UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington DC 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
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
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
(858) 456-6022
(Address and telephone number of principal executive offices)
Indicate by check mark whether 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
--- ---
The number of shares outstanding of the Registrant's Common Stock, $0.001 par
value, was 12,390,096 as of September 30, 2001, excluding 4,394,127 shares of
common stock held by the registrant and its subsidiaries.
PICO HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE NO.
--------
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets as of 3
September 30, 2001 and December 31, 2000
Consolidated Statements of Operations for the Three 4
and Nine Months Ended September 30, 2001 and 2000
Consolidated Statements of Cash Flows for 5
the Nine Months Ended September 30, 2001 and 2000
Notes to Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial 11
Condition and the Results of Operations
Item 3: Quantitative and Qualitative Disclosure About Market Risk 29
PART II: OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders 30
Item 6: Exhibits and Reports on Form 8-K 30
Signature 31
2
PART I: FINANCIAL INFORMATION
ITEM I: FINANCIAL STATEMENTS
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2001 2000
------------- -------------
ASSETS
Investments $ 163,679,521 $ 165,894,070
Cash and cash equivalents 14,262,472 13,644,312
Premiums and other receivables, net 17,480,391 19,032,603
Reinsurance receivables 25,278,833 27,594,039
Deferred policy acquisition costs 6,337,195 6,299,819
Land, mineral and water rights and water storage, net 126,412,033 137,235,241
Property and equipment, net 2,849,539 2,944,513
Net deferred income taxes 11,238,503 11,354,592
Goodwill 3,615,687 4,000,508
Other assets 7,749,179 7,144,937
------------- -------------
Total assets $ 378,903,353 $ 395,144,634
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 113,493,187 $ 121,541,722
Unearned premiums 25,795,634 25,505,189
Reinsurance balance payable 6,004,218 5,631,603
Bank and other borrowings 15,234,179 15,550,387
Excess of fair value of net assets acquired over purchase price 2,934,593 3,360,581
Other liabilities 13,832,314 14,441,802
------------- -------------
Total liabilities 177,294,125 186,031,284
------------- -------------
Minority interest 3,135,948 3,920,739
------------- -------------
Commitments and Contingencies (Note 4)
Common stock, $.001 par value; authorized 100,000,000 shares,
issued 16,784,223 in 2001 and 2000 16,784 16,784
Additional paid-in capital 235,844,655 235,844,655
Retained earnings 56,533,821 59,893,785
Accumulated other comprehensive loss (16,092,345) (12,732,978)
Treasury stock, at cost (4,394,127 common shares in 2001 and 2000) (77,829,635) (77,829,635)
------------- -------------
Total shareholders' equity 198,473,280 205,192,611
------------- -------------
Total liabilities and shareholders' equity $ 378,903,353 $ 395,144,634
============= =============
The accompanying notes are an integral part of the consolidated financial
statements.
3
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended September 30, Nine Months Ended September 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
Revenues:
Premium income $ 10,664,561 $ 8,272,417 $ 31,239,174 $ 23,464,106
Net investment income 2,451,414 2,498,325 7,733,542 5,999,480
Net realized loss on investments (2,924,038) (7,087,578) (5,208,278) (7,587,928)
Sale of land, water, and water storage 4,486,094 754,474 15,635,891 1,580,027
Other income 1,071,194 501,972 2,728,000 2,607,119
------------ ------------ ------------ ------------
Total revenues 15,749,225 4,939,610 52,128,329 26,062,804
------------ ------------ ------------ ------------
Expenses:
Loss and loss adjustment expenses 6,773,583 5,957,876 22,477,305 16,931,422
Insurance underwriting and other expenses 6,110,690 7,897,525 26,278,644 24,248,339
Cost of land, water, and water storage sold 163,995 137,683 6,873,051 466,274
------------ ------------ ------------ ------------
Total expenses 13,048,268 13,993,084 55,629,000 41,646,035
------------ ------------ ------------ ------------
Equity in income (loss) of unconsolidated
affiliates (1,176,837) 1,836,444 (1,020,782) 2,220,273
------------ ------------ ------------ ------------
Income (loss) from continuing operations before income
taxes, minority interest and accounting change 1,524,120 (7,217,030) (4,521,453) (13,362,958)
Expense (benefit) for federal, foreign and
state income taxes 186,485 (4,508,284) (1,857,369) (6,703,739)
------------ ------------ ------------ ------------
Income (loss) before minority interest and accounting
change 1,337,635 (2,708,746) (2,664,084) (6,659,219)
Minority interest in (income) loss
of subsidiaries 26,699 (97,150) 284,691 417,775
------------ ------------ ------------ ------------
Income (loss) before accounting change 1,364,334 (2,805,896) (2,379,393) (6,241,444)
Cumulative effect of change in accounting
principle, net (980,571) (4,963,691)
------------ ------------ ------------ ------------
Net income (loss) $ 1,364,334 $ (2,805,896) $ (3,359,964) $(11,205,135)
============ ============ ============ ============
Net income (loss) per common share - basic:
Continuing operations $ 0.11 $ (0.23) $ (0.19) $ (0.55)
Cumulative effect of change in accounting principle (0.08) (0.44)
------------ ------------ ------------ ------------
Net income (loss) per common share $ 0.11 $ (0.23) $ (0.27) $ (0.99)
------------ ------------ ------------ ------------
Weighted average shares outstanding 12,390,096 12,390,070 12,390,096 11,330,911
============ ============ ============ ============
Net income (loss) per common share - diluted:
Continuing operations $ 0.11 $ (0.23) $ (0.19) $ (0.55)
Cumulative effect of change in accounting principle (0.08) (0.44)
------------ ------------ ------------ ------------
Net income (loss) per common share $ 0.11 $ (0.23) $ (0.27) $ (0.99)
------------ ------------ ------------ ------------
Weighted average shares outstanding 12,408,408 12,390,070 12,390,096 11,330,911
============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
4
PICO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,
2001 2000
------------ ------------
OPERATING ACTIVITIES:
Net cash provided by (used in) operating activities $ 1,096,740 $(11,749,700)
------------ ------------
INVESTING ACTIVITIES:
Purchases of investments (76,281,671) (41,725,339)
Proceeds from sale of investments 60,300,507 7,470,282
Proceeds from maturity of investments 9,285,000 4,500,000
Proceeds from the sale of Semitropic 7,586,014
Investment in partnerships (6,208,799)
Advances to affiliates (500,000)
Purchases of property and equipment (678,498) (420,701)
Other investing activities, net 244,110 (188,229)
------------ ------------
Net cash provided by (used in) investing activities 455,462 (37,072,786)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from rights offering, net of costs of $197,000 49,833,842
Repayments of debt (2,479,464) (449,765)
Distributions to minority partners of Fishsprings Ranch, LLC (500,000)
Proceeds from borrowings 2,163,255
------------ ------------
Net cash provided by (used in) financing activities (816,209) 49,384,077
------------ ------------
Effect of exchange rate changes on cash (117,833) 434,662
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 618,160 996,253
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 13,644,312 36,738,373
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 14,262,472 $ 37,734,626
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest: $ 639,837 $ 692,421
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
5
PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of PICO Holdings, Inc. ("PICO") and Subsidiaries (the "Company") have been
prepared in accordance with the interim reporting requirements of Form
10-Q, pursuant to the rules and regulations of the United States Securities
and Exchange Commission (the "SEC"). Accordingly, they do not include all
of the information and notes required by accounting principles generally
accepted in the United States of America ("US GAAP") for complete financial
statements.
In the opinion of management, all adjustments and reclassifications
considered necessary for a fair and comparable presentation of financial
position as of September 30, 2001 and December 31, 2000, the results of
operations for the three and nine months ended September 30, 2001 and 2000,
and cash flows for the nine months ended September 30, 2001 and 2000, have
been included and are only of a normal recurring nature. Operating results
for the three and nine months ended September 30, 2001 are not necessarily
indicative of the results that may be expected for the year ending December
31, 2001. The three and nine month periods ended September 30, 2000 have
been restated to give effect to the change in accounting for medical
professional liability ("MPL") insurance loss reserves. See Note 5.
These financial statements should be read in conjunction with the
Company's audited financial statements and notes thereto, together with
Management's Discussion and Analysis of Financial Condition and the Results
of Operations and Risk Factors contained in the Company's Annual Reports on
Form 10-K for the year ended December 31, 2000 as filed with the SEC.
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
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses for each reporting period. The
significant estimates made in the preparation of the Company's consolidated
financial statements relate to the assessment of the carrying value of
investments, unpaid losses and loss adjustment expenses, deferred policy
acquisition costs, deferred income taxes, accounts and loans receivable,
and contingent liabilities. While management believes that the carrying
value of such assets and liabilities are appropriate as of September 30,
2001 and December 31, 2000, it is reasonably possible that actual results
could differ from the estimates upon which the carrying values were based.
2. EARNINGS (LOSS) PER SHARE
The Company applies the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings Per Share." Basic earnings or loss
per share is based on the actual weighted average common shares outstanding
during the period. Diluted earnings or loss per share is similar to basic
earnings per share, except the weighted shares outstanding includes the
dilutive effect of the Company's stock options. Such securities are
dilutive if the strike price is less than the average market price of the
Company's stock during the period and the Company has earnings for the
period. In computing earnings per share, all antidilutive securities are
ignored. For the three months ended September 30, 2001, there were 18,312
shares added to the diluted earnings per share and 832,000 options
excluded. For all other periods presented, there was no difference between
basic and diluted weighted shares outstanding. For the nine months ended
September 30, 2001, 1.4 million options were excluded from the
computations, and for the three and nine months ended September 30, 2000,
1.8 and 1.2 million options, respectively, were excluded from the
computation.
3. COMPREHENSIVE INCOME (LOSS)
The Company applies the provisions of SFAS No. 130, "Reporting
Comprehensive Income." Comprehensive income for the Company includes
foreign currency translation and unrealized holding gains and losses on
available for sale securities.
6
The components of comprehensive income (loss) are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
Comprehensive income (loss) 2001 2000 2001 2000
------------ ------------ ------------ ------------
Net income (loss) $ 1,364,334 $ (2,805,896) $ (3,359,964) $(11,205,135)
Net change in unrealized depreciation
on available for sale investments (1,532,359) (1,052,862) (3,936,853) (5,516,665)
Net change in foreign currency translation 514,364 244,449 577,486 (709,947)
------------ ------------ ------------ ------------
Total comprehensive income (loss) $ 346,339 $ (3,614,309) $ (6,719,331) $(17,431,747)
============ ============ ============ ============
Total comprehensive income (loss) for the three and nine months ended
September 30, 2001 is net of deferred income tax benefits of $1.9 million
and $2.8 million, respectively. For the three and nine months ended
September 30, 2000, total comprehensive loss is net of deferred income tax
benefits of $1.7 million and $891,000, respectively.
The components of accumulated comprehensive loss are as follows:
September 30, December 31,
2001 2000
----------------- -----------------
Unrealized depreciation on
available for sale investments $(10,914,601) $ (6,977,748)
Foreign currency translation (5,177,744) (5,755,230)
----------------- -----------------
Accumulated other comprehensive loss $(16,092,345) $ (12,732,978)
================= =================
Accumulated other comprehensive loss is net of deferred income tax
assets of $1.3 million at September 30, 2001, and $3.2 million at December
31, 2000.
In September 2000, PICO adopted the equity method of accounting for its
investment in Jungfraubahn Holding AG ("Jungfraubahn") due to management's
assessment that the Company had significant influence over Jungfraubahn as
evidenced by the Company's ownership percentage and a seat on the board of
directors. Management's determination was also based on the Company's
ability to obtain quarterly financial data from Jungfraubahn for inclusion
in the Company's consolidated financial statements. PICO also had the
expectation of receiving such information for the Company's future
financial periods. However, during the second quarter of 2001 and after
several discussions between Jungfraubahn and the Company, Jungfraubahn
decided that, for various reasons, they would no longer provide quarterly
financial data to PICO and that the sole source of financial information
available to the Company would be their semi-annual filings provided to the
Swiss Stock Exchange. Management believes, based on the guidelines of
Accounting Principles Board ("APB") No. 18, that the inability to get
timely quarterly financial information indicates the Company no longer has
significant influence, and, accordingly, PICO discontinued the equity
method of accounting for its investment in Jungfraubahn in the three months
ended June 30, 2001. PICO now accounts for the investment under SFAS No.
115 and, as a result of the change in accounting methodology, recorded an
unrealized loss net of tax of approximately $6 million in other
comprehensive loss for the three months ended June 30, 2001.
