Granite Construction Inc (GVA) 2006 Q2 法說會逐字稿

Good morning. My name is Amanda, and I will be your conference operator today. At this time, I would like to welcome everyone to the Granite Construction Second Quarter 2006 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. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two.

Thank you. I would now like to turn the call over to Jacque Underdown, Director of Investor Relations. Please go ahead, ma'am.

Good morning, everyone. Thank you for joining us today. This morning I'm joined here with Bill Dorey, President and Chief Executive Officer; Mark Boitano, Executive Vice President and Chief Operating Officer; David Watts, our Chairman of the Board; Bill Barton, Senior Vice President and Chief Financial Officer; Mike Donnino, Senior Vice President and Manager of our Heavy Construction Division; and Jim Roberts, Senior Vice President and Manager of our Branch Division.

You can find the earnings release and associated financials on our investor relations website at www.graniteconstruction.com. and today's call will be recorded. Please be aware that if you decide to ask a question, it will be included in both our live transmission, as well as in future use of recordings. As always, shareholders, analysts and employees can listen to a live webcast of today's call at our Granite investor relations website. We will be making statements during this call that are forward-looking statements. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in today's earnings press release, as well as the comments made during this conference call and in the management discussion and analysis section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. We do not take any duty to upgrade any forward-looking statements.

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

Good morning. Thanks, Jacque, and welcome everyone. On our call today, I will address our second quarter performance, our assessment of our markets, and our prospects going forward. Dave Watts is on our call today, and he will provide you with his perspective on public funding and the very interesting political environment that is affecting our business and that it could, we think, improve our business.

Okay. Let's review our second quarter. Overall, we are very pleased with our quarter, as well as the first half of the year. We are off to a great start, and our prospects for the balance of the year look very good. However, as you know, we have mixed results. Let's start with our Branch Division.

Any way you look at our second quarter Branch numbers, they are impressive. Revenue was up 18% to $471 million. Gross margin percentage was 18.4%, which is excellent. Operating income was up $31 million to 61.5 million, and for the six months ending June 30th, the Branch numbers are equally as impressive. Revenue for the six months ending June 30th was up 11% to $722 million. Gross margin percentage was again in that 18% range, 18.1%, and operating income was $80 million, compared with 29.5 million in 2005. That's solid performance and reflects a business operating in a strong market and reflects a business that is clearly capable of capitalizing on that market.

Equally as important as our Branch performance to date is our Branch backlog. It stands at 978 million, and that compares to 648 million a year ago. Despite the housing market leveling off, our overall private sector second quarter backlog is over 30% higher than a year ago. Many of our markets continue to exhibit considerable private sector strength, and we are seeing an active commercial market -- active private sector commercial market emerging. This along with our optimism regarding our public marketplace and the higher levels of public spending is very encouraging, and I think speaks to the strength of our Branch business and to our prospects for continued financial performance and growth.

Drilling into our construction materials business, we see that this business just continues to get better and contribute more to our bottom-line performance. Revenues for the quarter and for the year to date are both records, and our gross margin percentage for the quarter of 25.7% and for the year to date of 22% are also record breaking. Obviously, we are thrilled with our Branch performance, and we are optimistic that this momentum will continue into next year.

Clearly, one of the very important political events for our California business will be the California Bond Propositions which will be on the ballot in November. Those Bond measures have the capacity to provide fuel for our California business for years to come.

All right. Let's talk about our Heavy Construction Division. As we indicated in our press release, we experienced advance on several large projects which increased our forecasted cost to complete on those projects and lowered our expected profitability. In our second quarter, we had 48 active projects in our HCD portfolio. Eight of those projects had forecasted reduced profitability by a million dollars or more, and two projects experienced forecast improvements of over one million.

The net effect of these HCD forecast changes was the recognition of $27 million of consolidated losses in the quarter. It is important to remember that our conservative accounting system recognizes costs associated with any contract claims or pending change orders when they are incurred. However, we only recognize revenue if we have an executed contract change order to guarantee payment. We are hopeful that many of these issues that precipitated the need to recognize the losses this quarter will be resolved, and we will be able to recognize some offsetting revenue in the future.

Obviously, this pattern of deteriorating forecasts is a problem. This management team, as well as our Board, is well aware of that. However, our company-wide portfolio strategy is one built around diversification. Geographic diversification, diversification of customers and owners in both the public and private sector, diversification in the kinds of work we do, and diversification in the size of projects that we participate in. The capability to participate in markets from coast to coast and build a portfolio that includes large projects is important to our strategy. We have discussed our strategy to put our HCD business on track on prior calls, and I think it is appropriate to share more of the detail of that strategy today.

Our bid day strategy starts with bidding work more conservatively, and we've been more disciplined on bid day. We are incorporating lessons learned over the last two years into our proposals regarding the issues that we have experienced on large, complex projects. And this more conservative approach to the bidding process has added costs to our proposals over the last 12-to-18 months. We believe the market will support this bid day strategy and allow us to book the work necessary to sustain our HCD revenue and allow us to book backlog, which will consistently deliver more acceptable margins.

Our strategy also includes managing cash flow by focusing considerable effort on unresolved revenue issues. We have talked about unresolved revenue issues in the past, and we have developed more capacity to pursue these issues and collect the money we believe is owed. We believe that our work in this area will begin to pay dividends soon.

