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Granite Construction Inc. (NYSE:GVA)

Q3 2008 Earnings Call Transcript

October 30, 2008, 11:00 am ET

Executives

Jacque Fourchy – IR

Bill Dorey – President and CEO

LeAnne Stewart – SVP and CFO

Mark Boitano – EVP and COO

Jim Roberts – SVP and Granite West Manager

Mike Donnino – SVP and Granite East Manager

Analysts

Bob Labick – CJS Securities

Jack Kasprzak – BB&T Capital Markets

Rich Wesolowski – Sidoti & Company

Richard Paget – Morgan Joseph

Brian Rafn – Morgan Dempsey

Todd Vencil – Davenport

Avi Fisher – BMO Capital Markets

Joe Ritchie – Goldman Sachs

Operator

Good morning. My name is Kate and I will be your conference operator today. At this time, I would like to welcome everyone to the Granite Construction third quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator instructions)

Ms. Jacque Fourchy, you may begin your conference.

Jacque Fourchy

Good morning, and thank you for being with us today. I'm joined by Bill Dorey, President and Chief Executive Officer; LeAnne Stewart, Senior Vice President and Chief Financial Officer; Mark Boitano, Executive Vice President and Chief Operating Officer; Jim Roberts, Senior Vice President, Granite West Manager; and Mike Donnino, Senior Vice President, Granite East Manager.

Following our prepared remarks this morning we will turn the call over to your questions. Before we get started, I would like to remind you that this conference call may contain forward-looking statements and should be considered in conjunction with cautionary statement in our earnings release and in the company's most recently filed SEC reports. We do not take – undertake any duty to update any forward-looking statements.

With that, I will now turn the call over to Bill Dorey. Bill?

Bill Dorey

Thank you, Jacque, and good morning, everyone. During our prepared remarks I will review our third quarter performance and provide some insight into our markets. I'm going to spend a few minutes discussing our employee development initiative which we are committed to accelerating the leadership, operational and business skills of our people. It is these skills and capabilities that ensure our ability to deliver strong financial performance as well as our future growth. I'll then turn the call over to LeAnne to review our segment results and update our 2008 year-end guidance.

I am very pleased to report that our third quarter financial performance was excellent. Total company revenue, gross profit and earnings per share were all up from last year. Third quarter earnings per diluted share was a $1.36 on revenue of $898 million compared with the prior year's $1.28 on revenue of $846 million. Gross profit as a percentage of revenue for the third quarter was 16% and operating income was $74 million compared with $76 million in 2007.

Our teams all over the country continue to perform well despite challenging economic conditions. Our geographic diversification, wide range of customers and our diverse project portfolio is helping us compete effectively.

Now I'd like to walk you through what we are experiencing in both Granite East and Granite West. Let's start with the West. In most of our branch locations there is a steady flow of public work coming out to bid. To emphasize that point our estimators in the West have built – a bid a higher dollar volume of work in the first nine months of 2008 than in either 2007 or 2006. This is very encouraging.

In times like these one of our strategies is to concentrate on projects with tight completion schedules requiring a large skilled workforce and a significant amount of our own construction materials. In some cases these types of products provide us with a competitive advantage.

Since announcing our organizational realignment in early 2007, we have steadily built our large project capabilities in the West. In addition to our bread and butter work, we are pursuing several large projects that require experience and bonding capacity that many of our local competitors do not have.

Our teams in the West for example are expected to bid on several projects with total contract value over $50 million and one joint venture project over $2 billion in the next 12 months. We are mindful of the risks inherent with large projects and are maintaining strict management oversight of our project selection and the associated risks.

We are already demonstrating that we can successfully incorporate large projects into Granite West without compromising profitability. The timing of our realigned business model in the West is excellent and I expect large projects to contribute nicely to our 2009 revenues.

Turning to Granite East our bidding pipeline is full. We are currently following over $8 billion worth of projects which will bid over the next 12 months. These include highway, rail, airport, bridge and tunnel projects throughout our home markets in the East. Similar to our approach in the West, we are targeting projects that provide us an opportunity to capitalize on our capabilities, our financial strength, our joint venture relationships and our experience with owners we know well.

We are building momentum in Granite East. We purposefully slowed revenue growth in this division over the last several years to focus on execution and improved profitability. The result of that decision is reflected in our current financial performance.

As we conservatively grow our top line in Granite East we will continue to be highly selective regarding the work we bid and diligent in the way we evaluate risk. We believe we have developed the depth of talent and management oversight to successfully implement this strategy.

Now, let's talk briefly about federal transportation funding. As many of you know in early September, President Bush signed into law the Highway Trust Fund Restoration Act which provided over $8 billion for the Highway Trust Fund. Although the short-term problem has been resolved, longer term funding remains an issue. Shortly after the new President and Congress are sworn into office they will be tasked with re-authorizing the next highway bill.

