Note A - Summary of Significant Accounting Policies

Organization: CorVel Corporation (CorVel or the Company) provides services and programs nationwide that are designed to enable insurance carriers, third party administrators and employers with self-insured programs to administer, manage and control the cost of workers' compensation and other healthcare benefits.

Basis of Presentation: The consolidated financial statements include the accounts of CorVel and its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates: The preparation of financial statements in conforming with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements. Actual results could differ from those estimates. Significant estimates include the allowance for doubtful accounts, accrual for income taxes, and accrual for self-insurance reserves.

Cash and Cash Equivalents: Cash and cash equivalents consists of short-term highly-liquid investments with maturities of 90 days or less when purchased.

Fair Value of Financial Instruments: The carrying amounts of the Company's financial instruments (i.e. cash, accounts receivable, accounts payable, etc.) approximate their fair values at March 31, 2005 and 2006.

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 limited extent, on a percentage of savings achieved for the Company's clients. The revenue mix percentages shown below have been adjusted to include utilization review with the patient management services revenue. The percentages of revenues attributable to patient management and network solutions services for the fiscal years ended March 31, 2004, 2005, and 2006 are listed below.

Accounts Receivable: The majority of the Company's accounts receivable are due from companies in the property and casualty insurance industries. Credit is extended based on evaluation of a customer's financial condition and, generally, collateral is not required. Accounts receivable are due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. 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 customer's current ability to pay its obligation to the Company and the condition of the general economy and the industry as a whole. There has been no change in the reserve balance during the past two years. The Company writes off accounts receivable, along with sales adjustments, to cost of sales when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Accounts receivable includes $3,561,000 and $2,883,000 of unbilled receivables at March 31, 2005 and 2006, respectively. Unbilled receivables represent the revenue for the work performed for which has not yet been invoiced to the customer. Unbilled receivables are generally invoiced within the following month. No one customer accounted for 10% or more of accounts receivable at any of the fiscal years ended March 31, 2005, and 2006.

Property and Equipment: Additions to property and equipment are recorded at cost. The Company provides for depreciation on property and equipment using the straight-line method by charges to operations in amounts that allocate the cost of depreciable assets over their estimated lives as follows:

The Company capitalized software development costs intended for internal use. The Company accounts for internally developed software costs in accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Capitalized software development costs, intended for internal use, totaled $9,956,000 (net of $18,124,000 in accumulated amortization) and $9,057,000, (net of $21,999,000 in accumulated amortization) as of March 31, 2005 and 2006, respectively. These costs are included in computer software in property and equipment and are amortized over a period of five years.

Long-Lived Assets: The carrying amount of all long-lived assets is evaluated periodically to determine if adjustment to the depreciation and amortization period or to the unamortized balance is warranted. Such evaluation is based principally on the expected utilization of the long-lived assets and the projected, undiscounted cash flows of the operations in which the long-lived assets are deployed.

Goodwill: Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, provides that goodwill, as well as identifiable intangible assets with indefinite lives, should not be amortized. Impairments are recognized when the expected future undiscounted cash flows derived from such assets are less than their carrying value. We 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. This most recent impairment test was performed as of December 31, 2005. No impairment of long-lived assets has been recognized in the financial statements. Goodwill amounted to $12,642,000, (net of accumulated amortization of $2,047,000) at March 31, 2005 and $12,620,000, (net of accumulated amortization of $2,069,000) at March 31, 2006.

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.

Concentrations of Credit Risk: The Company performs periodic credit evaluations of its customers' financial condition and does not require collateral. No single customer accounted for more than 10% of accounts receivable in 2005 or 2006. Receivables are generally due within 30 days. Credit losses relating to customers in the workers' compensation insurance industry consistently have been within management's expectations. Substantially all of the Company's cash is invested in financial institutions in amounts which exceed the FDIC insurance levels but the Company has not experienced any losses from such concentrations.

Income Taxes: The Company provides for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities as measured by the enacted tax rates which are expected to be in effect when these differences reverse. Income tax expense is the tax payable for the period and the change during the period in net deferred tax assets and liabilities.

