1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K -------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ---------- ---------- COMMISSION FILE NUMBER 0-19291 CORVEL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------ DELAWARE 33-0282651 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 2010 MAIN STREET, SUITE 1020, IRVINE, CALIFORNIA 92614 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 851-1473 ------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK 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 [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of June 4, 1999, there were 8,129,000 shares of Common Stock outstanding, as adjusted for the 2-for-1 stock split in the form of a 100% dividend, paid on June 14, 1999. The Registrant does not have different classes of Common Stock and as of June 4, 1999, the aggregate market value of the Common Stock of the Registrant held by non-affiliates was $100,222,000, based upon the closing sale price of such stock on that date. For purposes of such calculation, only executive officers, board members, and beneficial owners of more than 10% of the Company's outstanding Common Stock are deemed to be affiliates.
2 DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Definitive Proxy Statement for the Annual Meeting of Stockholders to be held on or about August 5, 1999, as filed with the Commission pursuant to Regulation 14A, are incorporated by reference in Part III of this Report. Portions of the Registration Statement filed with the Commission on Form S-1 (SEC File No. 33-40629), the Company's Annual Reports on Form 10-K for the fiscal years ended March 31, 1995, March 31, 1994, March 31, 1993 and March 31, 1992, and the Company's filing on Form 8-K on February 28, 1997, are incorporated by reference in Part IV of this Report. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor for forward-looking statements. This Annual Report contains forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. The Company's actual results could differ materially from those projected in the forward-looking statements as a result of the factors described under "Cautionary Statement Regarding Forward-Looking Statements" and elsewhere in this Annual Report. Investors in the Company's securities should consider these factors.
3 CORVEL CORPORATION 1999 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS <TABLE> <CAPTION> PART I Page ---- <S> <C> <C> Item 1. Business 1 Item 2. Properties 13 Item 3. Legal Proceedings 13 Item 4. Submission of Matters to a Vote of Security Holders 14 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 14 Item 6. Selected Financial Data 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 7a. Quantitative and Qualitative Disclosures About Market Risk 15 Item 8. Financial Statements and Supplementary Data 15 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 15 PART III Item 10. Directors and Executive Officers of the Registrant 15 Item 11. Executive Compensation 15 Item 12. Security Ownership of Certain Beneficial Owners and Management 15 Item 13. Certain Relationships and Related Transactions 15 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 16 </TABLE>
4 This Annual Report on Form 10-K may contain forward-looking statements that involve risks and uncertainties. These statements may differ materially from actual future events and results of the Company. Please refer to the "Risk Factors" section of Form 10-K which identify some important risk factors that could cause actual results of the Company to differ from those contained in any forward-looking statements. PART I ITEM 1. BUSINESS. INTRODUCTION CorVel Corporation ("CorVel" or the "Company") is an independent nationwide provider of medical cost containment and managed care services designed to address the escalating medical costs of workers' compensation and other healthcare benefits, primarily coverage under group health and auto policies. The Company's services include automated medical fee auditing, early intervention, utilization review, medical case management, vocational rehabilitation services, and independent medical examinations. Such 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 health care claims. Workers' compensation regulations vary by state and the industry is highly fragmented. The Company's specialization in workers' compensation, breadth of services, information management systems, and ability to offer local services on a nationwide basis enhance its ability to compete in the workers' compensation market. The Company believes that payors and employers impacted by the increasing medical costs of workers' compensation will increasingly require services and programs to manage such costs. The Company's business strategy is to continue to expand its range of services, branch office network, and information management capabilities to respond to this need on both a local and national level. RECENT DEVELOPMENT On May 24, 1999, the Company announced that its Board of Directors authorized a 2-for-1 common stock split in the form of a 100% stock dividend. The additional shares were distributed on June 15, 1999 to stockholders of record on May 31, 1999. Historical common share amounts, per share amounts and stock option data for all periods presented have been restated to reflect this change in the Company's capital structure. INDUSTRY OVERVIEW Workers' compensation is a statutorily defined employee benefit, which varies on a state-by-state basis. Workers' compensation laws generally require employers to fully pay for employees' costs of medical treatment, lost wages, legal fees and other costs associated with work-related injuries and disabilities and, in certain jurisdictions, mandatory vocational rehabilitation. Companies provide such coverage to their employees through either the purchase of commercial insurance from private insurance companies, participation in state-run funds or through self-insurance. 1
