Prepared remarks
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. The operator provided instructions to participants. 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 market 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 in 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 remains a cornerstone in Granite's business 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 a substantial portion of those funds still available for deployment, we continue to benefit from a strong and robust transportation market. In May, the U.S. House of 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 it shifts the 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 funding 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 in 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 that 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 center site development. Within federal, we've invested for more than one decade to build our capabilities, establish customer relationships and broaden our geographic reach. From the Armed Forces to the Department of Homeland Security to the U.S. Army Corps of Engineers, we have participated in building our nation's federal infrastructure in a variety of civil projects across the United States and Guam. While the recently won tactical infrastructure projects provide near-term revenue growth in 2026 and 2027, we believe the greater opportunity lies in the 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, is another significant growth opportunity that stretches across our footprint. Granite has over one decade of experience working with developers, vertical builders and hyperscalers on the civil infrastructure needs of data center construction, primarily in the Pacific Northwest and Nevada. 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 one 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 end markets. We have the people, equipment, expertise and relationships to capitalize on these opportunities efficiently and at scale. This same platform also positions us to pursue additional end markets over time, including 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 disrupted production and sales activity across the Southeast during 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 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, plant 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 liquid asphalt and diesel costs were largely mitigated through a combination of fixed-forward contracts, physical storage, financial hedges and energy surcharges. I'm pleased with the resilient performance of our teams. Demand remains healthy. Pricing is tracking to expectations, and we continue to make investments in the 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 businesses 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 quarry 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 notes 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 and termination of the associated capped 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 billion to $5.4 billion. 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, leaves us well positioned to continue growing revenue across our footprint, whether serving clients in data center site development, intermodal rail infrastructure, federal projects or 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 were resilient through 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 that 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.
Questions and answers
The moderator will now provide instructions for the question-and-answer session. Our first question is from Brent Thielman with Oppenheimer.
Yes. I guess just first question on the thoughts on Materials and 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 we move into the second half.
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 in the external market. We're still seeing a lot of public infrastructure demand, in data centers in certain markets, and in manufacturing. Our teams are executing well on the pull-through strategy. So that's really positive in the quarter. Our pricing is still at mid-single digits on aggregate, so that's holding. So from a pricing and demand perspective, we feel really good. It is unfortunate we did have real severe weather in the Southeast, and we 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 right where we want to be by the time that we wrap up 2026.
Got it. Appreciate that, Kyle. I guess, just in terms of the organic growth outlook for 2027, you improved it from 6% to 8% to now plus 10%. In light of not having a highway reauthorization in place and that seemingly being pushed out, what gives you confidence around that improved profile? If you could unpack the different factors that led you to increase it, that would be helpful to hear.
Yes. I think there's probably two things that we point to. First is our strong CAP balance. Obviously, it's another record level and the 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 we have a lot more visibility into 2027. I think that's really combined with what we believe is still a healthy market, both in the public and the private sectors. So the bid opportunities are really strong. They 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 in 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 team is having there and then maybe what that can also grow to over time?
Yes. So last year, at this time, we had CAP of around $65 million within the data center space. Today, it's around $225 million. As I mentioned on the last call, we have dedicated leadership within that part of our business today leading that effort. Their job is to help coordinate and support all the local businesses we have within our home markets to support these clients and what they're trying to build. We've made a lot of strides in a very short amount of time, which we're encouraged by. The fact that we've had so much success really in the last six months or so tells you we have a great service 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 we think we're on track to doing that relatively quickly.
Appreciate the color there. Also, could we touch on this: I know Brent talked about margin recovery, but will there be further costs associated with quarry development activities that would keep margins down, or is that just a first-half issue?
I look at it more as the first-half environment. The plant setup and redevelopment was in the ballpark of about a $5 million impact in the quarter. So we wouldn't expect to see a similar drag in Q3 or Q4.
The next question comes from Trey Grooms with Stephens.
Could we talk about the preliminary DOT budgets for 2027 that are out there? Funding levels look pretty good in the Granite states, California's budget is above the national average, and Texas looks down, but I think that's more optical because they have a biennial budget. Taking that together with where we are on IIJA reauthorization and the likelihood of a continuing resolution, how are you thinking about the infrastructure demand backdrop as you look into fiscal 2027?
Yes. From an overall market perspective, we still feel like the public market is healthy. We're bidding more work. Today, we're capturing more work as well. So that's the first driver that tells us we're improving, and you can see it in our CAP. From an IIJA perspective, we're about 60% spent. Obviously, it will get allocated when it expires in September, but that spending will continue into 2027, 2028 and 2029, through 2030 likely. So it's not like the funds just turn off. We think there likely will be some sort of funding extension while they still sort out what BA250 will look like. There are three things we view in BA250 that are positive. First is that it looks like it will maintain a high level of public infrastructure investment. Second, it appears to be more formulaic than grant-based, which means 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 third, that approach aligns with our end market strategies. At these levels, combined with our end market strategies, we feel very confident that we can grow our business over the long haul. So today, it's to be determined what the final bill looks 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 share any details on the Kenny Seng acquisition, maybe how much it added to CAP or any other details, please?
Yes. Kenny Seng had almost a full quarter with us in Q2, and that business continues to perform very well. Integration has gone very well. Their CAP for the quarter is about $150 million.