Our strategy included adopting Branch Division practices designed to carry margins into our estimates when we are pricing company-owned equipment and company-produced materials. We have made significant progress toward our strategy of staffing our HCD regions to operate as self-contained, local business units that are closer to the work and much better equipped to execute our business plan. Certainly, and last, and arguably the most critical element of our HCD strategy is to execute effectively on our projects. We are developing our project management and project management staff, and we are investing in training from project management people to our craft employees. We are insisting that Granite policies and procedures are incorporated in all that we do, and we have raised expectations and tightened our oversight throughout the division.

We indicated in our first quarter call that the recovery of our HCD business would take time and that you should not expect dramatic improvement in this business this year. Our projects bid prior to 2004 simply needed to be put behind us. As a reference point, our HCD backlog that is expected to carry into 2007 will consist of only six projects totaling approximately $100 million from projects bid prior to 2004.

One last clarification. Because our World Trade Centre project is currently a cost-plus-a-fee contract without a defined scope or contract value, it is not included in our backlog. If we assume that Granite's portion of that project will be approximately $300 million and we include that amount in our backlog numbers, our HCD backlog would be slightly more than 1.8 billion, which is similar to a year ago.

Before we summarize our prospects going forward, I would like to spend a little time talking about the Granite Land Company. Our Land Company is a relatively small effort to invest capital in real estate development opportunities that in many instances are complimentary to our aggregate strategy, as well as our core construction business. Our Land Company has been part of our diversification strategy, which we have been nurturing for approximately five years, and you can see the effect of that effort in this quarter's financial results. The Land Company contributed 17.8 million in consolidated operating income to our second quarter. Our minority partner share of that is approximately $8 million. Our expectation is that our Land Company will be a regular contributor to our annual financial performance.

All right. Let's look forward. We are excited. We are expecting our markets to remain strong and for our overall 2006 performance to be excellent. Our Branch performance is expected to deliver operating income that exceeds our record performance of 2005, and our HCD business is expected to break even, provided we reach the percentage of completion threshold needed for profit recognition on several projects. Those projects are our U.S. 90 bridge in Mississippi, our I-15 project in Utah, our U.S. 20 project in Oregon, and the Jewfish Bridge project in Florida.

So with that, I'll turn this call over to Dave Watts, and Dave will provide you with his insights into the political environment.

Thank you, Bill. Good morning, everyone. Of course, the backbone to transportation funding is the federal Transportation Bill, and at the current moment, we have a lot of action dealing with fiscal year 2007 appropriations. The House passed a bill providing 39.1 billion for the [Coal] Highway Program, which is of most interest to us. There are other interesting and relevant portions of that Transportation Bill, as well. The Senate Appropriations Committee approved a similar funding measure on July 20th, but that has not come before the full Senate for vote.

As passed, if the Budget Bill is passed with these numbers, they both are over the administration level. Our experts in Washington, our association lobbyists say that a final fiscal year 2007 transportation funding bill will probably not be enacted until Congress reconvenes for the lame duck session after the November election. So that's the federal picture.

I would add one more thought to the federal picture, and that is the long-term solvency of the Highway Trust Fund is certainly in question. They are looking right now with the commission to study future funding because the trust fund is being drawn down rapidly at the current levels of appropriation and will be drawn to zero in just a couple of years.

So let's turn to the most important state in our market and that's California. The 2006-'07 budget was passed just a few weeks ago just before the end of June. It included full funding of Proposition 42, which is the sales tax on gasoline, and that's 1.4 billion. But it also included 1.4 billion in accelerated repayment of past loans that the Prop 42 account made to the general budget. This was very, very positive from a transportation infrastructure perspective.

The Bond measures that Bill referred to earlier were put on the ballot by the legislature. There are -- it's a five package, five-element package of infrastructure. Prop 1A is to ensure -- it provides a firewall of these Prop 42 sales tax revenues to be spent on transportation and not diverted for our other purposes. Prop 1B is a $20 billion transportation bond, and the others deal with schools, levies, and affordable housing.

Obviously, Prop 1A and Prop 1B is of great interest to us and to our industry, and we are mounting a campaign for the November election to get these passed. There are no signs of visible opposition to these bond measures; however, when you're talking about $39 billion in bonds in total, the voting public could take issue with that. So we can't take it for granted that these will pass. So they will require an active campaign to pass all five, and Granite is actively involved, along with our industry.

So that's the picture. It's an opportunity in California, which is probably a once-in-a-career opportunity for ensuring transportation funding for many years to come.

Bill, I'll turn it back over to you.

Okay. Before we go to questions, I'd like to maybe just talk to our employees around our system. We're up and running really hard right now. We're busy. We're running about as hard as we can run. It's going to be a long, hot summer for everyone involved, and I want to thank everyone in advance for all the work that no doubt we're all going to be doing this summer to make this year a great year for us.

And with that, I'll turn this call back to our moderator for questions.

[OPERATOR INSTRUCTIONS.]

Your first question is from Michael Dudas with Bear Stearns.

Good morning, gentlemen, and Jacque.

Good morning.

Dave Watts, it's interesting you mentioned a once-in-a-generation opportunity for November propositions. Could you maybe put a perspective what that means and how much of an impact that could have on the overall business, and could that cause a lot more tightness in materials, labor, more delay -- more complexity in the funding issues if this all comes to pass and how -- or will it be a long cycle that will come out of these propositions, if they get passed [inaudible]?

