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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 1934FOR THE QUARTERLY
PERIOD ENDED March 31, 2005oro
    

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
(Address of principal executive offices)
    
    46280
(Zip Code)
 (317) 574-6200  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 April 29, 2005, the Registrant had 7,921,113 shares of Common Stock outstanding.




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STANDARD MANAGEMENT CORPORATION INDEX Page NumberPart I.
    
    FINANCIAL INFORMATION:Item 1.
    
    Unaudited Financial StatementsConsolidated Balance
Sheets March 31, 2005 and December 31, 2004
    
    
    3Consolidated
Statements of Operations For the Three Months Ended March 31, 2005 and 2004
    
    
    4Consolidated
Statements of Shareholders Equity For the Three Months Ended March 31, 2005 and 2004
    
    
    5Consolidated
Statements of Cash Flows For the Three Months Ended March 31, 2005 and 2004
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    24Item 4.
    
    Controls and Procedures
    
    
    24Part II.
    
    OTHER INFORMATION:Item 1.
    
    Legal Proceedings
    
    
    25Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    25SIGNATURES
    
    
    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
  March 31
    
    
    December 312005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    439
    
    
    $
    1,121Accounts receivable, net
    
    
    1,477
    
    
    
    1,109Inventories
    
    
    969
    
    
    
    748Prepaid and other current assets
    
    
    836
    
    
    
    1,009Assets of discontinued operations
    
    
    1,841,309
    
    
    
    1,921,550Total current assets
    
    
    1,845,030
    
    
    
    1,925,537Property and equipment, net
    
    
    10,916
    
    
    
    11,299Assets held for sale
    
    
    738
    
    
    
    738Deferred financing fees, net
    
    
    2,451
    
    
    
    1,767Officer and other notes receivable, less current portion
    
    
    895
    
    
    
    912Investment in unconsolidated subsidiary
    
    
    160
    
    
    
    160Intangible assets, net
    
    
    1,209
    
    
    
    1,312Goodwill
    
    
    3,725
    
    
    
    3,725Other noncurrent assets
    
    
    2,295
    
    
    
    2,295Total assets
    
    $
    1,867,419
    
    
    $
    1,947,745LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,867
    
    
    $
    2,794Accrued expenses
    
    
    394
    
    
    
    143Current portion of long-term debt
    
    
    3,100
    
    
    
    3,297Liabilities of discontinued operations
    
    
    1,795,755
    
    
    
    1,829,877Total current liabilities
    
    
    1,802,116
    
    
    
    1,836,111Long-term debt, less current portion
    
    
    53,722
    
    
    
    50,443Other long-term liabilities
    
    
    1,148
    
    
    
    1,159Total liabilities
    
    
    1,856,986
    
    
    
    1,887,713Shareholders equity:Common stock
and additional paid in capital, no par value, 20,000,000 shares authorized, 9,446,191 shares outstanding in 2005 and 2004
    
    
    64,873
    
    
    
    64,369Retained deficit
    
    
    (39,989
    )
    
    
    (1,529
    )Treasury stock, at cost, 1,525,078 shares
    
    
    (7,703
    )
    
    
    (7,703
    )Accumulated other comprehensive income from continuing operations
    
    
    68
    
    
    
    68Accumulated other comprehensive income (loss) from discontinued operations
    
    
    (6,816
    )
    
    
    4,827Total shareholders equity
    
    
    10,433
    
    
    
    60,032Total liabilities and shareholders equity
    
    $
    1,867,419
    
    
    $
    1,947,745
 See accompanying notes to consolidated financial statements. 3




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS  Three Months EndedMarch 312005
    
    
    2004Net revenues
    
    $
    2,253
    
    
    $
    1,699Cost of sales
    
    
    1,781
    
    
    
    1,201Gross profit
    
    
    472
    
    
    
    498Selling, general and administrative expenses
    
    
    4,023
    
    
    
    2,867Depreciation and amortization
    
    
    528
    
    
    
    528Loss related to sale of business
    
    
    
    
    
    
    964Operating loss
    
    
    (4,079
    )
    
    
    (3,861
    )Interest expense
    
    
    1,124
    
    
    
    1,017Loss before income taxes
    
    
    (5,203
    )
    
    
    (4,878
    )Income tax expense (benefit)
    
    
    
    
    
    
    Net loss from continuing operations
    
    
    (5,203
    )
    
    
    (4,878
    )Income (loss) from discontinued operations, net of income taxes of
($21) and $345, respectively
    
    
    (33,257
    )
    
    
    3,111Net loss
    
    $
    (38,460
    )
    
    $
    (1,767
    )Loss per share  basic and dilutedLoss from continuing operations
    
    $
    (0.66
    )
    
    $
    (0.60
    )Income (loss) from discontinued operations
    
    
    (4.20
    )
    
    
    0.38Net loss available to common shareholders
    
    $
    (4.86
    )
    
    $
    (0.22
    )Weighted average shares outstanding
    
    
    7,921,113
    
    
    
    8,114,443
 See accompanying notes to consolidated financial statements. 4




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY  Common stock
    
    
    Retained
    
    
    
    
    
    
    Accumulated otherand additional
    
    
    earnings
    
    
    
    
    
    
    comprehensive incomeTotal
    
    
    paid in capital
    
    
    (deficit)
    
    
    Treasury stock
    
    
    (loss)Balance at January 1, 2004
    
    $
    72,447
    
    
    $
    68,078
    
    
    $
    9,338
    
    
    $
    (7,671
    )
    
    $
    2,702Comprehensive income:Net loss
    
    
    (1,767
    )
    
    
    
    
    
    
    (1,767
    )
    
    
    
    
    
    
    Change in unrealized gain on securities, net
of income tax provision of $6,725
    
    
    13,440
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,440Comprehensive income
    
    
    11,673Balance at March 31, 2004
    
    $
    84,120
    
    
    $
    68,078
    
    
    $
    7,571
    
    
    $
    (7,671
    )
    
    $
    16,142Balance at January 1, 2005
    
    $
    60,032
    
    
    $
    64,369
    
    
    $
    (1,529
    )
    
    $
    (7,703
    )
    
    $
    4,895Comprehensive loss:Net loss
    
    
    (38,460
    )
    
    
    
    
    
    
    (38,460
    )
    
    
    
    
    
    
    Change in unrealized loss on securities, net
of income tax benefits of $5,826
    
    
    (11,643
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,643
    )Comprehensive loss
    
    
    (50,103
    )Issuance of warrants
    
    
    518
    
    
    
    518
    
    
    
    
    
    
    
    
    
    
    
    Exercise of common stock options
    
    
    (14
    )
    
    
    (14
    )
    
    
    
    
    
    
    
    
    
    
    Balance at
March 31, 2005
    
    $
    10,433
    
    
    $
    64,873
    
    
    $
    (39,989
    )
    
    $
    (7,703
    )
    
    $
    (6,748
    )
 See accompanying notes to consolidated financial statements. 5




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  Three Months EndedMarch 312005
    
