10-Q 1 pico0630201310q.htm JUNE 30, 2013 SECOND QUARTER 10-Q PICO 06.30.2013 10Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-Q

SQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2013
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 033-36383
PICO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
California
(State or other jurisdiction of incorporation)
94-2723335
(IRS Employer Identification No.)

7979 Ivanhoe Avenue, Suite 300 La Jolla, California  92037
(Address of principal executive offices, including Zip Code)

(858) 456-6022
(Registrant’s telephone number, including area code)

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 S  No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes S  No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
£
 
Accelerated filer
S
 
Non-accelerated filer
£
 
Smaller reporting company
£
 
(Do not check if a smaller reporting company)
 
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes £ No S
On August 8, 2013, the registrant had 22,745,079 shares of common stock, $0.001 par value per share outstanding.




PICO HOLDINGS, INC.

FORM 10-Q
For the Six Months Ended June 30, 2013

TABLE OF CONTENTS
 
Page No.
 
 
Part I:  Financial Information
 
 
 
Item 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2:
 
 
 
Item 3:
 
 
 
Item 4:
 
 
 
Part II:  Other Information
 
 
 
Item 1:
 
 
 
Item 1A:
 
 
 
Item 2:
 
 
 
Item 3:
 
 
 
Item 4:
 
 
 
Item 5:
 
 
 
Item 6:

2



Part I: Financial Information

Item I: Condensed Consolidated Financial Statements (Unaudited)

PICO HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED
(In thousands)
 
June 30,
2013
 
December 31,
2012
 
 
ASSETS
 
 
 
Cash and cash equivalents
$
67,440

 
$
100,115

Investments ($46.6 million and $48.5 million measured at fair value at June 30, 2013, and December 31, 2012, respectively)
48,732

 
50,524

Notes and other receivables, net
18,716

 
10,487

Real estate and water assets, net
347,682

 
342,338

Property and equipment, net
124,907

 
128,654

Other assets
55,308

 
35,056

Total assets
$
662,785

 
$
667,174

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Accounts payable and accrued expenses
$
33,260

 
$
25,063

Deferred compensation
23,213

 
22,607

Debt
150,447

 
141,008

Total liabilities
206,920

 
188,678

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Common stock, $0.001 par value; authorized 100,000 shares, 25,818
issued and 22,745 outstanding at June 30, 2013, and 25,807 issued and 22,734 outstanding at December 31, 2012.
26

 
26

Additional paid-in capital
528,767

 
526,591

Retained (deficit) earnings
(17,470
)
 
5,215

Accumulated other comprehensive loss
(514
)
 
(2,014
)
Treasury stock, at cost (common shares: 3,073 in 2013 and 2012)
(56,593
)
 
(56,593
)
Total PICO Holdings, Inc. shareholders’ equity
454,216

 
473,225

Noncontrolling interest in subsidiaries
1,649

 
5,271

Total shareholders’ equity
455,865

 
478,496

Total liabilities and shareholders’ equity
$
662,785

 
$
667,174


The accompanying notes are an integral part of the condensed consolidated financial statements.


3



PICO HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME OR LOSS - UNAUDITED
(In thousands, except per share data)
 
Three Months Ended
 
Three Months Ended
 
Six Months Ended
 
Six Months Ended
 
June 30,
2013
 
June 30,
2012
 
June 30,
2013
 
June 30,
2012
REVENUES AND OTHER INCOME:
 
 
 
 
 
 
 
Sale of real estate and water assets
$
51,385

 
$
1,441

 
$
63,191

 
$
4,985

Sale of canola oil and meal
44,913

 
9,640

 
84,469

 
9,640

Sale of software
5,597

 
 
 
9,247

 
 
Other income
3,312

 
1,469

 
5,107

 
3,610

Total revenues and other income
105,207

 
12,550

 
162,014

 
18,235

 
 
 
 
 
 
 
 
COST OF SALES:
 
 
 
 
 
 
 
Cost of real estate and water assets sold
38,219

 
1,060

 
46,272

 
3,370

Cost of canola oil and meal sold
45,136

 
7,762

 
85,741

 
7,762

Cost of software sold
632

 
 
 
1,933

 
 
Total cost of sales
83,987

 
8,822

 
133,946

 
11,132

 
 
 
 
 
 
 
 
EXPENSES:
 
 
 
 
 
 
 
Operating and other costs
24,880

 
12,615

 
45,056

 
21,503

Impairment loss on real estate and water assets
1,410

 


 
1,410

 


Interest
1,719

 
1,290

 
3,418

 
2,305

Depreciation and amortization
2,824

 
427

 
5,357

 
832

Total costs and expenses
114,820

 
23,154

 
189,187

 
35,772

Loss from continuing operations before income taxes
(9,613
)
 
(10,604
)
 
(27,173
)
 
(17,537
)
Provision (benefit) for federal, foreign, and state income taxes
(114
)
 
125

 
(898
)
 
(1,073
)
Loss from continuing operations
(9,499
)
 
(10,729
)
 
(26,275
)
 
(16,464
)
Loss from discontinued operations, net of income taxes


 
(5,224
)
 


 
(4,606
)
Net loss
(9,499
)
 
(15,953
)
 
(26,275
)
 
(21,070
)
 Loss attributable to noncontrolling interests
1,790

 
520

 
3,590

 
741

Net loss attributable to PICO Holdings, Inc.
$
(7,709
)
 
$
(15,433
)
 
$
(22,685
)
 
$
(20,329
)

The accompanying notes are an integral part of the condensed consolidated financial statements.

4



PICO HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME OR LOSS - UNAUDITED, CONTINUED
(In thousands, except per share data)
 
Three Months Ended
 
Three Months Ended
 
Six Months Ended
 
Six Months Ended

June 30,
2013
 
June 30,
2012
 
June 30,
2013
 
June 30,
2012
Other Comprehensive Income:
 
 
 
 
 
 
 
Net loss
$
(9,499
)
 
$
(15,953
)
 
$
(26,275
)
 
$
(21,070
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized appreciation (depreciation) on available-for-sale securities
791

 
(645
)
 
1,543

 
894

Foreign currency translation
(279
)
 
94

 
(43
)
 
106

Total other comprehensive income (loss), net of tax
512

 
(551
)
 
1,500

 
1,000

Comprehensive loss
(8,987
)
 
(16,504
)
 
(24,775
)
 
(20,070
)
Comprehensive loss attributable to noncontrolling interests
1,790

 
520

 
3,590

 
741

Comprehensive loss attributable to PICO Holdings, Inc.
$
(7,197
)
 
$
(15,984
)
 
$
(21,185
)
 
$
(19,329
)
 
 
 
 
 
 
 
 
Net loss per common share – basic and diluted:
 
 
 
 
 
 
 
  Loss from continuing operations
$
(0.34
)
 
$
(0.45
)
 
$
(1.00
)
 
$
(0.69
)
  Loss from discontinued operations


 
(0.23
)
 


 
(0.20
)
Net loss per common share
$
(0.34
)
 
$
(0.68
)
 
$
(1.00
)
 
$
(0.89
)
Weighted average shares outstanding
22,737

 
22,769

 
22,735

 
22,747


The accompanying notes are an integral part of the condensed consolidated financial statements.


5



PICO HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY - UNAUDITED
SIX MONTHS ENDED JUNE 30, 2013 AND 2012
(In thousands)
 
 
Shares of Common
Stock Outstanding
 
Common
Stock
 
Additional Paid-in
Capital
 
Retained Earnings (Deficit)
 
Accumulated
Other
Comprehensive
Loss
 
Shares of Treasury
Stock
 
Treasury
Stock, at
Cost
 
Noncontrolling
Interest
 
Total
Beginning balance, January 1, 2013
 
25,807

 
$
26

 
$
526,591

 
$
5,215

 
$
(2,014
)
 
3,073

 
$
(56,593
)
 
$
5,271

 
$
478,496

Stock-based compensation expense
 

 
 
 
1,896

 
 
 
 

 
 
 
 
 
 
 
1,896

Exercise of restricted stock units
 
11

 


 

 
 
 
 
 

 


 
 
 


Changes in ownership of noncontrolling interest
 
 
 
 
 
280

 
 
 
 
 
 
 
 
 
(32
)
 
248

Net loss
 
 
 
 

 
 
 
(22,685
)
 
 
 
 
 
 

 
(3,590
)
 
(26,275
)
Unrealized appreciation on investments
 
 
 
 
 
 

 
 
 
1,543

 
 
 
 
 
 
 
1,543

Foreign currency translation
 
 
 
 
 
 

 
 
 
(43
)
 
 
 
 
 
 
 
(43
)
Ending balance, June 30, 2013
 
25,818

 
$
26

 
$
528,767

 
$
(17,470
)
 
$
(514
)
 
3,073

 
$
(56,593
)
 
$
1,649

 
$
455,865


 
 
Shares of Common
Stock Outstanding
 
Common
Stock
 
Additional Paid-in
Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Shares of Treasury
Stock
 
Treasury
Stock, at
Cost
 
Noncontrolling
Interest
 
Total
Beginning balance, January 1, 2012
 
27,122

 
$
27

 
$
546,608

 
$
34,288

 
$
(959
)
 
4,417

 
$
(78,152
)
 
$
7,850

 
$
509,662

  Stock-based compensation expense
 
 
 
 
 
1,980

 
 

 
 
 
 
 
 

 
 

 
1,980

  Exercise of restricted stock units
 
94

 
 
 
(1,019
)
 
 
 
 
 
30

 
(667
)
 
 
 
(1,686
)
  Retirement of PICO common stock
 
(1,207
)
 
(1
)
 
(18,278
)
 
 
 
 
 
(1,207
)
 
18,279

 
 
 

Net loss
 
 
 
 

 
 
 
(20,329
)
 
 
 
 
 
 

 
(741
)
 
(21,070
)
Unrealized appreciation on investments
 
 
 
 
 
 

 
 
 
894

 
 
 
 
 
 
 
894

Foreign currency translation
 
 
 
 
 
 

 
 
 
106

 
 
 
 
 
 
 
106

Ending balance, June 30, 2012
 
26,009

 
$
26

 
$
529,291

 
$
13,959

 
$
41

 
3,240

 
$
(60,540
)
 
$
7,109

 
$
489,886


The accompanying notes are an integral part of the condensed consolidated financial statements.

