Granite Construction - 10-Q quarterly report FY

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Commission File Number: 1-12911

 

585 W. Beach Street

Watsonville, California 95076

(831) 724-1011

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨Yes  xNo

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

The condensed consolidated financial statements included herein have been prepared by Granite Construction Incorporated (“we”, “us”, “our” or “Granite”) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2004. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted, although we believe the disclosures which are made are adequate to make the information presented not misleading. Further, the condensed consolidated financial statements reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly our financial position at September 30, 2005 and 2004 and the results of our operations and cash flows for the periods presented. The December 31, 2004 condensed consolidated balance sheet data was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Interim results are subject to significant seasonal variations and the results of operations for the three and nine months ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123-R”), which is a revision of SFAS 123. SFAS 123-R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” Generally, the approach to accounting for share-based payments in SFAS 123-R is similar to the approach described in SFAS 123. However, SFAS 123-R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values (i.e., pro forma disclosure is no longer an alternative to financial statement recognition). SFAS 123-R is effective for Granite beginning in fiscal year 2006. On March 29, 2005 the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”) which provides the SEC Staff’s views regarding interactions between SFAS 123-R and certain SEC rules and regulations and provides interpretations of the valuation of share-based payments for public companies. After reviewing the impact of implementing SFAS 123-R and SAB 107, we have determined that forfeitures of our restricted stock will need to be estimated and accounted for at the time of grant and updated based on actual forfeitures over the vesting period rather than accounting for forfeitures as they occur. Additionally, the adoption of SFAS 123-R and SAB 107 will cause a balance sheet reclassification of certain stock related items. Changing to an estimated forfeiture model and recording the balance sheet reclassification is not expected to have a material effect on our financial position, results of operations or cash flows.

Our gross profit in the three and nine months ended September 30, 2005 and 2004 includes the effects of significant changes in the estimates of the profitability of certain of our projects. The net effect of these estimate changes decreased gross profit in each period.

 

During the quarter ended September 30, 2005 the downward estimate changes in our Heavy Construction Division ("HCD") were made in response to design issues on design/build projects, changes in productivity assumptions, the costs associated with owner directed added scope changes and changes in cost expectations in response to market factors for labor and certain materials. In our Branch Division the downward estimate changes were due to unanticipated costs related to quality issues in work originally performed by a subcontractor on one project and changes in site conditions from our original expectations on a second project. The HCD projects with downward estimate changes during the quarter were at various stages of completion ranging from 45% to 70% and the two Branch Division projects with downward estimate changes in the quarter were 75% complete and 20% complete at September 30, 2005. These downward changes were partially offset by an increase in estimated profitability on one HCD project with an impact on gross profit for the quarter of approximately $1.0 million and the favorable resolution of certain outstanding issues on one Branch Division project with an impact on gross profit for the quarter of approximately $2.2 million.

 

The estimate changes in the first half of 2005 and the nine months ended September 30, 2004 were due to a variety of factors, including liquidated damages, recognition of costs associated with owner directed added scope changes, site conditions that differed from our expectations, design issues on design/build projects, subcontractor performance issues, increased overhead due to owner and weather delays and changes in productivity expectations.

 

We believe we have entitlement to additional compensation related to some of these downward estimate changes and are actively pursuing these issues with the contract owners. However, the amount and timing of any future recovery is highly uncertain and under our accounting policies we do not recognize revenue from contract changes until we have a signed change order or executed claim settlement. We believe that our current estimates of the gross profit for each of these projects are achievable. However, it is possible that the actual cost to complete will vary from our current estimate and any future estimate changes could be significant.

 

The net impact of these estimate changes by division is as follows:

 

Inventories consist primarily of quarry products valued at the lower of average cost or market.

