10-Q 1 q10_0209.txt SEPT 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 September 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES NO X 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 November 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 September 30, 2002 and December 31, 2001 2 Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2001 3 Consolidated Statement of Stockholders' Equity for the Nine Months Ended September 30, 2002 4 Consolidated Statements of Cash Flows for the Nine Months Ended September 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 8-12 Item 3. Quantitative and Qualitative Disclosures about Market Risk 12 Item 4. Controls and Procedures 12 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 Certifications 14-15 Exhibits 99.1-99.2 CEO and CFO Certifications 16-17

1 PART 1: FINANCIAL INFORMATION Item 1. Financial Statements SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED BALANCE SHEETS (Unaudited) September 30, December 31, ASSETS 2002 2001 ------------------------------------------------------------------------------- Cash and cash equivalents $ 11,122,547 $ 8,673,787 Investments in securities held to maturity 350,086 890,714 Certificates of deposit 1,400,000 1,300,000 Receivables 2,172,980 1,544,987 Prepaids and other assets 52,562 135,541 Deferred income taxes 951,600 916,000 ------------- ------------- Total current assets 16,049,775 13,461,029 ------------- ------------- Investment in securities held to maturity 3,654,343 4,083,452 Investment in securities available for sale 145,600 133,200 Certificate of deposit 100,000 100,000 Contracts with life insurance companies 91,251 92,337 ------------- ------------- Total long-term investments 3,991,194 4,408,989 ------------- ------------- Property and equipment, net of accum. depreciation 761,739 756,872 ------------- ------------- Deferred income taxes 1,011,800 731,000 ------------- ------------- $ 21,814,508 $ 19,357,890 ============= ============= LIABILITIES Reported and unreported claims payable $ 9,135,417 $ 8,238,361 Unearned premiums and administration fees 1,936,568 1,175,871 Accounts payable and accrued expenses 1,640,591 1,459,263 Contingency reserves payable 1,584,485 1,584,485 ------------- ------------- Total current liabilities 14,297,061 12,457,980 Contingency reserves payable 4,327,242 2,262,226 ------------- ------------- Total liabilities 18,624,303 14,720,206 ------------- ------------- Minority interest in subsidiaries 13,097 15,768 ------------- ------------- STOCKHOLDERS' EQUITY Class A preferred stock, issued 1,327 and 1,260 shares at September 30, 2002 and December 31, 2001, respectively 13,270 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 720,869 2,173,419 Accumulated other comprehensive income(loss) 6,448 (624) Less cost of Class C common treasury stock, 140,156 shares (1,329,179) (1,329,179) ------------- ------------- 3,177,108 4,621,916 ------------- ------------- $ 21,814,508 $ 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 Sept. 30, Nine Months Ended Sept. 30, 2002 2001 2002 2001 --------------------------------------------------------------------------------------- Revenues: Premiums, net of reins. ceded $ 19,467,837 $ 15,076,182 $ 56,496,119 $ 42,384,425 Third party administration fees 1,191,993 1,014,798 3,557,709 2,840,186 Investment income 115,370 164,574 359,743 543,815 Other income 373,302 279,058 1,047,653 757,647 ------------- ------------- ------------- ------------- Total revenues $ 21,148,502 $ 16,534,612 $ 61,461,224 $ 46,526,073 ------------- ------------- ------------- ------------- Operating expenses: Claims incurred, net of reins. recoveries $ 18,886,559 $ 12,592,451 $ 53,240,588 $ 35,931,224 Personnel expense 1,507,427 1,324,840 4,306,066 3,832,913 Commissions 727,319 2,494,055 2,212,793 3,660,856 Professional fees expense 214,370 183,111 680,610 703,645 Office expense 246,191 182,634 736,771 519,080 Advertising 117,158 105,458 434,105 295,349 Occupancy expense 198,983 221,083 582,170 607,119 State insurance taxes 251,871 188,770 730,184 487,203 Other general and administrative expenses 202,500 114,091 737,961 430,272 ------------- ------------- ------------- ------------- Total operating expenses $ 22,352,378 $ 17,406,493 $ 63,661,248 $ 46,467,661 ------------- ------------- ------------- ------------- Income(loss) before income taxes and minority interest $ (1,203,876) $ (871,881) $ (2,200,024) $ 58,412 Income taxes (benefit) (468,100) (241,177) (728,400) 70,173 ------------- ------------- ------------- ------------- (Loss) before minority interest $ (735,776) (630,704) $ (1,471,624) $ (11,761) Minority interest in (loss) of subsidiaries (8,347) (27,415) (19,074) (71,951) ------------- ------------- ------------- ------------- Net income (loss) $ (727,429) $ (603,289) $ (1,452,550) $ 60,190 ============= ============= ============= ============= Earnings (loss) per common share $ (0.53) $ (0.44) $ (1.06) $ 0.04 ============= ============= ============= ============= Weighted average number of common shares outstanding 1,365,604 1,365,604 1,365,604 1,383,859 ============= ============= ============= =============