4. COMMITMENTS AND CONTINGENCIES
In November 1998, Vidler Water Company, Inc., a PICO subsidiary,
entered into an operating lease to acquire 185,000 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 required Vidler to pay a minimum of $2.3 million per year for 10
years beginning October 1998. On October 7, 1998, PICO signed a Limited
Guarantee agreement with Semitropic Water Storage District ("Semitropic")
that required PICO to guarantee a maximum obligation of $3.2 million,
adjusted annually by the engineering price index. In May 2001, Vidler
permanently assigned 29.73% of its right, title and interest under the
operating lease to Newhall Land and Farming Company. As a result of the
permanent assignment by Vidler, PICO entered into an amended Limited
Guarantee agreement effective May 21, 2001. Under the amended Limited
Guarantee, the maximum obligation of PICO
7
was revised to $2.2 million adjusted annually by the engineering price
index. In September 2001, Vidler permanently assigned a further 54.05% of
its right, title and interest under the operating lease to Alameda County
Water District. Accordingly, PICO entered into a second amendment to the
Limited Guarantee effective September 28, 2001. Under the second amendment
to the Limited Guarantee, the maximum obligation of PICO was revised to
$519,000 adjusted annually by the engineering price index. The guarantee
expires October 7, 2008.
On January 10, 1997, Global Equity Corporation, a wholly owned PICO
subsidiary, commenced an action in British Columbia against MKG Enterprises
Corp. ("MKG") to enforce repayment of a $5 million loan made by Global
Equity to MKG. On the same day, the Supreme Court of British Columbia
granted an order preventing MKG from disposing of certain assets pending
resolution of the action. Global Equity subsequently brought a motion to
have a receiver-manager appointed for MKG, which motion has been adjourned.
In addition, in March 1999 Global Equity filed an action in the Supreme
Court of British Columbia against a third party. This action states the
third party had fraudulently entered into loan agreements with MKG.
Accordingly, under this action Global Equity is claiming damages from the
third party and restraining the third party from further action. During
2000 and the first quarter of 2001, Global Equity entered into settlement
negotiations with a third party to dispose of the remaining assets of MKG.
Due to the protracted nature of these discussions and the increasing
uncertainty of whether the remaining investment can be realized, Global
Equity wrote off the remaining balance of $500,000 of this investment in
the three months ended June 30 2001. (See Long Term Holdings segment in
Management's Discussion and Analysis of Financial Condition and Results of
Operations). Global Equity is currently reviewing its legal options before
deciding if it will continue pursuing the outstanding legal actions.
In connection with the sale of their interests in Nevada Land & Resource
Company, LLC, a wholly owned PICO subsidiary, by the former members, a
limited partnership agreed to act as consultant to Nevada Land in
connection with the maximization of the development, sales, leasing,
royalties or other disposition of land, water, mineral and oil and gas
rights with respect to the Nevada property. In exchange for these services,
the partnership was to receive from Nevada Land a consulting fee calculated
as 50% of any net proceeds that Nevada Land actually receives from the
sale, leasing or other disposition of all or any portion of the Nevada
property or refinancing of the Nevada property provided that Nevada Land
has received such net proceeds in a threshold amount equal to the aggregate
of: (i) the capital investment by Global Equity and the Company in the
Nevada property, (ii) a 20% cumulative return on such capital investment,
and (iii) a sum sufficient to pay the United States federal income tax
liability, if any, of Nevada Land in connection with such capital
investment. Either party could terminate this consulting agreement in April
2002 if the partnership had not received or become entitled to receive by
that time any amount of the consulting fee. No payments have been made
under this agreement through December 31, 1998. By letter dated March 13,
1998, Nevada Land gave notice of termination of the consulting agreement
based on Nevada Land's determination of default by the partnership under
the terms of the agreement. In November 1998, the partnership sued Nevada
Land for wrongful termination of the consulting contract. On March 12,
1999, Nevada Land filed a cross-complaint against the partnership for
breach of written contract, breach of fiduciary duty and seeking
declaratory relief. Effective September 1, 1999, the parties entered into a
settlement agreement wherein they agreed that the lawsuit would be
dismissed without prejudice, and that Nevada Land would deliver a report on
or before June 30, 2002 to the limited partnership of the amount of the
consulting fee which would be owed by Nevada Land to the limited
partnership if the consulting agreement were in effect.
In November 2000, BSND, Inc. ("BSND"), a wholly owned subsidiary of
Vidler Water Company, resolved a partnership dispute relating to Big
Springs Associates ("the Partnership"). The Partnership owns real estate
and water rights in Nevada. Under the terms of the agreement resolving the
Partnership dispute, BSND agreed to sell its interest in the Partnership to
the managing partner of the Partnership for $12.65 million. The agreement
also provided that if BSND did not receive the $12.65 million payment by
August 1, 2001, the managing partner would relinquish its interest in the
Partnership. BSND did not receive any payment from the managing partner
under the terms of the agreement by August 1 and, accordingly, under the
provisions of the agreement, BSND is now the sole partner of the
Partnership.
In September and December 2000, PICO Holdings loaned a total of $2.2
million to Dominion Capital Pty. Ltd. ("Dominion Capital"), a private
Australian company. (See Note 8 in the Company's 2000 Annual Report on Form
10-K.) In May 2001, one of the loans for $1.2 million became overdue.
Negotiations between PICO and Dominion Capital to reach a settlement
agreement on both the overdue loan of $1.2 million and the other loan of $1
million proved unsuccessful. Accordingly, PICO has commenced 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 a legal action and our ability to realize the assets
collateralizing the loans, PICO has fully provided for these loans and
interest accrued in the nine months ended September 30, 2001.
8
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.
5. CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS 138,
"Accounting for Certain Derivative Instruments and Hedging Activities." As
amended, SFAS No. 133 requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position,
measure those instruments at fair value and recognize changes in fair value
in earnings for the period of change unless the derivative qualifies as an
effective hedge that offsets certain exposure. As a result of this
adoption, the Company recorded a transition adjustment in the first quarter
of 2001 that decreased net income by approximately $1 million, net of a
$500,000 tax benefit, and increased other comprehensive income by the same
amount (no effect on shareholders' equity). These adjustments have been
reported as a cumulative effect of change in accounting principle. The
current impacts of SFAS No. 133 are included in realized investment gains
and losses on the statement of operations and primarily include the
fluctuation in the value of the warrants to purchase shares of HyperFeed
Technologies, Inc. The value of the warrants is determined each period
using the Black Scholes option pricing model. The model uses the current
market price of the common stock of HyperFeed, and the following
assumptions, updated each reporting period, in calculating an estimated
fair value: no dividend yield; a risk-free interest rate of 4.2% to 2.5%;
an expected life of one year; and a historical 5 year cumulative volatility
of 121% to 104%. The value of our 4.1 million warrants derived from the
model was $2.9 million at December 31, 2000 and $1.3 million at September
30, 2001. The change in value is reported within realized investment gains
or losses. Future effects on net income will depend on market conditions.
In the fourth quarter of 2000, the Company received notification from
the Ohio Department of Insurance ("ODI") that it would no longer permit the
Company to discount its medical professional liability insurance reserves
for statutory accounting practices. Accordingly, the Company discontinued
discounting its MPL reserves in its statutory filing with the ODI and in
its financial statements prepared in accordance with US GAAP for the year
ended December 31, 2000. The effect of this change was to increase the
unpaid losses and loss adjustment expenses reserve by $7.5 million, and a
cumulative effect of a change in accounting principle of $5 million, or
$0.44 per share, net of an income tax benefit of approximately $2.5
million. The adjustment has been reported as a cumulative effect of change
in accounting principle as of January 1, 2000.
6. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB approved Statement of Financial Accounting
Standard No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 141 prospectively prohibits the pooling
of interest method of accounting for business combinations initiated after
June 30, 2001. The provisions of this Statement are required to be applied
starting with fiscal years beginning after December 15, 2001. However, as
an exception, any goodwill resulting from acquisitions completed after June
30, 2001 will not be amortized. SFAS No. 142 also establishes a new method
of testing goodwill for impairment on an annual basis or on an interim
basis if an event occurs or circumstances change that would reduce the fair
value of a reporting unit below its carrying value. At September 30, 2001,
PICO's balance sheet included goodwill of $6 million, $2.4 million of which
is included within the investment in HyperFeed, and negative goodwill
("excess of fair value of net assets acquired over purchase price") of $2.9
million.
Management is in the process of determining the accounting treatment
for the Company's goodwill and negative goodwill; however, the adoption of
SFAS No. 142 could result in PICO ceasing to amortize goodwill as an
expense, and recording existing negative goodwill in income immediately as
the effect of a change in accounting principle. Also, under the new
standard, PICO will be required to test its goodwill for impairment, which
could have an adverse effect on future results of operations if there is an
impairment.
In August 2001, the FASB adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes
SFAS NO. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of" and defines an impairment as "the
condition that exists when the carrying amount of a long-lived asset (asset
group) is not recoverable and exceeds its fair value." Based on the SFAS
No. 121 framework, this statement develops a single accounting model for
the disposal of long-lived assets, whether previously held or newly
acquired. The statement will be effective for financial statements issued
for fiscal years beginning after December 15, 2001, and interim periods
within those
9
fiscal years, with initial application as of the beginning of the fiscal
year. Management has not determined the impact of this statement.
7. SEGMENT REPORTING
The Company is a diversified holding company engaged in five major
operating segments: Land, Mineral and Related Water Rights; Water Rights
and Water Storage; Property and Casualty Insurance; Medical Professional
Liability Insurance and Long Term Holdings.
The accounting policies of the reportable segments are the same as
those described in the Company's 2000 annual report on Form 10-K. Segment
performance is measured by revenues and segment profit before tax and
minority interest, in addition to changes in shareholders' equity. This
information provides the basis for calculation of return on shareholders'
equity, which is the main performance measurement used in analyzing segment
performance. The Company has operations and investments both in the U.S.
and abroad.
The following is a detail of revenues by segment:
Three Months Ended September 30, Nine Months Ended September 30,
2001 2000 2001 2000
----------------- ------------------- ----------------- -------------------
Land, Mineral and Related Water Rights $ 737,546 $ 609,229 $ 1,711,566 $ 1,852,634
Water Rights and Water Storage 4,757,086 937,433 16,068,625 1,554,877
Property and Casualty Insurance 12,731,911 9,927,789 37,577,397 28,377,211
Medical Professional Liability Insurance 300,940 508,821 (3,116,795) 1,520,169
Long Term Holdings (2,778,258) (7,043,662) (112,464) (7,242,087)
------------------------------------------------------------------------------
Total Revenues $ 15,749,225 $ 4,939,610 $ 52,128,329 $ 26,062,804
==============================================================================
The following is a detail of segment profit or loss before income taxes and
minority interest:
Three Months Ended September 30, Nine Months Ended September 30,
2001 2000 2001 2000
------------------------------------------------------------------
Land, Mineral and Related Water Rights $ 230,714 $ 167,876 $ 321,867 $ 211,877
Water Rights and Water Storage 3,517,575 (375,994) 4,715,804 (2,164,779)
Property and Casualty Insurance 2,098,174 160,680 3,125,174 695,299
Medical Professional Liability Insurance 159,098 107,408 (3,609,691) 658,000
Long Term Holdings (4,481,441) (7,277,000) (9,074,607) (12,763,355)
------------------------------------------------------------------
Income (Loss) Before Taxes and Minority Interest
Cumulative Effect of Changes In Accounting Principle $ 1,524,120 $ (7,217,030) $ (4,521,453) $ (13,362,958)
==================================================================
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECURITIES LAW. THESE INCLUDE, BUT ARE NOT LIMITED TO, STATEMENTS ABOUT THE
COMPANY'S INVESTMENT PHILOSOPHY, PLANS FOR EXPANSION, BUSINESS EXPECTATIONS, AND
REGULATORY FACTORS. THESE STATEMENTS REFLECT OUR CURRENT VIEWS ABOUT FUTURE
EVENTS WHICH COULD AFFECT OUR FINANCIAL PERFORMANCE. ALTHOUGH WE AIM TO PROMPTLY
DISCLOSE ANY NEW DEVELOPMENT WHICH WILL HAVE A MATERIAL IMPACT ON PICO, WE DO
NOT UNDERTAKE TO UPDATE ALL FORWARD-LOOKING STATEMENTS UNTIL OUR NEXT SCHEDULED
FORM 10-K OR FORM 10-Q FILING. YOU SHOULD NOT PLACE UNDUE RELIANCE ON
FORWARD-LOOKING STATEMENTS BECAUSE THEY ARE SUBJECT TO VARIOUS RISKS AND
UNCERTAINTIES, INCLUDING THOSE LISTED UNDER "RISK FACTORS" AND ELSEWHERE IN OUR
PREVIOUS SEC FILINGS, WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
SUCH FORWARD-LOOKING STATEMENTS, OR FROM OUR PAST RESULTS.
10
RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
INTRODUCTION
PICO Holdings, Inc. is a diversified holding company. We acquire interests
in assets and companies which our management believes:
- are undervalued at the time we buy them; and
- have the potential to provide a superior rate of return over time, after
considering the risk involved.
Our over-riding objective is to generate superior long term growth in
shareholders' equity, as measured by book value per share. To accomplish this,
we are seeking to build a profitable operating base and to realize gains from
our investment holdings. In the long term, we expect that most of the growth in
shareholders' equity will come from realized gains on the sale of assets, rather
than operating earnings. Accordingly, when analyzing PICO's performance, our
management places more weight on increased asset values than on reported
earnings.
