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Granite Construction Inc  (NYSE:GVA)
Q3 2018 Earnings Conference Call
Oct. 26, 2018, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Phil, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Granite Construction Investor Relations Third Quarter 2018 Conference Call.

This call 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 period. (Operator Instructions) 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 -- Vice President of Investor Relations and Government Affairs

Good morning. Welcome to the Granite Construction Incorporated third quarter 2018 earnings conference call. I am pleased to be here today with President and Chief Executive Officer, Jim Roberts; and Senior Vice President and Chief Financial Officer, Jigisha Desai.

We'll begin today with an overview of the company's safe harbor language. Some of the discussion today may include forward-looking statements. These forward looking statements are estimates reflecting the best judgment of senior management and reflect our current expectations regarding future events, occurrences, circumstances, activities, performance, outcomes and results. 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.

On October 09, the Company filed an 8-K, which provides a quarterly and annual look-back and mapping of our new reportable end market-focused segments. Our third quarter results reflect this new reporting structure.

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 and backlog. Please note that as applicable, these metrics exclude non-recurring acquisition-related expenses and one-time inauguration cost associated with the acquisition and integration of Layne Christensen Company and LiquiForce.

Reconciliations of certain non-GAAP measures are included as part of our earnings press releases as well as in company presentations, all of which are available on our Investor Relations website investor.graniteconstruction.com. Thank you.

Now I'd like to turn the call over to Granite Construction Incorporated, President and Chief Executive Officer, Jim Roberts.

James Roberts -- President and Chief Executive Officer,

Well, good morning everyone. Thank you for joining us to discuss Granite's performance. The third quarter of 2018 marks something of a starting point for Granite. About two weeks ago, we introduced end market focused reportable segments. This follows the deliberate strategic effort we have made to diversify and to grow both organically and via acquisition-led growth over the last five-plus years.

Our actions emphasize broadened geographic reach, new capabilities and activities that consistently enhance returns, growing opportunities for Granite's key stakeholders, from our shareholders and employees to our customers and our partners.

Granite employees have remained focused this year as we integrate new teams and as we expand the Granite brand as America's infrastructure company. We thank Granite employees for their dedication to our core values and especially to safety.

This year safety performance has been steady-to-improved across our business, but our focus remains on zero injuries, ensuring everyone gets home safely every single day.

In fact, safety is one of the key initial focus areas we have reinforced with the newest members of the Granite team. On top of the obvious people benefits working safely, translates consistently in the higher quality work and improved financial performance.

The emphasis on improved safety highlights the focus on our people and it aligns with our integration approach to equipment systems and process improvement. We thought it was important to begin by highlighting some examples of our strategy and action, both in our current results and in our strategic outlook, Jigisha will provide additional detail and color on the quarter.

Performance in the third quarter and really throughout 2018 has been outstanding. Revenue, profitability and our earnings, all are solidly higher this year and we expect these trends to continue for some time.

Revenue increased double digits for the quarter and for the year, even as our focus has remained on improved profitability in 2018. From a margin perspective, acquired businesses have delivered performance in line with our expectations, as our focus on improved bidding discipline is creating solid bottom-line performance. This year's work on pricing illustrates the broad leverage our business can exert to create bottom-line results.

Granite teams are market leaders. Recently, Engineering News-Record ranked Granite as the number one highway contractor in America and Water (ph) ranked number two in sanitary and storm sewers and number five in storage and solid waste.

In mining, we ranked at number five according to ENR and we finished at eighth nationally in power transmission and distribution. These markets will continue to fuel our future growth and profitability.

Across these diversified end markets, our focus remains on reinforcing the value of sustained pricing discipline to deliver consistent balanced risk-adjusted returns.

Despite healthy and growing demand in our transportation water and specialty segments, much of the work we are pursuing continues to be priced below what we believe are appropriate levels. This was impacted project win rates in 2018, most notably for transportation projects.

We are confident that our deliberate bottom line focus is sound practical and strategic. With solid demand trends across our business, we expect our approach will create significant top and bottom line value over the next few quarters and years, especially considering healthy near and long-term public and private market demand.

Through three quarters this year, increased discipline has contributed to consolidated gross profit margin of 11.6%, up 180 basis points from last year. Excluding acquisition-related expenses, adjusted net income more than doubled from 2017 and adjusted EBITDA margin increased more than 200 basis points to 7.1% at the end of Q3.

The business is performing well and we continue to set the bar higher across geographies and end markets. Now let's shift back to Granite's strategy.

Specifically, I want to spend a few minutes this morning discussing how these segment changes capture the well-communicated execution of our rolling five-year strategic plan. As our industry entered its steep recession in 2009 and 2010, we recognize that Granite's public transportation and public funding reliance were limiting factors for consistent reliable growth.

In the midst of weakening public transportation and infrastructure funding trends that did not bottom until 2013, unmanageable and unprecedented political risk also took hold, impacting our industry from Washington DC and from state houses across the country.

Infrastructure previously a nonpartisan point of general agreement recently has been tossed around in a new game of political football. Through this period we defined and set the path to extend Granite's reach and to broaden opportunities for long-term growth and more consistent returns.

We focused on internal resource and asset optimization and we invested in lean Six Sigma techniques that we refer to as continuous improvement. Perhaps most importantly, we refined opportunities by focusing on three key areas, including diversifying the sources and drivers of our project funding, diversifying our customer base with private market focus and emphasizing new but related end market growth opportunities.

Newer line capabilities will require to meaningfully enter our new end markets and geographies. The Kenny Construction addition at the end of 2012 now our Midwest operating group, was our first target for end market and geographic diversification. That move drove growth via the additions of tunnel, power, water and wastewater markets as well as a new geographic markets for our civil construction business.

Importantly, it introduced Granite to diversification, delivering incremental growth and improved profitability at a time when our nine decades old business remained mired in a pernicious trough.

Diversification, a defined strategic driver took hold as a key focus area across our business, and it created results. Empathizing relationship and customer management teams engaged and took action to develop new end market focus business plans.

