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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED March 31, 2004or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission file number: 0-20882 Standard Management Corporation  Indiana
    
    No. 35-1773567(State or other jurisdiction
of incorporation or organization)
    
    (I.R.S. Employer Identification No.)10689 N. Pennsylvania Street, Indianapolis, Indiana
    
    46280(Address of principal executive offices)
    
    (Zip Code)
 (317) 574-6200
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:   Yes  þ     No  o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act):   Yes  o     No  þ As of May 1, 2004, the Registrant had 8,114,446 shares of Common Stock
outstanding.




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STANDARD MANAGEMENT CORPORATION INDEX  
 Page NumberPart I.
    
    FINANCIAL INFORMATION:Item 1.
    
    Financial StatementsConsolidated Balance Sheets 
March 31, 2004 (Unaudited) and December 31, 2003 (Audited)
    
    
    3Consolidated Statements of Income 
For the Three Months Ended March 31, 2004 and 2003 (Unaudited)
    
    
    4Consolidated Statements of Shareholders Equity 
For the Three Months Ended March 31, 2004 and 2003 (Unaudited)
    
    
    5Consolidated Statements of Cash Flows 
For the Three Months Ended March 31, 2004 and 2003 (Unaudited)
    
    
    6Notes to Consolidated Financial Statements (Unaudited)
    
    
    7Item 2.
    

Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    25Item 4.
    
    Controls and Procedures
    
    
    25Part II.
    
    OTHER INFORMATION:Item 1.
    
    Legal Proceedings
    
    
    26Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    26Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    26SIGNATURES
    
    
    27EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32 SECTION 906 CERTIFICATION OF THE CEO AND CFO
  2




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PART I  FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS 
 STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands) March 31
    
    December 312004
    
    2003(Unaudited)
    
    (Audited)ASSETSInvestments:Securities available for sale:Fixed maturity securities, at fair value (amortized cost $1,672,315 in 2004
and $1,638,048 in 2003)
    
    $
    1,712,119
    
    
    $
    1,644,837Mortgage loans on real estate
    
    
    3,925
    
    
    
    3,937Policy loans
    
    
    11,981
    
    
    
    12,308Real estate
    
    
    1,013
    
    
    
    943Equity-indexed call options
    
    
    15,293
    
    
    
    19,711Other invested assets
    
    
    2,730
    
    
    
    590Short-term investments
    
    
    589
    
    
    
    2,690Total investments
    
    
    1,747,650
    
    
    
    1,685,016Cash and cash equivalents
    
    
    17,027
    
    
    
    17,296Accrued investment income
    
    
    16,513
    
    
    
    17,002Amounts due and recoverable from reinsurers
    
    
    35,741
    
    
    
    36,277Deferred policy acquisition costs
    
    
    158,373
    
    
    
    166,411Present value of future profits
    
    
    11,517
    
    
    
    16,508Goodwill and intangibles
    
    
    12,403
    
    
    
    10,961Property and equipment (less accumulated depreciation of $5,713 in 2004 and $5,286 in
2003)
    
    
    12,532
    
    
    
    12,770Federal income tax recoverable
    
    
    5,359
    
    
    
    6,429Other assets
    
    
    8,003
    
    
    
    5,201Total assets
    
    $
    2,025,118
    
    
    $
    1,973,871LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Insurance policy liabilities
    
    $
    1,861,518
    
    
    $
    1,841,545Accounts payable and accrued expenses
    
    
    16,938
    
    
    
    7,217Obligations under capital lease
    
    
    416
    
    
    
    551Mortgage payable
    
    
    6,750
    
    
    
    6,795Notes payable
    
    
    24,908
    
    
    
    21,000Deferred income taxes
    
    
    9,768
    
    
    
    3,616Payable to subsidiary trust issuer of company-obligated trust preferred
securities
    
    
    20,700
    
    
    
    20,700Total liabilities
    
    
    1,940,998
    
    
    
    1,901,424Shareholders Equity:Common stock and additional paid in capital, no par value:Authorized 20,000,000 shares; issued 9,629,524 in 2004 and 9,629,167 in
2003
    
    
    68,078
    
    
    
    68,078Treasury stock, at cost, 1,515,078 shares in 2004 and 2003
    
    
    (7,671
    )
    
    
    (7,671
    )Accumulated other comprehensive income
    
    
    16,142
    
    
    
    2,702Retained earnings
    
    
    7,571
    
    
    
    9,338Total shareholders equity
    
    
    84,120
    
    
    
    72,447Total liabilities and shareholders equity
    
    $
    2,025,118
    
    
    $
    1,973,871
 See accompanying notes to consolidated financial statements. 3




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, Dollars in Thousands, Except Per Share Amounts) Three Months EndedMarch 312004
    
    2003Revenues:Premium income
    
    $
    2,535
    
    
    $
    1,877Net investment income
    
    
    21,470
    
    
    
    21,146Call option income (loss)
    
    
    1,198
    
    
    
    (3,098
    )Net realized investment gain
    
    
    97
    
    
    
    9,927Policy income
    
    
    3,374
    
    
    
    2,233Sales of goods
    
    
    1,651
    
    
    
    692Fees and other income
    
    
    109
    
    
    
    349Total revenues
    
    
    30,434
    
    
    
    33,126Benefits and expenses:Benefits and claims
    
    
    2,335
    
    
    
    2,354Interest credited to interest-sensitive annuities and other financial products
    
    
    15,203
    
    
    
    11,651Amortization
    
    
    5,392
    
    
    
    3,583Amortization  sales inducements
    
    
    337
    
    
    
    441Amortization  net realized investment gains
    
    
    521
    
    
    
    5,855Other operating expenses
    
    
    5,410
    
    
    
    4,370Cost of goods sold
    
    
    1,641
    
    
    
    800Interest expense and financing costs
    
    
    1,017
    
    
    
    1,025Total benefits and expenses
    
    
    31,856
    
    
    
    30,079Income (loss) before federal income tax expense
    
    
    (1,422
    )
    
    
    3,047Federal income tax expense
    
    
    345
    
    
    
    1,037Net income (loss)
    
    $
    (1,767
    )
    
    $
    2,010Earnings per share:Basic
    
    $
    (.22
    )
    
    $
    .26Diluted
    
    
    (.22
    )
    
    
    .25
 See accompanying notes to consolidated financial statements. 4




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(Dollars in Thousands) Common stock and
    
    
    
    
    
    Accumulated otheradditional paid in
    
    Treasury
    
    comprehensive
    
    RetainedTotal
    
    capital
    
    stock
    
    income (loss)
    
    earningsBalance at January 1, 2003
    
    $
    87,734
    
    
    $
    63,857
    
    
    $
    (7,671
    )
    
    $
    11,739
    
    
    $
    19,809Comprehensive loss:Net income
    
    
    2,010
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,010Other comprehensive income:Change in unrealized loss on
securities, net
of tax benefit of
$(591)
    
