, everyone. Second quarter 2017 revenues were $762.9 million, up 26.2% from last year. Earnings per share in the quarter was $0.35, in line with last year. Our businesses recovered well from wet weather impacts in our seasonally weakest first quarter. Gross profit in the second quarter increased 1.9% to $74.6 million, with company gross profit margin of 9.8%. Year-to-date gross profit of $99.7 million is down 11.3% from last year. Second quarter SG&A expenses increased 5.5% year-over-year to $51.4 million. For the first half of 2017, SG&A expenses were $113.2 million compared to $104.8 million last year. The increase was split between selling expenses and compensation expenses. On a year-to-date basis SG&A as a percentage of revenue was 9.2%, down more than 80 basis points from last year. We believe that our current overall core cost structure will provide scalable benefits, allowing us to continue to manage costs amidst strong growth trends. The balance sheet remains strong with $286 million in cash and marketable securities at the end of the quarter, up $47 million from last June. As Jim noted, record backlog is the order of the day. Our teams are busy and we're quite pleased that we will stay busy for some time. Company contract backlog finished this June up 8.4% from last year at an all-time record $4.1 billion. Large Projects Construction segment backlog finished at a record level of 7.4% year-over-year at $2.8 billion. In the Construction segment, backlog finished at $1.27 billion, another record, up 10.6% from last year. It's quite encouraging to continue seeing our backlog reflect broad bookings across our businesses, end markets and geographies. Looking at the segment detail. Second quarter Construction segment revenues increased 29.6% to $429.3 million, with gross profit margin of 14.6% in line with 14.8% last year. Large Projects segment revenues increased 29% in the quarter to $254.5 million. The segment gross profit was breakeven in the quarter and is slightly above breakeven on a year-to-date basis, reflecting the underperforming mature projects we have discussed. In the second quarter, project write-downs totaled $23.8 million compared to $14.6 million in the second quarter of 2016. In addition, there were no project write-ups in this year's quarter compared to $9.8 million in the second quarter of 2016. Unfortunately, as we saw last quarter, acceleration to completion on these mature projects continue to be decretive to results. Typically, mature projects are consistent sources of profitability, so write-downs on these projects are particularly disappointing. Our focus on Large Projects Construction segment performance improvement remains unrelenting, but it will take some time to complete challenging projects, negotiate appropriate resolution with owner and deliver significantly improved returns. Moving now to Construction Materials where revenues in this segment increased 4.3% year-over-year in the second quarter to $79.2 million. Efficient aggregate and asphalt production which began at some locations in mid-April and accelerated through the quarter, allowed us to increase gross profit in the quarter to $11.6 million, up 10.3% from last year. Gross profit margin of 14.6% increased almost 80 basis points from a year ago, as gross profit and gross margin improvement was attributable to steady demand across geographies in the West. As Jim noted, despite the slow start to the year in our Materials segment, our continued expectations for demand growth and strong execution will help our Materials businesses deliver top and bottom line improvement this year. With that, I'd finish with our outlook. We're in the heart of the 2017 construction season and we're quite pleased to be busy across the country, executing on record company backlog. We currently expect mid- to high-teens consolidated revenue growth and consolidated EBITDA margin of 6% to 6.5%. Now before we take your questions, let me turn the call back to Jim.

[James Roberts:]

Thank you very much, Laurel. Granite is extremely well-positioned to benefit from private market opportunities and a strong increase in key public transportation markets, both this year and for the foreseeable future. Granite teams are winning profitable new work and are executing on profitable growth opportunities across our businesses. Our outlook and market visibility continues to point us significantly improved results for Granite, our shareholders, and our employees over the next few years. And, with that, we'll be happy to take your questions.

[Operator:]

Our first question will come from Alex Rygiel of FBR Capital Markets.

[Alex J. Rygiel:]

Good morning, Jim and Laurel, and congratulations on an outstanding new award number in the quarter.

