UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the Quarter ended September 30, 2003
Commission File No. 1-12911
GRANITE CONSTRUCTION INCORPORATED
Corporate Administration:
585 W. Beach StreetWatsonville, 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 by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of November 5, 2003.
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TABLE OF CONTENTS
Index
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PART I. FINANCIAL INFORMATION
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Item 1. FINANCIAL STATEMENTS (unaudited)
Granite Construction IncorporatedCONDENSED CONSOLIDATED BALANCE SHEETS(In thousands, except share and per share data)
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Granite Construction IncorporatedCONDENSED CONSOLIDATED STATEMENTS OF INCOME(Unaudited - in thousands, except per share data)
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Granite Construction IncorporatedCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited - in thousands)
The accompanying notes are an integral part of these condensed consolidated financial statements
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Granite Construction IncorporatedNOTES 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:
General:
We are one of the largest heavy civil contractors in the United States and are engaged in the construction of highways, dams, airports, mass transit facilities and other infrastructure-related projects. We have offices in California, Nevada, Arizona, Utah, Washington, Oregon, Alaska, Texas, Florida and New York. Our business involves two operating segments: the Branch Division and the Heavy Construction Division.
Our contracts are obtained primarily through competitive bidding in response to advertisements by federal, state and local agencies, 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, 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.
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 employees from those projects to estimating and bidding activities until another project assignment becomes available, 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 a very profitable year and decreasing expenses in less profitable years.
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Revenue: Total revenue for the three-month period ended September 30, 2003 decreased $3.5 million and for the nine-month period ended September 30, 2003 increased $39.9 million over the corresponding 2002 periods. Branch Division revenue for the nine month period in 2003 includes $161.1 million from our majority-owned Wilder Construction Company (“Wilder”) subsidiary, which was consolidated in our financial statements beginning in May 2002, versus $113.5 million in the nine month period in 2002. Branch Division revenue for the three-month period ended September 30, 2003 decreased over the corresponding 2002 period by $33.8 million and decreased for the nine month period (excluding Wilder revenue) by $88.7 million, due primarily to the continuing effects of a weaker general economy and uncertainty surrounding public funding, particularly in California (see “Outlook”). Revenue from our Heavy Construction Division increased 19.8% and 19.1% in the three and nine months ended September 30, 2003 over the corresponding periods in 2002 due primarily to the results from a higher backlog at the beginning of 2003.
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Backlog: Our backlog at September 30, 2003 of $1,900.1 million was $156.6 million, or 9.0%, higher than the backlog at September 30, 2002. Branch Division backlog decreased by $47.4 million, or 9.0%, from September 30, 2002 to September 30, 2003. The Branch Division backlog decrease occurred primarily in the public sector, where we have witnessed a decline in public funding in many of the states in which our branches are located.
Heavy Construction Division backlog at September 30, 2003 of $1,417.8 million represents an increase of $204.0 million, or 16.8%, from its backlog at September 30, 2002 and $22.6 million, or 1.6%, from its backlog at June 30, 2003. HCD’s awards for the third quarter of 2003 included a $62.3 million highway contract in New York, a $39.2 million share of a highway joint venture contract in Texas and a $96.4 million share of an elevated train joint venture contract in Pennsylvania.
Gross Profit: Gross profit as a percent of revenue increased to 14.1% in the third quarter of 2003 from 13.2% in the third quarter of 2002 and decreased to 12.4% in the nine months ended September 30, 2003 from 12.8% in the corresponding 2002 period. Gross profit margins in the quarter ended September 30, 2003 were positively impacted by higher profit margins from both material sales and construction in many branch locations due largely to more effective execution of the work and the inclusion of margin from two large HCD projects that reached the 25% completion threshold for profit recognition during the
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quarter. These increases were partially offset by lowered profit forecasts on several HCD projects, principally as a result of not performing as anticipated. Gross profit margins in the nine months ended September 30, 2003 were also negatively impacted by a higher volume of revenue from projects less than 25% complete, increased pressure on Branch Division margins due to increased competition resulting from reductions in various state and local transportation funding programs and revised profit forecasts on several HCD projects. We recognize revenue only to the extent of cost, deferring profit recognition, until a project reaches 25% complete. The amount of revenue generated from projects below the 25% completion threshold was approximately $45.0 million and $39.0 million for the three months ended September 30, 2003 and 2002, respectively, and $81.0 million and $58.0 million for the nine months ended September 30, 2003 and 2002, respectively.