6



PICO HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(In thousands)
 
Six Months Ended
 
Six Months Ended
 
June 30,
2013
 
June 30,
2012
OPERATING ACTIVITIES:
 
 
 
Cash used in operating activities - continuing operations
$
(35,598
)
 
$
(42,233
)
Cash used in operating activities - discontinued operations

 
(3,174
)
Net cash used in operating activities
(35,598
)
 
(45,407
)
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
Purchases of investments
(9,360
)
 
(6,300
)
Proceeds from sale of investments
13,894

 
8,561

Proceeds from maturity of investments


 
831

Purchases of property and equipment
(992
)
 
(25,486
)
Cash acquired in connection with purchase of Spigit, net of cash paid
174

 


Decrease (increase) in restricted deposits
1,495

 
(2,982
)
Other investing activities, net
14

 
52

Cash provided by (used in) investing activities - continuing operations
5,225

 
(25,324
)
Cash provided by investing activities - discontinued operations


 
1,925

Net cash provided by (used in) investing activities
5,225

 
(23,399
)
 
 
 
 
FINANCING ACTIVITIES:
 
 
 
  Repurchase of shares and payment of withholding taxes on RSU exercise


 
(1,019
)
Repayment of debt
(31,292
)
 
(2,789
)
Proceeds from debt
28,525

 
32,000

Net cash provided by (used in) financing activities - continuing operations
(2,767
)
 
28,192

 
 
 
 
Effect of exchange rate changes on cash
465

 
166

Decrease in cash and cash equivalents
(32,675
)
 
(40,448
)
Cash and cash equivalents beginning of the period
100,115

 
125,547

Cash and cash equivalents end of the period
67,440

 
85,099

Less cash and cash equivalents of discontinued operations at the end of the period

 
24,368

Cash and cash equivalents of continuing operations at the end of the period
$
67,440

 
$
60,731

 
 
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
Payment for federal, foreign, and state income taxes
$
109

 
$
2,984

Interest paid, net of amounts capitalized
$
5,407

 
$
2,072

Non-cash investing and financing activities:
 
 
 
Increase in assets from business combination
$
21,432

 


Increase in liabilities from business combination
$
20,377

 


Conversion of note receivable to common stock in Spigit
$
820

 
 
Accrued offering costs
$
1,678

 
 
Unpaid liability incurred for construction costs


 
$
3,718

Mortgage incurred to purchase real estate
$
4,691

 
$
360


The accompanying notes are an integral part of the condensed consolidated financial statements.

7



PICO HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of PICO Holdings, Inc. and subsidiaries (collectively, the “Company” or “PICO”) have been prepared in accordance with the interim reporting requirements of Form 10-Q, pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”).  Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete consolidated financial statements.

In the opinion of management, all adjustments and reclassifications considered necessary for a fair and comparable presentation of the financial statements presented have been included and are of a normal recurring nature. Operating results presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC.

The preparation of condensed consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses for each reporting period. The significant estimates made in the preparation of the Company’s condensed consolidated financial statements relate to the assessment of other-than-temporary impairments, and the application of the equity method of accounting, goodwill and intangibles, real estate and water assets, deferred income taxes, stock-based compensation, fair value of derivatives, purchase price allocation, and contingent liabilities. While management believes that the carrying value of such assets and liabilities are appropriate as of June 30, 2013, and December 31, 2012, it is reasonably possible that actual results could differ from the estimates upon which the carrying values were based.

Real Estate and Water Assets / Impairment Losses:

The Company’s real estate and water assets include certain intangible assets which consist primarily of certain water rights, water credits, and the exclusive right to use assets that the Company constructed and later dedicated to various municipalities located in select markets in Nevada, primarily in Washoe and Lyon counties. The rights have indefinite useful lives and are therefore not amortized. Intangible assets with indefinite lives are tested for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired, by comparing the fair value of the assets to their carrying amounts.

In response to specific events and changes in circumstances during the three months ended June 30, 2013, the Company completed impairment testing of its indefinite-lived intangible water assets. The fair value of these assets was calculated using discounted cash flow models that incorporated a wide range of assumptions including asset pricing, price escalation, discount rates, absorption rates, timing of sales, and costs. These models are sensitive to minor changes in any of the input variables. Given the decline in market prices for similar assets, increases in interest rates, and extended timing of expected absorptions, the Company adjusted its assumptions and judgments in the model from prior projections for the Fish Springs water credits and pipeline rights and Carson Lyon water assets. The changes in assumptions and judgments resulted in a fair value of the Fish Springs assets of approximately $83.9 million compared to its carrying value of $84.9 million resulting in an impairment loss of $993,000 reported in the statement of operations within impairment loss on real estate and water assets and was included in the results of operations of the water resource and water storage segment. This is the second such impairment loss recorded on this asset during the last three years. There were no other impairment losses on any other intangible assets recorded in the period.

Also during the three months ended June 30, 2013, the Company recorded an impairment loss on real estate with a carrying value of $4.1 million that was written down to its estimated fair value of $3.7 million resulting in an impairment charge of $417,000, which was included in earnings for the three and six months ended June 30, 2013. The impairment was recorded based on the estimated sales price the Company expects to receive upon the sale of this real estate.


8



All real estate and tangible water assets are classified as held and used until management commits to a plan to sell the asset, the asset can be sold in its present condition, the asset is being actively marketed for sale, and it is probable that the asset will be sold within the next 12 months.  At June 30, 2013 and December 31, 2012, the Company had real estate of $11.3 million and $2.9 million, respectively, classified as held for sale.

The costs assigned to the various components of real estate and water assets was as follows (in thousands):
 
June 30, 2013
 
December 31, 2012
Real estate
$
174,424

 
$
166,220

Real estate improvements
3,962

 
4,464

Water and water rights
85,399

 
86,764

Pipeline rights and water credits
83,897

 
84,890

 
$
347,682

 
$
342,338


Stock-Based Compensation:

Stock-based compensation expense is measured at the grant date based on the fair values of the awards and is recognized as expense over the period in which the share-based compensation vests.

At June 30, 2013, the Company had one stock-based payment arrangement outstanding:

The PICO Holdings, Inc. 2005 Long Term Incentive Plan (the “Plan”). The Plan provides for the grant or award of various equity incentives to PICO employees, non-employee directors, and consultants.  A total of 2,654,000 shares of common stock are issuable under the Plan and it provides for the issuance of incentive stock options, non-statutory stock options, free-standing, stock-settled stock appreciation rights (“SAR”), restricted stock awards, performance shares, performance units, restricted stock units (“RSU”), deferred compensation awards, and other stock-based awards.  The Plan allows for broker assisted cashless exercises and net-settlement of income taxes and employee withholding taxes.  Upon exercise of a SAR and RSU, the employee will receive newly issued shares of PICO Holdings common stock with a fair value equal to the in-the-money value of the award, less applicable federal, state and local withholding and income taxes (however, the holder of an RSU can elect to pay withholding taxes in cash).

Restricted Stock Units (RSU):

A summary of activity of the RSU is as follows:
 
RSU
Outstanding at January 1, 2013
467,716

Granted
15,435

Vested
(11,430
)
Outstanding at June 30, 2013
471,721

Unrecognized compensation cost (in thousands)
$
4,965


 The Company recorded stock based compensation expense of $950,000 and $920,000 during the three months ended June 30, 2013 and 2012 respectively, and $1.9 million and $2 million during the six months ended June 30, 2013 and 2012, respectively for the RSU outstanding during the period.

Stock-Settled Stock Appreciation Rights (SAR):

There were no SAR granted or exercised during the six months ended June 30, 2013 or 2012. There was no stock-based compensation expense recognized for SAR during the six months ended June 30, 2013 or 2012 as there were no unvested SAR in those periods.


9



A summary of SAR activity is as follows:
 
SAR
 
Weighted Average
Exercise Price
 
Weighted Average
Contractual Term
Outstanding at January 1, 2013
1,812,079

 
$
36.16

 
3.5 years
Expired
(195,454
)
 


 
 
Outstanding and exercisable at June 30, 2013
1,616,625

 
$
36.45

 
2.9 years

At June 30, 2013, none of the outstanding SAR were in-the-money.
 
