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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

     
(X)
  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2004

OR

     
(  )
  Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
  For the transition period from    to    

Commission File No. 1-12911

GRANITE CONSTRUCTION INCORPORATED

     
State of Incorporation:   I.R.S. Employer Identification Number:
Delaware   77-0239383

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 (X) No (  )

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of October 29, 2004.

     
Class   Outstanding

 
 
 
Common Stock, $0.01 par value   41,615,957 shares

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Index

                 
            Page
PART I. FINANCIAL INFORMATION     3  
    Item 1. Financial Statements (unaudited)     4  
      Condensed Consolidated Balance Sheets as of September 30, 2004, December 31, 2003 and September 30, 2003     4  
      Condensed Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2004 and 2003     5  
      Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003     6  
      Notes to the Condensed Consolidated Financial Statements     7  
    Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations     14  
    Item 3. Quantitative and Qualitative Disclosures About Market Risk     24  
    Item 4. Controls and Procedures     24  
PART II. OTHER INFORMATION     25  
    Item 1. Legal Proceedings     26  
    Item 2. Unregistered Sales of Equity Securities and Use of Proceeds     27  
    Item 3. Defaults Upon Senior Securities     27  
    Item 4. Submission of Matters to a Vote of Security Holders     28  
    Item 5. Other Information     28  
    Item 6. Exhibits     28  
SIGNATURES     29  
 EXHIBIT 10.1
 EXHIBIT 10.2
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2

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Table of Contents

PART I. FINANCIAL INFORMATION

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Table of Contents

Item 1. FINANCIAL STATEMENTS (unaudited)

Granite Construction Incorporated

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited — in thousands, except share and per share data)
                         
    September 30,   December 31,   September 30,
    2004
  2003
  2003
Assets
                       
Current assets
                       
Cash and cash equivalents
  $ 185,276     $ 69,919     $ 73,383  
Short-term marketable securities
    46,688       90,869       96,992  
Accounts receivable, net
    434,390       288,210       326,757  
Costs and estimated earnings in excess of billings
    61,023       31,189       42,170  
Inventories
    33,254       29,878       31,557  
Deferred income taxes
    22,152       22,421       22,602  
Equity in construction joint ventures
    21,068       42,250       35,750  
Other current assets
    41,757       43,915       10,149  
 
   
 
     
 
     
 
 
Total current assets
    845,608       618,651       639,360  
 
   
 
     
 
     
 
 
Property and equipment, net
    351,847       344,734       351,447  
 
   
 
     
 
     
 
 
Long-term marketable securities
    27,515       41,197       43,023  
 
   
 
     
 
     
 
 
Investments in affiliates
    13,044       18,295       19,218  
 
   
 
     
 
     
 
 
Other assets
    46,529       37,533       41,746  
 
   
 
     
 
     
 
 
 
  $ 1,284,543     $ 1,060,410     $ 1,094,794  
 
   
 
     
 
     
 
 
Liabilities and Stockholders’ Equity
                       
Current liabilities
                       
Current maturities of long-term debt
  $ 10,287     $ 8,182     $ 10,161  
Accounts payable
    219,890       135,468       152,282  
Billings in excess of costs and estimated earnings
    145,159       99,337       108,670  
Accrued expenses and other current liabilities
    146,015       105,717       130,089  
 
   
 
     
 
     
 
 
Total current liabilities
    521,351       348,704       401,202  
 
   
 
     
 
     
 
 
Long-term debt
    125,850       126,708       127,473  
 
   
 
     
 
     
 
 
Other long-term liabilities
    29,745       24,938       23,217  
 
   
 
     
 
     
 
 
Deferred income taxes
    45,775       44,297       40,011  
 
   
 
     
 
     
 
 
Commitments and contingencies
                       
Minority interest in consolidated subsidiaries
    29,632       10,872       9,867  
 
   
 
     
 
     
 
 
Stockholders’ equity
                       
Preferred stock, $0.01 par value, authorized 3,000,000 shares, none outstanding
                 
Common stock, $0.01 par value, authorized 100,000,000 shares; issued and outstanding 41,615,957 shares as of September 30, 2004, 41,528,317 shares as of December 31, 2003 and 41,533,436 shares as of September 30, 2003
    416       415       415  
Additional paid-in capital
    76,106       73,651       73,673  
Retained earnings
    467,271       442,272       432,567  
Accumulated other comprehensive income (loss)
    619       76       (592 )
 
   
 
     
 
     
 
 
 
    544,412       516,414       506,063  
Unearned compensation
    (12,222 )     (11,523 )     (13,039 )
 
   
 
     
 
     
 
 
 
    532,190       504,891       493,024  
 
   
 
     
 
     
 
 
 
  $ 1,284,543     $ 1,060,410     $ 1,094,794  
 
   
 
     
 
     
 
 

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

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Granite Construction Incorporated

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited — in thousands, except per share data)
                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Revenue:
                               
Construction
  $ 608,800     $ 496,669     $ 1,393,870     $ 1,162,534  
Material sales
    91,025       83,531       201,727       189,231  
 
   
 
     
 
     
 
     
 
 
Total revenue
    699,825       580,200       1,595,597       1,351,765  
 
   
 
     
 
     
 
     
 
 
Cost of revenue:
                               
Construction
    534,184       433,198       1,268,733       1,029,898  
Material sales
    70,293       64,943       161,088       153,608  
 
   
 
     
 
     
 
     
 
 
Total cost of revenue
    604,477       498,141       1,429,821       1,183,506  
 
   
 
     
 
     
 
     
 
 
Gross profit
    95,348       82,059       165,776       168,259  
General and administrative expenses
    44,007       42,533       116,465       115,478  
Gain on sales of property and equipment
    2,638       3,018       17,077       3,546  
 
   
 
     
 
     
 
     
 
 
Operating income
    53,979       42,544       66,388       56,327  
 
   
 
     
 
     
 
     
 
 
Other income (expense):
                               
Interest income
    1,353       1,145       4,068       4,633  
Interest expense
    (1,813 )     (1,939 )     (5,412 )     (6,577 )
Equity in income (loss) of affiliates
    3       (37 )     2,876       18,088  
Other, net
    59       86       154       2,364  
 
   
 
     
 
     
 
     
 
 
 
    (398 )     (745 )     1,686       18,508  
 
   
 
     
 
