Granite Construction Inc (GVA) 2007 Q3 法說會逐字稿

Good morning. My name is Vonda, and I will be your conference operator today. At this time, I would like to welcome everyone to the Granite Construction third quarter 2007 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)

Thank you. Miss Underdown, you may begin your conference.

Good morning, and thank you for joining us today. Today, I'm joined by 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; Jim Roberts, Senior Vice President, Granite West Manager; and Mike Donnino, Senior Vice President, Granite East Manager.

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 any future uses or recordings. As always, shareholders, analysts and employees can listen to a live webcast of the call on our website.

We will be making statements during this call that are forward-looking. 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 and the comments made during this conference call, as well as in the management's discussion and analysis section of our Form 10-K and other reports and filings with the SEC. We do not undertake any duty to update any forward-looking statements.

To help clarify the impact of the Company's organizational and strategic realignment on our financials, we have made restated historical segment results for the quarters and year ended 2006 available on Form 8-K that was filed Friday, October 19th.

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

Thanks, Jackie. Good morning, and thank you for joining us on our Granite Construction third quarter earnings call. On our call today, I will address the following topics. First, I will provide an update regarding our strategic realignment announced in February. Second, I will review the financial performance of our Granite West business segment, along with a qualitative short-term and long-term analysis of our business outlook in West. Third, I will review the financial performance for Granite East, and we will provide a qualitative business outlook for Granite East as well. And last, I will discuss our plan to return capital to our shareholders.

As we discussed in our second quarter call, our realignment to Granite West/Granite East is progressing nicely, and we are on track to have this transition completed by year end. All large projects west of the Rockies are now being reported as part of Granite West, with the exception of the SR-22 in southern California. We will continue to report the SR-22 in Granite East until it is completed and all outstanding claims are resolved.

I am very pleased and enthusiastic about our realignment, which has been designed to focus our project resources and ensure we consistently delivery much-improved large project operating performance across the Company, as well as to support continued growth in the west.

Our realignment has also positioned us to take full advantage of the opportunities funded by the California Transportation bonds, approved last November. Our employee commitment to our Granite East/Granite West organizational structure has been remarkable, and it has been invaluable to the success of this transition. I believe we are now aligned to consistently deliver performance, the performance we expect in both Granite West and Granite East.

Let's talk about Granite West and our financial performance. Revenue for the quarter was effectively flat compared to a year ago, and gross margins remained very strong at 19.4%. Gross margin percentage in the third quarter improved to 18.8% in 2007 versus 17.8% in 2006. This is outstanding performance. Clearly, our construction operations in the west are performing very well, driven by patience on bid day, strong backlog and excellent execution.

However, third-party construction material sales, as well as the gross margin on those sales, were down compared to a year ago due to the weaker housing market in some of the geographies in which we work and its effect on demand and its influence on our mix of products sold. Granite West backlog stands at $951 million at the end of the quarter, compared with $1.1 billion a year ago.

However, new awards for the quarter were $483 million, compared with $425 million a year ago. I believe this is a very positive sign and reflects our ability to capture medium- to large-sized public works projects out for bid in the west. These are the key projects we have been targeting.

Operating income for Granite West is comparable, year to date, to our record performance in 2006. Operating income for the quarter is off $15 million from last year.

As we have discussed with you on prior calls, we are experiencing increased competition in some of our markets, as capacity which would otherwise be consumed by the demand for housing construction migrates into the public works marketplace. We are primarily seeing this migration in our California markets, and it has increased the number of bidders on smaller public works projects. Other markets out of California have not been impacted much by the housing slowdown and remain quite strong.

This market condition in California could be offset by significant increases in public works funding next year. Proposition 1B funding in California continues to drive a great deal of our optimism. We expect Proposition 1B funding to add approximately $2 billion in new funding to the 2007/2008 Caltrans construction budget and an additional $2 billion for local cities, counties and transit districts.

Increased funding is expected to remain strong through 2010. There is no question that from a public works point of view in California, the next three years will be very exciting times for Granite West. Any upturn in the private development marketplace would certainly be additive to our anticipated increases in public funding. This would form the basis for a very healthy marketplace, which would support very strong long-term performance in our Granite West business.

Now let's discuss our Granite East business and our third quarter results. Our Granite East revenue for the quarter was down significantly from $260 million in 2006 to $183 million this quarter. This decline in revenue is primarily due to our commitment to right size our Granite East business so that we can consistently manage it profitably. Our gross profit for the quarter was $2.1 million in 2007 compared with a loss of $27 million in 2006. This is a significant improvement that we are pleased to report.

In the quarter, there were nine Granite East projects with forecast adjustments in excess of $1 million. Six projects experienced positive forecast adjustments, and three projects experienced negative adjustments. The net impact of these forecast adjustments at the consolidated project level was a negative $8.6 million. The most noteworthy negative adjustment was on the SR-22 project, where we recognized an additional $10.9 million in losses. It is unfortunate that this project continues to draw attention away from the positive changes that are occurring in our large project portfolio.

