Note: Prior year book value per share values have been adjusted to reflect the 1-for-5 Reverse Stock Split effective December 16, 1998 and the November 20, 1996 reverse merger of Physicians Insurance Company of Ohio and Citation Insurance Group. Book value per share is computed by dividing shareholders' equity by the net of total shares issued less shares held as treasury shares.
The activities and assets of PICO Holdings, Inc. today are quite different to those of Citation Insurance Group prior to its reverse merger with Physicians Insurance of Ohio, Inc. on November 20, 1996.
In 1999 Nevada Land & Resource Company, LLC recorded $5.4 million of revenue from selling approximately 48,715 acres of land. This represents an average price of $111.51 per acre, and compares to our average acquisition cost of $34.92 per acre for the land component of Nevada Land. Also during 1999, we sold non-strategic water rights for approximately $379,000.
This is the highest level of annual land sales since we acquired Nevada Land in 1997. In previous years, we did not aggressively pursue land sales until we had a complete understanding of potential land values from the study of "highest and best use".
1. increased demand for private land by mining companies due to more restrictive use of government land; 2. increased demand from parties seeking to buy land from us to use as currency to conduct land exchanges of their own; and 3. in an effort to accelerate land exchanges, Nevada Land has recently employed 2 specialist staff who will be physically located in the Bureau of Land Management offices.
Vidler is in the process of constructing a facility to store water underground at MBT Ranch, in the Harquahala Valley, approximately 75 miles west of the Phoenix metropolitan area. The facility will be capable of storing surplus water in a large aquifer underlying much of the valley. When needed, water will be recovered from the aquifer by groundwater wells.
The MBT Ranch water storage facility is strategically located adjacent to the Central Arizona Project Canal, a conveyance canal running from Lake Havasu to Phoenix and Tucson. We believe that proximity to the CAP is a competitive advantage, because it minimizes the cost of water conveyance facilities.
On November 1, 1999, Federal interstate water banking regulations were published which will allow water from the Colorado River to be stored offstream in Arizona's Lower Basin for use in the Lower Division States, Arizona, California and Nevada. Since year-end, these regulations have also been approved by the State of Arizona.
When complete, MBT Ranch Storage will be able to provide storage to effect interstate transfers of water. MBT Ranch Storage is likely to be the first privately-owned water storage facility for the Colorado River system, which is a primary source of water for the Lower Division States. Potential users include local governments in Arizona, the Las Vegas metropolitan area, California, and the Bureau of Reclamation.
In October, 1998, construction of the pilot program was completed and recharging began on schedule. The pilot plant was constructed to determine the most cost-effective method of recharging water, and to obtain hydrogeologic data required to submit the permit for the full-scale project. To this point, only the pilot facility has been permitted and constructed, and Vidler has not attempted to store water at commercial levels.
Vidler's full-scale recharge facility is anticipated to have the capacity to recharge 100,000 acre-feet per year and to store in excess of 1 million acre-feet in the aquifer underlying Harquahala Valley. Vidler's estimate of the aquifer's storage volume was primarily based on a hydrological report prepared by an independent engineering firm for the Central Arizona Water Conservation District in 1990. The report concluded that there is storage capacity of 3.7 million acre-feet, which is in excess of the 1 million acre-feet indicated by Vidler.
Recharge/recovery capacity is significant because it indicates how fast water can be stored underground or pumped from the underground. In wet years, it is important to have a high recharge capacity so that as much available water as possible may be stored. In dry years, the critical factor is the ability to recover water as quickly as possible. There is a long history of recovering water from the aquifer for agricultural users.
In 1999, Big Springs Ranch completed a land exchange with the Bureau of Land Management which exchanged approximately 70,499 acres of ranch land for approximately 6,398 acres of developable land in and around West Wendover, Nevada.
West Wendover is a rapidly-growing city adjacent to the Nevada/Utah border in the Interstate 80 corridor. Vidler is exploring its options for the land. These may include sales or joint ventures with developers.
In October, 1999, Vidler announced a public/private joint venture with Lincoln County which had filed more than 100,000 acre-feet of water rights applications, covering substantially all of the unappropriated water in the county. The joint venture intends to supply water to rapidly-growing communities in southern Nevada. The joint venture has announced an initial agreement to supply developers in Mesquite with up to 17,000 acre-feet of water and to construct the necessary infrastructure. The developers have a minimum take-or-pay obligation for 2,000 acre-feet in 2003, rising in annual increments of 2,000 acre-feet to 10,000 acre-feet in 2007. The take-or-pay obligation is comprised of a one-time reservation fee of $1,500 per acre-foot and an ongoing annual user fee, starting at $415 per acre-foot and escalating at 5%. A take-or-pay obligation means that the developers are required to pay Vidler for the agreed amount of water each year, whether they take it or not. Nothing has been received under this agreement to date.
Vidler has filed approximately 2,000 acre-feet of water rights applications at Sandy, Nevada.
Vidler has an 18.5% interest (i.e. right to participate) in a water storage facility at Semitropic, near the California Aqueduct, northwest of Bakersfield. Currently Vidler is not storing any water at Semitropic for third parties, however it is actively pursuing a number of
potential customers. In the future, Vidler will be able to provide storage to facilitate exchanges and water transfers within California, such as the transfer of water from northern California to southern California.
- generating cash flow from the water rights in Arizona, Nevada and Colorado through pursuing lease agreements or the sale of non-strategic assets; - completing permitting and construction of the MBT Ranch Storage facility and entering into agreements to lease storage capacity to customers; - leasing storage capacity to customers at Semitropic; and - pursuing present and additional water rights applications and partnerships to commercially develop water rights.
As a result of intense competition in the California marketplace and the company's strategy of carefully selecting the business which it is prepared to underwrite, Sequoia Insurance Company has experienced declines in net written premiums in each of the past 3 years. The rate of decline began to slow in the latter part of 1999, and written premiums are up slightly in both January and February, 2000, compared to the same months in 1999. Sequoia's management believes that premium volume will stabilize at around current levels, if not increase.
Sequoia may be able to earn a higher return on capital if it were able to use its current level of surplus to write more premium volume. To achieve this, Sequoia is examining two separate opportunities to offer selected lines of personal insurance through direct channels.
In 1998 and 1999, Sequoia and Citation "pooled," or shared, most of their premiums and expenses. Subject to regulatory approval, this pooling arrangement will be terminated from January 1, 2000. Citation has ceased to write new business, apart from a minor level in the State of Arizona.
Since our initial investment in HyperFeed, the company's revenues have grown from $13.4 million in 1995 to $33.1 million in 1999. Revenues were up 44% in the 1999 year, and climbed 50% to $9.1 million in the fourth quarter. When announcing the 1999 results on March 7, 2000, HyperFeed's Chief Financial Officer, John Juska, indicated that HyperFeed expected to be "profitable in the second half" of 2000 at the net income level.
Conex's principal asset is a 60% interest in Guizhou Jonyang Machinery Industry Limited, a joint venture which manufactures wheeled and tracked hydraulic excavation equipment in the Guizhou province of the People's Republic of China. Conex accounts for this stake by the equity method so the interest in the joint venture is not consolidated into the financial statements of either Conex or PICO.
SISCOM markets its own proprietary technology to the sports and broadcast industries. HyperVideo, SISCOM's flagship product, is emerging as a critical component for content companies and organizations seeking to manage and improve the value of their digital video assets. HyperVideo captures, annotates, stores, retrieves, edits, and outputs digital video. SISCOM is actively exploring ways to leverage this technology in the broadband delivery of combined video and related information associated with the digital assets, either through the internet or set-top boxes.
In the first quarter of 2000, a private oil and gas company acquired our interest in Prospect Oil & Gas for $1 million in stock.
On February 9, 2000, we registered on Form S-3 with the U. S. Securities and Exchange Commission to offer 6,546,497 shares of PICO stock at a price of $15 per share in a rights offering. You should refer to the Form S-3 dated February 9, 2000 for full information.