See Notes to Consolidated Financial Statements. 3 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 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 670 -- -- -- -- 670 Comprehensive (loss): Net (loss) -- -- (1,452,550) -- -- Net change in un- realized loss on securities avail- able for sale -- -- -- 7,072 -- Comprehensive (loss) -- -- -- -- -- (1,445,478) -------- ----------- ----------- --------- ------------ ----------- Balance, Sept. 30, 2002 $29,628 $3,749,342 $ 720,869 $ 6,448 $(1,329,179) $3,177,108 ======== =========== =========== ========= ============ ===========

See Notes to Consolidated Financial Statements. 4 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Nine Months Ended Sept. 30, 2002 2001 ---------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net (loss)income $ (1,452,550) $ 60,190 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 212,938 211,484 Minority interest in (loss) of subsidiaries (19,074) (71,951) Amortization of discounts and premiums on investments, net (110,258) (103,332) Gain on disposal of equipment (200) -- (Increase) decrease in receivables (627,993) 884,444 Decrease in prepaids and other assets 82,979 20,143 (Increase) decrease in deferred income taxes (316,400) 112,200 Increase in reported and unreported claims payable 897,056 1,071,583 Increase in unearned premiums and administration fees 760,697 7,465 Increase (decrease) in accounts payable and accrued expenses 181,328 (343,145) Increase in contingency reserves payable 2,065,016 1,575,125 ------------- ------------- Net cash provided by operating activities $ 1,673,539 $ 3,424,206 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of securities available for sale $ (5,328) $ (5,455) Held to maturity securities: Matured 1,280,000 810,000 Purchased (200,005) (1,065,221) Repayments on collateralized mortgage obligations -- 2,090 Proceeds from maturities of certificates of deposit 1,050,000 1,100,000 Purchase of certificates of deposit (1,150,000) (1,100,000) Decrease in contracts with life insurance companies 1,086 7,029 Purchase of property and equipment (217,805) (82,141) Proceeds from the sale of property and equipment 200 -- ------------- ------------- Net cash provided by (used in) investing activities $ 758,148 $ (333,698) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of capital stock $ 670 $ 1,010 Payment of dividends -- (69,930) Purchase of treasury stock -- (500,000) Increase (decrease) in minority investment of subsidiary 16,403 (327,589) ------------- ------------- Net cash provided by (used in) financing activities $ 17,073 $ (896,509) ------------- ------------- Increase in cash and cash equivalents $ 2,448,760 $ 2,193,999 CASH AND CASH EQUIVALENTS Beginning 8,673,787 7,439,514 ------------- ------------- Ending $ 11,122,547 $ 9,633,513 ============= ============= Supplemental Disclosures of Cash Flow Information Cash payments for: Income taxes, net of refunds $ 0 $ 0 Supplemental Disclosures of Noncash Investing And Financing Activities Decrease in unrealized loss on securities available for sale $ 7,072 $ 3,045

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. All references to earnings (loss) per share in the consolidated financial statements are to basic earnings (loss) per share, as the Company has no potentially issuable common stock. 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 of 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 September 30, 2002 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 19,924,793 $ 1,148,873 $ 74,836 $ 21,148,502 Intersegment revenues -- 63,306 -- 63,306 Segment (loss) (727,429) (52,269) (7,642) (787,340) Segment assets 21,406,723 1,219,620 547,038 23,173,381 The total segment loss is greater than the consolidated net loss by $59,911 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Three Months Ended September 30, 2001 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 15,669,036 $ 1,096,380 $ 72,420 $ 16,837,836 Intersegment revenues -- 57,652 -- 57,652 Segment profit (loss) (603,290) (347,752) 17,114 (933,928) Segment assets 18,863,713 993,117 624,895 20,481,725 The total segment loss is greater than the consolidated net loss by $330,639 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Nine Months Ended September 30, 2002 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 57,486,612 $ 3,746,237 $ 228,375 $ 61,461,224 Intersegment revenues -- 186,155 -- 186,155 Segment (loss) (1,452,550) (120,503) (88,339) (1,661,392) Segment assets 21,406,723 1,219,620 547,038 23,173,381 The total segment loss is greater than the consolidated net loss by $208,842 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Nine Months Ended September 30, 2001 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 43,376,974 $ 3,099,722 $ 315,943 $ 46,792,639 Intersegment revenues -- 169,815 -- 169,815 Segment profit (loss) 60,190 (469,869) 131,352 (278,327) Segment assets 18,863,713 993,117 624,895 20,481,725 The total segment profit is less than the consolidated net income by $338,517 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts.

5. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) was ($721,955) and ($600,397) for the three months ended September 30, 2002 and 2001, respectively, and ($1,445,478) and $63,235 for the nine months ended September 30, 2002 and 2001, respectively. The difference between comprehensive income (loss) and net income (loss) presented in the Consolidated Statements of Operations is attributed solely to change in unrealized gains and losses on securities available for sale during the periods presented. 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 September 30, 2002, the Company's HMO enrollment was approximately 39,500 enrollees, while its subsidiaries DAS and CW have enrollment of approximately 78,000 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 SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001 General The Company's net loss increased $124,140 to $727,429 for the three months ended September 30, 2002, as compared to a net loss of $603,289 for the three months ended September 30, 2001. This increase in net losses was primarily due to a net increase in operating expenses of $4,945,885, but was offset by an increase in total revenues of $4,613,890 and a decrease in income taxes of $226,923 for the three months ended September 30, 2002 as compared to September 30, 2001. Revenues Total revenues increased $4,613,890, or 27.9%, for the three months ended September 30, 2002, as compared to September 30, 2001. The revenues from the net premiums generated by the health maintenance organization increased $4,389,239, or 29.3%. This increase is attributable to a 17.1% increase in the number of enrollees and a 10.4% increase in the premiums earned per enrollee for the three months ended September 30, 2002, as compared to September 30, 2001. Revenues from the TPA fees increased by $177,195 due to the net increase in enrollment and expanded services with existing enrollment. Investment income decreased by $49,204 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 September 30, 2001. Operating Expenses Total operating expenses increased $4,945,885, or 28.4%, for the three months ended September 30, 2002, as compared to September 30, 2001. This was due to an increase in claims incurred, personnel expenses, professional fees, state insurance taxes, office expense and other general and administrative expenses, but was somewhat offset by a decrease in commissions. 8 Net claims expense generated by the health maintenance organization increased $6,212,013, or 49.1%. Average claims expense per enrollee increased 27.4% for the three months ended September 30, 2002, as compared to September 30, 2001, while the number of enrollees increased 17.1%. Recent trends indicate that claims per enrollee have increased faster than revenue per enrollee. The Company recently reapplied with the Division of Insurance to increase the standard rates charged to policyholders. This will effect all January 1, 2003 and future renewals, which increases revenue to offset the continued trend of rising claims costs. Personnel expense increased $182,587, or 13.8% for the three months ended September 30, 2002, as compared to September 30, 2001. This is due to the increased number of personnel needed from the increased enrollment and the annual salary adjustments made June of each year. Professional fees increased $31,259, or 17.1% for the three months ended September 30, 2002, as compared to September 30, 2001. Legal, accounting and actuarial fee increases reduced by the decrease in mental health network fees accounted for the majority of the change. State insurance taxes increased $63,101 for the three months ended September 30, 2002, as compared to September 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 $63,557 for the three months ended September 30, 2002, as compared to September 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 $88,409 for the three months ended September 30, 2002, as compared to September 30, 2001. Insurance expense increased as coverages were renewed which accounted for most of the increase. Commissions decreased $1,766,736 for the three months ended September 30, 2002 as compared to September 30, 2001 due to the payment of a settlement in 2001 relating to commissions. The decrease due to the settlement was offset by the increase in commissions paid, which increased as a result of increased premium revenue when compared to the prior year. Income Taxes Income tax benefit should represent 35% of income or loss, but fluctuates each period due to adjustments for permanent tax differences. For the three months ended September 30, 2002, income tax benefit represented 38.9% of the loss before taxes and minority interest. COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001 General The Company's net income decreased $1,512,740 to a net loss of $1,452,550 for the nine months ended September 30, 2002, as compared to net income of $60,190 for the nine months ended September 30, 2001. This decrease was primarily due to a net increase in operating expenses of $17,193,587, but were offset by an increase in total revenues of $14,935,151 and a decrease in income taxes of $798,573 for the nine months ended September 30, 2002 as compared to September 30, 2001. Revenues Total revenues increased $14,935,151, or 32.1%, for the nine months ended September 30, 2002, as compared to September 30, 2001. The revenues from the net premiums generated by the health maintenance organization increased $14,199,262, or 33.8%. This increase is attributable to a 22.1% increase in the number of enrollees and a 9.5% increase in the premiums earned per enrollee for the nine months ended September 30, 2002, as compared to September 30, 2001. Revenues from the TPA fees increased by $717,523 due to the net increase in enrollment and expanded services with existing enrollment. Investment income decreased by $184,072 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 September 30, 2001. 