Within just two years across the Granite portfolio, work in new end markets with new customers began contributing significantly to backlog revenue and profitability. We recognize then that our teams were capable of leveraging existing resources, expanding capabilities and delivering growth in a low demand transportation market with profitability above traditional transportation profit margins.

Effort toward acquisition-led expansion began to accelerate again in 2015 when we targeted Granite growth in water, power and rail markets. Our prudent and patience was rewarded and we capitalized on opportunities to execute the acquisitions of Layne Christensen and LiquiForce, allowing us to deliver on the next leg of our growth and diversification strategy.

We continue to review opportunities for Eastward geographic expansion of Granite's vertically integrated model. Simultaneously, we continue to target end market expansion, whether through bolt-on opportunities or through more significant investments in our existing end markets.

Granite's end market based segments, illustrate our strategy and action highlighting significant opportunities for our growth.

We believe this new presentation provides investors with an improved view into Granite with deeper visibility and insight than ever before. We also believe that our diversified end market focus is the most appropriate way to balance growth and risk opportunities for our business.

Our growth outlook is based on today's steady private market demand across end markets along with stable and improving infrastructure funding demand trends from the public sector. Granite's key Transportation and Water Infrastructure markets continue to improve steadily.

As a result, today's healthy balance of long-term public and private demand remains the best we have seen in well over a decade. Granite is extremely well positioned to continue to flourish and to grow, delivering on our vision as America's infrastructure company.

And with that, I hand it over to Jigisha with detail on our results and our 2018 outlook. Jigisha?

Jigisha Desai -- CFO

Thank you, Jim and good morning, everyone. Third quarter 2018 revenue was $1.06 billion up 10.3% from last year with year-to-date revenue higher by 10.9% at $2.43 billion. Excluding the impact of acquisition-related expenses, third quarter and year-to-date 2018 adjusted net income increased nearly 47% and more than 118% respectively from 2017. This translated into adjusted earning per share of $1.42 in the quarter and $1.85 on a year-to-date basis.

As was the case last quarter, adjusted EBITDA improved significantly in the third quarter, up 30.9% from 2017. On a year-to-date basis, adjusted EBITDA increased 62.5% year-over-year to $172.9 million. This figure already exceeds our full-year 2017 performance and at 7.1% year-to-date, it translates into 220 basis points of EBITDA margin improvement.

Third quarter gross profit increased 26.2% year-over-year and year-to-date gross profit increased 31.2% to $281.1 million. Year-to-date consolidated gross profit margin of 11.6% was at a 100 basis point improvement from 2017.

Our scalable cost structure continues to produce results. While third quarter and the year-to-date 2018 SG&A increased year-over-year, the increase was driven by acquisitions-related costs primarily acquired G&A. Excluding the impact of acquisition-related costs and overhead our core G&A expenses declined slightly year-over-year through Q3.

As Jim noted, we began the Layne and LiquiForce integration with an emphasis on safety. Our teams are working to deliver on cost synergies and growth opportunities while they continue to improve safety performance. Safety will remain a key focus as we work to capture and to create cost and growth synergies to drive overhead costs steadily lower over the next couple of years.

Granite's balance sheet remained strong with more than $300 million in cash and marketable securities at the end of Q3. We continue to target improved working capital trends and cash flow expectations, which are expected to further strengthen our capital structure, supporting the execution of our strategic plan.

Total contract backlog was $3.24 billion, down 23.5% year-over-year. Earlier in 2018, we received notification of certain project wins that are not yet included in our backlog. These three projects in California, Utah and Florida, totaled more than $825 million and are expected to enter our backlog in late 2018 and 2019.

Next, let's move to our new segments, extending our reach to deliver end market and geographic diversification in the growing water, wastewater and mining infrastructure markets, acquisitions have led to our new segment reporting.

In June, following the close of the Layne transaction, we announced the formation of the Water and Mineral Services operating group and we announced our new reportable segments. Granite's functional businesses continue to be managed in operating groups with our end market based segment well aligned with the execution of our rolling five-year strategic plan.

Our M&A activity in 2018 has enabled Granite to focus and align our strategic outlook with our end market focus on growth, profitability and risk weighted returns. The forward Kenny Underground and the LiquiForce businesses joined the Layne Inliner business to become Granite Inliner in the third quarter of 2018.

This newly combined chain is the largest part of the Water and Mineral Services Group, which also includes our Water Resources and Mining Services division.

Shifting to segment results, we begin today in the transportation segment. Granite is a national leader in the transportation and these markets are stable and improving, fueled by strengthening long-term public funding trends and by private, commercial and industrial demand that remains healthy.

This segment's portfolio now includes larger transportation projects that are primarily managed by our Heavy Civil operating group. In the third quarter, Transportation segment revenue decreased 2.2% year-over-year to $610.8 million. On a year-to-date basis, segment revenue has increased 3.5% from 2017 to $1.47 billion.

Quarterly gross profit increased 8.3% year-over-year with gross profit margin of 11.6% up more than 100 basis points from last year. Year-to-date gross profit increased 15.4% with a resulting gross profit margin of 9.4%, up about 100 basis points from 2017.

Year-over-year profit performance continues to support our efforts to raise prices in a healthy environment for most of our geographic markets. It also reflects the impact of ongoing work on several underperforming mature projects, which again had a negative impact on quarterly results as we anticipated.

For context, as previously constituted, the former larger project construction segment contributed a 4.3% gross profit margin performance in the third quarter, which translated into a year-to-date gross margin of 4.1%.

As expected throughout the year, we continue to benefit from the positive contribution of the more recent project wins in our portfolio. We continue to expect that large legacy projects that have been a drag on results for quite some time, should have a declining negative impact on segment results in 2019.

Transportation segment backlog decreased 30% year-over-year to $2.31 billion. We continue to increase our gross profit margin, operating income and cash flow expectations on all new work. Market opportunity remained robust as we patiently reshape our project portfolio, pursuing disciplined strategies that balance and limit project risk dynamics, reflected in our improved third quarter and year-to-date transportation segment results.

