10-Q 1 q10_0406filed.txt JUNE 30, 2004 QUARTERLY 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, 2004 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, including 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 July 28, 2004 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, 2004 and December 31, 2003 2 Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2004 and 2003 3 Consolidated Statement of Stockholders' Equity for the Six Months Ended June 30, 2004 4 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 5 Condensed 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, Use of Proceeds and Issuer Purchases of Equity Securities 12 Item 3. Defaults Upon Senior Securities 12 Item 4. Submission of Matters to a Vote of Security Holders 12 Item 5. Other Information 13 Item 6. Exhibits and Reports on Form 8-K 13 Signatures 13 1 PART 1: FINANCIAL INFORMATION Item 1. Financial Statements SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED BALANCE SHEETS June 30, December 31, ASSETS 2004 2003 (Unaudited) (Audited) -------------------------------------------------------------------------------------- Cash and cash equivalents $ 15,740,808 $ 14,518,442 Investment in securities held to maturity 518,396 409,138 Certificates of deposit 1,400,000 1,400,000 Receivables 2,032,737 2,490,688 Prepaids and other assets 78,500 75,500 Deferred income taxes 1,353,400 344,200 ------------- ------------- Total current assets 21,123,841 19,237,968 ------------- ------------- Investment in securities held to maturity 4,673,648 3,981,591 Investment in securities available for sale 148,900 148,600 Certificates of deposit 600,000 100,000 Contracts with life insurance companies and other 98,379 96,668 ------------- ------------- Total long-term investments 5,520,927 4,326,859 ------------- ------------- Property and equipment, net of accum. depreciation 481,536 581,353 ------------- ------------- Deferred income taxes 1,090,300 1,492,500 ------------- ------------- $ 28,216,604 $ 25,638,680 ============= ============= LIABILITIES Reported and unreported claims payable $ 10,136,264 $ 12,854,487 Unearned premiums and administration fees 2,632,685 2,275,579 Accounts payable and accrued expenses 1,733,984 1,477,274 Contingency reserves payable 3,015,157 -- ------------- ------------- Total current liabilities 17,518,090 16,607,340 Contingency reserves payable 4,182,185 6,080,812 ------------- ------------- Total liabilities 21,700,275 22,688,152 ------------- ------------- STOCKHOLDERS' EQUITY Class A preferred, voting, no par value, $10 stated value, 2,500 shares authorized; 1,438 and 1,424 shares issued and outstanding at June 30, 2004 and December 31, 2003; liquidation preference of outstanding shares of $14,380 and $14,240 at June 30, 2004 and December 31, 2003, respectively 14,380 14,240 Class B preferred, voting, no par value, $1 stated value, 2,500 shares authorized; 1,800 shares issued and outstanding; liquidation preference of outstanding shares of $1,800 1,800 1,800 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 Retained Earnings 4,064,716 496,484 Accumulated other comprehensive income 212 2,783 Less cost of Class C common treasury stock, 140,156 shares (1,329,179) (1,329,179) ------------- ------------- 6,516,329 2,950,528 ------------- ------------- $ 28,216,604 $ 25,638,680 ============= ============= See Condensed 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, 2004 2003 2004 2003 --------------------------------------------------------------------------------------- Revenues: Premiums, net of reins. ceded $ 20,116,591 $ 21,536,302 $ 40,883,153 $ 42,404,093 Third party administration fees 1,381,913 1,476,827 2,705,827 2,849,047 Investment income 85,228 88,683 180,387 192,870 Other income 298,275 356,225 659,299 699,197 ------------- ------------- ------------- ------------- Total revenues 21,882,007 23,458,037 44,428,666 46,145,207 ------------- ------------- ------------- ------------- Operating expenses: Claims incurred, net of reins. recoveries 15,548,384 19,047,765 32,121,306 38,595,158 Personnel expense 1,598,422 1,639,291 3,168,518 3,184,293 Commissions 835,955 830,894 1,667,639 1,651,032 Professional fees expense 207,470 279,173 519,507 471,523 Office expense 199,398 276,794 490,661 483,804 Advertising 176,075 159,408 306,605 276,612 Occupancy expense 185,355 238,808 417,293 455,041 State insurance taxes 253,346 275,096 491,257 522,877 Other general and administrative expenses 275,933 162,136 715,417 584,667 ------------- ------------- ------------- ------------- Total operating expenses 19,280,338 22,909,365 39,898,203 46,225,007 ------------- ------------- ------------- ------------- Income (loss) before income taxes and minority interest 2,601,669 548,672 4,530,463 (79,800) Income taxes (benefit) 872,800 5,188 958,100 (94,912) ------------- ------------- ------------- ------------- Income before minority interest 1,728,869 543,484 3,572,363 15,112 Minority interest in income of subsidiary 8,224 4,360 4,131 579 ------------- ------------- ------------- ------------- Net income $ 1,720,645 $ 539,124 $ 3,568,232 $ 14,533 ============= ============= ============= ============= Earnings per common share $ 1.26 $ 0.39 $ 2.61 $ 0.01 ============= ============= ============= ============= Comprehensive income $ 1,716,736 $ 539,926 $ 3,565,661 $ 14,835 ============= ============= ============= ============= Weighted average number of common shares outstanding 1,365,604 1,365,604 1,365,604 1,365,604 ============= ============= ============= ============= See Condensed 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, 2004 (Unaudited) Accumulated Additional Other Capital Paid-In Retained Comprehensive Treasury Stock Capital Earnings Income Stock Total -------------------------------------------------------------------------------------------- Balance, December 31, 2003 $31,098 $3,749,342 $ 496,484 $ 2,783 $(1,329,179) $2,950,528 Issuance of Class A preferred stock 140 -- -- -- -- 140 Comprehensive income: Net income -- -- 3,568,232 -- -- Net change in un- realized gain on securities avail- able for sale -- -- -- (2,571) -- Comprehensive income -- -- -- -- -- 3,565,661 -------- ----------- ------------ --------- ------------ ----------- Balance, June 30, 2004 $31,238 $3,749,342 $ 4,064,716 $ 212 $(1,329,179) $6,516,329 ======== =========== ============ ========= ============ =========== See Condensed 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, 2004 2003 ---------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 3,568,232 $ 14,533 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 116,987 143,492 Minority interest in income of subsidiary 4,131 579 Amortization of discounts and premiums on investments, net (56,315) (67,021) Decrease in receivables 457,951 180,645 (Increase) in prepaids and other assets (3,000) (5,114) (Increase) in deferred income taxes (607,000) (429,600) (Decrease) in reported and unreported claims payable (2,718,223) (301,592) Increase in unearned premiums and administration fees 357,106 7,821 Increase in accounts payable and accrued expenses 256,710 112,864 Increase in contingency reserves payable 1,116,530 1,454,622 ------------- ------------- Net cash provided by operating activities $ 2,493,109 $ 1,111,229 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of securities available for sale $ (2,870) $ (2,698) Held to maturity securities: Matured 55,000 212,000 Purchased (800,000) (199,483) Proceeds from maturities of certificates of deposit 500,000 500,000 Purchase of certificates of deposit (1,000,000) (500,000) (Increase) in contracts with life insurance companies (6,000) (7,000) Purchase of property and equipment (17,170) (14,921) ------------- ------------- Net cash (used in) investing activities $ (1,271,040) $ (12,102) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of capital stock $ 140 $ 920 Increase in minority investment of subsidiary 157 212 ------------- ------------- Net cash provided by financing activities $ 297 $ 1,132 ------------- ------------- Increase in cash and cash equivalents $ 1,222,366 $ 1,100,259 CASH AND CASH EQUIVALENTS Beginning 14,518,442 10,543,214 ------------- ------------- Ending $ 15,740,808 $ 11,643,473 ============= ============= Supplemental Disclosures of Cash Flow Information Cash payments for: Income taxes, net of (refunds) $ 1,645,000 $ (200,000) Supplemental Disclosures of Noncash Investing And Financing Activities (Decrease) increase in unrealized gain on securities available for sale $ (2,571) $ 302 See Condensed 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. EARNINGS PER COMMON SHARE Earnings per common share is calculated by dividing net income by the weighted average number of shares of the Class C Common Stock ("Common Stock") outstanding during the period. All references to earnings per share in the consolidated financial statements are to basic earnings 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 has a Stock Repurchase Program (the "Program"). 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. There were no shares repurchased through June 30, 2004 or in the fiscal year ended December 31, 2003. 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 2003 Annual Consolidated Financial Statements, which are included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003. The Company allocates payroll costs incurred based on the activities of admitting new enrollees and in adjudicating claims. 6 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. 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, 2004 HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 19,958,923 $ 1,464,287 $ 387,401 $ 21,810,611 Intersegment revenues -- 50,384 -- 50,384 Segment income(loss) 1,720,645 38,998 (106,263) 1,653,380 Segment assets 27,197,778 2,207,374 785,287 30,190,439 The total segment income is less than the consolidated net income by $67,265 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Three Months Ended June 30, 2003 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 21,508,050 $ 1,589,149 $ 415,809 $23,513,008 Intersegment revenues -- 63,306 -- 63,306 Segment income (loss) 539,124 65,835 (10,864) 594,095 Segment assets 21,457,718 1,712,285 651,686 23,821,689 The total segment income is greater than the consolidated net income by $54,971 because the equity in net income of subsidiaries has not been eliminated from the individual segment amounts. For the Six Months Ended June 30, 2004 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 40,621,276 $ 2,906,145 $ 683,501 $44,210,922 Intersegment revenues -- 113,551 -- 113,551 Segment income(loss) 