We intend to use the net proceeds of the offering for developing existing water and water storage assets, acquiring additional water assets, strategic investments, and general working capital needs. Also, see Note 23 of Notes to Consolidated Financial Statements, "Subsequent Events."
Citation discontinued writing artisan/contractors insurance in 1994, prior to our merger. See "Property and Casualty Insurance" for a more detailed discussion.
PICO's ongoing operations are organized into five segments: Land, Minerals and Related Water Rights; Water Rights and Water Storage; Property and Casualty Insurance; Medical Professional Liability Insurance; and Other Strategic Holdings.
Year Ended December 31, ------------------------------------- 1999 1998 1997 ---------- ---------- --------- (in millions) Land, Minerals and Related Water Rights $ 7.1 $ 2.8 $ 2.8 Water Rights and Water Storage 1.1 0.6 0.3 Property and Casualty Insurance 40.0 42.9 57.0 Medical Professional Liability Insurance 3.1 2.4 3.9 Other Strategic Holdings 3.4 (1.3) 26.0 ---------- ---------- --------- Total Revenues-Continuing Operations $ 54.7 $ 47.4 $ 90.0 ========== ========== =========
Revenues for 1999 were $54.7 million, compared to $47.4 million in 1998 and $90 million in 1997. Excluding realized investment gains and losses, revenues increased $2.4 million over 1998, primarily due to increased land sales in our land, minerals and related water rights operations, but were $14.4 million less than in 1997. Lower property and casualty insurance earned premiums accounted for most of the decline since 1997. Property and casualty insurance premiums and a reinsurance premium reduction from medical professional liability insurance resulted in premium income for 1999 that was slightly higher than in 1998. Property and casualty insurance premium writings declined in 1998, primarily due to more stringent underwriting standards applied to Citation's property and casualty insurance business, as well as continued aggressive competition for commercial multiple peril insurance business within California.
Total expenses for 1999 were $73.9 million, compared to $58.4 million in 1998 and $64.7 million in 1997. Included in the 1999 total were loss and loss adjustment expenses of $35.2 million, compared to $30.5 million during the same 1998 period, and $34.3 million during 1997. Loss and loss adjustment expenses would have been considerably lower had it not been for the significant reserve strengthening taken in 1999 by our insurance operations, as discussed above.
Expenses: Consulting and engineering 0.3 0.1 Interest 0.7 0.2 Operations and maintenance 0.9 0.2 Salaries and benefits 1.1 0.6 0.4 Professional fees 0.6 0.7 Depreciation and amortization 0.8 0.2 0.2 Taxes, licences and fees 0.2 0.1 General, administration and other 1.1 0.5 0.3 --------- --------- --------- 5.7 2.6 0.9 LOSS BEFORE TAX: Vidler Water Company, Inc. $ (4.6) $ (2.0) $ (0.6) ========= ========= =========
Vidler is in the process of constructing a facility to store water underground at MBT Ranch, in the Harquahala Valley. The facility will be capable of storing surplus water in a large aquifer underlying much of the valley. When needed, water can be recovered from the aquifer by groundwater wells.
The MBT Ranch Water Storage facility is strategically located adjacent to the Central Arizona Project Canal, a conveyance canal running from Lake Havasu to Phoenix and Tucson. We believe that proximity to the Central Arizona Project Canal is a competitive advantage, because it minimizes the cost of water conveyance facilities. Vidler intends to charge fees for both the recharge, or inflow, and recovery, or outflow, of water. Vidler also intends to charge an annual fee based on the amount of water stored.
Interest expense in 1999 of $700,000 relates to interest owing on notes assumed to acquire lands. The 1999 amount increased $500,000 from 1998 due to the additional land acquired.
Vidler controls water rights in Nevada, Arizona and Colorado. In Nevada and Arizona, Vidler controls approximately 12,000 acre-feet and 56,000 acre-feet, respectively. There are no known legal impediments for the sale of these water rights. In addition, there are no known legal impediments pertaining to the conveyance of the Nevada water. Conveyance of the Arizona water underlying Vidler's Arizona water rights is subject to additional regulatory approval. Vidler's Colorado water rights amount to approximately 3,000 acre-feet. Sale or transfer of certain of these rights may require approval by the state water courts.
Year Ended December 31, ----------------------- 1999 1998 1997 ---- ---- ---- P & C INSURANCE REVENUES: (in millions) Earned Premiums - Sequoia $ 16.9 $ 18.1 $ 32.8 Earned Premiums - Citation 17.5 18.1 17.4 Investment Income 5.0 5.5 5.6 Realized Investment Gains (0.2) 0.2 0.2 Other 0.8 1.0 1.0 ------ ------ ------ Total P&C Revenues $ 40.0 $ 42.9 $ 57.0 ====== ====== ====== P & C INSURANCE INCOME (LOSS) BEFORE TAXES: Sequoia Insurance Company $ 2.2 $ 3.6 $ 4.3 Citation Insurance Company (5.9) (0.8) 1.3 ------ ------ ------ Total P&C Income Before Taxes $(3.7) $ 2.8 $ 5.6 ====== ====== ====== Earned premiums comprise the majority of the Property and Casualty Insurance segment revenues. Premiums are earned pro-rata throughout the year according to the coverage dates of the underlying policies. Total Property and Casualty Insurance revenues for 1999 were $40 million compared to $42.9 million in 1998 and $57.0 in 1997. Declining earned premiums accounted for most of this decrease
Property and Casualty Insurance operations produced a $3.7 million loss before federal income taxes in 1999, compared to $2.8 million in income during 1998 and $5.6 million of income in 1997. Most of these variances between years was because the 1999 loss included $10.1 million in unfavorable prior years' claims experience, primarily from Citation's prior artisan/contractor line of insurance, which was no longer offered after 1995. This was partially offset by approximately $401,000 of favorable claims experience for prior years from Sequoia. In 1999, artisan/contractors or construction defects claims continued to be reported at a higher than expected rate, resulting in the need to once again increase loss reserves. Citation's average loss ratio, or the ratio of losses and loss adjustment expenses incurred to earned premiums, for all years from 1989 to 1995 for this insurance coverage is over 375%. This experience is not unique to Citation, but appears to be problematic for all insurers who have written this type of coverage in California in the 1980's and 1990's due to a number of factors, including:
- the general decline of the California real estate market in the early 1990's which tended to encourage property owners to seek a measure of relief through the filing of claims against contractors and related parties for construction defects; and - in recent years, three California judicial decisions have added great uncertainty to the statute of limitations for construction property damage claims and the duty of an insurer to defend the policyholder against such claims.
The 1998 $2.8 million income included approximately $3.7 million in unfavorable claims experience from Citation's artisan/contractors business, partially offset by $2.1 million of Sequoia's favorable claims experience. The 1997-98 "El Nino" phenomenon is estimated to have cost an additional $1 million in the first half of 1998.
As a result of these additions to claims reserves, Citation 's combined loss, loss adjustment expense and expense ratio increased to 152.6% in 1999 compared to 126.4% in 1998 and 117.7% in 1997.
CITATION'S GAAP INDUSTRY RATIOS 1999 1998 1997 Loss and LAE Ratio 111.7% 84.9% 84.8% Underwriting Expense Ratio 40.9% 41.5% 32.9% ------ ------ ------ Combined Ratio 152.6% 126.4% 117.7% ====== ====== ======
Industry ratios as determined on the basis of generally accepted accounting principles for Sequoia are:
Loss and loss adjustment expense ratios, underwriting expense ratios and combined ratios are calculated using net earned premiums as a denominator. Theoretically, a combined ratio of less than 100% indicates that the insurance company is making a profit on its base insurance business before consideration of investment income, realized investment gains or losses, extraordinary items, taxes and other non-insurance items.