To meet the nation's transportation needs, legislators will be charged with developing additional funding sources. More immediately, in effort to stimulate our flagging economy, key lawmakers are outlining the framework for legislation that could provide significant funding for our transportation infrastructure. Certainly, if this stimulus package was to pass it would be very good for the future of our business. We will be watching all of the funding conversations in Washington very closely.

Turning to the outlook for state funding, many states are experiencing budget shortfalls. While some of our projects have been delayed, we have not experienced projects being canceled as a result of funding issues. In California, we were pleased to see that Governor Schwarzenegger has preserved transportation funding for the 2008-2009 fiscal year.

Transportation funding has been one of the cornerstones of his second term and the current budget includes an increase in Proposition 1B, annual appropriations, from $4.4 billion to $4.7 billion. It also provides for the full funding of Proposition 42, which is the sales tax on gasoline that raises approximately $1 billion annually to be spent on transportation in California.

Shifting gears for a moment I would like to spend a few minutes highlighting our employee development initiative. We began this initiative eight years ago to accelerate the training and development of our people. Learning opportunities are created by seasoned operation people who accept a two-year rotation to facilitate the training and development of other employees.

During the course of this assignment they develop a deep understanding of our company and go back to their operational role at the end of their two-year commitment with skills that will help them advance their own career and become more valuable to Granite. We believe the development of our people is directly tied to our ability to deliver superior financial performance. It is also a key element in our retention strategy.

Now I will turn the call over to LeAnne.

LeAnne Stewart

Thank you, Bill. This morning I'm going to highlight our third quarter segment results and review our guidance for the balance of the year.

Let's start with Granite West. As Bill mentioned our branches continue to be challenged by a competitive bidding environment. Gross profit as a percent of revenue decreased slightly to 18% compared with 19% in the third quarter of 2007.

Operating income increased to $93 million compared with $90 million a year ago. Backlog in Granite West at the end of the third quarter decreased $35 million as compared to the third quarter last year largely due to a reduction in private sector work. I am pleased to report however that Granite West has been awarded approximately $100 million in new work since the end of the third quarter.

In our Materials business, revenues were flat relative to third quarter 2007 levels. Tons of aggregate sold were down 20% as compared to a year ago and tons of asphalt sold were flat year-over-year. Gross profit decreased from 22% in the third quarter of 2007 to 12% in the third quarter of 2008. This reduction in gross profit reflects a combination of factors. We are experiencing a decrease in demand for our higher margin aggregate products that are largely used in residential and commercial projects.

In addition, our cost to produce has continued to increase as a result of lower levels of production and higher raw material costs, particularly, diesel fuel and liquid asphalt. We continue to focus on cost controls in our plants and on better management of our inventory levels. We are also reducing personnel and limiting our hours of operation where appropriate.

Turning to Granite East, revenue for the division was $147 million compared with $183 million a year ago. Gross profit was 7% compared with 1% in 2007. Consolidated operating income was $4 million compared with an operating loss of $3 million last year, reflecting improved execution on Granite East projects.

Total backlog in Granite East at the end of the third quarter was $906 million compared with $1.4 billion a year ago. Our backlog does not include the full value of the anticipated World Trade Center work or the Houston light rail project.

We continue to book backlog for the World Trade Center as individual work packages are designed and priced. For the Houston light rail project we continue to negotiate contract terms and pricing.

Looking to total company backlog, we have three projects in Granite East and one project in Granite West that are pending award by the project owner. These projects would add approximately $500 million to our total company backlog.

Now let's turn to our year-end guidance. Our expectations for 2008 have improved. We now expect Granite West revenue for the year to be in the range of $1.95 billion to $2.05 billion with a corresponding growth profit between 17% and 18%. Granite East 2008 revenue is expected to be in the range of $650 million to $700 million with a corresponding gross profit margin between 17% and 18%.

Minority interest for the company is expected to be between $38 million and $43 million. Our longer term expectation for Granite East gross profit margin as a percent of revenue continues to be in the mid-teens.

Turning to the balance sheet, we have a strong conservatively leveraged balance sheet with zero net debt. Cash and marketable securities totaled $412 million at September 30th and include approximately $135 million of cash and cash equivalents from our consolidated joint venture.

As you may remember we are required to maintain approximately $150 million in cash to support our bonding capacity. Historically, the company has operated in conservative investment policy and has recently elected to invest even more conservatively in light of current market conditions.

Finally, given our strong cash position and approximately $146 million available under our existing credit facility, we do not anticipate the need to borrow funds in the current environment.

As we outlined last quarter we have introduced several cost containment programs across the company including the control of discretionary spending, headcount reduction and a process improvement initiative. We are embracing the opportunity to enhance productivity and improve the overall effectiveness of the organization. We are confident that these efforts will improve our future operating results and make Granite a stronger company over the long-term.

I'll now turn the call back to Bill.