The following table indicates the allocation of goodwill by reportable segment which is included in other assets on our condensed consolidated balance sheets:

Amortization expense related to intangible assets was approximately $151,000 and $453,000 for the three and nine months ended September 30, 2005, respectively, and approximately $161,000 and $457,000 for the three and nine months ended September 30, 2004. Amortization expense expected to be recorded in the future is as follows: $152,000 for the balance of 2005, $444,000 in 2006, $350,000 in 2007, $338,000 in 2008, $262,000 in 2009 and $971,000 thereafter.

We participate in various construction joint venture partnerships. Generally, each construction joint venture is formed to accomplish a specific project, is jointly controlled by the joint venture partners and is dissolved upon completion of the project. The joint venture agreements typically provide that our interest in any profits and assets, and our respective share in any losses and liabilities that may result from the performance of the contract are limited to our stated percentage interest in the project. Although each venture’s contract with the project owner typically requires joint and several liability among the joint venture partners, our agreements with our joint venture partners provide that each partner will assume and pay its full proportionate share of any losses resulting from a project. We have no significant commitments beyond completion of the contract.

We have determined that certain of these joint ventures are variable interest entities as defined by FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" ("FIN 46"). Accordingly, we have consolidated those joint ventures where we have determined that we are the primary beneficiary prospectively beginning January 1, 2004. At September 30, 2005, the joint ventures we have consolidated were engaged in construction projects with total contract values ranging from $14.6 million to $396.6 million. Our proportionate share of the consolidated joint ventures ranges from 52% to 70%.

Consistent with Emerging Issues Task Force Issue 00-01, “Investor Balance Sheet and Income Statement Display under the Equity Method for Investments in Certain Partnerships and Other Ventures,” we account for our share of the operations of construction joint ventures in which we are not the primary beneficiary on a pro rata basis in the consolidated statements of operations and as a single line item in the consolidated balance sheets. At September 30, 2005, the joint ventures in which we hold a significant interest but are not the primary beneficiary were engaged in construction projects with total contract values ranging from $3.9 million to $261.0 million. Our proportionate share of these joint ventures ranges from 25% to 40%.

 

We also participate in various "line item" joint venture agreements under which each partner is responsible for performing certain discrete items of the total scope of contracted work. The revenue for these discrete items is defined in the contract with the project owner and each venture partner bears the profitability risk associated with its own work. All partners in a line item joint venture are jointly and severally liable for completion of the total project under the terms of the contract with the project owner. There is not a single set of books and records for a line item joint venture. Each partner accounts for its items of work individually as it would for any self-performed contract. We account for our portion of these contracts as a project in our accounting system and include receivables and payables associated with our work on our balance sheet.

Although our agreements with our joint venture partners for both construction joint ventures and line item joint ventures provide that each party will assume and pay its share of any losses resulting from a project, if one of our partners is unable to pay its share, we would be fully liable under our contract with the project owner. Circumstances that could lead to a loss under our joint venture arrangements beyond our proportionate share include a partner’s inability to contribute additional funds to the venture in the event the project incurs a loss, or additional costs that we could incur should a partner fail to provide the services and resources toward project completion that had been committed to in the joint venture agreement. At September 30, 2005, approximately $279.5 million of work representing our partners’ share of joint venture contracts in progress had yet to be completed.

 

A reconciliation of the weighted average shares outstanding used in calculating basic and diluted net income per share in the accompanying condensed consolidated statements of operations is as follows:

 

Restricted stock representing approximately 63,000 shares for the nine months ended September 30, 2005 and approximately 374,000 shares and 339,000 shares for the three and nine months ended September 30, 2004, respectively, have been excluded from the calculation of diluted net income per share because their effects were anti-dilutive.

On June 23, 2005, Granite filed several post-trial motions seeking reconsideration by the trial court as well as a reduction in the amount of the judgment. These post-trial motions were heard in September 2005. If we do not agree with the judge's rulings for the post-trial motions, we intend to pursue an appeal. We anticipate that the appeal process will take between 12 and 18 months to complete. The judgment will accrue interest until it is satisfied. During the three months ended June 30, 2005, we recorded a provision of $9.3 million, which was estimated based on the amounts of the judgment described above.

