Granite Construction - 10-Q quarterly report FY

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarter ended March 31, 2003

Commission File No. 1-12911

GRANITE CONSTRUCTION INCORPORATED

Corporate Administration:

585 W. Beach Street
Watsonville, California 95076
(831) 724-1011

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ( X)      No  (  )

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of May 12, 2003.

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12(b)-2 of the Exchange Act) Yes (X)      No   (   )

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GRANITE CONSTRUCTION INCORPORATED

Index

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PART I. FINANCIAL INFORMATION

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Item 1. FINANCIAL STATEMENTS (unaudited)

Granite Construction Incorporated

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

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Granite Construction Incorporated

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

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Granite Construction Incorporated

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

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Granite Construction Incorporated

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Disclosure:

Results of Operations

Revenue: Revenue for the three months ended March 31, 2003 increased over the three months ended March 31, 2002 by $33.0 million or 12.3%. Branch Division revenue in 2003 included $17.7 million of revenue from our majority owned Wilder Construction Company (“Wilder”) subsidiary, which was consolidated in our financial statements beginning in the second quarter of 2002 and $6.9 million of revenue from the businesses acquired from Robinson Construction Company and Parnum Paving, Inc. in the second quarter of 2002 (“Northern California Businesses”). Excluding the Wilder and Northern

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California Businesses’ revenue, Branch Division revenue for the first quarter of 2003 decreased compared with the 2002 first quarter by $3.6 million or 2.4%. This $3.6 million decrease is attributable to a $9.6 million, or 21.3% decrease in Branch Division private sector revenue, partially offset by a $4.5 million, or 14.4% increase in revenue from the sale of materials and a $1.5 million, or 1.9% increase in public sector revenue. We believe the decreased private sector revenue was primarily due to a general slowdown in private development projects due to a weaker economic climate. The increased revenue from the sale of materials was due primarily to higher volume in many of our locations.

Revenue from our Heavy Construction Division increased $12.0 million, or 10.1%, in the quarter ended March 31, 2003 compared with the quarter ended March 31, 2002, due primarily to larger volume from higher backlog at the beginning of the 2003 quarter.

Backlog: Our backlog at March 31, 2003 of $1,870.8 million was $14.4 million higher than our backlog at December 31, 2002 and $531.6 million higher than our backlog at March 31, 2002. Our Branch Division backlog at March 31, 2003 and December 31, 2002 included backlog of $135.5 million and $95.2 million, respectively from our newly consolidated Wilder subsidiary and the Northern California Businesses acquired in the second quarter of 2002. HCD backlog increased $370.4 million, or 38.1%, from March 31, 2002 to March 31, 2003 due primarily to our expanded capabilities in bidding and executing the larger more complex work available in the market as well as the impact of our expansion into New York.

Our backlog of projects in the private sector increased by $10.4 million from December 31, 2002 to March 31, 2003, representing a $24.6 million increase in HCD backlog, partially offset by a decrease in Branch Division private sector backlog of $14.2 million, or 21.9%. We believe the decreased Branch Division private sector backlog was attributable to the impact of a slowdown in private development projects due to a relatively weak economic climate (see “Outlook”). Awards in the first quarter of 2003 included a $75.6 million tollroad extension project in Texas and a $18.3 million runway project in Alaska in our Wilder subsidiary.

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Gross Profit: Our gross profit as a percent of revenue increased to 10.9% in the first quarter of 2003 from 10.0% in the first quarter of 2002. Contributing to the increase was the absence of the first quarter 2002 recognition of additional costs to complete two New York area projects that negatively impacted gross margin in the 2002 quarter, partially offset by lower Branch Division margins, due primarily to the effect of increased competition in a challenging economic environment, and an increase in the revenue from projects less than 25% complete in the 2003 quarter from $25.4 million in 2002 to $41.0 million in 2003. We recognize revenue only to the extent of cost, deferring profit recognition, until a project reaches 25% complete.

Cost of revenue consists of direct costs on contracts, including labor and materials, subcontractor costs, direct overhead costs and equipment expense (primarily depreciation, maintenance and repairs). Although the composition of costs varies with each contract, our gross profit margins were not significantly impacted by changes in any one of these costs during the first quarter of 2003.

