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. During the year ended 2012, the Company sold the two companies that previously comprised the insurance in run-off segment. As a result of the transaction, the assets and liabilities of the insurance segment qualified as held for sale and were classified as discontinued operations in the accompanying consolidated financial statements as of the earliest period presented. Consequently, prior periods presented have been recast from amounts previously reported to reflect the insurance segment as discontinued operations.

The preparation of 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 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 March 31, 2013, and December 31, 2012, it is reasonably possible that actual results could differ from the estimates upon which the carrying values were based.

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 March 31, 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	—
Vested	—
Outstanding at March 31, 2013	467,716
Unrecognized compensation cost (in thousands)	$	5,565

The Company recorded stock based compensation expense of $946,000 and $1 million, for the three months ended March 31, 2013 and 2012, respectively for the RSU outstanding during the period.

During the three months ended March 31, 2012, 140,000 RSU vested which resulted in delivery of 94,176 newly issued shares of PICO common stock.

Stock-Settled Stock Appreciation Rights (SAR):

There were no SAR granted or exercised during the three months ended March 31, 2013 or 2012. There was no stock-based compensation expense recognized for SAR during the three months ended March 31, 2013 or 2012 as there were no unvested SAR in those periods.

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 March 31, 2013	1,616,625		$	36.45	3.1 years

At March 31, 2013, none of the outstanding SAR were in-the-money.

Business Combination:

At December 31, 2012, the Company owned 27% of the voting stock in Spigit, Inc. (“Spigit”), a privately held company that develops enterprise innovation software. Accordingly, the Company recorded its investment in Spigit 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 additional voting preferred stock (“Series F preferred stock”) in Spigit for $5 million and obtained additional common stock by converting existing outstanding term loans with Spigit. Simultaneous with the Company’s 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, as of March 31, 2013, Spigit’s capitalization consists only of Series F preferred stock which is owned entirely by the Company, and common stock. The effect of these transactions resulted in the Company owning approximately 67% of the total outstanding voting interest of Spigit. In accordance with applicable accounting guidance, the acquisition was accounted for under the acquisition method of accounting and as such, the results of Spigit were included in the Company's results of operations from the date of acquisition.

In conjunction with the 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 has met the pre - determined targets and accordingly the Company will invest a further $5 million in the Series F preferred stock upon satisfactory resolution of Spigit’s breach of its debt reporting covenant discussed below under Debt.

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 $10.2 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	10,249
Other assets	877
Total asset	26,533
Debt	(8,038		)
Deferred revenue	(8,271		)
Accounts payable and accrued liabilities	(4,068		)
Total liabilities	(20,377		)
Net assets acquired	$	6,156

The following table summarizes the proforma financial information of the Company as if the acquisition occurred at the beginning of the periods presented:



	March 31, 2013			March 31, 2012
Revenue	$	58,345		$	9,747
Net loss	$	(17,272	)	$	(7,599	)
Basic and diluted loss per share	$	(0.76	)	$	(0.33	)

Sale of 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.

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 VSOE, if available, TPE, if VSOE is not available, or 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.

Deferred Compensation:

The Company reports the investment returns generated in the deferred compensation accounts in revenues 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 March 31, 2013 and December 31, 2012, the Company had $23 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 $357,000 during the three months ended March 31, 2013 primarily due to an increase in the fair value of the assets of $618,000, 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 months ended March 31, 2013 and 2012 is compensation expense of $618,000 and $1.6 million, respectively.

Accumulated Other Comprehensive Loss:

The components of accumulated other comprehensive loss are as follows (in thousands):



	March 31, 2013			December 31, 2012

Net unrealized appreciation on available-for-sale investments	$	5,207		$	4,455
Foreign currency translation	(6,233		)	(6,469		)
Accumulated other comprehensive loss	$	(1,026	)	$	(2,014	)

The unrealized appreciation on available-for-sale investments is net of a deferred income tax liability of $2.9 million at March 31, 2013 and $2.4 million at December 31, 2012. The foreign currency translation is net of a deferred income tax asset of $3.1 million at March 31, 2013 and $3.3 million at December 31, 2012.

Real Estate and Water Assets:

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. No impairment charges were recorded during the three months ended March 31, 2013 or 2012.

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 March 31, 2013 and December 31, 2012, the Company had real estate of $7.9 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):



	March 31, 2013		December 31, 2012
Real estate	$	185,114	$	166,220
Real estate improvements	4,182		4,464
Water and water rights	86,992		86,764
Pipeline rights and water credits	84,890		84,890
	$	361,178	$	342,338

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 values of agricultural commodities inventories are recognized in earnings as a component of cost of canola oil and meal sold.

At March 31, 2013 and December 31, 2012, the Company had $14 million and $8.1 million, respectively, in inventory, the majority of which is considered readily marketable.

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.

Debt:

The Company has debt outstanding primarily related to its real estate and agribusiness operations. As of March 31, 2013, and in conjunction with the acquisition of the controlling financial interest and consolidation of Spigit, the Company has reported in the accompanying condensed consolidated balance sheets, an $8 million revolving credit facility Spigit has with Comerica Bank. The loan bears interest at prime plus 250 basis points, currently 5.75%, is due on June 30, 2013 and is collateralized by all of Spigit’s assets.

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:

Covenants:

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 March 31, 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 at least a minimum balance of $1 million during the term of the credit facility. Spigit was in compliance with each of these covenants as of March 31, 2013. Spigit is also required to produce audited financial statements within 120 days of its December 31 year end, which it had violated as of April 30, 2013. Under the terms of the revolving credit facility, the bank may declare the entire credit facility immediately due and payable. Spigit is attempting to obtain a waiver from the bank for this breach.

The following details the Company’s consolidated debt (in thousands):



	March 31, 2013		December 31, 2012
Construction Financing:
4.75% payments through 2017	$	88,008	$	89,500
Working Capital:
6% payments through 2017	8,000		5,000
Revolving Credit Facility:
5.75% due June 2013	8,039
Swiss Debt:
3.7% payments through 2014	13,164		13,655
3.8% payments through 2014	3,160		3,277
Mortgages:
4% to 4.5% payments through 2013	5,508		5,551
5% payments due from 2014 - 2016	5,116		425
6% to 6.5% payments through 2036	19,732		15,531
8% payments through 2013	464		464
10% payments through 2013	7,604		7,605
Other	15
	$	158,810	$	141,008

Related Party Receivables

As of March 31, 2013, the Company had loaned $750,000 to Northstar Agri Industries, LLC, the owner of the 12% interest in Northstar, which was used to finance certain of their operating expenses. Interest is charged at approximately 10% per annum. The maximum amount that may be borrowed is $750,000 and the balance payable is due on demand.

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 $784,000 and $1.2 million for the three months ended March 31, 2013 and 2012, respectively. The effective income tax rate for continuing operations was 4% and 17% for the three months ended March 31, 2013 and 2012, respectively. For the three months ended March 31, 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.

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.