Bill Dorey

Thank you, LeAnne. In summary, we are very pleased with our business performance. Our teams have done an excellent job, taking advantage of opportunities, improved execution and productivity and delivered impressive bottom line results that exceeded even our own expectations.

While it's too early for us to know what 2009 will bring, I'm confident that our people will capitalize on all of our future market opportunities. In the West, we are integrating large projects into our traditional branch portfolio that will help drive our Granite West business next year. In the East, we are maintaining solid margins and benefiting from overall improved execution. We expect to carefully and profitably grow the size of this business over time.

In addition, as LeAnne said, we are embracing the opportunity to increase efficiency and effectiveness at all levels of the organization. We are implementing cost saving initiatives and expect to see a reduction in general and administrative expenses on an absolute dollar basis in 2009.

I want to emphasize how valuable our business model is in this environment. Our diversification strategy is providing us with the ability to confront the current economic climate and deliver strong financial performance on projects across the country. We are geographically diverse and our revenue stream is not dependent on any one particular source.

We work for hundreds of different public agencies from coast to coast as well as many private clients. Add to that our strategic aggregate investments and we are well-positioned to deliver the goods in almost any environment. I believe our business model sets us apart from our competitors.

Before I open the call up for questions, I'd like to take this opportunity to thank all of our employees for their commitment and dedication to Granite. I know how hard you've been working and I want you to know how proud I am to be able to communicate to our shareholders how well we are doing. On behalf of all of us here in Watsonville, we want you to know how much we appreciate what you do for Granite everyday.

Now, I'll hand this call back to our moderator and we're happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) And your first question is from Bob Labick from CJS Securities.

Bob Labick – CJS Securities

Good morning. Congratulations on a strong quarter.

Bill Dorey

Thank you, Bob.

Bob Labick – CJS Securities

Okay. So I wanted to start with Granite West construction. Obviously, I think a lot of the strength versus our expectations came in the construction portion of Granite West with robust sales growth. Could you talk about the key drivers to that growth, particularly, in light of the aggregate volumes that you discussed down in the region? So what were the drivers of the growth in construction West?

Jim Roberts

Bob, this is Jim Roberts, I will be happy to answer that. Obviously, we're all ecstatic relative to the results of the third quarter in the construction business in the West. Really, the key is the fact that our teams out there are literally beating the estimate. They have increased their forecast because of the fact they have lowered their cost basis and the work that we've gotten up through the third quarter has been work with very good margin on it and when they beat those expectations, they certainly increase those margins. So it certainly comes down to the field hands and our teams out there just outperforming what are expectations were.

Bob Labick – CJS Securities

Got it. And then one of the things we were looking for starting in this quarter or I guess on a go-forward basis. You've obviously discussed the competitive environment on bids as being higher than a year ago. What – how should we expect gross margins to trend on a go-forward basis, particularly, with this very strong gross margin in the quarter?

Jim Roberts

Bob, that's a reasonable question. One of the things that our teams are doing and I think that Bill alluded to it in the opening discussion, was the fact that our teams are bidding just an enormous amount of work right now. And that gives us an opportunity to pick and choose the type of work that we are going to be competitive on and there are a lot of projects that do not have a significant level of competition and other projects that do. I think the key for us to try to keep our margins at a very reasonable level is to focus on the projects that we can vertically integrate with our skilled workforce and our materials, and find opportunities where we can have margins that will get close to where we're at to-date. It's definitely more competitive and it's going to be more difficult.

Bill Dorey

Bob, one of the – this is Bill Dorey. One of the interesting – if you want to use that word I suppose aspects of this business climate that we're in is clearly we've acknowledged that it is competitive out there, but one of the differences we see in this downturn for example than in compared to say 1992 is there is quite a bit of work to bid. There are opportunities to continue to bid work, and that's different from 1992. In 1992, the housing market went down and there wasn't a lot of public work out there, but there currently is a lot of public work to bid and that's what's driving our ability to be able to get out there and bid more work this year than we did in the prior two years.

Mark Boitano

(inaudible) from stimulus standpoint is what's going on currently in terms of discussions what they want to do try to generate jobs (inaudible) an additional increase in potential opportunities.

Bob Labick – CJS Securities

Great. And that was my follow-up to that was basically given the current credit crisis and crunch, expectations for '09 are going to be dependent on that stimulus bill or what would you expect going forward on new projects to bid out there during '09?

Jim Roberts

Bob, this is Jim again. Actually, the budgets that are out there today, assuming that they stay in place which we are very hopeful that they will do show quite a bit of work out there to bid between now and the first half of 2009. So there is plenty of work to bid. And the opportunities are there. I think key for us is to really focus on the right opportunities where we have advantages and then utilize that to obtain the bids. But we're pretty comfortable with the amount of work out to bid.

Bob Labick – CJS Securities

Great. I will get in back in queue. Thank you very much.

Jim Roberts

Thanks, Bob.

Operator

Your next question is from Jack Kasprzak from BB&T Capital Markets.