In spite of our SR-22 adjustment, Granite East operating profit increased $32 million quarter-over-quarter and $53 million year-over-year. We believe our large project backlog in Granite East is considerably better than it has been in the last several years. All of the key projects we have been discussing in our last two earnings calls are performing well, and we are becoming increasingly more confident that these projects will drive the Granite East turnaround that we are all anticipating.

To further illustrate the point, 14% of our Granite East backlog is forecast to break even going forward, and the balance, 86%, is expected to be profitable. At least two of these projects, the $420 million I-64 project in St. Louis and the $464 million ICC project in Maryland, will reach the completion threshold for profit recognition in 2008. This is a very exciting trend, which is contributing to the optimism we have for improved Granite East business performance in 2008 and beyond.

Now I would like to discuss two very important actions, which have been approved by our Board of Directors. Both actions are grounded in the philosophy of returning capital to shareholders in excess of our operational and planned strategic growth requirements through a combination of share repurchase and increased regular quarterly cash dividends. It is our belief that the long-term outlook for our business is excellent. Public works funding is expected to remain very strong throughout the country to address the need to repair aging infrastructure and build new capacity.

In addition, we are confident that our strategic realignment into Granite East and Granite West, as well as the operational improvements we have been making to our large project business, is beginning to pay off. We expect our Granite East projects to contribute to overall profitability and cash flow. This turnaround, along with the confidence we have in the long-term performance of our traditional, vertically integrated businesses in the west, is supporting our capital allocation philosophy.

In alignment with that philosophy, our Board has approved a $200 million share repurchase authorization. It is our believe that along with our desire to grow the size of our business and our geographic presence, using capital to repurchase shares is an appropriate use of capital. In addition, our Board has approved a 30% increase in our regular quarterly dividend from $0.10 per share to $0.13 per share, commencing with our fourth quarter dividend, which will be paid on January 15, 2008.

Our management team and our Board are squarely focused on our duty to continue to build a great Company, which is financially sound and able to capitalize on growth opportunities which create value for our shareholders. We believe returning capital to our shareholders, which is not required to support our operational needs and our growth strategy, is clearly in alignment with our overall goal to build shareholder value.

In conclusion, through nine months ending September 30th, our overall business has performed at record levels. Net income, year to date, is $94.9 million, compared with our previous net income record through three quarters of $77.6 million, which occurred last year.

We are very pleased with our business performance to date, which has occurred in spite of a challenging bidding environment in the west, and we expect to deliver record net income for the year and earnings per share in the range of $2.55 to $2.75 per share. That equates approximately to net income of $106 million to $114 million.

We are very bullish on the long-term view of our markets and the demand for our construction services as well as our construction materials. We intend to continue to invest in the development of our people and the tangible assets that will make us strong, financially resilient and able to deliver operational excellence over the long term.

I would like to take this opportunity once again to thank our employees for their continued commitment to Granite, to our mission, to our customers and to the stakeholders that depend on our performance. Your hard work has put us in a position to deliver our best year ever.

Now I would like to turn this call back to our moderator, and we would be happy to take any questions from our listeners.

Thank you. (OPERATOR INSTRUCTIONS)

Your first question comes from the line of Richard Rossi with Ferris, Baker Watts.

Good morning, everybody.

Hi, Rich.

A couple of things. You mentioned the 25% completion targets for those two large projects early next year. Do we have anything else that's sizable, either before the end of this year or anything else in '08 that could be meaningful to results?

Hi, Richard. This is Mike Donnino. As far as the large projects, really, the next two on the horizon are those two -- the I-64 in St. Louis and ICC. The I-64 will be near that threshold at year end, but probably will flow into 2008, and ICC will be later in the year.

Okay.

Rich, I think the World Trade Center will be a contributor in 2008. It's a small contributor in 2007, but it's really getting cranked up. It's going to turn quite a bit of volume in 2008. So I think we can look forward to that helping our performance in Granite East as well.

Okay. Actually, that was my next question, to see where the progress on that was. Also, in terms of the aggregate business, could you give us a sense of what tonnage was in the third quarter against year-ago numbers or against second quarter numbers?

Richard, this is Jim Roberts. Yes, I have some of those numbers, but I think approximately down a little bit, and we look at third quarter and year to date both on the aggregates. And one thing to remember is that we break that business into really three segments -- aggregates, asphalt and ready mix. And the asphalt is very close to being the same as last year, and aggregates are down a little bit.

All right. How is pricing in that marketplace now with things softening up a bit generally?

Well, interestingly enough, the pricing is very strong. It's very -- it definitely increases from the previous year, but not enough to offset some of the additional cost as well. And we're not seeing a significant reduction in costs. We're mostly looking from a volume basis.