[James Roberts:]

Yeah. Thank you, Alex.

[Alex J. Rygiel:]

Jim, you talked a little bit about the California transportation bill. You quoted some numbers with regards to the budget increasing from $2 billion to $4 billion, that's all fantastic. But the question for you is how much of that have we actually seen build into your backlogs to-date and how big of an opportunity is that in sort of new awards and revenue creation in 2017?

[James Roberts:]

Okay, Alex. Well, let me start it off by saying that the 2017-2018 California budget begins on July 1 and runs through June 30 of 2018. So, literally-speaking, none of the ramp-up for SB 1 is in our backlog yet. They've suggested that they've added $2.8 billion to the overall program for the fiscal year, with the majority of that coming in the second half of the year, which would be the first six months of 2018. They have also said that they will immediately infuse about $285 million into – we'll call it pavement preservation projects or maintenance projects, which we'll see hitting the street starting actually in July. So I would expect some ramp-up over our normal in 2017 – in the second half of 2017. And the larger portion of the ramp-up in the backlog relative to the SB 1 is going to be in the first half of 2018.

[Alex J. Rygiel:]

That's very helpful. And then as it relates to the new – the three new Large Projects that you put into backlog, how should we think about those projects being different than some of the Large Projects that you're having some challenges with today?

[James Roberts:]

Well, first of all, on average, they're a little smaller in nature. One of them isn't actually 100% granite job which we're focusing on, taking complete responsibility or taking a larger share in the jobs. They're built and been around a lot of the lessons that we've learned over the last year or two in some of the problems that we're struggling with. So, we've incorporated productions. We've incorporated labor issues. We've incorporated escalations. And we've done a very, very focused job on understanding the owner's requirements. Historically, the contract documents and the complexities of the contracts themselves on some of the older projects have caused us some issues, and we're well aware of what the potential issues on these projects are and we price them accordingly. And literally-speaking, they're the ones that we bid over the last 12 months that we're working on today. The newer ones are going quite well with the same kind of input that we put in on these brand-new ones. So, today, we're very confident that we priced them accordingly, significantly different than what we did two or three years ago.

[Alex J. Rygiel:]

And last question, as it relates to the Construction segment. The gross margins in the second quarter were down slightly year-over-year, yet revenues were up nicely, anything in particular? Was that just really a bad weather in April that just kind of lagged and dragged down the quarter, and sort of what are your thoughts on Construction gross margins in the second half of the year versus last year?

[James Roberts:]

Well, Alex, I'll tell you, and I mentioned this several times over the last year, the kind of margins that we're achieving in Construction today are quite nice. And historically, I've seen margins get up into the high-teens in the Construction business, and certainly if all the stars align, we could see ourselves moving higher in that range. I think, today, if you can keep in that 15% gross profit margin, you're doing a heck of a job in this industry. So I think what you're going to see with us as we ramp up our gross – ramp up our revenues, you're going to see the gross profits stay in the same range and maybe kick up as we start seeing an increase in opportunities. But I would tell you, whether it's 14.5%, 15%, 15.5%, those are really nice margins to be in, in the construction business.

[Alex J. Rygiel:]

Thank you very much.

[James Roberts:]

Thank you, Alex.

[Operator:]

Our next question comes from Jerry Revich of Goldman Sachs.

[Ben Burud:]

Hi, everyone. This is Ben Burud on for Jerry Revich. Good morning.

[James Roberts:]

Good morning, Ben.

[Ben Burud:]

I just wanted to touch on the outlook. Can you give us – can you talk about what gives you confidence on that front? Your EBITDA so far is down about $20 million year-over-year, but your guidance is for $20 million to $30 million of year-over-year growth. So what gives better by $50 million in the back half of this year? And can you talk about why the project losses on these mature projects won't continue going forward?