Well, Michael, the $20 billion transportation bond measure will be over ten years. So that money won't be all spent in just a few short years. The enduring amount coming from the sales tax on gasoline, which as you might recognize, does have some element of inflation to it, if the price of gasoline continues to rise gradually over time. That provides at least 1.4 billion a year and perhaps higher on a recurring basis in perpetuity, unless somebody changes it in the future from the Constitution. The Bond measure, of course, is a shot in the arm for about ten years. So that gives you some idea of the additional amounts which will be coming from both these measures.

We have been operating the last fiscal year, the current fiscal year with full funding of Prop 42. So that won't be a change. It will just ensure that that will continue. But the Bond measure represents a change. Certainly, the levy restoration and repair has an impact on the Heavy Construction Division and possibly afford us some business. But it no doubt will place -- and I'll let Bill and perhaps Mark Boitano comment on this -- place heavy demand on both services, materials, people, et cetera in our marketplace.

Michael, it's Mark. Just to add to Dave's comments, while there will be additional strain in the marketplace and to some degree the price sector moves a bit, as we've talked about, there will be some capacity available there. But I think most importantly for those that are established in California, this will lead to what we think is a better market for us. So I think all these are very positive. While there always are challenges that go with it, we think the ultimate outcome is something that we're looking forward to.

I appreciate those comments. Relative to your discussion in your prepared remarks on the Branch side, was there any regional issues that impacted, whether weather-wise or just certain better operations in certain regions throughout the west of the country that contributed such strong Branch growth?

Michael, this is Jim Roberts for the Branch Division. Yes, I would say there was some very positive weather patterns. The southern part of our business operated really just consistently and constantly through the winter. So our businesses basically in the southern California, Arizona, and the central part of California never missed a click the entire winter, and that was the basis of our real strong first quarter, and in the second quarter all the rest of the businesses clicked in, as well. So we were able to just come over the one-time winter hurdle very rapidly this year.

Okay. My final question would be relative to the HCD division, and I appreciate you going through in detail issues you're going to try to correct there. When you talked about the discipline issue, are there a lot more projects you're passing on or a lot more projects you're bidding higher margin and not getting? Could you give us a little sense of that? And, also, you talk about getting better project management, construction management skills. Is that internal or an external issue, and how difficult on an external basis is that going to be to tie it in relative to Granite's internal structures?

Okay. This is Mike Donnino with HCD. If I remember, there's about three questions in there.

Sorry about that.

I'll start with the training one. In the last, about the last three years, most of our people that we've added have been external and along with the internal promotions and so forth. We have our backlog leveling off, so we feel like we're closer to being where we need to be, as far as the number of people and quality. The training and the support, the support staff is just about in place throughout the country, and the training we've started in the [Sense] program for project management, area management, engineers, that is mostly internal. The program that has been developed has been done in-house.

As far as whether we're passing on more projects or not, we're still bidding about the same amount of work for about the last three years in raw dollars. So I don’t know that we're passing on any volume. I think the size of the job we're looking at is growing a little bit. So the number of projects we're looking at and bidding is probably less, which would also lead to a little lumpier backlog. For example, this year we've been second bidder on four projects totaling $900 million. So had we gotten one or more of those, our backlog would look a little different. So I think the opportunities are still there, pretty much still there in all regions.

And as far as the discipline, that's a matter of being a little bit more disciplined with our process and how we evaluate risk associated with these large projects and marking them up.

I think the other element, and we've mentioned this in the past, is that we're not actively out attempting to grow the size of this business. We'd like to sustain the business at about the same level that it is, and as Mike suggested, allow us to catch up with some of our staffing issues that has I think affected our performance over the last couple of years. So that's been our strategy, and part of the way that we govern that is to be more conservative on bid day, and we're hopeful that the market will support that strategy. We believe that it will, and it should help us get this business back on track.

Thanks, gentlemen.

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

Thanks. Good morning, everyone. My first question is, Bill Dorey, of the eight projects you mentioned of the 48 active in HCD where you took profit expectations down, were any of those in your New York market?

Yes.

Can you tell us how many of the eight or --?

Let's see. The eight projects, they're in five different regions. Three were in New York.

That's fine. How many of the 48 projects that you have are in New York? Do you know that?

Oh --

We do. I'm not sure we have it right --

I don't have the total --

We can get it here for you in just a minute.

That's fine.

We've got to count them up, but let's go to another question and we'll come back to that.

I was wondering, given the commentary about materials strength in California, what sort of pricing in materials are you seeing right now? I mean, if you look at the pure aggregates companies, Falcon Materials and [Mark Marion] Materials, they've seen a nice improvement in their rate of pricing in the last year or two. I assume that's what you -- you guys are benefiting from that, as well. Is that the case, and if you could tell us, sort of, the order of magnitude of pricing that you're setting? That might be helpful.

Jack, this is Jim Roberts. We're seeing -- we are seeing some price increases. Now, remember a component of that is also that the goods and the services that we utilize to produce materials, those costs are going up, as well. But we are seeing a healthy market. We are seeing increases in pricing, and we are also seeing an increase in the actual quantity of materials that are needed to service the retail and our internal businesses in the west. So our success is a combination of both the increased pricing in excess of our increased costs, as well as the increased tonnage, as well, of total product going out the door.