3,568,232 (22,126) (191,487) 3,354,619 Segment assets 27,197,778 2,207,374 785,287 30,190,439 The total segment income is less than the consolidated net income by $213,613 because the equity in net loss of subsidiaries has not been eliminated from the individual segment amounts. For the Six Months Ended June 30, 2003 --------------------------------------------------------------------------------------- HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external sources $ 42,383,664 $ 3,052,408 $ 745,102 $46,181,174 Intersegment revenues -- 122,305 -- 122,305 Segment income(loss) 14,533 61,124 (25,157) 50,500 Segment assets 21,457,718 1,712,285 651,686 23,821,689 The total segment income is greater than the consolidated net income by $35,967 because the equity in net income of subsidiaries has not been eliminated from the individual segment amounts.

5. COMPREHENSIVE INCOME AND LOSS Comprehensive income was $1,716,736 and $539,926 for the three months ended June 30, 2004 and 2003, respectively, and was $3,565,661 and $14,835 for the six months ended June 30, 2004 and 2003, respectively. The difference between comprehensive income and net income 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. 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. 7 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, 2004, the Company's HMO medical care enrollment was approximately 30,300, while its DAS and CW subsidiaries had combined medical care enrollment of approximately 69,000. 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 5,500. The resulting total population served by the Company through any of its products resulted in a total of approximately 107,100 members at June 30, 2004. 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, 2004 AND JUNE 30, 2003 General The Company's net income was $1,720,645 for the three months ended June 30, 2004 as compared to $539,124 for the three months ended June 30, 2003, which represents an increase of $1,181,521. The resulting increase in net income was primarily due to the decrease in total operating expenses to a greater amount than the decrease in revenues. Total revenues decreased $1,576,030 for the three months ended June 30, 2004, while total operating expenses decreased $3,629,027 for the same period. This was partially offset by the increase in the provision for income taxes of $867,612 for the three months ended June 30, 2004 as compared to June 30, 2003. Revenues Total revenues decreased $1,576,030, or 6.7%, for the three months ended June 30, 2004, as compared to June 30, 2003. The revenues from the net premiums generated by the HMO segment decreased $1,390,809, or 6.6%. This decrease is attributable to a decrease in the enrollment of 18.1%, but was offset by a 14.1% increase in the premiums earned per enrollee, for the three months ended June 30, 2004, as compared to June 30, 2003. Revenues from the TPA fees decreased by $94,914, or 6.4%, due to a decrease in enrollment, but was partially offset by the increase of fees generated per employee and additional services provided for the groups. Operating Expenses Total operating expenses decreased $3,629,027, or 15.8%, for the three months ended June 30, 2004, as compared to June 30, 2003. This was due to a decrease in claims incurred, professional fees, occupancy and office expense, but was partially offset by an increase in other general and administrative expense. Net claims expense generated by the HMO segment decreased $3,466,348, or 18.6%. Average claims expense per enrollee decreased 0.5% for the three months ended June 30, 2004, as compared to June 30, 2003, while the number of enrollees decreased 18.1%. Commissions and state insurance taxes decreased slightly since revenues generated from the HMO decreased but remained at a comparable percentage of revenue as expected. Professional fees decreased $71,703, or 25.7% due to the decrease in consultants used for the three months ended June 30, 2004, as compared to June 30, 2003. The second quarter decrease is a result of the fact that more of the services in 2004 were provided in the first quarter of 2004, as indicated in the Quarterly Report on Form 10Q for the period ended March 31, 2004. Occupancy expense decreased $53,453, or 22.4% for the three months ended June 30, 2004, as compared to June 30, 2003. Equipment maintenance and depreciation expense experienced the most significant decreases when comparing the periods. Maintenance decreased because of higher prior period maintenance costs that were not recurring and depreciation decreased due to a recent reduction in the purchase of capitalized assets. Office expenses decreased by $77,396, or 28.0% due to the timing of when the costs were incurred. The decrease in the second quarter offset the increase from the first quarter of 2004. Other general and administrative expenses increased $113,797 when compared to the prior year's quarter due to increased insurance expenses. The last two years have had significant higher insurance costs for liability, E&O coverage and D&O coverage due to numerous carriers discontinuing services and increased public scrutiny over financial statements of public entities. 