UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the Quarter ended June 30, 2004
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 July 28, 2004.
1
Index
2
PART I. FINANCIAL INFORMATION
3
Item 1. FINANCIAL STATEMENTS (unaudited)
Granite Construction IncorporatedCONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited — in thousands, except share and per share data)
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
Granite Construction Incorporated
5
6
7
Granite Construction IncorporatedNOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
8
9
10
11
12
13
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 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.
14
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 who had been working on those projects to estimating and bidding activities until another project is ready to start, which temporarily moves their salaries and other 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.
Results of Operations
Revenue: Revenue from our Branch Division for the three and six month periods ended June 30, 2004 increased over the corresponding 2003 periods by $59.1 million, or 21.1% and $53.9 million, or 11.9%, respectively. The growth in revenue reflects increases during the quarter in both public and private sector revenue. The increased private sector revenue reflects an increased demand created by a continuing strong housing market in California and other Branch Division locations. Additionally, the Branch Division benefited from improved weather, especially in the first part of the second quarter, compared to the same period in 2003, when it experienced higher than normal rainfall in many of the areas in which it operates.
15
Revenue from our Heavy Construction Division for the three and six month periods ended June 30, 2004 increased over the corresponding 2003 periods by $30.3 million, or 15.9%, and $70.3 million, or 22.0%, respectively. Included in HCD revenue during the three and six month periods ending June 30, 2004 is $25.6 million and $48.7 million, respectively, resulting from the consolidation of our partners’ share of construction joint venture revenue under FIN 46, “Consolidation of Variable Interest Entities” (“FIN 46”) (see Note 7 to the Condensed Consolidated Financial Statements). The remaining increase was due primarily to increased volume from a higher backlog at the beginning of the respective periods.
Backlog: Heavy Construction Division backlog of $1.4 billion at June 30, 2004 was $189.6 million, or 12.1%, lower than the HCD backlog at March 31, 2004 and $17.1 million, or 1.2%, lower than the HCD backlog at June 30, 2003. Included in the HCD backlog at June 30, 2004 and March 31, 2004 was $105.1 million and $122.9 million, respectively, resulting from the consolidation of our partners’ share of construction joint venture backlog under FIN 46 (see Note 7 to the Condensed Consolidated Financial Statements). The decrease in backlog over the prior periods was due primarily to a lack of new project awards in the quarter.
Branch Division backlog of $660.1 million at June 30, 2004 was $181.4 million, or 37.9%, higher than Branch Division backlog at March 31, 2004 and $123.9 million, or 23.1%, higher than Branch Division backlog at June 30, 2003. The increased backlog reflects increases in both private sector and public sector awards in the quarter ended June 30, 2004, including a $20.4 million airport expansion project in Utah, a $20.4 million pedestrian bridge project in Nevada, and a $35.7 million subdivision project in California. A sizeable percentage of Branch Division anticipated contract revenue in any year is not reflected in our backlog due to the short duration of smaller Branch Division projects that are initiated and completed during each year.
16
Gross Profit: We recognize revenue only equal to cost, deferring profit recognition, until a project reaches 25% completion. Because we have a large number of projects at various stages of completion in our Branch Division, this policy generally has little impact on the Branch Division’s gross profit on a quarterly or annual basis. However, HCD has fewer projects in process at any given time and those projects tend to be much larger than Branch Division projects. As a result, HCD gross profit as a percent of revenue can vary significantly in periods where one or several very large projects reach 25% completion and the deferred profit is recognized or conversely, in periods where backlog is growing rapidly and a higher percentage of projects are in their early stages with no associated gross margin recognition.
Additionally, we do not recognize revenue from contract claims until we have a signed settlement agreement and payment is assured and we do not recognize revenue from contract change orders until the contract owner has agreed to the change order. However, we do recognize the costs related to any contract claims or pending change orders when they are incurred. As a result, our gross profit as a percent of revenue can vary during periods when a large volume of change orders or contract claims are pending resolution (reducing gross profit percent) or, conversely, during periods where large change orders or contract claims are agreed to or settled (increasing gross profit percent). Although this variability can occur in both our Branch Division and HCD, it can be much more pronounced in HCD because of the larger size and complexity of its projects.
Gross profit as a percent of revenue in the Branch Division was negatively impacted by a larger volume of work performed on jobs less than 25% complete which grew from $11.2 million to $25.3 million for the three months ended June 30, 2003 and 2004, respectively, and from $12.0 million to $26.1 million for the six months ended June 30, 2003 and 2004, respectively. Additionally, the Branch Division incurred costs in the first quarter of 2004 of approximately $1.4 million associated with the closing of certain ready-mix concrete plants in preparation for their subsequent sale during the quarter (see Note 14 to the Condensed Consolidated Financial Statements).