5 Due to several factors, including a general rise in the cost of health care and the fact that the employer is required to pay all compensible medical costs of the employee without cost-sharing by the employee, both the volume and dollar amount of workers' compensation claims have increased in recent years, resulting in escalating costs to employers. While the group health insurance industry and employers have adopted cost containment strategies such as utilization review and the use of Health Maintenance Organizations ("HMOs") to stem the rising costs of non-workers' compensation medical care, the workers' compensation industry has been slower to respond to the problem of escalating medical costs. However, managed care in workers' compensation has been gaining acceptance during the past several years. Since workers' compensation benefits are mandated by law and are subject to extensive regulation, payors and employers do not have the same flexibility to alter benefits as they have with other health benefit programs. Many states do not permit employers to restrict a claimant's choice of provider, making it more difficult for employers to utilize managed care approaches such as HMOs and Preferred Provider Organizations ("PPOs"). However, in many states, employers have the right to direct employees to a specific primary health care provider during the onset of a workers' compensation case, subject to the right of the employee to change physicians after a specific period. In addition, workers' compensation programs vary from state to state, making it difficult for payors and multi-state employers to adopt uniform policies to administer, manage, and control the costs of benefits. As a result, managing the cost of workers' compensation requires approaches, which are tailored to the specified regulatory environment(s) in which the employer is operating. BUSINESS The Company offers services in two general categories, provider programs and patient management services, to assist its customers in managing the increasing medical costs of worker's compensation, group health and auto insurance, and monitoring the quality of care provided to claimants. PROVIDER PROGRAMS The Company's provider program services are designed to reduce the price paid by its customers for medical services rendered in workers' compensation cases. Medical cost containment services offered by the Company include automated medical fee auditing, preferred provider services, and retrospective utilization review. Automated Medical Fee Auditing Many states have adopted fee schedules which regulate the maximum allowable fees payable under workers' compensation for procedures performed by a variety of health treatment providers. Such schedules may also include fees for hospital treatment. The purpose of a fee schedule is to standardize the billing process by using uniform procedure descriptions and to set maximum reimbursement levels for each covered service. 2
6 Certain other states permit payors to pay workers' compensation medical costs limited to usual and customary charges for the relevant community. The Company provides automated medical fee auditing to assist the Company's customers in verifying that the fees charged by workers' compensation health care providers comply with state fee schedules, or are consistent with usual and customary charges. The Company offers its fee schedule auditing through a computerized medical bill review service called MedCheck, which combines automated data reporting and transmission capabilities. MedCheck consists of an on-line computer-based information system comprised of a proprietary software program which stores and accesses state-mandated fee schedules and licensed usual and customary charge information. MedCheck is also being utilized for the review of medical charges under certain non-workers' compensation insurance coverages. With the MedCheck service, the Company is capable of: o Checking for provider charges which exceed charges allowable under fee schedules or usual and customary charges, in accordance with the requirements of the relevant jurisdiction o Repricing provider bills to contractual PPO reimbursement levels o Checking for duplicate billing o Checking for billed services or procedures that are excessive, unnecessary or unrelated to treating the particular medical problem o Checking for "unbundled" billings where the medical services performed are billed in components, resulting in higher total charges than would be the case if the services were billed in the aggregate o Engaging in on site processing of claims o Sending claims data directly to carriers' databases, thereby reducing costs due to repetitive or erroneous data entry In addition to providing the MedCheck software suite, CorVel also supports insurers and administrators with a full array of out-source capabilities. The Company provides a proprietary national PPO, as well as case managers both on-site and from telephonic hub operations. Currently, CorVel has its MedCheck software installed in 70 offices nationwide, accessed by over 400 bill review operators. These systems can be interfaced to insurers thought the Company's wide area network (WAN) as well as through its web-site and virtual private networks (VPN's). When installed at an insurer, the MedCheck suite can accept electronic data interfaces (EDI) from CorVel and other sources. In addition, MedCheck can send its own files on to the mainframe claims administration systems of major insurers and other payors. The system is designed for easy access by claims adjusters and includes functionality for such part-time users within the claims payment environment. MedCheck includes an artificial intelligence (AI) module (First Review) which allows insurers to incorporate the latest in software intelligence. MedCheck's "First Review" module can incorporate intelligence unique to specific insurance programs. In addition to these AI features, MedCheck's development reflects CorVel's experience as one of the leading managed care companies in the country. CorVel has been providing medical bill review and PPO administration services for the casualty insurance industry for ten years. 3