Although slightly less favorable than in 1998, Sequoia's loss experience continued to be favorable in 1999 producing a loss and loss adjustment expense ratio of 53.5% compared to 52.3% in 1998 and 57.3% in 1997. Sequoia's loss ratio has improved over 1997, despite the negative pressures of the 1997-98 El Nino effect and the reinsurance pooling agreement between Sequoia and Citation, which went into effect on January 1, 1998. Management's efforts to reduce exposure to risk through re-underwriting risks in prior years and tighter underwriting and careful selection of risks are chiefly responsible for these improvements. Sequoia's 1999 underwriting expense ratio was 46.3%, up 2.9 percentage points from 1998 and 8.2 from 1997. Expense ratios have tended to escalate as a result of the decreasing level of earned premiums. In addition, in 1999 Sequoia's pension costs were abnormally inflated by the addition of $381,000 to fund its prior defined benefit pension plan, which was frozen as of December 31, 1991. Plan funds had declined as a result of fluctuations in the market value of its underlying securities.
Property and casualty insurance acquisition expenses were $9.8 million for 1999 compared to $11.2 million in 1998 and $12.1 million in 1997. Commissions to agents were $5.6 million in 1999, $6.7 million in 1998 and $7.7 million in 1997, reflecting the declining level of direct written premiums. Other acquisition expenses were $4 million in 1999, compared to $4.5 million in 1998 and $4.4 million in 1997. Although direct written premiums written decreased by 8.7% from 1997 to 1998, other acquisition expenses increased by 2.4%, or $109,000. This increase in other acquisition expenses resulted from a 1.5% increase in other expenses of PICO's commercial property and casualty insurance companies, Sequoia and Citation. Other expenses are those expenses of the insurance companies other than premium taxes, commissions, loss adjustment expenses and non-insurance expenses. These expenses include salaries, benefits and other expenses of sales and marketing staff. Although the levels of direct written premiums and insurance underwriting expenses has decreased (principally due to realizations of synergies and reductions of overhead expenses), the level of sales and marketing expenses has not decreased correspondingly. As a result, the percentage of other expenses (principally sales and marketing) has actually increased, resulting in a greater deferral of acquisition expenses as a percentage of unearned premiums. The impact of this 1.5% increase in the other expense acquisition percentage was to increase deferred acquisition costs at December 31, 1998 by approximately $279,000. As premiums increase or sales, marketing and other acquisition expenses decrease, this percentage should decrease to or below the 1997 level.
Year Ended December 31, -------------------------------- 1999 1998 1997 ---- ---- ---- (in millions) MED PROFESSIONAL LIABILITY REVENUES (CHARGES): Earned Premiums $ 1.9 $ (0.2) $ 0.2 Investment Income, Net of Expenses 1.2 2.6 3.7 --------- --------- --------- MPL Revenues $ 3.1 $ 2.4 $ 3.9 ========= ========= =========
Medical professional liability operations produced a 1999 pre-tax loss of approximately $4.8 million compared to a $4.4 million loss in 1998 and $800,000 of income in 1997. Results for all three years were negatively impacted by additions to loss and loss adjustment expense reserves of approximately $ 5 million in 1999, $5 million in 1998 and $2.2 million in 1997. These additions to reserves during the third quarter of 1997 and the fourth quarters of 1998 and 1999 were based upon actuarial analyses indicating some deterioration of Physicians' loss experience. The addition to 1999 loss and loss adjustment expense reserves included unfavorable development in most coverage years resulting in:
- an increase in direct and assumed loss and loss adjustment expense reserves of $2 million; - a decrease in ceded reinsurance reserves of $3.6 million; and - a $560,000 increase in general reserves for the future adjustment of claims (unallocated loss adjustment expense).
These increases were partially offset by $1.2 million from the discounting of these reserve increases.
The largest of these adjustments, the $3.6 million decrease in ceded (recoverable) reinsurance reserves, primarily resulted from prior years claims which were less severe (i.e. the average claim cost), but more frequent than originally expected. The effects of the increased frequency of claims were greater than the reduction in incurred losses due to the reduction in claims severity. As a result, direct incurred losses and loss adjustment expense increased by approximately $2 million. Since claims were less severe than expected, fewer met the reinsurance retention thresholds (i.e. the deductibles) and Physicians expects to recover $3.6 million less in reinsurance than it did previously. Partially offsetting these losses, Physicians was able to recover $1.9 million in reinsurance premiums from its reinsurers due
to the reduction in ceded loss reserves. In addition to these additions to reserves, claims payments in excess of established reserves throughout 1999 and loss reserve discount accretion added $3.3 million to 1999 incurred losses and loss adjustment expenses.
The addition to 1998 reserves included additions to loss and loss adjustment expense reserves for virtually all loss years (years in which losses were incurred). These additions primarily were necessitated by an increased incidence of claims reported on behalf of claimants that allegedly were injured as minors and had attained the age of majority. No significant unusual activity was noticed in this area in 1999.
Other Strategic Holdings revenues for 1999 were $3.4 million, compared to a charge of $1.3 million in 1998 and $26 million in income in 1997. Realized investment gains were $600,000 for 1999 compared to a $4.4 million loss in 1998 and $21.3 million in gains in 1997. The 1999 realized investment gains were net of an approximate $3.2 million write-down of an oil and gas equity investment.
Revenues for 1998 included approximately $8.2 million in write-downs of equity investments, partially offset by realized investment gains from the sale of equity securities. Included in the $21.3 million of 1997 realized investment gains was approximately $27 million, before taxes, resulting from the exercise of PICO's warrants to buy common stock of Resource America Inc. and the subsequent sale of that stock.
Other Strategic Holdings produced a 1999 loss before taxes of $11.3 million, compared to an $9.2 million loss in 1998 and income of $17.4 million in 1997. Included in the 1999 loss was a $3.2 million permanent write-down of an oil and gas investment due to lower than anticipated recoverable reserves. SISCOM contributed a $700,000 loss to 1999. Conex, excluding the equity in the loss of its sino-foreign joint venture, added a loss of $600,000. Realized investment losses, as shown in the previous table, accounted for nearly $4.4 million of the 1998 amount and realized investment gains of $21.3 million were included in 1997. As shown in the table below, PICO's Other Strategic Holdings income can fluctuate greatly from year to year. A number of factors contribute to these fluctuations, including, among other things, the mix of PICO's portfolio, timing of the realization of capital gains, the volume of trading and demand for individual securities PICO owns and fluctuations in the U.S. and world stock and bond markets in general. Therefore, future results cannot and should not be predicted based upon past performance alone. See "RISK FACTORS."
Loss in investee includes PICO's share of HyperFeed Technologies, Inc. losses for all years presented, plus Conex's losses in 1998 and in 1999 prior to its consolidation on August 1, plus the equity in the loss of Conex's sino-foreign joint venture for all of 1998 and 1999. The HyperFeed loss for 1999 was $2.1 million, compared to a $751,000 loss in 1998 and income of $256,000 in 1997.
Discontinued operations consists of the operations of PICO's former life and health insurance subsidiary, American Physicians Life Insurance Company, sold in 1998, and Global Equity Corporation's former Sri Lankan subsidiaries sold in 1997, which engaged in various activities including stock and commodity brokerage and agricultural services.
Sri Lankan operations are classified as discontinued in recognition of their sale in November and December 1997. These operations produced approximately $3.3 million in pre-tax income during 1997 as recorded in Global Equity Corporation's financial results, prior to the elimination of minority interests when consolidated with PICO. This included approximately $3.5 million of realized pre-tax gain in 1997 on the sale and reversal of a foreign currency translation adjustment relating to those operations of approximately $2.3 million, prior to recognition of minority interest. See Note 6 of Notes to the Consolidated Financial Statements, "Discontinued Operations."
Net proceeds of the offering will be used for developing existing water and water storage assets, acquiring additional water assets, strategic investments, and general working capital needs. Also, see Note 23 of Notes to Consolidated Financial Statements, "Subsequent Events."
During the period from April 23, 1997 until December 31, 1999, Nevada Land sold approximately 69,531 acres of land for $8.7 million and non-essential water assets for $379,000. NRLC provides a source of cash flow to finance the other operations in the group.
Vidler's initial objective was to assemble a portfolio of water and water storage assets that would form a viable base for further expansion. The current priority is to develop recurring cash flow from the existing assets. In addition, Vidler has entered into joint ventures with parties who lack the capital or expertise to commercially develop water rights, and continues to explore additional joint venture opportunities.
