GVA

Business Context and Reporting Period

Company: Granite Construction Incorporated
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2003
Business Overview: One of the largest heavy civil contractors in the U.S., operating through two segments: the Branch Division (local markets, materials) and the Heavy Construction Division (HCD) (major infrastructure projects).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 6.0% year-over-year for the six-month period. The Heavy Construction Division (HCD) drove this growth with an 18.8% increase, while the Branch Division revenue declined on a comparable basis due to weather and economic factors, despite the consolidation of the Wilder subsidiary.
• Profitability: Operating income decreased 46.5% to $13.3 million, primarily due to lower gross margins (11.2% vs 12.5%) and higher general and administrative expenses. Gross margins were compressed by a higher volume of revenue from projects less than 25% complete (where profit is deferred) and margin pressure in the Branch Division.
• Net Income: Net income increased 39.5% to $20.8 million. This increase was largely driven by a non-recurring $18.4 million gain recognized from the sale of the State Route 91 Toll Road Franchise by an affiliate (CPTC) and a $1.9 million gain on the sale of an investment in T.I.C. Holdings.
• Backlog: Total backlog increased 21.6% to $1.93 billion. HCD backlog grew 37.2% to $1.4 billion, while Branch Division backlog declined 6.1%.

Guidance, Outlook, and Risks

• Branch Division Outlook: Management anticipates 2003 operating income for the Branch Division to be down approximately 20% from 2002 levels. This is due to reduced transportation budgets in California (the largest market), uncertainty surrounding public funding, and increased bidding competition.
• HCD Outlook: The Heavy Construction Division remains strong with a robust backlog and continued demand for large infrastructure projects. The division is actively pursuing over $12 billion in potential opportunities over the next 12-18 months.
• California Budget Risk: Significant reductions in the California state transportation budget and the diversion of funds to the General Fund create uncertainty for the Branch Division through 2004. Current contracting levels in California represent a 50% reduction from historic averages.
• Accounting Contingencies:
  • FIN 46: Evaluation of variable interest entities could result in the consolidation of joint ventures, increasing assets by ~$108 million and liabilities by ~$100 million, with no impact on net income.
  • SFAS 150: Potential reclassification of Wilder subsidiary instruments could record a $22 million long-term liability and a $10 million cumulative effect charge in Q3 2003.
• Liquidity: The company maintains a $100 million revolving line of credit with $98.7 million available. Management believes current cash, securities, and credit facilities are sufficient for the next 12 months.

Investor Verification Checklist

• Non-Recurring Gains: Verify the sustainability of net income by excluding the $18.4 million CPTC franchise sale gain and $1.9 million TIC investment gain.
• Margin Compression: Assess the impact of the "25% completion rule" on gross margins and the extent of margin pressure in the Branch Division due to California budget cuts.
• Backlog Quality: Review the geographic and sector mix of the $1.93 billion backlog, noting the heavy reliance on the South (38.4%) and HCD (72.2%) versus the declining Branch Division.
• Accounting Changes: Monitor the Q3 2003 filing for the potential $10 million charge related to SFAS 150 and the impact of FIN 46 on balance sheet leverage.
• California Exposure: Evaluate the risk of further state funding reductions in California, which accounts for 34.1% of revenue and 15.4% of backlog.