    
    (1,374
    )
    
    
    
    
    
    
    
    
    
    
    (1,374
    )
    
    
    Other comprehensive loss
    
    
    (1,374
    )Comprehensive income
    
    
    636
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock and warrants
    
    
    4,001
    
    
    
    4,001
    
    
    
    
    
    
    
    
    
    
    
    Balance at March 31, 2003
    
    $
    92,371
    
    
    $
    67,858
    
    
    $
    (7,671
    )
    
    $
    10,365
    
    
    $
    21,819Balance at January 1, 2004
    
    $
    72,447
    
    
    $
    68,078
    
    
    $
    (7,671
    )
    
    $
    2,702
    
    
    $
    9,338Comprehensive income:Net loss
    
    
    (1,767
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,767
    )Other comprehensive income:Change in unrealized gain on
securities, net of
tax of $6,725
    
    
    13,440
    
    
    
    
    
    
    
    
    
    
    
    13,440
    
    
    
    --Other comprehensive income
    
    
    13,440
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    --Comprehensive income
    
    
    12,388
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    --Balance at March 31, 2004
    
    $
    84,120
    
    
    $
    68,078
    
    
    $
    (7,671
    )
    
    $
    16,142
    
    
    $
    7,571
 See accompanying notes to consolidated financial statements. 5




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, Dollars in Thousands) Three Months EndedMarch 312004
    
    2003Operating ActivitiesNet income (loss)
    
    $
    (1,767
    )
    
    $
    2,010Adjustments to reconcile net income to net cash provided by operating
activities:Amortization of deferred acquisition costs
    
    
    6,250
    
    
    
    9,879Deferral of acquisition costs
    
    
    10,404
    
    
    
    (14,555
    )Federal income taxes
    
    
    (726
    )
    
    
    (1,408
    )Depreciation and amortization
    
    
    458
    
    
    
    433Insurance policy liabilities
    
    
    24,946
    
    
    
    16,841Net realized investment gains
    
    
    (97
    )
    
    
    (9,927
    )Accrued investment income
    
    
    489
    
    
    
    2,130Other
    
    
    3,959
    
    
    
    (44
    )Net cash provided by operating activities
    
    
    43,916
    
    
    
    5,359Investing ActivitiesFixed maturity securities available for sale:Purchases
    
    
    (275,890
    )
    
    
    (621,939
    )Sales
    
    
    204,464
    
    
    
    459,713Maturities, calls and redemptions
    
    
    37,524
    
    
    
    59,965Short-term investments, net
    
    
    (8,545
    )
    
    
    (237
    )Purchase of assets from Alliance Center, Inc. (dba Apothecary Solutions)
    
    
    836
    
    
    
    Other investments, net
    
    
    (195
    )
    
    
    5Net cash used by investing activities
    
    
    (41,806
    )
    
    
    (102,493
    )Financing ActivitiesBorrowings
    
    
    3,300
    
    
    
    244Repayments of notes payable and preferred stock
    
    
    (44
    )
    
    
    Premiums received on interest-sensitive and other financial products
credited to policyholder account balances, net of premiums ceded
    
    
    58,102
    
    
    
    123,687Return of policyholder account balances on interest-sensitive annuities
and other
financial products
    
    
    (63,737
    )
    
    
    (53,414
    )Issuance of common stock and warrants
    
    
    
    
    
    
    2Net cash provided (used) by financing activities
    
    
    (2,379
    )
    
    
    70,519Net decrease in cash
    
    
    (269
    )
    
    
    (26,615
    )Cash and cash equivalents at beginning of year
    
    
    17,296
    
    
    
    60,197Cash and cash equivalents at end of year
    
    $
    17,027
    
    
    $
    33,582
 See accompanying notes to consolidated financial statements. 6




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following notes should be read along with the notes to the
consolidated financial statements included in the Form 10-K for the year ended
December 31, 2003 of Standard Management Corporation (we, our, us,
Standard Management or the Company). Standard Management is a holding company that a) distributes
pharmaceutical products and services through its health subsidiary and b)
develops, markets and/or administers annuity and life insurance products
through its insurance subsidiaries. Note 1  Basis of Presentation Our unaudited, consolidated financial statements reflect normal recurring
adjustments that are necessary to present fairly Standard Managements
financial position and results of operations on a basis consistent with that of
our prior audited consolidated financial statements. As permitted by rules and
regulations of the Securities and Exchange Commission applicable to quarterly
reports on Form 10-Q, we have condensed or omitted certain information and
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States (GAAP).
We have also reclassified certain amounts from the prior periods to conform to
the 2004 presentation. These reclassifications have no effect on net income or
shareholders equity. Results for interim periods are not necessarily
indicative of the results that may be expected for a full year. Effective February 6, 2004, our wholly owned subsidiary, Apothecary
Solutions Corporation (Apothecary Solutions), acquired certain assets of
Alliance Center, Inc. Apothecary Solutions is an institutional pharmacy. The
purchase price was $3.7 million, and additional contingent consideration of up
to $175,000 may be paid, based on a percentage of outstanding accounts
receivable collected. The purchase was accounted for under the purchase method
of accounting and resulted in recognizing a preliminary goodwill and
intangibles amount of $1.8 million. Under purchase accounting, we allocated
the total purchase price of the assets and liabilities acquired, based on a
determination of the fair values, and recorded the excess of acquisition cost
over net assets acquired as goodwill. Operating Segments Financial Services Our Financial Services segment consists of revenues earned and expenses
incurred from our insurance operations, particularly Standard Life Insurance
Company of Indiana (Standard Life) and Dixie National Life Insurance Company
(Dixie Life). Our primary insurance products include deferred annuities,
single premium immediate annuities and equity-indexed annuities. The
profitability of this segment is primarily a function of net investment spread
(the difference between the investment income earned on our investments less
the interest we credit to our policyholders), persistency of our in force
business, mortality experience and management of our operating expenses. Health Services Our Health Services segment, which was formed in 2002, and is conducted
primarily through our subsidiary U.S. Health Services Corporation, develops and
distributes retail and third party reimbursed pharmaceutical products and
services through direct-to-consumer as well as institutional channels. Our
primary customer base consists of consumers, academic institutions, skilled
nursing facilities, assisted living facilities, home health care agencies and
mental health facilities. In addition, U.S. Health Services acts as a
wholesale distributor/repackager and a pharmacy management solution to various
sectors of the veterinary care industry. The profitability of this segment is
primarily a function of gross margin on sales (the difference between sales and
cost of sales) and management of our operating expenses. Other Services Our Other Services segment consists of revenues and expenses primarily
related to corporate operations and financing costs. Use of Estimates The nature of the insurance business requires us to make estimates and
assumptions that affect the amounts reported in our consolidated financial
statements and accompanying notes. For example, we use significant estimates
and assumptions in calculating deferred policy acquisition costs, present value
of future profits, goodwill, future policy benefits and deferred federal income
taxes. If future actual experience differs from these estimates and
assumptions, our financial statements could be materially affected. 7