In the second quarter of 2004, HCD gross profit as a percent of revenue improved over the corresponding prior year period primarily due to profit recognized on three large projects that reached 25% complete during the quarter, partially offset by the recognition of approximately $5.4 million in additional costs attributable to unanticipated changes in project conditions at one project. On a year to date basis, HCD gross profit as a percent of revenue fell to 3.8% in 2004 from 9.2% in 2003 due to the recognition of increased costs of approximately $20.0 million in the first quarter of 2004 primarily related
17
to changes in our cost estimates for eight large projects. The amount attributable to each project ranged from approximately $0.5 million to $4.0 million. These forecast adjustments were made in response to unanticipated changes in project conditions occurring in the quarter, including costs associated with added scope changes, extended overhead due to owner and weather delays, design problems on design/build projects, subcontractor performance issues, changes in productivity expectations and higher than anticipated liquidated damages on two projects.
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).
General and Administrative Expenses: Salaries and related expenses in the three months and six months ended June 30, 2004 increased $0.6 million, or 3.2%, and $2.0 million, or 4.9%, respectively over the comparable periods in 2003 due primarily to a combination of higher payroll related benefits and normal salary increases. Incentive compensation, discretionary profit sharing and other variable compensation decreased in the six months ended June 30, 2004 compared with the comparable period in 2003 due primarily to lower profitability in the 2004 period. 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 expenses.
Gain on Sales of Property and Equipment: The increase in gain on sales of property and equipment in the six months ended June 30, 2004 as compared with the same period in 2003 was primarily due to a gain of approximately $10.0 million recognized on the sale of certain assets related to our ready-mix concrete business in Utah in the first quarter of 2004.
18
Other Income (Expense): The increase in equity in income of affiliates in the second quarter of 2004, compared with the second quarter of 2003 was due to the recognition of $2.1 million related to the gain on sale of certain assets by a partnership in which we hold a 9.0% interest. The decrease in equity in income of affiliates in the six months ended June 30, 2004, compared with the corresponding period in 2003 was due to $18.4 million in income recorded in the first quarter of 2003 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.
Provision for Income Tax: Our effective tax rate decreased to 33.5% in the six months ended June 30, 2004 from 36.2% in the six months ended June 30, 2003 due primarily to the effect of consolidating our partners’ share of construction joint venture income under FIN 46 (see Note 7 to the Condensed Consolidated Financial Statements). Generally, our construction joint ventures are not subject to income taxes on a stand-alone basis.
19
Outlook
As we progress through our construction season, we continue to be encouraged by the economic strength in many of our markets and the opportunities provided to us by both the private and public sectors. In addition, we are paying close attention to funding issues at both the state and federal levels that will likely have an impact on our business in the future.
As the forces that drive our Branch business improve, our outlook for this area of our business is becoming more optimistic. Despite the uncertainty of both state transportation funding and the Federal highway bill, all of our branch offices in the West are very busy bidding and building work. Although some locations are experiencing stronger markets than others, most of our branches expect that this improved level of activity is sustainable through the end of the construction season. While interest rates have risen slightly, the demand for residential and commercial site development work in the private sector continues to be a primary driver for a number of branches.
The pipeline of large projects available for bidding also remains full. Over the next six months, HCD’s potential bid list includes approximately $3.0 billion in highway, bridge and transit work across the U.S. and in Canada. Many of these opportunities would require our expertise in the design-build method of project delivery.
We continue to forecast that 2004 HCD operating income will be better than in 2003. Our ability to achieve this expectation is dependent on several factors, including reaching 25 percent completion on a large HCD project late this year. Although we are currently on schedule, and expect to stay on schedule, it is possible this project could reach 25 percent in early 2005 rather than late 2004.
On the political front, the most significant funding issue we are tracking relates to the reauthorization of the federal transportation bill. Before departing for their summer recess House and Senate negotiators failed to reach a compromise over the investment level for a multi-year federal transportation bill to replace the previous legislation (the 6-year $218 billion Transportation Equity Act for the 21st Century) that expired last September. Both houses are advocating bills that include funding levels for transportation that are significantly higher than the $256 billion proposed by the Bush Administration. Prior to the scheduled recess in late July, House Republican negotiators presented a version of the bill that would provide $284 billion in guaranteed funding, $5 billion less than the Senate’s proposal. Conferees were unable to agree on a final amount before the recess thereby resulting in a fifth extension measure that allows the federal highway and transit program to continue to operate under a temporary
20
authorization law. This fifth extension continues funding levels at the fiscal year 2004 levels through September 30, 2004. With the November Presidential election rapidly approaching, the upcoming challenge for Congress will be to pass legislation in the 20 legislative days that will be left when they return to work in September. For more information on the Federal Highway Bill, please visit the American Road and Transportation Builders Association website at www.artba.com.
In late July, California state legislators and Governor Schwarzenegger reached an agreement on a $105 billion state budget. As the result of the Governor’s renegotiation of certain Indian gaming compacts (Assembly Bill 687), an additional early repayment of $1.2 billion owed to transportation accounts by the general fund may occur. This additional money would be generated by a bond issue to be financed through State proceeds from the casino accords. Before the bond offering can take place, two gaming initiatives on the November ballot must be defeated. Governor Schwarzenegger is actively opposing both measures. For more information on the budget or the bond issue, please visit the state of California’s website at www.ca.gov or the Legislative Analyst Office website at www.lao.ca.gov.
