DEF 14A 1 proxy2002.txt PROXY STATEMENT FOR ANNUAL MEETING 2002 MAY 17, 2002 TO ALL CLASS A PREFERRED STOCKHOLDERS: Enclosed is the Notice of Annual Meeting of Stockholders, Proxy Statement, and Ballot and Proxy to: elect three directors of South Dakota State Medical Holding Company, Incorporated ("DAKOTACARE" or the "Company"), for a three-year term expiring at the Annual Meeting of Stockholders to be held in 2005. Also enclosed is the Company's 2001 Annual Report to Shareholders. The Ballot and Proxy must be received at the DAKOTACARE office and must be postmarked by June 2, 2002. If you have any questions, please call Bruce Hanson or Kirk Zimmer at DAKOTACARE at (605) 334-4000. Sincerely, /s/__L. Paul Jensen___ L. Paul Jensen Chief Executive Officer LPJ:sj Enc. DAKOTACARE 1323 South Minnesota Avenue Sioux Falls, SD 57105 BALLOT AND PROXY The undersigned hereby appoints K. Gene Koob, M.D., and James Engelbrecht, M.D., or either of them as proxy of the undersigned, with full power of substitution, for and in the name of the undersigned in the election of directors and such other business as may properly come before the Annual Meeting of Shareholders of DAKOTACARE to be held on June 6, 2002, at 9:15 a.m., MDT, or any adjournment thereof, for holders of Class A Preferred Stock and Class B Preferred Stock as of May 17, 2002. This is being solicited by the Board of Directors of South Dakota State Medical Holding Company, Incorporated. Election of Directors You have a total of three (3) votes to cast. Please vote below for any of the three (3) individuals nominated for directors with terms expiring in 2005. You may vote for NO MORE THAN three (3) individuals. Your three (3) votes may all be cast for one (1) individual or a combination of up to three (3) individuals. Indicate beside the nominee the number of votes you wish to cast for that individual. If you indicate more than three (3) votes in total, your ballot will be disqualified. You may withhold authority to vote for any nominee by drawing a line through or otherwise striking out the name of any individual. Individuals Nominated by Board of Directors _____James Reynolds, M.D. _____Mr. Van Johnson _____Mr. Bob Sutton Please return this ballot and proxy in the accompanying prepaid postage envelope. The Ballot and Proxy must be received at the DAKOTACARE office and must be postmarked no later than June 2, 2002. ______________________ Signature ______________________ Name (please print) ______________________ Date SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED 1323 South Minnesota Avenue Sioux Falls, SD 57105 NOTICE OF ANNUAL MEETING OF STOCKHOLDERS June 6, 2002 TO THE CLASS A AND B PREFERRED STOCKHOLDERS OF SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED: Notice is hereby given that the Annual Meeting of Stockholders of South Dakota State Medical Holding Company, Incorporated ("DAKOTACARE" or the "Company"), will be held on Thursday, June 6, 2002, at the Ramkota Hotel, Rapid City, South Dakota, at 9:15 a.m., MDT, for the following purposes: 1. To elect three directors of the Company for a three-year term expiring at the Annual Meeting of Stockholders to be held in 2005. 2. To consider such other business as may properly come before the stockholders for vote at the Annual Meeting. Only the stockholders of record of the Company's Class A Voting Preferred Stock and Class B Voting Preferred Stock at the close of business on May 17, 2002, will be entitled to receive notice of and to vote at the meeting or any adjournment thereof. A form of Ballot and Proxy and Proxy Statement containing more detailed information with respect to the matters to be considered at the Annual Meeting accompany this notice. NOTE: The Ballot and Proxy must be received at the DAKOTACARE office and must be postmarked by June 2, 2002. YOU ARE CORDIALLY INVITED TO ATTEND THE MEETING. WHETHER OR NOT YOU PLAN TO BE PERSONALLY PRESENT AT THE MEETING, PLEASE COMPLETE, DATE, AND SIGN THE ENCLOSED PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED ENVELOPE. IF YOU LATER DESIRE TO REVOKE YOUR PROXY, YOU MAY DO SO AT ANY TIME BEFORE IT IS EXERCISED. BY ORDER OF THE BOARD OF DIRECTORS, James Engelbrecht, M.D. Secretary May 17, 2002 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED 1323 South Minnesota Avenue Sioux Falls, South Dakota 57105 PROXY STATEMENT FOR ANNUAL MEETING OF STOCKHOLDERS JUNE 6, 2002 This Proxy Statement is furnished in connection with the solicitation of the enclosed proxy by the Board of Directors of South Dakota State Medical Holding Company, Incorporated (the "Company" or "DAKOTACARE"), for use at the Annual Meeting of Stockholders (the "Annual Meeting") to be held on Thursday, June 6, 2002, at 9:15 a.m., MDT time, at the Ramkota Hotel, Rapid City, South Dakota, and at any adjournment or postponement thereof. At the Annual Meeting, the Company's Class A and B stockholders will be asked to consider and vote upon the following proposals described in the enclosed Notice of Annual Meeting: 1. To elect three directors of the Company for a three-year term expiring at the Annual Meeting of Stockholders to be held in 2005. 2. To consider such other business as may properly come before the stockholders for vote at the Annual Meeting. This Proxy Statement and the form of Ballot and Proxy enclosed are being mailed to stockholders commencing on or about May 17, 2002. NOTE: The Ballot and Proxy must be received at the DAKOTACARE office and must be postmarked by June 2, 2002 (the "Deadline"). VOTING AND PROXY INFORMATION Shares of the Company's Class A Preferred Stock and Class B Preferred Stock represented by ballots and proxies in the form solicited will be voted in the manner directed by a stockholder. If no direction is made by a stockholder, the proxy will be treated as present for purposes of a quorum, but not voted for the election of directors. If no direction is made by a stockholder, at the discretion of the proxy holders, the proxy will be voted for any other matters that properly come before the stockholders for vote at the Annual Meeting. 1 A stockholder may revoke his or her Ballot and Proxy at any time before the Deadline by delivering to the Secretary of the Company a written notice of termination of the proxy's authority or by filing with the Secretary of the Company another timely Ballot and Proxy bearing a later date. Votes are cast by ballot and proxy for the Annual Meeting and will be tabulated by the inspectors of election appointed by the Company for the meeting, and the number of stockholders voting by proxy will determine whether or not a quorum is present. The inspectors of election will treat abstentions as shares that are present and entitled to vote for purposes of determining the presence of a quorum for all matters. Shares abstaining with respect to any matter will be treated as unvoted. Only the holders of the Company's Class A Preferred Stock and Class B Preferred Stock whose names appear of record on the Company's books at the close of business on May 17, 2002 (the "Record Date"), will be entitled to vote at the Annual Meeting. At the close of business on the Record Date, a total of 1,260 shares of Class A Preferred Stock, 1,300 shares of Class B Preferred Stock, and 1,365,604 shares of Class C Common Stock were outstanding. The holders of a majority of the Class A Preferred Stock and Class B Preferred Stock issued and outstanding and entitled to vote at the Annual Meeting, represented by proxy, will constitute a quorum for the transaction of business. If a quorum is not present, the Annual Meeting may be adjourned from time to time until a quorum is present. The election of each director will be decided by a plurality vote. The affirmative vote of the holders of a majority of the shares of Class A Preferred Stock and Class B Preferred Stock (voting as one class), represented at the Annual Meeting in person or by proxy, is necessary for the approval of all other matters proposed to the stockholders at the Annual Meeting. Each holder of the Company's Class A Preferred Stock and Class B Preferred Stock is entitled to one vote for each share held. There is a right to cumulate voting for the election of directors. In the exercise of cumulative voting rights, each holder of preferred shares is entitled to as many votes as shall equal the number of his preferred shares multiplied by the number of directors to be elected, and by giving written instructions to the Company they may cast all such votes for a single director or may distribute them among the directors to be voted for as he/she sees fit. Expenses in connection with the solicitation of proxies by the Board of Directors will be paid by the Company. Proxies are being solicited primarily by mail, but, in addition, officers and regular employees of the Company who will receive no extra compensation for their services may solicit proxies by telephone or telecopier. 2 AVAILABLE INFORMATION The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and is required to file periodic reports, proxy statements, and other information with the Securities and Exchange Commission (the "SEC") relating to its business, financial statements, and other matters. Such reports, proxy statements, and other information may be inspected and copied at the public reference facilities maintained by the SEC at Room 1024, 450 Fifth Street N.W., Washington, DC 20549, and at the SEC's regional offices located at 233 Broadway, New York, NY 10279, and 500 West Madison Street, Suite 1400, Chicago, IL 60661. Copies of such materials can also be obtained at prescribed rates from the public reference section of the SEC at 450 Fifth Street N.W., Washington, DC 20549. In addition, the SEC maintains a web site (address http://www.sec.gov) on the Internet that contains reports, proxy statements, and other information for companies like the Company which file electronically. ELECTION OF DIRECTORS Nominees and Voting Pursuant to the Company's Bylaws, the Board of Directors consists of ten directors who are elected for three-year terms expiring at each successive Annual Meeting of Stockholders. Currently, no director may serve more than three consecutive terms. The terms of Dr. James Reynolds, Mr. Van Johnson, and Mr. Bob Sutton expire at the 2002 Annual Meeting of Stockholders; the terms of Dr. James Engelbrecht, Dr. K. Gene Koob, and Dr. John Sternquist expire at the 2003 Annual Meeting of Stockholders; and the terms of Dr. Ben J. Henderson, Dr. Thomas L. Krafka, Dr. John E. Rittmann, and Dr. Stephan D. Schroeder expire at the 2004 Annual Meeting of Stockholders. The Bylaws currently require that eight of the directors be holders of Class A Voting Preferred Stock of the Company and two of the directors be consumers. The Articles of Incorporation restrict ownership of Class A Voting Preferred Stock to medical or osteopathic physicians who have executed Participating Physician Agreements with the Company. To assure equal eligibility and opportunity throughout the state of South Dakota and to avoid domination of the Board of Directors by any geographic area or areas, the number of physician directors from any one District Medical Society of the South Dakota State Medical Association cannot exceed two. The consumer directors may be from any geographic location which is served by South Dakota State Medical Holding Company and their residence does not affect the geographic restriction for physician directors. The consumer directors are currently Mr. Van Johnson and Mr. Bob Sutton. The officers of the Company are appointed by the Board of Directors and hold office until their successors are chosen and qualified. The Board of Directors has nominated the following three (3) individuals to serve as directors with terms expiring at the 2005 meeting of the shareholders: James Reynolds, M.D.; Mr. Van Johnson; and Mr. Bob Sutton. The Board of Directors has been 3 informed that each of the three (3) nominees is willing to serve as a director; however, if any nominee should decline or become unable to serve as a director for any reason, the proxy may be voted for such other person as the proxies shall, in their discretion, determine unless otherwise directed on the ballot and proxy. Nominee Information The following table sets forth certain information as of May 17, 2002, concerning the three nominees for election as directors of the Company with terms expiring at the 2005 meeting of the shareholders: Name Age Position with Company James Reynolds, M.D. 59 Director Mr. Van Johnson 57 Director Mr. Bob Sutton 33 Director Dr. Reynolds became a director of the Company in September 1999. He is a member of the South Dakota State Medical Association and has been engaged in the practice of cardiac surgery in Sioux Falls, South Dakota, since 1978. Mr. Johnson became a director of the Company in September 1999. He is a political lobbyist and former Executive Vice President of the South Dakota Auto Dealers Association. Mr. Sutton became a director of the Company in September 1999. He is the Executive Vice President of the South Dakota Banker's Association, and previously Mr. Sutton was the Executive Director of the South Dakota Petroleum Council from 1995 to 1998. Existing Board of Directors The following table sets forth certain information of the existing Board of Directors, excluding those nominated above, as of May 17, 2002. Name Age Position with Company James Engelbrecht, M.D. 55 Director K. Gene Koob, M.D. 59 Director John Sternquist, M.D. 53 Director Ben Henderson, D.O. 60 Director Thomas Krafka, M.D. 57 Director John Rittmann, M.D. 64 Director Stephan Schroeder, M.D. 51 Director Dr. Engelbrecht became a director of the Company in June 1997. He is a member of the South Dakota State Medical Association and has been engaged in the practice of internal medicine and rheumatology in Rapid City, South Dakota, since 1980. 