10-Q 1 q10_0206.txt JUNE 30, 2002 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30,2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 0-23430 South Dakota State Medical Holding Company, Incorporated (Exact name of registrant as specified in its charter) South Dakota 46-0401087 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1323 South Minnesota Avenue, Sioux Falls, South Dakota 57105 (Address of principal executive office) (Zip Code) (605) 334-4000 (Registrant's telephone number, including area code) ______________________________ (Former name, former address, and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 6, 2002 Class C Common Stock 1,365,604 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED FORM 10-Q INDEX Page Number Part 1. Financial Information (unaudited) Item 1. Financial Statements Consolidated Balance Sheets at June 30, 2002 and December 31, 2001 2 Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2002 and 2001 3 Consolidated Statement of Stockholders' Equity for the Six Months Ended June 30, 2002 4 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001 5 Notes to Consolidated Financial Statements 6-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-11 Item 3. Quantitative and Qualitative Disclosures about Market Risk 11 Part II. Other Information 12 Item 1. Legal Proceedings 12 Item 2. Changes in Securities and Use of Proceeds 12 Item 3. Defaults Upon Senior Securities 12 Item 4. Submission of Matters to a Vote of Security Holders 12 Item 5. Other Information 12 Item 6. Exhibits and Reports on Form 8-K 12 Signatures 13 Exhibits 99.1-99.2 CEO and CFO Certifications 14-15

1 PART 1: FINANCIAL INFORMATION Item 1. Financial Statements SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED BALANCE SHEETS (Unaudited) June 30, December 31, ASSETS 2002 2001 ------------------------------------------------------------------------------- Cash and cash equivalents $ 9,835,503 $ 8,673,787 Investments in securities held to maturity 638,526 890,714 Certificates of deposit 1,400,000 1,300,000 Receivables 1,436,673 1,544,987 Prepaids and other assets 55,125 135,541 Deferred income taxes 903,800 916,000 ------------- ------------- Total current assets 14,269,627 13,461,029 ------------- ------------- Investment in securities held to maturity 4,072,439 4,083,452 Investment in securities available for sale 138,500 133,200 Certificate of deposit 100,000 100,000 Contracts with life insurance companies 89,988 92,337 ------------- ------------- Total long-term investments 4,400,927 4,408,989 ------------- ------------- Property and equipment, net of accum. depreciation 813,372 756,872 ------------- ------------- Deferred income taxes 861,300 731,000 ------------- ------------- $ 20,345,226 $ 19,357,890 ============= ============= LIABILITIES Reported and unreported claims payable $ 8,457,186 $ 8,238,361 Unearned premiums and administration fees 1,460,437 1,175,871 Accounts payable and accrued expenses 1,302,768 1,459,263 Contingency reserves payable 1,584,485 1,584,485 ------------- ------------- Total current liabilities 12,804,876 12,457,980 Contingency reserves payable 3,620,303 2,262,226 ------------- ------------- Total liabilities 16,425,179 14,720,206 ------------- ------------- Minority interest in subsidiaries 21,444 15,768 ------------- ------------- STOCKHOLDERS' EQUITY Class A preferred stock, issued 1,281 shares 12,810 12,600 Class B preferred stock, issued 1,300 shares 1,300 1,300 Class C common stock, issued 1,505,760 shares 15,058 15,058 Additional paid-in capital 3,749,342 3,749,342 Retained earnings 1,448,298 2,173,419 Accumulated other comprehensive income(loss) 974 (624) Less cost of Class C common treasury stock, 2002 140,156 shares, 2001 140,156 shares (1,329,179) (1,329,179) ------------- ------------- 3,898,603 4,621,916 ------------- ------------- $ 20,345,226 $ 19,357,890 ============= =============

See Notes to Consolidated Financial Statements. 