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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, 2004
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 $106,209,458.
On March 9, 2005, the registrant had 12,366,440, shares of common stock, $.001
par value, outstanding, excluding 3,228,261 shares of common stock which are
held by the registrant's subsidiaries.
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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 2005
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, 2004.
2
PICO HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
No.
----
PART I................................................................... 4
Item 1. BUSINESS................................................... 4
Item 2. PROPERTIES................................................. 20
Item 3. LEGAL PROCEEDINGS.......................................... 20
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........ 20
PART II.................................................................. 21
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..................................... 21
Item 6. SELECTED FINANCIAL DATA.................................... 23
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS............................... 24
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISKS................................................... 63
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................ 63
Item 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE................................ 102
Item 9A. CONTROLS AND PROCEDURES.................................... 102
PART III................................................................. 104
Item 10. DIRECTORS AND EXECUTIVE OFFICERS AND CODE OF ETHICS OF THE
REGISTRANT.............................................. 104
Item 11. EXECUTIVE COMPENSATION..................................... 104
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.............................................. 104
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............. 104
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES..................... 104
PART IV.................................................................. 105
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K................................................ 105
SIGNATURES............................................................... 114
3
PART I
THIS ANNUAL REPORT ON FORM 10-K (INCLUDING THE MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SECTION) CONTAINS
FORWARD-LOOKING STATEMENTS REGARDING OUR BUSINESS, FINANCIAL CONDITION, RESULTS
OF OPERATIONS AND PROSPECTS, INCLUDING, WITHOUT LIMITATION, STATEMENTS ABOUT OUR
EXPECTATIONS, BELIEFS, INTENTIONS, ANTICIPATED DEVELOPMENTS, AND OTHER
INFORMATION CONCERNING FUTURE MATTERS. 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.
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 THE ACTUAL
RESULTS AND OUTCOMES COULD DIFFER FROM THOSE 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 and its subsidiaries are referred to as "PICO,"
"the Company," "we," and "our") 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 business is
worth, based on the private market value of its assets, earnings, and cash flow.
We prefer 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. We are also
interested in acquiring businesses and interests in businesses where there is
significant unrecognized value in land and other tangible assets.
We have acquired businesses and interests in businesses by the acquisition
of private companies, and the purchase of shares in public companies, both
directly through participation in financing transactions and through open market
purchases. When we buy a business or an interest in a business, we have a
long-term horizon, typically 5 years or more. Selected acquisitions may become
core operations; however, we are prepared to sell businesses if the price
received exceeds the return we expect to earn if we retain ownership. We expect
that most of our businesses and interests in businesses will eventually be sold
to other companies in the same industry 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 our net income and growth in shareholders' equity will come from realized
gains on the sale of businesses and interests in businesses, as opposed to
ongoing operating earnings. Consequently, we anticipate that PICO's earnings
will fluctuate from year to year, and that the results for any one year are not
necessarily indicative of our future performance.
4
Our business is separated into five major operating segments: Water
resource & water storage operations, real estate operations in Nevada, Business
Acquisitions & Financing, Insurance Operations in Run Off, and the operations of
HyperFeed Technologies, Inc. ("HyperFeed"). Our Business Acquisitions &
Financing segment contains businesses, interests in businesses, and other parent
company assets. Each of these business segments is discussed in greater detail
below.
Currently our major consolidated subsidiaries are:
- - Vidler Water Company, Inc. ("Vidler"), which develops and owns water rights
and water storage operations in the southwestern United States, primarily
in Nevada and Arizona;
- - Nevada Land & Resource Company, LLC ("Nevada Land"), which owns
approximately 1 million acres of land in Nevada, and the mineral rights and
water rights related to the property;
- - Citation Insurance Company, which is "running off" its historical property
& casualty and workers' compensation loss reserves, and Physicians
Insurance Company of Ohio, which is "running off" its medical professional
liability loss reserves; and
- - HyperFeed Technologies, which became a 51%-owned subsidiary in 2003.
HyperFeed is a developer and provider of software, ticker plant
technologies, and managed services to the financial markets industry.
In 2003, we closed on the sale of Sequoia Insurance Company ("Sequoia"),
which is accounted for in our consolidated financial statements for 2003 and
prior years as a discontinued operation. See "Discontinued Operations."
The address of our main office is 875 Prospect Street, Suite 301, La Jolla,
California 92037, and our telephone number is (858) 456-6022.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to those reports are made available on our
website (www.picoholdings.com) as soon as reasonably practicable after the
reports are electronically filed with the SEC. Our website also contains other
material about PICO, and links to other sites, including some of the companies
with which we are associated.
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 Bloomberg and other
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
The following section describes our subsidiaries and operating segments.
Unless otherwise indicated, we own 100% of each subsidiary.
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. We
develop new sources of water for municipal and industrial use, and necessary
storage infrastructure to facilitate the efficient allocation of available water
supplies. Vidler is not a water utility, and does not intend to enter into
regulated utility activities.
The inefficient allocation of available water between agricultural users
and municipal or industrial users, or the lack of available known water supply
in a particular location, provide opportunities for Vidler:
- - 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
resources 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, regulations and procedures are steadily being
developed to facilitate the interstate transfer of water; and
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- - 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.
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 or developed:
- - 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. At December 31, 2004, Vidler had "net
recharge credits" representing approximately 63,000 acre-feet of water in
storage on its own account at the Vidler Arizona Recharge Facility.
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; and
- - development of storage and distribution infrastructure to generate cash
flow from the purchase and storage of water for resale, and charging
customers fees for "recharge," or placing water into storage.
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 either monetize or develop
recurring cash flow from its most important assets by:
- - securing supply contracts utilizing its water rights in Arizona and Nevada;
and
- - storing additional water at the Vidler Arizona Recharge Facility, and
providing water supplies from net recharge credits already in storage.
Vidler has also entered into partnering arrangements with parties who have
water assets but lack the capital or expertise to commercially develop these
assets. Vidler continues to explore additional partnering opportunities
throughout the Southwest.
This table details the water rights and water storage assets owned by
Vidler at December 31, 2004. 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, being
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.
NAME OF ASSET & APPROXIMATE LOCATION BRIEF DESCRIPTION PRESENT COMMERCIAL USE
- ------------------------------------ ----------------- ----------------------
WATER RIGHTS
ARIZONA:
HARQUAHALA VALLEY GROUND WATER BASIN 15,023 acres of land, plus 3,149 acres under Leased to farmers
La Paz & Maricopa Counties Option
75 miles northwest of metropolitan Phoenix
35,699 acre-feet of transferable ground
water, plus 9,365 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
6
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 property on a revenue-sharing
basis
Washoe County, 40 miles north of Reno 8,000 acre-feet of permitted water rights,
which are transferable to the Reno/Sparks
area
LINCOLN COUNTY AGREEMENT Applications* for more than 100,000 Partnership to supply water to the
acre-feet of water rights through an planned Coyote Springs
agreement with Lincoln County, of which it development, which will be located
is currently anticipated that up to 40,000 approximately 40 miles north of
acre-feet will be permitted and put to use Las Vegas. The developer expects
in Lincoln County/northern Clark County. the first houses to go up in 2007.
The delivery of the water is
expected to occur over the
build-out of the project, which
could be 25 years or more.
2,100 acre-feet of permitted water rights in
the Tule Desert Groundwater Basin
570 acre-feet of permitted water rights at
Meadow Valley, located in Lincoln and Clark
counties
CLARK COUNTY
SANDY VALLEY 415 acre-feet of permitted water rights
Near the Nevada/California state line
In the Interstate 15 corridor Application for 1,000 acre-feet of water
rights
MUDDY RIVER WATER RIGHTS 221 acre-feet of water rights, plus
Approximately 35 miles east of Las approximately 46 acre-feet under option
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.
COLORADO:
COLORADO WATER RIGHTS 94 acre-feet of senior water rights Agreement to sell 94 acre-feet of
senior water rights to the City of
Golden, Colorado over a period of
11 years
185 acre-feet of senior water rights 66 acre-feet leased. The balance
is available for sale or lease.
Approximately 5.7 acre-feet were
sold to residential users in
Summit County in 2004.
WATER STORAGE
ARIZONA:
VIDLER ARIZONA RECHARGE FACILITY An underground water storage facility with Vidler is currently buying water
Harquahala Valley, Arizona estimated capacity exceeding 1 million and storing it on its own account.
acre-feet and annual recharge capability of At December 31, 2004, Vidler had
up to 35,000 acre-feet net recharge credits equivalent to
approximately 63,000 acre-feet of
water in Storage at the Arizona
Recharge Facility, as well as
3,250 acre-feet of water purchased
but not yet recharged. In
addition, Vidler has ordered
approximately 35,750 acre-feet of
water for purchase and recharge
in 2005.
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
7
NEVADA LAND & RESOURCE COMPANY, LLC
In April 1997, PICO paid $48.6 million to acquire 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 Elko County, in northeast
Nevada.
Nevada Land is the largest private landowner in the state of Nevada.
According to census data, Nevada has experienced the most rapid population
growth of any state in the United States for the past 18 years in a row. The
population of Nevada increased 66% in the 10 years ended April 1, 2000, and
increased another 15.7%, to approximately 2.3 million people, from 2000 to 2004.
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 commercial
potential of the property had not been maximized.
After acquiring Nevada Land, we completed a "highest and best use study"
which divided the land into seven 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 exchanges 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 and intends to improve. Where water rights are
permitted, we anticipate that the value, productivity, 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, 2004, Nevada Land
received consideration of approximately $33.5 million from the sale and exchange
of land and the sale of water rights. This is comprised of $31.6 million from
the sale of land, $752,000 of cash and land received in an exchange transaction,
and $1.1 million from the sale of water rights related to land that was sold.
Over this period, we have divested approximately 363,000 acres of land at an
average price of $92 per acre, which compares to our average basis of $42 in the
acres disposed of. The average gross margin percentage on the disposal of land
and water rights over this period is 54.1%. The average cost for the total land,
water, and mineral assets acquired with Nevada Land was $35 per acre.
At December 31, 2004, Nevada Land owned approximately 992,000 acres of
former railroad land. 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 east 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 8,626 acres of
deeded land and 500,000 acres of Forest Service and Bureau of Land
Management allotment land. There are 18,829 acre-feet of agricultural water
rights related to the property.
We anticipate continuing to sell smaller parcels of land for residential,
agricultural, and industrial use, and that significantly larger parcels of land
which has environmental, cultural, or historical value, will be divested through
exchange-type transactions. These transactions could be structured as outright
sales or as exchanges for land which is either more marketable or suitable for
future development.
In recent years, Nevada Land has filed additional applications for
approximately 70,480 acre-feet of water rights on the Company's lands. The
applications consist of:
- - on the former railroad lands, approximately 4,797 acre-feet of water rights
have been certificated and permitted, and applications are pending for
approximately 42,840 acre-feet of water use for agricultural, municipal,
and industrial use; and
- - 27,640 acre-feet of water rights for the beneficial use of irrigating
another 6,910 acres of Spring Valley Ranches.
8
BUSINESS ACQUISITIONS AND FINANCING
Our Business Acquisitions and Financing segment contains businesses,
interests in businesses, and other parent company assets.
PICO seeks to acquire businesses which we identify as undervalued based on
fundamental analysis -- that is, our assessment of what the business is worth,
based on the private market value of its assets, earnings, and cash flow. We
prefer 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. 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
businesses and interests in businesses where there is significant unrecognized
value in land and other tangible assets.
We have acquired businesses and interests in businesses through the
acquisition of private companies, and the purchase of shares in public
companies, both directly through participation in financing transactions 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 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 by 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 gap 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").
Between 1998 and 2002, 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 has been a
time lag between recovery in rig utilization in the U.S. and in international
markets.
We acquired our interest, at an average cost of approximately A$1.35 per
share, 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 A$1.70 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 A$2.70 per share. Immediately prior to Ensign's first bid,
AOG shares had been trading at A$1.40. We believe that our active participation
as shareholders was instrumental in achieving this positive outcome.
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, 2004, the market value (and carrying value) of
our European portfolio was $67.9 million. This includes our 22.3% interest in
Jungfraubahn Holding AG ("Jungfraubahn"), which had a market value (and carrying
value) of $40.8 million at the end of 2004.
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 intrinsic value is more
speculative, in an attempt to capitalize on areas of potentially greater growth
without incurring undue risk. At December 31, 2004, the total before-tax
carrying value of this portfolio was less than $500,000.
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.
9
In the foreseeable future, our acquisition efforts are likely to be focused
on domestic and foreign public companies, where we perceive greater scope for
value creation than with private companies.
INSURANCE OPERATIONS IN RUN OFF
Our Insurance Operations in Run Off segment is comprised of Physicians
Insurance Company of Ohio and Citation Insurance Company.
PHYSICIANS INSURANCE COMPANY OF OHIO
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 activities other than medical professional liability
insurance, 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 re-capitalized 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. At that time, Citation wrote various lines of
commercial property and casualty insurance and workers' compensation
insurance, primarily in California and Arizona. The operations of Sequoia
and Citation were combined, and eventually the business previously written
by Citation was transferred to Sequoia. At the end of 2000, Citation ceased
writing business and went into "run off." In 2003, we sold Sequoia
Insurance Company. See "Discontinued Operations" later in Item 1.
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, specialized 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 fixed-income investment assets decrease. Since interest 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, and merged Professionals into Physicians,
which simplified administration and reduced 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.
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 fixed-income
securities and unaffiliated common stocks in the "run off" insurance
company investment portfolios generated total returns upwards of 20% in
2003 and 22% in 2004, including total returns for the stocks component in
excess of 39% in 2003 and 41% in 2004. 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.
10
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, 2004, Physicians had $16.4 million in medical professional
liability loss reserves, net of reinsurance.
CITATION INSURANCE COMPANY
In 1996, Physicians completed a reverse merger with Citation's parent
company. In the past, Citation wrote various lines of commercial property and
casualty insurance and workers' compensation 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."
Prior to the reverse merger, Citation had been a direct writer of workers'
compensation insurance. Since PICO did not wish to be exposed to that line of
business, shortly after the merger was completed Citation reinsured 100% of its
workers compensation business with a subsidiary, Citation National Insurance
Company ("CNIC"), and sold CNIC to Fremont Indemnity Company ("Fremont") in
1997. As part of the sale of CNIC, all assets and liabilities, including the
assets which corresponded to the workers' compensation reserves reinsured with
CNIC, and all records, computer systems, policy files, and reinsurance
arrangements were transferred to Fremont. Fremont merged CNIC into Fremont, and
administered and paid all of the workers' compensation claims which had been
sold to it. From 1997 until the second quarter of 2003, Citation booked the
losses reported by Fremont, and recorded an equal and offsetting reinsurance
recoverable from Fremont, as an admitted reinsurer, for all losses and loss
adjustment expenses. This resulted in no net impact on Citation's reserves and
financial statements, and no net impact on PICO's consolidated financial
statements.
On June 4, 2003, the California Department of Insurance obtained a
conservation order over Fremont, and applied for a court order to liquidate
Fremont. On July 2, 2003, the California Superior Court placed Fremont in
liquidation. Since Fremont was no longer an admitted reinsurance company under
the statutory basis of insurance accounting, Citation reversed the $7.5 million
reinsurance recoverable from Fremont in both its statutory basis and GAAP basis
financial statements in the three months ended June 30, 2003 and year ended
December 31, 2003. Citation was unsuccessful in court action to recover deposits
reported as held by Fremont for Citation's insureds.
In September 2004, Citation entered into a third-party administration
agreement with Cambridge Integrated Services, Inc. to administer the claims
handling and claims payment for Citation's workers' compensation insurance
run-off book of business.
At December 31, 2004, Citation had $22.3 million in loss reserves, net of
reinsurance. Citation's loss reserves consist of $10.2 million for property and
casualty insurance, principally in the artisans/contractors line of business,
and $12.1 million for workers' compensation insurance.
HYPERFEED TECHNOLOGIES, INC.
HyperFeed is a provider of ticker plant technologies and fully managed
ticker plant services to the financial community. HyperFeed is a publicly traded
company, based in Chicago, Illinois, and became a 51%-owned subsidiary of PICO
Holdings on May 15, 2003, when we acquired direct ownership of a majority voting
interest. HyperFeed became a separate reporting segment from May 15, 2003.
Previously, HyperFeed was part of the Business Acquisitions & Financing segment.
PICO first invested in HyperFeed in 1995 through the purchase of common
stock. We invested further capital as debt, which was later converted to equity,
and received warrants for providing financing. In 2000, 2001, and 2002, we
further increased our holding through open market purchases, the conversion of
preferred stock, and the exercise of warrants. On May 15, 2003, PICO purchased
an additional 443,622.9 HyperFeed common shares in a private placement for $1.2
million, or approximately $2.705 per share (adjusted for the August 2003 1:10
reverse stock split). PICO now owns 1,546,311.7 HyperFeed common shares,
representing a voting ownership of approximately 51%.
During 2002 and 2003, HyperFeed restructured its operations, culminating in
the sale of its consolidated market data feed customers to Interactive Data
Corporation for $8.5 million on October 31, 2003.
11
DISCONTINUED OPERATIONS
SEQUOIA INSURANCE COMPANY
On March 31, 2003, we closed on the sale of Sequoia. The gross sale
proceeds were approximately $43.1 million, consisting of $25.2 million in cash
and a dividend of $17.9 million. The dividend included the common stocks
previously held in Sequoia's investment portfolio with a value of $16.4 million.
The common stocks included in the dividend primarily consisted of a number of
holdings in small-capitalization value stocks, which we believed were still
undervalued based on the private market value of the underlying assets,
earnings, and cash flow. These common stocks were added to the investment
portfolio of Physicians, which was Sequoia's direct parent company.
Physicians acquired Sequoia in 1995. Sequoia's core business was 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 wrote selected lines of personal insurance in California. 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 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 of unaffiliated stocks, bonds, and
cash equivalents earned returns (that is, interest and dividend income plus
realized and unrealized gains, before fees and taxes) of approximately 6.1% in
the last nine months of 2000, 10.4% in 2001, 12.6% in 2002, and 2.5% in the
first three months of 2003.
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.
HYPERFEED TECHNOLOGIES, INC.
During 2003, HyperFeed completed the sale of two businesses, which are now
recorded as discontinued operations:
- - its retail trading business, PCQuote.com, which was sold for $370,000 in
June 2003; and
- - its consolidated market data feed customers, which were sold to Interactive
Data Corporation, for $8.5 million. HyperFeed received $7 million in cash
on closing, and $500,000 during 2004. HyperFeed could realize an additional
$875,000 during 2005 if, and when, milestones are met.
EMPLOYEES
At December 31, 2004, PICO had 84 employees. A total of 9 employees were
engaged in land and related mineral rights and water rights operations; 5 in
water rights and storage operations; 3 in property and casualty insurance
operations; 2 in medical professional liability operations; and 17 in holding
company activities. HyperFeed Technologies, Inc. has 48 employees.
EXECUTIVE OFFICERS
The executive officers of PICO are as follows:
Name Age Position
---- --- --------
Ronald Langley 60 Chairman of the Board, Director
John R. Hart 45 President, Chief Executive Officer and Director
Richard H. Sharpe 49 Chief Operating Officer
James F. Mosier 57 General Counsel and Secretary
Maxim C. W. Webb 43 Chief Financial Officer and Treasurer
W. Raymond Webb 43 Vice President, Investments
John T. Perri 35 Vice President, Finance
12
Except for Maxim C. W. Webb, W. Raymond Webb and John T. Perri, 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. W. Raymond
Webb and John T. Perri were elected as officers of PICO in April 2003.
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.
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. Maxim 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. Raymond Webb has been with the Company since August 1999 as Chief
Investment Analyst and became Vice President, Investments in April 2003.
Mr. Perri has been Vice President, Finance of PICO since August 2003 and
served in various capacities since joining the Company in 1998, including
Financial Reporting Manager and Corporate Controller.
RISK FACTORS
In addition to the risks and uncertainties discussed in certain sections of
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 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,
the water resource business 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 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. If a business in which we
invest fails or its market value declines,we
13
could experience a material adverse effect on our business, financial condition,
the results of operations and cash flows. Additionally, 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 an inferior return on shareholders' equity. We
could also lose part or all of our capital in these businesses and experience
reductions in our net income, cash flows, assets and shareholders' equity.
FAILURE TO SUCCESSFULLY MANAGE NEWLY ACQUIRED COMPANIES COULD ADVERSELY AFFECT
OUR BUSINESS.
Our management of the operations of acquired businesses requires
significant efforts, including the coordination of information technologies,
research and development, sales and marketing, operations, and finance. These
efforts result in additional expenses and involve significant amounts of
management's time. 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. If we fail to integrate acquired businesses into our
operations successfully, we may be unable to achieve our strategic goals and the
value of your investment could suffer.
OUR ACQUISITIONS MAY NOT ACHIEVE EXPECTED RATES OF RETURN, AND WE MAY NOT
REALIZE THE VALUE OF THE FUNDS WE INVEST.
We will continue to make selective acquisitions, and endeavor to enhance
and realize additional value to these acquired companies through our influence
and control. You will be relying on the experience and judgment of management to
locate, select and develop new acquisition and investment opportunities. 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. We may not be able to find sufficient opportunities to
make this business strategy successful. Additionally, when any of our
acquisitions does not achieve acceptable rates of return or we do not realize
the value of the funds invested, we may write-down the value of such
acquisitions or sell the acquired businesses at a loss. We have made a number of
acquisitions in the past that have been highly successful, and we have also made
acquisitions that have lost either part or all of the capital invested. 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.
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.
WE MAY NOT BE ABLE TO SELL OUR INVESTMENTS WHEN IT IS ADVANTAGEOUS TO DO SO AND
WE MAY HAVE TO SELL THESE INVESTMENTS AT A DISCOUNT.
No active market exists for some of the companies in which we invest. We
invest in private companies that are not as liquid as investments in public
companies. Additionally, some of our investments may be in restricted or
unregistered stock of U.S. public
14
companies. Moreover, even our investments for which there is an established
market are subject to dramatic fluctuations in their market price. These
illiquidity factors may affect our ability to divest some of our investments
and could affect the value that we recieve for the sale of such investments.
OUR ACQUISITIONS OF AND INVESTMENTS IN FOREIGN COMPANIES SUBJECT US TO
ADDITIONAL MARKET AND LIQUIDITY RISKS WHICH COULD AFFECT THE VALUE OF OUR STOCK.
We have acquired, and may continue to acquire, shares of stock in foreign
public companies. Typically, these foreign companies are not registered with
the SEC and regulation of these companies is under the jurisdiction of the
relevant foreign country. The respective foreign regulatory regime may limit our
ability to obtain timely and comprehensive financial information for the foreign
companies in which we have invested. In addition, if a foreign company in which
we invest were to take actions which could be deleterious to its shareholders,
foreign legal systems may make it difficult or time-consuming for us to
challenge such actions. These factors may affect our ability to dispose of our
foreign investments or realize the full fair value of our foreign investments.
In addition, investments in foreign countries may give rise to complex
cross-border tax issues. We aim to manage our tax affairs efficiently, but given
the complexity of dealing with domestic and foreign tax jurisdictions, we may
have to pay tax in both the U.S. and in foreign countries, and we may be unable
to offset any U.S. tax liabilities with foreign tax credits. If we are unable to
manage our foreign tax issues, our financial condition and the results of
operations and cash flows could be adversely affected.
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 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
15
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, primarily located in Arizona and Nevada.
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 manage growth. If we are
unable to effectively transfer water rights, our liquidity will suffer and our
revenues would decline.
THE MARKET VALUES OF OUR REAL ESTATE AND WATER ASSETS ARE LINKED TO EXTERNAL
GROWTH FACTORS.
The real estate and water assets we hold have market values that are
significantly affected by the growth in population and the general state of the
local economies where our real estate and water assets are located, primarily in
the states of Arizona and Nevada.
In certain circumstances, we finance sales of real estate and water assets,
and we secure such financing through deeds of trust on the property, which are
only released once the financing has been fully paid off.
Purchasers of our real estate and water assets may default on their
financing obligations and the market value of the secured property may be
affected by the factors noted above. Accordingly, such defaults and declines in
market values may have an adverse effect on our business, financial condition,
and the results of operations and cash flows.
IF WE UNDERESTIMATE THE AMOUNT OF INSURANCE CLAIMS, OUR FINANCIAL CONDITION
COULD BE MATERIALLY MISSTATED AND OUR FINANCIAL CONDITION COULD SUFFER.
Our insurance subsidiaries may not have established reserves that are
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, commercial property and casualty,
and workers' compensation 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.
Furthermore, we have reinsurance agreements on all of our insurance books
of business with reinsurance companies. We base the level of reinsurance
purchased on our direct reserves on our assessment of the overall direct
underwriting risk.
We attempt to ensure that we have acceptable net risk, but it is possible
that we may underestimate the amount of reinsurance required to achieve the
desired level of net claims risk.
16
In addition, while we carefully review the creditworthiness of the
companies we have reinsured part, or all, of our initial direct underwriting
risk with, our reinsurers could default on amounts owed to us for their portion
of the direct insurance claim. Our insurance subsidiaries, as direct writers of
lines of insurance, have ultimate responsibility for the payment of claims, and
any defaults by reinsurers may result in our established reserves not being
adequate to meet the ultimate cost of losses arising from claims.
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, 2004
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.
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;
- - 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.
17
FLUCTUATIONS IN THE MARKET PRICE OF OUR COMMON STOCK MAY AFFECT YOUR ABILITY 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, 2004, the closing price
of our common stock on the NASDAQ National Market was $20.77 per share, compared
to $13.24 at December 31, 2002. On a quarterly basis between these two dates,
closing prices have ranged from a high of $22.00 to a low of $12.01.
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 rely on the services of 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.
MANAGEMENT'S USE OF ESTIMATES AND ASSUMPTIONS IN PREPARING FINANCIAL STATEMENTS
IN ACCORDANCE WITH ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES
OF AMERICA.
The preparation of our financial statements in conformity with U.S. GAAP
requires management to make estimates 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 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.
REPURCHASES OF OUR COMMON STOCK COULD HAVE A NEGATIVE EFFECT ON OUR CASH FLOWS
AND OUR STOCK PRICE.
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 a negative impact on our cash flows,
and could result in market pressure to sell our common stock. (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. New accounting pronouncements and varying
interpretations of
18
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.
For example, changes requiring that we record compensation expense in the
statement of operations for stock appreciation rights using the fair value
method, or changes in existing taxation rules related to stock appreciation
rights, could have a significant negative effect on our reported results as a
result of the variability of factors used to establish the fair value of stock
appreciation rights. In December 2004, the Financial Accounting Standards Board
("FASB") issued Statement 123 (Revised) which will take effect from the
beginning of the first interim or annual reporting period that begins after June
15, 2005. SFAS 123 (Revised) will require PICO to re-measure its stock
appreciation rights liability each reporting period from the effective date
using a fair value basis until the awards are settled. This future accounting
treatment could negatively impact our reported earnings.