Okay, all right. Onto the problem projects -- we've got three in the quarter that were -- the forecasts were adjusted downward, including the large adjustment in SR-22. Could you give us a sense of completion times for those three jobs?

Yes, the three jobs, and you've heard about two of them before. The SR-22, we're still on schedule to be physically complete by year end, with the exception of some landscaping. And even that is being accelerated as we speak.

The other one is -- the second one is a job in Austin, Texas. It's scheduled for completion this year as well, somewhere around November.

And the third job, which is a very profitable job for us, is a non-sponsored JV in New York, the South Ferry project, which adds some project closeout problems. And we kind of backed up this quarter on that project. But it, too, will be complete this year.

Okay. So all three of those jobs should not be an issue, a negative issue in '08?

That's correct.

And, of course --

And, Rich, we made -- in our scripted remarks, we made a point to try to emphasize that only 14% of our backlog is work that is forecast to break even, which, in sort of Granite code, means that it's work that we are losing money on and we've recognized all the losses at this point. And our forecast, if it is proper, should -- we should report cost equal to revenue until they're done, going forward. But only 14% of our backlog is in that condition today, and that's a huge change from a year ago.

No, I recognize that. Talking about that and looking forward to the recovery in your margins, we used to talk about heavy construction division margin recovery. And I forget now, but I think you used to be talking in the 6% to 8% area as a recovery rate, a recovery area for margins? Regardless of what it was, could you give us -- now that you've realigned these operations, could you give us some sense of what your margin target might be for in Granite East, going forward, let's say? And not even a specific time, but --

Rich, excuse me. Are you talking about new projects going forward? Or combined with the backlog in place?

I'm talking about what's in place now.

Well, that, obviously, as we burn off those zero jobs or those projects with no profit in them, that number goes up. And we're seeing that trend continue. As we burn those off, those numbers continue to go up. And as that 14% goes to zero, they should continue to do that and get us back towards our expectations for all of our projects.

And those expectations are?

Yes, the minimum we've been saying, I think, for a while now is our minimum expectation is 12% at the gross level.

Okay. That's for the total company?

Yes.

And I will tell you, Rich, the work that we're bidding today, certainly any complex design-build work is far beyond 12% on bid day.

Right, right. Lesson learned, right?

Lesson learned.

And then, one final thing. Of course, the tragedy in southern California. Is there anything -- first of all, is that having any impact on any of your projects? I don't think it would, but I'm checking that. And secondly, is there going to be a call on your equipment possibly in the coming weeks?

Richard, this is Mark Boitano. We're not seeing that, today. There has been no direct impact to our business, although we have some employees that may have been impacted. And as far as equipment goes, no, we don't see that having any sort of impact to our business.

Okay, that's it for me. Thanks very much.

Thanks, Rich.

Thank you. Your next question comes from the line of Bob Labick with CJS Securities.

Good morning.

Good morning, Bob.

Hi. The first question I wanted to ask, could you help us understand the timing of the Prop 1B funding and the additional public works funding? You alluded to $2 billion in Caltrans and potentially another $2 billion in additional public works. When should that, those projects be let? When should they be recognized by Granite on the P&L essentially?

Bob, this is Jim Roberts again. It's a good question, and it's something that we looked at very closely over the last couple of months. The latest information that we have from Caltrans is that 2007/2008 fiscal year, which is literally September through September of '07 through September '08, is -- shows about $2 billion of Prop 1B funds hitting the street in that timeframe.

And I think that Bill mentioned it as well is that when that Prop 1B passed, a portion of that, a very large portion of that also goes to the cities and counties and local municipalities. And so also, we see another $2 billion going to the local entities over the next 12 months as well.

And we really look at it like quarter by quarter. We do see a lot of it starting to hit the street in the fourth quarter of '07, and we see a lot of it hitting the street in the first quarter of '08 as well. And really, the next 12 months is probably the single most strongest part of that overall funding mechanism along with the '08, '09. So we think in the next 12 months, it should be hitting the street very strong, and we see the first quarter and second quarter of the next year hitting as strong as well.

But keep in mind, Bob, by the time that hits the street, gets big, gets let, work starts, there's a fair lag there. Could be several months to three or four months. So there is process in place that we have to go through in order to actually find ourselves with, number one, that work on our backlog and, number two, it contributing to our performance.

I think Caltrans is pretty dependable from a standpoint of meeting their schedule, get this work on the street. As Jim said, we've done a little research, in particular in the last several days, to try to make sure that we could communicate accurately what we can expect. And I think we're all pretty optimistic that the next six months are going to be wild, frankly. So we're pretty excited about that.

An interesting part, Bob -- this is Jim, again -- it looks like through the end of '09, they have a very strong program. And that's really exciting for us, that both '08 and '09 is where they've really targeted a big chunk of those 1B funds, a littler earlier than we anticipated originally. So that's actually good news.