Deferred Compensation:
 
The Company reports the investment returns generated in the deferred compensation accounts in other income with a corresponding increase in the trust assets (except in the case of PICO stock, which is reported as treasury stock, at cost). There is an increase in the deferred compensation liability when there is appreciation in the market value of the assets held, with a corresponding expense recognized in operating and other costs. In the event the trust assets decline in value, the Company reverses previously expensed compensation. The assets of the plan are held in rabbi trust accounts. Such accounts hold various investments that are consistent with the Company’s investment policy, and are accounted for and reported as available-for-sale securities in the accompanying condensed consolidated balance sheets. Assets of the trust are distributed according to predetermined payout elections established by each participant.

At June 30, 2013 and December 31, 2012, the Company had $23.2 million and $22.6 million, respectively, recorded as deferred compensation payable to various members of management and certain non-employee members of the board of directors of the Company.

The deferred compensation liability increased by $606,000 during the six months ended June 30, 2013 primarily due to an increase in the fair value of the assets of $867,000, offset by payments to participants. Included in operating and other costs in the accompanying condensed consolidated statements of operations and comprehensive income or loss for the three and six months ended June 30, 2013 is compensation expense of $249,000 and $867,000, respectively. For the three and six months ended June 30, 2012, operating and other costs included compensation recovery of $127,000 and expense of $1.5 million, respectively.

Accumulated Other Comprehensive Loss:

The components of accumulated other comprehensive loss are as follows (in thousands):
 
June 30,
2013
 
December 31,
2012
 
 
 
 
Net unrealized appreciation on available-for-sale investments
$
5,998

 
$
4,455

Foreign currency translation
(6,512
)
 
(6,469
)
Accumulated other comprehensive loss
$
(514
)
 
$
(2,014
)

The unrealized appreciation on available-for-sale investments is net of a deferred income tax liability of $3.3 million at June 30, 2013 and $2.4 million at December 31, 2012. The foreign currency translation is net of a deferred income tax asset of $3.3 million at June 30, 2013 and $3.3 million at December 31, 2012. During the three and six months ended June 30, 2013, the change in unrealized appreciation on available-for-sale securities was net of deferred income tax of $426,000 and $830,000, respectively, and net of reclassification adjustments of $406,000, and $547,000, respectively.

Inventory:

The Company classifies its canola seed as raw material inventory and canola oil and meal as finished goods inventory. Such inventory is carried at net realizable value as it is considered a readily marketable agricultural commodity that is readily convertible to cash because of its commodity characteristics, widely available markets, and international pricing mechanisms. This agricultural commodity inventory has quoted market prices in active markets or is directly correlated to an active market, may be sold without significant further processing and has predictable and insignificant disposal costs. Changes in the fair value of agricultural commodity inventories are recognized in earnings as a component of cost of canola oil and meal sold.
  

10



At June 30, 2013 and December 31, 2012, the Company had $7 million and $8.1 million, respectively, in inventory, the majority of which is considered readily marketable, included within other assets in the consolidated balance sheets.

Derivatives:

In the normal course of business, the Company uses derivative instruments to manage its exposure to movements associated with agricultural commodity prices. The Company generally uses exchange traded futures to minimize the effects of changes in the prices of agricultural commodities in its agricultural commodity inventories and forward purchase and sale contracts. The Company recognizes each of its derivative instruments as either assets or liabilities at fair value in its condensed consolidated balance sheets. While the Company considers exchange traded futures and forward purchase and sale contracts to be effective economic hedges, the Company does not designate or account for its commodity contracts as hedges. Changes in the fair value of these contracts and related readily marketable agricultural commodity inventories are included in cost of canola oil and meal sold in the condensed consolidated statements of operations and comprehensive income or loss.

Related Party Receivables

As of June 30, 2013, the Company had loaned $1 million to Northstar Agri Industries, LLC, the owner of the 12% interest in PICO Northstar Hallock, LLC (“Northstar”), which was used to finance certain of their operating expenses.  Interest is charged at approximately 10% per annum. 

Accounting for Income Taxes:

The Company's provision for income tax expense includes federal, foreign and state income taxes currently payable and those deferred because of temporary differences between the income tax and financial reporting bases of the assets and liabilities.  The liability method of accounting for income taxes also requires the Company to reflect the effect of a tax rate change on accumulated deferred income taxes in income in the period in which the change is enacted.
In assessing the realization of deferred income taxes, management considers whether it is more likely than not that any deferred income tax assets will be realized.  The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the period in which temporary differences become deductible.  If it is more likely than not that some or all of the deferred income tax assets will not be realized, a valuation allowance is recorded.
The Company recognizes any uncertain income tax positions on income tax returns at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.  An uncertain income tax position will not be recognized unless it has a greater than 50% likelihood of being sustained. The Company recognizes any interest and penalties related to uncertain tax positions in income tax expense.

The Company reported an income tax benefit of $114,000 and $898,000 for the three and six months ended June 30, 2013, respectively, and income tax expense of $125,000 and an income tax benefit of $1.1 million for the three and six months ended June 30, 2012, respectively. The effective income tax rate for continuing operations was 1% and 3% for the three and six months ended June 30, 2013, and 1% and 6% for the three and six months ended June 30, 2012, respectively. For the three and six months ended June 30, 2013 and 2012, the effective rate differs from the statutory rate of 35% primarily due to recording a full valuation allowance on the net deferred tax assets and certain non-deductible compensation expense.

Sale of Software:

The Company reports the sale and cost of software through its ownership in Spigit Inc. (“Spigit”), a privately held company that develops enterprise innovation software.

Revenue consists of fixed subscription fees for the Company’s software and services. The Company commences revenue recognition when all of the following conditions are met: (1) Persuasive evidence of an arrangement exists; (2) Subscription or services have been delivered to the customer; (3) Collection of related fees is reasonably assured; and (4) Related fees are fixed or determinable.


11



The Company’s customers do not have the contractual right to take possession of the software in substantially all transactions. Instead, the software is delivered through the internet from the Company’s hosting facilities. Fixed fee subscription services include access to the hosted software, set-up assistance and customer support, which are exclusively provided to direct customers by Spigit and considered non-separable deliverables. The Company recognizes the subscription fee ratably over the contracted term of the subscription agreement, generally one year. Revenue recognition commences on the later of the start date specified in the subscription arrangement, the date the customer’s first module is set-up and access is granted to the customer, and when all of the revenue recognition criteria have been met, including when any acceptance period lapses.

The Company’s consulting services consist of certain professional services, business process consulting and training services that are short-term in nature. Consulting services may be purchased separately at any time to complement or enhance the customers' experience in Spigit products and services.

The Company accounts for subscription and consulting services revenue as separate units of account. Subscription services are routinely sold separately by the Company as the consulting services are not essential to the functionality of the hosted application and customers renew their subscription without additional services. The Company allocates revenue to each unit of account based on a selling price hierarchy. The selling price for a deliverable is based on its vendor-specific objective evidence (VSOE), if available, third-party evidence (TPE), if VSOE is not available, or estimated selling price (ESP), if neither VSOE nor TPE are available. Since VSOE and TPE are not available for the Company’s subscription or consulting services, the Company uses ESP to allocate revenue. The Company establishes ESP within a range of selling prices considering multiple factors including, but not limited to, standalone sales, price list adjusted for discounting practices, and margin objectives.
 
Cost of Software Sold:

Cost of software sold primarily consists of costs related to hosting of the Company’s application suite and expenses related to its hosting facility, plus the cost of providing consulting services to our customers.

Software Development Costs

The Company accounts for costs related to the development of software products in accordance with the applicable authoritative guidance. For software products to be sold, leased, or otherwise marketed, the Company expenses all costs incurred to establish the technological feasibility of the software product and capitalizes qualifying costs incurred after technological feasibility is achieved. For software products developed or obtained for internal use, the Company capitalizes all related costs, beginning when it is determined that certain factors are present including, among others, that technology exists to achieve performance requirements. All costs that relate to the planning and post implementation phases of software developed for internal use are expensed as incurred.

Recent Accounting Pronouncements

In March 2013, the FASB issued accounting guidance which amends previous accounting guidance on foreign currency matters. This amendment provides guidance on foreign currency translation adjustments when a parent entity ceases to have a controlling interest on a previously consolidated subsidiary or group of assets. The guidance is effective for fiscal years beginning on or after December 15, 2013. The Company does not believe the adoption of this guidance will have a material impact on the consolidated financial condition, results of operations, cash flows or financial disclosures.


2.  Net Loss Per Share

Basic earnings or loss per share is computed by dividing net earnings by the weighted average number of shares outstanding during the period. Diluted earnings or loss per share is computed similarly to basic earnings or loss per share except the weighted average shares outstanding are increased to include additional shares from the assumed exercise of any common stock equivalents using the treasury method, if dilutive. The Company’s stock-settled SAR and RSU are considered common stock equivalents for this purpose.  The number of additional shares related to these common stock equivalents is calculated using the treasury stock method.

For the three and six months ended June 30, 2013 and 2012, the Company’s stock-settled SAR and RSU were excluded from the diluted per share calculation because their effect on the loss per share for continuing operations was anti-dilutive.