Jack Kasprzak – BB&T Capital Markets

Thanks. Good morning, everyone.

Bill Dorey

Good morning, Jack.

Jack Kasprzak – BB&T Capital Markets

Hi, congratulations on a great quarter, very nice. Can you tell us the net effect of changes to estimates in project profitability in the quarter? For example, in the second quarter, it was $21.8 million. Do you have that number for the third quarter?

LeAnne Stewart

I do, Jack. It's in the 10-Q which we should be filing this afternoon. Give me a second; I'm flipping to that table in here. In Granite East we had for the quarter increases, net increases in gross profit of about $6 million, $5.9 million to be exact and for the nine month period 2008, $52.5 million. And then for Granite West net increase in gross profit was $18.8 million for the three months ended September 2008 and $53.3 million for the nine months ended September 2008.

Jack Kasprzak – BB&T Capital Markets

Okay. Great. And I guess this question is for Bill. Last time we had mounting record state budget deficits, $60 billion, $70 billion and it wasn't the best time for public works construction, current forecasts are for state budget deficits to be even worse in total, $100 billion, and yet you guys are talking about the nice opportunities you have out there right now and even into '09. What gives this seems very unusual we to a point where states just can't delay spending anymore?

Bill Dorey

I think it depends on the state, what's happening in each state. Let's take California, for example. I mean gridlock is not a popular political point of view and Governor Schwarzenegger interestingly enough is built, and I said this in my prepared remarks, has built his second-term really around infrastructure. One of the things was infrastructure building. He was re-elected promoting the Prop 1B funding. We've certainly seen the benefit of that in our business. But we see other states that continue to want to invest in infrastructure. Hasn't suggest that they aren't budget issues in these states, but there are budget issues in these states but doesn't appear as if at least so far that infrastructure has been eliminated. And what we're seeing is what we're bidding frankly and as Jim suggested, we have plenty to bid in most of our business units. And what's interesting is that the larger work seems to be more prevalent as a ratio of the work that's out to bid. So once again, as we said in our prepared remarks, we think the timing for our realignment to prepare ourselves to be more effective on this larger work all the way across the country was pretty good. So we're hopeful that, that we'll be able to take advantage of that.

Jim Roberts

Jack, this is Jim. Let me add one thing to it. In addition to what Bill said you're also looking at job creation which I think is a huge political ticket today. And as we look at these states and we look at the unemployment rates going up, the states and the federal highway bill as well are job creation opportunities. And that's another good reasons for all of these states to really keep the transportation infrastructure work going.

Mark Boitano

I might also add, it's Mark, it lot of funding for the transportation work is taking place outside the normal state budget process, whether it's the individual sales tax initiatives by various areas, focus or whether it be by propositions that are again outside the normal budgetary process.

Jack Kasprzak – BB&T Capital Markets

Okay. Great. Thank you very much.

Operator

Your next question is from Rich Wesolowski from Sidoti & Company.

Rich Wesolowski – Sidoti & Company

Thanks a lot. Good morning.

LeAnne Stewart

Morning.

Bill Dorey

Hi, Rich.

Rich Wesolowski – Sidoti & Company

Bill or anyone really, it's very encouraging to see the projects in the West coming in above plan especially in a tough market. But it has been a big part of the branch story this year. You guys of course have a good window into your backlog that we lack. Are you comfortable on relying on those types of gains to bring you to the high teens branch construction margin as you move past the next one or two quarters?

Jim Roberts

Rich, this is Jim again. I think it's really too early to tell, to be honest. Certainly, we're encouraged by how well our teams are performing out in the field, but to go any further than the next quarter or so, it's just unknown. In fact at this time last year it was unknown. We just seem to be very opportunistic and find the opportunities out there that create the kind of margins that we need in this business. As Bill mentioned, I'm just like Bill, I'm very encouraged that our teams in the West will figure out a way to do it again.

Rich Wesolowski – Sidoti & Company

And secondly, have you seen a decline in liquid asphalt prices commensurate with crude oil over the last couple of months?

Jim Roberts

It's Jim again. We've seen a reduction in price of liquid asphalt commensurate with crude on a linear basis, no. But certainly a reduction, I think that they're starting to diverge in some nature relative to pricing of crude and liquid asphalt mostly from the supply-demand type issue in the liquid asphalt business. There's certainly a reduction in liquid asphalt production in the U.S. due to some refinery alterations. And so I think you're not going to sort of see them trail equivalently, but there is a reduction and there is plenty of supply out there for the remainder of this year which is very encouraging. Both of those aspects are very encouraging.

Rich Wesolowski – Sidoti & Company

Excellent. Thank you.

Operator

Your next question is from Richard Paget from Morgan Joseph.

Richard Paget – Morgan Joseph

Good morning, everyone.

Bill Dorey

Hi, Richard.

LeAnne Stewart

Hi.

Mark Boitano

Morning.