But increased tonnage is just a function of overall market demand?

Yes, it is.

Okay.

Yes, Jack, maybe just as a -- when the market, public market was slow here several years ago, we saw a drop off in our paving, the amount of asphalt paving we were doing, and as public markets come back, that part of our business has come back with it, and as a result, we've experienced some fairly decent returns in the asphalt side of our business as a result of that.

Okay. And do you know the -- with regard to the California budget that Dave Watts was talking about, do you have the overall budget number? I mean, last year I think it was four or 4.1 billion up from 900 million. Do you know what it is for that comparative number for fiscal '07?

Yes. It's pretty similar, Jack. It really hasn't changed much. It is in the four, $4.2 billion range for the next fiscal year, as well.

Maybe I could give you one statistic that I do have at the tip of my tongue. I spent some time here recently with the Director of Transportation for Caltrans, the Caltrans director, and he indicated to me that they had I believe it was 178 -- don't hold me to this precisely -- 178 major projects in this last fiscal year that they put out to bid. That was their goal and, in fact, they did let and award 178 projects. And in the same period for this next fiscal year, their goal, I believe, was 218. So I think their expectation is that they will do at least as much work in this next fiscal year as they had in the last.

Great. That's very helpful. Thanks very much.

I got that other information you asked. There's about ten projects of the 48 are in the northeast, and they represent, not counting the World Trade Center backlog which we'll discuss, that's about 18 to 20% of our backlog.

Thanks very much.

The next question is from Richard Rossie with Ferris, Baker, Watts.

Good morning, everybody.

Hi, Rich.

Just a couple of accounting issues. If we could just go through this other income. Where is the land sale? Is that in property and equipment?

The land sale, that land sale -- this is Bill Barton -- is sitting in operating income as part of its overall business.

Okay. So it's in operating income. And is that booked on the revenue side?

It has revenue and in the costs just like -- yes.

So if I add up the -- so is that the difference between the revenue add-up for both Branch and HCD in the total revenue number that you're showing?

That would be pretty much the --

I mean, for the most part? Okay.

Yes.

All right.

That would be the [other.]

Okay. And in the property and equipment sale, is that all just your normal equipment sales?

It's a combination of focused sales of excess properties, as well as equipment.

Oh, okay.

It's both.

But not in the Land business?

No, it's not part of the Land --

Got you.

-- the operation --

Okay. Bill, you mentioned that the Land business is going to be a regular issue for you, and obviously, so far it's been very positive. Could you give us some very general guidance of what kind of ranges of numbers we might look for? Is there any more likely this year and what kind of a range could equal next -- could next year equal this year?

Okay. Let me take a shot on that, and I want to be pretty careful here because I don't want to set any false expectations that might come back to haunt us. But we think this is a pretty good business. We have built a team, and this is not just something that we've done just in the last year. It's something that we've been working on for some time. We've got numerous investments really throughout the west that we've been nurturing. We think that we will begin to see the sale of those investments, so we will be harvesting the profit that we've been building in our portfolio over the last few years.

We will not see a regular occurrence in this from our Land company on a quarterly basis. As you might imagine, we don't expect to sell property every quarter out of this business. But I do think, and I said this in our prepared remarks, that we do believe that we can count on a regular, annual contribution from this business, but I'm not sure I could pinpoint any particular quarter in which it will come. And I think it's probably safe to tell you that we think that on an annual basis the contribution that we saw in this quarter is something that likely could be expected. So that's probably the best guidance that I can give you.

Okay. Will the minority interest change or is it a steady partner there?

Well, we have various partners. So when I say their annual contribution, I'm talking about the net amount.

Oh, okay, okay.

You follow me?

Yes, the net amount.

Got you.

[inaudible] depending on the [inaudible].

Okay. Going on to the aggregates, could we just get what tonnage production was for the quarter that was sold or total and how much you used internally?

I don't have that, Richard, off the top of my head.

We've got some folks in our financial reporting listening, and if they're listening and can get that to us before the call is over, we'll try to get that for you.

We're still in the process of building up new information, so this information may be not available at the moment, but we will provide it.

Okay. And on those jobs that you're hoping will reach the 25% mark this year, could you give us some sense of how much revenue has been associated with those 25 -- with those jobs and that 25%?

How much --?

How much revenues will you have booked between the beginning of those jobs to the point where they hit the 25% mark where you could book profit? You know, general. I mean, I'm not looking for -- obviously, not looking for an exact number.

I can do that but it will take a minute. So maybe I could [inaudible] ask another question.

Okay.

Bill, would this be maybe a good time to make -- I want to make one clarification here, Rich, and it will be in our Q, but we have taken a little different view, we are taking a little different view on our design build projects relative to our 25% threshold, and as we begin each of these projects, we're taking a look at whether or not 25% is actually the appropriate point in which to begin to book profits. Each job will be separate and will never be less than 25%. It might go up. We have anticipated that in my comments around these four projects, but I thought we should make that clear, since you referenced the 25%.

And that's reflective of both the experience you've had with that to date and the rocky road?

Yes.

And just the general structure of the deals in the business, I guess?

I think it is primarily our experience that we've had over the last couple of years, and we booked some profits that we had that reversed, and we don't want to do that. And, so, we just want to make darn sure when we start reporting profitability that we really have our arms around what we're communicating to our investors. So it's just I think an example of our conservative nature here at Granite.