     
 
     
 
 
Income before provision for income taxes and minority interest
    53,581       41,799       68,074       74,835  
Provision for income taxes
    16,904       15,131       21,759       27,090  
 
   
 
     
 
     
 
     
 
 
Income before minority interest
    36,677       26,668       46,315       47,745  
Minority interest in consolidated subsidiaries
    (3,892 )     (834 )     (8,833 )     (1,099 )
 
   
 
     
 
     
 
     
 
 
Net income
  $ 32,785     $ 25,834     $ 37,482     $ 46,646  
 
   
 
     
 
     
 
     
 
 
Net income per share
                               
Basic
  $ 0.81     $ 0.64     $ 0.93     $ 1.16  
Diluted
  $ 0.80     $ 0.63     $ 0.91     $ 1.14  
Weighted average shares of common stock
                               
Basic
    40,433       40,217       40,372       40,160  
Diluted
    41,083       40,908       40,974       40,741  
Dividends per share
  $ 0.10     $ 0.10     $ 0.30     $ 0.30  

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

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Granite Construction Incorporated

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited — in thousands)
                 
Nine Months Ended September 30,
  2004
  2003
Operating Activities
               
Net income
  $ 37,482     $ 46,646  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation, depletion and amortization
    46,709       51,371  
Gain on sales of property and equipment
    (17,077 )     (3,546 )
Change in deferred income taxes
    1,478        
Amortization of unearned compensation
    3,671       4,496  
Common stock contributed to ESOP
    3,989        
Minority interest in consolidated subsidiaries
    8,833       1,099  
Equity in income of affiliates
    (2,876 )     (18,088 )
Gain on sale of equity investment
          (1,853 )
Changes in assets and liabilities, net of the effects of FIN 46 consolidations:
               
Accounts receivable
    (105,035 )     (60,861 )
Inventories
    (3,376 )     (1,573 )
Equity in construction joint ventures
    (381 )     (11,421 )
Other assets
    3,007       3,801  
Accounts payable
    66,915       33,469  
Billings in excess of costs and estimated earnings, net
    (30,917 )     3,741  
Accrued expenses and other liabilities
    32,951       34,725  
 
   
 
     
 
 
Net cash provided by operating activities
    45,373       82,006  
 
   
 
     
 
 
Investing Activities
               
Purchases of marketable securities
    (46,247 )     (149,243 )
Maturities of marketable securities
    103,242       141,153  
Additions to property and equipment
    (48,922 )     (54,435 )
Proceeds from sales of property and equipment
    21,068       6,423  
Proceeds from sale of equity investment
          6,033  
Distributions from affiliates, net
    8,127       13,660  
Acquisition of minority interest
    (9,219 )      
Other investing activities
          (3,632 )
 
   
 
     
 
 
Net cash provided by (used in) investing activities
    28,049       (40,041 )
 
   
 
     
 
 
Financing Activities
               
Additions to long-term debt
    43,209       20,480  
Repayments of long-term debt
    (48,825 )     (28,767 )
Dividends paid
    (12,474 )     (11,610 )
Repurchases of common stock
    (6,331 )     (1,316 )
Contributions from minority partners
    6,024       1,465  
Distributions to minority partners
    (9,648 )     (420 )
Other financing activities
    266       (446 )
 
   
 
     
 
 
Net cash used in financing activities
    (27,779 )     (20,614 )
 
   
 
     
 
 
Increase in cash and cash equivalents
    45,643       21,351  
Cash and cash equivalents added in FIN 46 consolidations
    69,714        
Cash and cash equivalents at beginning of period
    69,919       52,032  
 
   
 
     
 
 
Cash and cash equivalents at end of period
  $ 185,276     $ 73,383  
 
   
 
     
 
 
Supplementary Information
               
Cash paid during the period for:
               
Interest
  $ 4,962     $ 7,204  
Income taxes
    3,204       8,819  
Non-cash investing and financing activity:
               
Restricted stock issued for services
    4,370       5,908  
Dividends accrued but not paid
    4,162       4,153  
Financed acquisition of long-term asset
    6,863       4,004  
Notes received from sale of assets
    8,893        

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

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Granite Construction Incorporated

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Basis of Presentation:
 
    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, 2003. 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 September 30, 2004 and 2003 and the results of our operations and cash flows for the periods presented. The December 31, 2003 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 nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year.
 
2.   Newly Effective and Recently Issued Accounting Pronouncements:
 
    In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” which is an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” and requires that a variable interest entity (“VIE”) be consolidated by a company that is considered to be the primary beneficiary of that VIE. In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46”) to address certain implementation issues.
 
    We were required to adopt FIN 46 no later than the end of the first interim or annual reporting period ending after March 15, 2004. As is common in the construction industry, we have entered into certain construction contracts with third parties through joint ventures and we have determined that certain of these joint ventures are VIEs. As a result of our adoption of FIN 46, we have consolidated all VIEs in which we are the primary beneficiary as of January 1, 2004 (See Note 7 to these condensed consolidated financial statements). We will continue to account for all other such joint ventures in accordance 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.”

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Granite Construction Incorporated

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

3.   Change in Accounting Estimate:
 
    During the three months ended March 31, 2004, we recognized increased project costs of approximately $20.0 million, primarily due to changes in our estimates of the cost to complete eight projects being performed by our Heavy Construction Division. The amount attributable to any individual project ranged from approximately $0.5 million to $4.0 million. These forecast adjustments were made in response to unanticipated changes in project conditions occurring during the three months ended March 31, 2004, resulting in changes to the estimates of the cost to complete the projects. These changes to the estimates were due to a variety of factors, including recognition of costs associated with added scope changes, extended overhead due to owner and weather delays, design problems on design/build projects, subcontractor performance issues, changes in productivity expectations and higher than anticipated liquidated damages on two projects. In the quarter ended June 30, 2004, additional costs of $5.4 million related to one of these projects was recognized, primarily due to a change in the estimate of the cost to complete the work related to a key project subcontract. In the quarter ended September 30, 2004, we recognized additional costs for two of these projects of approximately $4.0 million related primarily to delays and estimated rework resulting from the unusually wet third quarter weather in Florida and New Mexico.
 
4.   Inventories:
 
    Inventories consist primarily of quarry products valued at the lower of average cost or market.
 
