Knife River Corp (KNF) Q3 2026 Earnings Call Transcript

Thank you for joining us, and welcome to the Knife River Corporation Third Quarter Results Conference Call. After today's prepared remarks, we will host a question and answer session. If you would like to ask a question, please press star 1 to raise your hand. To withdraw your question, press star 1 again. I will now hand the conference over to Dara Dirks, Head of Investor Relations. Dara, please go ahead.

Good morning, everyone, and thank you for joining Knife River Corporation's third quarter results conference call. With me today are President and Chief Executive Officer Brian Gray and Chief Financial Officer Nathan Ring. A question and answer session will follow their prepared remarks. Today's discussion will contain forward-looking statements about future operational and financial expectations. Actual results may differ materially from those projected in today's forward-looking statements. For further detail, please refer to today's earnings release and the risk factors disclosed in our most recent filings with the SEC, which are available on our website and the SEC website. Except as required by law, we undertake no obligation to update our forward-looking statements. During this presentation, we will make references to certain non-GAAP information. These non-GAAP measures are defined and reconciled to the most directly comparable GAAP measure in today's earnings release and investor presentation. These materials are also available on our website. I would now like to turn the call over to Brian.

Thank you, Dara. Good morning, everyone. On the call today, we'll discuss our third quarter performance, characterized by resilience and led by substantial improvement in our aggregates business. We'll highlight the actions we're taking to help overcome some near-term headwinds. And most importantly, we'll discuss the initiatives underway that position us to drive long-term, profitable growth and value creation. While we have made progress on our margins since launching EDGE in 2023, we've been sharpening our edge and have identified additional paths to achieve further growth. First, let's start with our quarterly results. Our revenue increased 6% from the same time last year to $1.3 billion. Adjusted EBITDA was $272 million, and adjusted EBITDA margin was over 21%. We are especially pleased with our record third quarter in aggregates, where edge efforts helped drive improved profitability. We focused on increasing aggregate sales to third parties, and we targeted more paving work, which together supported 10% higher volumes year over year. We also increased aggregate prices mid-single digits while reducing our per-ton production costs. Combined, these efforts helped us realize a 240 basis point improvement in aggregate gross margin to nearly 30% for the quarter. These results demonstrate what we can accomplish with our edge initiatives. We believe there is potential for meaningful margin expansion across all of our product lines, with the largest opportunities still in aggregates. As we outlined in our September investor update, the external headwinds we faced in the second quarter, market dynamics, project delays, and higher fuel costs, carried into the third quarter. The impact has been most pronounced in contracting services throughout the year, which Nathan will address in his remarks. We believe these headwinds are transitory. We have seen similar cycles before and successfully managed through them. Our crews are focused on controlling what they can control, and I'm confident in our ability to manage near-term headwinds while continuing to build for future growth. Meanwhile, we are excited about the progress we are making as we implement new self-help initiatives to improve EBITDA and margins. Let me discuss some of the results we are seeing and the additional steps we are taking. Since it's been in 2023, we've been putting our edge initiatives to work to improve our business across the board. These efforts have contributed to growth in our adjusted EBITDA, adjusted EBITDA margin, and product line gross margins, highlighted by the 530 basis point improvement in aggregate gross margins. In addition to these results, the work our pit crews have done the past three years has also given us greater visibility into the substantial new opportunities we have to improve our operations in a meaningful way. While Edge 1.0 will continue, our new Sharper Edge program adds a new set of targeted line-of-sight improvements opportunities across three areas, operational excellence, commercial excellence, and organizational excellence. We have already begun implementing these initiatives, and we expect to meaningfully ramp the program over the next three years, with increased benefits each year. In operational excellence, we're focused on further improving productivity, reducing costs, and making the best use of our assets, and we're seeing results. Starting in aggregates, we improved plant runtime by 4% in the third quarter, and we reduced variable production costs by 5%, contributing to the 29.6% gross margin we achieved. With Sharper Edge, we are digging deeper into the day-to-day performance at each plant to unlock greater potential. We are focused on plant reconfigurations and automation, improved mine planning, and optimizing heavy equipment to each operation. We plan to deploy over $125 million of capital on these aggregate opportunities over the next three years. We expect these Sharper Edge investments will improve aggregate gross profit by approximately $1 per ton. We're also excited about the benefits we expect to see in the first half of 2027 at our aggregates expansion project in South Dakota, which we expect will add over 1 million tons per year to the regional market at highly accretive margins. These are exactly the type of projects at the heart of Sharper Edge, and we are pursuing similar organic expansions in other states. In ReadyMix, we have lowered cement costs by 5% year-to-date, even as suppliers added fuel surcharges to deliveries. With Sharper Edge, we'll continue managing our cementitious materials, focus on bulk purchasing strategies, and optimizing our mix designs. At the same time, we aim to improve truck utilization, including more effective load and haul configurations to lower costs and increase production. In Asphalt, we have reduced variable production costs by 7% year-to-date, despite the inflationary headwinds we face this summer. With Sharper Edge, we will continue to optimize mix designs to manage our costs, focus on maximizing the use of recycled materials, and minimizing specialty materials. And in Energy Services, our Sharper Edge efforts include plant automation, modernized rail and loading systems, and increased tank capacity. These efforts are designed We're trying to create efficiencies, lower costs, and enable additional and liquid asphalt sales. The second focus area is commercial excellence, where the goal is to ensure we're getting the full value for our materials and services. We're focused on three key areas. First, dynamic pricing. We continue to expand the use of pricing and coding tools supported by real-time analytics. These tools give our teams better visibility into costs, demand, and market conditions so we can price each job with more precision. With Sharper Edge, we are taking this a step further, and we'll be automating dashboards so regional leadership can track pricing and costs to ensure we are delivering on our targets. We expect this to strengthen accountability to our sales targets and improve customer service. Second is the standardized use of advanced technology to optimize pricing, improve profitability, and make knife over the supplier of choice. With Sharper Edge, our priority in this area is the full rollout and adoption of transactional software to give our sales teams greater visibility into pipelines, backlogs, pricing forecasts, and margins in each of our materials product lines. Third is our go-to market strategy. We're taking a more coordinated approach to pursuing opportunities across our footprint. This includes selling more materials to national contractors and developers. We're also marketing our capabilities across our 15-state footprint to customers who are building large, mission-critical projects, including data centers, power generation, and semiconductor facilities. Our vertically integrated model allows us to offer these customers a single partner with the materials and services they need. Lastly, we are focusing sharper-edge initiatives on organizational improvements to support our operations and reduce SG&A. We've begun streamlining certain administrative processes to remove inefficiencies and speed up decision-making. We started with a financial modernization initiative in accounting nearly a year ago, with the goal of trimming days off our monthly closing process so management gets actionable data more quickly. At the same time, we are focused on evolving our technology. In September, we hired a new executive to lead the AI transformation at Knife River. His team is actively working to become a true solutions provider to our operations in an effort to help drive profit. They have already delivered an AI bidding agent designed to help our estimators quickly search, score, and rank bidding opportunities, which we rolled out last month. They have several projects underway to automate processes and identify cost savings across our company, both at the back office and in our operations. All of these are tangible initiatives with clear line of sight to improved performance. We believe Sharper Edge gives us a clear roadmap to build on the foundation established through Edge 1.0. It is focused on opportunities we have identified, actions we can control, and measurable improvements to the business. Ultimately, it is about driving sustainable growth in adjusted EBITDA, margin expansion, and creating long-term value for our shareholders. We look forward to providing more detail on financial targets at our investor day in the coming months. Next, I'll turn the call over to Nathan to walk through our product line performance, capital position, and outlook. Nathan?