[James Roberts:]

Okay. Let's talk about the EBITDA movement going forward for the remainder of the year. First, the – certainly, the momentum that we built towards the second half of the second quarter is significant. The backlog is significant. The backlog is quite healthy and these markets will generate really nice earnings over the second half of the year as long as we have good weather. Again, I think that the way we're ramped up today that our guidance and our projections are quite in line with what we should be able to do. Again, a slow start due to weather. We've increased the workforce. We've increased the capabilities of our staff in our field. So I don't see any issue getting to the guidance that Laurel provided for you, assuming we have weather in the back half of the year, or normal weather so to speak. Now relative to Large Projects, what makes us think that we're not going to be – have the issues going forward? Very similar to what I said to Alex before. The pricing, the type of work that we're bidding, the relationships with the owners, being in control of projects; all of these dynamics put together been are really the focus of the newer work that gives us much more confidence that we're heading in the right direction. And the ones that we've actually started in the last 12 to 18 months are fairing quite well with a different approach towards our expectations. So again, I think that it is just a different approach towards the work, adding – putting more margin in there, more changes relative to the field productions and escalations going forward and the issues with the contracts themselves, and I think you're going to see nice results over the next couple of years.

[Ben Burud:]

Got it. And backing off of that, you mentioned you have growing confidence in your 2018 outlook. Can you flush out for us what kind of top-line growth do you see in both of the Construction segments based on the backlogs so far?

[James Roberts:]

Well, I'm going to hold off on that for now. We don't give guidance for that far out. But in general, I would just suggest to you that as we start seeing these public environments pick up, that's going to continue to create more growth for us. And the other thing that we're seeing today which is a really nice change is the private sector is getting stronger. Our commercial and industrial partners are really ramping up their workload. We still haven't seen the residential take off, but I do think there's more room for growth next year in the public sector especially when California and Washington start picking up the pace. And that takes into consideration also that we haven't even seen anything out of the federal government yet of any significance, and I don't anticipate anything in the near future. But if something did happen in late 2017 or early 2018, there's another opportunity of growth for us.

[Ben Burud:]

Got it. Thank you.

[James Roberts:]

Thank you very much.

[Operator:]

The next question will come from Michael Dudas of Vertical Research.

[Michael S. Dudas:]

Good morning, Jim, Laurel, Ron.

[James Roberts:]

Good morning, Mike.

[Ronald Botoff:]

Good morning, Mike.

[Michael S. Dudas:]

Regarding Large Projects, Jim or Laurel, will the acceleration accelerate in the third and fourth quarter? Or are we caught up on some of the things that'd been able to get these projects done quicker and will that require to see other types of reserves or charges that you may think about maybe in the next couple of quarters?

[James Roberts:]

Well, okay. So I'd say whether we accelerate any more, but I won't say that we are continuing to work at a very quick pace to complete the work in 2017. And I'd say by mid to the third quarter of 2018. So I think you'll see similar-type environments in Large Projects over the next couple of quarters. And then I think at 2018, you're going to start seeing it accelerating and getting even better at that point in time. But I do think that we've got two or three projects that we've been working hard on getting completed, and we're going to continue with those for the rest of the year.

[Laurel Krzeminski:]

Yeah. And, Mike, relative to the job forecast. Every quarter we update the forecast to the most recent information that we have. And as we progress along the job, we have new learnings and things that potentially change that and it requires us to revise our estimate. But at this point, we have our forecast that we've updated as of the end of Q2.

[Michael S. Dudas:]

And then the Q2 losses, you had $23 million. Are those over the similar projects we've seen in the last couple quarters?

[Laurel Krzeminski:]

Yes.

[Michael S. Dudas:]

Primarily? Terrific.

[Laurel Krzeminski:]

Yes.

[Michael S. Dudas:]

My follow-up question would be, Jim, for you. Elaborate a little bit more on the private sector. What end markets, geographies, are you targeting? Can you give us a sense where on a percent revenue or earnings basis private is in your construction or vertical business? And what's the potential with that going forward, given we get a pick-up in the economy? At the same time, you'll be busy trying to book on the public side, while the private margins can get more appropriate or stronger in a better bidding environment than the private side?