Sure. And one final thing on claims. I know it's a broad subject, but was there any material claims that were settled in the quarter that had a meaningful impact on the quarter's results?

There were some that were settled, Rich, but I don't think I would characterize any of them as being meaningful or something that we would talk about, and obviously our results certainly wouldn't suggest that. So I'd say the answer to that is probably no.

And, clearly, given the problem projects and what probably are substantial claims on a number of them, as we go forward, if those claims area favorably settled, I presume that you're going to alert us to those numbers?

If they're meaningful, yes.

Okay. Very good. That's all I've got for now.

Thanks, Rich.

Rich, the round numbers on those four projects, it looks like the unconsolidated revenue would be about 220 million.

So that would be Granite's portion.

The next question is from Brett [Filman] with D.A. Davidson.

Good morning. Just a quick question. I have most of my questions answered, but related to sale of gold during the quarter. Do you have anything left that you expect to sell? I know you said build that up over time and then report it.

That's a good question. Obviously, over time as we continue to process aggregates primarily here in California, there is a certain amount of it we process and separate out the [inaudible] as well as gold, and currently we look at that as an investment and over a long period of time we've been accumulating it and have recently been selling as a result of just the high pricing that the gold is now demanding. And, so, yes, we will probably -- we do have some additional gold that we have in reserve and no doubt will sell it over time.

Okay, great. Thank you.

The next question is from Richard Paget with Morgan Joseph.

Good morning.

Good morning.

You guys have talked about some of the cost inflation, how it has impacted you guys. How is it impacting your customers? I mean, have people all of a sudden looked at projects and said, "Okay, this money doesn't buy us many mileage," and you've seen some projects getting scaled back at all?

Well, I think the answer to that is, yes. What I think maybe the most vivid example is that the prices that the contractors are bidding is higher in some instances than the budget allocation that the agency has provided and there's a shortfall in funding. And some of those projects are being re-bid, redesigned, delayed and so forth to try and give the agency time to deal with that situation. Having said that, I think one of the realities that some of these agencies have come to is that this is a fact of life, and if they want these projects built, they're going to have to step up to the plate and pay today's prices. And, so, there's an awful lot of that work that is getting awarded, even though the pricing has driven the overall price of the project up.

And we've seen probably more jobs awarded that were over the engineer's estimate than we have in some time. So that in itself is telling us that they have come to that realization that their budget figures are stale, in terms of what's happening in the marketplace today. And then we have -- and maybe Mike can come back to this. We have several projects that we have bid or are in the process of bidding that have a dollar amount allocated to them, and the agency at that point, then, is concerned with how much of their budget they can get billed for the amount of dollars they have available.

Yes. Some of our large projects that we bid, one of the ones I referred to, was 30% over the engineer's estimate and two of the four projects that I discussed were not awarded below [inaudible]. What Mark is referring to is a change in the method of procurement. We're working on at least two projects, maybe more, that they have a maximum amount of funding, and if your proposal did not include the entire scope, then they have either options or they ask you to provide what scope you can build for that amount of money. The good thing is the recognition that the project is important. They want to get it built, even if it's not the entire project. So that is something that we've seen come up several times in the last 12 months.

And, Richard, this is Jim Roberts from the Branch Division perspective. We along with the industry associations have been working hard to educate our owners as to what the increased costs are to complete their work, so that they hopefully before putting more [inaudible] to bid adjust their estimates and budgets accordingly, so that they can have proper funding for these projects.

Okay. So for the most part, that period of bigger shock has mostly gone through?

Mostly gone through but still out there today. They're aware of it, but it's continuing and it's a continuing education process.

I think it has also caused them to look at the priority of certain projects and they realize they can't build that many projects or miles, and so they have to kind of look at what they think are the important ones and move them up the list.

You guys talked about public funding sources. Have you started to see more interest in private funding sources, especially for highways?

We are involved in several large projects that are private public partnerships of various types. That started a couple of years ago, and although the number of projects has increased and we're involved in, I would say, at least three or four major ones, not too many of them have come to fruition yet. I think your agencies are kind of working through their procedures and their methods, but that has increased and we're involved in several like that.

Okay. And, then, finally on your private backlog. Could you just give us a sense of what the breakdown, how much of that is leveraged towards the residential market versus non-res commercial?

I'm not so sure that we have that in front of us, Richard. We did -- we did a little review on that backlog, and we have actually a pretty healthy residential backlog in the Branch Division, but it's really questionable how long and for how much of a period of time that residential backlog will last, but right now it is staying wrong in the Branch Division. So we believe that there is work out in front of us for at least the next -- remainder of this year and beginning of next year, and we talked about that in the last quarter conference call, as well.

Just to give you some clarity, we have the ability to move back and forth between both public and private markets, so we see that if we have a little slow down here in the private side, it's easily moved to the public side. So from the standpoint of, as someone has mentioned earlier, the strain on resources, we've got the ability here to move back and forth between these various markets pretty easily.

In fact, I would consider that, Richard, to be a real strength of what we do in the Branch Division is our crews and our capabilities are really agile and can move from a highway job to a subdivision job quite easily. And that's been one of the benefits as we saw the public sector decrease probably five to six years ago and moved into residential in the private sector very rapidly, and if we need to move back to the public sector, we can do so. We don't see it going rapidly over just to the public sector, but we certainly have that ability.

