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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-18786
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PICO HOLDINGS, INC.
(Exact Name of Registrant as Specified in its Charter)
CALIFORNIA 94-2723335
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
875 PROSPECT STREET, SUITE 301
La Jolla, California 92037
(Address of Principal Executive Offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (858) 456-6022
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $.001 Par Value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III or this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
Approximate aggregate market value of the registrant's voting and non-voting
common equity held by non-affiliates of the registrant (based on the closing
sales price of such stock as reported in the NASDAQ National Market) on the last
business day of the registrant's most recently completed second fiscal quarter,
was $95,200,000.
On March 28, 2003, the Registrant had 12,379,242 shares of common stock, $.001
par value, outstanding, excluding 4,422,681 shares of common stock which are
held by the registrant and its subsidiaries.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT TO BE FILED WITH THE
COMMISSION PURSUANT TO REGULATION 14A IN CONNECTION WITH THE REGISTRANT'S 2003
ANNUAL MEETING OF STOCKHOLDERS, TO BE FILED SUBSEQUENT TO THE DATE HEREOF, ARE
INCORPORATED BY REFERENCE INTO PART III OF THIS REPORT. SUCH DEFINITIVE PROXY
STATEMENT WILL BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION NOT LATER
THAN 120 DAYS AFTER THE CONCLUSION OF THE REGISTRANT'S FISCAL YEAR ENDED
DECEMBER 31, 2002.
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PICO HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
No.
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PART I.............................................................................................................. 3
Item 1. BUSINESS.............................................................................................. 3
Item 2. PROPERTIES............................................................................................ 11
Item 3. LEGAL PROCEEDINGS..................................................................................... 11
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................... 12
PART II............................................................................................................. 12
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS................................ 12
Item 6. SELECTED FINANCIAL DATA.............................................................................. 13
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................................................ 14
Item7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.......................................... 54
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................................................... 54
Item 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE......................................................................... 92
PART III............................................................................................................ 92
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................................................... 92
Item 11. EXECUTIVE COMPENSATION................................................................................ 92
Item 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT...................................................................................... 92
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................................ 92
PART IV.............................................................................................................. 92
Item 14. CONTROLS AND PROCEDURES............................................................................... 92
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...................................... 93
SIGNATURES.......................................................................................................... 103
2
PART I
THIS ANNUAL REPORT ON FORM 10-K (INCLUDING THE SECTION REGARDING
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS) CONTAINS FORWARD-LOOKING STATEMENTS REGARDING OUR BUSINESS,
FINANCIAL CONDITION, RESULTS OF OPERATIONS AND PROSPECTS. WORDS SUCH AS
"EXPECTS," "ANTICIPATES," "INTENDS," "PLANS," "BELIEVES," "SEEKS," "ESTIMATES"
AND SIMILAR EXPRESSIONS OR VARIATIONS OF SUCH WORDS ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS, BUT ARE NOT THE EXCLUSIVE MEANS OF IDENTIFYING
FORWARD-LOOKING STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K. ADDITIONALLY,
STATEMENTS CONCERNING FUTURE MATTERS ARE FORWARD-LOOKING STATEMENTS.
ALTHOUGH FORWARD-LOOKING STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K
REFLECT THE GOOD FAITH JUDGMENT OF OUR MANAGEMENT, SUCH STATEMENTS CAN ONLY BE
BASED ON FACTS AND FACTORS CURRENTLY KNOWN BY US. CONSEQUENTLY, FORWARD-LOOKING
STATEMENTS ARE INHERENTLY SUBJECT TO RISKS AND UNCERTAINTIES AND ACTUAL RESULTS
AND OUTCOMES DISCUSSED IN OR ANTICIPATED BY THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES IN RESULTS AND
OUTCOMES INCLUDE WITHOUT LIMITATION THOSE DISCUSSED UNDER THE HEADING "RISK
FACTORS" BELOW, AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS ANNUAL REPORT ON
FORM 10-K. READERS ARE URGED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL
REPORT ON FORM 10-K. WE UNDERTAKE NO OBLIGATION TO REVISE OR UPDATE ANY
FORWARD-LOOKING STATEMENTS IN ORDER TO REFLECT ANY EVENT OR CIRCUMSTANCE THAT
MAY ARISE AFTER THE DATE OF THIS ANNUAL REPORT ON FORM 10-K. READERS ARE URGED
TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE IN THIS ANNUAL
REPORT, WHICH ATTEMPT TO ADVISE INTERESTED PARTIES OF THE RISKS AND FACTORS THAT
MAY AFFECT OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS AND
PROSPECTS.
ITEM 1. BUSINESS
INTRODUCTION
PICO Holdings, Inc. ("PICO," or "the Company") is a diversified holding
company. PICO seeks to acquire businesses and interests in businesses which we
identify as undervalued based on fundamental analysis -- that is, our assessment
of what the company is worth, based on the private market value of its assets,
earnings, and cash flow. We are the most interested in long-established
businesses, with a history of operating successfully through industry cycles,
recessions and geo-political disruptions, in basic, "old economy" industries.
Typically, the business will be generating free cash flow and have a low level
of debt or, alternatively, strong interest coverage ratios or the ability to
realize surplus assets. As well as being undervalued, the business must have
special qualities such as unique assets, a potential catalyst for change, or be
in an industry with attractive economics. Selected acquisitions will become core
operations; however, we are also interested in acquiring companies where the
real value is in land and other tangible assets, rather than in its operating
business.
We have acquired businesses and interests in businesses through the
purchase of private companies and shares in public companies, both directly
through participation in financings and through open market purchases. When we
buy a company, we have a long term horizon, typically 5 years or more; however,
we are prepared to sell companies if the price received exceeds the return we
expect to earn if we retain ownership. We expect that most of our interests in
businesses will eventually be sold to other companies in the same industry who
are seeking to expand or gain economies of scale.
Our objective is to generate superior long-term growth in shareholders'
equity, as measured by book value per share. Over time, we anticipate that most
of the growth in shareholders' equity will come from gains on the sale of
businesses, as opposed to on-going operating earnings.
Currently our major businesses are:
- - Vidler Water Company, Inc., which develops and owns water rights and
water storage operations;
- - Nevada Land & Resource Company, LLC, which owns land and the related
mineral rights and water rights;
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- - Citation Insurance Company, which is "running off" its historical property
and casualty loss reserves, and Physicians Insurance Company of Ohio, which
is "running off" its medical professional liability loss reserves; and
- - Sequoia Insurance Company, which writes property and casualty insurance in
California and Nevada. In October 2002, we signed a definitive agreement to
sell Sequoia, and the company is now accounted for as a discontinued
operation. The sale is expected to close on or around March 31, 2003.
The address of our main office is 875 Prospect Street, Suite 301, La Jolla,
California 92037, and our telephone number is (858) 456-6022.
Investors wishing to obtain more information may access our annual,
quarterly and other reports and information with the SEC. Investors can read and
copy any information we have filed with the SEC at the SEC's Public Reference
Room at 450 Fifth Street, NW, Washington, DC 20549. You can obtain additional
information about the operation of the Public Reference Room by calling the SEC
at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov)
that contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC, including us. We also
maintain an Internet site (www.picoholdings.com) that contains documents as soon
as reasonably practicable after such material is electronically filed with or
furnished to the SEC, as well as further material about PICO and links to other
sites, including some of the companies which we are associated with. You should
check the website periodically during the year for press releases and updated
information.
HISTORY
PICO was incorporated in 1981 and began operations in 1982. The company was
known as Citation Insurance Group until a reverse merger with Physicians
Insurance Company of Ohio on November 20, 1996. After the reverse merger, the
former shareholders of Physicians owned approximately 80% of Citation Insurance
Group, the Board of Directors and management of Physicians replaced their
Citation counterparts, and Citation Insurance Group changed its name to PICO
Holdings, Inc. You should be aware that some data on information services
pre-dating the reverse merger relates to the old Citation Insurance Group only,
and does not reflect the performance of Physicians prior to the merger.
SUBSIDIARY COMPANIES & MAJOR OPERATING SEGMENTS
This section describes our subsidiaries and operating segments. Unless
otherwise indicated, we own 100% of each subsidiary.
VIDLER WATER COMPANY, INC.
Vidler Water Company, Inc. ("Vidler") is the leading private company in the
water resource development business in the southwestern United States. PICO
identified water resource development in the Southwest as an attractive business
opportunity due to the continued growth in demand for water resulting from
population growth, economic development, environmental requirements, and the
claims of Native Americans. Vidler is not a water utility, and does not intend
to enter into regulated utility activities. We develop new sources of water for
municipal and industrial use, and necessary storage infrastructure to facilitate
the efficient allocation of available water supplies.
Opportunities for Vidler result from inefficient allocation of available
water between agricultural users and municipal or industrial users, or the lack
of available known water supply for a particular area:
- - the majority of water rights are currently owned or controlled by
agricultural users, and in many locations there are insufficient water
rights owned or controlled by municipal and industrial users to meet
present and future demand;
- - certain areas of the Southwest experiencing rapid growth have insufficient
supplies of known water to support future growth. Vidler identifies and
develops new water supplies for communities with no other known water to
support future growth;
- - currently there are not effective procedures in place for the transfer of
water from private parties with excess supply in one state to end-users in
other states. However, regulation and procedures are steadily being
developed to facilitate the interstate transfer of water; and
- - infrastructure to store water will be required to accommodate and allow
interstate transfer, and transfers from wet years to dry years. Currently
there is limited storage capacity in place.
4
We entered the water resource development business with the acquisition of
Vidler in 1995. At the time, Vidler owned a limited quantity of water rights and
related assets in Colorado. Since then, Vidler has acquired:
- - additional water rights and related assets, predominantly in Arizona and
Nevada. Vidler seeks to acquire water rights at prices consistent with
their current use, with the expectation of an increase in value if the
water right can be converted to a higher use. A water right is the legal
right to divert water and put it to beneficial use. Water rights are assets
which can be bought and sold. In some states, the use of the water can also
be leased. The value of a water right depends on a number of factors,
including location, the seniority of the right, and whether or not the
right is transferable. The majority of Vidler's water rights are in Nevada
and Arizona, the two states which are leading the nation in population
growth and new home construction. Our objective is to monetize our water
rights for municipal and industrial use in Arizona and Nevada. Typically,
our water rights are the most competitive source of water to support new
growth in municipalities and new industry in Arizona and Nevada; and
- - a water storage facility in Arizona and an interest in Semitropic, a water
storage facility in California. Our water storage facility in Arizona is
fully permitted and ready for commercial use, while water has been stored
commercially at Semitropic since 1995. PICO currently owns approximately
96.2% of Vidler.
Vidler is engaged in the following activities:
- - supplying water to end-users in the Southwest, namely water utilities,
municipalities, developers, or industrial users. The source of water could
be from identifying and developing a new water supply, or a change in the
use of water from agricultural to municipal and industrial use;
- - development of storage and distribution infrastructure, and then generating
cash flow from charging customers fees for "recharge," or placing water
into storage; and
- - purchase and storage of water for resale in dry years.
After an acquisition and development phase spanning several years, Vidler
completed its first significant sales of water rights for industrial use in 2001
and municipal use in 2002. Vidler's priority is to monetize or develop recurring
cash flow from its most important assets by:
- - securing significant supply contracts utilizing its water rights in Arizona
and Nevada; and
- - storing water at the Vidler Arizona Recharge Facility.
Vidler has also entered into joint ventures with parties who have water
assets but lack the capital or expertise to commercially develop these assets.
Vidler continues to explore additional joint venture opportunities throughout
the Southwest.
This table details the water rights and water storage assets owned by
Vidler at December 31, 2002. Please note that this is intended as a summary, and
that some numbers are rounded. Item 7 of this Form 10-K contains more detail
about these assets, recent developments affecting them, and the current outlook.
An acre-foot is a unit commonly used to measure the volume of water. An
acre-foot is the volume of water required to cover one acre to a depth of one
foot. As a rule of thumb, one acre-foot of water would sustain two families of
four persons each for one year.
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NAME OF ASSET & APPROXIMATE LOCATION BRIEF DESCRIPTION PRESENT COMMERCIAL USE
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WATER RIGHTS
Arizona:
Harquahala Valley Ground Water Basin 15,067 acres of land, plus 4,814 acres under Leased to farmers
La Paz & Maricopa Counties option
75 miles northwest of metropolitan Phoenix
35,795 acre-feet of transferable ground
water, plus 13,764 acre-feet under option
State legislation allows Harquahala
Valley ground water to be made
available as assured municipal water
supply to cities and communities in
Arizona through agreements with the
Central Arizona Ground Water
Replenishment District
- -----------------------------------------------------------------------------------------------------------------------------------
Nevada:
Fish Springs Ranch, LLC (51% Interest) & 8,600 acres of deeded ranchland Vidler is currently farming the
V&B, LLC (50% Interest) property. Cattle graze on part of the
Washoe County, 40 miles north of Reno 8,000 acre-feet of permitted water rights, property on a revenue sharing basis
which are transferable to the Reno/Sparks
area
5
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Lincoln County Joint Venture Applications* for more than 100,000 acre-feet
of water rights through a joint venture with
Lincoln County, of which it is currently
anticipated that up to 40,000 acre-feet
will be permitted and put to use in Lincoln
County.
2,100 acre-feet of permitted water rights
Option to acquire approximately 822
acre-feet of permitted water rights
at Meadow Valley
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Clark County
Sandy Valley 415 acre-feet of permitted water rights Agreement to supply water to support
Near the Nevada/California state line additional growth at Primm, Nevada once
in the Interstate 15 corridor An appeal has been filed regarding the the permitting of the additional water
balance of the application* (1,585 rights has been resolved
acre-feet of water rights)
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Muddy River Water Rights 221 acre-feet of water rights, plus
Approximately 35 miles east of approximately 45 acre-feet under option
Las Vegas, in the Interstate 15
corridor
*The numbers indicated for water
rights applications are the maximum
amount which we have filed for. In
some cases, we anticipate that the
actual permits received will be for
smaller quantities.
- -----------------------------------------------------------------------------------------------------------------------------------
West Wendover Approximately 6,300 acres of land
Adjacent to the Nevade/Utah state line surrounding West Vendover, Nevada
in the Interstate 80 corridor
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BIG SPRINGS RANCH Approximately 37,500 acres of deeded Leased to ranchers
65 miles from Elko in Elko ranch land
County, Nevada
6,000 acre-feet of certificated water rights
6,000 acre-feet of permitted water rights
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COLORADO:
COLORADO WATER RIGHTS 105 acre-feet of senior water rights Agreement to sell 105 acre-feet of
senior water rights to the City of
Golden, Colorado over a period of 13
years
163 acre-feet of senior water rights 65.73 acre-feet leased. Vidler has
applied for remaining water rights to be
upgraded, which will increase their
commercial value
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WET MOUNTAIN 600 acre-feet of priority water rights Sale in escrow, and expected to close
in 2003
- -----------------------------------------------------------------------------------------------------------------------------------
WATER STORAGE
ARIZONA:
VIDLER ARIZONA RECHARGE FACILITY An underground water storage facility with Vidler is currently buying water and
Harquahala Valley, Arizona estimated capacity exceeding 1 million storing it on its own account. At
acre-feet and permitted annual recharge December 31, 2002, Vidler had net
capability of up to 100,000 acre-feet recharge credits equivalent to
approximately 14,000 acre-feet of water
in storage at the Arizona Recharge
Facility
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CALIFORNIA:
SEMITROPIC WATER STORAGE FACILITY The right to store 30,000 acre-feet of
water underground until 2035. This
includes the right to minimum guaranteed
recovery of approximately 2,700
acre-feet of water every year, and the
right to recovery up to approximately
6,800 acre-feet in one year in certain
circumstances
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6
NEVADA LAND & RESOURCE COMPANY, LLC
In April 1997, PICO paid $48.6 million to acquire Nevada Land & Resource
Company, LLC ("Nevada Land"), which at the time owned approximately 1,352,723
acres of deeded land in northern Nevada, and the water, mineral, and geothermal
rights related to the property. Much of Nevada Land's property is
checker-boarded in square mile sections with publicly owned land. The lands
generally parallel the Interstate-80 corridor and the Humboldt River from
Fernley, in western Nevada, to West Wendover, in northeast Nevada.
Nevada Land is the largest private landowner in the state of Nevada.
According to census data, the population of Nevada increased 66% in the 10 years
ended April 1, 2000, which was the most rapid population growth of any state in
the United States. In the fifteen months from April 1, 2000 to July 1, 2001,
Nevada's population increased another 5.4%, to approximately 2.1 million people.
Most of the growth is centered in southern Nevada, which includes the city of
Las Vegas and surrounding municipalities. Land available for private development
in Nevada is relatively scarce, as governmental agencies own approximately 87%
of the land in Nevada.
Before we acquired Nevada Land, the property had been under the ownership
of a succession of railway companies, to whom it was a non-core asset.
Accordingly, when we acquired the company, we believed that the potential of the
property had never been exploited.
After acquiring Nevada Land, we completed a "highest and best use study"
which divided the land into 7 major categories. We developed strategies to
maximize the value of each type of asset, with the objective of monetizing
assets once they had reached their highest and best use. These strategies
include:
- - the sale of land and water rights. There is demand for land and water for a
variety of purposes including residential development, residential estate
living, farming, ranching, and from industrial users;
- - transactions where Nevada Land transfers parcels of its land in return for
land owned by other parties;
- - the development of water rights. Nevada Land has applied for additional
water rights on land it owns. Where water rights are permitted, we
anticipate that the value and marketability of the related land will
increase;
- - the development of land in and around growing municipalities; and
- - the management of mineral rights.
A cost basis has been assigned to each category of land and other asset, which,
in aggregate, equals Nevada Land's original purchase price.
During the period from April 23, 1997 to December 31, 2002, Nevada Land
received consideration of approximately $18.6 million from the sale and exchange
of land and the sale of water rights. This is comprised of $17 million in sales
of land, $752,000 of land received in a land exchange transaction, and $894,000
from the sale of water rights. Over this period, we sold 141,551 acres and
divested 25,828 acres in a land exchange. The average price received in land
disposals has been $106 per acre, compared to our average basis of $55 in the
acres disposed of, and the average cost of $35 per acre for the total land,
water, and mineral assets acquired.
At December 31, 2002, Nevada Land owned approximately 1,202,000 acres of
former railroad land. We anticipate continuing to sell parcels of land for
residential, agricultural, and industrial use, and that significantly larger
parcels could be divested through legislative and other exchange-type
transactions.
In addition to the former railroad property, Nevada Land has acquired:
- - 17,558 acres of land in a land exchange with a private landowner. This land
is contiguous with Native American tribal lands and is culturally
sensitive; and
- - Spring Valley Ranches, which is located approximately 40 miles west of Ely
in White Pine County, Nevada. This property was purchased out of bankruptcy
proceedings in 2000. We believe that the land has significant environmental
value. The real estate assets consist of approximately 9,500 acres of
deeded land and 500,000 acres of Forest Service and Bureau of Land
Management allotment land. There are 5,582 acre-feet of permitted
agricultural water rights related to the property.
Nevada Land has filed applications for an additional 105,516 acre-feet of
water rights on the Company's lands. The applications consist of:
- - 39,076 acre-feet of water rights for the beneficial use of irrigating the
related 9,769 acres of arable land, and 40,240 acre-feet of water rights
for municipal and industrial use, on the former railroad lands; and
- - 26,200 acre-feet of water rights for the beneficial use of irrigating
another 6,550 acres of Spring Valley Ranches.
7
In addition to the on-going sale of smaller parcels of land, Nevada Land
intends to divest larger parcels which have environmental, cultural, or
historical value. These transactions could be structured as outright sales or as
exchanges for land which is either more marketable or suitable for future
development.
BUSINESS ACQUISITIONS AND FINANCING
This segment contains businesses, interests in businesses, and other parent
company assets. This segment was referred to as Long-Term Holdings in prior
years.
PICO seeks to acquire businesses which we identify as undervalued based on
fundamental analysis -- that is, our assessment of what the company is worth,
based on the private market value of its assets, earnings, and cash flow. We are
the most interested in long-established businesses, with a history of operating
successfully through industry cycles, recessions and wars, in basic, "old
economy" industries. Typically the business will be generating free cash flow
and have a low level of debt or, alternatively, strong interest coverage ratios
or the ability to realize surplus assets quickly. As well as being undervalued,
the business must have special qualities such as unique assets, a potential
catalyst for change, or be in an industry with attractive economics. We are also
interested in acquiring companies where the real value is in land and other
tangible assets, rather than in its operating business.
We have acquired businesses and interests in businesses through the
purchase of private companies and shares in public companies, both directly
through participation in financings and through open market purchases. When we
buy a company, we have a long term horizon, typically 5 years or more, however
we are prepared to sell companies if the price received exceeds the return we
expect to earn if we retain ownership. We expect that most of our interests in
businesses will eventually be sold to other companies in the same industry who
are seeking to expand or gain economies of scale. Consistent with our focus on
increasing our shareholders' equity and book value per share, we anticipate that
most of the return from our interests in businesses will come from realized
gains on the ultimate sale of our holding, rather than dividends, equity income,
or operating earnings during our ownership.
When we acquire an interest in a public company, we are prepared to play an
active role, for example encouraging companies to use proper financial criteria
when making capital expenditure decisions, or providing financing or strategic
input.
At the time we acquire an interest in a public company, we believe that the
intrinsic value of the underlying business significantly exceeds the current
market capitalization. The difference between market price and intrinsic value
may persist for several years, and the stock price may decline while our
estimate of intrinsic value is stable or increasing. Sometimes, the gap is not
eliminated until another party attempts to acquire the company, as was the case
with our holding in Australian Oil & Gas Corporation Limited ("AOG").
Over the past 4 years, we became the largest shareholder in AOG, an
international provider of drilling services. We identified AOG as undervalued as
rig utilization, which is critical to earnings and cash flow for drilling
companies, had begun to recover in the U.S., but was still near cyclical lows in
the international markets where AOG operates. Historically, there is a lag
between recovery in rig utilization in the U.S. and in international markets.
We acquired our interest through open market purchases, the reinvestment of
dividends, and assisting AOG with a financing in early 2002. AOG had secured two
major new contracts with multinational oil companies, but needed to raise
capital to purchase equipment necessary to perform the contracts. We provided
AOG with a bridging loan facility, which was repaid with the proceeds of a
rights offering which we partly underwrote. After AOG's expanded activities and
earnings base became apparent, Ensign (Australia) Holdings Pty. Limited, a
subsidiary of a Canadian oil services company which was already a shareholder in
AOG, made a takeover offer for AOG at $A1.70 ($US0.93) per share. Ensign was
overbid by a number of other companies, before lifting its bid several times and
eventually acquiring AOG in July 2002 for $A2.70 ($US1.47) per share.
Immediately prior to Ensign's first bid, AOG shares had been trading at $A1.40
($US0.76).
Currently our only disclosed investment in the U.S. is a 44.1% interest in
HyperFeed Technologies, Inc. (NASDAQ: HYPR), a provider of financial market data
and data-delivery solutions to the financial services industry.
PICO began to invest in European companies in 1996. We have been
accumulating shares in a number of undervalued asset-rich companies,
particularly in Switzerland, which we believe will benefit from pan-European
consolidation. At December 31, 2002, the market value (and carrying value) of
our European portfolio was $33.6 million. This includes our 22.3% interest in
Jungfraubahn Holding AG ("Jungfraubahn"), which had a market value (and carrying
value) of $24 million at the end of 2002.
8
Before a substantial acquisition is made, after significant research and
analysis, we must be convinced that -- for an acceptable level of risk -- there
is sufficient value to provide the opportunity for superior returns. We also
have a small portfolio of alternative investments where, in previous years, we
deviated from our traditional value criteria in an attempt to capitalize on
areas of potentially greater growth without incurring undue risk. Given the
higher level of risk, we committed smaller sums to the alternative investments.
At December 31, 2002, the total after-tax carrying value of this portfolio was
less than $1 million.
During the late 1990's, the businesses we acquired were primarily private
companies and foreign public companies. During this period, we perceived that
acquisitions in these areas carried less downside risk and offered greater
upside potential than the acquisition opportunities available among publicly
traded companies in North America.
Following the decline of world stock markets over the past three years, in
the foreseeable future our acquisition efforts are likely to be focused on
domestic and foreign public companies, where there is greater scope for value
creation, rather than private companies.
INSURANCE OPERATIONS IN RUN OFF
This segment is comprised of Physicians Insurance Company of Ohio
("Physicians") and Citation Insurance Company ("Citation").
Until 1995, Physicians and The Professionals Insurance Company
("Professionals") wrote medical professional liability insurance, mostly in the
state of Ohio.
Due to persistent uneconomic pricing by competitors, Physicians and
Professionals were unable to generate adequate premium volume in 1994 and the
early part of 1995. Faced with these market conditions and the opportunity for
higher returns from non-medical professional liability insurance activities, in
1995 we concluded that maximum value would be obtained by placing Physicians in
"run off." This means handling the claims arising from its historical business,
but not writing new business. In addition, the future book of business --
essentially the opportunity to renew expiring policies -- was sold for $6
million in cash.
After Physicians went into "run off", the company expanded its insurance
operations by acquisition:
- - in 1995, we purchased Sequoia Insurance Company, which primarily wrote
commercial lines of insurance in California and Nevada. After the
acquisition, we recapitalized Sequoia, which provided the capital to
support growth in the book of business; and
- - in 1996, Physicians completed a reverse merger with the parent company of
Citation Insurance Company. In the past, Citation wrote commercial property
and casualty insurance, primarily in California and Arizona. After the
merger was completed, we identified redundancy between Sequoia and
Citation, and combined the operations of the two companies. After we
assumed management of Citation, we tightened underwriting standards
significantly and did not renew much of the business which Citation had
written previously. Eventually all business in California and Nevada was
transitioned to Sequoia, and at the end of 2000 Citation ceased writing
business and went into "run off."
Physicians and Citation obtain the funds to pay claims from the maturity of
fixed-income securities, the sale of investments, and collections from
reinsurance companies (that is, insurance companies who share in our claims
risk).
Typically, most of the revenues of an insurance company in "run off" come
from investment income on funds held as part of the insurance business. During
the "run off" process, as claims are paid, both the loss reserve liabilities and
the corresponding investment portfolio assets decrease. Since investment income
in this segment will decline over time, we are attempting to minimize segment
overhead expenses as much as possible. For example, in recent years we have
reduced head count and office space. In 2001, The Professionals Insurance
Company merged into Physicians, which will simplify administration and reduce
costs.
Although we regularly evaluate the strategic alternatives, we currently
believe that the most advantageous option is for Physicians' own claims
personnel to manage the "run off." We believe that this will ensure a high
standard of claims handling for our policyholders and, from the Company's
perspective, ensure the most careful examination of claims made to minimize loss
and loss adjustment expense payments. If we were to reinsure Physicians' entire
book of business and outsource claims handling, this would involve giving up
management of the corresponding investment assets.
9
Administering our own "run off" also provides us with the following
opportunities:
- - we retain management of the associated investment portfolios. After we
resumed direct management of our insurance company portfolios in 2000, we
believe that the return on our portfolio assets has been attractive in
absolute terms, and very competitive in relative terms. (The return
generated in the largest portfolio, Sequoia, is described in the next
section, "Discontinued Operations.") Since the claims reserves of the "run
off" insurance companies effectively recognize the cost of paying and
handling claims in future years, the investment return on the corresponding
investment assets, less non-insurance expenses, will accrue to PICO. We aim
to maximize this source of income; and
- - to participate in favorable development in our claims reserves if there is
any, although this entails the corresponding risk that we could be exposed
to unfavorable development.
As the "run off" progresses, at an indeterminate time in the future Physicians'
claims reserves may diminish to the point where it is more cost-effective to
outsource claims handling to a third party administrator.
At December 31, 2002, Physicians had $30.3 million in medical professional
liability loss reserves, net of reinsurance, and Citation had $14.6 million in
property and casualty insurance loss reserves, net of reinsurance, principally
in the artisans/contractors line of business.
DISCONTINUED OPERATIONS
In October 2002, we announced the signing of a definitive agreement to sell
Sequoia Insurance Company ("Sequoia"). It is anticipated that the sale will
close on or around March 31, 2003. The sale is conditional on the approval of
the California Department of Insurance, which was received on March 17, 2003,
and other customary closing conditions. The final sale price will be determined
after the closing. The base price of $40 million is subject to adjustment based
on movement in either shareholders' equity on a GAAP (that is, generally
accepted accounting principles) basis, or statutory surplus, between June 30,
2002 and the date of closing. In accordance with GAAP, Sequoia is now accounted
for as a discontinued operation in both 2002 and prior years in our financial
statements.
Sequoia's core business is property and casualty insurance in California
and Nevada, focusing on the niche markets of commercial insurance for small to
medium-sized businesses and farm insurance. Sequoia also writes selected lines
of personal insurance in California.
Physicians acquired Sequoia in 1995. During the period of our ownership,
Sequoia's management applied a selective approach to underwriting, aiming to
earn a profit from underwriting (that is, a profit before investment income),
and implemented numerous initiatives to improve efficiency and reduce expenses.
As a result, Sequoia has consistently had loss ratios and combined ratios better
than the industry averages. During 2000, 2001, and 2002, Sequoia generated
increased average premiums per commercial policy, and significant growth in its
book of business, with combined ratios of 106.3%, 105.4%, and 101.6%, in those
respective years.
From April 1, 2000, when we resumed direct management of Sequoia's
investment portfolio, the company's portfolio assets earned returns (that is,
interest and dividend income plus realized and unrealized gains, before fees and
taxes) of approximately 6.1% in the last 9 months of 2000, 10.4% in 2001, and
12.6% in 2002.
Despite these factors, Sequoia continued to generate a return on capital
lower than our expectation, and we concluded that value would be maximized by
sale of the company, particularly given the increasingly restrictive regulatory
& rating environment, and the highly competitive marketplace.
At December 31, 2002, Sequoia's net carrying value under GAAP was $37.3
million.
EMPLOYEES
At December 31, 2002, PICO had 128 employees. A total of 7 employees were
engaged in land and related mineral rights and water rights operations; 5 in
water rights and storage; 97 in property and casualty insurance operations; 3 in
medical professional liability operations; and 16 in holding company activities.
10
EXECUTIVE OFFICERS
The executive officers of PICO are as follows:
Name Age Position
---- --- --------
Ronald Langley 58 Chairman of the Board, Director
John R. Hart 43 President, Chief Executive Officer and
Director
Richard H. Sharpe 47 Chief Operating Officer
James F. Mosier 55 General Counsel and Secretary
Maxim C. W. Webb 41 Chief Financial Officer and Treasurer
Except for Maxim C. W. Webb, each executive officer of PICO was an
executive officer of Physicians prior to the 1996 merger between Physicians
Insurance Company of Ohio and Citation Insurance Group, the predecessors to PICO
Holdings, Inc. Each became an officer of PICO in November 1996 as a result of
the merger. Maxim C. W. Webb was an officer of Global Equity Corporation and
became an officer of PICO upon the effective date of the PICO/Global Equity
Corporation Combination in December 1998.
Mr. Langley has been Chairman of the Board of PICO since November 1996 and
of Physicians since July 1995. Mr. Langley has been a Director of PICO since
November 1996 and a Director of Physicians since 1993. Mr. Langley has been a
Director of HyperFeed Technologies, Inc., formerly, PC Quote, Inc. ("HyperFeed")
since 1995 and a Director of Jungfraubahn Holding AG since 2000.
Mr. Hart has been President and Chief Executive Officer of PICO since
November 1996 and of Physicians since July 1995. Mr. Hart has been a Director of
PICO since November 1996 and a Director of Physicians since 1993. Mr. Hart has
been a Director of HyperFeed since 1997, and a Director of SISCOM, Inc. since
November 1996.
Mr. Sharpe has served as Chief Operating Officer of PICO since November
1996, and in various executive capacities since joining Physicians in 1977.
Mr. Mosier has served as General Counsel and Secretary of PICO since
November 1996 and of Physicians since October 1984 and in various other
executive capacities since joining Physicians in 1981.
Mr. Webb has been Chief Financial Officer and Treasurer of PICO since May
14, 2001. Mr. Webb served in various capacities with the Global Equity
Corporation group of companies since 1993, including Vice President, Investments
of Forbes Ceylon Limited from 1994 through 1996. Mr. Webb became an officer of
Global Equity Corporation in November 1997 and Vice President, Investments of
PICO on November 20, 1998. Mr. Webb has been a Director of SISCOM, Inc. since
November 1996.
ITEM 2. PROPERTIES
PICO leases approximately 6,354 square feet in La Jolla, California for its
principal executive offices.
Physicians leases approximately 1,892 square feet of office space in
Columbus, Ohio for its headquarters. Sequoia leases office space for its and
Citation's headquarters in Monterey, California and for regional claims and
underwriting offices in Modesto, Monterey, Ventura, Visalia, Orange, Pleasanton,
San Jose, Bakersfield, Clovis and Sacramento, California as well as Midvale,
Utah. Nevada Land leases office space in Carson City, Nevada. Vidler and Nevada
Land hold significant investments in land, water rights and mineral rights in
the southwestern United States. See "Item 1-Business-Introduction."
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various litigation that arises in the ordinary
course of its business. Members of PICO's insurance group are frequently a party
in claims proceedings and actions regarding insurance coverage, all of which
PICO considers routine and incidental to its business. Based upon information
presently available, management is of the opinion that such litigation will not
have a material adverse effect on the consolidated financial position, the
results of operations or cash flows of the Company. Neither PICO nor its
subsidiaries are parties to any potential material pending legal proceedings
other than the following:
In 2000, PICO Holdings loaned a total of $2.2 million to Dominion Capital
Pty. Ltd. ("Dominion Capital"), a private Australian company. In 2001, $1.2
million of the loans became overdue. Negotiations between PICO and Dominion
Capital to reach a settlement agreement on both the overdue loan of $1.2 million
and the other loan of $1 million proved unsuccessful. Accordingly,
11
PICO has commenced legal actions through the Australian courts against Dominion
Capital to recover the total amount due to PICO Holdings. Due to the inherent
uncertainty involved in pursuing a legal action and our ability to realize the
assets collateralizing the loans, PICO has recorded an allowance for the total
outstanding balance of $2.3 million for the loans and interest. PICO has been
awarded summary judgment in relation to the principal and interest on the $1.2
million loan and, as a result, Dominion Capital has been placed in receivership.
The court appointed receiver is in the process of ascertaining Dominion
Capital's assets and liabilities. Discovery proceedings are under way in PICO's
lawsuit concerning the $1 million loan (with interest), and a trial date has
been set for June 2003.
See Note 14 of Notes to Consolidated Financial Statements, "Commitments and
Contingencies."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholder's during
the fourth quarter of 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of PICO is traded on the NASDAQ National Market under the
symbol PICO. The following table sets forth the high and low daily closing sale
prices as reported on the NASDAQ National Market. These reported prices reflect
inter-dealer prices without adjustments for retail markups, markdowns or
commissions.
2002 2001
-------------------------------- ---------------------------
High Low High Low
------------- ------------- ---------- ----------
1st Quarter $ 15.69 $ 12.57 $ 14.38 $ 11.88
2nd Quarter $ 17.42 $ 13.41 $ 14.62 $ 12.50
3rd Quarter $ 16.42 $ 11.00 $ 15.91 $ 10.80
4th Quarter $ 13.80 $ 8.33 $ 14.25 $ 10.70
On December 31, 2002, the closing sale price of PICO's common stock was
$13.24 and there were 1,047 holders of record.
PICO has not declared or paid any dividends in the last two years, and does
not expect to pay any dividends in the foreseeable future.
EQUITY COMPENSATION PLAN INFORMATION
(a) (b) (c)
PLAN CATEGORY NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES
BE ISSUED UPON EXERCISE PRICE OF OUTSTANDING OPTIONS, REMAINING AVAILABLE FOR
OF OUTSTANDING OPTIONS, WARRANTS AND RIGHTS FUTURE ISSUANCE UNDER EQUITY
WARRANTS AND RIGHTS COMPENSATION PLANS
(EXCLUDING SECURITIES
REFLECTED IN COLUMN (A)
Equity compensation plans approved
by security holders. 1,177,458 $15.00 None
Equity compensation plans not
approved by security holders. (1)
(2) (3) (4) (5) 509,784 $13.59 None
Total 1,687,242 None
12
(1) The Physicians Insurance Company of Ohio 1995 Non-Qualified Stock
Option Plan was approved by Physicians' Board of Directors effective
August 24, 1995. All options granted under this stock option plan are
fully vested and they all expire on August 24, 2005. When PICO
Holdings, Inc. became the sole shareholder of Physicians on November
20, 1996, PICO Holdings, Inc. assumed the stock options. The exercise
price for all options in this plan is $13.45 per option.
(2) An officer of the Company was granted 10,665 stock options by the
Company's Board of Directors, effective January 1, 1999. These stock
options expire on January 1, 2009. All are vested and the exercise
price is $13.25 per option.
(3) An officer of the Company was granted 20,000 stock options by the
Company's Board of Directors, effective August 6, 2001. The exercise
price is $15.00 per option and they expire on August 6, 2021. 13,333 of
these options are vested; the remaining 6,667 options will vest on
August 6, 2003.
(4) An employee of the Company was granted 16,223 stock options by the
Company's Board of Directors, effective August 2, 2001. The exercise
price is $15.00 per option and they expire on August 2, 2021. 10,816 of
these options are vested; the remaining 5,407 will vest on August 2,
2003.