We're developing the water segment into an efficient, disciplined and growing presence in the attractive water and wastewater market. We are particularly excited that this new significant portion of our business has delivered solid performance since entering the Granite portfolio.

Here, revenue rose significantly due to the impact of acquisitions, both on a quarterly and on a year-to-date basis. But more importantly, profit and margin performance was a solid contributor to results.

Quarterly gross profit increased to $24.1 million from only $1.8 million last year, with gross profit margin of 19.4% up more than 1400 basis points from last year. Year-to-date gross profit increased to $41.1 million from $9.8 million last year with gross profit margin of 19%, up nearly 1,000 basis points from 2017.

Year-over-year profit improvement is tied to solid execution on projects in the robust markets we target in the water segment. Water segment backlog increased significantly over a year to $364.8 million with the recent acquisitions providing most of the uplift.

The segment's bidding environment remains healthy mirroring steady to improving federal, state and local funding of municipal and investor-owned utilities. The specialty segment is comprised of diverse and highly variable projects and businesses, including tunnel, power, renewable energy and site development, in addition to logistics, materials management and a broadening portfolio of mining activities and capabilities.

In the third quarter, Specialty segment, revenue decreased 3.6% year-over-year to $190.8 million. On a year-to-date basis, segment revenue increased 2% to $461.1 million. Quarterly gross profit increased 1.1% year-over-year with gross profit margin up about 70 basis points to 14.7%.

Year-to-date, gross profit increased 15.1% year-over-year with gross profit margin up about 170 basis points to 14.2%. This profit improvement was attributable primarily to solid execution and consistent bidding discipline, which is producing improved margins on new work.

Specialty segment backlog decreased 27.6% year-over-year to $564.7 million based on steady project bond rates. The bidding environment in Granite Specialty segment also remains healthy, supported by steady public and private market demand.

The environment is expected to allow teams to continue to build backlog in order to grow this segment in 2019. Project diversity will balance Specialty segment returns and it will produce exciting opportunities for growth tied to future project wins across industries, geographies and across Granite's operating groups.

Over the past three to five years, our Materials segment has emphasized efficiency and relationship building to optimize asset utilization in steady and growing demand environment.

In the third quarter, Material segment revenue increased 32.1% year-over-year to $129.6 million and year-to-date revenue increased 30.4% to $276.3 million. Quarterly gross profit improved 9.9% year-over-year to $21.3 million from the prior year period with gross profit margin of 16.4%. Year-to-date, gross profit increased 30.6% year-over-year to $36.3 million from last year with gross profit margins steady at 13.1%.

The quarterly and year-to-date revenue and profit performance was attributable primarily to improved external demand across most markets, while maintaining an expectation of overall mid-teen gross margins in the segment.

We continue to emphasize operational discipline and growth strategies in both our traditional Construction Materials business as well as in the vertically integrated Liner Products business that we acquired.

Over time, increased demand and volume in the Materials segment will contribute to consistent improving margin performance and steady cash generation.

With that, let's discuss our outlook and some additional metrics that guide our view. Noting that we have taken on higher acquired overhead that will rationalize over the next couple of years, we expect SG&A as a percentage of revenue to finish slightly higher than last year's 7.5% level.

Our effective tax rate in the quarter was 12.8% driven by $7.6 million benefit, a discrete item related to revaluation of deferred tax assets and liabilities. In 2018, we expect our effective tax rate to finish in the high teens to low 20s percentage range.

Longer term, we expect Granite's tax rate on a go-forward basis to settle around the mid '20s percentage level. Our full-year expectations for 2018 including acquisitions are mid-teens revenue growth, which as always is subject to last year -- late year seasonality and adjusted EBITDA margin of 7.5% to 8.5%.

Now before we take your questions, let me turn the call back to Jim.

James Roberts -- President and Chief Executive Officer,

Thank you, Jigisha, Growth is here for our business across the end markets and geographies that we serve. We have planned for it and we have broadened the reach of our portfolio.

Optimism is growing at the long-awaited federal infrastructure action and Washington appears finally to be on the horizon. We hope that the recently passed Water Resources Development Act of 2018 is an example of the improved emphasis on infrastructure investment ahead.

The new water resources bill authorizes $3.7 billion for new Army Corps of Engineers Civil Works projects and $4.4 billion for the Environmental Protection Agency drinking water program. While extension of previous legislation this reauthorization marks a step-up in funding from previous bills.

Of course through November 06, a key focus remains on the effort to defeat Proposition 6 right here in California. While in California, we strongly recommend you vote, no.

We remain optimistic of the shortsighted, purely political, anti-transportation measure will be defeated. We believe the tide has changed with citizens committed to vote for investment and their communities in ever larger numbers.

Proposition 6 is one of more than 300 state and local transportation funding measures on voters' ballots on November 6. Today Granite is extremely well positioned to feed our strength, sharpen our capabilities and grow in all parts of our business.

Our transportation segment, the largest both our revenue and profit today will continue to be a source of significant growth and opportunity for Granite's teams across the country. Chronic under investment and stepped up spending trends, fuel our growth expectation and water infrastructure, whether for wastewater, dams, inland waterways or drinking water systems.

Our strategy was developed to capture the benefit of improving secular demand trends, across transportation water and other infrastructure markets. Across the infrastructure solutions, the roads and the pipes and the wires our grandparents and parents bill, continue to carry the weight of decades of underinvestment and they continue to crumble at scale.

Our businesses are positioned to create significant long-term benefits from investment to reduce chronic pent-up demand. Even in established mature markets, we continue to emphasize discipline. We're still very early cycle growth and investment opportunities. This effort is expected to fuel improved financial performance and a strengthening balance sheet to deliver on our growth plan through diversification and geographic expansion, providing significant, incremental economic value for Granite stakeholders.

And with that everyone, we will be happy to take your questions.

Questions and Answers:

Operator

(Operator instructions) Our first question comes from Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich -- Goldman Sachs -- Analyst

Yes, hi. Good morning, everyone.

