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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-18786
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PICO HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-2723335
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
875 PROSPECT STREET, SUITE 301
LA JOLLA, CALIFORNIA 92037
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (858) 456-6022
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III or this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
Approximate aggregate market value of the registrant's voting and non-voting
common equity held by non-affiliates of the registrant (based on the closing
sales price of such stock as reported in the NASDAQ National Market) on the last
business day of the registrant's most recently completed second fiscal quarter,
was $71,641,232.
On March 5, 2004, the registrant had 12,373,534 shares of common stock, $.001
par value, outstanding, excluding 4,428,389 shares of common stock which are
held by the registrant and its subsidiaries.
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DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT TO BE FILED WITH THE
COMMISSION PURSUANT TO REGULATION 14A IN CONNECTION WITH THE REGISTRANT'S 2004
ANNUAL MEETING OF STOCKHOLDERS, TO BE FILED SUBSEQUENT TO THE DATE HEREOF, ARE
INCORPORATED BY REFERENCE INTO PART III OF THIS REPORT. SUCH DEFINITIVE PROXY
STATEMENT WILL BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION NOT LATER
THAN 120 DAYS AFTER THE CONCLUSION OF THE REGISTRANT'S FISCAL YEAR ENDED
DECEMBER 31, 2003.
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PICO HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
No.
---
PART I.............................................................................................................. 4
Item 1. BUSINESS.............................................................................................. 4
Item 2. PROPERTIES............................................................................................ 19
Item 3. LEGAL PROCEEDINGS..................................................................................... 19
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................... 19
PART II............................................................................................................. 20
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS................................. 20
Item 6. SELECTED FINANCIAL DATA............................................................................... 21
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................................................ 22
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS........................................... 59
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................................... 59
Item 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE......................................................................... 97
Item 9A. CONTROLS AND PROCEDURES............................................................................... 97
PART III............................................................................................................ 97
Item 10. DIRECTORS AND EXECUTIVE OFFICERS AND CODE OF ETHICS OF THE REGISTRANT................................. 97
Item 11. EXECUTIVE COMPENSATION................................................................................ 97
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT...................................................................................... 97
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................................ 97
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES................................................................ 97
PART IV............................................................................................................. 98
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...................................... 98
SIGNATURES.......................................................................................................... 107
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PART I
THIS ANNUAL REPORT ON FORM 10-K (INCLUDING THE MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SECTION) CONTAINS
FORWARD-LOOKING STATEMENTS REGARDING OUR BUSINESS, FINANCIAL CONDITION, RESULTS
OF OPERATIONS AND PROSPECTS. WORDS SUCH AS "EXPECTS," "ANTICIPATES," "INTENDS,"
"PLANS," "BELIEVES," "SEEKS," "ESTIMATES" AND SIMILAR EXPRESSIONS OR VARIATIONS
OF SUCH WORDS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS, BUT ARE NOT
THE EXCLUSIVE MEANS OF IDENTIFYING FORWARD-LOOKING STATEMENTS IN THIS ANNUAL
REPORT ON FORM 10-K. ADDITIONALLY, STATEMENTS CONCERNING FUTURE MATTERS ARE
FORWARD-LOOKING STATEMENTS.
ALTHOUGH FORWARD-LOOKING STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K
REFLECT THE GOOD FAITH JUDGMENT OF OUR MANAGEMENT, SUCH STATEMENTS CAN ONLY BE
BASED ON FACTS AND FACTORS CURRENTLY KNOWN BY US. CONSEQUENTLY, FORWARD-LOOKING
STATEMENTS ARE INHERENTLY SUBJECT TO RISKS AND UNCERTAINTIES AND ACTUAL RESULTS
AND OUTCOMES DISCUSSED IN OR ANTICIPATED BY THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES IN RESULTS AND
OUTCOMES INCLUDE, WITHOUT LIMITATION, THOSE DISCUSSED UNDER THE HEADING "RISK
FACTORS" BELOW, AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS ANNUAL REPORT ON
FORM 10-K. READERS ARE URGED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL
REPORT ON FORM 10-K. WE UNDERTAKE NO OBLIGATION TO REVISE OR UPDATE ANY
FORWARD-LOOKING STATEMENTS IN ORDER TO REFLECT ANY EVENT OR CIRCUMSTANCE THAT
MAY ARISE AFTER THE DATE OF THIS ANNUAL REPORT ON FORM 10-K. READERS ARE URGED
TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE IN THIS ANNUAL
REPORT, WHICH ATTEMPT TO ADVISE INTERESTED PARTIES OF THE RISKS AND FACTORS THAT
MAY AFFECT OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS AND
PROSPECTS.
ITEM 1. BUSINESS
INTRODUCTION
PICO Holdings, Inc. (PICO and its subsidiaries are referred to as
"PICO," "the Company," "we," and "our") is a diversified holding company. PICO
seeks to acquire businesses and interests in businesses which we identify as
undervalued based on fundamental analysis -- that is, our assessment of what the
business is worth, based on the private market value of its assets, earnings,
and cash flow. We prefer long-established businesses, with a history of
operating successfully through industry cycles, recessions and geo-political
disruptions, in basic, "old economy" industries. Typically, the business will be
generating free cash flow and have a low level of debt, or, alternatively,
strong interest coverage ratios or the ability to realize surplus assets. As
well as being undervalued, the business must have special qualities such as
unique assets, a potential catalyst for change, or be in an industry with
attractive economics. We are also interested in acquiring businesses and
interests in businesses where there is significant unrecognized value in land
and other tangible assets.
We have acquired businesses and interests in businesses by the
acquisition of private companies, and the purchase of shares in public
companies, both directly through participation in financing transactions and
through open market purchases. When we buy a business or an interest in a
business, we have a long-term horizon, typically 5 years or more. Selected
acquisitions may become core operations; however, we are prepared to sell
businesses if the price received exceeds the return we expect to earn if we
retain ownership. We expect that most of our businesses and interests in
businesses will eventually be sold to other companies in the same industry
seeking to expand or gain economies of scale.
Our objective is to generate superior long-term growth in shareholders'
equity, as measured by book value per share. Over time, we anticipate that most
of our net income and growth in shareholders' equity will come from realized
gains on the sale of businesses and interests in businesses, as opposed to
ongoing operating earnings. Consequently, we anticipate that PICO's earnings
will fluctuate from year to year, and that the results for any one year are not
necessarily indicative of our future performance.
Currently our major operating businesses are:
- - Vidler Water Company, Inc. ("Vidler"), which develops and owns water
rights and water storage operations in the southwestern United States,
primarily in Nevada and Arizona;
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- - Nevada Land & Resource Company, LLC ("Nevada Land"), which owns
approximately 1.1 million acres of land in Nevada, and the mineral
rights and water rights related to the property;
- - Citation Insurance Company ("Citation"), which is "running off" its
historical property and casualty and workers' compensation loss
reserves, and Physicians Insurance Company of Ohio ("Physicians"),
which is "running off" its medical professional liability loss
reserves; and
- - HyperFeed Technologies, Inc. ("HyperFeed"), which became a 51%-owned
subsidiary in 2003. HyperFeed is a developer and provider of software,
ticker plant technologies, and managed services to the financial
markets industry.
On March 31, 2003, we closed on the sale of Sequoia Insurance Company
("Sequoia"), which is accounted for in our consolidated financial statements for
2003 and prior years as a discontinued operation. See "Discontinued Operations."
The address of our main office is 875 Prospect Street, Suite 301, La
Jolla, California 92037, and our telephone number is (858) 456-6022.
We maintain an Internet site (www.picoholdings.com) that makes
available, free of charge, our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon
as reasonably practicable after such material is electronically filed with the
SEC. Our website also contains other material about PICO, and links to other
sites, including some of the companies with which we are associated.
HISTORY
PICO was incorporated in 1981 and began operations in 1982. The company
was known as Citation Insurance Group until a reverse merger with Physicians
Insurance Company of Ohio on November 20, 1996. After the reverse merger, the
former shareholders of Physicians owned approximately 80% of Citation Insurance
Group, the Board of Directors and management of Physicians replaced their
Citation counterparts, and Citation Insurance Group changed its name to PICO
Holdings, Inc. You should be aware that some data on information services
pre-dating the reverse merger relates to the old Citation Insurance Group only,
and does not reflect the performance of Physicians prior to the merger.
SUBSIDIARY COMPANIES & MAJOR OPERATING SEGMENTS
This section describes our subsidiaries and operating segments. Unless
otherwise indicated, we own 100% of each subsidiary.
VIDLER WATER COMPANY, INC.
Vidler is the leading private company in the water resource development
business in the southwestern United States. PICO identified water resource
development in the Southwest as an attractive business opportunity due to the
continued growth in demand for water resulting from population growth, economic
development, environmental requirements, and the claims of Native Americans.
Vidler is not a water utility, and does not intend to enter into regulated
utility activities. We develop new sources of water for municipal and industrial
use, and necessary storage infrastructure to facilitate the efficient allocation
of available water supplies.
The inefficient allocation of available water between agricultural
users and municipal or industrial users, or the lack of available known water
supply for a particular area, provide opportunities for Vidler:
- - the majority of water rights are currently owned or controlled by
agricultural users, and in many locations there are insufficient water
rights owned or controlled by municipal and industrial users to meet
present and future demand;
- - certain areas of the Southwest experiencing rapid growth have
insufficient supplies of known water to support future growth. Vidler
identifies and develops new water supplies for communities with no
other known water to support future growth;
- - currently there are not effective procedures in place for the transfer
of water from private parties with excess supply in one state to
end-users in other states. However, regulation and procedures are
steadily being developed to facilitate the interstate transfer of
water; and
- - infrastructure to store water will be required to accommodate and allow
interstate transfer, and transfers from wet years to dry years.
Currently there is limited storage capacity in place.
We entered the water resource development business with the acquisition
of Vidler in 1995. At the time, Vidler owned a limited quantity of water rights
and related assets in Colorado. Since then, Vidler has acquired:
- - additional water rights and related assets, predominantly in Arizona
and Nevada. Vidler seeks to acquire water rights at prices
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consistent with their current use, with the expectation of an increase
in value if the water right can be converted to a higher use. A water
right is the legal right to divert water and put it to beneficial use.
Water rights are assets which can be bought and sold. In some states,
the use of the water can also be leased. The value of a water right
depends on a number of factors, including location, the seniority of
the right, and whether or not the right is transferable. The majority
of Vidler's water rights are in Nevada and Arizona, the two states
which are leading the nation in population growth and new home
construction. Our objective is to monetize our water rights for
municipal and industrial use in Arizona and Nevada. Typically, our
water rights are the most competitive source of water to support new
growth in municipalities and new industry in Arizona and Nevada; and
- - a water storage facility in Arizona and an interest in Semitropic, a
water storage facility in California. Our water storage facility in
Arizona is fully permitted and ready for commercial use, and at
December 31, 2003, Vidler had "net recharge credits" representing
approximately 34,000 acre-feet of water in storage on its own account.