Thank you, Brian. As Brian mentioned, the quarter demonstrated the resilience of our business, led by substantial improvement in our aggregates product line. We delivered higher volumes than last year across our materials product lines, while our commercial and operational initiatives helped offset the headwinds we experienced during the quarter and contributed to higher gross profit compared to the prior year. Starting with the aggregate product line, internal volumes increased 13% as we continue to benefit from additional paving activities. We'll see you next time. Together, these improvements helped drive gross margin to almost 30%, the highest level in the company's recent history. Aggregates also became the largest contributor to our gross profit for both the quarter and year to date, demonstrating continued progress toward increasing the contribution of aggregates to our overall business mix. Although we still have work to do, we are pleased with the progress we continue to make on this product line. For the full year, we expect volume growth of high single digits to low double digits, along with mid-single-digit pricing growth, and at least 150 basis points of gross margin expansion. In ReadyMix, volumes increased slightly during the quarter, supported by contributions from recent acquisitions in Texas and Montana, partially offset by lower residential and commercial demand in the West. Due to third-quarter volumes being below our expectations, we now expect full-year ready-mix volumes growth of high single to low double digits. Pricing also increased during the quarter, supported by our continued focus on sales training and dynamic pricing. Gross margin was lower, reflecting the geographic and end-market mix of volumes during the quarter. Turning to asphalt, volumes increased during the quarter, with internal volumes rising 10%, benefiting from higher paving activity in our contracting services business. Third-party volumes increased by 5% as we target sales to other contractors for their projects. For the full year, we now expect volumes to increase high single to low double digits. Our operational initiatives also continue to generate efficiencies, contributing to lower production costs at our plants during the quarter. Gross margin was lower than the prior year, primarily due to increased competition for paving work and higher input costs. For liquid asphalt, gross margin was 18.9% in the third quarter, primarily due to lower sales volumes in certain markets as well as higher material input costs. While energy services has phased margin pressure over the past two years, it remains margin accretive to the overall company. In contracting services, revenue grew by 9% during the quarter, driven by higher paving across our segments. This increased activity generated additional demand for upstream aggregates and asphalt businesses, demonstrating the benefits of our vertically integrated model. The mountain segment provides a clear example of this benefit, where we shifted our bidding strategy to place greater emphasis on asphalt paving and materials pull-through. Mountain asphalt volumes increased by almost 60%, with more than half coming from legacy operations. As Brian mentioned, transitory headwinds from competitive market conditions, higher fuel costs, and project delays have had the largest impact on our contracting services business. We saw margin compression as a result of fewer bid lettings in our more profitable markets, like Oregon, and increased competition in others. As such, we focused our bids where we could pull through our higher margin material sales, as I noted with the mountain segment, to offset this pressure. Our teams continue to right-size crews and equipment with current market demand and tightly manage variable operating costs, while also broadening the range of work we pursue. These actions, along with maintaining our disciplined approach to bidding, are focused on improving the quality of our work mix and driving better margin performance over time. For the second half of the year, we expect contracting margin to be 8 to 9 percent. Backlog ended the quarter at $857 million, down from the prior year. The year-over-year change partly reflects the higher level of contracting services revenue recognized during the third quarter compared to last year. As I just mentioned, we have also seen fewer bidding opportunities in certain markets for the quarter, including Oregon and Idaho, where funding delays have contributed to reduced project lettings. While industry data indicates that DOT budgets are slightly below prior year levels in some of our markets, overall budgets still remain near historically high levels, with approximately 32 percent of IJ funding still to be spent in Knife River markets. We're also encouraged by the bipartisan support for Build America 250. Reauthorization of the Surface Transportation Bill through 2031 would provide states certainty for their budgets, and we believe a supportive backdrop for public infrastructure investment across Knife River's markets. As we approach our busiest bidding season, our focus remains on disciplined bidding and building high-quality backlog that supports profitable growth across our vertically integrated business. Moving on to SG&A, expenses continue to track the expectations we shared earlier this year. We saw an increase in $4.4 million during the quarter, including $2.8 million from acquisitions completed over the past year. As we fully integrate these businesses, we expect to achieve greater SG&A leverage over time. As a percent of revenue, SG&A was 5.8% for the quarter, and for the full year, we continue to expect it to be comparable to 2025. Looking ahead, we anticipate SG&A as a percentage of revenue to decline as we execute our sharper-edge initiatives. Finally, switching to capital allocation, our priorities remain consistent. We are investing in our existing operations while pursuing margin-accretive organic and acquisition growth opportunities that offer attractive long-term returns. During the quarter, we invested $37 million in maintenance and improvement capital and $21 million to advance our aggregates expansion project in South Dakota and additional growth investments across our footprint. For the full year, we now expect maintenance and improvement capital expenditures between 5% and 6% of revenue, with acquisitions and organic growth investments incremental to that range. We have the balance sheet capacity and liquidity to support our strategic growth priorities. We entered the quarter with net leverage of 2.9 times and expect to continue deleveraging through year-end, finishing modestly above 2.5 times. Looking back at the third quarter, our edge initiatives continue to deliver improvements across the business, helping us navigate the headwinds we experienced during the quarter. Based on our performance through the third quarter and our projections for the remainder of the year, we now anticipate revenue of $3.375 billion to $3.425 billion and adjusted EBITDA of $475 million to $505 million. This outlook assumes normal weather and economic conditions for the remainder of the year and excludes the impact of potential acquisitions. With that, I will now turn back to Brian to provide closing remarks.