(5) An employee of the Company was granted 10,000 stock options by the
Company's Board of Directors, effective August 8, 2001. The exercise
price is $15.00 per option and they expire on August 8, 2021. 6,666 of
these options are vested; the remaining 3,334 will vest on August 8,
2003.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents PICO's selected consolidated financial data.
The information set forth below is not necessarily indicative of the results of
future operations and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Item 7 of this Form 10-K and the consolidated financial statements and the
related notes thereto included elsewhere in this document.
Year Ended December 31,
----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ------------- ------------- -------------- -------------
OPERATING RESULTS (In thousands, except share data)
Revenues:
Premium income earned (charged) $ (42) $ 980 $ 1,695 $ 19,447 $ 17,986
Net investment income (loss) 9,595 1,161 (1,694) 4,024 (1,198)
Sale of land, water and minerals 15,232 17,106 5,478 6,082 2,242
Other income 4,489 4,313 4,200 5,119 3,807
----------- ------------- ------------- -------------- -------------
Total revenues $ 29,274 $ 23,560 $ 9,679 $ 34,672 $ 22,837
=========== ============= ============= ============== =============
Income (loss) before discontinued
operations, extraordinary gain and
Cumulative effect of change in accounting
principle $ 1,110 $ 3,778 $ (7,290) $ (11,559) $ (14,050)
Income from discontinued operations, net 2,834 2,317 953 1,377 2,737
Extraordinary gain, net 442
Cumulative effect of change in accounting
principles, net 1,985 (981) (4,964)
----------- ------------- ------------- -------------- -------------
Net income (loss) $ 5,929 $ 5,114 $ (11,301) $ (9,740) $ (11,313)
=========== ============= ============= ============== =============
PER COMMON SHARE BASIC AND DILUTED:
Income (loss) from continuing operations $ 0.09 $ 0.30 $ (0.63) $ (1.28) $ (2.35)
Income from discontinued operations 0.23 0.19 0.08 0.15 0.46
Extraordinary gain, net of tax 0.05
Cumulative effect of change in accounting
principle 0.16 (0.08) (0.43)
----------- ------------- ------------- -------------- -------------
Net income (loss) $ 0.48 $ 0.41 $ (0.97) $ (1.08) $ (1.89)
=========== ============= ============= ============== =============
Weighted Average Shares Outstanding 12,375,466 12,384,682 11,604,120 8,998,442 5,981,814
=========== ============= ============= ============== =============
13
Year Ended December 31
-----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------- ------------- ------------- ------------- -------------
FINANCIAL CONDITION (In thousands, except per share data)
Assets $ 265,587 $ 270,742 $ 295,682 $ 289,004 $ 299,780
Unpaid losses and loss adjustment expenses,
net of discount (1999 and prior) $ 52,703 $ 61,538 $ 84,384 $ 99,719 $ 111,642
Bank and other borrowings $ 14,636 $ 14,596 $ 15,550 $ 15,705 $ 8,967
Discontinued operations, net $ 37,332 $ 33,266 $ 29,255 $ 27,149 $ 28,656
Total liabilities and minority interest $ 81,888 $ 96,110 $ 122,802 $ 146,648 $ 154,680
Shareholders' equity $ 221,032 $ 207,899 $ 202,105 $ 169,506 $ 173,756
Book value per share $ 17.86 $ 16.81 $ 16.31 $ 18.72 $ 19.42
Note: Prior year share values have been adjusted to reflect the 1-for-5
Reverse Stock Split effective December 16, 1998, and the treatment of
American Physicians Life Insurance Company and Sequoia Insurance
Company as discontinued operations. Book value per share is computed by
dividing shareholders' equity by the net of total shares issued less
shares held as treasury shares.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The consolidated financial statements and other portions of this Annual
Report on Form 10-K for the fiscal year ended December 31, 2002 including Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations," reflect the effects of (1) the restatements of our consolidated
financial statements for all years from 1996 to 2001 inclusive as filed on March
31, 2003 on Form 10-K/A for the fiscal year ended December 31, 2001, and (2)
presenting Sequoia Insurance Company as discontinued operations.
COMPANY SUMMARY, RECENT DEVELOPMENTS, AND FUTURE OUTLOOK
VIDLER WATER COMPANY, INC.
WATER RIGHTS
ARIZONA
At December 31, 2002, Vidler owned or had the right to acquire
approximately 49,559 acre-feet of transferable ground water in the HARQUAHALA
VALLEY, approximately 75 miles northwest of metropolitan Phoenix, Arizona.
Vidler owns 35,795 acre-feet, and we have the option to purchase a further
13,764 acre-feet. We believe that Vidler's water rights in the Harquahala Valley
represent the most practical and competitive source of water to support the
growth of greater metropolitan Phoenix, which is one of the fastest growing
areas in the nation.
Vidler's water rights in the Harquahala Valley are primarily located in
Maricopa County. According to census data, Maricopa County was the fastest
growing county in the U.S. between April 1, 2000 and July 1, 2001, with 53,367
new homes added, an increase of 4.3% in 15 months. Vidler anticipates that there
will be municipal demand for water from the Harquahala Valley to support the
growth of the west side cities in Maricopa County, which are part of greater
metropolitan Phoenix.
Any new residential development in Arizona must obtain a permit from the
Arizona Department of Water Resources certifying a "designated assured water
supply" sufficient to sustain the development for at least 100 years. The
Harquahala Valley ground water meets the designation of assured water supply. In
order for the ground water to be used by municipalities in the heavily populated
parts of Arizona, the water must be "wheeled", or transported, from the
Harquahala Valley to the end users. The Arizona State Legislature has passed
legislation which allows Harquahala Valley ground water to be made available as
assured water supply to cities and communities in Arizona through agreements
with the Central Arizona Groundwater Replenishment District.
In March 2002, Vidler concluded its first sale of Harquahala Valley ground
water for municipal use, with the sale of 3,645 acre-feet of water rights and
1,215 acres of land in the Harquahala Valley ground water basin, to golf course
developers near Scottsdale. The sale price represents $1,450 per acre-foot of
water. The sale added $5.2 million to revenues and approximately $1.9 million to
gross margin in 2002.
14
The Arizona State Legislature has passed several pieces of legislation
which recognize the Harquahala Valley ground water as a future municipal supply
for the Phoenix metropolitan area. In 1991, the expansion of irrigated farming
in the Valley was prohibited, and the transfer of the ground water to
municipalities was authorized. In order to protect the Harquahala Valley ground
water from large commercial and industrial users which were moving into the
Basin, legislation was enacted in 2000 placing restrictions on commercial and
industrial users utilizing more than 100 acre-feet of water annually. These
users are required to purchase irrigable land and to withdraw the water that
they need from the land at no more than 3 acre-feet per annum per acre of land.
Vidler has closed two sales of Harquahala Valley ground water to an
industrial user within the Harquahala Basin:
- - in March 2001, Vidler sold 6,496.5 acre-feet of water rights and 2,589
acres of land. This transaction added $9.4 million to revenues and $2.3
million to gross margin in 2001; and
- - in May 2002, Vidler sold 480 acre-feet of water rights and 240 acres of
land. This transaction added $1 million to revenues and $556,000 to gross
margin in 2002.
Vidler is working on further sales of Harquahala Valley ground water to
both industrial users and communities and developers in the Phoenix metropolitan
area who need to secure further water to support expected growth.
NEVADA
Vidler has been increasing its ownership of water rights in northern Nevada
through the purchase of ranch properties and entering into joint ventures with
parties owning water rights, which they wish to maximize the value of.
Nevada is the state experiencing the most rapid population growth and new
home construction in the United States. The population is concentrated in
southern Nevada, which includes the Las Vegas metropolitan area.
1. LINCOLN COUNTY
Vidler is working jointly with Lincoln County to locate and develop water
resources in Lincoln County, Nevada. Lincoln County and Vidler have filed
applications for more than 100,000 acre-feet of water rights, covering
substantially all of the unappropriated water in the County, with the intention
of supplying water to rapidly growing communities and industrial users. We
believe that this is the only known new source of water for Lincoln County.
Vidler anticipates that up to 40,000 acre-feet of water rights will
ultimately be permitted from these applications, and put to use in Lincoln
County. We anticipate demand from industrial users locating new facilities in
Lincoln County, and from municipalities. Under the Lincoln County Land Act, more
than 13,000 acres of publicly owned land in southern Lincoln County will be
offered for sale near the fast growing City of Mesquite. Additional water will
be required if this land is to be developed.
In 1998, Lincoln/Vidler filed for 14,000 acre-feet of water rights for
industrial use from the Tule Desert Groundwater Basin. In November 2002, the
Nevada State Engineer granted an application for 2,100 acre-feet of water
rights, and ruled that another 7,244 acre-feet could be granted, but would be
held in abeyance while Lincoln/Nevada pursues additional studies.
As previously disclosed, Lincoln/Vidler had reached conditional agreement to
sell an electricity-generating company between 6,700 and 9,000 acre-feet of
water, at $3,300 per acre-foot, for a new power plant to be located in southern
Lincoln County on a site which was to be acquired from Nevada Land. Due to the
unprecedented instability in the energy market and capital market conditions
affecting the electricity sector, the electricity-generating company decided not
to move forward with the project. Recognizing that a permitted site with
permitted water rights will have value once the energy market stabilizes, Vidler
purchased the project for $50,000 in February 2003. Vidler is currently
reviewing the project with energy companies and utilities. If a financial
closing with a third party occurs within two years of the purchase, Vidler is
required to make an additional payment to the seller of the project.
The Lincoln County undertaking is an example of a transaction where Vidler
can partner with an entity, in this case a governmental entity, to provide the
necessary capital and skills to commercially develop water assets.
2. SANDY VALLEY, NEVADA
In 1999, Vidler filed an application for approximately 2,000 acre-feet of
water rights near Sandy Valley, Nevada. In June 2002, the Nevada State Engineer
awarded Vidler 415 acre-feet of the water rights. Vidler has filed an appeal
regarding the balance of the water applied for.
15
Pending resolution of the final amount of water to be permitted, Vidler has
reached tentative agreement to put this water to beneficial use within Nevada,
to support additional growth at Primm, Nevada. Primm is a resort town on the
border between California and Nevada, in the Interstate 15 corridor. The water
rights awarded to Vidler are the only known water to support future growth in
Primm and surrounding areas in Nevada near the California state line.
3. MUDDY RIVER WATER RIGHTS
The Muddy River is a perennial river fed by the Muddy Springs in Southern
Nevada, originating in Nevada and flowing into Lake Mead. Currently, Muddy River
water rights are utilized for agriculture and electricity generation.
At December 31, 2002, Vidler owned approximately 221 acre-feet of Muddy
River water rights, and had the right to acquire an additional 45.6 acre-feet.
The Southern Nevada Water Authority has been acquiring Muddy River water rights
as a water resource for future growth.
4. FISH SPRINGS RANCH
During 2000, Vidler purchased a 51% interest in Fish Springs Ranch, LLC
("Fish Springs") and a 50% interest in V&B, LLC. These companies own the Fish
Springs Ranch and other properties totaling approximately 8,600 acres in Honey
Lake Valley in Washoe County, 45 miles north of Reno, Nevada. Approximately
8,000 acre-feet of permitted water rights associated with Fish Springs Ranch are
transferable to the Reno/Sparks area. The water rights at Fish Springs have been
identified as the most economical and proven new source of supply to support new
growth in the North Valley communities of Washoe County. This county was in the
top 2% of all counties in the U.S. for new home construction between April 1,
2000 and July 1, 2001. According to census data, almost 5,500 new homes were
constructed over that 15 month period, a 3.8% increase.
Vidler is holding discussions with a number of potential users for the Fish
Springs water rights, including developers and industrial users. There is strong
demand for water in the North Valleys, and few alternative sources of supply.
The future demand of the North Valleys area is estimated to exceed 12,000
acre-feet annually. If water from Fish Springs could be supplied to the North
Valleys, this would reduce their reliance on Truckee River water which comes
through Reno, thereby providing environmental benefits and additional water to
support growth in and around Reno, an area which has been experiencing
consistent growth.
In October 2002, the Regional Water Planning Committee accepted the North
Valley Water Supply Comparison report. This study re-evaluated the feasibility
and potential cost of supplying future North Valleys water demands with
continued exportation of water from the Truckee River Basin, or, alternatively,
meeting the demands from Fish Springs and two other basins. The study indicated
that groundwater from Fish Springs would be the most economical source of
supply. Alternatively, if the capacity of nearby transmission lines can be
expanded, we believe that Fish Springs Ranch would be an attractive site for
gas-fired electricity generation.
5. BIG SPRINGS RANCH
Big Springs Ranch consists of approximately 37,500 acres of deeded ranch
land, located approximately 65 miles east of Elko, Nevada, in the northeastern
part of the state. Currently the ranch land is leased to farmers, although parts
of the property have the potential for a higher and better use.
There are 6,000 acre-feet of certificated water rights at Big Springs Ranch,
which are the only known practical source of water to support new growth for
West Wendover, Nevada and Wendover, Utah.
In addition, there are 6,000 acre-feet of permitted water rights related to
the ranch, and Vidler has filed applications for an additional 5,950 acre-feet
of water rights.
6. WEST WENDOVER, NEVADA
In 1999, a land exchange was completed in which approximately 70,500 acres
of ranchland at Big Springs Ranch was exchanged with the Bureau of Land
Management for several parcels of developable land near West Wendover, Nevada,
totaling approximately 6,300 acres. West Wendover is adjacent to the Nevada/Utah
border in the Interstate 80 corridor. Governmental officials are considering a
proposal to adjust the state line and then merge the cities of West Wendover,
Nevada and Wendover, Utah. West Wendover is approximately 120 miles from Salt
Lake City, Utah, and attracts a significant number of drive-in visitors from
Utah, a state where gaming is prohibited. The land owned by Vidler will stay in
Nevada.
16
The first parcel to be developed is approximately 82 acres of industrial
land. In September 2002, Vidler sold 7 acres of unimproved land for $500,000, or
approximately $71,429 per acre, to a developer who is responsible for installing
offsite utilities and access road improvements for an industrial park. We
anticipate that these improvements will allow Vidler to sell the remaining 75
acres as higher-value industrial land.
Vidler is examining alternatives for the remaining parcels, including
industrial, commercial, hotel/casino, and residential development.
COLORADO
Vidler has almost completed the process of monetizing its water rights in
Colorado, through sale or lease.
In 2000, Vidler closed the sale of various water rights and related assets
to the City of Golden, Colorado for $1 million, and granted the City options to
acquire other water rights over the next 15 years. The City exercised options to
acquire water assets for $390,000 in 2001 and $145,000 in 2002. If the remaining
options are exercised, the present value of the aggregate purchase price is
approximately $1.4 million.
During 2002, Vidler closed on two previously disclosed agreements to sell
Colorado assets:
- - in March, Vidler sold its interest in Cline Ranch to Centennial Water and
Sanitation District, which added $2.1 million to revenues and $119,000 to
gross margin; and
- - in December, Vidler completed the sale of 86 acre-feet of water rights to
the East Dillon Water District, which added $3.1 million to revenues and
$401,000 to gross margin.
An agreement to sell the Wet Mountain water rights for approximately
$414,000 is in escrow, and scheduled to close in 2003. Discussions are
continuing to either lease or sell the remaining water rights in Colorado.
WATER STORAGE
1. VIDLER ARIZONA RECHARGE FACILITY
During 2000, Vidler completed the second stage of construction at its
facility to "bank," or store, water underground in the Harquahala Valley, and
received the necessary permits to operate a full-scale water "recharge"
facility. "Recharge" is the process of placing water into storage underground.
Vidler has the permitted right to recharge 100,000 acre-feet of water per year
at the Vidler Arizona Recharge Facility, and anticipates being able to store in
excess of 1 million acre-feet of water in the aquifer underlying much of the
valley. When needed, the water will be "recovered," or removed from storage, by
ground water wells.
Vidler has the only permitted, complete private water storage facility in
Arizona. Given that Arizona is the only southwestern state with surplus flows of
water available for storage, we believe that Vidler's is the only private water
storage facility where it is practical to "bank", or store, water for users in
other states, which is known as "interstate banking". Having a permitted water
storage facility also allows Vidler to acquire, and store, surplus water for
re-sale in future years.
The Vidler Arizona Recharge Facility is the first privately owned water
storage facility for the Colorado River system, which is a primary source of
water for the Lower Division States of Arizona, California, and Nevada. The
water storage facility is strategically located adjacent to the Central Arizona
Project ("CAP") aqueduct, a conveyance canal running from Lake Havasu to Phoenix
and Tucson. The water to be recharged will come from surplus flows of CAP water.
We believe that proximity to the CAP is a competitive advantage, because it
minimizes the cost of water conveyance.
Vidler is able to provide storage for users located both within Arizona and
out-of-state. Potential users include industrial companies, developers, and
local governmental political subdivisions in Arizona, and out-of-state users
such as municipalities and water agencies in Nevada and California. The Arizona
Water Banking Authority ("AWBA") has the responsibility for intrastate and
interstate storage of water for governmental entities.
17
Vidler intends to charge customers a fee based on the amount of water
"recharged," and then an additional fee when the water is "recovered." The
revenues generated from this asset will depend on the quantity of water which
the AWBA, and private users, store at the facility. The quantity of water stored
will depend on a number of factors, including the availability of water and
available storage capacity at publicly owned facilities.
We believe that a number of events in recent years have increased the
scarcity value of the project's storage capacity. At a public hearing in March
2000, the AWBA disclosed that the Bureau of Reclamation has indicated that,
before permits are issued for new facilities to store water for interstate
users, extensive environmental impact studies will be required. The AWBA also
indicated that the first priority for publicly owned storage capacity in Arizona
is to store water for Arizona users. At the same hearing, the states of
California and Nevada again confirmed that their demand for storage far exceeds
the total amount of storage available at existing facilities in Arizona.
Consequently, interstate users will need to rely, at least in part, on privately
owned storage capacity.
The Southern Nevada Water Authority Water Resource Plan, which can be
viewed at www.snwa.com, calls for 1.2 million acre-feet of water to be stored in
Arizona in order to meet forecast demand after 2015. The AWBA is currently
finalizing agreements to store water on behalf of Nevada. Once these agreements
have been concluded, the AWBA can begin to negotiate storage for California. The
AWBA will be able to store water at existing publicly owned sites and at the
Vidler Arizona Recharge Facility, which is one of the largest water storage
facilities. Vidler has agreed on a price of $48.00 per acre-foot of water
recharged in 2003, if any of the users represented by the AWBA store water at
the facility in 2003.
In addition to the potential demand from the public users represented by the
AWBA, demand from private users could potentially utilize up to 100% of the
site's storage capacity.
Vidler has not yet stored water for customers at the facility, but the
company has been recharging water for its own account since 1998, when the pilot
plant was constructed. Vidler purchased the water from the CAP, and intends to
resell this water at an appropriate time. At December 31, 2002, Vidler has net
recharge credits of approximately 14,000 acre-feet of water at the facility.
Once Vidler has concluded agreements to store water, it will know the rate
at which customers will need to be able to recover water. At that time, Vidler
will be able to design, construct, and finance the final stage of the project
which will allow full-scale recovery. The users of the facility will bear the
capital cost of the improvements required to recover water at commercial rates.
Vidler anticipates being able to recharge 100,000 acre-feet of water per
year at the facility, and to store in excess of 1 million acre-feet of water in
the aquifer. Vidler's estimate of the aquifer's storage volume is primarily
based on a hydrological report prepared by an independent engineering firm for
the Central Arizona Water Conservation District in 1990, which concluded that
there is storage capacity of 3.7 million acre-feet.
Recharge and recovery capacity is critical, because it indicates how
quickly water can be put into storage or recovered from storage. In wet years,
it is important to have a high recharge capacity, so that as much available
water as possible may be stored. In dry years, the crucial factor is the ability
to recover water as quickly as possible. There is a long history of farmers
recovering significant quantities of water from the Harquahala Valley ground
water aquifer for irrigation purposes.
2. SEMITROPIC
Vidler originally had an 18.5% right to participate in the Semitropic Water
Banking and Exchange Program, which operates a 1,000,000 acre-foot water storage
facility at Semitropic, near the California Aqueduct, northwest of Bakersfield,
California.
The strategic value of the guaranteed right to recover an amount of water
from Semitropic every year -- even in drought years -- became clear to water
agencies, developers, and other parties seeking a reliable water supply. For
example, developers of large residential projects in Kern County and Los Angeles
County must now be able to demonstrate that they have sufficient back-up
supplies of water in the case of a drought year before they are permitted to
begin development. Accordingly, during 2001, Vidler took advantage of current
demand for water storage capacity with guaranteed recovery, and began to sell
its interest in Semitropic. The strategic value of the guaranteed right to
recover water was again highlighted by two court decisions in February 2003
which held that developers could not rely on water from state water projects.
In May 2001, Vidler closed the sale of 29.7% of its original interest
(i.e., approximately 55,000 acre-feet of water storage capacity) to The Newhall
Land and Farming Company for $3.3 million, resulting in a pre-tax gain of $1.6
million. This transaction added $1.6 million to revenues and segment income in
2001.
18
In September 2001, Vidler closed the sale of another 54.1% of its original
interest (i.e., approximately 100,000 acre-feet of water storage capacity) to
the Alameda County Water District for $6.9 million, resulting in a pre-tax gain
of $4.1 million. This transaction added $4.1 million to revenues and segment
income in 2001.
Vidler's remaining interest includes approximately 30,000 acre-feet of
storage capacity. We have the guaranteed right to recover a minimum of
approximately 2,700 acre-feet every year. In some circumstances, we have the
right to recover up to approximately 6,800 acre-feet in any one year. We are
considering various alternatives for the remaining interest, including sale to
developers or industrial users. Currently Vidler is not storing any water at
Semitropic for third parties. Vilder is required to make annual payments of
$519,000 under its agreement with Semitropic Water Storage District.
OTHER PROJECTS
Vidler routinely evaluates the purchase of further water-righted properties
in Arizona and Nevada. Vidler also continues to be approached by parties who are
interested in obtaining a water supply, or discussing joint ventures to
commercially develop water assets and/or develop water storage facilities in
Arizona, Nevada, and other states.
NEVADA LAND & RESOURCE COMPANY, LLC
The majority of Nevada Land's revenues come from the sale of land and water
rights. In addition, various types of recurring revenue are generated from use
of the company's lands, including leasing, easements, and mineral royalties.
Nevada Land also generates interest revenue from land sales contracts where the
company has provided partial financing, and from temporary investment of the
proceeds of land and water rights sales.
Nevada Land recognizes revenue from land sales, and the resulting gross
profit or loss, when transactions close. On closing, the entire sales price is
recorded as revenue, and a gross margin is recognized depending on the cost
basis attributed to the land which was sold. Since the date of closing
determines the accounting period in which the sales revenue and gain are
recorded, Nevada Land's reported revenues and income fluctuate from period to
period, depending on the dates when specific transactions close.
In 2002, Nevada Land generated $2.8 million in revenues from the sale of
28,423 acres of former railroad land. The average sales price of $99 per acre
compares to our average basis of $40 per acre in the parcels which were sold,
and our average cost of $35 per acre for all of Nevada Land's land, water, and
mineral assets. In addition, Nevada Land sold 2,860 acre-feet of permitted water
rights for $270,000, as well as 28 acres of surplus land at Spring Valley
Ranches for $28,000.
In 2002, 32.8% of land sales were settled for cash, and Nevada Land
provided partial financing for the balance. Vendor financing has been
collateralized by the land conveyed, typically carries a 10% interest rate, and
is subject to a minimum 20% down payment.
BUSINESS ACQUISITIONS AND FINANCING
This section describes the most significant interests in public companies
included in this segment during 2002.
1. AUSTRALIAN OIL & GAS CORPORATION LIMITED
During 1998, 1999, 2000, and 2001, we accumulated a 20.7% shareholding in
AOG, a public company which provides on-shore oil rig services in Australia and
internationally.
In January 2002, AOG announced that it was raising additional capital to
purchase a new deep capacity drilling rig and to refit two existing rigs to
perform new long term drilling contracts with ExxonMobil Indonesia and Petroleum
Development-Oman. We assisted AOG with the capital raising, providing the
company with a short term $US4 million bridging facility, which was repaid with
the proceeds of a rights offering which we partly underwrote. As compensation we
received 666,666 common shares of AOG valued at $589,000, which were issued as
fees for establishing the loan facility and underwriting the rights offering
In July 2002, PICO accepted Ensign (Australia) Holdings Pty. Ltd's cash
offer of $A2.70 ($US1.47) for the AOG common shares and $A1.50 ($US0.82) for the
AOG options owned by PICO. The sale proceeds were $21.1 million. Over the life
of the investment, PICO recorded a total of $10.1 million in pre-tax income and
realized gains from AOG, including realized gains of $8.7 million in 2002.
19
2. HYPERFEED TECHNOLOGIES, INC.
HyperFeed provides financial market data and data-delivery solutions to the
financial services industry.
PICO first invested in HyperFeed in 1995 through the purchase of common
stock. We invested further capital in HyperFeed as debt, which was later
converted to equity, and received warrants for providing financing. In 2000 and
2001, we further increased our holding through open market purchases and the
conversion of preferred stock. In August 2002, we exercised warrants to buy
949,032 new shares of HyperFeed for approximately $305,000, or $0.3215 per
share, being the average closing bid price on the NASDAQ National Market for the
20 trading days preceding the exercise date. PICO now owns 11,026,888 HyperFeed
common shares, increasing our voting ownership to approximately 44.1%.
In 2002, HyperFeed generated revenues of $19.8 million, gross margin of
$7.1 million, and a net loss from operations of $4.6 million. Net cash flow from
operating activities was $2.2 million. At December 31, 2002, HyperFeed had $1.1
million in cash and cash equivalents.
In the fourth quarter of 2002, HyperFeed generated revenues of $4.5
million, gross margin of $1.6 million, and a net loss of $2.8 million. Net cash
flow from operating activities was $182,000.
We use the equity method to account for the common shares. HyperFeed
contributed an equity loss of $2 million to the Business Acquisitions and
Financing segment in 2002. The equity loss and other events affecting equity
recorded in 2002 reduced our carrying value of the HyperFeed common shares to
$498,000.
PICO still holds warrants to buy 3,106,163 shares of HyperFeed common stock
at an average price of $1.575 per share. At December 31, 2002, the warrants were
carried at estimated fair value of $65,000.
On August 16, 2002, HyperFeed disclosed in a press release that "the
Company's Board of Directors recently rejected two conditional and non-binding
offers to purchase HYPR at prices that the Company felt did not fully recognize
the intrinsic value of its technology and the opportunities available for more
substantial creation of shareholder value by more aggressively capitalizing on
its technological advantages." During August and September 2002, HyperFeed
announced a number of changes to senior management. On October 21, 2002,
HyperFeed announced a series of restructuring measures, including a 21% work
force reduction, the consolidation of excess facilities, and a refocusing on
profitable business segments, which HyperFeed "expected to result in $2.2
million in annual net expense reductions."
3. JUNGFRAUBAHN HOLDING AG
PICO owns 130,177 shares of Jungfraubahn, which represents approximately
22.3% of the Company. At December 31, 2002, the market (carrying) value of our
holding was $24 million.
In September 2002, we acquired 17,505 shares for approximately $2.8
million, and became the largest shareholder in Jungfraubahn. Despite the
increase in our shareholding to more than 20%, we continue to account for this
investment under SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." At this time, we do not believe that we have the requisite
ability to exercise "significant influence" over the financial and operating
policies of Jungfraubahn, and therefore do not apply the equity method of
accounting.
In February 2003, Jungfraubahn issued a press release containing an initial
review of 2002 operations, using Swiss accounting principles. The full text is
available on Jungfraubahn's web-site www.jungfraubahn.com (in the "Shareholders"
tab of the "Inside" section).
In the press release, Jungfraubahn indicated that it expected transport
revenues of approximately CHF (Swiss Francs) 83.7 million ($US54.5 million) for
2002. On a comparable basis, transport revenues declined by CHF 2.2 million
($US1.4 million) year over year to approximately CHF 71.9 million ($US46.8
million), however the consolidation of Grindelwald-First Aerial Cableway AG
("BGF") for the first time in 2002 added transport revenues of approximately CHF
11.8 million ($US7.7 million). As expected, visitor numbers from Japan,
Jungfraubahn's most important inbound market, and the USA were down
significantly, but the shortfall was partly made up by increased numbers of
passengers from other countries. For example, the number of visitors to
Jungfraujoch-Top of Europe declined 2.4% year over year. In addition, domestic
passenger numbers were down during the summer season due to prolonged poor
20
weather and the competing attraction of Expo.02.
In September 2002, Jungfraubahn announced its results for the six months to
June 30, 2002. In the accompanying Letter to Shareholders, Jungfraubahn
explained that the results could not be directly compared to the previous year
due to the consolidation of BGF for the first time. Reported revenues were CHF
(Swiss Francs) 53.8 million ($US35 million). EBITDA (i.e., earnings before
depreciation, interest, and taxes, a non-GAAP measure which investors frequently
use as a proxy for gross cash flow, as calculated by Jungfraubahn) was CHF 14.2
million ($US9.2 million), and net income was CHF 3.1 million ($US2 million), or
approximately CHF 5.4 per share ($US3.52). Jungfraubahn disclosed that without
BGF, passenger revenues would have declined by approximately CHF 600,000
($US391,000).
Jungfraubahn announced its results for the 2001 financial year on May 23,
2002, so the 2002 results will not be released until after this 10-K has been
filed. Jungfraubahn's 2001 results were the second best in Jungfraubahn's
history. Revenues were CHF 98.7 million ($US58.6 million), EBITDA as calculated
by Jungfraubahn was CHF 30.4 million ($US18.1 million), and net income was CHF
14.2 million ($US8.4 million), or CHF 24.4 per share ($US14.49). Jungfraubahn's
operating activities generated net cash flow of CHF 26.7 million ($US15.9
million).
In the most recent published balance sheet -- December 31, 2001 --
Jungfraubahn had book value of approximately CHF 505.9 ($US366.30) per share. At
December 31, 2002, Jungfraubahn's stock price was CHF 255 ($US184.64).
4. OTHER EUROPEAN INVESTMENTS
ACCU HOLDING AG
PICO owns 8,125 shares in Accu Holding, which represents a voting ownership
interest of approximately 28.3% of the Company. Due to a number of factors, we
do not have the ability to exercise significant influence over Accu Holding's
activities, so the investment is carried at market value under SFAS No. 115.
Accu Holding manufactures batteries at two plants in Switzerland. Accu is
adjusting its production and cost structure following a decline in demand for
batteries during the economic slowdown. The Company is also preparing to
redevelop the site of a former factory near Zurich, which could have significant
value.
Over the past 3 years, there has been a protracted downturn in global stock
markets, which has affected the stock prices of many publicly traded companies.
According to Bloomberg data, during 2000, 2001, and 2002, the Wilshire 5000
Index (the best known indicator of the performance of the broad U.S. stock
market) declined by 39.6%.
As part of our regular review of securities in an unrealized loss position
for the year ended December 31, 2002, we have determined that the decline in
market value of three unrelated investments in the Business Acquisitions &
Financing segment is other-than-temporary. The total charge recorded is $4.1
million (see "Business Acquisitions and Financing" segment in "Results of
Operations - Years Ended December 31, 2002, 2001, and 2000".) By definition, the
recording of a charge for other-than-temporary decline in accordance with
GAAP does not necessarily mean that we believe that the current decline in value
is permanent in economic terms.
A charge for other-than-temporary impairment is a non-cash charge recorded
as a realized loss. The basis of the investment is written down from its
original cost to current carrying value, which typically is the market price at
the balance sheet date when the provision is recorded.
It should be noted that:
- - such charges for other-than-temporary impairments do not affect book value
per share, as the after-tax decline in the market value of investments
carried under SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," is already reflected in shareholders equity in our
balance sheet; and
- - the carrying (book) value of the holding does not change. The impairment
simply reclassifies the decline from an unrealized decrease in
shareholders' equity to a realized loss in the Statement of Operations.
The written-down value becomes our new basis in the investment. In future
accounting periods, unrealized gains or losses from that level will be recorded
in shareholders' equity, and when the investment is sold a realized gain or loss
from that level will be recorded in the statement of operations. See "Results of
Operations -- Years Ended December 31, 2002, 2001, and 2000."
Given the recent deterioration in Accu Holdings core business, and our
assessment that there would continue to be downward pressure on Accu's stock
price in the short to medium term, during 2002 we concluded that the decline in
Accu's market value is
21
other-than-temporary, primarily due to the extent and duration of the decline
in the market value of the security. We recorded a $2.2 million pre-tax
impairment of our investment. This impairment was recorded as a realized loss
and has reduced the basis of the investment to its market (carrying) value of
$3.1 million at December 31, 2002. This other than temporary impairment did not
affect PICO's shareholders' equity or book value per share.
RAETIE ENERGIE AG
PICO owns 14,755 shares in Raetie Energie, which is a producer of hydro
electricity. At December 31, 2002, our investment in Raetia Energie had a basis
of $2.7 million and a market value of $5 million.
SIHL
In 2000 and 2001, we acquired approximately 10.6% of SIHL for $4 million,
through participation in a restructuring/capital raising and open market
purchases. SIHL's core business is digital imaging, but the company has surplus
property assets in and around Zurich, including a major development project
known as Sihlcity. Our investment in SIHL is accounted for under SFAS No. 115.
SIHL's operations were adversely affected by the economic downturn in late
2001 and 2002, and SIHL was unable to improve profitability and reduce debt as
previously expected.
In 2001, we recorded a pre-tax impairment of $2.1 million for an
other-than-temporary decline in the market value of this security, primarily due
to the extent and duration of the decline in the market value of the security.
During 2002, the stock continued to decline which, combined with an announcement
from SIHL that a total sale of the company for more than the current market
value of the stock was unlikely, caused us to record a further $1.6 million
pre-tax impairment for an other-than-temporary decline.
The impairments have reduced our basis in SIHL to $768,000, which is
equivalent to our carrying (market) value at December 31, 2002. Such
other-than-temporary impairments recorded in 2001 and 2002 did not affect PICO's
shareholders' equity or book value per share.
INSURANCE OPERATIONS IN RUN OFF
Although "run off" insurance companies no longer write policies, earned
premiums can still arise, for example from policies which were still in force
when the company went into "run off", or related to reinsurance. Our insurance
companies have purchased reinsurance from specialized insurance companies to
limit our potential losses on the insurance coverage we have provided to our
policyholders. There are various types of reinsurance contracts, including
"swing rated" contracts, where the premium we pay is adjusted retroactively
based on the actual loss experience on the block of business which was
reinsured. Under U.S. GAAP, if we need to pay for additional reinsurance this is
recorded as a reduction in earned premiums, and if reinsurance premiums are
returned to us, this is recorded as an increase in earned premiums.
Typically most of the revenues of an insurance company in "run off" come
from investment income (i.e., interest from fixed-income securities and
dividends from stocks) earned on funds held as part of their insurance business.
In addition, from time to time, gains or losses are realized from the sale of
investments.
Apart from bonds issued by the U.S. Treasury and government-sponsored
enterprises (e.g., Freddie Mac and FNMA) which are held as capital and as
deposits or collateral with state regulators, the fixed-income component of our
insurance company portfolios consists of high grade corporate issues with 10 or
less years to maturity. Every bond we own is rated "1" or "2" by the National
Association of Insurance Commissioners, which is the equivalent of
investment-grade from the ratings agencies. As of December 31, 2002, none of our
bond holdings had declined significantly from cost. We do not own any municipal
bonds, or any corporate bonds in the telecommunications, technology, utilities,
energy trading, automotive, and consumer finance sectors, and conglomerates
which experienced difficulties in 2001 and 2002.
The duration of a bond portfolio measures the amount of time it would take
for the cash flows from scheduled interest payments and bond maturities to equal
the current value of the portfolio. Duration is an important measure because it
indicates the sensitivity of the market value of a bond portfolio to changes in
interest rates. If interest rates increase, the market value of existing bonds
will decline. During periods when market interest rates decline, such as 2001
and 2002, the market value of existing bonds increases. Typically, the longer
the duration, the greater the sensitivity of the value of the bond portfolio to
changes in interest rates.
22
The maturity of securities in Citation's bond portfolio is structured to
match the projected pattern of claims payouts. At December 31, 2002, the
duration of Citation's bond portfolio was 3.9 years, and the duration of the
Physicians bond portfolio was 3.6 years. A duration of 5 years is generally
regarded as medium term.
The equities portion of the insurance company portfolios primarily consists
of positions in a limited number of small-capitalization value stocks in the
U.S. These positions have been accumulated at a significant discount to our
estimate of the private market value of each company's underlying "hard" assets
(i.e., land and other tangible assets). To a lesser extent, the insurance
companies buy smaller interests in fundamentally undervalued stocks with high
dividend yields, in the U.S. and selected foreign markets. Dividends and
realized gains or losses from stocks held in the insurance company portfolios
are reported in the Insurance Operations in Run Off segment (and in the case of
Sequoia, in Discontinued Operations).
The investment income, and therefore revenue, of a "run off" insurance
company is expected to decline over time as fixed-income investments mature or
are sold to provide the funds to pay down the company's claims reserves. Unless
there is adverse development in prior year loss reserves, typically the expenses
of an insurance company in "run off" will be lower than the expenses of an
insurance company which is actively writing business.