Richard Paget – Morgan Joseph

You said your balance sheet was in pretty good shape. Wondered if you guys could talk about maybe some other growth avenues in terms of acquisitions? Would that be something that you guys are still looking at? Especially since sellers expectations might be a little bit lower in this environment.

Bill Dorey

I think the answer is – first answer is our balance sheet is in good shape. Second answer is we want to keep it that way. And the third response would be absolutely we're looking for growth opportunities but not at the expense of leveraging our balance sheet beyond what we're comfortable with in this environment. So we're – I think we're doing what a lot of companies are doing right now which is trying to make sure we stay strong. We are uncertain as to what the future will bring. We're trying to get as efficient and effective internally as we can. We want to stay as strong as we can. But we are looking for growth opportunities and frankly we believe that those opportunities will get better if this environment gets tougher. So certainly want to be ready to take advantage of that – those opportunities when they present themselves.

Richard Paget – Morgan Joseph

And then you touched upon some of the potential stimulus plans out there that include infrastructure. I know I think there is one that is in the Senate right now and there is some other larger ones. Can you be a little bit more specific in terms of what you guys are potentially seeing? And then maybe in a best case scenario, when we might start seeing some money get spent?

Bill Dorey

We hear what you hear. We're not – we have no information that I think that the general public doesn't have around its subject. We may watch it closer than the average guy out there, in fact, I know we do. But we're encouraged by the conversations we're hearing. For the first time in a long time it certainly appears as if the prominent politicians in the country are talking about investing in infrastructure, they are talking about building, rebuilding the economy, creating jobs through infrastructure. I think that's a serious conversation. We're encouraged by it. I'm not sure I could put a time table on it. It really depends on what kind of work they put out. If they put for example, overlays, that kind of stuff that where you can spend a lot of money in a big hurry, it could be very, very good for Granite and companies like Granite around this country, particularly, material suppliers, companies that either do paving work or own their own hot plants. If they put this work out in larger projects, I think that's good for Granite too, but it won't show up as quickly because it takes longer to get that kind of work on the street.

Richard Paget – Morgan Joseph

Okay. Thanks. I'll get back in queue.

Operator

Your next question is from Brian Rafn from Morgan Dempsey.

Brian Rafn – Morgan Dempsey

Good morning, everyone.

Bill Dorey

Good morning.

Brian Rafn – Morgan Dempsey

Question for you from the standpoint of – maybe question for Jim. Now that we have another data point relative to what's going on in the West, is the roll out of the Caltrans kind of mid-sized work do you get a sense that there is an offset in profitability or dollars or the amount of contracts being bid to offset in California what you're seeing a decline in the private side, the industrial parks and the commercial and residential construction?

Bill Dorey

I'm not sure I quite understood that whole thing there, Brian. I will tell you that the Caltrans work is coming out in a very steady flow. As planned, we should commend Caltrans, they've really got a lot of work on the street, they're doing a nice job getting it out there. I'm not for sure what you mean by the private sector. Certainly, the competitors from the private sector have flowed over into the public sector work and that mid-level $1 million to $5 million range project is very, very competitive. That certainly is occurring and that's been occurring most of the year.

Brian Rafn – Morgan Dempsey

Okay. I guess I was just looking from the standpoint of demand, the offset in fully, kind of dollars available to be bid regardless of the competitive nature. The offset in more stimulus from the public work side versus the loss and what you've seen in the private side.

Bill Dorey

The public side is what they said it was going to be.

Brian Rafn – Morgan Dempsey

Okay. So that's somewhat (inaudible). Let me ask relative to your gross profitability. How important is it from the standpoint of the incentives that you would get, bonuses for finishing projects early. How material is that to the gross margin achievement?

Mark Boitano

I think I can answer that. While there are some incentives on some jobs for early completions or meeting certain milestones, the majority of our work isn't set up that way.

Bill Dorey

Yes, I wouldn't think that would be really very meaningful in the quarterly results.

Brian Rafn – Morgan Dempsey

Okay. And then finally, is there –

Bill Dorey

Is that correct, Jim?

Jim Roberts

Yes.

Brian Rafn – Morgan Dempsey

Okay. From the standpoint of is there a – as you look at the jobs in the public work side that are being bid out and I think the Army Corps of Engineers talked about, focused on bridges. If some 600,000 bridges in the United States, 26%, 28% of them are deficient structurally. Is there any hierarchy in what you're seeing in the importance from dams, tunnels, bridges, canals, highways, or is there a difference in projects coming out on the public works side that are more repair oriented versus new capacity? Five lane highways going to six lane or four lane to six lane.

Jim Roberts

This is Jim, Brian. We're actually seeing combination of both because there are some of these large jobs, in Granite East, Mike can certainly answer this as well. A lot of these large projects are capacity projects. I know the ITC job and some of the jobs Mike has in the East and in the West the majority of our work has been maintenance work and repair work. Although the large projects that we're bidding recently and the job we just finished up in Utah, I-15 job was a capacity job. So there is a combination of both.