5.   Property and Equipment:

                         
    September 30,   December 31,   September 30,
(in thousands)
  2004
  2003
  2003
Land
  $ 52,825     $ 53,583     $ 51,183  
Quarry property
    73,919       75,329       75,830  
Buildings and leasehold improvements
    79,631       64,276       61,951  
Equipment and vehicles
    698,330       693,657       694,215  
Office furniture and equipment
    16,566       13,926       13,363  
 
   
 
     
 
     
 
 
 
    921,271       900,771       896,542  
Less: accumulated depreciation, depletion and amortization
    569,424       556,037       545,095  
 
   
 
     
 
     
 
 
 
  $ 351,847     $ 344,734     $ 351,447  
 
   
 
     
 
     
 
 

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6.   Intangible Assets:
 
    The following table indicates the allocation of goodwill by reportable segment which is included in other assets on our condensed consolidated balance sheets:

                         
    September 30,   December 31,   September 30,
(in thousands)
  2004
  2003
  2003
Goodwill by segment:
                       
Heavy Construction Division
  $ 18,011     $ 18,011     $ 18,011  
Branch Division
    4,089       1,056       1,056  
 
   
 
     
 
     
 
 
Total Goodwill
  $ 22,100     $ 19,067     $ 19,067  
 
   
 
     
 
     
 
 

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

                         
    September 30, 2004
    Gross   Accumulated   Net
(in thousands)
  Value
  Amortization
  Value
Amortized intangible assets:
                       
Covenants not to compete
  $ 1,124     $ (725 )   $ 399  
Permits
    2,000       (461 )     1,539  
Trade names
    1,425       (310 )     1,115  
Other
    622       (250 )     372  
 
   
 
     
 
     
 
 
Total amortized intangible assets
    5,171       (1,746 )     3,425  
 
   
 
     
 
     
 
 
                         
    December 31, 2003
    Gross   Accumulated   Net
(in thousands)
  Value
  Amortization
  Value
Amortized intangible assets:
                       
Covenants not to compete
  $ 1,249     $ (674 )   $ 575  
Permits
    2,000       (361 )     1,639  
Trade names
    1,602       (991 )     611  
Acquired contracts
    900       (900 )      
Other
    622       (188 )     434  
 
   
 
     
 
     
 
 
Total amortized intangible assets
    6,373       (3,114 )     3,259  
 
   
 
     
 
     
 
 
                         
    September 30, 2003
    Gross   Accumulated   Net
(in thousands)
  Value
  Amortization
  Value
Amortized intangible assets:
                       
Covenants not to compete
  $ 1,249     $ (612 )   $ 637  
Permits
    2,000       (328 )     1,672  
Trade names
    1,602       (962 )     640  
Acquired contracts
    900       (900 )      
Other
    622       (167 )     455  
 
   
 
     
 
     
 
 
Total amortized intangible assets
    6,373       (2,969 )     3,404  
 
   
 
     
 
     
 
 

    Amortization expense related to intangible assets was approximately $161,000 and $457,000 for the three months and nine months ended September 30, 2004, respectively and approximately $181,000 and $896,000 for the three months and nine months ended September 30, 2003, respectively. Amortization expense expected to be recorded in the future is as follows: $154,000 for the balance of 2004, $646,000 in 2005, $485,000 in 2006, $391,000 in 2007, $379,000 in 2008 and $1,370,000 thereafter.

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

7.   Variable Interest Entities:
 
    We have determined that certain of the construction joint ventures in which we participate 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 on a prospective basis effective January 1, 2004. 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 interests in any profits and assets, and our respective share in any losses and liabilities that may result from the performance of the contract is limited to our stated percentage interest in the project. Although the 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.
 
    The joint ventures we have consolidated are engaged in construction projects with total contract values ranging from $63.6 million to $390.4 million. Our proportionate share of the consolidated joint ventures ranges from 52.0% to 69.0%. Included in our September 30, 2004 balance sheet are assets (primarily current assets) of $93.4 million and current liabilities of $76.4 million resulting from these consolidations. There was no material effect on our net income as a result of these consolidations for the three months and nine months ended September 30, 2004.
 
    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 $90.7 million to $221.4 million. Our proportionate share of these joint ventures ranges from 25.0% to 40.0%. Circumstances that could lead to a loss under these 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 September 30, 2004, approximately $275.0 million of work representing our partners’ share of proportionately consolidated joint venture contracts in progress had yet to be completed.
 
8.   Earnings Per Share:
 
    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 income is as follows:

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
(in thousands)
  2004
  2003
  2004
  2003
Weighted average shares outstanding
                               
Weighted average common stock outstanding
    41,617       41,533       41,568       41,443  
Less: weighted average restricted stock outstanding
    1,184       1,316       1,196       1,283  
 
   
 
     
 
     
 
     
 
 
Total
    40,433       40,217       40,372       40,160  
 
   
 
     
 
     
 
     
 
 
Diluted weighted average shares outstanding
                               
Basic weighted average shares outstanding
    40,433       40,217       40,372       40,160  
Effect of dilutive securities:
                               
Common stock options and units
    46       36       50       25  
Restricted stock
    604       655       552       556  
 
   
 
     
 
     
 
     
 
 
Total
    41,083       40,908       40,974       40,741  
 
   
 
     
 
     
 
     
 
 

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

    Restricted stock representing approximately 374,000 shares and 302,000 shares for the three months ended September 30, 2004 and 2003, respectively, and approximately 339,000 shares and 394,000 shares for the nine months ended September 30, 2004 and 2003, respectively, have been excluded from the calculation of diluted net income per share because their effects are anti-dilutive.
 
9.   Comprehensive Income:

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

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
(in thousands)
  2004
  2003
  2004
  2003
Net income
  $ 32,785     $ 25,834     $ 37,482     $ 46,646  
Other comprehensive income:
                               
Changes in net unrealized gains (losses) on investments
    15       196       543       810  
 
   
 
     
 
     
 
     
 
 
Total comprehensive income
  $ 32,800     $ 26,030     $ 38,025     $ 47,456  
 
   
 
     
 
     
 
     
 
 

10.   Provision for Income Taxes:
 
    Our effective tax rate decreased to 31.5% and 32.0% for the three and nine month periods ended September 30, 2004, respectively, from 36.2% for the corresponding periods in 2003 due primarily to the effect of consolidating our partners’ share of construction joint venture income under FIN 46 (see Note 7 to the Condensed Consolidated Financial Statements). Generally, our construction joint ventures are not subject to income taxes on a stand-alone basis.
 
