##### Table of Contents



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 June 30, 2004oro
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934
 Commission file number: 0-20882 Standard Management Corporation  Indiana
    
    No. 35-1773567(State or other jurisdiction
    
    (I.R.S. Employer Identification No.)of incorporation or organization)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 August 2, 2004, the Registrant had 7,931,113 shares of Common Stock
outstanding.




---



STANDARD MANAGEMENT CORPORATION INDEX Page NumberPart I.
    
    FINANCIAL INFORMATION:Item 1.
    
    Financial StatementsConsolidated Balance Sheets 
June 30, 2004 (Unaudited) and December 31, 2003 (Audited)
    
    
    3Consolidated Statements of Income 
For the Three Months and Six Months Ended June 30, 2004 and 2003 (Unaudited)
    
    
    4Consolidated Statements of Shareholders Equity 
For the Six Months Ended June 30, 2004 and 2003 (Unaudited)
    
    
    5Consolidated Statements of Cash Flows 
For the Six Months Ended June 30, 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
    
    
    28Item 4.
    
    Controls and Procedures
    
    
    28Part II.
    
    OTHER INFORMATION:Item 1.
    
    Legal Proceedings
    
    
    29Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    29SIGNATURES
    
    
    30EX-31.1 SECTION 302 CERTIFICATION OF THE CHAIRMAN & CEOEX-31.2 SECTION 302 CERTIFICATION OF THE PRESIDENT/CFOEX-32 SECTION 906 CERTIFICATION OFTHE CHAIRMAN/CEO/PRESIDENT/CFO
  2




---



##### Table of Contents



PART I  FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 June 30
    
    December 312004
    
    2003(Unaudited)
    
    (Audited)ASSETSInvestments:Securities available for sale:Fixed maturity securities, at fair value (amortized cost $1,683,869 in 2004
and $1,638,048 in 2003)
    
    $
    1,660,329
    
    
    $
    1,644,837Mortgage loans on real estate
    
    
    1,822
    
    
    
    3,937Policy loans
    
    
    11,613
    
    
    
    12,308Real estate
    
    
    929
    
    
    
    943Equity-indexed call options
    
    
    11,393
    
    
    
    19,711Other invested assets
    
    
    1,278
    
    
    
    2,690Short-term investments
    
    
    588
    
    
    
    590Total investments
    
    
    1,687,952
    
    
    
    1,685,016Cash and cash equivalents
    
    
    2,968
    
    
    
    17,296Accrued investment income
    
    
    16,540
    
    
    
    17,002Amounts due and recoverable from reinsurers
    
    
    35,177
    
    
    
    36,277Deferred policy acquisition costs
    
    
    173,692
    
    
    
    166,411Present value of future profits
    
    
    20,012
    
    
    
    16,508Goodwill and intangibles
    
    
    9,053
    
    
    
    10,961Property and equipment (less accumulated depreciation of $6,167 in 2004 and $5,286 in
2003)
    
    
    12,205
    
    
    
    12,770Federal income tax recoverable
    
    
    2,046
    
    
    
    6,429Deferred income taxes
    
    
    5,340
    
    
    
    Other assets
    
    
    7,223
    
    
    
    5,201Total assets
    
    $
    1,972,208
    
    
    $
    1,973,871LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Insurance policy liabilities
    
    $
    1,859,202
    
    
    $
    1,841,545Accounts payable and accrued expenses
    
    
    8,584
    
    
    
    7,217Obligations under capital lease
    
    
    296
    
    
    
    551Mortgage payable
    
    
    6,705
    
    
    
    6,795Notes payable
    
    
    24,373
    
    
    
    21,000Deferred income taxes
    
    
    
    
    
    
    3,616Payable to subsidiary trust issuer of company-obligated trust preferred
securities
    
    
    20,700
    
    
    
    20,700Total liabilities
    
    
    1,919,860
    
    
    
    1,901,424Shareholders Equity:Common stock and additional paid in capital, no par value:Authorized 20,000,000 shares; issued 9,446,191 in 2004 and 9,629,167 in
2003
    
    
    64,370
    
    
    
    68,078Treasury stock, at cost, 1,515,078 shares in 2004 and 2003
    
    
    (7,671
    )
    
    
    (7,671
    )Accumulated other comprehensive income (loss)
    
    
    (9,455
    )
    
    
    2,702Retained earnings
    
    
    5,104
    
    
    
    9,338Total shareholders equity
    
    
    52,348
    
    
    
    72,447Total liabilities and shareholders equity
    
    $
    1,972,208
    
    
    $
    1,973,871
 See accompanying notes to consolidated financial statements. 3




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME
  Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003Revenues:Premium income
    
    $
    1,827
    
    
    $
    2,424
    
    
    $
    4,362
    
    
    $
    4,301Net investment income
    
    
    20,625
    
    
    
    20,623
    
    
    
    42,095
    
    
    
    41,769Call option income
    
    
    131
    
    
    
    6,087
    
    
    
    1,329
    
    
    
    2,989Net realized investment gain
    
    
    129
    
    
    
    8,347
    
    
    
    226
    
    
    
    18,274Policy income
    
    
    4,246
    
    
    
    2,740
    
    
    
    7,620
    
    
    
    4,973Sales of goods
    
    
    1,841
    
    
    
    739
    
    
    
    3,492
    
    
    
    1,431Fees and other income
    
    
    131
    
    
    
    497
    
    
    
    240
    
    
    
    846Total revenues
    
    
    28,930
    
    
    
    41,457
    
    
    
    59,364
    
    
    
    74,583Benefits and expenses:Benefits and claims
    
    
    1,950
    
    
    
    3,246
    
    
    