    
    2004OPERATING ACTIVITIES:Net loss
    
    $
    (38,460
    )
    
    $
    (1,767
    )Net income (loss) from discontinued operations
    
    
    (33,257
    )
    
    
    3,111Net loss from continuing operations
    
    
    (5,203
    )
    
    
    (4,878
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    528
    
    
    
    528Changes in
assets and liabilities, excluding effects of business
acquisitions:Accounts receivable
    
    
    (368
    )
    
    
    (511
    )Inventories
    
    
    (221
    )
    
    
    (313
    )Prepaid and other current assets
    
    
    173
    
    
    
    (927
    )Accounts payable
    
    
    73
    
    
    
    (124
    )Accrued expenses
    
    
    249
    
    
    
    12Net realized loss on sale of MCO
    
    
    
    
    
    
    964Other
    
    
    103
    
    
    
    359Net cash used in operating activities of continuing operations
    
    
    (4,666
    )
    
    
    (4,890
    )INVESTING ACTIVITIES:Capital expenditures
    
    
    (41
    )
    
    
    (144
    )Cash paid for health services acquisitions, net of cash acquired
    
    
    
    
    
    
    (825
    )Change in other noncurrent assets, net
    
    
    16
    
    
    
    (351
    )Net cash used in investing activities of continuing operations
    
    
    (25
    )
    
    
    (1,320
    )FINANCING ACTIVITIES:Borrowings
    
    
    4,750
    
    
    
    3,300Cash received from discontinued operations
    
    
    1,364
    
    
    
    4,224Deferred financing costs paid
    
    
    (775
    )
    
    
    (310
    )Repayments of long-term debt
    
    
    (1,316
    )
    
    
    (45
    )Issuance of common stock
    
    
    (14
    )
    
    
    (16
    )Net cash provided by financing activities of continuing operations
    
    
    4,009
    
    
    
    7,153Net increase (decrease) in cash and cash equivalents of continuing operations
    
    
    (682
    )
    
    
    943Cash and cash equivalents at beginning of period
    
    
    1,121
    
    
    
    1,337Cash and cash equivalents at end of period
    
    $
    439
    
    
    $
    2,280
 See accompanying notes to consolidated financial statements. 6




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1  Basis of Presentation Standard Management Corporation and subsidiaries (we, our, us, Standard Management or
the Company), as of March 31, 2005, a) distributes pharmaceutical products and services through
its Health Services subsidiaries and b) develops, markets and/or administers annuity and life
insurance products through its Financial Services subsidiaries. As more fully described in Note 3
 Discontinued Operations, the Company has signed a definitive agreement to sell a substantial
portion of its Financial Services business and has reflected the to-be-sold business as
discontinued operations in the accompanying consolidated financial statements. As a result of the
discontinuance, the Company now reports within a single operating segment, which includes all of
our previously separately reported corporate services functions. All significant intercompany
transactions and balances have been eliminated in consolidation. The Health Services business, which was started by the Company in 2002 under its U.S. Health
Services Corporation subsidiary, 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 correctional 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 U.S. Health Services is primarily a function of gross margin on sales (the difference between
sales and cost of goods sold) and management of our operating expenses. As described more fully in
Note 4  Health Services Business Acquisitions, we expanded our Health Services operations through
business acquisitions in 2004. Our unaudited, consolidated financial statements reflect normal recurring adjustments that are
necessary to present fairly the Company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 and to reflect our discontinued operations separately from our
continuing operations. 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. These interim financial statements should be read along with our audited
consolidated financial statements included in our Form 10-K for the year ended December 31, 2004. The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ
materially from those estimates. Note 2  Summary of Significant Accounting Policies Revenue Recognition / Contractual Allowances Revenues are recognized at the time services or products are provided or delivered to the
customer. Upon delivery of products or services, the Company has no additional performance
obligation to the customer. The Company receives payments through reimbursement from Medicaid and
Medicare programs and directly from individual residents (private pay), private third-party
insurers and long-term care facilities. The Company records an estimated contractual allowance against non-private pay revenues and
accounts receivable. Accordingly, the net revenues and accounts receivable reported in the
Companys consolidated financial statements are recorded at the amount expected to be received.
Contractual allowances are adjusted to actual as cash is received and claims are reconciled. The
Company evaluates the following criteria in developing the estimated contractual allowance
percentages each month: historical contractual allowance trends based on actual claims paid by
third party payors; reviews of contractual allowance information reflecting current contract terms;
consideration and analysis of changes in customer base, product mix, payor mix reimbursement levels
or other issues that may impact contractual allowances. 7




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANACIAL STATEMENTS (UNAUDITED) (cont.) Note 2  Summary of Significant Accounting Policies (continued) Cash Equivalents Short-term investments that have a maturity of ninety days or less at acquisition are
considered cash equivalents. Investments in cash equivalents are carried at cost, which
approximates fair value. Allowance for Doubtful Accounts The Company utilizes the Aging Method to evaluate the adequacy of its allowance for doubtful
accounts. This method is based upon applying estimated standard allowance requirement percentages
to each accounts receivable aging category for each type of payor. The Company has developed
estimated standard allowance requirement percentages by utilizing historical collection trends and
its understanding of the nature and collectibility of receivables in the various aging categories
and the various payors of the Companys business. The standard allowance percentages are developed
by payor type as the accounts receivable from each payor type have unique characteristics. The
allowance for doubtful accounts is determined utilizing the Aging Method described above while also
considering accounts specifically identified as doubtful. Accounts receivable that Company
management specifically estimates to be doubtful, based upon the age of the receivables, the
results of collection efforts, or other circumstances, are reserved for in the allowance for
doubtful accounts until they are collected or written-off. Management believes the assumptions used in the Aging Method coupled with continued
improvements in the Companys collection patterns suggest the allowance for doubtful accounts is
adequate. However, because the assumptions underlying the Aging Method are based upon historical
data, there is a risk that the Companys current assumptions are not reflective of future
collection patterns. Changes in overall collection patterns can be caused by market conditions
and/or budgetary constraints of government funded programs such as Medicare and Medicaid. Such
changes can adversely impact the collectibility of receivables, but may not be addressed in a
timely fashion when using the aging method, until updates to the Companys periodic historical
collection studies are completed and implemented. At least annually, the Company updates it historical collection studies in order to evaluate
the propriety of the assumptions underlying the Aging Method. Any changes to the underlying
assumptions or impact of adverse events are implemented immediately. Changes to these assumptions
can have a material impact on the Companys bad debt expense, which is reported in the consolidated
statements of operations as a component of selling, general and administrative expenses. Inventories and Cost of Revenues Inventories, consisting of pharmaceuticals, medical supplies and equipment, are stated at the
lower of cost or market. Cost is determined primarily on the first-in, first-out (FIFO) method. Counts of inventories on hand are performed at least on a quarterly basis. Because the
Company does not utilize a perpetual inventory system, cost of goods sold, a component of cost of
revenues, is estimated using the latest acquisition cost and adjusted to actual by recording the
results of the quarterly count of actual physical inventories. There are no significant obsolescence allowances recorded since the Company writes off all
expired inventories and the Company has the ability to return a majority of its inventory before
expiration. Cost of revenues include the net product costs of pharmaceuticals sold and direct charges
attributable to providing revenue-generating services. Deferred Financing Costs Financing costs are deferred and amortized on a straight-line basis, which approximates the
effective interest method, over the terms of the related debt. 8