11.   Commitments and Contingencies:
 
    As disclosed in the Company’ Annual Report on Form 10-K for the years ended December 31, 2002 and 2003, our wholly-owned subsidiary, Granite Construction Company (“GCCO”), 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.
 
    As disclosed in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, plaintiffs’ Fourth Amended Complaint was filed on July 12, 2004. The Company and GCCO believe that the allegations in the lawsuit are without merit and intend to defend them vigorously.
 
    We are a party to a number of other legal proceedings 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, litigation is subject to inherent uncertainties. Were an unanticipated 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.

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

12.   Business Segment Information:
 
    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.
 
    The accounting policies of the segments are the same as those described in the summary of significant accounting policies contained in our 2003 Annual Report on Form 10-K. We evaluate performance based on operating profit or loss (excluding gain on sales of property and equipment) and does not include income taxes, interest income, interest expense or other income (expense). Unallocated other corporate expenses principally comprise corporate general and administrative expenses.
 
    Summarized Segment Information (in thousands):

                         
    Three Months Ended September 30,
    HCD
  Branch
  Total
2004
                       
Revenue from external customers
  $ 244,113     $ 455,712     $ 699,825  
Inter-segment revenue transfer
    (7,006 )     7,006        
 
   
 
     
 
     
 
 
Net revenue
    237,107       462,718       699,825  
Depreciation, depletion and amortization
    3,567       10,756       14,323  
Operating profit
    9,897       56,629       66,526  
 
   
 
     
 
     
 
 
2003
                       
Revenue from external customers
  $ 185,124     $ 395,076     $ 580,200  
Inter-segment revenue transfer
    (1,784 )     1,784        
 
   
 
     
 
     
 
 
Net revenue
    183,340       396,860       580,200  
Depreciation, depletion and amortization
    3,405       11,367       14,772  
Operating profit
    4,877       48,046       52,923  
 
   
 
     
 
     
 
 
                         
    Nine Months Ended September 30,
    HCD
  Branch
  Total
2004
                       
Revenue from external customers
  $ 644,612     $ 950,985     $ 1,595,597  
Inter-segment revenue transfer
    (17,296 )     17,296        
 
   
 
     
 
     
 
 
Net revenue
    627,316       968,281       1,595,597  
Depreciation, depletion and amortization
    10,403       32,170       42,573  
Operating profit
    8,887       74,670       83,557  
Property and equipment
    48,013       273,469       321,482  
 
   
 
     
 
     
 
 
2003
                       
Revenue from external customers
  $ 510,494     $ 841,271     $ 1,351,765  
Inter-segment revenue transfer
    (7,218 )     7,218        
 
   
 
     
 
     
 
 
Net revenue
    503,276       848,489       1,351,765  
Depreciation, depletion and amortization
    11,293       34,837       46,130  
Operating profit
    18,914       64,419       83,333  
Property and equipment
    43,600       288,099       331,699  
 
   
 
     
 
     
 
 

    Included in HCD operating income for the three and nine months ended September 31, 2004 is operating income from our newly consolidated joint ventures of $2,775 and $7,614, respectively (see Note 7 to the Condensed Consolidated Financial Statements).

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Granite Construction Incorporated
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

    Reconciliation of Segment Operating Profit to Consolidated Totals (in thousands):

                                 
    Three Months Ended   Nine Months Ended
    September 30,
  September 30,
    2004
  2003
  2004
  2003
Total operating profit for reportable segments
  $ 66,526     $ 52,923     $ 83,557     $ 83,333  
Gain on sales of property and equipment
    2,638       3,018       17,077       3,546  
Other income (expense), net
    (398 )     (745 )     1,686       18,508  
Unallocated other corporate income (expense), net
    (15,185 )     (13,397 )     (34,246 )     (30,552 )
 
   
 
     
 
     
 
     
 
 
Income before provision for income taxes and minority interest
  $ 53,581     $ 41,799     $ 68,074     $ 74,835  
 
   
 
     
 
     
 
     
 
 

13.   Investments in Affiliates:
 
    In June 2003, T.I.C. Holdings, Inc. (“TIC”) repurchased 0.3 million  shares of the TIC shares held by us for a cash payment of $6.0 million. We account for our investment in TIC using the cost method. This transaction reduced our ownership interest from 15.5% to 10.6% and resulted in a gain of $1.9 million, which is included in other income (expense) for the nine months ended September 30, 2003.
 
    In January 2003, the California Private Transportation Company, LP (“CPTC”), of which we are a 22.2% limited partner, closed the sale of the State Route 91 Toll Road Franchise to the Orange County Transportation Authority for $72.5 million in cash and the assumption of $135.0 million in long-term debt. We completed construction of the $60.4 million project in 1995 and have maintained an equity interest in the partnership since its inception. Included in other income (expense) for the nine months ended September 30, 2003 is $18.4 million related to this sale by CPTC.
 
14.   Acquisitions:
 
    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”, and the excess purchase price over fair value of the net tangible and intangible assets acquired, $3.0 million, was allocated to goodwill.
 
15.   Sale of Assets:
 
    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 through 2010. 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 nine months ended September 30, 2004.
 
16.   Reclassifications:
 
    Certain financial statement items have been reclassified to conform to the current year’s format. These reclassifications had no impact on previously reported net income, financial position or cash flows.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Disclosure

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and the future results of Granite that are based on current expectations, estimates, forecasts, and projections as well as the beliefs and assumptions of Granite’s management. Words such as “outlook”, “believes”, “expects”, “appears”, “may”, “will”, “should”, “anticipates” or the negative thereof or comparable terminology, are intended to identify such forward-looking statements. These forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K under the section entitled “Risk Factors”. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Report. Granite undertakes no obligation to revise or update publicly any forward-looking statements for any reason.

General

We are one of the largest heavy civil contractors in the United States and are engaged in the construction of highways, dams, airports, 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

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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.