Cash used in investing activities for 1999 was $17.5 million compared to cash flow provided by investing activities for 1998 of $40.8 million and $68.1 million in 1997. For 1999, purchases of available for sale investments for cash totaled $38.2 million and proceeds on sale amounted to $15.6 million. In 1998 purchases amounted to $15.6 million and proceeds on sale amounted to $24.8 million. 1998 cash investing activities included $17 million of cash received from the sale of APL, and $10.1 million receipt from the disposition of the Sri Lankan investments. In addition, in 1998 PICO sold property, generating approximately $6.5 million. In 1998 PICO used cash to pay
$1.7 million in direct costs associated with the acquisition of the remaining shares of Global Equity Corporation. In 1999 purchases of $4.6 million were made for additional land, water and mineral rights, compared to $4.1 million in 1998 and $2.3 million in 1997. The purchases were offset by sales of $4.9 million in net proceeds, of which $4.6 were from Nevada Land land and water rights sales and $300,000 from the sale of Vidler water rights. Total sales of $6.5 million included carryback financing at Nevada Land of $1.2 million. Net sales proceeds in 1998 were $518,000. The cash provided by investing activities in 1997 resulted primarily from $52 million of cash provided by net investment transactions, and $18.1 million of cash provided by consolidation of Global Equity Corporation. Specifically, significant uses of investment cash in 1997 include the purchase of Nevada Land for $48.6 million, and $36.7 million used to acquire shares of Global Equity Corporation common stock.
Of the $8.4 million net cash provided by financing activities during 1999, $5.7 million represents proceeds from bank financing for the purchase of additional Jungfraubahn shares and vendor financing amounting to $1.2 million for purchases of land in the Harquahala Valley of Arizona. Total financing to date on land purchases is $10 million. Financing activities during 1998 used cash of $1.4 million, primarily due to the purchase of PICO's own stock for $1.6 million, offset by $200,000 in proceeds received from the exercise of options on treasury shares, as discussed in Note 17 of Notes to Consolidated Financial Statements, "Related Party Transactions." During 1997, financing activities used $14.3 million primarily to repay borrowings, offset by proceeds of $2 million from the sale of Global Equity Corporation warrants.
We will continue to make selective investments, and endeavor to enhance and realize additional value to these acquired companies through our influence and control. This could involve the restructuring of the financing or management of the entities in which we invest and initiating and facilitating mergers and acquisitions. Any acquisition could result in the use of a significant portion of our available cash, significant dilution to you, and significant acquisition related charges. Acquisitions may also result in the assumption of liabilities, including liabilities that are unknown or not fully known at the time of the acquisition, which could have a material adverse effect on us.
Our ability to achieve an acceptable rate of return on any particular investment is subject to a number of factors which are beyond our control, including increased competition and loss of market share, quality of management, cyclical or uneven financial results, technological obsolescence, foreign currency risks and regulatory delays.
We generally make strategic investments and acquisitions that tend to be long term in nature. We invest in businesses that we believe to be undervalued or may benefit from additional capital, restructuring of operations or management or improved competitiveness through operational efficiencies with our existing operations. We may not be able to develop acceptable revenue streams and investment returns. We may lose part or all of our investment in these assets. The negative impacts on cash flows, income, assets and shareholders' equity may be temporary or permanent. We make investments for the purpose of enhancing and realizing additional value by means of appropriate levels of shareholder influence and control. This may involve restructuring of the financing or management of the entities in which we invest and initiating or facilitating mergers and acquisitions. These processes can consume considerable amounts of time and resources. Consequently, costs incurred as a result of these investments and acquisitions may exceed their revenues and/or increases
in their values for an extended period of time until we are able to develop the potential of these investments and acquisitions and increase the revenues, profits and/or values of these investments. Ultimately, however, we may not be able to develop the potential of these assets that we anticipated.
IF MEDICAL MALPRACTICE INSURANCE CLAIMS TURN OUT TO BE GREATER THAN THE RESERVES WE ESTABLISH TO PAY THEM, WE MAY NEED TO LIQUIDATE CERTAIN INVESTMENTS IN ORDER TO SATISFY OUR RESERVE REQUIREMENTS
Our insurance subsidiaries may not have established reserves adequate to meet the ultimate cost of losses arising from claims. It has been, and will continue to be, necessary for our insurance subsidiaries to review and make appropriate adjustments to reserves for claims and expenses for settling claims. Inadequate reserves could have a material adverse effect on our business, financial condition, results of operations and cash flows. Inadequate reserves could cause our financial condition to fluctuate from period to period and cause our financial condition to appear to be better than it actually is for periods in which insurance claims reserves are understated. In subsequent periods when we discover the underestimation and pay the additional claims, our cash needs will be greater than expected and our financial results of operations for that period will be worse than they would have been had our reserves been accurately estimated originally.
- the length of time in reporting claims; - the diversity of historical losses among claims; - the amount of historical information available during the estimation process; - the degree of impact that changing regulations and legal precedents may have on open claims; and - the consistency of reinsurance programs over time.
The cyclical trends in the industry and the industry's profitability can also be affected by volatile and unpredictable developments, including natural disasters, fluctuations in interest rates, and other changes in the investment environment which affect market prices of investments and the income generated from those investments. Inflationary pressures affect the size of losses and court decisions affect insurers' liabilities. These trends may adversely affect our business, financial condition, results of operations and cash flows by reducing revenues and profit margins, by increasing ratios of claims and expenses to premiums, and by decreasing cash receipts. Capital invested in our insurance companies may produce inferior investment returns during periods of downturns in the insurance cycle due to reduced profitability.
In the past few years, the National Association of Insurance Commissioners has developed risk-based capital measurements for both property and casualty and life and health insurers. These measurements prescribe the reserve levels that insurance companies must maintain. The Commissioners have delegated to the state regulators varying levels of authority based on the adequacy of an insurer's reserves. The insurance companies' reserve levels are reported annually in their statutory annual statements to the insurance departments.
Our insurance subsidiaries' ratings may not be maintained or increased, and a downgrade would likely adversely affect our business, financial condition, results of operations and cash flows. A.M. Best and Company's ("A.M. Best") ratings reflect the assessment of A.M. Best of an insurer's financial condition, as well as the expertise and experience of its management. Therefore, A.M. Best ratings are important to policyholders. A.M. Best ratings are subject to review and change over time. Failure to maintain or improve our A.M. Best ratings could have a material adverse effect on the ability of our insurance subsidiaries to underwrite new insurance policies, as well as potentially reduce their ability to maintain or increase market share. Management believes that many potential customers will not insure with an insurer that carries an A.M. Best rating of less than B+, and that customers who do so will demand lower rates.
- Sequoia Insurance Company B++ (Very Good) - Citation Insurance Company B+ (Very Good) - Physicians Insurance Company of Ohio NR-3 (rating procedure inapplicable) - The Professionals Insurance Company NR-3 (rating procedure inapplicable)
Insurance policy renewals have historically accounted for a significant portion of our net revenue. We may not be able to sustain historic renewal rates for our products in the future. A decrease in renewal rates would reduce our revenues. It would also decrease our cash receipts and the amount of funds available for investments and acquisitions. If we were not able to reduce overhead expenses correspondingly, this would adversely affect our business, financial condition, results of operations and cash flows.
At all times we intend to conduct our business so as to avoid being regulated as an investment company under the Investment Company Act of 1940. However, if we were required to register as an investment company, our ability to use debt would be substantially reduced, and we would be subject to significant additional disclosure obligations and restrictions on our operational activities. Because of the additional requirements imposed on an investment company with regard to the distribution of earnings, operational activities and the use of debt, in addition to increased expenditures due to additional reporting responsibilities, our cash available for investments would be reduced. The additional expenses would reduce income. These factors would adversely affect our business, financial condition, results of operations and cash flows.