James Roberts -- President and Chief Executive Officer,

Good morning, Jerry.

Jerry Revich -- Goldman Sachs -- Analyst

I'm wondering if you could talk about what level of decline you saw in your win rates as a result of the change in the pricing focus. In other words, is the overall bid environment or is the overall opportunity set intact or are you seeing the cadence of opportunities slowing?

James Roberts -- President and Chief Executive Officer,

Okay. Well, that's really important, Jerry because as mentioned, as we continue to raise our prices, our win rates too tend in the short run to drop slightly and I say that we've been normally in the 25% to 30% hit rate. And I would suggest today we're down probably in the 20% hit rate.

So yeah, there is a slight reduction there, but I do think that as you can see what it's doing, it's allowing us to create a more healthy bottom line, which but we believe is by far the more important dynamic of our business.

There is no slowdown in the overall market. The market is healthy. We're bidding more work today in our transportation segment than we have bid in recent times, probably in the last 10 years. So it's not an issue relative to the market. It's our opportunity to really focus on higher margins on bid day and then that will equalize itself as we believe the continued solid market will continue through the next several years and we believe that we'll be able to go back and capture higher win rates over time.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. Thank you. And then in terms of the prior segment reporting obviously, we've had a change here, but can you talk about what large construction margins would have looked like under the prior segment reporting, just so we can make an assessment of your progress on the remaining projects that you're working to roll off the books?

James Roberts -- President and Chief Executive Officer,

Okay. Jerry. So I believe that Jigisha addressed briefly in her comments that in Q3 large projects under the old segment reporting would've had a margin of about 4.3% and which brings the year-to-date margin in the large projects at about -- to about 4.1%.

So, as we mentioned that, that now rolls into the transportation segment, but we did tell the investor base that we certainly would relay that information in this call.

Jerry Revich -- Goldman Sachs -- Analyst

All right, thank you.

James Roberts -- President and Chief Executive Officer,

Thank you, Jerry.

Operator

The next question comes from Michael Dudas with Vertical Research Partners. Please go ahead.

Michael Dudas -- Vertical Research Partners -- Analyst

Good morning, gentlemen, Jigisha.

Jigisha Desai -- CFO

Hi, Mike. How are you?

James Roberts -- President and Chief Executive Officer,

Good morning, Mike.

Michael Dudas -- Vertical Research Partners -- Analyst

Jim, following up on transportation segment and dynamic with regard to your discipline on bidding and backlog, characterize some of the revenue growth we've seen this year and looking forward, how quickly some of the excess capacity going to get mopped up, relative to the demand trends in your important markets? And how we should think about as going into '19, so we should anticipate better margins when the revenue growth will be commensurate with the overall macro trends that we're seeing especially throughout the West?

James Roberts -- President and Chief Executive Officer,

Sure. I think maybe the way to look at it is that, as the markets continue to gain momentum, a reminder that -- and certainly will probably somebody will ask the question about SB 1 today, as SB 1 has started to gain traction in California, it was slower than anticipated.

So the back half of 2018 has seen some additional bidding opportunities and I think what needs to happen to match our revenue growth with the bidding opportunities out there in the environment is going to be a kind of a projection that, that market is going to stay steady in the long run.

So people get nervous, as do investors, and as do contractors that this is a short-term issue relative to the demand we believe and based on what we've seen in most of our markets, this is not a short-term issue. So as soon as the construction contractor base understands that, I think you'll see markets, the pricing start moving up and our hit rate will probably start moving up by the middle of next year.

Michael Dudas -- Vertical Research Partners -- Analyst

Thank you, Jim. And the follow-up maybe further on SB 1 or Prop 6, maybe elaborate on some of the optimism, some of the concrete or I guess if not that's no pun intended there issues regarding the advertisements and the focus from both sides on getting the message out and leading to the increased confidence that investors -- voters will repeat -- not choose to repeal SB 1?

James Roberts -- President and Chief Executive Officer,

Sure, well Proposition 6, as most of our investor base understands if it was a yes vote, it would repeal the SB-1 and additional investments that were put into place of April 2017, but what we see today in the surveys we've done that although it will be close and almost every credible survey that we've seen it is being defeated. Some have a wider spread than others.

So based on the direction, based on where we see it going with the feedback we've got, we've still got -- we can have here to get to get this thing to conclusion, we believe it will be defeated although I will tell you, Mike as we all know that surveys are one thing and reality when people go to vote or maybe possibly a different thing. So we will be keeping our pedal to the metal all the way until November 6.

Michael Dudas -- Vertical Research Partners -- Analyst

And there has been support from the Governor and other officials to get this thing going to booked now?

James Roberts -- President and Chief Executive Officer,

Absolutely. The Governor is a very strong proponent of SB 1. In fact, he was probably the one individual who put it into play with the legislature in '17 and he is out campaigning heavily to defeat Proposition 6.

Michael Dudas -- Vertical Research Partners -- Analyst

Thank you Jim.

James Roberts -- President and Chief Executive Officer,

Thanks Mike.

Operator

Okay. The next question comes from Kathryn Thompson with Thompson Research Group. Please go ahead.

Steven Ramsey -- Thompson Research Group. -- Analyst

Good morning. This is Steven Ramsey on for Kathryn. Can you maybe talk about the nuances of staying disciplined and bidding in the water market versus some of your more traditional larger businesses that you play in and kind of thinking about how you guys plan to run the water unit, if there are differences in how Layne approached the market?

James Roberts -- President and Chief Executive Officer,

Well that's Steve so, part of what we're doing today is integrating the business into the Granite system. And I mentioned it a little bit previously, but probably the biggest dynamic and the biggest change in the way that Layne around the water business versus Granite is that what we try to do is let them operate strictly as operating units and not worry about any corporate issues.

