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PICO > SEC Filings for PICO > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for PICO HOLDINGS INC /NEW


9-Nov-2012

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read together with the Unaudited Condensed Consolidated Financial Statements and accompanying Notes included elsewhere in this report, and the Consolidated Financial Statements and accompanying Notes included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Note About "Forward-Looking Statements"

This Quarterly Report on Form 10-Q (including the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section) contains "forward-looking statements," as defined in Section 21E of the United States Securities Exchange Act of 1934, as amended, regarding our business, financial condition, results of operations, and prospects, including, without limitation, statements about our expectations, beliefs, intentions, anticipated developments, and other information concerning future matters. Words such as "may", "will", "could", "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", "should", "target", "projects", "contemplates", "predicts", "potential", "continue" 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 Quarterly Report on Form 10-Q. Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on current expectations and assumptions. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and the actual results and outcomes could differ from what is expressed or implied 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 headings "Item 1A. Risk Factors" in our 2011 Annual Report on Form 10-K and in other filings made from time to time with the United States Securities and Exchange Commission ("SEC") after the date of this Quarterly Report on Form 10-Q. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to (and we expressly disclaim any obligation to) revise or update any forward-looking statement, whether as a result of new information, subsequent events, or otherwise (except as may be required by law), in order to reflect any event or circumstance which may arise after the date of this Quarterly Report on Form 10-Q. Readers are urged to carefully review and consider the various disclosures made in this Quarterly Report on Form 10-Q and our Form 10-K and other filings.

BUSINESS STRATEGY AND GOALS

PICO Holdings, Inc. is a diversified holding company. In this Quarterly Report, PICO and its subsidiaries are collectively referred to as "PICO," "the Company," or by words such as "we" and "our." We seek to build and operate businesses where we believe significant value can be created from the development of unique assets, and to acquire businesses which we identify as undervalued and where our management participation in operations can aid in the recognition of the business's fair value, as well as create additional value.

Our objective is to maximize long-term shareholder value. Our goal is to manage our operations to achieve a superior return on net assets over the long term, as opposed to short-term earnings. We own and operate several diverse businesses and assets. Our portfolio of businesses is designed to provide a mix of revenues and income from long - term assets that may require several years to develop and monetize and shorter - term operations that should generate recurring revenues each quarter.

As of September 30, 2012 our business is separated into four operating segments:
Water Resource and Water Storage Operations;
Real Estate Operations;
Agribusiness Operations; and
Corporate


As of September 30, 2012, our major consolidated subsidiaries are (wholly-owned unless noted):
Vidler Water Company, Inc. ("Vidler") which acquires and develops water resources and water storage operations in the southwestern United States, with assets and operations in Nevada, Arizona, Idaho, Colorado and New Mexico;
UCP, LLC ("UCP"), which acquires and develops partially-developed and finished residential housing lots in selected markets in California and Washington;
PICO Northstar Hallock, LLC, an 88% owned subsidiary, doing business as Northstar Agri Industries ("Northstar"), which has constructed a canola seed crushing facility in Hallock, Minnesota. The plant commenced full - scale production in the third quarter of 2012;
Physicians Insurance Company of Ohio ("Physicians"), which is "running off" its medical professional liability insurance loss reserves and is classified as discontinued operations in these condensed consolidated financial statements; and
Citation Insurance Company ("Citation"), which is "running off" its property and casualty insurance and workers' compensation loss reserves and is classified as discontinued operations in these condensed consolidated financial statements.

RESULTS OF OPERATIONS- THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011

The focus of our operations is building long-term shareholder value. Our revenues and results of operations can and do fluctuate widely from period to period. For example, we recognize revenue from the sale of real estate and water assets when specific transactions close, and as a result, sales of real estate and water assets for any individual quarter are not necessarily indicative of revenues for future quarters or the full financial year.

Operating Environment:

The housing slow-down that occurred in the U.S. in the past several years decreased the rate of growth in the Southwest and, as a result, the demand for our water and real estate assets in certain markets. Specific events occurred in those markets in previous periods that caused us to record impairment charges on our Fish Springs Ranch water credits and pipeline rights and our Carson Lyon water rights and certain real estate assets in 2011 and 2010. Any further deterioration in the markets in which we operate has the potential to require us to record additional impairment charges on our real estate and water assets.