7 At March 31, 1999, the Company was providing its MedCheck services to clients in approximately 44 states primarily through 70 branch offices. An important element of the Company's business strategy is to introduce MedCheck to additional existing branch offices and increase its use by current customers. The Company plans to continue to invest in the expansion of its MedCheck medical review software to better serve the claims processing needs of customers through automated interfacing with its customers' computer systems. Auto Managed Care During fiscal 1999, the Company announced the release of its MedCheck 2000 suite of medical review software. This latest version of the Company's MedCheck software designed to assist automobile insurers with the automation, review and payment of medical claims. The software is available for license and be accessed remotely on servers under Corvel's management. MedCheck 2000 is Y2K compliant and includes CorVel's latest release of "First Review", the Company's line of automated reviews employing artificial intelligence tools. CorVel's MedCheck bill review software has been a leading medical review product for ten years and is supported by CorVel's national network of offices and managed care professionals. The new automobile insurance module allows administrators to store benefit designs, administrative parameters, managed care guidelines and fee schedules and "usual and customary" databases. The software is specially designed to meet the emerging requirements managed care is placing upon the major insurers of automobile exposures. MedCheck 2000 is integrated with industry standard applications in word processing and e-mail. Preferred Provider Services PPOs are groups of hospitals, physicians and other health care providers that offer services at pre-negotiated rates to employee groups. PPO networks offer the employer an additional means of managing workers' compensation costs by reducing the per-unit price of medical services provided to employees. The Company provides its customers with access to its PPO network, "CorCare". Bills submitted from PPOs are identified through the MedCheck review process, and the submitted charges are then audited against the PPO schedule and against any applicable fee schedule or usual and customary charges. The fee approved for payment is the lower of the submitted charges or the lowest allowable fee identified. In-Patient Bill Review The Company expanded its line of bill review services by adding unique capabilities for reviewing in-patient medical reimbursement. This service, named MedCheck Select, provides a national database of hospital charges detailed by line item in each hospital's individual billing system. By converting differing hospital billing systems to a common database, the Company can create "usual and customary" expectations for hospital expenses. Revenues for this service expanded throughout the year, and add to the Company's line of in-patient medical review and PPO activities. 4
8 Retrospective Utilization Review The Company also offers manual fee auditing and retrospective utilization review services, including hospital bill and chiropractic bill auditing at a number of its branch offices. These services, performed primarily by Company employed registered nurses, are designed to confirm that medical care was delivered to the patient, the provider was authorized to perform the rendered service, the care was appropriate and covered by workers' compensation, and the charges for the delivered service were usual and customary. PATIENT MANAGEMENT SERVICES In addition to its provider program services, the Company offers a range of services designed to monitor the medical necessity and appropriateness of health care services provided to workers' compensation claimants and to expedite their return to work. The Company offers these services on a stand-alone basis, or as an integrated component of its medical cost containment services. Managed care services offered by the Company include early intervention ("Advocacy"), inpatient utilization review, medical case management, independent medical examinations ("IMEs") and vocational rehabilitation. Vocational Rehabilitation In certain states, vocational rehabilitation is a legislated benefit of workers' compensation, which assists the employee's return to former employment or another job function with similar economic value. The Company offers vocational services to reduce workers' compensation costs and expedite the injured employee's return to work. Vocational services include work capacity assessments, job analysis, transferable skill analysis, job modification, vocational testing, job placement assistance, labor market surveys and retraining. After an employee sustains an injury, the Company performs an analysis of the employee's current job and other potential jobs which could be performed for the employer, meets with the treating physician to determine the diagnosis and prognosis for return to work, presents job analyses to obtain a release to return to work, develops plans for employee training and generally monitors the employee's return to work. Medical Case Management The Company offers medical case management services where the injury is catastrophic or complex in nature, or where prolonged recovery is anticipated. In these cases, the Company's case managers confer with the attending physician, other providers, the patient and the patient's family to identify the appropriate rehabilitative treatment and most cost-effective health care alternatives, including transferring the patient from a hospital to an alternative care facility. Case managers may coordinate the services or care required and may arrange for special pricing of the required services. 5