Thank you, Nathan. I'd like to finish our quarterly recap where we started. We had a solid third quarter in a challenging operating environment, and we remain very optimistic about Knife River's ability to create long-term value. The short-term headwinds certainly had an impact, and I don't want to minimize that. But we should not confuse near-term challenges We have multiple paths to achieve EBITDA and margin growth, and we're running at them simultaneously. One is through our self-help efforts, which we continue to expand and improve. We're confident our sharper edge initiatives will drive meaningful growth in EBITDA and EBITDA margin. At the same time, we have major organic investments moving closer to completion, including aggregate expansion projects in South Dakota and Texas. I mentioned our South Dakota expansion earlier, which includes plant advancements and a rail network to extend our reach into new markets. We are looking at similar investments in our other regions. Aggregates growth is a key component of our sharper-edge initiatives and represents an important path to reaching our margin goals. Lastly, our M&A pipeline is active, and the industry in our higher-growth, midsize markets is highly fragmented with vertically integrated opportunities. We are well-respected in our markets and often the acquirer of choice. Whether it's self-help, organic efforts, or M&A growth, we believe we are well-positioned to capitalize on each of these opportunities to improve adjusted EBITDA and margins. While we have made meaningful progress since going public and launching EDGE, we believe there is much more growth ahead of us. Importantly, we know where those opportunities are, and we are actively pursuing them. Thank you for the time today. We will now open the call for questions.

We will now begin the question and answer session. Please limit yourself to one question and one follow-up. If you would like to ask a question, please press star 1 to raise your hand. To withdraw your question, press star 1 again. We ask that you pick up your handset when asking a question to allow for optimum sound quality. If you are muted locally, please remember to unmute your device. Please stand by while we compile the Q&A roster. Your first question comes from Brent Thielman with Oppenheimer and Quo. Please go ahead.

Hey, great. Thanks. Good morning. Brian, just on the sharper edge initiative, I'm wondering if there's particular markets or regions where you see the initiative kind of being more impactful to drive margins higher, you know, I guess post-edge. I'm wondering where you still see the well-hanging fruit in the business for improvement, regardless of market conditions.

Yeah, thanks, Brent. Yeah, we're excited to build on Edge 1.0 with Sharper Edge. The good thing is it does impact all four of our segments. We've got a line of sight, very specific opportunities that we've identified to go deploy that $125 million over the next three years in literally all four of our segments and in all of our product lines. I can tell you that it's very aggregate-centric and that the majority of that capital is going to be deployed at approximately, you know, 23 of our aggregate sites that we have already identified plant improvements and cost-saving opportunities. So very aggregates-focused, very operationally-focused, but the commercial excellence side of it and the organizational side of the initiative is also very meaningful. And, you know, organizational is a little bit new. We started this about a year ago of really taking a closer look at our internal processes and our systems and really just trying to find opportunities to streamline those processes to reduce our SG&A and, more importantly, get information out into the operator's hands to make quicker and better decisions. So, impacts both back office and out in the operations, impacts all four segments and all of our product lines, Brent. Very excited to share more details, more specific goals and targets at an upcoming investor day.