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 2  Mortgage Payable, Notes Payable and Trust Preferred Securities Our mortgage payable, notes payable and trust preferred securities were as
follows (dollars in thousands): Interest
    
    March 31
    
    December 31Rate (1)
    
    2004
    
    2003Mortgage payable
    
    
    7.326
    %
    
    $
    6,750
    
    
    $
    6,795Notes payable:Senior secured credit agreement
    
    
    5.92
    %
    
    
    20,000
    
    
    
    20,000Promissory notes
    
    
    2.52
    %
    
    
    1,608
    
    
    
    1,000Convertible notes
    
    
    7.00
    %
    
    
    3,300
    
    
    
    $
    24,908
    
    
    $
    21,000Trust preferred securities
    
    
    10.25
    %
    
    $
    20,700
    
    
    $
    20,700
   (1)
    
    Current weighted average rate at March 31, 2004. In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
46), which requires the consolidation of certain entities considered to be
variable interest entities (VIEs). An entity is considered to be a VIE when
it has equity investors who lack the characteristics of having a controlling
financial interest, or its capital is insufficient to permit it to finance its
activities without additional subordinated financial support. Consolidation of
a VIE by an investor is required when it is determined that the investor will
absorb a majority of the VIEs expected losses if they occur, receive a
majority of the entitys expected residual returns if they occur, or both. FIN
46 was effective for the first quarter of 2004. Our only VIE relates to our
trust preferred securities. Under FIN 46, we are required to deconsolidate the
wholly owned trust related to the trust preferred securities because it was a
VIE in which we are not considered to be the primary beneficiary. The
subsidiary trust was formed to issue preferred securities and, in turn,
purchase a like kind amount of subordinated debt from its parent company, which
provides interest and principal payments to fund the respective trust
obligations. Accordingly, the subordinated debt due to the trust was shown as
a liability and the related interest distributions will continue to be shown as
interest expense in our financial statements. The adoption had no impact on
our results of operations. We adopted FIN 46 on January 1, 2004 with prior
periods reclassified in the consolidated financial statements. Note 3  Net Unrealized Gain on Securities Available for Sale The components of the net unrealized gain on securities available for sale
in shareholders equity are summarized as follows (dollars in thousands): March 31
    
    December 312004
    
    2003Fair value of securities available for sale
    
    $
    1,712,119
    
    
    $
    1,644,837Amortized cost of securities available for sale
    
    
    1,672,315
    
    
    
    1,638,048Gross unrealized gain on securities available for sale
    
    
    39,804
    
    
    
    6,789Adjustments for:Deferred policy acquisition costs
    
    
    (9,577
    )
    
    
    (1,313
    )Present value of future profits
    
    
    (5,752
    )
    
    
    (1,114
    )Deferred federal income tax benefits
    
    
    (8,237
    )
    
    
    (1,512
    )Other
    
    
    (96
    )
    
    
    (148
    )Net unrealized gain on securities available for sale
    
    $
    16,142
    
    
    $
    2,702
 8




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 4  Earnings Per Share A reconciliation of income and shares used to calculate basic and diluted
earnings per share is as follows (dollars in thousands): Three Months EndedMarch 312004
    
    2003Income (loss):Net income (loss)  basic and diluted earnings per share
    
    $
    (1,767
    )
    
    $
    2,010Shares:Weighted average shares outstanding for basic earnings per share
    
    
    8,114,443
    
    
    
    7,870,298Effect of dilutive securities:Stock options
    
    
    
    
    
    
    5,307Stock warrants
    
    
    
    
    
    
    24,433Dilutive potential common shares
    
    
    
    
    
    
    29,740Weighted average shares outstanding for diluted earnings per share
    
    
    8,114,443
    
    
    
    7,900,038
 Note 5  Stock Option Plan During the three months ended March 31, 2004, under our 2002 Stock
Incentive Plan we granted options to purchase 20,000 shares of common stock at
a weighted average exercise price of $4.00 per share. SFAS No. 148, Accounting for Stock-Based Compensation-Transition and
Disclosure, was issued in December 2002. This statement amends SFAS No. 123,
Accounting for Stock-Based Compensation, to require more prominent disclosure
in both annual and interim financial statements. Adoption of SFAS No. 148 did
not impact our financial position or results of operation. SFAS No. 123, as
amended by SFAS No. 148, allows companies to either expense the estimated fair
value of stock options or to continue their current practice and disclose the
pro forma effects on net income and earnings per share had the fair value of
the options been expensed. We have elected to continue our practice of
recognizing compensation expense using the intrinsic value based method of
accounting and to provide the required pro forma information. The compensation
cost based on fair value at the grant date, which is consistent with the
provisions of SFAS No. 123, as amended by SFAS No. 148, would result in pro
forma net income and pro forma earnings per share of the following for the
three months ended March 31 (in thousands, except per share
amounts): 9




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 5  Stock Option Plan (continued) Three Months EndedMarch 312004
    
    2003Reported net income (loss)
    
    $
    (1,767
    )
    
    $
    2,010Add: Stock-based employee compensation
expense included in reported net
income
    
    
    
    
    
    
    Less: Total stock-based employee
compensation expense determined under
fair value based method for all grants.
    
    
    (85
    )
    
    
    (162
    )Pro forma net income (loss)
    
    $
    (1,852
    )
    
    $
    1,848Earnings per share:Basic  as reported
    
    $
    (.22
    )
    
    $
    .26Basic  pro forma
    
    
    (.23
    )
    
    
    .23Diluted  as reported
    
    
    (.22
    )
    
    
    .25Diluted  pro forma
    
    
    (.23
    )
    
    
    .23
 Note 6    Subsequent Events Effective April 1, 2004, we sold Medical Care & Outcomes, LLC back to its
original owners. We recognized a loss on the sale of Medical Care & Outcomes,
LLC of $964,000 effective in the first quarter of 2004 in the U.S. Health
Services segment. On April 19, 2004, we entered into a non-binding letter of intent with an
unaffiliated third party providing for the sale of our principal financial
services subsidiary Standard Life Insurance Company of Indiana, including its
subsidiary Dixie National Life Insurance Company. Consummation of the proposed
sale is subject to the satisfactory completion of due diligence by the proposed
buyers, the receipt by us of an opinion from our financial advisor that the
proposed consideration is fair to us from a financial point of view, the
negotiation and execution of a mutually satisfactory definitive stock purchase
agreement and a number of additional conditions, including the approval of our
shareholders, the consent of the holders of our outstanding trust preferred
securities to amendments to the governing instruments of such securities, the
receipt of various regulatory approvals and other customary closing conditions. 10