9 Advocacy During fiscal 1999, the Company announced the release of version 4.4 of its Advocacy suite of case management software. This version of Advocacy is designed to assist employers; insurers, TPA's and case management companies with the administration of managed care for disability patients. The software is available for licensure and is supported by CorVel's national network of offices and managed care professionals. Advocacy software is CorVel's line of case management tools for the managed care industry. The suite includes time management, utilization review, outcomes reporting, administrative capabilities, word processing, and integration with the internet as well as intranet communications. The new disability module allows administrators to store benefit designs, payroll information and absence management controls. The software helps operators determine available indemnity payments from the employer and coordinate case management information and issues. Protocols regarding length of disability are incorporated to guide the management of cases. Management and operations reports, electronic data interchange and billing are additional features of the software. Inpatient Utilization Review The Company offers pre-certification and concurrent utilization review services. The Company's pre-certification service is designed to be utilized prior to the injured employee's admission to the hospital. Upon notification by a claims manager or employer, a Company nurse reviews the appropriateness of the proposed plan of care, the need for inpatient hospitalization, and the appropriate length of stay. Under the Company's concurrent review service the nurse reviewers monitor the medical necessity and appropriateness of the patient's continued hospitalization through regular contact with the hospital and the patient's physician and may identify cases that lend themselves to alternate treatment settings or home care. Independent Medical Examinations The Company arranges for IMEs to assist customers in evaluating workers' compensation and other casualty claims. A medical examination involves the assessment of a person's condition often for use in determining the extent and nature of an injury. In general, a physician examines the patient and prepares a report that describes the nature and extent of injuries, as well as the future medical requirements. The Company provides IMEs through a network of independent physicians. As of March 31, 1999, the Company was providing IMEs through branch offices in eight states. OTHER SERVICES Internet Based Services The Company has announced an initiative to deliver a line of Internet-based sevices to employers, insurance carriers and PTAs. The Company expects to add services throughout fiscal 2000 a number of new service features, based upon the access and timeliness of Internet-based tools. The first service in this line will involve Internet access to the Company's network of preferred healthcare providers, a service now available and being utilized by CorVel clients. 6
10 The project is intended to capitalize upon CorVel's substantial investment in systems and software and rapidly evolving Internet technologies. The Company's initial offerings will also include transaction-based services. During the past two years, the Company has installed a company wide Intranet and is currently implementing improved wide area networking technologies. A corporate website has been established, however, most of the new services involve Internet connections provided on an exclusive basis for insurance companies and major employers. The Company's existing services are supported by relational database applications, which allow direct access from industry standard Internet browsers. Short Term Disability (STD) Management In addition to providing the Advocacy software suite, CorVel also supports employers and benefits administrators with a full array of out-sourced STD management capabilities. The Company provides case managers both on-site and from telephonic hub operations. Case management services are provided for STD, as well as LTD (long-term disability) exposures. CUSTOMERS AND MARKETING The Company's customers are workers' compensation insurers and, to a lesser extent, TPA's and self-administered employers. Many claims management decisions in workers' compensation are the responsibility of the local claims office of national or regional insurers. The Company's national branch office network has been established to enable the Company to market and offer its services at both a local and national account level. The Company is placing increasing emphasis on national account marketing. The marketing activities of the Company are conducted by account executives located in key geographic areas, and by national account executives from the corporate office. Most of the major workers' compensation insurance carriers conduct business with the Company. None of the Company's customers represented more than 10% of revenues in fiscal 1999. COMPETITION AND MARKET CONDITIONS The health care cost containment industry is highly fragmented and competitive. The intensity of competition can be expected to increase. The Company's primary competitors in the workers' compensation market are several large insurance carriers which offer one or more services similar to those offered by the Company, HMOs and numerous independent companies, typically on a local or regional basis. The Company also competes with national and local firms specializing in utilization review and with major insurance carriers and TPAs which have implemented their own internal utilization review services. Many of the Company's competitors are significantly larger and have greater financial and marketing resources than the Company. There can be no assurance that the Company will continue to maintain its existing performance, or be successful with any new products or in any new geographical markets it may enter. Moreover, the Company's customers may establish the in-house capability of performing services offered by the Company. 7