Water has been stored commercially at Semitropic since 1995.
At December 31, 2003, PICO owned approximately 96.2% of Vidler.
Vidler is engaged in the following activities:
- - supplying water to end-users in the Southwest, namely water utilities,
municipalities, developers, or industrial users. The source of water
could be from identifying and developing a new water supply, or a
change in the use of water from agricultural to municipal and
industrial use;
- - development of storage and distribution infrastructure, and then
generating cash flow from charging customers fees for "recharge," or
placing water into storage; and
- - purchase and storage of water for resale in dry years.
After an acquisition and development phase spanning several years,
Vidler completed its first significant sales of water rights for industrial use
in 2001 and municipal use in 2002. Vidler's priority is to monetize or develop
recurring cash flow from its most important assets by:
- - securing significant supply contracts utilizing its water rights in
Arizona and Nevada; and
- - storing water at the Vidler Arizona Recharge Facility.
Vidler has also entered into partnering arrangements with parties who
have water assets but lack the capital or expertise to commercially develop
these assets. Vidler continues to explore additional partnering opportunities
throughout the Southwest.
This table details the water rights and water storage assets owned by
Vidler at December 31, 2003. Please note that this is intended as a summary, and
that some numbers are rounded. Item 7 of this Form 10-K contains more detail
about these assets, recent developments affecting them, and the current outlook.
During 2003, Vidler disposed of all of its land and water rights at Big
Springs Ranch, Nevada; West Wendover, Nevada; and Wet Mountain, Colorado. See
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
An acre-foot is a unit commonly used to measure the volume of water. An
acre-foot is the volume of water required to cover one acre to a depth of one
foot. As a rule of thumb, one acre-foot of water would sustain two families of
four persons each for one year.
NAME OF ASSET & APPROXIMATE LOCATION BRIEF DESCRIPTION PRESENT COMMERCIAL USE
- ---------------------------------------------------------------------------------------------------------------
WATER RIGHTS
ARIZONA:
HARQUAHALA VALLEY GROUND WATER BASIN 15,067 acres of land, plus 4,814 acres under Leased to farmers
La Paz & Maricopa Counties option
75 miles northwest of metropolitan Phoenix
35,795 acre-feet of transferable ground
water, plus 13,764 acre-feet under option
State legislation allows Harquahala
Valley ground water to be made available
as assured municipal water supply to
cities and communities in Arizona through
agreements with the Central Arizona Ground
Water Replenishment District
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NEVADA:
FISH SPRINGS RANCH, LLC (51% INTEREST) & 8,600 acres of deeded ranchland Vidler is currently farming the
V&B, LLC (50% INTEREST) property. Cattle graze on part
of the property on a revenue-
Washoe County, 40 miles north of Reno 8,000 acre-feet of permitted water rights, sharing basis
which are transferable to the Reno/Sparks area
LINCOLN COUNTY AGREEMENT Applications* for more than 100,000 acre-feet
of water rights through an agreement with
Lincoln County, of which it is currently
anticipated that up to 40,000 acre-feet will
be permitted and put to use in Lincoln County.
2,100 acre-feet of permitted water rights in
the Tule Desert Groundwater Basin
570 acre-feet of permitted water rights at
Meadow Valley, located in Lincoln and Clark
counties
CLARK COUNTY
SANDY VALLEY 415 acre-feet of permitted water rights
Near the Nevada / California state line
In the Interstate 15 corridor Application for 1,000 acre-feet of water rights
MUDDY RIVER WATER RIGHTS 221 acre-feet of water rights, plus approximately
Approximately 35 miles east of Las Vegas, 46 acre-feet under option
in the Interstate 15 corridor
*The numbers indicated for water rights
applications are the maximum amount which we have
filed for. In some cases, we anticipate that the
actual permits received will be for smaller
quantities.
COLORADO:
COLORADO WATER RIGHTS 105 acre-feet of senior water rights Agreement to sell 105 acre-feet
of senior water rights to the City
of Golden, Colorado over a period
of 12 years
163 acre-feet of senior water rights 65.5 acre-feet leased.
WATER STORAGE
ARIZONA:
VIDLER ARIZONA RECHARGE FACILITY An underground water storage facility with Vidler is currently buying water
Harquahala Valley, Arizona estimated capacity exceeding 1 million acre-feet and storing it on its own account.
and permitted annual recharge capability of up At December 31, 2003, Vidler had
to 100,000 acre-feet net recharge credits equivalent to
approximately 34,000 acre-feet of
water in storage at the Arizona
Recharge Facility, as well as more
than 7,000 acre-feet of water
purchased but not yet recharged. In
addition, Vidler has ordered
approximately 29,000 acre-feet of
water for purchase and recharge in
2004.
CALIFORNIA:
SEMITROPIC WATER STORAGE FACILITY The right to store 30,000 acre-feet of water
underground until 2035. This includes the
right to minimum guaranteed recovery of
approximately 2,700 acre-feet of water every
year, and the right to recovery up to
approximately 6,800 acre-feet in one year in
certain circumstances
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NEVADA LAND & RESOURCE COMPANY, LLC
In April 1997, PICO paid $48.6 million to acquire Nevada Land, which at
the time owned approximately 1,352,723 acres of deeded land in northern Nevada,
and the water, mineral, and geothermal rights related to the property. Much of
Nevada Land's property is checker-boarded in square mile sections with publicly
owned land. The lands generally parallel the Interstate-80 corridor and the
Humboldt River from Fernley, in western Nevada, to Elko County, in northeast
Nevada.
Nevada Land is the largest private landowner in the state of Nevada.
According to census data, the population of Nevada increased 66% in the 10 years
ended April 1, 2000, which was the most rapid population growth of any state in
the United States. In the 3.25 years from April 1, 2000 to July 1, 2003, the
Nevada State Demographer estimates that the population of Nevada increased
another 14.9%, to approximately 2.3 million people. Most of the growth is
centered in southern Nevada, which includes the city of Las Vegas and
surrounding municipalities. Land available for private development in Nevada is
relatively scarce, as governmental agencies own approximately 87% of the land in
Nevada.
Before we acquired Nevada Land, the property had been under the
ownership of a succession of railway companies, to whom it was a non-core asset.
Accordingly, when we acquired the company, we believed that the potential of the
property had never been properly marketed.
After acquiring Nevada Land, we completed a "highest and best use
study" which divided the land into 7 major categories. We developed strategies
to maximize the value of each type of asset, with the objective of monetizing
assets once they had reached their highest and best use. These strategies
include:
- - the sale of land and water rights. There is demand for land and water
for a variety of purposes including residential development,
residential estate living, farming, ranching, and from industrial
users;
- - transactions where Nevada Land exchanges parcels of its land in return
for land owned by other parties;
- - the development of water rights. Nevada Land has applied for additional
water rights on land it owns. Where water rights are permitted, we
anticipate that the value and marketability of the related land will
increase;
- - the development of land in and around growing municipalities; and
- - the management of mineral rights.
A cost basis has been assigned to each category of land and other asset, which,
in aggregate, equals Nevada Land's original purchase price.
During the period from April 23, 1997 to December 31, 2003, Nevada Land
received consideration of approximately $23 million from the sale and exchange
of land and the sale of water rights. This is comprised of $21.1 million from
the sale of land, $752,000 of cash and land received in an exchange transaction,
and $1.1 million from the sale of water rights. Over this period, we have
divested approximately 242,510 acres of land at an average price of $90 per
acre, which compares to our average basis of $46 in the acres disposed of. The
average gross margin percentage on the disposal of land and water rights over
this period is 51.7%. The average cost for the total land, water, and mineral
assets acquired with Nevada Land was $35 per acre.
At December 31, 2003, Nevada Land owned approximately 1,110,000 acres
of former railroad land. In addition to the former railroad property, Nevada
Land has acquired:
- - 17,558 acres of land in a land exchange with a private landowner. This
land is contiguous with Native American tribal lands and is culturally
sensitive; and
- - Spring Valley Ranches, which is located approximately 40 miles west of
Ely in White Pine County, Nevada. This property was purchased out of
bankruptcy proceedings in 2000. We believe that the land has
significant environmental value. The real estate assets consist of
approximately 9,500 acres of deeded land and 500,000 acres of Forest
Service and Bureau of Land Management allotment land. There are 5,582
acre-feet of permitted agricultural water rights related to the
property.
We anticipate continuing to sell smaller parcels of land for
residential, agricultural, and industrial use, and that significantly larger
parcels of land which has environmental, cultural, or historical value, will be
divested through exchange-type transactions. These transactions could be
structured as outright sales or as exchanges for land which is either more
marketable or suitable for future development.
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In recent years, Nevada Land has filed additional applications for
approximately 96,000 acre-feet of water rights on the Company's lands. The
applications consist of:
- - on the former railroad lands, approximately 4,396 acre-feet of water
rights have been certificated and permitted, and applications are
pending for approximately 65,520 acre-feet of water use for
agricultural, municipal, and industrial use; and
- - 26,200 acre-feet of water rights for the beneficial use of irrigating
another 6,550 acres of Spring Valley Ranches.
BUSINESS ACQUISITIONS AND FINANCING
This segment contains businesses, interests in businesses, and other
parent company assets.
PICO seeks to acquire businesses which we identify as undervalued based
on fundamental analysis -- that is, our assessment of what the business is
worth, based on the private market value of its assets, earnings, and cash flow.
We prefer long-established businesses, with a history of operating successfully
through industry cycles, recessions and wars, in basic, "old economy"
industries. Typically, the business will be generating free cash flow and have a
low level of debt, or, alternatively, strong interest coverage ratios or the
ability to realize surplus assets. As well as being undervalued, the business
must have special qualities such as unique assets, a potential catalyst for
change, or be in an industry with attractive economics. We are also interested
in acquiring businesses and interests in businesses where there is significant
unrecognized value in land and other tangible assets.
We have acquired businesses and interests in businesses through the
acquisition of private companies, and the purchase of shares in public
companies, both directly through participation in financing transactions and
through open market purchases. When we buy a company, we have a long-term
horizon, typically 5 years or more; however, we are prepared to sell companies
if the price received exceeds the return we expect to earn if we retain
ownership. We expect that most of our interests in businesses will eventually be
sold to other companies in the same industry seeking to expand or gain economies
of scale. Consistent with our focus on increasing our shareholders' equity and
book value per share, we anticipate that most of the return from our interests
in businesses will come from realized gains on the ultimate sale of our holding,
rather than dividends, equity income, or operating earnings during our
ownership.
When we acquire an interest in a public company, we are prepared to
play an active role, for example encouraging companies to use proper financial
criteria when making capital expenditure decisions, or by providing financing or
strategic input.