It sounds extremely bullish, obviously. So, I guess, just in terms of your backlog, should we see anything in Q4 or is it really Q1, we'll see the backlog? And in Q2, 3, we'll start seeing it kind of hit the P&L, from what you just described?

I think it could be any of those quarters. It's a matter of when they actually hit the streets. And Mark's actually absolutely right. When they hit our books is actually after award, and that can take place 30 to 60 days, post award or post bid. So you should start to see some pretty nice adjustments in the first quarter of '08, even if they bid in the fourth quarter of '07.

Okay, terrific. And then, in terms of your share repurchase, obviously you have a significant amount of cash. You're drawing down the overall size of Granite East right now, which I imagine reduces the bonding requirements. Could you give us a sense of what levels of cash you need to maintain or you expect to maintain for the future bonding requirements, for the new right size of Granite East?

Okay, Bob, this is Bill Barton. And in essence, as a lot of our cash, as we have talked about in prior quarters, is tied up, continues to be tied up with our joint venture partners, the advanced payment through billings in excess of cost as well as requirement for bonding.

And in short term, we continue to have the same level of bonding requirements, and that will probably be in the short term continuing. Certainly, Granite East -- basically, it's both Granite East and Granite West, there's going to be a greater emphasis on larger projects on Granite West. So it may not effectively change the requirements for bonding. But certainly, the level of [cap] that we have today is meeting our needs with some excess, but it's not sufficient to do everything -- it's certainly sufficient to do -- to provide for our working capital and certainly will be one source of many that we'll use for our share repurchase.

Okay. And are there any restrictions on the timing of the share repurchase other than a blackout for this call and everything else, where you can begin 24 hours after [now]?

Yes. From our share repurchase program, approved by the Board, is open ended. Certainly our windows are closed until Monday, and the next period of time that it's open to is December 15th. We certainly have other tools that we can use, and we certainly will use that, as appropriate.

Okay, terrific. I will get back into queue. Thank you very much.

Thank you.

Your next question comes from the line of John Rogers with D.A. Davidson.

Hi. Good morning.

Hey, John.

A couple of things. One, did the Superior -- the acquisition up in Washington, how much did that add in the quarter? Or anything?

Usually, John, we don't dive down into individual business units. But I wouldn't suggest that it was significant enough to really have any kind of a play in the business results in the third quarter.

Okay. So it was -- all right, so it was minor?

It was insignificant.

Okay. So the falloff in the branch or the, I'm sorry, the Granite West, was primarily California, though?

Yes, primarily California.

Okay. And then, in terms of your comments about Granite East being breakeven for the year, are those still valid?

John, this is Mike Donnino. Net of the effects of the realignment and, of course, the SR-22, which has been a drag on the earnings this year, we would have made that easily. But at this point, we still believe that we can get to that breakeven, even with those issues.

For this year, so --

For the year, yes.

So that's a pretty big rebound in the fourth quarter on a reported basis? I mean, because you've got, what, a $13 million operating loss here to date.

Yes, well, that'd be true.

Okay, okay. And in terms of margins on the branch business, you've talked about the greater competition coming in. Are you seeing lower margins on the work that you're bidding right now and expecting that margin to improve as we go out into '08 and see more work coming? Or are you holding the line on margins now?

Yes, John, this is Jim again. It really depends on the job, the location. With our diversification of locations, we're seeing some very healthy markets in some locations. And some locations, we're seeing some very competitive markets.

So as the larger projects come out to bid, we do anticipate very nice margins in those jobs. We may see a reduction in some of the smaller work in order to stay competitive. We certainly don't like to suggest that at all, and our people are holding the line very strong out in the field. But overall, I think it depends on the individual location. It would be really not fair to tell you that you're going to see a reduction or an increase overall because some of these large projects and some of these locations, we can get a very healthy margin off.

Okay. But that's prospectively that you expect to see that margin improve? I'm just trying to understand the difference between what you're seeing right now and what you expect to see.

Well, we're seeing very -- looking at and listening to Bill's report, that kind of construction margin is excellent, where we're at today. We certainly want to see it stay at that level. That is our intent. And I think over the long term, that's where we intend to be. And from time to time, there are jobs that we will bid less than that, and time to time, there's jobs that we'll bid with a higher margin than that. It's really going to depend on the mix, to be honest.

Okay. Okay. And in terms of Granite Land Company, are you assuming any significant revenue or earnings out of that operations for the rest of this year? It had a pretty good third quarter.

Yes. John, this is Bill Barton.

Hey, Bill.

We're -- one thing about Granite Land Company, I think they have a good business, and it's certainly began to return pretty steady margins to the overall business. But it is very lumpy. If you look, compare one year over last, you can see that most of the profitability came out of the second quarter. So this is -- a lot of it's just based on when the sales take place.