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. These new or changed laws, regulations and standards are
subject to varying interpretations in many cases due to their lack of
specificity, and as a result, their application in practice may evolve over time
as new guidance is provided by regulatory and governing bodies, which could
result in continuing uncertainty regarding compliance matters and higher costs
necessitated by ongoing revisions to disclosure and governance practices. We are
committed to maintaining high standards of corporate governance and public
disclosure. As a result, our efforts to comply with evolving laws, regulations
and standards have resulted in, and are likely to continue to result in,
increased general and administrative expenses and a diversion of management time
and attention from revenue-generating activities to compliance activities. In
particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of
2002 and the related regulations regarding our required assessment of our
internal controls over financial reporting and our external auditors' audit of
that assessment has required the commitment of substantial financial and
managerial resources. In addition, it has become more difficult and more
expensive for us to obtain director and officer liability insurance, and we have
purchased coverage at substantially higher cost than in the past. We expect
these efforts to require the continued commitment of significant resources.
Further, our board members, chief executive officer, and chief financial officer
could face an increased risk of personal liability in connection with the
performance of their duties. As a result, we may have difficulty attracting and
retaining qualified board members and executive officers, which could harm our
business. If our efforts to comply with new or changes laws, regulations, and
standards differ from the activities intended by regulatory or governing bodies
due to ambiguities related to practice, our reputation could be harmed.
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 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.
19
THE FOREGOING FACTORS, INDIVIDUALLY OR IN AGGREGATE, COULD MATERIALLY ADVERSELY
AFFECT OUR OPERATING RESULTS AND CASH FLOWS AND FINANCIAL CONDITION AND COULD
MAKE COMPARISON OF HISTORIC OPERATING RESULTS AND CASH FLOWS AND BALANCES
DIFFICULT OR NOT MEANINGFUL.
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. Citation leases office space for a claims
office in Orange County, California. Vidler and Nevada Land lease office space
in Carson City, Nevada. HyperFeed leases 15,000 square feet of office space in
Chicago, Illinois, approximately 11,000 square feet of office space at two sites
in Aurora, Illinois, approximately 3,000 square feet of office space in New
York City and approximately 1,300 square feet of office space in San Francisco,
California. Vidler and Nevada Land hold significant investments in land, water
rights and mineral rights in the southwestern United States. We continually
evaluate our current and future space capacity in relation to our business
needs. We believe that our existing facilities are suitable and adequate to meet
our current business requirements. 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 past due. 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
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. 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.
A trial was held in July 2003 concerning both loans. The Company received the
Court's decision in August 2004 and was unsuccessful in its actions. In August
2004, the Company filed an appeal with the Australian Court of Appeal. After
filing the appeal, PICO and the individual who was the majority shareholder of
Dominion Capital entered into a deed of settlement and release agreement. Under
this agreement, both parties have agreed to discharge each other from any
further claims and obligations, including PICO discontinuing its appeal that was
filed in the Australian Court of Appeal.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 2004.
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of PICO is traded on the NASDAQ National Market under the
symbol "PICO." The following table sets out 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.
2004 2003
--------------- ---------------
High Low High Low
------ ------ ------ ------
1st Quarter $16.60 $15.31 $14.39 $12.01
2nd Quarter $19.04 $15.38 $14.37 $12.78
3rd Quarter $19.04 $17.12 $14.04 $12.83
4th Quarter $22.00 $18.57 $16.17 $13.10
On March 9, 2005, the closing sale price of PICO's common stock was $25.21
and there were approximately 686 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
On July 17, 2003, the Company's shareholders approved the PICO Holdings,
Inc. 2003 Stock Appreciation Rights ("SAR") program, which replaced the stock
option and call option programs previously in place. The stock options and call
options held by directors, employees, and consultants were surrendered and,
after shareholders' approval, replaced with SAR with the same exercise price.
There are now no stock options or call options outstanding.
All SAR are fully vested; however, a holder may only exercise a maximum of
20% of the SAR initially received in any twelve month period, except with the
permission of the Company's Compensation Committee. When a SAR is exercised, the
holder will receive a cash payment equal to the difference between the market
value of the underlying stock and the exercise price of the SAR. No shares of
stock are issued.
We believe that the accounting treatment for SAR is more transparent than
for stock options. The change in the "in the money" amount (i.e., the difference
between the market value of PICO stock and the exercise price of the SAR) of SAR
outstanding during each accounting period is recorded through the consolidated
statements of operations. An increase in the "in the money" amount of SAR is
recorded as an expense, and a decrease in the "in the money" amount of SAR will
be recorded as a reduction in expenses. Previously, we disclosed the fair value
of outstanding stock options but, in accordance with GAAP, we did not expense
this value in our statement of operations.
For 2003, a total expense of $6 million before taxes for SAR was recorded,
based on the last sale price of $15.67 for PICO stock on December 31, 2003. This
consists of a $3.5 million charge on the initial adoption of the SAR program on
July 17, 2003, and a $2.5 million expense to record the increase in the "in the
money" amount of SAR during the period from the adoption of the SAR Program
through the end of 2003. The $3.5 million pre-tax charge was one-time in nature,
as it expensed the "in the money" amount of SAR outstanding from the date that
the call options and stock options converted to SAR were originally issued,
through to July 17, 2003. After the related tax effect, the 2003 SAR expense
reduced book value per share by approximately 1.7% as of December 31, 2003.
For 2004, a total expense of $9.9 million before taxes for SAR was
recorded, based on the last sale price of $20.77 for PICO stock on December 31,
2004, and $113,000 in payments for 39,625 SAR exercised during 2004. After the
related tax effect, the cumulative SAR expense reduced book value per share by
approximately 4.2% as of December 31, 2004.
As of December 31, 2004, the Company has a total of 1,923,156 SAR
outstanding, with a weighted average exercise price of $12.59. Of this total,
1,895,656 SAR, with a weighted average exercise price of $12.55, were granted to
the Company's officers. A total of 80,000 SAR remain available for issuance.
21
(c)
(a) NUMBER OF SECURITIES
NUMBER OF SECURITIES TO (b) REMAINING AVAILABLE FOR
BE ISSUED UPON EXERCISE WEIGHTED-AVERAGE EXERCISE FUTURE ISSUANCE UNDER EQUITY
OF OUTSTANDING OPTIONS, PRICE OF OUTSTANDING OPTIONS, COMPENSATION PLANS
WARRANTS AND RIGHTS BY WARRANTS AND RIGHTS GRANTED (EXCLUDING SECURITIES
PLAN CATEGORY OFFICERS TO OFFICERS REFLECTED IN COLUMN (A)
- ---------------------------------- ----------------------- ----------------------------- ----------------------------
Equity compensation plans approved -- -- --
by security holders.(1)
Equity compensation plans not -- -- 41,317
approved by security holders.(2)
--- --- ------
Total -- -- 41,317
=== === ======
(1) On July 17, 2003, the Company's shareholders voted to adopt the PICO
Holdings, Inc. 2003 Stock Appreciation Rights Program (the "SAR Program")
to replace the Company's stock option plans and call option agreements. The
maximum number of SARs issuable under the SAR program may not exceed
2,042,781. 1,962,781 SARs were issued to the prior option holders upon
adoption of the SAR program at an exercise price equal to that of the
surrendered options (weighted average exercise price $12.63). Upon exercise
of the SAR, the holder is entitled to a cash benefit equal to the
difference between the exercise price and the then current market price of
PICO stock. Accordingly, no securities, options or warrants will be issued
by the Company on any exercise of the SAR. (See Stock-Based Compensation
section in Note 1 to the Company's consolidated financial statements
"Nature of Operations and Significant Accounting Policies")
(2) The Directors' and Officers' Deferred Compensation Arrangements are
described in Note 15 to the Company's notes to the consolidated financial
statements. ("Related-Party Transactions")
ISSUER PURCHASES OF EQUITY SECURITIES
(d) Maximum Number
(c) Total Number of Shares (or Approximate Dollar Value)
(or Units) Purchased as Part of Shares (or Units) that May
(a) Total number of (b) Average Price of Publicly Announced Yet Be Purchased Under the
Period shares purchased Paid per Share Plans or Programs (1) Plans or Programs (1)
- ------------------ ------------------- ----------------- ---------------------------- --------------------------------
10/1/04 - 10/31/04 1,185 $19.10
11/1/04 - 11/31/04 -- --
12/1/04 - 12/31/04 -- --
Note: Shares listed above are part of a deferred compensation plan for certain
directors and officers of PICO Holdings, Inc. These deferred compensation plans
are not part of a publicly announced plan and the maximum number of shares to
repurchase is unknown since the election to defer their compensation can be
increased or decreased at any time by the participating directors and officers.
(1) 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, 2004, no stock had been repurchased
under this authorization.
22
ITEM 6. SELECTED FINANCIAL DATA
The following table presents the Company'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,
-------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
OPERATING RESULTS (In thousands, except share data)
Revenues:
Premium income earned (charged) $ (42) $ 980 $ 1,695
Net investment income (loss) $ 9,065 $ 8,116 9,595 1,161 (1,694)
Sale of real estate and water assets 10,879 19,751 15,232 17,106 5,478
Other income 8,183 5,011 4,489 4,313 4,200
----------- ----------- ----------- ----------- -----------
Total revenues $ 28,127 $ 32,878 $ 29,274 $ 23,560 $ 9,679
=========== =========== =========== =========== ===========
Income (loss) before discontinued
operations, and cumulative effect of change
in accounting principle $ (10,636) $ (13,622) $ 1,110 $ 3,778 $ (7,290)
Income from discontinued operations, net 78 10,384 2,834 2,317 953
Cumulative effect of change in accounting
principles, net 1,985 (981) (4,964)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (10,558) $ (3,238) $ 5,929 $ 5,114 $ (11,301)
=========== =========== =========== =========== ===========
PER COMMON SHARE BASIC AND DILUTED:
Income (loss) from continuing operations $ (0.86) $ (1.10) $ 0.09 $ 0.30 $ (0.63)
Income from discontinued operations 0.01 0.84 0.23 0.19 0.08
Cumulative effect of change in accounting
principle 0.16 (0.08) (0.43)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (0.85) $ (0.26) $ 0.48 $ 0.41 $ (0.97)
=========== =========== =========== =========== ===========
Weighted Average Shares Outstanding 12,368,068 12,375,933 12,375,466 12,384,682 11,604,120
=========== =========== =========== =========== ===========
Year Ended December 31,
----------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
FINANCIAL CONDITION (In thousands, except per share data)
Assets (1) $354,631 $330,897 $265,587 $270,742 $295,682
Unpaid losses and loss adjustment expenses $ 55,944 $ 60,864 $ 52,703 $ 61,538 $ 84,384
Bank and other borrowings (1) $ 18,021 $ 15,377 $ 14,636 $ 14,596 $ 15,550
Discontinued operations, net (liabilities) assets $ (752) $ (1,351) $ 37,332 $ 33,266 $ 29,255
Total liabilities and minority interest (1) $113,942 $ 99,566 $ 81,888 $ 96,110 $122,802
Shareholders' equity $239,929 $229,160 $221,032 $207,899 $202,105
Book value per share $ 19.40 $ 18.52 $ 17.86 $ 16.81 $ 16.31
Note: Book value per share is computed by dividing shareholders' equity by the
net of total shares issued less shares held as treasury shares.
(1) Excludes balances classified as discontinued operations.
23
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, 2004, including Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations," reflect the effects of:
(1) presenting Sequoia Insurance Company and two businesses sold by HyperFeed
Technologies, Inc. as discontinued operations. See Note 2 of Notes to
Consolidated Financial Statements, "Discontinued Operations"; and
(2) presenting HyperFeed Technologies, Inc. as a separate segment beginning May
15, 2003. See Note 4 of Notes To Consolidated Financial Statements,
"Consolidation of HyperFeed Technologies, Inc."
COMPANY SUMMARY, RECENT DEVELOPMENTS, AND FUTURE OUTLOOK
VIDLER WATER COMPANY, INC.
BACKGROUND
We believe that continuing trends in Nevada and Arizona indicate strong
future demand for Vidler's water rights and water storage assets.
Based on census figures, in the three years ended July 1, 2003, the
population of Clark County, Nevada, which includes metropolitan Las Vegas,
increased 14.6% to almost 1.6 million residents. Around 70,000 people are moving
to the area annually. Currently Las Vegas takes most of its water supply from
Lake Mead. Due to the continued growth in demand for water and 5 years of
drought, the level of Lake Mead has reached 50 year lows. Accordingly, Las Vegas
is aggressively seeking to conserve water (e.g., rules have been introduced
restricting water use in new homes) and to diversify its sources of water
supply. At the same time, the increasing cost of housing in Las Vegas is leading
to more rapid growth in outlying areas within commuting distance.
Over time, we believe that these factors will lead to demand for water in
parts of southern Nevada where Vidler owns or has an interest in water rights,
including southern Lincoln County/northern Clark County and Sandy Valley and
Muddy River in Clark County. If growth management initiatives are introduced in
Las Vegas, this will lead to even more rapid growth in the areas surrounding
metropolitan Las Vegas.
In Arizona, the continued growth of the municipalities surrounding Phoenix
in Maricopa County is likely to lead to strong demand for Vidler's water rights
in the Harquahala Valley. According to census estimates, the population of
Maricopa County increased 9.5% in the three years to July 1, 2003, to almost 3.4
million residents. Many of the municipalities surrounding Phoenix/Scottsdale
where the growth is concentrated, do not receive allotments of water from the
Colorado River, and are therefore forced to find alternative supplies of water.
Due to the low level of Lake Mead, the states of Arizona, California, and
Nevada may be required to take no more than their current allotments of water
from the Colorado River. This is likely to increase demand for the net recharge
credits owned by Vidler, representing water which Vidler has in storage in its
Arizona Recharge Facility. We also anticipate demand from developers and other
entities to store water for various purposes, including back-up water supply for
dry years by developers, and assured water supply for new development projects.
The Central Arizona Water Conservation District ("CAWCD") is a three-county
water district servicing the most populous parts of the state, including
Maricopa County. A 2003 CAWCD study predicted that CAWCD will be able to use 9
million acre-feet of water from Arizona's Colorado River supplies in the years
from 2004 through 2050, assuming average annual precipitation. The CAWCD also
estimated that 8.6 million acre-feet will be required over the same period by
the Central Arizona Groundwater Replenishment District, the authority
responsible for protecting groundwater supplies in the CAWCD three-county
service area. The CAWCD also estimated demand of 3.5 million acre-feet from the
Arizona Water Bank for various purposes (e.g., use in Nevada), and a further 4.3
million acre-feet to replenish groundwater reserves. Based on these forecasts,
Arizona appears to be faced with a shortfall of 7.4 million acre-feet of water
in the period through 2050, which will require CAWCD to purchase additional
supplies.
24
The Southern Nevada Water Authority has released a master water resource
plan (which can be viewed at www.snwa.com) to develop and deliver water supplies
to meet regional growth demands. This plan consists of (1) the storage of water,
including up to 1.25 million acre-feet in Arizona, combined with (2) the
development of further water resources in Nevada. We believe that Vidler's
assets are favorably positioned to contribute to the water resource solutions
required in the Southwest.
WATER RIGHTS
ARIZONA
At December 31, 2004, Vidler owned or had the right to acquire
approximately 45,064 acre-feet of transferable ground water in the HARQUAHALA
VALLEY, approximately 75 miles northwest of metropolitan Phoenix, Arizona.
Vidler owns 35,699 acre-feet, and we have the option to purchase a further 9,365
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, the population of Maricopa County
increased 9.5% in the three years ended July 1, 2003, with the addition of
approximately 97,000 people per year. 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 Harquahala Valley 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.
The Arizona State Legislature has passed several pieces of legislation
which recognize the Harquahala Valley ground water as a future municipal supply
for the greater 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.
In 2001 and 2002, Vidler completed its first sales of Harquahala Valley
ground water for industrial use and municipal use:
- - in March 2001, Vidler sold 6,496.5 acre-feet of water rights and 2,589
acres of land to an industrial user, for $9.4 million;
- - in March 2002, Vidler sold 3,645 acre-feet of water rights and 1,215 acres
of land to golf course developers near Scottsdale, for $5.2 million; and
- - in May 2002, Vidler sold 480 acre-feet of water rights and 240 acres of
land to an industrial user, for $1 million.
Vidler is working on further sales of Harquahala Valley ground water. We
expect demand from communities and developers in the greater Phoenix
metropolitan area who need to secure further water to support expected growth.
In addition, as the boundaries of the greater Phoenix metropolitan area push
out, this is likely to lead to demand for water to support growth within the
Harquahala Valley itself.
NEVADA
Vidler has acquired water rights in northern Nevada through the purchase of
ranch properties, filing applications for new water rights, and entering into
partnering arrangements 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.
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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 with the intention
of supplying water for residential, commercial, and industrial use, as
contemplated by the County's approved master plan. 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 and northern Clark County.
Under the Lincoln County Land Act, more than 13,300 acres of federal land
in southern Lincoln County near the fast growing City of Mesquite was offered
for sale on February 9, 2005. According to press reports, the eight parcels
offered sold to various developers for approximately $47.5 million. The land was
sold without environmental approvals, water, and city services, which will be
required before development can proceed. Additional water supply will be
required in Lincoln County 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/Vidler pursues additional studies. In 2001,
Lincoln/Vidler 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. Energy companies and utilities are currently reviewing the
project.
The Lincoln County undertaking is an example of a transaction where Vidler
can partner with an entity, in this case a government entity, to provide the
necessary capital and skills to commercially develop water assets, thereby
providing a significant economic benefit to the partner where one previously did
not exist.
COYOTE SPRINGS
The Coyote Springs community is a planned mixed-use development to be
located approximately 40 miles north of Las Vegas, at the junction of U.S.
Highway 93 and State Highway 168. Coyote Springs is the largest privately-held
property for development in southern Nevada. The developer, Coyote Springs
Investment, LLC ("CSIL"), has received entitlements for approximately 50,000
residential units, 6 golf courses, and 1,200 acres of retail and commercial
development on 13,100 acres in Clark County. CSIL expects to receive additional
entitlements for its 29,800 acres in Lincoln County. Based on the entitlements
obtained so far, it is estimated that the community will require approximately
35,000 acre-feet of permanent water. Additional water will be required as
further entitlements are obtained. It is expected that full absorption of the
residential units will take 25 years or more.
Pardee Homes has agreed to be the master residential developer on the first
phase of the development. Construction of a golf course has begun, and CSIL has
stated that the first houses should start going up in 2007.
During 2004, Vidler entered into a partnership with CSIL to supply various
water resources required to support the development. We anticipate that Lincoln
County/Vidler could provide the majority of the water required for the project
from jointly filed applications for water rights in various basins in Lincoln
County. To provide water until permitted supplies are available, the Vidler/CSIL
partnership could use net recharge credits owned by Vidler in the Vidler Arizona
Recharge Facility, subject to approval by the relevant Nevada and Arizona water
authorities.
The Coyote Springs project is an example of how Vidler's water rights in
Nevada and water storage facility in Arizona could potentially interact to
provide water solutions in southern Nevada.
2. SANDY VALLEY, NEVADA
In June 2002, the Nevada State Engineer awarded Vidler 415 acre-feet of
water rights near Sandy Valley, Nevada. Vidler has filed another application for
1,000 acre-feet.
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The water rights awarded to Vidler are the only known water to support
future growth in Sandy Valley and surrounding areas in southwestern Nevada near
the California state line, including Primm, Nevada. Primm is a resort town on
the border between California and Nevada, in the Interstate 15 corridor. Primm
requires additional water to support future growth, which could result from
expansion of the existing hotel/casino and retail/commercial operations.
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; however,
in the future, we anticipate that Muddy River water rights may be utilized to
support development in southern Nevada. The Southern Nevada Water Authority has
been acquiring Muddy River water rights as a water resource to support future
growth in Clark County, Nevada.
At December 31, 2004, Vidler owned approximately 221 acre-feet of Muddy
River water rights, and had the right to acquire an additional 45.6 acre-feet.
4. FISH SPRINGS RANCH
In 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. The Nevada State
Demographer estimates that, in the three years ended July 1, 2004, the
population of Washoe County (including Reno/Sparks) increased by 8.6% to
approximately 383,000 people.
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 Valley's 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 ground water 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 AND WEST WENDOVER, NEVADA
In December 2003, Vidler closed on the sale of approximately 37,500 acres
of deeded ranch land and the related water rights at Big Springs Ranch for $2.8
million. The ranch land was located approximately 65 miles east of Elko, in
northeastern Nevada.
In December 2003, in a separate but related transaction, Vidler closed on
the sale of approximately 6,500 acres of developable land near West Wendover,
Nevada for $12 million. West Wendover is adjacent to the Nevada/Utah border in
the Interstate 80 corridor. The land at West Wendover was acquired in 1999
through a land exchange with the Bureau of Land Management, under which Vidler
gave up approximately 70,500 acres of ranch land at Big Springs Ranch in return
for the parcels of developable land.
The assets at Big Springs Ranch and West Wendover were different in nature
from Vidler's remaining assets in Arizona and Nevada, in that the land comprised
the bulk of the value of Big Springs Ranch and West Wendover, with the water
rights being a lesser component.
27
COLORADO
Vidler is completing the process of monetizing its water rights in
Colorado, through sale or lease:
- - in 2000, Vidler closed on 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 $145,000 in 2002, $146,000 in
2003, and $142,000 in 2004. If the remaining options are exercised, the
present value of the aggregate purchase price is approximately $1.1
million;
- - during 2002, Vidler closed on the sale of its interest in Cline Ranch for
$2.1 million and the sale of 86 acre-feet of water rights for $3.1 million;
- - in 2003, Vidler closed on the sale of the Wet Mountain water rights for
$414,000; and
- - in 2004, Vidler closed on the sale of approximately 6.5 acre-feet of water
rights for $266,000 to residential users in Summit County, Colorado.
Discussions are continuing to either lease or sell the remaining water rights in
Colorado, which are listed in the table in the Vidler section of Item 1,
"Business."
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
Colorado River 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.
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. At the end of 2004, Vidler had "net recharge credits"
representing approximately 63,000 acre-feet of water in storage at the facility,
and had purchased a further 3,250 acre-feet which was recharged in 2005. In
addition, Vidler has ordered another 35,750 acre-feet for purchase and recharge
in 2005. Vidler purchased the water from the CAP, and intends to resell this
water at an appropriate time.
Subject to approval by water authorities in Nevada and Arizona, Vidler
could supply net recharge credits to the Coyote Springs project. Vidler is in
discussions with a number of developers and other entities which, combined with
the Coyote Springs partnership, could lead to the sale of all of Vidler's net
recharge credits.
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If customers which already own water want to store it at Vidler's site, we
intend to charge a fee based on the amount of water "recharged," and then an
additional fee when the water is "recovered." The storage revenues generated
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 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 1.25 million acre-feet of water to be stored
in Arizona in order to meet forecast demand. 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.
Under an agreement which expired in 2004, Vidler had agreed on a price of $48.00
per acre-foot of water recharged for users represented by the AWBA.
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.
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 35,000 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 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.
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.
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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. Vidler is required to make annual payments of
approximately $530,000 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 southwestern states. We have the resources and
relationships to respond to new business opportunities which are consistent with
our strategic objectives.
NEVADA LAND & RESOURCE COMPANY, LLC
The majority of Nevada Land's revenues come from the sale of land and the
related water rights. In addition, various types of recurring revenue are
generated from use of the Nevada Land's properties, including leasing,
easements, and mineral royalties. Nevada Land also generates interest revenue
from land sales contracts where Nevada Land has provided partial financing, and
from temporary investment of the proceeds of land 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 2004, Nevada Land generated $10.5 million in revenues from the sale of
approximately 121,000 acres of former railroad land. The average sales price of
$87 per acre compares to our average basis of $35 per acre in the parcels which
were sold. In 2004, 40.1% of land sales were settled for cash, and Nevada Land
provided partial financing for the remainder. Vendor financing is collateralized
by the land conveyed, typically carries a 10% interest rate, and is subject to a
minimum 20% down payment.
In 2004, land sales were significantly higher than in recent years. The
$10.5 million in total sales consisted of 33 individual sales transactions,
reflecting demand for various types of land with various uses, including
rural-suburban-urban living, desert lands, and ranching.
During 2004, the market for many types of real estate in Nevada was
buoyant. We believe that higher prices for land in and around municipalities has
increased the demand for, and in some locations the price of, property 50 miles
or more from municipalities, which our lands typically are. It can take a year
or more to complete a land sale transaction, the timing of land sales is
unpredictable, and historically the level of land sales has fluctuated from year
to year. Accordingly, it should not be assumed that the higher level of sales in
2004 can be maintained.
BUSINESS ACQUISITIONS AND FINANCING
This section describes the most significant interests in public companies
included in this segment during 2004.
Excluding HyperFeed, we estimate that the common stock interests in public
companies reported in this segment generated a total return (i.e., realized and
unrealized gains, plus dividends received, in U.S. dollars) of approximately 39%
in 2004, compared to approximately 29% in 2003.
CONVERSION OF SWISS FRANC AMOUNTS TO U.S. DOLLARS
Income statement items (revenues, expenses, gains, and losses) for foreign
operations are translated into U.S. dollars using the average rate of exchange
for the year, and balance sheet items (assets and liabilities) are translated at
the actual exchange rate at the balance sheet date.
30
For the convenience of the reader, the average Swiss Franc exchange rate
for 2004 used for income statement items was CHF1.2279 to the U.S. dollar (2003:
CHF1.3280), and the actual Swiss Franc exchange rate at December 31, 2004 used
for balance sheet items was CHF1.1395 (December 31, 2003: CHF1.2402).
1. HYPERFEED TECHNOLOGIES, INC.
In 2001, 2002, and 2003 until May 15, PICO's investment in HyperFeed common
shares was recorded in this segment using the equity method under Accounting
Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for
Investments in Common Stock." Since May 15, 2003, when HyperFeed became a
consolidated subsidiary, its results have been recorded in a separate segment,
"HyperFeed Technologies"; however, PICO's investment in HyperFeed warrants is
still recorded in the Business Acquisitions and Financing segment.
After adjusting for HyperFeed's 1:10 reverse stock split in August 2003,
PICO holds warrants to buy approximately 310,616 shares of HyperFeed common
stock at an average price of $15.75 per share, exercisable by April 2005. At
December 31, 2004, the price of HyperFeed's common stock was $2.70, and the
warrants were carried at estimated fair value of zero.
2. JUNGFRAUBAHN HOLDING AG
PICO owns 1.3 million shares (adjusted for the 10:1 stock split during
2004) of Jungfraubahn, which represents approximately 22.3% of that company. At
December 31, 2004, the market (carrying) value of our holding was $40.8 million.
In September 2002, we increased our holding to more than 20% of
Jungfraubahn, and became the largest shareholder in that company. 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 2005, Jungfraubahn issued a press release containing an initial
review of 2004 operations, using Swiss accounting principles. The full text is
available on Jungfraubahn's website www.jungfraubahn.com. The contents of
Jungfraubahn's website are not incorporated in this 10-K.
In the press release, Jungfraubahn indicated that it expected passenger
traffic revenues of approximately CHF (Swiss Francs) 89.6 million (US$73
million) for 2004, a 4% increase year over year, and a financial "result similar
to that of the previous year." Jungfraubahn went on to say that the "2004/2005
winter season is progressing positively" with a 9.1% increase in guests in the
Jungfrau region through to the end of January 2005, and that forward bookings
from tour operators put the company in a "confident mood for the summer season."