Results of Operations

                                                                 
Revenue
  Three Months Ended September 30,
  Nine Months Ended September 30,
    2004
  2003
  2004
  2003
(in thousands)
  Amount
  Percent
  Amount
  Percent
  Amount
  Percent
  Amount
  Percent
Revenue by Division:
                                                               
Branch Division
  $ 462,718       66.1 %   $ 396,860       68.4 %   $ 968,281       60.7 %   $ 848,489       62.8 %
Heavy Construction Division
    237,107       33.9 %     183,340       31.6 %     627,316       39.3 %     503,276       37.2 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
 
  $ 699,825       100.0 %   $ 580,200       100.0 %   $ 1,595,597       100.0 %   $ 1,351,765       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Revenue by Geographic Area:
                                                               
California
  $ 255,906       36.6 %   $ 218,247       37.6 %   $ 558,960       35.0 %   $ 480,951       35.6 %
West (excluding California)
    239,041       34.2 %     205,412       35.4 %     487,207       30.5 %     468,067       34.6 %
Midwest
    23,546       3.4 %     20,313       3.5 %     59,654       3.7 %     44,988       3.3 %
Northeast
    88,362       12.6 %     38,825       6.7 %     221,920       13.9 %     109,151       8.1 %
South
    92,970       13.2 %     97,403       16.8 %     267,856       16.9 %     248,608       18.4 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
 
  $ 699,825       100.0 %   $ 580,200       100.0 %   $ 1,595,597       100.0 %   $ 1,351,765       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Revenue by Market Sector:
                                                               
Federal Agencies
  $ 48,333       6.9 %   $ 20,535       3.5 %   $ 98,438       6.2 %   $ 42,747       3.2 %
State Agencies
    214,576       30.7 %     241,433       41.6 %     542,873       34.0 %     544,785       40.3 %
Local Public Agencies
    246,309       35.2 %     159,976       27.6 %     526,107       33.0 %     398,924       29.5 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total Public Sector
    509,218       72.8 %     421,944       72.7 %     1,167,418       73.2 %     986,456       73.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Private Sector
    99,582       14.2 %     74,725       12.9 %     226,452       14.2 %     176,078       13.0 %
Material Sales
    91,025       13.0 %     83,531       14.4 %     201,727       12.6 %     189,231       14.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
 
  $ 699,825       100.0 %   $ 580,200       100.0 %   $ 1,595,597       100.0 %   $ 1,351,765       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 

Revenue: Revenue from our Branch Division for the three and nine month periods ended September 30, 2004 increased over the corresponding 2003 periods by $65.9 million, or 16.6%, and $119.8 million, or 14.1%, respectively. The growth in revenue reflects increases in both public and private sector revenue and the sale of materials. The increase in private sector revenue and sale of materials reflects the increase in demand created by the continuing strong housing market in California and other Branch Division locations. The increase in Branch Division public sector revenue during the quarter was primarily due to greater revenue from local government agency work, partially offset by the decrease in state government agency work, particularly in California. We continue to experience reduced awards from the California State Department of Transportation due to the continuing budgetary uncertainty in the state (see “Outlook”).

Revenue from our Heavy Construction Division for the three and nine month periods ended September 30, 2004 increased over the corresponding 2003 periods by $53.8 million, or 29.3%, and $124.0 million,

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or 24.6%, respectively. Included in HCD revenue during the three and nine month periods ended September 30, 2004 is $30.2 million and $78.9 million, respectively, resulting from the consolidation of our partners’ share of construction joint venture revenue under FIN 46, “Consolidation of Variable Interest Entities” (“FIN 46”) (see Note 7 to the Condensed Consolidated Financial Statements). The remaining increase was due primarily to the increase in volume from a higher backlog at the beginning of the respective periods in the Northeast.

                                                 
    September 30,   June 30,   September 30,
Backlog
  2004
  2004
  2003
(in thousands)
  Amount
  Percent
  Amount
  Percent
  Amount
  Percent
Backlog by Division:
                                               
Heavy Construction Division
  $ 1,711,224       73.8 %   $ 1,378,110       67.6 %   $ 1,417,794       74.6 %
Branch Division
    606,750       26.2 %     660,059       32.4 %     482,321       25.4 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
 
  $ 2,317,974       100.0 %   $ 2,038,169       100.0 %   $ 1,900,115       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Backlog by Geographic Area:
                                               
California
  $ 674,622       29.1 %   $ 322,591       15.8 %   $ 311,264       16.4 %
West (excluding California)
    377,770       16.3 %     442,695       21.7 %     310,053       16.3 %
Midwest
    144,973       6.3 %     32,507       1.6 %     44,703       2.4 %
Northeast
    599,593       25.9 %     683,054       33.5 %     561,494       29.6 %
South
    521,016       22.4 %     557,322       27.4 %     672,601       35.3 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
 
  $ 2,317,974       100.0 %   $ 2,038,169       100.0 %   $ 1,900,115       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Backlog by Market Sector:
                                               
Federal agencies
  $ 76,581       3.2 %   $ 113,384       5.5 %   $ 81,616       4.3 %
State agencies
    773,633       33.4 %     711,242       34.9 %     790,556       41.6 %
Local public agencies
    1,236,939       53.4 %     1,002,397       49.2 %     850,163       44.7 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total public sector
    2,087,153       90.0 %     1,827,023       89.6 %     1,722,335       90.6 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Private sector
    230,821       10.0 %     211,146       10.4 %     177,780       9.4 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
 
  $ 2,317,974       100.0 %   $ 2,038,169       100.0 %   $ 1,900,115       100.0 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 

Backlog: Heavy Construction Division backlog of $1.7 billion at September 30, 2004 was $333.1 million, or 24.2%, higher than the HCD backlog at June 30, 2004 and $293.4 million, or 20.7%, higher than the HCD backlog at September 30, 2003. Included in the HCD backlog at September 30, 2004 and June 30, 2004 was $305.1 million and $105.1 million, respectively, resulting from the consolidation of our partners’ share of construction joint venture backlog under FIN 46 (see Note 7 to the Condensed Consolidated Financial Statements). Additions to HCD backlog in the current quarter included a $390.4 million joint venture design-build freeway improvement project in California; a $135.6 million joint venture design-build highway reconstruction project in Minnesota; and a $58.9 million interchange reconstruction project in Florida. As described in Note 7 to the Condensed Consolidated Financial Statements, we began consolidating certain of our joint ventures under the requirements of FIN 46 in 2004. As a result, 100% of the backlog of consolidated joint ventures is included in our backlog, including the two joint venture awards mentioned above.