Right.

I think on a year-to-year basis going forward, I think there's opportunity for consistent performance. It's just on a quarter-to-quarter basis, it's going to be lumpy. We won't see any significant contribution from the land company for the balance of the year, John.

Okay. That's what I was just trying to understand in the range that you've given us here implied to the fourth quarter. Still pretty wide, but I assume that it has more to do with the large projects. I just wanted to be clear of that. Okay, okay. Thank you.

And your next question comes from the line of Jack Kasprzak with BB&T Capital Markets.

Hello, everybody. Actually, this is Paul Betz, BB&T. Going on, even further with what John was asking, with your expectations that Granite East will break even in the quarter, so at least $13 million in profit and nothing significant from the land division for the rest of the year, with the guidance you've given for the year, it kind of implies a midpoint range for Q4 of what you had last year in the fourth quarter earnings of about 35%, 37%.

But that quarter had a huge operating loss in the Granite East segment. So are we to infer that Granite West operating income will decline significantly year-over-year in the fourth quarter?

Compared to last year, Paul, I think that we will have a lower operating income in the fourth quarter. That's correct. Significantly, I'm not so sure that's the right word to use, but we do expect to date. Typically, in the fourth quarter, last year, we had great weather, fourth quarter. We certainly don't anticipate that in our earnings discussions. We look at more of a norm for weather. And when we do that, it would be a lower operating income in the west for the fourth quarter than last year.

Okay, thank you. Another question, the Prop 1B funding, you sound very optimistic on that. And you've stated before that these small residential contractors, you expect they wouldn't really compete for this type of business because they either don't have the equipment or the employees or the bonding level. Is that still a fair assumption? Like, do you still see the market being competitive for these huge projects that could come from the Prop 1B funding?

Paul, it's typically the smaller private contractors. When they work into the public sector, they will bid jobs, let's say, up to $1 million or $2 million and be very competitive for a very short period of time until they reach their capacity.

On the larger projects, we see a similar type of competition to what we've had in the past, and there's usually two, three, four bidders on every one of those large projects. We tend to be very competitive when they're in our home markets and capable of getting our share of that work, and we don't see that changing.

Okay. Thank you very much.

Your next question comes from the line of Rich Wesolowski with Sidoti & Company.

Thanks a lot. Good morning.

Hi, Rich.

On that point about the competition sitting out as you move up the ladder of project size, are the three jobs that you won and announced within the past six weeks or so, is the bid margin on those higher than, say, the average that you booked for the quarter in the west?

Higher than the average that we've booked for the quarter?

I'm just trying to figure out if the expected dynamic that you're going to have less competition for larger 1B work actually played out in the larger projects that you won within the last couple of weeks.

Rich, I know that two of the jobs that we announced I know had an excellent margin on them. I'm trying to remember. I don't remember specifically the third one. So those two jobs specifically, and I'm not going to suggest that that's anything exactly going forward, I think there are excellent margins in those jobs.

Okay. Last call, we had heard that the meet of the Prop 1B project letting would go through in 2009 and 2011. And now, it sounds like next six months through '09. Is that -- has your expectation substantially changed over the last three months?

Well, we're a little surprised, to be honest. But when we saw the detailed breakout from Caltrans, and really the big chunk of the funding is in, really, through the end of '09, but still a nice year in '10 and then dropping off pretty rapidly in '11 and '12.

We thought originally that it was going to be more well paced through the entire four- to five-year period. But surprisingly, they're willing to and ready to put some of that funding up front earlier than anticipated. So it's a little bit of a change of plans. We actually have a detailed list of all the work now, Rich, and we're very excited about their increased workload in the next 18 to 24 months.

Rich, that is a little different than the story that we had been communicating the last time we were out east, I know. It was our belief that Prop 1B might even peak in '09 and '10 and '11, and it's actually going to peak, if Caltrans does what they say they'll do -- and I believe they will -- it's going to peak in 2008. So that couldn't come at a better time for us. We're ready for it, we think. I think that generally the marketplace needs the stimulation. So it's a very good sign.

Do you think there's a risk of -- and I understand that the Prop 1B funds are segregated from the general fund. But do you think there's a risk that as the California fiscal stance weakens, if that is the case in the next two years, that they use those funds as an excuse to deplete the rest of the budget?

Well, I asked that question of Will Kempton, the Caltrans Director, this week, and he said absolutely not. But having said that, they are -- they believe that they will face some pressure in their typical budgeting process, their gas tax revenue funding and so forth.

We won't necessarily feel that for a couple years. But as they look out into the future, we're going to need to do some work politically here in the state to, once again, probably go to the voters or go to the legislature and shore up the transportation funding in the future.

So Prop 1B money is timely. It's real. It's going to get spent. It's going to get spent in the next several years. But underlying that, there is a fundamental flaw in transportation funding in the State of California that needs to be addressed. It's not an immediate problem, but it will be one that we'll have to deal with in the next several years.