The water rights held by us and the transferability of these rights to other uses and places of use are governed by the laws concerning water rights in the states of Arizona, California, Colorado and Nevada. The volumes of water actually derived from the water rights applications or permitted rights may vary considerably based upon physical availability and may be further limited by applicable legal restrictions. As a result, the amounts of acre-feet anticipated from the water rights applications or permitted rights do not in every case represent a reliable, firm annual yield of water, but in some cases describe the face amount of the water right claims or management's best estimate of such entitlement. Legal impediments exist to the sale or transfer of some of these water rights, which in turn may affect their commercial value. If we were unable to transfer or sell our water rights, we will not be able to make a profit, we will not have enough cash receipts to cover cash needs, and we may lose some or all of our value in our water rights investments.
We engage in various water rights acquisition, management, development, sale and lease activities. Accordingly, our long-term future profitability will be primarily dependent on our ability to develop and sell or lease water and water rights, and will be affected by various factors, including timing of acquisitions, transportation arrangements, and changing technology. To the extent we possess junior or conditional water rights, such rights may be subordinated to superior water right holders in periods of low flow or drought.
Our current water rights and the transferability of these rights to other uses and places of use are governed by the laws concerning water rights in the states of Arizona, California, Colorado and Nevada. The volumes of water actually derived from these rights may vary considerably based upon physical availability and may be further limited by applicable legal restrictions. Legal impediments exist to sale or transfer of some of these water rights which may affect their commercial value.
We anticipate that in the future, a significant amount of Vidler's revenues and asset value may be derived from a single asset, the MBT Ranch water storage facility. Currently, we have obtained only a pilot permit for the recharge and storage of a limited amount of water at that facility. We have not yet applied for a recovery permit and have applied for, but not yet received, a full-scale permit for that facility. There can be no assurance:
THE PRICE OF WATER IS VOLATILE, WHICH CAN HAVE A SIGNIFICANT EFFECT ON OUR COSTS OF ACQUIRING WATER AND THE PRICES AT WHICH WE ARE ABLE TO SELL WATER.
- exposure to fluctuations in exchange rates; - the imposition of governmental controls; - the need to comply with a wide variety of foreign and U.S. export laws; - political and economic instability; - trade restrictions; - changes in tariffs and taxes; - volatile interest rates;
- changes in certain commodity prices; - exchange controls which may limit our ability to withdraw money; - the greater difficulty of administering business overseas; and - general economic conditions outside the United States.
Statements or changes in opinions, ratings, or earnings estimates made by brokerage firms or industry analysts relating to the markets in which we do business or relating to us specifically could result in an immediate and adverse effect on the market price of our common stock.
We have several key executive officers. If they depart, it could have a significant adverse effect. In particular, Ronald Langley, our Chairman, and John R. Hart, our President and Chief Executive Officer, play key roles in investment decisions. Messrs. Langley and Hart have entered into employment agreements with us dated as of December 31, 1997, for a period of four years. Messrs. Langley and Hart are key to the implementation of our strategic focus, and our ability to successfully develop our current strategy is dependent upon our ability to retain the services of Messrs. Langley and Hart.
The Board of Directors has authority to issue up to 2 million shares of preferred stock and to fix the rights, preference, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders. Your rights as common stock holders will be subject to, and may be adversely affected by, the rights of the holders of the preferred stock. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock, thereby delaying, deferring or preventing a change in control of PICO. Furthermore, such preferred stock may have other rights, including economic rights senior to the common stock, and, as a result, the issuance thereof could have a material adverse effect on the market value of the common stock.
Reserves for reported claims are established on a case-by-case basis. Loss and loss adjustment expense reserves for incurred but not reported claims are estimated based on many variables including historical and statistical information, inflation, legal developments, the regulatory environment, benefit levels, economic conditions, judicial administration of claims, general trends in claim severity and frequency, medical costs and other factors which could affect the adequacy of loss reserves. Management reviews and adjusts incurred but not reported claims reserves regularly.
SEE SCHEDULE IN NOTE 13 OF NOTES TO PICO'S CONSOLIDATED FINANCIAL STATEMENTS, "RESERVES FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES" for additional information regarding reserve changes.
RECONCILIATION TO FINANCIAL STATEMENTS Gross Liability - end of year Reinsurance recoverable
On July 14, 1995, Physicians and Professionals entered into an Agreement for the Purchase and Sale of Certain Assets with Mutual Assurance Inc. This transaction was approved by Physicians' shareholders on August 25, 1995 and closed on August 28, 1995. Pursuant to the agreement, Physicians and Professionals sold their professional liability insurance business and related liability insurance business for physicians and other health care providers. Physicians and Professionals were engaged in, among other things, the business of offering medical professional liability insurance and related insurance to physicians and other health care providers principally located in Ohio.
Simultaneously with execution of the agreement, Physicians and Mutual entered into a reinsurance treaty pursuant to which Mutual agreed to assume all risks attaching after July 15, 1995 under medical professional liability insurance policies issued or renewed by Physicians on physicians, surgeons, nurses, and other health care providers, dental practitioner professional liability insurance policies including corporate and professional premises liability coverage issued by Physicians, and related commercial general liability insurance policies issued by Physicians, net of inuring reinsurance.
With regard to Sequoia, all policy and claims liabilities prior to August 1, 1995 have been 100% reinsured with Sydney Reinsurance Corporation and unconditionally guaranteed by QBE Insurance Group Limited. Sequoia, however, retains primary responsibility to its policyholders and claimants should Sydney and QBE fail. Sequoia's net retention for both property and casualty business, excluding umbrella coverage, is $150,000 per risk or occurrence. The working layers provide coverage up to $5.5 million excess of $150,000 per risk on property losses subject to occurrence limits and unlimited reinstatements. General liability coverage, excluding umbrella coverage, is provided up to $3 million excess of $150,000 per occurrence. Two excess catastrophe treaties provide additional property reinsurance up to $10 million each occurrence, excess of $500,000 each occurrence, with allowances for one full reinstatement each at pro rata pricing. Sequoia retains the first $100,000 of each umbrella loss up to $5 million. Facultative reinsurance is placed with various reinsurers.
See Note 12 of Notes to Consolidated Financial Statements, "Reinsurance" with regard to reinsurance recoverable concentration for all property and casualty lines of business, including medical professional liability, as of December 31, 1999. PICO remains contingently liable with respect to reinsurance contracts in the event that reinsurers are unable to meet their obligations under the reinsurance agreements in force.
PICO's balance sheets include a significant amount of assets and liabilities whose fair value are subject to market risk. Market risk is the risk of loss arising from adverse changes in market interest rates or prices. PICO currently has interest rate risk as it relates to its fixed maturity securities and mortgage 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. PICO's bank debt is short-term in nature as PICO generally secures rates for periods of approximately one to three years and therefore approximates fair value. At December 31, 1999, PICO had $47.3 million of fixed maturity securities and mortgage loans, $40.9 million of marketable equity securities that were subject to market risk, and $33.3 million of investments denominated in foreign currencies, primarily Swiss francs. PICO's investment strategy is to manage the duration of the portfolio relative to the duration of the liabilities while managing interest rate risk.
PICO uses two models to analyze the sensitivity of its assets and liabilities subject to the above risks. For its fixed maturity securities, and mortgage loans, PICO uses duration modeling to calculate changes in fair value. For its marketable securities PICO uses a hypothetical 20% decrease in the fair value to analyze the sensitivity of its market risk assets and liabilities. For investments denominated in foreign currencies PICO uses a hypothetical 20% decrease in the local currency of that investment. Actual results may differ from the hypothetical results assumed in this disclosure due to possible actions taken by management to mitigate adverse changes in fair value and because the fair value of 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 $502,000 for a 100 basis point decline in interest rates on its fixed securities and mortgage loans. The hypothetical 20% decrease in fair value of PICO's marketable equity securities produced a loss in fair value of $6.3 million that would impact the unrealized appreciation in shareholders' equity. The hypothetical 20% decrease in the local currency of PICO's foreign denominated investments produced a loss of $5.4 million that would impact the unrealized appreciation and foreign currency translation in shareholders' equity.