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Recent Developments On April 19, 2004, we entered into a non-binding letter of intent with an
unaffiliated third party providing for the sale of our principal financial
services subsidiary Standard Life Insurance Company of Indiana, including its
subsidiary Dixie National Life Insurance Company. Consummation of the proposed
sale is subject to the satisfactory completion of due diligence by the proposed
buyers, the receipt by us of an opinion from our financial advisor that the
proposed consideration is fair to us from a financial point of view, the
negotiation and execution of a mutually satisfactory definitive stock purchase
agreement and a number of additional conditions, including the approval of our
shareholders, the consent of the holders of our outstanding trust preferred
securities to amendments to the governing instruments of such securities, the
receipt of various regulatory approvals and other customary closing conditions. There can be no assurance that a definitive agreement will be entered into
with the proposed buyers, that our shareholders will approve the proposed
transaction or that any of the other conditions necessary to consummate the
proposed sale will be satisfied. If the sale is consummated, however, it is
the intention of management to exit the financial services business altogether
and focus the Companys operations exclusively on our more growth oriented
health services business. This would represent a fundamental shift in the
nature of our business. Historically, almost all of our revenue has come from
our financial services business. During fiscal 2003, Standard Life accounted
for approximately 98% of our total revenues. We only entered the health
services segment in 2002 and since that time, this business segment has
generated substantial net losses and very little revenue, primarily due to its
nature as a start-up operation. Management believes, however, that the more
growth oriented health services business provides a better opportunity to
increase shareholder value over the long-term than the more mature financial
services business. If the proposed sale is consummated our business without
the financial services segment would, for a time, have less cash flow from
operations, since our financial services business presently accounts for
substantially all cash flow from operations. However, we anticipate that any
sale will produce substantial cash proceeds and management intends to utilize a
significant (but not yet determined) portion of the net cash proceeds from such
sale for the expansion of our health services business and anticipate that such
amount will be sufficient to satisfy our liquidity needs for at least the next
24 to 36 months. Management also intends to use the proceeds of a sale to
fully repay our senior secured credit agreement. In the event the transaction is not consummated, we will consider a number
of alternatives available to us including, without limitation, seeking another
buyer for our financial services business, or continuing our business as it
currently exists and seeking additional capital through the public or private
equity or debt markets. 11




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   General The following discussion highlights the material factors affecting the
results of operations and the significant changes in balance sheet items.
Notes to the consolidated financial statements included in this report and the
notes to the consolidated financial statements included in our Form 10-K for
the year ended December 31, 2003, should be read in conjunction with this Form
10-Q. Comparison of the Three Month Period Ended March 31, 2004 and March 31, 2003: The following table summarizes the results of our operations (dollars in
thousands): Three Months EndedMarch 312004
    
    2003Income (loss) before federal income tax expense
    
    $
    (1,422
    )
    
    $
    3,047Federal income tax expense
    
    
    345
    
    
    
    1,037Net income (loss)
    
    
    (1,767
    )
    
    
    2,010
 Consolidated Results and Analysis: Net loss for the 2004 quarter was $1.8 million compared to net income of
$2.0 million for the 2003 quarter. Financial Services: Net income for the 2004 quarter was $1.2 million compared to $3.0 million
for the 2003 quarter. The 2004 quarter recognized net realized gains (net of
amortization) of $.5 million and improved spread income of $.2 million. The
2003 quarter recognized net realized gains (net of amortization) of $4.1
million, which is the primary reason for the decrease in net income for the
2004 quarter when compared to the 2003 quarter. Health Services: Net loss for the 2004 quarter was $2.6 million compared to a $.6 million
net loss for the 2003 quarter. The 2004 quarter included expenses associated
with the continued development of this segments operating platform of $.6
million, net realized loss of $1.0 million, amortization of intangible assets of $.1 million, and a deferred tax
valuation allowance of $.6 million. Comparatively, the 2003 quarter included
tax benefits of $.3 million. Other Services: Net loss for the 2004 quarter was $.3 million compared to a $.5 million
net loss for the 2003 quarter. 12




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Financial Services: Three Months EndedMarch 312004
    
    2003(Dollars in thousands)Premiums and Deposits Collected:Deferred annuities
    
    $
    12,307
    
    
    $
    49,275Equity-indexed annuities
    
    
    23,527
    
    
    
    36,891Single premium immediate annuities and other deposits
    
    
    35,984
    
    
    
    38,509Universal and interest-sensitive life
    
    
    133
    
    
    
    152Subtotal  interest-sensitive and other financial
products premium deposits
    
    
    71,951
    
    
    
    124,827Traditional life
    
    
    2,535
    
    
    
    1,877Total premiums and deposits collected
    
    $
    74,486
    
    
    $
    126,704Statement of Operations:Revenues:Premium income
    
    $
    2,535
    
    
    $
    1,877Policy income
    
    
    3,374
    
    
    
    2,233Net investment income
    
    
    21,438
    
    
    
    21,143Net
investment income  affiliated
    
    
    54
    
    
    
    58Call option gain (loss)
    
    
    1,198
    
    
    
    (3,098
    )Fees and other income
    
    
    101
    
    
    
    122Net realized investment gain
    
    
    1,061
    
    
    
    9,928Total revenues
    
    
    29,761
    
    
    
    32,263Benefits and expenses:Benefits and claims
    
    
    2,290
    
    
    
    2,354Interest credited to interest-sensitive annuities
and other financial products
    
    
    15,203
    
    
    
    11,651Amortization
    
    
    5,392
    
    
    
    3,583Amortization  sales inducements
    
    
    337
    
    
    
    441Amortization  net realized investment gains
    
    
    521
    
    
    
    5,855Operating expenses
    
    
    2,408
    
    
    
    1,978Operating expenses-affiliated
    
    
    1,456
    
    
    
    1,364Interest
expense and financing costs  affiliated.
    
    
    404
    
    
    
    423Total benefits and expenses
    
    
    28,011
    
    
    
    27,649Income before federal income tax expense
    
    
    1,750
    
    
    
    4,614Federal income tax expense
    
    
    595
    
    
    
    1,568Net income
    
    $
    1,155
    
    
    $
    3,046
 13




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   General:Our financial services segment consists of revenues earned and
expenses incurred from our insurance operations. Our primary products include
deferred annuities, single premium immediate annuities and equity-indexed
annuities. The profitability of this segment is primarily a function of net
investment spread (the difference between the investment income earned on our
investments less the interest we credit to our policyholders), persistency of
our in force business, mortality experience and management of our operating
expenses. Earnings from products accounted for as insurance policy liabilities are
primarily generated from the excess of net investment income earned over the
interest credited to the policyholder, or the investment spread. Our
investment spread is summarized as follows for the quarter ended March 31: 2004
    
    2003Net investment yield on invested assets
    
    
    5.05
    %
    
    
    5.82
    %Weighted average effective crediting rate
    
    
    3.28
    
    
    
    4.08Investment Spread
    
    
    1.77
    
    
    
    1.74
 The weighted average effective credited rate represents interest on
interest-sensitive liabilities, including equity-indexed annuities, offset by
gains on call option assets used to hedge equity-indexed annuity liabilities. Premium depositsconsist of deposits from our annuity products and other
financial products that do not incorporate significant mortality features. For
GAAP purposes, these premium deposits are not shown as premium income in the
income statement. A change in premium deposits in a single period does not
directly cause our operating income to change, although continued increases or
decreases in premiums may affect the growth rate of assets on which investment
spreads are earned.  
    
