General

We are one of the largest heavy civil contractors and producers of construction materials in the United States. We are engaged in the construction and improvement of streets, roads, highways and bridges as well as dams, airport infrastructure, mass transit facilities and other infrastructure-related projects. We produce construction materials through the use of our extensive aggregate reserves and plant facilities. We also operate a real estate development company on a significantly smaller scale. We have offices in Alaska, Arizona, California, Florida, Nevada, New York, Oregon, Texas, Utah and Washington.

Our contracts are obtained primarily through competitive bidding in response to advertisements by federal, state and local agencies and private parties and to a lesser extent through negotiation with private parties. Our bidding activity is affected by such factors as contract backlog, available personnel, current utilization of equipment and other resources, our ability to obtain necessary surety bonds and competitive considerations. Bidding activity, contract backlog and revenue resulting from the award of new contracts may vary significantly from period to period. We have three operating segments: Granite West, Granite East and Granite Land Company.

The three primary economic drivers of our business are (1) the overall health of the economy, (2) federal, state and local public funding levels, both nationally and locally and (3) population growth with the resulting private development. The level of demand for our services will have a direct correlation to these drivers. For example, a stagnant or declining economy will generally result in a reduced demand for construction in the private sector. This reduced demand increases competition for private sector projects and will ultimately also increase competition in the public sector as companies migrate from bidding on scarce private sector work to projects in the public sector. Greater competition can reduce our revenue growth and/or have a downward impact on gross profit margins. In addition, a stagnant or declining economy tends to produce less tax revenue, thereby decreasing a source of funds available for spending on public infrastructure improvements. There are funding sources that have been specifically earmarked for infrastructure spending, such as diesel and gasoline taxes, which are not as directly impacted by a stagnant or declining economy. However, even these funding sources can be temporarily at risk as state and local governments struggle to balance their budgets. Additionally, high fuel prices can have a dampening effect on consumption, resulting in overall lower tax revenue. Conversely, higher public funding as well as an expanding or robust economy will generally increase demand for our services and provide opportunities for revenue growth and margin improvement.

Our general and administrative costs include salaries and related expenses, incentive compensation, discretionary profit sharing, provision for doubtful accounts and other costs to support our business. In general, these costs will increase in response to the growth and the related increased complexity of our business. These costs will vary depending on the number of projects in process in a particular area and the corresponding level of estimating activity. For example, as large projects are completed or if the level of work slows down in a particular area, we will often re-assign project employees to estimating and bidding activities until another project gets underway, temporarily allocating their salaries and related costs from cost of revenue to general and administrative expense. Additionally, our compensation strategy for selected management personnel is to rely heavily on a variable cash and restricted stock performance-based incentive element. The cash portion of these incentives is expensed when earned while the restricted stock portion is expensed over the vesting period of the restricted stock award (generally three to five years). Depending on the mix of cash and restricted stock, these incentives can have the effect of materially altering general and administrative expenses from year to year.

Critical Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience; however, actual amounts could differ from those estimates.

Certain of our accounting policies and estimates require higher degrees of judgment than others in their application. These include the recognition of revenue and earnings from construction contracts, the valuation of real estate held for development and sale and other long-lived assets, and insurance estimates. We evaluate all of our estimates and judgments on an on-going basis.

Revenue Recognition for Construction Contracts

Our contracts with our customers are primarily either "fixed unit price" or "fixed price." Under fixed unit price contracts, we are committed to provide materials or services required by a project at fixed unit prices (for example, dollars per cubic yard of concrete poured or cubic yards of earth excavated). While the fixed unit price contract shifts the risk of estimating the quantity of units required for a particular project to the customer, any increase in our unit cost over the expected unit cost in the bid, whether due to inflation, inefficiency, faulty estimates or other factors, is borne by us unless otherwise provided in the contract. Fixed price contracts are priced on a lump-sum basis under which we bear the risk that we may not be able to perform all the work profitably for the specified contract amount. The percentage of fixed price contracts in our contract backlog decreased from approximately 72.0% at December 31, 2007 to approximately 68.7% at December 31, 2008. All state and federal government contracts and many of our other contracts provide for termination of the contract at the convenience of the party contracting with us, with provisions to pay us for work performed through the date of termination.