    4,285
    
    
    
    5,600Interest credited to interest-sensitive annuities and other financial products
    
    
    13,773
    
    
    
    21,123
    
    
    
    28,976
    
    
    
    32,774Amortization and depreciation
    
    
    7,573
    
    
    
    4,896
    
    
    
    13,302
    
    
    
    8,991Amortization  net realized investment gains
    
    
    44
    
    
    
    3,837
    
    
    
    565
    
    
    
    9,692Other operating expenses
    
    
    5,198
    
    
    
    5,375
    
    
    
    11,048
    
    
    
    9,674Cost of goods sold
    
    
    1,363
    
    
    
    442
    
    
    
    2,564
    
    
    
    1,242Interest expense and financing costs
    
    
    1,085
    
    
    
    989
    
    
    
    2,102
    
    
    
    2,014Total benefits and expenses
    
    
    30,986
    
    
    
    39,908
    
    
    
    62,842
    
    
    
    69,987Income (loss) before federal income tax expense
    
    
    (2,056
    )
    
    
    1,549
    
    
    
    (3,478
    )
    
    
    4,596Federal income tax expense
    
    
    411
    
    
    
    517
    
    
    
    756
    
    
    
    1,554Net income (loss)
    
    
    (2,467
    )
    
    $
    1,032
    
    
    $
    (4,234
    )
    
    $
    3,042Earnings per share:Basic
    
    $
    (.31
    )
    
    $
    .13
    
    
    $
    (.53
    )
    
    $
    .38Diluted
    
    
    (.31
    )
    
    
    .13
    
    
    
    (.53
    )
    
    
    .38
 See accompanying notes to consolidated financial statements. 4




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
  Commonstock and
    
    
    
    
    
    Accumulatedadditional
    
    
    
    
    
    otherpaid in
    
    Treasury
    
    comprehensive
    
    RetainedTotal
    
    capital
    
    stock
    
    income (loss)
    
    earningsBalance at January 1, 2003
    
    $
    87,734
    
    
    $
    63,857
    
    
    $
    (7,671
    )
    
    $
    11,739
    
    
    $
    19,809Comprehensive income:Net income
    
    
    3,042
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,042Other comprehensive income:Change in unrealized gain on
securities,
net of taxes of $3,854
    
    
    7,290
    
    
    
    
    
    
    
    
    
    
    
    7,290
    
    
    
    Comprehensive income
    
    
    10,332
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock and warrants
    
    
    3,999
    
    
    
    3,999
    
    
    
    
    
    
    
    
    
    
    
    Balance at June 30, 2003
    
    $
    102,065
    
    
    $
    67,856
    
    
    $
    (7,671
    )
    
    $
    19,029
    
    
    $
    22,851Balance at January 1, 2004
    
    $
    72,447
    
    
    $
    68,078
    
    
    $
    (7,671
    )
    
    $
    2,702
    
    
    $
    9,338Comprehensive loss:Net loss
    
    
    (4,234
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,234
    )Other comprehensive loss:Change in unrealized loss on
securities, net of
tax of $(6,314)
    
    
    (12,157
    )
    
    
    
    
    
    
    
    
    
    
    (12,157
    )
    
    
    Comprehensive loss
    
    
    (16,391
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock
    
    
    294
    
    
    
    294
    
    
    
    
    
    
    
    
    
    
    
    Exercise of common stock options and warrants
    
    
    (2
    )
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    Repurchase of MCO
    
    
    (4,000
    )
    
    
    (4,000
    )
    
    
    
    
    
    
    
    
    
    
    Balance at June 30, 2004
    
    $
    52,348
    
    
    $
    64,370
    
    
    $
    (7,671
    )
    
    $
    (9,455
    )
    
    $
    5,104
 See accompanying notes to consolidated financial statements. 5




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Six Months EndedJune 302004
    
    2003Operating ActivitiesNet income (loss)
    
    $
    (4,234
    )
    
    $
    3,042Adjustments to reconcile net income to net cash provided by operating
activities:Amortization of deferred acquisition costs
    
    
    12,716
    
    
    
    17,889Deferral of acquisition costs
    
    
    (11,792
    )
    
    
    (25,124
    )Federal income taxes
    
    
    (364
    )
    
    
    (4,377
    )Depreciation and amortization
    
    
    571
    
    
    
    683Insurance policy liabilities
    
    
    23,737
    
    
    
    27,084Net realized investment gains
    
    
    (1,144
    )
    
    
    (18,274
    )Net accrual of bond discount
    
    
    5,249
    
    
    
    3,014Accrued investment income
    
    
    462
    
    
    
    3Other
    
    
    1,741
    
    
    
    517Net cash provided by operating activities
    
    
    26,932
    
    
    
    4,457Investing ActivitiesFixed maturity securities available for sale:Purchases
    
    
    (389,664
    )
    
    
    (1,032,774
    )Sales
    
    
    250,644
    
    
    
    695,099Maturities, calls and redemptions
    
    
    90,936
    
    
    
    142,692Short-term investments, net
    
    
    18,091
    
    
    
    (4,924
    )Purchase of assets
    
    
    (1,809
    )
    
    
    Other investments, net
    
    
    (5,869
    )
    
    
    1,861Net cash used by investing activities
    
    
    (37,671
    )
    
    
    (198,046
    )Financing ActivitiesBorrowings
    
    
    3,300
    
    
    
    2,167Repayments of notes payable and preferred stock
    
    
    (591
    )
    
    
    Premiums received on interest-sensitive and other financial products
credited to policyholder account balances, net of premiums ceded
    
    
    135,888
    
    
    
    250,016Return of policyholder account balances on interest-sensitive
annuities and other
financial products
    