11 Legislative reforms in some states permit employers to designate health plans such as HMOs and PPOs to cover workers' compensation claimants. Because many health plans have the capacity to manage health care for workers' compensation claimants, such legislation may intensify competition in the market served by the Company. Within the past few years, several states have experienced decreases in the number of workers' compensation claims and the average cost per claim which have been reflected in workers' compensation insurance premium rate reductions in those states. The Company believes that declines in workers' compensation costs in these states are due principally to intensified efforts by payors to manage and control claim costs, to improved risk management by employers and to legislative reforms. If declines in workers' compensation costs occur in many states and persist over the long-term, they may have an adverse impact on the Company's business and results of operations. The Company competes on the basis of its specialization in workers' compensation, breadth of services, ability to offer local services on a nationwide basis, information management systems and independence from insurance carriers. GOVERNMENT REGULATION General Managed health care programs for workers' compensation are subject to various laws and regulations. Both the nature and degree of applicable government regulation vary greatly depending upon the specific activities involved. Generally, parties that actually provide or arrange for the provision of health care services, assume financial risk related to the provision of those services, or undertake direct responsibility for making payment or payment decisions for those services, are subject to a number of complex regulatory schemes that govern many aspects of their conduct and operations. In contrast, the management and information services provided by the Company to its customers typically have not been the subject of regulation by the federal government or the states. Since the managed health care field is a rapidly expanding and changing industry and the cost of providing health care continues to increase, it is possible that the applicable state and federal regulatory frameworks will expand to have a greater impact upon the conduct and operation of the Company's business. Under the current workers' compensation system, employer insurance or self-funded coverage is governed by individual laws in each of the 50 states and by certain federal laws. The management and information services that make up the Company's managed care program serve markets that have developed largely in response to needs of insurers, employers and large TPAs, and generally have not been mandated by legislation or other government action. On the other hand, the vocational rehabilitation case management marketplace within the workers' compensation system has been dependent upon the laws and regulations within those states that require the availability of specified rehabilitation services for injured workers. Similarly, the Company's fee schedule auditing services address market needs created by certain states' enactment of maximum permissible fee schedules for workers' compensation services. Changes in individual state regulation of workers' compensation may create a greater or lesser demand for some or all of the Company's services, or require the Company to develop new or modified services in order to meet the needs of the marketplace and compete effectively in that marketplace. 8
12 Medical Cost Containment Legislation Historically, governmental strategies to contain medical costs in the workers' compensation field have been generally limited to legislation on a state-by-state basis. For example, many states have implemented fee schedules those list maximum reimbursement levels for health care procedures. In certain states that have not authorized the use of a fee schedule, the Company adjusts bills to the usual and customary levels authorized by the payor. Opportunities for the Company's services could increase as more states legislate additional cost containment strategies. Conversely, the Company could be adversely affected if states elect to reduce the extent of medical cost containment strategies available to insurance carriers and other payors, or adopt other strategies for cost containment that would not support a demand for the Company's services. Healthcare Reform There has been considerable discussion of healthcare reform at both the federal level and in numerous state legislatures in recent years. Due to uncertainties regarding the ultimate features of reform initiatives and the timing of their enactment, the Company cannot predict which, if any, reforms will be adopted, when they may be adopted, or what impact they may have on the Company. Vocational Rehabilitation Legislation During the early 1970s, the case management marketplace within workers' compensation was dominated