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 and fuel). 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 nine months of 2003.
General and Administrative Expenses: General and administrative expenses increased by $2.4 million in the quarter ended September 30, 2003 compared with the September 2002 quarter and by $9.3 million in the nine months ended September 30, 2003 from the comparable 2002 period. Included in the increase for the nine months ended September 30, 2003 were costs of approximately $6.6 million associated with our Wilder subsidiary and our expansion into Northern California, both of which were first reflected in our costs in May 2002. Variable compensation increased in the three and nine-month periods ended September 30, 2003 due to higher income than in the comparable 2002 periods. 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.
Operating Income: Our Heavy Construction Division’s contribution to operating income decreased in the third quarter of 2003 compared with the third quarter of 2002 primarily due to lower gross margins as described in “Gross Profit” above and higher general and administrative expenses to support a higher volume of work. For the nine months ended September 30, 2003, HCD’s contribution to operating income increased due to the margin generated from higher 2003 revenue. Our Branch Division’s
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contribution to operating income increased in the third quarter of 2003 compared with the third quarter of 2002 primarily due to higher gross margins as described in “Gross Profit” above. For the nine months ended September 30, 2003, our Branch Division’s contribution to operating income decreased due to the factors described in “Revenue”, “Gross Profit” and “General and Administrative Expenses” above. Unallocated other corporate expenses principally comprise corporate general and administrative expenses.
Other Income (Expense): Included in equity in income (loss) of affiliates in the nine months ended September 30, 2003 is $18.4 million recognized in the first quarter of 2003 related to the sale of the State Route 91 toll road franchise by the California Private Transportation Corporation, of which we are a 22.2% limited partner. Additionally, included in other, net is approximately $1.9 million in gain recognized on the sale of a portion of our investment in T.I.C. Holdings, Inc. (“TIC”) back to TIC for a cash payment of approximately $6.0 million.
Provision for Income Taxes: Our effective tax rate increased to 36.2% for the three month period ended September 30, 2003 from 35.4% in the comparable period in 2002. The third quarter 2002 effective tax rate reflected an adjustment to reduce the 2002 annual rate to 36.2% from 37.5% due to the combined factors of higher percentage depletion deductions related to quarry properties and higher tax credits.
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Outlook
We remain cautiously optimistic on our outlook for the remainder of 2003 and into 2004, although we continue to face uncertainty due to a number of unresolved state and federal political issues and the continued strength and timing of the economic recovery in our markets. Nevertheless, we are encouraged by the performance of some of our California-based profit centers in what has been a challenging environment for the Branch Division. In addition, we believe that the Heavy Construction Division (HCD) will have a better year in 2004 than in 2003 – propelled by a healthy backlog of work.
Given the current climate in which we are operating, our Branch Division performed much better than expected in the quarter. We are pleased that despite decreased transportation funding and competitive pressures throughout the West, some of our California branches continue to generate strong performance. Although HCD has been a significant contributor to backlog in 2003, we do not anticipate it will contribute to 2003 earnings at the level that we had expected at the beginning of the year. Therefore, we currently expect earnings for the year 2003 to be in the range of $1.28 to $1.36 per diluted share, which includes the $18.4 million income related to the sale of the State Route 91 Tollroad Franchise by the California Private Transportation Corporation, of which Granite is a 22.2% limited partner, that was recorded in the first quarter of 2003.
Looking ahead to 2004, we do not anticipate a significant improvement in California’s economy as the new administration begins its attempts to turn the state’s fiscal crisis around. We believe that we will likely witness a highly competitive public sector market in most of our California locations. We also anticipate that the private sector market will remain active and be similar to what we have experienced so far in 2003, in most of our locations.