PHYSICIANS INSURANCE COMPANY OF OHIO
Physicians wrote its last policy in 1995; however, claims can be filed until
2017 resulting from events allegedly occurring during the period when Physicians
provided coverage.
By its nature, medical professional liability insurance involves a
relatively small number (frequency) of relatively large (severity) claims. We
have purchased excess of loss reinsurance to limit our potential losses. The
amount of risk we have retained on each claim varies depending on the accident
year but, in general, we are liable for the first $1 million to $2 million per
claim.
Due to the long "tail" (i.e., period of time between the occurrence of the
alleged event giving rise to the claim, and the claim being reported to us) in
the medical professional liability insurance business, it is difficult to
accurately quantify future claims liabilities and establish appropriate loss
reserves. Our loss reserves are adjusted in the fourth quarter of each year,
based on independent actuarial analysis of past, current, and projected claims
trends in the 12 months ended September 30 of each year. The actuarial study is
carried out annually, as data for a shorter period would be insufficient to form
valid estimates.
At December 31, 2002, medical professional liability reserves totaled $30.3
million, net of reinsurance, compared to $34.9 million net of reinsurance at
December 31, 2001, and $51.6 million net of reinsurance at December 31, 2000.
PHYSICIANS INSURANCE COMPANY OF OHIO -- LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Year Ended December 31,
------------------------------------------------------------
2002 2001 2000
------------- ------------- -------------
Direct Reserves $36.4 million $40.6 million $58.6 million
Ceded Reserves ( 6.1) ( 5.7) ( 7.0)
------------- ------------- -------------
Net Medical Professional Liability Insurance Reserves $30.3 million $34.9 million $51.6 million
============= ============= =============
At December 31, 2002, our direct reserves, or reserves before reinsurance,
essentially equaled the independent actuary's best estimate. The independent
actuary is continually reviewing our claims experience and projected claims
trends in order to arrive at the most accurate estimate possible. The
independent actuary did not explicitly forecast a range of reserves, but arrived
at a best estimate through weighting the results of five different projection
methods for each accident year, and in total. Under the different projection
methods, the lowest direct reserve calculation was approximately $25.3 million,
and the highest direct reserve calculation was $38.9 million. Consequently, our
loss reserves could be materially different depending on the particular method
of calculation chosen.
Changes in assumptions about future claims trends and the cost of handling
claims can lead to significant increases and decreases in our loss reserves.
When loss reserves are reduced, this is referred to as favorable development. If
loss reserves are increased, the development is adverse.
At December 31, 2002, approximately $10.5 million, or 28.9% of our direct
reserves were case reserves, which are the loss reserves established when a
claim is reported to us. Our provision for IBNR claims (i.e., the event giving
rise to the claim has allegedly occurred, but the claim has not been reported to
us) were $17.4 million, or 47.7% of our direct reserves. The loss adjustment
expense reserves, totaling $8.5 million, or 23.4% of direct reserves, recognize
the cost of handling claims over the next 14 years while the Physicians loss
reserves run off.
23
Over the past 3 years, the trends in open claims and claims paid have
been:
Year Ended December 31,
------------------------------------------------------------
2002 2001 2000
------------- -------------- -------------
Open claims at the start of the year 179 252 362
New claims reported during the year 24 37 36
Claims closed during the year - 59 -110 -146
------------- -------------- -------------
Open claims at the end of the year 144 179 252
============= ============== =============
Total claims closed during the year 59 110 146
Claims closed with no indemnity payment - 36 - 87 - 98
------------- -------------- -------------
Claims closed with an indemnity payment 23 23 48
Net indemnity payments $2,473,000 $4,142,000 $ 7,862,000
Net loss adjustment expense payments 1,072,000 1,947,000 3,004,000
------------- -------------- -------------
Total claims payments during the year $3,545,000 $6,089,000 $10,866,000
============= ============== =============
Average indemnity payment $108,000 $180,000 $164,000
During 2002, our medical professional liability insurance claims reserves,
net of reinsurance, decreased from $34.9 million to $30.3 million. Claims
payments for the year were approximately $3.6 million, accounting for 78% of the
net decrease in reserves during 2002. Due to continued favorable trends in the
"severity" (size) of claims, and, to a lesser extent, the "frequency" (number)
of claims, independent actuarial analysis of Physicians' loss reserves as of
September 30, 2002 concluded that Physicians' reserves against claims were
greater than the actuary's projections of future claims payments. Reserves were
increased in 10 of Physicians' 20 accident years from 1976 until 1996 (by $3.4
million), and reduced in the other 10 accident years (by $4.4 million),
resulting in a net reduction of approximately $1 million, or 2.9% of reserves at
the start of the year.
The net reduction in reserves of approximately $1 million was primarily a
product of the following factors:
- - due to a decrease in claims severity, Physicians reduced its reserve for
IBNR claims by approximately $3 million;
- - this was partially offset by a $2.2 million increase in the provision for
unallocated loss adjustment expense, which effectively recognized the cost
of handling Physicians' claims over the remaining run off; and
- - in addition, two adjustments related to reinsurance had a net effect of
$49,000 -- an increase in ceded reserves of $820,000, and a decrease in
reserves related to retroactive reinsurance of $771,000.
There were no changes in key actuarial assumption in 2002. It should be noted
that such actuarial analyses involves estimation of future trends in many
factors which may vary significantly from expectation, which could lead to
further reserve adjustments -- either increases or decreases -- in future years.
See "Critical Accounting Policies" and "Risk Factors."
The decline in severity is illustrated by the average indemnity payment
declining from approximately $180,000 in 2001 to approximately $108,000 in 2002.
We are currently projecting further decreases in severity in future years - at
December 31, 2002, the average case reserve per open claim was approximately
$73,000.
PHYSICIANS INSURANCE COMPANY OF OHIO - CHANGE IN LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Year Ended December 31,
-----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Beginning Reserves $34.9 million $51.6 million $53.7 million
Accounting Change - no longer Discounting 7.3
Loss & Loss Adjustment Expense Payments (3.6) (6.1) (10.9)
Re-estimation of Prior Year Loss Reserves (1.0) (10.6) 1.5
------------- ------------- -------------
Net Medical Professional Liability Insurance Reserves $30.3 million $34.9 million $51.6 million
============= ============= =============
------------- ------------- -------------
Re-estimation as a percentage of undiscounted beginning
reserves - 2.9% - 20.6% - 2.4%
============= ============= =============
During 2001, our medical professional liability insurance claims reserves,
net of reinsurance, decreased from $51.6 million to $34.9 million. Claims
payments for the year were $6.1 million, accounting for 36% of the net decrease
in reserves during 2001. Actuarial analysis of Physicians' loss reserves as of
September 30, 2001 concluded that Physicians' reserves against claims were
significantly greater than the actuary's projections of future claims payments
in 18 of 20 accident years, due to favorable trends in both the "frequency" and
"severity" of claims. Consequently, Physicians reduced its reserve for IBNR
claims by approximately $10.6 million, which accounted for the remaining 64% of
the net decrease in reserves for the year.
24
There was a change in a key actuarial assumption in 2001: when estimating
the reserves required for losses greater than $200,000 per claim, the
independent actuary began to use Physicians' own claims experience, rather than
industry averages. Since Physicians' own experience had been less severe than
the industry averages, the actuary reduced the reserves required for losses in
excess of $200,000 per claim, which contributed to the reduction in reserves. In
reaching the best estimate, the appointed actuary also took note of both a
decrease in the number of open claims, and favorable development in known claims
during 2001.
In 2000, our medical professional liability insurance claims reserves, net
of reinsurance, decreased from $53.7 million to $51.6 million. An accounting
change, implemented as of January 1, 2000, eliminated the discounting of loss
reserves, which increased reserves by $7.3 million, to $61 million. Claims
payments for the year were $10.9 million. Actuarial analysis of Physicians' loss
reserves as of September 30, 2000 concluded that Physicians' direct reserves
contained approximately $10 million in redundancy; however, this was more than
offset by $11.5 million of redundancy in reserves ceded to our reinsurance
companies. Consequently, Physicians increased reserves by approximately $1.5
million. There were no changes to key actuarial assumptions in 2000.
Since it is almost seven years since Physicians wrote its last policy, and
the direct IBNR claims reserve at December 31, 2002 is $17.4 million, it is
conceivable that further favorable development could be recorded in future years
if claims trends remain favorable, particularly claims severity. However, we
caution (1) that claims can be reported until 2017, and (2) against
over-emphasizing claims count statistics - for example, the last claims to be
resolved by a "run off" insurance company could be the most complex and the most
severe.
CITATION INSURANCE COMPANY
Citation went into "run off" from January 1, 2001. At December 31, 2002,
after two years of "run off," Citation had $14.6 million in loss and loss
adjustment expense reserves after reinsurance.
Approximately 85% of Citation's reserves are related to one line of
business, artisans/contractors liability insurance. The remaining 15% relate to
the remaining lines of commercial property and casualty insurance business. The
last of Citation's commercial property and casualty insurance policies expired
in 2001. As a general rule, based on state statutes of limitations, we believe
that:
- - new commercial property and casualty insurance claims can be filed in
Arizona until the end of 2003; but
- - no new commercial property and casualty insurance claims can be filed in
California. However, in certain limited circumstances, claims filing
periods may be extended.
We have purchased excess of loss reinsurance to limit our potential losses.
The amount of risk we have retained on each claim varies depending on the
accident year, but we can be liable for the first $50,000 to $250,000 per claim.
Citation wrote artisans/contractors insurance until 1995, the year before
Physicians merged with Citation's parent company. No artisans/contractors
business was renewed after the merger. Artisans/contractors liability insurance
has been a problematic line of business for all insurers who offered this type
of coverage in California during the 1980's and 1990's. California experienced a
severe recession in the early 1990's, which caused a steep downturn in real
estate values. In an attempt to improve their position, many homeowners filed
claims against developers of new home communities and condominiums, and related
parties such as general contractors, for alleged construction defects.
Citation's average loss ratio (i.e., the cost of making provision to pay claims
as a percentage of earned premium) for all years from 1989 to 1995 for this
insurance coverage is over 375%. The nature of this line of business is that we
receive a large number (high frequency) of small (low severity) claims.
Citation primarily insured subcontractors, and only rarely insured general
contractors. A large percentage of the claims received in 2002 related to
Additional Insured Endorsements ("AIE"). In general, these represent claims from
general contractors who were not direct policyholders of Citation's, but were
named as insureds on policies issued to the company's subcontractor
policyholders. Most of Citation's subcontractor insureds are not initially named
as defendants in construction defect law suits, but are drawn into litigation
against general contractors, typically when the general contractor's legal
expenses reach the limit of their own insurance policy. The courts have held
that subcontractors who performed only a minor role in the construction can be
held in on complicated litigation against general contractors. Accordingly, the
cost of legal defenses can be as significant as claims payments. Typically AEI
claims are shared among more than one subcontractor and more than one insurance
carrier. This reduces the expense to any one carrier, so AEI claims typically
involve smaller claims payments than claims from actual policyholders. Since
Citation sets an initial case reserve of $20,000 on most claims received, and
many AIE claims are closed for a smaller amount, Citation experienced favorable
loss development in 2002.
Citation's independent actuary has assumed that the reporting of new
artisan/contractors claims has peaked, and that new claims
25
will decline in future years. Although Citation wrote its last
artisans/contractors policy in 1995 and the statute of limitations in California
is 10 years, this can be extended in some situations.
Over the past 3 years, the trends in open claims and claims paid in the
artisans/contractors line of business has been:
Year Ended December 31,
----------------------------------------------------------
2002 2001 2000
-------------- ------------- --------------
Open claims at the start of the year 303 341 308
New claims reported during the year 227 197 251
Claims closed during the year - 240 - 235 - 218
-------------- ------------- --------------
Open claims at the end of the year 290 303 341
============== ============= ==============
Total claims closed during the year 240 235 218
Claims closed with no payment - 90 - 71 - 61
Claims closed with LAE payment only (no indemnity payment) - 40 - 49 - 36
-------------- ------------- --------------
Claims closed with an indemnity payment 110 115 121
============== ============= ==============
Due to the long "tail" (i.e., period between the occurrence of the alleged
event giving rise to the claim and the claim being reported to us) in the
artisans/contractors line of business, it is difficult to accurately quantify
future claims liabilities and establish appropriate loss reserves. Our loss
reserves are reviewed at September 30 and December 31 of each year by an
independent actuary who issues an opinion annually, as required by California
state law. The independent actuary analyzes past, current, and projected claims
trends for all active accident years, using several forecasting methods. The
appointed actuary believes this will result in more accurate reserve estimates
than using a single method. We typically book our reserves to the actuary's best
estimate, or above the actuary's best estimate.
Changes in assumptions about future claims trends and the cost of handling
claims can lead to significant increases and decreases in our loss reserves. Due
to the large number of claims received in the artisans/contractors line of
business in 1997, 1998, and 1999, Citation was forced to increase its reserves
in each of those years. Citation reduced claims reserves by $282,000 in 2000,
increased reserves by $56,000 in 2001, and reduced reserves by $889,000 in 2002.
In 2002, the change in reserves was less than 5% of total reserves at the start
of the relevant year. In 2001 and 2000, the reserve changes were less than 1% of
beginning reserves.
There have been no changes in key actuarial assumptions during 2000, 2001,
and 2002. See "Critical Accounting Policies" and "Risk Factors."
At December 31, 2002, Citation's net reserves were carried at $14.6 million,
approximately $1 million more than the actuary's best estimate. Given the
uncertainties inherent in projecting claims trends in the artisans/contractors
line of business, we elected to set higher reserves than the actuary's best
estimate, to partially guard against unexpected reserve increases in future
years if claims experience deteriorates. Consequently, if current claims trends
continue, it is conceivable that favorable development could be recorded in
future years.
CITATION INSURANCE COMPANY - LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
December 31, 2002 December 31, 2001 December 31, 2000
------------------------ ---------------------- -----------------------------
Direct Reserves $16.3 million $21.0 million $25.8 million
Ceded Reserves ( 1.7) (1.8) (2.4)
------------------------ ---------------------- -----------------------------
Net Reserves $14.6 million $19.2 million $23.4 million
======================== ====================== =============================
At December 31, 2002, $4.8 million of Citation's reserves (approximately
33%) were case reserves, $8.1 million of Citation's reserves represented
provision for IBNR claims (56%), and the unallocated loss adjustment expense
reserve was $1.7 million (11%).
26
The change in Citation's reserves over the past 3 years has resulted from:
CITATION INSURANCE COMPANY - CHANGE IN LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Year Ended December 31,
----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Beginning Reserves $19.2 million $23.4 million $34.6 million
Loss & Loss Adjustment Expense Payments (3.7) (4.5) (12.0)
Incurred Loss & Loss Adjustment Expense Payments For Current Year 0.2 1.1
Re-estimation of Prior Year Loss Reserves (0.9) 0.1 (0.3)
------------- ------------- -------------
Net Property & Casualty Insurance Reserves $14.6 million $19.2 million $23.4 million
------------- ------------- -------------
Re-estimation as a percentage of beginning reserves - 4.6% - 0.2% - 0.8%
------------- ------------- -------------
During 2002, Citation's property and casualty insurance claims reserves, net
of reinsurance, decreased from $19.2 million to $14.6 million. Claims payments
for the year were $3.7 million, accounting for approximately 80% of the net
decrease in reserves during 2002. Actuarial analysis of Citations' loss reserves
as of December 31, 2002 continued to show a redundancy in the carried reserves
of Citation, which we reduced during 2002 by $889,000. The reserve redundancy
reflects the reduction in the "severity" (size) of claims described in preceding
paragraphs.
During 2001, Citation's property and casualty insurance claims reserves, net
of reinsurance, decreased from $23.4 million to $19.2 million. Claims payments
for prior years reduced reserves by $4.5 million, and essentially accounted for
the net reduction in reserves for the year. This was partially offset by
$172,000 in incurred loss and loss adjustment expenses for the 2001 accident
year, consisting of paid losses of $54,000 and additions to reserves of
$118,000. A $56,000 increase in prior year loss reserves was recorded.
In 2000, Citation's property and casualty insurance claims reserves, net of
reinsurance, decreased from $34.6 million to $23.4 million. Claims payments for
prior years reduced reserves by $12 million, which led to the net reduction in
reserves for the year. This was partially offset by $1.1 million in incurred
loss and loss adjustment expenses for the 2000 accident year, consisting of paid
losses of $283,000 and additions to reserves of $817,000. Favorable development
of $282,000 was recorded in prior year loss reserves.
It should be noted that such actuarial analyses involves estimation of
future trends in many factors which may vary significantly from expectation,
which could lead to further reserve adjustments -- either increases or decreases
- -- in future years.
DISCONTINUED OPERATIONS
SEQUOIA INSURANCE COMPANY
In 2002, Sequoia generated direct written premiums of $68.3 million, a
26.2% increase from the previous year, primarily due to a 19.7% increase in the
average premium per commercial policy. The increase in average premium per
commercial policy resulted from various initiatives introduced by Sequoia's
management to improve the Company's underwriting results following disappointing
loss ratios in 2000 and 2001. These initiatives included a further tightening in
underwriting standards, and rate increases in most commercial lines.
The operating performance of insurance companies is frequently analyzed
using their "combined ratio." A combined ratio below 100% indicates that the
insurance company made a profit on its base insurance business, prior to
investment income, realized gains or losses, taxes, extraordinary items, and
other non-insurance items.
During our ownership, Sequoia managed its business with the aim of having a
combined ratio of less than 100% each year, although this was not always
achieved. Sequoia's combined ratios on a GAAP basis for the past 3 years were:
SEQUOIA'S GAAP INDUSTRY RATIOS
- -------------------------------------------------------------------------------------------------------------------
2002 2001 2000
------------ ----------- ------------
Loss and LAE Ratio 66.2% 69.1% 67.6%
Underwriting Expense Ratio 35.4% 36.3% 38.6%
------------ ----------- ------------
Combined Ratio 101.6% 105.4% 106.3%
- -------------------------------------------------------------------------------------------------------------------
27
For 2002, Sequoia's combined ratio was 101.6%, compared to 105.4% in 2001,
and 106.3% in 2000.
Sequoia's loss and loss adjustment expense ratio (i.e., the cost of making
provision to pay claims as a percentage of earned premiums) was 66.2% in 2002,
69.1% in 2001, and 67.6% in 2000. The relatively high loss ratios in 2000 and
2001 were caused by claims costs having risen faster than premium rates. The
increase in average premium per commercial policy described in preceding
paragraphs helped to restore underwriting margins, and contributed to the
improved loss ratio in 2002.
Sequoia's underwriting expense ratio (i.e., operating expenses as a
percentage of earned premiums) was 35.4% in 2002, compared to 36.3% in 2001, and
38.6% in 2000. The progressive reduction in the underwriting expense ratio was
primarily due to economies of scale. Sequoia's earned premiums grew by 11.3% in
2002 and 29.2% in 2001. As fixed underwriting expense items (i.e., expenses
which do not change with volume) were spread over a larger base of revenue,
these expenses declined as a percentage of earned premium.
SEQUOIA INSURANCE COMPANY - LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
December 31, 2002 December 31, 2001 December 31, 2000
------------------------ ---------------------- -----------------------------
Direct Reserves $49.2 million $36.9 million $37.2 million
Ceded Reserves (26.2) ( 15.7) (18.1)
------------------------ ---------------------- -----------------------------
Net Reserves $23.0 million $21.2 million $19.1 million
======================== ====================== =============================
Given the short reporting tail with the type of property and casualty
insurance business written by Sequoia, changes in prior year loss reserves tend
to represent a small percentage of the Company's total reserves.
CRITICAL ACCOUNTING POLICIES
PICO's principal assets and activities comprise:
- - Vidler Water Company and Nevada Land & Resource Company's land, water
rights, and water storage operations;
- - property and casualty insurance operations, and the "run off" of property
and casualty insurance and medical professional liability insurance loss
reserves; and
- - business acquisitions and financing.
Following is a description of what we believe to be the critical accounting
policies affecting our Company, and how we apply these policies.
1. ESTIMATION OF RESERVES IN INSURANCE COMPANIES
We must estimate future claims and ensure that our loss reserves are
adequate to pay those claims. This process requires us to make estimates about
future events. The accuracy of these estimates will not be known for many years.
For example, part of our claims reserves cover "IBNR" claims (i.e., the event
giving rise to the claim has occurred, but the claim has not been reported to
us). In other words, in the case of IBNR claims, we must provide for claims
which we do not know about yet.
At December 31, 2002, the loss reserves, net of reinsurance, of our three
insurance subsidiaries were:
- - Citation Insurance Company, $14.6 million;
- - Physicians Insurance Company of Ohio, $30.3 million. Physicians wrote its
last policy in 1995. However, under current law, claims can be made until
2017 for events which allegedly occurred during the periods when we
provided insurance coverage to medical professionals; and
- - Sequoia Insurance Company, $23 million.
Our medical professional liability insurance reserves are certified
annually by an independent actuary, as required by Ohio insurance law. Actuarial
estimates of our future claims obligations have been volatile. In 2002, there
was a $1 million net reduction after independent actuarial studies concluded
that Physicians' claims reserves were greater than projected claims payments,
and in 2001, we reduced claims reserves by $10.6 million. However, based on
independent actuarial analysis, we increased reserves by $1.5 million in 2000.
Accordingly, there can be no assurance that our claims reserves are adequate and
there will not be reserve increases or decreases in the future.
As required by California insurance law, the loss reserves of Citation
Insurance Company and Sequoia Insurance Company are reviewed quarterly, and
certified annually, by an independent actuarial firm.
28
See "Insurance Operations In Run Off," and "Discontinued Operations" on
preceding pages in Item 7.
2. CARRYING VALUE OF LONG-LIVED ASSETS
Our principal long-lived assets are land, water rights, and interests in
water storage operations owned by Vidler, and land at Nevada Land. At December
31, 2002, the total carrying value of land, water rights, and interests in water
storage assets was $116.8 million, or 29.5% of PICO's total assets.
As required by GAAP, our long-lived assets are reviewed regularly to ensure
that the estimated future undiscounted cash flows from these assets will at
least recover their carrying value. Our management conducts these reviews
utilizing the most recent information available; however, the review process
inevitably involves the significant use of estimates and assumptions.
In our water rights and water storage business, we develop some projects
and assets from scratch. This can require cash outflows (e.g., to drill wells to
prove that water is available) in situations where there is no guarantee that
the project will ultimately be commercially viable. If we determine that it is
probable that the project will be commercially viable, the costs of developing
the asset are capitalized (i.e., recorded as an asset in our balance sheet,
rather than being charged as an expense). If the project ends up being viable,
in the case of a sale, the capitalized costs are included in the cost of land
and water rights sold and applied against the purchase price. In the case of a
lease transaction or when the asset is fully developed and ready for use, the
capitalized costs are amortized (i.e., charged as an expense in our income
statement) and match any related revenues.
If we determine that the carrying value of an asset cannot be justified by
the forecast future cash flows of that asset, the carrying value of the asset is
written down to fair value immediately.
3. ACCOUNTING FOR INVESTMENTS AND INVESTMENTS IN UNCONSOLIDATED AFFILIATES
At December 31, 2002, PICO and its subsidiaries held equities with a
carrying value of approximately $47.4 million (excluding equities held by
Sequoia in Discontinued Operations). These holdings are primarily
small-capitalization value stocks listed in the U.S., Switzerland, and New
Zealand. Depending on the circumstances, and our judgment about the level of our
involvement with the investee company, we apply one of two accounting policies.
In the case of most holdings, we apply Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities". Under this method, the investment is carried at market value
in our balance sheet, with unrealized gains or losses being included in
shareholders' equity, and the only income recorded is from dividends.
In the case of investments where we have the ability to exercise
significant influence over the company we have invested in, we apply the equity
method under Accounting Principles Board ("APB") Opinion No. 18, "The Equity
Method of Accounting for Investments in Common Stock".
The application of the equity method (APB No. 18) to an investment may
result in a different outcome in our financial statements than market value
accounting (SFAS No. 115). The most significant difference between the two
policies is that, under the equity method, we include our proportionate share of
the investee's earnings or losses in our statement of operations, and dividends
received are used to reduce the carrying value of the investment in our balance
sheet. Under market value accounting, the only income recorded is dividends.
The assessment of what constitutes the ability to exercise "significant
influence" requires our management to make significant judgments. We look at
various factors in making this determination. These include our percentage
ownership of voting stock, whether or not we have representation on the investee
company's Board of Directors, transactions between us and the investee, the
ability to obtain timely quarterly financial information, and whether PICO
management can affect the operating and financial policies of the investee
company. When we conclude that we have this kind of influence, we adopt the
equity method and change all of our previously reported results of the investee
to show the investment as if we had applied equity accounting from the date of
our first purchase. This adds volatility to our reported results.
While the method of accounting we use clearly has no impact on the
underlying economic performance of the investee, the use of market value
accounting or the equity method can result in significantly different carrying
values at specific balance sheet dates, and contributions to our statement of
operations over the course of the investment. The total impact of the investment
on PICO's shareholders' equity over the entire life of the investment will be
the same whichever method is adopted.
29
For equity and debt securities accounted for under SFAS No. 115 which are
in an unrealized loss position, we regularly review whether the decline in
market value is other-than-temporary. In general, this review requires
management to consider several factors, including specific adverse conditions
affecting the investee's business and industry, the financial condition of the
investee, the long-term prospects of the investee, and the extent and duration
of the decline in market value of the investee. Accordingly, management has to
make important assumptions regarding our intent and ability to hold the
security, and our assessment of the overall worth of the security. Risks and
uncertainties in our methodology for reviewing unrealized losses for
other-than-temporary declines include our judgments regarding the overall worth
of the issuer and its long-term prospects, and our ability to realize on our
assessment of the overall worth of the business.
In a subsequent quarterly review, if we conclude that an unrealized loss
previously determined to be temporary is other-than-temporary, an impairment
loss will be recorded. The other-than-temporary impairment charge will have no
impact on our financial condition or book value per share, as the decline in
market value has already been recorded through shareholders' equity. However,
there will be an impact on our net income before and after tax and on our
reported earnings per share, due to recognition of the unrealized loss and tax
effects. When a charge for other-than-temporary impairment is recorded, our
basis in the security is decreased. Consequently, if the market value of the
security later recovers and we sell the security, a correspondingly greater gain
will be recorded in the statement of operations.
These accounting treatments add volatility to our statements of operations.
4. REVENUE RECOGNITION
Revenue on the sale of land, water, and water rights is recognized in full
when (a) there is a legally binding sale contract; (b) the profit is
determinable (i.e., the collectibility of the sales price is reasonably assured,
or any amount that will not be collectible can be estimated); (c) the earnings
process is virtually complete (i.e., we are not obliged to perform significant
activities after the sale to earn the profit, meaning we have transferred all
risks and rewards to the buyer); and (d) the buyer's initial and continuing
investment are adequate to demonstrate a commitment to pay for the property. If
these conditions are not met, we use the deposit method of accounting. Under the
deposit method of accounting, until the conditions to fully recognize a sale are
met, payments by the buyer are recorded as liabilities and no gain is
recognized.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
SHAREHOLDERS' EQUITY
At December 31, 2002, PICO had shareholders' equity of $221 million ($17.86
per share), compared to $207.9 million ($16.81 per share) as restated at the end
of 2001, and $202.1 million ($16.31 per share) as restated at the end of 2000.
Book value per share increased by 6.2% in 2002, and 3.1% in 2001.
The principal factors leading to the $13.1 million increase in
shareholders' equity were the $5.9 million net income and net movements of $4.5
million in unrealized appreciation in investments and $2.6 million in foreign
currency translation. In addition, $238,000 of new capital was subscribed to
exercise options. These factors were partially offset by a $94,000 increase in
treasury stock due to the purchase of PICO shares in deferred compensations
plans for directors and employees.
BALANCE SHEET
Total assets at December 31, 2002 were $396.2 million, compared to $374.4
million at December 31, 2001. Most of the $21.8 million increase in total assets
is attributable to an increase in Sequoia's investment portfolio related to
growth in that company's book of business, and an increase in the value of
equity and fixed-income securities. Total liabilities increased by $8.6 million,
primarily due to an increase in Sequoia's claims reserves related to growth in
that company's book of business, which was partially offset by a reduction in
the reserves of our insurance operations in run off, Physicians and Citation.
At December 31, 2002, on a consolidated basis, available for sale equity
securities showed a net unrealized gain of $10 million after tax. This total
consists of approximately $10.2 million in gains, partially offset by $170,000
in losses. No individual equity security had an unrealized loss, net of tax, of
more than $60,000.
30
ACCOUNTING FOR DISCONTINUED OPERATIONS
As Sequoia is now accounted for as a Discontinued Operation, under GAAP the
presentation of Sequoia's income, assets and liabilities, and cash flow in our
financial statements for all years in this 10-K has changed:
- - in our Consolidated Statements of Operations, Sequoia's after-tax income is
now recorded in one line, "Income from discontinued operations, net."
Consequently, Sequoia's revenues, expenses, and pre-tax income are no
longer reported separately, and are not included in the following segmental
analysis;
- - in the Consolidated Balance Sheet, Sequoia's assets are grouped in the
lines "Investments held by discontinued operations" and "Other assets of
discontinued operations," and its liabilities are combined in the lines
"Unpaid losses and loss adjustment expenses of discontinued operations" and
"Other liabilities of discontinued operations;" and
- - in the Consolidated Statements of Cash Flows, Sequoia's cash flow is
reported in one line in each category of cash flow.
NET INCOME (LOSS)
PICO reported net income of $5.9 million, or $0.48 per diluted share in
2002, compared with net income of $5.1 million, or $0.41 per diluted share in
2001, and a net loss of $11.3 million, or $0.97 per diluted share, in 2000.
2002
The $5.9 million net income reported in 2002 consisted of an $3.9 million
net income before a change in accounting principle, or $0.32 per share, and a
change in accounting principle which increased income by $2 million after-tax,
or $0.16 per share. From January 1, 2002, PICO adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and Intangible Assets," which requires
that goodwill and intangible assets with indefinite lives be tested for
impairment annually rather than amortized over time. The $2 million in net
income recognized reflected the surplus of negative goodwill arising from the
1996 reverse merger of Physicians and Citation Insurance Group (now known as
PICO Holdings, Inc.) over the write-off of goodwill items which were determined
to be impaired. See Note 20 of Notes to Consolidated Financial Statements,
"Cumulative Effect of Changes in Accounting Principle," and the Insurance
Operations in Run Off segment.
The $3.9 million in net income before a change in accounting principle was
comprised of:
- - income of $2.7 million before taxes and minority interest from continuing
operations;
- - a $2 million income tax expense;
- - the addition of $454,000 in minority interest, which reflects the interest
of outside shareholders in the losses of subsidiaries which are less than
100%-owned by PICO; and
- - income from discontinued operations (i.e., Sequoia) of $2.8 million after
tax and a change in accounting principle.
The $2 million tax expense for 2002 consists of several items, which are
detailed in Note 7 of Notes to the Consolidated Financial Statements, "Federal,
Foreign and State Income Tax." We do not need to pay any federal taxes in cash
for 2002 because prior year net operating loss carry-forwards offset our tax
provision for the year, however we have provided for the payment of
approximately $400,000 in state income taxes.
2001
In 2001, PICO generated $5.1 million in net income, consisting of $6.1
million in net income before a change in accounting principle, or $0.49 per
share, and a change in accounting principle which reduced income by $981,000
after-tax, or $0.08 per share. The change in accounting principle resulted from
the adoption of the Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This non-cash
charge recognized the accumulated after-tax decline in the estimated fair value
of warrants we own to buy shares in other companies (principally HyperFeed
Technologies, Inc.) from the date we acquired the warrants through to January 1,
2001. The decline in the estimated fair value of warrants during 2001 is
recorded in the Business Acquisitions and Financing segment.
The $6.1 million in net income before a change in accounting principle was
comprised of:
- - $5.8 million in income before taxes and minority interest;
- - a $2.4 million provision for income tax expense;
- - the addition of $358,000 in minority interest; and
- - income from discontinued operations (i.e., Sequoia) of $2.3 million
after-tax.
A gross provision for tax of approximately $3 million was partially offset
by $630,000 in tax benefits, primarily represented by a cash refund following a
successful appeal of a prior year tax ruling in Canada. We did not pay any taxes
in cash for 2001 because prior year net operating loss carry-forwards offset our
tax provision for the year.
31
2000
PICO incurred a net loss of $11.3 million in 2000. The $6.3 million net
loss before an accounting change consisted of a $17.4 million pre-tax loss,
which was partially offset by $9.4 million in income tax benefits and the
addition of $717,000 in minority interest. Income from discontinued operations
was $953,000. In addition, the cumulative effect of an accounting change reduced
income by $5 million after-tax. Until December 31, 1999, PICO had discounted the
carrying value of its medical professional liability claims reserves, to reflect
the fact that some claims will not be paid until many years in the future, but
funds from the corresponding premiums can be invested in the meantime. After
December 31, 1999, PICO's medical professional liability insurance subsidiaries
were no longer allowed to discount claims reserves in the statements they file
with the Ohio Department of Insurance, which are prepared on the statutory basis
of accounting. With this change in accounting principle, we eliminated the
discounting in our financial statements which are prepared on a GAAP basis.
The $9.4 million in tax benefits recorded in 2000 is made up of several
items. These include a $4.4 million cash refund resulting from the successful
appeal of a prior year tax ruling in Canada, and a $3.3 million expense which
was recognized to increase federal income tax valuation allowances recorded
against tax assets in some of our subsidiaries.
COMPREHENSIVE INCOME
In accordance with Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," PICO reports comprehensive income as well as
net income from the Consolidated Statement of Operations. Comprehensive income
includes items resulting in unrealized changes in shareholders' equity, such as
foreign currency translation and change in unrealized investment gains and
losses on available-for-sale securities.
Over the past three years, PICO has recorded:
- - comprehensive income of $13 million in 2002, primarily consisting of the
$5.9 million net income and movements of $4.5 million in net unrealized
appreciation in investments and $2.6 million in foreign currency
translation;
- - comprehensive income of $6.1 million in 2001, consisting of net income of
$5.1 million and a movement of $1.9 million in net unrealized appreciation
in investments, which were partially offset by a $955,000 reduction in
foreign currency translation; and
- - a $17.2 million comprehensive loss in 2000. This was comprised of the $11.3
million net loss, and movements of $4.3 million in net unrealized change in
investments and foreign currency translation of $1.6 million.
OPERATING REVENUES
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
2002 2001 2000
-------------- ------------- -------------
Vidler Water Company $13,777,000 $17,964,000 $3,123,000
Nevada Land & Resource Company 4,414,000 3,221,000 5,276,000
Business Acquisitions and Financing 8,458,000 (3,662,000) (5,237,000)
Insurance Operations in Run Off 2,625,000 6,037,000 6,517,000
-------------- ------------- -------------
Total Revenues $29,274,000 $23,560,000 $9,679,000
============== ============= =============
In 2002, total revenues were $29.3 million, compared to $23.6 million in
2001, and $9.7 million in 2000. Revenues in 2002 were $5.7 million higher than
in 2001. Revenues were $12.1 million higher in Business Acquisitions and
Financing and $1.2 million higher at Nevada Land, but $4.2 million lower at
Vidler and $3.4 million lower in the Insurance Operations in Run Off segment. In
2001, revenues were $13.9 million higher than in 2000, principally due to $14.8
million higher revenues from Vidler. The most significant items in the revenue
growth at Vidler were revenues of $9.4 million from the sale of water rights and
land in the Harquahala Valley, and $5.7 million from pre-tax gains on the sale
of interests in Semitropic.
During 2002, revenues were reduced by charges for other-than-temporary
impairment in three unrelated equity securities of $4.1 million. The
other-than-temporary impairment charges were calculated as the difference
between the investment's original basis and the current carrying value (i.e.,
market value).
Total expenses in 2002 were $24.4 million, compared to $18.2 million in
2001, and $25.8 million in 2000. The largest expense item in each of the past
three years was the cost of land and water rights sold -- $9.7 million in 2002,
compared to $7.6 million in 2001, and $4 million in 2000. The increase in
expenses in 2002 from 2001 is primarily attributable to reduced favorable
development in the claims reserves of the run off insurance operations.
Favorable reserve development is recorded as a reduction in expenses.
32
INCOME (LOSS) BEFORE TAXES AND MINORITY INTEREST
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000
------------------ ---------------- -----------------
Vidler Water Company $ (897,000) $ 4,989,000 $ (4,854,000)
Nevada Land & Resource Company 484,000 131,000 1,918,000
Business Acquisitions and Financing (1,181,000) (15,288,000) (16,438,000)
Insurance Operations in Run Off 4,300,000 15,996,000 1,971,000
------------------ ---------------- -----------------
Income (Loss) Before Taxes and Minority
Interest $2,706,000 $ 5,828,000 $(17,403,000)
================== ================ =================
The principal items in the $2.7 million in income before taxes and minority
interest in 2002 were:
- - Vidler incurred an $897,000 pre-tax loss on $13.8 million in revenues.
Vidler closed on two sales of water rights and land in the Harquahala
Valley Irrigation District, which added $6.2 million to revenues and $2.5
million to gross margin. In addition, Vidler closed on two previously
announced sales of water rights in Colorado which contributed $5.2 million
in revenues and approximately $520,000 in gross margin. The gross margin on
these water rights sales was more than offset by Vidler's on-going
operating expenses and the costs of developing water assets which will not
be monetized until future years;
- - income of $484,000 from Nevada Land on revenues of $4.4 million, which
included $3.1 million from the sale of land and water rights;
- - a $1.2 million loss before taxes from Business Acquisitions and Financing.