However, during 2012 there have been several indicators that suggest that the recovery in the housing market is gaining momentum. These indicators include declining inventory levels (especially for entry - level homes), reduced foreclosures (in California, for instance, new foreclosures have fallen to their lowest level since 2007), low mortgage rates, affordable home prices and increasing rent costs. We are unable to predict how sustainable the housing recovery might be, but we believe that a prolonged improvement in the general demand for housing will have a positive impact on the demand for our water and real estate assets.

Discontinued Operations:

During the nine months ended September 30, 2012, we signed an agreement to sell our insurance in run-off segment. As a result of the pending transaction, the assets and liabilities of the insurance segment have been classified as discontinued operations in the accompanying consolidated financial statements as of the earliest period presented. Consequently, the discussion and analysis that follows reflect the insurance in run-off segment as discontinued operations. PICO Shareholders' Equity

At September 30, 2012, we reported shareholders' equity of $477.1 million, or $20.95 per share, compared to $501.8 million, or $22.10 per share at December 31, 2011, a decrease in book value per share of $1.15, or 5.2%, during the first nine months of 2012. The $24.7 million decrease in shareholders' equity for the first nine months of 2012 was primarily due to a net loss of $25.6 million.


Treasury Stock

During the nine months ended September 30, 2012, the Company retired 1.4 million shares of PICO common stock owned by PICO Holdings that was previously classified as treasury stock, held at a cost of $22.9 million. The transactions reduced both the number of shares issued and the number of treasury shares and, as a result, did not affect the number of net shares outstanding and had no impact on either book value per share or earnings per share.

Total Assets and Liabilities

Total assets at September 30, 2012, were $702 million, compared to $688.1 million at December 31, 2011, an increase of $13.9 million. The net increase is primarily due to recording $8.7 million in receivables on the sale of canola oil and meal. Other significant increases in individual assets are due to purchases of real estate and development costs of $41 million in our real estate and water segment assets, offset by sales of real estate with a cost of $20.4 million. In addition, we capitalized approximately $21.6 million in construction costs on our canola seed crushing facility that was financed with debt.

During the first nine months of 2012, total liabilities increased by $40.5 million, from $178.4 million at December 31, 2011 to $218.9 million at September 30, 2012 primarily as a result of additional debt borrowed by Northstar and used for construction of the canola seed crushing plant.

Net Loss

We reported a net loss from continuing operations, after noncontrolling interest, of $7.2 million, or $0.32 per share and a net loss of $52.8 million, or $2.33 per share for the third quarter ended September 30, 2012 and 2011, respectively. For the nine months ended September 30, 2012, our reported net loss from continuing operations was $22.9 million or $1.01 per share, compared to a net loss of $58.7 million, or $2.58 per share for the first nine months of 2011.

Discontinued Operations

Our insurance in run-off companies are reported as discontinued operations as the sale of these entities is probable and we expect the sale will close before the end of 2012 on receipt of regulatory approvals of the transaction. During the three months ended September 30, 2012, we obtained approval from the California Department of Insurance. We anticipate receiving approval from the Ohio Department of Insurance and closing the transaction in the fourth quarter of 2012.

The discontinued operations reported a loss of $2.7 million and income of $8.7 million for the nine months ended September 30, 2012 and 2011, respectively. The results in 2012 include the expected loss on the sale of the segment of $6 million, offset by net income of $3.4 million. The income tax benefit for the loss on sale is estimated to be $3.6 million. However, consistent with our overall conclusion that it is not more likely than not we will recognize our total deferred tax assets, a full valuation allowance has been recorded and, as of September 30, 2012 we have not recognized the tax benefit arising on the disposal of the insurance companies.

Comprehensive Loss

For the third quarter of 2012, we reported a comprehensive loss of $6.6 million which consisted primarily of a net loss of $5.3 million, and a decrease of $949,000 in unrealized appreciation on available-for-sale securities.

For the first nine months of 2012, we reported a comprehensive loss of $25.9 million. This comprehensive loss consisted primarily of a net loss of $25.6 million.