Brian Rafn – Morgan Dempsey

Okay. And then –

Bill Dorey

Let me weigh on this just a little bit. One of the things that I've observed is that it really kind depends on which city you're in. If you're in an older city that's pretty well built out, often times a lot of the work is to repair aging infrastructure. But if you get into a city that's growing, particularly, a lot of the cities and towns down in the Southwest where people are moving to, it's often times capacity driven because the population is growing. So I think that it kind of depends where you are.

Brian Rafn – Morgan Dempsey

Okay. And then kind of a question that dovetails on that, Bill. Are you seeing any regional strength? Everyone is talking about the problems on Wall Street and budgets and how that effects the New York job economy versus say, the oil patch which has certainly done real well although albeit they've had the hurricane problems. Are you seeing any regional strength from those regional economies?

Bill Dorey

That's a good question. I don't know that we have any particular insight. Mike, have you got any thoughts on that?

Mike Donnino

Well, I think, this is Mike, by the way. I think the certain states just seem to do a better job of generating revenue streams for projects. I know in the Texas area they come up with innovative ways to finance different toll roads, added in some privatization type money. I think the northeast is totally driven by reconstruction and their aging infrastructure. The southeast is I believe is struggling a little. There's certainly the need down there and they're looking at various ways to do that. It's just that the economy down there really has slowed down and their tax revenues are down as well. So I think it's like Bill said, I think it really depends on the area and the – how sophisticated the states are in generating revenue streams.

Brian Rafn – Morgan Dempsey

Okay. Thanks, guys. I'll get back in line. Thanks.

Operator

Your next question is from Todd Vencil from Davenport.

Todd Vencil – Davenport

Hi, good morning.

Bill Dorey

Hi, Todd.

Todd Vencil – Davenport

Your guidance for the full year if I look at it the margins that you're indicating in the East would appear to imply that you're going to have a very big margin quarter in terms of gross margin in the fourth quarter. Am I doing my math right? And is there something in there that you guys are anticipating?

Mike Donnino

This is Mike again. I think we've been saying all year and we're anticipating that our ICC project will reach profit recognition and that will be a big boost for the quarter. I would caution you though that our jobs are all long-term and any one individual quarter it's really hard to examine and I think a rolling three quarter or four quarter deal is really a better look at it. But we do expect some additional revenue from – not additional revenue, but margin from the ICC and some other issues that we expect in the fourth quarter.

Todd Vencil – Davenport

Have you seen any adjustments that are indicated already that might help that out a little bit on other projects?

Mike Donnino

As we complete some of these projects and get further into them we continually evaluate our risk on the projects and make adjustments to our forecasts accordingly. And for several quarters now we've done a good job and as Jim indicated in the West we've been doing the same kind of thing in the East and beating our expectations and been able to adjust forecasts accordingly. And I think you've seen that in the last two or three quarters in our 10-Qs as far as the upward estimates versus the downward ones.

Todd Vencil – Davenport

Nice work on that. You guys have hinted or stated I guess a couple of times on the call that you're going to be sort of conservatively responsibly profitability growing the top line in the East. What should we be thinking about the pace on growth that you're targeting there? It sounds like you have the opportunities to bid and to a certain extent maybe it's in your hands how fast you want to grow it. How fast are you thinking about there?

Mike Donnino

Again, we look at each of these projects individually and it's really hard to put a number or percentage on the growth because if you were to hit, for example, the Houston project would hit our backlog, that would balloon our revenue fairly rapidly back up to the $1 billion range possibly on a consolidated basis so. But I think we're comfortable getting back over time to the levels that we were at in 2005 and 2006 as the opportunities present themselves. I think we built our oversight and our division support to handle revenues at those levels and we're comfortable expanding up to that level.

Todd Vencil – Davenport

Do you think we'll see backlog start to grow book-to-bill come back above one in 2009?

Mike Donnino

I do. As I said – as we said in our prepared comments, we've got pending projects right now that are about $500 million, $440 million I believe in Granite East that are pending award. And that does include the World Trade Center full value or the Houston project. And as Jim said we're bidding more work now than we have really since 2006. And we still even in the rest of 2008 we've got proposals in excess of $2 billion that are either in and being evaluated or will be turned in by year-end. So the opportunities are there.

Todd Vencil – Davenport

Okay. Final question on the West. Can you talk about what you guys are seeing out there in terms of aggregates pricing?

Jim Roberts

Todd, this is Jim. Yes, aggregate pricing is if you look at our discussion points, really, the overall business is fairly flat in revenue. Pricing is fairly stable as well. In other words, individual product pricing hasn't changed a lot, but one of the things that has changed is some of those higher priced what we consider to be more valuable products has diminished. Lot of those products are going into the private sector. So we're holding prices very strong right now with the anticipation that they'll stay that way.