Example, all the insurance and the bonding and all of the banking and the cash metrics and everything are all done away from the operating units. So they can focus strictly on the bidding and building of their work. Now there is no doubt that as Granite moves in and has a larger oversight of the water business that we do have reasonable expectations in terms of margins, but I would suggest to you that in the water market as you've seen in the results in the third quarter, their margins are pretty healthy right now and they have been.

The issue that was -- that needs to be dealt with is basically the SG&A attached to that business more so than the operational function of bidding and building. So what we're really focusing on are the synergies as we talked during the acquisition timeframe that we're talking about the synergistically creating a more efficient overhead to help build their business.

And we're seeing that today and the changing of the corporate structure with the Layne acquisition where a lot of those folks already are no longer in place because of the Granite folks are already here to handle those corporate functions, but operationally, we are using the same systems for bidding.

We are bringing the bidding systems in alignment with Granite today so that if you bid a job and the Inliner and we bid a job let's say up in the State of Washington or Utah or in Florida, they're all using the same system today. So we will continue to do that.

But overall the water business, the operating basis for it is very strong, the margins are strong. The key now is to integrate the two structural components together and reduce the overall size of the overhead.

Jigisha Desai -- CFO

I was going to also add that with the combination of Kenny Underground and LiquiForce, now we are a very meaningful player in the water market and that is going to be able to capitalize on some of the services, cross-selling services that wasn't available previously to Layne and now we have ability to do that.

James Roberts -- President and Chief Executive Officer,

Got it. And maybe the other thing I'll add here, Steven for you is that, as we saw the Layne business when we were looking into the diligence on it, it would have been undercapitalized for quite some time.

And so what we have been through is a cycle now. Since the acquisition in June, our CapEx cycle runs during the late summer months and they will be receiving additional monies to help stabilize and create a stronger asset base in their business, which we believe will create immediate value for them.

So they've just been undercapitalized and in not only repairs, but in acquisitions of new equipment to really optimize their business and we're going to, as we mentioned, from day one, we are in the middle of making sure they get what they need.

Steven Ramsey -- Thompson Research Group. -- Analyst

Excellent. And then, this may be kind of more of a stepping back or elementary questions, thinking about the Material segment, but could you remind us of your pricing strategy in internal versus external sales channels and is there anything on the pricing front that you would call out that would you raise prices enough that maybe the capacity doesn't get used up as much, but you still get solid revenue because of your pricing.

James Roberts -- President and Chief Executive Officer,

Okay. Steve. So, a couple things. I think it's really good. I'm glad you brought up materials. A lot of time as one of the smaller segments, it doesn't get really the discussion that it deserves, I've always said that as our Materials segment maneuvers it is the guiding light of what's going on in the marketplace.

And as you can see with significant revenue increase, the Materials business is starting to really show that their demand is increasing in the marketplace. We price inside versus outside very similarly and unless there is a specific job that may create, I'll call it a real value to the company, we might change the internal pricing, but on a day-to-day basing, the pricing of internal versus external is very, very similar.

And as a reminder that we have a huge fixed asset base of equipment and land reserves attached to that materials business and what we said is that as we create incremental value and incremental demand, there was a very large and we suggested is somewhere in the 40% incremental additional margin as we increase the overall amount of material coming through our products.

So volume alone will help the bottom line and simultaneously, we have raised prices and we are continuing to raise prices. So the combination of all of those will create a substantially healthier market as we go into 2019 and beyond and I always go back and make it clear to people that back in '05, '04, '05 and '06 when you look at our Materials business, our margins were substantially higher than they are today.

We're at about 13% for the year, which in itself is substantially higher than it was a few years back. It was as low as 3% during the downturn. So we've gone from 3% to 13%. I believe it needs to get up into the high teens, low '20s in order to be really the business we're looking at.

Steven Ramsey -- Thompson Research Group. -- Analyst

Great thank you.

James Roberts -- President and Chief Executive Officer,

Thank you, Steven.

Operator

The next question comes from Brent Thielman with D. A. Davidson. Please go ahead.

Brent Thielman -- D. A. Davidson -- Analyst

Thanks. Good morning.

James Roberts -- President and Chief Executive Officer,

Good morning, Brent.

Brent Thielman -- D. A. Davidson -- Analyst

Jim, on the transportation backlog I appreciate the comments about the wins not included $825 million. Last quarter you talked about four jobs for $875 million you're waiting to book. So one or two of those since last quarter's call and you had some new wins awards since then?

James Roberts -- President and Chief Executive Officer,

Well, the answer is yes and no. We did book the $50 million into the transportation segment in the quarter and the other three are still hanging out there, which we expect to be booked in late 2018 and 2019 as planned. Nothing's changed from our discussion last quarter.

Brent Thielman -- D. A. Davidson -- Analyst

Okay. I guess, that's the case, Jim and this is if you booked fairly sizable $50 million job in the backlog, that would still suggests the small project or other project work in transportation bookings were really low this quarter. I'm just trying to understand why the market is as strong as it is.

James Roberts -- President and Chief Executive Officer,

Well, I think that maybe another way to look at it is this. that remember we said our hit rate is down a little bit from what it was in previous years. We're burning a lot of it faster too. So what you're going to see I think and I try to relate as to everybody about two quarters ago.

You're going to start seeing more of the smaller work and you're going to start seeing that, that revenue will pickup and it will not be indicative of an equivalent amount of backlog buildup and because you're going to bid, you're going to burn it in the same quarter and so with margins coming up, which they are, we anticipated the revenue where we're at today, we anticipated the backlog in most respects where we're at today.

I think Brent, what will happen is that you're going to see a steady increase in our revenue and our backlog in transportation as the strength of the market continues to put into play.

So I don't think there's anything going on today in the transportation segment that is a surprise to us and I think that it is just more of a steady demand and allowing the market to absorb our higher margins in which we will begin to get a higher percentage of the win rate and it's, as I tell the Granite people, it is patience.

This is a very good market and to capitalize on it, we need to be patient and if you look at the margins that we're getting out of the business today, they are as healthy as we've seen in many, many years. So we are going, we're focusing on bottom line right now for the next several quarters as we well and then I believe you're going to see the big revenue uptick.