2 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended June 30, Six Months Ended June 30, 2002 2001 2002 2001 --------------------------------------------------------------------------------------- Revenues: Premiums, net of reins. ceded $ 18,931,379 $ 14,041,055 $ 37,028,282 $ 27,308,243 Third party administration fees 1,080,266 888,071 2,365,716 1,825,388 Investment income 123,594 178,895 244,373 379,241 Other income 353,743 273,686 674,351 478,589 ------------- ------------- ------------- ------------- Total revenues $ 20,488,982 $ 15,381,707 $ 40,312,722 $ 29,991,461 ------------- ------------- ------------- ------------- Operating expenses: Claims incurred, net of reins. recoveries $ 17,771,360 $ 11,680,324 $ 34,354,029 $ 23,338,773 Personnel expense 1,416,886 1,319,711 2,798,639 2,508,073 Commissions 720,258 569,882 1,485,474 1,166,801 Professional fees expense 220,491 226,803 466,240 520,534 Office expense 245,578 173,125 490,580 336,446 Advertising 155,335 96,459 316,947 189,891 Occupancy expense 195,280 201,223 383,187 386,036 State insurance taxes 239,925 149,604 478,313 298,433 Other general and administrative expenses 215,133 48,477 535,461 316,181 ------------- ------------- ------------- ------------- Total operating expenses $ 21,180,246 $ 14,465,608 $ 41,308,870 $ 29,061,168 ------------- ------------- ------------- ------------- Income (loss) before income taxes and minority interest $ (691,264) $ 916,099 $ (996,148) $ 930,293 Income taxes (benefit) (248,200) 389,600 (260,300) 311,350 ------------- ------------- ------------- ------------- Income (loss) before minority interest $ (443,064) 526,499 $ (735,848) $ 618,943 Minority interest in (loss) of subsidiaries (5,093) (30,074) (10,727) (44,537) ------------- ------------- ------------- ------------- Net income (loss) $ (437,971) $ 556,573 $ (725,121) $ 663,480 ============= ============= ============= ============= Earnings (loss)per common share $ (0.32) $ 0.40 $ (0.53) $ 0.48 ============= ============= ============= ============= Weighted average number of common shares outstanding 1,365,604 1,387,727 1,365,604 1,393,137 ============= ============= ============= =============

See Notes to Consolidated Financial Statements. 3 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY SIX MONTHS ENDED JUNE 30, 2002 (Unaudited) Accumulated Additional Other Capital Paid-In Retained Comprehensive Treasury Stock Capital Earnings Income(Loss) Stock Total ------------------------------------------------------------------------------------------- Balance, December 31, 2001 $28,958 $3,749,342 $2,173,419 $ (624) $(1,329,179) $4,621,916 Issuance of Class A preferred stock 210 -- -- -- -- 210 Comprehensive (loss): Net (loss) -- -- (725,121) -- -- Net change in un- realized loss on securities avail- able for sale -- -- -- 1,598 -- Comprehensive (loss) -- -- -- -- -- (723,523) -------- ----------- ----------- --------- ------------ ----------- Balance, June 30, 2002 $29,168 $3,749,342 $1,448,298 $ 974 $(1,329,179) $3,898,603 ======== =========== =========== ========= ============ ===========

See Notes to Consolidated Financial Statements. 4 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, 2002 2001 CASH FLOWS FROM OPERATING ACTIVITIES Net (loss)income $ (725,121) $ 663,480 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 146,507 140,751 Minority interest in (loss) of subsidiaries (10,727) (44,537) Amortization of discounts and premiums on investments, net (71,794) (66,056) Gain on disposal of equipment (200) -- Decrease in receivables 108,314 1,078,474 Decrease in prepaids and other assets 80,416 15,143 Decrease (increase) in deferred income taxes (118,100) 102,000 Increase in reported and unreported claims payable 218,825 617,535 Increase in unearned premiums and administration fees 284,566 174,421 (Decrease) in accounts payable and accrued expenses (156,495) (342,502) Increase in contingency reserves payable 1,358,077 1,025,732 ------------- ------------- Net cash provided by operating activities $ 1,114,268 $ 3,364,441 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of securities available for sale $ (3,702) $ (3,648) Held to maturity securities: Matured 535,000 410,000 Purchased (200,005) (1,065,221) Repayments on collateralized mortgage obligations -- 2,090 Proceeds from maturities of certificates of deposit 350,000 450,000 Purchase of certificates of deposit (450,000) (450,000) Decrease in contracts with life insurance companies 2,349 5,019 Purchase of property and equipment (203,007) (72,367) Proceeds from the sale of property and equipment 200 -- ------------- ------------- Net cash (used in) provided by investing activities $ 30,835 $ (724,127) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of capital stock $ 210 $ 400 Payment of dividends -- (69,930) Purchase of treasury stock -- (500,000) Increase (decrease) in minority investment of subsidiary 16,403 (324,776) ------------- ------------- Net cash provided by (used in) financing activities $ 16,613 $ (894,306) ------------- ------------- Increase in cash and cash equivalents $ 1,161,716 $ 1,746,008 CASH AND CASH EQUIVALENTS Beginning 8,673,787 7,439,514 ------------- ------------- Ending $ 9,835,503 $ 9,185,522 ============= ============= Supplemental Disclosures of Cash Flow Information Cash payments for: Income taxes, net of refunds $ 0 $ 0 Supplemental Disclosures of Noncash Investing And Financing Activities (Increase) decrease in unrealized loss on securities available for sale $ 1,598 $ (1,407)