At the time we acquire an interest in a public company, we believe that
the intrinsic value of the underlying business significantly exceeds the current
market capitalization. The gap between market price and intrinsic value may
persist for several years, and the stock price may decline while our estimate of
intrinsic value is stable or increasing. Sometimes, the gap is not eliminated
until another party attempts to acquire the company, as was the case with our
holding in Australian Oil & Gas Corporation Limited ("AOG").
Between 1998 and 2002, we became the largest shareholder in AOG, an
international provider of drilling services. We identified AOG as undervalued as
rig utilization, which is critical to earnings and cash flow for drilling
companies, had begun to recover in the U.S., but was still near cyclical lows in
the international markets where AOG operates. Historically, there has been a
time lag between recovery in rig utilization in the U.S. and in international
markets.
We acquired our interest, at an average cost of approximately A$1.35
per share, through open market purchases, the reinvestment of dividends, and
assisting AOG with a financing in early 2002. AOG had secured two major new
contracts with multinational oil companies, but needed to raise capital to
purchase equipment necessary to perform the contracts. We provided AOG with a
bridging loan facility, which was repaid with the proceeds of a rights offering
which we partly underwrote. After AOG's expanded activities and earnings base
became apparent, Ensign (Australia) Holdings Pty. Limited, a subsidiary of a
Canadian oil services company which was already a shareholder in AOG, made a
takeover offer for AOG at A$1.70 per share. Ensign was overbid by a number of
other companies, before lifting its bid several times and eventually acquiring
AOG in July 2002 for A$2.70 per share. Immediately prior to Ensign's first bid,
AOG shares had been trading at A$1.40.
PICO began to invest in European companies in 1996. We have been
accumulating shares in a number of undervalued asset-rich companies,
particularly in Switzerland, which we believe will benefit from pan-European
consolidation. At December 31, 2003, the market value (and carrying value) of
our European portfolio was $43.1 million. This includes our 22.4% interest in
Jungfraubahn Holding AG ("Jungfraubahn"), which had a market value (and carrying
value) of $26.7 million at the end of 2003.
Before a substantial acquisition is made, after significant research
and analysis, we must be convinced that -- for an acceptable level of risk --
there is sufficient value to provide the opportunity for superior returns. We
also have a small portfolio of alternative investments where, in previous years,
we deviated from our traditional value criteria in an attempt to capitalize on
areas of potentially greater growth without incurring undue risk. Given the
higher level of risk, we committed smaller sums to the alternative investments.
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At December 31, 2003, the total after-tax carrying value of this portfolio was
less than $100,000.
During the late 1990's, the businesses we acquired were primarily
private companies and foreign public companies. During this period, we perceived
that acquisitions in these areas carried less downside risk and offered greater
upside potential than the acquisition opportunities available among publicly
traded companies in North America.
In the foreseeable future our acquisition efforts are likely to be
focused on domestic and foreign public companies, where we perceive greater
scope for value creation than with private companies.
INSURANCE OPERATIONS IN RUN OFF
This segment is comprised of Physicians Insurance Company of Ohio and
Citation Insurance Company.
PHYSICIANS INSURANCE COMPANY OF OHIO
Until 1995, Physicians and The Professionals Insurance Company
("Professionals") wrote medical professional liability insurance, mostly in the
state of Ohio.
Due to persistent uneconomic pricing by competitors, Physicians and
Professionals were unable to generate adequate premium volume in 1994 and the
early part of 1995. Faced with these market conditions, and the opportunity for
higher returns from activities other than medical professional liability
insurance, in 1995 we concluded that maximum value would be obtained by placing
Physicians in "run off." This means handling the claims arising from its
historical business, but not writing new business. In addition, the future book
of business -- essentially the opportunity to renew expiring policies -- was
sold for $6 million in cash.
After Physicians went into "run off", the company expanded its
insurance operations by acquisition:
- - in 1995, we purchased Sequoia Insurance Company, which primarily wrote
commercial lines of insurance in California and Nevada. After the
acquisition, we re-capitalized Sequoia, which provided the capital to
support growth in the book of business; and
- - in 1996, Physicians completed a reverse merger with the parent company
of Citation Insurance Company. In the past, Citation wrote various
lines of commercial property and casualty insurance and workers'
compensation insurance, primarily in California and Arizona.
Physicians and Citation obtain the funds to pay claims from the
maturity of fixed-income securities, the sale of investments, and collections
from reinsurance companies (that is, specialized insurance companies who share
in our claims risk).
Typically, most of the revenues of an insurance company in "run off"
come from investment income on funds held as part of the insurance business.
During the "run off" process, as claims are paid, both the loss reserve
liabilities and the corresponding investment portfolio assets decrease. Since
investment income in this segment will decline over time, we are attempting to
minimize segment overhead expenses as much as possible. For example, in recent
years we have reduced head count and office space. In 2001, Professionals merged
into Physicians, which simplified administration and reduced costs.
Although we regularly evaluate the strategic alternatives, we currently
believe that the most advantageous option is for Physicians' own claims
personnel to manage the "run off." We believe that this will ensure a high
standard of claims handling for our policyholders and, from the Company's
perspective, ensure the most careful examination of claims made to minimize loss
and loss adjustment expense payments. If we were to reinsure Physicians' entire
book of business and outsource claims handling, this would involve giving up
management of the corresponding investment assets.
Administering our own "run off" also provides us with the following
opportunities:
- - we retain management of the associated investment portfolios. After we
resumed direct management of our insurance company portfolios in 2000,
we believe that the return on our portfolio assets has been attractive
in absolute terms, and very competitive in relative terms. Since the
claims reserves of the "run off" insurance companies effectively
recognize the cost of paying and handling claims in future years, the
investment return on the corresponding investment assets, less
non-insurance expenses, will accrue to PICO. We aim to maximize this
source of income; and
- - to participate in favorable development in our claims reserves if there
is any, although this entails the corresponding risk that we could be
exposed to unfavorable development.
10
As the "run off" progresses, at an indeterminate time in the future Physicians'
claims reserves may diminish to the point where it is more cost-effective to
outsource claims handling to a third party administrator.
At December 31, 2003, Physicians had $19.6 million in medical
professional liability loss reserves, net of reinsurance.
CITATION INSURANCE COMPANY
In 1996, Physicians completed a reverse merger with Citation's parent
company. In the past, Citation wrote various lines of commercial property and
casualty insurance and workers' compensation insurance, primarily in California
and Arizona.
After the merger was completed, we identified redundancy between
Sequoia and Citation, and combined the operations of the two companies. After we
assumed management of Citation, we tightened underwriting standards
significantly and did not renew much of the business which Citation had written
previously. Eventually all business in California and Nevada was transitioned to
Sequoia, and at the end of 2000 Citation ceased writing business and went into
"run off."
Prior to the reverse merger, Citation had been a direct writer of
workers' compensation insurance. Since PICO did not wish to be exposed to that
line of business, shortly after the merger was completed Citation reinsured 100%
of its workers compensation business with a subsidiary, Citation National
Insurance Company ("CNIC"), and sold CNIC to Fremont Indemnity Company
("Fremont") in 1997. As part of the sale of CNIC, all assets and liabilities,
including the assets which corresponded to the workers' compensation reserves
reinsured with CNIC, and all records, computer systems, policy files, and
reinsurance arrangements were transferred to Fremont. Fremont merged CNIC into
Fremont, and administered and paid all of the workers' compensation claims which
had been sold to it. Since 1997, Citation has booked the losses reported by
Fremont, and recorded an equal and offsetting reinsurance recoverable from
Fremont, as an admitted reinsurer, for all losses and loss adjustment expenses.
This resulted in no net impact on Citation's reserves and financial statements,
and no net impact on PICO's consolidated financial statements.
On June 4, 2003, the California Department of Insurance obtained a
conservation order over Fremont, and applied for a court order to liquidate
Fremont. On July 2, 2003, the California Superior Court placed Fremont in
liquidation.
Since Fremont went into liquidation in July 2003, Fremont is no longer
an admitted reinsurance company under the statutory basis of insurance
accounting. Consequently, Citation reversed the $7.5 million reinsurance
recoverable from Fremont in both its statutory basis and GAAP basis financial
statements in the three months ended June 30, 2003, which is reflected in the
accompanying consolidated financial statements. Citation will make a claim to
recover deposits reported as held by Fremont for Citation's insureds; however,
the ultimate outcome cannot be accurately predicted. Citation is pursuing its
rights to recover the reinsurance, and to have the deposit assets returned to
Citation to utilize against the workers' compensation claims obligations.
At December 31, 2003, Citation had $23.8 million in loss reserves, net
of reinsurance. Citation's loss reserves consist of $13.3 million for property
and casualty insurance, principally in the artisans/contractors line of
business, and $10.5 million for workers' compensation insurance.
HYPERFEED TECHNOLOGIES, INC.
HyperFeed is a developer and provider of ticker plant technologies,
software, and managed services to the financial markets industry. HyperFeed is a
publicly traded company, based in Chicago, Illinois, and became a 51%-owned
subsidiary of PICO Holdings on May 15, 2003, when we acquired direct ownership
of a majority voting interest. HyperFeed became a separate reporting segment
from May 15, 2003. In previous years and in 2003 until May 15, HyperFeed was
part of the Business Acquisitions & Financing segment.
PICO first invested in HyperFeed in 1995 through the purchase of common
stock. We invested further capital as debt, which was later converted to equity,
and received warrants for providing financing. In 2000, 2001, and 2002, we
further increased our holding through open market purchases, the conversion of
preferred stock, and the exercise of warrants. On May 15, 2003, PICO purchased
an additional 443,622.9 HyperFeed common shares in a private placement for $1.2
million, or approximately $2.705 per share (adjusted for the August 2003 1:10
reverse stock split). PICO now owns 1,546,311.7 HyperFeed common shares,
representing a voting ownership of approximately 51%.
During 2002 and 2003, HyperFeed restructured its operations,
culminating in the sale of its consolidated market data feed customers to
Interactive Data Corporation for $8.5 million on October 31, 2003. The sale has
strengthened HyperFeed's balance sheet -- at December 31, 2003, HyperFeed had
$4.7 million in cash -- and is expected to significantly reduce overhead and
operating expenses.
11
DISCONTINUED OPERATIONS
SEQUOIA INSURANCE COMPANY
On March 31, 2003, we closed on the sale of Sequoia. The gross sale
proceeds were approximately $43.1 million, consisting of $25.2 million in cash
and a dividend of $17.9 million. The dividend included the common stocks
previously held in Sequoia's investment portfolio with a value of $16.4 million.
The common stocks included in the dividend primarily consisted of a number of
holdings in small-capitalization value stocks, which we believed were still
undervalued based on the private market value of the underlying assets,
earnings, and cash flow. These common stocks were added to the investment
portfolio of Physicians, which was Sequoia's direct parent company.