PICO's financial statements as of December 31, 1999 and 1998 and for each of the three years in the period ended December 31, 1999 and the independent auditors' reports are included in this report as listed in the index of this report.
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999 AND 1998 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF PICO HOLDINGS, INC.
We have audited the accompanying consolidated balance sheets of PICO Holdings, Inc. and its subsidiaries (collectively "the Company") as of December 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1997 consolidated financial statements of Global Equity Corporation (all expressed in Canadian dollars), a 51.2% owned consolidated subsidiary as of December 31, 1997, which constituted 42% of consolidated total assets as of December 31, 1997. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Global Equity Corporation (all expressed in Canadian dollars), is based solely on the report of such other auditors.
In our opinion, based on our audits and the report of the other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of PICO Holdings, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America.
We have audited the consolidated statement of financial position of Global Equity Corporation ("GEC") as at December 31, 1997 and the consolidated statements of operations, deficit and changes in financial position for the year then ended. These financial statements are the responsibility of GEC's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards in Canada. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of GEC as at December 31, 1997 and the results of its operations and the changes in its financial position for the year then ended in accordance with generally accepted accounting principles in Canada.
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
PICO HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
PICO was incorporated in 1981 and began operations in 1982. The company was known as Citation Insurance Group until a reverse merger with Physicians Insurance Company of Ohio, Inc. ("Physicians") on November 20, 1996. After the reverse merger, the former shareholders of Physicians owned approximately 80% of Citation Insurance Group, the Board of Directors and management of Physicians replaced their Citation Insurance Group counterparts, and Citation Insurance Group changed its name to PICO Holdings, Inc. You should be aware that information pre-dating the reverse merger relates to the old Citation Insurance Group only, and does not reflect the performance of Physicians prior to the merger.
Effective December 16, 1998, PICO acquired the remaining 48.8% of the outstanding stock of Global Equity Corporation ("Global Equity") through a Plan of Arrangement (the "PICO/Global Equity Combination") whereby Global Equity shareholders received .4628 of a newly issued PICO common share for each Global Equity share surrendered. Immediately following the close of the transaction, PICO consummated a 1-for-5 reverse stock split (the "Reverse Stock Split"). Accordingly, all share amounts included herein are restated to reflect the Reverse Stock Split.
Conex Continental, Inc. ("Conex"). Conex is a Delaware corporation that trades on the Canadian Dealer Network. Conex's principal asset is a 60% interest in a sino-foreign joint venture that manufactures wheeled and tracked excavators.
HyperFeed Technologies, Inc. ("HyperFeed") is an Internet content and solutions provider to the financial services industry. HyperFeed has a number of business-to-business solutions, and its business-to-consumer subsidiary PCQuote.com, is an Internet-based provider of high performance, real-time financial data.
The accompanying consolidated financial statements include the accounts of the Company and its majority owned subsidiaries, and have been prepared in conformity with accounting principles generally accepted in the United States of America. All significant intercompany balances and transactions have been eliminated. Investments in which the Company owns between 20% to 50% of the voting interest and has the ability to exercise significant influence are accounted for under the equity method of accounting. Accordingly, the Company's share of income or losses are included in consolidated results. Currently, the Company classifies its 35% voting ownership in HyperFeed as an equity investment.
The preparation of financial statements in conformity with generally accepted accounting principles 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 unpaid losses and loss adjustment expenses, deferred policy acquisition costs, deferred income taxes and contingent liabilities. While management believes that the carrying value of such assets and liabilities are appropriate as of December 31, 1999 and 1998, it is reasonably possible that actual results could differ from the estimates upon which the carrying values were based.
The Company applies the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This statement, among other things, requires investment securities to be divided into three categories: held to maturity, available for sale, and trading. The Company classifies all investments as available for sale. Investments with a readily determinable fair value are carried at fair value. Unrealized gains or losses on investments recorded at fair value are recorded net of tax and included in accumulated other comprehensive income or loss.
Net investment income includes amortization of premium and accretion of discount on the level yield method relating to bonds acquired at other than par value. Realized investment gains and losses are included in income and are determined on the identified certificate basis and are recorded on a trade date basis.
The Company invests domestically and abroad. Approximately $41.8 million and $32.7 million of the Company's investments at December 31, 1999 and 1998, respectively, were invested internationally. The Company's most significant foreign currency exposure is in Swiss francs and Australian dollars.
Costs of the insurance companies that vary with and are primarily related to the acquisition of new and renewal insurance contracts, net of reinsurance ceding commissions, are deferred and amortized over the terms of the policies for property and liability insurance. Future investment income has been taken into consideration in determining the recoverability of such costs.
Goodwill represents the difference between the purchase price and the fair value of the net assets (including tax attributes) of companies acquired in purchase transactions. The Company recorded negative goodwill (i.e., excess of fair value of assets acquired over purchase price) as a result of the acquisition of Citation Insurance Group in November 1996. Negative goodwill is amortized using the straight-line method over 10 years. The Company recorded goodwill related to other purchase transactions, primarily its investment in HyperFeed and Conex and amortizes the balance over various lives not exceeding 10 years.
The Company applies the provisions of SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and periodically evaluates whether events or circumstances have occurred that may affect the estimated useful life or the recoverability of long-lived assets. Impairment of long-lived assets is triggered when the estimated future undiscounted cash flows (excluding interest charges) for the lowest level for which there are identifiable cash flows that are independent of the cash flows of other groups of assets do not exceed the carrying amount. The Company prepares and analyzes
cash flows at various levels of grouped assets. The Company reviews cash flows for significant individual assets held within a subsidiary, and for a subsidiary taken as a whole. If the events or circumstances indicate that the remaining balance may be permanently impaired, such potential impairment will be measured based upon the difference between the carrying amount and the fair value of such assets determined using the estimated future discounted cash flows (excluding interest charges) generated from the use and ultimate disposition of the respective long-lived asset.
MPL and other property and casualty insurance premiums written are earned principally on a monthly pro rata basis over the lives of the policies. The premiums applicable to the unexpired terms of the policies are included in unearned premiums.
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128, "Earnings Per Share," effective for financial statements issued after December 15, 1997. SFAS No. 128 requires dual presentation of "Basic" and "Diluted" earnings per share ("EPS") by entities with complex capital structures, replacing "Primary" and "Fully Diluted" EPS under Accounting Principles Board ("APB") Opinion No. 15. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in earnings. The Company adopted the new method of reporting EPS for the year ended December 31, 1997.
Stock options of 1 million, 1.1 million and 276,543 for 1999, 1998 and 1997, respectively and 223,187 warrants in 1998 were not included in the calculation of weighted average shares because the impacts of such instruments were anti-dilutive.
Financial statements of foreign operations are translated into U.S. dollars using average rates of exchange in effect during the year for revenues, expenses, gains and losses, and the exchange rate in effect at the balance sheet date for assets and liabilities. Unrealized exchange gains and losses arising on translation are reflected within accumulated other comprehensive loss.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including instruments embedded in other contracts
and for hedging activities. It requires recognition of all derivatives as either assets or liabilities in the consolidated balance sheet, and measure those instruments at fair value. The new standard, as amended by SFAS No. 137, becomes effective for fiscal years beginning after June 15, 2000. Management has not assessed the impacts this statement may have on the Company's consolidated financial statements.
On December 16, 1998, PICO acquired the remaining 48.8% of Global Equity, making it a wholly owned subsidiary. This was accomplished through an exchange of PICO shares for Global Equity shares at the exchange ratio of .4628 of a PICO share for each share of Global Equity. PICO issued a total of 6,810,426 shares of PICO common stock to former Global Equity shareholders. PICO subsidiaries hold 3,110,837 of these newly issued shares which are recorded at cost, as treasury stock in the consolidated balance sheets of the Company. Net of the shares issued to affiliates, PICO issued 3,699,589 common shares valued at the average market price per share 5 days before, and after the announcement of the transaction. This average was approximately $22.10 per share (post reverse split). In addition, PICO exchanged 223,187 PICO warrants with an exercise price of $23.80 per share for all the outstanding Global Equity warrants using the same exchange ratio. PICO also exchanged 484,967 stock options with the Global Equity officers, two current Global Equity directors and a former Global Equity director in exchange for surrendering their Global Equity stock options. These grants placed the participants in a substantially similar position regarding shares and exercise price and vesting. The acquisition was accounted for using the purchase method of accounting.