Segment Results of Operations

Our segment revenues and income or loss before taxes for the third quarter and
first nine months of 2012 and 2011 were:
                                         Three Months Ended             Nine Months Ended
Thousands of dollars                        September 30,                 September 30,
                                         2012           2011           2012           2011
Revenues:
Water Resource and Water Storage
Operations                           $    1,089     $      384     $    2,900     $    1,073
Real Estate Operations                   23,585         14,585         28,998         22,928
Agribusiness Operations                  42,084              1         51,768              8
Corporate                                   608          1,673          1,935          6,548
Total revenues                       $   67,366     $   16,643     $   85,601     $   30,557

Income (loss) before income taxes:
Water Resource and Water Storage
Operations                           $   (1,559 )   $  (17,470 )   $   (4,537 )   $  (20,532 )
Real Estate Operations                    2,237          2,244         (1,519 )          265
Agribusiness Operations                  (6,105 )         (695 )       (9,159 )       (1,668 )
Corporate                                (3,307 )       (2,369 )      (11,056 )       (4,006 )
Loss before income taxes             $   (8,734 )   $  (18,290 )   $  (26,271 )   $  (25,941 )

Third Quarter Revenues

Our third quarter revenues were $67.4 million in 2012, compared to $16.6 million in 2011, an increase of $50.8 million year-over-year. This increase was primarily due to a $42.1 million increase in revenue from sales of canola oil and meal during 2012, and an increase of $9.1 million in sales of real estate in UCP.

Third Quarter Costs and Expenses

Third quarter costs and expenses were $76.1 million in 2012, compared to $34.9 million in 2011, an increase in year-over-year expenses of $41.2 million. The increase in expenses is due to:

our agribusiness operations which reported a $40.2 million increase in cost of sales of canola oil and meal, and a $7.3 million increase in overhead, interest and depreciation expenses;

our real estate operations which reported an increase in cost of sales of $7.1 million;

offset by a decrease of $16.2 million in impairment charges in our water and water resource segment.

Third Quarter Loss Before Income Taxes

Our third quarter year-over-year net loss before income taxes decreased by $9.6 million primarily due to a $6.4 million increase in operating and other costs for overhead in our real estate and agribusiness segments offset by a reduction of $16.2 million impairment charge recorded in the water segment only in 2011.

Third Quarter Income Taxes and Noncontrolling Interest in Subsidiaries

In the third quarter of 2012, we reported a net loss of $5.3 million, or $0.23 per share. We recorded a $403,000 tax benefit and noncontrolling interests reported a loss of $1.1 million.

We reported a net loss of $49.9 million, or $2.20 per share for the third quarter of 2011 after a $25.8 million tax provision. During the three months ended September 30, 2011, noncontrolling interests reported income of $7.2 million due to reversing previously attributed losses in Fish Springs Ranch, LLC of $7.4 million. The reversal was recorded after we reassessed our previous method of attributing our 49% partner's share of the losses at Fish Springs.


Our effective tax rate for the third quarter of 2012 and 2011 was a tax benefit of 5% and tax expense of 141% respectively, compared to the Federal corporate income tax rate of 35%. In 2012 and 2011, the difference from the statutory rate is primarily due to the full valuation allowance recorded on our net deferred tax assets.

First Nine Months Revenues

First nine months revenues were $85.6 million in 2012, compared to $30.6 million in 2011, an increase of $55 million year-over-year. This increase was due to an increase in sales of canola oil and meal of $51.8 million, and an increase in sales of real estate at UCP of $6.6 million.

First Nine Months Costs and Expenses

First nine months costs and expenses were $111.9 million in 2012, compared to $56.5 million in 2011, an increase of $55.4 million. This increase in expenses is primarily due to a $48 million increase in cost of canola oil and meal sold, additional overhead, interest expense and depreciation expense in the agribusiness segment of $11.3 million, offset by a decrease of $16.2 million from an impairment charge recorded in 2011 and none in 2012.

First Nine Months Loss Before Income Taxes

Consistent with our reported revenue increasing $55 million and expenses increasing $55.4 million year-over-year primarily from our agribusiness and real estate operations, the nine month year-over-year loss before income taxes was mostly unchanged at $26.3 million and $25.9 million for 2012 and 2011, respectively.