Earnings Per Share: Earnings per common share-basic is based on the weighted average number of common shares outstanding during the period. Earnings per common shares-diluted are based on the weighted average number of common shares and common share equivalents outstanding during the period. In calculating earnings per share, earnings are the same for the basic and diluted calculations. Weighted average shares outstanding increased for diluted earnings per share due to the effect of stock options.

The difference between the basic shares and the diluted shares for each of the three fiscal years ended March 31, 2004, 2005, and 2006 is as follows:

734,332 anti-dilutive shares were excluded from the weighted shares calculation during the quarter ending March 31, 2006 because the option prices were below the average fair market value of the stock during the quarter.

Stock Based Compensation Plans: The Company has a stock-based employee compensation plan, which is described more fully in Note F. The Company applies the intrinsic value method provided by APB Opinion 25, Accounting for Stock Issued to Employees, and related Interpretations to account for its plans. In accordance with SFAS 148, the following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123, Accounting for Stock-Based Compensation, using the assumptions shown below, to its stock-based employee plans

The weighted average fair values at date of grant for options granted during fiscal 2004, 2005, and 2006 were $9.77, $7.49, and $6.60, respectively.

The fair value of each grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted average assumptions were used for fiscal years ending March 31, 2004, 2005 and 2006:

Recent Accounting Pronouncements: In December 2004, the FASB issued Statement of Financial Accounting Standards No. ("SFAS") 153, Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29 ("SFAS 153"), which is based on the principle that nonmonetary asset exchanges should be recorded and measured at the fair value of the assets exchanged, with certain exceptions. SFAS 153 amends Accounting Principles Board ("APB") Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the fair-value exception for nonmonetary exchanges of similar productive assets and replace it with a general exception for nonmonetary exchanges that do not have commercial substance. This statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005 (fiscal year beginning April 1, 2006 for the Company). The Company does not anticipate any material impact on its financial statements upon adoption of this statement.

In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment ("SFAS 123R"). This statement requires companies to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees. SFAS 123R eliminates the intrinsic value-based method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, that the Company currently uses. This statement is effective for the Company beginning in the first quarter of fiscal 2007. SFAS 123R offers alternate methods of adopting this standard. The Company is adopting SFAS 123R on a prospective basis in the first quarter of fiscal 2007 and will continue to use the Black-Scholes option pricing model to estimate the fair value of stock options granted. Based on current analyses and information, the Company expects that the combination of expensing stock options upon adoption of SFAS 123R and grants of other stock options will result in approximately $900,000 of additional non-cash compensation expense before income tax benefit in fiscal 2007. The Company's actual stock-based compensation expense could differ materially from this estimate depending upon the timing and magnitude of new awards, the number and mix of new awards, changes in the fair market value or volatility of the Company's common stock, as well as unanticipated changes in the Company's workforce.

In March 2005, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin 107 ("SAB 107") that expresses the views of the SEC regarding the interaction between SFAS 123R and certain SEC rules and regulations and provides the SEC's views regarding the valuation of share-based payment arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment transactions with non-employees, the transition from non-public to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS 123R in an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS 123R, the modification of employee share options prior to adoption of SFAS 123R, and disclosures in Management's Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS 123R. The Company is currently evaluating the impact that SAB 107 will have on its consolidated financial position, results of operations, and cash flows upon its adoption in 2007. The Company does not anticipate any material impact on its financial statements upon adoption of this statement.

In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3 ("SFAS 154"). SFAS 154 requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not anticipate any material impact on its financial statements upon adoption of this statement.

Note B -- Restatement

During fiscal year 2006, the Company determined that it should restate its financial statements as its accounting policy for leased properties was not in accordance with SFAS No. 13, "Accounting for Leases," as amended, and Financial Accounting Standards Board Technical Bulletin No. 88-1, "Issues Related to Accounting for Leases"; and its then-current method of accounting for rent on an actual basis rather than on a straight-line basis was not in accordance with Financial Accounting Standards Board Technical Bulletin No. 85-3 "Accounting for Operating Leases with Schedule Rent Increases." The Company determined that the impact on net income for fiscal year 2004 and 2005 was immaterial. The Company restated its consolidated balance sheet at March 31, 2005 and its consolidated statements of stockholders' equity for the fiscal years ended March 31, 2003, 2004 and 2005.