4 Dr. Koob became a director of the Company in June 1994. He is a member of the South Dakota State Medical Association and has been engaged as a neurologist in Sioux Falls, South Dakota, since 1974. Dr. Sternquist became a director of the Company in October 2000. He is a member of the South Dakota State Medical Association and has been engaged as a general surgeon in Yankton, South Dakota, since 1980. Dr. Henderson became a director of the Company in June 1995. He is a member of the South Dakota State Medical Association and has been engaged in the practice of internal medicine in Mobridge, South Dakota, since 1972. Dr. Krafka became a director of the Company in October 1998. He is a member of the South Dakota State Medical Association and has been engaged in the practice of radiology in Rapid City, South Dakota, since 1976. Dr. Rittmann became a director of the Company in June 1997. He is a member of the South Dakota State Medical Association and has been engaged in practice as a family practitioner in Watertown, South Dakota, since 1973. Dr. Schroeder became a director of the Company in October 1998. He is a member of the South Dakota State Medical Association and has been engaged in practice as a family practitioner in Miller, South Dakota, since 1980. Director Compensation Each Director receives $250 per Board meeting attended and is reimbursed for costs associated with the attendance of such meetings. The Company currently has no stock options or other equity-based compensation for its directors, officers, or other employees. Committees and Meetings of the Board of Directors The Board of Directors of the Company has an Executive Committee consisting of K. Gene Koob, M.D., Ben Henderson, D.O., and James Engelbrecht, M.D.; an Audit Committee consisting of K. Gene Koob, M.D., Stephan Schroeder, M.D., and James Engelbrecht, M.D.; a Nominating Committee; and a Credentialing Committee. The purpose of the Executive Committee is to transact business of an emergency nature and other matters specifically directed by the Board of Directors. The Executive Committee held no meetings during 2001. The purpose of the Audit Committee is to assure adequate and accurate accounting policies and procedures. The Audit Committee reviews and approves the audit function and other controls designed to enforce this function. The Audit Committee met once during 2001. 5 The purpose of the Nominating Committee is to propose at least one (1) eligible nominee for each director position to be filled and to file such nominations with the Secretary of the Board of Directors. The Nominating Committee consists of the President-Elect of the South Dakota State Medical Association, one Class A stockholder, and one director (James Engelbrecht, M.D.). The Nominating Committee met once in 2002 to make the current year nominations. The Nominating Committee will consider nominees from shareholders of the Company. The shareholder must submit a nominating petition giving the name and address of the person submitted for each director position, contain at least five (5) original signatures of holders of Class A Voting Preferred Stock of the Company, have attached to the nomination a statement signed by the candidate nominated that, if elected, he/she will serve as a director, and be filed with the Secretary of the Company at least forty (40) days prior to the annual meeting. The purpose of the Credentialing Committee is to oversee the credentialing function to assure a high-quality provider network for DAKOTACARE members and to provide a peer review function for credentialing and recredentialing. The Credentialing Committee consists of K. Gene Koob, M.D.; Ben Henderson, D.O.; James Engelbrecht, M.D.; John Rittmann, M.D.; and Thomas Krafka, M.D. The Credentialing Committee met three times in 2001. The Board of Directors held three meetings and one conference call during 2001. All incumbent directors attended at least 75% of the meetings of the Board and Committees of which they were members. Audit Committee Report The Audit Committee of the Board of Directors of the Company is responsible for assisting the Board in monitoring the integrity of the financial statements of the Company, compliance by the Company with legal and regulatory requirements, and the independence and performance of the Company's external auditors. The Audit Committee is comprised of directors who are independent of the Company. The Audit Committee has not yet adopted a written charter. The audited consolidated financial statements of the Company for the year ended December 31, 2001, were audited by McGladrey & Pullen, LLP. The Audit Committee reviews the audited financial statements annually and recommends to the Board of Directors that such financial statements be included in the Company's Annual Report on Form 10-K for filing with the Securities and Exchange Commission. As part of its activities, the Committee has: 1. Discussed with the independent auditing firm the matters required to be discussed by Statement on Auditing Standards No. 61; 6 2. Received the written disclosures and letters from the independent auditing firm required by Independence Standards Board Standard No. 1; 3. Discussed with the independent auditing firm the respective auditor's independence; and 4. As part of its meeting to be held in June 2002, the Audit Committee will review and discuss the audited financial statements of the Company with the auditors and management. The audit committee consists of Dr. James Engelbrecht, Dr. K. Gene Koob, and Dr. Stephan Schroeder. Audit Fees Fees for the most recent audit of the Company's consolidated and statutory financial statements and required reviews of the Company's financial information included in the Company's annual and quarterly SEC filings for 2001 were $69,200. No fees were paid to McGladrey and Pullen in 2001 for financial information systems design and implementation. All other fees paid to the Company's principal independent auditor for the year ended December 31, 2001, aggregated $13,341. Other fees primarily relate to an attestation agreed upon procedures engagement, audit of the Company's pension plan, tax return preparation, litigation support, and other consulting. The Audit Committee of the Board of Directors, after consideration of the matter, does not believe the provision of audit-related, tax-related, and nonaudit services, fees for which are disclosed above, is incompatible with maintaining the principal accountant's independence. Compensation Committee Report The Board of Directors currently performs the functions of a Compensation Committee. L. Paul Jensen participates in the deliberations of all officers' compensation except for his own. General Compensation Philosophy In 1997, the Company adopted an executive compensation philosophy under which total compensation was based on pay practices in the Company's geographical region and a person's experience and responsibilities to the Company. Currently, the executive compensation program does not include long-term incentive or equity compensation. Total compensation for 2001 was based on the median pay practices of comparably sized companies in DAKOTACARE's geographic region, the individual's years of experience, and level of responsibility. 7 CEO Compensation L. Paul Jensen does not have an employment contract, but the Company has established a deferred compensation agreement with him. A provision has been made for the future compensation which is payable upon the completion of the earlier of 25 years or any earlier retirement age specified by the Board of Directors by resolution. Mr. Jensen generally devotes a portion of his time to the Company and to the South Dakota State Medical Association. He received separate compensation from the South Dakota State Medical Association during 2001 which totaled $97,087, including retirement plan contribution. Mr. Jensen's salary for 2001 for the Company was $81,255. Compensation Committee Interlocks and Insider Participation The Board of Directors currently performs the functions of a Compensation Committee. L. Paul Jensen participates in the deliberation of all officers' compensation except for his own. There are no Compensation Committee interlocks with other companies and none of the nonemployee directors has been an officer, employee, or insider of the Company or its subsidiaries. EXECUTIVE COMPENSATION Name and Principal All Other Position Year Salary $ Compensation(1) L. Paul Jensen 2001 $81,255 $12,880 Chief Executive Officer 2000 $68,813 $11,495 1999 $22,500 $5,943 William Rossing, M.D. 2001 $121,253 $13,987 Vice President, 2000 $112,982 $12,800 Medical Director 1999 $110,055 $12,736 Kirk J. Zimmer 2001 $151,508 $19,324 Senior Vice President 2000 $130,645 $16,793 1999 $126,302 $16,684 Thomas N. Nicholson 2001 $145,386 $16,389 Vice President, Marketing 2000 $139,565 $15,857 1999 $130,055 $14,781 Barbara Smith 2001 $104,313 $11,896 Vice President 2000 $87,992 $9,926 1999 $83,398 $9,444 (1) Consists of retirement plan contribution and premiums paid on the deferred compensation plan. 8 The Company intends to enter into indemnification agreements with each executive officer and director. The Company maintains key person insurance of $250,000 on L. Paul Jensen and $188,700 on Kirk J. Zimmer. In connection with the employment of L. Paul Jensen and Kirk Zimmer, a provision has been made for future compensation which is payable upon the completion of the earlier of 25 years of service to the Company and related organizations or attainment of the age of 65. At December 31, 2001 and 2000, $78,112 and $89,036, respectively, was accrued under these contracts. PERFORMANCE GRAPH No graph is presented because there has been no established market or exchange for the trading of the Class C Common Stock or Class A Voting Preferred Stock. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company leases office space from the South Dakota State Medical Association. The Company has a one-year lease that automatically renews for one-year terms each January 1, unless terminated with at least 30 days notice prior to the end of the lease term. The 2002 lease requires a minimum annual rental payment of $227,784, which is paid on a monthly basis. Total rental payments for office space for the years December 31, 2001, 2000, and 1999, was $239,216, $217,162, and $204,870, respectively. The Company provides group health insurance coverage for employees of the South Dakota State Medical Association. Total premium income from the affiliate for the years ended December 31, 2001, 2000, and 1999, was $66,086, $55,689, and $48,330, respectively. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information, as of March 31, 2002, regarding the beneficial ownership of securities of the Company by (i) each person or group who is known by the Company to be the beneficial owner of more than 5% of the outstanding voting securities, (ii) all directors of the Company and nominees for directors, (iii) each individual named in the Summary Compensation Table, and (iv) all directors and executive officers of the Company as a group. The Company believes that the beneficial owners of the securities listed below, based on information furnished by such owners, have sole voting and investment power (or shares such powers with his or her spouse), subject to the terms of the respective classes of securities of the Company and the information contained in the notes to the table. 9 Name and Address of Amount & Nature of Percent Title of Class Beneficial Owner Beneficial Ownership of Class(1) Class B Preferred South Dakota State 1,300 100% Medical Association(2) Class A Preferred Lloyd Solberg, M.D.(3) 1 .08% Class C Common 135,330 9.91% Class A Preferred James Engelbrecht, M.D. 1 .08% Class C Common 1,160 .08% Class A Preferred Ben J. Henderson, D.O. 1 .08% Class C Common 1,060 .08% Class A Preferred K. Gene Koob, M.D. 1 .08% Class A Preferred Thomas Krafka, M.D. 1 .08% Class C Common 16,640 1.22% Class A Preferred John Rittmann, M.D. 1 .08% Class C Common 8,340 .61% Class A Preferred Stephan D. Schroeder, M.D. 1 .08% Class C Common 1,920 .14% Class A Preferred James Reynolds, M.D. 1 .08% Class C Common 50,440 3.69% Class A Preferred John Sternquist, M.D. 1 .08% Class C Common 560 .04% Class C Common Van Johnson -- -- Class C Common Bob Sutton -- -- Class C Common L. Paul Jensen(4) 5,760 .42% Class C Common Thomas Nicholson -- -- Class C Common William Rossing, M.D. 8,720 .64% Class C Common Kirk J. Zimmer 800 .06% Class A Preferred All Directors and Executive 8 .68% Officers as a Group Class C Common (14 people) 95,400 6.99% (1) Based on 1,260 shares of Class A shares and 1,365,604 shares of Class C Shares. (2) The South Dakota State Medical Association is an affiliated company. (3) Lloyd Solberg is neither a director nor an officer, but owns > 5% of non-voting stock. (4) L. Paul Jensen is the Chief Executive Officer of the South Dakota State Medical Association.