HCD is building momentum across the country and is targeting an additional $14.0 billion of work to bid on over the next 12-18 months. The division is entering the fourth quarter with $1.4 billion of backlog, a 17% increase over the same period last year. HCD continues to seek out new markets throughout the U.S. with healthy long-term transportation programs. As discussed below, these long-term programs are dependent in part on federal funding – making the federal highway bill reauthorization a key driver. Based in part on the strong backlog of work and a number of projects expected to reach the 25% complete stage, we anticipate that 2004 will be a better year for HCD.
On September 30, 2003, President Bush approved the Surface Transportation Extension Act of 2003, a bill to extend authorizations for federal highway, highway safety and transit programs until February 29, 2004. The bill, an extension to the 6-year Transportation Equity Act for the 21st Century (TEA-21), which expired on September 29, authorizes $14.7 billion for highway programs and $3.0 billion for transit. Although the bill was necessary to enable the Federal Highway Administration to reimburse states for road funding obligations, it does not the provide long-term certainty needed to enable the various state departments of transportations to plan their respective capital improvement programs.
Members of the House and Senate are now focusing on how to provide a significant increase to a long-term authorization bill. Transportation industry lobbyists continue to push for another 6-year bill that will be a substantial increase over the prior level of $218.0 billion. The Bush administration, which favors a $247.0 billion plan, opposes a fuel-tax increase while the House of Representatives’ $375.0 billion plan calls for indexing the fuel tax to inflation in order to raise additional revenues. Members of the House and Senate, and the Bush administration, undoubtedly face a number of difficult decisions, including the prospect of raising taxes in an election year. We understand how difficult an increase in the fuel tax will be to achieve given the pending election in November 2004 and therefore do not anticipate that President Bush would sign a bill that includes a tax increase.
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It also remains to be seen whether Congress will take action on a new 6 year bill or continue the current program and act on a new bill after the November 2004 election. Congress is also wrestling with the tax treatment of ethanol – an issue that has a significant impact on the Highway Trust Fund. Ethanol is being effectively mandated as a gasoline additive in many states, including California. Since ethanol is subject to a lower excise tax than gasoline, and a portion of the tax is retain by the general fund, this mandated displacement of gasoline volume will result in a loss in revenue to the General Fund. Senator Charles Grassley has proposed an overhaul of this tax treatment that would substantially restore lost revenues to the Highway Trust Fund, while retaining ethanol incentives. Although House and Senate conferees have apparently reached some agreement on this proposal, its implementation is being held up pending action on the federal transportation re-authorization legislation now scheduled to be taken up next year.
In California, voters recalled Gray Davis and elected Arnold Schwarzenegger as the state’s new governor. On or about November 17, Mr. Schwarzenegger will be sworn into office and will inherit the task of finding approximately $8.0 billion to sustain public services next year at current levels. Although it is too early to tell how transportation will fare under this new administration, Governor Elect Schwarzenegger has publicly stated, “the first step [to resolving the state’s transportation crisis] is to commit to no more stealing of transportation revenues.” He has also stated that he intends to carefully “review the state’s transportation needs and to create a multilevel transportation plan.” While we are encouraged by these statements, we must take a ‘wait and see’ approach before making any assumptions about the impact of the new administration on our business.
In summary, we are very pleased with our results so far this year in an uncertain economic environment. We feel that our diversification, both by project type and geographic location, has served us very well in this current market – and will continue to do so for the foreseeable future. While it is too early to accurately predict the outcome of the state and federal funding issues, and the extent to which we will be impacted, we are buoyed by a healthy backlog and an outstanding list of large projects on which to bid.
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Liquidity and Capital Resources
Cash provided by operating activities of $82.0 million for the nine months ended September 30, 2003 represents a $25.3 million increase from the amount provided by operating activities in the same period in 2002. This increase was primarily attributable to a larger growth in accounts payable in the first nine months of 2003 due to costs associated with higher revenue, particularly in the month of September, and a lower increase in accounts receivable in the same period due primarily to improved collections and a change in the mix between billed receivables and unbilled revenue (costs and estimated earnings in excess of billings). Changes in cash from operating activities primarily reflect seasonal variations based on the amount and progress of work being performed.