Brent Thielman -- D. A. Davidson -- Analyst

Okay. And so if I could, real quick on CapEx, it's a big step up this quarter understand what you said about Layne and some investment there, where should we be thinking about sort of recurring CapEx for the business going forward?

James Roberts -- President and Chief Executive Officer,

Yes, so historically, we've been in the mid 2% revenue range and I'm going to say that with where we are today, we're probably going to be in the 3% plus or minus range on revenue. So if tell me what's the model there, I think it'd be very safe.

Brent Thielman -- D. A. Davidson -- Analyst

Thanks.

Operator

(Operator Instructions) The next question comes from Sameer Rathod with Macquarie. Please go ahead.

Sameer Rathod -- Macquarie. -- Analyst

Hello and good morning. Just going back to backlog, so I guess I understand the strategy I think that makes a lot of sense, but when do you expect backlog to bottom then?

James Roberts -- President and Chief Executive Officer,

Well, OK. So I think it will depend Sameer and by the way, good morning, Sameer. It's going to depend on when we actually receive the awards on those $825 million of outstanding and that's where it's really important that we're transparent and we talk about what in the backlog.

Is it large project backlog? Is it in the older discussion points construction, transportation or water. So most of our backlog today outside of the larger work that $825 million is smaller day-to-day work, I think that has pretty much and I'm going to say bottomed out, but it will probably stay very steady for the next couple quarters. You're going to see an increase in the actual backlog because we will layer in this $800 million, but from that point forward, I think it's going to be a steady demand increase going forward.

So if you want to say has it bottomed out, it could have bottomed out where it is today, but I say that with making sure that our investor base focuses on large project, the moment you put one into play, you're going to get that blip.

And we will make sure that everybody understands that when we put one or two big ones in there, that there's a couple of big ones in there, because I think the more important backlog, not to take away from the large work is the size and the amount of all of the work going on in the smaller transportation and water segments across the country.

So backlog I think is kind of where you -- I don't think it's going to get any lower unless there's delays and awards because the market is pretty healthy right now in the bidding environment Sameer.

Sameer Rathod -- Macquarie. -- Analyst

Right. Okay, thank you.

James Roberts -- President and Chief Executive Officer,

Thanks Sameer.

Operator

The next question comes from Alex Rygiel with B. Riley FBR. Please go ahead.

Min Cho -- B. Riley FBR. -- Analyst

Great. Good morning. This is actually Min Cho for Alex. Good morning. Quick question about Prop 6, so if it passes, can you talk about how it really impacts your business? It sounds like you have so many other opportunities outside of SB 1. Could you maybe change your pricing strategy in California or just any updates there would be helpful.

James Roberts -- President and Chief Executive Officer,

You bet Min and all of the above. You are right. Strategically, we have diversified the company significantly over the last couple of years for exactly this reason, not because of this issue, but for this reason is that -- so that one event doesn't have an overly sizable impact on the company.

So we would need to probably adjust our pricing in California if SB 1 was defeated or Prop 6 got passed, but California in itself is a healthy market and I think people may be missing the fact that a lot of the local environments are very healthy. The state is still healthy with a very with a balanced budget. We also look into the private sector. The private sector is very strong in California.

So a big chunk of our work in California is coming from the private sector. We would most likely need to go ahead and have a little adjustment in our margins, but I don't think it's going to be a huge impact. There will be no impact in 2018.

And we're trying to figure out what it would be in 2019, but I don't think it's that big of an issue on 2019 because I think that a lot of the contractors in the state already today have been quite aggressive in building their backlog because they're not sure what's going to happen to Prop 6.

So they already have a lot of work on their books, but I think that you're exactly correct. It is such a healthy market in California that it will have a slight impact, but it's not going to be substantial.

Jigisha Desai -- CFO

Yes, in fact, we will be meeting with our leadership team in a couple of weeks to review our 2019 budget and our California Group will be coming with kind of before and after on with their SB 1 implications. So we will know more, obviously.

James Roberts -- President and Chief Executive Officer,

Yeah, and then as a reminder Min, we firmly believe that Proposition 6 will be defeated. And with that said, it would be bullish not to figure out what the opportunities would be coming our way if it did pass, but we based on where we are today, its full steam ahead with the anticipation that Prop 6 will be defeated.

Min Cho -- B. Riley FBR. -- Analyst

Hope that is the case. On the Materials business, I know it's kind of a new Materials group, but what percentage of that is the Layne liner product right now? And I guess I'm trying to get to is kind of what your organic revenue growth has been in the quarter. It seems like it was probably pretty flattish on a year-over-year basis.

James Roberts -- President and Chief Executive Officer,

So I would put liner products at about 10% of the Granite Materials business.

Min Cho -- B. Riley FBR. -- Analyst

Okay. So you did see an increase in the old Construction Materials business in the quarter?

James Roberts -- President and Chief Executive Officer,

Well, absolutely, absolutely.

Min Cho -- B. Riley FBR. -- Analyst

Great, thank you.

James Roberts -- President and Chief Executive Officer,

Yes. And I would suggest also Min that the Materials business as I always mentioned, it's healthy and it is a leading indicator of what's to come as well.

Min Cho -- B. Riley FBR. -- Analyst

Yeah. Great, thank you.

James Roberts -- President and Chief Executive Officer,

Thank you, Min.

Operator

The next question comes from Joe Giordano with Cowen. Please go ahead.

Joe Giordano -- Cowen -- Analyst

Hey, good morning, everyone. So I guess we kind of been talking about this throughout the -- throughout the call here, but Jim, what I think is critical is understanding how your business is operating today relative to what changes on November 7 one way or another?

Like if SB 1 is repealed, what kind of change are we talking about like order patterns? And if it remains, do we see this influx, I think that's like where people are struggling a little bit to just gauge what your current operating environment is like relative to the continued reality or not reality of SB 1.

James Roberts -- President and Chief Executive Officer,

Okay. So to kind of maybe put it into a little more granular, nothing is going to change in 2018. The way we see the events of Election Day are that it will slow down work that would have been put out in 2019. We know that.