Physicians acquired Sequoia in 1995. Sequoia's core business was
property and casualty insurance in California and Nevada, focusing on the niche
markets of commercial insurance for small to medium-sized businesses and farm
insurance. Sequoia also wrote selected lines of personal insurance in
California. During the period of our ownership, Sequoia's management applied a
selective approach to underwriting, aiming to earn a profit from underwriting
(that is, a profit before investment income), and implemented numerous
initiatives to improve efficiency and reduce expenses. As a result, Sequoia
consistently had loss ratios and combined ratios better than the industry
averages. During 2000, 2001, and 2002, Sequoia generated increased average
premiums per commercial policy, and significant growth in its book of business,
with combined ratios of 106.3%, 105.4%, and 101.6%, in those respective years.
From April 1, 2000, when we resumed direct management of Sequoia's
investment portfolio, the company's portfolio of unaffiliated stocks, bonds, and
cash equivalents earned returns (that is, interest and dividend income plus
realized and unrealized gains, before fees and taxes) of approximately 6.1% in
the last nine months of 2000, 10.4% in 2001, 12.6% in 2002, and 2.5% in the
first three months of 2003.
Despite these factors, Sequoia continued to generate a return on
capital lower than our expectation, and we concluded that value would be
maximized by sale of the company, particularly given the increasingly
restrictive regulatory & rating environment, and the highly competitive
marketplace.
HYPERFEED TECHNOLOGIES, INC.
During 2003, HyperFeed completed the sale of two businesses, which are
now recorded as discontinued operations:
- its retail trading business, PCQuote.com, which was sold for
$370,000 in June 2003; and
- its consolidated market data feed customers, which were sold
to Interactive Data Corporation, for $8.5 million. HyperFeed
received $7 million in cash on closing, and can realize an
additional $1.5 million as milestones are met over two years.
EMPLOYEES
At December 31, 2003, PICO had 110 employees. A total of 11 employees
were engaged in land and related mineral rights and water rights operations; 5
in water rights and storage operations; 1 in property and casualty insurance
operations; 2 in medical professional liability operations; and 16 in holding
company activities. HyperFeed Technologies, Inc. has 64 employees, and SISCOM
Corporation has 11 employees.
EXECUTIVE OFFICERS
The executive officers of PICO are as follows:
Name Age Position
---- --- --------
Ronald Langley 59 Chairman of the Board, Director
John R. Hart 44 President, Chief Executive Officer and Director
Richard H. Sharpe 48 Chief Operating Officer
James F. Mosier 56 General Counsel and Secretary
Maxim C. W. Webb 42 Chief Financial Officer and Treasurer
W. Raymond Webb 42 Vice President, Investments
John T. Perri 34 Vice President, Finance
Except for Maxim C. W. Webb, W. Raymond Webb and John T. Perri, each
executive officer of PICO was an executive officer of Physicians prior to the
1996 merger between Physicians Insurance Company of Ohio and Citation Insurance
Group, the
12
predecessors to PICO Holdings, Inc. Each became an officer of PICO in November
1996 as a result of the merger. Maxim C. W. Webb was an officer of Global Equity
Corporation and became an officer of PICO upon the effective date of the
PICO/Global Equity Corporation Combination in December 1998. W. Raymond Webb and
John T. Perri were elected as officers of PICO in April 2003.
Mr. Langley has been Chairman of the Board of PICO since November 1996
and of Physicians since July 1995. Mr. Langley has been a Director of PICO since
November 1996 and a Director of Physicians since 1993. Mr. Langley has been a
Director of HyperFeed Technologies, Inc., formerly, PC Quote, Inc. ("HyperFeed")
since 1995 and a Director of Jungfraubahn Holding AG since 2000.
Mr. Hart has been President and Chief Executive Officer of PICO since
November 1996 and of Physicians since July 1995. Mr. Hart has been a Director of
PICO since November 1996 and a Director of Physicians since 1993. Mr. Hart has
been a Director of HyperFeed since 1997, and a Director of SISCOM Corporation
and its predecessor company since November 1996.
Mr. Sharpe has served as Chief Operating Officer of PICO since November
1996, and in various executive capacities since joining Physicians in 1977.
Mr. Mosier has served as General Counsel and Secretary of PICO since
November 1996 and of Physicians since October 1984 and in various other
executive capacities since joining Physicians in 1981.
Mr. Maxim Webb has been Chief Financial Officer and Treasurer of PICO
since May 14, 2001. Mr. Webb served in various capacities with the Global Equity
Corporation group of companies since 1993, including Vice President, Investments
of Forbes Ceylon Limited from 1994 through 1996. Mr. Webb became an officer of
Global Equity Corporation in November 1997 and Vice President, Investments of
PICO on November 20, 1998.
Mr. Raymond Webb has been with the Company since August 1999 as Chief
Investment Analyst and became Vice President, Investments in April 2003.
Mr. Perri has been Vice President, Finance of PICO since August 2003
and served in various capacities since joining the Company in 1998, including
Financial Reporting Manager and Corporate Controller.
RISK FACTORS
In addition to the risks and uncertainties discussed in certain
sections of "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in Item 7 and elsewhere in this document, the following
risk factors should be considered carefully in evaluating PICO and its business.
The statements contained in this Form 10-K that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Exchange
Act, including statements regarding our expectations, beliefs, intentions, plans
or strategies regarding the future. All forward-looking statements included in
this document are based on information available to us on the date thereof, and
we assume no obligation to update any such forward-looking statements.
BECAUSE OUR OPERATIONS ARE DIVERSE, ANALYSTS AND INVESTORS MAY NOT BE ABLE TO
EVALUATE OUR COMPANY ADEQUATELY, WHICH MAY NEGATIVELY INFLUENCE OUR SHARE PRICE
PICO is a diversified holding company with operations in land and
related water rights and mineral rights; water rights and water storage;
insurance operations in run-off; and business acquisitions and financing. Each
of these areas is unique, complex in nature, and difficult to understand. In
particular, the water resource business is a developing industry within the
western United States with very little historical data, very few experts and a
limited following of analysts. Because we are complex, analysts and investors
may not be able to adequately evaluate our operations, and PICO in total. This
could cause them to make inaccurate evaluations of our stock, or to overlook
PICO, in general. These factors could have a negative impact on the trading
volume and price of our stock.
IF WE DO NOT SUCCESSFULLY LOCATE, SELECT AND MANAGE INVESTMENTS AND ACQUISITIONS
OR IF OUR INVESTMENTS OR ACQUISITIONS OTHERWISE FAIL OR DECLINE IN VALUE, OUR
FINANCIAL CONDITION COULD SUFFER
We invest in businesses that we believe are undervalued or that will
benefit from additional capital, restructuring of operations or improved
competitiveness through operational efficiencies.
13
Failures and/or declines in the market values of businesses we invest
in or acquire, as well as our failure to successfully locate, select and manage
investment and acquisition opportunities, could have a material adverse effect
on our business, financial condition, the results of operations and cash flows.
Such business failures, declines in market values, and/or failure to
successfully locate, select and manage investments and acquisitions could result
in inferior investment returns compared to those which may have been attained
had we successfully located, selected and managed new investments and
acquisition opportunities, or had our investments or acquisitions not failed or
declined in value. We could also lose part or all of our capital these
businesses and experience reductions in our net income, cash flows, assets and
shareholders' equity.
We will continue to make selective acquisitions, and endeavor to
enhance and realize additional value to these acquired companies through our
influence and control. This could involve the restructuring of the financing or
management of the entities in which we invest and initiating and facilitating
mergers and acquisitions. Any acquisition could result in the use of a
significant portion of our available cash, significant dilution to you, and
significant acquisition-related charges. Acquisitions may also result in the
assumption of liabilities, including liabilities that are unknown or not fully
known at the time of the acquisition, which could have a material adverse effect
on us.
We do not know of any reliable statistical data that would enable us to
predict the probability of success or failure of our acquisitions and
investments, or to predict the availability of suitable investments at the time
we have available cash. You will be relying on the experience and judgment of
management to locate, select and develop new acquisition and investment
opportunities. Sufficient opportunities may not be found and this business
strategy may not be successful. We have made a number of acquisitions in the
past that have been highly successful and we have also made acquisitions that
have lost money. Further details of realized and unrealized gains and losses can
be found in the Notes 1, 2, 3 and 4 to the accompanying consolidated financial
statements and in Item 7A in this Form 10-K.
Our ability to achieve an acceptable rate of return on any particular
investment is subject to a number of factors which are beyond our control,
including increased competition and loss of market share, quality of management,
cyclical or uneven financial results, technological obsolescence, foreign
currency risks and regulatory delays.
Our acquisitions may not achieve acceptable rates of return and we may
not realize the value of the funds invested; accordingly, these investments may
have to be written down or sold at their then-prevailing market values.
We may not be able to sell our investments in both private and public
companies when it appears to be advantageous to do so and we may have to sell
these investments at a discount. Investments in private companies are not as
marketable as investments in public companies. Investments in public companies
are subject to prices determined in the public markets and, therefore, values
can vary dramatically. In particular, the ability of the public markets to
absorb a large block of shares offered for sale can affect our ability to
dispose of an investment in a public company.
We may acquire shares of stock in U.S. public companies that are not
registered with the SEC, and we may not be able to register the stock during our
period of ownership. Accordingly, this may affect our ability to dispose of an
investment in a public company or achieve the full market price quoted by the
stock exchange that the particular stock is listed on.
To successfully manage newly acquired companies, we must, among other
things, continue to attract and retain key management and other personnel. The
diversion of the attention of management from the day-to-day operations, or
difficulties encountered in the integration process, could have a material
adverse effect on our business, financial condition, and the results of
operations and cash flows.
WE MAY MAKE INVESTMENTS AND ACQUISITIONS THAT MAY YIELD LOW OR NEGATIVE RETURNS
FOR AN EXTENDED PERIOD OF TIME, WHICH COULD TEMPORARILY OR PERMANENTLY DEPRESS
OUR RETURN ON INVESTMENTS
We generally make investments and acquisitions that tend to be long
term in nature. We acquire businesses that we believe to be undervalued or may
benefit from additional capital, restructuring of operations or management or
improved competitiveness through operational efficiencies with our existing
operations. We may not be able to develop acceptable revenue streams and
investment returns. We may lose part or all of our investment in these assets.
The negative impacts on cash flows, income, assets and shareholders' equity may
be temporary or permanent. We make investments for the purpose of enhancing and
realizing additional value by means of appropriate levels of shareholder
influence and control. This may involve restructuring of the financing or
management of the entities in which we invest and initiating or facilitating
mergers and acquisitions. These processes can consume considerable amounts of
time and resources. Consequently, costs incurred as a result of these
investments and acquisitions may exceed their revenues and/or increases in their
values for an extended period of time until we are able to develop the potential
of these
14
investments and acquisitions and increase the revenues, profits and/or values of
these investments. Ultimately, however, we may not be able to develop the
potential of these assets that we originally anticipated.