    Premium deposits for interest-sensitive and other financial products for
the first quarter of 2004 decreased $52.9 million or 42%, to $72.0
million, compared to the first quarter of 2003. Deferred annuities
decreased $37.0 million or 75%, to $12.3 million. Deposits from
equity-indexed annuities decreased $13.4 million or 36%, to $23.5
million. Single premium immediate annuities decreased $2.5 million or 7%,
to $36.0 million. Premium deposits decreased in 2004 due to management
actions to preserve spread income in response to market
conditions. Management actions included reducing crediting rates,
lowering agent commissions, and temporarily suspending sales of selected
products. Premium incomeconsists of premiums earned from 1) traditional life products
and 2) annuity products that incorporate significant mortality features.  
    
    Premium income for the first quarter of 2004 increased by $.7 million or
35%, to $2.5 million compared to the first quarter of 2003, as a result of
increased deposits from supplemental contracts with life contingencies. Policy incomerepresents 1) mortality income and administrative fees earned on
universal life products and 2) surrender income earned on terminated universal
life and annuity policies.  
    
    Policy income for the first quarter of 2004 increased $1.1 million or
51%, to $3.4 million compared to the first quarter of 2003. Policy income
increased due to an expected increase in surrenders in response to
management actions taken to reduce crediting rates on some of our deferred
annuity and equity-indexed products. The increase in annuity surrenders
generates greater surrender income from early termination charges
associated with these products. Net investment incomeincludes interest earned on invested assets which
fluctuates with changes in 1) the amount of average invested assets supporting
insurance liabilities and 2) the average yield earned on those invested assets.  
    
    Net investment income for the first quarter of 2004 increased by $.3
million or 1%, to $21.4 million compared to the first quarter of 2003. Net
investment income increased as a result of a $228.4 million, or 15.8%,
increase in the weighted average invested assets for the period which was
mostly offset by a decline in the net investment yield earned on average
invested assets to 5.05% for the first quarter of 2004, compared to 5.82%
for the first quarter of 2003. The decline in net investment yield is due
primarily to the timing of investing new premium deposits in assets which
currently earn lower yields than the portfolio yield. 14




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Net investment income  affiliatedincludes interest earned on real estate
investments with Other Services. Call option incomerelates to equity-indexed products that are hedged with call
options to limit risk against unusually high crediting rates from favorable
returns in the equity market. The market value of these options fluctuates
from period to period and is substantially offset by amounts credited to
policyholder account balances.  
    
    Call option income for the first quarter of 2004 increased to $1.2
million compared to call option losses of $3.1 million for the first
quarter of 2003. The call option income increase resulted from changes
in the market value of our call options due to changes in the S&P 500
Index and the DJIA Index. Fees and other incomeconsist of fee income related to servicing unaffiliated
blocks of business and experience refunds.  
    
    Fees and other income was $.1 million in 2004 and 2003. Net realized investment gain (loss)fluctuates from period to period and
generally arises when securities are sold in response to changes in the
investment environment. Realized investment gains (losses) can affect the
timing of the amortization of deferred acquisition costs and the present value
of future profits.  
    
    Net realized investment gain was $1.1 million in the first quarter of 2004, compared to $9.9 million in the first quarter
of 2003. The decline was largely due to a strategy in 2003 to realize tax benefits from capital loss carryforwards.  
    
    Approximately 99.0% of our fixed maturity securities are classified as investment grade at March 31, 2004. Benefits and claimsinclude 1) mortality experience, 2) benefits from other
policies that incorporate significant mortality features and 3) changes in
future policy reserves. Throughout our history, we have experienced periods of
higher and lower benefit claims. This volatility is not uncommon in the life
insurance industry and, over extended periods of time, periods of higher claims
experience tend to offset periods of lower claim experience.  
    
    Benefits and claims for the first quarter of 2004 decreased $.1 million
or 3%, to $2.3 million compared to the first quarter of 2003. Interest credited to interest sensitive annuities and other financial products
represents interest credited to insurance liabilities of the deferred
annuities, single premium immediate annuities, equity-indexed annuities and
other financial products. This expense fluctuates with changes in 1) the
average interest sensitive insurance liabilities, 2) the average credited rate
on those liabilities, 3) the market value fluctuations of call options and 4)
the impact of SFAS No. 133, Accounting for Derivatives Instruments and Hedging
Activities.  
    
    Interest credited in the first quarter of 2004 increased $3.6 million
or 30%, to $15.2 million compared to the first quarter of 2003, of
which $3.5 million related to equity-indexed annuity products and the
remaining $11.7 million related to all other interest sensitive
annuity and life insurance products. Interest credited increased $3.8
million due to the impact of improved equity market performance on
equity products. In addition, interest credited increased $1.4 million
due to a 16% increase in average interest sensitive liabilities of
$239.4 million compared to the first quarter of 2003, partially offset
by $1.6 million of reductions due to reduced crediting rates.  
    
    The weighted average credited rate on interest sensitive liabilities,
including equity-indexed annuities, for the first quarter of 2004 and
2003 was 3.56% and 3.20%, respectively. The increase in average
credited rate was due to the impact of improved equity market
performance on equity-indexed annuity crediting rates. When offset by gains
on call option assets used to hedge equity-indexed annuity liabilities, the
effective crediting rates for 2004 and 2003 were 3.28% and 4.08%,
respectively, a reduction of .80% from the prior period. 15




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Amortizationincludes 1) amortization of deferred acquisition costs (DAC)
related to capitalized costs of our insurance business sold and 2) amortization
related to the present value of our policies purchased from our acquired
insurance business.  
    
    Amortization for the first quarter of 2004 was $6.3 million, a decrease
of $3.6 million or 37%, compared to the first quarter of 2003. This
decrease primarily relates to a decrease in net realized gains of $9.0
million, which resulted in a decrease in amortization of $5.3 million
related to those gains. Operating expensesconsist of general operating expenses, including salaries,
net of deferrable amounts.  
    
    Other operating expenses for the first quarter of 2004 increased $.5
million or 26%, to $2.5 million compared to the first quarter of 2003. Operating expenses  affiliatedconsist of general operating expenses,
including rent and management fees paid to Standard Management and recorded in
the Other Services segment.  
    