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANACIAL STATEMENTS (UNAUDITED) (cont.) Note 2  Summary of Significant Accounting Policies (continued) Assets Held For Sale Assets held for sale represent investment property and improvements carried at the lower of
cost or fair value. Other noncurrent assets Other non current assets primarily represent fixed maturity securities and equity investments
in support of the insurance policy liabilities as well as other fixed maturity securities and
assets to be purchased from Standard Life in the proposed sale of Standard Life. Other long-term liabilities Other long-term liabilities primarily represent insurance policy liabilities not included in
the proposed sale of Standard Life. Note 3  Discontinued Operations  Financial Services Substantially all of our Financial Services business was operated through our wholly owned
subsidiary, Standard Life Insurance Company of Indiana (Standard Life) and its subsidiary, 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 business 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. As previously disclosed, the board and management of the Company considered a variety of
strategic alternatives to provide the Company with adequate financing to pursue its growth
strategies for the health services business it embarked on in 2002 and maximize long-term
shareholder value. After considering various options, management, in early 2005, committed to the
sale of Standard Life, including Dixie Life. On February 9, 2005, Standard Management entered into
a definitive Stock and Asset Purchase Agreement (the Agreement) with Capital Assurance
Corporation (Capital Assurance). The Agreement provides for the sale to Capital Assurance of (i)
100% of the capital stock of Standard Life, and (ii) $27 million
aggregate principal amount of surplus debentures issued by Standard Life in favor of Standard Management. The Agreement
represents the definitive terms for the transactions contemplated by the previously reported letter
of intent between the parties. Standard Management expects the transaction to close in the second
quarter of 2005. The purchase price under the Agreement is $79.5 million, subject to adjustment as described
below, which will be payable as follows: (i) $5 million of a new class of 7% cumulative
exchangeable preferred stock of Capital Assurance, (ii) assumption by Capital Assurance of
approximately $21 million in intercompany obligations of Standard Management to Standard Life and
(iii) the balance of the purchase price in cash. The cash portion of the purchase price will be
adjusted, post-closing, based on certain changes in the business of Standard Life occurring between
October 1, 2004 and the closing of the transaction, including adjustments for, among other things,
statutory gains from operations of Standard Life, credit related capital gains and losses,
including impairment losses, principal payments on the surplus debentures and capital expenditures
by Standard Life. Management currently estimates that based on anticipated adjustments, the
post-closing, as adjusted purchase price expected to be paid will be approximately $83 million. 9




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANACIAL STATEMENTS (UNAUDITED) (cont.) Note 3  Discontinued Operations  Financial Services (continued) Standard Management and Capital Assurance have made customary representations, warranties and
covenants in the Agreement, including, among others, covenants by Standard Management (i) to
conduct the business of Standard Life in the ordinary course and maintain necessary permits and
insurance policies during the interim period between the execution of the Agreement and closing,
(ii) to not engage in certain types of transactions during such period, (iii) to cause a meeting of
the shareholders of Standard Management to be held to approve the Agreement and the transactions
contemplated thereby, (iv) to not solicit proposals relating to an alternative sale or business
combination transaction and (v) subject to certain exceptions, not to enter into discussions
concerning or provide confidential information in connection with proposals for alternative sale or
business combination transactions. In addition, Standard Management has agreed to purchase certain
assets from Standard Life at closing for approximately $6 million. Consummation of the transactions contemplated by the Agreement is subject to customary
conditions, including (i) approval of the shareholders of Standard Management, (ii) absence of any
law or order prohibiting the closing, (iii) approval of the Indiana Department of Insurance, and
(iv) expiration or termination of the Hart-Scott-Rodino waiting period. In addition, each partys
obligation to consummate the transactions contemplated by the Agreement is subject to certain
customary conditions, including (i) with certain exceptions, the accuracy of the representations
and warranties of the other party and (ii) material compliance of the other party with its
covenants. Standard Management also agreed to undertake a solicitation of consents of the preferred
security holders of SMAN Capital Trust I, a wholly owned subsidiary of Standard Management (the
Trust) to an amendment to the indenture governing such securities at an estimated cost of
approximately $1 million to fund incentive payments in connection with obtaining such consents. If
adopted, the amendment would provide us additional financing flexibility by allowing us to enter
into certain business transactions, such as the sale of substantially all of our assets, without
the acquirer of such assets being required to assume our responsibilities under the indenture. In
the event the requisite consents to amend the indenture are not received, Standard Management has
the right to require Capital Assurance to assume Standard Managements obligations under the
indenture. If this event were to occur, Standard Management would receive less net cash proceeds
from the sale of Standard Life by the net face amount outstanding of the trust preferred
securities. Standard Management agreed to indemnify Capital Assurance and Standard Life for any losses
arising from breaches of any representation, warranty or covenant of Standard Management made in
the Agreement and for all pending litigation of Standard Life subject to the applicable survival
periods, if such losses exceed $500,000 in the aggregate. If such indemnification threshold is
exceeded, Standard Management would be responsible for paying $250,000 plus the amount of such loss
in excess of $500,000, up to a maximum amount equal to the purchase price for losses related to the
breach of certain representations and warranties, and up to a maximum amount equal to 50% of the
purchase price for breaches of certain other specified representations and warranties. The Agreement provides termination rights for both Standard Management and Capital Assurance,
and further provides that, upon termination of the Agreement under specified circumstances,
Standard Management may be required to pay Capital Assurance a termination fee ranging from $1.6
million to $3.2 million, depending on the circumstance leading to the termination, plus
reimbursement of up to $2 million of expenses incurred by Capital Assurance in connection with the
transaction since November 21, 2004. If the proposed sale is consummated, we estimate that, for federal income tax purposes, we
will recognize a capital loss on the sale of approximately $22 million, equal to the difference
between our adjusted tax basis in Standard Life and the amount realized from the proposed sale. We
may recognize a tax benefit in future periods from this capital loss provided that we recognize
capital gains within five years. In addition, for accounting purposes, we have recorded a $35
million impairment charge in the first quarter of 2005 related to the expected sale of Standard
Life, which is equal to the difference between the expected net book value of the assets sold on
the sale date and the purchase price expected to be paid by Capital Assurance in the proposed
transaction, plus transaction related expenses. 10




