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, including but not limited to legislative and administrative law and rule implementation or change; 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.

Overview

CorVel Corporation is an independent nationwide provider of medical cost containment and managed care services designed to address the escalating medical costs of workers' compensation and auto policies. The Company's services are provided to insurance companies, third-party administrators ("TPAs"), and self-administered employers to assist them in managing the medical costs and monitoring the quality of care associated with healthcare claims.

Network Solutions Services

The Company's Network Solutions services are designed to reduce the price paid by its customers for medical services rendered in workers' compensation cases, and auto policies and, to a lesser extent, group health policies. The network solutions services offered by the Company include automated medical fee auditing, preferred provider services, retrospective utilization review, independent medical examinations, MRI examinations, and inpatient bill review.

Patient Management Services

In addition to its network solutions services, the Company offers a range of patient management services, which involve working on a one-on-one basis with injured employees and their various healthcare professionals, employers and insurance company adjusters. Patient management services are designed to monitor the medical necessity and appropriateness of healthcare services provided to workers' compensation and other healthcare claimants and to expedite return to work. The Company offers these services on a stand-alone basis, or as an integrated component of its medical cost containment services.

Organizational Structure

The Company's management is structured geographically with regional vice-presidents who report to the President of the Company. Each of these regional vice-presidents is responsible for all services provided by the Company in his or her particular region and responsible for the operating results of the Company in multiple states. These regional vice presidents have area and district managers who are also responsible for all services provided by the Company in their given area and district.

Business Enterprise Segments

We operate in one reportable operating segment, managed care. The Company's services are delivered to its customers through its local offices in each region and financial information for the Company's operations follows this service delivery model. All regions provide the Company's patient management and network solutions services. Statement of Financial Accounting Standards, or SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," establishes standards for the way that public business enterprises report information about operating segments in annual consolidated financial statements. The Company's internal financial reporting is segmented geographically, as discussed above, and managed on a geographic rather than service line basis, with virtually all of the Company's operating revenue generated within the United States.

Under SFAS 131, two or more operating segments may be aggregated into a single operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles of SFAS 131, if the segments have similar economic characteristics, and if the segments are similar in each of the following areas: 1) the nature of products and services; 2) the nature of the production processes; 3) the type or class of customer for their products and services; and 4) the methods used to distribute their products or provide their services. We believe each of the Company's regions meet these criteria as they provide the similar services to similar customers using similar methods of production and similar methods to distribute their services.

Because we believe we meet each of the criteria set forth above and each of our regions have similar economic characteristics, we aggregate our results of operations in one reportable operating segment.

Summary of 2005 Annual Results

The Company reported revenues of $291 million for fiscal year ended March 31, 2005, a decrease of $14 million compared to fiscal year ended March 31, 2004. The Company reported sequential declining quarterly revenues for the first three quarters of fiscal year 2005. Sequential revenue decreases for the first three quarters of fiscal 2005 were .7%, 5.4%, and 3.3%. In the quarter ended March 31, 2005, the Company reported revenues of $72.8 million an increase in revenue of $3.0 million, or 4.3% over the $69.8 million reported in the previous quarter ended December 31, 2004. The revenue for the quarter ended March 31, 2005 also benefited from two extra business days in the quarter.

The lingering effects of the downturn in the national economy and its corresponding effect on the number of workplace injuries that have become longer-term disability cases, the considerable price competition given the flat-to-declining overall market, the increase in competition from local and regional competition, changes and the potential changes in state workers' compensation and auto managed care laws which can reduce demand for the Company's services, have created an environment where revenue and margin growth is more difficult to attain and where revenue growth is uncertain. Additionally, the Company's technology and preferred provider network competes against other companies, some of which have more resources available. Also, some customers may handle their managed care services in-house and may reduce the amount of services which are outsourced to managed care companies such as CorVel Corporation.

Results of Operations

The Company derives its revenues from providing patient management and network solutions services to payors of workers' compensation benefits, auto insurance claims and health insurance benefits. Patient management services include utilization review, medical case management and vocational rehabilitation. Network solutions revenues include fee schedule auditing, hospital bill auditing, independent medical examinations, diagnostic imaging review services and preferred provider referral services. In prior fiscal years, the Company included the revenue from utilization review with network solutions revenues. The Company determined it was more appropriate to include these revenues with patient management. The revenue mix percentages shown below have been adjusted to include utilization review with the patient management services revenue. This change did not affect the trend of the past few years of slow growth in the patient management services causing this service to represent a lesser portion of the Company's revenues. The percentages of revenues attributable to patient management and network solutions services for the fiscal years ended March 31, 2003, 2004, and 2005 are listed below.