IF WE UNDERESTIMATE THE AMOUNT OF INSURANCE CLAIMS, OUR FINANCIAL CONDITION
COULD BE MATERIALLY MISSTATED AND OUR FINANCIAL CONDITION COULD SUFFER
Our insurance subsidiaries may not have established reserves adequate
to meet the ultimate cost of losses arising from claims. It has been, and will
continue to be, necessary for our insurance subsidiaries to review and make
appropriate adjustments to reserves for claims and expenses for settling claims.
Inadequate reserves could have a material adverse effect on our business,
financial condition, and the results of operations and cash flows. Inadequate
reserves could cause our financial condition to fluctuate from period to period
and cause our financial condition to appear to be better than it actually is for
periods in which insurance claims reserves are understated. In subsequent
periods when we discover the underestimation and pay the additional claims, our
cash needs will be greater than expected and our financial results of operations
for that period will be worse than they would have been had our reserves been
accurately estimated originally.
The inherent uncertainties in estimating loss reserves are greater for
some insurance products than for others, and are dependent on:
- - the length of time in reporting claims;
- - the diversity of historical losses among claims;
- - the amount of historical information available during the estimation
process;
- - the degree of impact that changing regulations and legal precedents may
have on open claims; and
- - the consistency of reinsurance programs over time.
Because medical malpractice liability and commercial casualty claims
may not be completely paid off for several years, estimating reserves for these
types of claims can be more uncertain than estimating reserves for other types
of insurance. As a result, precise reserve estimates cannot be made for several
years following the year for which reserves were initially established.
During the past several years, the levels of the reserves for our
insurance subsidiaries have been very volatile. We have had to significantly
increase and decrease these reserves in the past several years.
Furthermore, we have reinsurance agreements on all of our insurance
books of business with reinsurance companies. We base the level of reinsurance
purchased on our direct reserves on our assessment of the overall direct
underwriting risk.
We attempt to ensure that we have acceptable net risk, but it is
possible that we may underestimate the amount of reinsurance required to achieve
the desired level of net claims risk.
In addition, while we carefully review the creditworthiness of the
companies we have reinsured part, or all, of our initial direct underwriting
risk with, our reinsurers could default on amounts owed to us for their portion
of the direct insurance claim. Our insurance subsidiaries, as direct writers of
lines of insurance, have ultimate responsibility for the payment of claims, and
any defaults by reinsurers may result in our established reserves not being
adequate to meet the ultimate cost of losses arising from claims.
Significant increases in the reserves may be necessary in the future,
and the level of reserves for our insurance subsidiaries may be volatile in the
future. These increases or volatility may have an adverse effect on our
business, financial condition, and the results of operations and cash flows.
STATE REGULATORS COULD REQUIRE CHANGES TO OUR CAPITALIZATION AND/OR TO THE
OPERATIONS OF OUR INSURANCE SUBSIDIARIES, AND/OR PLACE THEM INTO REHABILITATION
OR LIQUIDATION
Beginning in 1994, Physicians and Citation became subject to the
provisions of the Risk-Based Capital for Insurers Model Act which has been
adopted by the National Association of Insurance Commissioners for the purpose
of helping regulators identify insurers that may be in financial difficulty. The
Model Act contains a formula which takes into account asset risk, credit risk,
underwriting risk and all other relevant risks. Under this formula, each insurer
is required to report to regulators using formulas which measure the quality of
its capital and the relationship of its modified capital base to the level of
risk assumed in specific aspects of its operations. The formula does not address
all of the risks associated with the operations of an insurer. The formula is
intended to provide a minimum threshold measure of capital adequacy by
individual insurance company and does not purport to compute a target level of
capital. Companies which fall below the threshold will be placed into one of
four categories: Company Action Level, where the insurer must submit a plan of
corrective action; Regulatory Action Level, where the insurer must submit such a
plan of corrective
15
action, the regulator is required to perform such examination or analysis the
Superintendent of Insurance considers necessary and the regulator must issue a
corrective order; Authorized Control Level, which includes the above actions and
may include rehabilitation or liquidation; and Mandatory Control Level, where
the regulator must rehabilitate or liquidate the insurer. All companies'
risk-based capital results as of December 31, 2002 exceed the Company Action
Level.
IF WE ARE REQUIRED TO REGISTER AS AN INVESTMENT COMPANY, THEN WE WILL BE SUBJECT
TO A SIGNIFICANT REGULATORY BURDEN
At all times we intend to conduct our business so as to avoid being
regulated as an investment company under the Investment Company Act of 1940.
However, if we were required to register as an investment company, our ability
to use debt would be substantially reduced, and we would be subject to
significant additional disclosure obligations and restrictions on our
operational activities. Because of the additional requirements imposed on an
investment company with regard to the distribution of earnings, operational
activities and the use of debt, in addition to increased expenditures due to
additional reporting responsibilities, our cash available for investments would
be reduced. The additional expenses would reduce income. These factors would
adversely affect our business, financial condition, and the results of
operations and cash flows.
VARIANCES IN PHYSICAL AVAILABILITY OF WATER, ALONG WITH ENVIRONMENTAL AND LEGAL
RESTRICTIONS AND LEGAL IMPEDIMENTS, COULD IMPACT PROFITABILITY FROM OUR WATER
RIGHTS
The water rights held by us and the transferability of these rights to
other uses and places of use are governed by the laws concerning water rights in
the states of Arizona, Colorado and Nevada. The volumes of water actually
derived from the water rights applications or permitted rights may vary
considerably based upon physical availability and may be further limited by
applicable legal restrictions. As a result, the amounts of acre-feet anticipated
from the water rights applications or permitted rights do not in every case
represent a reliable, firm annual yield of water, but in some cases describe the
face amount of the water right claims or management's best estimate of such
entitlement. Legal impediments may exist to the sale or transfer of some of
these water rights, which in turn may affect their commercial value. If we were
unable to transfer or sell our water rights, we will not be able to make a
profit, we will not have enough cash receipts to cover cash needs, and we may
lose some or all of our value in our water rights acquisitions.
Water we lease or sell may be subject to regulation as to quality by
the United States Environmental Protection Agency acting pursuant to the federal
Safe Drinking Water Act. While environmental regulations do not directly affect
us, the regulations regarding the quality of water distributed affects our
intended customers and may, therefore, depending on the quality of our water,
impact the price and terms upon which we may in the future sell our water
rights.
OUR FUTURE WATER REVENUES ARE UNCERTAIN AND DEPEND ON A NUMBER OF FACTORS, WHICH
MAY MAKE OUR REVENUE STREAMS AND PROFITABILITY VOLATILE
We engage in various water rights acquisition, management, development,
and sale and lease activities. Accordingly, our long-term future profitability
will be primarily dependent on our ability to develop and sell or lease water
and water rights, and will be affected by various factors, including timing of
acquisitions, transportation arrangements, and changing technology. To the
extent we possess junior or conditional water rights, such rights may be
subordinated to superior water right holders in periods of low flow or drought.
In addition to the risk of delays associated with receiving all
necessary regulatory approvals and permits, we may also encounter unforeseen
technical difficulties which could result in construction delays and cost
increases with respect to our water and water storage development projects.
Our profitability is significantly affected by changes in the market
price of water. In the future, water prices may fluctuate widely as demand is
affected by climatic, demographic and technological factors.
OUR WATER ACTIVITIES MAY BECOME CONCENTRATED IN A LIMITED NUMBER OF ASSETS,
MAKING OUR GROWTH AND PROFITABILITY VULNERABLE TO FLUCTUATIONS IN LOCAL
ECONOMIES AND GOVERNMENTAL REGULATIONS
In the future, we anticipate that a significant amount of Vidler's
revenues and asset value will come from a limited number of assets, including
our water rights in the Harquahala Valley and the Vidler Arizona Recharge
Facility. Although we continue to acquire and develop additional water assets,
in the foreseeable future we anticipate that our revenues will still be derived
from a limited number of assets.
16
OUR WATER SALES MAY MEET WITH POLITICAL OPPOSITION IN CERTAIN LOCATIONS, THEREBY
LIMITING OUR GROWTH IN THESE AREAS
The transfer of water rights from one use to another may affect the
economic base of a community and will, in some instances, be met with local
opposition. Moreover, certain of the end users of our water rights, namely
municipalities, regulate the use of water in order to control or deter growth.
WE ARE DIRECTLY IMPACTED BY INTERNATIONAL AFFAIRS, WHICH DIRECTLY EXPOSES US TO
THE ADVERSE EFFECTS OF ANY FOREIGN ECONOMIC OR GOVERNMENTAL INSTABILITY
As a result of global investment diversification, our business,
financial condition, the results of operations and cash flows may be adversely
affected by:
- - exposure to fluctuations in exchange rates;
- - the imposition of governmental controls;
- - the need to comply with a wide variety of foreign and U.S. export laws;
- - political and economic instability;
- - trade restrictions;
- - changes in tariffs and taxes;
- - volatile interest rates;
- - changes in certain commodity prices;
- - exchange controls which may limit our ability to withdraw money;
- - the greater difficulty of administering business overseas; and
- - general economic conditions outside the United States.
Changes in any or all of these factors could result in reduced market
values of investments, loss of assets, additional expenses, reduced investment
income, reductions in shareholders' equity due to foreign currency fluctuations
and a reduction in our global diversification.
OUR COMMON STOCK PRICE MAY BE LOW WHEN YOU WANT TO SELL YOUR SHARES
The trading price of our common stock has historically been, and is
expected to be, subject to fluctuations. The market price of the common stock
may be significantly impacted by:
- - quarterly variations in financial performance and condition;
- - shortfalls in revenue or earnings from levels forecast by securities
analysts;
- - changes in estimates by such analysts;
- - product introductions;
- - our competitors' announcements of extraordinary events such as
acquisitions;
- - litigation; and
- - general economic conditions.
Our results of operations have been subject to significant
fluctuations, particularly on a quarterly basis, and our future results of
operations could fluctuate significantly from quarter to quarter and from year
to year. Causes of such fluctuations may include the inclusion or exclusion of
operating earnings from newly acquired or sold operations. At December 31, 2003,
the closing price of our common stock on the NASDAQ National Market was $15.67
per share, compared to $12.50 at December 31, 2001. On a quarterly basis between
these two dates, closing prices have ranged from a high of $16.17 to a low of
$8.33.
Statements or changes in opinions, ratings, or earnings estimates made
by brokerage firms or industry analysts relating to the markets in which we do
business or relating to us specifically could result in an immediate and adverse
effect on the market price of our common stock.