This was primarily comprised of an $8.7 million realized gain on the sale
of AOG common stock and options, which was more than offset by parent
company overhead of $6.6 million and $4.1 million in impairment charges for
other-than-temporary declines in the market value of investments. Such
other-than-temporary charges do not affect shareholders' equity, or book
value per share; and
- - $4.3 million in income from Insurance Operations in Run Off, consisting of
a $2.2 million pre-tax profit from Citation and a $2.1 million pre-tax
profit from Physicians.
VIDLER WATER COMPANY, INC.
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
REVENUES:
Sale of Land, Water Rights, & Water $ 12,118,000 $ 9,487,000 $ 1,509,000
Gain on sale of Semitropic Water Storage interests 5,701,000
Lease of Water 239,000 235,000 188,000
Lease of Agricultural Land 690,000 795,000 959,000
Other 730,000 1,746,000 467,000
------------ ------------ ------------
Segment Total Revenues $ 13,777,000 $ 17,964,000 $ 3,123,000
============ ============ ============
EXPENSES:
Cost of Land, Water Rights, & Water Sold (8,465,000) (6,796,000) (2,244,000)
Commission and Other Cost of Sales (515,000) (553,000)
Depreciation & Amortization (953,000) (1,285,000) (988,000)
Interest (496,000) (646,000) (821,000)
Operations, Maintenance & Other (4,245,000) (3,695,000) (3,924,000)
------------ ------------ ------------
Segment Total Expenses $(14,674,000) $(12,975,000) $ (7,977,000)
------------ ------------ ------------
INCOME (LOSS) BEFORE TAX $ (897,000) $ 4,989,000 $ (4,854,000)
============ ============ ============
Most of the water rights and water storage operations acquired by Vidler
since we entered the water business have been development-stage assets which
were not ready for immediate commercial use. Although Vidler began to generate
significant revenues from the sale of water rights in 2001, the segment is still
incurring costs related to long-lived assets which will not generate revenues
until future years, e.g., operating, maintenance, and amortization expenses at
storage facilities which are not yet storing water for customers.
Vidler generated total revenues of $13.8 million in 2002, compared to $18
million in 2001, and $3.1 million in 2000.
In 2002, Vidler generated $12.1 million in revenues from the sale of water
rights and land. This primarily represented four transactions, which generated
$11.4 million in revenues:
- - the sale of 3,645 acre-feet of transferable ground water and 1,215 acres of
land in the Harquahala Valley Irrigation District to golf course developers
near Scottsdale, Arizona. This transaction added $5.2 million to revenues
and $1.9 million to gross margin;
33
- - the sale of 480 acre-feet of water rights and 240 acres of land in the HVID
to a unit of Allegheny Energy, Inc., which added $1 million to revenues and
$556,000 to gross margin; and
- - two sales of water rights in Colorado -- Cline Ranch to Centennial Water
and Sanitation District, which added $2.1 million to revenues and $119,000
in gross margin, and 85 acre-feet of water rights to the City of East
Dillon, which added $3.1 million to revenues and $401,000 to gross margin.
In addition, Vidler sold 7 acres of unimproved land near West Wendover, Nevada
for $500,000, which contributed $83,000 to gross margin.
In 2001, Vidler's results were dominated by three transactions, which
generated $15.1 million in revenues:
- - the sale of 6,496.5 acre-feet of transferable ground water and 2,589 acres
of land in Arizona's Harquahala Valley Irrigation District to a unit of
Allegheny Energy, Inc. This transaction added $9.4 million to revenues,
comprised of the $9.1 million sales price and a $300,000 option fee earned,
and contributed $2.3 million to segment income;
- - the sale of 29.7% of Vidler's original interest in the Semitropic Water
Banking and Exchange Program (i.e., approximately 55,000 acre-feet of
storage capacity, out of the original 185,000 acre-feet) for $3.3 million.
This transaction added $1.6 million to revenues and to segment income; and
- - another sale of 54.1% of Vidler's original interest in the Semitropic Water
Banking and Exchange Program (i.e., approximately 100,000 acre-feet of
storage capacity) for $6.9 million. This transaction added $4.1 million to
revenues and to segment income.
In 2001 Vidler recognized revenues of $390,000 from the sale of water rights to
the City of Golden, Colorado.
During 2000, Vidler sold water rights and the related land and tunnel assets
to the City of Golden for $1 million, and 3,691 acre-feet of water which had
been "banked" at the Semitropic water storage facility for $509,000.
The leasing of agricultural land generated revenues of $690,000 in 2002,
$795,000 in 2001, and $959,000 in 2000. Agricultural land lease revenues have
decreased as a result of the sale of farm properties in the Harquahala Valley,
as described above.
Vidler generated revenue of $239,000 in 2002, $235,000 in 2001, and $188,000
in 2000 from leasing some of the company's Colorado water rights. These assets
are leased in perpetuity. The lease payments are indexed for inflation, with a
minimum annual escalation of 3%.
Other Revenues, which include interest and various revenues from properties
farmed by Vidler (e.g. sales of hay and cattle) were approximately $730,000 in
2002, $1.7 million in 2001, and $467,000 in 2000. In 2001, Other Revenues
included a $600,000 gain from granting an easement to El Paso Natural Gas
Company in the Harquahala Valley.
Total segment expenses, including the cost of water rights and other assets
sold, increased from $8 million in 2000, to $13 million in 2001, and $14.7
million in 2002. However, excluding the cost of water rights and other assets
sold and related selling costs, segment operating expenses were $5.7 million in
2000, $5.6 million in 2001, and $5.7 million in 2002.
In 2002, segment operating expenses were $68,000 higher than in 2001.
Decreases of $150,000 in interest expense and $332,000 in depreciation and
amortization charges were offset by a $550,000 increase in operations,
maintenance, and other expenses. This was primarily a result of professional
fees related to various legal issues and water rights applications in Nevada,
including the 2,100 acre-feet of water rights in the Tule Desert Groundwater
Basin permitted in 2002.
Segment operating expenses decreased $107,000 in 2001 from 2000, primarily
as a result of decreases of $175,000 in interest expense and $229,000 in
operations, maintenance, and other expenses, which were partially offset by
$297,000 higher depreciation and amortization charges. Interest expense declined
due to the repayment of the non-recourse debt on the Harquahala Valley farm
properties which were sold during the year. The decrease in operations and
maintenance expense was primarily due to a lower obligation to contribute to
operations and maintenance expense at the Semitropic water storage facility, as
our interest in the asset reduced. The increase in depreciation and amortization
expense was primarily due to the start of amortization of improvements at the
Vidler Arizona Recharge Facility. Since construction of the improvements
required to recharge water was complete and the facility was ready for use, from
March 1, 2001 Vidler began to amortize the improvements at the facility over 15
years. The annual amortization charge will be approximately $518,000, and the
charge for 2001 was $421,000.
Vidler recorded a segment loss of $897,000 in 2002, compared to segment
income of $5 million in 2001, and a segment loss of $4.9 million in 2000.
The segment result decreased $5.9 million from 2001 to 2002, primarily due
to the $5.7 million in gains from the sale of interests in Semitropic recorded
in 2001, which did not recur in 2002.
34
The principal causes of the $9.9 million improvement in the segment result
from 2000 to 2001 were the contributions to income of $5.7 million from the sale
of interests in Semitropic, $2.3 million from the Allegheny transaction, and
$600,000 from the easement granted in 2001.
NEVADA LAND & RESOURCE COMPANY, LLC
Year Ended December 31,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
REVENUES:
Sale of Land $ 2,843,000 $ 1,918,000 $ 3,725,000
Sale of Water Rights 270,000 244,000
Gain on Land Exchange 270,000
Lease and Royalty 721,000 707,000 716,000
Interest and Other 580,000 596,000 321,000
----------- ----------- -----------
Segment Total Revenues $ 4,414,000 $ 3,221,000 $ 5,276,000
=========== =========== ===========
EXPENSES:
Cost of Land and Water Rights Sold (1,275,000) (772,000) (1,751,000)
Operating Expenses (2,655,000) (2,318,000) (1,607,000)
----------- ----------- -----------
Segment Total Expenses $(3,930,000) $(3,090,000) $(3,358,000)
=========== =========== ===========
----------- ----------- -----------
INCOME BEFORE TAX $ 484,000 $ 131,000 $ 1,918,000
=========== =========== ===========
Nevada Land generated revenues of $4.4 million in 2002, compared to $3.2
million in 2001, and $5.3 million in 2000.
Most of the variation in revenue from year to year is caused by fluctuations
in the level of land sales. In 2002, Nevada Land recorded revenues of $2.8
million from the sale of 28,451 acres of land. In 2001, we generated $1.9
million in from the sale of 15,632 acres of land, compared to $3.7 million from
the sale of 28,245 acres in 2000.
Lease and royalty income amounted to $721,000 in 2002, compared to $707,000
in 2001, and $716,000 in 2000. Most of this revenue comes from land leases,
principally for grazing, agricultural, communications, and easements.
Interest and other revenues contributed $580,000 in 2002, compared to
$596,000 in 2001, and $321,000 in 2000.
In 2002, Nevada Land also generated $270,000 in revenues from the sale of
2,860 acre-feet of permitted water rights.
In 2000, Nevada Land generated revenues from the sale of 61 acre-feet of
certificated water rights for $244,000, and a $270,000 gain on a land exchange
transaction.
After deducting the cost of land sold, the gross margin on land sales was
$1.7 million in 2002, $1.1 million in 2001, and $2.2 million in 2000. This
represented a gross margin percentage of 59.6% in 2002, 59.8% in 2001, and 59.2%
in 2000. The gross margin on water right sales was $143,000 in 2002, and $12,000
in 2000.
Segment operating expenses were $2.7 million in 2002, $2.3 million in 2001,
and $1.6 million in 2000.
Segment operating expenses were unusually high in 2002 due to approximately
$900,000 in legal and related expenses related to land development issues. In
2001, segment expenses included a $541,000 write-down of Nevada Land's interest
in Silver State Land, LLC, an entity which had filed applications for
approximately 51,000 acre-feet of water rights in various locations
geographically unrelated to Nevada Land's properties. Since our priority is to
first pursue the water rights applications filed by Lincoln/Vidler and by Nevada
Land on its own properties, due to the uncertainty of realizing the value of
these applications we reduced the carrying value of Silver State to zero. The
Silver State water rights applications were the only water rights applications
with a carrying value in our financial statements.
Nevada Land recorded income of $484,000 in 2002, compared to $131,000 in
2001 and $1.9 million in 2000.
The $353,000 increase in segment income from 2001 to 2002 is primarily due
to the higher gross margin on land sales and the contribution from the water
rights sale, which exceeded the increase in operating expenses discussed in the
preceding paragraph. Segment income decreased $1.8 million from 2000 to 2001,
principally due to a $1.1 million reduction in the gross margin on land sales,
the $541,000 write down of Silver State, and the $270,000 land exchange gain
included in 2000.
35
BUSINESS ACQUISITIONS AND FINANCING
Year Ended December 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
BUSINESS ACQUISITIONS & FINANCING REVENUES (CHARGES):
Realized Gains (Losses):
On Sale or Impairment of Holdings $ 3,419,000 $ (3,531,000) $ (7,784,000)
SFAS No. 133 Change In Warrants 402,000 (2,453,000)
Investment Income 2,512,000 1,856,000 1,610,000
Other 2,125,000 466,000 936,000
------------ ------------ ------------
Segment Total Revenues (Charges) $ 8,458,000 $ (3,662,000) $ (5,238,000)
============ ============ ============
SEGMENT TOTAL EXPENSES (7,431,000) (10,097,000) (9,948,000)
------------ ------------ ------------
INCOME (LOSS) BEFORE INVESTEES' INCOME ( LOSS) $ 1,027,000 $(13,759,000) $(15,186,000)
Equity Share of Investees' Net (Loss) (2,208,000) (1,529,000) (1,252,000)
------------ ------------ ------------
(LOSS) BEFORE TAXES $ (1,181,000) $(15,288,000) $(16,438,000)
============ ============ ============
The Business Acquisitions and Financing segment recorded revenues of $8.5
million in 2002, compared to negative $3.7 million in 2001, and negative $5.2
million in 2000. Revenues in this segment vary considerably from year to year,
primarily due to fluctuations in net realized gains or losses on the sale or
impairment of holdings. Holdings are not sold on a regular basis, but when the
price of an individual security has significantly exceeded our target, or if
there have been changes which we believe limit further appreciation potential on
a risk-adjusted basis. Consequently, the amount of net realized gains or losses
recognized during any accounting period has no predictive value.
A net realized gain of $3.4 million was recognized in 2002. This principally
consisted of:
- - a $7.8 million gain on the sale of our common shares in AOG; which was
partially offset by
- - a $1.6 million charge for other-than-temporary impairment of our investment
in SIHL (see the SIHL section of the "Company Summary, Recent Developments
and Future Outlook" portion of Item 7);
- - a $2.2 million charge for other-than-temporary impairment of our investment
in Accu Holding (see the Accu Holding section of the "Company Summary,
Recent Developments and Future Outlook" portion of Item 7);
- - a $312,000 charge for other-than-temporary impairment of our investment in
Solpower Corporation. Solpower is a development stage company, which was
one of the final Alternative Investments discussed in Item 1. Given the
duration of the decline in value in this stock and the absence of factors
indicating otherwise, we determined that the decline is other-than-
temporary. Accordingly, we recorded a charge to reduce the basis of the
investment to zero at December 31, 2002. None of the other-than-temporary
impairments affect shareholders' equity or book value per share.
In addition, Statement of Financial Accounting Standards No. 133, "Accounting
For Derivative Instruments and Hedging Activities" income was $402,000,
primarily consisting of income of $900,000 from AOG options, which was partially
offset by a $410,000 reduction in the estimated fair value of HyperFeed
warrants.
In 2001, a $6 million net realized investment loss was recorded. This was
comprised of a $3 million in charges for other-than-temporary impairment of our
holdings in SIHL and Solpower, a $2.5 million SFAS No. 133 loss to reflect a
decrease in the value of warrants we own in other companies (principally
HyperFeed Technologies, Inc.) during 2001, and a $500,000 write-off of the
remaining carrying value of the loan to MKG Enterprises. In addition, although
this did not affect the segment, a cumulative effect of a change in accounting
principle reduced income by $981,000 to reflect the after-tax decline in the
estimated fair value of warrants during the period from the acquisition of the
various warrants through to December 31, 2000.
In 2000, a net realized loss of $7.8 million was incurred. This primarily
represented a $4.6 million loss on the sale of Conex, a $2.5 million write-down
of the loan to MKG Enterprises, and a $526,000 loss when a former employee
exercised an option which required PICO to sell existing shares in Vidler for
less than current book value. When PICO acquired Vidler in the merger with
Global Equity Corporation, call options had already been granted to certain
employees over existing shares in Vidler. All of these call options have now
been exercised.
In this segment, investment income includes interest on cash and short-term
fixed-income securities, and dividends from partially owned businesses.
Investment income totaled $2.5 million in 2002, $1.9 million in 2001, and $1.6
million in 2000. In 2002, investment income increased $656,000 year over year,
primarily due to higher interest income. In 2001, investment income was $246,000
higher than in 2000, principally due to the receipt of $391,000 in dividends
from AOG in 2001. AOG did not pay a dividend in 2000.
36
Other revenues were $2.1 million in 2002, $466,000 in 2001, and $936,000 in
2000.
PICO's equity share of investees' income (loss) represents our proportionate
share of the net income (loss) and other events affecting equity in the
investments which we carry under the equity method, less any dividends received
from those investments. In 2002, an equity share of investees' loss of $2.2
million was recorded, compared to equity share of investees' losses of $1.5
million in 2001, and $1.3 million in 2000. Here is a summary of the principal
investments which we accounted for under the equity method in each of the past
three years:
- -----------------------------------------------------------------------------------------------
2002 2001 2000
- -----------------------------------------------------------------------------------------------
HyperFeed HyperFeed HyperFeed
Conex's sino-foreign joint
venture -
until September 8, 2000
- -----------------------------------------------------------------------------------------------
Segment expenses were $7.4 million in 2002, compared to $10.1 million in
2001, and $9.9 million in 2000. The principal expenses recognized in this
segment are PICO's corporate overhead and operating expenses from SISCOM and, in
2000, Conex.
The Business Acquisitions And Financing segment produced pre-tax losses of
$1.2 million in 2002, $15.3 million in 2001, and $16.4 million in 2000.
In 2002, the segment loss consists of investment income of $2.5 million and
other revenues of $2.1 million, which were more than offset by the $2.2 million
equity share of investees' losses and segment expenses of $7.4 million. Segment
expenses include the accrual of $2 million in incentive compensation, other
parent company overhead of $4.6 million, and SISCOM expenses of $1.4 million.
Segment expenses were reduced by a $2.7 million benefit resulting from the
effect of appreciation in the Swiss Franc on an inter-company loan during 2002.
Our interests in Swiss public companies are held by Global Equity SA, a
wholly owned subsidiary which is incorporated in Switzerland. Part of Global
Equity SA's funding comes from a loan from PICO, which is denominated in Swiss
Francs. During accounting periods when the Swiss Franc appreciates relative to
the US dollar -- such as the 2002 year -- under GAAP we are required to record a
benefit through the statement of operations to reflect the fact that Global
Equity SA owes PICO more US dollars. In Global Equity SA's financial statements,
an equivalent debit is included in the foreign currency translation component of
shareholders' equity (since it owes PICO more dollars); however, this does not
go through the statement of operations. During accounting periods when the Swiss
Franc depreciates relative to the US dollar, opposite entries are made and an
expense is recorded in the statement of operations. Accordingly, we were
required to record a benefit of $2.7 million in our statement of operations in
2002, even though there was no net impact on shareholders' equity.
The 2001 segment loss includes investment income and other revenues of $2.3
million, which were more than offset by the $3 million in provisions for
other-than-temporary impairment in investments, the $2.5 million SFAS No. 133
loss, the $500,000 MKG realized loss, the $1.5 million equity share of
investees' losses, and segment expenses of $10.1 million. Segment expenses
include parent company overhead of $4.8 million, SISCOM expenses of $1.7
million, and a $270,000 expense related to the Swiss Franc loan to Global Equity
SA discussed in the previous paragraph. In 2001, segment expenses also included
a $2.3 million provision against loans to Dominion Capital Pty. Ltd. See Item 3,
"Legal Proceedings."
In 2000, the segment loss included investment income and other revenues of
$2.5 million. These were more than offset by the $7.8 million in realized losses
described above, segment expenses of $9.9 million, and our equity share of
investees' losses of $1.3 million. Segment expenses include a $2.3 million
operating loss from Conex for the period prior to its sale, and a $1.6 million
operating loss from SISCOM. The foreign currency expense was $41,000.
37
INSURANCE OPERATIONS IN RUN OFF
Year Ended December 31,
----------------------------------------
2002 2001 2000
----------- ----------- -----------
REVENUES (CHARGES):
Net Investment Income $ 2,269,000 $ 3,363,000 $ 4,155,000
Realized Gains On Sale or Impairment of Investments 387,000 1,112,000 73,000
Earned Premiums (42,000) 980,000 1,695,000
Negative Goodwill 568,000 568,000
Other 11,000 14,000 26,000
----------- ----------- -----------
Segment Total Revenues $ 2,625,000 $ 6,037,000 $ 6,517,000
=========== =========== ===========
EXPENSES:
Underwriting (Expenses) / Recoveries 1,675,000 9,959,000 (4,546,000)
----------- ----------- -----------
Segment Total Expenses $ 1,675,000 $ 9,959,000 $(4,546,000)
=========== =========== ===========
INCOME BEFORE TAXES:
Physicians Insurance Company of Ohio $ 2,120,000 $13,133,000 $ 768,000
Citation Insurance Company 2,180,000 2,863,000 1,203,000
----------- ----------- -----------
Income Before Taxes $ 4,300,000 $15,996,000 $ 1,971,000
=========== =========== ===========
The Insurance Operations in Run Off segment produced $4.3 million in pre-tax
income in 2002, consisting of pre-tax profits of $2.1 million from Physicians
and $2.2 million from Citation. In 2001, segment income was $16 million,
consisting of $13.1 million in income before taxes from Physicians, and $2.9
million from Citation. In 2000, segment income was $2 million, comprised of
$768,000 in pre-tax income from Physicians, and $1.2 million from Citation.
Once an insurance company has gone into run off and the last of its policies
has expired, typically most revenues will come from investment income. However,
even when an insurance company is in "run off", earned premium can arise. For
example, with "swing rated" reinsurance, the reinsurance premiums we pay are
recalculated based on actual loss experience (i.e., the number and size of
claims). Under GAAP, if we required to pay for additional reinsurance this is
recorded as a reduction in the earned premium line, while a reduction in the
amount of reinsurance we need to pay is recorded as an increase in earned
premiums.
PHYSICIANS INSURANCE COMPANY OF OHIO
Year Ended December 31,
----------------------------------------
2002 2001 2000
----------- ----------- -----------
MPL REVENUES:
Net Investment Income $ 679,000 $ 1,097,000 $ 1,543,000
Net Realized Investment Gain (Loss) (4,000) 750,000
Earned Premium 382,000 755,000 1,853,000
----------- ----------- -----------
Segment Total Revenues $ 1,057,000 $ 2,602,000 $ 3,396,000
=========== =========== ===========
MPL UNDERWRITING RECOVERIES (EXPENSES) $ 1,063,000 10,531,000 (2,628,000)
=========== =========== ===========
INCOME BEFORE TAXES $ 2,120,000 $13,133,000 $ 768,000
=========== =========== ===========
Physicians' total revenues were $1.1 million in 2002, compared to $2.6
million in 2001, and $3.4 million in 2000.
Revenues were $2.6 million in 2001, including a $750,000 net realized
investment gain. The net realized investment gain consisted of a $731,000 gain
on the redemption of all units held in the Rydex URSA mutual fund, and $19,000
in realized gains from the sale of bonds.
Investment income was $679,000 in 2002, $1.1 million in 2001, and $1.5
million in 2000. Investment income varies from year to year, depending on the
amount of fixed-income securities held in the portfolio and the prevailing level
of interest rates.
Physicians recorded earned premiums of $382,000 in 2002, compared to
$755,000 in 2001, and $1.9 million in 2000, representing a reduction in the
amount of reinsurance that we need to pay on "swing rated" contracts. The
reduced reinsurance requirement resulted from the reduction in IBNR reserves.
38
In 2002, Physicians recorded a $1.1 million underwriting recovery. The $1
million net reduction in reserves and a $439,000 benefit related to reinsurance
more than offset regular loss and loss adjustment expense and operating expenses
of $395,000 for the year. The $439,000 benefit represented the final
amortization of a deferred gain resulting from a reinsurance contract entered
into in 1994, where the gain was deferred and recognized as the related
reinsurance recoveries occurred. The changes in reserves are more fully
explained in the Physicians section of the "Company Summary, Recent
Developments, and Future Outlook" portion of Item 7.
In 2001, the segment reported a $10.5 million underwriting recovery, which
resulted in segment income of $13.1 million.
In 2000, after underwriting expenses of $2.6 million, which included a $1.5
million net increase in reserves, segment income of $768,000 was recorded. In
addition, reserves increased by $7.3 million due to the elimination of reserve
discount included in the cumulative effect of change in accounting principle.
The elimination of discounting did not affect the segment in 2000, but resulted
in a $5 million after-tax charge to income, which is shown in the "Cumulative
Effect of Change in Accounting Principle" line in our Consolidated Statement of
Operations. See Note 20 of Notes to Consolidated Financial Statements,
"Cumulative Effect of Change in Accounting Principle." Until the end of 1999, we
discounted our medical professional liability claims reserves to reflect the
fact that some claims will not be paid until future years, but funds from the
corresponding premiums can be invested in the meantime. From January 1, 2000, we
ceased discounting our reserves to be consistent with the accounting treatment
in our statutory financial statements.
CITATION INSURANCE COMPANY
Year Ended December 31,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
REVENUES:
Net Investment Income $ 1,590,000 $ 2,266,000 $ 2,612,000
Realized Investment Gains 391,000 362,000 73,000
Earned Premiums (424,000) 225,000 (158,000)
Negative Goodwill 568,000 568,000
Other 11,000 14,000 26,000
----------- ----------- -----------
Segment Total Revenues $ 1,568,000 $ 3,435,000 $ 3,121,000
=========== =========== ===========
EXPENSES:
----------- ----------- -----------
Underwriting (Expenses) / Recoveries $ 612,000 $ (572,000) $(1,918,000)
=========== =========== ===========
INCOME BEFORE TAXES $ 2,180,000 $ 2,863,000 $ 1,203,000
=========== =========== ===========
In 2002, Citation generated total revenues of $1.6 million. Revenues
primarily consisted of $1.6 million in investment income and realized gains of
$391,000, which were partially offset by a reduction in earned premiums of
$424,000 related to reinsurance. This represented additional reinsurance
required for the workers compensation line of business, which Citation stopped
writing in 1997, after PICO took over management of the company. Citation is not
liable for any additional reinsurance in this line of business. Citation
recorded approximately $889,000 of favorable development in prior year loss
reserves, which more than offset operating expenses of approximately $277,000,
resulting in a net underwriting recovery of $612,000. As a result of these
factors, Citation generated income of $2.2 million before taxes for 2002.
In 2001, Citation's revenues included investment income of $2.3 million,
earned premiums of $225,000, and negative goodwill amortization of $568,000
(explained in the following paragraph). The $225,000 in earned premiums
represents the final premiums earned from the policies on Citation's books when
the company went into "run off." After expenses of $570,000, Citation earned
income of $2.9 million before taxes for 2001. In 2001, an expense of $56,000 was
recorded for development in prior year loss reserves.
When Citation Insurance Group acquired Physicians in the reverse merger in
1996, a $5.7 million negative goodwill item arose because the fair value of the
assets acquired (i.e., Physicians) exceeded the cost of the investment (i.e.,
the fair value of the shares in Citation issued to Physicians shareholders). The
negative goodwill was being recognized as income over a period of 10 years in
this segment. On January 1, 2002, PICO adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Intangible Assets," which requires that
goodwill and intangible assets with indefinite lives be tested for impairment
annually rather than amortized over time. As a result of adopting this standard,
the remaining negative goodwill of approximately $2.8 million was recognized as
an extraordinary gain in 2002. See Note 1 of Notes to Consolidated Financial
Statements, "Nature of Operations and Significant Accounting Policies."
39
From 2001 to 2002, Citation's pre-tax profit declined by $683,000. In 2002,
a $612,000 underwriting recovery was recorded, as opposed to a $570,000 expense
the year before. However, this $1.2 million improvement was more than offset by
a $676,000 decrease in investment income, a $649,000 decrease in earned premium,
and the absence in 2002 of negative goodwill which added $568,000 to income in
2001. The reduction in investment income was primarily due to lower interest
income and, to a lesser extent, a reduction in invested assets as the "run off"
continued. In 2002, Citation recorded earned premiums of negative $424,000 due
to reinsurance as discussed in preceding paragraphs, as opposed to premiums of
$225,000 earned from the company's last property and casualty policies in 2001.
In 2000, Citation's revenues included investment income of $2.6 million,
earned premiums of negative $158,000, and negative goodwill amortization of
$568,000. Although Citation earned $564,000 in property and casualty premiums in
2000, this was more than offset by a $722,000 reduction in earned premiums
related to reinsurance. After expenses of $1.9 million, including a partially
offsetting $282,000 benefit from favorable development in prior year loss
reserves, Citation earned a $1.2 million pre-tax profit for 2000.
From 2000 to 2001, Citation's pre-tax profit increased $1.7 million. While
revenues increased $312,000 year over year, underwriting and other expenses
declined by $1.3 million after the company went into "run off."
Since Citation is in "run off," its Combined Ratio is no longer meaningful.
DISCONTINUED OPERATIONS
SEQUOIA INSURANCE COMPANY
Year Ended December 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
Revenues $ 52,439,000 $ 47,913,000 $ 36,136,000
Expenses
(47,861,000) (44,599,000) (34,798,000)
------------ ------------ ------------
Income Before Taxes $ 4,578,000 $ 3,314,000 $ 1,338,000
Income Taxes (1,545,000) (997,000) (385,000)
Cumulative Effect of Change in Accounting Principle, net (199,000)
------------ ------------ ------------
NET INCOME $ 2,834,000 $ 2,317,000 $ 953,000
============ ============ ============
Sequoia Insurance Company generated total revenues of $52.4 million in 2002,
compared to $47.9 million in 2001, and $36.1 million in 2000.
In 2002, Sequoia's revenues included earned premiums of $47.1 million,
investment income of $3.8 million, and a net realized gain on the sale of bonds
and stocks of $1.3 million. Earned premiums increased 11.3% from the previous
year, and consisted of $37.4 million from commercial lines and $9.7 million from
personal lines. For 2002, Sequoia reported a loss from operations (i.e., income
before investment income, realized gains, and taxes) of $517,000, and income
before taxes of $4.6 million. This included an additional expense of $622,000
due to adverse development in prior year loss reserves, principally in the 2001
accident year. After income taxes of $1.5 million and an $199,000 after-tax
expense for an accounting change, Sequoia contributed $2.8 million to net
income, which is recorded in the "Income from discontinued operations, net" line
in the Consolidated Statement of Operations. The accounting change represented
the write-off of goodwill items determined to be impaired, following the
adoption of SFAS No. 142.
In 2001, Sequoia's revenues included earned premiums of $42.3 million,
investment income of $3.7 million, and realized gains of $1.5 million. For 2001,
Sequoia reported a loss from operations (i.e., income before investment income,
realized gains, and taxes) of $1.9 million, and income before taxes of $3.3
million. This included an additional expense of $738,000 to recognize adverse
development in prior year loss reserves. After income taxes of $1 million,
Sequoia contributed $2.3 million to net income.
In 2000, Sequoia's revenues included $32.7 million in earned premiums, $2.8
million in investment income, and realized gains of $99,000. For 2000, Sequoia
reported a loss from operations of $1.5 million, which included an additional
expense of $252,000 to recognize adverse development in prior year loss
reserves, and income before taxes of $1.3 million. After income taxes of
$385,000, Sequoia contributed $953,000 to net income.
40
LIQUIDITY AND CAPITAL RESOURCES -- YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
CASH FLOW
PICO Holdings, Inc. is a diversified holding company. Our assets primarily
consist of our operating subsidiaries, holdings in other public companies,
marketable securities, and cash and cash equivalents. On a consolidated basis,
the Company had $22.1 million in cash and cash equivalents at December 31, 2002,
compared to $16.3 million at December 31, 2001.
In addition to the $22.1 million in consolidated cash and cash equivalents
as defined by GAAP, at December 31, 2002, the parent company held
investment-grade fixed-income securities maturing during 2003 with a market
value of $11.2 million.
Our cash flow position fluctuates depending on the requirements of our
operating subsidiaries for capital, and activity in our insurance company
investment portfolios. Our primary sources of funds include cash balances, cash
flow from operations, the sale of holdings, and -- potentially -- the proceeds
of borrowings or offerings of equity and debt. We endeavor to ensure that funds
are always available to take advantage of new opportunities.
In broad terms, the cash flow profile of our principal operating
subsidiaries is:
- - During the company's investment and development phase, Vidler Water
Company, Inc. utilized cash to purchase properties with significant water
rights, to construct improvements at the Vidler Arizona Recharge Facility,
to maintain and develop existing assets, to pursue applications for water
rights, and to meet financing and operating expenses. During this period,
we provided financing to meet Vidler's on-going expenses and to fund
capital expenditure and the purchase of additional water-righted
properties.
Vidler's water-related assets began to generate significant cash flow in
2001. As commercial use of these assets increases, we expect that Vidler
will start to generate free cash flow as receipts from leasing water or
storage, and the proceeds from selling land and water rights, begin to
overtake maintenance capital expenditure, financing costs, and operating
expenses. As water lease and storage contracts are signed, we anticipate
that Vidler may be able to monetize some of the contractual revenue
streams, which could potentially provide another source of funds;
- - Nevada Land & Resource Company, LLC is actively selling land which has
reached its highest and best use, and is not part of PICO's long-term
utilization plan for the property. Nevada Land's principal sources of cash
flow are the proceeds of cash sales, and collections of principal and
interest on sales contracts where Nevada Land has provided vendor
financing. Since these receipts and other revenues exceed Nevada Land's
operating costs, Nevada Land is generating strong positive cash flow;
- - At this stage of "run off", investment income more than covers Citation
Insurance Company's operating expenses. The funds required to pay claims
are coming from the maturity of fixed-income investments in the company's
investment portfolio, and recoveries from reinsurance companies;
- - As its "run off" progresses, Physicians Insurance Company of Ohio is
obtaining funds to pay operating expenses and claims from the maturity of
fixed-income securities, the realization of investments, and recoveries
from reinsurance companies; and
- - It is anticipated that the sale of Sequoia Insurance Company will close on
or around March 31, 2003. Until then, we expect that Sequoia will generate
positive cash flow from increased written premium volume. Shortly after a
policy is written, the premium is collected and the funds can be invested
for a period of time before they are required to pay claims. Until the sale
closes, free cash flow generated by Sequoia is being retained in the
company's investment portfolio.
The Departments of Insurance in Ohio and California prescribe minimum
levels of capital and surplus for insurance companies, and set guidelines for
insurance company investments. PICO's insurance subsidiaries structure the
maturity of fixed-income securities to match the projected pattern of claims
payments; however, it is possible that fixed-income and equity securities may
occasionally need to be sold at unfavorable times when the bond market and/or
the stock market are depressed.
As shown in the Consolidated Statements of Cash Flow, there was a $5.7
million net increase in cash and cash equivalents in 2002, compared to a $1.8
million net increase in 2001.
During 2002, Operating Activities generated cash of $10.8 million, compared
to $5.9 million used in 2001, and $20.3 million used in 2000.
The most significant cash inflows from operating activities were:
41
- - in 2002, approximately $12.1 million in proceeds from water rights and land
sold by Vidler and $8.5 million in cash generated by discontinued
operations (Sequoia); and
- - in 2001, $9.4 million in total receipts from Vidler's sale of water rights
and land in the Harquahala Valley Irrigation District.
In all three years, the principal uses of cash were operating expenses at
Vidler, claims payments by Physicians and Citation, and overhead expenses.
In 2002, Investing Activities used cash of $1.1 million. This primarily
represented the sale of our holding in AOG for $21.1 million and the subsequent
reinvestment of the proceeds in fixed-income securities and a marketable equity
security, and regular activity in the investment portfolios of our insurance
companies.
In 2001, Investing Activities generated cash of $9 million. The most
significant cash inflow was $10.2 million from the sale of part of our interest
in Semitropic. Significant cash outflows included the investment of
approximately $4 million in SIHL and AOG common stock. Most of the remaining
Investing Activities cash flow represents activity in the investment portfolios
of our insurance companies, and the temporary investment of surplus funds in
fixed-income securities.
Investing Activities used $28.4 million of cash in 2000. Most of the
Investing Activities cash flow represents activity in the investment portfolios
of our insurance companies, where the proceeds of cash and cash equivalents and
maturing fixed-income securities were reinvested in longer-dated corporate bonds
and, to a lesser extent, in small-capitalization value stocks. In addition,
Vidler made a $2.3 million payment related to the Semitropic Water Banking and
Exchange Program.
In 2002, Financing Activities used $1.4 million of cash, primarily due to
the repayment of $1.1 million in non-recourse borrowings collateralized by the
farm properties in the Harquahala Valley Irrigation District by Vidler, and a
net reduction of $586,000 in Swiss Franc borrowings. Despite these cash
payments, the level of borrowings shown on the balance sheet was unchanged year
over year, due to the effect of exchange rate movements on Swiss Franc
borrowings. The Swiss Franc borrowings form a partial currency hedge against our
Swiss assets.
Financing Activities used $1.8 million of cash in 2001. Vidler paid off
approximately $2.9 million in non-recourse borrowings collateralized by the farm
properties in the Harquahala Valley Irrigation District which it sold during the
year. Global Equity SA took on an additional $1.9 million of Swiss
Franc-denominated borrowings to help finance the acquisition of investments in
Swiss public companies.
In 2000, there was a $49.5 million cash inflow from Financing Activities,
principally due to the rights offering which raised $49.8 million in new equity
capital.
At December 31, 2002, PICO had no significant commitments for future
capital expenditures.
SHARE REPURCHASE PROGRAM
In October 2002, PICO's Board of Directors authorized the repurchase of up
to $10 million of PICO common stock. The stock purchases may be made from time
to time at prevailing prices through open market or negotiated transactions,
depending on market conditions, and will be funded from available cash.
As of December 31, 2002, no stock had been repurchased under this
authorization.
SUPPLEMENTARY DISCLOSURES
1. At December 31, 2002:
- - PICO had no "off balance sheet" financing arrangements;
- - PICO has not provided any debt guarantees; and
- - PICO has no commitments to provide additional collateral for financing
arrangements. PICO's Swiss subsidiary, Global Equity SA, has Swiss Franc
borrowings which partially finance the Company's European stock holdings.
If the market value of those stocks declines below certain levels, we could
be required to provide additional collateral or to repay a portion of the
Swiss Franc borrowings.