Okay. Finally, are liquid asphalt prices affecting the bidding or are the owner/engineers doing a better job at factoring that in this time around?

Rich, I think that they've done a much better job. They've adjusted their engineers' estimates to take into account some of the escalations that have occurred, not only on liquid asphalt, but obviously diesel and other energy-related products. We're not seeing the projects individually being under-funded like we did probably a year and a half ago.

Great. Thanks, a lot.

Your next question comes from the line of Michael Corelli with Barry Vogel & Associates.

Hi. Good morning. I don't want to beat a dead horse, but I just had a question about the guidance. It seems like if you break it out, I think you had approximately $0.28 a share a year ago in the fourth quarter, excluding some of the unusual-type items. And it looks like you're projecting about $0.27 to $0.47 this year, if I subtract your full year from the nine months.

And last year in what was the heavy construction division then, excluding unusual items, you had about a $58 million loss in the fourth quarter. And I believe you just said that you expect Granite East to be profitable in the fourth quarter to the point of where it would offset the losses for the year and be relatively breakeven. So right there would be a humongous positive swing in your earnings. So I don't understand why the low end of your range would be indicating flat earnings if you're, as you just said, not expecting a significant decline in the Granite West.

Well, I mean, I can certainly appreciate the confusion. And one of the things I think that, and I think we all need to make sure that we get right, is the minority interest calculations in the swings. The minority interest was a big impact to the loss that we posted last year and it's an impact in the other direction this year. So I would encourage you to look at how you calculate that minority interest in trying to find that solution to the guidance that we've given you.

I also think, and maybe Jim can help out here, we had a -- to use your word, we had a humongous year in Granite West in the fourth quarter. We had incredible momentum going into the quarter last year. We had great weather that carried through the end of the year. And I'm not going to say that we don't have momentum going into the fourth quarter. I think we do this year. But we don't know what the weather is going to do, and our market has changed some from a year ago. So we've got a lot of factors that we had to try to consider.

I think the other thing that maybe our listeners can appreciate is that we are trying to forecast numerous things when we try to forecast our work, our performance, going forward. Certainly, one of them is weather in the fourth quarter. We clearly have just a standard forecast challenge on our work.

But particularly in the instance of our large business in Granite East, we're trying to anticipate whether we will recover certain revenue issues, claim issues, and whether or not to include them in our fourth quarter forecasts. And there's a great deal of uncertainty around that, and it makes it very difficult to get precise in our -- when we provide guidance. We do our best. We try not to get too far ahead of ourselves and offer you guidance that we don't feel comfortable we can get to, and that's just how we do it.

Mike, let me, this is Jim -- let me add one thing. In the last two years, both the fourth quarter of '06 and the fourth quarter of '05, we had very, very dry years in the west. And that certainly created some opportunities that we hadn't seen in the past. And so, I would not -- I think our issues is that we would not expect that to be the norm.

And that's why when we look at our fourth quarter, we do anticipate weather issues that are going to lower our expectations for the quarter. And the last two years have just been very, very dry, and we're seeing that in the drought situation here now. So, certainly, our forecast is, on an average, it's based on weather conditions.

And keep in mind that whatever we don't build in the fourth quarter gets built the following year. So it's not like the work goes away. It just falls into a different reporting period. So I think it's -- again, this business is pretty difficult to quarter-by-quarter evaluate. You've got to look at it on a year-over-year kind of or a year-at-a-time basis. So work doesn't disappear. It just gets pushed into another period.

Okay. And then just a couple of quick follow-up questions. On the three problem projects you identified in the quarter, it sounds like they're all pretty much ending by year end. What's the read on what you would expect to happen with those projects in the fourth quarter? I mean, do you think there will be additional losses there? Do you think it's pretty well taken care of?

Well, we certainly hope that we don't have additional loss. We try to do our best to forecast those jobs for what we see ahead of us. But just the fact that they're all 95% plus complete would increase that probability of not having further problems. So it's our expectation that we've got that, those projects handled. And as I said, the one job is a very profitable job. That just backed up a little bit due to some issues we had at the close of the project.

Okay. And then, as far as the SG&A expense, obviously, it's grown pretty aggressively here recently. Is that still the anticipation that you need that as far as the growth that's going to be coming with the infrastructure spending in California, or are there going to be some efforts to try to tear that back at all?

Well, that's a really good question. I'm glad you asked that. Some of the SG&A is a product of adding our acquisition up in the Pacific Northwest. So there's some additive cost associated with that business.

The balance of it, you're right, is support for the growth that we expect over the long term in our business, particularly in Granite West. We have been positioning our business to continue to grow. As I suggested in the scripted remarks, we intend to continue to invest in our people and invest in tangible assets that will allow us to be strong in the long run. And to do that, we need the support to -- we need the SG&A support to make that growth happen, number one, and then support when it does.