    
    (142,186
    )
    
    
    (104,341
    )Net cash provided (used) by financing activities
    
    
    (3,587
    )
    
    
    147,842Net decrease in cash
    
    
    (14,328
    )
    
    
    (45,747
    )Cash and cash equivalents at beginning of year
    
    
    17,296
    
    
    
    60,197Cash and cash equivalents at end of period
    
    $
    2,968
    
    
    $
    14,450
 See accompanying notes to consolidated financial statements. 6




---



##### Table of Contents



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. Effective April 1, 2004, we sold Medical Care & Outcomes, LLC (MCO) back
to its original owners. We recognized a loss on the sale of MCO of $964,000 in
the first quarter of 2004 in the Health Services segment. MCO was originally
purchased with $4 million of common stock and other contingent consideration.
The divestiture of MCO resulted in the reversal of the original $4 million
purchase price and resulted in a decrease to equity of $4 million in the second
quarter of 2004. 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 academic institutions, skilled nursing
facilities, assisted living facilities, home health care agencies, mental
health facilities and consumers. 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 holding company operations and financing costs. 7




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1  Basis of Presentation (Continued) Use of Estimates The nature of our 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. 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
    
    June 30
    
    December 31Rate (1)
    
    2004
    
    2003Mortgage payable
    
    
    7.326
    %
    
    $
    6,705
    
    
    $
    6,795Notes payable:Senior secured credit agreement
    
    
    5.92
    %
    
    
    19,500
    
    
    
    20,000Promissory notes
    
    
    2.52
    %
    
    
    1,573
    
    
    
    1,000Convertible notes
    
    
    7.00
    %
    
    
    3,300
    
    
    
    $
    24,373
    
    
    $
    21,000Trust preferred securities
    
    
    10.25
    %
    
    $
    20,700
    
    
    $
    20,700
  (1)
    
    Current weighted average rate at June 30, 2004. As of June 30, 2004, the Company was in violation of one financial covenant
(debt leverage) under our senior secured credit agreement. The balance of this
indebtedness at June 30, 2004 was $19.5 million. We have obtained from the
lender a waiver of this covenant through March 31, 2005. The Company
anticipates being in compliance on or before March 31, 2005. Note 3  Net Unrealized Gain (Loss) on Securities Available for Sale The components of the net unrealized gain (loss) on securities available
for sale in shareholders equity are summarized as follows (dollars in
thousands): June 30
    
    December 312004
    
    2003Fair value of securities available for sale
    
    $
    1,660,329
    
    
    $
    1,644,837Amortized cost of securities available for sale
    
    
    1,683,869
    
    
    
    1,638,048Gross unrealized gain (loss) on securities available for sale
    
    
    (23,540
    )
    
    
    6,789Adjustments for:Deferred policy acquisition costs
    
    
    6,136
    
    
    
    (1,313
    )Present value of future profits
    
    
    3,146
    
    
    
    (1,114
    )Deferred federal income tax benefits
    
    
    4,802
    
    
    
    (1,512
    )Other
    
    
    1
    
    
    
    (148
    )Net unrealized gain (loss) on securities available for sale
    
    $
    (9,455
    )
    
    $
    2,702
 8




---



##### Table of Contents



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 Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003Income (loss):Net income (loss)  basic and diluted earnings per share
    
    $
    (2,467
    )
    
    $
    1,032
    
    
    $
    (4,234
    )
    
    $
    3,042Shares:Weighted average shares outstanding for basic earnings per share
    
    
    7,923,335
    
    
    
    8,057,089
    
    
    
    8,018,891
    
    
    
    7,963,694Effect of dilutive securities:Stock options
    
    
    
    
    
    
    75,422
    
    
    
    
    
    
    
    40,365Stock warrants
    
    
    
    
    
    
    32,959
    
    
    
    
    
    
    
    28,695Dilutive potential common shares
    
    
    
    
    
    
    108,381
    
    
    
    
    
    
    
    69,060Weighted average shares outstanding for diluted earnings per
share
    
    
    7,923,335
    
    
    
    8,165,470
    
    
    
    8,018,891
    
    
    
    8,032,754
 Note 5  Stock Option Plan During the three months ended June 30, 2004, under our 2002 Stock
Incentive Plan, we granted options to purchase 155,000 shares of common stock
at a weighted average exercise price of $3.72 per share. 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 and six months ended June 30 (in thousands, except
per share amounts): 9




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 5  Stock Option Plan (Continued) Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003Reported net income (loss)
    
    $
    (2,467
    )
    
    $
    1,032
    
    
    $
    (4,234
    )
    
    $
    3,042Add: 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
    
    
    105
    
    
    
    205
    
    
    
    190
    
    
    
    249Pro forma net income (loss)
    
    $
    (2,572
    )
    
    $
    827
    
    
    $
    (4,424
    )
    
    $
    2,793Earnings per share:Basic  as reported
    
    $
    (.31
    )
    
    $
    .13
    
    
    $
    (.53
    )
    
    $
    .38Basic  pro forma
    
    
    (.32
    )
    
    
    .10
    
    
    
    (.55
    )
    
    
    .35Diluted  as reported
    
    
    (.31
    )
    
    
    .13
    
    
    
    (.53
    )
    
    
    .38Diluted  pro forma
    
    
    (.32
    )
    
    
    .10
    
    
    
    (.55
    )
    