10 COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT Section 16(a) of the Securities Exchange Act of 1934 requires executive officers and directors, and persons who beneficially own more than ten percent (10%) of the Company's Class C Common Stock to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission ("SEC"), and furnish copies of those reports to the Company. Based solely on a review of the copies of such reports furnished to the Company, and written representations from the executive officers and directors, the Company believes that during 2001 all other filing requirements were complied with. OTHER MATTERS The Board of Directors of the Company knows of no matters that may come before the Annual Meeting other than those referred to above. However, if any procedural or other matters should properly come before the Annual Meeting calling for a vote of the stockholders, it is the intention of the persons named in the enclosed proxy to vote such proxy in accordance with their best judgment. INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS McGladrey & Pullen, LLP, served as the Company's independent certified public accountants for 2001 and is serving in that capacity for 2002. It is not expected that representatives of McGladrey & Pullen, LLP, will attend the Annual Meeting of Stockholders or have the opportunity to make a statement or respond to questions. STOCKHOLDER PROPOSALS FOR THE NEXT ANNUAL MEETING Any proposal by a stockholder to be presented at the 2003 Annual Meeting must be received at the Company's principal executive offices, 1323 South Minnesota Avenue, Sioux Falls, South Dakota 57105, addressed to James Engelbrecht, M.D., the Secretary of the Company, not later than January 17, 2003. BY ORDER OF THE BOARD OF DIRECTORS, James Engelbrecht, M.D. Secretary Dated: May 17, 2002 11 PLEASE BRING THIS WITH YOU TO THE MEETING AGENDA CORPORATE BODY MEETING OF SD STATE MEDICAL HOLDING COMPANY, INC. JUNE 6, 2002, 9:15 A.M. MDT RAMKOTA HOTEL RAPID CITY, SD AGENDA 14TH ANNUAL MEETING SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INC. 9:15 A.M. Ramkota Hotel June 6, 2002 Rapid City, SD I. CALL TO ORDER K. Gene Koob, M.D., President, Board of Directors II. ORDER OF BUSINESS A. Minutes of 2001 Annual Meeting B. Report of Election Process C. General Comments D. Other III. ADJOURNMENT DAKOTACARE 1323 South Minnesota Avenue Sioux Falls, SD 57105 BALLOT AND PROXY The undersigned hereby appoints K. Gene Koob, M.D., and James Engelbrecht, M.D., or either of them as proxy of the undersigned, with full power of substitution, for and in the name of the undersigned in the election of directors and such other business as may properly come before the Annual Meeting of Shareholders of DAKOTACARE to be held on June 6, 2002, at 9:15 a.m., MDT, or any adjournment thereof, for holders of Class A Preferred Stock and Class B Preferred Stock as of May 17, 2002. This is being solicited by the Board of Directors of South Dakota State Medical Holding Company, Incorporated. Election of Directors You have a total of three (3) votes to cast. Please vote below for any of the three (3) individuals nominated for directors with terms expiring in 2005. You may vote for NO MORE THAN three (3) individuals. Your three (3) votes may all be cast for one (1) individual or a combination of up to three (3) individuals. Indicate beside the nominee the number of votes you wish to cast for that individual. If you indicate more than three (3) votes in total, your ballot will be disqualified. You may withhold authority to vote for any nominee by drawing a line through or otherwise striking out the name of any individual. Individuals Nominated by Board of Directors _____James Reynolds, M.D. _____Mr. Van Johnson _____Mr. Bob Sutton Please return this ballot and proxy in the accompanying prepaid postage envelope. The Ballot and Proxy must be received at the DAKOTACARE office and must be postmarked no later than June 2, 2002. ______________________ Signature ______________________ Name (please print) ______________________ Date ANNUAL MEETING MINUTES SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED June 7, 2001 Ramkota Hotel 9:35 A.M. Sioux Falls, SD The 13th Annual Meeting of the South Dakota State Medical Holding Company, Incorporated, was held on Thursday, June 7, 2001, at 9:35 a.m. at the Ramkota Hotel, Sioux Falls, South Dakota. The meeting was called to order by President K. Gene Koob, M.D. The roll call was taken and the following Class A stockholder members were present: Stephen Gehring, M.D.; Richard Holm, M.D.; Robert Raszkowski, M.D.; Herb Saloum, M.D.; James Engelbrecht, M.D.; Steve Schroeder, M.D.; Mary Carpenter, M.D.; Steve Feeney, M.D.; Charles Hart, M.D.; Paul Eckrich, M.D.; James Hovland, M.D.; James Larson, M.D.; Gary Bruning, D.O.; Pierre Kamguia, M.D.; Robert Hohm, M.D.; Karl Blessinger, M.D.; Carey Buhler, M.D.; John Sall, M.D.; J. Michael McMillin, M.D.; Daniel Kennelly, M.D.; David Rossing, M.D.; Guy Tam, M.D.; Karla Murphy, M.D.; Rodney Parry, M.D.; David Bean, M.D.; Jem Hof, M.D.; H. Lee Ahrlin, M.D.; Victoria Herr, M.D.; H. Thomas Hermann, M.D.; Cynthia Weaver, M.D.; Douglas Traub, M.D.; Dale Gunderson, M.D.; Richard Kafka, M.D.; Tony Berg, M.D.; James Collins, M.D.; Kevin Bjordahl, M.D.; Alan Bloom, M.D.; John Vidoloff, M.D.; Leonard Kolodychuk, M.D.; Daniel Flaherty, M.D.; M. George Thompson, D.O.; Dan Blue, M.D.; Tom Braithwaite, M.D.; William Fuller, M.D.; Donald Humphreys, M.D.; John Oliphant, M.D.; Richard Howard, M.D.; Terry Yeager, M.D.; Jim Walery, M.D.; William O. Rossing, M.D.; Jim Reynolds, M.D.; D. Mark Brown, M.D.; David Barnes, M.D.; Beth Mikkelsen, M.D.; Tom Olson, M.D.; John Sternquist, M.D.; Wesley Sufficool, D.O.; Vassilia Young, M.D.; John Barlow, M.D.; Edward Seljeskog, M.D.; Richard Porter, M.D.; Norman Neu, M.D.; Monte Dirks, M.D.; and Gregg Tobin, M.D. The number of Class A shareholders represented by proxy was 277. The Class B stockholders were represented by the designee of the South Dakota State Medical Association. The President declared a quorum present for the purpose of conducting business of the corporation. The President called for consideration of the minutes of the last annual meeting. He referred the membership to the SDSMHC minutes in the printed material furnished to each member. The minutes were accepted as published and the reading thereof waived. Dr. Koob reported on the election results for the four vacant positions on the Board of Directors. The following persons were nominated for the election to the Board of Directors by the Nominating Committee: Ben Henderson, D.O.; Thomas Krafka, M.D.; John Rittmann, M.D.; and Stephan Schroeder, M.D. Dr. Koob indicated no other nominations had been received from the membership. There being no further nominations, the following persons were declared elected to serve on the Board of Directors: Ben Henderson, D.O.; Thomas Krafka, M.D.; John Rittmann, M.D.; and Stephan Schroeder, M.D. Next, Dr. Koob referred the members to the 2000 DAKOTACARE Annual Report that has been distributed to all Class A shareholders and the Class B shareholder. DAKOTACARE had a good year in 2000 and is anticipating 100,000 covered lives by the end of 2001. Dr. Koob stated that the staff and Board of Directors are always available and would welcome hearing your comments and concerns. Dr. Koob discussed the contract with the State of South Dakota. Effective July 1, 2001, DAKOTACARE will be taking over the claims payment portion for the State Members in addition to providing the provider network. Beginning June 1, 2001, Health Care Medical Technology, under the direction of Dr. Mike Rost, is handling the managed care services for State Members, which includes preauthorization and case management. There were some concerns expressed regarding the preauthorization process, and Dr. Koob recommended that the members review the preauthorization process in their offices over the next six months and to let DAKOTACARE staff and/or Board of Directors know what they think about the process. Some physicians expressed concern about the Addendum to DAKOTACARE Participating Physician Agreement, most specifically Part B on page 2, that was sent to all participating providers. Dr. Koob recommended that each individual physician read the contract and make their own decision on whether or not to sign the Addendum. Dr. Koob inquired whether any member of the corporate body had any other issues or concerns he/she wished to bring to the attention of the corporate body. There being no further questions, the meeting adjourned at 9:45 a.m. TO OUR SHAREHOLDERS: Two thousand one was a year of growth, challenges, and opportunities. While it was difficult to predict the pace of medical cost increase which we experienced during 2001, DAKOTACARE has made the appropriate adjustments to its premium, pricing and utilization structures, and many positive trends have emerged which leave us looking optimistically toward 2002. DAKOTACARE and its subsidiaries set many new financial and enrollment records in 2001,continuing our pattern of sustained growth for your company. Total enrollment from all products and services surpassed the 100,000 member mark in 2001. The Company and its subsidiaries ended the year with over 113,000 customers served in South Dakota and across the nation, securing our spot as one of the largest health care companies in the State of South Dakota. A large selection of health care plans, flexible ancillary products, stable premiums, and excellent service have all contributed to DAKOTACARE 's ability to achieve an enrollment growth rate exceeding 20% for the third consecutive year. Financially, total assets, total revenue, cash and investments, and claims reserves ended 2001 at record levels. These achievements reflect the approach to growth and risk which guides the operations of your Company, as we strive to create an environment in South Dakota where quality medical care can be delivered at a reasonable cost under the direction of South Dakota physicians. The Company reinforced its commitment to South Dakota physicians by returning over $1.3 million in contingency reserves to participating providers in 2001, as well as repurchasing over 33,000 shares of Class C stock through its stock repurchase program. With increasing hospital costs, pharmacy utilization and price increases at record levels, and new provider types all competing for a larger share of every claim dollar, DAKOTACARE has attempted to provide quality health care to its members while balancing the reimbursement pressures which are unavoidable in the present healthcare marketplace. Your company has much to celebrate as we look back at our first fifteen years of existence. With the changes this period has undergone, DAKOTACARE still provides its customers with the most comprehensive provider network ever created in this state, stable premiums for their healthcare dollar, and consistently excellent and attentive service. Whatever the demand for products and services, DAKOTACARE has adapted to the market 's needs and developed the mechanisms to deliver care, while remaining responsive to the needs of the state's providers as well. We enter 2002 poised for success, thanks in no small part to the continuing support and feedback from the Company 's shareholders, the steadfast commitment of its board members, the dedication of its talented staff, and its loyal agent force. Your company is unique in the industry, from its ownership structure to the way we deliver healthcare services, and we invite your interest and participation as we approach the new challenges and opportunities before us. K.Gene Koob,M.D. L.Paul Jensen South Dakota 's Own DAKOTACARE | 1 DESCRIPTION OF BUSINESS South Dakota State Medical Holding Company, Incorporated (the Company, Corporation or DAKOTACARE), was incorporated in the State of South Dakota on May 5, 1988. Its corporate offices are located at 1323 South Minnesota Avenue, Sioux Falls, South Dakota, 57105. The Articles of Incorporation permit the Company to engage in the development of quality comprehensive health care delivery systems; to conduct, promote, or operate alternative health care delivery systems and other contractual health service arrangements, including but not limited to, traditional third party reimbursement systems, preferred provider organizations, and health maintenance organizations (HMO). 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. Physicians who are members of the South Dakota State Medical Association and who complete the Company's credentialing process may participate with the Company by purchasing one share of Class A voting preferred stock of the Company for $10. The fee for non-members is $1,000. The South Dakota State Medical Association owns 100% of the Class B voting preferred stock of the Company, and through this ownership, maintains voting control of the Company. The Company's agreements with participating physicians stipulate compensation on a fee-for-service basis utilizing a relative value schedule developed by the Company. This schedule assigns a value (measured in number of units) for each individual service for which a physician may perform and submit a bill. These values are then multiplied by an overall value per unit assigned by the Company, and the product is the maximum amount allowed for payment to the physician. Actual reimbursement is at the lower of this product or the actual billed amount. The Company, at least annually, reviews the unit values and makes adjustments when considered necessary. The effect of this reimbursement mechanism is to establish a maximum allowable reimbursement, which is not dependent upon actual billed charges. Regardless of the physician bill, reimbursement will never exceed the maximum amount established by the relative value schedule. Physicians also may not bill patients for any excess of the billed charge over the amount allowed by the Company, but instead have contractually agreed to hold the patient harmless for any such amounts. The Company's agreements with participating physicians provide that up to 20% of fees for services provided, as submitted to and allowed by the Company, may be withheld to provide a contingency reserve that may be used to fund operations or meet other financial requirements of the Company. The percentage withheld for years 1999 through 2001 was 15%. The contingency reserve withholding is also designed to encourage efficient medical practice by the physicians. Less expensive medical outcomes enhance net income and consequently, an increased likelihood of contingency reserve payouts to the physicians. The amounts withheld may be paid to the participating physicians at the discretion of the Board of Directors of the Company, although the Company is not contractually obligated to pay out amounts withheld. Management estimates the expected amount of contingency reserves and records a liability based upon factors such as cash flow needs, net income, and accumulations of amounts withheld. The Company withheld from payment to the participating physicians $2,276,742 and $1,497,780 for the years ended December 31, 2001 and 2000, respectively. Payments to physicians are made at such times as the Board of Directors approves payouts. The recorded liability for contingency reserves at December 31, 2001 and 2000, was $3,846,711 and $2,875,472, respectively. The recorded liability is equal to actual amounts withheld plus or minus claims adjustments for each of the three years in the period ended December 31, 2001. In 1992, the Company incorporated DAKOTACARE Administrative Services, Incorporated (DAS), a wholly owned subsidiary of the Company. In 1994, the Company organized and then purchased a 50.11% interest in Dakota Health Plans, Incorporated (DHP). During December of 1998, DHP ceased business operations and the Company was formally dissolved in 2001. In January 1996, the Company incorporated DAKOTACARE Insurance, Ltd. (DIL), a wholly owned subsidiary of the Company. 