[James Roberts:]

Okay, Mike. So, first of all, about 20% of our backlog in the Construction segment today is literally in the private sector, which is an increase over what we've seen recently. So that's a really nice trend. And what happens really, over time, our private sector has been a higher gross profit return than our gross margin than our public sector. As we see the public sector start moving up and gaining ground here, I think that you're going to see the private sector move up also. There's certainly a saturation point with a certain number of the public side in regions. And when you ask about the regions, I'm going to say the entire West and the Midwest. We have a lot of private clients in the Midwest as well. And as the public market ticks up, then you start expanding the demand where they have very similar capacities. So I think over the next 6 months to 12 months, you're going to see the private market pricing come up more, just like you're going to see the public sector pricing come up. And I'm hopeful that we can continue to keep that percentage at that 20% or higher even. It is our desire to see the private sector be a stronger portion of our overall portfolio. We work real hard developing relationships with those private clients and keeping them as long-term clients. Over the last couple of years, it's been a strong focus on the business. So I think it's going to continue to do nicely. And I think today in the industrial and the commercial sectors, we've had a lot of repeat customers. And that's really going to be the key to the private business going forward.

[Michael S. Dudas:]

Thanks, Jim. Thanks, Laurel.

[James Roberts:]

Okay, Mike.

[Operator:]

And our next question comes from Joe Giordano of Cowen.

[Joseph Giordano:]

Hey. Good morning, guys.

[Laurel Krzeminski:]

Good morning.

[James Roberts:]

Good morning, Joe.

[Joseph Giordano:]

Can you comment on the level of backlog that you're comfortable taking on like when it becomes realistic for you to deliver on that? When does labor start becoming an issue? When do you max out on backlog?

[James Roberts:]

Okay. Well, I think backlog – first of all, we need to make sure we understand the burn rate on the backlog first. Some backlog burns faster; some backlog burns slower. On the Construction segment, let's go there first. On the Construction segment, I think there's room for a significant amount of increase in backlog and in revenue. And that's the turn business, where we keep turning these projects over very quickly. We have the ability in the company to expand in these local markets where we have a very strong presence and we have a very large access to the labor force. So I'm very comfortable in seeing that backlog and those revenues grow significantly over the next couple years. On the Large Projects, I think we want to be a little careful. We want to make sure that we grow backlog accordingly with our expectations to get that business back in line with our expected margins. So I think you might want to see that slow down a little bit as we go forward and the Construction segment pick up even more. But I don't think today, there's any issue relative to in being able to handle the amount of backlog we have. We have a tremendous amount of capacity and capabilities in the Construction and the Materials segment, and I think that growth is what you're going to see really grow over the next several years.

[Joseph Giordano:]

Okay. Great. And when we talk about the Large Projects, the bidding process, can you talk to like some – what are you doing differently specifically to get your head around unforeseen risk or how to evaluate that and protect yourself from it differently than you had before? And then – and maybe you can loop that in with kind of a cost/benefit analysis of how you look at, do you want to be a consolidating owner or do you want to be a minority partner in a project and how you – where do you think that kind of trends as a mix going forward?