WE MAY NOT BE ABLE TO RETAIN KEY MANAGEMENT PERSONNEL WE NEED TO SUCCEED, WHICH
COULD ADVERSELY AFFECT OUR ABILITY TO MAKE SOUND INVESTMENT DECISIONS
We have several key executive officers. If they depart, it could have a
significant adverse effect. Messrs. Langley and Hart, our Chairman and CEO,
respectively, are key to the implementation of our strategic focus, and our
ability to successfully develop our current strategy is dependent upon our
ability to retain the services of Messrs. Langley and Hart.
17
New employment agreements were entered into with Mr. Langley and Mr.
Hart on January 1, 2002 for a further four years. (See Part II, Item 8, Note 15,
"Related-Party Transactions").
MANAGEMENT'S USE OF JUDGMENT IN PREPARING FINANCIAL STATEMENTS IN ACCORDANCE
WITH ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES OF AMERICA.
The preparation our financial statements in conformity with U.S GAAP
requires management to make estimates, judgments and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent liabilities
at the date of financial statements and the reported amount of revenues and
expenses during the reporting period. We regularly evaluate our estimates, which
are based on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. The result of these
evaluations forms the basis for making judgments about the carrying values of
assets and liabilities and the reported amount of revenues and expenses that are
not readily apparent from other sources. The carrying values of assets and
liabilities and the reported amount of revenues and expenses may differ by using
different assumptions. In addition, in future periods, in order to incorporate
all known experience at that time, we may have to revise assumptions previously
made which may change the value of previously reported assets and liabilities.
This potential subsequent change in value may have a material adverse effect on
our business, financial condition, and the results of operations and cash flows.
See "Critical Accounting Policies" in Item 7.
COMMON STOCK TRANSACTIONS
Our Board of Directors has authorized the repurchase of up to $10
million of our common stock. The stock purchases may be made from time to time
at prevailing prices though open market, or negotiated transactions, depending
on market conditions, and will be funded from available cash resources of the
company. Such a repurchase program may have an impact on our cash flows. (Refer
to our Liquidity and Capital Resources in Item 7).
FUTURE CHANGES IN FINANCIAL ACCOUNTING STANDARDS MAY CAUSE ADVERSE UNEXPECTED
REVENUE FLUCTUATIONS AND AFFECT OUR REPORTED RESULTS OF OPERATIONS.
A change in accounting standards could have a significant effect on our
reported results and may even affect our reporting transactions completed before
the change is effective. New accounting pronouncements and varying
interpretations of pronouncements have occurred and may occur in the future.
Changes to existing rules or the questioning of current practices may adversely
affect our reported financial results of the way we conduct our business.
COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC
DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES.
Changing laws, regulations and standards relating to corporate
governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new
SEC regulations and NASDAQ Stock Market rules, are creating uncertainty for
companies such as ours. We are committed to maintaining high standards of
corporate governance and public disclosure. As a result, we intend to invest all
reasonably necessary resources to comply with evolving standards, and this
investment may result in increased general and administrative expenses and a
diversion of management time and attention from revenue-generating activities to
compliance activities.
ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO INVESTORS.
Some investors favor companies that pay dividends, particularly in
market downturns. We have never declared or paid any cash dividends on our
common stock. We currently intend to retain any future earnings for funding
growth and, therefore, we do not currently anticipate paying cash dividends on
our common stock.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE TO FUND THE GROWTH OF OUR BUSINESS,
AND FINANCING MAY NOT BE AVAILABLE.
We currently anticipate that our available capital resources and
operating income will be sufficient to meet our expected working capital and
capital expenditure requirements for at least the next 12 months. However, we
cannot assure you that such resources will be sufficient to fund the long-term
growth of our business. We may raise additional funds through public or private
debt or equity financings if such financings become available on favorable
terms, but such financing may dilute our stockholders. We cannot assure you that
you that any additional financing we need will be available on terms favorable
to us, or at all. If adequate funds are not available or are not available on
acceptable terms, we may not be able to take advantage of unanticipated
opportunities or otherwise respond to competitive pressures. In any such case,
our business, operating results or financial condition could be materially
adversely affected.
18
LITIGATION MAY HARM OUR BUSINESS OR OTHERWISE DISTRACT OUR MANAGEMENT.
Substantial, complex or extended litigation could cause us to incur
large expenditures and distract our management. For example, lawsuits by
employees, stockholders or customers could be very costly and substantially
disrupt our business. Disputes from time to time with such companies or
individuals are not uncommon, and we cannot assure that that we will always be
able to resolve such disputes out of court or on terms favorable to us.
THE FOREGOING FACTORS, INDIVIDUALLY OR IN AGGREGATE, COULD MATERIALLY ADVERSELY
AFFECT OUR OPERATING RESULTS AND CASH FLOWS AND FINANCIAL CONDITION AND COULD
MAKE COMPARISON OF HISTORIC OPERATING RESULTS AND CASH FLOWS AND BALANCES
DIFFICULT OR NOT MEANINGFUL.
ITEM 2. PROPERTIES
PICO leases approximately 6,354 square feet in La Jolla, California for
its principal executive offices.
Physicians leases approximately 1,892 square feet of office space in
Columbus, Ohio for its headquarters. Citation leases office space for a claims
office in Orange County, California. Vidler and Nevada Land lease office space
in Carson City, Nevada. Vidler and Nevada Land hold significant investments in
land, water rights and mineral rights in the southwestern United States. We
continually evaluate our current and future space capacity in relation to our
business needs. We believe that our existing facilities are suitable and
adequate to meet our current business requirements. See "Item
1-Business-Introduction."
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various litigation that arises in the
ordinary course of its business. Members of PICO's insurance group are
frequently a party in claims proceedings and actions regarding insurance
coverage, all of which PICO considers routine and incidental to its business.
Based upon information presently available, management is of the opinion that
such litigation will not have a material adverse effect on the consolidated
financial position, the results of operations or cash flows of the Company.
Neither PICO nor its subsidiaries are parties to any potential material pending
legal proceedings other than the following:
In 2000, PICO Holdings loaned a total of $2.2 million to Dominion
Capital Pty. Ltd. ("Dominion Capital"), a private Australian company. In 2001,
$1.2 million of the loans became past due. Negotiations between PICO and
Dominion Capital to reach a settlement agreement on both the overdue loan of
$1.2 million and the other loan of $1 million proved unsuccessful. Accordingly,
PICO commenced legal actions through the Australian courts against Dominion
Capital to recover the total amount due to PICO Holdings. Due to the inherent
uncertainty involved in pursuing a legal action and our ability to realize the
assets collateralizing the loans, PICO recorded an allowance for the total
outstanding balance of $2.3 million for the loans and interest. PICO has been
awarded summary judgment in relation to the principal and interest on the $1.2
million loan and, as a result, Dominion Capital has been placed in receivership.
A trial was held in July 2003 concerning both loans, and the Company is awaiting
judgment from the Australian courts.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders
during the fourth quarter of 2003.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of PICO is traded on the NASDAQ National Market under
the symbol "PICO." The following table sets out the high and low daily closing
sale prices as reported on the NASDAQ National Market. These reported prices
reflect inter-dealer prices without adjustments for retail markups, markdowns or
commissions.
2003 2002
-------------------------- ------------------------
High Low High Low
------- ------- ------- -------
1st Quarter $ 14.39 $ 12.01 $ 15.69 $ 12.57
2nd Quarter $ 14.37 $ 12.78 $ 17.42 $ 13.41
3rd Quarter $ 14.04 $ 12.83 $ 16.42 $ 11.00
4th Quarter $ 16.17 $ 13.10 $ 13.80 $ 8.33
On March 5, 2004, the closing sale price of PICO's common stock was
$16.57 and there were 770 holders of record.
PICO has not declared or paid any dividends in the last two years, and
does not expect to pay any dividends in the foreseeable future.
EQUITY COMPENSATION PLAN INFORMATION
On July 17, 2003, the Company's shareholders approved the PICO
Holdings, Inc. 2003 Stock Appreciation Rights ("SAR") program, which replaced
the stock option and call option programs previously in place. The stock options
and call options held by directors, employees, and consultants were surrendered
and, after shareholders' approval, replaced with SAR with the same exercise
price. There are now no stock options or call options outstanding.
All SAR are fully vested; however, a holder may only exercise a maximum
of 20% of the SAR initially received in any twelve month period, except with the
permission of the Company's Compensation Committee. When a SAR is exercised, the
holder will receive a cash payment equal to the difference between the market
value of the underlying stock and the exercise price of the SAR. No shares of
stock are issued.
We believe that the accounting treatment for SAR is more transparent
than for stock options. The change in the "in the money" amount (i.e., the
difference between the market value of PICO stock and the exercise price of the
SAR) of SAR outstanding during each accounting period is recorded through the
consolidated statements of operations. An increase in the "in the money" amount
of SAR is recorded as an expense, and a decrease in the "in the money" amount of
SAR will be recorded as a reduction in expenses. Previously, we disclosed the
fair value of outstanding stock options but, in accordance with GAAP, we did not
expense this value in our statement of operations.
For 2003, a total expense of $6 million before taxes for SAR was
recorded, based on the last sale price of $15.67 for PICO stock on December 31,
2003. This consists of a $3.5 million charge on the initial adoption of the SAR
program on July 17, 2003, and a $2.5 million expense to record the increase in
the "in the money" amount of SAR during the period from the adoption of the SAR
Program through the end of 2003. The $3.5 million pre-tax charge was one-time in
nature, as it expensed the "in the money" amount of SAR outstanding from the
date that the call options and stock options converted to SAR were originally
issued, through to July 17, 2003. After the related tax effect, the 2003 SAR
expense reduced book value per share by approximately 1.7% as of December 31,
2003.
The Company has a total of 1,962,781 SAR outstanding, with a weighted
average exercise price of $12.63. Of this total, 1,927,781 SAR, with a weighted
average exercise price of $12.59, were granted to the Company's officers. A
total of 80,000 SAR remain available for issuance.