2 | DAKOTACARE South Dakota 's Own DIL was formed to accept reinsurance risk on stop-loss policies of DAS and DHP customers, reinsurance risk on group term life insurance coverage of DAKOTACARE and DAS customers and other insurance risks. In August 2000, the Company organized and purchased a 54.35% interest in Carewest, Inc. (Carewest) and increased its ownership percentage in Carewest to 81.30% at December 31, 2001. The Articles of Incorporation of DAS, DHP and Carewest permit them to engage in the development of Third Party Administration(TPA) services for health and welfare plans. Carewest has subcontracted with DAS to perform a substantial part of the TPA activities. PRODUCTS AND MARKETING The Company markets its products under the trade name of DAKOTACARE. The Company has three reportable segments as defined by Financial Accounting Standards Board (FASB) Statement No. 131. The segments' products include group managed health care products (HMO), managed care and claims administration services for self-insured employer groups (TPA) and the reinsurance segment, which provides excess medical stop loss coverage to the self insured employer groups. A detailed analysis of the various segments is contained in the Notes to the Consolidated Financial Statements-Note 12. The Company markets its products through an exclusive network of independent insurance agents throughout South Dakota. The Company markets its products to employer groups with a minimum of two covered employees and its' customers range in size from employers of this size to its largest customer with over 12,850 employees. As of January 1, 2002, DAKOTACARE and its subsidiaries provided health care services to approximately 113,000 individuals, which also includes enrollment in ancillary product services for both the HMO and TPA products. Approximately 15% of the state's population and approximately 23% of DAKOTACARE's target market of approximately 450,000 is served by DAKOTACARE and its subsidiaries, which does not include Medicare and Medicaid populations, federal employee groups, the individual policy market, and other potential populations. The Company's HMO enrollment, which was approximately 30,000 at the end of 2000, increased to approximately 35,000 by the end of 2001. Net enrollment added effective January 1, 2002 was approximately 3,000 members. Commencing in 1993, the Company began its TPA business and by January 1, 2002, had enrolled approximately 65,000 enrollees, bringing the total individuals served by the Company and its' subsidiaries to approximately 103,000. The Company's HMO client disenrollment rate is lower than the industry rate as a whole. All underwriting and pricing decisions are made by the DAKOTACARE underwriting department based on underwriting policy and guidelines established by senior management. DAKOTACARE's underwriters evaluate the prior loss history, the inherent risk characteristics, and the demographic makeup of the applicants where appropriate. The Company's policy is to reinsure that portion of risk in excess of $125,000 in 2001 and 2000 of covered hospital inpatient expenses of any enrollee per contract year. The covered expenses are subject to a coinsurance provision which ranged from 50% to 90% in 2001 and 2000 based on average daily amounts specified in the plan. They are also subject to a $2,000,000 lifetime maximum benefit per enrollee in 2001 and 2000. The Company would be liable for any obligations that the reinsuring company is unable to meet under the reinsurance agreement. The reinsurance agreement also provides for enrollee benefits to be paid in the event the Company should cease operations or become insolvent, and a conversion privilege for all enrollees in the event of plan insolvency and for any enrollee that moves out of the service area of the Company. The Company operates under a license issued by the South Dakota Department of Commerce and Regulation, Division of Insurance, for the operation of the health maintenance organization. DAS and Carewest are also registered as third party administrators in South Dakota and several other states. The Company has also received certification from the South Dakota Department of Labor as a workers' compensation managed care plan. The Company continually seeks out and evaluates opportunities for future growth and expansion. These opportunities may include acquisitions or dispositions of segments of its operations, marketing of insurance products underwritten by other companies, the internal development of new products and techniques for the containment of health care costs, and the measurement of the outcomes and efficiency of health care delivered. South Dakota 's Own DAKOTACARE | 3 ENROLLMENT BY COUNTY DAKOTACARE supports its statewide enrollment with sales and service locations throughout South Dakota. As a DAKOTACARE member, you're never far away from a helpful voice. PROVIDERS BY CITY DAKOTACARE contracts with over 2000 participating providers in over 130 communities across South Dakota, as well as our national network of Centers of Excellence which provides transplant and trauma services not available in the state. We also have contracts with medical and pharmacy networks across the United States which enable us to serve our clients' employees who live outside the state. DAKOTACARE's Provider Network is unequaled in its ability to provide true savings to employers and freedom of choice to members. 4 | DAKOTACARE South Dakota 's Own Aurora 391 Beadle 2525 Bennett 63 Bon Homme 984 Brookings 6076 Brown 3807 Brule 674 Buffalo 2 Butte 528 Campbell 37 Charles Mix 827 Clark 917 Clay 2128 Codington 4960 Corson 55 Custer 600 Davison 3980 Day 728 Deuel 331 Dewey 123 Douglas 459 Edmunds 531 Fall River 354 Faulk 278 Grant 1158 Gregory 355 Haakon 206 Hamlin 694 Hand 477 Hanson 587 Harding 45 Hughes 6031 Hutchinson 972 Hyde 105 Jackson 157 Jerauld 360 Jones 85 Kingsbury 849 Lake 1937 Lawrence 1717 Lincoln 1386 Lyman 334 Marshall 347 McCook 542 McPherson 174 Mead 1330 Mellette 50 Miner 306 Minnehaha 26657 Moody 847 Pennington 6953 Perkins 107 Potter 336 Roberts 405 Sanborn 422 Shannon 53 Spink 1454 Stanley 819 Sully 223 Todd 47 Tripp 783 Turner 924 Union 932 Walworth 286 Yankton 2890 Ziebach 36
South Dakota's Own DAKOTACARE | 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS STOCK PRICES There is no active trading for shares of stock of the Company and the stock is not listed on any exchange or over-the-counter market, but a limited number of exchanges of Class C shares have occurred directly between interested buyers and sellers. The Company does not regularly receive price information on these transactions. The amended and restated Articles of Incorporation of the Company currently restrict the ownership of shares as follows: (i) the ownership of the Company's Class A voting preferred stock is restricted to medical or osteopathic physicians who have executed participating agreements with the Company and may not be issued to or held by any hospital, (ii) the ownership of the Company's Class B voting preferred stock is restricted to the South Dakota State Medical Association, and (iii) the ownership of the Company's Class C non-voting common stock is restricted to (a) medical or osteopathic physicians who have executed participating physician agreements with the Company, (b) a trust or self-directed individual retirement account controlled by such physicians, (c) professional corporations, partnerships, or other entities domiciled in the state of South Dakota, and in which a participating physician is a shareholder, partner, or employee in the practice of medicine, (d) management employees or agents of the Company, the South Dakota State Medical Association, the South Dakota Foundation for Medical Care, or (e) a spouse or child of a shareholder of the Company, if such shares were first held by one of the persons or entities entitled to own Class C common stock. In addition, the Class C non-voting common stock may not be issued or transferred to any hospital or to any natural person or entity who is not a resident or domiciliary of the state of South Dakota. SHARES ELIGIBLE FOR FUTURE SALE The Company's Class A voting preferred stock is nontransferable and ownership of the Company's Class B voting preferred stock is restricted to the South Dakota State Medical Association. Approximately 95,400 shares of the Company's Class C non-voting stock are currently owned by the officers and directors of the Company. All of the remaining Class C shares are eligible for resale under Rule 144(k) of the Securities Act of 1933, as amended, subject to the ownership restrictions contained in the Company's Amended and Restated Articles of Incorporation. HOLDERS As of March 21, 2002, there were 1,260 holders of record of Class A preferred stock, 1 holder of Class B preferred stock, and 694 holders of record of Class C common stock. There are no options or warrants outstanding. DIVIDENDS The Class A and B preferred stockholders are not entitled to dividends. The Company is not required to pay annual cumulative dividends to its Class C common stock. The Board of Directors, at its discretion, can elect to pay dividends in any amount subject to availability of funds and regulatory requirements. As long as the Company exceeds required regulatory capital as required by the Division, there are no dividend restrictions. Regulatory capital as required by the Division at December 31, 2001 and 2000 was $200,000 on a statutory basis of accounting, which the Company significantly exceeded. During 2001 and 2000, the Company paid dividends of $69,930 and $69,930, respectively, on Class C stock. 6 | DAKOTACARE South Dakota 's Own STOCK REPURCHASE PLAN As a service to the Company's shareholders to facilitate liquidity for Class C common stock (Common Stock) in the event of death, disability, or retirement of a shareholder, the Company's Board of Directors adopted a Stock Repurchase Program (Program) which was implemented 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. During 2001 and 2000, 33,003 and 34,341 shares, respectively, were acquired for the treasury under the Program. The value per share was computed using guidelines established in 1995 by an investment organization, and updated using audited consolidated financial statements. These calculations are tested for accuracy and consistency by an independent accounting firm. The purchase and sale of Common Stock under the Program is subject to repurchase conditions as described in the Program. UNREGISTERED SALES OF SECURITIES Ownership of the Company's Class A Voting Preferred Stock is restricted to medical or osteopathic physicians who have executed participating physician agreements with the Company. Class A Preferred Stock is nontransferable and holders of these shares do not receive dividends. Each such physician is issued one share of Class A Voting Preferred Stock upon execution of his or her participation agreement and the payment of $10 per share. Upon the termination of a physician's participation agreement, his or her share of Class A Preferred Stock is canceled. During 2001, the Company issued a net increase of 81 shares of Class A Preferred Stock to physicians who entered into participation agreements with the Company. To the extent that the registration provisions of the Securities Act of 1933, as amended, were applicable to these transactions, the Company relied on the exemption from registration contained in Section 4(2) of that act. South Dakota's Own DAKOTACARE | 7 TOTAL ASSETS 1997 $14,010,801 1998 14,277,389 1999 13,653,782 2000 17,703,578 2001 19,357,890 CASH & INVESTMENTS 1997 $10,399,993 1998 10,275,673 1999 9,818,075 2000 12,775,152 2001 14,281,153 2002 Claims Payment Distribution Hospital 54% Physician 33% Pharmacy 9% Other 4% TOTAL REVENUE 1997 $40,801,344 1998 41,420,418 1999 39,570,829 2000 49,332,786 2001 64,734,912 ENROLLMENT-JANUARY 1 1998 74,776 1999 78,585 2000 80,551 2001 89,359 2002 113,173 8 | DAKOTACARE South Dakota 's Own FINANCIAL REVIEW ------------------------------------------------------------------------------ Consolidated Balance Sheets Pages 10-11 Consolidated Statements of Operations Page 12 Consolidated Statements of Stockholders 'Equity Page 13 Consolidated Statements of Cash Flows Pages 14-15 Notes to Consolidated Financial Statements Pages 16-25 Independent Auditor 's Report on the Financial Statements Page 26 Management 's Discussion and Analysis of Financial Condition and Results of Operations Pages 27-30 Selected Financial Data Page 31 Directors and Executive Officers Page 32 Shareholder Information Page 32 Agent Directory Page 33
South Dakota 's Own DAKOTACARE | 9 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 AND 2000 ASSETS 2001 2000 ------------------------------------------------------------------------------- Current Assets Cash and cash equivalents $ 8,673,787 $ 7,439,514 Investment in securities held to maturity (Note 5) 890,714 455,018 Certificates of deposit 1,300,000 500,000 Receivables (Note 3) 1,544,987 1,869,688 Prepaids and other assets 135,541 101,430 Deferred income taxes (Note 8) 916,000 811,000 ---------------------------- TOTAL CURRENT ASSETS 13,461,029 11,176,650 ---------------------------- Long-Term Investments Investment in securities held to maturity (Note 5) 4,083,452 4,205,220 Investment in securities available for sale (Note 5) 133,200 125,400 Certificates of deposit 100,000 750,000 Contracts with life insurance companies 92,337 101,119 ---------------------------- 4,408,989 5,181,739 ---------------------------- Property and Equipment, at cost, net of accumulated depreciation 756,872 903,191 Deferred Income Taxes (Note 8) 731,000 442,000 ---------------------------- $19,357,890 $17,703,580 ============================
