This Management's Discussion and Analysis of Financial Condition and Results of Operations may include certain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including (without limitation) statements with respect to anticipated future operating and financial performance, growth and acquisition opportunities and other similar forecasts and statements of expectation. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and "should" and variations of these words and similar expressions, are intended to identify these forward- looking statements. Forward-looking statements made by the Company and its management are based on estimates, projections, beliefs and assumptions of management at the time of such statements and are not guarantees of future performance.

The Company disclaims any obligations to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information or otherwise. Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements made by the Company and its management as a result of a number of risks, uncertainties and assumptions. Representative examples of these factors include (without limitation) general industry and economic conditions; cost of capital and capital requirements; competition from other managed care companies; the ability to expand certain areas of the Company's business; shifts in customer demands; the ability of the Company to produce market-competitive software; changes in operating expenses including employee wages, benefits and medical inflation; governmental and public policy changes; dependence on key personnel; possible litigation and legal liability in the course of operations; and the continued availability of financing in the amounts and at the terms necessary to support the Company's future business.

The Company derives the majority of its revenues from providing patient management and provider program services to payors of workers' compensation benefits, auto insurance claims and health insurance benefits. Patient management services include early intervention, medical case management, and vocational rehabilitation. Provider program revenues include fee schedule auditing, hospital bill auditing, independent medical examinations, diagnostic imaging review services and preferred provider referral services. The percentages of revenues attributable to patient management and provider program services for the fiscal years ended March 31, 2001, 2002, and 2003 are listed below. In the prior fiscal years, the Company included the revenue from independent medical examinations with the patient management revenue. During fiscal 2003, the Company began including revenue from independent medical examinations with provider program services. The revenue mix for fiscal years 2001 and 2002 have been restated to be consistent with the presentation for fiscal 2003.

The following table sets forth, for the periods indicated, the percentage of revenues represented by certain items reflected in the Company's consolidated statements of income. The Company's past operating results are not necessarily indicative of future operating results.

Growth in Revenue
2002 Compared to 2001

Revenues for fiscal 2002 increased by 13% to $236 million from $210 million in fiscal 2001, an increase of $26 million. The majority of this growth came from provider program services, which grew 28% from $91 million in fiscal year 2001 to $116 million in fiscal 2002, primarily due to an increase in the number of bills reviewed along with an increase in the number of providers included in the Company's PPO network. Patient management services increased 1%, by $1 million from $119 million in fiscal 2001 to $120 million in fiscal 2002.

Revenues for fiscal 2003 increased by 20% to $283 million from $236 million in fiscal 2002, an increase of $47 million. The majority of this growth came from provider program services, which grew 33% from $116 million in fiscal year 2002 to $154 million in fiscal 2003, primarily due to an increase in the number of bills reviewed along with an increase in the number of providers included in the Company's PPO network. Approximately 25% of the increase was attributable to the acquisition of Ancicare, a national provider of diagnostic imaging services, in May 2002. Patient management services increased 7%, by $9 million from $120 million in fiscal 2002 to $129 million in fiscal 2003. This increase was due primarily to an increase in pricing along with a nominal increase in the case referral volume.

The Company's cost of revenues consists primarily of salaries, salary related taxes and benefits, rent, telephone, and costs related to the Company's computer operations, including depreciation and amortization. Costs of revenues increased from $172 million in fiscal 2001 and $193 million in fiscal 2002, to $231 million in fiscal 2003, primarily due to the increases in revenues as noted above.

Cost of revenues as a percentage of revenues was 82.1% during fiscal 2001 and decreased to 81.9% and 81.7% in fiscal 2002 and 2003, respectively. During fiscal 2002 and fiscal 2003, the cost of revenue percentage decreased primarily due to the growth rate in the program services compared to the patient management services. Provider program services, primarily medical bill auditing and provider program services, have a lower cost of services percentage than that of patient management services. There is no guarantee the cost of service percentage will remain constant or decrease, should the Company pursue a strategy of reducing price in order to obtain greater market share or if competition causes pricing pressure in the industry.

General and administrative expense increased from $16.4 million in fiscal 2001 and $18.8 million in fiscal 2002 to $25.1 million in fiscal 2003. This increase from fiscal 2001 to fiscal 2002 and 2003 was primarily due to increased MIS staff to support the Company's implementation of CareMC and further electronic data interface capabilities as required by customer needs. General and administrative expenses were 7.8%, 8.0%, and 8.9% of revenues for the years ended March 31, 2001, 2002 and 2003, respectively.

The Company's income tax expense for 2001, 2002, and 2003 was $7.9 million, $9.1 million, and $10.2 million, respectively. The increases in the income tax expense for 2002 and 2003 resulted primarily from an increase in profitability. The effective income tax rate for 2001, 2002, and 2003 was 37.5%, 38.0% and 38.0%, respectively. This rate differed from the statutory federal tax rate of 35.0% primarily due to state income taxes and certain non-deductible expenses.

The Company has funded its operations and capital expenditures primarily from cash flow from operations. Net working capital increased from $36 million to $38 million primarily due to the increase in net accounts receivable from $33 million at March 31, 2002 to $45 million at March 31, 2003. This increase was primarily due to an increase in revenues as noted above and an increase in the number of days sales outstanding (DSO) in accounts receivable from 50 days at March 31, 2002 to 56 days at March 31, 2003.