Income Statement Percentages

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.

Revenues for fiscal year 2004 increased by 8% to $305 million, from $283 million in fiscal year 2003, an increase of $22 million. The majority of this growth came from network solutions services, which grew 17% from $144 million in fiscal year 2003 to $167 million in fiscal year 2004. Approximately half of this increase was due to an increase in the CorCareRX services which increased from $3 million to $15 million. The CorCareRX service margins are the lowest amongst the network solutions services which contributed to the decrease in the Company's gross profit margin.

Additionally, $2 million of the revenue increase was due to the acquisition of ScanOne, a document imaging company, in June 2003 which is integrated with the bill review services. Revenue from patient management services decreased less than 1% from fiscal 2003 to fiscal 2004.

Revenues for fiscal year 2005 decreased by 4.7% to $291 million, from $305 million in fiscal year 2004, a decrease of $14 million. Nearly two-thirds of this decrease was attributable to the decrease in revenue from the Company's patient management services primarily due to a decrease in the patient management referrals received by the Company. The decrease was primarily the result of a continued softness in the national labor market, especially the manufacturing sector of the economy. The Company has been negatively impacted by a reduction in the overall claims volume due to employers implementing workplace safety programs. Employers have also been more aggressive in seeking early intervention services which the Company and the Company's competitors offer, decreasing the length of a claim and decreasing the need for on-site case management services. The rest of the decrease in revenues was attributable to a decrease in demand for the Company's network solution services, primarily demand for the IME and MRI services. Cost of Revenue

The Company's cost of revenues consist of direct expenses, costs directly attributable to the generation of revenue, and field indirect costs which are incurred in the field to support the operations in the field offices which generate the revenue. Direct costs are primarily case manager salaries, bill review analysts, related payroll taxes and fringe benefits, and costs for IME (independent medical examination), prescription drugs, and MRI providers. Most of the Company's revenues are generated in offices which provide both patient management services and network solutions services. The largest of the field indirect costs are manager salaries and bonus, account executive base pay and commissions, administrative and clerical support, field systems personnel, PPO network developers, related payroll taxes and fringe benefits, office rent, and telephone expense. Approximately 42.1% of the costs incurred in the field are field indirect costs which support both the patient management services and network solutions operations of the Company's field operations.

Change in Cost of Revenue

2004 Compared to 2003

Cost of revenues increased from $231 million to $254 million, an increase of $23 million or 10% compared to revenue growth of 8%. Cost of revenues increased by a greater actual dollar and greater percentage than revenue. This increase in cost of revenues exceeded the increase in revenues on a percentage and absolute dollar basis because approximately half of the revenue growth in fiscal 2004 is from CorCareRX which has low gross margins. The largest components of the direct costs are direct salaries for case managers and bill review analysts which increased by $1 million, or 1%, from $73 million to $74 million because of the limited increase in bill volume processed and lack of growth in case management referrals. IME and MRI provider costs increased by $6 million, or 20%, from $30 million to $36 million. CorCareRX provider costs increased by $11 million, from $3 million to $14 million, due to the increase in revenues noted above.

The largest components of the field indirect costs and the changes from fiscal 2003 to fiscal 2004 are: manager salaries, which remained relatively unchanged at approximately $18.5 million for both fiscal 2003 and 2004; and clerical salaries, which increased by $1 million, from $18 million to $19 million. The growth in the field salary costs was nominal as the Company reduced the field headcount (excluding the acquisition of ScanOne) by over 200 employees from December 2002 to March 2004.

The Company's cost of revenues decreased from $254 million in fiscal 2004 to $246 million in fiscal 2005, a decrease of 3.3% of $8 million. The decrease in cost of revenues is primarily attributable to the decrease in revenues noted above. The Company reduced their field employee headcount as revenue decreased. Approximately half of the decrease is attributable to a decrease in direct labor costs of $3.4 million. The Company has been working to decrease direct labor costs in response to the reduction in demand for the Company's services resulting from the soft national labor market. The Company also experienced lower direct costs for MRI and prescription drug patient management services of $2.4 million and $1.4 million respectively. The decreases in these costs are directly attributable to related decreases in these respective services.

General and Administrative Costs

During fiscals 2003, 2004 and 2005, approximately 60%, 62%, and 62%, respectively, of general and administrative costs consisted of corporate systems costs, which include the corporate systems support, implementation and training, amortization of software development costs, depreciation of the hardware costs in the Company's national systems, the Company's national wide area network, and other systems related costs. The remaining 38% of the general and administrative costs consist of national marketing, national sales support, corporate legal, corporate insurance, human resources, accounting, product management, new business development, and other general corporate expenses.