[James Roberts:]

You bet, Joe. So, there's a whole host of items that we've really undertaken over the last year, I will say, as we approach these new contracts. First of all, we're looking at taking a larger role on the projects that we have in the past, less of a minority role. If we do take a minority role, it'll be very, very close to being a equal share. We're looking at some smaller projects even, where we have complete control. We're looking at Granite-only projects where we're 100% in control of the projects. And I mentioned a large bridge project we just got, it's 100% Granite job. We're focusing on the clients that we know. We're focusing on the clients and the contract documents that allow us to be able to understand what the requirements and complexities of the contracts are. The other thing we've done that has really created a nice opportunity for us is we are heavily involved in coordinating up the designs. We've ramped up our own staff to help the designer create a more efficient design. So as that we get into design-build projects that the designs themselves are efficient, so that we're building a project that we have control of with the cost. So again – and then on top of that, we are increasing our expectations on margin. We're expecting a higher margin than we have historically with a more, I'll call it, reasonable bid with escalations inside the bids – labor productivity inside the bids that is more appropriate. So all across the board, I think there's a level of conservatism, there's a level of understanding the complexities of the projects, and huge part of it is getting and choosing the right projects; the ones that have less risk and more opportunity for return compared to risk.

[Joseph Giordano:]

Great. If I could just sneak one in on M&A, it's been a – what's holding you back here? Is it more like a you just haven't found like the right cultural fit or is it more valuation? Just some comment there.

[James Roberts:]

Well, I will tell you, Joe, that we are heavily focused on M&A. We have people that are dedicated to the process. We've come close over the last year and we haven't been able to get over the top yet. But I will tell you that there is a lot of work going on behind the scenes. And it's a combination of events – a combination on valuation, timing. Cultural fit has not been the biggest issue yet, and we've got several in the works. But I think we need to be patient and make the right deal for the company and make the right deal for the acquired, so that the merging of two companies is actually – creates the most value. It will happen. We just need to be a little patient.

[Joseph Giordano:]

Thanks, guys.

[James Roberts:]

Thank you.

[Operator:]

The next question will be from Nick Coppola of Thompson Research Group.

[Nicholas Andrew Coppola:]

Hey. Good morning.

[Laurel Krzeminski:]

Good morning.

[James Roberts:]

Good morning, Nick.

[Ronald Botoff:]

Good morning, Nick.

[Nicholas Andrew Coppola:]

So in Construction Materials, saw a year-over-year revenue improvement for the first time since Q4 2015. I know there was, in the past, some mix issues between external and internal. Maybe you could just talk more about performance this quarter, if there was anything different. What are the major drivers of the growth?

[James Roberts:]

Well, first of all, the committed volumes we have relative to our Materials business is quite high. So we've got a lot of – we'll call it backlog so to speak, in the Materials business. We had a little slow ramp-up out of April, with a big May and June. And I think it's more of we're starting to see most of our businesses fill in where maybe, over the last couple of years, we had some pretty hot markets and locations, and a lot of markets that were slower. Now we're seeing a broad opportunity of growth in the Materials business across the entire business portfolio. And I think you're going to continue to see that over the next couple of years. It's a pretty healthy, general environment all over the place. And you haven't even seen a lot of it kick in on SB 1 and some of the California increases yet. So we're pretty comfortable with the growth of that business continuing going forward.

[Nicholas Andrew Coppola:]

Okay. Any comment on what you're seeing in the price environment?

[James Roberts:]

Well, again, I think we're moving prices higher and it's really an interesting market. Every market is so different. It's a fragmented market. A lot of price increases are sticking in most of the markets. And I will say this, as the overall market gets to a saturation point of some nature over the next year, I think you're going to see even better increases in pricing. But so far, we've had some nice increases this year and in most locations they're sticking.

[Nicholas Andrew Coppola:]

Okay. And then on Construction, I want to make sure I understand the backlog performance up nicely; again, year-over-year. With the comments you made about the California benefit not really hitting yet, is that growth mostly private? Maybe just speak to where the wins have been there?

[James Roberts:]

Well, actually, Nick, it's across the board. I mentioned that about 20% of our backlog is in the private sector, so certainly, we've had nice growth in the private sector. But the public sector is starting to pick up as well and even more nicely than just going public and private. We're starting to see the cross geographies as well which is really nice to see. All of our businesses are picking up in the Midwest and the West. So, I would say it's a really nice, evenly spread, broad range of increases.