12



3.  Investments
 
The following tables report the cost and carrying value of available-for-sale investments at June 30, 2013 and December 31, 2012 (in thousands):
June 30, 2013
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Carrying
Value
Debt securities:
 
 
 
 
 
 
 
Corporate bonds
$
6,837

 
$
240

 
$
(32
)
 
$
7,045

Marketable equity securities
30,492

 
9,452

 
(427
)
 
39,517

Total
$
37,329

 
$
9,692

 
$
(459
)
 
$
46,562


December 31, 2012
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Carrying
Value
Debt securities:
 
 
 
 
 
 
 
Corporate bonds
$
7,758

 
$
324

 
$
(56
)
 
$
8,026

Marketable equity securities
33,847

 
7,212

 
(621
)
 
40,438

Total
$
41,605

 
$
7,536

 
$
(677
)
 
$
48,464


The following tables summarize the market value of those investments in an unrealized loss position for periods less than or greater than 12 months (in thousands):
 
June 30, 2013
 
December 31, 2012
Less than 12 months
Fair Value
 
Gross
Unrealized
Loss
 
Fair Value
 
Gross
Unrealized
Loss
Debt securities:
 
 
 
 
 
 
 
Corporate bonds
$
2,239

 
$
32

 
$
768

 
$
12

Marketable equity securities
2,727

 
277

 
5,193

 
615

Total
$
4,966

 
$
309

 
$
5,961

 
$
627


 
June 30, 2013
 
December 31, 2012
Greater than 12 months
Fair Value
 
Gross
Unrealized
Loss
 
Fair Value
 
Gross
Unrealized
Loss
Debt securities:
 
 
 
 
 
 
 
Corporate bonds


 


 
$
2,204

 
$
44

Marketable equity securities
$
1,609

 
$
150

 
45

 
6

Total
$
1,609

 
$
150

 
$
2,249

 
$
50



Marketable Equity Securities: The Company’s investment in marketable equity securities was $39.5 million at June 30, 2013, and principally consisted of common stock of publicly traded small-capitalization companies in the U.S. and select foreign markets.  At June 30, 2013, the Company reviewed its equity securities in an unrealized loss position and concluded certain of such securities were not other-than-temporarily impaired as the declines were not of sufficient duration and severity, and publicly-available financial information, collectively, did not indicate impairment.  The primary cause of the loss on those securities was normal market volatility. The securities that were deemed other-than-temporarily impaired were recorded as an impairment loss in the period. No significant impairment losses were recorded during the three or six months ended June 30, 2013. During the three and six months ended June 30, 2012 the Company recorded impairment losses of $76,000 and $998,000, respectively.
 

13



Debt Securities: The Company owns corporate bonds in its fixed maturity portfolio, which are purchased based on the maturity and yield-to-maturity of the bond and an analysis of the fundamental characteristics of the issuer.  At June 30, 2013, there were unrealized losses on certain bonds in the portfolio. The Company does not consider those bonds to be other-than-temporarily impaired because the Company expects to hold, and will not be required to sell, these particular bonds, and it expects to recover the entire amortized cost basis at maturity. There were no impairment losses recorded on debt securities during the three and six months ended June 30, 2013, and 2012.


4.  Disclosures About Fair Value of Financial Instruments:

Financial Fair Value Measurements:
 
The following tables set forth the Company’s financial assets and liabilities that were measured at fair value on a recurring basis at June 30, 2013, and December 31, 2012, by level within the fair value hierarchy. Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

At June 30, 2013, the Company classified $24.7 million of its marketable securities as Level 2 due to the trading volumes being lower than normal, coupled with wide bid/ask spreads, lack of current publicly available information, or few recent transactions. There were two securities, which accounted for $10.4 million of the June 30, 2013 Level 2 balance, that were transferred during the period from Level 1 to Level 2 classification because of low trading volumes, and bid/ask spreads greater than 10%.
  
At June 30, 2013 (in thousands):
Assets
Quoted Prices In
Active Markets
for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Balance at
June 30, 2013
Available-for-sale equity securities (1)
$
14,816

 
$
24,701

 
 
 
$
39,517

Available-for-sale debt securities (1)
$
7,045

 
 
 
 
 
$
7,045

Readily marketable inventory (2)
$
3,520

 
$
3,879

 
 
 
$
7,399

Derivative instruments (3)
$
679

 
$
2,085

 
 
 
$
2,764

Liabilities
 
 
 
 
 
 
 
Derivative instruments (3)
$
1,184

 
$
528

 
 
 
$
1,712



14



At December 31, 2012 (in thousands):
Assets
Quoted Prices In
Active Markets
for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Balance at
December 31,
2012
Available-for-sale equity securities (1)
$
27,977

 
$
12,461

 
 
 
$
40,438

Available-for-sale debt securities (1)
$
8,026

 
 
 
 
 
$
8,026

Readily marketable inventory (2)
$
3,152

 
$
3,773

 
 
 
$
6,925

  Derivative instruments (3)
$
96

 
$
2,257

 
 
 
$
2,353

Liabilities
 
 
 
 
 
 
 
Derivative instrument (3)
$
459

 
$
104

 
 
 
$
563


(1) Where there are quoted market prices that are readily available in an active market, securities are classified as Level 1 of the valuation hierarchy. Level 1 available-for-sale investments are valued using quoted market prices multiplied by the number of shares owned and debt securities are valued using a market quote in an active market. All Level 2 available-for-sale securities are one class because they all contain similar risks and are valued using market prices and include securities where the markets are not active, that is where there are few transactions, or the prices are not current or the prices vary considerably over time. Inputs include directly or indirectly observable inputs such as quoted prices. Level 3 available-for-sale securities would include securities where valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

(2) Readily marketable inventory are commodity inventories that are reported at fair value based on commodity exchange quotations. Canola seed inventories are valued based on the quoted market price multiplied by the quantity of inventory and are classified as Level 1. Canola oil and meal inventories are classified as Level 2 because the inputs are directly observable, such as the quoted market price of the corresponding soybean commodity.

(3) Included in this caption are three types of agricultural commodity derivative contracts: swaps, exchange traded futures, and forward commodity purchase and sale contracts. The exchange traded futures contracts are valued based on quoted prices in active markets multiplied by the number of contracts and are classified as Level 1. The swaps are classified as Level 2 because the inputs are directly observable, such as the quoted market prices for relevant commodity futures contracts. The swaps are valued based on the difference of the arithmetic average of the quoted market price of the relevant underlying multiplied by the notional quantities, and the arithmetic average of the prices specified in the instrument multiplied by the notional quantities.

Forward commodity purchase and sale contracts classified as derivatives are valued using quantitative models that require the use of multiple inputs including quoted market prices and various other assumptions including time value. These contracts are categorized as Level 2 and are valued based on the difference between the quoted market price and the price in the contract multiplied by the undelivered notional quantity deliverable under the contract.

Non-Financial Fair Value Measurements:

The following table sets forth the Company’s non-financial assets that were measured at fair value on a non-recurring basis for the six months ended June 30, 2013, by level within the fair value hierarchy. There were no such measurements during the six months ended June 30, 2012.

Assets measured at fair value on a non-recurring basis are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset.


15



Six Months Ended June 30, 2013 (in thousands):
Asset Description
Quoted Prices In Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
Total Loss
Intangible asset (exclusive right to use infrastructure and associated water credits) (1)
 
 
 
 
$
83,897

 
$
993

Real estate (2)
 
 
 
 
$
3,674

 
$
417


(1) As of June 30, 2013, the Company had a non-recurring fair value measurement for an intangible asset with a carrying amount of $84.9 million that was written down to its estimated fair value of $83.9 million resulting in an impairment charge of $993,000, which was included in earnings for the three and six months ended June 30, 2013. The implied fair value was calculated using a discounted cash flow model that incorporated a wide range of assumptions including current asset pricing, price escalation, discount rates, absorption rates, timing of sales, and costs. Given the decline in market prices for similar assets, increases in interest rates, and extended timing of expected absorptions, the Company adjusted its assumptions and judgments in the model from prior projections for the Fish Springs water credits and pipeline rights and Carson Lyon water assets.

(2) As of June 30, 2013, the Company had a non-recurring fair value measurement of real estate assets with a carrying value of $4.1 million that was written down to its estimated fair value of $3.7 million resulting in an impairment charge of $417,000, which was included in earnings for the three and six months ended June 30, 2013. The impairment was recorded based on the estimated sales price the Company expects to receive upon the sale of this real estate.


Estimated Fair Value of Financial Instruments Not Carried at Fair Value:

The following table presents the carrying value and fair value of the Company’s financial instruments which are not carried at fair value at June 30, 2013 and December 31, 2012. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The level within the fair value hierarchy in which the fair value measurements are classified include measurements using quoted prices in active markets for identical assets or liabilities (Level 1), quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active (Level 2), and significant valuation assumptions that are not readily observable in the market (Level 3). As of June 30, 2013 and December 31, 2012, the fair values of cash and cash equivalents, accounts payable and receivable approximated their carrying values because of the short-term nature of these assets or liabilities. The estimated fair value of the Company's debt is based on cash flow models discounted at the then-current interest rates and an estimate of the then-current spread above those rates at which the Company could borrow, which are level 3 inputs in the fair value hierarchy. The estimated fair value of the Company’s other investments, which is an investment in preferred stock of a private company, cannot be reasonably estimated.