The work that has been put out and kind of a misnomer is that it will still be put out if it has been funded, which the majority of it has been funded and it won't change the way we do business in California.

It may make a slight adjustment in the margins as they go forward, but as you can tell from where we are today in California without picking up a lot of work, our business is very healthy and it's because of the different types of work that we're doing in California, not just DoT transportation type work.

So we're really kind of saying to ourselves that it's business as usual. It will be in emotional letdown if Proposition 6 was to pass. It will not have an immediate effect on the California business and I'm comfortable our business units will maneuver around it very quickly in 2019, if it passes.

So I don't think there is -- I do think that a lot of people we're talking about this significant binary opportunity that occurs on Election Day and I understand why, but if the -- if we had been reliant on SB 1 monies since April 17 to be where we are in California, it would be much more of a binary event than it is, but we have not been.

Joe Giordano -- Cowen -- Analyst

So fair to say what we're seeing now from your operations, does not really reflect some massive uptick from SB 1 related spending anyway, so it's kind of a run --

James Roberts -- President and Chief Executive Officer,

That is absolutely correct, Joe. And I said -- and as I've said, Joe, it does not kick in as quickly for Granite as it may have for other competitors in the market strictly because of our pricing mechanism. So, and it was somewhat anticipated and talked about a year ago and so no, we have not seen the big uptick due to SB 1.

Joe Giordano -- Cowen -- Analyst

Okay. And then my related question there, and we've talked a lot about the pricing mechanisms in California and how you guys have been more vigilant there. Now a lot of times in the past, we've talked about when the private market is really strong and really helps your ability to push price in new public markets and your comment that the private markets are still really strong seems to be a little bit of dislocation to what you're talking about with the ability to get price and on that win rate.

So can we talk about how that dynamic is maybe changed a little bit or people just like you said building backlog because they're nervous and being more aggressive now and then normally would be in a strong private sector environment?

James Roberts -- President and Chief Executive Officer,

Well, I think what's happened Joe, is that as the markets have strengthened that you start seeing competitors migrate into one camp or the other and Granite is large enough where we always migrate into both camps.

But what you've seen is the maneuverability of certain companies going over to the private sector. Other companies going to the public sector. The public sector, that group has been competitive as we anticipated. The private sector is pretty much the sector that we deal in on the private side as the larger private sector.

We've talked about following certain industrial and technology companies that we have a very close relationship with. That part has been very healthy and is staying very healthy.

So our bookings are very steady year-over-year on the private sector, in fact increasing and you got to look at it two separate camps right now and when I say competitive, it's been very competitive on the public side because a lot of people are strictly playing in the public side today because there's enough work there for them to not migrate back into the private side.

Operator

The next question comes from Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich -- Goldman Sachs -- Analyst

Yes. Thank you for taking the follow-up. Jim, I am wondering if you could talk about your guidance revision this year, so nice to see margins moving up, but the topline expectations came down. Can you just talk about whether that was driven by Layne or the base business, weather etcetera.

Can you just give us some context in terms of the moving pieces around the negative revision to the top line in the guide?

James Roberts -- President and Chief Executive Officer,

I spend more energy on the positive revision on the percentage of EBITDA margin than the negative perspective on the revenue Jerry. So let's look at the glass half full here.

Jerry Revich -- Goldman Sachs -- Analyst

And basically the margins. So great to see the margins absolutely.

James Roberts -- President and Chief Executive Officer,

There you go, Jerry. So yes, I believe that what we're trying to suggest there is that our plan is exactly working. We have had a slight reduction in revenue and a refocus on the bottom line and it's working with an expectation that our EBITDA margins are moving up and we're not as aggressive on the revenue side as we could be if we wanted to be and I've told some investors that we probably could have optimized a little bit better.

We kind of could have been more aggressive and seeing that regarding that revenue back up to maybe the high teens, low '20s, but we don't think that's the best thing for the company in the long run.

We think that what we are doing today is creating another level of margin expectations that will stick with the company for quite some time.

So I believe it is a -- please be patient. It is an environment where bottom line is more important than top line and top line is going to come. The markets are plenty strong enough for us to get that top line at any point in time. That is not an issue.

The issue is to try to get that top line up, while retaining the bottom line margins and to do that, we have to mandate a certain type of margin on the bottom line in the short run and then the top line will come with it.

Jerry Revich -- Goldman Sachs -- Analyst

And in terms of the length of that transition, how should we be thinking about that playing out clearly big step change this quarter? So should we think about comps from a top line standpoint being pretty tough through the first half of '19 for top line, but hopefully improving for margins. Is that the way to think about it?

James Roberts -- President and Chief Executive Officer,

Yeah. I would actually suggest to you that I think there's going to be a very methodical steady healthy growth over the next three years and we've talked a little bit about this Jerry, that if you wanted to just be from a modeling standpoint just straight line it with a really nice growth over the next three to five years, I think that's very important.

We try not to blow it out in one quarter or another quarter. We're trying to create a long-term methodical revenue stream and our growth on the overall business is very healthy. It's an exciting time to be able to now take these acquisitions and build those businesses into healthier businesses. So I would just suggest that the growth -- the revenue side will grow steadily in 2019.

Jerry Revich -- Goldman Sachs -- Analyst

Even though the backlog is down entering the year and even though we're pushing pricing more and as a result the win rates are down. You're still comfortable with organic top line growth through '19?

James Roberts -- President and Chief Executive Officer,

Absolutely in fact Jerry. I think that's exactly what I've been trying to say maybe not saying it well enough is that the market is strong enough, is very, is very strong enough to be able to support nice revenue growth in 2019 and beyond while maintaining margin expectations and it's just a matter which one you do first and we've decided over the last 12 months to focus on margin improvement first, revenue improvement will come along and the market is pretty strong enough to drive those revenue expectations.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. Thank you.

James Roberts -- President and Chief Executive Officer,

Thank you, Jerry.