The following is a summary of the effects of these changes on the Company's consolidated balance sheet at March 31, 2005 and the consolidated statements of stockholders' equity as of and for the fiscal years ended March 31, 2003, 2004 and 2005.

The restatement had an insignificant impact on the consolidated statements of income and no impact on the consolidated statements of cash flows for the fiscal years ended March 31, 2004 and 2005 and therefore no changes have been reflected. The Company's historical income statement for the fiscal year ended March 31, 2005 properly reflected the Company's lease expense in accordance with FAS 13.

Note C - Property and Equipment

Property and equipment consists of the following at March 31, 2005 and 2006:

Note D - Accrued Liabilities

Accrued liabilities consist of the following at March 31, 2005 and 2006:

See Footnote B for comments related to the restatement of the March 31, 2005 balance.

Note E - Income Taxes

The income tax provision consists of the following for the three years ended March 31, 2004, 2005 and 2006:

The following is a reconciliation of the income tax provision from the statutory federal income tax rate to the effective rate for the three years ended March 31, 2004, 2005 and 2006:

Income taxes paid totaled $6,455,000, $2,711,000 and $6,624,000 for the years ended March 31, 2004, 2005, and 2006, respectively.

Deferred taxes at March 31, 2005 and 2006 are:

Prepaid expenses and taxes include $1,225,000 and $1,162,000 at March 31, 2005 and March 31, 2006, respectively, for income taxes due in the first quarter of the succeeding fiscal year.

Note F - Stock Options

Under the Company's Restated 1988 Executive Stock Option Plan, ("the Plan") as in effect at March 31, 2006, options for up to 5,955,000 shares (adjusted for the two-for-one stock split in the form of a dividend in June 1999 and the three-for-two stock split in the form of the dividend in August 2001) of the Company's common stock may be granted to key employees, non-employee directors and consultants at prices not less than 85% of the fair value of the stock at the date of grant as determined by the Board. Options granted under the Plan may be either incentive stock options or non-statutory stock options and options granted generally vest 25% one year from date of grant and the remaining 75% vesting ratably each month for the next 36 months. The options generally expire at the end of five years from date of grant.

Summarized information for all stock options for the past three fiscal year follows:

The weighted average exercise price for exercisable options at March 31, 2004, 2005, and 2006, was $20.47, $23.57 and $26.84, respectively.

The following table summarizes the status of stock options outstanding and exercisable at March 31, 2006:

Note G - Employee Stock Purchase Plan

The Company maintains an Employee Stock Purchase Plan ("ESPP") which was amended by approval of the Company's stockholders in September 2005 to allow employees of the Company and its subsidiaries to purchase shares of common stock on the last day of two six-month purchase periods (i.e. March 31 and September 30) at a purchase price which is 95% of the closing sale price of shares as quoted on NASDAQ on the last day of such purchase period. Prior to the purchase period beginning October 1, 2005, the purchase price was equal to 85% of the closing sale price of shares as quoted on NASDAQ on the first or last day of the purchase period, whichever was lower. In September 2005, the shareholders approved to amend the plan to the purchase price formula noted above. Employees are allowed to contribute up to 20% of their gross pay. A maximum of 950,000 shares has been authorized for issuance under the ESPP, as amended. As of March 31, 2006, 750,831 shares had been issued pursuant to the ESPP. Summarized ESPP information is as follows:

In accordance with FASB Technical Bulletin 97-1, the fair value of this stock purchase plan has been included in the pro forma disclosures contained in Note A, Stock Based Compensation Plans.

Note H - Treasury Stock and Subsequent Event

During fiscals 2004, 2005, and 2006, the Company continued to repurchase shares of its common stock under a plan originally approved by the Company's Board of Directors in 1996. Including an expansion authorized in March 2005, the total number of shares authorized to be repurchased is 7,100,000 shares. Purchases may be made from time to time depending on market conditions and other relevant factors. The share repurchases for fiscal years ending March 31, 2004, 2005 and 2006 are as follows:

The repurchased shares were recorded as treasury stock, at cost, and are available for general corporate purposes. The repurchases were financed from cash generated from operations.