    
    .35
 Note 6  Subsequent Event On August 2, 2004, the Company announced that it has, through its U.S.
Health Services subsidiary, signed a definitive agreement to acquire SVS Vision
Holding Company (SVS Vision) for $16 million in cash. SVS Vision is a fully
integrated vision network consisting of an insurance entity, manufacturing
facilities, 52 retail outlets, and is affiliated with over 500 doctors in the
United States. SVS Vision has annual revenues of approximately $35 million with
approximately $4 million in earnings before interest, taxes, depreciation, and
amortization, and has a 31-year track record in the optical industry. This
transaction is expected to close in the third quarter subject to regulatory
approval and other conditions. The Company anticipates funding the purchase
price with a combination of cash on hand, the net proceeds of private sales of
equity or debt securities, a portion of the proceeds from the sale of certain
assets of the Company and/or borrowings under a new credit facility currently
being negotiated. We previously reported that 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. We have subsequently ceased negotiations on the definitive
agreements for that transaction and on July 23, 2004, we entered into a new,
non-binding letter of intent with one of the parties to the April 19 letter of
intent. The new letter of intent contemplates transactions designed to
ultimately result in the sale of Standard Life by December 31, 2004. An
initial closing would be held by September 30, 2004 and thereafter, the
proposed buyer would have the option to acquire all of the stock of Standard
Life by December 31, 2004. 10




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS Recent Developments Letter
of Intent We previously reported that 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. We have subsequently ceased negotiations on the definitive
agreements for that transaction and on July 23, 2004, we entered into a new,
non-binding letter of intent with one of the parties to the April 19 letter of
intent. The new letter of intent contemplates transactions designed to
ultimately result in the sale of Standard Life by December 31, 2004. An
initial closing would be held by September 30, 2004 and thereafter, the
proposed buyer would have the option to acquire all of the stock of Standard
Life by December 31, 2004. The proposed consideration would consist principally of cash but also an
equity interest in an entity formed by the proposed buyer for the purpose of
acquiring Standard Life. The closing of the transactions would be subject to
numerous conditions including the negotiation and execution of definitive
agreements, approval of our shareholders at a meeting called for such purpose,
receipt by us of an opinion from our financial advisor that the proposed
consideration is fair to us from a financial point of view, 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 definitive agreements with respect to the
transactions will be entered into, that our shareholders will approve the sale
of Standard Life or that any of the other conditions necessary to consummate
the proposed transactions will be satisfied. However, if the proposed
transactions are consummated, it is the intention of management, as previously
stated in connection with the April 19 letter of intent, 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 transactions are consummated, our business
without the Financial Services segment would, for a time, have significantly
less cash flow from operations, since our financial services business presently
accounts for substantially all of our cash flow from operations. However, we
anticipate that the transactions will produce substantial cash proceeds and
management intends to utilize a significant (but not yet determined) portion of
the net cash proceeds from the proposed transactions for the expansion of our
health services business and anticipates 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 from the transaction to reduce by
at least $10 million our senior credit facility and for general
corporate purposes. In the event the proposed transactions are 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. Acquisition of SVS Vision On August 2, 2004, the Company announced that it has, through its U.S.
Health Services subsidiary, signed a definitive agreement to acquire SVS Vision
Holding Company (SVS Vision) for $16 million in cash. SVS Vision is a fully
integrated vision network consisting of an insurance entity, manufacturing
facilities, 52 retail outlets, and is affiliated with over 500 doctors in the
United States. SVS Vision has annual revenues of approximately $35 million with
approximately $4 million in earnings before interest, taxes, depreciation, and
amortization, and has a 31-year track record in the optical industry. This
transaction is expected to close in the third quarter subject to regulatory
approval and other conditions. The acquisition of SVS Vision is a part of the
Companys plan to enhance its health services operations. The Company
anticipates funding the purchase price with a combination of cash on hand, the
net proceeds of private sales of equity or debt securities, a portion of the
proceeds from the sale of certain assets of the Company and/or borrowings under
a new credit facility currently being negotiated. 11




---



##### Table of Contents



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 and Six Month Periods Ended June 30, 2004 and
June 30, 2003: The following table summarizes the results of our operations (dollars in
thousands): Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003Income (loss) before federal income tax expense
    
    $
    (2,056
    )
    
    $
    1,549
    
    
    $
    (3,478
    )
    
    $
    4,596Federal income tax expense
    
    
    411
    
    
    
    517
    
    
    
    756
    
    
    
    1,554Net income (loss)
    
    $
    (2,467
    )
    
    $
    1,032
    
    
    $
    (4,234
    )
    
    $
    3,042
 Consolidated Results and Analysis: For the quarter ended June 30, 2004, net loss was $2.5 million compared to
net income of $1.0 million for the 2003 quarter. Financial Services: Net income for the current quarter was $.8 million compared to $2.7
million for the 2003 quarter. The decline in net income was primarily due to a
decline in net realized gains of $4.4 million (net of amortization) partially
offset by an increase in the current quarters spread income and
favorable mortality experience. Health Services: Net loss for the current quarter was $2.2 million compared to a $.9
million net loss for the 2003 quarter. The 2004 quarter included increased
expenses associated with the continued development of this segments operating
platform of $.2 million, amortization of
intangible assets of $.1 million and a tax valuation of $.7 million. Other Services: Net loss for the current quarter was $1.0 million compared to a $.8 million
net loss for the 2003 quarter. 12




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Financial Services: Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003(Dollars in thousands)
    
    (Dollars in thousands)Premiums and Deposits Collected:Deferred annuities
    
    $
    13,205
    
    
    $
    41,155
    
    
    $
    25,512
    
    
    $
    90,430Single premium immediate annuities and other
deposits
    
    
    34,176
    
    
    
    46,721
    
    
    
    70,160
    
    
    
    85,230Equity-indexed annuities
    
    
    17,887
    
    
    
    38,622
    
    
    
    41,414
    
    
    