- - Vidler, a PICO subsidiary, is party to a lease to acquire 30,000 acre-feet
of underground water storage privileges and associated rights to recharge
and recover water located near the California Aqueduct, northwest of
Bakersfield. The agreement requires a minimum payment of $378,000 per year
adjusted annually by the engineering price index until 2007. PICO signed a
Limited
42
Guarantee agreement with Semitropic Water Storage District ("Semitropic")
that requires PICO to guarantee Vidler's annual obligation up to $519,000,
adjusted annually by the engineering price index.
AGGREGATE CONTRACTUAL OBLIGATIONS:
The following table provides a summary of our contractual cash obligations
and other commitments and contingencies.
Payments Due by Period
---------------------------------------------------------------------------------
Contractual Obligations Less than 1 year 1 -3 years 3 -5 years More than 5 years Total
- ----------------------- ---------------- ---------- ---------- ----------------- -----
Bank borrowings $ 8,804,790 $ 8,804,790
Other borrowings 496,790 $ 2,066,524 $ 368,508 $ 2,731,053 5,662,875
Capital leases 45,669 122,683 168,352
Operating leases 844,839 2,203,979 550,028 3,287,700 6,886,546
----------- ----------- --------- ----------- -----------
Total $10,192,088 $ 4,393,186 $ 918,536 $ 6,018,753 $21,522,563
=========== =========== ========= =========== ===========
2. EFFECT OF STOCK OPTIONS
The following table is included as supplementary disclosure to show the
effect on book value per share, which is our key benchmark, if all outstanding
stock options are exercised.
GPG CALL OPTIONS
In 1993, Guinness Peat Group PLC -- which was the largest shareholder in
Physicians at the time -- granted Ronald Langley and John R. Hart (now the
Company's Chairman and CEO) call options to buy part of GPG's investment in
Physicians at a price equal to GPG's cost ("GPG call options"). Since these call
options were granted by GPG over shares it owned in Physicians, the economic
cost of the options was borne by GPG. In 1998, when GPG subsequently sold its
investment in Physicians, the Company purchased the shares subject to the
options from GPG at the exercise price and assumed the call option obligations.
This now equates to call options to acquire 355,539 shares of PICO stock at an
average exercise price of $3.94 per share. The shares purchased from GPG have
been accounted for as treasury stock. As illustrated in the following table, if
these options had been exercised at December 31, 2002, there would have been a
reduction in book value per share of approximately 2.2%.
DIRECTOR AND MANAGEMENT OPTIONS
At December 31, 2002, the Company's directors and management hold options
to acquire 1,687,242, new shares of PICO stock. The options are exercisable at
prices ranging from $13.25 to $15.00 per share, with an average exercise price
of approximately $14.57 per share. At December 31, 2002, all of these options
were "out of the money" (i.e., exercisable at a price higher than the last sale
price for PICO stock, which was $13.24). Typically an option-holder will only
exercise an option if the stock price is greater than the exercise price.
However to illustrate the potential effect, if the GPG call options and all
director and management options had been exercised at December 31, 2002, there
would have been a reduction in book value per share of approximately 4.1%.
SHAREHOLDERS' EQUITY NUMBER OF SHARES OUTSTANDING BOOK VALUE CHANGE IN BOOK
(EXCLUDING TREASURY SHARES) PER SHARE VALUE PER SHARE
Reported as of December 31, 2002 $221,031,704 12,379,242 $17.86
Pro forma for exercise of GPG call + $1,400,824 +355,539
options
-------------------------------------------------
$222,432,528 12,734,781 $7.47 - 2.2%
Pro forma for exercise of directors + $24,583,116 + 1,687,242
and management options -------------------------------------------------
$247,015,644 14,422,023 $17.13 - 4.1%
43
3. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires that a liability
be recorded in the guarantor's balance sheet upon issuance of a guarantee at its
fair value. In addition, FIN 45 requires certain disclosures about each of the
entity's guarantees. The Company will apply the recognition provisions of FIN 45
prospectively to guarantees issued after December 31, 2002. The disclosure
provisions of FIN 45 are included herein.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation, Transition and Disclosure. SFAS No. 148 provides alternative
methods of transaction for those entities that elect to voluntarily adopt the
fair value accounting provisions of SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 148 also requires more prominent disclosures of the pro
forma effect of using the fair value method of accounting for stock-based
employee compensation as well as pro forma disclosure of the effect in interim
financial statements. The transition and annual disclosure provisions of SFAS
No. 148 included herein. The interim disclosure requirements are effective for
the first interim period ending December 15, 2002. The Company has not elected
to adopt the fair value accounting provisions of SFAS No. 123.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.
FIN 46 requires the consolidation of certain variable interest entities by the
primary beneficiary of the entity if the equity investment at risk is not
sufficient to permit the entity to finance its activities without additional
subordinated financial support from other parties or if the equity investors
lack the characteristics of a controlling financial interest. FIN 46 is
effective for variable interest entities created or acquired after January 31,
2003. For variable interest entities created or acquired prior to February 1,
2003, the provisions of FIN 46 must be applied in the first interim or annual
period beginning after June 15, 2003. The Company believes the effect of the
adoption of FIN 46 will not have any effect on its results of operations and
financial position.
RISK FACTORS
In addition to the risks and uncertainties discussed in the preceding
sections of "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and elsewhere in this document, the following risk
factors should be considered carefully in evaluating PICO and its business. The
statements contained in this Form 10-K that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Exchange
Act, including statements regarding our expectations, beliefs, intentions, plans
or strategies regarding the future. All forward-looking statements included in
this document are based on information available to us on the date thereof, and
we assume no obligation to update any such forward-looking statements.
BECAUSE OUR OPERATIONS ARE DIVERSE, ANALYSTS AND INVESTORS MAY NOT BE ABLE TO
EVALUATE OUR COMPANY ADEQUATELY, WHICH MAY NEGATIVELY INFLUENCE OUR SHARE PRICE
PICO is a diversified holding company with operations in land and related
water rights and mineral rights; water rights and water storage; insurance
operations in run-off, and business acquisitions and financing. Each of these
areas is unique, complex in nature, and difficult to understand. In particular,
water rights is a developing industry within the western United States with very
little historical data, very few experts and a limited following of analysts.
Because we are so complex, analysts and investors may not be able to adequately
evaluate our operations, and PICO in total. This could cause them to make
inaccurate evaluations of our stock, or to overlook PICO, in general. These
factors could have a negative impact on the trading volume and price of our
stock.
IF WE DO NOT SUCCESSFULLY LOCATE, SELECT AND MANAGE INVESTMENTS AND ACQUISITIONS
OR IF OUR INVESTMENTS OR ACQUISITIONS OTHERWISE FAIL OR DECLINE IN VALUE, OUR
FINANCIAL CONDITION COULD SUFFER
We invest in businesses that we believe are undervalued or that will
benefit from additional capital, restructuring of operations or improved
competitiveness through operational efficiencies.
Failures and/or declines in the market values of businesses we invest in or
acquire, as well as our failure to successfully locate, select and manage
investment and acquisition opportunities, could have a material adverse effect
on our business, financial condition, the results of operations and cash flows.
Such business failures, declines in market values, and/or failure to
successfully locate, select and manage investments and acquisitions could result
in inferior investment returns compared to those which may have been attained
had we successfully located, selected and managed new investments and
acquisition opportunities, or had our investments or acquisitions not failed or
declined in value. We could also lose part or all of our capital these
businesses and experience reductions in our net income, cash flows, assets and
shareholders' equity.
44
We will continue to make selective acquisitions, and endeavor to enhance
and realize additional value to these acquired companies through our influence
and control. This could involve the restructuring of the financing or management
of the entities in which we invest and initiating and facilitating mergers and
acquisitions. Any acquisition could result in the use of a significant portion
of our available cash, significant dilution to you, and significant
acquisition-related charges. Acquisitions may also result in the assumption of
liabilities, including liabilities that are unknown or not fully known at the
time of the acquisition, which could have a material adverse effect on us.
We do not know of any reliable statistical data that would enable us to
predict the probability of success or failure of our acquisitions and
investments, or to predict the availability of suitable investments at the time
we have available cash. You will be relying on the experience and judgment of
management to locate, select and develop new acquisition and investment
opportunities. Sufficient opportunities may not be found and this business
strategy may not be successful. We have made a number of acquisitions in the
past that have been highly successful and we have also made acquisitions that
have lost money. Further details of realized and unrealized gains and losses can
be found in the notes 1,2,3 and 4 to the accompanying consolidated financial
statements and in Item 7A in this Form 10-K.
Our ability to achieve an acceptable rate of return on any particular
investment is subject to a number of factors which are beyond our control,
including increased competition and loss of market share, quality of management,
cyclical or uneven financial results, technological obsolescence, foreign
currency risks and regulatory delays.
Our acquisitions may not achieve acceptable rates of return and we may not
realize the value of the funds invested; accordingly, these investments may have
to be written down or sold at their then-prevailing market values.
We may not be able to sell our investments in both private and public
companies when it appears to be advantageous to do so and we may have to sell
these investments at a discount. Investments in private companies are not as
marketable as investments in public companies. Investments in public companies
are subject to prices determined in the public markets and, therefore, values
can vary dramatically. In particular, the ability of the public markets to
absorb a large block of shares offered for sale can affect our ability to
dispose of an investment in a public company.
We may acquire shares of stock in U.S. public companies that are not
registered with the SEC, and we may not be able to register the stock during our
period of ownership. Accordingly, this may affect our ability to dispose of an
investment in a public company or achieve the full market price quoted by the
stock exchange that the particular stock is listed on.
To successfully manage newly acquired companies, we must, among other
things, continue to attract and retain key management and other personnel. The
diversion of the attention of management from the day-to-day operations, or
difficulties encountered in the integration process, could have a material
adverse effect on our business, financial condition, and the results of
operations and cash flows.
WE MAY MAKE INVESTMENTS AND ACQUISITIONS THAT MAY YIELD LOW OR NEGATIVE RETURNS
FOR AN EXTENDED PERIOD OF TIME, WHICH COULD TEMPORARILY OR PERMANENTLY DEPRESS
OUR RETURN ON INVESTMENTS
We generally make investments and acquisitions that tend to be long term in
nature. We acquire businesses that we believe to be undervalued or may benefit
from additional capital, restructuring of operations or management or improved
competitiveness through operational efficiencies with our existing operations.
We may not be able to develop acceptable revenue streams and investment returns.
We may lose part or all of our investment in these assets. The negative impacts
on cash flows, income, assets and shareholders' equity may be temporary or
permanent. We make investments for the purpose of enhancing and realizing
additional value by means of appropriate levels of shareholder influence and
control. This may involve restructuring of the financing or management of the
entities in which we invest and initiating or facilitating mergers and
acquisitions. These processes can consume considerable amounts of time and
resources. Consequently, costs incurred as a result of these investments and
acquisitions may exceed their revenues and/or increases in their values for an
extended period of time until we are able to develop the potential of these
investments and acquisitions and increase the revenues, profits and/or values of
these investments. Ultimately, however, we may not be able to develop the
potential of these assets that we originally anticipated.
IF WE UNDERESTIMATE THE AMOUNT OF INSURANCE CLAIMS, OUR FINANCIAL CONDITION
COULD BE MATERIALLY MISSTATED AND OUR FINANCIAL CONDITION COULD SUFFER
45
Our insurance subsidiaries may not have established reserves adequate to
meet the ultimate cost of losses arising from claims. It has been, and will
continue to be, necessary for our insurance subsidiaries to review and make
appropriate adjustments to reserves for claims and expenses for settling claims.
Inadequate reserves could have a material adverse effect on our business,
financial condition, and the results of operations and cash flows. Inadequate
reserves could cause our financial condition to fluctuate from period to period
and cause our financial condition to appear to be better than it actually is for
periods in which insurance claims reserves are understated. In subsequent
periods when we discover the underestimation and pay the additional claims, our
cash needs will be greater than expected and our financial results of operations
for that period will be worse than they would have been had our reserves been
accurately estimated originally.
The inherent uncertainties in estimating loss reserves are greater for some
insurance products than for others, and are dependent on:
- - the length of time in reporting claims;
- - the diversity of historical losses among claims;
- - the amount of historical information available during the estimation
process;
- - the degree of impact that changing regulations and legal precedents may
have on open claims; and
- - the consistency of reinsurance programs over time.
Because medical malpractice liability and commercial casualty claims may
not be completely paid off for several years, estimating reserves for these
types of claims can be more uncertain than estimating reserves for other types
of insurance. As a result, precise reserve estimates cannot be made for several
years following the year for which reserves were initially established.
During the past several years, the levels of the reserves for our insurance
subsidiaries have been very volatile. We have had to significantly increase and
decrease these reserves in the past several years.
Significant increases in the reserves may be necessary in the future, and
the level of reserves for our insurance subsidiaries may be volatile in the
future. These increases or volatility may have an adverse effect on our
business, financial condition, and the results of operations and cash flows.
STATE REGULATORS COULD REQUIRE CHANGES TO OUR CAPITALIZATION AND/OR TO THE
OPERATIONS OF OUR INSURANCE SUBSIDIARIES, AND/OR PLACE THEM INTO REHABILITATION
OR LIQUIDATION
Beginning in 1994, Physicians and Citation became subject to the provisions
of the Risk-Based Capital for Insurers Model Act which has been adopted by the
National Association of Insurance Commissioners for the purpose of helping
regulators identify insurers that may be in financial difficulty. The Model Act
contains a formula which takes into account asset risk, credit risk,
underwriting risk and all other relevant risks. Under this formula, each insurer
is required to report to regulators using formulas which measure the quality of
its capital and the relationship of its modified capital base to the level of
risk assumed in specific aspects of its operations. The formula does not address
all of the risks associated with the operations of an insurer. The formula is
intended to provide a minimum threshold measure of capital adequacy by
individual insurance company and does not purport to compute a target level of
capital. Companies which fall below the threshold will be placed into one of
four categories: Company Action Level, where the insurer must submit a plan of
corrective action; Regulatory Action Level, where the insurer must submit such a
plan of corrective action, the regulator is required to perform such examination
or analysis the Superintendent of Insurance considers necessary and the
regulator must issue a corrective order; Authorized Control Level, which
includes the above actions and may include rehabilitation or liquidation; and
Mandatory Control Level, where the regulator must rehabilitate or liquidate the
insurer. All companies' risk-based capital results as of December 31, 2002
exceed the Company Action Level.
IF WE ARE REQUIRED TO REGISTER AS AN INVESTMENT COMPANY, THEN WE WILL BE SUBJECT
TO A SIGNIFICANT REGULATORY BURDEN
At all times we intend to conduct our business so as to avoid being
regulated as an investment company under the Investment Company Act of 1940.
However, if we were required to register as an investment company, our ability
to use debt would be substantially reduced, and we would be subject to
significant additional disclosure obligations and restrictions on our
operational activities. Because of the additional requirements imposed on an
investment company with regard to the distribution of earnings, operational
activities and the use of debt, in addition to increased expenditures due to
additional reporting responsibilities, our cash available for investments would
be reduced. The additional expenses would reduce income. These factors would
adversely affect our business, financial condition, and the results of
operations and cash flows.
46
VARIANCES IN PHYSICAL AVAILABILITY OF WATER, ALONG WITH ENVIRONMENTAL AND LEGAL
RESTRICTIONS AND LEGAL IMPEDIMENTS COULD IMPACT PROFITABILITY FROM OUR WATER
RIGHTS
The water rights held by us and the transferability of these rights to
other uses and places of use are governed by the laws concerning water rights in
the states of Arizona, Colorado and Nevada. The volumes of water actually
derived from the water rights applications or permitted rights may vary
considerably based upon physical availability and may be further limited by
applicable legal restrictions. As a result, the amounts of acre-feet anticipated
from the water rights applications or permitted rights do not in every case
represent a reliable, firm annual yield of water, but in some cases describe the
face amount of the water right claims or management's best estimate of such
entitlement. Legal impediments may exist to the sale or transfer of some of
these water rights, which in turn may affect their commercial value. If we were
unable to transfer or sell our water rights, we will not be able to make a
profit, we will not have enough cash receipts to cover cash needs, and we may
lose some or all of our value in our water rights acquisitions.
Water we lease or sell may be subject to regulation as to quality by the
United States Environmental Protection Agency acting pursuant to the federal
Safe Drinking Water Act. While environmental regulations do not directly affect
us, the regulations regarding the quality of water distributed affects our
intended customers and may, therefore, depending on the quality of our water,
impact the price and terms upon which we may in the future sell our or water
rights.
OUR FUTURE WATER REVENUES ARE UNCERTAIN AND DEPEND ON A NUMBER OF FACTORS, WHICH
MAY MAKE OUR REVENUE STREAMS AND PROFITABILITY VOLATILE
We engage in various water rights acquisition, management, development, and
sale and lease activities. Accordingly, our long-term future profitability will
be primarily dependent on our ability to develop and sell or lease water and
water rights, and will be affected by various factors, including timing of
acquisitions, transportation arrangements, and changing technology. To the
extent we possess junior or conditional water rights, such rights may be
subordinated to superior water right holders in periods of low flow or drought.
In addition to the risk of delays associated with receiving all necessary
regulatory approvals and permits, we may also encounter unforeseen technical
difficulties which could result in construction delays and cost increases with
respect to our water and water storage development projects.
Our profitability is significantly affected by changes in the market price
of water. In the future, water prices may fluctuate widely as demand is affected
by climatic, demographic and technological factors.
OUR WATER ACTIVITIES MAY BECOME CONCENTRATED IN A LIMITED NUMBER OF ASSETS,
MAKING OUR GROWTH AND PROFITABILITY VULNERABLE TO FLUCTUATIONS IN LOCAL
ECONOMIES AND GOVERNMENTAL REGULATIONS
In the future, we anticipate that a significant amount of Vidler's
revenues and asset value will come from a limited number of assets, including
our water rights in the Harquahala Valley and the Vidler Arizona Recharge
Facility. Although we continue to acquire and develop additional water assets,
in the foreseeable future we anticipate that our revenues will still be derived
from a limited number of assets.
OUR WATER SALES MAY MEET WITH POLITICAL OPPOSITION IN CERTAIN LOCATIONS, THEREBY
LIMITING OUR GROWTH IN THESE AREAS
The transfer of water rights from one use to another may affect the
economic base of a community and will, in some instances, be met with local
opposition. Moreover, certain of the end users of our water rights, namely
municipalities, regulate the use of water in order to control or deter growth.
WE ARE DIRECTLY IMPACTED BY INTERNATIONAL AFFAIRS, WHICH DIRECTLY EXPOSES US TO
THE ADVERSE EFFECTS OF ANY FOREIGN ECONOMIC OR GOVERNMENTAL INSTABILITY
As a result of global investment diversification, our business, financial
condition, the results of operations and cash flows may be adversely affected
by:
- - exposure to fluctuations in exchange rates;
- - the imposition of governmental controls;
- - the need to comply with a wide variety of foreign and U.S. export laws;
- - political and economic instability;
- - trade restrictions;
47
- - changes in tariffs and taxes;
- - volatile interest rates;
- - changes in certain commodity prices;
- - exchange controls which may limit our ability to withdraw money;
- - the greater difficulty of administering business overseas; and
- - general economic conditions outside the United States.
Changes in any or all of these factors could result in reduced market
values of investments, loss of assets, additional expenses, reduced investment
income, reductions in shareholders' equity due to foreign currency fluctuations
and a reduction in our global diversification.
OUR COMMON STOCK PRICE MAY BE LOW WHEN YOU WANT TO SELL YOUR SHARES
The trading price of our common stock has historically been, and is
expected to be, subject to fluctuations. The market price of the common stock
may be significantly impacted by:
- - quarterly variations in financial performance and condition;
- - shortfalls in revenue or earnings from levels forecast by securities
analysts;
- - changes in estimates by such analysts;
- - product introductions;
- - our competitors' announcements of extraordinary events such as
acquisitions;
- - litigation; and
- - general economic conditions.
Our results of operations have been subject to significant fluctuations,
particularly on a quarterly basis, and our future results of operations could
fluctuate significantly from quarter to quarter and from year to year. Causes of
such fluctuations may include the inclusion or exclusion of operating earnings
from newly acquired or sold operations. At December 31, 2002, the closing price
of our common stock on the NASDAQ National Market was $13.24 per share, compared
to $12.4375 at December 31, 2000. On a quarterly basis between these two dates,
closing prices have ranged from a high of $16.57 at June 30, 2002 to a low of
$11.00 at September 30, 2002. During 2002, closing prices have ranged from a low
of $8.33 per share on October 10 to a high of $17.42 on April 16.
Statements or changes in opinions, ratings, or earnings estimates made by
brokerage firms or industry analysts relating to the markets in which we do
business or relating to us specifically could result in an immediate and adverse
effect on the market price of our common stock.
WE MAY NOT BE ABLE TO RETAIN KEY MANAGEMENT PERSONNEL WE NEED TO SUCCEED, WHICH
COULD ADVERSELY AFFECT OUR ABILITY TO MAKE SOUND INVESTMENT DECISIONS
We have several key executive officers. If they depart, it could have a
significant adverse effect. . Messrs. Langley and Hart, our Chairman and CEO,
respectively, are key to the implementation of our strategic focus, and our
ability to successfully develop our current strategy is dependent upon our
ability to retain the services of Messrs. Langley and Hart.
New employment agreements were entered into with Mr. Langley and Mr. Hart
on January 1, 2002 for a further four years. (See Part II, Item 8, Note 15,
"Related-Party Transactions").
MANAGEMENT'S USE OF JUDGMENT IN PREPARING FINANCIAL STATEMENTS IN ACCORDANCE
WITH ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES OF AMERICA.
The preparation our financial statements in conformity with U.S GAAP requires
management to make estimates, judgments and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent liabilities at the
date of financial statements and the reported amount of revenues and expenses
during the reporting period. We regularly evaluate our estimates, which are
based on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. The result of these
evaluations forms the basis for making judgments about the carrying values of
assets and liabilities and the reported amount of revenues and expenses that are
not readily apparent from other sources. The carrying values of assets and
liabilities and the reported amount of revenues and expenses may differ by using
different assumptions. In addition, in future periods, in order to
48
incorporate all known experience at that time, we may have to revise assumptions
previously made which may change the value of previously reported assets and
liabilities. This potential subsequent change in value may have a material
adverse effect on our business, financial condition, and the results of
operations and cash flows. See "Critical Accounting Policies" in Item 7.
COMMON STOCK TRANSACTIONS
Our Board of Directors has authorized the repurchase of up to $10 million of our
common stock. The stock purchases may be made from time to time at prevailing
prices though open market, or negotiated transactions, depending on market
conditions, and will be funded from available cash resources of the company.
Such a repurchase program may have an impact on our cash flows. (Refer to our
Liquidity and Capital Resources in Item 7).
FUTURE CHANGES IN FINANCIAL ACCOUNTING STANDARDS MAY CAUSE ADVERSE UNEXPECTED
REVENUE FLUCTUATIONS AND AFFECT OUR REPORTED RESULTS OF OPERATIONS.
A change in accounting standards could have a significant effect on our
reported results and may even affect our reporting transactions completed before
the change is effective. Any changes requiring that we record compensation
expense in the statement of operations for employee stock options using the fair
value method could have a significant negative effect on our reported results.
New accounting pronouncements and varying interpretations of pronouncements have
occurred and may occur in the future. Changes to existing rules or the
questioning of current practices may adversely affect our reported financial
results of the way we conduct our business.
COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC
DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES.
Changing laws, regulations and standards relating to corporate
governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new
SEC regulations and Nasdaq Stock Market rules, are creating uncertainty for
companies such as ours. We are committed to maintaining high standards of
corporate governance and public disclosure. As a result, we intend to invest all
reasonably necessary resources to comply with evolving standards, and this
investment may result in increased general and administrative expenses and a
diversion of management time and attention from revenue-generating activities to
compliance activities.
ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO INVESTORS.
Some investors favor companies that pay dividends, particularly in
market downturns. We have never declared or paid any cash dividends on our
common stock. We currently intend to retain any future earnings for funding
growth and, therefore, we do not currently anticipate paying cash dividends on
our common stock.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE TO FUND THE GROWTH OF OUR BUSINESS,
AND FINANCING MAY NOT BE AVAILABLE.
We currently anticipate that our available capital resources and
operating income will be sufficient to meet our expected working capital and
capital expenditure requirements for at least the next 12 months. However, we
cannot assure you that such resources will be sufficient to fund the long-term
growth of our business. We may raise additional funds through public or private
debt or equity financings if such financings become available on favorable
terms, but such financing may dilute our stockholders. We cannot assure you that
you that any additional financing we need will be available on terms favorable
to us, or at all. If adequate funds are not available or are not available on
acceptable terms, we may not be able to take advantage of unanticipated
opportunities or otherwise respond to competitive pressures. In any such case,
our business, operating results or financial condition could be materially
adversely affected.
LITIGATION MAY HARM OUR BUSINESS OR OTHERWISE DISTRACT OUR MANAGEMENT.
Substantial, complex or extended litigation could cause us to incur
large expenditures and distract our management. For example, lawsuits by
employees, stockholders or customers could be very costly and substantially
disrupt our business. Disputes from time to time with such companies or
individuals are not uncommon, and we cannot assure that that we will always be
able to resolve such disputes out of court or on terms favorable to us.
49
THE FOREGOING FACTORS, INDIVIDUALLY OR IN AGGREGATE, COULD MATERIALLY ADVERSELY
AFFECT OUR OPERATING RESULTS AND COULD MAKE COMPARISON OF HISTORIC OPERATING
RESULTS AND BALANCES DIFFICULT OR NOT MEANINGFUL.
REGULATORY INSURANCE DISCLOSURES
Liabilities for Unpaid Loss and Loss Adjustment Expenses
Liabilities for unpaid loss and loss adjustment expenses are estimated based
upon actual and industry experience, and assumptions and projections as to
claims frequency, severity and inflationary trends and settlement payments. Such
estimates may vary from the eventual outcome. The inherent uncertainty in
estimating reserves is particularly acute for lines of business for which both
reported and paid losses develop over an extended period of time.
Several years or more may elapse between the occurrence of an insured
medical professional liability insurance or casualty loss, the reporting of the
loss and the final payment of the loss. Loss reserves are estimates of what an
insurer expects to pay claimants, legal and investigative costs and claims
administrative costs. PICO's insurance subsidiaries are required to maintain
reserves for payment of estimated losses and loss adjustment expenses for both
reported claims and claims which have occurred but have not yet been reported.
Ultimate actual liabilities may be materially more or less than current reserve
estimates.
Reserves for reported claims are established on a case-by-case basis. Loss
and loss adjustment expense reserves for incurred but not reported claims are
estimated based on many variables including historical and statistical
information, inflation, legal developments, the regulatory environment, benefit
levels, economic conditions, judicial administration of claims, general trends
in claim severity and frequency, medical costs and other factors which could
affect the adequacy of loss reserves. Management reviews and adjusts incurred
but not reported claims reserves regularly.
The liabilities for unpaid losses and loss adjustment expenses of Physicians
and Citation were $52.7 million at December 31, 2002, $61.5 million at December
31, 2001, and $84.4 million at December 31, 2000 before reinsurance reserves,
which reduce net unpaid losses and loss adjustment expenses. Of those amounts,
the liabilities for unpaid loss and loss adjustment expenses of prior years
decreased by $2.3 million in 2002, and 11.1 million in 2001, and increased by
$8.3 million in 2000. The 2000 increase included $7.5 million of accumulated
discount on reserves that was expensed as a result of our decision to
discontinue discounting reserves effective January 1, 2000. See Note 21 of Notes
to Consolidated Financial Statements, "Cumulative Effect of Change in Accounting
Principle." These changes to prior years' reserves were due to the following:
CHANGE IN UNPAID LOSS AND LAE RESERVES FOR PRIOR YEARS
2002 2001 2000
----------------- ------------------- -----------------
Increase (decrease) in provision for prior year claims $ (1,907,552) $ (10,571,292) $ 1,048,408
Retroactive reinsurance (438,879) (529,993) (267,653)
Cumulative effect of an accounting change 7,520,744
----------------- ------------------- -----------------
Net increase (decrease) in liabilities for unpaid loss
and LAE of prior years $ (2,346,431) $ (11,101,285) $ 8,301,499
================= =================== =================
See schedule in Note 11 of Notes to PICO's Consolidated Financial
Statements, "Reserves for Unpaid Loss and Loss Adjustment Expenses" for
additional information regarding reserve changes.
Although insurance reserves are certified annually by independent actuaries
for each insurance company as required by state law, significant fluctuations in
reserve levels can occur based upon a number of variables used in actuarial
projections of ultimate incurred losses and loss adjustment expenses.
All of PICO's insurance companies seek to reduce the loss that may arise
from individually significant claims or other events that cause unfavorable
underwriting results by reinsuring certain levels of risk with other insurance
carriers. Various reinsurance treaties
50
remain in place to limit PICO's exposure levels.
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
The following table presents the development of balance sheet liabilities
for 1992 through 2002 for all continuing operations property and casualty lines
of business and medical professional liability insurance. The "Net liability as
originally estimated" line shows the estimated liability for unpaid losses and
loss adjustment expenses recorded at the balance sheet date on a discounted
basis, prior to 2000, for each of the indicated years. Reserves for other lines
of business that Physicians ceased writing in 1989, which are immaterial, are
excluded. The "Gross liability as originally estimated" represents the estimated
amounts of losses and loss adjustment expenses for claims arising in all prior
years that are unpaid at the balance sheet date on an undiscounted basis,
including losses that had been incurred but not reported.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997
------------ ------------- ------------- ------------- ------------- ------------
(IN THOUSANDS)
Net liability as originally estimated: $159,804 $179,390 $153,212 $135,825 $153,891 $110,931
Discount 31,269 32,533 20,144 16,568 12,217 9,159
Gross liability as originally estimated: 191,073 211,923 173,356 152,393 166,108 120,090
Cumulative payments as of:
One year later 41,559 34,207 35,966 26,331 54,500 37,043
Two years later 73,012 69,037 61,263 63,993 88,298 57,622
Three years later 103,166 90,904 93,906 85,649 107,094 73,096
Four years later 116,278 118,331 110,272 99,730 121,698 82,249
Five Years later 139,028 128,773 119,879 110,299 130,247 89,398
Six years later 143,562 136,820 129,819 115,312 137,462
Seven years later 148,426 145,683 132,394 118,396
Eight years later 156,620 147,386 134,811
Nine years later 157,975 149,443
Ten years later 159,922
Liability re-estimated as of:
One year later 197,275 183,560 170,411 145,824 166,870 129,225
Two years later 179,763 184,138 163,472 145,031 182,963 145,543
Three years later 182,011 176,308 162,532 150,439 193,498 146,618
Four years later 176,304 178,544 165,696 155,183 194,423 135,930
Five Years later 181,721 178,584 167,145 157,973 183,333 133,958
Six years later 181,868 178,371 167,821 149,074 181,705
Seven years later 181,029 178,717 160,233 147,525
Eight years later 183,229 171,926 160,188
Nine years later 179,052 170,935
Ten years later 178,462
Cumulative Redundancy (Deficiency) $12,611 $40,988 $13,168 $4,868 ($15,598) ($13,868)
51
Year Ended December 31,
-----------------------------------------------------------------------------
1998 1999 2000 2001 2002
------------- ------------- -------------- ------------ -------------
(In thousands)
Net liability as originally estimated: $89,554 $88,112 $74,896 $54,022 $44,905
Discount 8,515 7,521
Gross liability before discount
as originally estimated 98,069 95,633 74,896 54,022 44,905
Cumulative payments as of:
One year later 23,696 22,636 9,767 7,210
Two years later 41,789 31,987 16,946
Three years later 50,968 39,150
Four years later 58,129
Five Years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Liability re-estimated as of:
One year later 114,347 96,727 63,672 52,115
Two years later 115,539 85,786 61,832
Three years later 104,689 83,763
Four years later 102,704
Five Years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative Redundancy (Deficiency) ($4,635) $11,870 $13,064 $1,907
RECONCILIATION TO FINANCIAL STATEMENTS
Gross liability - end of year $84,284 $61,497 $52,686
Reinsurance recoverable (9,388) (7,475) (7,780)
-------------- ------------ -------------
Net liability - end of year 74,896 54,022 44,906
Reinsurance recoverable 9,388 7,475 7,780
-------------- ------------ -------------
84,284 61,497 52,686
Discontinued personal lines insurance 100 41 17
-------------- ------------ -------------
Balance sheet liability $84,384 $61,538 $52,703
============== ============ =============
Gross re-estimated liability - latest $75,778 $61,594
Re-estimated recoverable - latest (13,946) (9,479)
-------------- ------------
Net re-estimated liability before
discount - latest 61,832 52,115
-------------- ------------
Net re-estimated liability - latest $61,832 $52,115
============== ============
Net cumulative redundancy before discount $13,064 $1,907
============== ============
Each decrease or increase amount includes the effects of all changes in
amounts during the current year for prior periods. For example, the amount of
the redundancy related to losses settled in 1994, but incurred in 1991, will be
included in the decrease or increase amount for 1991, 1992 and 1993. Conditions
and trends that have affected development of the liability in the past may not
necessarily occur in the future. For example, Physicians commuted reinsurance
contracts in several different years that significantly increased the estimate
of net reserves for prior years by reducing the recoverable loss and loss
adjustment expense reserves for those years. Accordingly, it may not be
appropriate to extrapolate future increases or decreases based on this table.
The data in the above table is based on Schedule P from each of Physician's
and Citation's 1992 to 2002 Annual Statements, as filed with state insurance
departments; however, the development table above differs from the development
displayed in Schedule P, Part-2, of the insurance Annual Statements as Schedule
P, Part-2, excludes unallocated loss adjustment expenses.
52
LOSS RESERVE EXPERIENCE
The inherent uncertainties in estimating loss reserves are greater for some
insurance products than for others, and are dependent on the length of the
reporting lag or "tail" associated with a given product (i.e., the lapse of time
between the occurrence of a claim and the report of the claim to the insurer),
on the diversity of historical development patterns among various aggregations
of claims, the amount of historical information available during the estimation
process, the degree of impact that changing regulations and legal precedents may
have on open claims, and the consistency of reinsurance programs over time,
among other things. Because medical professional liability insurance and
commercial casualty claims may not be fully paid for several years or more,
estimating reserves for such claims can be more uncertain than estimating
reserves in other lines of insurance. As a result, precise reserve estimates
cannot be made for several years following a current accident year for which
reserves are initially established.
There can be no assurance that the insurance companies have established
reserves adequate to meet the ultimate cost of losses arising from such claims.
It has been necessary, and will over time continue to be necessary, for the
insurance companies to review and make appropriate adjustments to reserves for
estimated ultimate losses and loss adjustment expenses. To the extent reserves
prove to be inadequate, the insurance companies would have to adjust their
reserves and incur a charge to income, which could have a material adverse
effect on PICO's financial results.
Reconciliation of Unpaid Loss and Loss Adjustment Expenses
An analysis of changes in the liability for unpaid losses and loss
adjustment expenses for 2002, 2001 and 2000 is set forth in Note 11 of Notes to
PICO's Consolidated Financial Statements, "Reserves for Unpaid Loss and Loss
Adjustment Expenses."
REINSURANCE
Medical Professional Liability Insurance through Physicians Insurance
Company of Ohio
On July 14, 1995, Physicians entered into an Agreement for the Purchase and
Sale of Certain Assets with Mutual Assurance, Inc. This transaction closed on
August 28, 1995. Pursuant to the agreement, Physicians sold their professional
liability insurance business and related liability insurance business for
physicians and other health care providers.
Simultaneously with execution of the agreement, Physicians and Mutual
entered into a reinsurance treaty pursuant to which Mutual agreed to assume all
risks attaching after July 15, 1995 under medical professional liability
insurance policies issued or renewed by Physicians on physicians, surgeons,
nurses, and other health care providers, dental practitioner professional
liability insurance policies including corporate and professional premises
liability coverage issued by Physicians, and related commercial general
liability insurance policies issued by Physicians, net of applicable
reinsurance.
Prior to July 1, 1993, Physicians ceded a portion of the risk it wrote under
numerous reinsurance treaties at various retentions and risk limits. However,
during the last two accident years that Physicians wrote premium (July 1, 1993
to July 15, 1995), Physicians ceded reinsurance contracts through TIG
Reinsurance Company (rated A [Strong] by Standard & Poors), Transatlantic
Reinsurance Company (rated AA [Very Strong] by S&P) and Cologne Reinsurance
Company of America (rated BBBpi [Good] by S&P). Physicians ceded insurance to
these carriers on an automatic basis when retention limits were exceeded.
Physicians retained all risks up to $200,000 per occurrence. All risks above
$200,000, up to policy limits of $5 million, were transferred to reinsurers,
subject to the specific terms and conditions of the various reinsurance
treaties. Physicians remains primarily liable to policyholders for ceded
insurance should any reinsurer be unable to meet its contractual obligations.
Property and Casualty Insurance through Citation Insurance Company and
Sequoia Insurance Company
Effective January 1, 1998, Sequoia and Citation entered into an
inter-company reinsurance pooling agreement for business in force as of January
1, 1998 and business written thereafter. Per the agreement, Citation ceded 100%
of its net premium and losses to Sequoia and Sequoia then ceded 50% of its net
premiums and losses to Citation. Sequoia and Citation shared equally in the
underwriting expenses. This arrangement was terminated effective January 1,
2000.