[Nicholas Andrew Coppola:]

Okay. And then as a result of that, are you seeing improvement in the competitive environment in pricing?

[James Roberts:]

We're starting to see it. And as I always say, it will first depend on the number of bidders. And then you'll see price changes. And across the board as we get in to the middle of the year is when we start seeing a reduction in the number of competitors, and we're starting to see that now. So it'll interesting to see, Nick, what happens in the back half of the year relative to the number of competitors on bids, but we're able to get our price increases into our bids today, but we'll see what happens in the marketplace over the next, I' d say, three months to nine months with the number of bidders. In our industry, what happens is that the smaller bidders end up just stop bidding projects when they get full. And we'll see that quite quickly when the market changes.

[Nicholas Andrew Coppola:]

Okay. All right. Thanks for taking my questions.

[James Roberts:]

Thank you, Nick.

[Operator:]

And our next question comes from Bobby Burleson of Canaccord.

[Robert Joseph Burleson:]

Hi, guys. Congratulations on the record backlog.

[James Roberts:]

Thank you, Bobby.

[Robert Joseph Burleson:]

Just to – just to kind of trying to understand this cycle versus the past upcycle, if we look back 10 years ago. What are some of the important differences that we should consider with respect to Granite in terms of the opportunities this time around versus last time?

[James Roberts:]

Well, that's an interesting discussion point, Bobby. So, when you go back 10 years ago, it was really interesting to watch the dynamics of the growth. I think it was actually buoyed more by the private sector than the public sector. And we actually saw a large portion of our growth in the residential sector and that doesn't even really exist in today's marketplace in terms of growth. So the difference today is that, I think you're seeing a very strong commercial and industrial private sector. Back then, you saw heavy residential increase that was really the main reason. And secondarily, I actually think the public sector in the forward-looking next 12 months to 48 months, I think you're going to see the public sector substantially stronger than it was 10 years ago. So I think the big issue going forward is going to be what's going on with residential? Is it going to come back or not? We have not seen it affect our business yet.

[Robert Joseph Burleson:]

Okay. Great. And then in terms of customers responding to greater demand, you guys are seeing an uptick potentially here in the second half of 2017 and then accelerating in 2018, are there any geographies that you expect to lead that process in terms of timing?

[James Roberts:]

Well, certainly California is where we're seeing the largest growth opportunities right now with SB 1 kicking in. And honestly, in the Western market, you're seeing a very strong private sector as well. So, I think you're going to see the West pick up a little faster than the rest of the country based on some of the public sector increases that they put into play with some of the big measures – Measure M and a lot of the big local measures in the West as well, certainly Sound Transit up in Washington. But I do think that there's a steady uptick in the industry across the country with – will make it really nice for all the businesses to have healthy environments and then a very strong business in the West.

[Robert Joseph Burleson:]

Okay. Great. And you guys mentioned pricing getting stronger in kind of the bid work you guys are doing. Is there anything else you're doing in terms of derisking the contracts that can drive margins higher?

[James Roberts:]

Well, I think that derisking the contracts – I wish we had the ability to do that. We – but we certainly can price the risk and we are. And I will tell you over the last couple of years, some of the things that we've been – we've experienced over the last several years, all those experiences are now incorporated inside of our bids, and that's one way to derisk them. The other thing is as we actually have a very strong risk matrix that we attached to every one of those Large Projects, and that matrix is being priced appropriately now; what we put in these projects has contingency. And again, lessons learned certainly create a stronger format for the core part of the estimates going forward, and we're incorporating all those lessons into the bids we have right now.

[Robert Joseph Burleson:]

Okay. Great. Thank you.

[James Roberts:]

Thank you, Bobby.

[Operator:]

Our next question will come from Bill Newby of D. A. Davidson.

[William Newby:]

Good morning, guys. Thanks for taking my questions.

[James Roberts:]

Thank you, Bill.

[Laurel Krzeminski:]

Good morning.