In June 2006, the Company's Board of Directors authorized an increase in the number of shares to be repurchased by 1,000,000 shares to 8,100,000 shares.

Note I - Commitments and Contingencies

The Company leases office facilities under noncancelable operating leases. Some of these leases contain escalation clauses. Future minimum rental commitments under operating leases at March 31, 2006 are $10,307,000 in fiscal 2007, $8,595,000 in fiscal 2008, $6,084,000 in fiscal 2009, $3,397,000 in fiscal 2010, $1,470,000 in fiscal 2011, and $612,000 thereafter. Total rental expense of $11,365,000, $12,379,000 and $12,312,000 was charged to operations for the years ended March 31, 2004, 2005, and 2006, respectively. The cost of leasehold improvements are capitalized as incurred and amortized over the life of the lease.

The Company is involved in litigation arising in the normal course of business. Management believes that resolution of these matters will not result in any payment that, in the aggregate, would be material to the financial position or results of the operations of the Company.

Note J - Savings Plan

The Company maintains a retirement savings plan for its employees, which is a qualified plan under Section 401(k) of the Internal Revenue Code. Full-time employees that meet certain requirements are eligible to participate in the plan. Contributions are made annually, primarily at the discretion of the Company's Board of Directors. Contributions of $150,000 were charged to operations for the years ended March 31, 2004. There was no employer contribution for the fiscal years ended March 31, 2005 and March 31, 2006.

Note K - Shareholder Rights Plan

During fiscal 1997, the Company's Board of Directors approved the adoption of a Shareholder Rights Plan. The Shareholder Rights Plan provides for a dividend distribution to CorVel stockholders of one preferred stock purchase right for each outstanding share of CorVel's common stock under certain circumstances. In April 2002, the Board of Directors of CorVel approved an amendment to the Company's existing shareholder rights agreement to extend the expiration date of the rights to February 10, 2012, increase the initial exercise price of each right to $118 and enable Fidelity Management & Research Company and its affiliates to purchase up to 18% of the shares of common stock of the Company without triggering the stockholder rights. The limitations under the stockholder rights agreement remain in effect for all other stockholders of the Company. The rights are designed to assure that all shareholders receive fair and equal treatment in the event of any proposed takeover of the Company and to encourage a potential acquirer to negotiate with the Board of Directors prior to attempting a takeover. The rights have an exercise price of $118 per right, subject to subsequent adjustment. The rights trade with the Company's common stock and will not be exercisable until the occurrence of certain takeover-related events.

Generally, the Shareholder Rights Plan provides that if a person or group acquires 15% or more of the Company's common stock without the approval of the Board, subject to certain exception, the holders of the rights, other than the acquiring person or group, would, under certain circumstances, have the right to purchase additional shares of the Company's common stock having a market value equal to two times the then-current exercise price of the right.

In addition, if the Company is thereafter merged into another entity, or if 50% or more of the Company's consolidated assets or earning power are sold, then the right will entitle its holder to buy common shares of the acquiring entity having a market value equal to two times the then-current exercise price of the right. The Company's Board of Directors may exchange or redeem the rights under certain conditions.

Note L - Line of Credit

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 expired in September 2005. Borrowings under this agreement had bore 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, 2005 or during the fiscal year ended March 31, 2006. The loan covenants had required 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 all times during fiscal year ended March 31, 2005 and during fiscal 2006 during the periods when the line of credit was in place.

Note M - Quarterly Results (Unaudited)

The following is a summary of unaudited quarterly results of operations for the two years ended March 31, 2005 and 2006:

Note N - Segment Reporting

The Company derives the majority of its revenues from providing patient management and network solutions services to payors of workers' compensation benefits, automobile 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 the prior fiscal years, the Company included the revenue from utilization review with network solutions revenues.

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. Each of the Company's regions meet these criteria as they provide the similar services to similar customers using similar methods of productions and similar methods to distribute their services.

Because the Company meets each of the criteria set forth above and each of our regions have similar economic characteristics, the Company aggregates its results of operations in one reportable operating segment.