    Affiliated operating expenses was $1.5 million and $1.4 million in 2004 and 2003,
respectively. Interest expense and financing costs  affiliatedrepresents interest expense
incurred on the surplus debentures issued to Standard Management.  
    
    Affiliated interest expense and financing costs decreased 4% to
$404,000. The decline in interest expense resulted from the decline in
the prime rate compared to the first quarter of 2003.  
    
    The weighted average interest rate for the first quarter of 2004 and
2003 was 6.00% and 6.25%, respectively. Federal income tax expense  
    
    Federal income tax expense decreased $1.0 million to $.6 million
compared to the first quarter of 2003. The effective tax rate was 34%
for the first quarter of 2004 and 2003. 16




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Health Services: Three Months EndedMarch 312004
    
    2003(Dollars in thousands)Statement of Operations:Sales
    
    $
    1,651
    
    
    $
    692Cost of goods sold
    
    
    1,201
    
    
    
    800Total gross margin
    
    
    450
    
    
    
    (108
    )Salaries
    
    
    1,106
    
    
    
    363Other operating expenses
    
    
    744
    
    
    
    291Other operating expenses  affiliated
    
    
    23
    
    
    
    Depreciation and amortization
    
    
    216
    
    
    
    71Interest expense and financing costs.
    
    
    14
    
    
    
    8Net realized investment loss
    
    
    964
    
    
    
    Total expenses
    
    
    3,067
    
    
    
    733Loss before income taxes
    
    
    (2,617
    )
    
    
    (841
    )Federal income tax benefit
    
    
    
    
    
    
    (286
    )Net loss
    
    $
    (2,617
    )
    
    $
    (555
    )
 General:Our Health Services segment consists of revenues earned and expenses
incurred from our pharmaceutical operations. Our primary customer base
consists of consumers, academic institutions and mental health facilities. The
profitability of this segment is primarily a function of gross margin on sales
(the difference between sales and cost of sales and fulfillment costs) and
management of our operating expenses. Sales  
    
    Sales for the first quarter of 2004 increased by $1.0 million or 138%
to $1.7 million compared to the first quarter of 2003, primarily related
to the acquisition of Apothecary Solutions. Salaries  
    
    Total salaries for the first quarter of 2004 increased by $.7 million
or 205% to $1.1 million compared to the first quarter of 2003, due to
the additional salary expense associated with the acquisition of
Apothecary Solutions and the continued development of the Health
Services segments operating platform and infrastructure. Other Operating Expenses  
    
    Operating expenses for the first quarter of 2004 increased by $.5
million or 156% to $.7 million compared to the first quarter of 2003,
due to the acquisition of Apothecary Solutions and the marketing costs
associated with the continued development of the Health Services
segments operating platform and infrastructure, as well as ongoing
concentrated marketing initiatives since its organization in 2002. 17




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Federal income tax benefit  
    
    Federal income tax benefit decreased by $.3 million to zero, compared
to the first quarter of 2003 due to a 100% valuation allowance on the
net loss for 2004. Net realized loss on investment  
    
    Net realized loss on investment for the first quarter of 2004
increased by $1.0 million compared to the first quarter of 2003 as a
result of our sale of Medical Care & Outcomes, LLC back to its original
owners, as of April 1, 2004. 18




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Other Services: Three Months EndedMarch 312004
    
    2003(Dollars in thousands)Statement of Operations:Operating income  affiliated
    
    $
    1,479
    
    
    $
    1,364Interest income  affiliated
    
    
    404
    
    
    
    422Fees and other income (loss)
    
    
    (32
    )
    
    
    (73
    )Total revenues
    
    
    1,851
    
    
    
    1,713Net
investment expenses  affiliated
    
    
    54
    
    
    
    58Other operating expenses
    
    
    1,348
    
    
    
    1,440Interest expense and financing costs
    
    
    1,004
    
    
    
    1,017Total expenses
    
    
    2,406
    
    
    
    2,515Loss before income taxes
    
    
    (555
    )
    
    
    (802
    )Federal income tax benefit
    
    
    (250
    )
    
    
    (321
    )Net loss
    
    $
    (305
    )
    
    $
    (481
    )
 General:Our Other Services segment consists of revenues and expenses primarily
related to corporate operations and financing costs. Operating income  affiliatedconsists of income from the Financial Services
segment related to management fees and rental income.  
    
    Operating income  affiliated increased $.1 million or .1%, to $1.5
million compared to the first quarter of 2003 due to increased rental
income. Interest income  affiliatedconsists of interest income from the Financial
Services segment related to the surplus debentures issued by Standard
Management.  
    
    Interest income  affiliated was $.4 million in 2004 and 2003. Net investment expenses  affiliatedrepresent interest expense paid to the
Financial Services segment. Other operating expensesconsist of corporate operating expenses, including
salaries.  
    
    Other operating expenses decreased $.1 million or 13%, to $1.3
million compared to the first quarter of 2003. Interest expense and financing costsrepresents interest expense incurred and
the amortization of debt issuance costs.  
    
    Interest expense and financing costs was $1.0 million in 2004 and
2003. Federal income tax benefit  
    