 (In thousands)
June 30, 2013
 
December 31, 2012
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial liabilities:
 
 
 
 
 
 
 
Debt
$
150,447

 
$
160,793

 
$
141,008

 
$
137,024



16



Derivatives:

The table below summarizes the notional amount of open derivative positions.
 
June 30, 2013
 
Exchange Traded
 
Non-Exchange Traded
 
 
 
(Short)(1)
 
Long(1)
 
(Short)(1)
 
Long(1)
 
Unit of Measure
Futures
 
 
 
 
 
 
 
 
 
Agricultural Commodities
(33,444
)
 
42,050

 
 
 
 
 
Tons
Natural Gas
 
 
120,000

 
 
 
 
 
MMBtus
Forwards
 
 
 
 
(89,011
)
 
42,670

 
Tons
Swaps
 
 
 
 
 
 
33,500

 
Tons

(1) Exchange and non-exchange traded futures, forwards, and swaps are presented on a gross (short) and long position basis.

The gross derivative asset or liability is included within its respective other assets or liabilities account balance in the accompanying condensed consolidated balance sheets.

The table below summarizes the effect of derivative instruments on the condensed consolidated statements of operations and comprehensive income or loss (in thousands).
 
Gain (Loss) Recognized in Income on Derivatives
 
 
 
Six Months Ended
 June 30,
 
Location
 
2013
 
2012
Futures(1)
Cost of canola oil and meal sold
 
$
3,134

 
$
784

Forwards(1)
Cost of canola oil and meal sold
 
280

 
(1,263
)
Swaps(1)
Cost of canola oil and meal sold
 
431

 
(5,711
)
 
 
 
$
3,845

 
$
(6,190
)
 
 
 
 
 
 
Futures(2)
Operating and other costs
 

 
$
(708
)
Forwards(2)
Operating and other costs
 

 
707

Swaps(2)
Operating and other costs
 

 
1,884

 
 
 
$

 
$
1,883


(1) Represents the activity post-completion of the Company’s canola processing plant.

(2) Represents the activity pre-completion of the Company’s canola processing plant.


5.  Debt

The Company has debt outstanding primarily within its real estate and agribusiness operations. As of June 30, 2013, the Company was in compliance with all construction financing debt covenants. If our canola business continues to report losses, it is possible we could breach one or more of our debt covenants which would require us to obtain a waiver from our lenders, or it could require us to provide additional capital into the business. As of June 30, 2013, the Company had approximately $39.3 million of unused loan commitments within our real estate operations.

As of June 30, 2013, and in conjunction with the acquisition of the controlling financial interest and consolidation of Spigit, the Company reported an $8 million debt owed by Spigit under a revolving credit facility with Comerica Bank. The loan bears interest at prime plus 250 basis points, currently 5.75%, was due on June 30, 2013 and is collateralized by all of Spigit’s assets. The loan was not repaid on the due date, and is currently in default.


17



The bank has the right to terminate or reduce the line of credit upon (i) any material adverse effect on the business, operations, property or financial condition of the Company, (ii) any material adverse effect on the ability of Spigit to repay borrowings or otherwise perform, observe or comply with any of its other obligations under the line of credit, (iii) any material adverse effect on the validity or enforceability of any of the material rights or remedies of the bank, or (iv) any material adverse effect on any of the security interests and liens of the bank in any property constituting collateral.

The loan agreement contains certain significant reporting and financial covenants as follows:

Spigit is required to achieve gross bookings (funds that are expected to be received from customers in the near future based on accepted orders or contracts), calculated on a rolling two quarter basis, as of June 30, 2013 of $9.1 million and is required to achieve an 85% renewal rate of its customer licenses. In addition, the bank requires Spigit to maintain a majority of its cash with the bank, with a minimum balance of $1 million during the term of the credit facility. Spigit is also required to produce audited financial statements within 120 days of its December 31 year end. At June 30, 2013, Spigit had not produced audited financial statements and during the period had a cash balance less than the minimum requirement. Spigit is in discussions with the bank to obtain an agreement that would extend the due date of the loan to August 31, 2013. Under the proposed terms of the agreement, the bank would not waive any existing breaches of the loan covenants, but would not call the loan during the extension period. See Note 7 for additional information regarding the Company’s investment in Spigit.

The following details the Company’s consolidated debt (in thousands):
 
June 30, 2013
 
December 31, 2012
Construction Financing:
 
 
 
       4.75% payments through 2017
$
86,517

 
$
89,500

Working Capital:
 
 
 
6% payments through 2017
5,750

 
5,000

Revolving Credit Facility:
 
 
 
5.75% due June 2013 (in default)
8,035

 
 
Swiss Debt:
 
 
 
3.7% payments through 2014
13,233

 
13,655

3.8% payments through 2014
3,176

 
3,277

Mortgages:
 
 
 
4% to 4.75% payments through 2013
5,365

 
5,551

5% payments due from 2014 - 2016
5,116

 
425

6% to 6.5% payments through 2036
15,173

 
15,531

8% payments through 2013
464

 
464

10% payments through 2013
7,605

 
7,605

Other
13

 
 
 
$
150,447

 
$
141,008



6.  Segment Reporting

PICO is a diversified holding company engaged in five operating and reportable segments: Water Resource and Water Storage Operations, Real Estate Operations, Agribusiness Operations, Enterprise Software, and Corporate. The Enterprise Software segment was started during 2013 due to the acquisition of Spigit.

The accounting policies of the reportable segments are the same as those described in the Company’s 2012 Annual Report on Form 10-K filed with the SEC, and in Footnote 1. 


18



Management analyzes segments using the following information:

Segment assets (in thousands):
 
June 30,
2013
 
December 31,
2012
Total Assets:
 
 
 
Water Resource and Water Storage Operations
$
214,363

 
$
210,189

Real Estate Operations
161,452

 
145,978

Agribusiness Operations
161,788

 
165,961

Enterprise Software
24,146

 
 
Corporate
101,036

 
145,046

 
$
662,785

 
$
667,174


Segment revenues and income or loss before taxes (in thousands): 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
Water Resource and Water Storage Operations
$
24,848

 
$
355

 
$
25,032

 
$
1,811

Real Estate Operations
27,991

 
1,589

 
39,930

 
5,413

Agribusiness Operations
44,914

 
9,658

 
84,479

 
9,684

Enterprise Software
5,597

 


 
9,247

 


Corporate
1,857

 
948

 
3,326

 
1,327

Total revenues
$
105,207

 
$
12,550

 
$
162,014

 
$
18,235

 
 
 
 
 
 
 
 
Income (Loss) before income taxes:
 
 
 
 
 
 
 
Water Resource and Water Storage Operations
$
4,677

 
$
(1,817
)
 
$
2,536

 
$
(2,979
)
Real Estate Operations
(1,758
)
 
(2,411
)
 
(2,470
)
 
(3,756
)
Agribusiness Operations
(8,760
)
 
(2,528
)
 
(18,475
)
 
(3,054
)
Enterprise Software
(1,559
)
 


 
(2,709
)
 


Corporate
(2,213
)
 
(3,848
)
 
(6,055
)
 
(7,748
)
Total loss before income taxes
$
(9,613
)
 
$
(10,604
)
 
$
(27,173
)
 
$
(17,537
)


7.  Business Combinations

At December 31, 2012, the Company owned 27% of the voting stock in Spigit and accordingly, recorded its investment as an unconsolidated affiliate using the equity method of accounting. However, the Company had not recorded any losses reported by Spigit since 2011, as previous losses had reduced the carrying value of the Company’s investment in Spigit to zero at December 31, 2011.

Effective January 31, 2013, the Company acquired its initial investment of Series F preferred stock (“Series F preferred stock”) and obtained effective control of Spigit for $5 million and obtained additional common stock by converting existing outstanding term loans with Spigit. Simultaneous with the Company’s initial acquisition of the Series F preferred stock, Spigit completed a one-for-five reverse split of certain other preferred shares outstanding. All issuances of Spigit’s preferred stock prior to the Series F preferred stock were then converted to common stock such that Spigit’s capitalization consisted only of Series F preferred stock, which is owned entirely by the Company, and common stock. In accordance with applicable accounting guidance, the initial acquisition was accounted for under the acquisition method of accounting and as such, the results of Spigit were consolidated with the Company's results of operations from the initial date of acquisition.


19



In conjunction with the initial acquisition, the Company also agreed to invest an additional $5 million by May 31, 2013 if Spigit, as of April 30, 2013, achieved certain pre-determined operational cash flow targets established by the Company. Spigit met the pre-determined targets and accordingly, during the three months ended June 30, 2013, the Company invested a further $1.8 million and received additional Series F preferred stock. The balance was invested subsequent to June 30, 2013 as Spigit required the cash to fund its operations. The Company owns approximately 69% of the total outstanding voting interest of Spigit at June 30, 2013.

The allocation of the acquired assets and liabilities requires extensive use of accounting estimates and judgments to allocate the purchase price to tangible and intangible assets acquired and liabilities assumed based on respective fair values. The Company’s purchase price allocations are preliminary and subject to revision as more detailed analyses are completed and additional information about the fair value of assets and liabilities becomes available, including information relating to tax matters and finalization of the Company’s valuation of identified intangible assets. The major classes of assets to which the Company preliminarily allocated the purchase price were goodwill of $5.1 million and identifiable intangible assets of $11 million. The measurement periods for purchase price allocations end as soon as information on the facts and circumstances becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a recasting of the amounts allocated to goodwill, retroactive to the periods in which the acquisitions occurred.