We use the percentage of completion accounting method for construction contracts in accordance with the American Institute of Certified Public Accountants Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Revenue and earnings on construction contracts, including construction joint ventures, are recognized using the percentage of completion method in the ratio of costs incurred to estimated final costs. Revenue in an amount equal to cost incurred is recognized prior to contracts reaching 25% completion. The related profit is deferred until the period in which such percentage completion is attained. It is our judgment that until a project reaches 25% completion, there is insufficient information to determine what the estimated profit on the project will be with a reasonable level of assurance. In the case of large, complex design/build projects we may continue to defer profit recognition beyond the point of 25% completion based on an evaluation of specific project risks. The factors considered in this evaluation of risk associated with each design/build project include the stage of design completion, the stage of construction completion, status of outstanding purchase orders and subcontracts, certainty of quantities, certainty of schedule and the relationship with the owner.

Revenue from contract claims is recognized when we have a signed settlement agreement and payment is assured. Revenue from contract change orders, which occur in most large projects, is recognized when the owner has agreed to the change order in writing. Provisions are recognized in the consolidated statements of income for the full amount of estimated losses on uncompleted contracts whenever evidence indicates that the estimated total cost of a contract exceeds its estimated total revenue. Contract cost consists of direct costs on contracts, including labor and materials, amounts payable to subcontractors, direct overhead costs and equipment expense (primarily depreciation, fuel, maintenance and repairs). Depreciation is provided using accelerated methods for construction equipment. Contract cost is recorded as incurred and revisions in contract revenue and cost estimates are reflected when known. The completion threshold for the start of contract profit recognition is applied to all percentage of completion projects unless and until we project a loss on the project, in which case the estimated loss is immediately recognized.

The accuracy of our revenue and profit recognition in a given period is almost solely dependent on the accuracy of our estimates of the cost to complete each project. Our cost estimates for all of our significant projects use a highly detailed "bottom up" approach and we believe our experience allows us to provide materially reliable estimates. There are a number of factors that can contribute to changes in estimates of contract cost and profitability. The most significant of these include the completeness and accuracy of the original bid, costs associated with added scope changes, extended overhead due primarily to owner and weather delays, subcontractor performance issues, changes in productivity expectations, site conditions that differ from those assumed in the original bid (to the extent contract remedies are unavailable), the availability and skill level of workers in the geographic location of the project and a change in the availability and proximity of equipment and materials. The foregoing factors as well as the stage of completion of contracts in process and the mix of contracts at different margins may cause fluctuations in gross profit between periods and these fluctuations may be significant. Substantial changes in cost estimates, particularly in our larger, more complex projects have had, and can in future periods have, a significant effect on our profitability.

Valuation of Real Estate Held for Development and Sale and other Long Lived Assets

Real estate held for development and sale and other long-lived assets, which include property, equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We assess impairment of long-lived assets in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment of Long-Lived Assets. Circumstances which could trigger an impairment review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; or current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life.

Recoverability is assessed based on the carrying amount of the asset and its fair value, which is generally determined based on the sum of the cash flows expected to result from the use and eventual disposal of the asset. An impairment loss is recognized in the consolidated statements of income when the carrying amount is not recoverable and exceeds fair value. In 2008 and 2007 our analyses determined that portions of our real estate held for development and sale were impaired. As a result, we recorded impairment charges for the years ended 2008 and 2007 in the amount of $4.5 million and a $3.0 million, respectively.

The process of estimating future cash flows related to an asset involves significant judgment, including future cash inflows related to the use or eventual sale of the asset and future cash outflows related to the development or use of the asset. Although we believe the estimates and assumptions we used in testing for impairment are reasonable and supportable, significant changes in any one of our assumptions could produce a significantly different result.

Insurance Estimates

We carry insurance policies to cover various risks, primarily general liability and workers compensation, under which we are liable to reimburse the insurance company for a portion of each claim paid. The amounts that we are liable for generally range from the first $0.5 million to $1.0 million per occurrence. We accrue for the estimated ultimate liability for incurred losses, both reported and unreported, using actuarial methods based on historic trends modified, if necessary, by recent events. Changes in our loss assumptions caused by changes in actual experience would result in a change in our assessment of the ultimate liability that could have a material effect on our operating results and financial position.

Results of Operations

Comparative Financial Summary
Years ended December 31,                       2008           2007          2006
(in thousands)
Total revenue                              $   2,674,244   $ 2,737,914   $ 2,969,604
Gross profit                                     468,720       410,744       295,720
Operating income                                 216,691       174,885        88,636
Other income                                      16,739        23,509        24,381
Provision for income taxes                        67,692        65,470        38,678
Minority interest in consolidated
subsidiaries                                     (43,334 )     (20,859 )       6,170
Net income                                       122,404       112,065        80,509

Our results of operations for the year ended December 31, 2008 reflect a 14.1% improvement in gross profit over 2007. This was driven by improvements in Granite East, partially offset by slightly lower margins in Granite West. Granite Land Company experienced a gross loss during the period versus a gross profit in 2007. The increase in minority interest reflects the increased profitability of joint venture work and an increase in the volume or size of our joint venture work.