It is clear that if we did get a slowdown at all and the revenue growth of our Company, our SG&A shows up, we'll watch that. We do not intend to overreact to that because so much of our SG&A is not what I think you would typically see in a lot of companies. It's not administration activities. A lot of it is estimating, engineers that support the work in the field. A great deal of it is spent in that regard, and this is very -- these people are very skilled, very technical, very committed to the Company. It takes years and years and years to build that skill set.

So our hope is that we will -- well, it's more than a hope. We will continue to employ these people and continue to use all of our efforts to grow the business so that our revenue will support the people we have.

Is there any opportunity to cut it at the acquired company?

I'm sorry?

Is there any opportunity for you to take costs out at the acquired company?

Let me address that. That really is pretty insignificant relative to what we're trying to accomplish. I think the acquired company, and I think you're talking about Superior up in the Pacific Northwest, we're just getting our feet on the ground.

What happens, really, any time we acquire a company, Mike, we have some pretty significant transition costs in order to go in and work on equipment, how to realign the business. They've done an excellent job up there. We've got a great time up in the Pacific Northwest. That'll probably naturally change in '08 as we get some of these transition costs behind us. It's not a cutting of people at all. It's more of getting the transition costs behind us.

All right. And then just finally, it looked like your tax rate was higher in the quarter. Could you talk about what happened there and what we should expect going forward?

Okay, this is Bill Barton, and the tax rate generally follows the income. And one of that affects it really is minority interest, which is not affected by the -- it's not part of our tax base. It's passed on to our joint venture partners.

And so, that level, as it changes, can affect the affected tax rate, and that's one of the things that changes from quarter to quarter a lot. If you want to look forward, our estimate of what the tax rate could be is around 31%.

Okay, thank you.

Your next question comes from the line of Michael Lewittes with JL Advisors.

Hi, how are you? On the weather question that you were just discussing, if you were to assume that the weather stayed phenomenal this year and is as good as it was last year and the year before, so no change, which I know is not your assumption, but no change in the weather -- then what would your fourth quarter guidance have been?

How about a simple answer of better?

How much better? How much of weather is in that fourth quarter guidance?

That's a really good question, Michael. And it's probably such a detailed question. It's hard to answer. We typically expect very little cause and effect in the month of December. And obviously, that's the third of fourth quarter. And if that was a dry December, it would probably be very productive in December. So, a third of it is probably anticipated to not even provide any value.

Okay, thanks.

Thank you. Your next question comes from the line of Todd Vencil with Davenport & Company.

Hey, guys. How are you?

Good morning.

Let me sort of go back around and follow up on the prior question about materials pricing. You said it was up year-over-year. Have you seen any sort of sequential or spot declines in any of your materials pricing?

Todd, this is Jim again. I think one of the things that we have seen, which has obviously affected the operating income in the materials side of our business, is the product mix. And there are certain products that we were providing into the residential market that we're not providing today. They were pretty good margin-related products.

So what we're seeing on a day-to-day basis is the pricing is staying strong. Certain products that are higher-margin products, we're just not seeing the volume that we've seen in the past years.

Okay, so just to ask it again in a little bit different way, on a same-product, same-store basis, are you seeing any slippage sort of sequentially?

Not on same-product, same basis, no.

Got it. Okay. And then I hate to do this to you and everybody else, but I'm still scratching my head over the Q4 guidance. So maybe let me think about it a different way and let's ignore the year-over-year comparison, but just think about it, if you'll indulge me, in terms of a comparison of what we just saw this quarter, in the third quarter.

I mean, first of all, we're not assuming any write-downs in the east division. Is that correct? Or any losses from write-downs? If we had, we would have already included them. Is that right?

That'd be correct.

That is correct.

Okay. Are you assuming any sort of decline in revenue beyond sort the normal seasonal pattern from the third quarter?

Ask that again.

Do you think revenue is going to fall more from the third quarter to the fourth quarter than it typically does just seasonally? And again, just sort of factoring out the last couple years if you want to. Are you looking for a normal seasonal decline in top line, or is it worse than that because of the bidding situation in California?

Well, that's really a good question. I think our Granite East revenues are expected to be lower just because they're headed in that direction and have been.

And that's a function of the size of the backlog primarily, right?

It's a function of size of the backlog and the burn-off rate that we're seeing coming out of that backlog.

Okay.

And I don't want to speak for Jim and Granite West, but I think, as we've suggested, we've got some markets in California that, where it has become tougher. And as a result, we have slowed down in some of those markets, and I expect that revenue will be lower as a product of that. But I want to make sure that I don't over-emphasize that because we've got markets out of California that are really pretty good.