In August 2004, Jungfraubahn announced its results for the six months to
June 30, 2004. Reported revenues were CHF 56.3 million (US$44.9 million). Net
income was CHF 5.4 million (US$4.2 million), or approximately CHF 0.93 per share
(US$0.74), a 23% increase year over year.
Jungfraubahn announced its results for the 2003 financial year in May 2004,
so the 2004 results will not be released until after this 10-K has been filed.
Revenues were CHF 111.9 million (US$84.2 million), and net income was CHF 13.5
million (US$10.1 million), or CHF 2.3 per share (US$1.74). Jungfraubahn's
operating activities generated net cash flow of CHF 31.1 million (US$23.5
million).
In the most recent published balance sheet -- December 31, 2003 --
Jungfraubahn had shareholders' equity of CHF 309.8 million, or approximately CHF
53.1 (US$42.80) book value per share. At December 31, 2004, Jungfraubahn's stock
price was CHF 35.5 (US$ 31.15). At December 31, 2003, Jungfraubahn's stock price
was CHF 25.4 (US$ 20.48).
3. OTHER EUROPEAN INVESTMENTS
RAETIA ENERGIE AG
PICO owns approximately 80,000 shares in Raetia Energie, which is a
producer of hydro electricity. At December 31, 2004, our investment in Raetia
Energie had a basis of $4.2 million, and a market value of $17.2 million.
31
We first purchased this stock in 1997, increased our holding in 1998, 2002
& 2003, and sold part of our holding in 2004. Over the life of the investment so
far, we have generated a total return (i.e., realized and unrealized gains, plus
dividends received in U.S. dollars) upwards of 325%.
During 2003, the carrying value of our holding appreciated by $5.8 million
(almost 105%) in U.S. dollars. In 2004, our holding in Raetia generated a total
return of $6.5 million (almost 58%), consisting of approximately $6.3 million in
realized and unrealized gains, and $194,000 in dividends.
ACCU HOLDING AG
PICO has acquired 29,294 shares in Accu Holding, which represents a voting
ownership interest of approximately 29.2%. 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. Following
a decline in demand for batteries during the 2001-2003 economic slowdown, Accu
adjusted its production and cost structure. Accu is also preparing to redevelop
the site of a former factory near Zurich, which could have significant value.
Our initial holding (14,164 shares) in Accu had a cash cost of
approximately $5 million. During 2004, we subscribed for our full entitlement
in, and partly underwrote, a 1:1 rights offering at CHF100 per share, acquiring
an additional 15,130 shares for approximately $1.2 million.
The Accu stock price declined significantly during 2002, 2003, and 2004. As
explained in the Business Financing and Acquisitions portion of "Results of
Operations -- Years Ended December 31, 2004, 2003, and 2002," we regularly
review stocks which have declined in price from our cost. If we determine that
the decline in market value is other-than-temporary, we record a charge which
writes our basis in the investment 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 charges for
other-than-temporary impairments do not affect shareholders' equity or book
value per share, since the after-tax decline in the market value of investments
carried under SFAS No. 115 is already reflected in shareholders equity in our
balance sheet. Also, the carrying (book) value of the holding does not change.
If the stock price subsequently recovers, the basis does not change.
Given the extent and duration of the decline in the market price of Accu
stock, we determined that the decline in Accu's market value is also
other-than-temporary. Accordingly, we recorded pre-tax charges for
other-than-temporary impairment of our holding in Accu of $2.2 million in 2002,
$823,000 in 2003, and $1.3 million in 2004. These charges were recorded as
realized losses and reduced the basis of the investment. At December 31, 2004,
the holding had a basis of $2.7 million, and a market (carrying) value of $3
million (CHF3.4 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. Our investment in SIHL is accounted for under SFAS No. 115.
At the time, SIHL's core business was digital imaging, but the company had
surplus property assets in and around Zurich, including a major development
project known as Sihlcity. 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 2003, SIHL sold its
core business, and announced a debt restructuring with its banks. Although there
is no longer a public trading market for SIHL, the agreement with the banks
provides the shareholders with a partial return in certain circumstances.
Due to the extent and duration of the decline in the market value of SIHL
stock, we recorded pre-tax charges for other-than-temporary impairment of our
holding in SIHL of $1.6 million in 2002, and $293,000 in 2003. A $547,000 charge
for permanent impairment in 2004 reduced our basis in SIHL to zero at December
31, 2004.
INSURANCE OPERATIONS IN RUN OFF
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.
32
In broad terms, Physicians and Citation hold cash and fixed-income
securities corresponding to their loss reserves and state capital & deposit
requirements, and the excess is invested in small-capitalization value stocks in
the U.S. and selected foreign markets.
Given the very low level of interest rates, we expect to generate limited
income and no capital gains from our bond holdings. To maintain liquidity and to
guard against capital losses which would be brought on by higher interest rates,
our bond holdings are concentrated in issues maturing in 5 years or less. At
December 31, 2004, the duration of Citation's bond portfolio was 4.0 years, and
the duration of the Physicians bond portfolio was 2.7 years. The duration of a
bond portfolio measures the amount of time it will take for the cash flows from
scheduled interest payments and the maturity of bonds to equal the current value
of the portfolio. Duration 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 2002, 2003, and 2004, 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. Duration of less
than 5 years is generally regarded as medium term, and less than 3 years is
generally regarded as short term.
Typically, we hold bonds issued by the U.S. Treasury and
government-sponsored enterprises (e.g., Freddie Mac and FNMA) only to the extent
required for capital under state insurance codes, or as required for deposits or
collateral with state regulators. Otherwise, the bond portfolios consist almost
entirely of investment-grade corporate issues with 10 or less years to maturity.
As of December 31, 2004, none of our bond holdings had declined significantly
from cost. We do not own any municipal bonds, and did not own any corporate
bonds in the telecommunications, technology, utilities, energy trading,
automotive, and consumer finance sectors, or conglomerates which experienced
difficulties in recent years.
The equities component of the insurance company portfolios is concentrated
on a limited number of asset-rich 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). The insurance company portfolios also have a
degree of international diversification through holdings of small-capitalization
value stocks in New Zealand and Australia, and selected large-capitalization
resource stocks with world class mining operations in foreign countries.
Dividends and realized gains or losses from stocks held in the insurance company
portfolios are reported in the Insurance Operations in Run Off segment.
During 2004 and January 2005, we sold our holdings in the shares of
Keweenaw Land Association, Limited (Pink Sheets: KEWL). Keweenaw owns
approximately 155,000 acres of northern hardwood timberlands on the Upper
Peninsula of Michigan, including some acreage with a higher and better use than
timberland. The Keweenaw stock price increased 55% in 2003, and 35% in 2004. We
had been accumulating shares of Keweenaw since 1998, and earned a total return
over the life of the investment of better than 20% per annum.
In 2004, we estimate that the total return on the fixed-income securities
and unaffiliated common stocks in Citation's portfolio was approximately 22.0%,
including approximately 44% for the stocks component (53.7% of the portfolio at
December 31, 2004). We estimate that the total return on the fixed-income
securities and unaffiliated common stocks in Physicians' portfolio was
approximately 25.5% in 2004, including approximately 41% for the stocks
component (64.3% of the portfolio at December 31, 2004).
In 2003, we estimate that the total return on the fixed-income securities
and unaffiliated common stocks in Citation's portfolio was approximately 19.6%,
including better than 40% for the stocks component (40.7% of the portfolio at
December 31, 2003). We estimate that the total return on the fixed-income
securities and unaffiliated common stocks in Physicians' portfolio was
approximately 21.5% in 2003, including better than 39% for the stocks component
(53.7% of the portfolio at December 31, 2003).
Over time, the investment assets and investment income of a "run off"
insurance company is expected to decline, as fixed-income investments mature or
are sold to provide the funds to pay down the company's claims reserves.
However, since the sale of Sequoia closed on March 31, 2003, the investment
assets of the Insurance Operations in Run Off segment have actually increased,
as appreciation in stocks has more than offset the maturity or sale of
fixed-income securities to pay claims.
The financial results of insurance companies in "run off" can be volatile
if there is favorable or unfavorable development in the loss reserves. For
example, in 2003 Physicians recorded significant income from favorable reserve
development, but Citation recorded a significant loss in 2003, partly due to
increases in the workers' compensation and property and casualty insurance loss
reserves.
33
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 reviewed by management every quarter and are
assessed 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.
At December 31, 2004, medical professional liability reserves totaled $16.4
million, net of reinsurance, compared to $19.6 million net of reinsurance at
December 31, 2003, and $30.3 million net of reinsurance at December 31, 2002.
PHYSICIANS INSURANCE COMPANY OF OHIO - LOSS AND
LOSS ADJUSTMENT EXPENSE RESERVES
Year Ended December 31,
---------------------------------------------
2004 2003 2002
------------- ------------- -------------
Direct Reserves $19.6 million $23.6 million $36.4 million
Ceded Reserves (3.2) (4.0) (6.1)
------------- ------------- -------------
Net Medical Professional Liability Insurance Reserves $16.4 million $19.6 million $30.3 million
============= ============= =============
At December 31, 2004, 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 $18.3 million,
and the highest direct reserve calculation was $21.3 million. Consequently, our
loss reserves could differ depending on the particular method of calculation
chosen.
Changes in assumptions about future claim trends, and the cost of handling
claims, could 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 referred to as adverse or
unfavorable.
At December 31, 2004, approximately $7.5 million, or 38% of our direct
reserves were case reserves, which are the loss reserves established when a
claim is reported to us. Our provision for incurred but not reported claims
("IBNR", i.e., the event giving rise to the claim has allegedly occurred, but
the claim has not been reported to us) was $7.6 million, or 39% of our direct
reserves. The loss adjustment expense reserves, totaling $4.5 million, or 23% of
direct reserves, recognize the cost of handling claims over the next 12 years
while Physicians' loss reserves run off.
34
Over the past 3 years, the trends in open claims and claims paid have been:
Year Ended December 31,
------------------------------------
2004 2003 2002
---------- ---------- ----------
Open claims at the start of the year 68 144 179
New claims reported during the year 11 22 24
Claims closed during the year -38 -98 -59
---------- ---------- ----------
Open claims at the end of the year 41 68 144
========== ========== ==========
Total claims closed during the year 38 98 59
Claims closed with no indemnity payment -22 -91 -36
---------- ---------- ----------
Claims closed with an indemnity payment 16 7 23
Net indemnity payments $1,778,000 $3,048,000 $2,473,000
Net loss adjustment expense payments 898,000 912,000 1,072,000
---------- ---------- ----------
Total claims payments during the year $2,676,000 $3,960,000 $3,545,000
========== ========== ==========
Average indemnity payment $ 111,000 $ 435,000 $ 108,000
PHYSICIANS INSURANCE COMPANY OF OHIO - CHANGE IN LOSS AND
LOSS ADJUSTMENT EXPENSE RESERVES
Year Ended December 31,
--------------------------------------------------
2004 2003 2002
--------------- --------------- --------------
Beginning Reserves $ 19.6 million $ 30.3 million $ 34.9 million
Loss & Loss Adjustment Expense Payments (2.7) (4.0) (3.6)
Re-estimation of Prior Year Loss Reserves (0.5) (6.7) (1.0)
--------------- --------------- --------------
Net Medical Professional Liability Insurance Reserves $ 16.4 million $ 19.6 million $ 30.3 million
=============== =============== ==============
Re-estimation as a percentage of undiscounted beginning reserves - 2.5% - 22.1% - 2.9%
=============== =============== ==============
During 2004, our medical professional liability insurance claims reserves,
net of reinsurance, decreased by $3.2 million, from $19.6 million to $16.4
million. Claims and loss adjustment expense payments for the year were
approximately $2.7 million, accounting for 84% of the net decrease in reserves.
During 2004, Physicians continued to experience favorable trends in the
"severity" (size) of claims, and, to a lesser extent, the "frequency" (number)
of claims. Consequently, independent actuarial analysis of Physicians' loss
reserves concluded that Physicians' reserves against claims were greater than
the actuary's projections of future claims payments. Reserves were reduced in 16
of Physicians' 20 accident years from 1976 until 1996, resulting in a net
reduction of approximately $489,000, or 2.5% of reserves at the start of the
year.
The net reduction in reserves of approximately $489,000 was primarily due
to a decrease in claims severity. Physicians reduced its reserve for IBNR claims
by approximately $403,000, and decreased its provision for unallocated loss
adjustment expense (which effectively recognizes the cost of handling
Physicians' claims over the remaining run off) by $86,000.
As shown in the table above, in 2004 Physicians made $1.8 million in net
indemnity payments to close 16 cases, an average indemnity payment of $111,000
per case. Total claims payments in 2004 were less than anticipated, and the
average indemnity payment returned to more typical levels than in 2003. At
December 31, 2004, the average case reserve per open claim was approximately
$181,000.
There were no changes in key actuarial assumption in 2004. 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."
During 2003, our medical professional liability insurance claims reserves,
net of reinsurance, decreased by $10.7 million, from $30.3 million to $19.6
million. Claims and loss adjustment expense payments for the year were
approximately $4 million, accounting for 37% of the net decrease in reserves.
During 2003, Physicians continued to experience favorable trends in the
"severity" (size) of claims, and, to a lesser extent, the "frequency" (number)
of claims. Consequently, independent actuarial analysis of Physicians' loss
reserves concluded that Physicians' reserves against claims were significantly
greater than the actuary's projections of future claims
35
payments. Reserves were reduced in all of Physicians' 20 accident years from
1976 until 1996, resulting in a net reduction of approximately $6.7 million, or
22.1% of reserves at the start of the year.
In 2003 Physicians made $3 million in net indemnity payments to close 7
cases, an average indemnity payment of $435,000 per case. Although total claims
payments in 2003 were less than anticipated, the average indemnity payment was
higher than in 2002 and our future projection, due to the mix of cases closed in
2003. There were no changes in key actuarial assumptions in 2003.
During 2002, our medical professional liability insurance claims reserves,
net of reinsurance, decreased $3.6 million, from $34.9 million to $30.3 million.
Loss and loss adjustment expense 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 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. There were no changes in key actuarial assumption in
2002.
Since it is almost nine years since Physicians wrote its last policy, and
the direct IBNR claims reserve at December 31, 2004 is $11.8 million ($10.9
million net of reinsurance), it is conceivable that further favorable
development could be recorded in future years if claims trends remain favorable,
particularly claims severity. However, given that favorable development of $6.7
million was recognized in 2003 and $503,000 in 2004, there is less potential for
favorable development in future years than there has been in the past. In
addition, 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
PROPERTY AND CASUALTY INSURANCE LOSS RESERVES
Citation went into "run off" from January 1, 2001. At December 31, 2004,
after four years of "run off," Citation had $10.2 million in property and
casualty insurance loss and loss adjustment expense reserves, after reinsurance.
Approximately 99.5% of Citation's net property and casualty insurance
reserves are related to one line of business, artisans/contractors liability
insurance. The remaining 0.5% is comprised of commercial property and casualty
insurance policies, all of which expired in 2001. As a general rule, based on
state statutes of limitations, we believe that no new commercial property and
casualty insurance claims can be filed in California and Arizona, although in
these states claims filing periods may be extended in certain limited
circumstances.
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, 2003, and 2004
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 Citation'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, AIE
claims are shared among more than one subcontractor and more than one insurance
carrier. This reduces the expense to any one carrier, so AIE claims typically
involve smaller claims payments than claims from actual policyholders.
36
Although Citation wrote its last artisans/contractors policy in 1995 and
the statuto 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,
-----------------------
2004 2003 2002
---- ---- ----
Open claims at the start of the year 317 290 303
New claims reported during the year 183 290 227
Claims closed during the year -283 -263 -240
---- ---- ----
Open claims at the end of the year 217 317 290
==== ==== ====
Total claims closed during the year 283 263 240
Claims closed with no payment -158 -106 -90
Claims closed with LAE payment only (no indemnity payment) -39 -40 -40
---- ---- ----
Claims closed with an indemnity payment 86 117 110
==== ==== ====
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 regularly reviewed, and certified annually by an independent
actuarial firm, 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.
Changes in assumptions about future claim trends and the cost of handling
claims can lead to significant increases and decreases in our property and
casualty 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. In 2000 and 2001,
reserve changes were less than 1% of beginning reserves. In 2002, primarily due
to reduced severity of claims as described in preceding paragraphs, Citation
reduced reserves by $889,000, representing a 4.6% change in beginning reserves.
However, in 2003 Citation increased reserves by $847,000, or 5.8% of beginning
reserves, primarily due to the increased number of new claims received (higher
frequency). In 2004, we reduced reserves by $254,000, or 1.9% of beginning
reserves, principally due to reduced severity of claims.
There were no changes in key actuarial assumptions during 2002, 2003, and
2004. See "Critical Accounting Policies" and "Risk Factors."
At December 31, 2004, Citation's net property and casualty reserves were
carried at $10.2 million, approximately equal to the actuary's best estimate.
CITATION INSURANCE COMPANY - PROPERTY & CASUALTY INSURANCE LOSS AND LOSS
ADJUSTMENT EXPENSE RESERVES
December 31, 2004 December 31, 2003 December 31, 2002
----------------- ----------------- -----------------
Direct Reserves $11.6 million $14.8 million $16.3 million
Ceded Reserves (1.4) (1.5) (1.7)
----- ----- -----
Net Reserves $10.2 million $13.3 million $14.6 million
===== ===== =====
At December 31, 2004, $1.6 million of Citation's net property and casualty
reserves (approximately 16%) were case reserves, $3.5 million represented
provision for IBNR claims (33%), and the loss adjustment expense reserve was
$5.1 million (51%).
37
The change in Citation's reserves over the past 3 years has resulted from:
CITATION INSURANCE COMPANY - CHANGE IN PROPERTY & CASUALTY INSURANCE LOSS AND
LOSS ADJUSTMENT EXPENSE RESERVES
Year Ended December 31,
---------------------------------------------
2004 2003 2002
------------- ------------- -------------
Beginning Reserves $13.3 million $14.6 million $19.2 million
Loss & Loss Adjustment Expense Payments (2.8) (2.2) (3.7)
Incurred Loss & Loss Adjustment Expense Payments For Current Year
Re-estimation of Prior Year Loss Reserves (0.3) 0.9 (0.9)
----- ----- -----
Net Property & Casualty Insurance Reserves $10.2 million $13.3 million $14.6 million
===== ===== =====
Re-estimation as a percentage of beginning reserves - 1.9% + 5.8% - 4.6%
===== ===== =====
During 2004, Citation's property and casualty insurance claims reserves,
net of reinsurance, decreased from $13.3 million to $10.2 million. Claims
payments for the year were $2.8 million. Following actuarial analysis during
2004, Citation decreased loss reserves by $254,000 due to favorable development
in the artisans/contractors book of business resulting from decreased claims
severity.
During 2003, Citation's property and casualty insurance claims reserves,
net of reinsurance, decreased from $14.6 million to $13.3 million. Claims
payments for the year were $2.2 million. Following actuarial analysis during
2003, Citation increased loss reserves by $847,000 due to adverse development in
the artisans/contractors book of business resulting from an increased frequency
of new claims.
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 Citation's loss
reserves as of December 31, 2002 showed a redundancy in the carried reserves of
Citation, which we reduced during 2002 by $889,000. The reserve redundancy
reflected a reduction in the "severity" (size) of claims.
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.
WORKERS' COMPENSATION LOSS RESERVES
Until 1997, Citation was a direct writer of workers' compensation insurance
in California, Arizona, and Nevada. In 1997, Citation reinsured 100% of its
workers' compensation business with a subsidiary, Citation National Insurance
Company ("CNIC"), and sold CNIC to Fremont Indemnity Company ("Fremont"). As
part of the sale of CNIC, all assets and liabilities, including the assets which
corresponded to the workers' compensation reserves reinsured with CNIC, and all
records, computer systems, policy files, and reinsurance arrangements were
transferred to Fremont. Fremont merged CNIC into Fremont, and administered and
paid all of the workers' compensation claims which had been sold to it. From
1997 until the second quarter of 2003, Citation booked the losses reported by
Fremont but recorded an equal and offsetting reinsurance recoverable from
Fremont (as an admitted reinsurer) for all losses and loss adjustment expenses.
This resulted in no net impact on Citation's reserves and financial statements.
On July 2, 2003, the California Superior Court placed Fremont in
liquidation. Since Fremont is in liquidation, it was no longer an admitted
reinsurance company under the statutory basis of insurance accounting.
Consequently, Citation reversed the reinsurance recoverable from Fremont of
approximately $7.5 million in its financial statements prepared on both the
statutory basis and GAAP basis in the second quarter of 2003.
In June 2004, Citation filed litigation to recover its workers'
compensation trust deposits held by Fremont prior to the liquidation, in the
amount of $7.1 million. In September 2004, the court ruled against Citation.
Considering the potential cost and apparent limited prospect of obtaining
relief, Citation decided not to appeal.
Workers' compensation has been a problematic line of business for all
insurers who offered this type of coverage in California during the 1990's. We
believe that this is primarily due to claims costs escalating at a greater than
anticipated rate, in particular for medical care.
38
The nature of this line of business is that we receive a relatively small
number (low frequency) of relatively large (high severity) claims. Although the
last of Citation's workers' compensation policies expired in 1998, new workers'
compensation claims can still be filed for events which allegedly occurred
during the term of the policy. The state statute of limitations is 10 years, but
claims filing periods may be extended in some circumstances. At December 31,
2004, Citation had 227 open workers' compensation claims. Although the total
number of open claims was unchanged from 227 at December 31, 2003, 17 claims
were closed during the year, which was offset by an additional 17 claims being
allocated to Citation from the Fremont liquidation. Few new claims have been
filed in the past 3 years. Since Citation ceased writing workers' compensation
coverage 6 years ago, most of the claims which are still open tend to be severe,
and likely to lead to claims payments for a prolonged period of time.
At December 31, 2004, Citation had workers' compensation reserves of $24.8
million before reinsurance, and $12.1 million after reinsurance. Citation
purchased excess reinsurance to limit its potential losses in this line of
business. In general, we have retained the risk on the first $150,000 to
$250,000 per claim. The workers' compensation reserves are reinsured with
General Reinsurance, a subsidiary of Berkshire Hathaway, Inc.
CITATION INSURANCE COMPANY - WORKERS' COMPENSATION LOSS AND LOSS ADJUSTMENT
EXPENSE RESERVES
December 31, 2004 December 31, 2003
----------------- -----------------
Direct Reserves $24.8 million $22.4 million
Ceded Reserves (12.7) (11.9)
----- -----
Net Reserves $12.1 million $10.5 million
===== =====
It is difficult to accurately quantify future claims liabilities and
establish appropriate loss reserves in the workers' compensation line of
business 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); and
- - the extended period over which policy benefits are paid.
Our workers' compensation loss reserves were reviewed at December 31, 2004 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. Our reserves are typically booked at close to the
actuary's best estimate. Until 2003, we booked the direct reserves and an equal
offsetting reinsurance recoverable based on reports provided by Fremont.
Changes in assumptions about future trends in claims and the cost of
handling claims can lead to significant increases and decreases in our loss
reserves.
Following independent actuarial analysis at September 30, 2004 and December
31, 2004, Citation increased its workers' compensation net loss reserves by $1.2
million, or approximately 11.4% of $10.5 million in net reserves at the start of
2004. This adverse development was primarily due to an increase in projected
medical care costs. There can be no assurance that our workers' compensation
reserves will not develop adversely in the future, particularly if medical care
costs continue to inflate.
When the Fremont reinsurance recoverable was reversed after Fremont went
into liquidation in 2003, our workers' compensation reserves were approximately
$7.5 million. Following independent actuarial analysis at September 30, 2003 and
December 31, 2003, Citation increased its workers' compensation net loss
reserves by $3 million, or approximately 39.9% of the initial $7.5 million in
reserves. This adverse development was primarily as a result of setting reserves
at a more realistic level than Fremont had previously carried them based on
management and actuarial review and assessment of claims files after Fremont had
been placed in liquidation.
39
The change in Citation's workers' compensation reserves during 2003 and
2004 resulted from:
CITATION INSURANCE COMPANY - CHANGE IN WORKERS' COMPENSATION LOSS AND LOSS
ADJUSTMENT EXPENSE RESERVES
YEAR ENDED DECEMBER 31,
-------------------------------
2004 2003
-------------- --------------
Beginning Net Reserves $ 10.5 million $ 0.0 million
Reversal of reinsurance recoverable from Fremont 7.5
------ ------
Adjusted Beginning Net Reserves $ 10.5 million $ 7.5 million
Liability for Loss and Loss Adjustment Expense payments 0.4
Re-estimation of Prior Year Loss Reserves 1.2 3.0
------ ------
Net Workers' Compensation Insurance Reserves $ 12.1 million $ 10.5 million
====== ======
Re-estimation as a percentage of adjusted beginning reserves +11.4% +39.9%
There were no changes in key actuarial assumptions during 2003 and 2004. 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."
At December 31, 2004, Citation's net workers' compensation reserves were
carried at $12.1 million, approximately equal to the actuary's best estimate.
Approximately $3.7 million of Citation's net workers' compensation reserves
(30%) were case reserves, $5.5 million represented provision for IBNR claims
(45%), and the unallocated loss adjustment expense reserve was $2.9 million
(25%).
Until September 30, 2004, the workers' compensation claims were handled by
Fremont and the California Insurance Guarantee Association. Since then, the
workers' compensation claims have been handled by a third-party administrator on
Citation's behalf.
HYPERFEED TECHNOLOGIES
During 2003, HyperFeed continued to restructure its operations, which
culminated in the sale of two business units:
- - in June 2003, HyperFeed sold its retail trading business, PCQuote.com, for
approximately $370,000; and
- - in November 2003, HyperFeed sold its consolidated market data feed service
contracts for $8.5 million. HyperFeed recorded a gain on the sale of $6.6
million in 2003.
Through these disposals, HyperFeed exited two low margin businesses, and
replaced the business with revenues from providing products and services to the
purchasers. In addition, the sale of the businesses reduced HyperFeed's
operating expenses.
Now, HyperFeed is purely a developer and provider of software, ticker plant
technologies, and managed services to the financial markets industry.
During 2004, HyperFeed's revenues increased, and its net losses narrowed,
each quarter. The net losses recorded were $2.2 million in the first quarter,
$1.7 million in the second quarter, $663,000 in the third quarter, and $354,000
in the fourth quarter.
At December 31, 2004, HyperFeed had $194,000 in cash and cash equivalents,
and $465,000 in borrowings. PICO has extended a $1.5 million secured convertible
promissory note to HyperFeed. This note was not drawn upon at December 31, 2004;
however, $575,000 was drawn in February 2005.
For more detail on HyperFeed's operations, financial condition, and
prospects, please refer to HyperFeed's Annual Report on Form 10-K, which will be
filed with the SEC on or before March 31, 2005. The contents of HyperFeed's 10-K
are not incorporated into this 10-K.
40
CRITICAL ACCOUNTING POLICIES
PICO's principal assets and activities comprise:
- - Vidler and Nevada Land's land, water rights, and water storage operations;
- - the "run off" of property and casualty insurance, workers' compensation,
and medical professional liability insurance loss reserves;
- - business acquisitions and financing; and
- - HyperFeed Technologies.