See Notes to Consolidated Financial Statements. 10 | DAKOTACARE South Dakota 's Own LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000 ------------------------------------------------------------------------------- Current Liabilities Reported and unreported claims payable (Note 7) $ 8,238,361 $ 5,831,471 Unearned premiums and administration fees 1,175,871 1,026,511 Accounts payable and accrued expenses 1,459,263 1,712,748 Contingency reserves payable (Note 6) 1,584,485 1,300,000 ---------------------------- TOTAL CURRENT LIABILITIES 12,457,980 9,870,730 ---------------------------- Contingency Reserves Payable (Note 6) 2,262,226 1,575,472 ---------------------------- Minority Interest in Subsidiaries 15,768 349,331 ---------------------------- Commitments and Contingencies (Notes 4 and 13) Stockholders' Equity (Note 9) Class A preferred, voting, no par value, $10 stated value, 2,500 shares authorized; 1,260 and 1,179 shares issued at December 31, 2001 and 2000 12,600 11,790 Class B preferred, voting, no par value, $1 stated value, 2,500 shares authorized; issued and outstanding 1,300 shares 1,300 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 Retained earnings 2,173,419 2,960,959 Accumulated other comprehensive (loss) (624) (1,223) Less cost of Class C common treasury stock, 2001 140,156 shares, 2000 107,153 shares (1,329,179) (829,179) ---------------------------- 4,621,916 5,908,047 ---------------------------- $19,357,890 $17,703,580 ============================
South Dakota's Own DAKOTACARE | 11 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2001, 2000 and 1999 2001 2000 1999 -------------------------------------------------------------------------------------------- Revenues: Premiums $ 58,528,766 $ 44,090,588 $ 34,705,625 Less premiums ceded for reinsurance (536,260) (517,055) (457,120) ------------ ------------ ------------ 57,992,506 43,573,533 34,248,505 Third party administration fees 4,075,143 3,371,746 3,060,583 Investment income 687,788 767,185 513,599 Other income 1,142,958 711,488 605,401 ------------ ------------ ------------ TOTAL REVENUES 63,898,395 48,423,952 38,428,088 ------------ ------------ ------------ Operating expenses: Claims incurred 51,709,053 35,286,842 30,539,355 Less reinsurance recoveries (93,629) (136,291) (444,296) ------------ ------------ ------------ 51,615,424 35,150,551 30,095,059 Personnel expenses 5,212,268 4,486,221 4,084,953 Commissions 4,200,967 1,757,300 1,385,917 Professional fees expenses 867,813 1,075,733 1,040,665 Office expenses 746,715 687,326 680,132 Occupancy expenses 768,696 787,892 693,391 State insurance taxes 686,283 541,413 418,872 Advertising expenses 409,074 417,676 386,280 Other general and administrative expenses 727,854 641,616 457,181 ------------ ------------ ------------ TOTAL OPERATING EXPENSES 65,235,094 45,545,728 39,242,450 ------------ ------------ ------------ INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST (1,336,699) 2,878,224 (814,362) Income taxes (benefit) (Note 8) (527,767) 1,034,917 (196,943) ------------ ------------ ------------ INCOME (LOSS) BEFORE MINORITY INTEREST (808,932) 1,843,307 (617,419) Minority interest in income (loss) of subsidiaries (91,322) (110,670) 4,395 ------------ ------------ ------------ NET INCOME (LOSS) $ (717,610) $ 1,953,977 $ (621,814) ============ ============ ============ Earnings (loss) per common share $ (0.52) $ 1.38 $ (0.43) ============ ============ ============
See Notes to Consolidated Financial Statements. 12 | DAKOTACARE South Dakota 's Own SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 Class A Class B Comprehensive Preferred Preferred Income(Loss) Stock Stock - --------------------------------------------------------------------------------------- Balance, December 31, 1998 $ 11,050 $ 1,300 Issuance of Class A preferred stock 850 - Redemption of Class A preferred stock (420) - Dividends paid ($0.05 per share) on Class C common stock - - Purchase of treasury stock (Note 9) - - Comprehensive (loss): Net (loss) $ (621,814) - - Net change in unrealized loss on securities available for sale (26,276) - - ----------- Comprehensive (loss) $ (648,090) ------------------------------------------- Balance, December 31, 1999 11,480 1,300 Issuance of Class A preferred stock 950 - Redemption of Class A preferred stock (640) - Dividends paid ($0.05 per share) on Class C common stock - - Purchase of treasury stock (Note 9) - - Comprehensive income: Net income $1,953,977 - - Net change in unrealized loss on securities available for sale 33,691 - - ----------- Comprehensive income $1,987,668 ------------------------------------------- Balance, December 31, 2000 11,790 1,300 Issuance of Class A preferred stock 1,230 - Redemption of Class A preferred stock (420) - Dividends paid ($0.05 per share) on Class C common stock - - Purchase of treasury stock (Note 9) - - Comprehensive (loss): Net (loss) $ (717,610) - - Net change in unrealized loss on Securities available for sale 599 - - ----------- Comprehensive (loss) $ (717,011) ------------------------------------------- Balance, December 31, 2001 $ 12,600 $ 1,300 ============================
See Notes to Consolidated Financial Statements. Accumulated Class C Additional Other Common Paid-In Retained Comprehensive Treasury Stock Capital Earnings (Loss) Stock Total ------------------------------------------------------------------------------------------ $ 15,058 $3,749,342 $ 1,771,993 $ (8,638) $ (280,480) $ 5,259,625 - - - - - 850 - - - - - (420) - - (73,267) - - (73,267) - - - - (298,699) (298,699) - - (621,814) - - (621,814) - - - (26,276) - (26,276) -------------------------------------------------------------------------------------- 15,058 3,749,342 1,076,912 (34,914) (579,179) 4,239,999 - - - - - 950 - - - - - (640) - - (69,930) - - (69,930) - - - - (250,000) (250,000) - - 1,953,977 - - 1,953,977 - - - 33,691 - 33,691 ------------------------------------------------------------------------------------ 15,058 3,749,342 2,960,959 (1,223) (829,179) 5,908,047 - - - - - 1,230 - - - - - (420) - - (69,930) - - (69,930) - - - - (500,000) (500,000) - - (717,610) - - (717,610) - - - 599 - 599 -------------------------------------------------------------------------------------- $ 15,058 $3,749,342 $ 2,173,419 $ (624) $(1,329,179) $ 4,621,916 ======================================================================================
See Notes to Consolidated Financial Statements. South Dakota's Own DAKOTACARE | 13 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 2001 2000 1999 ---------------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income (loss) $ (717,610) $1,953,977 $ (621,814) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 287,969 336,776 329,472 Minority interest in income (loss) of subsidiaries (91,322) (110,670) 4,395 Amortization of discounts and premiums on investments, net (140,797) (134,399) (130,662) Loss on disposal of equipment - 16,076 - Loss on sale of equity securities - 27,437 - (Increase) decrease in receivables 324,701 (940,660) 323,752 (Increase) decrease in prepaids and other assets (34,111) 39,083 13,417 (Increase) decrease in deferred income taxes (394,000) (204,400) 33,400 Increase in reported and unreported claims payable 2,406,890 1,164,218 257,631 Increase (decrease) in accounts payable and accrued expenses (253,485) 894,347 98,632 Increase in unearned premiums and administration fees 149,360 176,734 10,734 Increase in contingency reserves payable 971,239 152,121 32,783 ------------------------------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 2,508,834 3,370,640 351,740 ------------------------------------------ Cash Flows From Investing Activities Available for sale securities: Purchased (7,201) (46,310) (6,976) Sales - 213,564 - Held to maturity securities: Matured or called 890,000 437,248 560,000 Purchased (1,065,221) (1,484,233) - Repayments on collateralized mortgage obligations 2,090 8,485 55,839 Proceeds from maturities of certificates of deposit 1,200,000 1,000,000 1,075,000 Purchase of certificates of deposit (1,350,000) (1,200,000) (1,000,000) (Increase) decrease in contracts with life insurance companies 8,782 5,970 (15,245) Purchase of property and equipment (141,650) (145,566) (526,943) ------------------------------------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (463,200) (1,210,842) 141,675 ------------------------------------------
See Notes to Consolidated Financial Statements. 14 | DAKOTACARE South Dakota 's Own 2001 2000 1999 ------------------------------------------ Cash Flows From Financing Activities Proceeds from issuance of capital stock $ 1,230 $ 950 $ 850 Redemption of capital stock (420) (640) (420) Payment of dividends (69,930) (69,930) (73,267) Purchase of treasury stock (500,000) (250,000) (298,699) Increase (decrease) in minority investment in subsidiary (242,241) 105,000 - ------------------------------------------ NET CASH (USED IN) FINANCING ACTIVITIES (811,361) (214,620) (371,536) ------------------------------------------ INCREASE IN CASH AND CASH EQUIVALENTS 1,234,273 1,945,178 121,879 Cash and Cash Equivalents Beginning 7,439,514 5,494,336 5,372,457 ------------------------------------------ Ending $8,673,787 $7,439,514 $5,494,336 ========================================== Supplemental Disclosures of Cash Flow Information Cash payments for: Income taxes, net of refunds $ 200,000 $1,007,032 $ (250,000) Supplemental Disclosures of Noncash Investing and Financing Activities (Increase) decrease in unrealized loss on securities available for sale $ 599 $ 33,691 $ (26,276)
South Dakota's Own DAKOTACARE | 15 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS: South Dakota State Medical Holding Company, Incorporated (the Company), is a South Dakota licensed health maintenance organization (HMO) d/b/a DAKOTACARE. The Company has contracted with hospitals, physicians and other providers to provide health care services to policyholders. Policyholders are employee groups located in South Dakota. A summary of the Company's significant accounting policies follows: PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, DAKOTACARE Administrative Services, Incorporated (DAS), and DAKOTACARE Insurance, LTD. (DIL), its 50.11% owned subsidiary, Dakota Health Plans, Incorporated (DHP), and its 81.30% owned subsidiary (54.35% at December 31, 2000), Carewest, Inc. (Carewest). DAS and Carewest are third party administrators of health care plans for independent employer companies. DIL's primary activity is in providing reinsurance quota share excess medical stop loss coverage to DAS' self funded customers. In December 1998, DHP ceased business operations and was formally dissolved during 2001 with no material effect on the consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation. BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the liabilities for contingency reserves payable and reported and unreported claims payable. CASH AND CASH EQUIVALENTS: For purposes of reporting the statements of cash flows, the Company includes as cash equivalents all cash accounts and highly liquid debt instruments which are not subject to withdrawal restrictions or penalties. Certificates of deposit are considered investments as all have been purchased with maturities in excess of ninety days. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents. INVESTMENT SECURITIES: Investment securities classified as held to maturity are those debt securities that the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs, or changes in general economic conditions. These securities are stated at amortized cost. Investment securities classified as available for sale are marketable equity securities and those debt securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Investment securities available for sale are carried at fair value. Unrealized gains or losses are reported as increases or decreases in comprehensive income, net of the related deferred tax effect, if any. Premiums and discounts on investments in debt securities are amortized over their contractual lives, except for collateralized mortgage obligations, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses on the sale of investment securities are determined using the specific identification method. DEPRECIATION: Building and building improvements are depreciated using straight-line methods over the estimated useful lives of the assets, which are twenty to thirty-nine years. Depreciation on furniture, equipment and automobiles is computed using straight-line methods based upon the estimated useful lives of the respective assets, which is principally five to seven years. A summary of property and equipment is as follows: 2001 2000 ---------------------------------- Furniture, equipment and automobiles $ 2,390,194 $ 2,248,544 Building and building improvements 53,370 53,370 Other 134,818 134,818 ---------------------------------- 2,578,382 2,436,732 Less accumulated depreciation 1,821,510 1,533,541 ---------------------------------- $ 756,872 $ 903,191 ================================== 16 | DAKOTACARE South Dakota 's Own SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS REVENUE RECOGNITION: Premiums are billed in advance of their respective coverage periods. Income from such premiums is recorded as earned during the coverage period; the unearned portion of premiums received prior to the end of the coverage period is recorded as unearned premiums. Revenue is reduced by reinsurance premiums ceded to reinsurance companies. Third party administration fees are recorded as earned in the period in which the related services are performed. The unearned portion of fees received but not earned prior to the end of the contract is recorded as unearned administration fees. REPORTED AND UNREPORTED CLAIMS PAYABLE: The coverage offered by the Company is on an occurrence basis which provides for payment of claims which occur during the period of coverage regardless of when the claims are reported. Reported and unreported claims payable consist of actual claims reported to be paid and estimates of health care services rendered but not reported and to be paid. The liabilities for reported and unreported claims payable have been estimated by utilizing statistical information developed from historical data, current enrollment, health service utilization statistics and other related information. In addition, the Company uses the services of an independent actuary in the determination of its year end liabilities. The accruals are continually monitored and reviewed and as adjustments to the estimated liabilities become necessary, such adjustments are reflected in current operations. INCOME TAXES: Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. 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. