Business Context and Reporting Period
Company: Granite Construction Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2007
Overview: Granite Construction is a major heavy civil contractor operating in the U.S. In February 2007, the company realigned its operations into two geographic reportable segments: Granite West (decentralized branch offices in the West, including materials sales) and Granite East (large, complex infrastructure projects in the East). The company also operates a real estate subsidiary, Granite Land Company (GLC).
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 |
|---|---|---|
| Total Revenue | $846,313 | $2,104,849 |
| Gross Profit | $136,637 | $312,307 |
| Gross Margin | 16.1% | 14.8% |
| Operating Income | $75,965 | $137,227 |
| Net Income | $53,300 | $94,897 |
| Diluted EPS | $1.28 | $2.28 |
| Cash and Cash Equivalents | $265,605 | $265,605 (Balance Sheet) |
| Working Capital | $385,213 | $385,213 |
| Total Debt (Current + Long-term) | $166,999 | $166,999 (Balance Sheet) |
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 10.1% for the three months and 6.4% for the nine months compared to 2006. This was driven by a slowdown in private sector residential construction (impacting Granite West) and the completion of large projects in Granite East.
- Profitability Improvement: Despite lower revenue, Net Income increased 16.6% (three months) and 22.3% (nine months). This was primarily due to significantly improved gross margins in Granite East, which moved from a loss in 2006 to profitability in 2007 due to fewer negative project forecast adjustments.
- Segment Performance:
- Granite West: Revenue declined due to the housing slowdown, but gross margin remained stable at 19.4% (three months) and improved to 19.3% (nine months).
- Granite East: Revenue declined significantly, but gross margin improved from -10.4% to 1.1% (three months) and from -5.2% to 1.4% (nine months).
- GLC: Revenue increased significantly due to real estate sales, with a gross margin of 45.1%.
- Acquisitions: The company acquired assets of the Superior Group of Companies for $58.6 million in April 2007 and an asphalt concrete manufacturer for $17.7 million in June 2007.
Guidance, Outlook, and Risks
- 2007 EPS Guidance: Management expects full-year 2007 earnings per share in the range of $2.55 to $2.75.
- Outlook: The company anticipates a strong increase in public sector work in California in 2008 due to transportation-related ballot measures passed in 2006. Management expects underperforming large projects to be completed within the next six months.
- Capital Allocation: In October 2007, the Board authorized a new $200 million share repurchase program, replacing the previous $25 million program.
- Key Risks and Contingencies:
- Project Estimates: Significant changes in project profitability estimates remain a risk. In Q3 2007, Granite East had a net reduction in gross profit of $8.6 million due to estimate changes, though this was an improvement over the $39.9 million reduction in the prior year.
- Joint Venture Losses: Two joint venture projects are forecast at a loss. One partner may lack the ability to contribute its full share of required capital, potentially exposing Granite to additional costs.
- Legal Proceedings:
- DBE Issues: Proposed sanctions of $4.3 million (Hiawatha Project) and $200,000 (I-494 Project) related to Disadvantaged Business Enterprise compliance. Final amounts are uncertain.
- Environmental: Fines of $240,000 and a criminal investigation regarding storm water runoff on the US Highway 20 project.
- Silica Litigation: Ten active lawsuits; management believes liability is remote.
- Real Estate: Approximately $43.9 million of real estate held for sale is related to residential projects in a slowing market; management assessed no impairment as of September 30, 2007, but future impairment is possible.
Investor Verification Checklist
- Granite East Turnaround: Verify the sustainability of the margin improvement in Granite East and the timeline for the completion of previously underperforming projects.
- Joint Venture Exposure: Assess the financial stability of minority partners in the two loss-making joint ventures and the potential for Granite to absorb additional costs.
- California Public Funding: Monitor the actual awarding of public sector contracts in California resulting from the 2006 ballot measures to validate the 2008 revenue outlook.
- Legal Sanctions: Track the resolution of the DBE compliance investigations to determine if the proposed sanctions ($4.5 million total) will be finalized or reduced.
- Real Estate Valuation: Review the valuation of the $43.9 million residential real estate portfolio for potential impairment charges in future quarters given the housing market slowdown.