Following is a description of what we believe to be the critical accounting
policies affecting PICO, 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, 2004, the loss reserves, net of reinsurance, of our two
insurance subsidiaries were:
- - Citation, $22.3 million; and
- - Physicians, $16.4 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.
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. Reserves were
reduced by $503,000 in 2004, $6.7 million in 2003, $1 million in 2002, and $10.6
million in 2001, after independent actuarial studies concluded that Physicians'
claims reserves were greater than projected claims payments. There can be no
assurance that our claims reserves are adequate and that there will not be
reserve increases or decreases in the future.
Citation's loss reserves are reviewed regularly, and certified annually by
an independent actuarial firm, as required by California insurance law.
In addition, we have to make judgments about the recoverability of
reinsurance owed to us on direct claims reserves. In making this assessment, we
carefully review the creditworthiness of reinsurers, as well as relying on
schedules in statutory filings with state Departments of Insurance which show
separate deposits held as assets for the benefit of reinsureds.
As discussed on preceding pages in the "Insurance Operations in Run Off"
section of Item 7, during 2003 we booked a reversal of reinsurance recoverable
of approximately $7.5 million from Fremont Indemnity Company, which fully
reserved against the reinsurance recoverable from Fremont.
See "Insurance Operations In Run Off" and "Regulatory Insurance Disclosure"
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, 2004, the total carrying value of land, water rights, and interests in water
storage assets was $110.7 million, or 31% 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, especially
the estimated market values of our real estate and water assets.
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
41
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, in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" and SFAS No. 142, "Goodwill and Other
Intangible Assets."
3. ACCOUNTING FOR INVESTMENTS AND INVESTMENTS IN UNCONSOLIDATED AFFILIATES
At December 31, 2004, PICO and its subsidiaries held equities with a
carrying value of approximately $143 million. These holdings are primarily
small-capitalization value stocks listed in the U.S., Switzerland, New Zealand,
and Australia. 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 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 being 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 from dividends
received.
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 from 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.
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 in any individual year during 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.
For equity and debt securities accounted for under SFAS No. 115 which are
in an unrealized loss position in local currency terms, 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 shareholders' equity or book value per share, as the decline in market
value will already have been recorded through shareholders' equity. However,
there will be an impact on reported income before and after tax and on our
earnings per share, due to recognition of the unrealized loss
42
and related 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 for investments and investments in
unconsolidated affiliates add volatility to our statements of operations.
4. REVENUE RECOGNITION
We recognize revenue on the sale of real estate and water rights based on
the guidance of FASB No. 66, "Accounting for Sales of Real Estate".
Specifically, we recognize revenue when:
(a) there is a legally binding sale contract;
(b) the profit is determinable (i.e., the collectability of the sales price is
reasonably assured, or any amount that will not be collectable 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 sufficient to demonstrate
a commitment to pay for the property.
Unless all of these conditions are 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 received from the buyer are recorded as
liabilities and no gain is recognized
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
SHAREHOLDERS' EQUITY
At December 31, 2004, PICO had shareholders' equity of $239.9 million
($19.40 per share), compared to $229.2 million ($18.52 per share) at the end of
2003, and $221 million ($17.86 per share) at the end of 2002. Book value per
share increased 4.8% in 2004, compared to increases of 3.7% in 2003, and 6.2% in
2002.
The principal factors leading to the $10.7 million increase in
shareholders' equity during 2004 were the net increases of $21.1 million in
unrealized appreciation in investments and $374,000 in foreign currency
translation. These factors were partially offset by the $10.6 million net loss
and a $121,000 increase in treasury stock due to the purchase of PICO shares in
deferred compensation plans for directors.
BALANCE SHEET
Total assets at December 31, 2004 were $354.6 million, compared to $330.9
million at December 31, 2003. During 2004, total assets increased by $23.7
million, principally due to a $46.6 million increase in equity securities, which
was partially offset by a $13.1 million decrease in fixed-income securities and
a $6.9 million reduction in cash. Approximately 75% of the $46.6 million year
over year increase in equity securities is attributable to an increase in the
market value of equity securities during 2004, and the balance is due to net new
purchases of stocks.
At December 31, 2004, on a consolidated basis, available for sale equity
securities showed a net unrealized gain of $41.5 million after tax. This total
consists of approximately $41.6 million in gains, partially offset by $73,000 in
losses.
Total liabilities at December 31, 2004 were $112.4 million, compared to
$95.9 million at December 31, 2003. During 2004, total liabilities increased by
$16.5 million, primarily due to a $9.8 million increase in liabilities related
to the PICO Holdings, Inc. Stock Appreciation Rights ("SAR") Program, and a $9.2
million increase in deferred tax liabilities. See "Business Acquisitions and
Financing" segment analysis later in Item 7, and Note 7 of Notes to the
Consolidated Financial Statements, "Federal, Foreign and State Income Tax."
NET INCOME
PICO reported a net loss of $10.6 million, or $0.85 per share in 2004,
compared to a net loss of $3.2 million, or $0.26 per share in 2003, and net
income of $5.9 million, or $0.48 per diluted share in 2002.
43
2004
The net loss of $10.6 million, or $0.85 per share, consisted of:
- - a $16.9 million loss before taxes and minority interest from continuing
operations; which was partially offset by
- - a $3 million income tax benefit;
- - the add-back of $3.2 million in minority interest, which reflects the
interest of outside shareholders in the net losses of subsidiaries which
are less than 100%-owned by PICO (principally HyperFeed); and
- - income from discontinued operations of $78,000 after tax.
The $3 million tax benefit for 2004 consists of several items, which are
detailed in Note 7 of Notes to the Consolidated Financial Statements, "Federal,
Foreign and State Income Tax."
2003
The net loss of $3.2 million, or $0.26 per share, consisted of:
- - a $13.8 million loss before taxes and minority interest from continuing
operations; and
- - the deduction of $1 million in minority interest, which reflects the
interest of outside shareholders in the net income of subsidiaries which
are less than 100%-owned by PICO; partially offset by
- - a $1.2 million income tax benefit; and
- - income from discontinued operations of $10.5 million after tax.
2002
The $5.9 million net income reported in 2002 consisted of $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."
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; and
- - income from discontinued operations of $2.8 million after tax and a change
in accounting principle.
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
measures changes in shareholders' equity, and includes unrealized items which
are not recorded in the Consolidated Statement of Operations, for example,
foreign currency translation and the change in investment gains and losses on
available-for-sale securities.
Over the past three years, PICO has recorded:
- - comprehensive income of $10.9 million in 2004, primarily consisting of net
increases of $21.1 million in net unrealized appreciation in investments
and $374,000 in foreign currency translation, which were partially offset
by the $10.6 million net loss;
- - comprehensive income of $8.2 million in 2003, primarily consisting of net
increases of $10.9 million in net unrealized appreciation in investments
and $570,000 in foreign currency translation, which were partially offset
by the $3.2 million net loss; and
- - 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.
44
OPERATING REVENUES
YEAR ENDED DECEMBER 31,
---------------------------------------
2004 2003 2002
----------- ----------- -----------
Vidler Water Company $ 1,964,000 $16,816,000 $13,777,000
Nevada Land & Resource Company 11,560,000 5,889,000 4,414,000
Business Acquisitions and Financing 2,852,000 5,549,000 8,458,000
Insurance Operations in Run Off 5,747,000 3,245,000 2,625,000
HyperFeed Technologies 6,004,000 1,379,000
----------- ----------- -----------
Total Revenues $28,127,000 $32,878,000 $29,274,000
=========== =========== ===========
In 2004, total revenues were $28.1 million, compared to $32.9 million in
2003, and $29.3 million in 2002. Revenues decreased by $4.8 million year over
year in 2004, and increased by $3.6 million year over year in 2003.
Total expenses in 2004 were $45 million, compared to $46.2 million in 2003,
and $24.4 million in 2002. In 2004, the largest expense item was SAR expense of
$9.9 million, consisting of a $9.8 million increase in SAR liability resulting
from a 32.6% increase in the PICO stock price during 2004, and approximately
$113,000 in payments on SAR exercised. In the preceding two years, the largest
expense item was the cost of land and water rights sold -- $12.6 million in
2003, and $9.7 million in 2002. See "Business Acquisitions and Financing"
segment analysis later in Item 7.
INCOME (LOSS) BEFORE TAXES AND MINORITY INTEREST
YEAR ENDED DECEMBER 31,
-----------------------------------------
2004 2003 2002
------------ ------------ -----------
Vidler Water Company $ (5,701,000) $ (543,000) $ (897,000)
Nevada Land & Resource Company 5,290,000 2,004,000 484,000
Business Acquisitions and Financing (15,156,000) (8,112,000) (1,181,000)
Insurance Operations in Run Off 4,060,000 (2,902,000) 4,300,000
HyperFeed Technologies (5,390,000) (4,225,000)
------------ ------------ -----------
Income (Loss) Before Taxes and
Minority Interest $(16,897,000) $(13,778,000) $ 2,706,000
============ ============ ===========
The principal items in the $16.9 million loss before taxes and minority
interest in 2004 were:
- - Vidler incurred a $5.7 million loss on $2 million in revenues. Vidler did
not close on any significant sales of water rights or land and related
assets in 2004, however Vidler incurred on-going operating expenses and the
costs of developing water assets which will not be monetized until future
years;
- - income of $5.3 million from Nevada Land on revenues of $11.6 million, which
included $10.5 million in revenues from the sale of land;
- - a $15.2 million loss from Business Acquisitions and Financing, which
included a $9.9 million SAR expense;
- - income of $4.1 million from Insurance Operations in Run Off, consisting of
profits of $3.4 million from Physicians and $643,000 from Citation. Segment
income was boosted by $3 million in realized gains on the sale of
investments; and
- - a $5.4 million loss from the continuing operations of HyperFeed.
45
VIDLER WATER COMPANY, INC.
YEAR ENDED DECEMBER 31,
-----------------------------------------
2004 2003 2002
----------- ------------ ------------
REVENUES:
Sale of Real Estate & Water Assets $ 408,000 $ 15,360,000 $ 12,118,000
Lease of Agricultural Land 485,000 703,000 690,000
Interest 471,000 80,000 107,000
Other 600,000 673,000 862,000
----------- ------------ ------------
Segment Total Revenues $ 1,964,000 $ 16,816,000 $ 13,777,000
=========== ============ ============
EXPENSES:
Cost of Real Estate & Water Assets (240,000) (10,682,000) (8,465,000)
Commission and Other Cost of Sales (601,000) (515,000)
Depreciation & Amortization (1,184,000) (1,020,000) (953,000)
Interest (403,000) (431,000) (496,000)
Overhead (1,574,000) (1,400,000) (1,233,000)
Project Expenses (4,264,000) (3,225,000) (3,012,000)
----------- ------------ ------------
Segment Total Expenses $(7,665,000) $(17,359,000) $(14,674,000)
=========== ============ ============
----------- ------------ ------------
LOSS BEFORE TAX $(5,701,000) $ (543,000) $ (897,000)
=========== ============ ============
Since we entered the water resource business, the water rights and water
storage operations acquired by Vidler 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 $2 million in 2004, compared to $16.8
million in 2003 and $13.8 million in 2002.
In 2004, Vidler did not close on any significant sales of water rights and
land; however, revenues of $408,000 and gross margin of $168,000 were generated
from the sale of water rights in Colorado.
In 2003, Vidler generated $15.4 million in revenues from the sale of water
rights and land. This primarily represented two transactions, which generated
$14.8 million in revenues:
- - the sale of approximately 6,500 acres of land and the related water rights
near West Wendover, Nevada. This transaction added $12 million to revenues
and $4.1 million to gross margin; and
- - the sale of approximately 37,500 acres of land and the related water rights
at Big Springs Ranch in Elko County, Nevada. This transaction added $2.8
million to revenues and $505,000 to gross margin.
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;
- - 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.
Other Revenues include lease income from water rights in Colorado and
various revenues from properties farmed by Vidler (e.g., sales of hay and
cattle).
In 2004, interest revenue was $471,000, which was significantly higher than
in previous years due to interest earned on notes receivable resulting from the
sale of land and water rights at West Wendover and Big Springs Ranch in 2003.
46
A principal payment on the West Wendover note was not made as scheduled on
September 30, 2004. Further payments of $1.2 million were received in the fourth
quarter of 2004. We are currently negotiating repayment of the remaining
principal, which was approximately $2.7 million at December 31, 2004, in 2005
and 2006. The debt is secured by a first Deed of Trust on the property at West
Wendover. The lands were sold for $12 million, and the buyer has outlaid
approximately $10 million for the down payment and subsequent principal
repayments.
The Big Springs Ranch note was scheduled to be fully repaid in 2004;
however $250,000 in principal was outstanding at December 31, 2004. Full payment
is expected in 2005.
Total segment expenses, including the cost of water rights and other assets
sold, were $7.7 million in 2004, $17.4 million in 2003, 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 $7.4 million in 2004,
$6.1 million in 2003, and $5.7 million in 2002.
To increase transparency, the line "Operations, Maintenance, and Other
Expenses" reported in previous years is now broken into two components, Overhead
Expenses and Project Expenses.
Overhead Expenses consist of costs which are not related to the development
of specific water resources, such as salaries and benefits, rent, and audit
fees. Overhead Expenses were $1.6 million in 2004, $1.4 million in 2003, and
$1.2 million in 2002.
Project Expenses consist of costs related to (1) the development of water
resources which do not meet the criteria to be capitalized (recorded as assets);
and (2) the development and maintenance of existing water resources, such as
repairs & maintenance, property taxes, and professional fees. Project Expenses
are recorded as expenses are incurred, and fluctuate from period to period
depending on activity regarding Vidler's various water resource projects.
Project Expenses were $4.3 million in 2004, $3.2 million in 2003, and $3 million
in 2002. Project expenses principally relate to:
- - the operation and maintenance of the Vidler Arizona Recharge Facility;
- - the development of water rights in the Tule Desert groundwater basin (part
of the Lincoln County agreement);
- - the utilization of water rights at Fish Springs Ranch as future municipal
water supply for the north valleys of the Reno, Nevada area; and
- - the operation of Fish Springs Ranch, and maintenance of the associated
water rights.
In 2004, segment operating expenses (i.e., all expenses other than cost of
sales and related selling expenses) were $1.3 million higher than in 2003,
principally due to a $1 million increase in project expenses.
In 2003, segment operating expenses were $383,000 higher than in 2002,
principally due to increases of $213,000 in project expenses, and $167,000 in
overhead.
Vidler recorded a segment loss of $5.7 million in 2004, compared to segment
losses of $543,000 in 2003 and $897,000 in 2002.
The 2004 segment loss was $5.2 million greater than in 2003, primarily as a
result of a $3.9 million decrease in the gross margin from the sale of land and
water rights and a $1.3 million increase in segment operating expenses year over
year.
The 2003 segment loss was $354,000 less than in 2002. The narrower loss
resulted from a $940,000 increase in the gross margin from the sale of land and
water rights, which was partially offset by a $203,000 decrease in other
revenues and a $383,000 increase in segment operating expenses.
47
NEVADA LAND & RESOURCE COMPANY, LLC
YEAR ENDED DECEMBER 31,
---------------------------------------
2004 2003 2002
----------- ----------- -----------
REVENUES:
Sale of Land $10,472,000 $ 4,141,000 $ 2,843,000
Sale of Water Rights 250,000 270,000
Lease and Royalty 611,000 695,000 721,000
Interest and Other 477,000 803,000 580,000
----------- ----------- -----------
Segment Total Revenues $11,560,000 $ 5,889,000 $ 4,414,000
=========== =========== ===========
EXPENSES:
Cost of Land and Water Rights Sold (4,257,000) (1,968,000) (1,275,000)
Operating Expenses (2,013,000) (1,917,000) (2,655,000)
----------- ----------- -----------
Segment Total Expenses $(6,270,000) $(3,885,000) $(3,930,000)
=========== =========== ===========
INCOME BEFORE TAX $ 5,290,000 $ 2,004,000 $ 484,000
=========== =========== ===========
Nevada Land generated revenues of $11.6 million in 2004, compared to $5.9
million in 2003, and $4.4 million in 2002.
In each of the past 3 years, land sales have been the largest contributor
to revenues in this segment. It can take a year or more to complete a land sale
transaction, the timing of land sales is unpredictable, and historically the
level of land sales has fluctuated from year to year. Accordingly, it should not
be assumed that the higher level of sales in 2004 can be maintained. In 2004,
Nevada Land recorded revenues of $10.5 million from the sale of 120,683 acres of
land. In 2003, Nevada Land recorded revenues of $4.1 million from the sale of
75,131 acres of land, compared to $2.8 million in revenues from the sale of
28,451 acres of land in 2002. Nevada Land also generated revenues from the sale
of water rights of $250,000 in 2003, and $270,000 in 2002.
Lease and royalty income amounted to $611,000 in 2004, compared to $695,000
in 2003, and $721,000 in 2002. Most of this revenue comes from land leases,
principally for grazing, agricultural, communications, and easements.
Interest and other revenues contributed $477,000 in 2004, compared to
$803,000 in 2003 and $580,000 in 2002.
After deducting the cost of land sold, the gross margin on land sales was
$6.2 million in 2004, $2.2 million in 2003, and $1.7 million in 2002. This
represented a gross margin percentage of 59.3% in 2004, 54.3% in 2003, and 59.6%
in 2002.
Segment operating expenses were $2 million in 2004, $1.9 million in 2003,
and $2.7 million in 2002. Segment operating expenses were unusually high in 2002
due to approximately $900,000 in legal and other expenses related to land
development issues.
Nevada Land recorded income of $5.3 million in 2004, compared to $2 million
in 2003, and $484,000 in 2002.
The $3.3 million increase in segment income from 2003 to 2004 is
principally attributable to a $4 million increase in gross margin on land sales
year over year, partially offset by a reduction of $660,000 in all other revenue
items and a $96,000 increase in operating expenses. Segment income increased
$1.5 million from 2002 to 2003, primarily due to a $553,000 increase in gross
margin on land sales year over year, and the unusually high expenses of
approximately $900,000 in 2002, which did not recur in 2003.
Not only were land sales in 2004 significantly higher in previous years,
but Nevada Land provided partial financing for almost 60% of land sales in 2004,
as opposed to approximately 28% of cumulative land sales in the preceding years.
Consequently, we anticipate that interest income generated from land sales
receivables will make a greater contribution to segment revenues and income in
2005 than in previous years.
48
BUSINESS ACQUISITIONS AND FINANCING
YEAR ENDED DECEMBER 31,
-----------------------------------------
2004 2003 2002
------------ ------------ -----------
BUSINESS ACQUISITIONS & FINANCING REVENUES (CHARGES):
Realized Gains (Losses):
On Sale or Impairment of Holdings $ 840,000 $ 1,707,000 $ 3,419,000
SFAS No. 133 Change In Warrants (556,000) 461,000 402,000
Investment Income 2,088,000 2,092,000 2,512,000
Other 480,000 1,289,000 2,125,000
------------ ------------ -----------
Segment Total Revenues (Charges) $ 2,852,000 $ 5,549,000 $ 8,458,000
============ ============ ===========
SEGMENT TOTAL EXPENSES (18,008,000) (13,096,000) (7,431,000)
------------ ------------ -----------
INCOME (LOSS) BEFORE INVESTEES' INCOME ( LOSS) $(15,156,000) $ (7,547,000) $ 1,027,000
Equity Share of Investees' Net (Loss) (565,000) (2,208,000)
------------ ------------ -----------
(LOSS) BEFORE TAXES $(15,156,000) $ (8,112,000) $(1,181,000)
============ ============ ===========
The Business Acquisitions and Financing segment recorded revenues of $2.9
million in 2004, compared to $5.5 million in 2003 and $8.5 million in 2002.
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. We do not sell holdings on a regular basis. A holding may be sold if
the price of a 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. In addition, in
this segment various income items relate to specific investments held during a
particular accounting period. Since investments change over time, results in
this segment are not necessarily comparable from year to year.
In 2004, net realized gains were $284,000. Net realized gains on the sale
or impairment of holdings were $840,000. This primarily represented realized
gains of $1.4 million on the sale of Keweenaw Land Association Limited and $1
million on the sale of two unrelated foreign stocks, which were largely offset
by charges of $1.3 million for other-than-temporary impairment of our holding in
Accu Holding AG during 2004, and $547,000 for impairment of our holding in SIHL
during 2004. In addition, a $556,000 charge to reduce the carrying value of our
HyperFeed warrants to zero, was recorded as a realized loss in accordance with
Statement of Financial Accounting Standards No. 133, "Accounting For Derivative
Instruments and Hedging Activities"
In 2003, net realized gains of $2.2 million were recorded. This primarily
represented $1.7 million in realized gains on the sale of two unrelated foreign
stocks. In addition, as explained in the following paragraphs, a $1.1 million
realized gain on the sale of most of our holding in MC Shipping, Inc. was offset
by $1.1 million in charges for other-than-temporary impairment of our holdings
in Accu Holding AG and SIHL, which reflected a decline in the market value of
those securities during 2003. Finally, SFAS No. 133 income was $461,000,
primarily representing an increase in the estimated fair value of HyperFeed
warrants during 2003.
In 2002, a net realized gain of $3.4 million was recognized. 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;
- - a $2.2 million charge for other-than-temporary impairment of our investment
in Accu Holding; and
- - a $312,000 charge for other-than-temporary impairment of our investment in
Solpower Corporation.
In addition, income of $402,000 was recorded under SFAS No. 133, 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.
We regularly review any securities in which we have an unrealized loss. If
we determine that the decline in market value is other-than-temporary, under
GAAP we record a charge to reduce the basis of the security from its original
cost to current carrying value, which is usually the market price at the balance
sheet date when the provision is recorded. The determination is based on various
factors, including the extent and the duration of the unrealized loss. A charge
for other-than-temporary impairment is a non-cash charge, which is recorded as a
realized loss.
It should be noted that:
- - 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 consolidated statement of
operations.
49
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. For example,
during 2003 and 2004 we sold our holding in MC Shipping, Inc. Although this
resulted in realized gains of $1.3 million under GAAP in 2003 and 2004, the
gains only recovered part of a charge for other-than-temporary impairment of
this holding recorded in 1998.
In this segment, investment income includes interest on cash and short-term
fixed-income securities, and dividends from partially owned businesses.
Investment income totaled $2.1 million in 2004, $2.1 million in 2003, and $2.5
million in 2002. Investment income fluctuates depending on the level of cash and
temporary investments, the level of interest rates, and the dividends paid by
partially owned businesses.
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. We did not carry any investments under the
equity method in 2004. Our equity share of investees' losses, principally
HyperFeed, was $565,000 in 2003 and $2.2 million in 2002.
Segment expenses were $18 million in 2004, $13.1 million in 2003, and $7.4
million in 2002. The principal expenses recognized in this segment are PICO's
corporate overhead, and the U.S. dollar change in value of a Swiss franc
inter-company loan.
The Business Acquisitions And Financing segment produced pre-tax losses of
$15.2 million in 2004, $8.1 million in 2003, and $1.2 million in 2002.
In 2004, the segment loss consists of investment income of $2.1 million and
a total of $764,000 in realized gains and other revenues, which were more than
offset by segment expenses of $18 million. Segment expenses include $9.9 million
related to the PICO Holdings, Inc. 2003 Stock Appreciation Rights ("SAR")
Program, the accrual of $1.7 million in incentive compensation, other parent
company overhead of $6.6 million, $385,000 in interest expense on our Swiss
Franc borrowings, and $1.5 million in SISCOM expenses. SISCOM ceased operations
in January 2005, so we expect that SISCOM expenses should be minimal in 2005 and
eliminated in future years. Segment expenses were reduced by a $2.1 million
benefit resulting from the effect of appreciation in the Swiss Franc on an
inter-company loan during 2004.
During 2003, the Company's shareholders approved the PICO Holdings, Inc.
2003 SAR Program, which replaced the stock option and call option programs
previously in place. The change in the "in the money" amount (i.e., the
difference between the market value of PICO stock and the exercise price of the
SAR) of SAR outstanding during each accounting period is recorded through the
consolidated statements of operations. An increase in the "in the money" amount
of SAR (i.e., if the price of PICO stock rises during the accounting period) is
recorded as an expense, and a decrease in the "in the money" amount of SAR (if
the price of PICO stock declines) will be recorded as a reduction in expenses.
In 2004, SAR expense was $9.9 million, consisting of a $9.8 million increase in
SAR liability, and $113,000 in payments on the exercise of SAR. The increase in
SAR liability resulted from a $5.10 per share (32%) increase in the PICO stock
price during 2004, which represented an increase of approximately $63.1 million
in PICO's equity market capitalization. See "Equity Compensation Plan
Information" in Item 5, "Market for Registrant's Common Equity and Related
Stockholder Matters."
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 2002, 2003, and 2004 -- 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 $2.1 million before tax in our statement of
operations in 2004, even though there was no net impact on shareholders' equity,
before any related tax effects.
In 2003, the segment loss consists of the $2.2 million net realized
investment gains, investment income of $2.1 million, and other revenues of $1.3
million, which were more than offset by the $565,000 equity share of investees'
losses and segment expenses of $13.1 million. Segment expenses include $6
million related to the SAR Program, the accrual of $1.3 million in incentive
compensation, other parent company overhead of $6.6 million, and $1.5 million in
SISCOM expenses. The $6 million SAR expense consisted of a $3.5 million charge
on the initial adoption of the SAR program in July 2003, and a $2.5 million
expense to record the
50
increase in the "in the money" amount of SAR during the period from July 17,
2003 through the end of 2003. Segment expenses were reduced by a $2.3 million
benefit resulting from the effect of appreciation in the Swiss Franc on an
inter-company loan during 2003.
In 2002, the segment loss consists of the $3.8 million in net realized
investment gains, 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.
INSURANCE OPERATIONS IN RUN OFF
YEAR ENDED DECEMBER 31,
---------------------------------------
2004 2003 2002
----------- ------------ ----------
REVENUES (CHARGES):
Net Investment Income $ 2,765,000 $ 2,680,000 $2,269,000
Realized Gains On Sale or Impairment of Investments 2,982,000 562,000 387,000
Earned Premiums (42,000)
Other 3,000 11,000
----------- ------------ ----------
Segment Total Revenues $ 5,747,000 $ 3,245,000 $2,625,000
=========== ============ ==========
EXPENSES:
Underwriting (Expenses) / Recoveries (1,687,000) (6,147,000) 1,675,000
----------- ------------ ----------
Segment Total Expenses $(1,687,000) $ (6,147,000) $1,675,000
=========== ============ ==========
INCOME (LOSS) BEFORE TAXES:
Physicians Insurance Company of Ohio $ 3,417,000 $ 7,314,000 $2,120,000
Citation Insurance Company 643,000 (10,216,000) 2,180,000
----------- ------------ ----------
Income (Loss) Before Taxes $ 4,060,000 $ (2,902,000) $4,300,000
=========== ============ ==========
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
and realized gains or losses on the sale of the securities investments which
correspond to the insurance company's reserves and shareholders' equity.
However, even when an insurance company is in "run off", earned premium can
arise. For example, with "swing rated" reinsurance, the reinsurance premiums are
recalculated based on actual loss experience (i.e., the number and size of
claims). Under GAAP, if we are required to pay for additional reinsurance this
is recorded as a reduction in earned premiums, while a reduction in the amount
of reinsurance we need to pay is recorded as in increase in earned premiums.