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. SEGMENT REPORTING: Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company's operations are classified into three business segments. EARNINGS (LOSS) PER COMMON SHARE: Earnings (loss) per common share was calculated by dividing net income (loss) by the weighted average number of Class C common shares outstanding during each period. The weighted average number of Class C common shares outstanding was 1,379,258 in 2001, 1,412,869 in 2000 and 1,448,600 in 1999. All references to earnings (loss) per share in the consolidated financial statements are to basic earnings (loss) per share, as the Company has no potentially issuable common stock. NOTE 2. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and cash equivalents and certificates of deposit: The carrying amount approximates fair value because of the relative short maturity of those instruments. Investments: Fair values for the Company's investment securities are based on quoted market prices. At December 31, 2001, the carrying amount and fair value of the Company's investment securities was $5,107,366 and $5,236,548, respectively. At December 31, 2000, the carrying amount and fair value of the Company's investment securities was $4,785,638 and $4,866,245, respectively. Accrued interest receivable: The carrying amount approximates fair value due to the nature of the balances recorded. South Dakota's Own DAKOTACARE | 17 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3. RECEIVABLES Receivables consist of the following: 2001 2000 -------- ---------- Income taxes $ 347,000 $ 13,600 Drug manufacturer chargebacks 286,170 272,853 Subrogation, net of recovery expenses 140,000 72,730 Coordination of benefits recoverable 116,300 50,300 Third party administrator receivables 109,784 12,178 Reinsurance 84,088 51,158 Hospital receivables 75,790 70,000 Premiums 67,962 79,040 Funds withheld by ceding insurer 56,362 145,470 Interest 51,281 38,238 Lawsuit settlement - 850,000 Other 210,250 214,121 ---------- ---------- 1,544,987 1,869,688 Less allowance for doubtful accounts - - ---------- ---------- $1,544,987 $1,869,688 ========== ========== NOTE 4. REINSURANCE The Company's policy is to reinsure that portion of risk in excess $125,000 of covered hospital inpatient expenses of any enrollee per contract year, subject to a coinsurance provision which ranged from 50% to 90% based on average daily amounts specified in the plan, and a $2,000,000 lifetime maximum benefit per enrollee. The Company would be liable for any obligations that the reinsuring company is unable to meet under the reinsurance agreement. This reinsurance agreement also provides for enrollee benefits to be paid in the event the Company should cease operations or become insolvent, and a conversion privilege for all enrollees in the event of plan insolvency and for any enrollee that moves out of the service area of the Company. NOTE 5. INVESTMENT SECURITIES Investment securities at December 31, 2001 are as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value -------------------------------------------------------- Debt securities held to maturity: Obligations of U.S. treasury, government agencies and corporations $ 952,097 $ 57,106 $ - $1,009,203 Obligations of state and political subdivisions 3,335,293 61,293 (29,205) 3,367,381 Corporate bonds 686,776 39,988 - 726,764 ------------------------------------------------------- $4,974,166 $ 158,387 $ (29,205) $5,103,348 ======================================================== Equity securities available for sale: Bond mutual fund $ 133,824 $ - $ (624) $ 133,200 ========================================================
18 | DAKOTACARE South Dakota 's Own SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amortized cost and estimated fair values of debt securities, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. December 31, 2001 ------------------------------ Amortized Estimated Cost Fair Value ------------------------------ Due in one year $ 890,714 $ 901,648 Due after one year through five years 1,543,523 1,625,645 Due after five years through ten years 1,911,168 1,963,949 Due after ten years 628,761 612,106 ------------------------------ $ 4,974,166 $ 5,103,348 ==============================
Investment securities at December 31, 2000 are as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value -------------------------------------------------------- Debt securities held to maturity: Obligations of U.S. treasury, government agencies and corporations $1,315,979 $ 37,177 $ (3,261) $1,349,895 Obligations of state and political subdivisions 2,657,348 36,977 (6,516) 2,687,809 Corporate bonds 684,822 16,263 - 701,085 U.S. governmental agency collateralized mortgage obligations 2,089 - (33) 2,056 -------------------------------------------------------- $4,660,238 $ 90,417 $ (9,810) $4,740,845 ======================================================== Equity securities available for sale: Bond mutual fund $ 126,623 $ - $ (1,223) $ 125,400 ========================================================
The components of other comprehensive income (loss) - net change in unrealized (loss) on securities available for sale are as follows: Years Ended December 31, ------------------------------------------ 2001 2000 1999 ------------------------------------------ Unrealized holding gain (loss) arising during the period $ 599 $ 6,254 $ (26,276) Add reclassification adjustment for net losses realized in net income - 27,437 - ------------------------------------------ Net change in unrealized(loss) before income taxes 599 33,691 (26,276) Income taxes - - - ------------------------------------------ Other comprehensive income - net change in unrealized (loss) on securities available for sale $ 599 $ 33,691 $(26,276) ==========================================
There were no sales of debt or equity securities during the years ended December 31, 2001 and 1999, and accordingly, no reclassification adjustments on investment securities for those years. Proceeds from the sale of securities available for sale in 2000 were $213,564 and resulted in gross losses of $27,437. At December 31, 2001 and 2000, no individual investments in obligations of state and political subdivisions exceeded 10% of the Company's equity. At December 31, 2001 and 2000, the Company had certificates of deposit of $900,000 and $700,000, respectively, on deposit with the South Dakota Department of Commerce and Regulation, Division of Insurance (Division of Insurance), to meet the deposit requirement of state insurance laws. NOTE 6. CONTINGENCY RESERVES PAYABLE The Company's agreements with participating physicians provide that up to 20% of fees for services provided, as submitted to the Company, may be withheld to provide a contingency reserve that may be used to fund operations or meet other financial requirements of the Company. The percentage withheld for the years 1999 through 2001 was 15%. The amounts withheld may be paid to the participating physicians at the discretion of the Board of Directors of the Company, although the Company is not contractually obligated to pay out amounts withheld. Management estimates the expected amount of contingency reserves to be paid to participating physicians and records a liability based upon factors such as cash flow needs, net income, and accumulations of amounts withheld. Payments to physicians are made at such times as the Board of Directors approves payouts. The recorded liability at December 31, 2001 is equal to actual amounts withheld for the years ended December 31, 2001 and 2000. During 1999, the Company's Board of Directors, with approval from the Division of Insurance, voted to write off $1,043,131 of contingency reserves withheld in 1997, which reduced claims expense in 1999 and was accounted for as a change in accounting estimate. This change had the effect of decreasing the net loss for 1999 by $688,470, or $.48 per common share, net of income taxes. South Dakota's Own DAKOTACARE | 19 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7. REPORTED AND UNREPORTED CLAIMS PAYABLE Activity in the liability for reported and unreported claims payable is summarized as follows: 2001 2000 1999 --------------------------------------------------- Balance at January 1 $ 5,831,471 $ 4,667,253 $ 4,409,622 --------------------------------------------------- Incurred related to: Current year 51,684,791 36,025,786 30,226,506 Prior years (69,367) (875,235) 911,684 Contingency reserves written off - - (1,043,131) --------------------------------------------------- Total incurred 51,615,424 35,150,551 30,095,059 --------------------------------------------------- Paid related to: Current year 43,493,105 29,842,349 24,240,777 Prior years 5,748,359 4,195,142 5,321,000 --------------------------------------------------- Total paid 49,241,464 34,037,491 29,561,777 --------------------------------------------------- Less reinsurance recoverables at January 1 (51,158) - (275,651) Plus reinsurance recoverables at December 31 84,088 51,158 - --------------------------------------------------- Balance at December 31 $ 8,238,361 $ 5,831,471 $ 4,667,253 ===================================================
NOTE 8. INCOME TAX MATTERS The Company is taxable as a property and casualty insurance company under section 831 of the Internal Revenue Code. The code prescribes certain adjustments to book income to arrive at taxable income which include adjustments to unearned premiums, discounting of loss reserves and proration of tax-exempt income. In addition, increases in contingency reserves, which are included as claims expenses, are not allowable as tax deductions until actually paid. The Company files a consolidated income tax return with its wholly-owned subsidiaries, DAS and DIL. In 2001, the consolidated income tax return also includes Carewest. The components of income tax expense as of December 31 are as follows: 2001 2000 1999 --------------------------------------- Current (recoverable) $ (133,767) $1,239,317 $ (230,343) Deferred (benefit) (394,000) (204,400) 33,400 --------------------------------------- $ (527,767) $1,034,917 $ (196,943) ======================================= Total income tax expense differed from the amounts computed by applying the U.S. federal income tax rate of 35 percent to income before income taxes as a result of the following: 2001 2000 1999 --------------------------------------- Computed "expected" tax expense (benefit) $ (468,000) $1,007,000 $(285,000) Tax exempt interest (43,709) (40,487) (42,788) Lobbying 7,188 5,562 2,977 Change in valuation allowance for deferred tax assets 9,000 27,700 108,400 Effect of tax rate brackets and other (32,246) 35,142 19,468 --------------------------------------- $ (527,767) $1,034,917 $(196,943) =======================================
20 | DAKOTACARE South Dakota 's Own SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The net deferred tax assets consist of the following components at December 31: 2001 2000 ---------------------------- Deferred tax assets: Contingency reserves payable $ 1,308,000 $ 978,000 Reported and unreported claims payable 81,000 57,000 Unearned premiums 72,000 68,000 Accrued expenses and other 233,000 226,000 Net operating loss carryforward of subsidiaries 178,000 148,000 ---------------------------- 1,872,000 1,477,000 Less valuation allowance 157,000 148,000 ---------------------------- 1,715,000 1,329,000 ---------------------------- Deferred tax liability: Property and equipment (68,000) (76,000) ---------------------------- $ 1,647,000 $ 1,253,000 ============================ Reflected on the accompanying balance sheets as follows: 2001 2000 ---------------------------- Current assets $ 916,000 $ 811,000 Noncurrent assets 731,000 442,000 ---------------------------- $ 1,647,000 $ 1,253,000 ============================
NOTE 9. CAPITAL STOCK The Class A voting preferred stock is not entitled to receive dividends or other distributions, except for redemption by the Company. In the event of a liquidation, each share of Class A preferred stock would be given priority over Class B and C stock and would be entitled to receive a preferential payment in an amount up to (and not to exceed) its stated value of $10 per share. The Class A preferred stock is restricted to ownership by medical and osteopathic physicians who have executed a participating physician agreement with the Company and may not be issued to or held by a hospital. The Class B voting preferred stock is restricted to ownership by the South Dakota State Medical Association, an affiliated company, and is not entitled to receive dividends. The Class C nonvoting common stock is not entitled to cumulative dividends and has no preference in a liquidation. The Class C common stock is restricted to ownership by the following persons or entities: (1) physicians entitled to ownership of Class A stock, (2) a trust or self-directed individual retirement account controlled by a physician entitled to ownership of Class A stock, (3) a professional corporation, partnership or other entity domiciled in the State of South Dakota and in which a physician entitled to ownership of Class A stock is a shareholder, partner, or employee in the practice of medicine, (4) management, employees or agents of the Company, the South Dakota State Medical Association, or the South Dakota Foundation for Medical Care, or (5) the spouse or children of such physician or other person set forth in (1) or (4) above. To facilitate liquidity for Class C common stock (Common Stock) in the event of death, disability, or retirement of a shareholder, the Company's Board of Directors has a Stock Repurchase Program (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 of the Program in compliance with applicable laws. During 2001 and 2000, 33,003 and 34,341 shares, respectively, were acquired for the treasury under the Program. South Dakota's Own DAKOTACARE | 21 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Regulatory capital as required by the Division of Insurance at December 31, 2001 and 2000 was $200,000 on a statutory basis of accounting, which the Company significantly exceeded. As long as the Company exceeds required regulatory capital, it is not restricted by the Division of Insurance in the amount of dividends it may pay. The Company is also subject to risk based capital (RBC) requirements promulgated by the National Association of Insurance Commissioners (NAIC). The RBC standards establish uniform minimum capital requirements for insurance companies. The RBC formula applies various weighting factors to financial balances or various levels of activities based on the perceived degree of risk. The Company exceeded regulatory action level RBC at December 31, 2001. NOTE 10. TRANSACTIONS WITH AFFILIATE The Company leases office space