    Federal income tax benefit was $.3 million in 2004 and 2003. 19




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Liquidity and Capital Resources Liquidity of Standard Management (Parent Company) Standard Management is a financial and health services holding company
whose liquidity requirements are met through payments received from our
subsidiaries. These payments include 1) surplus debenture interest, 2)
dividends, 3) management fees, 4) equipment rental fees, 5) lease income and 6)
allocation of taxes through a tax sharing agreement. All of these payments in
the Financial Services segment are subject to restrictions under applicable
insurance laws and are used to pay our operating expenses and meet our debt
service obligations. These internal sources of liquidity have been
supplemented in the past by external sources such as revolving credit
agreements and long-term debt and equity financing in the capital markets. Potential Cash Available for 2004 We anticipate that available cash from our existing working capital,
surplus debenture interest, dividends, management fees, equipment rental fees,
lease income and tax sharing payments will be adequate to meet our anticipated
parent company cash requirements for 2004. The following describes our
potential sources of cash in 2004. Surplus Debenture Interest:We loaned $27.0 million to Standard Life
pursuant to unsecured surplus debenture agreements (Surplus Debentures),
which requires Standard Life to make quarterly interest payments at a variable
corporate base rate plus 2% per annum, and annual principal payments of $1.0
million per year beginning in 2007 and concluding in 2033. The interest and
principal payments are subject to quarterly approval by the Indiana Department
of Insurance, depending upon satisfaction of certain financial tests relating
to levels of Standard Lifes capital and surplus and general approval of the
Commissioner of the Indiana Department of Insurance. We currently anticipate
that these quarterly approvals will be granted. Assuming the approvals are
granted and the December 31, 2003 interest rate of 6.00% continues, we expect
to receive interest income of $1.6 million from the Surplus Debentures in 2004. Dividendspaid from Standard Life are limited by laws applicable to
insurance companies. As an Indiana domiciled insurance company, Standard Life
may pay a dividend or distribution from its surplus profits, without the prior
approval of the Commissioner of the Indiana Department of Insurance, if the
dividend or distribution, together with all other dividends and distributions
paid within the preceding twelve months, does not exceed the greater of 1) net
gain from operations or 2) 10% of surplus, in each case as shown in its
preceding annual statutory financial statements. In 2003, we did not receive
dividends from our insurance subsidiaries. In 2004, we could receive dividends
of approximately $1.9 million from Standard Life, without regulatory approval
and an additional $8.5 million with regulatory approval. Any dividends we
might receive from U.S. Health Services are not limited by any regulatory
authority, although we do not expect that we will receive any dividends from
U.S. Health Services during 2004 as we continue to incur losses in the Health
Services segment as we continue to develop its operating platform and
infrastructure. Management Fees: Pursuant to a management services agreement, Standard
Life paid $3.6 million during 2003 for certain management services related to
the production of business, investment of assets and evaluation of
acquisitions. In addition, Dixie Life paid Standard Life $.7 million in 2003
for certain management services provided. Both of these agreements provide
that they may be modified or terminated by the applicable Departments of
Insurance in the event of financial hardship of Standard Life or Dixie Life.
In 2004, we expect to receive management fees of $3.6 million from Standard
Life. Equipment Rental Fees:In 2003, we charged subsidiaries $1.1 million for
the use of our equipment. In 2004, we expect to receive $1.1 million of
equipment rental fees from Standard Life. Lease Income:Effective January 1, 2002, we entered into a lease
agreement with Standard Life whereby Standard Life leases approximately 43,000
square feet of our corporate headquarters in Indianapolis. During 2003, we
received approximately $.8 million in lease income from Standard Life and we
expect to receive the same amount in 2004. Also associated with this lease,
Standard Life is responsible for its share of building maintenance expenses.
During 2003, we were reimbursed $.7 million in maintenance expenses for 2003
and 2002. We expect to be reimbursed $.3 million in maintenance expense in
2004. 20




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Estimated Cash Required in 2004 The following are the characteristics of our mortgage payable, notes
payable and trust preferred securities, including estimated required payments
in 2004. Mortgage Payable: The following are characteristics of our mortgage payable agreement at
March 31, 2004:  
    
    outstanding balance of $6.8 million;  
    
    weighted average interest rate of 7.33% per annum;  
    
    principal and interest payments: $57,000 per month through December 2011;  
    
    interest payments required in 2004 based on current balances will be $.5 million;  
    
    note may be prepaid on or before January, 2005 at 105% and declining to 101% after December 2008. Notes Payable: The following are characteristics of our promissory notes at March 31, 2004:  
    
    outstanding balance of $1.6 million;  
    
    interest rate of 2.52% per annum; The following are characteristics of our senior secured credit agreement at March 31, 2004:  
    
    outstanding balance of $20 million;  
    
    weighted average interest rate of 5.92% per annum;  
    
    principal payments: $1.5 million to be paid in 2004, $2.0 million to
be paid in 2005, $2.1 million to be paid in 2006, and $2.2 million to be
paid in 2007. The remaining principal payment of $12.2 million due in
2008.  
    
    subject to certain restrictions and financial and other covenants;  
    
    interest payments required in 2004 based on current balances will be $1.2 million. The following are characteristics of our convertible notes at March 31, 2004:  
    
    outstanding balance of $3.3 million;  
    
    interest rate of 7% per annum;  
    
    interest payments required in 2004 based on current balances will be $.1 million. 21




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Trust Preferred Securities:These securities represent an undivided
beneficial interest in the assets of SMAN Capital Trust I, a Delaware business
trust organized to purchase our junior subordinated debentures and issue
preferred securities. The assets of the Trust consist solely of the
debentures, which were purchased by the Trust with the proceeds of the
offering. On August 9, 2001, the Trust completed a public offering of $20.7
million of its 10.25% preferred securities. The Trust used the proceeds of
this offering to purchase our 10.25% junior subordinated debentures. The following are characteristics of our trust preferred securities at
March 31, 2004:  
    
    outstanding balance of $20.7 million;  
    
    annual distribution rate of 10.25%; distributions may be deferred up to 20 consecutive quarters;  
    
    matures August 9, 2031;  
    
    may be redeemed on or after August 9, 2006 at $10 per security plus accumulated and unpaid distributions;  
    
    distributions required in 2004 based on current balances will be $2.1 million;  
    
    distributions are classified as interest expense. General:On a consolidated basis we reported net cash provided by
operations of $43.9 million and $5.4 million for the first quarter of 2004 and
2003, respectively. At April 1, 2004, we had parent company only cash and
short-term investments of $1.2 million that are available for general corporate
purposes. Annual parent company operating expenses (not including interest
expense) were $5.5 million for 2003 and 2002, respectively. Contractual Obligations:During the first quarter of 2004, there were no
significant changes in our reported payments due under contractual obligations
at December 31, 2003. Off-Balance Sheet Arrangements:We have no off-balance sheet
arrangements. Liquidity of Financial Services Financial Services:The principal liquidity requirements of Standard Life
are its 1) contractual obligations to policyholders, 2) Surplus Debenture
interest, dividends, management fees and rental fees to Standard Management and
3) operating expenses. The primary source of funding for these obligations has
been cash flow from premium income, net investment income, investment sales and
maturities and sales of annuity products. These sources of liquidity for
Standard Life significantly exceed scheduled uses. Liquidity is also affected
by unscheduled benefit payments including death benefits, policy withdrawals
and surrenders. The amount of withdrawals and surrenders is affected by a
variety of factors such as renewal interest crediting rates, interest rates for
competing products, general economic conditions, Standard Lifes A.M. Best
rating and events in the industry that affect policyholders confidence. In
October 2003, A.M. Best confirmed Standard Lifes rating of (B+), or very
good. The policies and annuities issued by Standard Life contain provisions that
allow policyholders to withdraw or surrender their policies under defined
circumstances. These policies and annuities generally contain provisions, which
apply penalties or otherwise restrict the ability of policyholders to make such
withdrawals or surrenders. Standard Life closely monitors the surrender and
policy loan activity of its insurance products and manages the composition of
its investment portfolios, including liquidity, to ensure it has sufficient
cash resources in light of such activity. 22