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANACIAL STATEMENTS (UNAUDITED) (cont.) Note 3  Discontinued Operations  Financial Services (continued) Standard Management has filed with the Securities and Exchange Commission (SEC) and
delivered to shareholders of record as of April 4, 2005 definitive proxy materials relating to (i)
the special meeting of shareholders to be held for the purpose of approving the Agreement and the
transactions contemplated thereby and (ii) the solicitation of consents from holders of trust
preferred securities of SMAN Capital Trust I to an amendment to the Indenture relating to such
securities. Standard Management has set May 18, 2005 as the date for a special meeting of
shareholders to vote on the approval of the proposed sale. Use of Cash Proceeds. Based on managements expectations regarding the anticipated
adjustment in the purchase price, and assuming a final, post-adjustment purchase price of $83
million, we expect the net cash proceeds from the sale, before deducting transaction related fees
and expenses, to be approximately $57 million. We intend to use such cash proceeds as follows:  
    approximately $17.7 million for the repayment in full of a bank line of credit;
    approximately $6 million to purchase certain assets from Standard Life at closing
pursuant to the Agreement;
    approximately $4.3 million for professional fees (investment bankers, attorneys,
accountants) and miscellaneous other expenses (filing fees, printing and mailing proxy
materials, prepayment penalties, severance payments, etc.);
    approximately $1 million to fund incentive payments in connection with obtaining the
consent of the trust preferred holders;
    $.5 million to reduce the principal amount outstanding under the mortgage on our
corporate headquarters (paid March 21, 2005); and
    the remaining approximately $27.5 million as working capital to support and expand
our health services business, including through selected strategic acquisitions. In addition, we anticipate that Standard Life, after the sale, will continue to lease space
from us at our corporate headquarters for at least three years for $480,000 per year. We also
anticipate receiving $350,000 of annual dividends under the $5 million of newly issued 7%
cumulative exchangeable preferred stock we expect to receive as partial consideration in our sale
of Standard Life. 11




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (cont.) Note 3  Discontinued Operations  Financial Services (continued) The following tables summarize the financial position and operating results of our
discontinued operations as of and for quarters ended on the dates indicated (in thousands): Standard Life
Unaudited Condensed Consolidated Balance Sheet March 31
    
    
    December 31,2005
    
    
    2004Assets:Total investments
    
    $
    1,635,917
    
    
    $
    1,686,396Deferred policy acquisition costs and present value of future profits
    
    
    181,203
    
    
    
    174,172Other assets
    
    
    24,189
    
    
    
    60,982Assets of discontinued operations
    
    $
    1,841,309
    
    
    $
    1,921,550Liabilities:Insurance policy liabilities
    
    $
    1,790,990
    
    
    $
    1,824,736Accounts payable and accrued expenses
    
    
    4,765
    
    
    
    5,141Liabilities of discontinued operations
    
    $
    1,795,755
    
    
    $
    1,829,877
 Standard Life
Unaudited Condensed Consolidated Income Statement March 31
    
    
    March 31,2005
    
    
    2004Revenues
    
    $
    26,362
    
    
    $
    29,698Benefits, claims, interest credited and amortization
    
    
    18,756
    
    
    
    23,743Operating and other expenses
    
    
    5,884
    
    
    
    2,499Impairment charge
    
    
    35,000
    
    
    
    Income tax expense (benefit)
    
    
    (21
    )
    
    
    345Income (loss) from discontinued operations
    
    $
    (33,257
    )
    
    $
    3,111
 Note 4  Health Services Business Acquisitions During 2003, the Company acquired the business assets of MyDoc.com for $645,000 paid in the
form of cash of $145,000 and a seller note of $500,000. Additionally, we acquired the stock of
Medical Care & Outcomes, LLC (MCO) in 2003 with $4 million of our common stock. We later sold
MCO back to the original owners (other than a 5% interest valued at $160,000) in April 2004. We
recognized a loss on the sale and related severance costs for a prior owner/employee of $964,000.
This divestiture resulted in the return of our common stock and therefore a decrease to equity in
April 2004 of $4 million. Effective February 6, 2004, our newly-formed 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 was paid in the form of cash of
$0.8 million and the assumption of $2.9 million of debt and a seller note. 12




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (cont.) Note 4  Health Services Business Acquisitions (continued) Had the Apothecary acquisition and MCO divestiture been consummated on January 1, 2004, pro
forma results of operations for the quarter ended March 31, 2004 would have been as follows: Net revenues
    
    $
    2,229Gross profits
    
    
    648Operating loss
    
    
    (3,896
    )Net loss from continuing operations
    
    
    (3,896
    )Net loss per share from continuing operations
    
    $
    (0.49
    )
 The pro forma information does not purport to be indicative of the results that actually would
have been obtained if the transaction had occurred at an earlier date and is not intended to be a
projection of future results or trends. Effective May 13, 2004, the Company acquired the business assets of RoyalMed, LLC for 50,000
shares of our common stock. The purchase price included contingent consideration, based on a
targeted closing sales price of our common stock on the anniversary date of the acquisition over
the two years following closing. The contingent consideration has been recognized as additional
paid in capital. Note 5  Stock Option Plan Statement of Financial Accounting Standards No. 123, as amended by SFAS No. 148, allows
companies to either expense the estimated fair value of stock options or to continue the earlier
practice of accounting for stock options at intrinsic value 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 loss and pro forma loss per share of the following
for the three months ended March 31 (in thousands, except per share amounts): Three
Months Ended March 312005
    
    
    2004Reported net loss from continuing operations
    
    $
    (5,203
    )
    
    $
    (4,878
    )Less: Total
stock-based employee compensation expense determined under fair value based method for all grants
    
    
    (41
    )
    
    
    (85
    )Pro forma net loss from continuing operations
    
    $
    (5,244
    )
    
    $
    (4,963
    )Loss per share from continuing operations:Basic and diluted  as reported
    
    $
    (0.66
    )
    
    $
    (0.60
    )Basic and diluted  pro forma
    
    $
    (0.66
    )
    
    $
    (0.61
    )
 13




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (cont.) Note 6  Indebtedness Our long-term debt was as follows (dollars in thousands): March 31
    
    
    December 31Interest Rate(1)
    
    2005
    
    
    2004Mortgages payable
    
    7.32%
    
    $
    6,072
    
    
    $
    6,607Senior secured credit facility
    
    5.84%
    
    
    18,000
    
    
    
    18,500Promissory notes
    
    2.96%
    
    
    1,601
    
    
    
    1,8836% convertible notes
    
    6.00%
    
    
    2,750
    
    
    
    2,7507% convertible notes
    
    7.00%
    
    
    3,300
    
    
    
    3,300Other convertible notes
    
    7.73%
    
    
    4,750
    
    
    
    Subordinated debentures
    
    
    
    
    20,700
    
    
    
    20,700Total indebtedness
    
    
    
    
    57,173
    
    
    
    53,740Less debt discount on other convertible notes
    
    
    
    
    351
    
    
    
    Less current portion
    
    
    
    
    3,100
    
    
    
    3,297Total long-term debt, less current portion
    
    
    