Todd Vencil – Davenport

Okay. Thanks a lot.

Operator

Your next question is from Avi Fisher from BMO Capital Markets.

LeAnne Stewart

Avi?

Operator

Mr. Fisher, your line is open. We'll move on to a follow-up question from Rich Wesolowski.

Rich Wesolowski – Sidoti & Company

Okay. Thanks. Caught me off guard. The old claims backlog from the time when Granite East wasn't doing as well as it is now, how much of that has been reconciled and how much is left? Not numbers but just on a broad view.

Mike Donnino

This is Mike again. Of course the biggest one was early in the year when we settled the SR22 dispute and we still have a number of those. I'd say the quantity is probably half what it used to be some. And there is not – there is one, maybe a handful that sizable and then a whole bunch of other ones that generally we resolve over time without getting too far into the disputes process.

Rich Wesolowski – Sidoti & Company

Okay. So the 2009 Granite East income, whatever it is, will look at lot more like whatever the ongoing projects contribute?

Mike Donnino

As I have said before, I think resolution, creation and resolution of those types of issues is an ongoing thing. You see a little bit of it every quarter and then when something big happens you might see a spike. We've done a better job over the last couple of years evaluating risk in our projects so that has limited our write-downs. And it's also as those risks pass and we complete projects it's – we've been able to harvest some of that contingency set aside for those risks. So again, I think going forward it's going to be an ongoing part of our business, but it will just come out into the wash of our mid-teens expectations for overall margins.

Rich Wesolowski – Sidoti & Company

If you look at the East quarters and I know this is not a quarter to quarter business, but they've been highly volatile if you rip out the project changes, is there anything to be glean there other than just the stages of the contracts in backlog?

Mark Boitano

I think further (inaudible) as Mike's point that it's not a quarter to quarter business and you got to look at it over a long period of time.

Rich Wesolowski – Sidoti & Company

Okay. And then finally, can you give a little detail on how you aim to reduce the SG&A expenses aside from the headcount? Maybe even just a few anecdotal examples would help.

LeAnne Stewart

I can speak to that, this is LeAnne. We have a whole bunch of things that we're working on, some things in process, some things still in the planning stage, but some examples would be a corporate travel program, taking advantage of more consolidated purchasing opportunities. We mentioned in the prepared remarks process improvement initiatives, so really stepping back from how we do any myriad of things and trying to figure out if there is ways to do it more efficiently, more simply, utilize technology more effectively, all those sorts of things.

Rich Wesolowski – Sidoti & Company

Perfect. Thank you again.

Operator

And Avi Fisher has rejoined the queue.

Avi Fisher – BMO Capital Markets

Okay. Can you hear me this time?

Bill Dorey

We can.

Avi Fisher – BMO Capital Markets

Okay. Thanks for taking my questions and good morning, guys. Is there a victory parade for this?

Bill Dorey

Good morning.

Mark Boitano

(inaudible) down.

Avi Fisher – BMO Capital Markets

I got a list of questions. You mentioned that ICC reaches profit recognition is for 4Q. Are there any other projects that are hitting profit recognition or we should expect to either in 4Q or 1Q or coming forward?

Mike Donnino

This is Mike again. We had one in the third quarter of about call it a mid-size job and then ICC in the fourth quarter. I don't believe there is anything else in the near future.

Avi Fisher – BMO Capital Markets

Okay. And again, I know you don't look at this business exclaims it's part of the business, but excluding claims East margins were fairly low. Is that an impact of the ICC – the size of the ICC project at no margin?

Mike Donnino

It is. That project is ramping up and doing, you can do the math. It's $450 million jobs got to be done in three years so when they're peak construction which we're getting to, they were burning several millions of dollars a month and with no margin it does have a sizable effect especially in this quarter.

Avi Fisher – BMO Capital Markets

So this will be kind of a troughish, next quarter you'll see a true-up and then we'll see a run rate? Hopefully.

Mike Donnino

Except it's happening on different jobs every quarter, but yes.

Avi Fisher – BMO Capital Markets

If you just look at that one, and I know you can't just do that. In terms of the material costs, you mentioned that input costs are coming down or starting to come down and if you look out at the pricing of input costs they seem to be coming down, but they're coming down into what seems to be the seasonally slow quarter. Do you guys – I don't know what you do normally, but do you build inventory in the seasonally slow quarters? Can you take advantage of the lower input cost to do that?

Jim Roberts

This is Jim. That's a really good question. We started an energy group – let's say six months ago to really focus on exactly what you're suggesting is that take advantage of some spot market pricing and some longer term play and the answer is we do not build inventories of significance in the off season which certainly we're entering that has lower price bases, but we're starting to do more of that. It is not a significant issue today. I think if you ask that question 12 months to 24 months from now, I might have a different answer for you because we are strategically looking at doing exactly that.

