Granite Construction Incorporated — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions. The interim statements are unaudited, and the company notes significant seasonality.
Business context and financial performance
Granite is a heavy civil construction and construction materials company, with a real estate investment and development business. Its results are exposed to public infrastructure funding, economic conditions, competition, and construction project cost estimates.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $670.9 million | $720.3 million | $1,345.7 million | $1,528.7 million |
| Gross profit | $76.2 million | $105.7 million | $131.6 million | $258.3 million |
| Gross margin | 11.4% | 14.7% | 9.8% | 16.9% |
| Operating income (loss) | $32.2 million | $46.3 million | $(10.8) million | $93.5 million |
| Net income (loss) attributable to Granite | $38.7 million | $30.6 million | $(9.0) million | $57.5 million |
| Diluted earnings (loss) per share | $0.99 | $0.79 | $(0.24) | $1.49 |
Q3 consolidated net income was $43.3 million, including an $8.0 million income tax benefit; $4.6 million was attributable to noncontrolling interests. For the nine-month period, consolidated net income was $2.9 million, but $11.9 million attributable to noncontrolling interests resulted in a loss attributable to Granite.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $10.6 million, down from $58.3 million. Investing cash outflow was $34.4 million and financing cash outflow was $57.3 million. Cash declined $81.1 million to $257.9 million.
- Cash, cash equivalents and marketable securities totaled $388.3 million at September 30. This includes $103.4 million of consolidated joint venture cash, generally unavailable for Granite’s working capital. Excluding that joint venture cash, the corresponding total was approximately $285.0 million.
- Current assets were $1,100.0 million and current liabilities $585.4 million. The company reported $225.0 million of senior notes and $55.6 million of non-recourse real estate debt, of which $39.2 million was current. Non-recourse debt is recourse to the relevant real estate entities, not Granite.
- A $150 million unsecured revolving credit facility had no borrowings outstanding; $4.2 million of letters of credit were outstanding. Granite was compliant with debt covenants at quarter-end, but warned that it was reasonably likely to breach certain credit agreement financial covenants as early as Q4 2010 without an amendment or other lender relief. Discussions with lenders were ongoing.
- Capital expenditures were $30.2 million for the nine months; the company expected up to $40 million for full-year 2010. Dividends were $0.13 per share for the quarter and $0.39 per share year to date.
Material changes versus the prior comparable period
- Nine-month revenue fell 12.0%, and gross profit fell 49.1%; Granite cited reduced available work, intense bidding competition, lower margins in beginning backlog, and fewer public-sector projects. 2009 construction revenue also included $82.9 million from federally funded security projects substantially completed that year.
- Construction revenue declined 20.1% year to date, and segment gross margin fell to 9.5% from 17.6%. Large Project Construction revenue declined 5.8%; its gross profit was affected by project design issues, lower productivity, and the absence of a $17.3 million 2009 claims settlement.
- Construction Materials revenue rose 10.5% year to date, but gross profit fell to $9.5 million from $17.6 million, partly due to fixed costs at new facilities. Q3 materials revenue and gross profit improved with pent-up demand following wet weather.
- SG&A declined 10.4% year to date to $153.8 million, but did not offset the decline in gross profit. Lower capital spending and reduced purchases of property and equipment contributed to the lower investing cash outflow.
- Total contract backlog was $1.64 billion, up 5.8% from September 2009 and 5.6% from June 2010. Large Project backlog increased from June to $1.14 billion; Construction backlog was $497.1 million, down from June but above September 2009.
Outlook, risks and unusual items
- Management described market conditions as very challenging and expected them to persist into 2011 or beyond, citing public budget constraints, weak private development, property oversupply, restricted financing, and intense competition. It identified more than $10 billion of Large Project bidding opportunities. Subsequent to quarter-end, it reported awards and notices to proceed expected to enter backlog in Q4, including a roughly $306 million Washington highway project award for the company.
- An Enterprise Improvement Plan announced October 25, 2010 includes a workforce reduction affecting about 13% of salaried employees, cost-saving initiatives, and plans to divest the real estate investment business and certain fixed assets. Management estimated $36–$40 million of benefit to 2011 pretax income and $99–$145 million of restructuring and impairment charges, mostly in Q4 2010. Most charges were expected to be noncash impairments; timing and amounts depend partly on market conditions and asset sales.
- On a major Oregon highway project, unexpected hillside movement damaged portions of completed bridge structures. The company and project owner were assessing remedies; Granite said it could not reasonably estimate the financial impact and made no estimate revision for the issue.
- Disclosed legal matters include investigations into disadvantaged-business-enterprise compliance on Minnesota and New York projects, and a federal investigation into stormwater runoff on an Oregon project. A San Diego false-claims lawsuit seeks treble damages and civil penalties; Granite considers the requested relief remote. The company stated that adverse legal outcomes could nevertheless materially affect results, cash flows or liquidity.
- Construction joint venture partners may have joint and several performance obligations if a partner fails to perform. Granite reported $648.6 million of its share of remaining revenue on unconsolidated construction joint venture contracts, but said it could not estimate additional amounts that might be required beyond remaining work costs.
- Project profitability relies on cost-to-complete estimates; contract claims and change orders are not recognized as revenue until agreed in writing. For the nine months, significant estimate revisions reduced construction gross profit by $0.4 million and increased Large Project Construction gross profit by $6.5 million. The company also reported a $3.3 million benefit from tax examinations and a lapsed tax-year statute of limitations.
Important facts for investors to verify
- Whether Granite amended its revolving credit agreement before any covenant breach, and how covenant compliance and borrowing availability evolved after September 30.
- Actual Q4 restructuring and impairment charges, cash costs, asset-sale proceeds, and whether the projected 2011 savings of $36–$40 million were achieved.
- Progress, costs and any recognized exposure related to the Oregon hillside movement and the disclosed legal or government investigations.
- Whether backlog converted into revenue at expected margins, particularly given the high share of Large Project backlog and substantial revenue from projects where profit recognition was deferred.
- Liquidity available to Granite excluding joint venture cash, and the effect of ongoing operating cash needs, non-recourse real estate debt, and partner obligations.