20
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
NUMBER OF SECURITIES TO REMAINING AVAILABLE FOR
BE ISSUED UPON WEIGHTED-AVERAGE EXERCISE FUTURE ISSUANCE UNDER
EXERCISE OF OUTSTANDING PRICE OF OUTSTANDING EQUITY COMPENSATION PLANS
OPTIONS, WARRANTS AND OPTIONS, WARRANTS AND (EXCLUDING SECURITIES
PLAN CATEGORY RIGHTS BY OFFICERS RIGHTS GRANTED TO OFFICERS REFLECTED IN COLUMN (a)
- ------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved
by security holders.(1) - - -
Equity compensation plans not
approved by security holders.(2) - - 34,262
- ------------------------------------------------------------------------------------------------------------------
Total - - 34,262
- ------------------------------------------------------------------------------------------------------------------
(1) On July 17, 2003 the Company's shareholders voted to adopt the PICO
Holdings, Inc. 2003 Stock Appreciation Rights Program (the "SAR
Program") to replace the Company's stock option plans and call option
agreements. The maximum number of SARs issuable under the SAR program
may not exceed 2,042,781. 1,962,781 SARs were issued to the prior
option holders upon adoption of the SAR program at an exercise price
equal to that of the surrendered options (weighted average exercise
price is $12.63). Upon exercise of the SAR, the holder is entitled to a
cash benefit equal to the difference between the exercise price and the
then current market price of PICO stock. Accordingly, no securities,
options or warrants will be issued by the Company on any exercise of
the SAR. (See Stock-Based Compensation section in Note 1 to the
Company's consolidated financial statements "Nature of Operations and
Significant Accounting Policies")
(2) The Directors' and Officers Deferred Compensation Arrangements are
described in Note 15 to the Company's notes to the consolidated
financial statements. ("Related-Party Transactions")
ITEM 6. SELECTED FINANCIAL DATA
The following table presents the Company's selected consolidated
financial data. The information set forth below is not necessarily indicative of
the results of future operations and should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this Form 10-K and the consolidated financial
statements and the related notes thereto included elsewhere in this document.
Year Ended December 31,
--------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- ----------
(In thousands, except share data)
OPERATING RESULTS
Revenues:
Premium income earned (charged) $ (42) $ 980 $ 1,695 $ 19,447
Net investment income (loss) $ 8,116 9,595 1,161 (1,694) 4,024
Sale of land, water and minerals 19,751 15,232 17,106 5,478 6,082
Other income 5,011 4,489 4,313 4,200 5,119
----------- ----------- ----------- ----------- ----------
Total revenues $ 32,878 $ 29,274 $ 23,560 $ 9,679 $ 34,672
=========== =========== =========== =========== ==========
Income (loss) before discontinued
operations, extraordinary gain and
cumulative effect of change in accounting principle $ (13,736) $ 1,110 $ 3,778 $ (7,290) $ (11,559)
Income from discontinued operations, net 10,498 2,834 2,317 953 1,377
Extraordinary gain, net 442
Cumulative effect of change in accounting principles, net 1,985 (981) (4,964)
----------- ----------- ----------- ----------- ----------
Net income (loss) $ (3,238) $ 5,929 $ 5,114 $ (11,301) $ (9,740)
=========== =========== =========== =========== ==========
PER COMMON SHARE BASIC AND DILUTED:
Income (loss) from continuing operations $ (1.11) $ 0.09 $ 0.30 $ (0.63) $ (1.28)
Income from discontinued operations 0.85 0.23 0.19 0.08 0.15
Extraordinary gain, net of tax 0.05
Cumulative effect of change in accounting principle 0.16 (0.08) (0.43)
----------- ----------- ----------- ----------- ----------
Net income (loss) $ (0.26) $ 0.48 $ 0.41 $ (0.97) $ (1.08)
=========== =========== =========== =========== ==========
Weighted Average Shares Outstanding 12,375,933 12,375,466 12,384,682 11,604,120 8,998,442
=========== =========== =========== =========== ==========
21
Year Ended December 31
----------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(In thousands, except per share data)
FINANCIAL CONDITION
Assets (1) $ 330,078 $ 265,587 $ 270,742 $ 295,682 $ 289,004
Unpaid losses and loss adjustment expenses,
net of discount, 1999 and prior (1) $ 60,864 $ 52,703 $ 61,538 $ 84,384 $ 99,719
Bank and other borrowings (1) $ 15,377 $ 14,636 $ 14,596 $ 15,550 $ 15,705
Discontinued operations, net $ (1,351) $ 37,332 $ 33,266 $ 29,255 $ 27,149
Total liabilities and minority interest (1) $ 99,566 $ 81,888 $ 96,110 $ 122,802 $ 146,648
Shareholders' equity $ 229,160 $ 221,032 $ 207,899 $ 202,105 $ 169,506
Book value per share $ 18.52 $ 17.86 $ 16.81 $ 16.31 $ 18.72
Note: Book value per share is computed by dividing shareholders' equity by
the net of total shares issued less shares held as treasury shares.
(1) Excludes balances classified as discontinued operations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The consolidated financial statements and other portions of this Annual Report
on Form 10-K for the fiscal year ended December 31, 2003, including Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," reflect the effects of:
(1) presenting Sequoia Insurance Company and two businesses sold by
HyperFeed Technologies, Inc. as discontinued operations. See Note 2 of
Notes to Consolidated Financial Statements, "Discontinued Operations";
and
(2) presenting HyperFeed Technologies, Inc. as a separate segment beginning
May 15, 2003. See Note 4 of Notes To Consolidated Financial Statements,
"Consolidation of HyperFeed Technologies, Inc."
COMPANY SUMMARY, RECENT DEVELOPMENTS, AND FUTURE OUTLOOK
VIDLER WATER COMPANY, INC.
BACKGROUND
We believe that continuing trends in Nevada and Arizona indicate strong
future demand for Vidler's water rights and water storage assets.
Based on figures prepared by the Nevada State Demographer, in the year
ended July 2003, the population of Clark County, Nevada, which includes
metropolitan Las Vegas, increased 4.6% to more than 1.6 million residents.
Around 70,000 people are moving to the area annually. Currently Las Vegas takes
most of its water supply from Lake Mead. Due to the continued growth in demand
for water and 5 years of drought, the level of Lake Mead has reached 50 year
lows. Accordingly, Las Vegas is aggressively seeking to conserve water (e.g.,
rules have been introduced restricting water use in new homes) and to diversify
its sources of water supply. At the same time, the increasing cost of housing in
Las Vegas is leading to more rapid growth in outlying areas within commuting
distance.
Over time, we believe that these factors will lead to demand for water
in parts of southern Nevada where Vidler owns or has an interest in water
rights, including Sandy Valley and Muddy River in Clark County, and southern
Lincoln County. If growth management initiatives are introduced in Las Vegas,
these will lead to even more rapid growth in the areas surrounding metropolitan
Las Vegas.
22
In Arizona, the continued growth of the municipalities surrounding
Phoenix in Maricopa County is likely to lead to strong demand for Vidler's water
rights in the Harquahala Valley. The Arizona State Demographer estimates that
the population of Maricopa County increased 10.6% in the 3.25 years from April
1, 2000 until July 1, 2003, to almost 3.4 million residents. Many municipalities
surrounding Phoenix/Scottsdale do not receive allotments of water from the
Colorado River, and are therefore forced to find alternative supplies of water.
Due to the low level of Lake Mead, the states of Arizona, California,
and Nevada may be required to take no more than their current allotments of
water from the Colorado River. This is likely to increase demand for the net
recharge credits owned by Vidler, representing water which Vidler has in storage
in its Arizona Recharge Facility. We also anticipate demand from developers and
other entities to store water for various purposes, including back-up water
supply for dry years by developers, and assured water supply for new development
projects.
The Central Arizona Water Conservation District ("CAWCD") is a
three-county water district servicing the most populous parts of the state,
including Maricopa County. A recent CAWCD study predicted that CAWCD will be
able to use 9 million acre-feet of water from Arizona's Colorado River supplies
in the years from 2004 through 2050, assuming average annual precipitation. The
CAWCD also estimated that 8.6 million acre-feet will be required over the same
period by the Central Arizona Groundwater Replenishment District, the authority
responsible for protecting groundwater supplies in the CAWCD three-county
service area. The CAWCD also estimated demand of 3.5 million acre-feet from the
Arizona Water Bank for various purposes (e.g., use in Nevada), and a further 4.3
million acre-feet to replenish groundwater reserves. Based on these forecasts,
Arizona appears to be faced with a shortfall of 7.4 million acre-feet of water
in the period through 2050, which will require CAWCD to purchase additional
supplies.
The Southern Nevada Water Authority has released a master water plan
(which can be viewed at www.snwa.com) to develop and deliver water supplies to
meet regional growth demands. This plan consists of (1) the storage of water,
including up to 1.25 million acre-feet in Arizona' combined with (2) the
development of further water resources in Nevada. We believe that Vidler's
assets are favorably positioned to contribute to the water resource solutions
required in the Southwest.
WATER RIGHTS
ARIZONA
At December 31, 2003, Vidler owned or had the right to acquire
approximately 49,559 acre-feet of transferable ground water in the HARQUAHALA
VALLEY, approximately 75 miles northwest of metropolitan Phoenix, Arizona.
Vidler owns 35,795 acre-feet, and we have the option to purchase a further
13,764 acre-feet. We believe that Vidler's water rights in the Harquahala Valley
represent the most practical and competitive source of water to support the
growth of greater metropolitan Phoenix, which is one of the fastest growing
areas in the nation.
Vidler's water rights in the Harquahala Valley are primarily located in
Maricopa County. According to census data, Maricopa County was the fastest
growing county in the U.S. between April 1, 2000 and July 1, 2001, with 53,367
new homes added, an increase of 4.3% in 15 months. Vidler anticipates that there
will be municipal demand for water from the Harquahala Valley to support the
growth of the west side cities in Maricopa County, which are part of greater
metropolitan Phoenix.
Any new residential development in Arizona must obtain a permit from
the Arizona Department of Water Resources certifying a "designated assured water
supply" sufficient to sustain the development for at least 100 years. The
Harquahala Valley ground water meets the designation of assured water supply. In
order for the ground water to be used by municipalities in the heavily populated
parts of Arizona, the water must be "wheeled," or transported, from the
Harquahala Valley to the end users. The Arizona State Legislature has passed
legislation which allows Harquahala Valley ground water to be made available as
assured water supply to cities and communities in Arizona through agreements
with the Central Arizona Groundwater Replenishment District.
The Arizona State Legislature has passed several pieces of legislation
which recognize the Harquahala Valley ground water as a future municipal supply
for the greater Phoenix metropolitan area. In 1991, the expansion of irrigated
farming in the Valley was prohibited, and the transfer of the ground water to
municipalities was authorized. In order to protect the Harquahala Valley ground
water from large commercial and industrial users which were moving into the
Basin, legislation was enacted in 2000 placing restrictions on commercial and
industrial users utilizing more than 100 acre-feet of water annually. These
users are required to purchase irrigable land and to withdraw the water that
they need from the land at no more than 3 acre-feet per annum per acre of land.
23
In 2001 and 2002, Vidler completed its first sales of Harquahala Valley
ground water for industrial use and municipal use:
- - in March 2001, Vidler sold 6,496.5 acre-feet of water rights and 2,589
acres of land to an industrial user, for $9.4 million;
- - in March 2002, Vidler sold 3,645 acre-feet of water rights and 1,215
acres of land to golf course developers near Scottsdale, for $5.2
million; and
- - in May 2002, Vidler sold 480 acre-feet of water rights and 240 acres of
land to an industrial user, for $1 million.