Okay. Thanks, Brian. I guess the follow-up, maybe more specific to contracting services, been a tougher year, obviously. I understand some of the challenging market dynamics today, and those might continue. But are these initiatives you're undertaking, whether short-term, medium-term, can they return that group to kind of the low double-digit margin performance next year, or do you need more market cooperation?

Yeah, the market cooperation, and the good news is that there's demand for our services and the products that we provide, specifically asphalt paving. And with the Build 250 Act, you know, that we expect to be passed early next year, and the bipartisan support that we have in each one of our states for ongoing funding, there's strong demand for our products and services. And so, you know, we've had a lull that we've seen recently in some bid-letting opportunities, specifically in the third quarter in a few of our markets, but we fully expect that that is a cycle. It's a cycle that we've been in before, and it will come out of, and that we're very well positioned to go out and capture, you know, the work that we do, specifically asphalt paving, and the benefit of that is the pull-through of those higher-margin upstream materials, Whether that's liquid asphalt, hot mix asphalt, and or aggregate. So, you know, we have initiatives underway. We've got some AI tools that are helping our estimators prospect for better leads that could lead to higher margins where we have the ability to pivot between public and private work. We're still heavily geared towards low bid public funded asphalt paving projects, but we certainly have the ability to pivot and go do more private work when the time is right. So, there's opportunities for us to continue to have margin expansion, Brent, over today's, you know, backlog and the performance we've had this year. We actually saw sequentially in our backlog for the first time in five quarters that our backlog margin went up at the end of the third quarter compared to the end of the second quarter. So, we do see that we're headed in the right direction in our contracting services.

Great.

Thank you. Yep. Thank you.

Your next question comes from Catherine Thompson with Thompson Research Group. Please go ahead.

Hi. The first question is more on the near term for the quarter just reported, in particular an update on the geographic mix and the impact on earnings, particularly on margins. And stepping back, how has this changed over the past couple of years, especially in light of some of the challenges that Oregon has been and where Oregon is today as an overall mix and, you know, broadly how this impacts margins? Thank you.

Yeah, thank you, Catherine. I mean, Region Mix has certainly had an impact on our overall EBITDA margins for the year. As you know, Catherine, Oregon is a very important state for Knife River. And so let me just provide some additional context for your appreciation. Oregon's been Knife River's largest state, both from a revenue standpoint and an EBITDA perspective, for more than a decade. And its EBITDA margin has been in excess of 20% for the past three years, including this quarter's performance, which is actually higher in the third quarter year over year. So they've been doing a great job of raising the margins, and it's a very important state to Knife River. But as we've discussed, you know, for the last two years, I mean, the state funding has had significant slowdown and had a dramatic impact on our revenue and its overall contribution to the Knife River's, you know, overall portfolio. I do get to be very specific with you, Catherine. I mean, Oregon was about 24% of our total revenue back in 2024, and today it's less than 17%, or a total decline of about 740 basis points as a percentage of our total revenue. So, it's been a challenge. It's absolutely had an impact on our overall EBITDA margin profile, and that has been the challenge. But there's good news in that. I mean, first, that we've been here before with these types of funding issues, and like other states, I've got full confidence, being an Oregonian, that we will get through and they will get through their funding challenges. There's strong public support to improve Oregon's roads. There's strong bipartisan political support to fund it. There are roads and bridges in Oregon that have to get fixed, and I can tell you that we are very well positioned to capture that work when it returns. I think as the third quarter results suggest, I mean, our crews, our management team in Oregon are not just standing around waiting for that to happen. They've been actively controlling the things they can control. They're right-sizing their crews and the equipment pools. They're selling materials to contractors doing other work, including private work. And so all of this has led to higher margins for the quarter and, again, continued EBITDA margin performance in excess of 20%. So I think it's understatement to say that we're well positioned in Oregon to capture the opportunities when we come out of this cycle that we're in right now. So yeah, Oregon has had a big impact on our overall region mix and obviously our percent of EBITDA margin.

Okay, great. Thank you. Yep. Yep. Shifting to backlogs, we are – during our quarterly survey season, we heard from a wide variety of companies, private companies, that state DOTs are slowing lettings to create urgency going into the federal highway bill reauthorization, which we're currently on a CR. My question to you is, are you seeing that in the states in which you participate? And how would that impact? You know, if so, is that – could explain some of the backlog that you reported in the quarter? Thanks very much for taking my questions today. Yeah, thank you, Catherine.

I think it absolutely explains why our backlog is down 14%. We obviously had strong revenue generation in the third quarter. But the fewer bid-letting opportunities, yes, we have noticed that. Don't know exactly the reasons, if it's because they are trying to put some political pressure to have Congress pass a long-term reauthorization bill, which we fully expect that they will. It could also be a higher inflationary cost. I mean, our customers, specifically the DOTs, are getting hit with those fuel escalations and oil escalation clauses. And so, yes, we have seen a slowdown in bid opportunities. Specifically, we've talked about Oregon. We've seen it in Idaho. Idaho's down almost 40% in bid lettings for the year. So we've seen fewer bid lettings in some of our markets in the Midwest. Texas, which is a big state with a massive budget, their bid lettings were down 25% for the year. So we have seen softness in the bid lettings. That's led to a little bit lower backlog, but it also has created the market dynamics that we have been talking about for the last two quarters and, frankly, had a fairly large impact on our contracting margins in the third quarter and year to date. Thank you.