See Notes to Consolidated Financial Statements. 5 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The consolidated financial statements of South Dakota State Medical Holding Company, Incorporated, d/b/a DAKOTACARE, (the "Company") and its wholly-owned subsidiaries, DAKOTACARE Administrative Services, Incorporated (DAS), and DAKOTACARE Insurance Ltd. (DIL), and its 84.02% owned subsidiary, CareWest, Inc. (CW) contained in this report are unaudited but reflect all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial information for the periods presented and are not necessarily indicative of the results to be expected for the full year. 2. EARNINGS (LOSS) PER COMMON SHARE Earnings (loss) per common share is calculated by dividing net income (loss) by the weighted average number of Class C common shares outstanding during the period. 3. TREASURY STOCK As a service to the Company's shareholders to facilitate liquidity for Class C common stock (Common Stock) in the event of death, disability, or retirement of a shareholder, the Company's Board of Directors adopted a Stock Repurchase Program (Program) in February 1998. Participation in the Program is voluntary. No shareholder is required to sell his or her shares of Common Stock under the Program nor is the Company required to purchase any Common Stock under the Program. The purchase and sale of Common Stock under the Program is subject to repurchase conditions as described in the Program. The Board of Directors of the Company may, at any time, modify or terminate the Program. The Company may also, at its discretion, offer to repurchase shares of Common Stock outside the Program in compliance with applicable laws. 4. SEGMENT INFORMATION The Company has three reportable segments: Health Maintenance Organization (HMO), Third Party Administration (TPA) and Reinsurance. The HMO segment consists of the operations of the Company. The Company is a South Dakota licensed HMO engaged in the development of comprehensive health care delivery systems. The TPA segment consists of the operations of DAS and CW. These subsidiaries are TPA's of health care plans for independent employer companies. The reinsurance segment consists of the operations of DIL. DIL's primary activity is in providing reinsurance quota share excess medical stop loss coverage to DAS's self funded customers. The Company evaluates performance and allocates resources based on net income determined under accounting principles generally accepted in the United States of America. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies as indicated in the Company's 2001 Annual Consolidated Financial Statements. The Company allocates payroll costs incurred based on the activities of admitting new enrollees and in adjudicating claims. The HMO segment profit (loss) includes the equity in earnings (loss) of the TPA and reinsurance segments. Intersegment revenues primarily relate to equipment rental charges which are based on the depreciation on the underlying assets. Segment assets include the investment in subsidiaries. 6 The Company's reportable segments are derived from the operations of the Company and subsidiaries that offer different products. The reportable segments are managed separately because they provide distinct services. For the Three Months Ended June 30, 2002 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 19,198,265 $ 1,213,692 $ 77,025 $ 20,488,982 Intersegment revenues -- 73,280 -- 73,280 Segment (loss) (437,971) (46,675) (8,571) (493,217) Segment assets 20,004,176 1,138,231 543,817 21,686,224 The total segment loss is greater than the consolidated net loss by $55,246 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Three Months Ended June 30, 2001 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 14,290,626 $ 991,586 $ 95,837 $ 15,378,049 Intersegment revenues -- 62,052 -- 62,052 Segment profit (loss) 556,573 (57,036) 30,620 530,157 Segment assets 18,566,914 1,155,457 599,233 20,321,604 The total segment profit is less than the consolidated net income by $26,416 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Six Months Ended June 30, 2002 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 37,561,819 $ 2,597,364 $ 153,539 $ 40,312,722 Intersegment revenues -- 122,849 -- 122,849 Segment (loss) (725,121) (68,234) (80,697) (874,052) Segment assets 20,004,176 1,138,231 543,817 21,686,224 The total segment loss is greater than the consolidated net loss by $148,931 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Six Months Ended June 30, 2001 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 27,707,938 $ 2,003,342 $ 243,523 $ 29,954,803 Intersegment revenues -- 112,163 -- 112,163 Segment profit (loss) 663,480 (122,117) 114,238 655,601 Segment assets 18,566,914 1,155,457 599,233 20,321,604 The total segment profit is less than the consolidated net income by $7,879 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts.