During this period, Citation and Sequoia had the same reinsurance
program. For property business, reinsurance provided coverage of $10.4 million
excess of $150,000 per occurrence. For casualty business, excluding umbrella
coverage, reinsurance provided coverage of $4.9 million excess of $150,000 per
occurrence. Umbrella coverages were reinsured $9.9 million excess of $100,000
per
53
occurrence. The catastrophe treaties for 1998 and thereafter provided coverage
of 95% of $14 million excess of $1 million per occurrence. Facultative
reinsurance was placed with various reinsurers.
Effective January 1, 2002, Sequoia increased its retention for property
and casualty losses from $150,000 to $200,000 per occurrence. Therefore,
reinsurance provides property coverage of $10.3 million excess of $200,000 per
occurrence, and casualty coverage of $4.8 million excess of $200,000 per
occurrence. In addition, Sequoia changed the umbrella reinsurance from $9.9
million excess of $100,000 per occurrence to 98% quota share reinsurance for the
first $5 million. Therefore, Sequoia will retain 2% of each umbrella loss while
the reinsurance provides for 98% of each umbrella loss. The reinsurance for
umbrella business $5 million excess of $5 million per occurrence remains at
100%. The catastrophe treaties for 2002 provide coverage of 70% for $1.5 million
excess of $1 million per occurrence, and 95% for $12.5 million per occurrence
excess of $2.5 million. Citation does not require reinsurance from 2002 onwards,
as its last policy expired in December 2001.
Where the reinsurers are "not admitted" for regulatory purposes, Sequoia and
Citation presently maintain sufficient collateral with approved financial
institutions to secure cessions of paid losses and outstanding reserves.
All policy and claims liabilities of Sequoia prior to August 1, 1995 have
been 100% reinsured with Sydney Reinsurance Corporation and unconditionally
guaranteed by QBE Insurance Group Limited.
See Note 10 of Notes to Consolidated Financial Statements, "Reinsurance,"
with regard to reinsurance recoverable concentration for all property and
casualty lines of business as of December 31, 2002. PICO remains contingently
liable with respect to reinsurance contracts in the event that reinsurers are
unable to meet their obligations under the reinsurance agreements in force.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PICO's balance sheets include a significant amount of assets and liabilities
whose fair value are subject to market risk. Market risk is the risk of loss
arising from adverse changes in market interest rates or prices. PICO currently
has interest rate risk as it relates to its fixed maturity securities and
mortgage participation interests, equity price risk as it relates to its
marketable equity securities, and foreign currency risk as it relates to
investments denominated in foreign currencies. Generally, PICO's borrowings are
short to medium term in nature and therefore approximate fair value. At December
31, 2002, PICO (including the investments held by discontinued operations) had
$112.6 million of fixed maturity securities and mortgage participation
interests, $61.4 million of marketable equity securities that were subject to
market risk, of which $41.1 million were denominated in foreign currencies,
primarily Swiss francs. PICO's investment strategy is to manage the duration of
the portfolio relative to the duration of the liabilities while managing
interest rate risk.
PICO uses two models to analyze the sensitivity of its assets and
liabilities subject to the above risks. For its fixed maturity securities, and
mortgage participation interests, PICO uses duration modeling to calculate
changes in fair value. For its marketable securities, PICO uses a hypothetical
20% decrease in the fair value to analyze the sensitivity of its market risk
assets and liabilities. For investments denominated in foreign currencies, PICO
uses a hypothetical 20% decrease in the local currency of that investment.
Actual results may differ from the hypothetical results assumed in this
disclosure due to possible actions taken by management to mitigate adverse
changes in fair value and because the fair value of securities may be affected
by credit concerns of the issuer, prepayment rates, liquidity, and other general
market conditions. The sensitivity analysis duration model produced a loss in
fair value of $3.6 million for a 100 basis point decline in interest rates on
its fixed securities and mortgage participation interests. The hypothetical 20%
decrease in fair value of PICO's marketable equity securities produced a loss in
fair value of $12.3 million that would impact the unrealized appreciation in
shareholders' equity. The hypothetical 20% decrease in the local currency of
PICO's foreign denominated investments produced a loss of $6.5 million that
would impact the foreign currency translation in shareholders' equity.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PICO's financial statements as of December 31, 2002 and 2001 and for each of
the three years in the period ended December 31, 2002 and the independent
auditors' report is included in this report as listed in the index.
54
SELECTED QUARTERLY FINANCIAL DATA
Summarized unaudited quarterly financial data (in thousands, except share
and per share amounts) for 2002 and 2001 are shown below. In management's
opinion, the interim financial data contains all adjustments necessary for a
fair presentation of results for such interim periods and are of a normal
recurring nature. The following as reported figures differ from previously
reported quarterly results due to reporting Sequoia Insurance Company as a
discontinued operation (Recasted). During 2002, the Company determined that it
needed to record other-than-temporary impairments on marketable securities and
reverse the equity method accounting for the investment in Jungfraubahn
(Restated). As a result the first three quarters for the year ended December 31,
2002 have been restated from the amounts previously reported. The quarterly
periods for the year ended December 31, 2001 have been previously restated in
the Company's 2001 Form 10-K/A filed with the Securities and Exchange
Commission.
AS RESTATED AND RECASTED
THREE MONTHS ENDED
---------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2002 2002 2002 2002
-------------- --------------- -------------- --------------
Premium income (charge) $ (425) $ 383
Net investment income and
net realized gain (loss) 644 1,513 7,173 265
Sale of land and water rights 7,365 1,552 872 5,443
Total revenues 8,971 4,324 9,105 6,874
Net income (loss) 1,864 (149) 3,248 966
-------------- --------------- -------------- --------------
Basic:
Net income (loss) per share $ 0.15 $ (0.01) $ 0.26 $ 0.08
============== =============== ============== ==============
Weighted average common
and equivalent shares
outstanding 12,367,021 12,373,856 12,381,878 12,379,242
Diluted:
Net income (loss) per share $ 0.15 $ (0.01) $ 0.26 $ 0.08
============== =============== ============== ==============
Weighted average common
and equivalent shares
outstanding 12,376,660 12,498,923 12,381,878 12,379,242
-------------- --------------- -------------- --------------
AS RESTATED IN 2001 10-K/A AND RECASTED
THREE MONTHS ENDED
------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2001 2001 2001 2001
-------------- -------------- --------------- --------------
Premium income (charge) $ 102 $ 77 $ 42 $ 761
Net investment income and
net realized gain (loss) 957 2,831 (2,218) (409)
Sale of land and water rights 9,095 440 6,101 1,470
Total revenues 10,855 5,614 3,315 3,574
Net income (loss) (1,439) (1,534) 866 7,221
-------------- -------------- --------------- --------------
Basic:
Net income (loss) per share $ (0.12) $ (0.12) $ 0.07 $ 0.58
============== ============== =============== ==============
Weighted average common
and equivalent shares
outstanding 12,390,096 12,390,096 12,390,096 12,386,616
Diluted:
Net income (loss) per share $ (0.12) $ (0.12) $ 0.07 $ 0.58
============== ============== =============== ==============
Weighted average common
and equivalent shares
outstanding 12,390,096 12,390,096 12,408,408 12,386,616
-------------- -------------- --------------- --------------
AS PREVIOUSLY REPORTED AND RECASTED
THREE MONTHS ENDED
-------------------------------------------------
March 31, June 30, September 30,
2002 2002 2002
-------------- --------------- --------------
Premium income (charges) $ (425)
Net investment income and
net realized gains 1,592 2,137 5,580
Sale of land and water rights 7,365 1,459 872
Total revenues 9,918 4,947 7,512
Net income 2,714 425 1,728
-------------- --------------- --------------
Basic:
Net income per share $ 0.22 $ 0.03 $ 0.14
============== =============== ==============
Weighted average common
and equivalent shares
outstanding 12,367,021 12,373,856 12,381,878
Diluted:
Net income per share $ 0.22 $ 0.03 $ 0.14
============== =============== ==============
Weighted average common
and equivalent shares
outstanding 12,376,660 12,498,923 12,381,878
-------------- --------------- --------------
55
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2002 AND 2001
AND FOR EACH OF THE
THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 2002
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report ....................................... 57
Consolidated Balance Sheets as of December 31, 2002 and 2001 ....... 58-59
Consolidated Statements of Operations for the Years Ended
December 31, 2002, 2001 and 2000 .............................. 60
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 2002, 2001, and 2000 .................. 61-63
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000 ............................... 64
Notes to Consolidated Financial Statements .......................... 65-92
56
INDEPENDENT AUDITORS' REPORT
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF PICO HOLDINGS, INC.
We have audited the accompanying consolidated balance sheets of PICO Holdings,
Inc. and its subsidiaries (collectively "the Company") as of December 31, 2002
and 2001, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of PICO Holdings, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 20 to the financial statements, in 2002 the Company changed
its accounting for goodwill as a result of the adoption of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets,"
and in 2000 the Company changed its method of accounting for medical
professional liability claims reserves.
DELOITTE & TOUCHE LLP
San Diego, California
March 27, 2003
57
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
ASSETS
2002 2001
------------ ------------
Investments (Note 3):
Available for sale:
Fixed maturities $ 47,566,764 $ 48,780,129
Equity securities 47,430,192 42,485,827
Investment in unconsolidated affiliates (Note 4) 498,214 2,583,590
------------ ------------
Total investments - continuing operations 95,495,170 93,849,546
Investments held by discontinued operations (Note 2) 78,442,627 63,993,830
------------ ------------
Total investments 173,937,797 157,843,376
Cash and cash equivalents 22,079,082 16,342,374
Premiums and other receivables, net (Note 6) 5,472,834 7,045,408
Reinsurance receivables (Note 10) 7,832,708 7,508,838
Accrued investment income 425,100 742,849
Land and related mineral rights and water rights (Note 5) 116,790,891 125,997,642
Property and equipment, net (Note 8) 2,143,746 2,185,418
Goodwill and intangibles, net (Note 1) 807,853
Net deferred income taxes (Note 7) 6,079,810 9,089,062
Other assets 9,267,845 7,172,983
Other assets of discontinued operations (Note 2) 52,138,398 39,682,961
------------ ------------
Total assets $396,168,211 $374,418,764
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
58
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED
DECEMBER 31, 2002 AND 2001
LIABILITIES AND SHAREHOLDERS' EQUITY
2002 2001
----------------- ------------------
Policy liabilities and accruals:
Unpaid losses and loss adjustment expenses (Note 11) $ 52,703,113 $ 61,537,910
Unpaid losses and loss adjustment expenses of discontinued operations (Note 2) 49,162,995 36,911,143
Reinsurance balance payable 538,000 3,319,333
Deferred gain on retroactive reinsurance 438,879
Other liabilities 10,902,399 10,362,344
Bank and other borrowings (Note 20) 14,636,017 14,596,302
Excess of fair value of net assets acquired over purchase price (Note 1) 2,792,597
Other liabilities of discontinued operations (Note 2 ) 44,085,976 33,499,559
----------------- ------------------
Total liabilities 172,028,500 163,458,067
----------------- ------------------
Minority interest 3,108,007 3,062,190
----------------- ------------------
Commitments and Contingencies (Note 10, 11, 12, 13, 14, 15, 19 and 20)
Common stock, $.001 par value; authorized 100,000,000; 16,801,923 issued and outstanding
at December 31, 2002 and 16,784,223 issued and outstanding at December 31, 2001 16,802 16,784
Additional paid-in capital 236,082,703 235,844,655
Accumulated other comprehensive income (loss) (Note 1) 3,833,676 (3,225,867)
Retained earnings 59,320,715 53,391,570
----------------- ------------------
299,253,896 286,027,142
Less treasury stock, at cost (common shares: 4,422,681 in 2002 and 4,415,607 in 2001) (78,222,192) (78,128,635)
----------------- ------------------
Total shareholders' equity 221,031,704 207,898,507
----------------- ------------------
Total liabilities and shareholders' equity $ 396,168,211 $ 374,418,764
================= ==================
The accompanying notes are an integral part of the
consolidated financial statements.
59
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
------------ ------------ ------------
Revenues:
Premium income (charges) $ (41,796) $ 979,952 $ 1,695,194
Net investment income (Note 3) 5,385,209 6,035,825 6,092,371
Net realized gain (loss) on investments (Note 3) 4,209,632 (4,874,594) (7,786,266)
Sale of land and water rights 15,231,769 17,106,174 5,478,263
Other income 4,489,425 4,313,071 4,199,213
------------ ------------ ------------
Total revenues 29,274,239 23,560,428 9,678,775
------------ ------------ ------------
Costs and expenses:
Loss and loss adjustment (recoveries) expenses (Note 11) (2,346,314) (10,929,282) 1,880,761
Cost of land and water rights sold 9,740,137 7,568,229 3,995,508
Interest expense 795,193 1,031,994 1,121,864
Depreciation and amortization 1,420,806 1,197,073 1,891,592
Other operating costs 14,750,371 17,335,321 16,940,189
------------ ------------ ------------
Total costs and expenses 24,360,193 16,203,335 25,829,914
------------ ------------ ------------
Equity in loss of unconsolidated affiliates (2,208,070) (1,529,060) (1,252,020)
------------ ------------ ------------
Income (loss) before income taxes and minority interest 2,705,976 5,828,033 (17,403,159)
Provision (benefit) for federal, foreign and state income taxes (Note 7) 2,049,565 2,409,501 (9,396,690)
------------ ------------ ------------
Income (loss) before minority interest 656,411 3,418,532 (8,006,469)
Minority interest in loss of subsidiaries 454,184 358,449 717,076
------------ ------------ ------------
Income (loss) from continuing operations 1,110,595 3,776,981 (7,289,393)
Income from discontinued operations, net (Note 2) 2,833,806 2,317,495 952,528
------------ ------------ ------------
Income (loss) before cumulative changes in accounting principles 3,944,401 6,094,476 (6,336,865)
------------ ------------ ------------
Cumulative effect of changes in accounting principles, net (Note 21) 1,984,744 (980,571) (4,963,691)
------------ ------------ ------------
Net income (loss) $ 5,929,145 $ 5,113,905 $(11,300,556)
============ ============ ============
Net income (loss) per common share - basic and diluted:
Income (loss) from continuing operations $ 0.09 $ 0.30 $ (0.62)
Discontinued operations 0.23 0.19 0.08
Cumulative effect of changes in accounting principles 0.16 (0.08) (0.43)
------------ ------------ ------------
Net income (loss) per common share $ 0.48 $ 0.41 $ (0.97)
============ ============ ============
Weighted average shares outstanding 12,375,466 12,384,682 11,604,120
============ ============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
60
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Accumulated Other
Comprehensive Loss
--------------------------
Net
Unrealized
Additional Appreciation Foreign
Common Paid-In Retained (Depreciation) Currency Treasury
Stock Capital Earnings on Investments Translation Stock Total
-------- ------------- ----------- -------------- ---------- -------- -------------
Balance, January 1, 2000 $ 13,449 $ 186,004,827 $ 59,578,221 $ 7,967,135 $ (6,227,902) $(77,829,635) $ 169,506,095
Comprehensive Loss for 2000
Net loss (11,300,556)
Net unrealized
depreciation
on investments
net of deferred
tax of $2.2 million (4,355,660)
Foreign currency translation (1,587,908)
Total Comprehensive Loss (17,244,124)
Rights offering, net of
$193,000 of expenses 3,335 49,839,828 49,843,163
-------- ------------- ------------ ----------- ------------ ------------ -------------
Balance, December 31, 2000 $ 16,784 $ 235,844,655 $ 48,277,665 $ 3,611,475 $ (7,815,810) $(77,829,635) $ 202,105,134
======== ============= ============ =========== ============ ============ =============
The accompanying notes are an integral part of the
consolidated financial statements.
61
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY, CONTINUED
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Accumulated Other
Comprehensive Loss
----------------------------------
Additional Net Unrealized Foreign
Common Paid-In Retained Appreciation Currency
Stock Capital Earnings on Investments Translation
------------ ------------------ --------------- ---------------- ---------------
Balance, December 31, 2000 $ 16,784 $ 235,844,655 $ 48,277,665 $ 3,611,475 $ (7,815,810)
Comprehensive Loss for 2001
Net income 5,113,905
Net unrealized appreciation on investments
net of deferred tax of $996,000 and
reclassification adjustment of $556,000 1,933,582
Foreign currency translation (955,114)
Total Comprehensive Income
Acquisition of 21,846 shares of
treasury stock for deferred
compensation plans
------------ ------------------ --------------- ---------------- ---------------
Balance, December 31, 2001 $ 16,784 $ 235,844,655 $ 53,391,570 $ 5,545,057 $ (8,770,924)
============ ================== =============== ================ ===============
Treasury
Stock Total
---------------- ----------------
Balance, December 31, 2000 $ (77,829,635) $ 202,105,134
Comprehensive Loss for 2001
Net income
Net unrealized appreciation on investments
net of deferred tax of $996,000 and
reclassification adjustment of $556,000
Foreign currency translation
Total Comprehensive Income 6,092,373
Acquisition of 21,846 shares of
treasury stock for deferred
compensation plans (299,000) (299,000)
---------------- ----------------
Balance, December 31, 2001 $ (78,128,635) $ 207,898,507
================ ================
The accompanying notes are an integral part of the consolidated financial
statements
62
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY, CONTINUED
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Accumulated Other
Comprehensive Income
-----------------------------------
Additional Net Unrealized Foreign
Common Paid-In Retained Appreciation Currency
Stock Capital Earnings on Investments Translation
----------- ------------------ --------------- ------------------ ---------------
Balance, December 31, 2001 $ 16,784 $ 235,844,655 $ 53,391,570 $ 5,545,057 $ (8,770,924)
Comprehensive Income for 2002
Net income 5,929,145
Net unrealized appreciation on investments
net of deferred tax of $2 million and
reclassification adjustment of $588,000 4,454,385
Foreign currency translation 2,605,158
Total Comprehensive income
Acquisition of shares of treasury stock for
deferred compensation plans
Exercise of stock options 18 238,048
----------- ------------------ --------------- ------------------ ---------------
Balance, December 31, 2002 $16,802 $ 236,082,703 $ 59,320,715 $ 9,999,442 $ (6,165,766)
=========== ================== =============== ================== ===============
Treasury
Stock Total
------------------ ------------------
Balance, December 31, 2001 $ (78,128,635) $ 207,898,507
Comprehensive Income for 2002
Net income
Net unrealized appreciation on investments
net of deferred tax of $2 million and
reclassification adjustment of $588,000
Foreign currency translation
Total Comprehensive income 12,988,688
Acquisition of shares of treasury stock for
deferred compensation plans (93,557) (93,557)
Exercise of stock options 238,066
------------------ ------------------
Balance, December 31, 2002 $ (78,222,192) $ 221,031,704
================== ==================
The accompanying notes are an integral part of the consolidated financial
statements
63
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 5,929,145 $ 5,113,905 $(11,300,556)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Provision for deferred taxes 1,990,042 3,850,740 (4,561,644)
Cumulative effect of accounting change (1,984,744) 980,571 (2,557,053)
Depreciation and amortization 1,420,806 1,197,073 1,891,592
(Gain) loss on sale of investments (4,209,632) 4,874,594 7,786,266
Gain on sale of interest in Semitropic (5,700,720)
Loss on condemnation of property 201,822
Allowance for uncollectible accounts 2,633,204 114,812
Equity in loss of unconsolidated affiliates 2,208,070 1,529,060 1,252,020
Minority interest (454,184) (358,449) (717,076)
Changes in assets and liabilities, net of effects of acquisitions:
Premiums and other receivables 1,572,574 (282,066) (637,942)
Land, water and mineral rights 9,425,589 4,922,434 (8,922,701)
Income taxes (324,837) 612,915
Reinsurance receivable (323,870) 2,205,782 8,836,099
Reinsurance payable (2,781,333) (928,187) (5,675,446)
Deferred policy acquisition costs 2,410,614
Deferred gain on retroactive insurance (438,879) (529,993) (267,653)
Unpaid losses and loss adjustment expenses (8,834,797) (22,845,944) (15,334,795)
Unearned premiums 27 (293,909) 258,616
Net operating cash provided by discontinued operations 8,499,963 1,077,534 12,887,132
Other adjustments, net (1,171,032) (3,223,606) (6,424,574)
------------ ------------ ------------
Net cash provided by (used in) operating activities 10,847,745 (5,900,992) (20,349,374)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of available for sale investments:
Fixed maturities 21,566,412 15,010,568 2,247,068
Equity securities 23,168,694 6,071,383 242,697
Proceeds from maturity of investments 48,646,426 16,970,000 9,400,000
Purchases of available for sale investments:
Fixed maturities (68,074,673) (28,912,393) (12,826,988)
Equity securities (15,106,827) (6,768,109) (8,300,403)
Semitropic lease payment (378,429) (378,429) (2,333,640)
Proceeds from the sale of interest in Semitropic 10,202,733
Proceeds from the condemnation of property 1,098,178
Purchases of property and equipment (457,109) (395,667) (786,617)
Investments in and advances to affiliates (1,390,851)
Net investing cash used by discontinued operations (10,622,501) (4,156,457) (14,152,173)
Other investing activities, net 116,803 273,000 (537,258)
------------ ------------ ------------
Net cash provided by (used in) investing activities (1,141,204) 9,014,807 (28,438,165)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of bank and other borrowings (4,177,517) (2,903,407) (329,968)
Proceeds from borrowings 2,670,348 1,949,321
Cash received on exercise of stock options 238,066
Cash paid to minority shareholders of partnership (500,000)
Proceeds from rights offering, net 49,843,163
Cash paid for purchase of PICO stock (for deferred compensation plans) (93,557) (299,000)
------------ ------------ ------------
Net cash provided by (used in) financing activities (1,362,660) (1,753,086) 49,513,195
------------ ------------ ------------
Effect of exchange rate changes on cash (2,607,173) 390,763 140,427
------------ ------------ ------------
Net increase in cash and cash equivalents 5,736,708 1,751,492 866,083
Cash and cash equivalents, beginning of year 16,342,374 14,590,882 13,724,799
------------ ------------ ------------
Cash and cash equivalents, end of year $ 22,079,082 $ 16,342,374 $ 14,590,882
============= ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 856,983 $ 880,000 $ 847,000
============= ============ ============
Income taxes recovered $ (1,190,000) $ (4,907,000)
============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
64
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES:
Organization and Operations:
PICO Holdings, Inc. and subsidiaries (collectively, "PICO" or "the
Company") is a diversified holding company.
Currently PICO's major activities are:
- owning and developing water rights & water storage operations through
Vidler Water Company, Inc.;
- owning and developing land and the related mineral rights and water
rights through Nevada Land & Resource Company, LLC;
- the acquisition and financing of businesses;
- "running off" the loss reserves of Citation Insurance Company and
Physicians Insurance Company of Ohio.
PICO was incorporated in 1981 and began operations in 1982. The company was
known as Citation Insurance Group until a reverse merger with Physicians
Insurance Company of Ohio ("Physicians") on November 20, 1996. Following the
reverse merger, the Company changed its name to PICO Holdings, Inc.
On December 16, 1998, PICO acquired the remaining 48.8% of the outstanding
stock of Global Equity Corporation ("Global Equity") through a Plan of
Arrangement (the "PICO/Global Equity Combination") whereby Global Equity
shareholders received 0.4628 of a newly issued PICO common share for each Global
Equity share surrendered. Immediately following the close of the transaction,
PICO effected a 1-for-5 reverse stock split (the "Reverse Stock Split").
The Company's primary subsidiaries as of December 31, 2002 are as follows:
Vidler Water Company, Inc. ("Vidler"). Vidler is a 96.2% owned Delaware
corporation. Vidler's business involves identifying end users, namely water
utilities, municipalities or developers, in the Southwest who require water, and
then locating a source and supplying the demand, either by utilizing the
company's own assets or securing other sources of supply. These assets comprise
water rights in the states of Colorado, Arizona, and Nevada, and water storage
facilities in Arizona and California.
Nevada Land & Resource Company, LLC ("Nevada Land"). Nevada Land is a
Delaware Limited Liability Company, which owns approximately 1.2 million acres
of land in northern Nevada. Nevada Land's business includes selling land and
water rights, and leasing property.
Sequoia Insurance Company ("Sequoia"). Sequoia is a California insurance
company licensed to write insurance coverage for property and casualty risks
("P&C") within the states of California and Nevada. Sequoia writes business
through independent agents and brokers. During 2002, PICO agreed to sell
Sequoia, and consequently has reported its results as discontinued operations in
the accompanying consolidated financial statements. Unless indicated otherwise,
information in these Notes to Consolidated Financial Statements exclude Sequoia.
Citation Insurance Company ("Citation"). Citation is a California-domiciled
insurance company licensed to write commercial property and casualty insurance
in Arizona, California, Colorado, Nevada, Hawaii, New Mexico and Utah. Citation
ceased writing premiums in December 2000, and is now "running off" the loss
reserves from its existing business.
Physicians Insurance Company of Ohio ("Physicians"). Prior to selling its
book of medical professional liability ("MPL") insurance business in 1995,
Physicians engaged in providing MPL insurance coverage to physicians and
surgeons, primarily in Ohio. On August 28, 1995, Physicians entered into an
agreement with Mutual Assurance, Inc. ("Mutual") pursuant to which Physicians
sold its recurring MPL insurance business to Mutual. Physicians is in "run off."
This means that it is handling claims arising from historical business, and
selling investments when funds are needed to pay claims.
65
SISCOM, Inc. ("SISCOM"). SISCOM is a Colorado corporation that is a
software developer and systems integrator for video-based content management
systems for the professional broadcast, sports, and entertainment industries.
Unconsolidated Affiliates:
Investments in which the Company owns at least 20% but not more than 50% of
the voting interest and, or has the ability to exercise significant influence
are generally accounted for under the equity method of accounting. Accordingly,
the Company's share of the income or loss of the affiliate is included in PICO's
consolidated results. Currently, the only significant investment the Company
classifies as an equity affiliate is HyperFeed Technologies, Inc. ("HyperFeed").
HyperFeed provides financial market data and data delivery solutions to the
financial services industry. PICO owns approximately 44% of the outstanding
voting stock of HyperFeed.
Principles of Consolidation:
The accompanying consolidated financial statements include the accounts of
the Company and its majority-owned and controlled subsidiaries, and have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("US GAAP"). All significant intercompany balances and
transactions have been eliminated.
Use of Estimates in Preparation of Financial Statements:
The preparation of financial statements in accordance with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities at the date of
the financial statements and the reported amounts of revenues and expenses for
each reporting period. The significant estimates made in the preparation of the
Company's consolidated financial statements relate to the assessment of the
carrying value of investments, unpaid losses and loss adjustment expenses,
deferred policy acquisition costs, land and water rights, deferred income taxes
and contingent liabilities. While management believes that the carrying value of
such assets and liabilities are appropriate as of December 31, 2002 and 2001, it
is reasonably possible that actual results could differ from the estimates upon
which the carrying values were based.
Revenue Recognition:
Sale of Land, Water and Water Rights
Revenue on the sale of land, water, and water rights is recognized in full
when (a) there is a legally binding sale contract; (b) the profit is
determinable (i.e., the collectibility of the sales price is reasonably assured,
or any amount that will not be collectible can be estimated); (c) the earnings
process is virtually complete (i.e., the Company is not obliged to perform
significant activities after the sale to earn the profit, meaning the Company
has transferred all risks and rewards to the buyer); and (d) the buyer's initial
and continuing investment are adequate to demonstrate a commitment to pay for
the property. If these conditions are not met, the Company records the cash
received as a deposit until the conditions to recognize full profit are met.
Investments:
The Company's investment portfolio at December 31, 2002 and 2001 is
comprised of investments with fixed maturities, including U.S. government bonds,
government sponsored enterprise bonds, and investment-grade corporate bonds;
equity securities, including common stock, and common stock purchase warrants;
and mortgage participation interests.
The Company applies the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The Company classifies all investments as available for
sale. Unrealized investment gains or losses on securities available for sale are
recorded directly to shareholders' equity as accumulated other comprehensive
income, or loss, net of applicable tax effects. The Company also applies the
provisions of Accounting Principles Board ("APB") Opinion No. 18, "The Equity
Method of Accounting for Investments in Common Stock," for investments where
management determines the Company has the ability to exercise significant
influence over the operating and financial policies of the investee. The
Company's share of the income or loss of the investee is included in the
consolidated statement of operations and any dividends are recorded as a
reduction in the carrying value of the investment.
66
The Company regularly and methodically reviews the carrying value of its
investments for impairment. When there is a decline in value of an investment to
below cost, that is deemed other-than-temporary, a loss is recorded within net
realized losses in the consolidated statement of operations and the security is
written down to its fair value. Impairment charges of $4.1 million, $3 million
and $161,000 are included in realized losses for the years ended December 31,
2002, 2001 and 2000, respectively related to various securities where the
unrealized losses had been deemed other-than-temporary. If a security is
impaired and continues to decline in value, additional impairment charges are
recorded in the period of the decline if deemed other-than-temporary. Subsequent
recoveries of such securities are reported as an unrealized gain and part of
other comprehensive results in future periods. Realized gains on impaired
securities are recorded only when sold. Included in 2001 and 2000 are impairment
charges of $500,000 and $2.5 million, respectively, related to loans where
recovery of the outstanding amounts due was deemed unlikely. (See Note 15)
Net investment income includes amortization of premium and accretion of
discount on the level yield method relating to bonds acquired at other than par
value. Realized investment gains and losses are included in income and are
determined on the specific identity basis and are recorded on a trade date
basis.
The Company has subsidiaries and makes acquisitions in the U.S. and abroad.
Approximately $41.1 million and $36.8 million of the Company's investments at
December 31, 2002 and 2001, respectively, were invested internationally,
including equity values of affiliates. The Company's most significant foreign
currency exposure at December 31, 2002 is in Swiss francs.
Cash and Cash Equivalents:
Cash and cash equivalents include highly liquid instruments purchased with
original maturities of three months or less.
Land, Water Rights, Water Storage and Land Improvements:
Land, water rights, water storage, and land improvements are carried at
cost. Water rights consist of various water interests acquired independently or
in conjunction with the acquisition of real properties. Water rights are stated
at cost and, when applicable, consist of an allocation of the original purchase
price between water rights and other assets acquired based on their relative
fair values. In addition, costs directly related to the acquisition and
development of water rights are capitalized. This cost includes, when
applicable, the allocation of the original purchase price, costs directly
related to acquisition, and interest and other costs directly related to
developing land and water rights for its intended use. Amortization of land
improvements is computed on the straight-line method over the estimated useful
lives of the improvements ranging from 5 to 15 years. Provision is made for any
diminution in value that is considered to be other-than-temporary.
Property and Equipment:
Property and equipment are carried at cost, net of accumulated
depreciation. Depreciation is computed on the straight-line method over the
estimated lives of the assets. Buildings and leasehold improvements are
depreciated over 15-20 years, office furniture and fixtures are generally
depreciated over seven years, and computer equipment is depreciated over 3
years. Maintenance and repairs are charged to expense as incurred, while
significant improvements are capitalized. Gains or losses on the sale of
property and equipment are included in other income.
Goodwill and Intangibles:
Goodwill represents the difference between the purchase price and the fair
value of the net assets (including tax attributes) of companies acquired in
purchase transactions. Intangibles are generally assets arising out of a
contractual or legal right. The Company applies the provisions of newly enacted
SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." Consequently, goodwill and intangible assets that have
indefinite useful lives will not be amortized but rather will be tested at least
annually, or on an interim basis if an event occurs or circumstances change that
would reduce the fair value of a reporting unit below its carrying value for
impairment. The adoption of SFAS No. 142 is reflected in Company's consolidated
financial statements as a cumulative effect of change in accounting principle.
The cumulative adjustment of $2 million is comprised of a gain from recognizing
negative goodwill of $2.8 million offset by write-off's of goodwill of $800,000.
The positive goodwill of $800,000 was deemed impaired based on the present value
of the underlying cash flows. Included within the caption "Other assets of
discontinued operations" is $2.2 million of intangible assets that are being
amortized over seven years.
67
Impairment of Long-Lived Assets:
The Company applies the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." As such, the Company records an
impairment charge when the condition exists where the carrying amount of a
long-lived asset (asset group) is not recoverable and exceeds its fair value.
Impairment of long-lived assets is triggered when the estimated future
undiscounted cash flows, excluding interest charges, for the lowest level for
which there are identifiable cash flows that are independent of the cash flows
of other groups of assets do not exceed the carrying amount. The Company
prepares and analyzes cash flows at appropriate levels of grouped assets under
SFAS No. 144. If the events or circumstances indicate that the remaining balance
may be permanently impaired, such potential impairment will be measured based
upon the difference between the carrying amount and the fair value of such
assets determined using the estimated future discounted cash flows, excluding
interest charges, generated from the use and ultimate disposition of the
respective long-lived asset.
Reinsurance:
The Company records all reinsurance assets and liabilities on the gross
basis, including amounts due from reinsurers and amounts paid to reinsurers
relating to the unexpired portion of reinsured contracts (prepaid reinsurance
premiums).
Unpaid Losses and Loss Adjustment Expenses:
Reserves for MPL and property and casualty insurance unpaid losses and loss
adjustment expenses include amounts determined on the basis of actuarial
estimates of ultimate claim settlements, which include estimates of individual
reported claims and estimates of incurred but not reported claims. The methods
of making such estimates and for establishing the resulting liabilities are
continually reviewed and updated based on current circumstances, and any
adjustments are reflected in current operations.
Income Taxes:
The Company's provision for income tax expense includes federal, state,
local and foreign income taxes currently payable and those deferred because of
temporary differences between the income tax and financial reporting bases of
the assets and liabilities. The liability method of accounting for income taxes
also requires the Company to reflect the effect of a tax rate change on
accumulated deferred income taxes in income in the period in which the change is
enacted.
In assessing the realization of deferred income taxes, management considers
whether it is more likely than not that any deferred income tax assets will be
realized. The ultimate realization of deferred income tax assets is dependent
upon the generation of future taxable income during the period in which
temporary differences become deductible. If future income does not occur as
expected, a deferred income tax valuation allowance may be established or
modified.
Earnings per Share:
Basic earnings per share are computed by dividing net earnings by the
weighted average shares outstanding during the period. Diluted earnings per
share are computed similar to basic earnings per share except the weighted
average shares outstanding are increased to include additional shares from the
assumed exercise of stock options and warrants using the treasury method, if
dilutive. The number of additional shares is calculated by assuming that the
outstanding options and warrants were exercised, and that the proceeds were used
to acquire shares of common stock at the average market price during the period.
For the year ended December 31, 2000, earnings per share for basic and
diluted is the same as the calculation of diluted earnings per share excludes
the options and warrants outstanding during the year because the Company
reported a loss from continuing operations and consequently the impact of those
options and warrants would be anti-dilutive. For the years ended December 31,
2002 and 2001, there was no difference between basic and diluted earnings per
share because the average stock price of PICO stock during the year was less
than the strike prices of the options outstanding and to include those options
would be anti-dilutive to the calculation. Stock options of 1.7 million in 2002,
1.8 million in 2001, 1.1 million in 2000 were excluded from the calculation of
the diluted weighted average shares outstanding.
68
Stock-Based Compensation:
In December 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and
Disclosure". SFAS No. 148 provides alternative methods of transition for those
entities that elect to voluntarily adopt the fair value accounting provision of
SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 also
requires more prominent disclosures of the pro forma effect of using the fair
value method of accounting for stock based employee compensation as well as pro
forma disclosure of the effect in interim financial statements. The transition
and annual disclosure provision of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure requirements are
effective for the first interim period ending after December 15, 2002. PICO has
not elected to adopt the fair value accounting provisions of SFAS No. 123, but
rather has elected to continue accounting for stock based compensation under the
intrinsic value method of APB No. 25, "Accounting for Stock Issued to
Employees."
Had compensation cost for the Company's stock-based compensation plans been
determined consistent with SFAS No. 148, the Company's net loss and net loss per
share would approximate the following pro forma amounts for the years ended
December 31:
2002 2001 2000
--------------- ----------------- ----------------
Reported net income (loss) $ 5,929,145 $ 5,113,905 $ (11,300,556)
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of income tax (445,555) (711,521) (2,616,496)
--------------- ----------------- ----------------
Pro forma net income (loss) $ 5,483,590 $ 4,402,384 $ (13,917,052)
=============== ================= ================
Reported net income (loss) per share: basic and diluted $ 0.48 $ 0.41 $ (0.97)
=============== ================= ================
Pro forma net income (loss) per share: basic and diluted $ 0.44 $ 0.36 $ (1.20)
=============== ================= ================
The effects of applying SFAS No. 148 in this pro forma disclosure are not
indicative of future amounts.
Comprehensive Income (Loss):
Comprehensive income or loss includes foreign currency translation, and
unrealized holding gains and losses, net of taxes on available for sale
securities. The components are as follows:
December 31,
2002 2001
----------- ------------
Net unrealized gain on securities $ 9,999,442 $ 5,545,057
Foreign currency translation (6,165,766) (8,770,924)
----------- ------------
Accumulated other comprehensive income (loss) $ 3,833,676 $ (3,225,867)
=========== ============
The accumulated balance is net of deferred income tax liabilities of $3.5
million and $1.5 million at December 31, 2002 and 2001, respectively.
Translation of Foreign Currency:
Financial statements of foreign operations are translated into U.S. dollars
using average rates of exchange in effect during the year for revenues,
expenses, gains and losses, and the exchange rate in effect at the balance sheet
date for assets and liabilities. Unrealized exchange gains and losses arising on
translation are reflected within accumulated other comprehensive income or loss.