from the South Dakota State Medical Association (Association). The Company has a one year lease which automatically renews for one year terms each January 1, unless terminated with at least 30 days notice prior to the end of the lease term. The 2001 lease required minimum rental payments of $211,016 and was terminated on December 31, 2001. On January 1, 2002, the Company entered into a three year lease with the Association, which requires minimum monthly rentals of $18,982. On January 1, 2001, Carewest entered into a three year lease which requires minimum monthly rentals of $1,500. The Company also has entered into other short-term lease agreements for which the total rental commitment at December 31, 2001 was not significant. Total rental payments for the years ended December 31, 2001, 2000 and 1999 were $239,216, $217,162 and $204,870, respectively. The Company provides group health insurance coverage for employees of the Association. Total premium income from the affiliate for the years ended December 31, 2001, 2000 and 1999 was $66,086, $55,689 and $48,330, respectively. NOTE 11. RETIREMENT PLAN AND DEFERRED COMPENSATION The Company is included in a qualified money-purchase pension plan with the South Dakota State Medical Association and the South Dakota Foundation for Medical Care. This multiple-employer plan covers employees who have attained age 21, and have completed one year of service. Contributions, which are required under the plan, were an amount equal to 11.5% of the participants' compensation for the twelve-month periods ending September 1, 2001, 2000 and 1999. Retirement plan expense for the years ended December 31, 2001, 2000 and 1999 was $374,633, $275,421 and $238,689, respectively. In connection with employment contracts between the Company and certain officers, provision has been made for future compensation which is payable upon the completion of the earlier of 25 years of service to the Company and related organizations or attainment of the age of 65 or any earlier retirement age specified by the Board of Directors by resolution. The Company is making payments to a retired officer. At December 31, 2001 and 2000, $78,112 and $89,036, respectively, was accrued under these contracts. NOTE 12. 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, DHP and Carewest, which 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' 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. The Company allocates payroll costs incurred based on the activities of admitting new enrollees and in adjudicating claims. The HMO segment profit includes the equity in earnings (loss) of the TPA and reinsurance segments. Intersegment revenues primarily relate to equipment rental charges which are based on the depreciation on the underlying assets. 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. 22 | DAKOTACARE South Dakota 's Own SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended December 31, 2001 HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external customers $ 58,945,048 $ 4,388,962 $ 410,350 $ 63,744,360 Intersegment revenues - 233,662 - 233,662 Investment income 653,296 25,480 9,012 687,788 Depreciation expense 76,212 211,757 - 287,969 Segment profit (loss) (717,610) (421,426) 176,069 (962,967) Equity in net (loss) of subsidiaries (154,035) - - (154,035) Income tax (benefit) (478,400) (49,367) - (527,767) Segment assets 18,915,606 1,286,102 622,372 20,824,080 Year Ended December 31, 2000 HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external customers $ 44,194,355 $ 3,588,674 $ 661,462 $ 48,444,491 Intersegment revenues - 255,824 - 255,824 Investment income 685,367 63,040 18,778 767,185 Depreciation expense 80,549 256,227 - 336,776 Segment profit (loss) 1,953,977 (168,270) 78,139 1,863,846 Equity in net income of subsidiaries 20,539 - - 20,539 Income tax expense 1,004,667 30,250 - 1,034,917 Segment assets 16,838,497 1,839,801 598,647 19,276,945 Year Ended December 31, 1999 HMO TPA Reinsurance Totals -------------------------------------------------------- Revenues from external customers $ 34,048,724 $ 3,259,507 $ 646,836 $ 37,955,067 Intersegment revenues - 241,325 - 241,325 Investment income 455,461 44,138 14,000 513,599 Depreciation expense 88,147 241,325 - 329,472 Segment (loss) (621,814) (267,738) (200,888) (1,090,440) Equity in net (loss) of subsidiaries (473,021) - - (473,021) Income tax (benefit) (55,950) (140,993) - (196,943) Segment assets 12,905,809 1,699,895 457,870 15,063,574
South Dakota's Own DAKOTACARE | 23 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2001 2000 1999 --------------------------------------------- Revenues Total external revenues for reportable segments $ 63,744,360 $ 48,444,491 $ 37,955,067 Intersegment revenues for reportable segments 233,662 255,824 241,325 Elimination of intersegment revenues (233,662) (255,824) (241,325) Elimination of net income (loss)of subsidiaries (154,035) 20,539 (473,021) --------------------------------------------- Total consolidated revenues $ 63,898,395 $ 48,423,952 $ 38,428,088 ============================================= Income or Loss Total income (loss) for reportable segments $ (962,967) $ 1,863,846 $ (1,090,440) Elimination of equity in net (loss) of subsidiaries (154,035) 20,539 (473,021) Minority interest in income (loss) of subsidiaries (91,322) (110,670) 4,395 --------------------------------------------- Total consolidated net income (loss) $ (717,610) $ 1,953,977 $ (621,814) ============================================= Assets Total assets for reportable segments $ 20,824,080 $ 19,276,945 $ 15,063,574 Elimination of intercompany receivable (234,696) (153,092) (135,058) Elimination of investment in subsidiaries (1,231,494) (1,420,273) (1,274,734) --------------------------------------------- Total consolidated assets $ 19,357,890 $ 17,703,580 $ 13,653,782 =============================================
NOTE 13. LITIGATION During 1998, a substantial claim was filed against the Company in circuit court which alleged wrongful nonrenewable of a sales agency contract and sought compensatory and punitive damages. The lawsuit was settled in 2001 and all payables and expenses are fully recorded in the accompanying 2001 consolidated financial statements. In addition, the Company is involved in other legal actions in the ordinary course of its business. Although the outcome of any such legal actions cannot be predicted, in the opinion of management, there is no legal proceeding pending against or involving the Company for which the outcome is likely to have a material adverse effect upon the consolidated financial position or results of operations of the Company. NOTE 14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Year ended December 31, 2001 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------------------------------------------------------------------------------------------- Total revenues $14,609,754 $15,381,707 $16,534,612 $17,372,322 Claims incurred, net 11,658,449 11,680,324 12,592,451 15,684,200 Total operating expenses 14,595,560 14,465,608 17,406,493 (1)18,767,433 Net income (loss) 106,907 556,573 (603,289) (777,801) Earnings (loss) per share $ 0.08 $ 0.40 $ (0.44) $ (0.57) Year ended December 31, 2000 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------------------------------------------------------------------------------------------- Total revenues $10,812,637 $11,612,390 $12,350,361 $13,648,564 Claims incurred, net 7,380,452 7,774,623 8,992,386 11,003,090 (2) Total operating expenses 9,775,972 10,322,148 11,418,495 14,029,113 Net income (loss) 679,234 788,872 647,474 (161,603) Earnings (loss) per share $ 0.47 $ 0.55 $ 0.46 $ (0.11)
(1) Includes the settlement of a lawsuit (Note 13). (2) Includes an $850,000 receivable (reduction of incurred amount) and $420,000 payable (increase in incurred amount) relating to the settlement of two separate lawsuits relating to claims paid in prior years. 24 | DAKOTACARE South Dakota 's Own SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets. Statement 141 eliminates the pooling method for accounting for business combinations, requires that intangible assets that meet certain criteria be reported separately from goodwill, and requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. Statement 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life, requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life, requires the carrying value of goodwill which exceeds its implied fair value to be recognized as an impairment loss. The provisions of FASB Statement 141 apply to all business combinations initiated after June 30, 2001 and all business combinations accounted for by the purchase method for which the date of acquisition is July 1, 2001, or later. The provisions of FASB Statement 142 are required to be implemented by the Company in the first quarter of 2002. The adoption of these new standards should have no significant impact on the Company's financial position or results of operations. The FASB also recently issued Statement 143, Accounting for Asset Retirement Obligations. Statement 143, which is effective for fiscal years beginning after June 15, 2002, covers the accounting for closure or removal-type costs that are incurred with respect to long-lived assets. The nature of the Company's business and long-lived assets is such that adoption of this new standard should have no significant impact on the Company's financial position or results of operations. In August 2001, the FASB issued Statement 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes FASB No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. Statement 144 also supersedes certain aspects of APB 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, with regard to reporting the effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations in the period incurred rather than as of the measurement date as presently required by APB 30. Additionally, certain dispositions may now qualify for discontinued operations treatment. The provisions of Statement 144 are required to be applied for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this new standard should have no significant impact on the Company's financial position or results of operations. South Dakota's Own DAKOTACARE | 25 INDEPENDENT AUDITOR 'S REPORT McGLADREY & PULLEN, LLP ------------------------- Certified Public Accountants To the Board of Directors South Dakota State Medical Holding Company, Incorporated d/b/a DAKOTACARE Sioux Falls, South Dakota We have audited the accompanying consolidated balance sheets of South Dakota State Medical Holding Company, Incorporated d/b/a DAKOTACARE and subsidiaries as of December 31, 2001 and 2000,and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001.These financial statements are the responsibility of the Company 's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of South Dakota State Medical Holding Company,Incorporated d/b/a DAKOTACARE and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. /s/___McGladrey & Pullen, LLP____________ Sioux Falls,South Dakota March 15,2002 26 | DAKOTACARE South Dakota 's Own MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following operating statistics are presented for DAKOTACARE's operation as A health maintenance organization only and do not include the operations of its subsidiaries for the years ended December 31, 2001, 2000, 1999, and 1998. The results indicated in the following tables are not indicative of future operating results. The combined ratio, which reflects underwriting results but not investment and ancillary income, is a traditional measure of the underwriting performance of a health maintenance organization. A combined ratio of less than 100% indicates underwriting profitability while a combined ratio in excess of 100% indicates an underwriting loss. Years Ended December 31, ----------------------------- 2001 2000 1999 1998 ---- ---- ---- ---- Loss ratio 89.4% 81.4% 87.5% 85.9% Expense ratio 15.0 15.1 15.8 15.0 ----- ----- ---- ---- Combined ratio 104.4% 96.5% 103.3% 100.9% ===== ====== ====== ====== The loss ratio is computed by dividing the net claims expense into net premium revenue. The Company's results of operations will be affected by the changes in the loss ratio. The loss ratio may vary from period to period depending principally on claims experience. The expense ratio is computed by taking the sum of the remaining operating expenses of the health maintenance organization divided by net premium revenue. The net increase in the loss ratio was due to increased claims and cost per claim on a per member basis, which was greater than the increased revenues on a per member basis. The expense ratio remained fairly constant as a percentage of revenues which indicate that the expenses paid increased proportionately with the increase in revenues. See Comparison of Years December 31, 2001 and December 31, 2000 and Comparison of Years December 31, 2000 and December 31, 1999. RESULTS OF OPERATIONS GENERAL The following results of operations include the operations of DAKOTACARE and Its subsidiaries for the years ended December 31, 2001, 2000, and 1999. COMPARISON OF YEARS DECEMBER 31, 2001 AND DECEMBER 31, 2000 GENERAL The Company's net income decreased $2,671,587 to a loss of $717,610 for the year ended December 31, 2001, as compared to income of $1,953,977 for the year ended December 31, 2000. This decrease was primarily due to an increase in net claims expense of $16,464,873, an increase in administrative expenses of $3,224,493, and a decrease in minority interest in loss of subsidiaries of $19,348. These were offset by an increase in net premium revenues of $14,718,973, an increase in other revenues of $1,055,470, and an decrease in income taxes of $1,562,684. REVENUES Total revenues increased $15,474,443, or 32.0%, for the year ended December 31, 2001, as compared to December 31, 2000. Revenues from net premiums generated by the health maintenance organization increased $14,660,319. This increase is attributable to a 23.7% increase in the number of enrollee months and a 8.4% increase in the net premium earned per enrollee for the year ended December 31, 2001, as compared to December 31, 2000. Revenues from the third party administration fees increased by $703,397 due to increased fees per enrollee totalling 4.1% and increased enrollee months of 7.9%. Investment income decreased $79,397 due primarily to decreased average rates earned on invested assets, but was somewhat offset by the increase in the amount of invested assets during the year. South Dakota's Own DAKOTACARE | 27 MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.) OPERATING EXPENSES Total operating expenses increased $19,689,366, or 43.2%, for the year ended December 31, 2001, as compared to December 31, 2000. The change was due primarily to an increase in claims