7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The Company markets its products under the tradename of DAKOTACARE. Its products include group managed health care products such as HMO products and cafeteria plan administration and workers compensation managed care services. Its subsidiaries' (DAS and CW) products are managed care and claims administration services for self-insured employer groups. Its subsidiary, DIL, accepts reinsurance risk on some of DAS's self-funded and insured customers' life and stop-loss insurance policies. The Company and its subsidiaries DAS and CW, market their products through a network of independent insurance agents throughout South Dakota. The Company contracts with over 98% of the physicians in the state of South Dakota, 100% of the hospitals in the state of South Dakota, and many other health care providers to provide medical services to its enrollees. At June 30, 2002, the Company's HMO enrollment was approximately 40,000 enrollees, while its subsidiaries DAS and CW have enrollment of approximately 72,500 enrollees under their Administrative Services Only (ASO) business. This discussion and analysis contains certain forward-looking terminology such as "believes," "anticipates," "will," and "intends," or comparable terminology. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Potential purchasers of the Company's securities are cautioned not to place undue reliance on such forward-looking statements which are qualified in their entirety by the cautions and risks described herein and in other reports filed by the Company with the Securities and Exchange Commission. COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001 General The Company's net income decreased $994,544 to a net loss of $437,971 for the three months ended June 30, 2002, as compared to net income of $556,573 for the three months ended June 30, 2001. This decrease was primarily due to a net increase in operating expenses of $6,714,638, but were offset by an increase in total revenues of $5,107,275 and a decrease in income taxes of $637,800 for the three months ended June 30, 2002 as compared to June 30, 2001. Revenues Total revenues increased $5,107,275, or 33.2%, for the three months ended June 30, 2002, as compared to June 30, 2001. The revenues from the net premiums generated by the health maintenance organization increased $4,890,324, or 34.8%. This increase is attributable to a 24.0% increase in the number of enrollees and a 9.0% increase in the premiums earned per enrollee for the three months ended June 30, 2002, as compared to June 30, 2001. Revenues from the TPA fees increased by $192,195 due to the net increase in enrollment and expanded services with existing enrollment. Investment income decreased by $55,301 due to lower yields overall. The reduction in income due to the lower yields was partially offset by an increase in invested assets when compared to the quarter ended June 30, 2001. Operating Expenses Total operating expenses increased $6,714,638, or 46.4%, for the three months ended June 30, 2002, as compared to June 30, 2001. This was due to an increase in claims incurred, personnel expenses, commissions, advertising, state insurance taxes, office expense and other general and administrative expenses. 8 Net claims expense generated by the health maintenance organization increased $6,091,036, or 52.1%. Average claims expense per enrollee increased 22.2% for the three months ended June 30, 2002, as compared to June 30, 2001, while the number of enrollees increased 24.0%. Recent trends indicate that claims per enrollee have increased faster that revenue per enrollee. The Company recently reapplied with the Division of Insurance to increase the standard rates charged to policyholders. This will effect all July 1, 2002 and future renewals, which increases revenue in hopes of keeping pace with these increased claims costs. Personnel expense increased $97,175, or 7.4% for the three months ended June 30, 2002, as compared to June 30, 2001. This