Currently our major assets and activities are:
- owning and developing land and the related water rights and mineral rights
through Nevada Land & Resource Company, LLC, which owns approximately
1,238,830 acres of land in northern Nevada;
- owning and developing water rights and water storage operations through
Vidler Water Company, Inc.;
- property and casualty insurance;
- "running off" the loss reserves of our medical professional liability
insurance companies; and
- making long term value-based investments in other public companies.
SUMMARY
Segment revenues and income (loss) before taxes, minority interest, and the
cumulative effect of changes in the accounting principle for the third quarter
and the first nine months of 2001 and 2000 were:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------ --------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
REVENUES:
Land, Minerals & Related Water Rights $ 737,000 $ 609,000 $ 1,711,000 $ 1,853,000
Water Rights & Water Storage Assets 4,757,000 937,000 16,069,000 1,555,000
Property & Casualty Insurance 12,732,000 9,928,000 37,577,000 28,377,000
Medical Professional Liability Insurance 301,000 509,000 (3,117,000) 1,520,000
Long Term Holdings (2,778,000) (7,043,000) (112,000) (7,242,000)
------------ ------------ ------------ ------------
Total Revenues $ 15,749,000 $ 4,940,000 $ 52,128,000 $ 26,063,000
============ ============ ============ ============
INCOME (LOSS) BEFORE TAXES, MINORITY
INTEREST & CUMULATIVE EFFECT OF CHANGES IN
ACCOUNTING PRINCIPLES:
Land, Minerals & Related Water Rights $ 231,000 $ 168,000 $ 322,000 $ 212,000
Water Rights & Water Storage Assets 3,517,000 (376,000) 4,716,000 (2,165,000)
Property & Casualty Insurance 2,098,000 161,000 3,125,000 695,000
Medical Professional Liability Insurance 159,000 107,000 (3,610,000) 658,000
Long Term Holdings (4,481,000) (7,277,000) (9,074,000) (12,763,000)
------------ ------------ ------------ ------------
TOTAL $ 1,524,000 $ (7,217,000) $ (4,521,000 $(13,363,000)
============ ============ ============ ============
PICO reported net income of $1.4 million, or $0.11 per basic and diluted
share, for the quarter ended September 30, 2001. The profit for the quarter
consisted of $1.5 million in income before income taxes and minority interest,
$186,000 in income tax expense, and the addition of $27,000 to reflect the
interest of the minority shareholders in the losses of consolidated subsidiaries
which are not wholly owned. Significant items in the $1.5 million income before
income taxes and minority interest for the third quarter include:
- a $4.1 million gain from the sale of part of our interest in the Semitropic
water storage facility;
- income of $2.1 million from the Property and Casualty Insurance segment,
including investment income of $1.6 million and realized gains of $228,000;
and
- a loss of $3.2 million from a decrease in the value of warrants we own in
other companies, principally HyperFeed Technologies, Inc., which we are now
required to recognize through the income statement under Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities."
11
PICO recorded comprehensive income of $346,000 for the quarter. This was
comprised of net income of $1.4 million and a foreign currency translation
credit of $514,000, which were partially offset by $1.5 million of unrealized
diminution in the value of investments.
In the third quarter of 2000, PICO reported a net loss of $2.8 million, or
$0.23 per basic and diluted share, and a comprehensive loss of $3.6 million. The
net loss for the quarter consisted of a $7.2 million loss before taxes and
minority interest, $4.5 million in income tax benefits, and a minority interest
deduction of $97,000. The comprehensive loss was comprised of the $2.8 million
net loss and $1.1 million in unrealized diminution in the value of investments,
which were partially offset by a $244,000 foreign currency translation credit.
For the nine months ended September 30, 2001, PICO reported a net loss of
$3.4 million, or $0.27 per basic and diluted share. The reported net loss
consisted of a $2.4 million net loss before an accounting change, and a change
in accounting principle which had the cumulative effect of reducing income by
$981,000 after taxes, or $0.08 per share. The accounting change was due to the
adoption of the Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities." This non-cash charge
recognized the accumulated after-tax decline in the estimated fair value of
warrants we own to buy shares in other companies, primarily HyperFeed
Technologies, Inc. as of January 1, 2001.
The nine-month net loss before the accounting change consisted of a $4.5
million loss before taxes and minority interest, which was partially offset by a
$1.8 million income tax benefit and the addition of $285,000 of minority
interest. The most significant items in the $4.5 million loss before income
taxes and minority interest include:
- income of $2.3 million from the sale of water rights and land in the
Harquahala Valley Irrigation District;
- gains of $5.7 million from the sale of part of our interest in the
Semitropic water storage facility;
- income of $3.1 million from the Property and Casualty Insurance segment,
including investment income of $4.6 million and realized gains of $885,000;
- a $4.1 million realized loss on the redemption of a mutual fund held in the
Physicians Insurance Company of Ohio investment portfolio. The decline in
value of this investment was already reflected in shareholders' equity, so
the effect on book value was minimal. PICO has no other investments in
mutual funds or derivative instruments, apart from warrants to buy shares
in other companies, principally HyperFeed Technologies, Inc.;
- provisions of $2.8 million against the carrying value of investments and
loans; and
- a $1.5 million loss from a decrease in the value of warrants under SFAS
133, principally HyperFeed.
The comprehensive loss for the nine months was $6.7 million, comprised of
the $3.4 million net loss and $3.9 million unrealized depreciation in
investments, which were partially offset by a $577,000 foreign currency
translation gain. The $3.9 million unrealized diminution in investments includes
a $6 million initial reduction when we ceased to account for our investment in
Jungfraubahn Holding AG under the equity method in the second quarter of 2001.
As explained in the Long Term Holdings segment discussion, this is only an
adjustment to the carrying value of Jungfraubahn in our balance sheet, and does
not reflect any change in the potential market value of our investment.
In the first nine months of 2000, PICO incurred a net loss of $11.2
million, or $0.99 per basic and diluted share, which included a separate change
in accounting principle that reduced income by $5 million after taxes, or $0.44
per share. This non-cash charge was taken to eliminate the discounting of
medical professional liability reserves in our financial statements from the
beginning of 2000. The net loss for the first nine months of 2000 was comprised
of a $13.4 million loss before income taxes and minority interest, partially
offset by income tax benefits of $6.7 million and the add-back of $418,000 of
minority interest. The $17.4 million comprehensive loss for the first nine
months of 2000 was comprised of the $11.2 million net loss, $5.5 million of
unrealized diminution in investments, and negative currency translation of
$710,000.
At September 30, 2001, PICO had shareholders' equity of $198.5 million, or
$16.02 per share, compared to $198.1 million ($15.99 per share) at June 30,
2001, and $205.2 million ($16.56 per share) at December 31, 2000. The decrease
in shareholders' equity during the first nine months of 2001 resulted from the
$6.7 million comprehensive loss, which includes the initial $6 million reduction
when we ceased equity accounting for Jungfraubahn in the second quarter of 2001.
In the third quarter of 2001, revenues were $15.7 million, compared to $4.9
million during the third quarter of 2000. The increase primarily resulted from
the $4.1 million gain on the sale of an interest in Semitropic, $2.8 million
higher revenues in the Property and Casualty Insurance segment, and the
non-recurrence of net realized investment losses which reduced revenues by $7.1
million in the third quarter of the prior year.
12
Revenues were $52.1 million for the first nine months of 2001, compared to
$26.1 million during the first nine months of 2000. The increase primarily
resulted from $9.4 million in total revenues from sale of water rights and land
in the Harquahala Valley Irrigation District, $5.7 million in gains from the
sale of interests in Semitropic, $9.2 million higher revenues in the Property
and Casualty Insurance segment, and $2.4 million lower realized investment
losses.
Detailed information on the performance and outlook for each segment is
contained later in this report; however, the major factors affecting PICO's
third quarter and nine-month results were:
LAND, MINERALS & RELATED WATER RIGHTS
Nevada Land earned income of $231,000 for the third quarter of 2001,
compared to income of $168,000 in the third quarter of 2000. The $63,000
improvement in the segment result is primarily due to a $130,000 higher gross
margin on land sales in 2001, partially offset by lower royalty revenues.
For the first nine months of 2001, Nevada Land generated income of
$322,000, compared to $212,000 the year before. Segment income increased by
$110,000 year over year, primarily as a result of $124,000 growth in interest
and other revenues and a $135,000 reduction in operating expenses, which more
than offset a $114,000 lower gross margin from land sales. In the first nine
months of 2000, Nevada Land expensed an unusually large amount of professional
fees related to initiatives to accelerate the utilization and monetization of
the company's lands. Professional fees returned to more typical levels in 2001,
which contributed to the year over year reduction in operating expenses.
WATER RIGHTS & WATER STORAGE ASSETS
Vidler's revenues for the third quarter and first nine months of 2001
reflect our first major water transactions, and are substantially higher than in
the same periods in 2000 when Vidler's most important water assets had not yet
generated significant revenues.
Vidler's $4.8 million in total revenues for the third quarter of 2001 are
dominated by a $4.1 million gain from the sale of part of our interest in the
Semitropic water storage facility. Due to the gain on sale, which more than
offset Vidler's operating expenses, the segment reported income before taxes of
$3.5 million in the third quarter of 2001, compared to a $376,000 pre-tax loss
in the same quarter in 2000.
In the first nine months of 2001, Vidler's total revenues of $16.1 million
primarily consisted of $9.4 million in total revenues from the sale of part of
our water rights in the Harquahala Valley Irrigation District and the $5.7
million in gains from selling part of our interest in Semitropic. Due to the
$2.3 million in income from the sale of the Harquahala Valley water rights and
the $5.7 million in Semitropic gains, Vidler reported pre-tax income of $4.7
million in the first nine months of 2001, as opposed to a loss before taxes of
$2.2 million the year before.
PROPERTY AND CASUALTY INSURANCE
Segment income increased markedly from 2000 levels in both the third
quarter and the nine months. This was primarily as a result of Sequoia
generating an underwriting profit in the third quarter of 2001, as opposed to
underwriting losses in the first six months of 2001, and both the third quarter
and first nine months of 2000. The improved underwriting result is due to a
tightening of underwriting standards, favorable reserve development, and
seasonal factors -- the third quarter includes the summer months and typically
generates an underwriting profit. Improved results from Citation, and higher
levels of investment income and realized gains also contributed to the increase
in segment income.
During the third quarter of 2001, segment revenues increased by $2.8
million, or 28.2%, from the previous year, primarily as a result of $2.4
million, or 28.9%, growth in earned premiums, and increases of $213,000 in
investment income and $196,000 in realized gains. Segment income of $2.1 million
for the third quarter of 2001 was comprised of a $1.5 million profit from
Sequoia and $609,000 from Citation. In the third quarter of 2000, claims costs
were unusually high resulting in segment income of just $161,000, consisting of
a $184,000 profit from Sequoia and a $23,000 loss from Citation.
For the first nine months of 2001, segment revenues increased $9.2 million,
or 32.4%, due to $7.7 million, or 33.1%, growth in earned premiums and increases
of $760,000 in investment income and $780,000 in realized gains. Segment income
was $3.1 million, consisting of profits of $1.1 million from Sequoia and almost
$2 million from Citation. In the first nine months of 2000, segment income of
$695,000 was comprised of profits of $253,000 from Sequoia and $442,000 from
Citation.
13
MEDICAL PROFESSIONAL LIABILITY INSURANCE
This segment is diminishing as the "run off" of our medical professional
liability loss reserves continues.
The segment generated revenues of $301,000 and income of $159,000 in the
third quarter of 2001, compared to revenues of $509,000 and income of $107,000
in the previous year.
The segment's results for the first nine months of 2001 were dominated by a
$4.1 million realized loss on the sale of an investment in a mutual fund in the
first and second quarters of 2001. Due to the realized loss, segment revenues
were negative $3.1 million for the first nine months of 2001, and the segment
incurred a $3.6 million pre-tax loss. Excluding the realized loss, the segment
would have reported income of $448,000 for the nine months. In the first nine
months of 2000, revenues were $1.5 million and segment income was $658,000.
LONG TERM HOLDINGS
This segment contains our long term investments in public companies,
subsidiaries, and other investments which individually are too small to
constitute a segment, and parent (i.e., holding) company assets. Our principal
long term holdings are HyperFeed Technologies, Inc., Jungfraubahn Holding AG,
and Australian Oil & Gas Corporation Limited.
In the third quarter of 2001, the segment incurred a $4.5 million loss.
This was primarily due to a $3.2 million SFAS 133 reduction in the carrying
value of warrants, and our $1.2 million equity share of the net losses of
companies we account for under the equity method. Investment income and other
revenues of $392,000 were more than offset by segment expenses of $526,000.
Segment expenses were unusually low due to a $1.1 million foreign currency gain
on an inter-company loan, which partially offset parent company overhead of $1.1
million and other expenses.