Okay, great. That's it for me, thanks.

The next question is from Robert Labick with CJS Securities.

Good morning. This is actually Frank Wooten for Bob Labick. Most of the questions have already been asked, but in the company's history there have been a couple of periods where you guys have had a little bit of trouble in the labor markets finding qualified engineers at reasonable prices. Can you just give me a little bit of clarity on what's going on there and what you guys are seeing?

I can speak for that from the Branch Division perspective. We certainly have seen that there is demand for engineers. We have stepped up our recruiting process, and I'm happy to say that we've actually increased our recruiting of engineers dramatically over a year ago at this time. And so we see the market not still very strong, but we see our ability to attract engineers increasing, and I think that's just the healthiness of Granite, and we have a very strong relationship with colleges and very strong relationship in the industry, and we're really making a very strong move on getting more engineers into our business, and it was very successful in the last six months.

I believe in the Heavy Division, we're moving along the same path as Jim's division. One difference in the larger projects where you need more experienced people, there is a severe strain on those resources right now, and that's why we're increasing our development efforts, training efforts for those people that would do that, and I see that continuing for a while as these big projects start to come out.

As far as -- I don't know if you're referring to craft labor or professional people but the craft labor is also strained, especially in the non [inaudible] market and, again, it has driven up prices for the non-union labor over the last several years, and we continue to see that. We're trying to price that into our bid as best we can and continue our training and development of those craft folks, as well.

I want to -- I say this -- it seems like I say this, make this point every conference call, and I'll make it again because I think it's important, and that is that I wouldn't call it maybe a shortage but to some degree the lack of the ability to just go out and hire everybody that we need can certainly be viewed as a problem, but on the other hand, it is an important factor in what is making the market that we're the beneficiary of, because if there was -- if there was people all over the place to be available to do this work, the market would not be as strong as it is, and it's important for you all to appreciate that it may be a long-term challenge for the industry and certainly for Granite, as well, it does provide the short-term environment that we are the beneficiary of today or at least adds to it.

Good. Thank you very much.

The next question is from Brian [Rather] with Morgan Dempsey Capital.

Good morning, guys.

Good morning.

A question about the shift in business, turn business at the Branch. Do you guys have, as you shift from some of the private residential to more of a commercial private or some of the public state highway stuff that's in the Branch Division, is there a difference in bid quote cycles or cash collection cycles or margin differences, or is that pretty [mute]?

Interesting question, Brian. In fact, we did a little research on that yesterday just to kind of see how our public sector work is faring relative to our private sector work, and interestingly enough, they're both very healthy today and very similar types of return expectations in both markets, and I would not consider the cash flow or the billing cycle to be different in any appreciable manner at all. So really for us it's probably somewhat transparent, in terms of the financial implications of going from public to private in today's market.

Okay, okay. Jumping over to the HCD side, some of these projects, of the eight projects that you guys had to write down, how many of those would have been design build?

Three of the eight.

Three of the eight were design build. Is there a pattern -- and I've asked this before -- in subcontractor performance or geological or topography problems or material supply or issues with owners? That's a pattern or is it just a myriad of change problems?

Well, as Bill stated, probably the one common thing is that the larger projects seem to have issues with the owner, and we do expect to recover some of those write downs over time by settling change orders that aren't executed yet and/or claims for issues with the owners.

As far as some of the -- and those tend to be the big -- the common things throughout some of the regions, though, are the escalation of labor in a non-union market, escalations of some material, fuel, delivery, and/or shortages of some materials, aggregate demand, asphalt in some cases where they not only -- they may or may not have a price differential but could affect your overall schedule which tends to run your overhead and the length of your project up. So other than that, I don't believe we have any comment [inaudible].

Okay, okay. And if you went back and looked at the heavy construction side of the business, say, back in the late '90s versus what it is today, are some of those write-downs a function of the complexity of the design build work and of large-scale size of the project, or do you get a sense that there's with the owners a kind of a shift or a transfer of more risk to you, the roads contractor, and they're trying to somewhat [decease] maybe their risk profile?

Yeah, I think you've hit on the thing. On the larger projects, especially the design builds, the contracts are more onerous from our point of view, and we are asked to take on risks that we didn't in the '90s for sure. Things like right of way, not necessarily purchasing it but facilitating the purchase [inaudible]. Utility [inaudible], environmental issues, some permitting, those kind of things in these large projects. Some of them are our responsibility. And those kind of things we didn't really get into in the '90's.

Mike, I think it might be -- this might be a good time to maybe just comment on the evolution that we have gone through as an organization as we've transitioned and begun to recognize the implications of those, the evolution, really of this design build arena and how the ownership has gotten I think more sophisticated in transferring risk and how we've dealt with that or maybe failed to deal with that, at least through that transitionary period.

I think as we've -- we were caught a little bit by surprise on some of these issues and how they mounted quickly. It has taken us some time to get support for resolving these things and working through the process of getting it settled. And we put additional support in the form of our people, as well as consultants from in our regions. We have worked through these issues as we've come to them. But as I said before, as the projects get bigger, so do the issues. And issues in the '90s that you might have settled with the resident engineer face to face, when they get to be big like some of these projects, it takes many levels of approval. In some cases owners that have a representative in between them and ourselves on the project

Okay. Bill, you talked about --

Can I add to that?

Sure.

