10-Q 1 q10_0309filed.txt 9/30/2003 10-Q 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, 2003 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 October 28, 2003 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, 2003 and December 31, 2002 2 Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2003 and 2002 3 Consolidated Statement of Stockholders' Equity for the Nine Months Ended September 30, 2003 4 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002 5 Notes to Consolidated Financial Statements 6-7 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 13 Item 1. Legal Proceedings 13 Item 2. Changes in Securities and Use of Proceeds 13 Item 3. Defaults Upon Senior Securities 13 Item 4. Submission of Matters to a Vote of Security Holders 13 Item 5. Other Information 13 Item 6. Exhibits and Reports on Form 8-K 13 Signatures 13 Exhibit 31.1 14 Exhibit 31.2 15 Exhibit 32.1 CEO Certification 16 Exhibit 32.2 CFO Certification 17 1 PART 1: FINANCIAL INFORMATION Item 1. Financial Statements SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED BALANCE SHEETS September 30, December 31, ASSETS 2003 2002 (Unaudited) (Audited) -------------------------------------------------------------------------------------- Cash and cash equivalents $ 13,026,521 $ 10,543,214 Investment in securities held to maturity 772,550 448,229 Certificates of deposit 1,400,000 1,400,000 Receivables 2,098,660 2,045,091 Prepaids and other assets 52,556 49,998 Deferred income taxes 313,400 891,400 ------------- ------------- Total current assets 17,663,687 15,377,932 ------------- ------------- Investment in securities held to maturity 3,958,048 4,277,417 Investment in securities available for sale 148,400 146,500 Certificate of deposit 100,000 100,000 Contracts with life insurance companies 103,532 93,532 ------------- ------------- Total long-term investments 4,309,980 4,617,449 ------------- ------------- Property and equipment, net of accum. depreciation 589,935 702,621 ------------- ------------- Deferred income taxes 1,024,000 -- ------------- ------------- $ 23,587,602 $ 20,698,002 ============= ============= LIABILITIES Reported and unreported claims payable $ 10,181,311 $ 9,906,383 Unearned premiums and administration fees 2,759,910 2,315,745 Accounts payable and accrued expenses 1,531,410 1,318,078 Contingency reserves payable 2,215,750 2,215,750 ------------- ------------- Total current liabilities 16,688,381 15,755,956 Contingency reserves payable 5,123,136 2,974,808 ------------- ------------- Total liabilities 21,811,517 18,730,764 ------------- ------------- Minority interest in subsidiary 3,781 6,676 ------------- ------------- STOCKHOLDERS' EQUITY Class A preferred, voting, no par value, $10 stated value, 2,500 shares authorized; 1,433 and 1,350 shares issued and outstanding at September 30, 2003 and December 31, 2002; liquidation preference of outstanding shares of $14,330 and $13,500 at Sept. 30, 2003 and December 31, 2002, respectively 14,330 13,500 Class B preferred, voting, no par value, $1 stated value, 2,500 shares authorized; 1,800 and 1,300 shares issued and outstanding at September 30, 2003 and December 31, 2002; liquidation preference of outstanding shares of $1,800 and $1,300 at Sept. 30, 2003 and December 31, 2002, respectively 1,800 1,300 Class C common, nonvoting, $.01 par value, 10,000,000 shares authorized; issued 1,505,760 shares 15,058 15,058 Additional paid-in capital 3,749,342 3,749,342 Accumulated (deficit) (682,985) (495,488) Accumulated other comprehensive income 3,938 6,029 Less cost of Class C common treasury stock, 140,156 shares (1,329,179) (1,329,179) ------------- ------------- 1,772,304 1,960,562 ------------- ------------- $ 23,587,602 $ 20,698,002 ============= ============= 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 September 30, Nine Months Ended September 30, 2003 2002 2003 2002 --------------------------------------------------------------------------------------- Revenues: Premiums, net of reins. ceded $ 22,287,362 $ 19,467,837 $ 64,691,455 $ 56,496,119 Third party administration fees 1,385,321 1,191,993 4,234,368 3,557,709 Investment income 91,639 115,370 284,509 359,743 Other income 360,475 373,302 1,059,672 1,047,653 ------------- ------------- ------------- ------------- Total revenues 24,124,797 21,148,502 70,270,004 61,461,224 ------------- ------------- ------------- ------------- Operating expenses: Claims incurred, net of reins. recoveries 20,926,031 18,886,559 59,521,189 53,240,588 Personnel expense 1,523,211 1,507,427 4,707,504 4,306,066 Commissions 804,041 727,319 2,455,073 2,212,793 Professional fees expense 203,906 214,370 675,429 680,610 Office expense 192,265 246,191 676,069 736,771 Advertising 102,095 117,158 378,707 434,105 Occupancy expense 167,749 198,983 