The Company believes that cash from operations, existing working capital, line of credit, and funds from exercise of stock options granted to employees are adequate to fund existing obligations, repurchase shares of the Company's common stock, introduce new services, and continue to develop health care related businesses. The Company regularly evaluates cash requirements for current operations and commitments, and for capital acquisitions and other strategic transactions. The Company may elect to raise additional funds for these purposes, either through debt or additional equity, the sale of investment securities or otherwise, as appropriate.

As of March 31, 2003, the Company had $6 million in cash and cash equivalents, invested primarily in short-term, highly liquid investments with maturities of 90 days or less.

Net cash provided by operating activities was $22 million in 2003 compared to $27 million in 2002. The decrease in operating cash flows of $5 million was primarily due to the increase in the number of days sales outstanding (DSO) in accounts receivable from 50 days at March 31, 2002 from 56 days at March 31, 2003. Net income increased from $15 million in 2002 to $17 million in 2003.

Net cash provided by operating activities was $27 million in 2002 compared to $24 million in 2001. The increase in operating cash flows of $3 million was primarily due to the increase in net income from $13 million in 2001 to $15 million in 2002 along with a decrease in accounts receivable DSO from 57 days in 2001 to 50 days in 2002.

Net cash flow used in investing activities was $17 million in 2003 compared to $11 million in 2002. The increase in cash flow used in investing activities was primarily due to the $3 million investment in the acquisition of Ancicare, noted above, and an increase in purchases of property and equipment from $11 million in 2002 to $14 million in 2003.

Net cash flow used in investing activities was $11 million in 2002 compared to $10 million in 2001. The increase in cash flow used in investing activities was due to the increase in the purchases of property and equipment, primarily computer equipment and capitalized software.

Net cash flow used in financing activities was $12 million in 2003 compared to $13 million in 2002. The decrease in cash flow used in financing activities was primarily due to an increase in the amount of cash generated from the proceeds from the exercise of employee stock options and the employee stock purchase plan from $2 million in 2002 to $3 million in 2003.

In 1996, the Company's Board of Directors authorized the repurchases of the Company's common stock. Including an expansion authorized in April 2002, the total number of shares authorized to repurchase has now been increased to 6,100,000 shares, adjusted for the three-for-two stock split in the form of a dividend in August 2001. As of March 31, 2003, the Company had repurchased 5.2 million shares for $84 million. The Company repurchased $15 million of its common stock in both 2002 and 2003.

Net cash flow used in financing activities was $13 million in 2002 compared to $10 million in 2001. The increase in cash flow used in financing activities was primarily due to an increase in the amount of the Company's common stock repurchased by the Company from $14 million in 2001 to $15 million in 2002 along with a decrease in the amount of cash generated from the proceeds from the exercise of employee stock options and the employee stock purchase plan from $3 million in 2001 to $2 million in 2002.

In April 2003, the Company entered into a credit agreement with a financial institution to provide borrowing capacity of up to $5 million. This agreement expires in September 2004. Borrowings under this agreement bears interest, at the Company's option, at a fluctuating LIBOR-based rate 1.25% or at the financial institution's prime lending rate. There have been no borrowings under this line of credit.

The Company has historically required substantial capital to fund the growth of its operations, particularly working capital to fund the growth in accounts receivable and capital expenditures. The Company believes, however, that the cash balance at March 31, 2003 along with anticipated internally generated funds and the available line of credit would be sufficient to meet the Company's expected cash requirements for at least the next twelve months.

The SEC defines critical accounting policies as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

The following is not intended to be a comprehensive list of our accounting policies. Our significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States of America, with no need for management's judgment in their application. There are also areas in which management's judgment in selecting an available alternative would not produce a materially different result.

We have identified the following accounting policies as critical to us: 1) revenue recognition, 2) allowance for uncollectible accounts, 3) valuation of long-lived assets, 4) accrual for self-insured costs, and 5) accounting for income taxes.

Revenue recognition: The Company's revenues are recognized primarily as services are rendered based on time and expenses incurred. A certain portion of the Company's revenues are derived from fee schedule auditing which is based on the number of provider charges audited and, to a lesser extent, on a percentage of savings achieved for the Company's clients.

Allowance for uncollectible accounts: The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customers' current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

Valuation of long-lived assets - We assess the impairment of identifiable intangibles, property, plant and equipment, goodwill and investments whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

• significant underperformance relative to expected historical or projected future operating results;
• significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
• significant negative industry or economic trends;
• significant decline in our stock price for a sustained period; and
• our market capitalization relative to net book value.

Accrual for self-insurance costs - The Company self-insures for the group medical costs and workers' compensation costs of its employees. The Company purchases stop loss insurance for large claims. Management believes that the self-insurance reserves are appropriate; however, actual claims costs may differ from the original estimates requiring adjustments to the reserves.

Accounting for income taxes - As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. If the Company was to establish a valuation allowance or increase this allowance in a period, the Company must include an expense within the tax provision in the consolidated statement of income. Significant management judgment is required in determining our provision for income taxes and our deferred tax assets and liabilities.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123." This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. The Company expects to continue to account for stock options under APB No. 25. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the notes to the consolidated financial statements.