Revenue

Total Revenue
Years ended December 31,             2008                       2007                      2006
(in thousands)                Amount        Percent      Amount       Percent      Amount       Percent
Revenue by Division:
Granite West               $   1,970,196        73.7   $ 1,928,751        70.4   $ 1,927,996        64.9
Granite East                     695,035        26.0       768,451        28.1     1,006,617        33.9
Granite Land Company               9,013         0.3        40,712         1.5        34,991         1.2
Total                      $   2,674,244       100.0   $ 2,737,914       100.0   $ 2,969,604       100.0

Granite West Revenue
Years ended December
31,                                 2008                         2007                      2006
(in thousands)             Amount          Percent         Amount      Percent       Amount      Percent
California:
Public sector          $      697,551            67.8   $    595,733       56.7   $    537,967       48.5
Private sector                106,489            10.4        215,770       20.5        300,245       27.0
Material sales                224,736            21.8        239,660       22.8        272,039       24.5
Total                  $    1,028,776           100.0   $  1,051,163      100.0   $  1,110,251      100.0
West (excluding
California):
Public sector          $      721,922            76.7   $    563,392       64.2   $    508,559       62.2
Private sector                 91,119             9.7        178,156       20.3        171,166       20.9
Material sales                128,379            13.6        136,040       15.5        138,020       16.9
Total                  $      941,420           100.0   $    877,588      100.0   $    817,745      100.0
Total Granite West:
Public sector          $    1,419,473            72.0   $  1,159,125       60.1   $  1,046,526       54.3
Private sector                197,608            10.0        393,926       20.4        471,411       24.4
Material sales                353,115            18.0        375,700       19.5        410,059       21.3
Total                  $    1,970,196           100.0   $  1,928,751      100.0   $  1,927,996      100.0

Granite West Revenue: Revenue from Granite West for the year ended December 31, 2008 increased by $41.4 million, or 2.1%, compared with the year ended December 31, 2007. The increase in public sector revenue was primarily attributable to profitable progress toward completion of federally funded security projects and the positive effect of the resolution of significant uncertainties on certain projects. The decreases in private sector and materials revenue were driven by the ongoing contraction of credit markets and residential construction in all geographic areas in which Granite West operates. We continue to see additional competition for the available public sector work, as competitors migrate from increasingly scarce private sector work.

Granite East Revenue
Years ended December
31,                              2008                     2007                     2006
(in thousands)            Amount       Percent     Amount      Percent      Amount       Percent
Revenue by
Geographic Area:
Midwest                $    175,763        25.3   $  93,896        12.2   $    43,480         4.3
  Northeast                 125,024        18.0     196,653        25.6       259,462        25.8
South                       128,454        18.5     125,164        16.3       217,647        21.6
  Southeast                 221,167        31.8     299,084        38.9       281,568        28.0
West                         44,627         6.4      53,654         7.0       204,460        20.3
Total                  $    695,035       100.0   $ 768,451       100.0   $ 1,006,617       100.0
Revenue by Market
Sector:
Public sector          $    675,188        97.1   $ 747,580        97.3   $   979,475        97.3
Private sector               19,847         2.9      20,871         2.7        27,042         2.7
Material sales                    -           -           -           -           100           -
Total                  $    695,035       100.0   $ 768,451       100.0   $ 1,006,617       100.0
Revenue by Contract
Type:
Fixed unit price       $     56,543         8.1   $ 128,501        16.7   $   243,103        24.2
Fixed price,
including
design/build                638,492        91.9     639,950        83.3       763,395        75.8
Other                             -           -           -           -           119           -
Total                  $    695,035       100.0   $ 768,451       100.0   $ 1,006,617       100.0

Granite East Revenue: Revenue from Granite East for the year ended December 31, 2008 decreased by $73.4 million, or 9.6%, compared with the year ended December 31, 2007. This decrease is reflective, in part, of our plan to slow revenue growth in the division over the last several years to focus on execution and improved profitability. Geographically, the largest decreases were experienced in the Southeast and Northeast due primarily to certain large projects nearing completion. Increases in the Midwest and South resulted from revenue contributions from progress on a large design/build project in St. Louis, Missouri and project productivity on a bridge project in Mississippi, respectively.

The following table provides additional information about revenue from our large projects for the years ended December 31, 2008, 2007 and 2006:

Large Project Revenue
Years ended December 31,       2008          2007          2006
(in thousands)
Granite West               $    245,514   $  160,232   $    185,474
Number of projects*                   8            6              6
Granite East               $    621,215   $  732,086   $    889,201
Number of projects*                  19           31             28
Total                      $    866,729   $  892,318   $  1,074,675
Number of projects*                  27           37             34

* Includes only projects with a total contract value greater than $50.0 million and over $1.0 million of revenue in the respective periods.