The following table reflects unaudited pro forma combined results of operations of the Company and Global Equity on the basis that the acquisition had taken place at the beginning of the fiscal year for the period presented:
The Black Scholes pricing model incorporates assumptions in calculating an estimated fair value. The following assumptions were used in the computations: no dividend yield for all years; a risk-free interest rate of 5%; a two year expected life; and a historical 4 year cumulative volatility of 133%.
The market value of the common shares and preferred shares based on the December 31, 1999 closing price of HyperFeed common stock was approximately $11 million and $22.1 million, respectively.
At December 31, 1998, the investment in HyperFeed consisted of 2,370,000 shares of common stock (representing 16.7% of the common shares outstanding) and 4,786,538 shares of preferred stock, representing a 24% diluted voting interest and an additional 4,055,195 common stock warrants, which on a diluted basis would represent an additional 17% voting interest. The investment in common stock and preferred stock have a combined carrying value of $5 million, net of deferred tax at December 31, 1998. At December 31, 1998, the common stock warrants are carried in accordance with SFAS No. 115 at an estimated fair value of $6.1 million, prior to $683,000 in deferred tax, using the Black Scholes pricing model. The pre-tax unrealized gain on the warrants was $2 million. The market value of the common shares and preferred shares based on the December 31, 1998 closing price of HyperFeed common stock was approximately $5 million and $10.2 million, respectively.
shares of common stock at $1 per share, for net proceeds of $4.7 million. As a result, PICO's voting ownership declined from 27.8% prior to the transaction to 16.6%. This gave rise to a dilution gain of $997,000. Deferred taxes are provided on each dilution transaction.
In December 1998, the Company converted its $2.5 million HyperFeed debenture, $3.3 million line of credit and $969,000 in accrued interest into 1,907,463 shares of HyperFeed Series A voting convertible preferred shares, 2,879,077 series B voting convertible preferred shares, and 3,106,163 million warrants to purchase HyperFeed common shares, expiring in 2006. The value of the preferred shares and warrants was determined using a relative fair value approach and consequently, no gain or loss was recorded on the transaction.
Through its subsidiary Nevada Land, the Company owns land, mineral and related water rights. Through its subsidiary Vidler, the Company owns water rights and water storage consisting of various real properties in California, Arizona, Colorado and Nevada. The costs assigned to the various components at December 31, were as follows:
At December 31, 1999, the book value of Vidler's interest in the Semitropic Water Storage facility was $4.0 million. During the first ten years of the agreement through November, 2008, Vidler is required to make a minimum annual payment of $2.3 million. In return, Vidler is entitled to store up to 185,000 acre-feet of water underground at Semitropic for 35 years. The cash payments made during the first ten years are being capitalized and the asset is being amortized over its useful life of thirty-five years. In 1999, the $2.3 million payment was capitalized to water storage, and $667,000 of expense was amortized against it. In addition, Vidler is required to pay annual operating and maintenance costs. In 1999, operating costs of $863,000 were charged to the water rights and water storage segment.
On June 16, 1997, the Company announced a definitive agreement to sell its life and health insurance subsidiary, American Physicians Life ("American Physicians"). The closing was completed on December 4, 1998. Proceeds from the sale were $17 million in cash. On August 21, 1997, Global Equity announced an agreement to sell its Sri Lankan subsidiaries. The closings occurred during 1997 for consideration of $17.3 million in cash and $7.7 million in marketable securities. Approximately $15 million of the $25 million purchase price was received in 1997, and the remaining balance was received in 1998.
Significant components of the Company's deferred tax assets and liabilities are as follows at December 31:
The deferred tax asset valuation allowance as of December 31, 1999 relates to the net operating loss carryforwards (NOL's) of Global Equity and its subsidiaries. Global Equity and its subsidiaries are subject to rules that limit the ability to utilize their NOL's. Due to these limitations and the uncertainty of future taxable income, a valuation allowance has been recorded for the deferred tax asset that may not be realized. The deferred tax asset valuation allowance as of December 31, 1998 also include amounts related to NOL's of PICO and its U. S. consolidated subsidiaries. During 1999, U.S. tax legislation was enacted that removed certain limitations on the Company's ability to utilize its U.S. NOL's. As a result of this legislation, the valuation allowance for these losses was removed. Deferred tax assets and liabilities, the recorded valuation allowance, and federal income tax expense in future years can be significantly affected by changes in circumstances that would influence management's conclusions as to the ultimate realization of deferred tax assets.
Provision has not been made for U.S. or additional foreign tax on the undistributed earnings of foreign subsidiaries. It is not practical to estimate the amount of additional tax that might be payable. At December 31, 1999 and 1998, the Company had an income tax receivable of $3.6 million and $6.5 million, respectively. The aggregate NOL's of approximately $44.1 million expire between 1999 and 2013. There is a $1.4 million annual limitation on the utilization of the NOL's of PICO, Citation and Sequoia.
Depreciation expense was $1 million, $1.3 million, and $873,000, in 1999, 1998, and 1997, respectively.
On December 16, 1998, PICO acquired the remaining shares of Global Equity. This was accomplished through an exchange of PICO shares for Global Equity shares at the exchange ratio of .4628 of a PICO share for each share of Global Equity. PICO issued a total of 6,810,426 shares of PICO common stock to former Global Equity shareholders. PICO subsidiaries hold 3,110,837 of these newly issued shares which are recorded as treasury stock in the consolidated balance sheets of the Company. Following the transaction, PICO had 13,328,778 shares of common stock issued and outstanding of which 4,380,779 million are accounted for as treasury stock, at cost in the consolidated balances sheets. In addition, PICO exchanged 223,187 PICO warrants with an exercise price of $23.80 per share for all the outstanding Global Equity warrants using the same exchange ratio. The original October 23, 1998 expiration date of the warrants was extended to June 30, 1999. During 1999, 120,000 of the warrants were exercised for $2.9 million. The remaining warrants expired. No other warrants exist. PICO also exchanged 484,967 stock options to Global Equity officers, two current Global Equity directors and a former Global Equity director in exchange for surrendering their Global Equity stock options. These grants placed the participants in a substantially similar position regarding shares and exercise price, vested according to their original terms.
On July 23, 1998, Guinness Peat Group plc ("GPG") sold 672,517 unregistered shares of PICO common stock to several institutional investors, representing substantially all of GPG's holdings in PICO. PICO acquired 412,846 of the above shares at a cost of $1.6 million, and assumed call option obligations for the delivery of these shares when the options are exercised. These call options expire on December 30, 2003 and are held by PICO's chairman of the board and president and chief executive officer. On December 31, 1998, 57,307 of these options were exercised for a total of $200,000.
PICO Holdings' 1998 Option Plan. PICO is authorized to issue 100,000 shares of common stock pursuant to awards granted in various forms, including incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended), non-qualified stock options, and other similar stock-based awards. On October 22, 1998, PICO granted 100,000 non-qualified common stock options to an officer of the Company at an exercise price of $15.625 per share. The options granted vest monthly over three years, expiring October 22, 2008. During 1999, 61,111 of these options expired when the officer left the Company.
Had compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS No. 123, the Company's net income (loss) and net income (loss) per share would approximate the following pro forma amounts for the years ended December 31:
All reinsurance assets and liabilities are shown on a gross basis in the accompanying consolidated financial statements. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Such amounts are included in "reinsurance receivables" in the consolidated balance sheets as follows:
In 1994, the Company entered into a retroactive reinsurance arrangement with respect to its MPL business. As a result, Physicians initially recorded a deferred gain on retroactive reinsurance of $3.4 million in 1994. Deferred gains are being amortized into income over the expected payout of the underlying claims using the interest method. The unamortized gain as of December 31, 1999 and 1998 was $1.2 million and $1.8 million, respectively.