The financial results of insurance companies in run off can be volatile if
there is favorable or unfavorable development in the loss reserves. Physicians
recorded income from favorable reserve development in 2003 and 2004; however,
Citation recorded a significant loss in 2003, principally due to the reversal of
the $7.5 million Fremont reinsurance recoverable and $3.9 million in reserve
increases in the property and casualty insurance and workers' compensation loss
reserves. See the Citation section of the "Company Summary, Recent Developments,
and Future Outlook" portion of Item 7.
The Insurance Operations in Run Off segment generated income of $4.1
million in 2004, consisting of $3.4 million from Physicians and $643,000 from
Citation. In 2003, the segment incurred a $2.9 million loss, consisting of a
$7.3 million profit from Physicians, which was more than offset by a $10.2
million loss from Citation. In 2002, the segment generated income of $4.3
million, consisting of $2.1 million from Physicians and $2.2 million from
Citation.
PHYSICIANS INSURANCE COMPANY OF OHIO
YEAR ENDED DECEMBER 31,
------------------------------------
2004 2003 2002
---------- ---------- ----------
MPL REVENUES:
Net Investment Income $1,546,000 $1,353,000 $ 679,000
Net Realized Investment Gain (Loss) 2,109,000 84,000 (4,000)
Earned Premium 382,000
---------- ---------- ----------
Segment Total Revenues $3,655,000 $1,437,000 $1,057,000
========== ========== ==========
---------- ---------- ----------
MPL UNDERWRITING RECOVERIES (EXPENSES) $ (238,000) $5,877,000 $1,063,000
========== ========== ==========
INCOME BEFORE TAXES $3,417,000 $7,314,000 $2,120,000
========== ========== ==========
51
Physicians' total revenues were $3.7 million in 2004, compared to $1.4
million in 2003 and $1.1 million in 2002.
Investment income was $1.5 million in 2004, compared to $1.4 million in
2003 and $679,000 in 2002. Investment income varies from year to year, depending
on the amount of fixed-income securities in the portfolio, the prevailing level
of interest rates, and the dividends paid on the common stocks in the portfolio.
Investment income was significantly higher in 2003 and 2004 than in 2002 due to
the expansion of Physicians' investment portfolio in April 2003, following the
receipt of the proceeds from selling Sequoia.
The $2.1 million net realized investment gain recorded in 2004 included a
$1.7 million gain on the sale of shares in Keewenaw Land Association Limited and
gains on the sale of various other portfolio holdings.
Physicians recorded earned premiums of $382,000 in 2002, representing a
reduction in the amount of reinsurance that we need to pay on "swing rated"
contracts. The reduced reinsurance requirement resulted from a reduction in IBNR
reserves in 2002.
In 2004, Physicians' operating and underwriting expenses totaled $238,000.
A $489,000 net reduction in reserves partially offset Physicians' regular loss
and loss adjustment expense and operating expenses of $727,000 in 2004. 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 2003, Physicians recorded a $5.9 million underwriting recovery. The $6.7
million net reduction in reserves more than offset regular loss and loss
adjustment expense and operating expenses of $876,000 for the year.
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.
CITATION INSURANCE COMPANY
YEAR ENDED DECEMBER 31,
---------------------------------------
2004 2003 2002
----------- ------------ ----------
REVENUES:
Net Investment Income $ 1,219,000 $ 1,327,000 $1,590,000
Realized Investment Gains 873,000 478,000 391,000
Earned Premiums (424,000)
Other 3,000 11,000
----------- ------------ ----------
Segment Total Revenues $ 2,092,000 $ 1,808,000 $1,568,000
=========== ============ ==========
EXPENSES:
Underwriting (Expenses) / Recoveries $(1,449,000) $(12,024,000) $ 612,000
=========== ============ ==========
INCOME (LOSS) BEFORE TAXES $ 643,000 $(10,216,000) $2,179,000
=========== ============ ==========
In 2004, Citation generated total revenues of $2.1 million, primarily
consisting of $1.2 million in investment income and net realized investment
gains of $873,000 from the sale of various portfolio holdings. Underwriting
expenses totaled $1.4 million, including a net increase in loss reserves of
$932,000, consisting of a $1.2 million increase in workers' compensation
reserves, which was partially offset by a $254,000 reduction in property and
casualty insurance reserves. Consequently, Citation recorded income of $643,000
before taxes for 2004.
In 2003, Citation generated total revenues of $1.8 million, primarily
consisting of $1.3 million in investment income and net realized investment
gains of $478,000. Underwriting expenses totaled $12 million, including the $7.5
million reversal of the reinsurance recoverable from Fremont related to the
workers' compensation book of business. Underwriting expenses also included
increases in reserves of $3 million in workers' compensation, and $847,000 in
property and casualty insurance, due to unfavorable development in prior year
loss reserves. As a result of these factors, Citation incurred a loss of $10.2
million before taxes for 2003.
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. 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.
52
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."
The $10.9 million improvement in Citation's result from 2003 to 2004, and
$12.4 million deterioration from 2002 to 2003, is primarily due to the
reinsurance reversal and reserve increases recorded in 2003.
HYPERFEED TECHNOLOGIES
YEAR ENDED DECEMBER 31,
---------------------------------
2004 2003 2002
------------ ----------- ----
REVENUES:
Service $ 5,995,000 $ 1,363,000
Investment Income 9,000 16,000
------------ -----------
Segment Total Revenues $ 6,004,000 $ 1,379,000
============ ===========
EXPENSES:
Cost of Service (1,585,000) (1,069,000)
Depreciation and Amortization (870,000) (624,000)
Other (8,939,000) (3,911,000)
------------ -----------
Segment Total Expenses $(11,394,000) $(5,604,000)
============ ===========
SEGMENT LOSS BEFORE TAXES $ (5,390,000) $(4,225,000)
============ ===========
In 2004, HyperFeed generated $6 million in revenues. Service revenues were
$6 million and the costs of service were $1.6 million, resulting in gross margin
of $4.4 million. After the deduction of $9.8 million in other operating
expenses, HyperFeed generated a segment loss before taxes and minority interest
of $5.4 million.
During the period from May 15, 2003 (commencement of consolidation) to
December 31, 2003, HyperFeed generated $1.4 million in revenues. Service
revenues were $1.4 million and the costs of service were $1.1 million, resulting
in gross margin of $294,000. After $4.5 million in other operating expenses,
HyperFeed generated a segment loss of $4.2 million.
For more detail, please refer to HyperFeed's Annual Report on Form 10-K,
which will be filed with the SEC on or before March 31, 2005. The contents of
HyperFeed's 10-K are not incorporated into this 10-K.
DISCONTINUED OPERATIONS
SEQUOIA INSURANCE COMPANY
YEAR ENDED DECEMBER 31,
----------------------------------
2004 2003 2002
---- ------------ ------------
Revenues $ 16,433,000 $ 52,439,000
Expenses (12,759,000) (47,861,000)
------------ ------------
Income Before Taxes $ 3,674,000 $ 4,578,000
Income Taxes (1,285,000) (1,545,000)
Cumulative Effect of Change in Accounting Principle, net (199,000)
------------ ------------
NET INCOME $ 2,389,000 $ 2,834,000
============ ============
In the first three months of 2003 prior to its sale, Sequoia Insurance
Company generated income of $2.4 million after-tax, which is included in the
"Income from discontinued operations, net of tax" line in the Consolidated
Statement of Operations for 2003.
In 2002, Sequoia generated income of $2.8 million after-tax.
53
PICO also recorded a $443,000 after-tax gain from the sale of Sequoia in
2003, which forms part of the "Gain on disposal of discontinued operations, net"
line in the Consolidated Statement of Operations for 2003.
DISCONTINUED OPERATIONS OF HYPERFEED
YEAR ENDED DECEMBER 31,
-----------------------------
2004 2003 2002
--------- ---------- ----
Income (Loss) Before Taxes $(422,000) $ 545,000
Gain on Sale of Discontinued Operations Before Taxes 500,000 7,008,000
--------- ----------
Income & Gain Before Taxes $ 78,000 $7,553,000
Income Taxes
--------- ----------
NET INCOME $ 78,000 $7,553,000
========= ==========
In 2004, the discontinued operations of HyperFeed generated a net gain of
$78,000 after-tax, compared to after-tax income of $7.7 million in 2003.
In 2004, HyperFeed recorded a $500,000 pre-tax gain from the sale of the
discontinued operations, which forms part of the "Gain on disposal of
discontinued operations, net" line in the Consolidated Statement of Operations
for 2004. This gain was partially offset by a loss from discontinued operations
of $422,000 before taxes, which is included in the "Income from discontinued
operations, net of tax" line in the Consolidated Statement of Operations for
2004.
During the period from May 15, 2003 until December 31, 2003, the
discontinued operations of HyperFeed generated income of $545,000 after-tax,
which is included in the "Income from discontinued operations, net of tax" line
in the Consolidated Statement of Operations for 2003. HyperFeed also recorded a
$7 million after-tax gain from the sale of the discontinued operations in 2003,
which forms part of the "Gain on disposal of discontinued operations, net" line
in the Consolidated Statement of Operations for 2003.
LIQUIDITY AND CAPITAL RESOURCES -- YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
CASH FLOW
PICO's 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 $17.4 million in cash and cash equivalents
at December 31, 2004, compared to $24.3 million at December 31, 2003.
In addition to cash and cash equivalents, at December 31, 2004 the
consolidated group held fixed-income securities with a market value of $39.5
million and equities with a market value of $143 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 acquisition opportunities.
In broad terms, the cash flow profile of our principal operating
subsidiaries is:
- - As commercial use of Vidler's water assets increases, we expect that Vidler
will generate free cash flow as receipts from leasing water or storage
capacity, and the proceeds from selling land and water rights, begin to
overtake maintenance capital expenditure, financing costs, and operating
expenses;
- - Nevada Land is actively selling land which has reached its highest and best
use. 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. These receipts and other
revenues exceed Nevada Land's operating costs, so Nevada Land is generating
strong cash flow;
- - Investment income more than covers the operating expenses of the "run off"
insurance companies, Physicians and Citation. The funds required to pay
claims are coming from the maturity of fixed-income investments, the
realization of fixed-income and stocks held in their investment portfolios,
and recoveries from reinsurance companies; and
54
- - HyperFeed maintains its own cash & cash equivalent balances, and
borrowings. At December 31, 2004, HyperFeed had approximately $194,000 in
cash and cash equivalents, and $465,000 in borrowings. PICO has extended a
$1.5 million line of credit to HyperFeed. This line of credit was not drawn
upon at December 31, 2004; however, $575,000 was drawn in February 2005.
The Departments of Insurance in Ohio and California prescribe minimum
levels of capital and surplus for insurance companies, set guidelines for
insurance company investments, and restrict the amount of profits which can be
distributed as dividends. Typically, PICO's insurance subsidiaries structure the
maturity of fixed-income securities to match the projected pattern of claims
payments. When interest rates are at very low levels, to insulate the capital
value of the bond portfolios against a decline in value which could be brought
on by a future increase in interest rates, the bond portfolios may have a
shorter duration than the projected pattern of claims payments.
As shown in the Consolidated Statements of Cash Flow, there was a $6.9
million net decrease in cash and cash equivalents in 2004, compared to a $2.2
million net increase in 2003, and a $5.7 million net increase in 2002.
During 2004, Operating Activities used cash of $7 million, compared to
$426,000 used in 2003, and $10.8 million generated in 2002.
The most significant cash inflows from operating activities were:
- - in 2004, the collection of $6.3 million of principal on two collateralized
notes receivable, related to Vidler's sale of assets at Big Springs Ranch
and West Wendover in 2003, and $4.2 million from cash land sales by Nevada
Land;
- - in 2003, approximately $4 million in proceeds of land and related assets
sold by Nevada Land, and $5.5 million from the cash portion of two
significant sales of land and related assets by Vidler; and
- - 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).
In all three years, the principal uses of cash were operating expenses at Vidler
and Nevada Land, claims payments by Physicians and Citation, and overhead
expenses in the Business Acquisitions and Financing segment.
In 2004, Investing Activities generated cash of $580,000. The sale and
maturity of fixed-income securities exceeded new purchases, providing a $12.3
million net cash inflow. During 2004, a net $7.6 million was invested in stocks,
consisting of $10.9 million in sales, and $18.5 million of new purchases. The
sales principally represented the sale of Keweenaw stock by the parent company
and Physicians, and the sale of two Swiss stocks by Global Equity SA. In
addition, $1.3 million was expended to purchase the minority shareholdings in
Vidler and SISCOM.
Investing Activities generated cash of $5.0 million in 2003. The cash
inflow in 2003 primarily resulted from cash received of $25.1 million from the
sale of Sequoia (gross proceeds of approximately $43 million, less the $17.9
million dividend of common stocks and debt securities received). The remaining
2003 cash flow items principally reflect the net investment of $6.3 million in
fixed-income securities and $10.9 million in marketable equity securities, and
the payment of $1.2 million in cash to acquire additional shares of HyperFeed.
The net investment in fixed-income securities represents routine activity in the
investment portfolios of our insurance companies, and the temporary investment
of surplus funds in fixed-income securities. The investment in marketable equity
securities principally represents the net investment of $6.9 million of common
stocks by the insurance companies, and the net investment of $2.6 million in
common stocks by the parent company and Global Equity SA.
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 marketable fixed-income and equity securities,
and regular activity in the investment portfolios of our insurance companies.
In 2004, Financing Activities provided cash of $1.5 million. This was
principally due to a $2.4 million increase in Swiss franc borrowings to fund
additional purchases of stocks in Switzerland, which was partially offset by the
repayment of $1.3 million in borrowings by Vidler.
Financing Activities used $617,000 of cash in 2003, primarily due to the
repayment of $534,000 in non-recourse borrowings collateralized by farm
properties owned by Vidler. In addition, during 2003 Global Equity S.A. repaid
borrowings to a Swiss bank of $9.1 million (CHF 12.1 million) and took out an
equivalent amount of new borrowings from another Swiss bank.
55
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.
We believe that our cash and cash equivalent balances and short-term
investments will be sufficient to satisfy cash requirements for at least the
next twelve months. Although we cannot accurately predict the effect of
inflation on our operations, we do not believe that inflation has had, or is
likely in the foreseeable future to have, a material impact on our net revenues
or results of operations.
At December 31, 2004, 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, 2004, no stock had been repurchased under this
authorization.
COMMITMENTS AND SUPPLEMENTARY DISCLOSURES
1. AT DECEMBER 31, 2004:
- - 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 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 as of December 31, 2004.
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------
Less than 1 More than 5
Contractual Obligations year 1 -3 years 3 -5 years years Total
----------- ----------- ----------- ----------- -----------
Bank borrowings $14,067,457 $14,067,457
Operating leases $ 1,265,510 2,003,754 $ 958,439 $ 2,928,900 7,156,603
Expected claim payouts 10,314,030 19,057,041 12,867,924 13,755,380 55,994,375
Capital leases 35,364 37,929 73,293
Other borrowings 314,304 1,538,356 1,374,478 652,671 3,879,809
----------- ----------- ----------- ----------- -----------
Total $11,929,208 $36,704,537 $15,200,841 $17,336,951 $81,171,537
=========== =========== =========== =========== ===========
56
2. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the Emerging Issues Task Force (EITF) reached consensus on
the remaining issues for Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments," and as a result reached
a final consensus on an other-than-temporary impairment model for debt and
equity securities within the scope of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and equity securities that are not
subject to the scope of SFAS No. 115 and not accounted for under the equity
method of accounting (i.e., cost method investments). The EITF also reached a
consensus that the three-step model used to determine other-than-temporary
impairments must be applied prospectively to all current and future investments,
in interim or annual reporting periods beginning after June 15, 2004. On
September 30, 2004, the FASB issued FASB Staff Position (FSP) EITF Issue 03-1-1,
"Effective Date of Paragraphs 10-20 of EITF 03-1, The Meaning of Other Than
Temporary Impairment," delaying the effective date for the recognition and
measurement guidance of EITF 03-1 on impairment loss that is other than
temporary (i.e., steps two and three of the three-step impairment model), as
contained in paragraphs 10-20, until certain implementation issues are addressed
and a final FSP providing implementation guidance is issued. The disclosure
requirements of the EITF consensus remain in effect. Quantitative and
qualitative disclosure requirements for investments accounted for under SFAS No.
115 were effective for the first annual reporting period ending after December
15, 2003. We have disclosed such quantitative and qualitative information in the
notes to our consolidated financial statements as of December 31, 2004. All new
disclosure requirements related to cost method investments are effective for the
annual reporting periods ending after June 15, 2004. Comparative information for
the periods prior to the period of initial application is not required.
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion
No. 29, Accounting for Nonmonetary Transactions. The Statement is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. Earlier application is permitted for nonmonetary asset exchanges occurring
in fiscal periods beginning after the date of issuance. The provisions of this
Statement shall be applied prospectively. The amendments made by Statement 153
are based on the principle that exchanges of nonmonetary assets should be
measured based on the fair value of the assets exchanged. Further, the
amendments eliminate the narrow exception for nonmonetary exchanges of similar
productive assets and replace it with a broader exception for exchanges of
nonmonetary assets that do not have commercial substance. Previously, Opinion 29
required that the accounting for an exchange of a productive asset for a similar
productive asset or an equivalent interest in the same or similar productive
asset should be based on the recorded amount of the asset relinquished.
Management does not believe adoption of this statement will have a material
effect on the Company's consolidated financial statements.
In December 2004, FASB issued Statement 123(Revised) which replaces FASB
Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123(Revised)
is effective for public entities that do not file as small business issuers--as
of the beginning of the first interim or annual reporting period that begins
after June 15, 2005. Statement 123, as originally issued in 1995, established as
preferable a fair-value-based method of accounting for share-based payment
transactions with employees. However, that Statement permitted entities the
option of continuing to apply the guidance in Opinion 25, as long as the
footnotes to financial statements disclosed what net income would have been had
the preferable fair-value-based method been used. The new Statement establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. It also addresses transactions in
which an entity incurs liabilities in exchange for goods or services that are
based on the fair value of the entity's equity instruments or that may be
settled by the issuance of those equity instruments. This Statement focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. This Statement does not change the
accounting guidance for share-based payment transactions with parties other than
employees provided in Statement 123 as originally issued and EITF Issue No.
96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services."
This Statement does not address the accounting for employee share ownership
plans, which are subject to AICPA Statement of Position 93-6, Employers'
Accounting for Employee Stock Ownership Plans. This Statement requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award--the
requisite service period (usually the vesting period). No compensation cost is
recognized for equity instruments for which employees do not render the
requisite service. Employee share purchase plans will not result in recognition
of compensation cost if certain conditions are met; those conditions are much
the same as the related conditions in Statement 123. PICO Holdings has a cash
based SAR plan which is included in these provisions and described as a
Share-based Liability plan. As noted in the notes to the accompanying
consolidated financial statements, PICO currently records compensation expense
under the variable plan method using the intrinsic value of the SARs. However,
the new rules will require PICO to re-measure its liability each reporting
period using a fair value approach until the awards are settled. Management is
currently assessing the impact adoption of this statement will have on the
Company's consolidated financial statements in 2005.
57
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 or workers'
compensation claim, 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 $56.0 million at December 31, 2004, $60.9 million
at December 31, 2003, and $52.7 million at December 31, 2002 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 increased by $443,000 in 2004, $4.7 million in 2003, and decreased by $2.3
million in 2002. These changes to prior years' reserves were due to the
following:
CHANGE IN UNPAID LOSS AND LAE RESERVES FOR PRIOR YEARS
2004 2003 2002
-------- ---------- -----------
Increase (decrease) in provision from prior year claims $443,284 $4,667,024 $(1,907,552)
Retroactive insurance (438,879)
-------- ---------- -----------
Net increase (decrease) in liabilities for unpaid loss
and LAE of prior years $443,284 $4,667,024 $(2,346,431)
======== ========== ===========
See 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.
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
The following table presents the development of balance sheet liabilities
for 1994 through 2004 for all continuing operations property and casualty and
workers' compensation 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.
58
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- --------- --------- --------
(IN THOUSANDS)
Net liability as originally estimated: $153,212 $135,825 $ 153,891 $ 110,931 $ 89,554
Discount 20,144 16,568 12,217 9,159 8,515
Gross liability as originally
estimated: 173,356 152,393 166,108 120,090 98,069
Cumulative payments as of:
One year later 35,966 26,331 54,500 37,043 23,696
Two years later 61,263 63,993 88,298 57,622 41,789
Three years later 93,906 85,649 107,094 73,096 50,968
Four years later 110,272 99,730 121,698 82,249 58,129
Five Years later 119,879 110,299 130,247 89,398 64,119
Six years later 129,819 115,312 137,462 95,454
Seven years later 132,394 118,396 143,532
Eight years later 134,811 121,837
Nine years later 137,602
Ten years later
Liability re-estimated as of:
One year later 170,411 145,824 166,870 129,225 114,347
Two years later 163,472 145,031 182,963 145,543 115,539
Three years later 162,532 150,439 193,498 146,618 104,689
Four years later 165,696 155,183 194,423 135,930 102,704
Five Years later 167,145 157,973 183,333 133,958 107,409
Six years later 167,821 149,074 181,705 138,520
Seven years later 160,233 147,525 185,201
Eight years later 160,188 141,028
Nine years later 153,869
Ten years later
Cumulative Redundancy (Deficiency) $ 19,487 $ 11,365 ($19,093) ($18,430) ($9,340)
59
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1999 2000 2001 2002 2003 2004
------- ------- ------- -------- -------- --------
(IN THOUSANDS)
Net liability as originally estimated: $88,112 $74,896 $54,022 $ 44,906 $ 43,357 $ 36,603
Discount 7,521
Gross liability before discount as
originally estimated: 95,633 74,896 54,022 44,906 43,357 36,603
Cumulative payments as of:
One year later 22,636 9,767 7,210 6,216 6,515
Two years later 31,987 16,946 13,426 12,729
Three years later 39,150 23,162 19,939
Four years later 45,140 29,675
Five Years later 51,566
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Liability re-estimated as of:
One year later 96,727 63,672 52,115 49,574 43,115
Two years later 85,786 61,832 56,782 49,331
Three years later 83,763 66,494 56,540
Four years later 88,460 66,275
Five Years later 88,167
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative Redundancy (Deficiency) $ 7,466 $ 8,621 $(2,518) $ (4,425) $ 242
RECONCILIATION TO FINANCIAL STATEMENTS
Gross liability - end of year $ 52,686 $ 60,847 $ 53,905
Reinsurance recoverable (7,780) (17,490) (17,302)
-------- -------- --------
Net liability - end of year 44,906 43,357 36,603
Reinsurance recoverable 7,780 17,490 17,302
-------- -------- --------
52,686 60,847 53,905
Discontinued personal lines
insurance 17 17 51
Liability to California Insurance
Guarantee Association for
Workers' Compensation payouts 2,038
-------- -------- --------
Balance sheet liability $ 52,703 $ 60,864 $ 55,994
======== ======== ========
Gross re-estimated liability -
latest $ 70,156 $ 61,513
Re-estimated recoverable - latest (20,824) (18,398)
-------- --------
Net re-estimated liability - latest $ 49,332 $ 43,115
======== ========
Net cumulative redundancy
(deficiency) ($4,426) $ 242
======== ========
Each decrease or increase 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 1994 to 2004 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.
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
60
professional liability insurance, commercial casualty and workers' compensation
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 that are 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 statement of operations and financial condition.
Reconciliation of Unpaid Loss and Loss Adjustment Expenses
An analysis of changes in the liability for unpaid losses and loss
adjustment expenses for 2004, 2003 and 2002 is set forth in Note 11 of Notes to
PICO's Consolidated Financial Statements, "Reserves for Unpaid Loss and Loss
Adjustment Expenses."
REINSURANCE
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 remain in place to limit PICO's exposure
levels. See Note 10 of Notes to PICO's Consolidated Financial Statements,
"Reinsurance." PICO's insurance subsidiaries are contingently liable with
respect to reinsurance contracts in the event that reinsurers are unable to meet
their obligations under the reinsurance agreements in force.
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
Odyssey America Reinsurance Corporation, a subsidiary of Odyssey Re Holdings
Corp. (rated A by A. M. Best Company) and Medical Assurance Company, a wholly
owned subsidiary of Pro Assurance Group (rated A- by Standard & Poors).
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
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 coverage's were reinsured $9.9 million excess of $100,000 per
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.
61
Citation does not require reinsurance from 2002 onwards for all its
property and casualty lines of business, as its last policy expired in December
2001.
If the reinsurers are "not admitted" for regulatory purposes, Citation has
to maintain sufficient collateral with approved financial institutions to secure
cessions of paid losses and outstanding reserves.
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, 2004. Citation 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.
Workers' Compensation Insurance through Citation Insurance Company
Claims and Liabilities Related to the Insolvency of Fremont Indemnity
Company
In 1997, pursuant to a Quota Share Reinsurance Agreement (the "Reinsurance
Agreement"), Citation ceded its California workers' compensation insurance
liabilities to Citation National Insurance Company ("CNIC") and transferred all
administrative services relating to these liabilities to Fremont. The
Reinsurance Agreement became effective upon Fremont's acquisition, with approval
from the California Department of Insurance (the "Department"), of CNIC on or
about June 30, 1997. Thereafter, on or about December 31, 1997, CNIC merged,
with Department approval, with and into Fremont. Accordingly, since January 1,
1998, Fremont has been both the reinsurer and the administrator of the
California workers' compensation business ceded by Citation.
During the period from June 30, 1997 (the date on which Citation ceded its
workers' compensation insurance liabilities) through July 2, 2003 (the date on
which Fremont was placed in liquidation), Fremont maintained a workers'
compensation insurance securities deposit in California for the benefit of
claimants under workers' compensation insurance policies issued, or assumed, by
Fremont.
Concurrent with Fremont's posting of the portion of the total deposit that
related to Citation's insureds, Citation reduced its own workers' compensation
insurance reserves by the amount of that deposit.
On June 4, 2003, the Superior Court of the State of California for the
County of Los Angeles (the "Liquidation Court") entered an Order of Conservation
over Fremont and appointed the California Department of Insurance Commissioner
(the "Commissioner") as the conservator. Pursuant to such order, the
Commissioner was granted authority to take possession of all of Fremont's
assets, including its rights in the deposit for Citation's insureds. Shortly
thereafter, on July 2, 2003, the Liquidation Court entered an Order appointing
the Commissioner as the liquidator of Fremont's Estate.
Shortly thereafter, Citation concluded that, because Fremont had been
placed in liquidation, Citation was no longer entitled to take a reinsurance
credit for the deposit for Citation's insureds under the statutory basis of
accounting. Consequently, Citation reversed the $7.5 million reinsurance
recoverable from Fremont in its June 30, 2003 financial statements prepared on
the statutory basis of accounting. In addition, Citation made a corresponding
provision for the reinsurance recoverable from Fremont at June 30, 2003 for GAAP
purposes.
In June 2004, Citation filed litigation against the California Department
of Insurance in the Superior Court of California to recover its workers'
compensation trust deposits held by Fremont prior to Fremont's liquidation.