    75,513Universal and interest-sensitive life
    
    
    130
    
    
    
    146
    
    
    
    263
    
    
    
    298Subtotal
 interest-sensitive and other
financial products
    
    
    65,398
    
    
    
    126,644
    
    
    
    137,349
    
    
    
    251,471Traditional
life
    
    
    1,827
    
    
    
    2,424
    
    
    
    4,362
    
    
    
    4,301Total premiums and deposits collected
    
    $
    67,225
    
    
    $
    129,068
    
    
    $
    141,711
    
    
    $
    255,772Statement of Operations:Revenues:Premium income
    
    $
    1,827
    
    
    $
    2,424
    
    
    $
    4,362
    
    
    $
    4,301Policy income
    
    
    4,246
    
    
    
    2,740
    
    
    
    7,620
    
    
    
    4,973Net investment income
    
    
    20,633
    
    
    
    20,587
    
    
    
    42,071
    
    
    
    41,730Net investment income  affiliated
    
    
    95
    
    
    
    55
    
    
    
    149
    
    
    
    113Call option gain
    
    
    131
    
    
    
    6,087
    
    
    
    1,329
    
    
    
    2,989Fees and other income
    
    
    124
    
    
    
    21
    
    
    
    225
    
    
    
    143Net realized investment
gain
    
    
    129
    
    
    
    8,346
    
    
    
    1,190
    
    
    
    18,274Total revenues
    
    
    27,185
    
    
    
    40,260
    
    
    
    56,946
    
    
    
    72,523Benefits and expenses:Benefits and claims
    
    
    2,007
    
    
    
    3,246
    
    
    
    4,297
    
    
    
    5,600Interest
credited to interest-sensitive
annuities and other financial products
    
    
    13,691
    
    
    
    21,123
    
    
    
    28,894
    
    
    
    32,774Amortization
    
    
    6,421
    
    
    
    4,172
    
    
    
    12,150
    
    
    
    8,196Amortization  net realized investment gains
    
    
    44
    
    
    
    3,838
    
    
    
    565
    
    
    
    9,693Operating expenses
    
    
    1,960
    
    
    
    1,938
    
    
    
    4,368
    
    
    
    3,916Operating expenses  affiliated
    
    
    1,456
    
    
    
    1,363
    
    
    
    2,912
    
    
    
    2,727Interest expense and financing costs  affiliated
    
    
    402
    
    
    
    421
    
    
    
    806
    
    
    
    844Total benefits and expenses
    
    
    25,981
    
    
    
    36,101
    
    
    
    53,992
    
    
    
    63,750Income before federal income tax expense
    
    
    1,204
    
    
    
    4,159
    
    
    
    2,954
    
    
    
    8,773Federal income tax expense
    
    
    411
    
    
    
    1,413
    
    
    
    1,006
    
    
    
    2,981Net income
    
    $
    793
    
    
    $
    2,746
    
    
    $
    1,948
    
    
    $
    5,792
 13




---



##### Table of Contents



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 credited 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 three and six months ended
June 30: Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003Net investment yield on invested assets
    
    
    4.86
    %
    
    
    5.26
    %
    
    
    4.99
    %
    
    
    5.52
    %Weighted average effective crediting rate
    
    
    3.15
    
    
    
    3.89
    
    
    
    3.22
    
    
    
    3.98Investment spread
    
    
    1.71
    
    
    
    1.37
    
    
    
    1.77
    
    
    
    1.54
 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. Quarterly analysis:  
    
    Premium deposits for interest-sensitive and other financial
products for the second quarter of 2004 decreased $61.2
million or 48%, to $65.4 million compared to the second
quarter of 2003. Deferred annuities decreased $28.0 million
or 68%, to $13.2 million. Deposits from equity-indexed
annuities decreased $20.7 million or 54%, to $17.9 million.
Single premium immediate annuities decreased $12.5 million or
27%, to $34.2 million. Premium deposits decreased in the
second quarter of 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. Year-to-date analysis:  
    
    Premium deposits for interest-sensitive and other financial
products for the first six months of 2004 decreased $114.1
million or 45%, to $137.3 million compared to the first six
months of 2003. Deferred annuities decreased $64.9 million or
72%, to $25.5 million. Deposits from equity-indexed annuities
decreased $34.1 million or 45%, to $41.4 million. Single
premium immediate annuities decreased $15.1 million or 18%, to
$70.2 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. Quarterly analysis:  
    
    Premium income for the second quarter of 2004 decreased $.6 million or
25%, to $1.8 million compared to the second quarter of 2003, as a result
of decreased deposits from ordinary life products and supplemental
contracts with life contingencies. 14




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Year-to-date analysis:  
    
    Premium income for the first six months of 2004 increased $.1 million or
1%, to $4.4 million compared to the first six months of 2003. 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. Quarterly analysis:  
    
    Policy income for the second quarter of 2004 increased $1.5
million or 55%, to $4.2 million compared to the second 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 annuity products. The
increase in annuity surrenders generates greater surrender
income from early termination charges associated with these
products. Year-to-date analysis:  
    
    Policy income for the first six months of 2004 increased $2.6
million or 53%, to $7.6 million compared to the first six
months 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 annuity 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. Quarterly analysis:  
    
    Net investment income for the second quarter of 2004 increased
$.1 million to $20.6 million compared to the second quarter of
2003. Net investment income increased as a result of a $135.4
million, or 8.9%, 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
4.86% for the second quarter of 2004, compared to 5.26% for
the second 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. Year-to-date analysis:  
    