    $
    53,722
    
    
    $
    50,443
  (1)
    Current weighted average rate as of March 31, 2005 A $500,000 prepayment of principal on our mortgage payable was made in March 2005 related to
the proposed sale of Standard Life. The senior secured credit facility includes a revolving loan and term loan portion and is
expected to be terminated and fully paid off upon the sale of Standard Life. Absent the sale, the
credit facility is scheduled to terminate in November 2008. As of March 31, 2005, the Company was
in violation of two financial covenants (debt leverage and intercompany debt) under our senior
secured credit facility. We have obtained waivers of the covenants
through the earlier of: (i) the
sale of Standard Life or (ii) September 30, 2005. On February 10, 2004, we issued $3.3 million of our 7% unsecured convertible notes due 2009.
The notes are convertible at a price equal to $4.20 per share at any time at the holders option
subject to certain conditions. On November 30, 2004, we issued $2.75 million of our 6% mandatory unsecured convertible notes
due 2008. The notes are convertible into shares of our common stock at a price equal to an
adjusted $3.28 per share at any time at the holders option subject to certain conditions. On March 21, 2005, we issued $4.75 million of our other convertible notes. Principal
payments are due in monthly installments beginning September 2005 through March 2008 and bear
interest at the prime rate plus 2% with a floor of 7.25%, unless such rate is reduced in the event
that the trading price of our common stock increase above certain levels. Also, we may pay
interest and principal in shares of our common stock instead of cash under certain circumstances.
The notes were issued with a detachable warrant that allows the holder to purchase 532,511 shares
of our common stock at an exercise price of $3.90 per share. This warrant was valued at $351,000
and is reflected as a discount on the issuance of the convertible debt and will be amortized into
interest expense over the term of the notes. The warrant expires, if unexercised, in March 2010.
These notes are convertible at any time at the holders option at a rate of $3.28 per share,
subject to certain conditions. Because our common shares were trading at less than effective
conversion price upon issuance of the notes, no value was assigned to the conversion feature. Additional warrants were issued to advisors in the above transaction that allows the holders
to purchase 50,000 shares and 30,619 shares of our common stock at an exercise price of $3.28 and
$3.90 per share, respectively. These warrants were valued at $62,000 and are reflected as
additional deferred financing costs on the issuance of the convertible debt and will be amortized
into interest expense over the term of the notes. 14




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (cont.) Note 6  Indebtedness (continued) The subordinated debentures are due to the Trust and are due in August 2031. The Trust, in
turn, owes $20.7 million of 10.25% preferred securities to certain investors under terms that are
similar the terms of the debentures. Since all income and cash flows into the Trust benefit the
preferred securities holders rather than Standard Management, the Trust is not consolidated with
Standard Management. Interest paid for the three months ended March 31, 2005 and 2004 was $1.1 million and $1.0
million, respectively. Note 7  Shareholders Equity Historically
we have issued warrants to purchase common stock (i) as a component of the
purchase price of health services acquisitions (ii) in connection with the issuance of convertible
debt, and (iii) as an inducement to our independent agents for annuity sales. During the first
quarter 2005, we had 287,000 warrants expire unexercised. In addition, during the first quarter
2005 we issued (i) 125,000 warrants recorded as a charge of $105,000 (ii) 532,511 warrants recorded
as debt discount of $351,000, and (iii) 80,619 warrants recorded as deferred financing fees of
$62,000. The following table represents outstanding warrants to purchase common stock: Warrants
OutstandingExercise
    
    
    March 31
    
    
    December 31Issue
Date
    

Expiration
    

Price
    
    

2005
    
    

2004January 2002
    
    January 2005
    
    $
    6.02
    
    
    
    
    
    
    
    287,000June 2002
    
    June 2005
    
    
    7.61
    
    
    
    89,500
    
    
    
    89,500October 2002
    
    October 2007
    
    
    4.92
    
    
    
    10,000
    
    
    
    10,000March 2005
    
    March 2010
    
    
    3.28
    
    
    
    175,000
    
    
    
    March 2005
    
    March 2010
    
    
    3.90
    
    
    
    563,130
    
    
    
    837,630
    
    
    
    386,500
 15




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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 Our Discontinued Operations  Financial Services consists of revenues earned and expenses
incurred from our insurance operations, principally conducted by our subsidiary Standard Life
Insurance Company of Indiana (Standard Life) and its subsidiary, 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. As previously disclosed, the board and management of the Company considered a variety of
strategic alternatives to provide the Company with adequate financing to pursue its growth
strategies for the health services business it embarked on in 2002 and maximize long-term
shareholder value. After considering various options, management, in early 2005, committed to the
sale of Standard Life, including Dixie Life. On February 9, 2005, Standard Management entered into
a definitive Stock and Asset Purchase Agreement (the Agreement) with Capital Assurance
Corporation (Capital Assurance). The Agreement provides for the sale to Capital Assurance of (i)
100% of the capital stock of Standard Life, and (ii) $27 million aggregate principal amount of
surplus debentures issued by Standard Life in favor of Standard Management. The Agreement
represents the definitive terms for the transactions contemplated by the previously reported letter
of intent between the parties. Standard Management expects the transaction to close in the second
quarter of 2005. The purchase price under the Agreement is $79.5 million, subject to adjustment as described
below, which will be payable as follows: (i) $5 million of a new class of 7% cumulative
exchangeable preferred stock of Capital Assurance, (ii) assumption by Capital Assurance of
approximately $21 million in intercompany obligations of Standard Management to Standard Life and
(iii) the balance of the purchase price in cash. The cash portion of the purchase price will be
adjusted, post-closing, based on certain changes in the business of Standard Life occurring between
October 1, 2004 and the closing of the transaction, including adjustments for, among other things,
statutory gains from operations of Standard Life, credit related capital gains and losses,
including impairment losses, principal payments on the surplus debentures and capital expenditures
by Standard Life. Management currently estimates that based on anticipated adjustments, the
post-closing, as adjusted purchase price expected to be paid will be approximately $83 million. Standard Management and Capital Assurance have made customary representations, warranties and
covenants in the Agreement, including, among others, covenants by Standard Management (i) to
conduct the business of Standard Life in the ordinary course and maintain necessary permits and
insurance policies during the interim period between the execution of the Agreement and closing,
(ii) to not engage in certain types of transactions during such period, (iii) to cause a meeting of
the shareholders of Standard Management to be held to approve the Agreement and the transactions
contemplated thereby, (iv) to not solicit proposals relating to an alternative sale or business
combination transaction and (v) subject to certain exceptions, not to enter into discussions
concerning or provide confidential information in connection with proposals for alternative sale or
business combination transactions. In addition, Standard Management has agreed to purchase certain
assets from Standard Life at closing for approximately $6 million. Consummation of the transactions contemplated by the Agreement is subject to customary
conditions, including (i) approval of the shareholders of Standard Management, (ii) absence of any
law or order prohibiting the closing, (iii) approval of the Indiana Department of Insurance, and
(iv) expiration or termination of the Hart-Scott-Rodino waiting period. In addition, each partys
obligation to consummate the transactions contemplated by the Agreement is subject to certain
customary conditions, including (i) with certain exceptions, the accuracy of the representations
and warranties of the other party and (ii) material compliance of the other party with its
covenants. Standard Management also agreed to undertake a solicitation of consents of the preferred
security holders of SMAN Capital Trust I, a wholly owned subsidiary of Standard Management (the
Trust) to an amendment to the indenture governing such securities at an estimated cost of
approximately $1 million to fund incentive payments in connection with obtaining such consents. If
adopted, the amendment would provide us additional financing flexibility by allowing us to enter
into certain business transactions, such as the sale of substantially all of our assets, without
the acquirer of such assets being required to assume our responsibilities under the indenture. In the event the requisite
consents to amend the indenture are not received, Standard 16