In September 2004, the Superior Court ruled against Citation's action. As a
result, Citation did not receive any distribution from the California Insurance
Guarantee Association or Fremont and will not receive any credit for the deposit
held by Fremont for Citation's insureds.
In consideration of the potential cost and the apparent limited prospect of
obtaining relief, Citation decided not to file an appeal.
Reinsurance Agreements on Workers' Compensation Insurance Liabilities
In addition to the reinsurance agreements with Fremont noted above,
Citation's workers' compensation insurance liabilities from policy years 1986 to
1997 retain additional reinsurance coverage with General Reinsurance, a wholly
owned subsidiary of Berkshire Hathaway, Inc. (Standard & Poors rating of AAA.)
Policy years 1986 and 1987 have a Company retention of $150,000; policy years
1988 and 1989 have a Company retention of $200,000 and policy years 1990 through
to 1997 have a Company retention of $250,000.
See Note 10 of Notes to Consolidated Financial Statements, "Reinsurance,"
with regard to reinsurance recoverable concentration for Citation's workers'
compensation line of business as of December 31, 2004. Citation 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.
62
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, 2004, PICO had $39.5 million of fixed maturity securities and mortgage
participation interests, $143 million of marketable equity securities that were
subject to market risk, of which $81 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 report 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 $857,000 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 $28.6 million that would impact the unrealized appreciation in
shareholders' equity, net of the related tax effect. The hypothetical 20%
decrease in the local currency of PICO's foreign denominated investments
produced a loss of $13.5 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, 2004 and 2003 and for each
of the three years in the period ended December 31, 2004 and the independent
auditors' report is included in this report as listed in the index.
63
SELECTED QUARTERLY FINANCIAL DATA
Summarized unaudited quarterly financial data (in thousands, except share
and per share amounts) for 2004 and 2003 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.
THREE MONTHS ENDED
--------------------------------------------------------
March 31, June 30, September 30, December 31,
2004 2004 2004 2004
----------- ----------- ------------- ------------
Net investment income and
net realized gain 743 1,782 704 5,836
Sale of land and water rights 276 2,096 1,151 7,355
Total revenues 2,397 5,766 4,307 15,658
Net income (loss) (5,018) (4,532) (2,183) 1,174
----------- ----------- ----------- -----------
Basic and Diluted:
Net income (loss) per share $ (0.41) $ (0.37) $ (0.18) $ 0.09
=========== =========== =========== ===========
Weighted average common
and equivalent shares
outstanding 12,370,264 12,368,928 12,367,664 12,366,479
THREE MONTHS ENDED
--------------------------------------------------------
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
----------- ----------- ------------- ------------
Net investment income and
net realized gain 328 3,624 1,445 2,720
Sale of land and water rights 20 2,196 2,002 15,533
Total revenues 1,483 6,412 4,571 20,413
Net income (loss) 856 (2,001) (3,190) 1,097
----------- ----------- ----------- -----------
Basic and Diluted:
Net income (loss) per share $ 0.07 $ (0.16) $ (0.26) $ 0.09
=========== =========== =========== ===========
Weighted average common
and equivalent shares
outstanding 12,379,042 12,375,610 12,375,610 12,373,534
64
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2004 AND 2003
AND FOR EACH OF THE
THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 2004
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Accounting Firms ................... 66-67
Consolidated Balance Sheets as of December 31, 2004 and 2003 ......... 68-69
Consolidated Statements of Operations for the Years Ended
December 31, 2004, 2003 and 2002 .................................. 70
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 2004, 2003, and 2002 ................................. 71-73
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2004, 2003 and 2002 .................................. 74
Notes to Consolidated Financial Statements ........................... 75-101
65
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of PICO Holdings, Inc.
We have audited the accompanying consolidated balance sheets of PICO Holdings,
Inc. and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2004. 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 did not audit the financial statements of HyperFeed Technologies,
Inc. (a 51% owned consolidated subsidiary) for the year ended December 31, 2003,
which statements reflect total assets of $9,714,258 as of December 31, 2003, and
net income of $1,600,818 for the year then ended. Those statements were audited
by other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to the amounts included for HyperFeed Technologies, Inc.,
is based solely on the report of such other auditors.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 and the report of
other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, such
consolidated financial statements present fairly, in all material respects, the
financial position of PICO Holdings, Inc. and subsidiaries as of December 31,
2004 and 2003, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2004, 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.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, based on the
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 11, 2005 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
/s/ Deloitte & Touche LLP
San Diego, California
March 11, 2005
66
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
HyperFeed Technologies, Inc.:
We have audited the consolidated balance sheet of HyperFeed Technologies, Inc.
and subsidiary as of December 31, 2003, and the related consolidated statements
of operations, stockholders' equity, and cash flows for the year then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of HyperFeed
Technologies, Inc. and subsidiary as of December 31, 2003, and the results of
their operations and their cash flows for the year then ended, in conformity
with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Chicago, Illinois
March 4, 2004
67
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
ASSETS
2004 2003
------------ ------------
Investments (Note 3):
Available for sale:
Fixed maturities $ 39,479,216 $ 52,615,376
Equity securities 142,978,213 96,306,035
------------ ------------
Total investments 182,457,429 148,921,411
Cash and cash equivalents 17,407,138 24,348,693
Notes and other receivables, net (Note 6) 14,951,973 16,430,541
Reinsurance receivables (Note 10) 17,157,329 17,714,012
Real estate and water assets (Note 5) 110,700,456 112,270,280
Property and equipment, net (Note 8) 2,436,921 3,117,521
Net deferred income taxes (Note 7) 29,577
Other assets 9,512,807 7,246,695
Other assets of discontinued operations (Note 2) 6,970 818,537
------------ ------------
Total assets $354,631,023 $330,897,267
============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
68
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED
DECEMBER 31, 2004 AND 2003
LIABILITIES AND SHAREHOLDERS' EQUITY
2004 2003
------------ ------------
Policy liabilities and accruals:
Unpaid losses and loss adjustment expenses (Note 11) $ 55,994,375 $ 60,863,884
Reinsurance balance payable 673,024 671,031
Stock appreciation rights payable (Notes 1 and 9) 15,731,741 5,969,762
Other liabilities 11,989,257 10,871,288
Bank and other borrowings (Note 19) 18,020,559 15,376,640
Net deferred income taxes (Note 7) 9,193,060
Other liabilities of discontinued operations (Note 2 ) 759,372 2,169,879
------------ ------------
Total liabilities 112,361,388 95,922,484
------------ ------------
Minority interest 2,340,337 5,814,381
------------ ------------
Commitments and Contingencies (Notes 10, 11, 12, 13, 14, 15 and 19)
Common stock, $.001 par value; authorized 100,000,000; 16,801,923 issued and outstanding
at December 31, 2004 and 2003 16,802 16,802
Additional paid-in capital 236,089,222 236,082,703
Accumulated other comprehensive income (Note 1) 36,725,700 15,283,404
Retained earnings 45,524,219 56,082,903
------------ ------------
318,355,943 307,465,812
Less treasury stock, at cost (common shares: 4,435,444 in 2004 and 4,428,389 in 2003) (78,426,645) (78,305,410)
------------ ------------
Total shareholders' equity 239,929,298 229,160,402
------------ ------------
Total liabilities and shareholders' equity $354,631,023 $330,897,267
============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
69
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
------------ ------------ -----------
Revenues:
Sale of real estate and water assets $ 10,879,172 $ 19,751,160 $15,231,769
Net investment income (Note 3) 5,799,357 5,370,104 5,385,209
Net realized gain on investments (Note 3) 3,265,505 2,745,657 4,209,632
Service revenue 5,994,688 1,363,925
Premium charge (41,796)
Other 2,188,114 3,647,748 4,489,425
------------ ------------ -----------
Total revenues 28,126,836 32,878,594 29,274,239
------------ ------------ -----------
Costs and expenses:
Operating and other costs 25,568,411 19,203,015 15,055,461
Stock appreciation rights expense 9,874,865 5,969,762
Cost of real estate and water assets sold 4,496,652 12,648,864 9,740,137
Cost of service revenue 1,585,129 1,069,174
Loss and loss adjustment (recoveries) expenses (Note 11) 443,284 4,667,024 (2,346,314)
Interest expense 792,076 721,322 795,193
Depreciation and amortization 2,263,355 1,813,114 1,115,716
------------ ------------ -----------
Total costs and expenses 45,023,772 46,092,275 24,360,193
------------ ------------ -----------
Equity in loss of unconsolidated affiliates (564,785) (2,208,070)
------------ ------------ -----------
Income (loss) before income taxes and minority interest (16,896,936) (13,778,466) 2,705,976
Provision (benefit) for federal, foreign and state income taxes (Note 7) (3,047,721) (1,202,407) 2,049,565
------------ ------------ -----------
Income (loss) before minority interest (13,849,215) (12,576,059) 656,411
Minority interest in (income) loss of subsidiaries 3,212,811 (1,045,605) 454,184
------------ ------------ -----------
Income (loss) from continuing operations (10,636,404) (13,621,664) 1,110,595
Income (loss) from discontinued operations, net (Note 2) (422,280) 2,933,366 2,833,806
Gain on sale of discontinued operations, net 500,000 7,450,486
------------ ------------ -----------
Income (loss) before cumulative change in accounting principle (10,558,684) (3,237,812) 3,944,401
Cumulative effect of change in accounting principle, net (Note 20) 1,984,744
------------ ------------ -----------
Net income (loss) $(10,558,684) $ (3,237,812) $ 5,929,145
============ ============ ===========
Net income (loss) per common share - basic and diluted:
Income (loss) from continuing operations $ (0.86) $ (1.10) $ 0.09
Discontinued operations 0.01 0.84 0.23
Cumulative effect of change in accounting principle 0.16
------------ ------------ -----------
Net income (loss) per common share $ (0.85) $ (0.26) $ 0.48
============ ============ ===========
Weighted average shares outstanding 12,368,354 12,375,933 12,375,466
============ ============ ===========
The accompanying notes are an integral part of the
consolidated financial statements.
70
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Accumulated Other
Comprehensive Income
---------------------------
Additional Net Unrealized Foreign
Common Paid-In Retained Appreciation Currency Treasury
Stock Capital Earnings on Investments Translation Stock Total
-------- ------------ ----------- -------------- ----------- ------------ ------------
Balance, January 1, 2002 $16,784 $235,844,655 $53,391,570 $5,545,057 $(8,770,924) $(78,128,635) $207,898,507
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 12,988,688
Acquisition of shares of treasury
stock for deferred compensation
plans (93,557) (93,557)
Exercise of stock options 18 238,048 238,066
------- ------------ ----------- ---------- ----------- ------------ ------------
Balance, December 31, 2002 $16,802 $236,082,703 $59,320,715 $9,999,442 $(6,165,766) $(78,222,192) $221,031,704
======= ============ =========== ========== =========== ============ ============
The accompanying notes are an integral part of the
consolidated financial statements
71
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY, CONTINUED
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Accumulated Other
Comprehensive Income
---------------------------
Additional Net Unrealized Foreign
Common Paid-In Retained Appreciation Currency Treasury
Stock Capital Earnings on Investments Translation Stock Total
------- ------------ ----------- -------------- ----------- ------------ ------------
Balance, December 31, 2002 $16,802 $236,082,703 $59,320,715 $ 9,999,442 $(6,165,766) $(78,222,192) $221,031,704
Comprehensive Income for 2003
Net loss (3,237,812)
Net unrealized appreciation on
investments net of deferred
tax of $3.7 million and
reclassification adjustment
of $1.5 million 10,879,588
Foreign currency translation 570,140
Total Comprehensive Income 8,211,916
Acquisition of shares of treasury
stock for deferred compensation (83,218) (83,218)
plans
------- ------------ ----------- ----------- ----------- ------------ ------------
Balance, December 31, 2003 $16,802 $236,082,703 $56,082,903 $20,879,030 $(5,595,626) $(78,305,410) $229,160,402
======= ============ =========== =========== =========== ============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
72
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Accumulated Other
Comprehensive Income
---------------------------
Additional Net Unrealized Foreign
Common Paid-In Retained Appreciation Currency Treasury
Stock Capital Earnings on Investments Translation Stock Total
------- ------------ ------------ -------------- ----------- ------------ ------------
Balance, December 31, 2003 $16,802 $236,082,703 $ 56,082,903 $20,879,030 $(5,595,626) $(78,305,410) $229,160,402
Comprehensive Income for 2004
Net loss (10,558,684)
Net unrealized appreciation on
investments net of deferred
tax of $11 million and
reclassification adjustment
of $2.2 million 21,068,132
Foreign currency translation 374,164
Total Comprehensive Income 10,883,612
Acquisition of treasury stock for
deferred compensation plans (121,235) (121,235)
Other 6,519 6,519
------- ------------ ------------ ------------ ----------- ------------ ------------
Balance, December 31, 2004 $16,802 $236,089,222 $ 45,524,219 $41,947,162 $(5,221,462) $(78,426,645) $239,929,298
======= ============ ============ ============ =========== ============ ============
The accompanying notes are an integral part of the
consolidated financial statements
73
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(10,558,684) $ (3,237,812) $ 5,929,145
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities, net of acquisitions:
Provision for deferred taxes (2,211,306) (876,207) 1,990,042
Cumulative effect of accounting change (1,984,744)
Depreciation and amortization 4,127,120 2,757,493 1,420,806
(Gain) loss on sale of investments (3,265,505) (2,745,657) (4,209,632)
(Gain) loss on sale of fixed assets 70,183 23,737 (8,939)
Gain on sale of Sequoia (1,568,278)
Allowance for uncollectible accounts 308,917 270,000
Impairment of goodwill on purchases of SISCOM 194,095
Equity in loss of unconsolidated affiliates 564,785 2,208,070
Minority interest (3,212,811) 1,045,605 (454,184)
Changes in assets and liabilities, net of effects of acquisitions:
Notes and other receivables 1,169,650 (9,467,051) 1,572,574
Other liabilities 1,117,972 (85,106) 540,055
Other assets (2,333,997) 217,549 (2,006,486)
Real estate and water assets 2,740,891 9,914,760 9,425,589
Income taxes (9,291) 71,846
Reinsurance receivable 556,683 (9,881,304) (323,870)
Reinsurance payable 1,993 133,031 (2,781,333)
SAR payable 9,761,978 5,969,762
Deferred gain on retroactive insurance (438,879)
Unpaid losses and loss adjustment expenses (4,869,509) 8,160,771 (8,834,797)
Net operating cash provided by (used in) discontinued operations (598,940) (1,558,754) 8,499,963
Other adjustments, net 6,516 (135,323) 304,365
------------ ------------ ------------
Net cash provided by (used in) operating activities (7,004,045) (426,153) 10,847,745
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of available for sale investments:
Fixed maturities 18,334,850 12,637,514 21,566,412
Equity securities 10,871,372 14,735,268 23,168,694
Proceeds from maturity of investments 5,325,000 27,537,091 48,646,426
Purchases of available for sale investments:
Fixed maturities (11,322,556) (46,476,107) (68,074,673)
Equity securities (18,503,481) (25,667,968) (15,106,827)
Proceeds from the sale of Sequoia 25,144,350
Purchases on minority interest in subsidiaries (1,322,138)
Real estate and water asset capital expenditure (790,961) (2,315,322) (378,429)
Capitalized software costs (1,382,361)
Purchases of property and equipment (669,598) (490,078) (457,109)
Proceeds from sales of property and equipment 40,249
Net investing cash used by discontinued operations (10,622,501)
Other investing activities, net (98,429) 116,803
------------ ------------ ------------
Net cash provided by (used in) investing activities 580,376 5,006,319 (1,141,204)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of bank and other borrowings (1,344,516) (9,645,053) (4,177,517)
Proceeds from borrowings 2,908,196 9,111,446 2,670,348
Cash received on exercise of stock options (HyperFeed in 2004) 41,416 238,066
Cash paid for purchase of PICO stock (for deferred compensation plans) (121,235) (83,218) (93,557)
------------ ------------ ------------
Net cash provided by (used in) financing activities 1,483,861 (616,825) (1,362,660)
------------ ------------ ------------
Effect of exchange rate changes on cash (2,001,747) (1,693,730) (2,607,173)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (6,941,555) 2,269,611 5,736,708
Cash and cash equivalents, beginning of year 24,348,693 22,079,082 16,342,374
------------ ------------ ------------
Cash and cash equivalents, end of year $ 17,407,138 $ 24,348,693 $ 22,079,082
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 826,894 $ 327,608 $ 856,983
============ ============ ============
Income taxes paid $ 179,635 $ 555,600
============ ============ ============
The accompanying notes are an integral part of the consolidated
financial statements
74
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 and water storage operations in the
southwestern United States through Vidler Water Company, Inc.;
- - owning and developing land and the related mineral rights and water rights
in Nevada through Nevada Land & Resource Company, LLC;
- - the acquisition and financing of businesses;
- - "running off" the insurance 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.
The Company's primary operating subsidiaries as of December 31, 2004 are as
follows:
Vidler Water Company, Inc. ("Vidler"). Vidler is a wholly owned Nevada
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
Nevada Limited Liability Company, which owns approximately 1 million acres of
land in northern Nevada. Nevada Land's business includes selling land and water
rights, and leasing property.
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 property and casualty and workers' compensation lines
of business. This means that it is handling claims arising from historical
business, and selling investments when funds are needed to pay claims.
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.
HyperFeed Technologies, Inc. ("HyperFeed"). HyperFeed is a developer and
provider of software, ticker plant technologies and managed services to the
financial markets industry. PICO owns approximately 51% of the outstanding
voting stock of HyperFeed.
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, there are no investments the Company considers
an unconsolidated equity affiliate.
75
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, real
estate and water assets, deferred income taxes and contingent liabilities. While
management believes that the carrying value of such assets and liabilities are
appropriate as of December 31, 2004 and 2003, it is reasonably possible that
actual results could differ from the estimates upon which the carrying values
were based.
Revenue Recognition:
Sale of Real Estate and Water Assets
Revenue on the sale of real estate and water assets conforms with Statement
of Financial Accounting Standards ("SFAS") No. 66, "Accounting for Sales of Real
Estate," and 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 obligated 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.
Service Revenue (HyperFeed Technologies)
HyperFeed derives revenue primarily from licensing technology and providing
management and maintenance services of HTPX and HBox software, ticker plant
technologies, and managed services. Additionally, HyperFeed derives revenue from
the development of customized software.
HyperFeed applies the provisions of Statement of Position 97-2, "Software
Revenue Recognition," as amended, which specifies the following four criteria
that must be met prior to recognizing revenue: (1) persuasive evidence of the
existence of an arrangement, (2) delivery, (3) fixed or determinable fee, and
(4) probable collection. In addition, revenue earned on software arrangements
involving multiple elements is allocated to each element based on the relative
fair value of the elements.
Investments:
The Company's investment portfolio at December 31, 2004 and 2003 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 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.
76
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 gains or losses in the consolidated statement of operations and the
security is written down to its fair value. Impairment charges of $1.9 million,
$1.1 million, and $4.1 million are included in realized losses for the years
ended December 31, 2004, 2003 and 2002, 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.
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 revenues, are
determined on an average basis and recorded on the trade date.
The Company has subsidiaries and makes acquisitions in the U.S. and abroad.
Approximately $81 million and $51.5 million of the Company's investments at
December 31, 2004 and 2003, respectively, were invested internationally,
including equity values of affiliates. The Company's most significant foreign
currency exposure at December 31, 2004 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.
Real Estate and Water Assets:
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 of water
rights are capitalized. This cost includes, when applicable, the allocation of
the original purchase price and other costs directly related to acquisition, and
any costs incurred to get the property ready 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.
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 three
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 revenues.
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 SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." Consequently, goodwill and intangible assets that have indefinite
useful lives are not amortized but rather are 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 the Company's consolidated financial
statements for the year ended December 31, 2002 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 the
write-off of goodwill of $800,000. The positive goodwill of $800,000 was deemed
impaired based on the present value of the underlying cash flows.
77
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 is 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 and workers' compensation
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 similarly to basic earnings per share except the weighted
average shares outstanding are increased to include additional shares from the
assumed exercise of any common stock equivalents, typically stock options, using
the treasury method, if dilutive. The number of additional shares is calculated
by assuming that the common stock equivalents were exercised, and that the
proceeds were used to acquire shares of common stock at the average market price
during the period.
In July 2003, the Company adopted a Stock Appreciation Rights Plan whereby
all stock options outstanding were exchanged for stock appreciation rights
(SAR). The rights are not considered common stock equivalents for purposes of
earnings per share because they are not converted into common shares of the
Company when a SAR is exercised. Any benefit is paid in cash. Consequently, the
Company does not have any common stock equivalents to consider for purposes of
the weighted average shares outstanding for diluted earnings per share and
therefore, basic and diluted shares outstanding will be identical.
For the year ended December 31, 2002, 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 at
that time, and to include those options would be anti-dilutive to the
calculation. Stock options of 1.7 million in 2002 were excluded from the
calculation of the diluted weighted average shares outstanding.
78
Stock-Based Compensation:
In July 2003, all 1,687,242 outstanding stock options were voluntarily
surrendered by employees and Directors. On July 17, 2003, the Company's
shareholders voted to adopt the PICO Holdings, Inc. 2003 Stock Appreciation
Rights Program (the "SAR program") to replace the Company's stock option plans
and call option agreements. Upon adoption of the SAR program, all 355,539
outstanding options under call option agreements were also surrendered by the
holders. The maximum number of SARs issuable under the plan may not exceed
2,042,781. 1,962,781 SARs were issued to the prior option holders upon adoption
of the SAR program at an exercise price equal to that of the surrendered
options. All rights are fully vested, never expire, and only 20% of the initial
number can be exercised by an individual in any 12 month period unless
permission is given by the Compensation Committee. Upon exercise, the holder is
entitled to a cash benefit equal to the difference between the exercise price
and the then current market price of PICO stock. During 2004, 39,625 SARs were
exercised and $113,000 was paid to the holders. No SARs were exercised in 2003.
Compensation cost is measured at the end of each period as the amount by
which the quoted market price of PICO stock exceeds the exercise price. Changes
in the quoted market price are reflected as an adjustment to the accrued
compensation obligation and compensation expense in the Company's consolidated
financial statements. The Company recorded compensation expense of $9.9 million
and $6 million for the years ended December 31, 2004 and 2003, respectively,
representing the difference between the exercise price of the vested SARs and
the market value of PICO stock at the end of the reporting period, which was
$20.77 per share. This expense is reported in the accompanying consolidated
statement of operations. In addition, a liability of $15.7 million at December
31, 2004 and $6 million at December 31, 2003 is reported in the accompanying
consolidated balance sheets.
The following table summarizes the SARs outstanding at December 31, 2004:
SARs Outstanding
Weighted
Range of Exercise Number Average
Prices Outstanding Exercise Price
- ----------------- ---------------- --------------
$3.49 - $4.74 355,539 $ 3.93
$13.25 - $13.45 450,936 13.45
$15.00 1,116,681 15.00
--------- ------
1,923,156 $12.59
========= ======
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 until SFAS 123 Revised becomes effective after
June 15, 2005. PICO has elected to not adopt the fair value accounting
provisions of SFAS No. 123, and will continue accounting for stock-based
compensation under the intrinsic value method of APB No. 25, "Accounting for
Stock Issued to Employees."
79
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 income
or loss per share would approximate the following pro forma amounts for the
years ended December 31:
2004 2003 2002
------------ ----------- ----------
Reported net income (loss) $(10,558,684) $(3,237,812) $5,929,145
Add: Stock-based compensation recorded, net of tax 6,517,411 3,940,043
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of tax (8,844,608) (445,555)
------------ ----------- ----------
Pro forma net income (loss) $ (4,041,273) $(8,142,377) $5,483,590
============ =========== ==========
Reported net income (loss) per share: basic and diluted $ (0.85) $ (0.26) $ 0.48
============ =========== ==========
Pro forma net income (loss) per share: basic and diluted $ (0.33) $ (0.61) $ 0.44
============ =========== ==========
The effects of applying SFAS No. 148 in this pro forma disclosure are not
indicative of future amounts.
No fair value compensation is reported in the table above for 2004 since
all awards vested on July 17, 2003 and no additional grants have been made. The
fair value of each SAR granted in 2003 and stock option granted in previous
years is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions: no dividend yield;
risk-free interest rate of 1% for grants in 2003; expected life of a SAR is
estimated at 5 years, expected life of a stock option is generally estimated at
10 years; and volatility of 36% for the 2003 grants. No stock options were
granted in 2002.
The Black-Scholes model was used in estimating the fair value of the
Company's SARs that are fully vested and are non-transferable. This model
requires the input of highly subjective assumptions including the expected stock
price volatility and estimated life of the SAR. Because the Company's SARs have
characteristics significantly different from those of any like instrument that
is publicly traded, and because changes in the subjective input assumptions can
materially change the fair value estimate, management believes the existing
model does not necessarily provide a reliable single measure of the fair value
of its SARs.
Comprehensive Income:
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,
-------------------------
2004 2003
----------- -----------
Net unrealized gain on securities $41,947,162 $20,879,030
Foreign currency translation (5,221,462) (5,595,626)
----------- -----------
Accumulated other comprehensive income $36,725,700 $15,283,404
=========== ===========
The accumulated balance is net of deferred income tax liabilities of $18.2
million and $7.2 million at December 31, 2004 and 2003, 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.
80
Recent Accounting Pronouncements:
In March 2004, the Emerging Issues Task Force (EITF) reached consensus on
the remaining issues for Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments," and as a result reached
a final consensus on an other-than-temporary impairment model for debt and
equity securities within the scope of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and equity securities that are not
subject to the scope of SFAS No. 115 and not accounted for under the equity
method of accounting (i.e., cost method investments). The EITF also reached a
consensus that the three-step model used to determine other-than-temporary
impairments must be applied prospectively to all current and future investments,
in interim or annual reporting periods beginning after June 15, 2004. On
September 30, 2004 the FASB issued FASB Staff Position (FSP) EITF Issue 03-1-1,
"Effective Date of Paragraphs 10-20 of EITF 03-1, The Meaning of Other Than
Temporary Impairment," delaying the effective date for the recognition and
measurement guidance of EITF 03-1 on impairment loss that is other than
temporary (i.e., steps two and three of the three-step impairment model), as
contained in paragraphs 10-20, until certain implementation issues are addressed
and a final FSP providing implementation guidance is issued. The disclosure
requirements of the EITF consensus remain in effect. Quantitative and
qualitative disclosure requirements for investments accounted for under SFAS No.
115 were effective for the first annual reporting period ending after December
15, 2003. We have disclosed such quantitative and qualitative information in the
notes to our consolidated financial statements as of December 31, 2004. All new
disclosure requirements related to cost method investments are effective for the
annual reporting periods ending after June 15, 2004. Comparative information for
the periods prior to the period of initial application is not required.