General and Administrative Expenses: General and Administrative expenses increased by $6.1 million in the three months ended March 31, 2003 compared with the three months ended March 31, 2002. Included in the increase was approximately $5.1 million in costs associated with the newly consolidated Wilder subsidiary and the Northern California Businesses acquired in the second quarter of 2002. Variable compensation increased in the first quarter of 2003 due primarily to higher discretionary profit sharing associated with the CPTC investment income recognition (see “Other Income/Expense”). Other general and administrative costs include information technology, occupancy, office equipment and supplies, depreciation, travel and entertainment, outside services, advertising and marketing, training and other miscellaneous expenses, none of which individually exceeded 10% of total general and administrative expense.

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Operating Loss: Our Branch Division’s contribution to operating income decreased in the first quarter of 2003 compared with the first quarter of 2002 due primarily to the factors described in “Gross Profit” above and operating losses generated by the newly consolidated Wilder subsidiary and the Northern California Businesses, which are typical in the first quarter due to the climates in which they operate. Our Heavy Construction Division’s contribution to operating income increased in the first quarter of 2003 compared with the first quarter of 2002 due primarily to increased volume at a higher profit margin as described in “Revenue” and “Gross Profit” above. Unallocated other corporate expenses principally comprise corporate general and administrative expenses.

Other Income(Expense): Included in other income (expense) in the first quarter of 2003 is $18.4 million related to the sale of the State Route 91 Tollroad Franchise by the California Private Transportation Corporation, of which we are a 22.2% limited partner. Excluding this transaction, equity in income of affiliates decreased largely due to the impact of discontinuing recording the results of T.I.C. Holdings, Inc. and Wilder in other income under the equity method of accounting during the second quarter of 2002.

Provision for Income Taxes: Our effective tax rate decreased to 36.2% in the first quarter of 2003 from 37.5% in the first quarter of 2002 due to the combined factors of higher percentage depletion deductions related to quarry properties and higher tax credits.

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Outlook

While our business continues to perform well in a challenging market environment, our short-term outlook remains uncertain due to political and economic factors that have yet to be resolved on both the state and federal levels. As we discussed in the Outlook section of our Annual Report on Form 10-K, some of the major issues we are following at this time are both the budget deficits in states in which we are active and the reauthorization of the federal highway bill.

California Budget Issue

Although the majority of states are facing fiscal deficits, no other state is confronted with a larger budget shortfall than California. Projections from the Legislative Analyst’s Office Fiscal Outlook and the Administration’s2003-2004 Governor’s Budget estimates the shortfall in California to be between $21.1 billion and $34.6 billion, respectively. A number of proposals for revenue increases and cost reductions to close this deficit have been put forward. Governor Gray Davis’ original proposal includes a $1.8 billion cut in transportation funding, largely consisting of the suspension of the Proposition 42 transfer of the sales tax revenues derived from gasoline sales in 2003-04 ($1.1 billion), the “forgiveness” of a scheduled General Fund loan repayment to the State Highway Account ($500 million), and recapturing Transportation Congestion Relief Program funds not yet allocated in 2002-2003 ($100 million). Transportation revenues from the regular state cents-per-gallon excise tax on fuel may be borrowed on a short-term basis but must be repaid under the provisions of Proposition 2, passed in 1998.

In contrast, both California State Assembly and Senate Budget subcommittees have taken the position that any diversion of transportation revenues be made in the form of loans rather than a suspension of Proposition 42. Suspension would mean that the sales taxes on gasoline would not have to be repaid into transportation funds. This position is in line with the stand taken by the Republican caucuses in both legislative houses. A suspension of Proposition 42 takes two-thirds vote in both houses.

The state’s Transportation Congestion Relief Program (TCRP) is a one-time plan created by Governor Gray Davis in an attempt to reduce traffic congestion. Originally, the TCRP was funded by the state’s general fund surplus. In 2001, California’s economic downturn significantly reduced the state’s income and loans from the TCRP were made to the State General Fund. The Governor’s original budget proposal sought to have these loans forgiven, although the Legislature has moved in the direction of deferring repayment, rather than forgiving the loans. On May 7, an Assembly Budget Sub-committee voted to provide $207 million to meet cash flow obligations of previously allocated TCRP funds and an additional $252 million for TCRP allocations in 2003-04.