For the first nine months of 2001, the segment loss was $9.1 million. The
major components of the nine-month loss were $3.6 million in parent company
overhead, $2.8 million in provisions against loans and investments, a $1.5
million SFAS 133 loss, and our $1 million equity share of the net losses of
companies we account for under the equity method. Investment income and other
revenues of $1.9 million were more than offset by other segment expenses
totaling approximately $2 million.
In the third quarter of 2000, the segment incurred a $7.3 million loss,
primarily due to $7.1 million in realized investment losses. Investment income
and other revenues were $77,000, segment expenses were $2.1 million, and equity
income was $1.8 million. For the first nine months of 2000, the segment loss was
$12.8 million, primarily due to realized investment losses of $7.7 million and
$2.1 million in operating losses from Conex prior to its sale, which were
partially offset by $2.2 million of equity income. Other revenues were $451,000,
and other segment expenses were approximately $5.6 million.
LAND, MINERALS AND RELATED WATER RIGHTS
NEVADA LAND & RESOURCE COMPANY, LLC
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------- ---------------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
REVENUES:
Sale of Land $ 401,000 $ 245,000 $ 840,000 $ 1,071,000
Lease and Royalty 219,000 278,000 510,000 545,000
Interest and Other 117,000 86,000 361,000 237,000
----------- ----------- ----------- -----------
Segment Total Revenues $ 737,000 $ 609,000 $ 1,711,000 $ 1,853,000
=========== =========== =========== ===========
EXPENSES:
Cost of Land Sales $ (164,000) $ (138,000) $ (349,000) $ (466,000)
Operating Expenses (342,000) (303,000) (1,040,000) (1,175,000)
----------- ----------- ----------- -----------
Segment Total Expenses $ (506,000) $ (441,000) $(1,389,000) $(1,641,000)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
INCOME BEFORE TAX $ 231,000 $ 168,000 $ 322,000 $ 212,000
=========== =========== =========== ===========
Nevada Land & Resource Company, LLC owns approximately 1,238,830 acres of deeded
land in northern Nevada, and the mineral rights and water rights specifically
related to that property. We are pursuing three strategies to monetize these
assets:
- the sale of land where there is little potential to further enhance value
(e.g., agricultural land which does not have a higher and better use);
- increasing the highest and best use of land wherever possible, for example,
by applying for water rights; and
14
- exchanging portions of our land, which have environmental, cultural, and/or
historical value, with governmental agencies and others for more marketable
lands, in particular, property with development potential near growing
communities or along the Interstate 15 and Interstate 80 corridors. We are
working on a number of potential land exchange transactions, which are
expected to take several years to complete. In some cases, we may form
joint ventures with developers in order to participate in the upside from
developing the land acquired.
In the meantime, it is likely that Nevada Land's reported results will continue
to be dominated by land sales.
Nevada Land does not recognize land sales contracts as revenues until the
sales transactions close. Consequently, revenues and the gross margin from land
sales fluctuate from quarter to quarter depending on the closing of specific
transactions, and land sales revenues and gross margin for any individual
quarter are not indicative of likely full-year revenues and gross margin.
In the third quarter of 2001, Nevada Land closed the sale of approximately
5,200 acres of land for $401,000, an average sales price of $77 per acre. Our
average basis in the land sold was $32 per acre, resulting in a gross margin of
$45 per acre, or $237,000 in total. Lease and royalty revenues contributed
$219,000 and other revenues $117,000, resulting in segment total revenues of
$737,000.
In the third quarter of 2000, segment total revenues of $609,000 included
$245,000 from the sale of 1,759 acres of land, an average sales price of $139
per acre. Our average basis in the acreage sold was $78 per acre, and the gross
margin from land sales was $107,000, or $61 per acre. Lease and royalty revenues
were $278,000, and other revenues $86,000.
The segment generated income of $231,000 for the third quarter of 2001,
compared to $168,000 in the previous year. The $63,000 improvement in the
segment result was primarily due to a $130,000 higher gross margin from land
sales, partially offset by $73,000 lower royalties received and $39,000 higher
operating expenses.
During the first nine months of 2001, Nevada Land closed the sale of
approximately 9,643 acres of land for $840,000, an average sales price of $87.
Our average basis in the acreage sold was $36, resulting in a gross margin of
$51 per acre, or $491,000. Lease and royalty revenues contributed $510,000 and
other revenues were $361,000, resulting in segment total revenues of $1.7
million. Following operating expenses of $1 million, segment income was
$322,000.
In the first nine months of 2000, Nevada Land reported total revenues of
$1.9 million, comprised of $1.1 million in proceeds from the sale of 9,583 acres
of land, lease and royalty revenues of $545,000, and other revenues of $237,000.
The land sales averaged $112 per acre, compared to our average basis of $49 per
acre, resulting in a gross margin of $63 per acre, or $605,000. After operating
expenses of $1.2 million, segment income was $212,000.
For the nine month period, segment income increased by $110,000, as a
$135,000 drop in operating expenses (primarily lower professional fees) and a
$124,000 increase in other revenues (principally interest) more than offset a
$114,000 decrease in gross margin from land sales and $35,000 lower lease and
royalty revenues. Professional fees related to the use of our lands were
unusually large in the first nine months of 2000, which led to the reduction in
operating expenses year over year. The increase in other revenues was due to
higher interest income earned on the proceeds of cash sales and receivables
where Nevada Land has provided partial financing.
During 2000 and the first nine months of 2001, Nevada Land filed
applications for an additional 64,316 acre-feet of water rights related to its
lands. Where these applications are successful, we anticipate that the value and
marketability of the associated land will increase. The applications consist of:
- 39,076 acre-feet of agricultural water rights for the beneficial use of
irrigating the related 13,025 acres of land; and
- 25,240 acre-feet of water rights for industrial use.
Nevada Land intends to file additional applications for water rights related to
its lands.
Discussions are continuing with several electricity-generating companies
that are looking for sites to construct new power plants in northern Nevada.
Nevada Land has a supply of suitable land in various locations which also offer
the other essential requirements of water for cooling, access to the electricity
grid, and availability of feedstock (i.e., a fuel source) through either natural
gas transmission lines for gas-fired stations or rail transport for coal-fired
stations.
15
WATER RIGHTS AND WATER STORAGE ASSETS
VIDLER WATER COMPANY, INC.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------- ----------------------------------
2001 2000 2001 2000
---------------- ------------------ ----------------- ----------------
REVENUES:
Sale of Land and Water Rights $ 9,095,000
Option Premiums Earned 300,000
Gain on sale of Semitropic Water Storage interest $4,086,000 5,701,000
Sale of Water $ 509,000 $ 509,000
Lease of Water 110,000 47,000 195,000 134,000
Agricultural Land Leases 201,000 216,000 606,000 729,000
Provision for Loss on Condemnation (442,000)
Other 360,000 165,000 614,000 183,000
---------------- ------------------ ----------------- ----------------
Segment Total Revenues $4,757,000 $ 937,000 $16,069,000 $ 1,555,000
================ ================== ================= ================
EXPENSES:
Cost of Land and Water Rights Sold $(6,524,000)
Commission and other cost of sales (546,000)
Depreciation and Amortization $ (327,000) $ (220,000) (1,049,000) $ (636,000)
Interest (157,000) (200,000) (504,000) (604,000)
Operations, Maintenance & Other (756,000) (893,000) (2,730,000) (2,480,000)
---------------- ------------------ ----------------- ----------------
Segment Total Expenses $(1,240,000) $ (1,313,000) $(11,353,000) $(3,720,000)
---------------- ------------------ ----------------- ----------------
INCOME (LOSS) BEFORE TAX $3,517,000 $ ( 376,000) $ 4,716,000 $(2,165,000)
================ ================== ================= ================
This segment is comprised of two distinct but inter-related activities: the
ownership and development of water rights in Nevada, Arizona, and Colorado; and
our interests in water storage facilities in Arizona and California.
We entered the water business with the realization that most of the assets
which Vidler acquired were not ready for immediate commercial use, and that
there would be a lead-time in developing and then commercializing these assets.
Vidler's water assets did not begin to generate significant revenues until the
first quarter of 2001. In 2000 and prior years, Vidler was generating only
modest revenues from the lease and sale of water assets in Colorado and from
leasing agricultural land. At the same time, Vidler was incurring costs
associated with the development of assets and expansion of the water rights
portfolio, which resulted in operating losses during the start-up years.
Vidler's results for the first nine months of 2001 were dominated by three
transactions:
- the sale of 6,496.5 acre-feet of transferable ground water, and the related
2,589 acres of land, in Arizona's Harquahala Valley Irrigation District in
the first quarter. This transaction added $9.4 million to revenues and $2.3
million to segment income and is included in Vidler's results for the first
nine months of 2001;
- the sale of 29.7% of Vidler's original interest in the Semitropic Water
Banking and Exchange Program (i.e., approximately 55,000 acre-feet of
storage capacity, out of the original 185,000 acre-feet) for $3.3 million in
the second quarter. This transaction added $1.6 million to revenues and to
segment income, and is included in Vidler's results for the first nine
months of 2001; and
- the further sale of 54.1% of Vidler's original interest in the Semitropic
Water Banking and Exchange Program (i.e., approximately 100,000 acre-feet of
storage capacity) for $6.9 million in the third quarter. This transaction
added $4.1 million to revenues and to segment income, and is included in
Vidler's results for both the third quarter and the first nine months of
2001.
In the third quarter of 2001, Vidler generated total revenues of $4.8
million, including a $4.1 million pre-tax gain from the second sale of part of
our original interest in Semitropic. After operating expenses of $1.2 million
for the quarter, segment income was $3.5 million.
Throughout 2000, Vidler was concentrating on the development and
commercialization of its assets and the company's water rights and water storage
assets were not generating significant revenues. This is reflected in the
segment results for the third quarter of 2000 when segment total revenues of
$937,000 were dominated by a $509,000 sale of water banked at Semitropic.
Following operating expenses of $1.3 million, the segment incurred a loss of
$376,000.
The $3.9 million improvement in segment income year over year is primarily
due to the $4.1 million Semitropic gain recorded in 2001. In total, operating
expenses decreased by $73,000 year over year. Although the depreciation and
amortization charge
16
increased by $107,000, primarily due to amortization of improvements at the
Vidler Arizona Water Recharge Facility which began in 2001, this was more than
offset by a $180,000 lower expenses in the interest and operations, maintenance
and other categories. Interest expense decreased by $43,000 due to the repayment
of non-recourse financing on the farm properties in the Harquahala Valley which
were sold in the Allegheny transaction. Operations, maintenance and other
charges decreased by $137,000, primarily due to lower operations and maintenance
expenses for Semitropic as our interest in the asset decreased.
In the first nine months of 2001, Vidler generated segment revenues of
$16.1 million. The principal revenue items were $9.4 million from the Harquahala
Valley sale (consisting of the $9.1 million sales price and a $300,000 option
premium earned) and pre-tax gains of $5.7 million from the two sales of
interests in Semitropic. Revenues were reduced by a $442,000 provision for loss
on the condemnation (i.e., compulsory acquisition) of a commercially zoned
property in Mesa, Arizona due to freeway construction. This land, which was
located in greater metropolitan Phoenix, was not part of Vidler's water
business. It was acquired in association with MBT Ranch in 1996, and was being
held for resale. The Arizona Department of Transportation condemned the land for
$858,000, which is $442,000 less than the value that Vidler was carrying the
property at, and less than two recent appraisals obtained by Vidler. Vidler
disputes the value at which the Department condemned the land, and intends to
initiate legal proceedings if the dispute cannot be resolved.
After deducting the cost of land and water rights sold and related selling
costs, and operating costs of $4.3 million, segment income for the first nine
months of 2001 was $4.7 million.
In the first nine months of 2000, segment total revenues were $1.5 million,
operating expenses were $3.7 million, and the segment incurred a loss of $2.1
million.
Segment income improved by almost $6.9 million year over year, principally
due to the $2.3 million contribution from the sale of Harquahala Valley water
rights and land, and the $5.7 million in pre-tax gains from the sale of
interests in Semitropic.
The expansion of Vidler's asset base during 2000, including the acquisition
of Fish Springs Ranch in July 2000 and Spring Valley Ranches in September 2000,
contributed to increase in other operating revenues and operations, maintenance,
and other expenses. Other revenues increased by $431,000, primarily due to sales
of hay grown at Fish Springs Ranch. In total, operating expenses increased by
$563,000. The depreciation and amortization charge increased by $413,000,
primarily as a result of beginning to amortize improvements at the Vidler
Arizona Recharge Facility beginning in March 2001. Operations, maintenance, and
other expenses increased by $250,000 as lower operations and maintenance
expenses for Semitropic were more than offset by the inclusion of operating
costs of the two ranch properties. These increases were partially offset by a
$100,000 decrease in interest expense due to the repayment of non-recourse debt
on some of the Harquahala Valley farm properties which were sold.