Avi Fisher – BMO Capital Markets

Got you. Okay. Thank you. In the Granite West backlog, how much of that, I look at Prop 1B spending, I also look at the border fence as two issues that are sustaining a lot of work as well in addition to the several probably thousands of smaller and mid-sized projects. But how much of the border fence is in that work and when do you expect that to end?

Jim Roberts

Okay. Let me – several questions there. How much of the border? I don't have that off the top of my head. But the majority of the border fence work will conclude by 12/31 or the end of Q1 '09 as mandated by Homeland Security. And I don't have the exact numbers off the top of my head. I'm sure that Jacque could work on that if we needed to for you. Other work that we have is our work is spread around pretty good. The DOT work, we have some federal work and we actually have some private work as well so the one question there relative to the border fence work, detail wise I don't have the exact numbers for you in front of me, Avi.

Avi Fisher – BMO Capital Markets

That's okay, but that's a little bit of good color. In terms of the four net projects sort of in the pipeline, I haven't – I know that at least one of them is kind of held up because the bond funding hasn't come through because of the credit issues. Are they all related to that or are they all have different issues holding them up?

Mike Donnino

Avi, this is Mike. Are you talking about the three that we said are pending award?

Avi Fisher – BMO Capital Markets

Exactly.

Mike Donnino

In the East one of them is western Wake and the bond sales have been delayed a little bit although they got some good news the other day and did get approval for their TIFIA loan from the federal government so we expect that to move forward and hopefully near maybe have a bond sale by year-end hopefully. Another large project is an alternate to one of the border fence jobs. So that's a somewhat of a funding issue. And the third one is the project in New York which was approved for award actually I believe it was yesterday and so that should be happening fairly quick.

Avi Fisher – BMO Capital Markets

Okay. So the number two would be the border fence that requires obviously the Senate to do something in terms of –

Mike Donnino

No, actually, I think they've got money, it's a matter of which projects they want to apply it to.

Avi Fisher – BMO Capital Markets

Okay. Thanks for that color there. Quick question on minority interest. I noticed that that number tends to be all over the place, but it was lower than I expected. Does that imply sort of delayed orders or awards at the joint venture line? Are there any big issues at the joint venture line that we should be aware of? Claims, projects that are below profit level – lower than – lower profit than expected?

LeAnne Stewart

No, I don't – Avi, this is LeAnne. I don't think there is anything in there particularly that you need to be aware of. As we work through projects allocating income to minority shareholders, working through our minority interest holders, working through settlements, those kinds of things, you're going to see that number move around from time to time. But there's nothing particularly interesting in there.

Avi Fisher – BMO Capital Markets

Okay. Thank you. In terms of real estate side, there were commercially [ph] no impairment costs this quarter. Obviously, if you thought you have, you have them, but should we think maybe there was a little surprising. Have we sort of fleshed out most that we thought we were going to have?

Bill Dorey

We think so. The way we operate our real estate business is we don't recognize any profit unless we sell something and there is not a lot being sold right now. So we're continuing to advance the projects that we have through permit processing, preparing the projects for sale in the future. We're working our system and working our strategy, we're not selling a lot right now, and I don't expect that to change in the near future. We're still very confident that the portfolio has value and we're very rigorous by the way, Avi, in how we evaluate that portfolio on a quarterly basis. And if there is a deterioration that would cause us to recognize that we will recognize it. And we did that once again this quarter and we did not find a reason to do that so we're confident that in the long run it's a good business for us.

Avi Fisher – BMO Capital Markets

Alright. Well, nice work on the quarter and will speak to you soon.

Bill Dorey

Thank you.

Mike Donnino

Thank you.

Operator

Your next question is from Joe Ritchie from Goldman Sachs.

Joe Ritchie – Goldman Sachs

Good morning, everyone. I have one question and I apologize if I missed it earlier. Of the 24 million to 25 million in changes and estimates that you spoke about earlier on both divisions, what portion of that was related to claim resolutions versus just getting the projects done quicker, more cost effectively?

LeAnne Stewart

We don't have that level of detail with the information right now here, but I would say it's a combination of stuff. I wouldn't say that there are any particularly large claims that were resolved this quarter.

Bill Dorey

No, it was – claim resolution played a very small part in the write-ups of those projects during the quarter. And I think that's good news.

Joe Ritchie – Goldman Sachs

That's great. And thanks for the color.

Operator

There is a follow-up question from Richard Paget.

Richard Paget – Morgan Joseph

My question was answered. Thanks.

Operator

(Operator instructions) And at this time, there are no further questions.

Bill Dorey

So I'll take the call back. Thank you, moderator, and thank you all for joining us this morning. We appreciate the interest you have in our company and as I stated before I am very pleased with how our business is performing and I'm proud of the people that make it all happen. If you have any additional questions our team will be available here in Watsonville for the balance of the day and thank you for being with us this morning.

Operator

This concludes today's conference call and you may now disconnect. Thank you.

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Source: Granite Construction Inc. Q3 2008 Earnings Call Transcript
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