Cash used by investing activities of $40.0 million for the nine months ended September 30, 2003 represents a $74.4 million decrease from the amount used in investing activities in the same period in 2002. The decrease was largely due to cash received from the sale of the State Route 91 Toll Road franchise by the California Private Transportation Corporation, of which we are a 22.2% limited partner, the absence of cash expended for acquisitions of businesses in 2003 and lower net purchases of marketable securities. We have budgeted approximately $59.0 million for capital expenditures in 2003, 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 $20.6 million for the nine months ended September 30, 2003, a decrease of $11.4 million from the same period in 2002. The decrease was mainly due to lower net repayments of long-term debt by our Wilder subsidiary, and the absence of cash expended to repurchase our common stock in 2003, partially offset by increased cash dividends paid to shareholders and the absence of proceeds from the exercise of warrants in 2003.
On June 27, 2003, we entered into an agreement for a $100.0 million bank revolving line of credit, which allows for unsecured borrowings for up to three years through June 27, 2006, with interest rate options. Outstanding borrowings under the revolving line of credit are at our choice of selected LIBOR rates plus margin (1.25% at September 30, 2003) that is recalculated quarterly. This line of credit replaces a $60.0 million line of credit we entered into in June of 2001. Additionally, we have standby letters of credit totaling $1.4 million, of which $1.2 million reduces the amount available under the line of credit. The unused and available portion of the line of credit at September 30, 2003 was $98.8 million. Restrictive covenants under the terms of this line of credit include the maintenance of certain financial ratios and tangible net worth (as defined) of approximately $386.0 million. We are in compliance with these covenants and the covenants of our other debt agreements at September 30, 2003.
Additionally, our Wilder subsidiary has a bank revolving line of credit of $10.0 million that expires in September 2005; there were no amounts outstanding under that line of credit at September 30, 2003.
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Our cash and cash equivalents and short-term and long-term marketable securities totaled $213.4 million at September 30, 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:
FIN 46
In January 2003, the Financial Accounting Standards Board (“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 was 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 at the end of the first interim or annual period ending after December 15, 2003. As more fully described in our Annual Report on Form 10-K under the section entitled “Critical Accounting Policies,” we participate in various construction joint ventures in order to share expertise, risk and resources for certain highly complex projects. We are currently evaluating whether certain of these jointly controlled entities meet the definition of a Variable Interest Entity in FIN 46. If all of the entities being evaluated met the definition and we were required to consolidate them, the effect on our financial position would be an increase in assets (primarily current assets) of approximately $110.0 million and an increase in current liabilities of approximately $85.0 million. Additionally, consolidation of these entities would increase our revenue and cost of revenue, but there would be no impact on net income.
SFAS 150
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). It was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. On November 7, 2003 the FASB issued FASB Staff Position No. 150-3 (“FSP 150-3”) “Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” FSP 150-3 requires that implementation of certain provisions of SFAS 150 be deferred indefinitely, including those provisions that pertain to mandatorily redeemable financial instruments of nonpublic entities and the measurement provisions (but not the classification provisions) for certain mandatorily redeemable noncontrolling interests.
Substantially all of the non-Granite held common shares of our majority-owned subsidiary, Wilder Construction Company (“Wilder”) are redeemable by the holder upon retirement, voluntary termination,
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death or permanent disability. Approximately 60% of these shares are outside the scope of APB Opinion No. 25, “Accounting for Stock Issued to Employees” and are therefore subject to the provisions of SFAS 150. Wilder generally has up to eight years to pay the redemption price following a redemption event, as defined in its shareholder agreements, and the redemption price is adjusted each year, primarily for the Wilder net income attributable to the shares. Pursuant to FSP 150-3, we have adopted the classification provisions of SFAS 150 by reclassifying the carrying amount of these Wilder shares from minority interest in consolidated subsidiaries to other long-term liabilities on our balance sheet. If all of these Wilder shares had been redeemed at the September 30, 2003 redemption price, a payment of approximately $13.0 million would have been required.
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, a thirty-month term with six-month settlement periods 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
We carried out an evaluation, under the supervision of 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-15(e) and 15d-15(e) 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, as of September 30, 2003, 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 Securities and Exchange Commission’s rules and forms.
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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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