Our 2000 Form 10-K contains a detailed description of our water rights and
water storage assets. The following section updates this information where
necessary, and outlines new developments during the first nine months of 2001:
WATER RIGHTS
ARIZONA
HARQUAHALA VALLEY WATER RIGHTS
In March 2001, Vidler closed the sale of 6,496.5 acre-feet of transferable
ground water, and the related 2,589 acres of land, in the Harquahala Valley
Irrigation District, which is located approximately 75 miles northwest of
metropolitan Phoenix, Arizona. The sales price of $9.1 million represents $1,400
per acre-foot of transferable Harquahala Valley ground water. The transaction
resulted in pre-tax income of $2.3 million; however we paid $4.4 million in cash
to acquire the assets which were sold, resulting in a $5 million cash surplus.
The cash-on-cash pre-tax internal rate of return on the investment was almost
140%. This is not an accounting measure, but a supplemental disclosure of the
actual rate of return on the cash invested in these assets. Most of the
difference between the $2.3 million pre-tax income on a GAAP basis and the $5
million cash surplus was recorded as an increase in book value at the time of
the PICO/Global Equity combination in 1998.
Following the Allegheny transaction, Vidler owns, or has the right to
acquire, approximately 49,500 acre-feet of transferable Harquahala Valley ground
water. Discussions are continuing to supply this water to municipalities,
developers, and industrial users.
Under state legislation, the Central Arizona Canal Project is committed to
convey up to 20,000 acre-feet of Harquahala Valley ground water to cities and
communities in Arizona as an assured municipal water supply. Vidler is able to
supply this water and is
17
meeting with communities and developers in the Phoenix metropolitan area, some
of whom need to secure further water supply to cater for expected growth. Vidler
has entered into an agreement to sell 3,645 acre-feet of Harquahala Valley
ground water to the City of Scottsdale for $4.7 million, or $1,300 per
acre-foot. The sale is expected to close in December 2001.
NEVADA
In recent years, Vidler has increased its holdings of water rights in
northern Nevada through the purchase of ranch properties and entering into joint
ventures with parties with water rights which they wish to commercially develop
. Nevada is the state experiencing the most rapid population growth in the US.
According to the most recent census, the population of Nevada increased 66% in
the last decade. Most of the growth is centered in southern Nevada, which
includes the city of Las Vegas and surrounding municipalities.
LINCOLN COUNTY PUBLIC/PRIVATE JOINT VENTURE
In October 1999, Vidler announced a public/private joint venture with
Lincoln County, Nevada. The joint venture has filed applications for more than
100,000 acre-feet of water rights in Lincoln County, Nevada.
The joint venture has entered into an agreement to supply an
electricity-generating company with a minimum of 6,700 acre-feet of water, and a
maximum of 9,000 acre-feet of water, at $3,300 per acre-foot. We currently
anticipate supplying approximately 7,000 acre-feet of water. The sale of the
water is subject to the electricity-generating company obtaining permitting and
financing for a new power plant. The agreement specifies a closing date of July
2003. Under the terms of the joint venture, when a water sale occurs, Vidler
will recover its costs, with the two parties splitting the remaining revenues on
a 50:50 basis.
During the first quarter of 2001, Vidler agreed to purchase 822.29
acre-feet of permitted water rights in Meadow Valley, which is located in
Lincoln County. The agreement entered escrow in March 2001. Vidler is in
discussions to commercially utilize these water rights by supplying the water to
an industrial user through the joint venture with Lincoln County.
SANDY, NEVADA
Vidler has applied for approximately 2,000 acre-feet of water rights near
Sandy, Nevada. A hearing related to the application, originally scheduled for
September, has been postponed until December 2001. Once the water rights have
been permitted, we have agreed to supply the water to support additional growth
at Primm, Nevada, a resort town on the border between California and Nevada, in
the Interstate 15 corridor.
FISH SPRINGS RANCH
Vidler has a 51% interest in Fish Springs Ranch, LLC 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 related to the ranch are transferable to the Reno area.
Vidler is holding discussions with potential customers, including
developers and industrial users. Potentially water could be supplied to
customers in the north valleys, which would reduce their reliance on river water
which comes through Reno, thereby providing additional water to support growth
in and around Reno. Alternatively, if the capacity of nearby transmission lines
can be expanded, we believe that Fish Springs Ranch would be an attractive site
for a gas-fired power station.
WATER STORAGE
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" refers to the process of placing water into storage
underground. Vidler has the permitted right to recharge 100,000 acre-feet 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 the
Harquahala Valley.
Vidler is able to provide storage for both intrastate users and interstate
users at the facility. Potential users include local governmental political
subdivisions and developers within Arizona, and out-of-state users such as the
Las Vegas metropolitan area and California. The Arizona Water Banking Authority
has the responsibility for intrastate and interstate storage of water for public
entities. The Authority has indicated that the first priority for publicly owned
storage capacity in Arizona is to store water for Arizona users. Therefore,
interstate users will need to rely, at least in part, on privately owned storage
capacity.
18
In April 2001, Vidler reached agreement with the Arizona Water Banking
Authority concerning the terms under which water can be stored at the facility
for the public users represented by the Authority. Vidler will charge a water
storage fee of $45.00 per acre-foot of water recharged during 2001. The fee will
be $46.50 per acre-foot for water recharged in 2002, and $48.00 per acre-foot
for water recharged in 2003. The agreement concludes on December 31, 2003.
Vidler has not begun to store water for customers at the Arizona Recharge
Facility. The ultimate revenues generated will depend on the quantity of water
which the Arizona Water Banking Authority, and other users, store at the
facility. The Authority has not yet indicated whether the users it represents
will store water this year. This will depend on a number of factors, including
the availability of water and available storage capacity at other facilities.
Vidler is also in discussions with private entities to store water at the
facility. At present, there is a limited volume of water available for storage
due to dry conditions in Arizona; however, surplus flows of water should become
available for storage now that the period of peak agricultural demand has ended.
Vidler anticipates beginning to store water for customers once potential
interstate users have concluded their agreements with the state of Arizona and
federal agencies. Ultimately, Vidler expects to fully utilize the facility as
recently projected storage requirements for Nevada and California alone exceed
the total amount of storage available at existing facilities in Arizona.
Since construction of the improvements required to recharge water is
complete and the facility is ready for use, on March 1, 2001, Vidler began to
amortize the improvements at the facility over 15 years. The annual amortization
charge will be approximately $504,000. The amortization charges were $126,000
for the third quarter, and $284,000 for the nine months.
At September 30, 2001, Vidler had recharged approximately 4,000 acre-feet
of water at the facility. Vidler purchased the water from the Central Arizona
Project for its own account, and intends to store the water until it is sold to
an end user.
SEMITROPIC WATER STORAGE FACILITY
Vidler originally had an 18.5% interest in the Semitropic Water Banking and
Exchange Program. This included the right to store up to 185,000 acre-feet of
water underground at the Semitropic Water Storage facility, near the California
Aqueduct, northwest of Bakersfield, California.
This is Vidler's only asset in California, which has proved a difficult
state in which to operate due to the large number of entities involved in the
water industry, each serving a different, and sometimes conflicting,
constituency. In the meantime, the strategic value of the guaranteed right to
recover an amount of water from Semitropic every year -- even drought years --
has become clear to water agencies, developers, and other parties seeking a
reliable water supply. Accordingly, Vidler elected to take advantage of current
demand and began to sell its interest in the asset.
On May 21, 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. This transaction resulted in a
pre-tax gain of $1.6 million, which was recorded in the second quarter of 2001
and is included in Vidler's nine-month results.
On September 30, 2001, Vidler closed the sale of another 54.1% of its
original interest (i.e., approximately 100,000 acre-feet of storage capacity) to
the Alameda County Water District for $6.9 million. This transaction resulted in
a pre-tax gain of $4.1 million, which was recorded in the third quarter of 2001
and is included in Vidler's results for both the third quarter and the nine
months.
Vidler's remaining interest in Semitropic represents approximately 30,000
acre-feet of water storage capacity. We are considering various alternatives for
the remaining interest, including sale to developers or industrial users.
OTHER PROJECTS
- Vidler is evaluating the purchase of further water-righted properties in
Arizona and, potentially, Nevada; and
- Vidler 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. We believe
that Vidler has become the leading private water rights aggregator in
Arizona and Nevada, and the leading private owner-operator of water storage
in Arizona. Our presence in these markets has consolidated our expertise
and reputation for providing solutions to both end-users who require water
and to parties who are otherwise unable to commercially develop water
assets.
19
PROPERTY AND CASUALTY INSURANCE
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------- ----------------------------------
2001 2000 2001 2000
---------------- ------------------ ----------------- ----------------
P&C INSURANCE REVENUES:
Sequoia - Earned Premiums $10,623,000 $8,279,000 $31,020,000 $23,112,000
Citation - Earned Premiums 41,000 (6,000) 220,000 352,000
Investment Income 1,618,000 1,405,000 4,642,000 3,882,000
Realized Investment Gains 228,000 32,000 885,000 105,000
Other 222,000 218,000 810,000 926,000
---------------- ------------------ ----------------- ----------------
Segment Total Revenues $12,732,000 $9,928,000 $37,577,000 $28,377,000
================ ================== ================= ================
P&C INSURANCE EXPENSES:
Loss & Loss Adjustment Expense $(6,774,000) $(5,958,000) $(22,483,000) $(16,932,000)
Underwriting Expenses (3,860,000) (3,809,000) (11,969,000) (10,750,000)
---------------- ------------------ ----------------- ----------------
Segment Total Expenses $(10,634,000) $(9,767,000) $(34,452,000) $(27,682,000)
P&C INSURANCE INCOME (LOSS) BEFORE TAXES:
Sequoia Insurance Company $ 1,489,000 $ 184,000 $ 1,139,000 $ 253,000
Citation Insurance Company 609,000 ( 23,000) 1,986,000 442,000
---------------- ------------------ ----------------- ----------------
INCOME BEFORE TAXES $ 2,098,000 $ 161,000 $ 3,125,000 $ 695,000
================ ================== ================= ================
The Property and Casualty segment is comprised of Sequoia Insurance Company
and Citation Insurance Company, which are headquartered in Monterey, California.
Sequoia is the only one of PICO's insurance subsidiaries which is writing
new business. Traditionally, Sequoia's core business has been commercial
property and casualty insurance in California and Nevada, focusing on the niche
markets of small to medium-sized businesses and farms. In May 2000, Sequoia's
book of business in personal lines of insurance increased significantly with the
acquisition of Personal Express Insurance Services, Inc. Personal Express, which
operates in the central California cities of Bakersfield and Fresno, has a
unique business model -- writing insurance direct with the customer, but with
local offices providing local service for underwriting and claims.
In prior years, Citation wrote commercial property and casualty insurance
in California, Nevada, and Arizona. The business previously written by Citation
has been transitioned to Sequoia, and Citation is now in "run off." This means
that Citation is handling claims arising from historical business, but not
writing any new business. Although the company ceased writing business in
December 2000, Citation will earn premiums each quarter this year until the
final in-force policy expires in December 2001.
As a result of these factors, the individual results of Sequoia and
Citation cannot be directly compared to previous years.
SEGMENT WRITTEN PREMIUMS
For the first nine months of 2001, the segment generated $38.2 million of
direct written premiums, comprised of $32.2 million in commercial lines of
insurance and $6 million in personal lines. In the first nine months of 2000,
segment direct written premiums were $33.4 million, consisting of $28.9 million
in commercial lines of insurance and $4.5 million in personal lines. Most of the
14.2% total growth in direct written premiums resulted from two important
developments which occurred in the second quarter of 2000:
- the $3.3 million, or 11.2%, lift in direct written premium volume in
commercial lines principally resulted from new policies issued following
the increase in Sequoia's A.M. Best rating to "A-" (Excellent). This
enabled Sequoia to compete for business in a new segment -- customers which
only purchase coverage from insurance companies with an "A" rating; and
- the acquisition of Personal Express, which led to a 33.6%, or $1.5 million,
increase in direct written premiums in personal lines.
In the third quarter of 2001, the segment generated $14.6 million of direct
written premiums, comprised of $11.1 million in commercial lines of insurance
and $3.5 million in personal lines. In the third quarter of 2000, segment total
direct written premiums of $14.3 million consisted of $10.7 million in
commercial lines and $3.6 million in personal lines. For the quarter, direct
written premiums grew 2.5% year over year, principally due to higher average
premiums per policy in commercial lines. Volume growth was slower than for the
first six months of 2001, for two principal reasons:
- the "A" rating and Personal Express acquisition have been in effect for the
third quarter of both years, resulting in a higher premium base in the
previous year; and
- during 2000, Sequoia's loss ratio, and consequently underwriting results,
deteriorated because growth in claims costs had outpaced growth in
effective premium rates in recent years. In 2001, Sequoia introduced a
number of initiatives to improve its
20
loss ratio, for example, ceasing to provide coverage for certain types of
business and increasing rates for commercial automobile coverage. Rate
increases are also planned in other lines of business. While these
initiatives have led to an increase in average premiums per policy, the
effect on premiums generated has been partially offset by some loss of
business. On an annualized basis, average direct written premiums per
policy in commercial lines are up an estimated 10.3% from 2000, but the
number of commercial policies written is approximately 1.9% lower. Despite
the decline in the policy count, the overall effect on profitability is
expected to be positive. Due to the lag between a policy being "written"
and the premium being "earned" (i.e., recorded as revenue over the life of
the policy), the full effect of these initiatives will not be reflected in
Sequoia's reported segment results until 2002.