Physicians and PRO prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Ohio Department of Insurance ("Ohio Department"). Citation and Sequoia prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the California Department of Insurance. Prescribed statutory accounting practices include guidelines contained in various publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Ohio Department's prescribed accounting practices do not allow for discounting of claim liabilities. However, for the three years ended December 31, 1999, the Ohio Department permitted Physicians to discount its losses and loss adjustment expenses related to its MPL claims to reflect anticipated investment income. Permission was granted due primarily to the longer claims settlement period related to MPL business as compared to most other types of property and casualty insurance lines of business. Property and casualty insurance companies are permitted to discount claims liabilities under generally accepted accounting principles to the extent that the discounting of claims liabilities is prescribed or permitted by statutory accounting principles.
In November 1998, Vidler 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 requires Vidler to pay for these privileges and rights a minimum of $2.3 million per year for 10 years beginning October 1998. The agreement calls for the lease payments to be adjusted annually by the engineering price index. The $2.3 million minimum annual lease payment is included in the above summary of future minimum rental payments. On October 7, 1998, PICO signed an agreement guaranteeing payment of Vidler's obligations under the agreement. The maximum obligation under this guarantee is $3.2 million, adjusted annually by the engineering price index. The guarantee expires October 7, 2008.
In connection with the sale of their interests in Nevada Land 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.
Under the terms of the joint venture agreement between Conex and the sino-foreign joint venture in The People's Republic of China, Conex has a commitment to fund a third tranche of financing in the amount of $5 million. This liability has been recorded in the financial statements.
In January 1997, the consulting arrangements with two directors were terminated and replaced with a revised consulting contract that increased the annual base consulting fees for the two directors to $800,000 each beginning January 1, 1997. On December 31, 1997, these two directors became employees of the Company; the terms of employment were similar to the consultant arrangements described above. The employment agreements entered into by the two directors superceded the prior consulting agreements. Each is entitled to an incentive award based on the growth of the Company's book value per share in excess of a threshold that is calculated as 80% of the previous five year average return for the S&P 500. No award was paid during 1999, 1998 or 1997 under this program.
On March 6, 1996, Charles E. Bancroft, the President and Chief Executive Officer of Sequoia entered into an incentive agreement with Sequoia after its acquisition by Physicians. Under the terms of this incentive agreement, Mr. Bancroft is to receive a payment equal to ten percent of the increase in Sequoia's value upon his retirement, removal from office for reasons other than cause, or the sale of Sequoia to a third party. For purposes of the incentive agreement, the increase in Sequoia's value is to be measured from August 1, 1995; the date Physicians acquired Sequoia. Mr. Bancroft was not eligible to receive any incentive payment, until he was continuously employed by Sequoia from August 1, 1995 through August 1, 1998. On March 20, 1998 this incentive agreement was clarified to include the combined increase in value of Sequoia and Citation. The increase in value of Citation will be measured from January 1, 1998. The Company recorded compensation expense related to this arrangement of $210,000, $110,000 and $250,000 during the years ended December 31, 1999, 1998 and 1997, respectively.
The Company and its insurance subsidiaries are subject to regulation by the insurance departments of the states of domicile and other states in which the companies are licensed to operate and file financial statements using statutory accounting practices prescribed or permitted by the respective Departments of Insurance. Prescribed statutory accounting practices include a variety of
The Company and its wholly-owned insurance subsidiaries' policyholders' surplus and net income (loss) as of and for the years ended December 31, 1999, 1998 and 1997 on the statutory accounting basis are as follows:
Certain insurance subsidiaries are owned by other insurance subsidiaries. In the table above, investments in such subsidiary-owned insurance companies are reflected in statutory surplus of both the parent and subsidiary-owned insurance company. As a result, at December 31, 1999, 1998, and 1997, statutory surplus of approximately $28.8 million, $27.1 million and $37.8 million, respectively, is reflected in both the parent and subsidiary-owned insurance companies.
The Company is a diversified holding company engaged in five major operating segments: Land, Mineral and Related Rights; Water Rights and Water Storage; Property and Casualty Insurance Operations; Medical Professional Liability ("MPL") Insurance Operations and Other Strategic Holdings.
Segment performance is measured by revenues and segment profit before tax 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. In addition, assets identifiable with segments are disclosed as well as capital expenditures, and depreciation and amortization. The Company has operations and investments both in the U.S. and abroad. Information by geographic region is also similarly disclosed.
PICO is engaged in land, water and mineral rights operations through its subsidiary Nevada Land. Nevada Land owns approximately 1.28 million acres of land and related mineral and related water rights in northern Nevada. Revenue is generated by land sales, land development, land exchanges and leasing for grazing, agricultural and other uses. Revenue is also generated from the development of water rights and mineral rights in the form of outright sales and royalty streams.
- acquiring water rights, redirecting the water to its highest and best use, and then generating cash flow from either leasing the water or selling the right; - development of storage and distribution infrastructure; - purchase and storage of water for resale in dry years; and - working with municipalities and state legislators to facilitate the passing of legislation which will result in the efficient allocation of water.
Vidler's business involves identifying end users, namely municipalities or developers, in the Southwest who require water, and then locating a source and supplying the demand, utilizing the company's own assets where possible.
PICO's Property and Casualty Insurance operations are conducted by our California-based subsidiaries Sequoia and Citation.
As expected during the run-off process, the bulk of this segment's revenues come from investment income. The Physicians' and Professionals' portfolios contain some of the Company's strategic investments.
The Other Strategic Holdings segment comprises investments where we own less than 50% of the company, and our smaller subsidiaries.
PICO invests in companies, which our management identifies as undervalued based on fundamental analysis. Typically the stocks will be selling for less than tangible book value or appraised intrinsic value (i.e. what we think the company is worth). Often the stocks will also be trading for low ratios of earnings and cash flow, or on high dividend yields. Additionally the company must have special qualities, such as unique assets, potential catalysts for change, or attractive industry characteristics.
(A) Other strategic holdings identifiable assets include certain investments held by one of the Company's regulated insurance subsidiaries, which is no longer writing new business. Management believes that this component of the insurance subsidiary's assets is in excess of the amount of the subsidiary's assets that will be required to settle its claims liabilities. The amount of the insurance subsidiary's assets included in the Investment Operations segment at December 31, 1999 and 1998 was insignificant compared to $6 million of December 31, 1997. Investment charges were approximately $0.2 million and $1.6 million and investment revenues were $2 million, for the years ended December 31, 1999, 1998, and 1997, respectively.
- CASH AND CASH EQUIVALENTS, SHORT-TERM INVESTMENTS, RECEIVABLES, PAYABLES AND ACCRUED LIABILITES: Carrying amounts for these items approximate fair value because of the short maturity of these instruments.
- INVESTMENTS: Fair values are estimated based on quoted market prices, or dealer quotes for comparable securities. Fair value of warrants to purchase common stock of publicly traded companies is estimated based on values determined by the use of accepted valuation models at the time of acquisition. Fair value for equity securities that do not have a readily determinable fair value is estimated based on the value of the underlying common stock. The Company regularly evaluates the carrying value of securities to determine whether there has been any diminution in value that is other than temporary and adjusts the value accordingly.
- - INVESTMENT IN AFFILIATE: Investments in which the Company owns between 20% and 50%, and has the ability to significantly influence the operations and policies of the investee are carried at equity value. The balance of the investment is regularly evaluated for impairment.
The financing commitment relates to a $5 million capital contribution by Conex to the sino-foreign joint venture. This commitment is anticipated to be drawn down as required.
At December 31, 1999 and 1998, bank and other borrowings consists of loans and promissory notes borrowed to finance the purchase of land and investment securities. The weighted average interest rate on these borrowings was approximately 6.9% and 8.5% at December 31, 1999 and 1998, respectively.
The lands and water assets collateralize the notes incurred to purchase lands.
On February 9, 2000, PICO registered on Form S-3 with the U. S. Securities and Exchange Commission to offer 6,546,497 shares of PICO stock at a price of $15 per share through a rights offering.