Branch Division backlog of $606.8 million at September 30, 2004 was $53.3 million, or 8.1%, lower than Branch Division backlog at June 30, 2004 and $124.4 million, or 25.8%, higher than Branch Division backlog at September 30, 2003. The decrease in backlog compared to June 30, 2004 reflects normal seasonal variation in the timing of awards and construction activity. The increase in backlog compared to September 30, 2003 reflects an increase in both private and public sector awards, primarily in western states other than California. The increase in public sector backlog at September 30, 2004 compared with September 30, 2003 reflects an increase in backlog from local government agency projects, partially

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offset by the decrease in backlog from state government agency projects. 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
  Three Months Ended September 30,
  Nine Months Ended September 30,
(in thousands)
  2004
  2003
  2004
  2003
Branch Division
  $ 77,064     $ 68,364     $ 132,995     $ 122,204  
Percent of division revenue
    16.7 %     17.2 %     13.7 %     14.4 %
Heavy Construction Division
  $ 18,691     $ 13,366     $ 33,522     $ 42,818  
Percent of division revenue
    7.9 %     7.3 %     5.3 %     8.5 %
Other gross profit (loss)
  $ (407 )   $ 329     $ (741 )   $ 3,237  
 
   
 
     
 
     
 
     
 
 
Total gross profit
  $ 95,348     $ 82,059     $ 165,776     $ 168,259  
 
   
 
     
 
     
 
     
 
 
Percent of total revenue
    13.6 %     14.1 %     10.4 %     12.4 %
 
   
 
     
 
     
 
     
 
 

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. However, we do recognize the costs related to any contract claims or pending change orders when they are incurred. 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.

Gross profit as a percent of revenue in the Branch Division was negatively impacted by the larger volume of work performed on jobs less than 25% complete which grew from $12.3 million to $27.3 million for the three months ended September 30, 2003 and 2004, respectively, and from $13.0 million to $28.9 million for the nine months ended September 30, 2003 and 2004, respectively. Additionally, the Branch Division incurred costs in the first quarter of 2004 of approximately $1.4 million associated with the closing of certain ready-mix concrete plants in preparation for their subsequent sale during the quarter (see Note 15 to the Condensed Consolidated Financial Statements).

HCD gross profit as a percent of revenue for the three months ended September 30, 2004 and 2003 reflect increased cost forecasts for several HCD projects, including approximately $4.0 million recognized in connection with two projects in the third quarter 2004 primarily due to delays and estimated rework

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resulting from the unusually wet third quarter weather in Florida and New Mexico (see Note 3 to the Condensed Consolidated Financial Statements). Additionally, the HCD gross profit margin in the third quarter 2004 was slightly negatively impacted by the increase in volume of work performed on jobs less than 25% complete, which grew from $32.8 million to $44.1 million for the three months ended September 30, 2003 and 2004, respectively. On a year to date basis, HCD gross profit as a percent of revenue fell to 5.3% in 2004 from 8.5% in 2003 due largely to the recognition of higher costs related to changes in estimated cost to complete eight large projects (see Note 3 to the Condensed Consolidated Financial Statements).

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
  Three Months Ended September 30,
  Nine Months Ended September 30,
(in thousands)
  2004
  2003
  2004
  2003
Salaries and related expenses
  $ 20,080     $ 19,311     $ 63,540     $ 60,725  
Incentive compensation, discretionary profit sharing and other variable compensation
    11,841       11,927       17,711       20,962  
Other general and administrative expenses
    12,086       11,295       35,214       33,791  
 
   
 
     
 
     
 
     
 
 
Total
  $ 44,007     $ 42,533     $ 116,465     $ 115,478  
 
   
 
     
 
     
 
     
 
 
Percent of revenue
    6.3 %     7.3 %     7.3 %     8.5 %
 
   
 
     
 
     
 
     
 
 

General and Administrative Expenses: Salaries and related expenses in the three months and nine months ended September 30, 2004 increased $0.8 million, or 4.0%, and $2.8 million, or 4.6%, respectively over the comparable periods in 2003 due primarily to a combination of higher payroll related benefits and normal salary increases. Incentive compensation, discretionary profit sharing and other variable compensation decreased in the nine months ended September 30, 2004 compared with the corresponding period in 2003 due primarily to lower Heavy Construction Division profitability in the 2004 period. Other general and administrative costs include information technology, occupancy, office equipment and supplies, depreciation, travel and entertainment, outside services, advertising and marketing, training and other miscellaneous expenses, none of which individually exceeded 10% of total general and administrative expenses.

                                 
Gain on Sales of Property and        
Equipment
  Three Months Ended September 30,
  Nine Months Ended September 30,
(in thousands)
  2004
  2003
  2004
  2003
Gain on sales of property and equipment
  $ 2,638     $ 3,018     $ 17,077     $ 3,546  

Gain on Sales of Property and Equipment: The increase in gain on sales of property and equipment in the nine months ended September 30, 2004 as compared with the same period in 2003 was 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.

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Other Income (Expense)
  Three Months Ended September 30,
  Nine Months Ended September 30,
(in thousands)
  2004
  2003
  2004
  2003
Interest income
  $ 1,353     $ 1,145     $ 4,068     $ 4,633  
Interest expense
    (1,813 )     (1,939 )     (5,412 )     (6,577 )
Equity in income (loss) of affiliates
    3       (37 )     2,876       18,088  
Other, net
    59       86       154       2,364  
 
   
 
     
 
     
 
     
 
 
Total
  $ (398 )   $ (745 )   $ 1,686     $ 18,508  
 
   
 
     
 
     
 
     
 
 

Other Income (Expense): The decrease in equity in income of affiliates in the nine months ended September 30, 2004, compared with the corresponding period in 2003 was due to $18.4 million in income recorded in the first quarter of 2003 related to the sale of the State Route 91 Toll Road Franchise by the California Private Transportation Corporation, of which we are a 22.2% limited partner.