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Management has the right to require Capital Assurance to assume Standard Managements obligations under the indenture. If this event
were to occur, Standard Management would receive less net cash proceeds from the sale of Standard
Life by the net face amount outstanding of the trust preferred securities. Standard Management agreed to indemnify Capital Assurance and Standard Life for any losses
arising from breaches of any representation, warranty or covenant of Standard Management made in
the Agreement and for all pending litigation of Standard Life subject to the applicable survival
periods, if such losses exceed $500,000 in the aggregate. If such indemnification threshold is
exceeded, Standard Management would be responsible for paying $250,000 plus the amount of such loss
in excess of $500,000, up to a maximum amount equal to the purchase price for losses related to the
breach of certain representations and warranties, and up to a maximum amount equal to 50% of the
purchase price for breaches of certain other specified representations and warranties. The Agreement provides termination rights for both Standard Management and Capital Assurance,
and further provides that, upon termination of the Agreement under specified circumstances,
Standard Management may be required to pay Capital Assurance a termination fee ranging from $1.6
million to $3.2 million, depending on the circumstance leading to the termination, plus
reimbursement of up to $2 million of expenses incurred by Capital Assurance in connection with the
transaction since November 21, 2004. If the proposed sale is consummated, we estimate that, for federal income tax purposes, we
will recognize a capital loss on the sale of approximately $22 million, equal to the difference
between our adjusted tax basis in Standard Life and the amount
realized from the proposed sale. We
may recognize a tax benefit in future periods from this capital loss provided that we recognize
capital gains within five years. In addition, for accounting purposes, we have recorded a $35
million impairment charge in the first quarter of 2005 related to the expected sale of Standard
Life, which is equal to the difference between the expected net book value of the assets sold on
the sale date and the purchase price expected to be paid by Capital Assurance in the proposed
transaction, plus transaction related expenses. Standard Management has filed with the SEC and delivered to shareholders of record as of April
4, 2005 definitive proxy materials relating to (i) the special meeting of shareholders to be held
for the purpose of approving the Agreement and the transactions contemplated thereby and (ii) the
solicitation of consents from holders of trust preferred securities of SMAN Capital Trust I to an
amendment to the Indenture relating to such securities. Standard Management has set May 18, 2005
as the date for a special meeting of shareholders to vote on the approval of the proposed sale. Use of Cash Proceeds. Based on managements expectations regarding the anticipated
adjustment in the purchase price, and assuming a final, post-adjustment purchase price of $83
million, we expect the net cash proceeds from the sale, before deducting transaction related fees
and expenses, to be approximately $57 million. We intend to use such cash proceeds as follows:  
    approximately $17.7 million for the repayment in full of a bank line of credit;
    approximately $6 million to purchase certain assets from Standard Life at closing
pursuant to the Agreement;
    approximately $4.3 million for professional fees (investment bankers, attorneys,
accountants) and miscellaneous other expenses (filing fees, printing and mailing proxy
materials, prepayment penalties, severance payments, etc.);
    approximately $1 million to fund incentive payments in connection with obtaining the
consent of the trust preferred holders;
    $.5 million to reduce the principal amount outstanding under the mortgage on our
corporate headquarters (paid March 21, 2005); and
    the remaining approximately $27.5 million as working capital to support and expand
our health services business, including through selected strategic acquisitions. In addition, we anticipate that Standard Life, after the sale, will continue to lease space
from us at our corporate headquarters for at least three years for $480,000 per year. We also
anticipate receiving $350,000 of annual dividends under the $5 million of newly issued 7%
cumulative exchangeable preferred stock we expect to receive as partial consideration in our sale
of Standard Life. 17




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##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Comparison of the Three Month Periods Ended March 31, 2005 and March 31, 2004: 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, 2004, should be read in conjunction with this Form 10-Q. Continuing Operations: Net revenues  
    Sales for the first quarter of 2005 increased $.6 million or 33% to $2.3 million compared to the first
quarter of 2004, primarily related to the acquisition of Apothecary
Solutions. Additionally, the growth in
our veterinary line of business positively impacted our sales. Cost of sales  
    Cost of sales for the first quarter of 2005 increased by $.6 million or 48% to $1.8 million compared to the
first quarter of 2004, primarily related to the sales growth in our veterinary products which carry lower
margins. Gross profit  
    Gross profit for the first quarter of 2005 decreased to 21% from 29% in the first quarter of 2004, primarily
a result of increased sales in veterinary sales that carry lower margins than other sources of revenues. Selling, general and administrative  
    Selling, general and administrative expenses for the first quarter of 2005 increased by $1.2 million or 40%.
The increase is primarily related to expenses related to the sale of Standard Life for legal, professional
and other fees of $.8 million, increases in the continued marketing and selling efforts in the Health
Services area of $.3 million and due to the acquisition of Apothecary Solutions of $.1 million. Depreciation and amortization  
    Depreciation and amortization remained unchanged at $.5 million in the first quarter of 2005 and 2004. Loss related to sale of business  
    Loss related to sale of business for the first quarter of 2004 represents the loss on the sale of MCO. Interest expense  
    Interest expense for the first quarter of 2005 increased by $.1 million or 10% to $1.1 million compared to the
first quarter of 2004, primarily due to the issuance of $6 million of convertible debt during 2004. Federal income tax benefit  
    Provision for federal income tax remained zero due to a 100% valuation allowance on the net losses in the first
quarter of 2005 and 2004. 18




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Discontinued Operations: General:
Our former Financial Services segment has been reclassified as discontinued operations during 2005
due to managements decision in early 2005 to sell Standard Life. The former Financial Services
segment consists of revenues earned and expenses incurred from our insurance operations. Our
primary products include deferred annuities, equity-indexed annuities and single premium immediate
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 the in force business, mortality experience and management of
our operating expenses. Income (loss) from Discontinuing Operations:  
    Net loss for the current quarter was $33.3 million compared to net income of $3.1 million
for the 2004 quarter. The current quarter was primarily impacted by an impairment charge of
$35 million in the first quarter of 2005 related to the expected sale of Standard Life, which
is equal to the difference between the expected net book value of the assets sold on the sale
date and the purchase price expected to be paid by Capital Assurance in the proposed
transaction, plus transaction related expenses. Additionally, the current quarter was
impacted by a decline in net realized gains of $.9 million net of income taxes, a decrease in
net spread income and policy income of $.4 million net of income taxes and net of amortization
and unfavorable mortality of $.1 million. 19