incurred, commissions, state insurance taxes, personnel expenses, office expenses, and other general and administrative expenses. These increases were offset by a decrease in professional fees expenses. Net claims expense increased by $16,464,873, or 46.8%, for the year ended December 31, 2001, as compared to December 31, 2000. The average claims paid per enrollee increased by 19.0% while the number of enrollee months increased by 23.7%. The Company contracts with an actuary annually to review the cost of claims related to each coverage type and accordingly determine the prices to charge for each coverage type for the next year. Our new rates will be in effect during the second quarter of 2002, at which time management expects that revenues will increase per member to cover the increased claims costs. Commissions and state insurance taxes increased by $2,443,667 and $144,870, respectively, in 2001 as compared to 2000 due primarily to increased premium revenues and third party administration fees earned by the Company. The settlement of a lawsuit aforementioned in Part 1, Item III also increased commissions when compared to the prior year. Personnel expenses increased $726,047, or 16.2%, in 2001 as compared to 2000. This was due primarily to annual compensation adjustments and an increase in staffing needs due to the increased volume. Office expense increased $59,389, or 8.6%, largely due to increased postage costs resulting from additional clientele and membership. Other general and administrative expenses increased $86,238, or 13.4%, in 2001 as compared to 2000. This was primarily due to the increased insurance costs related to liability and other insurance coverages. INCOME TAXES Income tax (benefit) expense represents 39.5% and 35.9% of (loss) income before income taxes and minority interest for the years ended December 31, 2001 and 2000, respectively. Permanent tax differences and the change in the valuation allowance recorded against deferred income tax assets increased the provision percentage above the expected 34% in 2001 and 2000. The valuation allowance was originally added in 2000. See Note 8 of the Notes to Consolidated Financial Statements. COMPARISON OF YEARS DECEMBER 31, 2000 AND DECEMBER 31, 1999 GENERAL The Company's net income increased $2,575,791 to income of $1,953,977 for the year ended December 31, 2000, as compared to a loss of $621,814 for the year ended December 31, 1999. This increase was primarily due to an increase in net premium income of $9,325,028, an increase in other revenues of $670,836, and an increase in minority interest in loss of subsidiaries of $115,065. These were offset by an increase in net claims expense of $5,055,492, an increase in administrative expenses of $1,247,786, and an increase in income taxes of $1,231,860. REVENUES Total revenues increased $9,995,864, or 26.0%, for the year ended December 31, 2000, as compared to December 31, 1999. Revenues from net premiums generated by the health maintenance organization increased $9,315,180. This increase is attributable to a 16.2% increase in the number of enrollee months and a 9.9% increase in the net premium earned per enrollee for the year ended December 31, 2000, as compared to December 31, 1999. Revenues from the third party administration fees increased by $311,163 due to increased fees per enrollee totalling 7.5%. Enrollee months also increased by 2.6%. Investment income increased $253,586 due primarily to an increase in the amount of average invested assets during the year and higher interest rates earned. 28 | DAKOTACARE South Dakota 's Own MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.) OPERATING EXPENSES Total operating expenses increased $6,303,278, or 16.1%, for the year ended December 31, 2000, as compared to December 31, 1999. The change was due primarily to an increase in claims incurred, personnel expenses, commissions, occupancy expenses, state insurance taxes, and other general and administrative expenses. During 1999, the Company's Board of Directors, with approval from the Division of Insurance, voted to write off $1,043,131 of contingency reserves withheld in 1997, which reduced claims expense in 1999. Net claims expense increased by $5,055,492, or 16.8%, for the year ended December 31, 2000, as compared to December 31, 1999. The average claims paid per enrollee increased by 1.5% while the number of enrollee months increased by 16.2%. Commissions and state insurance taxes increased by $371,383 and $122,541, respectively, in 2000 as compared to 1999 due to the increased premium income of the HMO. Personnel expenses increased $401,268, or 9.8%, in 2000 as compared to 1999. This was due primarily to annual compensation adjustments and an increase in staffing needs due to the increased volume. Occupancy expense increased $94,501, or 13.6%, due to increased depreciation expense resulting from the additional equipment purchased in 1999. Other general and administrative expenses increased $184,435, or 40.3%, in 2000 as compared to 1999. This was primarily due to the continued addition of licenses and service fees in using computer databanks for information. Insurance expenses also increased due to rising costs and coverage increases elected. A fee settlement of a subsidiary is also included in the increase. INCOME TAXES Income tax expense (benefit) represents 35.9% and 24.2% of income (loss) before income taxes and minority interest for the years ended December 31, 2000 and 1999, respectively. Permanent tax differences and the change in the valuation allowance recorded against deferred income taxes increased the provision percentage above the expected 34% in 2000. The valuation allowance was originally added in 1999, which reduced the amount of income tax benefit below the expected tax rate of 34%. See Note 8 of the Notes to Consolidated Financial Statements. 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 decreased by $861,806 to $2,508,834 for the year ended December 31, 2001, as compared to 2000. Net cash provided by operating activities decreased primarily due to decreases in net income to a net loss and decreases in accounts payable and accrued expenses since December 31, 2000. The decrease in cash provided was offset by a decrease in receivables, an increase in reported and unreported claims payable and an increase in contingency reserves payable since December 31, 2000. Other uses of cash and cash equivalents were for the payment of dividends, the purchases of property and equipment, the purchase of treasury stock, and the purchase of securities held to maturity. The Company has invested cash not currently needed in operations into intermediate-term bonds, consisting primarily of municipal bonds, U.S. government securities and corporate bonds. At December 31, 2001, the Company has certificates of deposit of $900,000 on deposit with the Division to meet the deposit requirements of state insurance laws. South Dakota's Own DAKOTACARE | 29 MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.) The Company is not contractually obligated to pay out contingency reserves withheld but has historically elected to pay out a majority of amounts withheld. In 2001, the Company paid $1,305,503 which was the total withheld for claims incurred in 1999. Typically, two years lapse from the date the contingency reserves are withheld to the date which the corresponding amounts are paid to the participating physicians. Currently, the reserves withheld from claims with a date of service in 2001 and 2000 are the only amounts remaining within the contingent reserve payable. The Company believes that cash flows generated by operations, withholding of contingency reserves, cash on hand, and short-term investment balances will be sufficient to fund operations, pay out projected contingency reserves payable, and pay dividends on the Class C common stock. INFLATION A substantial portion of the Company's operating expenses consist of health care costs, which, in the general economy, have been rising at a rate greater than that of the overall Consumer Price Index. The Company believes that its cost control measures and risk sharing arrangements reduce the effect of inflation on such costs. Historically, market conditions and the regulatory environment in which the Company operates have permitted the Company to offset a portion or all of the impact of inflation on the cost of health care benefits through premium increases. If the Company was not able to continue to increase premiums, a material adverse impact on the Company's operations could result. Inflation does not have a material effect on the remainder of the Company's operating expenses. 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not have any material market 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 market risk is limited. 30 | DAKOTACARE South Dakota 's Own SELECTED FINANCIAL DATA The following information for the Company is as of and for the years ended December 31, 2001, 2000, 1999, 1998, and 1997(dollars in thousands, except per share data): Years Ended December 31, ------------------------------------------- 2001 2000 1999 1998 1997 ------- ------- ------- ------ ------- Income Statement Data: Net premiums $57,993 $43,574 $34,249 $35,718 $34,754 Third party administration fees 4,075 3,372 3,061 3,081 3,628 Investment income 688 767 514 607 615 Total revenues 63,898 48,424 38,428 40,053 39,581 Net claims incurred 51,615 35,151 30,095 30,615 30,976 Other operating expenses 13,620 10,395 9,147 8,835 8,727 Income (loss) before income taxes and minority interest (1,337) 2,878 (814) 603 (122) Net income (loss) (718) 1,954 (622) 483 (110) ======= ======= ======= ======= ======= Earnings (loss) per common share $ (0.52) $ 1.38 $ (0.43) $ 0.33 $ (0.07) ======= ======= ======= ======= ======= Balance Sheet Data: Invested assets and cash $15,273 $13,576 $10,425 $10,876 $10,981 Total assets 19,358 17,704 13,654 14,277 14,011 Reported and unreported claims payable 8,238 5,831 4,667 4,410 4,164 Contingency reserves payable 3,847 2,875 2,723 2,691 2,964 Total liabilities 14,736 11,796 9,414 9,017 8,807 Stockholders' equity 4,622 5,908 4,240 5,260 5,204
Earnings (loss) per common share was calculated by dividing net income (loss) by the weighted average number of Class C common shares outstanding during each period as follows: 2001 1,379,258; 2000 1,412,869; 1999 1,448,600; 1998 1,482,635 shares; 1997 1,505,760 shares. South Dakota's Own DAKOTACARE | 31 DIRECTORS AND EXECUTIVE OFFICERS DIRECTORS K.GENE KOOB,M.D., President Neurology Associates, Neurologist BEN J.HENDERSON,D.O., Vice President Mobridge Medical Clinic, Internist JAMES A.ENGELBRECHT,M.D., Secretary/Treasurer Dakota Regional Rheumatology, Rheumatologist THOMAS L.KRAFKA,M.D. Radiology Associates, Radiologist JAMES R.REYNOLDS,M.D. North Central Heart Institute Cardiac, Thoracic and Vascular Surgeon JOHN E.RITTMANN,M.D. Brown Clinic, Family Practitioner STEPHAN D.SCHROEDER,M.D. Hand County Clinic, Family Practitioner JOHN C.STERNQUIST,M.D. Yankton Medical Clinic, General Surgeon MR.R.VAN JOHNSON Political Lobbyist MR.BOB L.SUTTON South Dakota Bankers Association, Executive Vice President EXECUTIVE OFFICERS MR.L.PAUL JENSEN, Chief Executive Officer MR.KIRK J.ZIMMER, Senior Vice President MS.SHARON K.DUNCAN, Vice President, System Operations MR.BRUCE E.HANSON, Vice President, Finance MR.SCOTT L.JAMISON, Vice President, Provider Relations MR.DEAN M.KROGMAN, Vice President, External Operations MR.BRIAN E.MEYER, Vice President, Information Systems MR.THOMAS N.NICHOLSON, Vice President, Sales and Marketing WILLIAM O.ROSSING,M.D., Vice President, Medical Director SHAREHOLDER INFORMATION CORPORATE HEADQUARTERS DAKOTACARE 1323 South Minnesota Avenue Sioux Falls, South Dakota 57105 (605)334-4000 INDEPENDENT PUBLIC ACCOUNTANTS McGladrey & Pullen, LLP Sioux Falls, South Dakota CORPORATE COUNSEL Securities Matters: Gray, Plant, Mooty, Mooty & Bennett, P.A. Minneapolis, Minnesota General Matters: Frieberg, Zimmer, Duncan and Nelson, L.L.P. Parker, South Dakota TRANSFER AGENT The First National Bank in Sioux Falls Sioux Falls, South Dakota FORM 10-K The Company has filed an annual report with the Securities and Exchange Commission on Form 10-K. Shareholders may obtain a copy of this report, without charge, by writing: Investors Relations DAKOTACARE 1323 South Minnesota Avenue Sioux Falls, SD 57105 ANNUAL MEETING The annual meeting of shareholders will be held at the Ramkota Hotel in Rapid City, South Dakota, on Thursday June 6,2002,at 9:15 a.m. INTERNET ADDRESS To access information about DAKOTACARE including provider directories, product and service information, and wellness issues, visit our home page via the internet. Our address is www.dakotacare.com 32 | DAKOTACARE South Dakota 's Own AGENT DIRECTORY Our statewide network of 35 DAKOTACARE sales agencies assures that our clients receive the local attention to service that they desire. 1 KARLEN &ASSOCIATES, INC. Aberdeen, SD (605)225-9011 2 INSURANCE PLUS Aberdeen, SD (605)225-4270 3 NORTHERN HILLS INSURANCE Belle Fourche, SD (605)892-2727 4 JENSEN INSURANCE &REAL ESTATE Beresford, SD (605)763-2675 5 DELLA TSCHETTER INSURANCE Brookings, SD (605)692-2078 6 FIRST WESTERN INSURANCE Custer, SD (605)673-2214 7 COBURN INSURANCE AGENCY Deadwood, SD (605)578-3456 8 KLEIN FIRST WESTERN INSURANCE Hot Springs, SD (605)745-7900 9 FLANAGAN AGENCY Huron, SD (605)352-3512 10 KUNDERT-WILLIAMS INSURANCE AGENCY Madison, SD (605)256-6608 11 DICE FINANCIAL SERVICES Mitchell, SD (605)996-7171 12 OAHE AGENCY Mobridge, SD (605)845-2649 13 MAXWELL & BOWAR AGENCY, INC. Parkston, SD (605)928-7956 14 BOB CLARK INSURANCE, INC. Pierre, SD (605)224-4049 15 BOB CLARK INSURANCE, INC. Rapid City, SD (605)348-7410 16 PROFESSIONAL INSURORS Rapid City, SD (605)343-1111 17 TIMOTHY KATTKE Redfield, SD (605)472-1445 18 BOEN AND ASSOCIATES, INC. Sioux Falls, SD (605)336-0425 19 COR INSURANCE Sioux Falls, SD (605)977-5900 20 CHASING HAWK INSURANCE Sioux Falls, SD (605)335-8322 21 INNOVATIVE EMPLOYER SOLUTIONS Sioux Falls, SD (605)371-8836 22 NORTHWESTERN GROUP MARKETING SERVICES Sioux Falls, SD (605)361-9788 23 OLSON &ASSOCIATES INSURORS, INC. Sioux Falls, SD (605)335-7777 24 PARKS INSURANCE Sioux Falls, SD (605)362-6047 25 DALE SHADE Sioux Falls, SD (605)336-0460 26 TERRY TENDLER Sioux Falls, SD (605)334-3700 27 WOLLMAN INSURANCE AGENCY Sioux Falls, SD (605)334-0004 28 BAER 'S INSURANCE AGENCY Spearfish, SD (605)642-4711 29 JACOBSON FIRST WESTERN INSURANCE Sturgis, SD (605)347-4644 30 CHANEY-COR INSURANCE Vermillion, SD 57069 31 JUDITH OLNEY Wall, SD (605)279-2545 32 KINSMAN INSURANCE AGENCY Watertown, SD (605)886-4911 33 STOUDT 'S INSURANCE AGENCY, INC. Watertown, SD (605)886-9719 34 CIHAK INSURANCE Yankton, SD (605)665-9393 35 COR TRUST - RAYMOND JAMES FINANCIAL SERVICE Yankton, SD (605)668-0800 South Dakota's Own DAKOTACARE | 33