Your next question comes from Trey Grooms with Stevens. Please go ahead.

Hey, good morning, Brian, Nathan.

I guess it's, hey, good morning.

So on page five, you laid out some of the actions you guys are taking to, you know, help navigate some of these near-term headwinds. So, just curious, when do you see, you know, these actions start to bear some fruit, maybe apart from edge, but, you know, just in the absence of a meaningful, you know, change in the demand environment, should we start to see some improvement going into next year, or how should we be thinking about the timing there, just given some of those changes you guys have made?

Yeah, I mean, let me talk about diesel to begin with and the mitigation efforts that we have been taking. They are bearing fruit. We have recouped the majority of our actual direct impact as it relates to diesel. As we've talked about before, we consume about 25 million gallons of diesel per year. Our third quarter is our largest year, Trey. And we saw, you know, you've seen at the pumps that the diesel prices went up about 40%. So it was a large impact. Because of our commercial excellence teams and the work that our sales teams are doing, we recouped the majority of that direct impact to Knife River through our fuel surcharges and the escalations that we're getting from the DOTs. What's lagging and what we're not necessarily recovering full recovery on are more of the indirect costs And the impact it's having on our cost of goods sold and our purchases going into some of our heavier bulk materials into ready mix and asphalt and other product lines. So, yeah, there's been the fruits of our labor. We can see that on the energy costs. The delayed jobs, yes, that has been an impact in the second and third quarter. The asphalt paving specifically that we had budgeted and forecasted and built inventories of aggregates to go out and perform is behind schedule, but they are paving now, and all that work gets shifted forward into either later this quarter or primarily next year, including the work at Pearl Harbor out on the P209 project. That was a job that we had forecasted to produce a fair amount of concrete with our on-site batch plant, and that has been delayed for project scheduling reasons into next year. So, again, those EBITDA dollars and those impacts that were headwinds for us in the third quarter, we will see those benefits next year. The market dynamics, Trey, is one that, again, we're right-sizing our crews. I'm excited to announce that if you look at contracting services and you look at the things that we can control, we actually were able to lower our costs of labor as a percent of revenue by 120 basis points for the quarter. So, in other words, the direct labor going out to job sites, the indirect labor that's in the office, as a percent of our revenue, we lowered that. So, we are controlling the things that we can control. We're right-sizing equipment pools and crews for the market demand that we've got. I think the fix to our market dynamics is to get on the other end of the cycle, to get certainty with the infrastructure funding at the federal level, Continue to support the states that we're in to continue to find more funding at the state level, and that quickly fixes itself, and we will see, you know, margins expand again there. So not a lot I can do in control on the price of diesel, obviously, or the DOT funding and bid lettings, but certainly are mitigating those impacts, and we are seeing results on those even in the third quarter.

Yep. Got it. Understood. Thanks for that. And then maybe a little longer term or bigger picture, just around sharper edge. So you guys had laid out long-term margin targets at 20%. Again, it's long-term, and I understand it's not a straight line to get there, and there's market impacts and whatnot. But my question is, as you look at the things you're laying out here with Sharper Edge, is that expected to be incremental to that 20% target over the long term? I know we might get more at Investor Day, but just to make sure we're thinking about this right.

Definitely will provide more detail at Investor Day, Trey, in a couple of months. But no, I would say that Sharper Edge is a continuation of our Edge efforts that we laid out three years ago. Obviously, Edge 1.0 was very focused on dynamic pricing, and most of the margin expansion that we enjoyed at the beginning of that was related to dynamic pricing and getting the full value of our materials. We also, you know, launched the pit crews out into the fields, and I can tell you that the majority of the work they were doing were quick fixes while they were on site, lower capital-intensive improvements, and certainly saw, and we continue to see, I mean, we've had over 500 basis point improvements since launching EDGE in our aggregates margins. The Sharper Edge is a continuation of those efforts and taking some of the work that the pit crews have done and they have identified very specific larger capital improvement projects to automate our plants to completely reconfigure facilities to change our mine planning. And this is where we've announced the $125 million of investment over the next three years that will be very targeted to our aggregate operations. There'll be some money spent in other product lines, but the majority of that's going to be aggregates. It's also going to lead to an incremental dollar per ton, or what we're currently doing, as it relates to those improvements. That's going to boost our way and help us get to those long-term targets. We've talked a fair amount about the project in South Dakota, the aggregate expenditure project in South Dakota. That will be coming online the first half of next year. Those are at margins that are highly accretive to our existing margins. Sharper Edge is to look for more projects exactly like that. So very aggregate-centric, very specific capital deployment program to improve all of our operations, but specifically aggregates. And then, I've obviously talked about the reduction in SG&A as part of that, and again, that's one of our multiple pathways to get to the long-term targets that we've stated earlier. So, does that help you with that in context?

Yes. Yes, it does. Thank you, Brian. Best of luck and look forward to Investor Day. Thanks, Trey.