First Nine Months Income Taxes and Noncontrolling Interest in Subsidiaries

In the first nine months of 2012, we reported a net loss of $25.6 million, or $1.13 per share. We recorded a $1.5 million tax benefit and noncontrolling interests reported a loss of $1.9 million.

We reported a net loss of $49.9 million for the first nine months of 2011 after a $22.1 million income tax expense. During the nine months ended September 30, 2011, the noncontrolling interests reported income of $5.3 million due primarily to reversing previously attributed losses in Fish Springs Ranch, LLC of $5.9 million. The reversal was recorded after we reassessed our previous method of attributing our 49% partner's share of the losses at Fish Springs.

Our effective tax rate for the first nine months of 2012 and 2011 was a tax benefit of 6% and tax expense of 85% respectively, compared to the Federal corporate income tax rate of 35%. In 2012 and 2011, the difference in the rate is primarily due to the full valuation allowance recorded on our net deferred tax assets.


                  WATER RESOURCE AND WATER STORAGE OPERATIONS
                                             Three Months Ended         Nine Months Ended
Thousands of dollars                           September 30,              September 30,
                                             2012         2011          2012         2011
Revenues:
Sale of real estate and water assets      $    872     $     151     $    886     $     213
Net investment income                            6             6           19           163
Other                                          211           227        1,995           697
Total revenues                               1,089           384        2,900         1,073

Costs and expenses:
Cost of real estate and water assets sold     (478 )         (33 )       (481 )         (40 )
Impairment of water assets                               (16,224 )                  (16,224 )
Interest expense                               (16 )                      (50 )         (28 )
Depreciation and amortization                 (344 )        (297 )       (996 )        (882 )
Overhead                                    (1,258 )        (705 )     (4,081 )      (2,642 )
Project expenses                              (552 )        (595 )     (1,829 )      (1,789 )
Total costs and expenses                    (2,648 )     (17,854 )     (7,437 )     (21,605 )
Loss before income taxes                  $ (1,559 )   $ (17,470 )   $ (4,537 )   $ (20,532 )

Historically, Vidler's revenues have been volatile and infrequent. Since the date of closing generally determines the accounting period in which the sales revenue and cost of sales are recorded, Vidler's reported revenues and income fluctuate from period to period, depending on the dates when specific transactions close. Consequently, sales of real estate and water assets in any one year are not necessarily indicative of likely revenues in future years.

Segment Revenues

There were no significant sales of water rights and related real estate assets in the third quarter and first nine months of both 2012 and 2011. Revenues generated in the third quarter and first nine months of 2012 and 2011 consisted of lease income from our ranch and farm properties and interest from the financing of certain water asset sales. In addition, in the first nine months of 2012, we recorded $1.3 million of income when an option contract with a potential purchaser of our Lincoln County, Nevada, power plant project expired. In addition, during the third quarter of 2012 we sold 98 acre - feet of water rights in Lincoln County, Nevada for $864,000. The sale of these water rights contributed $388,000 to the segment's results for both the third quarter and first nine months of 2012.

Segment Expenses

Overhead expenses consisted of costs which are not related to the development of specific water resources, such as salaries and benefits, rent, and audit fees. Overhead expenses of $1.3 million in the third quarter of 2012 were higher by $553,000 when compared to overhead expenses in the third quarter of 2011 of $705,000.

Overhead expenses were $4.1 million for the first nine months of 2012 compared to $2.6 million in the first nine months of 2011, an increase of $1.5 million year-over-year. This increase was largely due to reallocated salaries, benefits and associated overhead for employees who previously operated in our real estate segment but are now working in Vidler to develop Vidler's existing and prospective water resource projects.


Project expenses consist of costs related to the development of existing water resources, such as maintenance and professional fees. Project expenses are expensed as appropriate and fluctuate from period to period depending on activity with Vidler's various water resource projects. Project expenses principally relate to:
the operation and maintenance of the Vidler Arizona Recharge Facility;
the development of water rights in the Tule Desert groundwater basin and the Dry Lake Valley (both part of the Lincoln County, Nevada agreement);
the utilization of water rights at Fish Springs Ranch as a future municipal water supply for the north valleys of the Reno, Nevada area; and
the operation of our farm properties in Idaho and maintenance of the associated water rights.