Change in General and Administrative Costs

2004 Compared to 2003

General and administrative expense increased from $25 million in fiscal 2003 to $26 million in fiscal 2004. General and administrative costs were 9% of revenues for each of these two years. Almost all of this increase was due to increase in systems costs from $15 million in fiscal 2003 to $16 million in fiscal 2004, was primarily due to increased staff for field support and for customer needs. Systems costs were approximately 5% of revenues for fiscal 2003 and 2004, respectively. Other general and administrative costs remained unchanged at $10 million from fiscal 2003 to fiscal 2004.

Change in General and Administrative Costs

2005 Compared to 2004

General and administrative expense increased $2 million from $26 million in fiscal 2004 to $28 million in fiscal 2005. General and administrative expense increased as a percentage of revenue, by 1.2%, from 8.5% of revenue in fiscal 2004 to 9.7% of revenue in fiscal 2005. The increase was related to increased expenditures in systems and increases in depreciation and amortization from prior year capital investments in technology. Systems costs included in general and administrative costs increased by $1.7 million, from $15.6 million in fiscal 2004 to $17.3 million in fiscal 2005. This increase was due to the Company's continued increase in investment in technology. The Company is continuing to invest in and advance its scanning and document management capabilities for their customers as well as for internal use. The Company also continued making improvements to its primary data center and its second data center as part of its business continuity planning.

Income Tax Provision

The Company's income tax expense for fiscal 2003, fiscal 2004, and fiscal 2005 were $10 million, $9 million, and $6 million respectively. The decrease in fiscal 2004 and 2005 resulted primarily from a decrease in income before income taxes from fiscal 2003 to fiscal 2005. The effective income tax rates for fiscal 2003, fiscal 2004, and fiscal 2005 were 38%, 37%, and 38% respectively. This rate differed from the statutory federal tax rate of 35.0% primarily due to state income taxes and certain non-deductible expenses.

Liquidity and Capital Resources

The Company has historically funded its operations and capital expenditures primarily from cash flow from operations, and to a lesser extent, option exercises. The Company's net accounts receivables have historically averaged below 60 days of average sales. Property, net of accumulated depreciation, has averaged approximately 10% or less of annual revenue. These historical ratios of investments in assets used in the business has allowed the Company to generate sufficient cash flow to repurchase $113 million of its common stock during the past nine fiscal years, without incurring debt, on cumulative net earnings of $130 million.

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 healthcare 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.

Net working capital decreased from $41 million to $39 million, primarily due to a $1 million increase in accounts payable and accrued liabilities and a $1 million decrease in prepaid expenses. Both the increase in liabilities and decrease in prepaid expenses are due to normal fluctuations in the timing of the Company's payments for insurance, income taxes and other goods and services.

As of March 31, 2005, the Company had $9 million in cash and cash equivalents, invested primarily in short-term, highly liquid investments with maturities of 90 days or less.

In April 2003, the Company entered into a credit agreement with a financial institution to provide borrowing capacity of up to $5 million. In March 2005, the Company's Board of Directors authorized an increase in the credit agreement by $5 million, to $10 million. This agreement expires in April 2006. Borrowings under this agreement bear interest, at the Company's option, at a fluctuating LIBOR-based rate plus 1.25% or at the financial institution's prime lending rate. There were no borrowings under the line of credit at March 31, 2004 or March 31, 2005. The loan covenants require the Company to maintain a quick ratio of at least 2:1, a tangible net equity of at least $45 million, and have positive net income. The Company was in compliance with these covenants at March 31, 2005.

The Company believes, however, that the cash balance at March 31, 2005 along with anticipated internally generated funds and the available line of credit will be sufficient to meet the Company's expected cash requirements for at least the next twelve months.

Net cash provided by operating activities was $22 million in 2003 compared to $28 million in 2004. The improvement in cash flow from operations of $6 million was primarily due to the improvement in the accounts receivable days sales outstanding from 56 days at March 31, 2003 to 54 days at March 31, 2004. During the prior fiscal year, an increase in accounts receivable created a $10 million use in cash from operating activities. Because the fiscal year 2004 revenue increase was less than the fiscal year 2003 revenue increase and the days sales outstanding decreased, accounts receivable, excluding the accounts receivable acquired in the ScanOne acquisition decreased from fiscal 2003 to fiscal 2004.