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Liquidity and Capital Resources Liquidity of Standard Management (Parent Company) We are a holding company whose capital requirements are met through payments received from our
subsidiaries. These payments have historically included 1) surplus debenture interest, 2)
dividends, 3) management fees, 4) equipment rental fees, 5) lease income and 6) allocation of
income taxes, all of which have been subject to restrictions under applicable insurance laws and
are used to pay our operating expenses and meet our debt service obligations. Historically, the
vast majority of our dividend income, management fee income, rental fee income and lease income
have come from Standard Life, which accounted for approximately 94% of our consolidated revenues in
2004. If the proposed sale of Standard Life is consummated, we will no longer have this source of
funds and will rely primarily on our health services operations. In addition, we will no longer
receive interest on the Surplus Debentures (as defined below), which we intend to sell to Capital
Assurance along with the stock of Standard Life. However, if the sale of Standard Life is
consummated, we will receive a substantial amount of cash proceeds as described below. Additionally, we have borrowed significant amounts from Standard Life to finance the
operations of our Health Services business. As of March 31, 2005, the aggregate amount of such
borrowings was approximately $20.5 million. As part of the purchase price for Standard Life,
Capital Assurance would assume this indebtedness. These internal sources of liquidity are
supplemented by external sources such as revolving credit agreements and long-term debt and equity
financing in the capital markets. We currently have $18 million outstanding with our senior
secured credit facility with a bank. There is currently no availability under this facility. If
the proposed sale of Standard Life is consummated, we intend to repay this facility in full. Potential Cash Available for 2005 Historically, from a parent company perspective, available cash from our existing working
capital and from the sources described above would be anticipated to be sufficient to fund our cash
requirements for the following year. However, while we expect that such sources will be sufficient
to fund our operations until the completion of our pending sale of Standard Life, we expect to have
available approximately $27.5 million of net cash proceeds from that sale to fund our subsequent
operations and our growth strategies for our U.S. Health Services business. Should the cash
proceeds from the sale of Standard Life be substantially reduced from our current expectation (as
may be the case as described in the following paragraph), we will need to obtain additional sources
of funds in order to grow our health services business in accordance with our current plan. There
can be no assurances that such funding will be available under terms and conditions that are
favorable to use, if at all. In conjunction with our efforts to sell Standard Life, Standard Management also agreed to
undertake a solicitation of consents of the preferred security holders of the Trust to an amendment
to the indenture governing such securities at an estimated cost of approximately $1 million to fund
incentive payments in connection with obtaining such consents. If adopted, the amendment would
provide us additional financing flexibility by allowing us to enter into certain business
transactions, such as the sale of substantially all of our assets, without the acquirer of such
assets being required to assume our responsibilities under the indenture. In the event the
requisite consents to amend the indenture are not received, Standard Management has the right to
require Capital Assurance to assume Standard Managements obligations under the indenture. If this
event were to occur, the cash proceeds to be received by us in the sale would be reduced by the
approximately $20.7 million aggregate liquidation amount of trust preferred securities outstanding,
which would reduce the net amount of cash expected to be available to us to operate and expand our
health services business from approximately $27.5 million to approximately $7 million. Such an
event would make it more likely that we would have to secure additional debt or equity financing to
carry out our business plan, and there can be no assurance that we could obtain such financing on
acceptable terms or at all. While we fully anticipate the sale of Standard Life to be consummated and for such sale to
provide significant net cash proceeds to the Company, the following paragraphs assume that such
sale does not occur in order to describe our liquidity circumstances in that event (as well as our
circumstances up through the date of sale). Surplus Debenture Interest.We loaned $27.0 million to Standard Life pursuant to
unsecured surplus debenture agreements (Surplus Debentures), which require 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 20




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   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 (Commissioner). For the
quarters ended March 31, 2005, December 31, 2004 and September 31, 2004 the Commissioner had not
yet approved our request of $1.4 million in aggregate interest payments. Assuming the approvals
are granted and the March 31, 2005 interest rate of 7.5% continues, we expect to receive interest
income of $2.0 million from the Surplus Debentures in 2005, assuming a full year ownership of
Standard Life. Dividends paid 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, if the
dividend or distribution, together with all other dividends and distributions paid within the
preceding 12 months, does not exceed the greater of i) net gain from operations or ii) 10% of
surplus, in each case as shown in its preceding annual statutory financial statements. In 2004 and
2003, there were no dividends received from our subsidiaries. In 2005, we could receive dividends
of $1.1 million from Standard Life, without regulatory approval and an additional $5.6 million with
regulatory approval. However, we do not expect to receive dividends from our subsidiaries in 2005. Management Fees. Pursuant to a management services agreement, Standard Life paid us $
3.6 million during 2004 and 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 $.9 million and $.7 million in 2004 and 2003, respectively, 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 2005, we expect to receive management fees of $3.6 million from Standard Life, assuming a
full year ownership of Standard Life. Equipment Rental Fees. In 2004, we received $1.1 million from Standard Life for the
use of our equipment and we expect to receive the same amount in 2005, assuming a full year
ownership of 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 2004, we received approximately $.8 million in lease income
from Standard Life and we expect to receive the same amount in 2005, assuming a full year ownership
of Standard Life. Also associated with this lease, Standard Life is responsible for its share of
building maintenance expenses. During 2004, we received $.3 million in maintenance expenses. We
expect to receive $.3 million in maintenance expense in 2005, assuming a full year ownership of
Standard Life. Anticipated Sale of Standard Life. Based on managements expectations regarding the
estimated adjusted purchase price for Standard Life, and assuming a final, post-adjustment purchase
price of $83 million, we expect the net cash proceeds from the sale, before deducting transaction
related fees and expenses, to be approximately $57 million. We intend to use such cash proceeds as
follows:  
    approximately $17.7 million for the repayment in full of a bank line of credit;
    approximately $6 million to purchase certain assets from Standard Life at closing pursuant to the Agreement;
    approximately $4.3 million for professional fees (investment bankers, attorneys,
accountants) and miscellaneous other expenses (filing fees, printing and mailing proxy
materials, prepayment penalties, severance payments, etc.);
    approximately $1 million to fund incentive payments in connection with obtaining the
consent of the trust preferred holders;
    $.5 million to reduce the principal amount outstanding under the mortgage on our
corporate headquarters (paid March 21, 2005); and
    the remaining approximately $27.5 million as working capital to support and expand our
health services business, including through selected strategic acquisitions. In addition, we anticipate that Standard Life, after the sale, will continue to lease space
from us at our corporate headquarters for at least three years for $480,000 per year. We also
anticipate receiving $350,000 of annual dividends under the $5 million of newly issued 7% perpetual
-cumulative exchangeable preferred stock we expect to receive as partial consideration in our sale of Standard Life. 21