SEGMENT RESULTS
In the first nine months of 2001, segment total revenues of $37.6 million
included earned insurance premiums of $31.2 million, $4.6 million in investment
income (i.e., interest and dividend income), and $885,000 in realized gains from
the sale of investments. Segment income before taxes for the first nine months
of 2001 was $3.1 million, consisting of income of $1.1 million from Sequoia and
$2 million from Citation.
In the first nine months of 2000, the segment generated total revenues of
$28.4 million, earned premiums of $23.5 million, investment income of $3.9
million, and realized gains of $105,000. Segment income before taxes was
$695,000, comprised of profits of $253,000 from Sequoia and $442,000 from
Citation.
Most of the $9.2 million increase in segment revenues in the nine-month
period was due to a $7.7 million, or 33.1%, increase in net earned premiums. Due
to the lag between a policy being "written" and the premium being "earned" as
revenue, the growth in earned premiums in the first nine months of 2001 reflects
the higher volume of business written in the last three quarters of 2000 and the
first half of 2001.
In addition, segment investment income increased by $760,000, or 19.6%,
year over year. This primarily reflected a higher average income yield on the
portfolio due to a refocusing of the fixed-income component on to high-grade
corporate bonds and, to a lesser extent, an increase in invested assets
resulting from the growth in Sequoia's written premium. In addition, gains of
$885,000 were realized from the sale of bonds and stocks held in the insurance
company investment portfolios. Most of the gains resulted from the sale of bonds
with less than 3 years to maturity, which released funds for reinvestment in
longer dated bonds at higher yields to maturity. The amount of realized gains
varies from quarter to quarter and has no predictive value.
For the third quarter of 2001, segment total revenues of $12.7 million
included $10.7 million in earned premiums, $1.6 million of investment income,
and realized gains of $228,000. Segment income for the quarter was $2.1 million,
consisting of income of $1.5 million from Sequoia and $609,000 from Citation.
In the third quarter of 2000, segment total revenues were $9.9 million,
primarily represented by earned premiums of $8.3 million and investment income
of $1.4 million. In the third quarter, which includes the summer months, the
Property and Casualty Insurance segment typically generates an underwriting
profit. However, in 2000 segment income was just $161,000, principally due to
unusually high claims costs which limited Sequoia's contribution to just
$184,000. In addition, Citation incurred a $23,000 loss.
SEQUOIA INSURANCE COMPANY
In the third quarter of 2001, Sequoia generated total revenues of $11.9
million, including $10.6 million in earned premiums, $976,000 in investment
income, and $228,000 in realized gains. The earned premiums were comprised of
$8.6 million in commercial lines and almost $2 million in personal lines. Due to
the growth in the commercial insurance book of business and the Personal Express
acquisition, earned premiums increased by $2.3 million, or 28.3%, year on year,
with the growth being split roughly equally between commercial and personal
lines.
In the third quarter of 2001, Sequoia generated an operating profit (i.e.,
income before investment income, realized gains, and taxes) of $285,000. This
was a marked improvement on recent quarters, when operating losses have been
incurred, primarily due to losses for current year claims being above
expectation because premium rates had not kept up with the rate of increase in
claims costs, such as construction, medical care, and automobile repair. In
addition, Sequoia recorded approximately $328,000 of favorable development in
prior year loss reserves during the third quarter.
For the first nine months of 2001, Sequoia generated total revenues of
$35.1 million, including $31 million in earned premiums. Sequoia incurred an
operating loss, as defined in the previous paragraph, of $2.5 million for the
nine months. This was due to seasonal factors, because the nine months includes
the winter months when an underwriting loss is not unusual, and
higher-than-
21
expected costs for current year claims. After including $2.8 million
in investment income and $871,000 in realized gains, Sequoia contributed $1.1
million to segment income for the nine months. Reserve development was
immaterial over the nine months, with an expense of $11,000 being recorded.
As explained earlier in this section, Sequoia's results are not directly
comparable year over year.
In the third quarter of 2000, Sequoia generated total revenues of $9.2
million, including $8.3 million in earned premiums and $773,000 in investment
income, and a pre-tax profit of $184,000.
In the first nine months of 2000, Sequoia generated total revenues of $25.5
million, including $23.1 million in earned premiums and $1.9 million in
investment income, and contributed $253,000 to segment income.
The operating performance of insurance companies is frequently analyzed
using their "combined ratio." A combined ratio below 100% indicates that the
insurance company made a profit on its base insurance business, prior to
investment income, realized investment gains or losses, extraordinary items,
taxes, and other non-insurance items. Sequoia aims to have a combined ratio of
less than 100% each year.
Sequoia's combined ratio, determined on the basis of GAAP, for the third
quarter and first nine months of 2001 and 2000 was:
SEQUOIA'S GAAP INDUSTRY RATIOS
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2000 2001 2000
Loss and Loss Adjustment Expense Ratio 62.6% 65.5% 71.6% 67.0%
Underwriting Expense Ratio 35.3% 42.9% 37.7% 42.4%
------------------ ---------------- -------------------- -----------------
Combined Ratio 97.9% 108.4% 109.3% 109.4%
================== ================ ==================== =================
The loss and loss adjustment expense ratio -- i.e., claims costs as a
percentage of premium revenues -- for the third quarter of 2001 (62.6%) showed
considerable improvement from the first six months of 2001 (76.2%) and the third
quarter of 2000 (65.5%). This was due to the initial effects of the tighter
underwriting standards, the favorable reserve development recorded during the
quarter, and seasonal factors discussed in preceding paragraphs.
The third quarter's underwriting expense ratio (35.3%) also reflected
improvement from the first six months of 2001 (39.0%) and the third quarter of
last year (42.9%). This is due to fixed costs being spread over a greater base
of premium, and due to a greater percentage of Personal Express business in the
premium mix, which does not carry a commission expense.
CITATION INSURANCE COMPANY
Citation generated $839,000 of revenues in the third quarter of 2001,
including $642,000 in investment income and earned premium of $41,000 from the
few remaining policies. Citation contributed $609,000 to segment income for the
quarter.
For the first nine months of 2001, Citation's $2.5 million in total
revenues included $1.9 million in investment income and earned premium of
$220,000. Citation's contribution to segment income was almost $2 million for
the nine months.
During 2000, when the company was still writing business, Citation
generated revenues of $2.8 million and a pre-tax profit of $442,000 in the nine
months, and revenues of $774,000 and a segment loss of $23,000 in the third
quarter.
As of September 30, 2001, the "run off" of Citation's loss reserves appears
to be proceeding in line with expectation. Only immaterial amounts of adverse
reserve development have been recorded year to date, being $32,000 in the third
quarter and $44,000 in the nine months. So far in 2001, given that Citation has
minimal underwriting and overhead expenses, and that very little development in
prior year loss reserves has been recorded, a significant proportion of the
company's investment income has translated into pre-tax profit. As Citation
continues to pay down its loss reserves during run off, the company's portfolio
will shrink as the proceeds of maturing investments go to pay claims.
Accordingly, it is anticipated that investment income and the contribution to
segment income from Citation will decrease over time.
Since Citation is in "run off," its combined ratio is not meaningful.
22
RESERVES
At September 30, 2001, our property and casualty insurance loss reserves
were $41.5 million, net of reinsurance, compared to $42.2 million at June 30,
2001, and $42.5 million at December 31, 2000.
PROPERTY AND CASUALTY INSURANCE - LOSS AND LOSS EXPENSE RESERVES
SEPTEMBER 30, 2001 JUNE 30, 2001 DECEMBER 31, 2000
------------------------ ---------------------- -----------------------------
SEQUOIA INSURANCE COMPANY:
Direct Reserves $38.6 million $ 39.5 million $ 37.2 million
Ceded Reserves (17.5) (18.3) (18.1)
------------------------ ---------------------- -----------------------------
Net Reserves $21.1 million $ 21.2 million $ 19.1 million
======================== ====================== =============================
CITATION INSURANCE COMPANY:
Direct Reserves $21.7 million $ 22.5 million $ 25.8 million
Ceded Reserves ( 1.3) (1.5) (2.4)
------------------------ ---------------------- -----------------------------
Net Reserves $20.4 million $ 21.0 million $ 23.4 million
======================== ====================== =============================
MEDICAL PROFESSIONAL LIABILITY INSURANCE
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2000 2001 2000
----------------- ------------------ ----------------- ----------------
MPL REVENUES:
Net Investment Income $282,000 $509,000 $ 941,000 $1,520,000
Realized Investment Gain (Loss) 19,000 (4,058,000)
================= ================== ================= ================
Segment Total Revenues $301,000 $509,000 $(3,117,000) $1,520,000
================= ================== ================= ================
MPL EXPENSES:
Underwriting Expenses $(142,000) $(402,000) $ (493,000) $(862,000)
----------------- ------------------ ----------------- ----------------
Segment Total Expenses $(142,000) $(402,000) $ (493,000) $(862,000)
================= ================== ================= ================
INCOME (LOSS) BEFORE TAX $159,000 $107,000 $(3,610,000) $658,000
================= ================== ================= ================
Until 1995, Physicians Insurance Company of Ohio and The Professionals
Insurance Company wrote medical professional liability insurance, mostly in the
state of Ohio. Both companies are now in "run off," so this segment's revenues
come entirely from investment income and gains or losses from the realization of
investments. The level of investment assets and loss reserve liabilities in the
segment are decreasing as claims are paid, and investments are sold when funds
are needed to make the payments. Accordingly, it is anticipated that the
investment income in this segment will decline over time.
In the third quarter of 2001, the segment generated revenues of $301,000,
consisting of net investment income of $282,000 and $19,000 in realized gains
from the sale of bonds. After operating expenses of $142,000, the segment
produced pre-tax income of $159,000.
For the first nine months of 2001, segment revenues were negative $3.1
million, comprised of $941,000 in net investment income and net realized
investment losses of $4.1 million. Following operating expenses of $493,000, the
segment incurred a pre-tax loss of $3.6 million. Excluding the net realized
investment loss, the segment would have reported income of $448,000.
The net investment loss was realized on the redemption of our entire
holding in the Rydex URSA Fund, a mutual fund which was held in the investment
portfolio of Physicians Insurance Company of Ohio. This mutual fund is designed
to deliver a return which is the inverse of the return on the S&P 500 Index, and
was acquired in 1995 when Physicians had greater exposure to listed stocks. The
sharp decline in the S&P 500 Index during the first 4 months of 2001 led to a
corresponding increase in the value of the Rydex URSA Fund. During the first and
the second quarters of 2001, we redeemed the investment for a total realized
loss of $4.1 million (before taxes). When the loss was realized, there was only
a minor effect on book value because the unrealized depreciation, after the
related tax benefit, was already reflected in shareholders' equity.
In the third quarter of 2000, net investment income was $509,000, operating
expenses were $402,000, and segment income was $107,000. In the first nine
months of 2000, the segment recorded net investment income of $1.5 million,
operating expenses of
23
$862,000, and income before taxes of $658,000. The segment results for the third
quarter and first nine months of 2000 have been restated to reflect a change in
accounting principle, which eliminated the discounting of loss reserves and the
related reserve discount accretion expense with effect from January 1, 2000.
At September 30, 2001, our medical professional liability loss reserves
were $47.1 million, net of reinsurance, compared to $48.3 million at June 30,
2001, and $51.6 million at December 31, 2000. Therefore, over the first nine
months of 2001, our medical professional liability reserves have declined by
approximately 8.7%. Although the September 30, 2001 complete actuarial analysis
of our medical professional liability reserves is not yet complete, we currently
believe that the "run off" is proceeding in line with -- and possibly slightly
better than -- actuarial projections.
MEDICAL PROFESSIONAL LIABILITY INSURANCE - LOSS AND LOSS EXPENSE RESERVES
SEPTEMBER 30, 2001 JUNE 30, 2001 DECEMBER 31, 2000
------------------------ ---------------------- -----------------------------
Direct Reserves $53.2 million $55.2 million $58.6 million
Ceded Reserves (6.1) (6.9) (7.0)
------------------------ ---------------------- -----------------------------
Net Medical Professional Liability Reserves $47.1 million $48.3 million $51.6 million
======================== ====================== =============================
LONG TERM HOLDINGS
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------- ------------------------------------------
2001 2000 2001 2000
-------------- -------------------- --------------------- --------------------
LONG TERM HOLDINGS REVENUES:
Realized Investment Losses $ (7,120,000) $ (500,000) $ (7,693,000)
Investment Income $ 333,000 673,000 1,572,000 672,000
SFAS 133 Change in Warrants (3,170,000) (1,533,000)
Other 59,000 (596,000) 349,000 (221,000)
-------------- -------------------- --------------------- --------------------
Segment Total Revenues $ (2,778,000) $ (7,043,000) $ (112,000) $ (7,242,000)
============== ==================== ===================== ====================
SEGMENT TOTAL EXPENSES (526,000) (2,071,000) (7,941,000) (7,741,000)
-------------- -------------------- --------------------- --------------------
LOSS BEFORE INVESTEE INCOME $ (3,304,000) $ (9,114,000) $(8,053,000) $(14,983,000)
-------------- -------------------- --------------------- --------------------
EQUITY SHARE OF INVESTEES' NET INCOME (1,177,000) 1,837,000 (1,021,000) 2,220,000
-------------- -------------------- --------------------- --------------------
LOSS BEFORE TAXES $ (4,481,000) $ (7,277,000) $(9,074,000) $(12,763,000)
============== ==================== ===================== ====================
This segment contains our long term investments in public companies,
subsidiaries, and other assets which individually are too small to constitute a
segment, and parent (i.e., holding) company assets. Revenues and results in this
segment vary considerably from quarter to quarter, primarily due to fluctuations
in net realized gains or losses on the sale of investments. PICO does not sell
investments on a regular basis, but when the price of an individual security has
significantly exceeded our target, or if there have been changes which we
believe limit further appreciation potential on a risk-adjusted basis.