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Changes in interest rates may affect our incidence of policy surrenders
and other withdrawals. In addition to the potential effect on liquidity,
unanticipated withdrawals in a changing interest rate environment could
adversely affect our earnings if we were required to sell investments at
reduced values to meet liquidity demands. We manage our asset and liability
portfolios in order to minimize the adverse earnings effect of changing market
interest rates. We seek assets that have duration characteristics similar to
the liabilities that they support. We also prepare cash flow projections and
perform cash flow tests under various market interest rate scenarios to assist
in evaluating liquidity needs and adequacy. Our insurance subsidiaries
currently expect available liquidity sources and future cash flows to be
adequate to meet the demand for funds. Statutory surplus is computed according to rules prescribed by the
National Association of Insurance Commissioners as modified by the Indiana
Department of Insurance, or the state in which our insurance subsidiaries do
business. Statutory accounting rules are different from GAAP and are intended
to reflect a more conservative perspective. With respect to new business,
statutory accounting practices require that: 1) acquisition costs (primarily
commissions and policy issue costs) and 2) reserves for future guaranteed
principal payments and interest in excess of statutory rates, be expensed in
the year the new business is written. These items cause a reduction in
statutory surplus or surplus strain in the year written for many insurance
products. We design our products to minimize such first-year losses and in
2003, none of our products cause a statutory loss in the year written. Our
long-term growth goals contemplate continued growth in our insurance
businesses. To achieve these growth goals, our insurance subsidiaries will need
to increase statutory surplus. Additional statutory surplus may be secured
through various sources such as internally generated statutory earnings,
infusions with funds generated through our debt or equity offerings, or mergers
with other life insurance companies. If additional capital is not available
from one or more of these sources, we believe that we could reduce surplus
strain through the use of reinsurance or through reduced writing of new
business. We believe that the operational cash flow of Standard Life will be
sufficient to meet our anticipated needs for 2004. As of March 31, 2004,
Standard Life had statutory capital and surplus for regulatory purposes of
$63.2 million. As the annuity business produced by Standard Life increases,
Standard Life expects to satisfy statutory capital and surplus requirements
through statutory profits and through additional capital contributions by
Standard Management. Net cash flow from operations on a statutory basis of
Standard Life was $4.9 million for the first quarter of 2004 and $48.7 million
for the first quarter of 2003. The decrease is primarily due to a decline in
annuity premium deposits. If the need arises for cash, which is not readily
available, additional liquidity could be obtained from the sale of invested
assets. Liquidity of Health Services Health Services:The principal liquidity requirements of our Health
Services segment are its 1) cost of goods sold, 2) operating expenses, and 3)
future acquisitions. The primary source of funding for these obligations has
been cash flow from 1) pharmaceutical sales, 2) internal and external
borrowings, and 3) capital contributions from Standard Management. The
liquidity requirements of our Health Services segment have significantly
exceeded cash flow from pharmaceutical sales. We believe that the operational cash flow of our Health Services segment
will not be sufficient to meet our anticipated operational needs for 2004.
Therefore, this segment is expected to continue to fund its cash needs through
internal and external borrowings and capital contributions from Standard
Management. As of March 31, 2004, our Health Services subsidiary had equity
of $(3.9) million. Forward-looking Statements All statements, trend analyses, and other information contained in this
quarterly report on Form 10-Q or any document incorporated by reference herein
relative to markets for our products and trends in our operations or financial
results, as well as other statements including words such as anticipate,
believe, plan, estimate, expect, intend, and other similar
expressions, constitute forward-looking statements under the Private Securities
Litigation Reform Act of 1995. Forward-looking statements include, without
limitation, statements relating to our ability to consummate the sale of
Standard Life, our ability to pay interest on the debentures (and of the Trust
to make the corresponding distributions on the preferred securities) following
a sale of Standard Life, the prospects of our company after a sale of Standard
Life when operating only in the health services segment. These forward-looking
statements are subject to known and unknown risks, uncertainties and other
factors which may cause actual results to be materially different from those
contemplated by the forward-looking statements. Such factors include, but are
not limited to: 23




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES    
    
    Our ability to consummate the sale of Standard Life.  
    
    Our ability to successfully operate a health services business with limited industry experience.  
    
    General economic conditions and other factors, including prevailing interest rate levels, and stock market performance,
which may affect our ability to sell products, the market value of our investments and the lapse rate and profitability of
our policies.  
    
    Our ability to achieve anticipated levels of operational efficiencies at recently acquired companies, as well as through
other cost-saving initiatives.  
    
    Customer response to new products, distribution channels and marketing initiatives.  
    
    Mortality, morbidity and other factors which may affect the profitability of our insurance products.  
    
    Changes in the federal income tax laws and regulation which may affect the relative tax advantages of some of our products.  
    
    Increasing competition in the sale of our products.  
    
    Regulatory changes or actions, including those relating to regulation of financial services affecting bank sales and
underwriting of insurance products, regulation of the sale, underwriting and pricing of insurance products.  
    
    The availability and terms of future acquisitions and our ability to identify, acquire and successfully integrate
acquisitions in the health services segment.  
    
    The risk factors or uncertainties listed from time to time in any document incorporated by reference herein.  
    
    Increasing competition in the sale of our products.  
    
    Regulatory changes or actions, including those relating to regulation of financial services affecting bank sales and
underwriting of insurance products, regulation of the sale, underwriting and pricing of insurance products.  
    
    The availability and terms of future acquisitions, including our ability to integrate any acquired companies.  
    
    The risk factors or uncertainties listed from time to time in any document incorporated by reference herein. 24




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our market risks and the way they are managed are summarized in our
discussion and analysis of financial condition and results of operations in our
Form 10-K for the year ended December 31, 2003. There have been no material
changes in 2004 to these risks or the management of these risks. 
 ITEM 4. CONTROLS AND PROCEDURES Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rule
13a-4c under the Securities Exchange Act of 1934) as of March 31, 2004 (the
Evaluation Date). They have concluded that, as of the Evaluation Date, our
disclosure controls and procedures were adequate and effective. There were no
significant changes in our internal controls or in other factors that could
significantly affect disclosure controls and procedures subsequent to the
Evaluation Date. 25




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS We are involved in various legal proceedings in the normal course of
business. In most cases, these proceedings involve claims under insurance
policies or other contracts. The outcome of these legal proceedings are not
expected to have a material adverse effect on the consolidated financial
position, liquidity, or future results of our operations based on our current
understanding of the relevant facts and law. 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES On February 19, 2004, we sold $3.3 million of our 7% convertible notes due
2009 to 27 accredited investors. As part of the sale of these securities, we
paid selling commissions of $231,000. The notes are convertible at a price
equal to $7.00 per share. The sale of these securities were made pursuant to
Section 4(2) under the Securities Act of 1933, as amended, and Rule 506 of
Regulation D. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits  31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.  31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.  32
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K None. 26




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Dated: May 17, 2004 STANDARD MANAGEMENT CORPORATION
(Registrant)By:
    /s/ RONALD D. HUNTERRonald D. HunterChairman of the Board and
Chief Executive Officer
(Principal Executive Officer) By:
    /s/ GERALD R. HOCHGESANGGerald R. HochgesangSenior Vice President and Treasurer
(Chief Accounting Officer) 27