9 Operating Expenses Total operating expenses increased $17,193,587, or 37.0%, for the nine months ended September 30, 2002, as compared to September 30, 2001. This was due to an increase in claims incurred, personnel expenses, advertising, state insurance taxes, office expense and other general and administrative expenses. The reduction in commissions slightly offset these increases. Net claims expense generated by the health maintenance organization increased $17,019,390, or 47.2%. Average claims expense per enrollee increased 20.6% for the nine months ended September 30, 2002, as compared to September 30, 2001, while the number of enrollees increased 22.1%. 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 January 1, 2003 and future renewals, which increases revenue to offset the continued trend of rising claims costs. Personnel expense increased $473,153, or 12.3% for the nine months ended September 30, 2002, as compared to September 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. Advertising expense increased $138,756 for the nine months ended September 30, 2002 as compared to September 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 have increased $242,981 for the nine months ended September 30, 2002, as compared to September 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 $217,691 for the nine months ended September 30, 2002, as compared to September 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 $307,689 for the nine months ended September 30, 2002, as compared to September 30, 2001. The impaired portion of the carrying value of a subsidiary was expensed and accounted for about half of the increase in this amount. Insurance expense also increased significantly as coverages were renewed and rates increased. Commissions decreased $1,448,063 for the nine months ended September 30, 2002 as compared to September 30, 2001 due to the payment of a settlement in 2001 relating to commissions. The decrease due to the settlement was offset by the increase in commissions paid, which increased as a result of increased premium revenue when compared to the prior year. 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 nine months ended September 30, 2002, income tax benefit represented 33.1% 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 $1,750,667 to $1,673,538 for the nine months ended September 30, 2002, as compared to September 30, 2001. Cash provided by operations was mainly attributed to 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 nine months ended September 30, 2002, an increase in receivables and an increase in deferred income taxes. 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 nine months ended September 30, 2002, which caused the increase in contingency reserves payable. The increase in receivables was due mainly to the increase in income taxes receivable. Deferred income taxes also increase due to the large amount of contingency Reserves which are not deductible for income taxes until they are paid. Cash flows provided from investing activities were a result of securities which matured. Funds were used mainly for the purchase of securities and equipment. Certificates of deposit which matured were all rolled over into new certificates. 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 nine months ended September 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. Even though cash flows may provide for the payment of dividends and contingency reserves, the board of directors determine the amounts that are paid. Risk based capital requirements, budgeted cash expenditures and a number of other factors may influence the board's decision for these payments. CRITICAL ACCOUNTING POLICIES Our significant accounting policies are summarized in the footnotes to our financial statements for our latest 10K which we filed March 31, 2002. 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 11 increase premiums, a material adverse impact on the Company's operations could result. Inflation has not had a material effect on the remainder of the Company's operating expenses. 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. Item 4. Controls and Procedures (a) Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this quarterly report on Form 10-Q, our principal executive officer and principal financial officer have concluded that our disclosure and controls procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. (b) Changes in internal controls. There were no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 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 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:_11/15/2002___ By: _/s/L. Paul Jensen_____ L. Paul Jensen Chief Executive Officer (Duly Authorized Officer) Date:_11/15/2002___ By: _/s/Kirk J. Zimmer_____ Kirk J. Zimmer Senior Vice President (Principal Financial Officer) 13 Certifications I, L. Paul Jensen, certify that: 1. I have reviewed this quarterly report on Form 10-Q of South Dakota State Medical Holding Company, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. __/s/__ L. Paul Jensen_____ L. Paul Jensen Chief Executive Officer November 15, 2002 14 I, Bruce E. Hanson, certify that: 1. I have reviewed this quarterly report on Form 10-Q of South Dakota State Medical Holding Company, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/_Bruce E. Hanson__ Bruce E. Hanson Chief Finance Officer November 15, 2002 15 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 September 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 November 15, 2002 16 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 September 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 November 15, 2002 17

SD STATE MEDICAL HOLDING CO INC 10-Q