Your next question comes from Garrick Schmoyce with DA Davidson. Please go ahead.

Oh, hi. Thanks for taking that question. I'm going to follow up on the backlog. I'm just wondering how you're thinking about balancing backlog dollars with margin. It's good to hear that margin has improved, but will you be at a point here again in which you might need to trade margin for growing the backlog, just given some of the DOT headwinds that you spoke to?

Yeah, I think that's a case-by-case, market-by-market analysis. And I think you could look at what we did in the mountain region this last year, and you saw it in the third quarter. They had lower margins, Garrick, and we made a very intentional decision to go out and secure additional asphalt paving work. And you can see the benefit. I mean, the overall EBITDA in the mountain region for the quarter was 10% more than it was a year ago. But we don't have to do that in every market. It will be selective. We'll continue to be disciplined. And we'll look for the right opportunities to take advantage of our value integration model. And so I think more work coming into the pipeline of bid lettings will certainly help that a lot as far as margins. And we are well positioned to capture that. The thing we like about our vertical integrated model is that we can have multiple opportunities to win on bid day. We can bid that work, as we've talked about in the past, as a prime contractor. We can bid that work to go out and do just the specific work that we do as a subcontractor, and maybe that's most likely asphalt paving for a larger prime, or we will sell our asphalt to a competitor or we'll sell our aggregates to an asphalt producer. I mean, we've got multiple ways to win, and so that will help offset the margin, you know, challenges in the bid room that we're seeing now. But, you know, I think more work is going to definitely help that situation, Eric.

Okay. No, thanks for that. Wanted to look ahead to 2027. I know we're not there yet, but I was wondering if you could speak to any preliminary expectations you might have regarding volume and pricing, I'm thinking, you know, about aggregates primarily, but any other comments you might have about some of the downstream businesses would be great.

Yeah, I think the glide path that you've seen us on pricing and enjoying some healthy prices on aggregates is going to continue. I think the demand environment, I think, continues to be strong. I mean, I think this is a lull in bid lettings that we are seeing. The infrastructure scorecard is still at a D+. There's bipartisan support, and so I think once we get more certainty at the federal level, we will see the public demand continue. I mean, even at today's dollars, most of our DOT budgets are at or near record levels, and so that's a very important vehicle for us is DOT funding, but we're also seeing good opportunities that is public funding, but not necessarily the traditional DOT. I mean, in our markets that we work in, there's a lot of military spending that we're going on, and we're benefiting from one of those big projects right now in Hawaii, another big project up in Grand Forks at the Air Force Base up there. So there's military spending that we're seeing. And then, obviously, the non-resi side next year, we sit very well in the markets that we're in. These midsize markets that we operate in have become attractive areas for developers to build some of these larger warehousers, data centers. We've got some of those in our backyard right now, and we will benefit from that next year. We are 12 miles from a very large project outside of Bryan, Texas, and there's data centers being built in Wyoming and in Oregon and North Dakota right now. So we see that demand environment going into next year continuing to be strong. Our commercial excellence team should allow us to continue to have the pricing momentum that we've enjoyed the past couple of years. And then you couple that with our new, very line of sight, very targeted initiatives to control costs and improve productivity. I'm excited about what I see in 2027.

Okay. Thank you very much. Best of luck. Thank you.

Your next question comes from Sharif El-Sabahi with Bank of America. Please go ahead.

Hi. Good morning. I just want to put a bit of a finer point on the backlog discussion. I understand you're working on prospecting better margin work, but just with to the lower margin that's in backlog This year. How should we think about the impact of that rolling out over the coming few quarters?

Yeah, I think an important part of that, Sharif, is that I had mentioned that for the first time in five quarters that we have seen our backlog margin improve sequentially from the end of the second quarter to the end of the third quarter. And so I think that's something I've been watching very closely, and I think that's a good sign. The other thing that I can tell you is that because we have the ability to pivot and go look at private work and not just public work, and that our crews are very geared to go out and do that type of work, that should also help that situation. And the ultimate solution to this problem is, again, to pass the long-term, reauthorize the transportation bill at the federal level and start fixing the roads and bridges that we know that the engineers and the public works directors and the state engineers have said need to get fixed. And so that is a cycle we've seen before. We've lived through this before, and we've seen our backlog fluctuate before. So I've got good confidence that we'll continue to rebuild that backlog. We're going into the heart of our bidding season right now. I mean, our busiest bidding periods are from November through April, especially in the markets that we operate in. And so, you know, anxious to give more updates on our backlog and where we see that going again as the year progresses next year.

And then I understand you're going into the bidding season and, you know, the federal funding is sort of a key item to monitor, but you mentioned there's been a few more bid opportunities this quarter. What other signs are you watching or, you know, what sign points are you looking forward to see letting them improve here?

Yeah, we have the new AI software called Prospect. It's an internal tool that our team has recently built. That is yielding some new information that we had not seen before. We're broadening our reach and getting data points that are different. I can tell you that some of our states that are slower are looking at adjacent states to go into, specifically Oregon going into Washington and other adjacent states we may not be currently working in. So, you know, we are aggressively pursuing work. We know the importance of our vertically integrated model and that the vehicle that the contracting services provides to pull through additional materials is important. But I'd also look at our third-party sales from our materials divisions to our competing contractors on bid day. I mean, if we don't get the work as a contractor, I can tell you, if you look at our third-party sales, those have increased, and that's a very concentrated effort that our commercial sales teams are focused on, is not putting all the pressure on bid day to build backlog, but to go out and get the higher margin materials that we benefit from on the material side of the business.