622,790 582,170 State insurance taxes 291,551 251,871 814,428 730,184 Other general and administrative expenses 119,765 202,500 704,432 737,961 ------------- ------------- ------------- ------------- Total operating expenses 24,330,614 22,352,378 70,555,621 63,661,248 ------------- ------------- ------------- ------------- Loss before income taxes and minority interest (205,817) (1,203,876) (285,617) (2,200,024) Income taxes (benefit) (100) (468,100) (95,012) (728,400) ------------- ------------- ------------- ------------- Loss before minority interest (205,717) (735,776) (190,605) (1,471,624) Minority interest in loss of subsidiary (3,687) (8,347) (3,108) (19,074) ------------- ------------- ------------- ------------- Net loss $ (202,030) $ (727,429) $ (187,497) $ (1,452,550) ============= ============= ============= ============= Loss per common share $ ($0.15) $ (0.53) $ ($0.14) $ ($1.06) ============= ============= ============= ============= Weighted average number of common shares outstanding 1,365,604 1,365,604 1,365,604 1,365,604 ============= ============= ============= ============= 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, 2003 (Unaudited) Accumulated Additional Other Capital Paid-In Accumulated Comprehensive Treasury Stock Capital (Deficit) Income Stock Total -------------------------------------------------------------------------------------------- Balance, December 31, 2002 $29,858 $3,749,342 $ (495,488) $ 6,029 $(1,329,179) $1,960,562 Issuance of Class A preferred stock 830 -- -- -- -- 830 Issuance of Class B preferred stock 500 -- -- -- -- 500 Comprehensive loss: Net loss -- -- (187,497) -- -- Net change in un- realized gain on securities avail- able for sale -- -- -- (2,091) -- Comprehensive loss -- -- -- -- -- (189,588) -------- ----------- ------------ --------- ------------ ----------- Balance, Sept. 30, 2003 $31,188 $3,749,342 $ (682,985) $ 3,938 $(1,329,179) $1,772,304 ======== =========== ============ ========= ============ =========== 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 September 30, 2003 2002 ---------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net (loss) $ (187,497) $ (1,452,550) Adjustments to reconcile net (loss) to net cash provided by operating activities: Depreciation 200,924 212,938 Minority interest in (loss) of subsidiary (3,108) (19,074) Amortization of discounts and premiums on investments, net (98,300) (110,258) Gain on disposal of equipment -- (200) (Increase) in receivables (53,568) (627,993) (Increase) decrease in prepaids and other assets (2,558) 82,979 (Increase) in deferred income taxes (446,000) (316,400) Increase in reported and unreported claims payable 274,928 897,056 Increase in unearned premiums and administration fees 444,165 760,697 Increase in accounts payable and accrued expenses 213,332 181,328 Increase in contingency reserves payable 2,148,328 2,065,016 ------------- ------------- Net cash provided by operating activities $ 2,490,646 $ 1,673,539 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of securities available for sale $ (3,992) $ (5,328) Held to maturity securities: Matured 292,000 1,280,000 Purchased (199,483) (200,005) Proceeds from maturities of certificates of deposit 1,100,000 1,050,000 Purchase of certificates of deposit (1,100,000) (1,150,000) (Increase) decrease in contracts with life insurance companies (10,000) 1,086 Proceeds from the sale of property and equipment -- 200 Purchase of property and equipment (88,238) (217,805) ------------- ------------- Net cash (used in) provided by investing activities $ (9,713) $ 758,148 ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of capital stock $ 1,330 $ 670 Increase in minority investment of subsidiary 1,044 16,403 ------------- ------------- Net cash provided by financing activities $ 2,374 $ 17,073 ------------- ------------- Increase in cash and cash equivalents $ 2,483,307 $ 2,448,760 CASH AND CASH EQUIVALENTS Beginning 10,543,214 8,673,787 ------------- ------------- Ending $ 13,026,521 $ 11,122,547 ============= ============= Supplemental Disclosures of Cash Flow Information Cash payments for: Income taxes, net of (refunds) $ 70,000 $ 0 Supplemental Disclosures of Noncash Investing And Financing Activities Increase (decrease) in unrealized gain on securities available for sale $ (2,091) $ 7,072 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 majority 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. NET LOSS PER COMMON SHARE Loss per common share is calculated by dividing net loss by the weighted average number of shares of the Class C Common Stock ("Common Stock") outstanding during the period. All references to loss per share in the consolidated financial statements are to basic 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 