8 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 June 30, 2004, the income tax provision represented 33.5% of the income before taxes and minority interest. The changes in the components of the deferred tax assets accounted for adjustments to the valuation allowance and for the provision to vary as a percentage. 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. A significant portion of the Company's valuation allowance has been reversed and the Company anticipates that future income tax expense will be closer to a 35% effective tax rate. COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2004 AND JUNE 30, 2003 General The Company's net income was $3,568,232 for the six months ended June 30, 2004 as compared to $14,533 for the six months ended June 30, 2003, which represents an increase of $3,553,699. The resulting increase in net income was primarily due to the decrease in total operating expenses to a greater amount than the decrease in revenues. Total revenues decreased $1,716,541 for the six months ended June 30, 2004, while total operating expenses decreased $6,326,804 for the same period. This was partially offset by the increase in the provision for income taxes of $1,053,012 for the six months ended June 30, 2004 as compared to June 30, 2003. Revenues Total revenues decreased $1,716,541, or 3.7%, for the six months ended June 30, 2004, as compared to June 30, 2003. The revenues from the net premiums generated by the HMO segment decreased $1,458,620, or 3.5%. This decrease is attributable to a decrease in the enrollment of 17.2%, but was offset by a 16.5% increase in the premiums earned per enrollee, for the six months ended June 30, 2004, as compared to June 30, 2003. Revenues from the TPA fees decreased by $143,220, or 5.0%, due to a decrease in enrollment, but was partially offset by the increase of fees generated per employee and additional services provided for the groups. Operating Expenses Total operating expenses decreased $6,326,804, or 13.7%, for the six months ended June 30, 2004, as compared to June 30, 2003. This was due to a decrease in claims incurred and occupancy expense, but was partially offset by an increase in professional fees and other general and administrative expenses. Net claims expense generated by the HMO segment decreased $6,468,178, or 17.0%. Average claims expense per enrollee increased 0.2% for the six months ended June 30, 2004, as compared to June 30, 2003, while the number of enrollees decreased 17.2%. Occupancy expense decreased by $37,748, or 8.3%, due to a decrease in depreciation expense for the Company. Professional fees increased $47,984, or 10.2% due to the increase in fees paid to consultants used for the six months ended June 30, 2004 as compared to June 30, 2003. The extra services were provided to assist management in assessing strengths and needs of the Company to ensure continued success. Other general and administrative expenses increased $130,750, or 22.4%, when compared to the prior year due to increased insurance expenses. The last two years have had significant higher insurance costs for liability, E&O coverage and D&O coverage due to numerous carriers discontinuing services and increased public scrutiny over financial statements of public entities. 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 six months ended June 30, 2004, the income tax provision represented 21.1% of the income before taxes and minority interest. The generation of taxable income which can be used to realize recorded deferred tax assets for which a valuation allowance was previously recorded, and changes in the components of the deferred tax assets accounted for the reversal of a portion of the valuation allowance and for the provision to be smaller than expected. 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. A significant portion of the Company's valuation allowance has been reversed and the Company anticipates that future income tax expense will be closer to a 35% effective tax rate. 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. Net cash provided by operating activities increased by $1,381,880 to $2,493,109 for the six months ended June 30, 2004, as compared to June 30, 2003. Cash provided by operations was mainly attributed to net income, the decrease in receivables, the increase in unearned premiums and administration fees, the increase in accounts payable and accrued expenses, and an increase in contingency reserves payable. The cash provided by this increase was partially offset by an increase in deferred income taxes and a decrease in reported and unreported claims payable. Receivables decreased due to the collection of various receivables since December 31, 2003. Most were related to bonus and incentive receivables. Unearned premiums and administrative expenses and accounts payable and accrued expenses increased since December 31, 2003. The increases for these accounts are normal fluctuations which occur within the accounts as cash flow is received or paid on these accounts. There was no payment of contingency reserves to physicians for the six months ended June 30, 2004, and the claims withheld from physician payments paid in 2004 increased the contingency reserves payable since December 31, 2003. Deferred income taxes increased primarily due to the increase in contingency reserves payable, which are not deductible until paid to the physicians. Reported and unreported claims payable decreased due to the decrease in enrollment and thus a decrease in reserves needed on the HMO and Reinsurance segments. Cash flows used in investing and financing activities increased from the prior year. The net increase in the amount of certificates of deposit purchased was $500,000 and the net increase in the amount of securities purchased was approximately $601,000. Equipment was also purchased in the normal course of business, but was minimal. 