After the verdict in Eldredge was issued, plaintiff filed a motion seeking monetary sanctions against Granite in the amount of $26.8 million (a multiple of the jury verdict) based on allegations that Granite and/or its trial counsel improperly withheld and/or attempted to influence testimony in respect to the case. Granite’s opposition and plaintiff’s reply have been filed with the Court. We believe that the plaintiff has failed to submit any meaningful proof to support these allegations, that the motion is without merit and that it is highly unlikely that the motion will be granted. The judge decided after the sanctions motion was heard in September 2005 to reserve any decision until after the appeal and calendared the motion for a status check in September 2006.

Granite Construction Company, as a member of a joint venture, Wasatch Constructors, is among a number of construction companies and the Utah Department of Transportation that were named in a lawsuit filed in the United States District Court for the District of Utah. The plaintiffs are two independent contractor truckers who filed the lawsuit on behalf of the United States under the federal False Claims Act seeking to recover damages and civil penalties in excess of $46.4 million.

The original complaint was filed in January 1999 and the Third Amended Complaint was filed in February 2003. On May 30, 2003, Wasatch Constructors and the coordinated defendants filed their motion to dismiss the Third Amended Complaint. On December 23, 2003, the Court issued its order granting Wasatch Constructors’ and the coordinated defendants’ motion to dismiss the Third Amended Complaint but allowed the plaintiffs one last opportunity to amend their complaint. Plaintiffs’ Fourth Amended Complaint was filed on July 12, 2004.

 

On October 5, 2005, the District Court granted Wasatch Constructors' motion to dismiss the entire case. The Court dismissed the case with prejudice and without leave to amend. The plaintiffs have an opportunity to appeal the Court's decision to dismiss.

 

Granite Construction Company is one of approximately one hundred defendants in six California State Court lawsuits served against Granite in 2004 and one in 2005 in Alameda and San Francisco Counties where seven plaintiffs have, by way of various causes of action, including strict product and market share liability, alleged personal injuries caused by exposure to silica products and related materials during plaintiffs’ use or association with sand blasting or grinding concrete. The plaintiffs in each lawsuit have categorized the defendants as equipment defendants, respirator defendants, premises defendants and sand defendants. We have been identified as a sand defendant, meaning a party that manufactured, supplied or distributed silica-containing products. Our preliminary investigation revealed that we have not knowingly sold or distributed abrasive silica sand for sandblasting. We have been dismissed in all of these lawsuits in which we have been served. In addition, we have been apprised of nine complaints brought by eleven individual plaintiffs that are based on similar allegations of exposure to silica containing products being filed, but not served, against Granite and more than one hundred other defendants in California State Court. We are investigating the specific allegations against Granite for these new complaints.

We are a party to a number of other legal proceedings arising in the normal course of business and believe that the nature and number of these proceedings are typical for a construction firm of our size and scope. Our litigation typically involves claims regarding public liability or contract related issues. While management currently believes, after consultation with counsel, that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on our financial position or overall trends in results of operations or cash flows, litigation is subject to inherent uncertainties. Were an unfavorable ruling to occur, there exists the possibility of a material adverse impact on the results of operations, cash flows and/or financial position for the period in which the ruling occurs.

Branch Division operating income for the nine months ended September 30, 2005 includes a $9.3 million provision for a legal judgment (see Note 11).

 

Summarized segment information is as follows:

A reconciliation of segment operating profits to consolidated totals is as follows:

On June 24, 2005, we entered into an agreement for a $150.0 million bank revolving line of credit, which replaced the $100.0 million line of credit we entered into in June 2003. The new revolving line of credit allows for unsecured borrowings for up to five years through June 24, 2010, with interest rate options. Interest on outstanding borrowings under the revolving line of credit is at our choice of selected LIBOR rates plus a margin that is recalculated quarterly. The margin was 0.75% at September 30, 2005. The unused and available portion of this line of credit was $118.6 million at September 30, 2005. Restrictive covenants under the terms of our debt agreements require the maintenance of certain financial ratios and the maintenance of tangible net worth (as defined). We were in compliance with these covenants at September 30, 2005.