Project expenses of $552,000 and $595,000 in the third quarter of 2012 and 2011, respectively and $1.8 million in both the first nine months of 2012 and 2011 were largely unchanged.

The year over year segment loss decreased by $15.9 million and $16 million for the third quarter and the first nine months, respectively. This improvement was almost entirely due to an impairment charge on our Fish Springs Ranch water assets of $16.2 million that was recorded in the third quarter of 2011. There were no impairment charges recorded in the third quarter and first nine months of 2012.

                             REAL ESTATE OPERATIONS
                                     Three Months Ended           Nine Months Ended
Thousands of dollars                    September 30,               September 30,
                                      2012          2011          2012           2011
Revenues:
Sale of real estate - Nevada Land                $     77                     $    288
Sale of real estate - UCP         $   23,300       14,216     $    28,270       21,655
Net investment income                     58           93             201          373
Lease income and other                   227          199             527          612
Total revenues                        23,585       14,585          28,998       22,928

Costs and expenses:
Cost of real estate - Nevada Land                     (25 )                        (44 )
Cost of real estate - UCP            (17,011 )     (9,864 )       (20,378 )    (15,761 )
Interest expense                        (335 )                     (1,012 )        (69 )
Operating expenses                    (4,002 )     (2,452 )        (9,127 )     (6,789 )
Total costs and expenses             (21,348 )    (12,341 )       (30,517 )    (22,663 )
Income (Loss) before income taxes $    2,237     $  2,244     $    (1,519 )   $    265

As of September 30, 2012, our businesses in the real estate operations segment are primarily conducted through UCP and its operations in California and Washington. Our real estate operations for 2011 also include the results of Nevada Land & Resource Company ("Nevada Land") which owned real estate and certain water, mineral and geothermal rights in northern Nevada. We sold the remaining land owned by Nevada Land in December 2011 and, accordingly, the real estate segment's future results no longer include the revenues, costs and net income from the sale of real estate and lease income in Nevada Land.

Our real estate sales are contingent upon numerous factors and, as such, the timing and volume of real estate sales in any one quarter is unpredictable. Historically, the level of real estate sales has fluctuated from period to period. Accordingly, it should not be assumed that the level of sales as reported will be maintained in future years.

In the following discussion, gross margin is defined as revenue less cost of sales, and gross margin percentage is defined as gross margin divided by revenues.


Segment Assets

UCP purchases and develops finished, partially - finished, entitled, and partially-entitled residential lots and, in some cases, also constructs and sells homes on certain of its finished lots. Primarily, these residential lots are located in select California markets. However, during 2011 and 2012, we have acquired both finished and entitled lots in the Puget Sound market area of Washington. As of September 30, 2012, UCP owns or controls a total of 1,114 finished lots, 990 partially completed lots, 2,411 approved lots (lots with tentative maps or equivalent approvals) and 753 potential lots with no material approvals (most of these potential lots are properties we have under option). Of the 5,268 lots we own or control in total, 2,763 are located in the Central Valley region of California, 1,632 in the Monterey region of California, 108 in the Bay Area of California and 765 in the Central Puget Sound market area of Seattle, Washington.

Of these lots, 56 are completed homes or homes under construction in California and, based on current conditions, it is our intention to start construction of homes on a further 140 lots in California in the next twelve months. Currently, we are seeing strong indicators - both in our specific markets as well as nationally - of a housing recovery. These indicators include modestly rising home prices, tightening supplies of inventory and increased rates of turnover of the available housing inventory. The continued strength and depth of the housing recovery, as well as our operating capacity, will determine how many homes we ultimately construct on our inventory of finished lots and those lots that we are in the process of developing into finished lots.

As of September 30, 2012, we have invested capital of over $134.6 million for the acquisition and development of these lots. Approximately $33.1 million of this capital has been financed by project specific debt, substantially all of which is non - recourse.

Segment Revenues

In the third quarter of 2012, segment total revenues were $23.6 million. UCP sold 5 homes and 198 lots in the third quarter of 2012 for total sales proceeds . . .

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