                                 
Provision for Income Taxes
  Three Months Ended September 30,
  Nine Months Ended September 30,
(in thousands)
  2004
  2003
  2004
  2003
Provision for income taxes
  $ 16,904     $ 15,131     $ 21,759     $ 27,090  
Effective tax rate
    31.5 %     36.2 %     32.0 %     36.2 %

Provision for Income Taxes: Our effective tax rate decreased to 31.5% and 32.0% for the three and nine month periods ended September 30, 2004, respectively, from 36.2% for the corresponding periods in 2003 due primarily to the effect of consolidating our partners’ share of construction joint venture income under FIN 46 (see Note 7 to the Condensed Consolidated Financial Statements). Generally, our construction joint ventures are not subject to income taxes on a stand-alone basis. On October 22, 2004, Congress passed the American Jobs Creation Act of 2004 (the “Act”). The Act includes a deduction based on income from qualified domestic production activities which will be phased in from 2005 through 2010. We are currently evaluating the provisions of the Act and are investigating the impact of this new deduction on our future effective tax rate.

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Outlook

The economy in the western United States, where 70.7% of our third quarter 2004 revenues were generated, is steady. The Branch Division continues to experience continuing demand for private sector work in the residential, commercial and industrial markets. Our business is also benefiting from a strong public sector bidding environment in Arizona, Utah and Nevada. The state of California, however, continues to struggle, spending more than it is collecting in tax revenues. While Governor Schwarzenegger has pledged his support to increase transportation funding, the California Department of Transportation (“Caltrans”) has yet to increase the amount of traditional road construction work being bid. We remain hopeful, however, that funds budgeted for California transportation improvements will be converted into transportation projects in 2005. In 2004, local governments, such as cities and counties, provided unexpectedly strong funding, which drove much of our Branch business, and we expect that strength to continue next year.

Going forward, the strength of the private sector, as well as the local agency work and construction materials business will all play a key role in the Branch Division’s ability to maintain its current performance. In particular, there continues to be a healthy demand for its services and construction materials related to the residential, commercial and industrial markets in the West. The amount of Caltrans work available will depend in large part on several state and federal transportation funding issues that may or may not be resolved in 2005.

Many states continue to invest in large transportation projects (typically valued at over $100.0 million), which our Heavy Construction Division is well positioned to pursue. HCD recently opened an estimating office in Minneapolis where it is currently completing work on the $329.6 million Hiawatha Light Rail Design-Build project. In addition, the division is pursuing two projects in Canada. Although the division’s margin performance has, in part, been impacted by its rapid growth, we are taking steps to build the infrastructure to support our growth and return to traditional margins. All of our HCD regions: National, Texas, Southeast, Granite Halmar and Western are focused on improving project execution and performance. The Company’s outlook for an improved performance from HCD is contingent on an increase in gross margins on its projects going forward.

In an unusual twist of good news, the defeat of two gambling initiatives, Proposition 68 and 70, on the November 2nd ballot in California will help reinvigorate the state’s transportation accounts by as much as $1.2 billion. As part of the agreements made in June of this year between Governor Schwarzenegger and five Indian gaming tribes, the tribes will finance a $1.2 billion bond that will be used to accelerate repayment of Proposition 42 revenues previously borrowed from transportation accounts to close the budget deficit. The defeat of these propositions protects these gaming compacts and paves the way for this one-time early repayment to transportation. These funds could be available during the first half of 2005, provided litigation is resolved and the bonds are let.

From a federal perspective, the House and Senate approved legislation on September 30, 2004 to extend the federal highway, transit and safety programs through May 31, 2005. The sixth extension passed the House and was approved unanimously by the Senate and signed into law by the President. While the extension provides for another eight months of spending, the annual appropriations process is ongoing. Although many are interpreting the eight-month extension as the end of the Transportation Act for the 21st Century (“TEA-21”) reauthorization efforts for the year, that may not be the case. There also remains the possibility that other legislation, including TEA-21 reauthorization, could be brought up during the “lame duck” session after the November election.

After a lengthy debate, a permanent “fix” for the ethanol tax treatment problem as it relates to highway funding was adopted as part of the recent corporate tax bill. In the future, the 2.5 cents excise tax on ethanol will go to the Highway Trust Fund and the cost of the 5.2 cents per gallon differential treatment of

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ethanol will no longer negatively impact the Highway Trust Fund. The Associated General Contractors of America estimates that these changes will generate an additional $3.0 billion a year for transportation.

Looking at guidance for the current year, we expect the Branch Division operating income to be in line with its 2003 performance. In addition, we are no longer forecasting a large HCD project to reach 25% complete this year and now expect to recognize the associated profit for that project when it reaches 25% complete in 2005. Our fiscal year 2004 earnings guidance is in the range of $1.15 to $1.20 per diluted share. It is important to note that the amount of work we are able to complete in the fourth quarter can vary significantly due to weather.

In summary, although the outcome of the state and federal funding issues remain uncertain, we are confident that the on-going need to maintain and expand the capacity of our nation’s infrastructure will provide us with ample opportunity to continue to grow our business.

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Liquidity and Capital Resources

                 
    Nine Months Ended September 30,
(in thousands)
  2004
  2003
Cash and cash equivalents
  $ 185,276     $ 73,383  
Net cash provided by (used in):
               
Operating activities
    45,373       82,006  
Investing activities
    28,049       (40,041 )
Financing activities
    (27,779 )     (20,614 )
Capital expenditures
    (48,922 )     (54,435 )

Our primary sources of liquidity are cash flows from operations and borrowings under our credit facilities. We expect the principal use of funds for the foreseeable future will be for capital expenditures, working capital, debt service, acquisitions and other investments. We have budgeted $58.0 million for capital expenditures in 2004, which includes amounts for construction equipment, aggregate and asphalt plants, buildings, leasehold improvements and the purchase of land and aggregate reserves.

Our cash and cash equivalents and short-term and long-term marketable securities totaled $259.5 million at September 30, 2004, and includes $68.3 million of cash from our newly consolidated joint ventures (see Note 7 to the Condensed Consolidated Financial Statements). This joint venture cash is for the working capital needs of each joint venture’s project. The decision to distribute cash must generally be made jointly by all of the partners. We believe that our current cash and cash equivalents, short-term investments, cash generated from operations and amounts available under our existing credit facilities will be sufficient to meet our expected working capital needs, capital expenditures, financial commitments and other liquidity requirements associated with our existing operations through the next twelve months and beyond. If we experience a significant change in our business such as the execution of a significant acquisition, we would likely need to acquire additional sources of financing.