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion
No. 29, Accounting for Nonmonetary Transactions. The Statement is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. Earlier application is permitted for nonmonetary asset exchanges occurring
in fiscal periods beginning after the date of issuance. The provisions of this
Statement shall be applied prospectively. The amendments made by Statement 153
are based on the principle that exchanges of nonmonetary assets should be
measured based on the fair value of the assets exchanged. Further, the
amendments eliminate the narrow exception for nonmonetary exchanges of similar
productive assets and replace it with a broader exception for exchanges of
nonmonetary assets that do not have commercial substance. Previously, Opinion 29
required that the accounting for an exchange of a productive asset for a similar
productive asset or an equivalent interest in the same or similar productive
asset should be based on the recorded amount of the asset relinquished.
Management does not believe adoption of this statement will have a material
effect on the Company's consolidated financial statements.
In December 2004, FASB issued Statement 123(Revised) which replaces FASB
Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123(Revised)
is effective for public entities that do not file as small business issuers--as
of the beginning of the first interim or annual reporting period that begins
after June 15, 2005. Statement 123, as originally issued in 1995, established as
preferable a fair-value-based method of accounting for share-based payment
transactions with employees. However, that Statement permitted entities the
option of continuing to apply the guidance in Opinion 25, as long as the
footnotes to financial statements disclosed what net income would have been had
the preferable fair-value-based method been used. The new Statement establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. It also addresses transactions in
which an entity incurs liabilities in exchange for goods or services that are
based on the fair value of the entity's equity instruments or that may be
settled by the issuance of those equity instruments. This Statement focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. This Statement does not change the
accounting guidance for share-based payment transactions with parties other than
employees provided in Statement 123 as originally issued and EITF Issue No.
96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services."
This Statement does not address the accounting for employee share ownership
plans, which are subject to AICPA Statement of Position 93-6, Employers'
Accounting for Employee Stock Ownership Plans. This Statement requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award--the
requisite service period (usually the vesting period). No compensation cost is
recognized for equity instruments for which employees do not render the
requisite service. Employee share purchase plans will not result in recognition
of compensation cost if certain conditions are met; those conditions are much
the same as the related conditions in Statement 123. PICO Holdings has a cash
based SAR plan which is included in these provisions and described as a
Share-based Liability plan. As noted in the notes to the accompanying
consolidated financial statements, PICO currently records compensation expense
under the variable plan method using the intrinsic value of the SARs. However,
the new rules will require PICO to re-measure its liability each reporting
period
81
using a fair value approach until the awards are settled. Management is
currently assessing the impact adoption of this statement will have on the
Company's consolidated financial statements in 2005.
2. DISCONTINUED OPERATIONS:
On March 31, 2003, the sale of Sequoia Insurance Company ("Sequoia") closed
for gross proceeds of $43.1 million, which consisted of $25.2 million in cash
and a dividend of equity and debt securities previously held by Sequoia with a
market value of $17.9 million. The net income from Sequoia included in PICO's
condensed consolidated results for the year ended December 31, 2003 was $2.4
million, which is reported as "Income from discontinued operations, net." The
Company also recorded a $443,000 gain on sale, net of estimated income taxes of
$281,000 and selling costs of $845,000, which is reported as "Gain on disposal
of discontinued operations, net" for the year ended December 31, 2003.
HyperFeed, a 51% owned subsidiary of the Company, sold its consolidated
market data feed service contracts and its retail trading business in 2003 and
recorded a gain within discontinued operations of $7 million. In 2004, HyperFeed
recorded a gain of $500,000 within discontinued operations on the sale of its
Consolidated Market Data Feed business as certain milestones on the sale were
met. These gains are included in the accompanying consolidated statements of
operations in the line item titled "Gain on disposal of discontinued operations,
net" for the years ended December 31, 2004 and 2003. For the year ended December
31, 2004, HyperFeed generated a loss of $422,000 from discontinued operations.
During the 2003 period HyperFeed was a consolidated subsidiary of the Company,
discontinued operations generated income of $545,000. Such amounts are included
in "Income from discontinued operations, net," The assets and liabilities of
this HyperFeed operation are reported as discontinued operations in the December
31, 2004 and 2003 balance sheets.
In accordance with SFAS No. 144, Sequoia's results and the results of the
HyperFeed operation have been reclassified for all periods presented as
discontinued operations in the accompanying consolidated financial statements.
The results of operations from discontinued operations and any gain on sale are
each reported separately, net of tax on the face of the statement of operations.
The results of HyperFeed's discontinued operation are not material and not
presented in detail in these notes to the Company's consolidated financial
statements. The following is a detail of Sequoia's results for the period
included in the accompanying consolidated financial statements:
82
STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2003
AND YEAR ENDED DECEMBER 31, 2002:
2003 2002
----------- -----------
Revenues:
Premium income $13,478,457 $47,102,301
Net investment income and realized gains/losses 2,863,487 5,096,002
Other income 91,303 241,195
----------- -----------
Total revenues 16,433,247 52,439,498
Expenses:
Loss and loss adjustment expenses 7,657,813 31,175,373
Policy acquisition costs 4,163,270 15,048,726
Insurance underwriting and other expenses 938,341 1,636,727
----------- -----------
Total expenses 12,759,424 47,860,826
----------- -----------
Income before income taxes and cumulative effect 3,673,823 4,578,672
Provision for income taxes 1,284,974 1,545,761
Cumulative effect of change in
accounting principle, net (199,105)
----------- -----------
Net income $ 2,388,849 $ 2,833,806
=========== ===========
Income per common share - basic and diluted $ 0.19 $ 0.23
=========== ===========
3. INVESTMENTS:
At December 31, the cost and carrying value of investments were as follows:
Gross Gross
Unrealized Unrealized Carrying
Cost Gains Losses Value
------------ ----------- ----------- ------------
2004:
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government - sponsored enterprises $ 10,544,388 $ 53,575 $ (16,993) $ 10,580,970
Corporate securities 23,621,118 727,452 (123,324) 24,225,246
Mortgage participation interests 4,673,000 4,673,000
------------ ----------- --------- ------------
38,838,506 781,027 (140,317) 39,479,216
Equity securities 83,759,017 59,316,810 (97,614) 142,978,213
------------ ----------- --------- ------------
Total $122,597,523 $60,097,837 $(237,931) $182,457,429
============ =========== ========= ============
Gross Gross
Unrealized Unrealized Carrying
Cost Gains Losses Value
------------ ----------- ---------- ------------
2003:
Fixed maturities:
U.S. Treasury securities
and obligations of U.S.
government - sponsored enterprises $ 7,082,293 $ 329,102 $ 7,411,395
Corporate securities 39,610,609 968,512 (48,140) 40,530,981
Mortgage participation interests 4,673,000 4,673,000
------------ ----------- --------- ------------
51,365,902 1,297,614 (48,140) 52,615,376
Equity securities 69,745,247 26,811,054 (250,266) 96,306,035
------------ ----------- --------- ------------
Total $121,111,149 $28,108,668 $(298,406) $148,921,411
============ =========== ========= ============
83
The amortized cost and carrying value of investments in fixed maturities at
December 31, 2004, 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 $ 606,508 $ 606,631
Due after one year through five years 23,522,246 24,002,744
Due after five years 10,036,752 10,196,841
Mortgage participation interests 4,673,000 4,673,000
----------- -----------
$38,838,506 $39,479,216
=========== ===========
Net investment income is as follows for each of the years ended
December 31:
2004 2003 2002
---------- ---------- ----------
Investment income:
Fixed maturities $1,956,838 $2,465,683 $3,060,988
Equity securities 2,556,841 1,951,462 1,143,870
Other 1,318,073 999,387 1,201,470
---------- ---------- ----------
Total investment income 5,831,752 5,416,532 5,406,328
Investment expenses: (32,395) (46,428) (21,119)
---------- ---------- ----------
Net investment income $5,799,357 $5,370,104 $5,385,209
========== ========== ==========
Pre-tax net realized gain or loss on investments is as follows for each of
the years ended December 31:
2004 2003 2002
----------- ----------- -----------
Gross realized gains:
Fixed maturities $ 205,017 $ 142,509 $ 383,576
Equity securities and other investments 5,629,155 3,797,245 8,842,416
----------- ----------- -----------
Total gain 5,834,172 3,939,754 9,225,992
----------- ----------- -----------
Gross realized losses:
Fixed maturities (50,393) (33,960) (320,949)
Equity securities and other investments (2,518,274) (1,160,137) (4,695,411)
----------- ----------- -----------
Total loss (2,568,667) (1,194,097) (5,016,360)
----------- ----------- -----------
Net realized gain $ 3,265,505 $ 2,745,657 $ 4,209,632
=========== =========== ===========
Realized Gains
During 2004, the Company sold various securities generating $5.8 million in
realized gains. The most significant gain in 2004 was a $3.2 million gain from
the sale of Keweenaw Land Association. In 2003, the Company realized a gain of
$1.5 million on the sale of shares in Guinness Peat Group. PICO sold its holding
of Australian Oil and Gas in 2002 for cash proceeds of $21.1 million, realizing
a gain of $8.8 million on the sale.
Realized Losses
Included in realized losses are impairment charges on securities. During
2004, 2003 and 2002, the Company recorded other-than-temporary impairments of
$1.9 million, $1.1 million and $4.1 million, respectively, on equity securities
to recognize what are expected to be other-than-temporary declines in value. The
impairment charges are primarily from two securities, Accu Holding and SIHL.
84
Accu Holding:
At December 31, 2004, the Company owned 29.2% of Accu Holding AG, a Swiss
corporation. 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 "Accounting for Certain Investments in Debt and Equity
Securities." In 2004, 2003 and 2002, the Company recorded other-than-temporary
impairments of $1.3 million, $823,000 and $2.2 million, respectively, due to the
severity and duration of the decline of Accu's stock price. At December 31,
2004, Accu's market value was $3 million.
SIHL:
In 2004, the value of the investment in SIHL continued to decline. Given
the severity and duration, the cause of the decline and lack of any evidence to
support a recovery of the fair value, Management recorded an impairment charge
of $547,000 effectively reducing the carrying amount to zero. The stock
continues to trade, however, there is no material market value of the investment
at December 31, 2004. In 2003, the Company recorded other-than-temporary
impairment of $293,000. At December 31, 2003, the market value of SIHL was
$433,000. 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 other-than-temporary impairment of $1.6 million. The charge reduced
the basis in SIHL to $768,000, which was equivalent to market value at December
31, 2002.
Jungfraubahn Holding AG:
At December 31, 2004, the Company owned 1,308,160 (after a 10 for 1 split)
shares of Jungfraubahn, which represents approximately 22.4% of the outstanding
shares of Jungfraubahn. At December 31, 2004, the market value of the investment
was $40.8 million and had an unrealized gain of $15.4 million, before tax. At
December 31, 2003, the Company owned 130,577 shares of Jungfraubahn, which
represented approximately 22.4% of the outstanding shares of Jungfraubahn. At
December 31, 2003, the market value of the investment was $26.7 million and had
an unrealized gain of $3.5 million, before tax. During 2002, the Company
acquired 17,505 shares for approximately $2.8 million, and became the largest
shareholder in Jungfraubahn.
Despite ownership of more than 20% of the voting stock of Jungfraubahn, the
Company continues to account for this investment under SFAS No. 115. 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 does not apply the equity method of accounting.
4. CONSOLIDATION OF HYPERFEED TECHNOLOGIES, INC:
On May 15, 2003 the Company increased its ownership of HyperFeed from 44%
to 51% by purchasing 443,623 shares for $1.2 million and accordingly, now has a
controlling financial interest through a direct ownership of a majority voting
interest. Consequently, PICO consolidated HyperFeed's results from the date of
acquisition forward. The acquisition was accounted for using the purchase method
of accounting and accordingly, the accompanying consolidated financial
statements include the revenues and expenses and costs of HyperFeed beginning
May 15, 2003. Prior to May 15, the Company accounted for its investment in
HyperFeed using the equity method of accounting. The following is an allocation
of the purchase price to the assets acquired and liabilities assumed at the date
of acquisition:
Purchase price $ 1,200,000
===========
Allocation of Purchase Price:
Cash 1,221,866
Receivables 761,459
Property and equipment, net 1,551,182
Other assets 2,564,765
Accounts payable and accrued liabilities (3,493,802)
Other liabilities (69,032)
Minority interest (1,336,438)
-----------
$ 1,200,000
===========
85
The following are the unaudited pro forma results of PICO for the years
ended December 31, 2003 and 2002 assuming the acquisition had taken effect at
the beginning of the period:
2003 2002
------------ -----------
Total revenues $ 33,098,458 $49,070,635
Income (loss) before taxes and minority interest (15,449,874) 337,367
Net income (loss) (3,514,185) 5,019,980
Net income (loss) per share: basic and diluted $ (0.28) $ 0.41
In 2003, HyperFeed sold its consolidated market data feed service contracts
and its retail trading business and recorded gains within discontinued
operations of $7 million. Based on PICO's 51% ownership, net of minority
interest, the gain to PICO was approximately $3.6 million. HyperFeed also
recorded a gain within discontinued operations of $500,000 in 2004, as certain
milestones of the sale of the Consolidated Market Data Feed business were met.
At December 31, 2004 and 2003, the Company's investment in HyperFeed
consisted of 1.5 million shares of common stock, representing 51% of the common
shares outstanding; and 310,616 common stock warrants which on a diluted basis
would represent an additional 5% voting interest if exercised. At December 31,
2004, the warrants have no fair value as the exercise price is substantially
higher than the market price of HyperFeed stock and the warrants expire in April
2005. At December 31, 2003, the carrying value of the investment in common stock
warrants was an estimated fair value of $556,000, 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 market value of the common shares at December 31, 2004 and 2003 based
on the closing price of HyperFeed common stock is $4.2 million and $9.5 million,
respectively.
The Black-Scholes pricing model incorporates assumptions in calculating an
estimated fair value. The following assumptions were used in the computations in
each of the three years ended December 31, 2004: no dividend yield for all
years; a risk-free interest rate ranging from 1% - 2%; a one year expected life;
and a historical cumulative volatility ranging from 109% to 139%.
At December 31, 2002, the Company's investment in HyperFeed consisted of
1.1 million shares of common stock, representing 44% of the common shares
outstanding; and 310,616 common stock warrants which on a diluted basis would
represent an additional 6% voting interest if exercised. During 2002, PICO
exercised 94,903 common stock warrants in HyperFeed for $305,000. The common
stock was 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 difference between the carrying value of the
investment and the underlying equity in the net assets or liabilities of
HyperFeed was 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.
During the three years ended December 31, 2004, HyperFeed recorded various
capital transactions that affected PICO's voting ownership percentage. In 2003,
through acquisition of additional shares, PICO increased its ownership to 51%.
During 2002, the voting percentage declined slightly due to HyperFeed issuing
new shares upon option exercises, then ownership increased by approximately 2%
upon PICO's exercise of 94,903 common stock purchase warrants and accordingly,
PICO increased its voting ownership to 44% at December 31, 2002.
86
5. REAL ESTATE AND WATER ASSETS:
Through its subsidiary Nevada Land, the Company owns land and the related
mineral rights and water rights. Through its subsidiary Vidler, the Company owns
land and 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:
2004 2003
------------ ------------
Nevada Land:
Land and related mineral rights and water rights $ 37,642,378 $ 42,193,587
------------ ------------
Vidler:
Water and water rights 25,999,698 24,214,843
Land 35,482,710 35,457,247
California water storage (Semitropic) 2,036,240 1,759,739
Land improvements, net 9,539,430 8,644,864
------------ ------------
73,058,078 70,076,693
------------ ------------
$110,700,456 $112,270,280
============ ============
Through November 2008, Vidler is required to make a minimum annual payment
for the Semitropic water storage facility of $378,000. These payments are being
capitalized and the asset is being amortized over its useful life of thirty-five
years. Amortization expense was $102,000 in each of the three years ended
December 31, 2004. At December 31, 2004 and 2003, Vidler owns the right to store
30,000 acre-feet of water. Vidler is also required to pay annual operating and
maintenance charges and for the years ended December 31, 2004, 2003 and 2002,
the Company expensed a total of $148,000, $155,000 and $152,000, respectively.
6. NOTES AND OTHER RECEIVABLES:
Notes and other receivables consisted of the following at December 31:
2004 2003
----------- -----------
Notes receivable $12,741,852 $13,118,122
Trade receivable 1,121,298 510,490
Interest receivable 462,631 589,322
Other receivables 985,109 4,663,211
----------- -----------
15,310,890 18,881,145
Allowance for doubtful accounts (358,917) (2,450,604)
----------- -----------
$14,951,973 $16,430,541
=========== ===========
Notes receivable, primarily from the sale of real estate and water assets
have a weighted average interest rate of 8% and a weighted average life to
maturity of approximately 5 years at December 31, 2004.
During 2004, other accounts receivable of $2.3 million due from Dominion
Capital Pty. Ltd ("Dominion"), for which a provision for uncollectibility was
recorded as expense in 2002, were taken off the books as the Company was unable
to recover any outstanding amounts.
At December 31, 2004, notes receivable include $3 million of receivables
arising from sales of properties in West Wendover, Nevada in 2003. The
properties were sold in 2003 for $14.8 million, and through December 31, 2004
the buyer made principal and interest payments of approximately $12.2 million.
The balance of the receivables was due to be repaid by December 31, 2004.
However, the regularly scheduled principal and interest payment due at December
31, 2004 has not been received and the receivables are past due. The Company is
negotiating with the buyer for collection of the balance due. The receivables
are secured by a Deed of Trust over the entire property sold to the buyer. The
Company has not recorded an allowance for bad debt at December 31, 2004 because
the Company believes the receivable is fully realizable by the value of the land
secured by the Deed of Trust. During 2005, the Company received $697,000 of the
balance owed and anticipates collecting the remaining $2.3 million.
87
7. FEDERAL, FOREIGN AND STATE INCOME TAX:
The Company and its U.S. subsidiaries (excluding HyperFeed) 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.
HyperFeed has various deferred tax balances, primarily NOL's, which are fully
valued (and excluded from the table below). The valuation of such timing
differences creates a $1.8 million and $1.5 million permanent item in PICO's tax
provision for 2004 and 2003, respectively, as noted in the rate reconciliation
below.
Significant components of the Company's deferred tax assets and liabilities
are as follows at December 31:
2004 2003
----------- -----------
Deferred tax assets:
Net operating loss carryforwards $ 8,876,386 $10,077,295
SAR expense 5,478,064 2,029,719
Capital loss carryforwards 152,278 1,304,859
Loss reserves 2,797,075 2,790,391
Basis difference on securities 1,158,813
Unrealized depreciation on securities 34,788 148,345
Impairment charges 2,968,817 3,095,168
Depreciation on fixed assets 974,079 670,285
Allowance for bad debts 963,894 963,894
Employee benefits 646,293 111,550
Cumulative loss on SFAS 133 derivatives 1,385,576 1,346,962
Other 1,444,529 1,779,474
----------- -----------
Total deferred tax assets 26,880,592 24,317,942
Deferred tax liabilities:
Unrealized appreciation on securities 17,816,101 6,995,708
Revaluation of real estate and water assets 10,855,277 10,383,777
Foreign receivables 2,317,623 1,608,240
Installment land sales 1,781,292 1,931,688
Accretion of bond discount 83,097 81,855
Capitalized lease 279,313 279,313
Other 1,696,284 1,763,119
----------- -----------
Total deferred tax liabilities 34,828,987 23,043,700
Net deferred tax asset (liability) before
valuation allowance (7,948,395) 1,274,242
Valuation allowance (1,244,665) (1,244,665)
----------- -----------
Net deferred income tax asset (liability) $(9,193,060) $ 29,577
=========== ===========
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. In
addition, as a result of the California Assembly Bill 263, which passed the
California Legislature in 2004, the Company will amend its 1997, 1998 and 2002
California income tax returns and pay income tax and interest of approximately
$1 million by March 31, 2005. Among other things, this Bill established the
dividend received deduction from inter-company dividends. The Company has fully
provided for this liability at December 31, 2004 and 2003.
88
Pre-tax income (loss) from continuing operations for the years ended
December 31 was under the following jurisdictions:
2004 2003 2002
------------ ------------ -----------
Domestic $(15,660,549) $(12,548,084) $ 6,639,696
Foreign (1,236,387) (1,230,382) (3,933,720)
------------ ------------ -----------
Total $(16,896,936) $(13,778,466) $ 2,705,976
============ ============ ===========
Income tax expense (benefit) from continuing operations for each of the
years ended December 31 consists of the following:
2004 2003 2002
----------- ----------- -----------
Current tax expense (benefit):
U.S. federal and state $ (908,367) $ (326,200) $ 2,471,607
Foreign 71,952 (2,412,084)
----------- ----------- -----------
Total current tax expense (benefit) (836,415) (326,200) 59,523
----------- ----------- -----------
Deferred tax expense (benefit):
U.S. federal and state $(1,957,765) $ (177,746) $ 5,334,617
Foreign (253,541) (698,461) (3,344,575)
----------- ----------- -----------
Total deferred tax expense (benefit) (2,211,306) (876,207) 1,990,042
----------- ----------- -----------
Total income tax expense (benefit) $(3,047,721) $(1,202,407) $ 2,049,565
=========== =========== ===========
The difference between income taxes provided at the Company's federal
statutory rate and effective tax rate is as follows:
2004 2003 2002
----------- ----------- -----------
Federal income tax provision (benefit) at statutory rate $(5,744,958) $(4,723,807) $ 920,032
Change in valuation allowance 835,917 (2,980,872)
Write off of NOL's previously valued and other items (809,124) 493,420 2,264,119
Foreign rate differences 277,366 243,870 854,064
Valuation of losses in HyperFeed 1,832,458 1,515,739
Permanent differences 1,396,537 432,454 992,222
----------- ----------- -----------
Total $(3,047,721) $(1,202,407) $ 2,049,565
=========== =========== ===========
89
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
within the difference between statutory and effective tax rates reflect foreign
results taxed at the local statutory rate, which can be as much as 25% lower
than the U.S. statutory rate of 34%. At December 31, 2004 and 2003, the Company
had no material federal income tax payable or receivable. As of December 31,
2004, the Company has a U.S. net operating loss carryforward of $25.7 million,
which includes $3.7 million of which that may not be utilized due to certain
limitations imposed by current tax law.
The Company's U.S. NOL's (excluding HyperFeed) expire as follows:
Year Amount
- ------------------- -----------
2009 $ 2,588,804
2010 619,708
2018 4,883,482
2019 1,885,412
2020 10,723,873
2021 1,013,710
2024 3,946,467
-----------
25,661,456
Valuation allowance (3,660,779)
-----------
Total $22,000,677
===========
8. PROPERTY AND EQUIPMENT:
The major classifications of the Company's fixed assets are as follows at
December 31:
2004 2003
----------- -----------
Office furniture, fixtures and equipment $ 6,366,383 $ 6,760,616
Building and leasehold improvements 1,352,303 1,870,473
----------- -----------
7,718,686 8,631,089
Accumulated depreciation (5,281,765) (5,513,568)
----------- -----------
Property and equipment, net $ 2,436,921 $ 3,117,521
=========== ===========
Depreciation expense was $1.2 million, $1.1 million and $456,000 in 2004,
2003, and 2002, respectively.
9. SHAREHOLDERS' EQUITY:
Stock Appreciation Rights Plan
PICO Holdings 2003 Stock Appreciation Rights Plan. On July 2, 2003, all
1,687,242 outstanding stock options were voluntarily surrendered by employees
and directors. On July 17, 2003, the Company's shareholders voted to adopt the
PICO Holdings, Inc. 2003 Stock Appreciation Rights Program (the "SAR program")
to replace the Company's stock option plans and call option agreements. Upon
adoption of the SAR program, all 355,539 outstanding options under call option
agreements were also surrendered by the holders. The maximum number of SARs
issuable under the SAR program may not exceed 2,042,781. 1,962,781 were issued
to the prior option holders upon adoption of the SAR program at an exercise
price equal to that of the surrendered options. In future periods, in the case
of "in the money" SARs (i.e., the market price of PICO stock is higher than the
exercise price of the SAR), a charge or benefit is recorded in the Company's
consolidated financial statements. The charge or benefit will recognize the
change during the period in the difference between the exercise price of "in the
money" SARs and the market value of PICO stock at the end of the period. SARs
are not considered common stock equivalents for earnings per share computations
because they are not converted into common shares of the Company when exercised.
90
A summary of the status of the Company's stock options is presented below
for the years ended December 31:
2003 2002
--------------------- ---------------------
Weighted Weighted
Shares Average Shares Average
Underlying Exercise Underlying Exercise
Options Prices Options Prices
---------- -------- ---------- --------
Outstanding at beginning of year 1,687,242 $14.57 1,780,720 $14.60
Granted
Exercised (17,700) 13.45
Canceled / expired / exchanged (1,687,242) 14.57 (75,778) 15.62
---------- ----------
Outstanding at end of year 1,687,242 14.57
---------- ------
Exercisable at end of year 1,668,909 14.57
---------- ------
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 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 as follows:
2004 2003
----------- -----------
Estimated reinsurance recoverable on:
Unpaid losses and loss adjustment expense $17,302,699 $17,490,157
Reinsurance recoverable (payable) on paid losses and loss expenses (145,370) 223,855
----------- -----------
Reinsurance receivables $17,157,329 $17,714,012
=========== ===========
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.
CONCENTRATION OF REINSURANCE AT DECEMBER 31, 2004
Reported Unreported Reinsurer
Claims Claims Balances
----------- ---------- -----------
Odyssey America Reinsurance Corporation $ 312,612 $ 350,000 $ 662,612
Medical Assurance 2,038,951 492,745 2,531,696
General Reinsurance 7,136,581 5,730,513 12,867,094
National Reinsurance Corporation 152,343 152,356 304,699
North Star Reinsurance Corp. 375,296 93,003 468,299
Swiss American Reinsurance Corporation 375,296 93,003 468,299
----------- ---------- -----------
$10,391,079 $6,911,620 $17,302,699
=========== ========== ===========
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.
91
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. This deferred
gain was amortized into income over the expected payout of the underlying claims
using the interest method. For the year ended December 31, 2002, the final
balance of the deferred gain of $439,000 was recorded in income.
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:
2004 2003 2002
---------- ---------- -----------
Direct premiums written $ 21
Reinsurance premiums assumed 427
Reinsurance premiums ceded (42,217)
-----------
Net premiums written $ -- $ -- $ (41,769)
========== ========== ===========
Direct premiums earned 27
Reinsurance premiums assumed 394
Reinsurance premiums ceded (42,217)
-----------
Net premiums earned $ -- $ -- $ (41,796)
========== ========== ===========
Losses and loss adjustment expenses incurred (recovered):
Direct 1,159,439 4,941,702 859,948
Assumed 192,102 137,376 (49,314)
Ceded (908,257) (412,054) (3,156,948)
---------- ---------- -----------
Net losses and loss adjustment expense (recovery) 443,284 4,667,024 (2,346,314)
========== ========== ===========
11. RESERVES FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES:
Reserves for unpaid losses and loss adjustment expenses on MPL, property
and casualty and workers' compensation business represent management's estimate
of ultimate losses and loss adjustment expenses and fall within an actuarially
determined range of 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.