    Net investment income for the first six months of 2004
increased $.3 million or 1%, to $42.1 million compared to the
first six months of 2003. Net investment income increased as a
result of a $155.5 million, or 10.2%, 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 4.99% for the first six months of 2004,
compared to 5.52% for the first six months 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. 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. 15




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Quarterly analysis:  
    
    Call option income for the second quarter of 2004 decreased
$6.0 million to $.1 million compared to the second quarter of
2003. The call option income decrease resulted from changes
in the market value of our call options due to changes in the
S&P 500 Index and the DJIA Index. Year-to-date analysis:  
    
    Call option income for the first six months of 2004 decreased
$1.7 million to $1.3 million compared to the first six months
of 2003. The call option income decrease 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. Quarterly analysis:  
    
    Fees and other income for the second quarter of 2004 increased
$.1 million to $.1 million compared to the second quarter
2003. Year-to-date analysis:  
    
    Fees and other income for the first six months of 2004
increased $.1 million to $.2 million compared to the first six
months of 2003. Net realized investment gainfluctuates 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. Quarterly analysis:  
    
    Net realized investment gain for the second quarter of 2004
decreased $8.2 million to $.1 million, compared to the second
quarter of 2003. The decline was largely due to a strategy in 2003 to realize tax benefits from capital loss
carryforwards. Year-to-date analysis:  
    
    Net realized investment gain for the first six months of 2004
decreased $17.1 million to $1.2 million compared to the first
six months of 2003. The decline was largely due to a strategy in 2003 to realize tax benefits from capital loss
carryforwards.  
    
    Approximately 99% of our fixed maturity securities are classified as investment grade at June 30, 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. Quarterly analysis:  
    
    Benefits and claims for the second quarter of 2004 decreased
$1.2 million or 38%, to $2.0 million compared to the second
quarter of 2003. Year-to-date analysis:  
    
    Benefits and claims for the first six months of 2004 decreased
$1.3 million or 23%, to $4.3 million compared to the first six
months of 2003. 16




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 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. Quarterly analysis:  
    
    Interest credited in the second quarter of 2004 decreased $7.4
million or 35%, to $13.7 million compared to the second
quarter of 2003, of which $2.7 million related to
equity-indexed annuity products and the remaining $11.0
million related to all other interest-sensitive annuity and
life insurance products. Interest credited decreased $8.4
million due to the impact of less favorable market performance
on equity products. The decrease was offset by $3.0 million
due to an 11% increase in average interest sensitive
liabilities of $167.8 million compared to the second quarter
of 2003, partially reduced by $2.0 million of reductions due
to reduced crediting rates.  
    
    The weighted average credited rate on interest-sensitive
liabilities, including equity-indexed annuities, for the
second quarter of 2004 and 2003 was 3.18% and 5.51%,
respectively. The decrease in average credited rate was due to
the impact of less favorable 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
quarters were 3.15% and 3.89%, respectively, a reduction of
..74%. Year-to-date analysis:  
    
    Interest credited in the first six months of 2004 decreased
$3.9 million or 12%, to $28.9 million compared to the first
six months of 2003, of which $6.3 million related to
equity-indexed annuity products and the remaining $22.6
million related to all other interest-sensitive annuity and
life insurance products. Interest credited decreased $4.9
million due to the impact of less favorable market performance
on equity products. The decrease was offset by $4.6 million
due to a 13% increase in average interest sensitive
liabilities of $197.1 million compared to the first six months
of 2003, partially reduced by $3.6 million of reductions due
to reduced crediting rates.  
    
    The weighted average credited rate on interest-sensitive
liabilities, including equity-indexed annuities, for the first
six months of 2004 and 2003 was 3.38% and 4.39%, respectively.
The decrease in average credited rate was due to the impact of
less favorable 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 periods were
3.22% and 3.98%, respectively, a reduction of .76%. 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. Quarterly analysis:  
    
    Amortization for the second quarter of 2004 decreased $1.5
million or 19%, to $6.5 million compared to the second quarter
of 2003. This decrease primarily relates to lower net realized
gains of $8.2 million, which resulted in a decrease in
amortization of $3.8 million related to those gains offset by
a $2.3 million increase in amortization of DAC related costs. Year-to-date analysis:  
    
    Amortization for the six months of 2004 decreased $5.2 million
or 29%, to $12.7 million compared to the second quarter of
2003. This decrease primarily relates to lower net realized
gains of $17.1 million, which resulted in a decrease in
amortization of $9.1 million related to those gains offset by
a $3.9 million increase in amortization of DAC related costs. 17




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Operating expensesconsist of general operating expenses, including salaries,
net of deferrable amounts. Quarterly analysis:  
    
    Other operating expenses were $2.0 million for the second quarter 2004 compared to $1.9 million for 2003. Year-to-date analysis:  
    
    Other operating expenses for the first six months of 2004 increased $.5 million or 12%, to $4.4 million compared to
the first six months of 2003 due to increased salary expense. Operating expenses  affiliatedconsist of general operating expenses,
including rent and management fees paid to Standard Management and recorded in
the Other Services segment. Quarterly analysis:  
    
    Affiliated operating expenses for the second quarter 2004
increased $.1 million to $1.5 million compared to the second
quarter 2003. Year-to-date analysis:  
    
    Affiliated operating expenses increased $.2 million or 7% to
$2.9 million compared to the first six months of 2003 due to
increased rental expense. Interest expense and financing costs  affiliatedrepresents interest expense
incurred on the surplus debentures issued to Standard Management. Quarterly analysis:  
    
    Affiliated interest expense and financing costs were $.4 million for the second quarter 2004 and 2003, respectively. Year-to-date analysis:  
    
    Affiliated interest expense and financing costs were $.8 million for the second quarter 2004 and 2003, respectively. Federal income tax expense Quarterly analysis:  
    