The following table summarizes the consideration transferred and the estimated fair values of net assets acquired and liabilities assumed (in thousands):
Consideration transferred:
 
Cash paid
$
5,000

Term loan converted to common stock
820

Fair value of the noncontrolling interest
248

Fair value of the Company’s existing investment prior to the acquisition
88

 
$
6,156

Net assets acquired:
 
Cash
$
5,174

Property, plant and equipment
1,524

Accounts receivable
3,608

Goodwill
5,101

Intangible assets
10,976

Other assets
877

Total assets
27,260

Debt
(8,038
)
Deferred revenue
(8,271
)
Accounts payable and accrued liabilities
(4,795
)
Total liabilities
(21,104
)
Net assets acquired
$
6,156


The following table summarizes the proforma financial information of the Company as if the acquisition occurred January 1, 2012:
 
Six Months Ended
 
June 30, 2013
 
June 30, 2012
Revenue
$
163,551

 
$
27,465

Net loss
$
(23,469
)
 
$
(24,823
)
Basic and diluted loss per share
$
(1.03
)
 
$
(1.09
)



20



8.  Commitments and Contingencies

Neither PICO nor its subsidiaries are parties to any potentially material pending legal proceedings other than the following.

PICO Holdings, Inc:

On August 16, 2011 and August 26, 2011, Ronald Dennis and George Assad, respectively, each filed a shareholder derivative complaint, purportedly on behalf of the Company, against the Company's directors in the Superior Court of California, County of San Diego, (the “Derivative Actions”). The Derivative Actions allege a combination of claims for breach of fiduciary duty, gross mismanagement, contribution and indemnification, abuse of control, waste of corporate assets and unjust enrichment in connection with the May 13, 2011 shareholder advisory vote on the Company's 2010 executive compensation pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act and the 2010 executive compensation underlying the vote.  The complaints seek monetary damages, equitable relief in the form of disgorgement, attachment, impoundment or imposition of a constructive trust over portions of the 2010 executive compensation, the implementation and administration of certain internal control procedures related to executive compensation, and costs and attorney's fees.  The Dennis complaint seeks a declaration that the May 13, 2011 advisory vote rebutted the business judgment regarding the Company's Board of Directors' approval of the 2010 executive compensation.

The Company removed each of the Derivative Actions to the United States District Court, Southern District of California and filed motions to dismiss each of the Derivative Actions.  The plaintiff in each of the Derivative Actions filed a motion to remand the Derivative Actions to the Superior Court of California, County of San Diego.

On January 6, 2012, the District Court granted in part the Company's motion to dismiss and granted in part plaintiffs' motions to remand, remanding certain claims to the Superior Court of the State of California.  The plaintiffs appealed, and the Company cross-appealed, the federal district courts rulings. On March 29, 2012, the Superior Court of California stayed the Derivative Actions pending the appeal and cross-appeal in the Ninth Circuit Court of Appeals. Briefing on the appeal and cross-appeal is complete.  The Ninth Circuit Court of Appeals had scheduled oral argument on the appeals and cross-appeals for June 4, 2013.  On July 31, 2013, the Ninth Circuit Court of Appeals held that the United States District Court, Southern District of California lacked jurisdiction over the case and, as a result, reversed the partial dismissal ordered by the district court.  As a result of the order from the Ninth Circuit Court of Appeals, the case will be remanded to the Superior Court of California, County of San Diego for further proceedings. An estimate of the possible range or outcome of this litigation cannot be made. However, the Company does not believe this litigation will result in a material impact to the condensed consolidated financial statements.
 
Fish Springs Ranch, LLC:

In September 2007, the Company reached a $7.3 million financial settlement with the Pyramid Lake Paiute Tribe of Indians relating to the exportation of water from the properties owned by Fish Springs Ranch, LLC. The settlement is pending ratification by the United States Congress, but we cannot be certain as to when the United States Congress will act on this matter. The Company has paid $3.7 million to the Tribe and accrued $3.6 million for the balance owed. No material developments occurred relating to this dispute or the settlement agreement during the first six months of 2013.

The Company is subject to various other litigation matters that arise in the ordinary course of its business. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly subjective and requires judgments about future events. When evaluating contingencies, we may be unable to provide a meaningful estimate due to a number of factors, including the procedural status of the matter in question, the presence of complex or novel legal theories, and/or the ongoing discovery and development of information important to the matters. In addition, damage amounts claimed in litigation against us may be unsupported, exaggerated or unrelated to possible outcomes, and as such are not meaningful indicators of our potential liability. We regularly review contingencies to determine the adequacy of our accruals and related disclosures. The amount of ultimate loss may differ from these estimates, and it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.

21



Whether any losses finally determined in any claim, action, investigation or proceeding could reasonably have a material effect on our business, financial condition, results of operations or cash flows will depend on a number of variables, including: the timing and amount of such losses; the structure and type of any remedies; the significance of the impact any such losses, damages or remedies may have on our condensed consolidated financial statements; and the unique facts and circumstances of the particular matter that may give rise to additional factors.


9. Subsequent Events

Definitive Merger:

In August 2013, Spigit signed a definitive merger agreement with another privately held enterprise software company. Under the terms of agreement, Spigit shareholders will receive 30% of the ownership of the merged company on a fully diluted basis and, as such, PICO will own approximately 22.6% of the merged company on a fully diluted basis.  The closing of the merger is subject to various contingencies including obtaining Spigit shareholder approval, and the successful completion of additional financing.

Public Offering:

On July 17, 2013, UCP Inc., PICO’s newly created, wholly-owned subsidiary, sold 7,750,000 shares of its Class A common stock at $15 per share in an initial public offering to outside investors. Net proceeds to UCP Inc. were $108.1 million before direct offering costs. UCP, Inc. was incorporated as a Delaware corporation on May 7, 2013 and is a holding company. After receiving the proceeds from the public offering, UCP, Inc. acquired an equity interest in UCP, LLC, its sole material asset. As the sole managing member of UCP, LLC, UCP, Inc. will control all of the business and affairs of UCP, LLC and its subsidiaries and will consolidate the results of operations of UCP, LLC in its condensed consolidated financial statements.

Prior to the offering, PICO’s existing wholly-owned subsidiary, UCP, LLC, amended its operating agreement to, among other things, designate UCP, Inc. as the sole managing member of UCP, LLC, establish UCP, LLC Series B Units (owned by UCP, Inc.), and to reclassify PICO's existing membership interests into UCP, LLC Series A Units (which represent 57.7% of the economic interest in UCP, LLC). The UCP, LLC Series B Units rank on a parity with the UCP, LLC Series A Units as to distribution rights and rights upon liquidation, winding up or dissolution.

UCP, Inc. has two securities outstanding after the public offering: Class B common stock which was issued to PICO and entitles PICO to one vote per Series A Unit held currently, 57.7% of the voting interest of UCP, Inc. and the Class A common stock that was sold in the public offering which controls the remaining 42.3% of the vote. In addition to voting, the Class A common stock also entitles the holder to 42.3% of the economic interest of UCP, LLC.

As a result of the transaction, PICO’s voting ownership in UCP, Inc. (and its economic ownership in UCP LLC) was reduced to 57.7%. However, given the controlling financial interest PICO owns, it will consolidate UCP Inc. in its condensed consolidated financial statements and record noncontrolling interest for the remaining 42.3% ownership interest, starting in the third quarter of 2013.

Concurrent with the public offering, PICO entered into various agreements with UCP, Inc. including an investor rights agreement, an exchange agreement, and a tax receivable agreement.

Investor Rights Agreement
 
The investor rights agreement provides PICO the right to nominate two individuals for election to the UCP, Inc. board of directors for as long as PICO owns 25% or more of the combined voting power of the outstanding Class A and Class B common stock and one individual for as long as it owns at least 10%. The agreement will terminate when PICO owns less than 10% of the combined voting power of the outstanding Class A and Class B common stock or when PICO is no longer required to consolidate UCP, Inc.'s financial condition and results of operations in its condensed consolidated financial statements, whichever is later.


22



Exchange Agreement

The exchange agreement grants PICO the right to exchange its UCP, LLC Series A Units for shares of Class A common stock of UCP, Inc. on a one-for-one basis. As PICO exchanges its UCP, LLC Series A Units, PICO's interest in UCP, LLC will be correspondingly decreased. UCP, LLC will make an election under Section 754 of the Internal Revenue Code effective for each taxable year in which an exchange of UCP, LLC Series A Units for shares of UCP, Inc. Class A common stock occurs, which may result in an adjustment to the tax basis of the assets owned by UCP, LLC at the time of an exchange of Series A Units. The increases in tax basis may also decrease gains (or increase losses) on future dispositions of certain assets to the extent tax basis is allocated to those assets.

Tax Receivable Agreement
 
The tax receivable agreement entered into by PICO and UCP, Inc. provides for a sharing of the value of the tax benefits between PICO and UCP, Inc generated from the exchange of shares discussed above. UCP, Inc. will make a payment to PICO of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that it realizes as a result of increases in tax basis. UCP, Inc. and its Class A common stockholders will benefit from the remaining 15% of cash savings, if any, in income tax that is realized by UCP, Inc. Cash savings in income tax will be computed by comparing the actual income tax liability to the amount of such taxes that would have been paid had there been no increase in the tax basis of the tangible and intangible assets of UCP, LLC as a result of the exchanges. The term of the tax receivable agreement will continue until all such tax benefits have been utilized or expired.
 