the Common Stock in the event of death, disability, or retirement of a shareholder, the Company's Board of Directors adopted a Stock Repurchase Program (the "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 2002 Annual Consolidated Financial Statements, which are included in the Company's Annual Report on Form 10-K. The Company allocates payroll costs incurred based on the activities of admitting new enrollees and in adjudicating claims. The HMO segment income includes the equity in net income(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, 2003 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 21,989,359 $ 1,487,276 $ 347,573 $23,824,208 Intersegment revenues -- 63,689 -- 63,689 Segment income (loss) (202,030) 137,954 (438,543) (502,619) Segment assets 22,791,148 2,206,717 401,468 25,399,333 The total segment loss is greater than the consolidated net loss by $300,589 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. 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 Nine Months Ended September 30, 2003 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 64,373,023 $ 4,539,684 $1,092,675 $70,005,382 Intersegment revenues -- 185,994 -- 185,994 Segment income(loss) (187,499) 199,078 (463,700) (452,121) Segment assets 22,791,148 2,206,717 401,468 25,399,333 The total segment loss is greater than the consolidated net loss by $264,622 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.

5. COMPREHENSIVE LOSS Comprehensive loss was $204,423 and $721,955 for the three months ended September 30, 2003 and 2002, respectively, and was $189,588 and $1,445,478 for the nine months ended September 30, 2003 and 2002, respectively. The difference between comprehensive loss and net loss presented in the Consolidated Statements of Operations is attributed solely to the 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 DAS and CW subsidiaries' 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 DAS and CW subsidiaries 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, 2003, the Company's HMO medical care enrollment was approximately 37,500, while its DAS and CW subsidiaries had combined medical care enrollment of approximately 68,200. The Company also offers ancillary products and the resulting exclusive enrollment under the HMO was approximately 2,300, while its DAS and CW subsidiaries had combined ancillary product exclusive enrollment of approximately 15,000. The resulting total population served by the Company through any of its products resulted in a total of approximately 123,000 members at September 30, 2003. 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, 2003 AND SEPTEMBER 30, 2002 General The Company's net loss decreased $525,399 to $202,030 for the three months ended September 30, 2003, as compared to a net loss of $727,429 for the three months ended September 30, 2002. This decrease in net loss was primarily due to the increase in total revenues over the increase in total operating expenses. Total revenues increased $2,976,295 for the three months ended September 30, 2003, while total operating expenses increased $1,978,236 for the same period. This was somewhat offset by the decrease in the benefit for income taxes of $468,000 for the three months ended September 30, 2003 as compared to September 30, 2002. Revenues Total revenues increased $2,976,295, or 14.1%, for the three months ended September 30, 2003, as compared to September 30, 2002. The revenues from the net premiums generated by the health maintenance organization increased $2,548,697, or 13.1%. This increase is attributable to a 19.6% increase in the premiums earned per enrollee and a decrease in the enrollment of 5.4% for the three months ended September 30, 2003, as compared to September 30, 2002. Revenues from the TPA fees increased by $193,328, or 16.2%, due to an increase in enrollment, additional fees generated per enrollee and an increase in pharmacy rebates associated with the enrollment. Investment income decreased by $23,731 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, 2002. 8 Operating Expenses Total operating expenses increased $1,978,236, or 8.9%, for the three months ended September 30, 2003, as compared to September 30, 2002. This was due to an increase in claims incurred, commissions, and state insurance taxes, but was somewhat offset by a decrease in office, occupancy, and other general and administrative expenses. Net claims expense generated by the health maintenance organization increased $1,363,007, or 7.2%. Average claims expense per enrollee increased 13.3% for the three months ended September 30, 2003, as compared to September 30, 2002, while the number of enrollees decreased 5.4%. Commissions and state insurance taxes increased a total of $116,402, or 11.9%, due to the increase in net