by the provision of medical management services. Such services were purchased at the option of insurance carriers with little or no support from legislative efforts within any of the states. By the mid-1970s, it became popular for states to legislate either supportive programs for vocational rehabilitation or, in some cases, mandatory vocational rehabilitation statutes. SHAREHOLDER RIGHTS PLAN During fiscal 1997, the Company's Board of Directors approved the adoption of a Shareholder Rights Plan. The Rights Plan, which is similar to rights plans adopted by numerous other public companies, provides for a dividend distribution to CorVel stockholders of one preferred stock purchase "Right" for each outstanding share of CorVel's Common Stock. The Rights are designed to assure that all stockholders 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 $62.50 per right, adjusted for the two-for-one stock split paid on June 14, 1999, subject to subsequent adjustment. Initially, the Rights will trade with the Company's common stock, and will not be exercisable until the occurrence of certain takeover-related events. Generally, the 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. 9
13 In addition, if the Company is thereafter merged into another entity, of 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. EMPLOYEES As of March 31, 1999, CorVel had approximately 2,500 employees, including nurses, therapists, counselors and other employees. No employees are represented by any collective bargaining unit. Management considers its relationship with its employees to be good. RISK FACTORS Past financial performance is not necessarily a reliable indicator of future performance, and investors in the Company's Common Stock should not use historical performance to anticipate results or future period trends. The Company's business and the market price of the Company's Common Stock are subject to numerous risks and uncertainties. Some of those risks are described below. Other risks are presented elsewhere in this Form 10-K. See, in particular, "Management's Discussion and Analysis of Financial Condition and Results of Operations". POTENTIAL ADVERSE IMPACT OF GOVERNMENT REGULATION. Many states, including a number of those in which the Company transacts business, have licensing and other regulatory requirements applicable to the Company's business. Approximately half of the states have enacted laws that require licensing of businesses, which provide medical review services, such as the Company. Some of these laws apply to medical review of care covered by workers' compensation. These laws typically establish minimum standards for qualifications of personnel, confidentiality, internal quality control and dispute resolution procedures. These regulatory programs may result in increased costs of operation for the Company, which may have an adverse impact upon the Company's ability to compete with other available alternatives for health care cost control. In addition, new laws regulating the operation of managed care provider networks have been adopted by a number of states. These laws may apply to managed care provider networks having contracts with the Company or to provider networks, which the Company may organize. To the extent the Company is governed by these regulations, it may be subject to additional licensing requirements, financial and operational oversight and procedural standards for beneficiaries and providers. Regulation in the health care and workers' compensation fields is constantly evolving. The Company is unable to predict what additional government regulations, if any affecting its business may be promulgated in the future. The Company's business may be adversely affected by failure to comply with existing laws and regulations, failure to obtain necessary licenses and government approvals or failure to adapt to new or modified regulatory requirements. Proposals for health care legislative reforms are regularly considered at the federal and state levels. To the extent that such proposals affect workers' compensation, such proposals may adversely affect the Company's business and results of operations. 10
14 In addition, changes in workers' compensation laws or regulations may impact demand for the Company's services, require the Company to develop new or modified services to meet the demands of the marketplace or modify the fees that the Company may charge for its services. One of the proposals which has been considered is 24-hour health coverage, in which the coverage of traditional employer-sponsored health plans is combined with workers' compensation coverage to provide a single insurance plan for work-related and non-work-related health problems. Incorporating workers' compensation coverage into conventional health plans may adversely affect the market for the Company's services. POSSIBLE LITIGATION AND LEGAL LIABILITY. The Company, through its utilization management services, makes recommendations concerning the appropriateness of providers' medical treatment plans of patients throughout the country, and as a result, could be exposed to claims for adverse medical consequences. The Company does not grant or deny claims for payment of benefits and the Company does not believe that it engages in the practice of medicine or the delivery of medical services. There can be no assurance, however, that the Company will not be subject to claims or litigation related to the grant or denial of claims for payment of benefits or allegations that the Company engages in the practice of medicine or the delivery of medical services. In addition, there can be no assurance that the Company will not be subject to other litigation that may adversely affect the Company's business or results of operations. The Company maintains