Facing such a significant fiscal challenge, the budget process will likely be long and drawn out and will not get started in earnest until the State issues its May budget revision which more accurately projects tax revenues. Though the deadline for a final California State budget is June 15, 2003, it is unlikely that the legislature will meet the deadline largely due to the requirement for a two-thirds vote of the Legislature on the final bills. The negotiations will be highly politically charged. In 2002, the deadline was exceeded by 67 days.

Federal Highway Bill Reauthorization

On the federal front, the Federal Transportation Reauthorization process is underway. The current federal highway bill, the Transportation Equity Act for the 21st Century (TEA 21), is scheduled to expire on September 30, 2003. In February 2003 , the President released his fiscal year 2004 budget that proposed funding for highways in FY’04 at $29.3 billion, gradually escalating over a 6-year period to just over $33 billion in FY’09. Viewed by the bipartisan leadership of the House Transportation and Infrastructure (T&I) committee as being inadequate to meet the needs of the nation’s transportation program, members

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responded to the President’s budget with a proposal which provides $375 billion over six years for both highways and transit – a 70% increase over the prior bill.

Although the House Budget Committee has rejected the T&I proposal, the committee did succeed in achieving inclusion of language in the House budget resolution that would allow increased funding for highways if new revenue sources could be found. According to the T&I committee, measures to increase Highway Trust Fund (HTF) revenues include: drawing down the existing balance in the HTF; restoring the interest to the HTF; eliminating user fee evasion; directing all revenues from the existing gasohol use fees to the HTF and reimbursing the HTF for lost revenues from the gasohol user fee subsidy or eliminate the subsidy altogether. Another major point of contention is whether steps will be taken to increase and/or index the federal gas tax.

In April, 2003, the Conference Committee reached agreement on a budget resolution that funds highways at $231 billion, which falls midway between the Senate’s $255 billion level and the House’s $206 billion level. The non-binding budget resolution will be used as the blueprint for tax and spending decisions in FY 2004 and beyond, including transit and highway spending. House and Senate transportation leadership are reportedly displaying a strong show of unity in achieving the highest possible funding levels for transit and highways.

Operations

Operationally, it is still too early in the year to predict how our Branch Division will fare this year, particularly in California. We do have some concern as to the overall effect the California budget situation will have on our business and at what point an economic recovery is likely. While some of our branches are continuing to witness demand for site development for residential and commercial construction, others are anticipating a down year due to the current economic environment and its negative impact on the demand for private sector work in their areas. As we have noted in the past, a slowdown in private sector work generally translates into increased competition in the public sector bidding arena. While we have begun to see competition increase in some of our markets, it is too early to determine if this is an ongoing trend, and if so, how long it will continue. It is possible that our Branch Division operating income could be as much as 15% to 20% lower for the year ending December 31, 2003 than it was in 2002. However, we believe that a strong performance in HCD in 2003 has the potential to offset this possible decrease.

Looking ahead for HCD, operating margins could improve substantially in 2003 over 2002 based on the current backlog of ongoing work. They continue to witness a very good bidding environment across the country and over the past few years has seen a significant increase in transit and rail construction projects. While funding for many of these projects is guaranteed federal funding and/or supported by alternative funding mechanisms, Granite’s capabilities have also expanded over the years to enable us to pursue a greater variety of transportation-related projects. HCD is targeting these new opportunities and pursuing new markets in Missouri, Washington and Virginia while also continuing to pursue projects in its core geographic markets such as Texas, Florida and New York. There are several large highway, bridge and rail projects that HCD has its sights on including four highway projects in North Carolina totaling approximately $350 million, several highway and bridge projects in Washington totaling approximately $500 million, and light rail projects in Arizona, California, Oregon and Washington.

As is always the case, weather can play a significant role in the course of our operations. In the beginning of the second quarter of this year, we experienced unseasonably wet weather in most of our Branch Division markets. In some of these areas, rainfalls averaged 250 percent of normal, compared to last April where these same locations witnessed less than normal rainfall. As a result, it is possible that this wet weather could negatively impact revenues in the Branch Division for the month of April.

In summary, while we remain cautiously optimistic for the months ahead, we are very pleased with the strength of our current backlog and HCD’s potential bidding opportunities. We will be closely monitoring the transportation funding programs at the state and federal levels and will continue to move

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forward on our strategy to grow the Company both internally and through acquisitions and to improve our financial performance in both divisions.