Granite Land Company Revenue: Revenue from GLC for the year ended December 31, 2008 decreased by $31.7 million, or 77.9%, compared to the year ended December 31, 2007. GLC's revenue is dependent on the timing of real estate sales transactions, which are relatively few in number and can cause variability in the timing of revenue and profit recognition. The current real estate downturn and associated tightening of credit markets has had a direct impact on the anticipated timing of several GLC development projects.

Contract Backlog

Total Contract Backlog
December 31,                               2008                       2007
(in thousands)                      Amount        Percent      Amount      Percent
Contract Backlog by Division:
Granite West                    $      788,872        46.4   $   854,142       41.0
Granite East                           910,524        53.6     1,230,403       59.0
Total                           $    1,699,396       100.0   $ 2,084,545      100.0



Granite West Contract Backlog
December 31,                                     2008                     2007
(in thousands)                            Amount       Percent      Amount     Percent
California:
Public sector                          $    430,421        94.8   $  352,398       83.9
Private sector                               23,841         5.2       67,479       16.1
Total                                  $    454,262       100.0   $  419,877      100.0
West (excluding California):
Public sector                          $    319,271        95.4   $  398,380       91.7
Private sector                               15,339         4.6       35,885        8.3
Total                                  $    334,610       100.0   $  434,265      100.0
Total Granite West contract backlog:
Public sector                          $    749,692        95.0   $  750,778       87.9
Private sector                               39,180         5.0      103,364       12.1
Total                                  $    788,872       100.0   $  854,142      100.0

Granite West Contract Backlog: Granite West contract backlog of $788.9 million at December 31, 2008 was $65.3 million, or 7.6%, lower than at December 31, 2007. The reduction in contract backlog was primarily a result of the ongoing contraction of residential construction and credit markets. The reduced residential demand has also increased competition on public sector work, as competitors migrate from the increasingly scarce private sector work. Granite West project awards in the fourth quarter 2008 included a $44.0 million highway rehabilitation project in California and a $42.7 million highway reconstruction project near the California-Nevada border.

Granite East Contract Backlog
December 31,                                     2008                      2007
(in thousands)                            Amount       Percent      Amount      Percent
Contract Backlog by Geographic Area:
  Midwest                               $   163,795        18.0   $   328,971       26.8
  Northeast                                 250,232        27.5       133,052       10.8
South                                        91,720        10.0       144,210       11.7
Southeast                                   402,062        44.2       613,057       49.8
West                                          2,715         0.3        11,113        0.9
Total                                  $    910,524       100.0   $ 1,230,403      100.0

Contract Backlog by Market Sector:
Public sector                        $ 906,470      99.6   $ 1,213,484      98.6
Private sector                           4,054       0.4        16,919       1.4
Total                                $ 910,524     100.0   $ 1,230,403     100.0
Contract Backlog by Contract Type:
Fixed unit price                     $  14,086       1.5   $    64,580       5.2
Fixed price including design/build     896,438      98.5     1,165,823      94.8
Total                                $ 910,524     100.0   $ 1,230,403     100.0

Granite East Contract Backlog: Granite East contract backlog of $910.5 million at December 31, 2008 was $319.9 million, or 26.0%, lower than at December 31, 2007. The decrease reflects progress on construction projects. While we continued to focus on selective bidding opportunities with higher bid margins, project awards during the year ended December 31, 2008 included a $33.8 million freeway project in Texas and a $161.4 million transit project in New York. We are a member of a joint venture team that is currently in pricing negotiations with Houston Metro for the design and construction of the proposed expansion of the Houston Rapid Transit system, and received $37.9 million in awards from Houston Metro for preliminary work associated with this project. Also, we received $67.8 million in additional awards related to our 20% share of a joint venture project to construct a transportation hub at the World Trade Center in New York. As of December 2008, the total joint venture contract value stands at approximately $1.0 billion. However, we currently expect total revenue for this contract to exceed $2.5 billion of which our share could exceed $500.0 million, the majority of which should be awarded by year end 2009.

The following tables provide additional information about our large project contract backlog at December 31, 2008 and 2007:

Large Project Contract Backlog

December 31,                       2008           2007
(dollars in thousands)
Granite West                     $   243,818   $   223,952
Number of projects**                       6             5
Granite East                     $   868,638   $ 1,189,998
Number of projects**                      14            18
Total                            $ 1,112,456   $ 1,413,950
Number of projects**                      20            23

. . .