    Federal income tax expense decreased $1.0 million to $.4
million compared to the second quarter of 2003. The effective
tax rate was 34% for the second quarter of 2004 and 2003. Year-to-date analysis:  
    
    Federal income tax expense decreased $2.0 million to $1.0
million compared to the first six months of 2003. The
effective tax rate was 34% for the first six months of 2004
and 2003. 18




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Health Services: Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003(Dollars in thousands)
    
    (Dollars in thousands)Statement of Operations:Sales
    
    $
    1,841
    
    
    $
    739
    
    
    $
    3,492
    
    
    $
    1,431Cost of goods sold
    
    
    1,363
    
    
    
    442
    
    
    
    2,564
    
    
    
    1,242Total gross margin
    
    
    478
    
    
    
    297
    
    
    
    928
    
    
    
    189Salaries
    
    
    1,381
    
    
    
    454
    
    
    
    2,487
    
    
    
    817Other operating expenses
    
    
    1,039
    
    
    
    1,147
    
    
    
    1,783
    
    
    
    1,438Other operating expenses   affiliated
    
    
    24
    
    
    
    
    
    
    
    47
    
    
    
    Amortization and depreciation
    
    
    227
    
    
    
    88
    
    
    
    443
    
    
    
    159Interest expense and financing costs
    
    
    15
    
    
    
    7
    
    
    
    29
    
    
    
    15Net realized investment loss
    
    
    
    
    
    
    
    
    
    
    964
    
    
    
    Total expenses
    
    
    2,686
    
    
    
    1,696
    
    
    
    5,753
    
    
    
    2,429Loss before income taxes
    
    
    (2,208
    )
    
    
    (1,399
    )
    
    
    (4,825
    )
    
    
    (2,240
    )Federal income tax benefit
    
    
    
    
    
    
    (475
    )
    
    
    
    
    
    
    (761
    )Net loss
    
    $
    (2,208
    )
    
    $
    (924
    )
    
    $
    (4,825
    )
    
    $
    (1,479
    )
 General:Our Health Services segment consists of revenues earned and expenses
incurred from our pharmaceutical operations. Our primary customer base
consists of academic institutions, mental health facilities and consumers. 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 Quarterly analysis:  
    
    Sales for the second quarter of 2004 increased $1.1 million or
149%, to $1.8 million compared to the second quarter of 2003,
primarily related to the acquisition of Apothecary Solutions
in February 2004. Year-to-date analysis:  
    
    Sales for the first six months of 2004 increased $2.1 million
or 144% to $3.5 million compared to the first six months of
2003, primarily related to the acquisition of Apothecary
Solutions. Total expenses Quarterly analysis:  
    
    Total expenses for the second quarter of 2004 increased $1.0
million or 58%, to $2.7 million compared to the second quarter
of 2003, primarily related to the acquisition of Apothecary
Solutions and expenses related to the continued development of
this segments selling and marketing platform. Year-to-date analysis:  
    
    Total expenses for the first six months of 2004 increased $3.3
million or 137%, to $5.7 million compared to the first six
months of 2003, primarily related to the acquisition of
Apothecary Solutions, the realized loss on the sale of MCO and
the continued development of this segments selling and
marketing platform. 19




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Net realized loss on investment Year-to-date analysis:  
    
    Net realized loss on investment for the first six months of
2004 increased $1.0 million compared to the first six months
of 2003 due to the sale of MCO. Federal income tax benefit Quarterly analysis:  
    
    Federal income tax benefit decreased $.5 million to zero,
compared to the second quarter of 2003 due to a 100%
valuation allowance on the net loss in 2004. Year-to-date analysis:  
    
    Federal income tax benefit decreased $.8 million to zero,
compared to the first six months of 2003 due to a 100%
valuation allowance on the net loss in 2004. Net loss Quarterly analysis:  
    
    Net loss for the second quarter of 2004 increased $1.3
million or 139%, to $2.2 million compared to the second
quarter of 2003. Net loss in the 2004 and 2003 periods is
due to additional salary expense and marketing costs
associated with the continued development of the Health
Services segments operating platform and infrastructure, as
well as ongoing concentrated marketing initiatives. Year-to-date analysis:  
    
    Net loss for the first six months of 2004 increased $3.3
million or 226%, to $4.8 million compared to the first six
months of 2003. Net loss in the 2004 and 2003 periods is
due to additional salary expense and marketing costs
associated with the continued development of the Health
Services segments operating platform and infrastructure, as
well as ongoing concentrated marketing initiatives. 20




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Other Services: Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003(Dollars in thousands)
    
    (Dollars in thousands)Statement of Operations:Operating income  affiliated
    
    $
    1,478
    
    
    $
    1,363
    
    
    $
    2,957
    
    
    $
    2,727Interest income  affiliated
    
    
    402
    
    
    
    422
    
    
    
    806
    
    
    
    844Fees and other income (loss)
    
    
    (145
    )
    
    
    51
    
    
    
    (177
    )
    
    
    (22
    )Total revenues
    
    
    1,735
    
    
    
    1,836
    
    
    
    3,586
    
    
    
    3,549Net investment expenses  affiliated
    
    
    95
    
    
    
    55
    
    
    
    149
    
    
    
    113Other operating expenses
    
    
    1,631
    
    
    
    1,935
    
    
    
    2,979
    
    
    
    3,375Interest expense and financing costs
    
    
    1,061
    
    
    
    981
    
    
    
    2,065
    
    
    
    1,998Total expenses
    
    
    2,787
    
    
    
    2,971
    
    
    
    5,193
    
    
    
    5,486Loss before income taxes
    
    
    (1,052
    )
    