Reclassifications:
Certain amounts in the financial statements for prior periods have been
reclassified to conform to the current year presentation.
69
Recent Accounting Pronouncements:
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN 45 requires that a liability
be recorded in the guarantor's balance sheet upon issuance of a guarantee at its
fair value. In addition, FIN 45 requires certain disclosures about each of the
entity's guarantees. The Company will apply the recognition provisions of FIN 45
prospectively to guarantees issued after December 31, 2002. The disclosure
provisions of FIN 45 are included herein.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation, Transition and Disclosure". SFAS No. 148 provides alternative
methods of transaction for those entities that elect to voluntarily adopt the
fair value accounting provisions of SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 148 also requires more prominent disclosures of the pro
forma effect of using the fair value method of accounting for stock-based
employee compensation as well as pro forma disclosure of the effect in interim
financial statements. The transition and annual disclosure provisions of SFAS
No. 148 included herein. The interim disclosure requirements are effective for
the first interim period ending December 15, 2002. The Company has not elected
to adopt the fair value accounting provisions of SFAS No. 123.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51".
FIN 46 requires the consolidation of certain variable interest entities by the
primary beneficiary of the entity if the equity investment at risk is not
sufficient to permit the entity to finance its activities without additional
subordinated financial support from other parties or if the equity investors
lack the characteristics of a controlling financial interest. FIN 46 is
effective for variable interest entities created or acquired after January 31,
2003. For variable interest entities created or acquired prior to February 1,
2003, the provisions of FIN 46 must be applied in the first interim or annual
period beginning after June 15, 2003. The Company has no significant interest in
variable interest entities and believes the effect of the adoption of FIN 46
will not be material to its results of operations and financial position.
2. DISCONTINUED OPERATIONS/DISPOSITIONS:
DISCONTINUED OPERATIONS:
On October 21, 2002, PICO signed a definitive agreement to sell Sequoia
Insurance Company. It is anticipated that the sale will close on or around March
31, 2003. The sale is conditional on the approval of the California Department
of Insurance, which was received on March 17, 2003, and other customary closing
conditions. The final sale price will be determined after the closing, with a
base price of $40 million, which is subject to adjustment based on movement in
either US GAAP shareholders' equity or statutory surplus between June 30, 2002
and the date of closing. Consequently, in accordance with SFAS No. 144,
Sequoia's results of operations for all periods presented have been reclassified
as discontinued operations in the accompanying consolidated financial
statements. Certain major assets and liabilities of Sequoia are grouped and
presented on the face of the accompanying consolidated balance sheets as assets
and liabilities of discontinued operations, and results of operations from
discontinued operations are shown on the face of the statement of operations as
a single line. The following is a detail of Sequoia's results for the period
included in the accompanying consolidated financial statements:
70
BALANCE SHEETS AT DECEMBER 31:
2002 2001
----------------- -----------------
Cash $ 838,851 $ 1,019,250
Investments 78,442,627 63,993,830
Premium receivables 13,973,024 11,031,053
Reinsurance receivables 26,485,523 16,274,268
Deferred policy acquisition costs 8,615,621 6,913,589
Intangible assets 2,182,777 2,679,561
Other assets 42,602 1,765,240
----------------- -----------------
Total assets 130,581,025 103,676,791
Unpaid loss and loss adjustment expense 49,162,995 36,911,143
Unearned Premiums revenues 35,687,057 28,143,269
Accrued Expenses and other liabilities 8,398,919 5,356,290
----------------- -----------------
Total liabilities 93,248,971 70,410,702
----------------- -----------------
Carrying value $ 37,332,054 $ 33,266,089
================= =================
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31:
2002 2001 2000
---------------- ---------------- ----------------
Revenues:
Premium income $47,102,301 $ 42,309,724 $ 32,740,560
Net investment income and realized gains/losses 5,096,002 5,187,166 2,867,853
Other income 241,195 416,841 527,206
---------------- ---------------- ----------------
Total Revenues 52,439,498 47,913,731 36,135,619
Expenses:
Loss and loss adjustment expenses 31,175,373 29,231,602 22,145,457
Policy acquisition costs 15,048,726 13,047,108 10,106,968
Insurance underwriting and other expenses 1,636,727 2,320,563 2,545,198
---------------- ---------------- ----------------
Total expenses 47,860,826 44,599,273 34,797,623
---------------- ---------------- ----------------
Income before income taxes and cumulative effect 4,578,672 3,314,458 1,337,996
Provision for income taxes 1,545,761 996,963 385,468
Cumulative effect of change in
accounting principle, net (199,105)
---------------- ---------------- ----------------
Net income $ 2,833,806 $ 2,317,495 $ 952,528
================ ================ ================
Income per common share - basic and diluted $ 0.23 $ 0.19 $ 0.08
================ ================ ================
On September 8, 2000, the Company sold its investment in Conex for nominal
consideration, and recorded a pretax loss on the sale of $4.6 million ($1.8
million after tax). The reported results in 2000 include Conex as a consolidated
subsidiary until September 8, 2000. Conex's primary asset was a 60% joint
venture that manufactures wheeled and tracked excavators in the People's
Republic of China.
Conex accounted for its 60% interest in the sino-foreign joint venture
using the equity method of accounting due the fact that it did not have majority
financial control over the policies and procedures of the joint venture. The
functional currency for
71
joint venture is the Chinese Renminbi.
The following is the results of operations of Conex for the period in 2000
prior to its disposition:
2000
-----------
Expenses $ 1,393,721
Equity in losses of
unconsolidated affiliates 889,627
-----------
Loss from operations 2,283,348
Minority interest (168,988)
-----------
Net loss $ 2,114,360
===========
3. INVESTMENTS:
At December 31, the cost and carrying value of investments held by
continuing operations were as follows:
Gross Gross
Unrealized Unrealized Carrying
2002: Cost Gains Losses Value
----------------- --------------- ----------------- -----------------
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government - sponsored enterprises $ 7,157,734 $ 486,594 $ 7,644,328
Corporate securities 34,427,283 822,153 35,249,436
Mortgage participation interests 4,673,000 4,673,000
------------ ----------- ---------- ------------
46,258,017 1,308,747 47,566,764
Equity securities 40,782,699 6,813,729 (166,236) 47,430,192
Investment in unconsolidated affiliates 498,214 498,214
------------ ----------- ---------- ------------
Total $ 87,538,930 $ 8,122,476 $ (166,236) $ 95,495,170
============ =========== ========== ============
Gross Gross
Unrealized Unrealized Carrying
2001: Cost Gains Losses Value
------------------ ---------------- ------------------ -----------------
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government - sponsored enterprises $ 8,985,011 $ 261,236 $ (90,457) $ 9,155,790
Corporate securities 34,670,812 894,550 (614,004) 34,951,358
Mortgage participation interests 4,673,000 4,673,000
------------------ ---------------- ------------------ -----------------
48,328,823 1,155,786 (704,461) 48,780,148
Equity securities 38,447,389 4,986,281 (947,862) 42,485,808
Investment in unconsolidated affiliates 2,583,590 2,583,590
------------------ ---------------- ------------------ -----------------
Total $ 89,359,802 $ 6,142,067 $ (1,652,323) $ 93,849,546
================== ================ ================== =================
72
The amortized cost and carrying value of investments in fixed maturities at
December 31, 2002, by contractual maturity, are shown below. Expected maturity
dates may differ from contractual maturity dates because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
Amortized Carrying
Cost Value
------------------- -------------------
Due in one year or less $ 16,794,655 $ 16,826,277
Due after one year through five years 14,027,346 15,075,098
Due after five years 10,763,016 10,992,389
Mortgage participation interests 4,673,000 4,673,000
------------------- -------------------
$ 46,258,017 $ 47,566,764
=================== ===================
Investment income is summarized as follows for each of the years ended
December 31:
2002 2001 2000
---------------- --------------- ---------------
Investment income:
Fixed maturities $ 3,060,988 $ 2,877,173 $ 3,512,818
Equity securities 1,143,870 1,461,990 136,114
Other 1,201,470 1,728,894 2,571,991
---------------- --------------- ---------------
Total investment income 5,406,328 6,068,057 6,220,923
Investment expenses: (21,119) (32,232) (128,552)
---------------- --------------- ---------------
Net investment income $ 5,385,209 $ 6,035,825 $ 6,092,371
================ =============== ===============
Pre-tax net realized gain or loss on investments is as follows for each of
the years ended December 31:
2002 2001 2000
----------- ----------- -----------
Gross realized gains:
Fixed maturities $ 383,576 $ 406,554 $ 73,161
Equity securities and other investments 8,842,416 729,084
----------- ----------- -----------
Total gain 9,225,992 1,135,638 73,161
----------- ----------- -----------
Gross realized losses:
Fixed maturities (320,949) (83,949)
Equity securities and other investments (4,695,411) (5,926,283) (7,859,427)
----------- ----------- -----------
Total loss (5,016,360) (6,010,232) (7,859,427)
----------- ----------- -----------
Net realized gain (loss) $ 4,209,632 $(4,874,594) $(7,786,266)
=========== =========== ===========
73
During 2002, 2001 and 2000, the Company recorded other-than-temporary
impairments of $4.1 million, $3 million, and $161,000, respectively, on
equity securities to recognize what is expected to be other-than-temporary
declines in value primarily due to the extent and duration of the decline
in market values of the equity securities. In addition, in 2001 and 2000,
the Company recorded losses on loans of $500,000 and $2.5 million,
respectively, to recognize other-than-temporary declines in the value of
loans.
During 2002, the Company sold its interest in Australian Oil and Gas
("AOG") for a realized gain of $8.8 million in response to a take over bid.
The sale proceeds of $21.1 million were received in cash. At December 31,
2001, the Company owned 9,867,391 shares valued at a total market price of
$7.5 million. During 2001, the Company purchased 1,026,732 shares of AOG
for $941,000 and received 414,615 shares as a dividend valued at $333,000.
Accu Holding:
During the fourth quarter of 2000, the Company increased its voting
ownership in Accu Holding AG, a Swiss corporation, to 28.3%. PICO lacks the
ability to exercise significant influence based on consideration of a
number of factors and therefore accounts for the holding using SFAS No.
115. Our original investment in Accu Holding had a cost basis of $5.5
million and a market value of $3.1 million. Given the recent deterioration
in Accu's core business, and the Company's assessment that there would
continue to be downward pressure on Accu's stock price in the short to
medium term, during 2002 the Company concluded that the decline in Accu's
market value was other-than-temporary, and recorded a $2.2 million pre-tax
impairment loss. This was recorded as a realized loss and has reduced the
cost basis of the investment to its market value of $3.1 million at
December 31, 2002.
SIHL:
In 2001, the Company recorded a pre-tax provision of $2.1 million for
an other-than-temporary decline in the market value of this security.
During 2002, the stock continued to decline which, combined with an
announcement from SIHL that a total sale of the company for more than the
current market value of the stock was unlikely, caused the Company to
record an additional $1.6 million pre-tax impairment for an
other-than-temporary decline. The charge reduced our basis in SIHL to
$768,000, which is equivalent to market value at December 31, 2002.
Jungfraubahn:
The Company owns 130,177 shares of Jungfraubahn, which represents
approximately 22.3% of the outstanding shares of Jungfraubahn. At December
31, 2002, the market value of the investment was $24 million and had an
unrealized gain of $2.4 million, net of tax. During 2002, the Company
acquired 17,505 shares for approximately $2.8 million, and became the
largest shareholder in Jungfraubahn. Despite the increase in our
shareholding to more than 20%, the Company continues to account for this
investment under SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." At this time, the Company does not believe that it
has the requisite ability to exercise "significant influence" over the
financial and operating policies of Jungfraubahn, and therefore do not
apply the equity method of accounting.
4. INVESTMENTS IN UNCONSOLIDATED AFFILIATES:
HyperFeed Technologies, Inc.:
At December 31, 2002, the Company's investment in HyperFeed consisted
of 11,026,888 shares of common stock, representing 44% of the common shares
outstanding; and 3,106,163 common stock warrants which on a diluted basis
would represent an additional 6% voting interest if exercised. During 2002,
PICO exercised 949,032 common stock warrants in HyperFeed for $305,000. The
common stock is recorded using the equity method of accounting. At December
31, 2002, the carrying value of the investment in common stock was $498,000
after recording losses of $2 million before tax and the common stock
warrants are valued at an estimated fair value of $65,000, using the
Black-Scholes option-pricing model. The warrants are reported as a
derivative instrument under the provisions of SFAS No. 133 and consequently
gains and losses for each period are reflected in the caption "Net Realized
Loss on Investments" in the Statement of Operations. The difference between
the carrying value of the investment and the underlying equity in the net
assets or liabilities of HyperFeed is
74
considered goodwill, which is no longer being amortized beginning
January 1, 2002. For the year ended December 31, 2002, no goodwill was
amortized given the provisions of SFAS No. 142.
The Black-Scholes pricing model incorporates assumptions in
calculating an estimated fair value. The following assumptions were used
in the computations: no dividend yield for all years; a risk-free
interest rate of 1% - 2.5%; a one year expected life; and a historical 5
year cumulative volatility of 109% to 126%.
At December 31, 2001, the Company's investment in HyperFeed
consisted of 10,077,856 shares of common stock, representing 42.4% of
the common shares outstanding; and 4,055,195 common stock warrants which
on a diluted basis would represent an additional 14.5% voting interest
if exercised. The common stock is recorded using the equity method of
accounting and has a carrying value of $2.1 million at December 31,
2001. The difference between the carrying value of the investment and
the underlying equity in the net assets or liabilities of HyperFeed is
considered goodwill and was being amortized over 10 years on a
straight-line basis. At December 31, 2001, the common stock warrants
were valued at an estimated fair value of $527,000, prior to a $1.2
million deferred tax asset, using the Black-Scholes option-pricing
model. The warrants are reported as a derivative instrument under the
provisions of SFAS 133 and consequently the loss for the 2001 year is
reflected in the caption "Net Realized Loss on Investments" in the
Statement of Operations. The cumulative change in fair value from the
date of acquisition to January 1, 2001 was a decline of $1.3 million and
is recorded net of a deferred tax benefit on the Statement of
Operations.
During the three years ended December 31, 2002, HyperFeed recorded
various capital transactions that affected PICO's voting ownership
percentage. During 2002, our voting percentage declined slightly due to
the issue of new shares for option exercises, and increased by
approximately 2% upon PICO's exercise of 949,032 common stock purchase
warrants. In 2001, HyperFeed issued 491,000 shares of common stock
related to an acquisition which resulted in a dilution gain of $352,000
to PICO. In 2000, HyperFeed issued 164,000 shares of common stock
related to conversion of stock options, which resulted in a dilution
gain to PICO of approximately $208,000. Deferred taxes are provided on
each dilution transaction. These transactions diluted PICO's ownership
percentage approximately 1% to 35% at June of 2001 and through the
conversion of preferred shares and exercise of warrants, PICO increased
its voting ownership to 42.4% by the end of December 31, 2001, and to
44% at December 31, 2002.
In 2001, the Company converted its HyperFeed Series A voting
convertible preferred shares, and its Series B voting convertible
preferred shares into 7,462,856 newly issued common shares. After the
conversion, PICO owned 42.4% of the outstanding voting interest.
The market value of the common shares at December 31, 2002 and 2001
based on the closing price of HyperFeed common stock is $3.3 million,
and $6.1 million, respectively.
5. LAND AND RELATED MINERAL RIGHTS AND WATER RIGHTS:
Through its subsidiary Nevada Land, the Company owns land and the
related mineral rights and water rights. Through its subsidiary Vidler, the
Company owns water rights and water storage assets consisting of various real
properties in California, Arizona, Colorado and Nevada. The costs assigned to
the various components at December 31, were as follows:
2002 2001
------------ ------------
Nevada Land:
Land and related mineral rights and
water rights $ 43,973,852 $ 45,249,039
------------ ------------
Vidler:
Water and water rights 20,339,440 24,530,412
Land 43,685,803 46,803,276
California water storage 1,483,238 1,206,737
Land improvements, net 7,308,558 8,208,178
------------ ------------
72,817,039 80,748,603
------------ ------------
$116,790,891 $125,997,642
============ ============
75
At December 31, 2002 and 2001, the book value of Vidler's interest in
the Semitropic Water Storage facility was $1.5 million and $1.2 million,
respectively. Through November 2008, Vidler is required to make a minimum
annual payment. These 11 payments are being capitalized and the asset is
being amortized over its useful life of thirty-five years. In 2001, Vidler
sold approximately 84% of its right, title and interest under the lease for
a gain of $5.7 million As a result, at December 31, 2002 and 2001, Vidler
owns the right to store 30,000 acre-feet of water and is required to make a
minimum annual payment of $373,000. The amortization expense in 2002 and
2001 was $102,000 and $438,000, respectively. In addition, Vidler is
required to pay annual operating and maintenance charges and for the years
ended December 31, 2002, 2001 and 2000, the Company expensed a total of
$152,400, $146,000, and $889,000, respectively.
6. PREMIUMS AND OTHER RECEIVABLES:
Premiums and other receivables consisted of the following at
December 31:
2002 2001
----------- -----------
Finance receivables 4,480,001 5,961,567
Trade receivables 51,835 49,288
Other accounts receivable 3,441,602 3,535,157
----------- -----------
7,973,438 9,546,012
Allowance for doubtful accounts (2,500,604) (2,500,604)
----------- -----------
$ 5,472,834 $ 7,045,408
=========== ===========
Finance receivables are primarily from the sale of land and at December
31, 2002, have a weighted average interest rate of 8.75% and a weighted
average life to maturity of approximately 7 years.
Other accounts receivable include $2.3 million due from Dominion Capital
Pty. Ltd ("Dominion"), which is affiliated with the Company through a mutual
ownership in Solpower Corporation. During 2001, an allowance for the total
outstanding balance owed by Dominion of $2.3 million was recorded due to the
uncertainty surrounding the recovery of the balance.
7. FEDERAL, FOREIGN AND STATE INCOME TAX:
The Company and its U.S. subsidiaries file a consolidated federal income
tax return. Non-U.S. subsidiaries file tax returns in various foreign
countries. Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and
liabilities are as follows at December 31:
76
2002 2001
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 10,042,312 $ 11,798,883
Capital loss carryforwards 2,947,945
Loss reserves 5,707,325 6,198,519
Unrealized depreciation on securities 1,595,524
Deferred gain on retroactive reinsurance 149,219
Equity in unconsolidated affiliates 2,201,760 1,392,552
Write down of securities 1,500,266 3,809,825
Deferred loss on SFAS No. 133 939,807 505,144
Other, net 4,153,696 1,625,796
------------ ------------
Total deferred tax assets 24,545,166 30,023,407
------------ ------------
Deferred tax liabilities:
Discounting of reserves 2,823,237 2,823,237
Unrealized appreciation on securities 2,068,933 308,705
Revaluation of surface, water and mineral rights 11,737,924 12,991,330
Land sales 1,065,315 1,065,315
Accretion of bond discount 81,886 76,825
Capitalized lease 279,313 279,313
------------ ------------
Total deferred tax liabilities 18,056,608 17,544,725
------------ ------------
Net deferred tax assets before
valuation allowance 6,488,558 12,478,682
Less valuation allowance (408,748) (3,389,620)
------------ ------------
Net deferred tax asset $ 6,079,810 $ 9,089,062
============ ============
The deferred tax asset valuation allowance as of December 31, 2001
related primarily to the net operating loss carryforwards (NOL's) of Global
Equity, a Canadian company. Global Equity is subject to rules that limit the
ability to utilize their NOL's. Due to these limitations and the uncertainty
of future taxable income, these NOL's were written off against the existing
valuation allowance in 2002. Deferred tax assets and liabilities, the
recorded valuation allowance, and federal income tax expense in future years
can be significantly affected by changes in circumstances that would
influence management's conclusions as to the ultimate realization of deferred
tax assets.
The State of California has completed income tax audits on the
Company's consolidated tax returns for tax years ended December 31, 1997 and
1998. As part of these audits the California Franchise Tax Board ("FTB") is
challenging, among other things, the Company's ability to deduct dividends
received from PICO's non-California insurance company. Based partly on the
recent California Court of Appeal decision in Ceridian vs. Franchise Tax
Board, the FTB is challenging the Company's ability to exclude intercompany
dividends from income tax. The Company has formally appealed the proposed
assessments and is currently awaiting a hearing before the California State
Board of Equalization ("SBE").
Although the ultimate outcome of these audits is uncertain, management
believes the Company is adequately reserved in the event the additional state
income taxes assessments are upheld.
Pre-tax income (loss) from continuing operations for the years ended
December 31 was under the following jurisdictions:
2002 2001 2000
------------ ------------ ------------
Domestic $ 6,639,696 $ 9,193,763 $(12,467,862)
Foreign (3,933,720) (3,365,730) (4,935,297)
------------ ------------ ------------
Total $ 2,705,976 $ 5,828,033 $(17,403,159)
============ ============ ============
77
Income tax expense (benefit) from continuing operations for each of the
years ended December 31 consists of the following:
2002 2001 2000
----------- ----------- -----------
Current tax expense (benefit):
U.S. federal $ 2,471,607 $ (826,850) $ (184,053)
Foreign (2,412,084) (614,389) (4,650,993)
----------- ----------- -----------
Total current tax expense (benefit) 59,523 (1,441,239) (4,835,046)
----------- ----------- -----------
Deferred tax expense (benefit):
U.S. federal $ 5,334,617 $ 4,179,761 $(4,427,326)
Foreign (3,344,575) (329,021) (134,318)
----------- ----------- -----------
Total deferred tax expense (benefit) 1,990,042 3,850,740 (4,561,644)
----------- ----------- -----------
Total income tax expense (benefit) $ 2,049,565 $ 2,409,501 $(9,396,690)
=========== =========== ===========
The difference between income taxes provided at the Company's federal statutory
rate and effective tax rate is as follows:
2002 2001 2000
---------------- ---------------- -----------------
Federal income tax provision (benefit) at statutory rate $ 920,032 $ 1,981,531 $ (5,917,074)
Book tax difference on sale of securities (1,247,596)
Settlement of tax appeal (495,976) (4,398,731)
Change in valuation allowance (2,980,872) (367,434) 3,285,416
Write off of NOL's previously valued and other deferred items 2,264,119
Amortization of goodwill (63,165) 208,268
Non-deductible capital loss (166,750)
Investment valuation (971,105)
Foreign rate differences 854,064
Permanent differences 992,222 1,354,545 (189,118)
---------------- ---------------- -----------------
Total $ 2,049,565 $ 2,409,501 $ (9,396,690)
================ ================ =================
78
Provision has not been made for U.S. or additional foreign tax on the
$2.5 million of undistributed earnings of foreign subsidiaries. It is not
practical to estimate the amount of additional tax that might be payable.
Rate differences of $854,000 at December 31, 2002 reflect foreign losses tax
effected at the local statutory rate, which is typically as much as 20%
lower than the US statutory rate of 34%. At December 31, 2002 and 2001, the
Company had no federal income tax payable or receivable; however, at
December 31, 2002, the Company had a state tax payable of $400,000. As of
December 31, 2002, the Company has net operating loss carryforwards of $29
million. The Company has consolidated NOL's that expire as follows:
EXP DATE NOL
-------- ---
12/31/2009 5,096,217
12/20/2011 624,195
12/31/2017 863,947
12/31/2018 5,068,173
12/31/2019 5,517,521
12/31/2020 10,774,089
6/30/2021 1,013,710
----------------
TOTAL 28,957,852
----------------
8. PROPERTY AND EQUIPMENT:
The major classifications of the Company's fixed assets are as follows
at December 31:
2002 2001
----------- -----------
Office furniture, fixtures and equipment $ 3,555,103 $ 3,856,210
Building and leasehold improvements 1,333,025 1,135,071
----------- -----------
4,888,128 4,991,281
Accumulated depreciation (2,744,382) (2,805,863)
----------- -----------
Property and equipment, net $ 2,143,746 $ 2,185,418
=========== ===========
Depreciation expense was $456,000, $598,000, and $617,000 in 2002, 2001,
and 2000, respectively.
9. SHAREHOLDERS' EQUITY:
At the Annual Meeting of Shareholders on October 19, 2000, shareholders
voted to amend the Articles of Incorporation to eliminate the Company's
preferred shares. This amendment became effective January 16, 2001.
On February 9, 2000, PICO registered on Form S-3 with the U. S.
Securities and Exchange Commission to offer 6,546,497 shares of PICO stock
at a price of $15 per share through a rights offering. Shareholders were
offered 1 right to buy 1 new share at $15 for every 2 common shares held at
March 1, 2000.
In March 2000, an investment partnership registered as PICO Equity
Investors, L.P. acquired 3,333,333 shares of PICO stock for approximately
$50 million. PICO Equity Investors, an entity managed by PICO Equity
Investors Management, LLC, which is owned by three of PICO's current
directors (including PICO's chairman of the board and PICO's president and
chief executive officer), will exercise all voting and investment decisions
with respect to these shares for up to 10 years. There is no monetary
compensation for the management of either partnership. PICO used the $49.8
million net proceeds to develop existing water and water storage assets,
acquire additional water assets, acquire investments, and for general
working capital needs.
79
Stock Option Plans
PICO Holdings 1995 Non-Qualified Stock Option Plan. PICO was authorized
to issue 521,030 shares of common stock pursuant to awards granting
non-qualified stock options to full-time employees (including officers) and
directors. The options granted to employees vested at a rate of 33% upon
grant and 33% per year on each of the first two anniversaries of the date of
grant. A total of 512,005 options have been issued from this plan and at
December 31, 2002 452,896 are outstanding. The Company granted stock options
in 1996 and 1995 under this plan in the form of non-qualified stock options.
All issued options from this plan are fully vested.
PICO Holdings 1998 Stock Option Agreement. PICO was authorized to issue
100,000 shares of common stock pursuant to awards granted in various forms,
including incentive stock options (intended to qualify under Section 422 of
the Internal Revenue Code of 1986, as amended), non-qualified stock options,
and other similar stock-based awards. In October 1998, PICO granted 100,000
non-qualified common stock options to an officer of the Company at an
exercise price of $15.625 per share. These options were cancelled during
2001.
PICO Holdings 1998 Global Equity/PICO Stock Option Plan. In December
1998, PICO assumed 484,967 options to existing Global Equity option holders
pursuant to the acquisition of the remaining shares of Global Equity by
exchanging PICO options for Global Equity options. The options granted from
this plan placed the participants in an economically equivalent position
regarding the number of shares, exercise price, and with vesting according
to their original terms. The options expired at December 31, 2002.
PICO Holdings 1999 Stock Option Agreement. PICO is authorized to issue
10,665 shares of common stock pursuant to awards granted as non-qualified
stock options and other similar stock-based awards. In January 1999, PICO
granted 10,665 non-qualified common stock options to an officer of the
Company at an exercise price of $13.25 per share. The options were
immediately vested and expire in 10 years.
PICO Holdings 2000 Non-Statutory Stock Option Plan. PICO is authorized
to issue 1,200,000 shares of common stock to employees and non-employee
directors of and consultants to the Company, pursuant to awards granted as
non-qualified stock options. In April 2000, PICO granted, subject to
approval by the Company's shareholders obtained in October 2000, 1,091,223
non-qualified common stock options to employees and non-employee directors
of the Company (1,082,223 to employees and 9,000 to directors) at an
exercise price of $15 per share. All options in this plan are fully vested
at December 31, 2002.
In July 2001, PICO granted 100,000 non-statutory stock options to an
employee at an exercise price of $15 per share. All options in this plan are
fully vested at December 31, 2002. They expire in July 2021.
In August 2001, PICO granted 8,777 non-statutory stock options to an
employee at an exercise price of $15 per share. A total of 2,925 of these
stock options vested in August 2001, 2,926 stock options vested in August
2002, and 2,926 stock options will vest on August 2, 2003. All options in
this plan will expire in August 2021.
PICO Holdings 2001 Stock Option Agreements. PICO is authorized to issue
46,223 shares of common stock pursuant to awards granted in individual
non-qualified stock option agreements. In August 2001, PICO granted the
total to three employees of the Company. The exercise price for these
non-statutory stock options is $15 per share. One-third of these stock
options vested in August 2001, one-third vested in August 2002, and the
remaining will vest in August 2003. All of these non-statutory stock options
expire in August 2021.
80
A summary of the status of the Company's stock options is presented
below for the years ended December 31:
2002 2001 2000
------------------------- ---------------------------- ------------------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Underlying Exercise Underlying Exercise Underlying Exercise
Options Prices Options Prices Options Prices
------------- ---------- ---------------- ---------- ---------------- ------------
Outstanding at beginning of year 1,780,720 $14.60 1,834,599 $ 14.93 1,046,575 $ 15.83
Granted 155,000 15.00 1,091,223 15.00
Exercised (17,700) 13.45
Canceled - expired (75,778) 15.62 (208,879) 17.72 (303,199) 18.31
------------ --------------- ---------------
Outstanding at end of year 1,687,242 14.57 1,780,720 14.60 1,834,599 14.93
Exercisable at end of year 1,668,909 14.57 1,349,312 14.48 1,113,117 14.88
Weighted-average fair value
of options granted during
the year $ 8.52 $ 7.15
========== ============
The following table summarizes information about stock options
outstanding at December 31, 2002:
Options Outstanding Options Exercisable
- -------------------------------------------------------------- ---------------------------
Weighted
Average Weighted
Number Remaining Average Number Weighted
Range of Outstanding Contractual Exercise Exercisable Average
Exercise Prices at 12/31/02 Life Price at 12/31/02 Exercise Price
- -------------------- ------------- ----------- ----------- ------------- ------------
$13.25 to $14.40 466,561 2.72 $13.45 463,561 $13.45
$15.00 1,220,681 17.37 $15.00 1,205,348 $15.00
------------- -------------
$13.25 to $15.00 1,687,242 13.35 $14.57 1,668,909 $14.57
============= =============
The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions for grants in each year: no dividend yield;
risk-free interest rates are different for each grant, and range from 4.9%
to 6.97%; expected lives of options are estimated at 10 years for 2001 and
2000; and volatility of 42% for the 2001 grants and 51% for the 2000 grants.
No options were granted in 2002.
10. REINSURANCE:
In the normal course of business, the Company's insurance subsidiaries
have entered into various reinsurance contracts with unrelated reinsurers.
The Company's insurance subsidiaries participate in such agreements for the
purpose of limiting their loss exposure and diversifying their risk.
Reinsurance contracts do not relieve the Company's insurance subsidiaries
from their obligations to policyholders. All reinsurance assets and
liabilities are shown on a gross basis in the accompanying consolidated
financial statements. Amounts recoverable from reinsurers are estimated in a
manner consistent with the claim liability associated with the reinsured
policy. Such amounts are included in "reinsurance receivables" in the
consolidated balance sheets at December 31 is as follows:
2002 2001
---------- ----------
Estimated reinsurance recoverable on:
Unpaid losses and loss adjustment expense $7,780,432 $7,474,854
Reinsurance recoverable on paid losses and loss expenses 52,276 33,984
---------- ----------
Reinsurance receivables $7,832,708 $7,508,838
========== ==========
Unsecured reinsurance risk is concentrated in the companies shown in the
table below. The Company remains contingently liable with respect to
reinsurance contracts in the event that reinsurers are unable to meet their
obligations under the reinsurance agreements in force.
81
CONCENTRATION OF REINSURANCE AT DECEMBER 31, 2002
Reported Unreported Reinsurer
Claims Claims Balances
--------------- --------------- ---------------
TIG Reinsurance Group $ 312,612 $ (3,630) $ 308,982
Mutual Assurance, Inc. 4,492,471 1,299,904 5,792,375
General Reinsurance 853,029 853,029
National Reinsurance Corporation 428,532 428,532
North Star Reinsurance Corp. 185,722 185,722
Swiss American Reinsurance Corporation 185,722 185,722
--------------- --------------- ---------------
$ 6,458,088 $ 1,296,274 $ 7,754,362
=============== =============== ===============
The Company entered into a reinsurance treaty in 1995 with Mutual
Assurance Inc. ("Mutual") in connection with the sale of Physicians' MPL
business to Mutual. This treaty is a 100% quota share treaty covering all
claims arising from policies issued or renewed with an effective date after
July 15, 1995. At the same time, Physicians terminated two treaties entered
into in 1994 and renewed in 1995. The first of these was a claims-made
agreement under which Physicians' retention was $200,000, for both
occurrence and claims-made insurance policies. Claims are covered up to $1
million. The second treaty reinsured claims above $1 million up to policy
limits of $5 million on a true occurrence and claims-made basis, depending
on the underlying insurance policy.
In 1994, the Company entered into a retroactive reinsurance arrangement
with respect to its MPL business. As a result, Physicians initially recorded
a deferred gain on retroactive reinsurance of $3.4 million in 1994. Deferred
gains were amortized into income over the expected payout of the underlying
claims using the interest method. Deferred gains of $439,000, $530,000 and
$268,000 in 2002, 2001 and 2000, respectively were recorded in income. The
unamortized gain at December 31, 2002 was zero and $439,000 at December 31,
2001.
The following is a summary of the net effect of reinsurance activity on
the consolidated financial statements for each of the years ended
December 31:
2002 2001 2000
------------ ------------ ------------
Direct premiums written $ 21 $ (18,918) $ 510,364
Reinsurance premiums assumed 427 804 439,122
Reinsurance premiums ceded (42,217) 704,158 (6,888,981)
------------ ------------ ------------
Net premiums written $ (41,769) $ 686,044 $ (5,939,495)
============ ============ ============
Direct premiums earned 27 274,978 696,695
Reinsurance premiums assumed 394 816 (7,230)
Reinsurance premiums ceded (42,217) 704,158 1,005,729
------------ ------------ ------------
Net premiums earned $ (41,796) $ 979,952 $ 1,695,194
============ ============ ============
Losses and loss adjustment
expenses incurred (recovered):
Direct 859,948 (9,190,670) (2,979,776)
Assumed (49,314) (63,091) (756,306)
Ceded (3,156,948) (1,675,521) 5,616,843
------------ ------------ ------------
Net losses and loss adjustment
expense (recovery) (2,346,314) (10,929,282) 1,880,761
============ ============ ============
11. RESERVES FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES:
Reserves for unpaid losses and loss adjustment expenses on MPL and
property and casualty business represent management's estimate of ultimate
losses and loss adjustment expenses and fall within an actuarially
determined range of
82
reasonably expected ultimate unpaid losses and loss adjustment expenses.
Reserves for unpaid losses and loss adjustment expenses are estimated
based on both company-specific and industry experience, and assumptions and
projections as to claims frequency, severity, and inflationary trends and
settlement payments. Such estimates may vary significantly from the eventual
outcome. In management's judgment, information currently available has been
appropriately considered in estimating the loss reserves and reinsurance
recoverable of the insurance subsidiaries.
Physicians prepares its statutory financial statements in accordance
with accounting practices prescribed or permitted by the Ohio Department of
Insurance ("Ohio Department"). Citation and Sequoia prepare their statutory
financial statements in accordance with accounting practices prescribed or
permitted by the California Department of Insurance. Prescribed statutory
accounting practices include guidelines contained in various publications of
the National Association of Insurance Commissioners ("NAIC"), as well as
state laws, regulations, and general administrative rules. Permitted
statutory accounting practices encompass all accounting practices not so
prescribed. The Ohio Department's prescribed accounting practices do not
allow for discounting of claim liabilities. However, for years prior to
2000, the Ohio Department permitted Physicians to discount its losses and
loss adjustment expenses related to its MPL claims to reflect anticipated
investment income. Permission was granted due primarily to the longer claims
settlement period related to MPL business as compared to most other types of
property and casualty insurance lines of business. In 2000 the Ohio
Department of Insurance withdrew permission to discount MPL claims reserves
in Physicians' statutory financial statements. In addition, Physicians no
longer discounts MPL reserves in its GAAP financials. Activity in the
reserve for unpaid claims and claim adjustment expenses was as follows for
each of the years ended December 31:
2002 2001 2000
------------ ------------ ------------
Balance at January 1 $ 61,537,910 $ 84,383,854 $ 99,718,649
Less reinsurance recoverable (7,474,854) (9,387,965) (11,461,973)
------------ ------------ ------------
Net balance at January 1 54,063,056 74,995,889 88,256,676
------------ ------------ ------------
Incurred loss and loss adjustment expenses
for current accident year claims 117 172,003 1,100,006
Incurred loss and loss adjustment expenses
(recoveries) for prior accident year claims (1,907,552) (10,571,292) 1,048,408
Retroactive reinsurance (438,879) (529,993) (267,653)
------------ ------------ ------------
Total incurred (recovered) (2,346,314) (10,929,282) 1,880,761
------------ ------------ ------------
Effect of retroactive reinsurance 438,879 529,993 267,653
------------ ------------ ------------
Cumulative effect of accounting change 7,520,744
------------ ------------ ------------
Payments for claims occurring during:
Current accident year (50) (54,591) (282,587)
Prior accident years (7,232,890) (10,478,953) (22,647,358)
------------ ------------ ------------
Total paid (7,232,940) (10,533,544) (22,929,945)
------------ ------------ ------------
Net balance at December 31 44,922,681 54,063,056 74,995,889
Plus reinsurance recoverable 7,780,432 7,474,854 9,387,965
------------ ------------ ------------
Balance at December 31 $ 52,703,113 $ 61,537,910 $ 84,383,854
============ ============ ============
During 2001, medical professional liability insurance claims reserves,
net of reinsurance, decreased from $51.6 million to $34.9 million and during
2002 decreased from $34.9 million to $30.3 million. Actuarial analysis of
Physicians' loss reserves concluded that Physicians' reserves against claims
were significantly greater than the actuary's projections of future claims
payments. Accordingly, Physicians reduced its claims reserves by
approximately $11.2 million in 2001.