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   Estimated Cash Required in 2005 The Company has estimated required interest payments of $3.1 million and estimated required
principal payments of $2.9 million for the remainder of 2005 related to our mortgages payable,
promissory notes, notes payable and subordinated debentures. As of March 31, 2005, the Company was in violation of two financial covenants (debt leverage
and intercompany debt) under our senior secured credit facility. The balance of this indebtedness
on March 31, 2005 was $18 million. We have obtained waivers of the covenants through the earlier
of: i) the sale of Standard Life or ii) September 30, 2005. Cash Flows Our net cash used in operating activities during the first quarter of 2005 was $4.7 million
compared to cash used in operating activities of $4.9 million in the first quarter of 2004. The
net cash used in operating activities is mainly attributable to expenses associated with the continued
development of U. S. Health Services operating platform, as well as interest expense and salary
expense at the holding company level. Our net cash used in investing activities during the first quarter of 2005 was $0 compared to
cash used in investing activities of $1.3 million in the first quarter of 2004. Our net cash inflow from financing activities during the first quarter of 2005 was $4.0
million compared to net cash inflow from financing activities of $7.1 million in the first quarter
of 2004. The net cash inflow is mainly attributable to increased borrowings under our new
convertible notes and due to borrowings and cash received from our discontinued operations
partially offset by repayments on our long-term debt. Contractual Obligations:During the first quarter of 2005, there were no significant
changes in our reported payments due under contractual obligations at December 31, 2004. Off-Balance Sheet Arrangements:We have no off-balance sheet arrangements. Liquidity of Discontinued Operation  Financial Services The principal capital 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 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 July 2004, Standard Life received a rating from A.M. Best of (B),
or fair with a stable outlook, a one-category reduction from its previous rating of (B+), or
very good. The policies and annuities issued by Standard Life contain provisions that allow certain
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 NAIC as modified by the
Indiana Department of Insurance, or the states 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 2005 none of our products caused a statutory loss in the year written. Absent the
sale of Standard Life, 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 2005. As of March 31, 2005, Standard Life had statutory capital and surplus
for regulatory purposes of $68 million. Net cash outflow from operations on a statutory basis of
Standard Life, after payment of benefits and operating expenses, was
$29.4 million during the first three
months of 2005. The decrease is primarily due to a decline in annuity premium deposits and an
increase in surrenders. 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 The principal capital 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 1) cash flow from pharmaceutical sales, 2) internal borrowings from Standard
Management and external borrowings, and 3) capital contributions from Standard Management. The
capital requirements of our Health Services segment have significantly exceeded revenues 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 2005. Therefore, this segment is expected
to continue to fund its cash needs through the proceeds of the sale of Standard Life, external
borrowings and capital contributions from Standard Management. See Liquidity of Standard
Management (Parent Company)  Potential Cash Available for 2005 above. 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 that support
distributions made on the trust preferred securities (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 business. 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 satisfy the contractual conditions necessary to consummate the sale of
Standard Life.
    The ability of our management team to successfully operate a health services business
with the limited experience in that industry.
    Our ability to expand our health services business both organically and through
acquisitions, including our ability to identify suitable acquisition candidates, acquire
them at favorable prices and successfully integrate them into our business.
    General economic conditions and other factors, including prevailing interest rate
levels, and stock market performance, which may affect our ability to obtain additional
capital when needed and on favorable terms.
    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.
    Increasing competition in the sale of our products.
    The risk factors or uncertainties listed from time to time in our Annual Report on Form
10-K for the year ended December 31, 2004 and any document incorporated by reference
herein. This Quarterly Report on Form 10-Q also contains forward-looking statements specifically
relating to our insurance business. If the proposed sale of Standard life is not consummated and
we continue to operate in the financial services sector, the following additional factors may cause
actual results to differ from those contemplated by the forward-looking statement:  
    Mortality, morbidity and other factors which may affect the profitability of our
insurance 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.
    Changes in the federal income tax laws and regulation which may affect the relative tax
advantages of some of our products. We
caution you that, while forward-looking statements reflect our good faith beliefs, these
statements are not guarantees of future performance. In addition, we disclaim any obligation to
publicly update or revise any forward-looking statement, whether as a result of new information,
future events or otherwise, except as required by law. 
 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 Annual Report on Form 10-K for the year ended
December 31, 2004. There have been no material changes in 2005 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, 2005 (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. 24




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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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS On March 21, 2005, Standard Management issued a $4.75 million Secured Convertible Term Note
due on or before March 21, 2008 (the Note). A summary of the material terms of the Securities
Purchase Agreement, the Note, the warrant attached to the Note (the Warrant) and the registration
rights agreement is described in the Companys Current Report on Form 8-K filed on March 25, 2005.
Additional warrants were issued to advisors in the above transaction that allows the holders to
purchase 175,000 shares of our common stock at an exercise price of $3.28 per share and 30,619
shares of our common stock at an exercise price of $3.90 per share. On November 30, 2004, we issued $2.75 million of our 6% mandatory unsecured convertible notes
due 2008. The notes are convertible at a price equal to $3.28 per share at any time at the
holders option subject to certain conditions. The issuance and sale of the notes were made in
reliance on the exemption from registration provided in Regulation D, Rule 506 under Section 4(2)
of the Securities Act as a transaction by an issuer not involving a public offering. The notes were
acquired by two accredited investors for investment with no view toward the resale or distribution
thereof. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits  2.1
    Stock and Asset Purchase Agreement, dated February 9, 2005, by and between Standard
Management Corporation and Capital Assurance Corporation (incorporated by reference to
Current Report on Form 8-K filed on February 14, 2005).4.1
    Securities Purchase Agreement, dated March 21, 2005, between Standard Management
Corporation and Laurus Master Fund, Ltd., including the form of Secured Convertible Term
Note and Warrant (incorporated by reference to Current Report on Form 8-K filed on March
25, 2005).4.2
    Registration Rights Agreement, dated March 21, 2005, between Standard Management
Corporation and Laurus Master Fund, Ltd. (incorporated by reference to Current Report on
Form 8-K filed on March 25, 2005).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 On March 25, 2005 we filed a report on Form 8-K with the Commission related to issuance of a $4.75
million Secured Convertible Term Note due on or before March 21, 2008. On March 25, 2005 we filed a report on Form 8-K with the Commission related to the release of our
financial results for the fourth quarter 2004. On February 14, 2005 we filed a report on Form 8-K with the Commission related to a signed
definitive agreement to sell our life insurance subsidiary Standard Life Insurance Company of
Indiana. On February 3, 2005 we filed a report on Form 8-K with the Commission related to the resignation of
Robert J. Salyers, a non-management director of Standard Management Corporation. 25




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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES   On January 21, 2005 we filed a report on Form 8-K with the Commission related to the termination of
the Stock Purchase Agreement dated August 13, 2004 whereby it was to acquire all of the outstanding
capital stock of iCare Medical Supply, Inc. On January 20, 2005 we filed a report on Form 8-K with the Commission related to the termination of
the Merger Agreement whereby we were to acquire all of the outstanding capital stock of SVS Vision
Holding Company. 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 16, 2005
    
    STANDARD MANAGEMENT CORPORATION(Registrant)By: /s/ Ronald D. HunterRonald D. HunterChairman of the Board andChief Executive Officer(Principal Executive Officer)By: /s/ Michael B. EdwardsMichael B. EdwardsVice President and Corporate Controller(Chief Accounting Officer)
 27