Operating Cash Flows

2005 Compared to 2004

Net cash provided by operating activities decreased from $28 million in fiscal 2004 to $26 million in fiscal 2005. The decrease in cash provided by operations was primarily due to the decrease in net income from $16 million in fiscal 2004 to $10 million in fiscal 2005. This decrease in cash provided by operating activities due to the decrease in net income was partially offset by decrease of $1 million in prepaid expenses and taxes along with a $2 million increase in accounts and taxes payable.

Investing Activities

2004 Compared to 2003

Net cash flow used in investing activities was $17 million both fiscal 2003 and fiscal 2004 in both business acquisitions and property additions. The Company paid $4 million for acquired businesses in fiscal 2004 compared to $3 million in fiscal 2003. Purchases of property and equipment decreased from $14 million in fiscal 2003 to $13 million in fiscal 2004 partially due to the reduction in the growth in the Company's revenues.

Investing Activities

2005 Compared to 2004

Net cash flow used in investing activities decreased from $17 million in fiscal 2004 to $12 million in fiscal 2005. This reduction was due primarily to the reduction in the amount paid for business acquisitions from $4 million in fiscal 2004 to $80,000 in fiscal 2005. Purchases of property and equipment decreased from $13 million in fiscal 2004 to $11.5 million in fiscal 2005 partially due to the reduction in the Company's business volume. The Company expects future expenditures for property and equipment to increase if revenues increase.

Financing Activities

2004 Compared to 2003

Net cash flow used in financing activities was $12 million in fiscal 2003 compared to $8 million in fiscal 2004. The decrease in cash flow used in financing activities was primarily due to a decrease in the amount spent by the Company to repurchase its common stock from $15 million in fiscal 2003 to $12 million in fiscal 2004. The Company repurchased 461,527 shares in fiscal 2003 and 342,121 shares in fiscal 2004.

Financing Activities

2005 Compared to 2004

Net cash flow used in financing activities increased from $8 million in 2004 to $14 million in 2005. The increase in cash flow used in financing activities was primarily due to the increased amount spent to repurchase of the Company's common stock. In fiscal 2004, the Company purchased $12 million worth of common stock (342,121 shares, at an average price of $35.53 per share). In fiscal 2005, the Company purchased $17 million in common stock (691,720 shares, at an average price of $24.86 per share). Cash proceeds from the exercise of stock options decreased from $3 million in fiscal 2004 to $2 million in fiscal 2005. If the Company continues to generate cash flow from operating, investing, and financing activities, the Company may continue to repurchase its common shares on the open market or identify other businesses to acquire.

The following table set forth our contractual obligations at March 31, 2005, which are future minimum lease payments due under noncancelable operating leases:

Critical Accounting Policies

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 A 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. No one customer accounted for 10% or more of accounts receivable at any of the fiscal years ended March 31, 2003, 2004, and 2005.

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.

When we determine that the carrying value of intangibles, long-lived assets and related goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, impairments are recognized when the expected future undiscounted cash flows derived from such assets are less than their carrying value, except for investments. We generally measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. A loss in the value of an investment will be recognized when it is determined that the decline in value is other than temporary. No impairment of long-lived assets has been recognized in the financial statements.

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. The Company determines its estimated self-insurance reserves based upon historical trends along with outstanding claims information provided by its claims paying agents.

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.

Recently Issued Accounting Standards

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" (FAS No. 123(R)), which amends FASB Statement Nos. 123 and 95. FAS No. 123(R) requiring all companies to measure compensation expense for all share-based payments (including employee stock options) at fair value and recognize the expense over the related service period. Additionally, excess tax benefits, as defined in FAS No. 123(R), will be recognized as an addition to paid-in capital and will be reclassified from operating cash flows to financing cash flows in the Consolidated Statements of Cash Flows. In April 2005, the effective date of FAS No. 123(R) was delayed for the Company until the quarter ending June 30, 2006. We are currently evaluating the effect that FAS No. 123(R) will have on our financial position, results of operations and operating cash flows.

In March 2004, the FASB issued EITF Issue No. 03-1 (EITF 03-1), "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments." EITF 03-1 includes new guidance for evaluating and recording impairment losses on certain debt and equity investments when the fair value of the investment security is less than its carrying value. In September 2004, the FASB delayed the effective date for the measurement and recognition provisions until the issuance of additional implementation guidance. The delay does not suspend the requirement to recognize impairment losses as required by existing authoritative literature. We will evaluate the impact of this new accounting standard on our process for determining other-than-temporary impairments of applicable debt and equity securities upon final issuance.