Granite Construction - 10-Q quarterly report FY

 

For the transition period from                                         to                                        

Commission File No. 1-12911

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 þ No o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of
July 28, 2005.

 

(Unaudited – in thousands, except shares and per share data)

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

(Unaudited – in thousands, except per share data)

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

(Unaudited — in thousands)

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 June 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 six months ended June 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. We are currently reviewing the impact of implementing SFAS 123-R and SAB 107 on our consolidated financial statements.

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), which is an interpretation of FASB Statement No. 143, “Accounting for Asset Retirement Obligations,” and requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. This Interpretation is effective for fiscal years ending after December 15, 2005. Accordingly, we are required to adopt FIN 47 in our fiscal year ended December 31, 2005. We are currently reviewing the impact of implementing FIN 47 on our consolidated financial statements.

The following table indicates the net reduction in gross profit from changes in our estimate of the cost to complete certain Heavy Construction Division projects:

These forecast adjustments were made in response to unanticipated changes in project conditions occurring during the periods when recorded and 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. At June 30, 2005, three of the five projects adjusted in the quarter were greater than 90% complete, one was approximately 76% complete and the remaining project was approximately 36% complete; one of the projects was a joint venture for which we are not the sponsoring partner. We believe we have entitlement to additional compensation related to some of these 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.

Additionally, during the three months ended March 31, 2005, our Branch Division recognized a reduction of gross profit of approximately $2.5 million, due to a change in our estimate of project profitability related to certain unresolved and disputed issues on one project.

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:

The following intangible assets are included in other assets on our condensed consolidated balance sheets:

Amortization expense related to intangible assets was approximately $151,000 and $302,000 for the three and six months ended June 30, 2005, respectively, and approximately $151,000 and $296,000 for the three and six months ended June 30, 2004. Amortization expense expected to be recorded in the future is as follows: $303,000 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, 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 FIN 46. Accordingly, we have consolidated those joint ventures where we have determined that we are the primary beneficiary prospectively beginning January 1, 2004. The joint ventures we have consolidated are engaged in construction projects with total contract values ranging from $14.6 million to $391.4 million. Our proportionate share of the consolidated joint ventures ranges from 52.0% to 70.0%.

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 have determined 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. The joint ventures in which we hold a significant interest but are not the primary beneficiary are 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%.

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 June 30, 2005, approximately $325.3 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 189,000 shares and 417,000 shares for the three months ended June 30, 2005 and 2004, respectively, and approximately 94,000 shares and 321,000 shares for the six months ended June 30, 2005 and 2004, respectively, have been excluded from the calculation of diluted net income per share because their effects are anti-dilutive.

The components of comprehensive income, net of tax, are as follows:

Our effective tax rate decreased to 28.7% and 27.0% for the three and six month periods ended June 30, 2005, respectively, from 34.0% and 33.5% for the corresponding periods in 2004, respectively, due primarily to a discrete period tax benefit of approximately $3.5 million related to the provision for a legal judgment recorded in the second quarter of 2005 (see Note 11) and an increase in our partners’ share of consolidated construction joint venture income. Generally, our construction joint ventures are not subject to income taxes on a stand-alone basis. Additionally, our effective tax rate for the 2005 periods reflect the estimated impact of a deduction based on income from qualified domestic production activities under the American Jobs Creation Act of 2004. We currently expect our effective tax rate for the year ending December 31, 2005 to be approximately 30.0%.

A $9.3 million judgment was entered in June 2005 against our wholly owned subsidiary Granite Construction Company (“Granite”) by the District Court Clark County, Nevada in an action entitled Eldredge Vs. Las Vegas Valley Water District, Granite, et al. The civil lawsuit was initially brought by a former employee of Granite against the Las Vegas Water District in June 2000. The plaintiff subsequently filed an Amended Complaint on June 10, 2003, bringing Granite into the action and seeking compensation in addition to the worker’s compensation payments the employee previously accepted for injuries sustained when a trench excavation collapsed. The jury issued a verdict finding against Granite on two causes of action, assault and battery and intentional infliction of emotional distress. The damages awarded past and future lost wages, medical expenses and pain and suffering. Although no punitive damages were assessed, Granite’s insurance carrier has denied coverage for this judgment.

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. We anticipate that these post-trial motions will be heard in September 2005. If we do not prevail in the post-trial motions, we fully 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. We anticipate the motion will be heard in September 2005.

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 May 27, 2005, the Court granted Wasatch Constructors’ motion to dismiss that part of the plaintiffs’ Fourth Amended Complaint, which alleged fraud on behalf of Wasatch Constructors with respect to charges to the Government for excess truck weight. The Court denied the motion to dismiss the remaining allegations of plaintiffs’ complaint. Wasatch Constructors has filed a Petition to Appeal with the United States Court of Appeals for the 10^th Circuit as to the Court’s decision to deny the motion to dismiss the remaining allegations. In addition, Wasatch Constructors has filed with the Court a separate motion to dismiss the entire case.

Granite Construction Company is one of approximately one hundred defendants in six California State Court lawsuits filed in 2004 in Alameda and San Francisco Counties where six 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 five of these lawsuits and continue to evaluate our exposure on the remaining lawsuit. In addition, we recently have been apprised of ten new complaints brought by 11 individual plaintiffs and that are based on similar allegations of exposure to silica containing products being filed, but not served, against Granite and more than a hundred other defendants in California State Court. We are investigating the specific allegations against Granite for these ten 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.