12. EMPLOYEE BENEFIT PLAN:
PICO maintains a 401(k) Defined Contribution Plan covering substantially
all employees of the Company. Matching contributions are based on a
percentage of employee compensation. In addition, the Company may make a
discretionary contribution at the end of the Plan's fiscal year within
limits established by the Employee Retirement Income Securities Act. Total
contribution expense incurred by the Company, including payments to
employees of Sequoia Insurance Company, was $837,000 in 2002, $855,000 in
2001 and $864,000 in 2000.
83
13. REGULATORY MATTERS:
The regulations of the Departments of Insurance in the states where the
Company's insurance subsidiaries are domiciled generally restrict the
ability of insurance companies to pay dividends or make other distributions.
Based upon statutory financial statements filed with the insurance
departments as of December 31, 2002, $4.3 million was available for
distribution by the Company's wholly-owned insurance subsidiaries to the
parent company without the prior approval of the Department of Insurance in
the states in which the Company's insurance subsidiaries are domiciled.
14. COMMITMENTS AND CONTINGENCIES:
The Company leases some of its offices under non-cancelable operating
leases that expire at various dates through October 2008. Rent expense was
$1 million for each year in the three years ended December 31, 2002.
Future minimum rental payments required under the leases for the years
ending December 31, are as follows:
2003 844,839
2004 860,129
2005 784,137
2006 559,713
2007 550,028
Thereafter 3,287,700
---------
Total $6,886,546
==========
Vidler, a PICO subsidiary, is party to a lease to acquire 30,000
acre-feet of underground water storage privileges and associated rights to
recharge and recover water located near the California Aqueduct, northwest
of Bakersfield. The agreement requires a minimum payment of $378,000 per
year adjusted annually by the engineering price index until 2007. PICO
signed a Limited Guarantee agreement with Semitropic Water Storage District
("Semitropic") that requires PICO to guarantee Vidler's annual obligation up
to $519,000, adjusted annually by the engineering price index.
In 2000, PICO Holdings loaned a total of $2.2 million to Dominion
Capital Pty. Ltd. ("Dominion Capital"), a private Australian company. In
2001, $1.2 million of the loans became overdue. Negotiations between PICO
and Dominion Capital to reach a settlement agreement on both the overdue
loan of $1.2 million and the other loan of $1 million proved unsuccessful.
Accordingly, PICO has commenced a legal action through the Australian courts
against Dominion Capital to recover the total amount due to PICO Holdings.
Due to the inherent uncertainty involved in pursuing legal action, and our
ability to realize the assets collateralizing the loans, PICO has recorded
an allowance for the total outstanding balance of $2.3 million for the loans
and interest. PICO has been awarded summary judgment in relation to the
principle and interest on the $1.2 million loan and, as a result, Dominion
Capital has been placed in receivership. The court appointed receiver is in
the process of ascertaining Dominion Capital's assets and liabilities. A
court trial date has been set for June 30, 2003 in connection with PICO's $1
million loan and interest.
The Company is subject to various other litigation that arises in the
ordinary course of its business. Based upon information presently available,
management is of the opinion that such litigation will not have a material
adverse effect on the consolidated financial position, results of operations
or cash flows of the Company.
15. RELATED-PARTY TRANSACTIONS:
The employment agreements entered into with Ronald Langley and John R.
Hart in 1997 and renewed for 4 years on January 1, 2002 for annual base
salaries of $800,000 subject to annual adjustment in January of each year in
the same percentage applicable to PICO's other staff members in an amount
deemed adequate to provide for inflation, cost of living, and
84
20 merit increases based on the CPI and major compensation studies. Each is
also entitled to an incentive award based on the growth of the Company's
book value per share in excess of a threshold that is calculated as 80% of
the previous five year average total return for the S&P 500. At December 31,
2002, the growth in book value per share exceeded the threshold and an award
was accrued in the accompanying consolidated financial statements of $1.5
million. No award was paid during 2001 or 2000 under this program.
On March 27, 2000, PICO sold 3,333,333 shares of common stock to PICO
Equity Investors, LP ("PEI") in a rights offering. PEI is managed by PICO
Equity Investors Management, LLC, which is owned by three of PICO's current
directors (including PICO's chairman of the board and PICO's president and
chief executive officer). PICO Equity Investors will exercise all voting and
investment decisions with respect to these shares for up to 10 years. There
is no monetary compensation for management of either partnership.
On March 6, 1996, Charles E. Bancroft, the President and Chief Executive
Officer of Sequoia entered into an incentive agreement with Sequoia after
its acquisition by Physicians. Under the terms of this incentive agreement,
Mr. Bancroft is to receive a payment equal to ten percent of the increase in
Sequoia's value upon his retirement, removal from office for reasons other
than cause, or the sale of Sequoia to a third party. For purposes of the
incentive agreement, the increase in Sequoia's value is to be measured from
August 1, 1995; the date Physicians acquired Sequoia. Mr. Bancroft was not
eligible to receive any incentive payment, until he was continuously
employed by Sequoia from August 1, 1995 through August 1, 1998. The Company
recorded compensation expense related to this arrangement of $283,000,
250,000 and $160,000 during the years ended December 31, 2002, 2001 and
2000, respectively. The total accrued incentive will be paid upon the
successful completion of the pending sale of Sequoia, which is expected to
close on or around March 31, 2003.
Certain of the Company's subsidiaries had stock option arrangements with
officers and other employees for stock of the respective subsidiary. Options
are granted under these arrangements at the estimated fair value of the
subsidiary's stock at the time of grant. Therefore, no compensation was
recorded by the Company related to these arrangements. During 2000, 19,037
options to acquire 1.9% of the existing shares of Vidler were exercised for
$109,000 and a loss, calculated in accordance with Staff Accounting Bulletin
No. 51, of $526,000 before tax was recorded on the sale.
In 1998, the Company entered into an agreement with its president and
chief executive officer to defer a portion of his 1998 regular compensation
in a deferred compensation Rabbi Trust account held in the name of the
Company. The deferrals are included within the Company's consolidated
balance sheet. Salary deferrals to the trust amounted to $316,000 for 1998.
There were no deferrals into this trust in 2002, 2000 or 2001. During 2002,
four other Directors elected to defer all or part of their fees into a Rabbi
Trust account. Combined deferrals to these accounts were $94,000 for the
year. The trusts purchase only PICO stock on the open market. The PICO
common stock held in the accounts is subject to the claims of outside
creditors, and is reported as treasury stock in the consolidated financial
statements.
In August 1998, the Company acquired 412,846 shares of its common stock
at a cost of $1.6 million, and assumed call option obligations for the
delivery of these shares when the options are exercised. These call options
expire on December 30, 2003 and are held by the chairman of PICO's board and
its chief executive officer. On December 31, 1998, 57,307 of these options
were exercised for $200,000.
During 2000, the Company sold its interest in Conex Continental Inc. to
Dominion Japan, a Japanese corporation. PICO and Dominion, through its
parent, Dominion Capital Pty. Ltd., each have an ownership interest in the
common stock of Solpower Corporation. PICO accounts for Solpower at cost and
records gains or losses under SFAS 115. PICO loaned Solpower $500,000 to
purchase its 50% interest in Protocol Resource Management, Inc. and PICO
acquired the other 50% of Protocol. The loan bears interest at 10.8% and
PICO received a warrant to purchase 1 million shares of Solpower common
stock. PICO recorded its interest in Protocol using the equity method of
accounting. In 2002, PICO purchased the remaining 50% of Protocol by
redeeming the loan with Solpower. Later in 2002, PICO sold its entire
interest in Protocol to an unrelated third party for $400,000. During 2000,
PICO loaned approximately $2.2 million to Dominion Capital Pty. Limited. The
loans bear interest at a weighted rate of 10.2% and were due in 2001. In May
2001, one of the loans for $1.2 million became overdue. Negotiations between
PICO and Dominion Capital to reach a settlement agreement on both the
overdue loan of $1.2 million and the other loan of $1 million proved
unsuccessful. Accordingly, PICO has commenced legal actions through the
Australian courts against Dominion Capital to recover the total amount due
to PICO Holdings. Due to the inherent uncertainty involved in pursuing a
legal action and our ability to realize the assets collateralizing the
loans, PICO recorded an allowance for the total outstanding balance of $2.3
million for the loans and interest during 2001.
85
16. STATUTORY INFORMATION:
The Company and its insurance subsidiaries are subject to regulation by
the insurance departments of the states of domicile and other states in
which the companies are licensed to operate and file financial statements
using statutory accounting practices prescribed or permitted by the
respective Departments of Insurance. Prescribed statutory accounting
practices include a variety of publications of the National Association of
Insurance Commissioners, as well as state laws, regulations and general
administrative rules. Permitted statutory accounting practices encompass all
accounting practices not so prescribed. Physicians had received written
approval from the Ohio Department of Insurance to discount its medical
professional liability unpaid loss and loss adjustment expense reserves,
including related reinsurance recoverable using a 4% discount rate through
December 31, 1999. Effective January 1, 2000, the Ohio Department of
Insurance withdrew its permission for Physicians to discount reserves.
Statutory practices vary in certain respects from generally accepted
accounting principles. The principal variances are as follows:
(1) Certain assets are designated as "non-admitted assets" and charged to
shareholders' equity for statutory accounting purposes (principally
certain agents' balances and office furniture and equipment).
(2) Deferred policy acquisition costs are expensed for statutory accounting
purposes.
(3) Equity in net income of subsidiaries and affiliates is credited directly
to shareholders' equity for statutory accounting purposes.
(4) Fixed maturity securities are carried at amortized cost.
(5) Loss and loss adjustment expense reserves and unearned premiums are
reported net of the impact of reinsurance for statutory accounting
purposes.
The Company and its wholly-owned insurance subsidiaries' policyholders'
surplus and net income (loss) as of and for the years ended December 31,
2002, 2001 and 2000 on the statutory accounting basis are as follows:
2002 2001 2000
------------ ------------ ------------
Physicians Insurance Company of Ohio: (Unaudited)
Statutory net income (loss) $ (4,856,572) $ 5,412,626 $ 10,212,601
Policyholders' surplus 42,266,183 42,859,837 33,996,556
The Professionals Insurance Company: (1)
Statutory net income $ 130,790
Policyholders' surplus 3,773,247
Sequoia Insurance Company: (2)
Statutory net loss $ (1,499,260) $ (50,861) $ (2,660,660)
Policyholders' surplus 32,301,520 29,271,877 23,442,970
Citation Insurance Company:
Statutory net income $ 1,641,070 $ 2,317,209 $ 4,549,292
Policyholders' surplus 17,665,606 16,629,106 14,328,017
(1) The Professionals Insurance Company was merged with Physicians Insurance
Company of Ohio on December 21, 2001.
(2) Sequoia Insurance Company is classified as discontinued operations.
Sequoia Insurance Company is a wholly owned subsidiary of Physicians
Insurance Company of Ohio. In the table above, the statutory surplus of
Sequoia ($32.3 million in 2002, $29.3 million in 2001, and $23.4 million in
2000) is also reflected in statutory surplus of Physicians.
17. SEGMENT REPORTING:
PICO Holdings, Inc. is a diversified holding company. The Company
acquire businesses which management believes are undervalued at the time,
and have the potential to provide a superior rate of return over time, after
considering the risk involved. The over-riding objective is to generate
superior long-term growth in shareholders' equity, as measured by book value
per share. The Company accounts for segments as described in the significant
accounting policies in Note 1.
86
Currently the major businesses are owning and developing water rights
and water storage operations through Vidler Water Company, Inc.; owning and
developing land and the related mineral rights and water rights through
Nevada Land & Resource Company, LLC; "running off" the property and casualty
loss reserves of Citation Insurance Company and the medical professional
liability loss reserves of Physicians Insurance Company of Ohio; the
acquisition and financing of businesses; and property and casualty insurance
in California and Nevada through Sequoia Insurance Company. In October 2002,
the Company signed a definitive agreement to sell Sequoia, and is therefore
accounted for as a discontinued operation.
Segment performance is measured by revenues and segment profit before
tax. In addition, assets identifiable with segments are disclosed as well as
capital expenditures, and depreciation and amortization. The Company has
operations and investments both in the U.S. and abroad. Information by
geographic region is also similarly disclosed.
Water Rights and Water Storage
Vidler is engaged in the following water rights and water storage
activities:
o acquiring water rights, redirecting the water to its highest and best
use, and then generating cash flow from either leasing the water or
selling the right;
o development of storage and distribution infrastructure; and
o purchase and storage of water for resale in dry years.
Land and Related Mineral Rights and Water Rights
PICO is engaged in land and related mineral rights and water rights
operations through its subsidiary Nevada Land. Nevada Land owns
approximately 1.2 million acres of land and related mineral and water rights
in northern Nevada. Revenue is generated by land sales, land exchanges and
leasing for grazing, agricultural and other uses. Revenue is also generated
from the development of water rights and mineral rights in the form of
outright sales and royalty agreements.
Insurance Operations in Run Off
This segment is comprised of Physicians Insurance Company of Ohio and
Citation Insurance Company.
Until 1995, Physicians and Professionals wrote medical professional
liability insurance, mostly in the state of Ohio. Professionals merged with
and into Physicians on December 21, 2001. Physicians has stopped writing new
business and is being "run off." This means that it is handling claims
arising from historical business, and selling investments when funds are
needed to pay claims.
In the past, Citation wrote commercial property and casualty insurance
in California and Arizona. Sequoia now directly writes all business in
California and Nevada. Citation ceased writing business in December 2000,
and is now "running-off" the loss reserves from its existing business.
In this segment, revenues come from premiums earned on policies written
and investment income on the assets held by the insurance companies. As
expected during the run-off process, the bulk of this segment's revenues
come from investment income. Investments directly related to the insurance
operations are included within those segments. The assets of discontinued
operations are included within the Insurance Run Off segment as the equity
of the discontinued operations is owned by Physicians.
Business Acquisitions and Financing
This segment contains businesses, interests in businesses, and other
parent company assets.
PICO seeks to acquire businesses which are as undervalued based on
fundamental analysis -- that is, the assessment of what the company is
worth, based on the private market value of its assets, and/or earnings and
cash flow. The Company has acquired businesses and interests in businesses
through the purchase of private companies and shares in public companies,
both directly through participation in financings and from open market
purchases. The business must have special qualities, such as unique assets,
a potential catalyst for change, or it is in an industry with attractive
characteristics. When buying a company, the Company has a long term horizon,
typically 5 years or more, however the Company is prepared to sell if the
price received
87
exceeds the return, the Company expects to earn if held.
Segment information by major operating segment follows:
Land and Related Water Rights Insurance Business
Mineral Rights and Water Operations in Acquisitions &
and Water Rights Storage Run Off Finance Consolidated
------------- ------------- ------------- ------------- -------------
2002:
Revenues $ 4,414,084 $ 13,777,016 $ 2,625,420 $ 8,457,719 $ 29,274,239
Income (loss) before income taxes 483,513 (897,344) 4,299,987 (1,180,180) 2,705,976
Identifiable assets 60,406,824 82,428,762 219,325,970 34,006,655 396,168,211
Depreciation and amortization 83,605 953,186 332,357 51,658 1,420,806
Capital expenditures 188,197 215,434 11,040 42,438 457,109
2001:
Revenues (charges) $ 3,221,433 $ 17,964,295 $ 6,036,784 $ (3,662,084) $ 23,560,428
Income (loss) before income taxes 131,385 4,988,994 15,996,147 (15,288,493) 5,828,033
Identifiable assets 59,682,078 97,215,882 181,532,258 35,988,546 374,418,764
Depreciation and amortization 57,901 1,284,611 (391,986) 246,547 1,197,073
Capital expenditures 42,556 277,014 76,097 395,667
2000:
Revenues (charges) $ 5,275,770 $ 3,123,287 $ 6,517,363 $ (5,237,645) $ 9,678,775
Income (loss) before income taxes 1,917,828 (4,854,404) 1,970,815 (16,437,398) (17,403,159)
Identifiable assets 52,001,901 108,214,951 167,962,768 63,902,833 392,082,453
Depreciation and amortization 27,951 988,011 (137,327) 1,012,957 1,891,592
Capital expenditures 627,367 7,784 151,466 786,617
88
Segment information by geographic region follows:
United
States Canada Europe Australia Consolidated
------------------------------------------------------------- -------------------
2002
- ----
Revenues (charges) $ 31,943,501 $ (2,669,262) $ 29,274,239
Income (loss) before income taxes 6,611,242 (3,905,266) 2,705,976
Identifiable assets 360,469,577 35,698,634 396,168,211
Depreciation and amortization 1,420,806 1,420,806
Capital expenditures 457,108 457,108
2001
- ----
Revenues $ 24,099,049 $ (928,422) $ 389,801 $ 23,560,428
Income before income taxes 5,880,863 (52,830) 5,828,033
Identifiable assets 341,371,349 25,558,071 7,489,344 374,418,764
Depreciation and amortization 1,197,073 1,197,073
Capital expenditures 395,667 395,667
2000
- ----
Revenues (charges) $ 12,014,142 $(2,481,956) $ 146,589 $ 9,678,775
Income (loss) before income taxes (16,738,379) (2,616,005) 1,951,225 (17,403,159)
Identifiable assets 351,546,996 2,114,952 30,269,015 $8,151,490 392,082,453
Depreciation and amortization 1,891,592 1,891,592
Capital expenditures 786,617 786,617
18. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that fair value:
- CASH AND CASH EQUIVALENTS, SHORT-TERM INVESTMENTS, RECEIVABLES, PAYABLES
AND ACCRUED LIABILITIES: Carrying amounts for these items approximate
fair value because of the short maturity of these instruments.
- INVESTMENTS: Fair values are estimated based on quoted market prices, or
dealer quotes for the actual or comparable securities. Fair value of
warrants to purchase common stock of publicly traded companies is
estimated based on values determined by the use of accepted valuation
models at the time of acquisition. Fair value for equity securities that
do not have a readily determinable fair value is estimated based on the
value of the underlying common stock. The Company regularly evaluates
the carrying value of securities to determine whether there has been any
diminution in value that is other-than-temporary and adjusts the value
accordingly.
- INVESTMENT IN AFFILIATE: Investments in which the Company owns between
20% and 50%, and/or has the ability to significantly influence the
operations and policies of the investee, are carried on the equity
method. The balance of the investment is regularly evaluated for
impairment by comparing the carrying value to quoted market prices.
- BANK AND OTHER BORROWINGS: Carrying amounts for these items approximate
fair value because current interest rates and, therefore, discounted
future cash flows for the terms and amounts of loans disclosed in Note
20, are not significantly different from the original terms.
89
December 31, 2002 December 31, 2001
-------------------------------------- --------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
----------------- ---------------- ---------------- -----------------
Financial assets:
Fixed maturities $ 47,566,764 $ 47,566,764 $ 48,780,129 $ 48,780,129
Equity securities 47,430,194 47,430,194 42,485,827 42,485,827
Investment in unconsolidated affiliates 498,214 3,308,066 2,583,590 6,602,760
Cash and cash equivalents 22,079,082 22,079,082 16,342,374 16,342,374
Financial liabilities:
Bank and other borrowings 14,636,017 14,636,017 14,596,302 14,596,302
19. BANK AND OTHER BORROWINGS:
At December 31, 2002 and 2001, bank and other borrowings consisted of
loans and promissory notes incurred to finance the purchase of land and
equity securities. The weighted average interest rate on these borrowings
was approximately 5.4% and 7.2% at December 31, 2002, and 2001, respectively
with principal and interest due throughout the term.
2002 2001
------------------ -----------------
3.33% (5.58% in 2001) Swiss loans $ 8,804,790 $ 7,844,084
7% - 8% Notes due:
2003 137,011
2007 - 2008 179,947 208,280
8.5% Notes due:
2004 1,114,848 1,155,120
2008 - 2009 2,988,091 3,141,837
2019 772,076 1,563,063
9% -10% Notes due:
2003 183,366 171,277
2008 455,888 512,641
------------------ -----------------
$ 14,636,017 $ 14,596,302
================== =================
Global Equity SA has a loan facility with a Swiss bank which matures
by March 2003, for a maximum of $10.9 million (15 million CHF) based on a
margin not higher than 30% of the securities deposited with the bank. It
is anticipated the Company will refinance the loan facility when it
becomes due. The actual amount available is dependent on the value of the
collateral held after a safety margin established by the bank. It may be
used as an overdraft or for payment obligations arising from securities
transactions. At December 31, 2002 and 2001, $8.8 million bearing
interest at 3.33% and $7.8 million bearing interest at 5.58% is
outstanding.
At December 31, 2002 and 2001, $5.8 million and $6.8 million,
respectively of the total outstanding borrowings was held within Vidler,
primarily incurred to finance the acquisition of lands in the Harquahala
Valley. The weighted average rate of interest on these notes is 8.5% and
is collateralized by the purchased properties.
90
The Company's future minimum principal debt repayments for the years
ending December 31 are as follows:
2003 $ 9,347,249
2004 1,411,641
2005 372,978
2006 404,588
2007 368,508
Thereafter 2,731,053
-------------------------------
Total $14,636,017
===========
20. CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLE:
Effective July 1, 2001 the Company adopted SFAS No. 141, "Business
Combinations," and effective January 1, 2002, SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 141 prospectively prohibits the pooling
of interests method of accounting for business combinations initiated after
June 30, 2001. SFAS No. 142 establishes a new method of testing
goodwill for impairment on an annual basis or on an interim basis if an
event occurs or circumstances change that would reduce the fair value of a
reporting unit below its carrying value. The adoption of SFAS No. 142 is
reflected in Company's consolidated financial statements as a cumulative
effect of change in accounting principle. The cumulative adjustment of $2
million is comprised of a gain from recognizing negative goodwill of $2.8
million offset by write-off's of goodwill of $800,000. Had the Company
ceased amortizing goodwill as of the first day of the earliest period
presented, net income or loss for each of the years ended December 31, would
be as follows:
2002 2001 2000
----------- ----------- -----------
Net income (loss) as reported 5,929,145 5,113,905 (11,300,556)
Amortization of goodwill, net 321,152 518,884
Cumulative effect of change in accounting principle (1,984,744)
----------- ----------- -----------
Pro forma net income (loss) 3,944,401 5,435,057 (10,781,672)
=========== =========== ===========
Net income (loss) per share
basic and diluted as reported $ 0.48 $ 0.41 $ (0.97)
Amortization of goodwill, net 0.03 0.04
Cumulative effect of change in accounting principle (0.16)
----------- ----------- -----------
Adjusted net income (loss) per share $ 0.32 $ 0.44 $ (0.93)
=========== =========== ===========
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS 138,
"Accounting for Certain Derivative Instruments and Hedging Activities." As
amended, SFAS 133 requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position measure
those instruments at fair value and recognize changes in fair value in
earnings for the period of change unless the derivative qualifies as an
effective hedge that offsets certain exposure. As a result of this adoption,
the Company recorded a transition adjustment in the first quarter of 2001
that decreased net income by approximately $1 million, net of a $500,000 tax
benefit and increased other comprehensive income by the same amount (no
effect on shareholders' equity). These adjustments are reported as a
cumulative effect of change in accounting principle in the accompanying
consolidated financial statements.
In the fourth quarter of 2000, the Company received notification from
the Ohio Department of Insurance that it would no longer permit the Company
to discount its MPL reserves for statutory accounting practices.
Accordingly, the Company discontinued discounting its MPL reserves in its
statutory filing with the Ohio Department of Insurance and financial
statements prepared in accordance with GAAP for the year ended December 31,
2000. The effect of this change was to increase the unpaid losses and loss
adjustment expenses reserve by $7.5 million and a cumulative effect of
accounting principle of $5 million, or $0.43 per share, net of an income tax
benefit of approximately $2.5 million. Had the change been made as of
91
the first day of the earliest period presented, the net loss and loss per
share for 1999 and 1998 would have been reduced by $995,000 and $0.11 per
share and $643,000, and $0.11 per share, respectively.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this item regarding directors will be set forth
in the section headed "Election of Directors" in our definitive proxy statement
with respect to our 2003 annual meeting of shareholders, to be filed on or
before April 30, 2003 and is incorporated herein by reference. Information
regarding executive officers is set forth in Item 1 of Part 1 of this Report
under the caption "Executive Officers".
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be set forth in the section headed
"Executive Compensation" in our 2003 definitive proxy statement and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be set forth in the section headed
"Security Ownership of Certain Beneficial Owners and Management" in our 2003
definitive proxy statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be set forth in the section headed
"Certain Relationships and Related Transactions" and "Compensation Committee,
Interlocks and Insider Participation" in our definitive 2003 proxy statement and
is incorporated herein by reference.
PART IV
ITEM 14. CONTROLS AND PROCEDURES
(a) Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures, as such term is defined under Rule 13a-14(c)
promulgated under the Securities Exchange Act of 1934, as amended, within the 90
day period prior to the filing date of this report. Based on this evaluation,
our principal executive officer and principal financial officer concluded that
our disclosure controls and procedures were effective as of that date.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above.
92
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL STATEMENTS.
Independent Auditors' Report .................................. 57
Consolidated Balance Sheets as of December 31, 2002 and 2001 .. 58-59
Consolidated Statements of Operations for the Years
Ended December 31, 2002, 2001 and 2000 .................. 60
Consolidated Statements of Shareholders' Equity
for the Years Ended December 31, 2002, 2001 and 2000 .... 61-63
Consolidated Statements of Cash Flows for the Years
Ended December 31, 2002, 2001 and 2000 .................. 64
Notes to Consolidated Financial Statements .................... 65-92
2. FINANCIAL STATEMENT SCHEDULES.
Independent Auditors' Report................................... 94
Schedule I - Condensed Financial Information of Registrant..... 95-96
Schedule II - Valuation and Qualifying Accounts................ 97
Schedule V - Supplementary Insurance Information............... 98-100
93
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES
To the Shareholders and Board of Directors of
PICO Holdings, Inc.:
We have audited the consolidated financial statements of PICO Holdings, Inc. and
subsidiaries (the "Company") as of December 31, 2002 and 2001, and for each of
the three years in the period ended December 31, 2002, and have issued our
report thereon dated March 27, 2003 which report includes an explanatory
paragraph relating to the adoption of Statement of Financial Accounting
Standards No 142, "Goodwill and Intangible Assets" in 2002 and a change in
accounting for medical professional liability claims reserves in 2000; such
report is included elsewhere in this Form 10-K. Our audits of the consolidated
financial statements also included the financial statement schedules of the
Company, listed in Item 15. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion such financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly in all material respects the information set forth
therein.
DELOITTE & TOUCHE LLP
San Diego, California
March 27, 2003
94
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
December 31, December 31,
2002 2001
------------- -------------
ASSETS
Cash and cash equivalents $ 13,430,400 $ 1,559,584
Investments in subsidiaries 144,352,868 134,957,362
Equity securities and other investments 27,682,994 29,279,888
Deferred income taxes 5,483,344 10,486,309
Other assets 38,683,506 32,690,726
------------- -------------
Total assets $ 229,633,112 $ 208,973,869
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expense and other liabilities $ 8,601,408 $ 1,075,362
------------- -------------
Common stock, $.001 par value, authorized 100,000,000 shares: issued 16,801,923
at December 31, 2002 and 16,784,223 at December 31, 2001 16,802 16,784
Additional paid-in capital 236,082,703 235,844,655
Accumulated other comprehensive income (loss) 3,833,676 (3,225,867)
Retained earnings 59,320,715 53,391,570
------------- -------------
299,253,896 286,027,142
Less treasury stock, at cost (2002: 4,422,681 shares and 2001: 4,415,607 shares) (78,222,192) (78,128,635)
------------- -------------
Total shareholders' equity 221,031,704 207,898,507
------------- -------------
Total liabilities and shareholders' equity $ 229,633,112 $ 208,973,869
============= =============
This statement should be read in conjunction with the notes to the consolidated
financial statements included in the Company's 2002 Form 10-K
95
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF OPERATIONS FOR THE
YEARS ENDED DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
Investment income (loss), net $ 13,913,246 $ 3,058,533 $ (4,067,068)
Equity in income (loss) of subsidiaries (1,422,091) 8,424,280 357,935
------------ ------------ ------------
Total revenues (charges) 12,491,155 11,482,813 (3,709,133)
Expenses 9,862,307 8,587,153 6,055,643
------------ ------------ ------------
Income (loss) from continuing operations before income taxes 2,628,848 2,895,660 (9,764,776)
Benefit for income taxes 1,518,253 (881,321) (2,475,383)
------------ ------------ ------------
Income (loss) before cumulative effect 1,110,595 3,776,981 (7,289,393)
Income from discontinued operations, net 2,833,806 2,317,495 952,528
Cumulative effect of accounting change, net 1,984,744 (980,571) (4,963,691)
------------ ------------ ------------
Net income (loss) $ 5,929,145 $ 5,113,905 $(11,300,556)
============ ============ ============
CONDENSED STATEMENTS OF CASH FLOWS
Cash flow from operating activities: 2002 2001 2000
------------ ------------ ------------
Net income (loss) $ 5,929,145 $ 5,113,905 $(11,300,556)
Adjustments to reconcile net income (loss) to net cash
used or provided by operating activities:
Equity in (income) loss of subsidiaries 1,422,091 (8,424,280) (357,935)
Income from discontinued operations, net (2,833,806) (2,317,495) (952,528)
Cumulative effect of accounting change, net (1,984,744) 980,571 4,963,691
Changes in assets and liabilities:
Accrued expenses and other liabilities 8,367,856 (1,478,664) (15,765,565)
Other assets (1,831,625) 1,882,161 (37,926,455)
------------ ------------ ------------
Net cash provided by (used in) operating activities 9,068,917 (4,243,802) (61,339,348)
------------ ------------ ------------
Cash flow from investing activities:
Sale of investments 21,100,950 1,771,284 12,910,084
Purchase of investments (18,443,560)
------------ ------------ ------------
Net cash provided by investing activities 2,657,390 1,771,284 12,910,084
Cash flow from financing activities:
Cash received from exercise of stock options 238,066
Cash received from rights offering, net 49,843,163
Purchase of treasury shares for deferred compensation plans (93,557) (299,000)
------------ ------------ ------------
Net cash provided by (used in) financing activities 144,509 (299,000) 49,843,163
------------ ------------ ------------
Increase in cash and cash equivalents 11,870,816 (2,771,518) 1,413,899
Cash and cash equivalents, beginning of year 1,559,584 4,331,102 2,917,203
------------ ------------ ------------
Cash and cash equivalents, end of year $ 13,430,400 $ 1,559,584 $ 4,331,102
============ ============ ============
This statement should be read in conjunction with the notes to the consolidated
financial statements included in the Company's Form 10-K
96
SCHEDULE II
PICO HOLDINGS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Additions
-----------------
Balance at Charged to Balance
Beginning Costs and End
Description of Period Expenses Deductions of Period
----------- -------------- ----------------- -------------- --------------
Year-end December 31, 2002:
Allowance for doubtful accounts $ 2,500,604 $ 2,500,604
Deferred tax valuation allowance $ 3,389,620 $ (2,980,872) 408,748
Year-end December 31, 2001:
Allowance for doubtful accounts $ 164,300 $ 2,633,204 $ (296,900) $ 2,500,604
Deferred tax valuation allowance $ 3,757,054 $ (367,434) $63,389,620
Year-end December 31, 2000:
Allowance for doubtful accounts $ 49,488 $ 114,812 $ 164,300
Deferred tax valuation allowance $ 471,638 $ 3,285,416 $ 3,757,054
97
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
December 31, 2002
Losses,
Claims Losses
and Loss Net and Other Net
Expense Premium Investment Loss Operating Premiums
Reserves Revenue Income Recoveries Expenses Written
------------- ----------------- ----------------- ----------------- ---------------- -------------
Medical
professional
liability $ 36,398 $ 382 $ 679 $ (1,458) $ 395 $ 382
Other property
and casualty 16,305 (424) 1,589 (889) 276 (424)
------------- ----------------- ----------------- ----------------- ---------------- -------------
Total medical
professional
liability and property
and casualty 52,703 (42) 2,268 (2,347) 671 (42)
Other operations 3,117 26,035
------------- ----------------- ----------------- ----------------- ---------------- -------------
Total continuing $ 52,703 $ (42) $ 5,385 $ (2,347) $ 26,706 $ (42)
============= ================= ================= ================= ================ =============
98
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
December 31, 2001
Losses,
Claims Losses
and Loss Net and Other Net
Expense Premium Investment Loss Operating Premiums
Reserves Revenue Income Expenses Expenses Written
------------ ---------- ------------ ----------- ------------ ----------
Medical
professional
liability $ 40,543 $ 755 $ 1,097 $ (11,158) $ 626 $ 755
Other property
and casualty 20,995 225 2,266 228 343 225
------------ ---------- ------------ ----------- ------------ ----------
Total medical
professional
liability and property
and casualty 61,538 980 3,363 (10,930) 969 980
Other operations 2,673 26,164
------------ ---------- ------------ ----------- ------------ ----------
Total continuing $ 61,538 $ 980 $ 6,036 $ (10,930) $ 27,133 $ 980
============ ========== ============ =========== ============ ==========
99
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
December 31, 2000
Expenses Premiums Revenue Income Expenses Expenses Written
--------------- --------------- ------------- --------------- --------------- ------------- ------------
Medical
professional
liability $ 58,610 $ 1,853 $ 1,543 $ 1,063 $ 1,565 $ 1,853
Other property
and casualty 25,774 $ 294 (158) 2,612 818 1,100 (158)
--------------- --------------- ------------- --------------- --------------- ------------- ------------
Total medical
professional
liability and property
and casualty 84,384 294 1,695 4,155 1,881 2,665 1,695
Other operations 1,323 21,284
--------------- --------------- ------------- --------------- --------------- ------------- ------------
Total continuing $ 84,384 $ 294 $ 1,695 $ 5,478 $ 1,881 $ 23,949 $ 1,695
=============== =============== ============= =============== =============== ============= ============
100
3. EXHIBITS
Exhibit
Number Description
------ -----------
+ 3.1 Amended and Restated Articles of Incorporation of PICO.
++ 3.2 Amended and Restated By-laws of PICO.
+++ 10.57 PICO 1995 Non-Qualified Stock Option Plan.
++++ 10.58 PICO 2000 Nonstatutory Stock Option Plan.
21. Subsidiaries of PICO. See "Notes To Consolidated Financial
Statements, 1. Nature of Operations and Significant
Accounting Policies."
23.1. Independent Auditors' Consent - Deloitte & Touche LLP.
99.1. Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2. Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
-------------
+ Incorporated by reference to exhibit of same number filed with
Form 8-K dated December 4, 1996.
++ Filed as Appendix to the prospectus in Part I of Registration
Statement on Form S-4 (File No. 333-06671).
+++ Incorporated by reference to exhibit filed with Physicians'
Registration Statement No. 33-99352 on Form S-1 filed with the
SEC on November 14, 1995.
101
++++ Incorporated by reference to Proxy Statement for Annual Meeting
of Shareholders to be Held on October 19, 2000, dated September
8, 2000, and filed with the SEC on September 11, 2000.
(B) REPORTS ON FORM 8-K.
There were no Form 8-K filings in 2002.
102
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 2003
PICO Holdings, Inc.
By: /s/ John R. Hart
------------------------------------
John R. Hart
Chief Executive Officer
President and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below on March 31, 2003 the following persons in the
capacities indicated.
/s/ Ronald Langley Chairman of the Board
- ----------------------------------------
Ronald Langley
/s/ John R. Hart Chief Executive Officer, President and Director
- ---------------------------------------- (Principal Executive Officer)
John R. Hart
/s/ Maxim C. W. Webb Chief Financial Officer and Treasurer
- ---------------------------------------- (Chief Accounting Officer)
Maxim C. W. Webb
/s/ S. Walter Foulkrod, III, Esq. Director
- ----------------------------------------
S. Walter Foulkrod, III, Esq.
/s/ Richard D. Ruppert, MD Director
- ----------------------------------------
Richard D. Ruppert, MD
/s/ Carlos C. Campbell Director
- ----------------------------------------
Carlos C. Campbell
/s/ Robert R. Broadbent Director
- ----------------------------------------
Robert R. Broadbent
/s/ John D. Weil Director
- ----------------------------------------
John D. Weil
103
CERTIFICATIONS
I, John R. Hart, certify that:
1. I have reviewed this annual report on Form 10-K of PICO Holdings,
Inc.("the Registrant"):
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
(b) evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Registrant's
ability to record, process, summarize and report financial data
and have identified for the Registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
The Registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003 /s/ John R. Hart
------------------
John R. Hart
Chief Executive Officer
104
CERTIFICATIONS
I, Maxim C. W. Webb, certify that:
1. I have reviewed this annual report on Form 10-K of PICO Holdings, Inc.
("the Registrant"):
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the Registrant's
ability to record, process, summarize and report financial data
and have identified for the Registrant's auditors any material
weaknesses in internal controls; and
b. any fraud whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
6. The Registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: March 31, 2003 /s/ Maxim C. W. Webb
------------------------------
Maxim C. W. Webb
Chief Financial Officer and Treasurer
105