professional liability insurance and such other coverages as the Company believes are reasonable in light of the Company's experience to date. There can be no assurance; however, that such insurance will be sufficient or available in the future at reasonable cost to protect the Company from liability which might adversely affect the Company's business or results of operations. COMPETITION. The Company faces competition from HMOs, PPOs, TPAs and other managed health care companies. The Company believes that, as managed care techniques continue to gain acceptance in the workers' compensation marketplace, CorVel's competitors will increasingly consist of nationally focused workers' compensation managed care service companies, insurance companies, HMOs and other significant providers of managed care products. Legislative reforms in some states permit employers to designate health plans such as HMOs and PPOs to cover workers' compensation claimants. Because many health plans have the ability to manage medical costs for workers' compensation claimants, such legislation may intensify competition in the markets served by the Company. Many of the Company's current and potential competitors are significantly larger and have greater financial and marketing resources than those of the Company, and there can be no assurance that the Company will continue to maintain its existing clients or its past level of operating performance or be successful with any new products or in any new geographical markets it may enter. CHANGES IN MARKET DYNAMICS. Within the past few years, several states have experienced decreases in the number of workers' compensation claims and the average cost per claim which have been reflected in workers' compensation insurance premium rate reductions in those states. The Company believes that declines in workers' compensation costs in these states are due principally to intensified efforts by payors to m manage and control claim costs, to improved risk management by employers and to legislative reforms. If declines in workers' compensation costs occur in many states and persist over the long-term, they may have an adverse impact on the Company's business and results of operations. 11
15 DEPENDENCE UPON KEY PERSONNEL. The Company is dependent to a substantial extent upon the continuing efforts and abilities of certain key management personnel. In addition, the Company faces competition for experienced employees with professional expertise in the workers' compensation managed care area. The loss of, or the inability to attract, qualified employees could have a material adverse effect on the Company's business and results of operations. RISKS RELATED TO GROWTH STRATEGY. The Company's strategy is to continue its internal growth and, as strategic opportunities arise in the workers' compensation managed care industry, to consider acquisitions of, or relationships with, other companies in related lines of business. As a result, the Company is subject to certain growth-related risks, including the risk that it will be unable to retain personnel or acquire other resources necessary to service such growth adequately. Expenses arising from the Company's efforts to increase its market penetration may have a negative impact on operating results. In addition, there can be no assurance that any suitable opportunities for strategic acquisitions or relationships will arise or, if they do arise that the transactions contemplated thereby could be completed. If such a transaction does occur, there can be no assurance that the Company will be able to integrate effectively any acquired business into the Company. In addition, any such transaction would be subject to various risks associated with the acquisition of businesses, including the financial impact of expenses associated with the integration of businesses. There can be no assurance that any future acquisition or other strategic relationship will not have an adverse impact on the Company's business or results of operations. If suitable opportunities arise, the Company anticipates that it would finance such transactions, as well as its internal growth, through working capital or, in certain instances, through debt or equity financing. There can be no assurance, however, that such debt or equity financing would be available to the Company on acceptable terms when, and if, suitable strategic opportunities arise. During the past fiscal year, the Company has made efforts to increase its presence and revenue in the group health market with moderate success. Managed care in this market is maturer than managed care in workers' compensation and has numerous large competitors, primarily HMOs. The Company has limited experience in the group health market. There can be no assurance that the Company will be successful in this market. Certain aspects of the Company's business are dependent upon its ability to store, retrieve, process and manage data and to maintain and upgrade its data processing capabilities. Interruption of data processing capabilities for any extended length of time, loss of stored data, programming errors or other computer problems could have a material adverse effect on the Company's business and results of operations. In addition, the company's results of operations are highly dependent upon the ability of management to expeditiously retrieve and analyze financial information from its nation-wide branch network. The company is currently in the process of installing new company-wide management information software and there can be no assurance that the installation of this new system will proceed according to plan. 12