Liquidity and Capital Resources

Cash provided by operating activities of $26.5 million for the three months ended March 31, 2003 represents a $29.2 million increase from the amount used in operating activities in the same period in 2002. Changes in cash from operating activities primarily reflect seasonal variations based on the amount and progress of work being performed. As is typical in the our first quarter, accounts receivable, accounts payable, billings in excess of costs, net and accrued expenses are substantially lower than at December 31, 2002 due to lower first quarter volume.

Cash provided by investing activities of $8.6 million for the three months ended March 31, 2003 represents a $14.7 million increase from the amount used in investing activities in the same period in 2002, largely due to cash received related to the sale of the State Route 91 Tollroad Franchise by the California Private Transportation Corporation, of which we are a 22.2% limited partner. We have budgeted $68.3 million for capital expenditures in 2003, including Wilder, which includes amounts for construction equipment, aggregate and asphalt plants, buildings, leasehold improvements and the purchase of aggregate reserves.

Cash used by financing activities was $12.1 million for the three months ended March 31, 2003 and principally included payments of long-term debt and dividends during the quarter.

In addition to its working capital and cash generated from operations, we currently have access to funds under a $60.0 million bank revolving line of credit of which $58.7 million was available at March 31, 2003. Additionally, our Wilder subsidiary has a bank revolving line of credit of $10.0 million, all of which was available at March 31, 2003. Both lines of credit expire in June 2004.

Our cash and cash equivalents and short-term and long-term marketable securities totaled $189.4 million at March 31, 2003. We believe that our current cash and cash equivalents, short-term marketable securities, cash generated from operations and amounts available under our existing credit facilities will be sufficient to meet our expected working capital needs, capital expenditures, financial commitments and other liquidity requirements associated with our existing operations through at least the next twelve months.

Recent Accounting Pronouncements: In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations,” which was effective for our fiscal year beginning January 1, 2003. SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 requires, among other things, that the retirement obligations be recognized when they are incurred and displayed as liabilities on the balance

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sheet. In addition, the asset’s retirement costs are to be capitalized as part of the asset’s carrying amount and subsequently allocated to expense over the asset’s useful life. The adoption of SFAS 143 did not have a material effect on our financial position, results of operations or cash flows.

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires certain disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. FIN 45 supercedes FASB Interpretation No. 34, “Disclosure of Indirect Guarantees of Indebtedness of Others”. The disclosure provisions of FIN 45 are effective for financial statements of both interim and annual periods that end after December 15, 2002 and the initial recognition and measurement provisions are effective on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of the prospective measurement provisions of this statement did not have a material effect on our financial position, results of operations or cash flows.

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51.” FIN 46 addresses consolidation accounting for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We are in the process of assessing the impact, if any, of FIN 46 on our financial position or results of operations.

Website Access

Our website address is www.graniteconstruction.com. On our website we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. The information on our website is not incorporated into, and is not part of, this report.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In February 2003, we entered into two interest rate swap agreements in order to gain access to the lower borrowing rates normally available on floating-rate debt, while avoiding the prepayment and other costs that would be associated with refinancing our long-term fixed-rate debt. The swaps purchased have a combined notional amount of $50.0 million, six-month maturity and provide for us to pay variable interest at LIBOR plus a set rate spread and receive fixed interest of between 6.54% and 6.96% The notional amount does not quantify risk or represent assets or liabilities, but rather, is used in the determination of cash settlement under the swap agreement. As a result of purchasing these swaps, we will be exposed to credit losses from counter-party non-performance; however, we do not anticipate any such losses from these agreements, which are with a major financial institution. The agreements will also expose us to interest rate risk should LIBOR rise during the term of the agreements. These swap agreements are accounted for under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”). Under the provisions of SFAS 133, we initially recorded the interest rate swaps at fair value, and subsequently recorded any changes in fair value in other income, net. Fair value is determined based on quoted market prices, which reflect the difference between estimated future variable-rate payments and future fixed-rate receipts.

Item 4. CONTROLS AND PROCEDURES

Within 90 days prior to the date of filing of this Report, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in the reports we file under the Exchange Act, within the time periods specified in the SEC’s rules and forms.

There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation described above.

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PART II. OTHER INFORMATION

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, David H. Watts, certify that:

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CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, William E. Barton, certify that:

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