Estimating the amount of payments to be made under the Tax Receivable Agreement is dependent upon a number of factors, including:
 
the timing of any exchanges of UCP, LLC Series A Units for shares of Class A common stock, as the increase in any tax deductions will vary depending on the fair market value of the depreciable and amortizable assets of UCP, LLC at the time of any such exchanges, and this value may fluctuate over time;
the price of the Class A common stock of UCP, Inc. at the time of any exchanges of UCP, LLC Series A Units for shares of Class A common stock (since the increase in the share of the basis in the assets of UCP, LLC, as well as the increase in any tax deductions, will be related to the price of the Class A common stock at the time of any such exchanges);
the tax rates in effect at the time of the increased amortization and depreciation deductions or other realized tax benefits; and
the amount, character and timing of UCP, Inc.'s taxable income.
 
If UCP, Inc. does not have taxable income in a given taxable year, the company will not be required to make payments under the tax receivable agreement for that taxable year because no tax savings will have been realized.



23



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, 2012.

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 Annual Report on Form 10-K for the year ended December 31, 2012, in Item 1A of Part II of this Quarterly Report on Form 10-Q, 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 and 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 both long-term assets that may require several years to develop and monetize and shorter-term operations that should generate recurring revenue each quarter.

As of June 30, 2013 our business is separated into five operating segments:
Water Resource and Water Storage Operations;
Real Estate Operations;
Agribusiness Operations;
Enterprise Software; and
Corporate


24



As of June 30, 2013, 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 (See -Real Estate Operations for additional information relating to our ownership of UCP); 
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;
Spigit, Inc. (“Spigit”) a 69% owned subsidiary that develops enterprise innovation software.


RESULTS OF OPERATIONS — THREE AND SIX MONTHS ENDED JUNE 30, 2013 AND 2012

Overview of Economic Conditions and Impact on Results of Operations

The economic environment and housing slow-down in the U.S. during the past several years significantly decreased the rate of growth in the Southwest and the demand for our water and real estate assets in certain markets. However, we have seen improvement in the housing markets recently which has led to increased levels of real estate development activity. We believe that a continuation of the housing recovery will ultimately lead to increased demand for our real estate and water assets. However, any deterioration in the markets in which we operate has the potential to cause additional impairment losses on our real estate and water assets.

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.

PICO Shareholders’ Equity

Our shareholders’ equity declined $19 million or $0.85 per share, during the six months ended June 30, 2013, from $473.2 million, or $20.82 per share at December 31, 2012 to $454.2 million, or $19.97 per share at June 30, 2013. The decrease in our shareholders’ equity was primarily due to the $22.7 million net loss during the period.

Business Combination

Effective January 31, 2013, the Company acquired additional voting preferred stock in Spigit, Inc., a privately held company that develops enterprise innovation software (“Spigit”), in an initial transaction for $5 million by obtaining newly issued shares directly from Spigit. During the second quarter of 2013, the Company made additional investments of $1.8 million. As a result of these transactions, the Company’s voting ownership increased from 27% at December 31, 2012 to 69% at June 30, 2013. In accordance with applicable accounting guidance, the initial acquisition was accounted for under the acquisition method of accounting and, as such, the results of Spigit were consolidated with the Company's results of operations from the date of acquisition. The Company reported the results of Spigit as a new reportable segment. The acquisition and consolidation of Spigit increased the Company’s assets and liabilities by approximately $21.4 million and $20.4 million, respectively.

Total Assets and Liabilities

Total assets decreased by $4.4 million from $667.2 million at December 31, 2012 to $662.8 million at June 30, 2013. The Company’s real estate and water assets increased $5.3 million primarily due to acquisitions and development costs in real estate projects in UCP. Notes and other receivables and other assets increased by $28.5 million primarily due to the business combination of Spigit, which accounted for $21.4 million of the increase. Cash and cash equivalents decreased $32.7 million as the Company used cash to fund the acquisition and development of its real estate projects, and for overhead and other operating costs. During the first half of 2013, total liabilities increased by $18.2 million, from $188.7 million at December 31, 2012 to $206.9 million at June 30, 2013. The change was due to an increase in the Company’s debt balance of $9.4 million, primarily from the consolidation of the $8 million bank loan owed by Spigit, and an increase of $8.2 million in other liabilities which was primarily due to the consolidation of Spigit’s $7.4 million deferred revenue balance.


25



Net Loss

We reported a net loss from continuing operations, after noncontrolling interest, of $7.7 million, or $0.34 per share and $10.2 million, or $0.45 per share for the second quarter ended June 30, 2013 and 2012, respectively. The decrease in our net loss resulted from a year-over-year decrease in the losses reported within our real estate and water resources segments, offset by an increase in the loss reported within our agribusiness segment. For the six months ended June 30, 2013, our reported net loss was $22.7 million or $1.00 per share, compared to a net loss of $15.7 million or $0.69 per share for the first half of 2012.

Noncontrolling Interests

The net loss attributable to noncontrolling interest represents the share of net income or loss from our less than wholly-owned consolidated subsidiaries that is allocated, based on relative ownership percentage, to the noncontrolling shareholders of those entities. Currently, the most significant subsidiaries that are less than wholly-owned in our condensed consolidated financial statements are Northstar, Fish Springs, and beginning January 31, 2013, Spigit. Loss attributable to noncontrolling interests was $1.8 million and $520,000 for the three months ended June 30, 2013 and 2012, respectively. A total of $2.3 million of the noncontrolling interest recorded during the six months ended June 30, 2013 was in our agribusiness operations based on a reported net loss in that segment of $18.5 million.

Comprehensive Loss

For the second quarter of 2013, we reported a comprehensive loss of $7.2 million which consisted primarily of a net loss of $7.7 million, offset by an increase of $791,000 in unrealized appreciation on available-for-sale securities.

For the first half of 2013, we reported comprehensive loss of $21.2 million. This comprehensive loss consisted of a net loss of $22.7 million, offset by an increase of $1.5 million in unrealized appreciation on available-for-sale securities.

Segment Results of Operations

Our segment revenue and loss before income taxes for the second quarter and first half of 2013 and 2012 were:
 
Three Months Ended
 
 
 
Six Months Ended
 
 
Thousands of dollars
June 30,
 
 
 
June 30,
 
 
 
2013
 
2012
 
Change
 
2013
 
2012
 
Change
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Water Resource and Water Storage Operations
$
24,848

 
$
355

 
$
24,493

 
$
25,032

 
$
1,811

 
$
23,221

Real Estate Operations
27,991

 
1,589

 
26,402

 
39,930

 
5,413

 
34,517

Agribusiness Operations
44,914

 
9,658

 
35,256

 
84,479

 
9,684

 
74,795

Enterprise Software
5,597

 


 
5,597

 
9,247

 


 
9,247

Corporate
1,857

 
948

 
909

 
3,326

 
1,327

 
1,999

Total revenue
$
105,207

 
$
12,550

 
$
92,657

 
$
162,014

 
$
18,235

 
$
143,779

 
 
 
 
 
 
 
 
 
 
 
 
Loss before income taxes:
 
 
 
 
 
 
 
 
 
 
 
Water Resource and Water Storage Operations
$
4,677

 
$
(1,817
)
 
$
6,494

 
$
2,536

 
$
(2,979
)
 
$
5,515

Real Estate Operations
(1,758
)
 
(2,411
)
 
653

 
(2,470
)
 
(3,756
)
 
1,286

Agribusiness Operations
(8,760
)
 
(2,528
)
 
(6,232
)
 
(18,475
)
 
(3,054
)
 
(15,421
)
Enterprise Software
(1,559
)
 


 
(1,559
)
 
(2,709
)
 


 
(2,709
)
Corporate
(2,213
)
 
(3,848
)
 
1,635

 
(6,055
)
 
(7,748
)
 
1,693

Loss before income taxes
$
(9,613
)
 
$
(10,604
)
 
$
991

 
$
(27,173
)
 
$
(17,537
)
 
$
(9,636
)


26



Second Quarter Revenue

The majority of our recurring revenue is expected to occur in our agribusiness and real estate operations. Both of these segments generate revenue from volume sale of their products. Our second quarter revenue was $105.2 million in 2013, compared to $12.6 million in 2012, an increase of $92.6 million year-over-year.  This increase was primarily due to a $35.3 million increase in revenue due to added sales volume in our agribusiness operations, a $26.4 million increase in sales of real estate primarily from selling more residential homes, and a $24.5 million increase in revenue in our water resources and water storage operations, primarily due to the sale of real estate and water assets in Arizona, and the sale of our farm properties in Idaho.

Second Quarter Costs and Expenses

Second quarter costs and expenses were $114.8 million in 2013, compared to $23.2 million in 2012, an increase in year-over-year expenses of $91.6 million.  Our agribusiness operations increased production and sales and consequently, reported an increase in expenses of $41.5 million, primarily from a $37.4 million increase in cost of sales of canola oil and meal, and a $4.1 million increase in overhead, interest and depreciation expenses. Our real estate segment reported an increase in expenses of $25.7 million which was primarily due to a $20.5 million increase in cost of its real estate sales. Additionally, our water resources and water storage operations reported an increase in expenses of $18 million primarily from an increase in cost of real estate and water assets sold.