is due to the increased number of personnel needed from the increased enrollment. Commissions increased $150,376 for the three months ended June 30, 2002, as compared to June 30, 2001. Enrollment increases of 24.0% in the health maintenance organization and enrollment increases of 15.1% in the TPA combined to increase commissions. Advertising expense increased $58,876 for the three months ended June 30, 2002 as compared to June 30, 2001. This fluctuates each year based on the strategy and timing for spending the budgeted amount. The total amount budgeted for 2002 was increased about 10% from last year's budget. State insurance taxes increased $90,321 for the three months ended June 30, 2002, as compared to June 30, 2001. Since the expense is directly related to the premiums collected by the health maintenance organization, the increase in premium revenue increased these fees. Office expense increased $72,453 for the three months ended June 30, 2002, as compared to June 30, 2001. All components of office expense increased as a result of increased enrollment and claims for the Company. Office expense is comprised of postage, supplies, printing and telephone costs. Other general and administrative expenses increased $166,656 for the three months ended June 30, 2002, as compared to June 30, 2001. The difference in the carrying value and the underlying equity in the net assets of a subsidiary was expensed and accounted for most of the increase in this account. Insurance expense also increased as coverages and rates continue to increase. Professional fees remained relatively constant even though accounting fees continue to increase. The reduction of utilization fees offset the other increases. Income Taxes Income tax expense or benefit should represent 35% of income or loss, but fluctuates each period due to adjustments for permanent tax differences. For the three months ended June 30, 2002, income tax benefit represented 35.9% of the loss before taxes and minority interest. COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001 General The Company's net income decreased $1,388,601 to a net loss of $725,121 for the six months ended June 30, 2002, as compared to net income of $663,480 for the six months ended June 30, 2001. This decrease was primarily due to a net increase in operating expenses of $12,247,702, but were offset by an increase in total revenues of $10,321,261 and a decrease in income taxes of $571,650 for the six months ended June 30, 2002 as compared to June 30, 2001. Revenues Total revenues increased $10,321,261, or 34.4%, for the six months ended June 30, 2002, as compared to June 30, 2001. The revenues from the net premiums generated by the health maintenance organization increased $9,810,023, or 36.2%. This increase is attributable to a 24.8% increase in the number of enrollees and a 9.2% increase in the premiums earned per enrollee for the six months ended June 30, 2002, as compared to June 30, 2001. Revenues from the TPA fees increased by $540,328 due to the net increase in enrollment and expanded services with existing enrollment. Investment income decreased by $134,868 due to lower yields overall. The reduction in income due to the lower yields was partially offset by an increase in invested assets when compared to the quarter ended June 30, 2001. 9 Operating Expenses Total operating expenses increased $12,247,702, or 42.1%, for the six months ended June 30, 2002, as compared to June 30, 2001. This was due to an increase in claims incurred, personnel expenses, commissions, advertising, state insurance taxes, office expense and other general and administrative expenses. The reduction in professional fees slightly offset these increases. Net claims expense generated by the health maintenance organization increased $10,807,377, or 46.2%. Average claims expense per enrollee increased 17.1% for the six months ended June 30, 2002, as compared to June 30, 2001, while the number of enrollees increased 24.8%. Recent trends indicate that claims per enrollee have increased faster that revenue per enrollee. The Company recently reapplied with the Division of Insurance to increase the standard rates charged to policyholders. This will effect all July 1, 2002 and future renewals, which increases revenue in hopes of keeping pace with these increased claims costs. Personnel expense increased $290,566, or 11.6% for the six months ended June 30, 2002, as compared to June 30, 2001. This is due to the increased number of personnel needed from the increased enrollment and the annual salary raises given to existing employees. Commissions increased $318,673 for the six months ended June 30, 2002, as compared to June 30, 2001. Enrollment increases of 24.8% in the health maintenance organization and enrollment increases of 15.4% in the TPA combined to increase commissions. Advertising expense increased $127,056 for the six months ended June 30, 2002 as compared to June 30, 2001. This fluctuates each year based on the strategy and timing for spending the budgeted amount. The total amount budgeted for 2002 was increased about 10% from last year's budget. State insurance taxes are increased $179,880 for the six months ended June 30, 2002, as compared to June 30, 2001. Since the expense is directly related to the premiums collected by the health maintenance organization, the increase in premium revenue increased these fees. Office expense increase $154,134 for the six months ended June 30, 2002, as compared to June 30, 2001. All components of office expense increased as a result of increased enrollment and claims for the Company. Office expense is comprised of postage, supplies, printing and telephone costs. Other general and administrative expenses increased $219,280 for the six months ended June 30, 2002, as compared to June 30, 2001. The difference in the carrying value and the underlying equity in the net assets of a subsidiary was expensed and accounted for about half of the increase in this account. Insurance expense also increased as coverages and rates continue to increase. Professional fees decreased by $54,294, even though accounting fees increased from the prior year. The reduction of utilization fees offset the increases in accounting fees. Income Taxes Income tax expense or benefit should represent 35% of income or loss, but fluctuates each period due to adjustments for a valuation allowance for deferred tax assets and permanent tax differences. For the six months ended June 30, 2002, income tax benefit represented 26.1% of the loss before taxes and minority interest. The valuation allowance for deferred tax assets exists due to the fact that losses incurred by a subsidiary has no prior cumulative taxable income from which to recover the taxes. Even though the subsidiary files within the consolidated tax return, cumulative losses are nondeductible due to an agreement signed with the government of the foreign subsidiary, which prohibits the deductions until income is produced by the subsidiary. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of cash have been premium and fee revenue, collection of premiums in advance of the claims costs associated with them, and an agreement with participating physicians in which a percentage of fees for services is withheld for cash flows of the Company. The Company in the past has had borrowings from banks and affiliated companies, but currently does not need to borrow for liquidity purposes. 10 Net cash provided by operating activities decreased by $2,250,173 to $1,114,268 for the six months ended June 30, 2002, as compared to June 30, 2001. Cash provided by operations was mainly attributed to the decrease in receivables, the increase in reported and unreported claims payable, the increase in unearned premiums, and the increase in contingency reserves payable. The cash provided by these changes were somewhat offset by the net loss for the six months ended June 30, 2002. The decrease in receivables was due to the collection of receivables from the prior year end. Reported and unreported claims payable have increased since the increase in enrollment has required additional reserves. Unearned premiums increased since the prior year end, which is due to the higher premium income and fluctuates based somewhat on the timing of premiums received from clients. Generally as enrollment changes, the unearned premiums will change based on increases or decreases in premium levels. There was no payment of contingency reserves payable to physicians for the six months ended June 30, 2002, which caused the increase in contingency reserves payable. Cash flows provided from investing activities was fairly minimal for the six months ended June 30, 2002. Funds were used mainly for the purchase of securities, certificates of deposit and equipment. Securities and certificates of deposit which matured offset the cash spent on purchasing the new securities and certificates of deposit. Most of the equipment purchased was additional computer equipment needed due to the continued growth of the Company and its efforts to continue to increase efficiencies. The Company is not contractually obligated to pay out the contingency reserves withheld but has historically