    
    (1,135
    )
    
    
    (1,607
    )
    
    
    (1,937
    )Federal income tax benefit
    
    
    
    
    
    
    (345
    )
    
    
    (250
    )
    
    
    (666
    )Net loss
    
    $
    (1,052
    )
    
    $
    (790
    )
    
    $
    (1,357
    )
    
    $
    (1,271
    )
 General:Our Other Services segment consists of revenues and expenses primarily
related to holding company operations and financing costs. Operating income  affiliatedconsists of income from the Financial Services
segment related to management fees and rental income. Quarterly analysis:  
    
    Operating income  affiliated increased $.1 million or 8%, to
$1.5 million compared to the second quarter of 2003 due to
increased rental income. Year-to-date analysis:  
    
    Operating income  affiliated increased $.2 million or 8%, to
$3.0 million compared to the first six months 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. Quarterly analysis:  
    
    Interest income  affiliated was $.4 million in the second quarter 2004 and 2003. Year-to-date analysis:  
    
    Interest income  affiliated was $.8 million in the first six months of 2004 and 2003. 21




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES Net investment expenses  affiliatedrepresent interest expense paid to the
Financial Services segment. Other operating expensesconsist of holding company operating expenses,
including salaries. Quarterly analysis:  
    
    Other operating expenses decreased $.3 million or 16%, to $1.6
million compared to the second quarter of 2003 due to decreased salary
expense. Year-to-date analysis:  
    
    Other operating expenses decreased $.4 million or 12%, to $3.0
million compared to the first six months of 2003 due to decreased salary
expense. Interest expense and financing costsrepresents interest expense incurred and
the amortization of debt issuance costs. Quarterly analysis:  
    
    Interest expense and financing costs increased $.1 million or 8%, to
$1.1 million in the second quarter 2004 and 2003 due to additional debt
balances in 2004. Year-to-date analysis:  
    
    Interest expense and financing costs increased $.1 million or 3%, to
$2.0 million in the first six months of 2004 and 2003 due to additional
debt balances in 2004. Federal income tax benefit Quarterly analysis:  
    
    Federal income tax benefit decreased by $.3 million compared to the
second quarter of 2003 due to a 100% valuation allowance on the net loss
in 2004. Year-to-date analysis:  
    
    Federal income tax benefit decreased by $.4 million compared to the
first six months of 2003 due to a valuation allowance on a part of the
net loss in 2004. 22




---



##### Table of Contents



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 6.0% 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 Standard Life $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. 23




---



##### Table of Contents



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
June 30, 2004:  
    
    outstanding balance of $6.7 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 June 30, 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 June 30, 2004:
    
    outstanding balance of $19.5 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.As of June 30, 2004, the Company was in violation of one financial
covenant (debt leverage) under our senior secured credit agreement. The
balance of this indebtedness at June 30, 2004 was $19.5 million. We have
obtained from the lender a waiver of this covenant through March 31, 2005. The
Company anticipates being in compliance on or before March 31, 2005.The following are characteristics of our convertible notes at June 30, 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. 24




---



##### Table of Contents



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
June 30, 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 $26.9 million and $4.5 million for the first six months of 2004
and 2003, respectively, with increase in 2004 primarily due to a decrease in a deferral of acquisition
costs. At July 1, 2004, we had parent company only cash and short-term
investments of $.1 million that are available for general corporate purposes.
Annual parent company operating expenses (not including interest expense) were
$5.5 million for both 2003 and 2002. Contractual Obligations:During the first six months 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
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 . 25




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES 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. 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
2004, 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 June 30, 2004,
Standard Life had statutory capital and surplus for regulatory purposes of
$68.6 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 $7.5 million for the first six months of 2004 and $92.8
million for the first six months 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. In addition, we anticipate funding the purchase price for the SVS
Vision acquisition with a combination of cash on hand, the net proceeds of private sales of
equity or debt securities, a portion of the proceeds from the sale of certain
of our assets and/or borrowings under a new credit facility currently being
negotiated. As of June 30, 2004, our Health Services segment had equity of
$(9.8) million. 26




---



##### Table of Contents



STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES As discussed under Recent Developments, we have entered into a
non-binding letter of intent to sell our principal financial services
subsidiary and continue the business of Standard Management solely in the
health services sector. Substantially all of the Companys revenues and cash
flows have historically come from our financial services business. The
proposed sale is subject to a number of conditions as described under Recent
Developments and no assurance can be given that the proposed transaction will
be consummated. If it is consummated, however, and the Company continues
operations solely in the health services sector, the Company would, for a time,
have significantly less cash flow from operations. However, we anticipate that
the transaction will produce substantial cash proceeds and management intends
to utilize a significant (but not yet determined) portion of the net cash
proceeds from the proposed transaction for the expansion of our Health Services
business and anticipates 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 from the transaction to reduce by at least
$10 million our senior secured
credit facility and for general corporate purposes. 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:  
    
    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. 27




---



##### Table of Contents



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 June 30, 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. 28




---



##### Table of Contents



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 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 On May 18, 2004, we filed a report on Form 8-K with the Commission related
to 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. On May 18, 2004, we filed a report on Form 8-K with the Commission related
to the release of our financial results for the first quarter of 2004. 29




---



##### Table of Contents



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: August 13, 2004 STANDARD MANAGEMENT CORPORATION(Registrant)By: /s/ RONALD D. HUNTERRonald D. HunterChairman of the Board andChief Executive Officer(Principal Executive Officer)By: /s/ GERALD R. HOCHGESANGGerald R. HochgesangSenior Vice President and Treasurer(Chief Accounting Officer)
 30