Second Quarter Loss Before Income Taxes

Our second quarter year-over-year net loss before income taxes decreased by $991,000 primarily due to a $6.2 million and a $1.6 million increase in the loss reported by our agribusiness and our enterprise software segments, respectively, which offset a $6.5 million increase in the gain reported by our water resource and water storage operations and a decrease in the loss reported by our real estate and corporate operations of $653,000 and $1.6 million, respectively.

Second Quarter Income Taxes and Noncontrolling Interest in Subsidiaries

In the second quarter of 2013, we reported a net loss of $7.7 million, or $0.34 per share.  We recorded a $114,000 tax benefit and noncontrolling interests reported a loss of $1.8 million.

We reported a net loss of $15.4 million, or $0.68 per share for the second quarter of 2012 after a $125,000 tax provision.  During the three months ended June 30, 2012, noncontrolling interests reported expense of $520,000
 
Due to the full valuation allowance on our net deferred taxes, our effective tax rate for the second quarter of 2013 and 2012 was a tax benefit of 1% and a tax provision of 1% respectively, compared to the Federal corporate income tax rate of 35%.

First Half Revenue

Our first half revenue was $162 million in 2013, compared to $18.2 million in 2012, an increase of $143.8 million year-over-year.  This increase was primarily due to a $74.8 million increase in agribusiness revenue as we commenced crushing canola seed and selling canola oil and meal after the first quarter of 2012, a $34.5 million increase in sale of real estate due primarily to selling more residential homes and a $23.2 million increase in revenue in our water resource and water storage operations due to the sale of real estate and water assets in Arizona, and the sale of our farm properties in Idaho.

First Half Costs and Expenses

First half costs and expenses were $189.2 million in 2013, compared to $35.8 million in 2012, an increase in year-over-year expenses of $153.4 million.  Our agribusiness operations reported an increase in expenses of $90.2 million, primarily from a $78 million increase in cost of sales of canola oil and meal, and a $12.2 million increase in overhead, interest and depreciation expenses. Our real estate segment reported an increase in expenses of $33.2 million primarily due to a $26.3 million increase in the cost of real estate sold. The costs and expenses in our water resource and water storage operations increased $17.7 million primary due to the cost of the real estate and water sold during the period. Lastly, our enterprise software operations reported expenses and overhead of $12 million for the first half of 2013 primarily from salaries and benefits.


27



First Half Loss Before Income Taxes

Our first half year-over-year net loss before income taxes increased by $9.6 million primarily due to a $15.4 million increase in the loss reported by our agribusiness segments, offset by a $5.5 million year-over-year increase in income reported in our water resource and water storage operations.

First Half Income Taxes and Noncontrolling Interest in Subsidiaries

In the first half of 2013, we reported a net loss of $22.7 million, or $1.00 per share.  We recorded an $898,000 tax benefit and noncontrolling interests reported a loss of $3.6 million.

We reported a net loss of $20.3 million, or $0.89 per share for the first half of 2012 after a $1.1 million tax benefit.  During the six months ended June 30, 2012, noncontrolling interests reported a loss of $741,000.
 
Due to the full valuation allowance on our net deferred taxes, our effective tax rate for the first half of 2013 and 2012 was a tax benefit of 3% and 6% respectively, compared to the Federal corporate income tax rate of 35%.
WATER RESOURCE AND WATER STORAGE OPERATIONS
 
Three Months Ended
 
 
 
Six Months Ended
 
 
Thousands of dollars
June 30,
 
 
 
June 30,
 
 
 
2013
 
2012
 
Change
 
2013
 
2012
 
Change
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Sale of real estate and water assets
$
23,663

 
$
5

 
$
23,658

 
$
23,666

 
$
15

 
$
23,651

Other
1,185

 
350

 
835

 
1,366

 
1,796

 
(430
)
Total revenue
24,848

 
355

 
24,493

 
25,032

 
1,811

 
23,221

 

 

 
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of real estate and water assets sold
(16,639
)
 
(1
)
 
(16,638
)
 
(16,639
)
 
(3
)
 
(16,636
)
Impairment of water assets
(993
)
 


 
(993
)
 
(993
)
 


 
(993
)
Interest expense
(11
)
 
(17
)
 
6

 
(22
)
 
(34
)
 
12

Depreciation and amortization
(333
)
 
(331
)
 
(2
)
 
(658
)
 
(653
)
 
(5
)
Overhead
(1,248
)
 
(1,330
)
 
82

 
(2,741
)
 
(2,823
)
 
82

Project expenses
(947
)
 
(493
)
 
(454
)
 
(1,443
)
 
(1,277
)
 
(166
)
Segment total expenses
(20,171
)
 
(2,172
)
 
(17,999
)
 
(22,496
)
 
(4,790
)
 
(17,706
)
Income (loss) before income taxes
$
4,677

 
$
(1,817
)
 
$
6,494

 
$
2,536

 
$
(2,979
)
 
$
5,515

 
Historically, Vidler and its subsidiaries’ revenue has 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 revenue 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 revenue in future years.

Segment Revenue

We closed two sale transactions in June 2013 which, in aggregate, contributed the majority of the segment revenue for both the second quarter and the first half of 2013. We sold 1,021 acres of land and 3,063 acre-feet of groundwater rights located in the Harquahala Valley, Arizona, for sale proceeds of $10 million and a gross margin of $6.3 million. In addition, we also sold two farms in Idaho for sale proceeds of $13.7 million and a gross margin of $763,000. The two farms that were sold also generated lease revenue of $726,000 and $218,000 for the first half of 2013 and 2012, respectively. From the third quarter of 2013, we will no longer record any lease revenue or operating costs associated with the two farms that were sold.

There were no significant sales of water rights and related real estate assets in the second quarter and first half of 2012.  Revenue generated in the second quarter and first half of both 2013 and 2012 also consisted of lease income from our ranch and farm properties. In addition, in the first half of 2012, due to the expiration of an option we had entered in to with a potential purchaser of our Lincoln County, Nevada power plant project, we generated revenues of $1.3 million from the option fees we had previously recorded as unearned.

28




Segment Expenses

In the second quarter of 2013, our total expenses increased by $18 million compared to 2012 and by $17.7 million in the first half of 2013 as compared to 2012. The primary reason for the increase in total expenses was the increase in the cost of real estate and water assets of $16.6 million in both the second quarter and first half of 2013 as compared to 2012. The increase in cost of sales was due to the two sale transactions that closed in June, 2013 as noted in Segment Revenue above.

Overhead expenses were almost unchanged for both the second quarter and first half of 2013 as compared to 2012. Total overhead was $1.2 million in the second quarter of 2013 as compared to $1.3 million in the second quarter of 2012. Overhead was $2.7 million for the first half of 2013 as compared to $2.8 million in the first half of 2012.

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;
the operation of our farm properties in Idaho; and
certain exploration costs for water resource development in New Mexico

Project expenses declined by $454,000 in the second quarter of 2013 as compared to the second quarter of 2012 and the year-over-year project costs were unchanged at $1.4 million and $1.3 million in first half of both periods. As noted above, from the third quarter of 2013 we will no longer record any lease revenue or operating costs associated with our farm properties in Idaho as the two farms were sold in June, 2013.

The impairment charge of $993,000 recorded in the second quarter and first half of 2013 related to our Fish Springs water asset in Washoe County, Nevada. During the second quarter of 2013, specific events occurred in Washoe County that caused us to update our discounted cash flow models that calculate an estimated fair value for our Fish Springs Ranch water credits and pipeline rights. The changes in assumptions relate to the timing of future estimated sales of our water assets as well as inputs in to the discount rate. As a result of updating our discounted cash flow models, the fair value of our Fish Springs water asset was estimated at $83.9 million compared to its then carrying value of $84.9 million. Consequently, in the second quarter and first half of 2013, we recorded the $993,000 difference as an impairment charge to reflect the decrease in the estimated fair value of the asset.

The year-over-year segment results of operations increased by $6.5 million for the second quarter and by $5.5 million for the first six months. The increase in the year-over-year results of operations for both periods was due primarily to the gross margin of $6.3 million generated in the second quarter and first half of 2013 from the sale of land and water rights in the Harquahala Valley, Arizona.



29



REAL ESTATE OPERATIONS
 
Three Months Ended
 
 
 
Six Months Ended
 
 
Thousands of dollars
June 30,
 
 
 
June 30,
 
 
 
2013
 
2012
 
Change
 
2013
 
2012
 
Change
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Sale of real estate and water assets
$
27,722

 
$
1,435

 
$
26,287

 
$
39,525

 
$
4,970

 
$
34,555

Other
269

 
154

 
115

 
405

 
443

 
(38
)
Total revenue
27,991

 
1,589

 
26,402

 
39,930

 
5,413

 
34,517

 

 

 
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of real estate and water assets sold
(21,581
)
 
(1,059
)
 
(20,522
)
 
(29,632
)
 
(3,367
)
 
(26,265
)
Interest expense


 
(324
)
 
324

 


 
(677
)
 
677