9 The Company is not contractually obligated to pay out the contingency reserves Withheld. No dividends have been declared or paid for the six months ended June 30, 2004. 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 determines the amounts to be paid, subject to approval from the Division of Insurance. Risk based capital requirements, budgeted cash expenditures and a number of other factors may influence the Board's decision for these payments. 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. CRITICAL ACCOUNTING POLICIES Our significant accounting policies are summarized in the footnotes to the Company's financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2003, which was filed with the Securities and Exchange Commission on April 14, 2004. 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. There were no material changes made to the Company's critical accounting estimates or assumptions or the judgments affecting the application of those estimates and assumptions. 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. 10 Item 4. 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. PART II: OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities None-Although the Company has in place a Stock Repurchase Program, which was publicly announced on March 4, 1998, no shares of Common Stock were repurchased during the Company's second quarter Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders At the Company's Annual Meeting of Shareholders held on June 10, 2004, the following directors were elected to serve a term of three years expiring at the Annual Meeting of Shareholders to be held in 2007: Dr John Rittmann Dr. Thomas Krafka Dr. Stephan Schroder Dr. Thomas Luzier The other continuing directors are as follows: Dr. James Reynolds Mr. Van Johnson Dr. James Engelbrecht Mr. Bob Sutton Dr. John Sternquist Dr. Vance Thompson Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a)31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Senior Vice President and Chief Operating Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.3 Certification of Vice President Finance and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Senior Vice President and Chief Operating Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.3 Certification of Vice President Finance and 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. 11 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:_08/06/2004___ By: _/s/ L. Paul Jensen____ L. Paul Jensen Chief Executive Officer (Duly Authorized Officer) Date:_08/06/2004___ By: _/s/ Kirk J. Zimmer____ Kirk J. Zimmer Senior Vice President/Chief Operating Officer (Principal Financial Officer) 12 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 officers 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 changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) 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 officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): 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 Date: August 06, 2004 Exhibit 31.2 CERTIFICATIONS I, Kirk J. Zimmer, 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 officers 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 changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) 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 officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): 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/__Kirk J. Zimmer____ Kirk J. Zimmer Senior Vice President/Chief Operating Officer Date: August 06, 2004 Exhibit 31.3 CERTIFICATIONS 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 officers 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 changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) 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 officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): 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 Vice President Finance/Chief Financial Officer Date: August 06, 2004 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 June 30, 2004, 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 06, 2004 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. 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 June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Kirk Zimmer, Senior Vice President and COO 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/ Kirk J. Zimmer_____ Senior Vice President/Chief Operating Officer August 06, 2004 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Exhibit 32.3 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, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Bruce Hanson, Vice President Finance and CFO 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____ Vice President Finance/Chief Finance Officer August 06, 2004 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. 17

SD STATE MEDICAL HOLDING CO INC 10-Q