Operator

The next question comes from Michael Dudas with Vertical Research Partners. Please go ahead.

Michael Dudas -- Vertical Research Partners -- Analyst

Yeah, Jim, just wanted to touch base on couple things. One maybe can review for sort of Jigisha your thoughts on the balance sheet and target ratios, how comfortable you are with your debt, net debt and in some of the things you're working toward improving the cash flow moving into 2019.

And then Jim, maybe if you could review how you're thinking about what you've acquired say the Permian business, international business. I know you said you would be looking all different opportunities that you've had in the company here for several months. Maybe you could share thoughts on how that -- you're thinking about that relative to our position in Granite?

Jigisha Desai -- CFO

Yeah, so let me address the balance sheet question first. Very comfortable with our strong balance sheet. We had the two tranches that we had assumed from Layne. One has already been converted -- partially converted, which was about the $100 million tranche.

We have a one that's outstanding $70 million that we will take it out in November and even -- and will replace it with our revolving facility and even with that additional debt, our leverage is going to be significantly below than what we typically expect.

And so -- and from a liquidity perspective, it's pretty strong as of third quarter. The large projects, cash contributions are what has driven the variability in the cash flow for the year and with the addition of Layne that changes our kind of risk profiles because these are small duration jobs, which means that the cash generation is much more predictable. So, from a balance sheet perspective I'm very comfortable.

James Roberts -- President and Chief Executive Officer,

Yes, maybe and then if that satisfy the balance sheet discussion there might before we move on to some of the other businesses?

Michael Dudas -- Vertical Research Partners -- Analyst

Yes sure.

James Roberts -- President and Chief Executive Officer,

Okay Mike. So certainly we have with the acquisition of Layne brought in several businesses, what we call midstream and certainly the international businesses. Relative to that we've actually as discussed in previous calls have considered divesting on some of the businesses, considered enhancing others and consider strengthening some.

So we are still in the play, potentially divesting of one or more of the businesses and some of those plays are in action as we speak and we'll be able to give further notice on it in the very near future.

Michael Dudas -- Vertical Research Partners -- Analyst

Excellent Jim, Thank you.

James Roberts -- President and Chief Executive Officer,

Thanks Mike.

Operator

The next question comes from Brent Thielman with DA Davidson. Please go ahead.

Brent Thielman -- D. A. Davidson -- Analyst

Yes, thanks. Jigisha, the $63 million in assets held for sale, does that pertain to what you were just discussing Jim on the Midstream side or is that something else?

Jigisha Desai -- CFO

It is.

James Roberts -- President and Chief Executive Officer,

Yeah, I think that when you look into the queue, you'll see that we do have certain amount of value set aside for assets for sale.

Brent Thielman -- D. A. Davidson -- Analyst

Got it, OK. And then I don't think we dove into it, but could you just update us exactly where the problem, large projects are. I know you want to put these behind us, but still in front of us to some extent.

What's left on these and I guess should we see a similar situation as we did in the last 12 months as we go into the fourth quarter, first quarter maybe you slow these things down, expedite the good jobs such that the margins could actually increase further from here because of that. Just little more help there?

James Roberts -- President and Chief Executive Officer,

Yes, Brent, I think that is absolutely what we intend to have happened. We've mentioned several times before we made the change -- the segment change that on the large project segment, previously we have three jobs that were still in play that were slow, mature projects that were certainly slowing down the bottom line.

Two of them will be essentially completed in 2018. One of them has a longer tail attached to it and if we were to be go back and talk about large projects in itself, what we've suggested is that taking our current numbers and it was in the 4% range, we do believe that is a mid-teen margin business and that we would have stated it would take through 2020 to get it back there because of some of that lag that will just unfortunately still be there.

But a very simple way to look at that portion of the transportation segment is somewhat of a straight line between now and the end of 2020 getting it back to the mid-teens margins.

Brent Thielman -- D. A. Davidson -- Analyst

Okay. So Jim, it would before carrying into 2019, I don't know how much is left. is it large enough that it could prevent you from getting to a 10% plus EBITDA margin next year?

James Roberts -- President and Chief Executive Officer,

I don't have that answer in front of me, but in the big -- in the bigger scheme of Granite, it will have a play in the transportation segment, but the remainder of our business will have a much larger offset to it. So it will have substantially less of an impact on the business in 2019 than the top large projects in 2018.

Jigisha Desai -- CFO

Plus Brent we'll be updating our guidance in February when we announce our fourth quarter results too.

Brent Thielman -- D. A. Davidson -- Analyst

Okay. All right. Thanks guys.

James Roberts -- President and Chief Executive Officer,

You bet.

Operator

The final question comes from Brian Rafn with Morgan Dempsey. Please go ahead. Brian has dropped off the Q&A session. This is the end of Q&A. And now I'd like to turn the call back over to our hosts.

James Roberts -- President and Chief Executive Officer,

Okay well everybody, thank you as always for your questions. A quick note for our shareholders and investors Jigisha, Ron and I will be on the road and at conferences visiting our operations and investors around the country in the fourth quarter.

So please reach out to Ron and we will look forward to speaking with all of you and meeting with you whenever possible. And as always thank you to all of our employees for keeping your fellow worker safe and for exhibiting Granite's core values every single day.

As always, Jigisha, Ron and I are available for follow-up if you have any further questions and thank you for joining us today everybody.

Jigisha Desai -- CFO

Thank you.

Duration: 65 minutes

Call participants:

Ronald Botoff -- Vice President of Investor Relations and Government Affairs

James Roberts -- President and Chief Executive Officer,

Jigisha Desai -- CFO

Jerry Revich -- Goldman Sachs -- Analyst

Michael Dudas -- Vertical Research Partners -- Analyst

Steven Ramsey -- Thompson Research Group. -- Analyst

Brent Thielman -- D. A. Davidson -- Analyst

Sameer Rathod -- Macquarie. -- Analyst

Min Cho -- B. Riley FBR. -- Analyst

Joe Giordano -- Cowen -- Analyst

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