We have two reportable segments: the Branch Division and the Heavy Construction Division (“HCD”). The Branch Division is composed of branch offices, including our majority owned subsidiary, Wilder Construction Company (“Wilder”), that serve local markets, while HCD pursues major infrastructure projects throughout the nation. HCD focuses on building larger heavy-civil projects with contract durations that are frequently greater than two years, while the Branch Division projects are typically smaller in size and shorter in duration. HCD has been the primary participant in our construction joint ventures. Substantially all of our revenue from the sale of materials is from the Branch Division.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies contained in our 2004 Annual Report on Form 10-K. We evaluate performance based on operating profit or loss (excluding gain on sales of property and equipment) and exclude income taxes, interest income, interest expense or other income (expense). Unallocated other corporate expenses principally comprise corporate general and administrative expenses.

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

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 0.875% at June 30, 2005. The unused and available portion of this line of credit was $120.1 million at June 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 June 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 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 six months ended June 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 six months ended June 30, 2005 reflect improved results from our operating divisions compared with the corresponding periods in 2004, particularly in our Branch Division which realized higher revenue and gross margins on construction projects and on the sales of construction materials. These improvements were partially offset by additional costs recorded due to changes in the estimates of the cost to complete certain projects and the recognition of a provision related to an unfavorable legal judgment.

Branch Division Revenue: Revenue from our Branch Division for the three and six month periods ended June 30, 2005 increased over the corresponding 2004 periods by $61.8 million, or 18.2%, and $113.8 million, or 22.5%, respectively. The higher revenue reflects increases in private sector construction revenue and sales of construction materials as a result of the increase in demand created by the continuing strong housing market, particularly in the Central Valley of California (from Sacramento to Bakersfield) and in Northern Nevada.

HCD Revenue: Revenue from our Heavy Construction Division for the three months and six months ended June 30, 2005 increased over the corresponding 2004 periods by $56.2 million, or 25.5%, and $88.0 million, or 22.6%, respectively, due primarily to the increase in volume from a higher backlog at the beginning of the respective periods. Approximately $24.5 million of the growth in HCD revenue for

the three and six month periods ended June 30, 2005 represented revenue related to our minority partners’ share of work in our consolidated construction joint ventures.

HCD Backlog: Heavy Construction Division backlog of $1.9 billion at June 30, 2005 was $178.8 million, or 8.8%, lower than at March 31, 2005, and $474.3 million, or 34.4%, higher than at June 30, 2004. Approximately $153.0 million of the growth in HCD backlog from June 30, 2004 to June 30, 2005 represented an increase in our minority partners’ share of consolidated joint venture backlog. Additions to HCD backlog in the current quarter included a $44.9 million site preparation project in New York.

Branch Division Backlog: Branch Division backlog of $647.9 million at June 30, 2005 was $65.1 million, or 11.2%, higher than at March 31, 2005 due primarily to increases in public sector awards, particularly from state and local government agencies in most of the states in which the Branch Division operates. The growth in state government agency backlog from March 31, 2005 to June 30, 2005 includes an increase of approximately $13.3 million from the state of 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.

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 in writing. However, we do recognize the estimated costs related to any contract claims or pending change orders when the additional work is identified. 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 is more pronounced in HCD because of the larger size and complexity of its projects.

Branch Division gross profit as a percent of revenue for the three months and six months ended June 30, 2005 increased relative to the corresponding periods in 2004 due primarily to improved performance on construction projects and higher gross margin on the sales of construction materials due to higher unit selling prices. On a year-to-date basis, Branch Division gross profit was negatively impacted by approximately $2.5 million related to the estimated impact of certain unresolved and disputed issues on one project recorded in the first quarter of 2005. Branch Division gross profit in the first quarter 2004 includes costs of approximately $1.4 million associated with the closing of certain ready-mix concrete plants in preparation for their subsequent sale during that quarter (see Note 15 to the Condensed Consolidated Financial Statements).

HCD gross profit as a percent of revenue was lower in the second quarter of 2005 compared to the second quarter of 2004 due primarily to an increase in the net impact of downward contract estimate changes. In the second quarter of 2005 we recognized additional costs of approximately $11.0 million related to changes in estimates of costs to complete five of our HCD projects compared with approximately $5.4 million in such additional costs related to one of our HCD projects in the second quarter of 2004 (See Note 3 to the Condensed Consolidated Financial Statements). We believe we have entitlement to additional compensation related to some of these additional costs and are actively pursuing these claims with the contract owners. However, the amount and timing of any future recovery is highly uncertain.

Additionally, HCD gross profit as a percent of revenue was negatively impacted by a higher volume of work performed on jobs less than 25% complete, which rose to $49.4 and $80.1 million in the three and six months ended June 30, 2005, respectively, from $29.3 million and $50.4 million, respectively, in the corresponding periods in 2004. These reductions were partially offset by the impact of a large project reaching 25% complete during the quarter ended June 30, 2005

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, 2005 increased $1.7 million, or 8.5%, and $3.2 million, or 7.5%, over the comparable periods in 2004 due primarily to a combination of increased headcount, higher payroll related benefits and normal salary increases. Incentive compensation, discretionary profit sharing and other variable compensation increased in the three months and six months ended June 30, 2005 compared with the corresponding periods in 2004 due to higher profitability in the 2005 periods. Additionally, the six month

period ended June 30, 2004 included significant forfeitures of unvested restricted stock which have the effect of reducing our expense in the period of forfeiture. Other general and administrative costs include information technology, occupancy, office equipment and supplies, depreciation, travel and entertainment, advertising and marketing, training and other miscellaneous expenses, none of which individually exceeded 10% of total general and administrative expenses.

Provision for Legal Judgment: In June 2005, we recorded a provision of $9.3 million related to an unfavorable judgment in a legal proceeding (see Note 11 to the Condensed Consolidated Financial Statements).

Gain on Sales of Property and Equipment: Gain on sales of property and equipment was significantly higher in the six months ended June 30, 2004 as compared with the six months ended June 30, 2005 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.