premiums and TPA fees for the three months ended September 30, 2003 as compared to September 30, 2002. Office expenses decreased by $53,926, or 21.9%, for the three months ended September 30, 2003 as compared to September 30, 2002. This decrease was mostly attributable to a decrease in office supplies, but was somewhat offset by an increase in postage costs. Occupancy expense decreased $31,234, or 15.7% due to decreased maintenance and repairs. Other general and administrative expenses decreased $82,735 for the three months ended September 30, 2003, as compared to September 30, 2002. This decrease was attributable to the reduction of insurance expense. Income Taxes Income tax expense or benefit should represent 35.0% 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 three months ended September 30,2003, income tax benefit represented 0.0% of the income before taxes and minority interest. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance is also effected by the losses incurred by a subsidiary which 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. COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002 General The Company's net loss decreased $1,265,053 to $187,497 for the nine months ended September 30, 2003, as compared to a net loss of $1,452,550 for the nine months ended September 30, 2002. This decrease in net loss was primarily due to the increase in total revenues over the increase in total operating expenses. Total revenues increased $8,808,780 for the nine months ended September 30, 2003, while total operating expenses increased $6,894,373 for the same period. This net increase in operating income was somewhat offset by the decrease in the benefit from income tax of $633,388 for the nine months ended September 30, 2002 as compared to September 30, 2002. Revenues Total revenues increased $8,808,780, or 14.3%, for the nine months ended September 30, 2003, as compared to September 30, 2002. The revenues from the net premiums generated by the health maintenance organization increased $7,334,495, or 13.0%. This increase is attributable to a 17.8% increase in the premiums earned per enrollee and a decrease in the enrollment of 4.1% for the nine months ended September 30, 2003, as compared to September 30, 2002. Revenues from the TPA fees increased by $676,659 due to a 2.8% increase in enrollment and additional fees generated with existing enrollment. Investment income decreased by $75,234 due to lower yields overall. The lower income generated by the lower yields was partially offset by an increase in invested assets when compared to the nine month period ended September 30, 2002. 9 Operating Expenses Total operating expenses increased $6,894,373, or 10.8%, for the nine months ended September 30, 2003, as compared to September 30, 2002. This was due to an increase in claims incurred, personnel expense, commissions, occupancy expense, and state insurance taxes, but was somewhat offset by a decrease in advertising. Professional fees and other general and administrative expenses remained relatively constant in total when comparing the nine months ended September 30, 2003 against September 30, 2002. Net claims expense generated by the health maintenance organization increased $5,152,608, or 9.7%. Average claims expense per enrollee increased 14.4% for the nine months ended September 30, 2003, as compared to September 30, 2002, while the number of enrollees decreased 4.1%. Personnel expense increased $401,438, or 9.3% for the nine months ended September 30, 2003, as compared to September 30, 2002. This is due to the increased number of personnel and the annual salary adjustments made June of each year. Some of the increase in personnel was needed to eliminate and reduce expenses for temporary help. Commissions and state insurance taxes increased a total of $326,524, or 11.1%, due to the increase in net premiums and TPA fees for the nine months ended September 30, 2003 as compared to September 30, 2002. Occupancy expense increased $40,620, or 7.0% due to increased depreciation expense. Advertising somewhat offset the overall operating expense increases by decreasing $55,398, or 12.8% for the nine months ended September 30, 2003, as compared to September 30, 2002. The overall advertising budget was increased for the year, but the advertising agency is responsible in determining the timing of the ads used. The reduction is simply the timing of the advertising and by the end of the year, there should be a small increase compared to last year. Professional fees expense slightly decreased due to the additional consulting used in the implementation of HIPAA and the use of specialists in examining pharmacy rebates and contracts to save costs for the future. These increased costs were offset by the reduction in temporary help, which kept overall costs similar to the prior year's amount. Other general and administrative expenses slightly decreased also as insurance expense decreased. Income Taxes Income tax expense or benefit should represent 35.0% 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, 2003, income tax benefit represented 33.3% of the loss before taxes and minority interest. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance is also effected by the losses incurred by a subsidiary which 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 increased by $817,107 to $2,490,646 for the nine months ended September 30, 2003, as compared to September 30, 2002. Cash provided by operations was mainly attributed to the increases in reported and unreported claims payable, unearned premiums and administration fees, accounts payable and accrued expenses, and contingency reserves payable. Reported and unreported claims payable increased due to higher reserves reported for outstanding claims. Cost per claim increases were greater than the reduction caused by reduced membership, thus increasing the amount needed for reserves payable. Unearned premiums and administration fees increase as the amount of premiums increase in general. With premiums continuing to increase, we anticipate this number to continue to increase, also. Increases in accounts payable and accrued expenses fluctuate, but are also effected by the increase in client stop loss fees payable to the reinsurer. These have increased significantly within the last year and thus have increased the related payables to the carriers. There was no payment of contingency reserves to physicians for the nine months ended September 30, 2003, which caused the increase in contingency reserves payable. Deferred income taxes increased primarily due to the increase in contingency reserves payable, which are not deductible until paid to the physicians and thus increase the future tax benefit to be received when they are paid. Cash flows provided by (used in) investing and financing activities were minimal. The HMO segment had bonds mature, while the reinsurance segment used cash on hand to purchase short term treasury securities. Equity securities were purchased with the reinvestment of dividends from the equity securities. Equipment was also purchased in the normal course of business. Eleven Certificates of Deposit matured and were invested into new Certificates of Deposit, which generated no cash flow. 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, 2003. 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 the Company's financial statements its Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 29, 2003. 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. 11 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 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. Disclosure Controls and Procedures As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in the Company's internal control over financial reporting during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 12 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 31.1 Section 302(a) Certification of Chief Executive Officer Exhibit 31.2 Section 302(a) Certification of Chief Financial Officer Exhibit 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) No reports on Form 8-K have been filed during the quarter for which this report is filed. 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:_11/14/2003___ By: _/s/ L. Paul Jensen____ L. Paul Jensen Chief Executive Officer (Duly Authorized Officer) Date:_11/14/2003___ By: _/s/ Kirk J. Zimmer____ Kirk J. Zimmer Senior Vice President (Principal Financial Officer) 13 EXHIBIT 31.1 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/__L. Paul Jensen_ L. Paul Jensen Chief Executive Officer November 14, 2003 14 EXHIBIT 31.2 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/__Bruce E. Hanson_ Bruce E. Hanson Chief Finance Officer November 14, 2003 15 Exhibit 32.1 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, 2003, 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 14, 2003 A signed original of this written statement required by Section 906 has been provided to South Dakota State Medical Holding Co., Inc. and will be retained by South Dakota State Medical Holding Co., Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 16 Exhibit 32.2 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, 2003, 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 14, 2003 A signed original of this written statement required by Section 906 has been provided to South Dakota State Medical Holding Co., Inc. and will be retained by South Dakota State Medical Holding Co., Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 17

SD STATE MEDICAL HOLDING CO INC 10-Q