Consequently, the amount of net realized gains or losses recognized during any
accounting period has no predictive value.
Our largest long term holdings are HyperFeed Technologies, Inc.,
Jungfraubahn Holding AG, and Australian Oil & Gas Corporation Limited. The
details of our investment in each company at the end of the quarter were:
--------------------------------------- -------------------- --------------- -------------------- ------------------- -------------
SEPTEMBER 30, 2001 CARRYING VALUE ACCOUNTING METHOD SHARE EQUIVALENTS MARKET PRICE
CARRYING VALUE BEFORE TAXES:
HyperFeed Technologies, Inc. Common $ 2,407,000 Equity method 10,077,856 $1.02
Warrants 1,257,000 Fair value 4,055,195
--------------- -------------------
Total $3,664,000 14,133,051
Jungfraubahn Holding AG 17,111,000 Market value 112,672 $151.86
Australian Oil & Gas Corporation 6,034,000 Market value 9,450,000 $0.64
Limited
---------------
Total carrying value before taxes $26,809,000
Deferred taxes 776,000
---------------
CARRYING VALUE, NET OF TAXES $27,585,000
--------------------------------------- -------------------- --------------- -------------------- ------------------- -------------
24
At September 30, 2001, these three long term holdings had a potential
market value (before taxes) of approximately $34.7 million, and a carrying value
(before taxes) of $26.8 million. After allowing for related tax assets, the
tax-effected carrying value of the holdings was $27.6 million, or 13.9% of
PICO's shareholders' equity.
HYPERFEED TECHNOLOGIES, INC.
During September 2001, the principal and accrued dividends on the HyperFeed
Series A and Series B preferred stock held by PICO and its subsidiaries were
converted into HyperFeed common shares at a conversion price of $1.03 per share.
PICO received 7,462,856 common shares on conversion, increasing our voting
ownership of HyperFeed from approximately 35% to approximately 42.4%.
At September 30, 2001, PICO held the following securities in HyperFeed:
- 10,077,856 common shares, which had a carrying value of $2.4 million
(before taxes), compared to a potential market value of $10.3 million
(before taxes) based on the official closing price of $1.02 on September
28, 2001; and
- warrants to buy 4,055,195 shares. The exercise price for the warrants to
buy 3,106,163 shares is fixed at $1.575 per share. However, the warrants to
buy 949,032 shares are exercisable at the lesser of the stated exercise
price, which averages approximately $1.844, or the then market price of the
common stock. At September 30, 2001, the warrants were carried at estimated
fair value of $1.3 million (before taxes).
On October 29, 2001, HyperFeed reported a net loss of $1.7 million for the
third quarter, and a net loss of $2.1 million for the first nine months of 2001.
In both periods the net loss includes a $927,000 non-cash charge to recognize
the accrued unpaid dividends on the Series A and Series B preferred stock which
PICO converted to HyperFeed common shares during the third quarter.
In the third quarter of 2001, compared to the preceding second quarter,
HyperFeed's revenues declined by $1.1 million, or 11.7%. Revenues from the
HyperFeed institutional business declined by 6.1% sequentially; however,
revenues from the PCQuote business, which is oriented to individual investors,
declined by 24.9%. The HyperFeed business contributed a gross margin of $2.6
million for the quarter, compared to $174,000 for the PCQuote business. Although
total gross margin declined by $738,000 (or 20.9%) sequentially, HyperFeed was
able to reduce operating expenses by $1 million (or 22.0%). This resulted in a
$256,000 narrower net loss of $766,000 before preferred dividends for the
quarter.
In the accompanying news release, Jim Porter, Chairman and CEO of
HyperFeed, explained that the PCQuote business had been "a strain" on the
quarter's results, and that a restructuring had been implemented "to bring the
costs associated with this business in line with the declining revenue base."
HyperFeed estimated that "the resulting savings from the restructuring will be
around $300,000 per month beginning in the fourth quarter of this year." At
September 30, 2001, HyperFeed had cash and cash equivalents of $744,000.
JUNGFRAUBAHN HOLDING AG
On May 21, 2001, when Jungfraubahn announced its annual results, 2000 was
described as an exceptional year, whose results "will not be easily repeated."
In particular, passenger numbers and revenues benefited from a 100-year
anniversary promotion by a bank, Raiffeisen.
On August 31, 2001, Jungfraubahn announced its results for the first six
months of 2001. Revenues declined by 5.4 million Swiss Francs (i.e., CHF), or
10.6%, year over year to CHF45.7 million, principally due to the absence of
revenues from the Raiffeisen campaign. Due to the CHF5.4 million reduction in
revenue and a CHF2.1 million increase in operating expenses, EBITDA declined
CHF7.5 million to CHF10.3 million, and net income dropped CHF7.6 million to
CHF3.3 million, or CHF5.6 per share. In addition, the sale of art contributed an
extraordinary profit of CHF1.4 million. Jungfraubahn did not publish a half-year
balance sheet, but at December 31, 2000, book value per share was CHF485. On
September 30, 2001, Jungfraubahn's stock price was CHF245, and CHF1 equaled
$US0.6198.
During 2000, we began to use the equity method to account for our
investment in Jungfraubahn Holding AG, given that we owned approximately 19.3%
of the company, that we had a representative on the board of directors, and that
we received the necessary quarterly financial information in a timely manner.
After we adopted the equity method, we included our proportionate share of
Jungfraubahn's net income in the line "Equity Share of Investees' Net Income" in
our income statement, and the investment was carried in our balance sheet at our
proportionate share of Jungfraubahn's net assets.
However, based on our inability to obtain financial information for the
second quarter of 2001, and the absence of a commitment to provide quarterly
financial statements on an on-going basis, we believe that we do not have the
requisite "significant influence"
25
for the equity method to be applied. Accordingly, we ceased to account for the
investment under the equity method from the start of the second quarter (i.e.,
from April 1, 2001), and reverted to market value accounting under Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The impact of this change on our financial
statements is:
- in our income statement for the first nine months of 2001, we recorded a
$667,000 dividend received from Jungfraubahn in investment income during
the second quarter, and $241,000 of income in the line "Equity Share of
Investees' Net Income" for the first quarter when the equity method was
applied. No income related to Jungfraubahn was recorded during the third
quarter; and
- in the balance sheet, from April 1, 2001 we began to record the investment
at market value. This was approximately $6 million less than our previous
carrying value because the share price of Jungfraubahn is less than that
company's book value per share (i.e., net assets). This caused a reduction
in shareholders' equity of approximately $6 million, or $0.48 per PICO
share. This is a change in accounting treatment only, and does not reflect
any change in the potential value of our investment in Jungfraubahn.
OTHER LONG TERM HOLDINGS
On September 30, 2001, PICO held 9,450,000 shares in Australian Oil & Gas
Corporation Limited, equivalent to 19.9% of the company. Under Australian
securities laws, unless we make a tender offer for the whole company, PICO can
only increase its shareholding in AOG by purchasing a maximum of 3% of the
company every six months, and through participation in AOG's dividend
reinvestment plan. On September 24, 2001, our Chairman, Ron Langley, joined
AOG's Board of Directors. Given our percentage ownership and Board
representation, we are in the process of determining whether we have the ability
to exercise "significant influence" over AOG, as defined for equity accounting
purposes. We have contacted AOG and requested an on-going commitment to provide
timely quarterly financial statements, so that the equity method could
potentially be applied to our investment in AOG. Currently AOG provides its
shareholders with half-yearly financial information in accordance with the
requirements of the Australian Stock Exchange.
On September 5, 2001, AOG announced that it had returned to profit in the
financial year to June 30, 2001. AOG's revenues increased 86.1% to $A130.1
million ($A1 = $US0.4912), and the company reported net income of $A8 million,
or $A0.17 per share. Rig utilization improved during the year, from an average
of 54% in the first half to 65% in the second half. The increase in utilization
during the year appears to have translated into profit growth, with net income
for the second half estimated at $5 million, compared to $3 million in the first
half. In the letter accompanying the results, AOG indicated that rig utilization
was "running at over 75%" and that "barring unforeseen events inherent in the
contracting industry, profitability should be maintained or increased."
During the second quarter, we participated in a restructuring and capital
raising by Sihl, a Swiss public company. Sihl's core business is digital
imaging, but the company has surplus property assets in and around Zurich. We
own 150,000 shares in Sihl, or 9.9% of the company, with a carrying value of
approximately $3.1 million (before taxes) at September 30, 2001.
THIRD QUARTER SEGMENT RESULTS
The introduction of SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," has added to the volatility in our reported results.
Under SFAS 133, the change in estimated fair value (before taxes) of derivative
instruments during an accounting period is recognized through the income
statement for that period. In the case of PICO, SFAS 133 applies to our
investment in warrants to buy shares in other companies, principally HyperFeed
Technologies, Inc.
In the third quarter of 2001, revenues of negative $2.8 million were
recorded in the Long Term Holdings segment. Revenues were reduced by a $3.2
million SFAS 133 loss due to an unrealized reduction in the estimated fair value
of warrants we own, primarily to buy shares in HyperFeed, during the third
quarter. At June 30, 2001, when the price of HyperFeed common stock was $2.12,
the estimated fair value of the warrants was $4.5 million. At September 30,
2001, when the price of HyperFeed common stock was $1.02, the estimated fair
value of the warrants was $1.3 million. Segment revenues for the quarter also
included investment income of $333,000, and other revenues of $59,000.
Segment total expenses of $526,000 were recorded for the third quarter of
2001. Parent company overhead of $1.1 million and other segment expenses were
partially offset by a $1.1 million accounting gain resulting from the effect of
appreciation in the Swiss Franc on an inter-company loan during the quarter.
Most of our investments 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 the third quarter of 2001, the Swiss Franc rose sharply
relative to the US dollar, more than recovering the decline
26
experienced during the first six months of the year. Since we do not consider
the inter-company loan to be permanent, under GAAP, when the Swiss Franc
declines, we are required to record a charge through the income statement to
reflect the fact that Global Equity SA owes PICO fewer US dollars. Conversely,
if the Swiss Franc appreciates, we are required to record a gain since Global
Equity SA owes PICO more US dollars. However, under GAAP, the equivalent debit
or credit in the financial statements of Global Equity SA (since it owes PICO
fewer or more US dollars) is included in shareholders' equity on the translation
of its assets and liabilities into US dollars, and does not go through the
income statement. Accordingly, PICO was required to record gains of $1.1 million
in the third quarter and $22,000 for the nine months, although these were offset
by equivalent decreases in the foreign currency translation component of
shareholders' equity. Consequently, the currency effect on the inter-company
loan has no net impact on book value.
After recording a $1.2 million loss, representing our share of the net
losses of investments which we account for under the equity method (primarily
HyperFeed), the segment recorded a pre-tax loss of $4.5 million for the third
quarter of 2001.
In the third quarter of 2000, segment revenues were negative $7 million.
Realized investment losses of $7.1 million were recognized, principally due to a
$4.6 million loss on the sale of Conex Continental, Inc. and a $2.5 million
provision against a loan to MKG Enterprises Corp. The segment also recorded
investment income of $673,000 and other revenues of negative $596,000. After
expenses of $2.1 million and equity income of $1.8 million (principally from
Jungfraubahn), the segment incurred a loss before taxes of $7.3 million. The
segment loss includes an $890,000 operating loss from Conex prior to its sale.
NINE MONTH SEGMENT RESULTS
For the first nine months of 2001, segment revenues were negative $112,000.
Revenues were reduced by a $1.5 million SFAS 133 decrease in the value of
warrants during the nine months, and a $500,000 provision for loss on MKG, which
were partially offset by investment income of $1.6 million and other revenues of
$349,000. After expenses of $7.9 million and our $1 million proportionate share
of the net losses for companies we account for under the equity method
(principally HyperFeed), the segment incurred a pre-tax loss of $9.1 million.
Segment expenses include a $2.3 million provision against the principal and
accrued interest on the loans receivable from Dominion Capital Pty. Limited, and
parent company overhead of $3.6 million for the nine months.