Management prepares its statutory financial statements of Physicians in
accordance with accounting practices prescribed or permitted by the Ohio
Department of Insurance ("Ohio Department"). Conversely, Management prepares its
statutory financial statements for Citation 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 prescribed accounting practices of the Ohio Department of
Insurance do not allow for discounting of claim liabilities. Activity in the
reserve for unpaid claims and claim adjustment expenses was as follows for each
of the years ended December 31:
92
2004 2003 2002
------------ ------------ ------------
Balance at January 1 $ 60,863,884 $52,703,113 $61,537,910
Less reinsurance recoverable (17,490,157) (7,780,432) (7,474,854)
------------ ----------- -----------
Net balance at January 1 43,373,727 44,922,681 54,063,056
------------ ----------- -----------
Incurred loss and loss adjustment expenses
for current accident year claims 117
Incurred loss and loss adjustment expenses
(recoveries) for prior accident year claims 443,284 4,667,024 (1,907,552)
Retroactive reinsurance (438,879)
------------ ----------- -----------
Total incurred (recovered) 443,284 4,667,024 (2,346,314)
------------ ----------- -----------
Effect of retroactive reinsurance 438,879
-----------
Payments for claims occurring during:
Current accident year (50)
Prior accident years (5,125,335) (6,215,978) (7,232,890)
------------ ----------- -----------
Total paid (5,125,335) (6,215,978) (7,232,940)
------------ ----------- -----------
Net balance at December 31 38,691,676 43,373,727 44,922,681
Plus reinsurance recoverable 17,302,699 17,490,157 7,780,432
------------ ----------- -----------
Balance at December 31 $ 55,994,375 $60,863,884 $52,703,113
============ =========== ===========
In 2004, Physicians reported positive development of $489,000 in its
medical professional line of business. Citation's property and casualty line of
business also reported positive development in 2004 of $254,000 but reported
$1.2 million in adverse development in its workers' compensation line of
business. In 1997, Citation ceded its workers' compensation business to Fremont
Indemnity Company ("Fremont"). However, in July 2003, Fremont was placed in
liquidation and as a result Citation recorded a provision of $7.5 million of
reinsurance recoverable from Fremont, which is included in incurred loss and
loss adjustment expenses for the year ended December 31, 2003. In addition,
during 2003, Citation also recorded adverse development in its property and
casualty business of $3.9 million. The $11.4 million in negative development in
Citation is offset by $6.7 million of positive development within Physicians'
medical professional liability loss reserves, reduced after actuarial analysis
concluded that Physicians' reserves against claims were significantly greater
than the actuary's projections of future claims payments.
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 for
the years ended December 31, 2004, 2003 and 2002 was $397,000, $427,000 and
$837,000, respectively.
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, 2004, $9.6 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 2009. Rent expense for the
years ended December 31, 2004, 2003 and 2002 for office space was $959,000,
$323,000 and $1 million, respectively.
93
Vidler 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.
Future minimum payments under all leases for the years ending December 31,
are as follows:
Year
- ----------
2005 $1,265,510
2006 1,045,543
2007 958,211
2008 481,353
2009 477,086
Thereafter 2,928,900
----------
Total $7,156,603
==========
In 1997, pursuant to a Quota Share Reinsurance Agreement, Citation
Insurance Company ("Citation") ceded its workers' compensation insurance
business to Fremont Indemnity Company ("Fremont"). Fremont maintained a security
deposit for the benefit of claimants under workers' compensation insurance
policies issued, or assumed, by Fremont. A portion of that deposit was
specifically allocated for the benefit of Citation. Consequently, Citation
reduced its own workers' compensation insurance reserves by the amount of the
deposit. On June 4, 2003, the Superior Court of the State of California for the
County of Los Angeles entered an Order of Conservation over Fremont and
appointed the California Department of Insurance Commissioner as the
conservator. Pursuant to such order, the Commissioner was granted authority to
take possession of all of Fremont's assets, including the Citation deposit. On
July 2, 2003, the Liquidation Court entered an Order appointing the Commissioner
as liquidator of Fremont.
Under Citation's interpretation of the applicable law, Citation's allocated
deposit assets are required to be (i) held by the Commissioner in trust,
"separate and apart" from Fremont's general account and other assets of its
estate, and (ii) applied solely towards the payment of the assumed claims and
allocated claims expenses arising from the workers' compensation insurance
policies that Citation ceded/transferred to Fremont and its
predecessor-in-interest. Citation requested that the Commissioner, in his
capacity as the liquidator, (i) maintain Citation's allocated deposit assets
separate and apart from other assets of the estate and (ii) apply the same
solely to the payment of the direct and assumed claims and allocated claims
expenses arising from the workers' compensation insurance liabilities that
Citation ceded/transferred to Fremont. Alternatively, Citation requested that
the Commissioner pay Citation's ceded liabilities from the totality of Fremont's
Special Schedule P Deposit on a pari passu basis with Fremont's direct and
assumed workers' compensation claims and allocated claims expenses.
The Commissioner has refused to comply with Citation's request; instead,
the Commissioner indicated that he intended to transfer the Citation deposit to
the California Insurance Guarantee Association ("CIGA").
As Fremont had been placed in liquidation and therefore was no longer an
admitted reinsurer, Citation was no longer entitled to take a reinsurance credit
for the Citation deposit under the statutory basis of accounting. Consequently,
during 2003 Citation reversed $7.5 million reinsurance recoverable from Fremont
in its financial statements prepared on the statutory basis of accounting. In
addition, Citation made a corresponding provision for the reinsurance
recoverable from Fremont for GAAP purposes. Accordingly, Citation has, for both
its statutory and GAAP financial statements, provided for the reinsurance
recoverable from Fremont on its workers' compensation policy liabilities.
In June 2004, Citation filed litigation in the Superior Court of California
to recover its workers' compensation trust deposits held by Fremont prior to the
liquidation in the amount of $7.1 million. On September 28, 2004, the court
ruled against Citation. Therefore, Citation will not receive any distributions
from Fremont or CIGA and will not receive any credit for the deposit. In
consideration of the potential cost and the apparent limited prospect of
obtaining relief, the Company has decided not to appeal.
In 2000, PICO 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 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
94
collateralizing the loans, PICO recorded an allowance in 2001 for the total
outstanding balance of $2.3 million for the loans and interest. A trial was held
in July 2003 in the Australian courts concerning both loans. The Company
received the Court's decision in August 2004 and was unsuccessful in its
actions. The Company filed an appeal with the Australian courts. After filing
the appeal, PICO and the individual who was the majority shareholder of Dominion
Capital entered into a deed of settlement and release agreement. Under this
agreement, both parties have agreed to discharge each other from any further
claims and obligations, including PICO discontinuing its appeal that was filed
in the Australian Court of Appeal.
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 provide 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 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. The growth in book value per share exceeded the
threshold each year in the three years ended December 31, 2004 and an award was
accrued in the accompanying consolidated financial statements of $1.2 million,
$935,000 and $1.5 million, respectively. In addition, four other executive
officers of the Company were awarded incentive compensation for the three years
ended December 31, 2004 totaling $426,000, $321,000 and $497,000, respectively,
and have been accrued in the accompanying consolidated financial statements.
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
the chairman of the board, and its 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.
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 was 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. The Company recorded
compensation expense related to this arrangement of $105,000, $283,000, and
$250,000 during the years ended December 31, 2003, 2002 and 2001, respectively.
The total accrued balance of $1.3 million was paid upon completion of the sale
of Sequoia, which closed on March 31, 2003.
The Company entered into agreements with its president and chief executive
officer, and certain other officers and Directors, to defer compensation into
Rabbi Trust accounts held in the name of the Company. The total value of the
Rabbi Trusts of $2.7 million, of which $858,000 represents PICO stock with the
balance in various stocks and bonds, is included in the Company's consolidated
balance sheets. Within these accounts, John Hart owns 19,940 PICO shares, Dr.
Richard Ruppert owns 2,505 PICO shares, John Weil owns 8,067 PICO shares, Robert
Broadbent owns 8,166 PICO shares, and Carlos Campbell owns 2,639 PICO shares.
The trustee for the accounts is Huntington National Bank. The accounts are
subject to the claims of outside creditors, and any PICO stock held in the
accounts is reported as treasury stock in the consolidated financial statements.
On November 2, 2004, the Company entered into a Secured Convertible
Promissory Note Agreement ("Note") with the Company's 51%-owned subsidiary,
HyperFeed. Under the terms of the Note, HyperFeed may borrow up to $1.5 million
from the Company, at a rate of interest of 8%. Any amounts borrowed under this
Note, together with accrued interest, are to be repaid by November 1, 2005. The
Company can elect to convert all or any part of the principal and interest
outstanding into common stock of HyperFeed. The conversion price per share is
the lower of either the price per share on the date of the Company's election to
exercise its conversion right or the price per share as of the date of execution
of the Note ($3.00). The maximum number of shares that may be issued under these
conversion rights is 611,000. In February 2005, HyperFeed borrowed $575,000
under the Note.
95
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.
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
policyholders' surplus 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, 2004,
2003 and 2002 on the statutory accounting basis are as follows:
2004 2003 2002
----------- ----------- -----------
(Unaudited)
Physicians Insurance Company of Ohio:
Policyholders' surplus $43,255,603 $45,778,599 $42,266,183
Statutory net income (loss) $ 9,628,569 $ 7,659,200 $(4,856,572)
Citation Insurance Company:
Policyholders' surplus $19,293,135 $14,303,039 $17,665,606
Statutory net income (loss) $ 562,129 $(7,589,951) $ 1,641,070
Sequoia Insurance Company: (1)
Statutory net loss $(1,499,260)
Policyholders' surplus $32,301,520
(1) Sequoia Insurance Company, sold in March 2003, is classified as
discontinued operations.
17. SEGMENT REPORTING:
PICO Holdings, Inc. is a diversified holding company. The Company acquires
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 Company's 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.
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 and
workers' compensation loss reserves of Citation Insurance Company and the
medical professional liability loss reserves of Physicians Insurance Company of
Ohio; and the acquisition and financing of businesses.
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.
96
Water Rights and Water Storage
Vidler is engaged in the following water rights and water storage
activities:
- - 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;
- - development of storage and distribution infrastructure; and
- - 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
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 its subsidiaries wrote medical professional
liability insurance, primarily in the state of Ohio. Physicians has stopped
writing new business and 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.
In the past, Citation wrote commercial property and casualty insurance in
California and Arizona and workers' compensation insurance in California.
Citation ceded all its workers' compensation business in 1997, and ceased
writing property and casualty business in December 2000 and is in run off.
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 Sequoia, reported as discontinued
operations for all periods presented, are included within the Insurance Run Off
segment in those years as the equity of the discontinued operations was owned by
Physicians. Sequoia was sold on March 31, 2003.
HyperFeed Technologies, Inc.
HyperFeed is a developer and provider of software, ticker plant
technologies and managed services to the financial markets industry. PICO owns
approximately 51% of the outstanding voting stock of HyperFeed.
Business Acquisitions and Financing
This segment contains businesses, interests in businesses, and other parent
company assets.
PICO seeks to acquire businesses which are 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 exceeds the return the Company
expects to earn if held.
97
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 HyperFeed Consolidated
---------------- ------------ ------------- -------------- ----------- ------------
2004:
Revenues $11,559,905 $ 1,963,943 $ 5,747,244 $ 2,851,629 $ 6,004,115 $ 28,126,836
Income (loss) before income taxes 5,290,153 (5,701,110) 4,059,818 (15,156,217) (5,389,580) (16,896,936)
Identifiable assets 47,391,982 83,533,742 131,824,847 87,905,906 3,974,546 354,631,023
Depreciation and amortization 90,757 1,183,829 15,526 108,978 711,163 2,110,253
Capital expenditures 25,536 2,976,546 23,267 122,753 1,746,429 4,894,531
2003:
Revenues $ 5,889,560 $16,815,624 $ 3,244,748 $ 5,548,563 $ 1,380,099 $ 32,878,594
Income (loss) before income taxes 2,004,626 (543,146) (2,902,354) (8,111,741) (4,225,851) (13,778,466)
Identifiable assets 46,267,828 88,134,979 118,351,511 68,278,691 9,864,258 330,897,267
Depreciation and amortization 82,344 1,020,341 22,551 63,511 591,772 1,780,519
Capital expenditures 44,496 2,447,180 3,577 77,186 232,961 2,805,400
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 27,267 51,658 1,115,716
Capital expenditures 188,197 593,863 11,040 42,438 835,538
98
Segment information by geographic region follows:
United
States Europe Consolidated
------------ ------------ -------------
2004
Revenues $ 27,616,915 $ 509,921 $ 28,126,836
Loss before income taxes (15,623,800) (1,273,136) (16,896,936)
Identifiable assets 285,687,909 68,943,114 354,631,023
Depreciation and amortization 2,110,253 2,110,253
Capital expenditures 4,894,531 4,894,531
2003
Revenues $ 32,722,396 $ 156,198 $ 32,878,594
Loss before income taxes (12,548,084) (1,230,382) (13,778,466)
Identifiable assets 285,378,620 45,518,647 330,897,267
Depreciation and amortization 1,780,519 1,780,519
Capital expenditures 2,805,400 2,805,400
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 1,115,716 1,115,716
Capital expenditures 835,538 835,538
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. 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 19, are not
significantly different from the original terms.
99
December 31, 2004 December 31, 2003
--------------------------- -------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ ------------ ----------- -----------
Financial assets:
Fixed maturities $ 39,479,216 $ 39,479,216 $52,615,376 $52,615,376
Equity securities 142,978,213 142,978,213 96,306,035 96,306,035
Cash and cash equivalents 17,407,138 17,407,138 24,348,693 24,348,693
Financial liabilities:
Bank and other borrowings 18,020,559 18,020,559 15,376,640 15,376,640
19. BANK AND OTHER BORROWINGS:
At December 31, 2004 and 2003, 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 4.1% and 5.1% at December 31, 2004, and 2003, respectively, with
principal and interest due throughout the term.
2004 2003
----------- -----------
2.74% (3.27% in 2003) Swiss loans $13,602,457 $10,079,021
5.25% Notes due on demand 465,000
7% - 8% Notes due:
2005 - 2008 73,293 263,664
8.5% Notes due:
2005 and 2004 240,511 1,042,571
2006 - 2009 2,660,293 2,821,265
2010 - 2019 652,671 750,217
9% -10% Notes due:
2005 73,793
2006 - 2008 252,541 419,902
----------- -----------
$18,020,559 $15,376,640
=========== ===========
Global Equity AG has a loan facility with a Swiss bank of which $11 million
(12.5 million CHF) matures in May 2006 and $2.6 million ($3 million CHF) matures
in August 2006, for a maximum of $13.6 million (15.5 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, 2004 and 2003, $3.9 million and $5.2 million, respectively,
of the total outstanding borrowings were recorded within Vidler, primarily
incurred to finance the acquisition of lands in the Harquahala Valley in
Arizona. The weighted average interest rate of these notes is 8.5% and is
collateralized by the purchased properties.
100
The Company's future minimum principal repayments for the years ending
December 31 are as follows:
2005 $ 814,668
2006 13,981,835
2007 370,940
2008 825,967
2009 1,374,479
Thereafter 652,670
-----------
Total $18,020,559
===========
20. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:
Effective January 1, 2002 the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 142 discontinued amortization of goodwill and
established 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-offs of goodwill of $800,000.
101
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
evaluated the effectiveness of our disclosure controls and procedures, as such
term is defined under Rule 13a-15(e) promulgated under the Securities Exchange
Act of 1934, as amended. Based on this evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures were effective as of the end of the period covered by this annual
report.
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation of the company's consolidated
financial statements and related information appearing in this report.
Management believes that the consolidated financial statements fairly present
the form and substance of transactions and that the financial statements
reasonably present the company's financial position and results of operations in
conformity with generally accepted accounting principles. Management also has
included in the company's financial statements amounts that are based on
estimates and judgments, which it believes are reasonable under the
circumstances.
Deloitte & Touche LLP, an independent registered public accounting firm,
audits the company's consolidated financial statements in accordance with the
standards of the Public Company Accounting Oversight Board and provides an
objective, independent review of the fairness of reported operating results and
financial position.
The board of directors of the company has an Audit Committee composed of
three independent directors. The committee meets periodically with financial
management and Deloitte & Touche LLP to review accounting, control, auditing and
financial reporting matters.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Company management is responsible for establishing and maintaining adequate
internal control over financial reporting, as defined in Exchange Act Rules
13a-15(f). Under the supervision and with the participation of company
management, including the principal executive officer and principal financial
officer, the company conducted an evaluation of the effectiveness of its
internal control over financial reporting based on the framework in Internal
Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on the company's evaluation
under the framework in Internal Control-Integrated Framework, management
concluded that the company's internal control over financial reporting was
effective as of December 31, 2004. Management's assessment of the effectiveness
of internal control over financial reporting as of December 31, 2004 has been
audited by Deloitte & Touche LLP, as stated in its report, which is included
herein.
102
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of PICO Holdings, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that PICO
Holdings, Inc. and subsidiaries (the "Company") maintained effective internal
control over financial reporting as of December 31, 2004, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2004, is fairly
stated, in all material respects, based on the criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements as of and for the year ended December 31, 2004 of the Company and our
report dated March 11, 2005 expressed an unqualified opinion on those financial
statements.
/s/ Deloitte & Touche LLP
San Diego, California
March 11, 2005
103
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CODE OF ETHICS 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 2005 annual meeting of shareholders, to be filed on or
before April 30, 2005 and is incorporated herein by reference. The information
required by this item regarding the Company's code of ethics will be set forth
in the section headed "Code Of Ethics" in our definitive 2005 proxy statement
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 2005 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
2005 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 2005 proxy
statement and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item will be set forth in the section
headed "Fees Paid to Deloitte & Touche LLP" in our definitive 2005 proxy
statement and is incorporated herein by reference.
104
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS.
1. FINANCIAL STATEMENTS.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Reports ................................. 66-67
Consolidated Balance Sheets as of December 31, 2004 and 2003 68-69
Consolidated Statements of Operations for the Years
Ended December 31, 2004, 2003 and 2002 ..................... 70
Consolidated Statements of Shareholders' Equity
for the Years Ended December 31, 2004, 2003 and 2002 ....... 71-73
Consolidated Statements of Cash Flows for the Years
Ended December 31, 2004, 2003 and 2002 ..................... 74
Notes to Consolidated Financial Statements .................... 75-101
2. FINANCIAL STATEMENT SCHEDULES.
Independent Auditors' Report .................................. 106
Schedule I - Condensed Financial Information of Registrant .... 107-108
Schedule II - Valuation and Qualifying Accounts ............... 109
Schedule V - Supplementary Insurance Information .............. 110-112
105
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of PICO Holdings, Inc.
We have audited the consolidated financial statements of PICO Holdings, Inc. and
subsidiaries (the "Company") as of December 31, 2004 and 2003, and for each of
the three years in the period ended December 31, 2004, management's assessment
of the effectiveness of the Company's internal control over financial reporting
as of December 31, 2004, and the effectiveness of the Company's internal control
over financial reporting as of December 31, 2004, and have issued our reports
thereon dated March 11, 2005 (which report on the consolidated financial
statements includes an explanatory paragraph relating to the adoption of
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets in 2002); such reports are included elsewhere in this Form
10-K. Our audits also included the consolidated financial statement schedules of
the Company listed in Item 15. These consolidated 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 consolidated
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.
/s/ Deloitte & Touche LLP
San Diego, California
March 11, 2005
106
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
December 31, December 31,
2004 2003
------------ ------------
ASSETS
Cash and cash equivalents $ 9,291,851 $ 6,646,086
Investments in subsidiaries (eliminated in consolidation) 205,073,285 159,428,214
Equity securities and other investments 11,967,876 33,111,733
Deferred income taxes
7,188,824 7,852,006
Otherassets (Intercompany receivable of $32.3 million in 2004, and
$26.7 million in 2003 eliminated in consolidation) 33,434,215 39,409,614
------------ ------------
Total assets $266,956,051 $246,447,653
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expense and other liabilities $ 27,026,753 $ 17,287,251
------------ ------------
Common stock, $.001 par value, authorized 100,000,000 shares:
issued 16,801,923 at December 31, 2004 and at December 31, 2003 16,802 16,802
Additional paid-in capital 236,089,222 236,082,703
Accumulated other comprehensive income 36,725,700 15,283,404
Retained earnings 45,524,219 56,082,903
------------ ------------
318,355,943 307,465,812
Less treasury stock, at cost (2004: 4,435,444 shares and 2003: 4,428,389
shares) (78,426,645) (78,305,410)
------------ ------------
Total shareholders' equity 239,929,298 229,160,402
------------ ------------
Total liabilities and shareholders' equity $266,956,051 $246,447,653
============ ============
This statement should be read in conjunction with the notes to the consolidated
financial statements included in the Company's 2004 Form 10-K
107
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
2004 2003 2002
------------ ------------ -----------
Investment income, net (Intercompany interest of $3.1 million in
2004,
$3.2 million in 2003, and $3 million in 2002 eliminated in $ 5,484,542 $ 6,417,240 $13,913,246
consolidation)
Equity in loss of subsidiaries (2,135,617) (8,528,754) (1,422,091)
------------ ------------ -----------
Total revenues (charges) 3,348,925 (2,111,514) 12,491,155
Expenses (Intercompany interest of $1.1 million in 2004, $1.7
million in 2003, and $1.7 million in 2002 eliminated
in consolidation) 18,639,014 15,017,239 9,862,307
------------ ------------ -----------
Income (loss) from continuing operations before income taxes (15,290,089) (17,128,753) 2,628,848
Provision (benefit) for income taxes (4,653,685) (3,392,527) 1,518,253
------------ ------------ -----------
Income (loss) before cumulative effect (10,636,404) (13,736,226) 1,110,595
Income from discontinued operations, net 77,720 10,498,414 2,833,806
Cumulative effect of accounting change, net 1,984,744
------------ ------------ -----------
Net income (loss) $(10,558,684) $ (3,237,812) $ 5,929,145
============ ============ ===========
CONDENSED STATEMENTS OF CASH FLOWS
2004 2003 2002
------------ ------------ ------------
Cash flow from operating activities:
Net income (loss) $(10,558,684) $ (3,237,812) $ 5,929,145
Adjustments to reconcile net income (loss) to net cash used
or provided by operating activities:
Equity in loss of subsidiaries 2,135,617 8,528,754 1,422,091
Income from discontinued operations, net (77,720) (10,498,414) (2,833,806)
Cumulative effect of accounting change, net (1,984,744)
Changes in assets and liabilities:
Accrued expenses and other liabilities 9,739,501 8,685,843 8,367,856
Other assets 6,638,581 (3,094,770) (1,831,625)
------------ ------------ ------------
Net cash provided by operating activities 7,877,295 383,601 9,068,917
------------ ------------ ------------
Cash flow from investing activities:
Proceeds from sale of investments 10,988,612 8,539,180 21,100,950
Proceeds from maturities of investments 18,673,000
Purchase of investments (16,105,426) (34,296,877) (18,443,560)
------------ ------------ ------------
Net cash provided by (used in) investing activities (5,116,814) (7,084,697) 2,657,390
Cash flow from financing activities:
Cash received from exercise of stock options 238,066
Other 6,519
Purchase of treasury shares for deferred compensation
plans (121,235) (83,218) (93,557)
------------ ------------ ------------
Net cash provided by (used in) financing activities (114,716) (83,218) 144,509
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 2,645,765 (6,784,314) 11,870,816
Cash and cash equivalents, beginning of year 6,646,086 13,430,400 1,559,584
------------ ------------ ------------
Cash and cash equivalents, end of year $ 9,291,851 $ 6,646,086 $ 13,430,400
============ ============ ============
This statement should be read in conjunction with the notes to the consolidated
financial statements included in the Company's Form 10-K
108
SCHEDULE II
PICO HOLDINGS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Additions (1)
Balance at Charged to Balance
Beginning Costs and End
Description of Period Expenses Deductions of Period
- ----------------------------------- ---------- -------------- ----------- ---------
Year-end December 31, 2004:
Allowance for doubtful accounts $2,450,604 308,917 $(2,400,604) $ 358,917
Deferred tax valuation allowance $1,244,665 1,244,665
Year-end December 31, 2003:
Allowance for doubtful accounts $2,500,604 420,000 $ (470,000) $2,450,604
Deferred tax valuation allowance $ 408,748 835,917 1,244,665
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
(1) Includes $150,000 in 2003 from the consolidation of HyperFeed.
109
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(IN THOUSANDS)
DECEMBER 31, 2004
Losses,
Claims Losses
and Loss Net and Other
Expense Investment Loss Operating
Reserves Income Expenses Expenses
-------- ---------- -------- ---------
Medical professional liability $19,593 $3,656 $(489) $ 728
Property and casualty
and workers' compensation 36,401 2,092 932 516
------- ------ ----- -------
Total medical professional
liability and property and
casualty and workers'
compensation 55,994 5,748 443 1,244
Other operations 51 43,337
------- ------ ----- -------
Total continuing $55,994 $5,799 $ 443 $44,581
======= ====== ===== =======
110
SCHEDULE V
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
December 31, 2003
Losses, Losses
Claims Net and Other
and Loss Investment Loss Operating
Expenses Income Expenses Expenses
-------- ---------- -------- ---------
Medical professional liability $23,626 $1,353 $(6,753) $ 876
Property and casualty and
workers' compensation 37,238 1,327 11,420 604
------- ------ ------- -------
Total medical professional
liability and property
and casualty and workers'
compensation 60,864 2,680 4,667 1,480
Other operations 2,690 39,945
------- ------ ------- -------
Total continuing $60,864 $5,370 $ 4,667 $41,425
======= ====== ======= =======
111
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
Property and casualty
and workers' compensation 16,305 (424) 1,589 (888) 276 (424)
------- ----- ------ ------- ------- -----
Total medical professional
liability and property
and casualty workers'
compensation 52,703 (42) 2,268 (2,346) 671 (42)
Other operations 3,117 26,035
------- ----- ------ ------- ------- -----
Total continuing $52,703 $ (42) $5,385 $(2,346) $26,706 $ (42)
======= ===== ====== ======= ======= =====
112
EXHIBITS
Exhibit
Number Description
- --------- -----------
+ 3.1 Amended and Restated Articles of Incorporation of PICO.
++ 3.2 Amended and Restated By-laws of PICO.
+++ 10.1 PICO Holdings, Inc. 2003 Stock Appreciation Rights Program.
++++ 10.2 Employment Agreement of Ronald Langley.
++++ 10.3 Employment Agreement of John R. Hart.
++++ 10.4 Bonus Plan of Dorothy A. Timian-Palmer.
++++ 10.5 Bonus Plan of Stephen D. Hartman.
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.
23.2 Independent Auditors' Consent - KPMG LLP.
31.1 Certification of Chief Executive Officer pursuant to
Rule 13a-14(a)/15d-14(a) as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Rule 13a-14(a)/15d-14(a) as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to
U.S.C. Section 1350 (Section 906 of the
Sarbanes-Oxley Act of 2002).
32.2 Certification of Chief Financial Officer pursuant to
U.S.C. Section 1350 (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 Proxy Statement for Annual Meeting of
Shareholders to be Held on July 17, 2003, dated May 27, 2003, and filed
with the SEC on April 30, 2003.
++++ Incorporated by reference to exhibit of same number filed with Form 8-K
dated February 24, 2005.
(B) REPORTS ON FORM 8-K.
None
113
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 11, 2005
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 11, 2005 by 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
114