As we discussed last quarter, we are subject to oil price volatility as it relates to our use of liquid asphalt in our production of asphaltic concrete and diesel fuel for our rolling stock equipment. We manage our exposure to these price changes by monitoring these commodities and pricing them into our projects and contracts accordingly. Some of our contracts include clauses for liquid asphalt escalation and de-escalation that provide protection in the event that oil product prices change significantly. Although we are exposed to price spikes in projects that do not include such clauses, this can be mitigated when prices come down. In addition, we are exposed to steel price increases and delivery delays on some of our HCD projects that are currently under construction. While we do have some exposure in these areas of our business, we have not been materially impacted to date.
Looking forward, although our long-term visibility is affected by funding legislation at the state and federal levels that has yet to be resolved, we are encouraged by the bidding opportunities we are witnessing for both divisions. We will continue to implement our strategy to grow the Company both internally and through acquisitions and focus on execution to improve our financial performance in both divisions.
21
Liquidity and Capital Resources
Our primary sources of liquidity are cash flows from operations and borrowings under our credit facilities. We expect the principal use of funds for the foreseeable future will be for capital expenditures, working capital, debt service, acquisitions and other investments. We have budgeted $58.0 million for capital expenditures in 2004, which includes amounts for construction equipment, aggregate and asphalt plants, buildings, leasehold improvements and the purchase of land and aggregate reserves.
Our cash and cash equivalents and short-term and long-term marketable securities totaled $208.0 million at June 30, 2004, and include cash from our newly consolidated joint ventures (see Note 7 to the Condensed Consolidated Financial Statements). We believe that our current cash and cash equivalents, short-term investments, 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 the next twelve months and beyond. If we experience a significant change in our business such as the execution of a significant acquisition, we would likely need to acquire additional sources of financing.
Cash used in operating activities of $15.0 million for the six months ended June 30, 2004 represents a $44.0 million decrease from the amount provided by operating activities during the same period in 2003. The decrease was primarily due to lower net income in the first six months of 2004 compared to the same period in 2003, cash of approximately $10.0 million used to purchase and develop properties held for sale, and a decrease in billings in excess of cost, net in the first six months of 2004. Additionally, there was higher growth in accounts receivable that was substantially offset by higher growth in accounts payable due to higher revenue in the second quarter of 2004 compared with the second quarter of 2003.
Cash provided by investing activities of $5.7 million for the six months ended June 30, 2004 represents a $3.0 million decrease from the amount provided by investing activities during the same period in 2003. Investing activities in the first six months of 2004 included cash paid for the acquisition of additional interest in our majority-owned subsidiary, Wilder Construction Company (“Wilder”), and cash received from the sale of certain assets by one of our equity method investments. Investing activities in the first six months of 2003 included cash received from the sale of the State Route 91 toll road franchise by CPTC and proceeds from the partial sale of our investment in T. I. C. Holdings, Inc.
Cash used by financing activities was $17.8 million for the six months ended June 30, 2004, an increase of $5.6 million from the same period in 2003. The increase was mainly due to purchases of our common stock for contribution to the ESOP in 2004, and net distributions to minority partners in our consolidated
22
construction joint ventures in 2004, and was partially offset by net proceeds from borrowings under a line of credit at one of our consolidated subsidiaries in the 2004 period.
We had standby letters of credit totaling approximately $1.4 million outstanding at June 30, 2004, all of which expire during 2004.
In addition to our working capital and cash generated from operations, we currently have access to funds under a $100.0 million bank revolving line of credit, which allows for unsecured borrowings for up to three years through June 27, 2006. Outstanding borrowings under the revolving line of credit are at our choice of selected LIBOR rates plus a margin that is recalculated quarterly. The margin was 1.25% at June 30, 2004. The unused and available portion of this line of credit was $98.8 million at June 30, 2004. Additionally, our Wilder subsidiary has a bank revolving line of credit of $10.0 million that expires in June 2006. Approximately $6.3 million was outstanding under the Wilder line of credit at June 30, 2004.
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) of approximately $397.7 million. We were in compliance with these covenants at June 30, 2004. Additionally, our Wilder subsidiary has restrictive covenants (on a Wilder stand-alone basis) under the terms of its debt agreements that include the maintenance of certain ratios of working capital, liabilities to net worth and tangible net worth and restrict Wilder capital expenditures in excess of specified limits. Wilder was in compliance with these covenants at June 30, 2004. Failure to comply with these covenants could cause the amounts due under the debt agreements to become currently payable.
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.
23
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There was no significant change in our exposure to market risk during the six months ended June 30, 2004.
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, as of June 30, 2004. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
There was no change in our internal control over financial reporting during the quarter ended June 30, 2004 that materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
24
PART II. OTHER INFORMATION
25
Item 1. LEGAL PROCEEDINGS
26
Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
Item 3. DEFAULTS UPON SENIOR SECURITIES
27
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
28
Item 5. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
29
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.
30