Granite Construction Incorporated — FY2010 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2010. Granite is a U.S. heavy-civil contractor and construction-materials producer, with a smaller real estate investment and development business. Its reportable segments are Construction, Large Project Construction, Construction Materials and Real Estate. Approximately 83.3% of 2010 revenue came from government-funded contracts.
Financial performance and liquidity
| Metric | FY2010 | FY2009 |
|---|---|---|
| Revenue | $1.763 billion | $1.963 billion |
| Gross profit / margin | $177.8 million / 10.1% | $349.5 million / 17.8% |
| Operating income (loss) | $(109.3) million | $129.2 million |
| Net income (loss) attributable to Granite | $(59.0) million; diluted EPS $(1.56) | $73.5 million; diluted EPS $1.90 |
| Operating cash flow | $29.3 million | $64.3 million |
| Capital expenditures | $37.0 million | $87.6 million |
| Cash, cash equivalents and marketable securities | $395.7 million | $458.3 million |
| Working capital | $475.1 million | $500.6 million |
| Contract backlog | $1.899 billion | $1.402 billion |
Revenue fell 10.2% year over year. Construction revenue decreased 18.1%, Large Project Construction revenue decreased 3.2%, while Construction Materials revenue increased 7.8%. Gross profit fell sharply as margins contracted across the three construction-related segments.
For Q4 2010, revenue was $417.2 million and gross profit was $46.2 million (11.1% margin). The quarter recorded a consolidated net loss of $65.4 million and a loss attributable to Granite of $50.0 million, including approximately $107.3 million of restructuring charges.
At year-end, total debt was approximately $280.5 million, including $225.0 million of senior notes and $55.3 million of mortgage debt associated with real estate entities. Granite also had a $100 million secured revolving credit facility with no revolving loans outstanding; standby letters of credit were approximately $3.2 million. The filing reports compliance with the main credit-facility covenants at year-end, but also discloses cross-defaults discussed below.
Material changes and unusual items
- Enterprise Improvement Plan: Announced in October 2010, the plan targets cost reductions and operational efficiencies and calls for an orderly divestiture of the real estate investment business over about three years, subject to market conditions.
- Restructuring and impairment: FY2010 restructuring charges were $109.3 million, including $86.3 million of real estate investment impairments, $12.6 million in severance, and charges for facility consolidation and asset impairments. Management estimated annual pre-tax savings of $28.3 million from 2010 workforce reductions.
- Backlog growth: Year-end backlog rose 35.5% overall, primarily on large public infrastructure awards. Large Project Construction backlog increased 37.5% to $1.434 billion; approximately $1.1 billion of total backlog was expected to be completed during 2011. Backlog may be canceled or modified and is not a guarantee of revenue or profit.
- Project risk: An Oregon highway project experienced unexpected hillside movement and damage to completed bridge structures. Granite recorded a $10.2 million reduction in project profitability in 2010, expects the dispute over responsibility to extend beyond the 2011 construction season, and cannot reasonably estimate the ultimate financial impact.
- Debt defaults: Two consolidated real estate entities were in default on certain debt agreements at December 31, 2010; additional real estate-entity defaults occurred after year-end. Cross-default provisions caused Granite to be in default under its senior-note and revolving-credit agreements at year-end. Granite reported that these corporate-level defaults were cured by February 15, 2011, while discussions continued with lenders regarding remaining real estate debt defaults. The real estate loans are non-recourse to Granite, but cross-default exposure remains relevant.
Outlook, risks and contingencies
Management expected challenging market conditions to persist through 2011 and possibly beyond, citing weak public funding, limited private development, intense bidding competition and constrained financing. Construction Materials sales volumes and pricing were relatively consistent with 2009, but remained well below prior-decade highs. Granite anticipated up to $54 million of 2011 capital expenditures and $2 million to $15 million of additional restructuring charges in 2011 and beyond. The filing provides no specific revenue or earnings guidance.
Key risks include cost overruns and estimate changes on fixed-price contracts; weather and schedule delays; commodity-price volatility; dependence on public-sector customers and government budgets; project backlog cancellations; bonding capacity; joint-venture joint-and-several obligations; and environmental, safety and permitting requirements. The filing also identifies government investigations and litigation involving disadvantaged-business-enterprise compliance, alleged stormwater-permit violations on the US Highway 20 project, and a False Claims Act suit concerning San Diego fire-debris cleanup. Granite could not estimate potential penalties for several matters; it considered the City of San Diego’s requested relief remote.
Management and the independent auditor concluded that internal control over financial reporting was effective as of December 31, 2010; the auditor issued an unqualified opinion on the financial statements and controls.
Investor verification points
- Assess whether backlog awards convert to revenue and acceptable margins, especially given the high public-sector concentration and backlog cancellation provisions.
- Review the assumptions supporting the $86.3 million real estate impairment, the planned divestiture, and any further funding needs or asset-sale proceeds.
- Monitor remaining real estate debt defaults, lender negotiations, cross-default protections, and compliance with tightening credit-facility leverage covenants.
- Track the Oregon highway ground-movement dispute, carrying costs, corrective-work responsibility, and any change to the project’s estimated profitability.
- Follow the DBE investigations and other legal matters for sanctions, damages, government-contracting restrictions or changes in the company’s estimates.
- Compare 2011 cost savings, restructuring charges and capital spending with management’s stated expectations; the filing does not provide earnings guidance.