The next question comes from Kathryn Thompson with Thompson Research Group.
Just a follow-up on your comments on strong organic sales performance in the second half and in '27. Is the CAP growth that gives you this confidence or other factors? And any other just additional color you can give on that organic cadence?
Thanks, Kathryn. It really is, first and foremost, the CAP, and we have great visibility with our CAP today. At this point in the year, we know where things are going to head for the balance of the year in 2026. We also know how that CAP is going to burn through 2027. That gives us a lot of confidence from a CAP perspective in 2027. The market is healthy and strong. We have a really strong bid pipeline, so we have an idea of the work that we're bidding today, both in the public sector and the private sector. We know what our typical hit rates are, and that gives us a lot of confidence that we'll have the work that we need to make up the balance of that growth in 2027.
Okay. Great. And obviously, a lot of focus on data center site prep work and data center growth. But broadly, stepping back and looking at the forest for the trees, there's just a broad trend of more things being built in the U.S. It would be helpful if you could, even if it's anecdotal story, tell us what you're seeing in terms of how Granite participates in the build-out of the industrial complex in the U.S. market.
What we like about where we're headed with data center growth is that it's something we've done for ten years or so, and we do it very well. The strength of our business is the home markets and the optionality that the home markets bring with our crews. Our crews within our home markets can perform work on data centers, streets, highways, airports, mine sites and refineries. That gives us a lot of optionality to be flexible, and that's a real differentiator for Granite. Our job today with our end market strategy is connecting these key clients across these home markets and geographies so we can deliver for them at a high level.
The next question comes from Adam Bubes with Goldman Sachs. Anuj Khandelwal is on the line on behalf of Adam.
So to what extent are you seeing fuel inflation or other cost pressures impact margins across your Construction and Materials business? And as diesel costs move higher, are you generally able to incorporate those increases into new bids and recover them through pricing? Or is there typically a lag?
From an overall energy perspective, our teams have done a really nice job mitigating the energy price volatility in the marketplace today. From a net dollars perspective, we're a little bit more positive than negative, which is what we indicated we would be last quarter as well. Our Materials segment teams implemented an energy surcharge back in Q1 2021, and we also use physical storage and fixed-forward contracts. So we feel as though we're getting that covered and are slightly positive to neutral. On the Construction side, a lot of our public works contracts have escalators and de-escalators for certain commodities, which provides support and helps derisk. We price most of our work at 100% design as scheduled, which allows us to obtain contractor coverage and supplier coverage and lock those things in. We also limit our pricing exposure on contracts to less than four years generally. Those are part of our derisking efforts to create a consistently profitable business. The results reflect the effort of the whole team, and they've done a very good job.
Got it. And one more. So what type of customers are you currently engaging with on future bids? And how would you characterize the depth of the data center opportunity pipeline?
When we have 100% design, we can go out and get coverage on items that have potential risk, including certain energy-related items, and lock those prices into the contract. There are always elements like diesel and labor that require estimation of future prices. Labor can be a bit more variable in future years, though many of our union partner agreements in the West are already locked in. We factor in labor escalators as needed. In terms of customers, we are engaging with developers, vertical builders and hyperscalers in the data center space and also pursuing public sector clients, rail, federal and standard transportation owners. The data center pipeline is robust across our footprint, and we continue to see meaningful opportunity driven by AI and digital infrastructure investment.
Our next question comes from Michael Dudas with Vertical Research Partners.
Can you hear me now?
Yes, we got you, Mike.
Great. Yes. So Kyle, maybe just refresh us, you talked about certainly organic growth, which is helpful for next year and added with that supported by acquisitions. So where do we stand on the pipeline? Remind us like average size, what you're focused on? And in that pipeline, the type of companies, maybe where the valuations are relative to what you've paid for some others in the last 18 to 24 months? And are they more negotiated or open book? Just to get a sense of that and the timing so we can get a sense of how it's going to flow through your business over the next two to three years.
Right now, there's still a really strong deal pipeline, and that will allow us to execute on the strategic priorities we've had in place, which include strengthening and supporting our existing businesses and continuing to build out our Southeast platform. We have a strong corporate development team that self-sources many deals; roughly three-quarters are self-sourced and about one-quarter are bank-led processes that we review. Valuations have stayed fairly consistent, but they vary by sector—whether it's a VI business, Construction or Materials only. Our expectation is that we'll complete a few more deals by the end of the year in Q3 and Q4. In terms of spend by the end of the year, our best guess today is somewhere in the $200 million to $400 million range. Timing is always hard to predict, but that's our current view.
And is that a spend in 2027 and beyond? Is that the type of level you're looking at? Or is it going to be a little bit more opportunistic?
We've been somewhere between $300 million to $800 million over the last few years. I would look at that as a possible range of outcomes in future years today.
This is the end of the Q&A session. And now I would like to turn the call back over to Mr. Larkin.
Okay. Well, thank you for joining the call today. As always, we want to thank our teams for all the work they put into delivering a strong quarter. Thank you for joining the call and your interest in Granite. We look forward to speaking with you all soon.
The conference has concluded. Thank you for attending today's presentation. You may now disconnect.