And actually, in pockets of California that are excellent as well. I do think, and Bill mentioned it earlier, I thought it was a right-on statement, that we just had humongous momentum going into the fourth quarter of last year. We've got good momentum going into the fourth quarter of this year.

Right.

That's probably the difference more in just a sense of where we're at. The projects are healthy. The markets, most of the markets are good, but just not with that same level of momentum that was at this point in time last year.

Okay, so this, the third quarter, if I've got my numbers right, I probably don't, but you were down sort of single digits revenue year-over-year. I mean, are you looking at 20%? Is that -- I'm trying to pick a high number here. Are you going to be at 20%, year over year, on the top line, you think? Or is that unreasonable?

For the Company or for Granite West?

For Granite West.

I think that's a hard question to answer. I think 20% is probably on the high side, but again I think weather will be a big determining factor on that.

Okay, fair enough. And then, margins in Granite West -- are you looking for some kind of massive decline there? Or perhaps some drifting down just on the competitive pressures?

I think, Todd, one of our philosophies is that we'll probably see a reduction volume before we see a reduction in margin percentage. So our intent is to try to stay very strong in our expectations on bid day, stay very strong on our expectations in our materials business on margin percentages and see how the markets react.

So I would hope that our margin percentages would be the last thing that we would see a decline, if we see a decline at all. There's a very strong chance of that in the fourth quarter and in the first quarter of '08 that we'll have the backlog that we expect and with the margins that we expect. So I don't anticipate a significant reduction in margins at this time, although the market will dictate exactly where we're going to end up at.

Okay. And then, one final question. As you mentioned, you used the word right-sizing the large projects business and right-sizing Granite East. Is there, I mean, do you guys have kind of a run rate in mind or a size in mind around that? Or are you just going to sort of feel your way toward that as we go along?

No. I think the size that we are right now is about where we want to be, but it varies so much because of the minority interest on these larger projects. For example, ICC and the I-64 job, our partner shares approach 50% of the project. So it depends, as far as what you guys see as the revenue, depends on the mix of the type of job and the type of ventures that we have to build the projects. But I think we're comfortable with kind of where we're at and the size right now with the three regions.

Okay. So based on -- and I don't know if you want to answer this, but I'll give it a shot. Based on what your outlook is for the fourth quarter and the mix of the jobs and the varying levels of minority interest on them, what -- how does that minority interest level pencil out for you?

Well, I think what we said is we expect to continue to improve next year and to contribute to the earnings on the bottom line. Again, like Bill mentioned, the minority interest on the operating income level can deceive you a little bit on quarter-over-quarter or year-over-year, like some of the other callers were saying.

And your last question comes from the line of [Jerry Riviera] from [SBC Capital].

Hey, everybody.

Good morning, Jerry.

Good morning. Just a question on Caltrans. Your trailing 12-month sales in Granite West were roughly $2 billion. What percent of that, or what portion of that, came from Caltrans work?

I don't have that answer in front of me, Jerry. This is Jim.

Okay.

I don't know. We can certainly get that for you. It's certainly not something that is unable to find, but I don't have it sitting at the table with us.

No, but we'll provide it.

We'll get it for you, Jerry.

Okay. And then, just on the sales, your Granite West materials, sell 7%. And then, did I catch it correctly that you said volumes for materials were only down slightly?

Volume on the [AG] side is down approximately 10%.

Oh, okay. Because you said volume's down slightly and pricing up slightly, and that didn't necessarily pencil out to down 7%.

The biggest downside on the volume, I think I said originally, Jerry, was in the AG side.

Okay.

And then, the asphalt side is fairly healthy relative to last year. And the difference also is the relative product mix, not just the volume, but also the type of product that we're selling.

Okay, so, you're selling less high margin and less high price product.

There you go. Exactly.

Okay. All right, no follow-up. Thanks.

And there are no further questions at this time.

All right. Thank you all for tuning in for our call, today. I think maybe just in closing I'd like to reiterate that, speaking for myself and I think our whole team here, we're really pleased with our year. We're really happy that we have, we think, Granite East turned around, headed in the right direction. We've got great people, great assets. We have, I think, proven over the last couple of years, particularly in the west, that we can execute when we have the work.

We certainly believe that the Proposition 1B money in California is going to be a big stimulant to our marketplace, and it couldn't have come really at a better time. And what we've discovered in the last several days in dialogue with Caltrans that it's likely to come faster than we had anticipated. So that's very good news. We will do our level best to closeout our fourth quarter as strong as we can. If we can improve on the guidance that we've provided you, we'll certainly try to do that.

We're looking forward to 2008. We know we're going to get improved performance in 2008 out of Granite East, and we're looking forward for continued strong performance at Granite West, and to be able to continue to build this Company, this great Company that we're all working so hard to do. So, with that, thank you for listening, and we will be around the rest of the morning if anyone has questions.

This concludes today's Granite Construction third quarter 2007 earnings conference call. You may now disconnect.