Cash provided by operating activities of $45.4 million for the nine months ended September 30, 2004 represents a $36.6 million decrease from the amount provided by operating activities during the same period in 2003. The decrease was primarily due to lower net income in the first nine months of 2004 compared to the same period in 2003, cash of approximately $10.0 million used to purchase and develop properties held for sale, a decrease in cash flow from billings in excess of cost, net in the first nine months of 2004 and higher accounts receivable balances. Our costs and estimated earnings in excess of billings have increased from $42.2 million at September 30, 2003 to $61.0 million at September 30, 2004, due primarily to the growth in revenue from the 2003 to the 2004 period as well as an increase in the number of projects with billing provisions that require completion of discrete components of work rather than the more typical monthly unit price billing terms. Such billing provisions result in delays in our ability to bill and receive payment from the project owner. Our accounts receivable have increased from $326.8 million at September 30, 2003 to $434.4 million at September 30, 2004 due to the combined factors of the inclusion of approximately $41.0 million of accounts receivable from our newly consolidated joint ventures under FIN 46, higher revenue in the 2004 quarter and higher accounts receivable from retention provisions in our contracts, which are generally due upon completion of the projects and acceptance by the contract owner. The growth in retention receivables is largely due to an increase in the number of large HCD projects that are nearing completion at September 30, 2004 compared with September 30, 2003.

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Cash provided by investing activities of $28.0 million for the nine months ended September 30, 2004 represents a $68.1 million increase from the amount used by investing activities during the same period in 2003. The increase was primarily due to an increase in net maturities of marketable securities in the 2004 period which were reinvested in shorter-term cash equivalent investments to take advantage of recent changes in interest rates.

Cash used by financing activities was $27.8 million for the nine months ended September 30, 2004, an increase of $7.2 million from the same period in 2003. The increase was mainly due to $4.0 million used to purchase our common stock for contribution to the ESOP in 2004, and net distributions to minority partners in our consolidated construction joint ventures in 2004.

We had standby letters of credit totaling approximately $1.4 million outstanding at September 30, 2004, which will expire between February and April 2005.

In addition to our working capital and cash generated from operations, we currently have access to funds under a $100.0 million bank revolving line of credit, which allows for unsecured borrowings through June 2006. Outstanding borrowings under the revolving line of credit are at our choice of selected LIBOR rates plus a margin that is recalculated quarterly. The margin was 1.25% at September 30, 2004. The unused and available portion of this line of credit was $98.8 million at September 30, 2004. Additionally, our Wilder subsidiary has a bank revolving line of credit of $10.0 million that expires in June 2006. There were no amounts outstanding under the Wilder line of credit at September 30, 2004.

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) of approximately $411.5 million. We were in compliance with these covenants at September 30, 2004. Additionally, our Wilder subsidiary has restrictive covenants (on a Wilder stand-alone basis) under the terms of its debt agreements that include the maintenance of certain ratios of working capital, liabilities to net worth and tangible net worth and restrict Wilder capital expenditures in excess of specified limits. Wilder was in compliance with these covenants at September 30, 2004. Failure to comply with these covenants could cause the amounts due under the debt agreements to become currently payable.

Website Access

Our website address is www.graniteconstruction.com. On our website we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. The information on our website is not incorporated into, and is not part of, this report.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There was no significant change in our exposure to market risk during the nine months ended September 30, 2004.

Item 4. CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision of and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended as of September 30, 2004. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

There was no change in our internal control over financial reporting during the quarter ended September 30, 2004 that materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

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PART II. OTHER INFORMATION

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Item 1. LEGAL PROCEEDINGS

As disclosed in the Company’ Annual Report on Form 10-K for the years ended December 31, 2002 and 2003, our wholly-owned subsidiary, Granite Construction Company (“GCCO”), 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.

As disclosed in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, plaintiffs’ Fourth Amended Complaint was filed on July 12, 2004. The Company and GCCO believe that the allegations in the lawsuit are without merit and intend to defend them vigorously.

We are a party to a number of other legal proceedings 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, litigation is subject to inherent uncertainties. Were an unanticipated 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.

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Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the three months ended September 30, 2004, we did not sell any of our equity securities that were not registered under the Securities Act of 1933, as amended. The following table sets forth information regarding the repurchase of shares of our common stock during the three months ended September 30, 2004:

Issuer Purchases of Equity Securities

                                 
                    Total number of Approximate dollar
                    shares purchased value of shares that
                    as part of publicly may yet be
    Total number of   Average price   announced plans purchased under the
Period
  shares purchased1
  paid per share
  or programs2
plans or programs2
July 1, 2004 through July 31, 2004
                    $ 22,787,537  
August 1, 2004 through August 31, 2004
                    $ 22,787,537  
September 1, 2004 through September 30, 2004
    3,144     $ 22.80           $ 22,787,537  
 
   
 
     
 
     
 
         
 
    3,144     $ 22.80                
 
   
 
     
 
     
 
         

1   The total number of shares purchased includes: (i) shares purchased for contribution to our Employee Stock Ownership Plan; and (ii) shares purchased in connection with employee tax withholding for shares granted under our 1990 Equity Incentive Plan and our 1999 Equity Incentive Plan.
 
2   On October 16, 2002, we publicly announced that our Board of Directors had authorized us to repurchase up to $25.0 million worth of shares of our Company’s common stock at management’s discretion.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

Item 5. OTHER INFORMATION

None

Item 6. EXHIBITS

     
10.1
  First Amendment Agreement to the June 27, 2003 Credit Agreement, dated as of September 15, 2004 among Granite Construction Incorporated and six enumerated financial institutions, and Bank of America, N.A., as Administrative Agent
 
   
10.2
  Consent and Agreement of Guarantors from the Subsidiaries of Granite Construction Incorporated as Guarantors of financial accommodations pursuant to the terms of the First Amendment Agreement dated as of September 15, 2004
 
   
31.1
  Certification of Principal Executive Officer Pursuant to Rule 13a-15(e)
 
   
31.2
  Certification of Principal Financial Officer Pursuant to Rule 13a-15(e)
 
   
32.1
  Certification of Chief Executive Officer Pursuant to 18 U.S.C. section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
   
32.2
  Certification of Chief Financial Officer Pursuant to 18 U.S.C. section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  GRANITE CONSTRUCTION INCORPORATED
 
 
Date: November 4, 2004  By:   /s/ William E. Barton    
    William E. Barton   
    Senior Vice President and Chief Financial Officer   
 

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