 

In April 2004, we purchased an additional 643,348 shares of Wilder common stock for a cash payment of $9.2 million. As a result of this transaction, our interest in Wilder increased from 60.3% to 75.0%. The acquisition was accounted for in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations.”

In March 2004, we sold certain assets related to our ready-mix concrete business in Utah for cash of $10.0 million and promissory notes with an estimated fair value of $8.9 million which are payable in annual installments from 2005 through 2010, the first of which has been paid. The sale transaction resulted in the recognition of a gain of approximately $10.0 million, which is included in gain on sales of property and equipment for the nine months ended September 30, 2004.

Certain financial statement items have been reclassified to conform to the current period's format. These reclassifications had no impact on previously reported results of operations, financial position or cash flows.

 

We are one of the largest heavy civil contractors in the United States and are engaged in the construction of highways, dams, airport runways, mass transit facilities and other infrastructure-related projects. We have offices in Alaska, Arizona, California, Florida, Minnesota, Nevada, New York, Oregon, Texas, Utah and Washington. Our business involves two operating segments: the Branch Division and the Heavy Construction Division (“HCD”).

Our contracts are obtained primarily through competitive bidding in response to advertisements by federal, state and local agencies and private parties and to a lesser extent through negotiation with private parties. Our bidding activity is affected by such factors as backlog, current utilization of equipment and other resources, our ability to obtain necessary surety bonds and competitive considerations. Bidding activity, backlog and revenue resulting from the award of new contracts may vary significantly from period to period.

The two primary economic drivers of our business are (1) federal, state and local public funding levels and (2) the overall health of the economy, both nationally and locally. The level of demand for our services will have a direct correlation to these drivers. For example, a weak economy will generally result in a reduced demand for construction in the private sector. This reduced demand increases competition for fewer private sector projects and will ultimately also increase competition in the public sector as companies migrate from bidding on scarce private sector work to projects in the public sector. Greater competition can reduce revenue growth and/or increase pressure on gross profit margins. A weak economy also tends to produce less tax revenue, thereby decreasing the funds available for spending on public infrastructure improvements. There are funding sources that have been specifically earmarked for infrastructure spending, such as gasoline taxes, which are not necessarily directly impacted by a weak economy. However, even these funds can be temporarily at risk as state and local governments struggle to balance their budgets. Conversely, higher public funding and/or a robust economy will increase demand for our services and provide opportunities for revenue growth and margin improvement.

Our general and administrative costs include salaries and related expenses, incentive compensation, discretionary profit sharing and other variable compensation, as well as other overhead costs to support our overall business. In general, these costs will increase in response to the growth and the related increased complexity of our business. These costs may also vary depending on the number of projects in process in a particular area and the corresponding level of estimating activity. For example, as large projects are completed or if the level of work slows down in a particular area, we will often re-assign project employees to estimating and bidding activities until another project gets underway, temporarily moving their salaries and related costs from cost of revenue to general and administrative expense. Additionally, our compensation strategy for selected management personnel is to rely heavily on a variable cash and restricted stock performance-based incentive element. The cash portion of these incentives is expensed when earned while the restricted stock portion is expensed over the vesting period of the stock (generally five years). Depending on the mix of cash and restricted stock, these incentives can have the effect of increasing general and administrative expenses in very profitable years and decreasing expenses in less profitable years.

Our results of operations for the three months and nine months ended September 30, 2005 reflect higher results from our Branch Division compared with the corresponding periods in 2004. These improvements were partially offset by additional costs recorded due to changes in the estimates of the cost to complete certain projects in both operating divisions, but primarily HCD, and the recognition of a provision related to an unfavorable legal judgment in the second quarter of 2005.