Because I think there's an important theme here that I tried to address in our opening remarks. We are bidding this work more conservatively today to try to really react to what we've learned, and arguably it took us longer to learn that than maybe it should have, but we've definitely learned a lesson and it's being considered in our -- on bid day today.

And number two, and I provided this statistic and maybe it's worth mentioning again, as we look forward into 2007 in our HDC backlog in our portfolio, we do have only six projects bid prior to 2004, and that total amount of backlog is approximately 100 million that we expect that we're going to carry forward. And so as we move through this transitionary period, we're hopeful and we're working towards trying to make sure that we've made that shift and are properly pricing the risks associated with this large design build work into our bids on bid day.

Okay, okay. You also talked -- one of your remedies you said were putting some focus on recovery of these unrealized revenues. Is that to be construed as more a process of mediation or arbitration or that you're quicker to go to litigation, and give us a sense as to what you want to put behind that?

I think what it means is that we're quicker, first of all, to recognize an issue and to give support to the project and deal with it. Many of these large issues taken -- it could be in the form or estimating from the regional office to help them price something. It could be in the form of scheduling help. It could be in the form of legal help. But we have a more structured process to review these things on a monthly basis and provide support to the project [inaudible] and deal with them.

Okay. There has been some discussion and even Barron's ran an article about the privatization of toll roads and some third parties that are taking over some of these public toll authorities. Does that translate to you guys as better road maintenance maybe going forward, or is it just the same old song and dance?

Well, maybe I can -- maybe I can give some thoughts to your question there. While I'm not going to say it was maybe the same old song and dance, as far as our position in that potential change, the project still has to be built. We'll be part of those teams however they may be formulated, and if we see the markets available to us to be involved in "the maintenance" side of the equation, we've looked at in the past. We'll continue to look at it, and if it's something that we think fits our program, we'll address it at that time.

Okay. Bill, you mentioned too, can you give us a sense of the scope or the size you talked about in the project portfolio for Granite Land company. Can you give us a sense as to maybe how many projects you'd have and maybe the scope? Is it [tract] housing, industrial parks, commercial parks, subdivision?

It's primarily land development as opposed to vertical building to begin with. We have a current allocation of capital of 35 million, which we could increase to 50 without a lot of effort. We don’t have -- I think we probably have under 30 million at the moment that's invested, and I believe it's over about 12 or 13 projects. So you can see that most of these projects are relatively small, several million dollars at a crack, and part of our strategy is not to risk the company in real estate development but to geographically diversify our investments over a lot of the geographies that we have a local presence in, although we are invested in a few that we don't have quite the local presence. Most of them we have somewhat of a local presence. And most of them are with a partner, ideally a well-funded, honest, legitimate partner that we think a lot of that we can trust, and this business I think has a lot of potential.

Yes. But, Bill, does -- is there a transitioning time? I mean, do you exit the project and your partner then gets into the vertical building side, or is the partner and you really there to develop the real estate and then you exit the other?

We're joined at the hip. I don't think that we have any projects -- don't hold me to this but after -- I don't think we have any projects that we and our partners would not exit at the same time.

Okay, okay. And what -- the mining component primarily you mentioned the gold. I mean, are there other precious metals that you're pulling out, too, the stockpiles that you have, silver and whatnot?

No.

Okay, okay.

Our Branch Division manager is across the table telling me aggregate is the precious metal that we're --

Aggregate is a precious metal, all right. So the [inaudible].

It's simply gold. It's a small amount that we harvest in one particular spot, but it's -- we mentioned -- I was telling Bill Barton, it's probably the most regular income that we have, because every ton that goes through that plant delivers a small amount of gold to the bottom line.

Yes. Well, with the cash in your balance sheet, you guys are the Fort Knox of the road contractors so any kind of --

Interestingly enough, we've had just a tremendous cash producing first half of the year. Our cash flow has just been phenomenal. You can see that in the Q, and so, yes, we're really pleased with our cash-producing capacity right now.

One final question for you guys. You've talked about building your networks out and actually buying and acquiring gravel quarries and raw materials. Obviously, the demand components probably price that as a multiple of EBITDA higher and higher and higher. Are you having problems finding quarries and that, and is there a geographic difference in availability?

This is Jim Roberts. From the Branch Division side of the house here, we are actively pursuing not just quarries but businesses, as well. And we're also looking at, and we talked about this previously, Greenfielding which is starting the material reserves from scratch. We're having some success. We have actually opened a new quarry in southern Monterey County just recently. We're actually permitting a couple in southern California.

And I mentioned in the last quarter, as well, that from an acquisition and an expansion process, we are really pursuing the western U.S., and I mentioned that I hope that we would be able to close a deal in '06, and I'm hoping still that we will be able to. So we're actively pursuing. It is competitive. I think one of the things that we are trying to do is to find some relationship building opportunities so that people want Granite to be the acquirer of their businesses, and we need to negotiate and work very strong with them to give them what they need and also to provide opportunities for us. So we think the acquisitions are out there and we've actually got a lot stronger team of people working on that to open up more opportunities for us.

What is, from the standpoint of permitting and EPA and that environmental, how tough is that on the Greenfield side and does that vary state to state?

It's very difficult. Very difficult in the State of California for sure. We -- although if you have patience and you perform the projects appropriately with a team of people that address the concerns of the local agencies, the neighbors, the environment, the timing is long term, but the opportunities are pretty good. So you just have to be able to be patient, very patient to be allow these to occur.