[William Newby:]

Just wanted to drill down a little bit more on the Large Projects segment and how the expectation is going into the back half of this year I guess. Is there any more color you guys can provide on what gives you confidence in the fact that you won't take any more write-downs on those problem projects and that we've got those under control now?

[James Roberts:]

Well again, I think Laurel said it a little bit earlier, that every project, we price them out and forecast them as we see them every quarter. And we'll continue to do it as we go forward. And there's nothing that would say that we haven't got everything right. We believe we've got it right. But we also believe that a lot of the projects that we have today are going to be doing quite well. So we're going to continue to do the best we can to complete the jobs that are nearing completion. And could there be write-downs? Certainly there could be. We're not aware of any at the moment. But at the same time, there could be write-ups on other jobs. And we're looking at more of a longer-term projection on Large Projects to get us back to our expected returns over the next couple years.

[Laurel Krzeminski:]

Yeah, and, Bill, the nature of this business is that you have contracts where you have some, like Jim said, write-ups and write-downs. It's just the nature of the business.

[William Newby:]

Okay. And then switching gears. And as you look across all your geographical markets and a lot of these states pushing these funding initiatives through, are you seeing any changes in the average project size as these guys have a bigger runway of funding?

[James Roberts:]

That's an interesting question. I think that we have over the last couple years seen a little bit of an uptick in the average-sized project. I think the real key for us, Bill, is which projects do we go after. And as the market gets healthier, we go after projects where we see the greatest opportunity to create the most value for the company. And in some cases, it will be a real small project if, for example, we can negotiate it with an owner and create more value for the company. So I do think, on average, the projects are a little bit bigger. I think the cost inside those projects is going up, so the pricing is going to go up as well. But we just focus on the ones that have the most value for the company.

[William Newby:]

Great. Thanks, guys.

[James Roberts:]

Thank you, Bill.

[Operator:]

Our next question is a follow-up from Joe Giordano of Cowen.

[Joseph Giordano:]

Hey, Jim. Just one last one for me. Now that Sound Transit and Measure M, and SB 1 have all gone through, is there anything else nationally that we should be thinking about state and local and other jurisdictions that could be meaningful for you over the next 12 months to 18 months, something like that?

[James Roberts:]

Well, Joe, certainly the federal government. I mentioned that they've done a...

[Joseph Giordano:]

Yeah.

[James Roberts:]

...as we all know, have done very little of nothing. And they've actually proposed some reductions, which the Senate has overridden, which was a good deal. So I think that, yeah. And I think something's going to happen on a national infrastructure plan. But I just think we need to be patient there as well and I don't think anything is going to happen until the end of 2017 or maybe hopefully some time in 2018. Individual state-wide, I think that it's going to be a consistent run rate going forward. And I think that a lot of the measures that they passed so far, we haven't seen the financial implications of them yet. So the positive things in Sound Transit, some of the states that we've seen, gas tax increases haven't even taken effect yet. I think let's see where it goes, but I do not know of any other significant measures at this time that are in the run. But I will imagine that these states will continue to increase their levels of investment because the needs are getting so much greater than the funding right now.

[Joseph Giordano:]

Okay. Thank you.

[James Roberts:]

Thank you, Joe.

[Operator:]

The next question will come from Brian Rafn of Morgan Dempsey Capital.

[Brian Gary Rafn:]

Morning, Jim, Laurel.

[James Roberts:]

Good morning, Brian.

[Laurel Krzeminski:]

Good morning.

[Brian Gary Rafn:]

Hey, let me ask a little bit of a strategic question and we've been beating this like a dead horse, but I'll take another swing. If you go back to the late 1990s, you go back to the 2000s, your mix of business and branch turn was maybe 70/30 to Heavy Civil or two-thirds, one-third. It's a book/bill and get paid-type business contracts less than a half. When you saw a fall off in residential, Heavy Civil ended up going almost two-third, one-third, and now more 50/50. Is that strategically for you guys just a tougher business to manage from a profitability standpoint, more larger contracts, more design build, much more complexity than maybe Dave Watts or Bill Dorey faced?