Thank you.

Yep.

Your next question comes from Timna Tanners with Wells Fargo. Please go ahead.

Yeah. Hey, good morning, everyone. I wanted to dig in a little bit more. Hello. I wanted to ask a little bit more about the project delays. And, of course, when you talk about some of the measures being transient, you know, it'd be helpful to understand what gives you that conviction. From past cycles, when you do see these project delays, have they resulted in eventual projects going forward, or do they result in cancellations at some point?

No, great question. So, the project delays that we've talked about, there's three very specific projects. It's the Highway 6 project in Texas, the Highway State Route 190 in Texas, and then the P209 concrete supply project in Hawaii. Tim, no, we've not seen any projects that are part of our backlog that have been canceled or delayed or waiting for funding. These are scheduling delays, weather-related delays, really just phasing of construction activity. We're pouring concrete underwater in Hawaii on that dry dock at Pearl Harbor, and they needed to finish driving the piles before we could pour the concrete. So this is not a matter of funding or uncertainty where we're worried about these projects being delayed. This truly is just construction phasing just related to permitting, engineering, and those types of events out on the job site. So, nothing in our backlog have we seen be delayed or potentially canceled because of any kind of funding situations.

Okay. Thanks for that. I wanted to ask also, you talked about continuing to look at M&A, but you're also a little bit outside of your target leverage ratio. So, do you pause M&A until you kind of get back in that range, or how are you thinking about the cadence there?

So, let Nathan take that one.

Yeah, good morning. Thank you for the question. And so if we go back to a few quarters, well, first, just let's look at the landscape for where our balance sheet stands today. We do have a very strong balance sheet. In fact, our liquidity is at $566 million. Of that $118 million is cash. So one of the first questions we get is, are you able to still respond quickly if there's an opportunity? I think our liquidity position indicates that. From the strength of the balance sheet standpoint, back to your 2.9, the thing I would remind you is that this is a part of the year to where we start to get back towards net leverage near our target of 2.5 times. We do anticipate being modestly above that. But what I have shared in previous quarters, which is important, is that we would look at going near three times for the right organic project, for the right acquisition project, keeping in mind that we would look at the cash flows, the returns and margins of that project, that it would quickly get us back to that 2.5 times. So, Tim, I think from a balance sheet standpoint, good liquidity, cash flows this year from a cash flow from operations to EBITDA conversion, probably close to 55%, and then the willingness temporarily to go to that near three times all indicate that if we do have good opportunities come through, we're still in a very good position to pursue them.

All right. Thank you. Your next question comes from Chris Ellinghouse with Siebert Williams-Schenk. Please go ahead.

How are you today? Good morning, Chris. Good, thank you. Brian, you seem confident on the reauthorization, but have you got any concerns that, you know, particularly we'll see what the I don't know what the election looks like today. And, you know, even though it may be, you know, pretty universal across parties, maybe that's not necessarily the primary goals initially of the new Congress. So do you have any concerns about the timing of reauthorization at all?

You know, I don't have any concerns that they're going to get it done, Chris, because they have to, and they know that, and there's full support for that, and they understand the cost of delays. Our industry associations have done a great job at educating legislators in Congress that the longer you wait and kick the can down the road, the more exponentially expensive it gets, and so they all understand that. And so, yes, I mean, the timing, I would say I'm not going to speculate on that other than the work has been done. There's been a lot of very good work done in the last Congress. There is full support at the administrators, at the administration, and in both the House and the Senate on both the Democrats and Republican side. So, you know, I do expect that that's going to get passed sooner than later. It's a top priority. I mean, the economy that we've been talking about, and you turn on the news, you hear it every day, a very important part of the economy is to keep freight and people moving and not in congestion and that you have safe roads and bridges to be driving on, and everybody agrees with that. And so, yeah, I'm not going to speculate on the timing, Chris. I just have a full conviction that it's going to get done sooner than later, like it always has, and we'll stay tuned and watch the election results tonight.

Okay. Similar lines. Have you got any update to your sense of sort of the cadence of when Oregon will address sort of right-sizing its DOT budget?

Yeah. They're talking about it a lot. They're doing more than talking. I mean, they've got work groups. They're traveling the state. They're prioritizing projects. They are reorganizing the departments. They are looking for leadership. There's a lot of activities going on in Oregon. This has been a couple years down the road now. This started early in 25. And so, again, Oregonians, both taxpayers and engineers and roadmasters, know the cost of delaying these projects, Chris. And they become much more expensive to fix and consume a lot more materials the longer you wait. And I can tell you there are lots of potholes and cracked roads and aging bridges that have got to get fixed in Oregon. So everybody knows that. They're working hard on it and fully expect that when the time is right for the legislature to come back into session early next year, that that's going to be one of their top priorities.

Okay.

Appreciate it. Thanks. Yep. Thank you, Chris.

Your next question comes from Yvonne Yee with Wolf Research. Please go ahead.

Either, Ivan.

Please ensure you unmute. Moving on to Rohit Seth with B. Riley. Please go ahead, Rohit.

Hey, thanks for taking my question. Just on the 4Q guide, you got the range at $95 million to $125 million. You did about $119 million last year. Can you just walk us through the scenarios to get you to the high end and the low end and the midpoint?