elected to pay out a majority of the amounts withheld. No dividends have been declared or paid for the six months ended June 30, 2002. Future dividend payments are dependent on operations and liquidity of the Company. The Company believes that cash flows generated by operations, withholding of contingency reserves payable, cash on hand, and short-term investment balances will be sufficient to fund operations, pay out the projected contingency reserves payable, and pay dividends on the Class C common stock. CRITICAL ACCOUNTING POLICIES Our significant accounting policies are summarized in the footnotes to our financial statements. One of our most critical policies is also discussed below. Estimates are used extensively in determining the claims liability at the date of the balance sheet. The information used to determine the liability is historical data, current enrollment levels and other trends as they may apply. The liability is then adjusted to a number which represents management's best estimate at that time. The actual liability may change continuously for 18 months, but becomes more determinable as the length of time increases from the balance sheet date. INFLATION A substantial portion of the Company's operating expenses consist of health care costs, which, in the general economy, have been rising at a rate greater than that of the overall Consumer Price Index. The Company believes that its cost control measures and risk sharing arrangements reduce the effect of inflation on such costs. Historically, market conditions and the regulatory environment in which the Company operates have permitted the Company to offset a portion or all of the impact of inflation on the cost of health care benefits through premium increases. If the Company was not able to continue to increase premiums, a material adverse impact on the Company's operations could result. Inflation does not have a material effect on the remainder of the Company's operating expenses. 11 TRENDS, EVENTS, OR UNCERTAINTIES In recent years, there has been a trend by clients to switch to plans with higher employee cost-sharing levels in order to maintain lower premiums. As a provider of cost effective managed care plans for medium and small employers, the Company believes it is delivering products and services that address current health care reform issues. The Company will continue to evaluate its business strategy as necessary to maximize its ability to adapt to the changing health care marketplace. Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company does not have any material risk as defined by Item 305 of Regulation S-K. The Company has market risk with its cash and investments, but due to the conservative nature of the invested assets, management feels that the market risk is limited. PART II: OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of Stockholders was held June 8, 2002. Three Directors were elected to serve through the annual meeting of 2005. None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 99--CEO and CFO Certification (b) No reports on Form 8-K have been filed during the quarter for which this report is filed. 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. South Dakota State Medical Holding Company, Incorporated (Registrant) Date:_08/15/2002___ By: _/s/L. Paul Jensen_____ L. Paul Jensen Chief Executive Officer (Duly Authorized Officer) Date:_08/15/2002___ By: _/s/Kirk J. Zimmer_____ Kirk J. Zimmer Senior Vice President (Principal Financial Officer) 13 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. Sec. 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of South Dakota State Medical Holding Company, Inc., dba DAKOTACARE(the "Company") on Form 10-Q for the period ended June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, L. Paul Jensen, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that [to the best of my knowledge]: (1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. __/s/__ L. Paul Jensen_____ Chief Executive Officer August 15, 2002 14 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. Sec. 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of South Dakota State Medical Holding Company, Inc., dba DAKOTACARE(the "Company") on Form 10-Q for the period ended June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Bruce Hanson, Chief Finance Officer of the Company, certify, pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that [to the best of my knowledge]: (1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/_Bruce E. Hanson__ Chief Finance Officer August 15, 2002 15

SD STATE MEDICAL HOLDING CO INC 10-Q