[James Roberts:]

Wow, I'm not going to say anything about whether Dave or Bill faced it, because they'll probably give me a call, Brian, so we've got to be careful on that one. But at the same time, I do think that the owners have created much more difficult contracts today than they were probably, I'll say, 10 to 20 years ago. The owners have gotten smarter. They're putting more risks on the contractors, on the design build joint ventures. So definitely, there's more risk involved, and that's why I said earlier that it is so important that we raise the expectations of our industry with the amount of risk that we're seeing in the projects today. And I think what happened over the last and I'll say five to seven years, Brian, is that as the owners created more complexity and complications inside the contracts, contractors kept pricing with the same kind of margin expectations, and that was a mistake. And today, with the amount of risk in these projects, the margin expectations need to be significantly different.

[Brian Gary Rafn:]

Yeah. No, I get it. Certainly, they're trying to transfer that liability and it's like free agency in the NFL, if somebody is willing to pay for a ridiculous contract. But you're seeing – would you say it's a fair question that – or comment that you're seeing from the industry, more guys in line saying discipline. We're going to bid it, we're not going to chase that complexity without payment?

[James Roberts:]

Well, I will tell you this. I can't speak for other companies except for those that we joint venture with, and those partners are coming to the table with us with the same level of expectations today which is significantly different than it was three to five years ago.

[Brian Gary Rafn:]

Okay. And then from the standpoint, you talk a little bit about being selective with types of projects, geographies and owners. Are you also selective in other lessons learned, maybe with partners in the past that maybe don't share your culture or there are – might be issues, without mentioning names that you would stay away from in the future?

[James Roberts:]

I would say, I'm not sure there's any that I would stay from, but I would say that there are a host of partners that are specifically better suited for certain types of work. And so that if we're doing a bridge project, a highway project, a port water project, there are certain contractors and partners that we specifically think are better suited to team with. And so, we look at each job individually and every one of our contracted partners has merits depending on the type of work.

[Brian Gary Rafn:]

Okay. And just one more. What do you see on the Kenny side relative to tunnels and that type of thing. What is the complexity on those types? Because that's a fairly significant challenge in an engineering job. What type of issues in that side of the business do you relative to large contracts and complexity, and the type of situations you're talking with the design build?

[James Roberts:]

Yeah. Well, there's no doubt the complexities in the tunnel industry are significant. I would say this; it's interesting that that industry is fairly consolidated. I will tell you that we have a very senior group inside the Kenny Granite organization that participate in three or four projects at one time. And I will say that a lot of these tunnel projects are bid-built. I haven't seen too many of them that are design-built. So, the owners are taking a lot of responsibility for the designs. And certainly, when you get into a subterrain geological formations, different water table issues, they can be significant issues. And we're seeing a lot of upfront engineering work on the tunnel projects, probably more or so than we see in a standard design-build. So, we know what we have going in. And again a lot of it is – I'm not going to call it repetitive because anytime you get under the ground, the formations are substantially different. But our teams at Kenny have seen almost everything in the country, and the owners do a really nice job of putting the bid packages together.

[Brian Gary Rafn:]

Great. Thank you.

[James Roberts:]

All right, Brian. Thank you.

[Operator:]

This is the end of the Q&A session. I would now like to turn the call back over to our hosts.

[James Roberts:]

Hello, everybody. Thank you for your questions. And a quick note for our shareholders and analysts, we'll be on the road in August and September at investor events, so please do not hesitate to reach out to see if we can get together for a visit. And thank you to all of our employees for keeping all of your fellow workers safe and for exhibiting Granite's core values every single day. As always, Laurel, Ron, and I are available for follow-up if you have any further questions. Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.