Yes, the patience, is that a multi-year type patience?

Absolutely. Even longer than multi-year. It could be five to ten years.

Oh, okay, that long. Okay.

And we have a lot of those in the Q today that we started years ago and we continue to start several of these every year, and obviously over a period of time you have a couple of them permitted every couple of years.

Okay. So you actually have a backlog of these Greenfield sites then?

Yes, we do.

Would you be willing to comment how many? Tens of them or hundreds or them or what --?

I wouldn’t say hundreds, but probably in the neighborhood of less than ten or ten, somewhere --

Okay, okay. All right. Good enough. Superb job, guys.

The next question is from Rich Wesolowski with Sidoti & Company.

Hi. Thank you. Can you confirm that there were no contracts out of the eight in HCD that were booked after year end 2004?

Yes.

Okay. Moving to the Branch, we've spoken that some of the contractors that might be busy with housing work could come over towards a better public transportation market. Have you yet to see that occur or even more competitors in general? Is it having effect on your pricing in your Q2 new work versus where you were even three or four quarters ago?

I think we've seen a real movement today. The highway work, one of the things I stressed earlier was, Rich, that we're pretty capable of going back and forth. There aren't too many contractors out there capable of going back and forth. There are some and Mark mentioned the private market contractors moving into the public sector market. We know who they are. They haven't migrated a whole lot into that market, a little bit, and I think time will tell, but a lot of these projects are beyond their capabilities, as well. So they're going to be, the migration of the residential contractor to the public sector market will be in the smaller public sector market jobs, not in the big work. And I think it could occur more so than it has. That's yet to be seen.

Okay. Certainly, the Branch backlog has expanded. Can you talk a little bit about the duration of how long you expect a lot of these projects to stretch out to what you've already booked relative to what you would historically see?

Well, obviously our backlog is healthy. It's 50% greater than it was at this time last year. What I would say is that the difference between HCD and the Branch Division obviously is our backlog duration is much shorter. We do believe that a lot of our backlog will be very healthy carried forward into 2007, but the majority of our backlog is typically eaten up within the 12-month period in which we are -- procure the work. But we are seeing right now the ability to carry the big jobs and the book jobs that will carry into the 2007 business, and we think that's very healthy for us. So I don't want to speculate beyond 2007, but the second half of 2006 and probably the first half of 2007 has a very healthy backlog.

Thanks a lot.

[OPERATOR INSTRUCTIONS.]

Your next question is from Alan Mitrani with Sylvan Lake Asset Management.

Hi, guys. Good quarter. I may have missed this because I've been on a bunch of conference calls this morning, so I apologize if you're repeating yourselves, but do you have a sense -- well, two questions. First of all, did weather impact you at all in the quarter either negatively, taking away certain days, too much rain?

I don't think so. I think, I mean, obviously weather may have an impact locally from time to time but, no, as a whole pretty straight-forward.

Thank you. And, then, relative to either your aggregates division or as it relates to your Branch, maybe you can give a sense. What percent do you think -- I know it's hard -- is related to residential, and then are you seeing any slowdown in any residential bid jobs? And, lastly, what about -- can you distinguish between residential type jobs that are sort of related to new build versus ongoing things that happen regardless of what the interest rates are in the economy?

That was addressed in some respect earlier. We don’t really differentiate between residential and private in terms of being able to break it down for you right now. We've said and what we've said in the last quarter and I'll continue to say it again in this quarter is that, although the overall private sector seems to be cooling off a little bit, we look at it as kind of a shift from the residential market to more of a commercial and industrial market. We tend to follow the residential market. So it's fairly static today, and we don't dive down into the actual type of work in the private sector. So I wouldn't be able to answer that for you in terms of stats.

Okay. I appreciate that. Thank you.

Your next question is from Joshua [Polick] of Goldman Sachs.

Hey, guys. One quick question. I just wanted to double check on one thing that land sells is something that you would see not every quarter but some quarters. Is that something that we should not expect for the rest of '06?

I'm sorry. Could you repeat the question?

The question was, you guys said that the land sales is something that you guys don't expect to see every quarter but something that you guys should definitely contribute annually. Are you guys expecting that to continue to contribute in '06 since it was pretty decent?

We may have a small additional contribution in '06. I don't think it's anything that would be considered material or something that I would encourage you to try to anticipate in your model. But we -- our guidance that we reluctantly gave earlier was that the expectation is that we would have an annual contribution going forward that would likely be similar to what we experienced from a net standpoint in this quarter.

It won't be necessarily the same quarter every year.

No, it won't.

[inaudible].

Understood.

I think the main point is that we simply want you all to appreciate that this is part of our strategy. We would hope that you would not consider our contributions from our Land Company to be a one-time only event. And we just want you to appreciate that this is part of our ongoing business today. We intend to nurture that business and hopefully grow it.

Thank you.

At this time there are no further questions. Do you have any further remarks?

Well, if there are no further questions, we really appreciate the interest that you all are taking in our company, and as I suggested to our employees, we're doing really well as an organization. We are really proud of our quarter. We're really proud of what we expect to do this year, and we're really proud of the people that make it happen. So I would invite you all to get back to us through the balance of the day. We will be here if you have further questions. And once again, thank you for your interest in Granite Construction.

Thank you for participating in today's conference call. You may now disconnect.