As disclosed in the Long Term Holdings section of Item 7 in our 2000 Form
10-K, PICO had made short term advances of $2.2 million to Dominion Capital Pty.
Limited, an Australian company. The advances consisted of two loans, which were
due to be repaid in 2001. A loan for $1.2 million became past due in May 2001,
and the other loan of $1 million became past due in September 2001. The assets
collateralizing the loans include real estate in Australia. We have instituted
legal proceedings in Australia to realize on the collateral and to obtain
additional legal remedies, if required. Given that both loans are past due, and
given the delays and uncertainties inherent in the legal process and realizing
on the collateral, we have fully provided against the principal and accrued
interest on both loans, which totals $2.3 million.
In the first nine months of 2000, revenues of negative $7.2 million were
recorded in the segment. This was primarily due to realized investment losses of
$7.7 million, consisting of a $4.6 million loss on the sale of Conex, a $2.5
million provision against MKG Enterprises Corp., and a $562,000 realized loss on
the sale of existing shares in Vidler to satisfy option obligations. Investment
income of $672,000 more than offset other revenues of negative $221,000.
Following expenses of $7.7 million and equity income of $2.2 million
(principally from Jungfraubahn), the segment incurred a $12.8 million pre-tax
loss. The segment loss for the nine months includes a $2.1 million operating
loss from Conex prior to its sale.
LIQUIDITY AND CAPITAL RESOURCES -- THREE AND NINE MONTHS ENDED SEPTEMBER 30,
2001 AND 2000
PICO Holdings, Inc. is a diversified holding company. Our assets primarily
consist of investments in our operating subsidiaries, investments in other
public companies, and cash and cash equivalents. On a consolidated basis, the
Company had $14.3 million in cash and cash equivalents at September 30, 2001,
compared to $13.6 million at December 31, 2000.
Our cash flow position fluctuates depending on the requirements of our
operating subsidiaries for capital, and activity in our investment portfolios.
Our primary sources of funds include cash balances, cash flow from operations,
the sale of investments, and -- potentially -- the proceeds of borrowings or
equity offerings. We endeavor to ensure that funds are always available to take
advantage of new investment opportunities.
27
In broad terms, the cash flow profile of our principal operating
subsidiaries is:
- Nevada Land & Resource Company, LLC is actively selling land which has
reached its highest and best use, and is not part of PICO's long-term
utilization plan for the property. Nevada Land's principal sources of cash
flow are the proceeds of cash sales, and collections of principal and
interest on sales contracts where Nevada Land has provided vendor
financing. Since these receipts and other revenues exceed Nevada Land's
operating costs, Nevada Land is generating strong positive cash flow which
provides funds to finance other group activities;
- During the company's investment and development phase, Vidler Water
Company, Inc. utilized cash to purchase properties with significant water
rights, to construct improvements at the Vidler Arizona Recharge Facility,
to maintain and develop existing assets, to pursue applications for water
rights, and to meet financing and operating expenses. During this period,
other group companies provided financing to meet Vidler's on-going expenses
and to fund capital expenditure and the purchase of additional
water-righted properties.
Vidler's water-related assets began to generate significant cash flow in
the first quarter of 2001. As commercial use of these assets increases, we
expect that Vidler will start to generate free cash flow as income from
leasing water or storage and the proceeds from selling land and water
rights begin to overtake maintenance capital expenditure, financing costs,
and operating expenses. As water lease and storage contracts are signed, we
anticipate that Vidler may be able to monetize some of the contractual
revenue streams, which could potentially provide another source of funds;
- Sequoia Insurance Company is currently generating positive cash flow from
increased written premium volume. Shortly after a policy is written, the
premium is collected and the funds can be invested for a period of time
before they are required to pay claims. Free cash flow generated by Sequoia
is being deployed in the company's investment portfolio;
- Citation Insurance Company has ceased writing business and is "running off"
its existing claims reserves. Investment income more than covers Citation's
operating expenses. Most of the funds required to pay claims are coming
from the maturity of fixed-income investments in the company's investment
portfolio and recoveries from reinsurance companies; and
- As the "run off" progresses, Physicians Insurance Company of Ohio and The
Professionals Insurance Company are obtaining funds to pay operating
expenses and claims from the maturity of fixed-income securities, the
realization of investments, and recoveries from reinsurance companies.
The Departments of Insurance in Ohio and California prescribe minimum
levels of capital and surplus for insurance companies, and set guidelines for
insurance company investments. PICO's insurance subsidiaries structure the
maturity of fixed-income securities to match the projected pattern of claims
payments; however, it is possible that fixed income and equity securities may
occasionally need to be sold at unfavorable times when the bond market and/or
the stock market are depressed.
There was a $618,000 net increase in cash and cash equivalents in the first
nine months of 2001, compared to a $996,000 net increase in the first nine
months of 2000.
During the first nine months of 2001, Operating Activities generated $1.1
million of cash. The most significant cash inflow was $9.4 million in total
receipts from the sale of water rights in the Harquahala Valley. The most
significant uses of cash were operating expenses, and claims payments by our
"run off" insurance subsidiaries.
In the first nine months of 2000, Operating Activities used cash of $11.7
million, primarily due to the purchase of Spring Valley Ranches for
approximately $4.9 million, and the payment of insurance claims by the "run off"
insurance companies and operating costs at Vidler.
In the first nine months of 2001, Investing Activities generated cash of
$455,000. The most significant cash inflow was $7.6 million from the sale of
part of our interest in Semitropic. Cash outflows included the investment of
$3.4 million in Sihl, a Swiss public company, and $817,000 to increase our
shareholding in AOG. In addition, Nevada Land and Vidler invested approximately
$8.7 million in high-grade corporate bonds with less than 1 year to maturity to
maximize the return on the proceeds of land and water rights sales.
28
Most of the remaining Investing Activities cash flow represents activity in
the investment portfolios of our insurance companies:
- Sequoia Insurance Company, which is the only insurance company writing new
business, has been realigning its bond portfolio through the purchase of
high-grade corporate bonds with 4 to 10 years to maturity, utilizing the
proceeds from the sale of bonds with lower yields to maturity; and
- the "run off" companies structure their fixed-income portfolios to match
the projected pattern of claims payouts, utilizing the proceeds of maturing
fixed-income securities, the sale of investments, investment income, and
recoveries from reinsurance companies.
In the first nine months of 2000, Investing Activities used $37.1 million
in cash. The majority of the cash outflow represented:
- activity in our insurance company investment portfolios, where the proceeds
of cash and cash equivalents and maturing fixed-income securities were
reinvested in longer-dated corporate bonds and small capitalization value
stocks;
- the investment of $6.2 million to purchase interests in Fish Springs Ranch,
LLC and V&B, LLC, which own water-righted ranch property and associated
lands in northern Nevada; and
- the acquisition of Personal Express for approximately $3 million.
Financing Activities used $816,000 of cash in the first nine months of
2001. Vidler paid off approximately $2.5 million in non-recourse borrowings
collateralized by the farm properties in the Harquahala Valley Irrigation
District which it sold to Allegheny. Global Equity SA took on an additional $2.2
million of Swiss Franc-denominated bank borrowings to help finance the
acquisition of investments in Swiss public companies, principally Sihl.
In the first nine months of 2000, there was a $49.4 million cash inflow
from Financing Activities due to the rights offering which raised $49.8 million
in new equity capital in March 2000.
At September 30, 2001, PICO had no other significant commitments for future
capital expenditures, other than in the ordinary course of business.
PICO is committed to maintaining Sequoia's capital and statutory surplus at
a minimum of $7.5 million. At September 30, 2001, Sequoia had approximately
$28.1 million in capital and statutory surplus. PICO also aims to maintain
Sequoia's A.M. Best rating at or above its present "A-" (Excellent) level. At
some time in the future, this may require the injection of additional capital.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company'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. The
Company currently has interest rate risk as it relates to its fixed maturity
securities and mortgage loans, equity price risk as it relates to its marketable
equity securities, and foreign currency risk as it relates to investments
denominated in foreign currencies. The Company's bank debt is short-term in
nature as the Company generally secures rates for periods of approximately three
to five years and therefore approximates fair value. At September 30, 2001, the
Company had $110.6 million of fixed maturity securities and mortgage loans,
$53.1 million of marketable equity securities that were subject to market risk,
and $35.1 million of investments denominated in foreign currencies, primarily
Swiss francs. The Company's investment strategy is to manage the duration of the
portfolio relative to the duration of the liabilities while managing interest
rate risk.
The Company uses two models to analyze the sensitivity of its assets and
liabilities subject to the above risks. For its fixed maturity securities, and
mortgage loans, the Company uses duration modeling to calculate changes in fair
value. For its marketable securities, the Company 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, the Company
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 a 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 $1.5 million for a 100 basis point increase in interest rates on
its fixed securities and mortgage loans. The hypothetical 20% decrease in fair
value of the Company's marketable equity securities produced a loss in fair
value of $10.1 million that would impact the unrealized appreciation in
shareholders' equity. The hypothetical 20% decrease in the local currency of the
Company's net foreign denominated investments produced a loss of $5.4 million
that would impact the unrealized appreciation and foreign currency translation
in shareholders' equity.
29
PART II: OTHER INFORMATION
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
None.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits:
See Exhibit Index.
(b) Reports on Form 8-K:
None
30
PICO HOLDINGS, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements 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.
PICO HOLDINGS, INC.
Dated: November 8, 2001 By: /s/ MAXIM C.W. WEBB
--------------------------------------------
Maxim C.W. Webb
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
31
EXHIBITS INDEX
Exhibit
Number Description
------ -----------
+ 2.2 Agreement and Plan of Reorganization, dated as of May 1,
1996, among PICO, Citation Holdings, Inc. and Physicians and
amendment thereto dated August 14, 1996 and related Merger
Agreement.
+++++ 2.3 Second Amendment to Agreement and Plan of Reorganization
dated November 12, 1996.
# 2.4 Agreement and Debenture, dated November 14, 1996 and
November 27, 1996, respectively, by and between Physicians
and HyperFeed Technologies, Inc. Purchase and Sale Agreement
by, between and among Nevada Land & Resource
# 2.5 Company, LLC, Global Equity, Western Water Company and
Western Land Joint Venture dated April 9, 1997.
+++++3.1 Amended and Restated Articles of Incorporation of PICO.
+ 3.2.2 Amended and Restated By-laws of PICO.
-10.55 Consulting Agreements, effective January 1, 1997, regarding
retention of Ronald Langley and John R. Hart as consultants
by Physicians and Global Equity.
++ 10.57 PICO 1995 Stock Option Plan
-+++ 10.58 Key Employee Severance Agreement and Amendment No. 1
thereto, each made as of November 1, 1992, between PICO and
Richard H. Sharpe and Schedule A identifying other
substantially identical Key Employee Severance Agreements
between PICO and certain of the executive officers of PICO.
+++ 10.59 Agreement for Purchase and Sale of Shares, dated May 9,
1996, among Physicians, Guinness Peat Group plc and Global
Equity.
++ 10.60 Agreement for the Purchase and Sale of Certain Assets,
dated July 14, 1995 between Physicians, PRO and Mutual
Assurance, Inc.
++ 10.61 Stock Purchase Agreement dated March 7, 1995 between
Sydney Reinsurance Corporation and Physicians.
++++ 10.63 Amendment No. 1 to Agreement for Purchase and Sale of
Certain Assets, dated July 30, 1996 between Physicians, PRO
and Mutual Assurance, Inc.
## 18. Letter from Deloitte and Touche LLP regarding change in
accounting principle.
# 21. Subsidiaries of PICO.
### 28. Form S-8, Registration Statement under the Securities Act
of 1933, for the PICO Holdings, Inc. Employees 401(k)
Retirement Plan and Trust, Registration No. 333-36881.
#### 29. Form S-8, Registration Statement under the Securities Act
of 1933, for the Physicians Insurance Company of Ohio 1995
Non-Qualified Stock Option Plan and assumed by PICO
Holdings, Inc., Registration No. 333-32045.
--------------------------------------------------------------
+ Filed as Appendix to the prospectus in Part I of
Registration Statement on Form S-4
(File No. 333-06671)
++ Incorporated by reference to exhibit filed with
Physicians' Registration Statement No. 33-99352 on
Form S-1 filed with the SEC on November 14, 1995.
+++ Incorporated by reference to exhibit filed with
Registration Statement on Form S-4
(File no. 333-06671).
++++ Incorporated by reference to exhibit filed with
Amendment No. 1 to Registration Statement No.
333-06671 on Form S-4.
+++++ Incorporated by reference to exhibit of same number
filed with Form 8-K dated December 4, 1996.
32
- Executive Compensation Plans and Agreements.
# Incorporated by reference to exhibit of same number
filed with Form 10-K dated April 15, 1997.
## Incorporated by reference to exhibit of same number
filed with Form10-K dated March 29, 2001.
### Incorporated by reference to Form S-8 filed with the
Securities and Exchange Commission (File No. 333-36881).
#### Incorporated by reference to Form S-8 filed with the
Securities and Exchange Commission (File No. 333-32045).
33