Yeah, I'll talk, you know, kind of to put some stakes on that. We obviously guide to normal weather. And as you know, as we're entering into November, December, that can fluctuate a lot. And so last year, we had very favorable weather in the fourth quarter and performed work literally up until a couple weeks before Christmas. And so, you know, if we continue to, if we were to have favorable weather in November, December, that would put us toward the high side of that. If we get some early winter, that really does shut a lot of our operations down. And so that would probably be the largest put and take for the remainder of the year. Obviously, we've talked enough about this, but we are out paving right now, and we have a schedule to go pave in Texas on those two big projects, and so we've put that as our midpoint of this paving schedule that we've got. There's some hopes that they could expedite and get some additional tonnages out of there yet this year that would put us a little on the high side, but we've also seen a lot of delays for the last six months, and so that would put us on the low side. The other thing that I'd say that this time of year, we're closing out jobs, and there's opportunities to earn a fair amount of quality bonuses for the work that we do, and those incentives, those bonuses get paid typically at the end of the job, and as do some of the fuel escalators and oil escalators. And so depending on the timing of us closing out some of the work that we're currently working on and some of the lags that we've seen of getting the few escalations, that could have a positive or negative impact on the fourth quarter. So that's also baked within that range. So those would be the large puts and takes for the fourth quarter.

Yeah, the only thing I'd add to that, and it's an important point you made, Rohit, with the end of the quarter for us as it relates to the bonuses and incentives that Brian's talked about, we actually see in the fourth quarter for contracting services, and you look over the last four years, historically, that fourth quarter for contracting services actually has higher gross margin than the third quarter and actually the year-to-date on average. So, as Brian talks about that, this is something that we do see. It depends upon, like you said, as those jobs close out, but that opportunity has traditionally been good for us and could be something on the high side as they close out that we have traditionally seen.

Is that why your contract assets are up, you know, more than doubled from last year?

Is that why our contract...

The contract assets from the balance sheet?

Yeah, part of that also has to do with, from an accounting perspective, we did do a change year over year with how we do need to book retention. And so last year, that was part of the receivables. This year, it's actually part of the cost and access account. So there was just a change in accounting. We have a footnote for you in the 10-2 that helps explain that further. But that's really the key change that occurred year over year for our receivables, as well as our growth.

Okay. Okay. And then just back on the volume, you cited some, you know, some lightings in key states, Idaho, down double digit. I'm looking at my contract award data down about 16% for your footprint over the last 12 months. That's going to hit you in this fourth quarter, in the first half of 2027. And so I'm just curious, you know, you guys do more infrastructure than some of your peers, and just curious how you think about volumes in the first half of 2027. Do you have enough data center work, another private work to offset that? Are you expecting like down volumes in the first half, maybe better second half? Just curious on how you guys see that going through.

The next three months are very important for us, and we have a lot of this. It's the peak of our bidding season. November, December, January, February is really where the majority of our bidding works out. So, yes, our backlog is down about the same amount that your analysis shows, but we have time to make that up. We don't perform a ton of contracting services work this time of year without securing it, so that's going to be a very important part of this. But, yes, we do have some very good projects that are in our backyards that are non-resi private jobs that are large impact projects that we are currently selling materials to. And that, you know, on the material side of the business, that's what gives us a fairly strong conviction that we'll continue to have materials volume growth going into next year. So including this fourth quarter.

Okay, great. And just, okay, thanks.

The next question comes from Yvonne Yee with Wolf Research. Please go ahead.

Hey, guys. Can you hear me now?

We can.

Great. Sorry about that. I just want to hear your comments on the drivers or gross margin improvement going forward. Do you see more potential upside from pricing or more so from cost cutting? Just want to see what's the bigger lever for you.

Thank you. No, I appreciate that. And so we're pulling on both levers. And I think I've mentioned in the past that the most meaningful margin expansion that we've had for the part of Edge 1.0 really was implementing dynamic pricing and getting full value for our materials to continue to optimize pricing through the dashboards and the automated tools that we've got. We certainly have benefited from the work that pit crews have done out in the operations, but I do believe that the Sharper Edge initiative really is geared more on the cost structure side of things, whether that's back office or out in the operations. All of our product lines, those line of sight, very targeted opportunities are geared to increase production, to increase the sales capabilities, but also primarily geared to lower our costs. And so that's where we would see margin expansion going forward. Thanks, Ivan, for that question.

And last thing, just on, since it's election day, we'd love to just hear your thoughts on the Oregon governor race, expected impact to spending, depending on the outcome, just any color there. Thank you.

Yeah, no, I think we'll be paying attention to that race very closely. Both candidates, obviously, like all Oregonians, they support safe bridges and smooth roads. There's no debate around the support for that. And so, certainly when I get back to the hotel here in Bismarck, I'll be turning on the news and watching the results in Oregon. So, I appreciate that.

This concludes the Q&A session. I will now turn the call back to Mr. Brian Gray for closing remarks.

Thank you. As always, we want to thank our teams for the work they put in this quarter and everything they're doing to position Knife River for future growth and long-term success. Thank you for joining the call today. We look forward to discussing the details of our sharper edge at our investor day in the next few months. Thank you.

This concludes today's call. Thank you for attending. You may now disconnect.