Vidler is working on further sales of Harquahala Valley ground water to
both industrial users and communities and developers in the greater Phoenix
metropolitan area who need to secure further water to support expected growth.
NEVADA
Vidler has been increasing its ownership of water rights in northern
Nevada through the purchase of ranch properties and entering into joint ventures
with parties owning water rights, which they wish to maximize the value of.
Nevada is the state experiencing the most rapid population growth and
new home construction in the United States. The population is concentrated in
southern Nevada, which includes the Las Vegas metropolitan area.
1. LINCOLN COUNTY
Vidler is working jointly with Lincoln County to locate and develop
water resources in Lincoln County, Nevada. Lincoln County and Vidler have filed
applications for more than 100,000 acre-feet of water rights with the intention
of supplying water to communities and industrial users. We believe that this is
the only known new source of water for Lincoln County. Vidler anticipates that
up to 40,000 acre-feet of water rights will ultimately be permitted from these
applications, and put to use in Lincoln County.
Under the Lincoln County Land Act, more than 13,000 acres of publicly
owned land in southern Lincoln County is to be offered for sale near the fast
growing City of Mesquite. The first release of land under the Lincoln County
Land Act is expected to occur later in 2004. Additional water will be required
if this land is to be developed.
In 1998, Lincoln/Vidler filed for 14,000 acre-feet of water rights for
industrial use from the Tule Desert Groundwater Basin. In November 2002, the
Nevada State Engineer granted an application for 2,100 acre-feet of water
rights, and ruled that another 7,244 acre-feet could be granted, but would be
held in abeyance while Lincoln/Vidler pursues additional studies.
In 2001, Lincoln/Vidler reached conditional agreement to sell an
electricity-generating company between 6,700 and 9,000 acre-feet of water, at
$3,300 per acre-foot, for a new power plant to be located in southern Lincoln
County on a site which was to be acquired from Nevada Land. Due to the
unprecedented instability in the energy market and capital market conditions
affecting the electricity sector, the electricity-generating company decided not
to move forward with the project. Recognizing that a permitted site with
permitted water rights will have value once the energy market stabilizes, Vidler
purchased the project for $50,000 in February 2003. Energy companies and
utilities are currently reviewing the project.
The Lincoln County undertaking is an example of a transaction where
Vidler can partner with an entity, in this case a government entity, to provide
the necessary capital and skills to commercially develop water assets.
2. SANDY VALLEY, NEVADA
In June 2002, the Nevada State Engineer awarded Vidler 415 acre-feet of
water rights near Sandy Valley, Nevada. Vidler has filed another application for
1,000 acre-feet.
The water rights awarded to Vidler are the only known water to support
future growth in Sandy Valley and surrounding areas in southwestern Nevada near
the California state line, including Primm, Nevada. Primm is a resort town on
the border between California and Nevada, in the Interstate 15 corridor. Primm
requires additional water to support future growth, which could result from
expansion of the existing hotel/casino and retail/commercial operations.
3. MUDDY RIVER WATER RIGHTS
The Muddy River is a perennial river fed by the Muddy Springs in
Southern Nevada, originating in Nevada and flowing into Lake Mead. Currently,
Muddy River water rights are utilized for agriculture and electricity
generation; however, in the future, we
24
anticipate that Muddy River water rights may be utilized to support development
in southern Nevada. The Southern Nevada Water Authority has been acquiring Muddy
River water rights as a water resource to support future growth in Clark County,
Nevada.
At December 31, 2003, Vidler owned approximately 221 acre-feet of Muddy
River water rights, and had the right to acquire an additional 45.6 acre-feet.
4. FISH SPRINGS RANCH
In 2000, Vidler purchased a 51% interest in Fish Springs Ranch, LLC
("Fish Springs") and a 50% interest in V&B, LLC. These companies own the Fish
Springs Ranch and other properties totaling approximately 8,600 acres in Honey
Lake Valley in Washoe County, 45 miles north of Reno, Nevada. Approximately
8,000 acre-feet of permitted water rights associated with Fish Springs Ranch are
transferable to the Reno/Sparks area. The water rights at Fish Springs have been
identified as the most economical and proven new source of supply to support new
growth in the North Valley communities of Washoe County. This county was in the
top 2% of all counties in the U.S. for new home construction between April 1,
2000 and July 1, 2001. According to census data, almost 5,500 new homes were
constructed over that 15 month period, a 3.8% increase.
Vidler is holding discussions with a number of potential users for the
Fish Springs water rights, including developers and industrial users. There is
strong demand for water in the North Valleys, and few alternative sources of
supply. The future demand of the North Valleys area is estimated to exceed
12,000 acre-feet annually. If water from Fish Springs could be supplied to the
North Valleys, this would reduce their reliance on Truckee River water which
comes through Reno, thereby providing environmental benefits and additional
water to support growth in and around Reno, an area which has been experiencing
consistent growth.
In October 2002, the Regional Water Planning Committee accepted the
North Valley Water Supply Comparison report. This study re-evaluated the
feasibility and potential cost of supplying future North Valley's water demands
with continued exportation of water from the Truckee River Basin, or,
alternatively, meeting the demands from Fish Springs and two other basins. The
study indicated that ground water from Fish Springs would be the most economical
source of supply. Alternatively, if the capacity of nearby transmission lines
can be expanded, we believe that Fish Springs Ranch would be an attractive site
for gas-fired electricity generation.
5. BIG SPRINGS RANCH AND WEST WENDOVER, NEVADA
In December 2003, Vidler closed on the sale of approximately 37,500
acres of deeded ranch land and the related water rights at Big Springs Ranch for
$2.8 million. The ranch land was located approximately 65 miles east of Elko, in
northeastern Nevada.
In December 2003, in a separate but related transaction, Vidler closed
on the sale of approximately 6,500 acres of developable land near West Wendover,
Nevada for $12 million. West Wendover is adjacent to the Nevada/Utah border in
the Interstate 80 corridor. The land at West Wendover was acquired in 1999
through a land exchange with the Bureau of Land Management, under which Vidler
gave up approximately 70,500 acres of ranch land at Big Springs Ranch in return
for the parcels of developable land.
The assets at Big Springs Ranch and West Wendover were different in
nature from Vidler's remaining assets in Arizona and Nevada, in that the land
comprised the bulk of the value of Big Springs Ranch and West Wendover, with the
water rights being a lesser component.
COLORADO
Vidler is completing the process of monetizing its water rights in
Colorado, through sale or lease:
- - in 2000, Vidler closed on the sale of various water rights and related
assets to the City of Golden, Colorado for $1 million, and granted the
City options to acquire other water rights over the next 15 years. The
City exercised options to acquire water assets for $390,000 in 2001,
$145,000 in 2002, and $146,000 in 2003. If the remaining options are
exercised, the present value of the aggregate purchase price is
approximately $1 million;
- - during 2002, Vidler closed on the sale of its interest in Cline Ranch
for $2.1 million and the sale of 86 acre-feet of water rights for $3.1
million; and
- - in 2003, Vidler closed on the sale of the Wet Mountain water rights for
$414,000.
Discussions are continuing to either lease or sell the remaining water rights in
Colorado.
25
WATER STORAGE
1. VIDLER ARIZONA RECHARGE FACILITY
During 2000, Vidler completed the second stage of construction at its
facility to "bank," or store, water underground in the Harquahala Valley, and
received the necessary permits to operate a full-scale water "recharge"
facility. "Recharge" is the process of placing water into storage underground.
Vidler has the permitted right to recharge 100,000 acre-feet of water per year
at the Vidler Arizona Recharge Facility, and anticipates being able to store in
excess of 1 million acre-feet of water in the aquifer underlying much of the
valley. When needed, the water will be "recovered," or removed from storage, by
ground water wells.
Vidler has the only permitted, complete private water storage facility
in Arizona. Given that Arizona is the only southwestern state with surplus flows
of water available for storage, we believe that Vidler's is the only private
water storage facility where it is practical to "bank," or store, water for
users in other states, which is known as "interstate banking." Having a
permitted water storage facility also allows Vidler to acquire, and store,
surplus water for re-sale in future years.
The Vidler Arizona Recharge Facility is the first privately owned water
storage facility for the Colorado River system, which is a primary source of
water for the Lower Division States of Arizona, California, and Nevada. The
water storage facility is strategically located adjacent to the Central Arizona
Project ("CAP") aqueduct, a conveyance canal running from Lake Havasu to Phoenix
and Tucson. The water to be recharged will come from surplus flows of CAP water.
We believe that proximity to the CAP is a competitive advantage, because it
minimizes the cost of water conveyance.
Vidler is able to provide storage for users located both within Arizona
and out-of-state. Potential users include industrial companies, developers, and
local governmental political subdivisions in Arizona, and out-of-state users
such as municipalities and water agencies in Nevada and California. The Arizona
Water Banking Authority ("AWBA") has the responsibility for intrastate and
interstate storage of water for governmental entities.
Vidler intends to charge customers a fee based on the amount of water
"recharged," and then an additional fee when the water is "recovered." The
revenues generated from this asset will depend on the quantity of water which
the AWBA, and private users, store at the facility. The quantity of water stored
will depend on a number of factors, including the availability of water and
available storage capacity at publicly owned facilities.
We believe that a number of events in recent years have increased the
scarcity value of the project's storage capacity. At a public hearing in March
2000, the AWBA disclosed that the Bureau of Reclamation has indicated that,
before permits are issued for new facilities to store water for interstate
users, extensive environmental impact studies will be required. The AWBA also
indicated that the first priority for publicly owned storage capacity in Arizona
is to store water for Arizona users. At the same hearing, the states of
California and Nevada again confirmed that their demand for storage far exceeds
the total amount of storage available at existing facilities in Arizona.
Consequently, interstate users will need to rely, at least in part, on privately
owned storage capacity.
The Southern Nevada Water Authority Water Resource Plan, which can be
viewed at www.snwa.com, calls for 1.25 million acre-feet of water to be stored
in Arizona in order to meet forecast demand. The AWBA is currently finalizing
agreements to store water on behalf of Nevada. Once these agreements have been
concluded, the AWBA can begin to negotiate storage for California. The AWBA will
be able to store water at existing publicly owned sites and at the Vidler
Arizona Recharge Facility, which is one of the largest water storage facilities.
Under the current agreement, which expires in 2004, Vidler has agreed on a price
of $48.00 per acre-foot of water recharged for users represented by the AWBA.
In addition to the potential demand from the public users represented
by the AWBA, demand from private users could potentially utilize up to 100% of
the site's storage capacity.
Vidler has not yet stored water for customers at the facility, but the
company has been recharging water for its own account since 1998, when the pilot