16 In addition, the Company expects that a considerable amount of its future growth will depend on its ability to process and manage claims data more efficiently and to provide more meaningful healthcare information to customers and payors of healthcare. There can be no assurance that the Company's current data processing capabilities will be adequate for its future growth, that it will able to efficiently upgrade its systems to meet future demands, or that the Company will be able to develop, license or otherwise acquire software to address these market demands as well or as timely as its competitors POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Company's Common Stock following this offering may be highly volatile. Factors such as variations in the Company's revenues, earnings and cash flow, general market trends in the workers' compensation managed care market, and announcements of innovations by the Company or its competitors could cause the market price of the Common Stock to fluctuate substantially. Specifically, the year-to-year percentage growth in operating results for the Company's four most recently completed fiscal years was lower than the growth rates historically experienced by the Company. The Company's slower growth rate in those fiscal years was partially attributable to a reduction in the growth rate of health care expenditures nationally, contributing to a reduction in the growth of claims processed by the Company. There can be no assurance that the Company's growth rate in the future, if any will be at or near historical levels. In addition, the stock market has in the past experienced price and volume fluctuations that have particularly affected companies in the health care and managed care markets resulting in changes in the market price of the stock of many companies which may not have been directly related to the operating performance of those companies. IMPORTANCE OF INTELLECTUAL PROPERTY RIGHTS. The Company has made significant investments in the development and maintenance of its proprietary software systems and data. The Company relies largely on its own security systems, confidentiality procedures and employee nondisclosure agreements to maintain the confidentiality and security of its proprietary information. Unauthorized access by third parties to the Company's information systems, the existence of computer viruses in the Company's data or software and misappropriation of the Company's proprietary information may have a material adverse effect on the Company's business and results of operations. ITEM 2. PROPERTIES. The Company's principal executive office is located in Irvine, California in approximately 3,500 square feet of leased space. The lease expires in August 2002. The Company leases its branch offices, which range in size up to approximately 11,000 square feet. The lease terms for the branch offices range from monthly to five years. The Company believes that its facilities are adequate for its current needs and that suitable additional space will be available as required. ITEM 3. LEGAL PROCEEDINGS. The Company is involved in litigation arising in the normal course of business. The Company believes that resolution of these matters will not result in any payment that, in the aggregate, would be material to the financial position or financial operations of the Company. 13
17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to a vote of stockholders during the quarter ended March 31, 1999. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. MARKET INFORMATION The Company's Common Stock is traded on the Nasdaq National Market under the symbol CRVL. The quarterly high and low sales prices for the Company's Common Stock for fiscal years 1998 and 1999 as reported by Nasdaq are set forth below for the periods indicated as adjusted for the 2-for-1 stock split in the form of a 100% dividend paid on June 14, 1999: <TABLE> <CAPTION> FISCAL YEAR ENDED MARCH 31, 1998: High Low <S> <C> <C> Quarter Ended June 30, 1997: $ 15.75 $11.50 Quarter Ended September 30, 1997: 19.75 14.38 Quarter Ended December 31, 1997: 21.38 17.88 Quarter Ended March 31, 1998: 20.44 16.50 FISCAL YEAR ENDED MARCH 31, 1999: Quarter Ended June 30, 1998: $ 20.00 $ 16.50 Quarter Ended September 30, 1998: 19.94 16.25 Quarter Ended December 31, 1998: 19.00 16.88 Quarter Ended March 31, 1999: 18.50 17.00 </TABLE> The last sales price for the Company's Common Stock as reported by NASDAQ on June 4, 1999 was $19.69 as adjusted for the 2-for-1 stock split in the form of a dividend paid on June 14, 1999. As of June 4, 1999, there were 508 holders of record of the Company's Common Stock. The Company has never paid any cash dividends on its Common Stock and has no current plans to do so. ITEM 6. SELECTED FINANCIAL DATA. The selected consolidated financial data of the Company appears in a separate section of this Annual Report on Form 10-K on page F-1. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Management's Discussion and Analysis of Financial Condition and Results of Operations appears in a separate section of this Annual Report on Form 10-K beginning on page F-2. 14
18 ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Market risk generally represents the risk that losses may occur in the values of financial instruments as a result of movements in interest rates, foreign currency exchange rates and commodity prices. The Company has no market risks in these areas. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Company's consolidated financial statements and schedule, as listed under Item 14, appear in a separate section of this Annual Report on Form 10-K beginning on page F-7 and S-1, respectively. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The sections titled "Directors and Nominees," "Executive Officers of the Company," and "Compliance with Section 16(a) of the Exchange Act" appearing in the Company's Definitive Proxy Statement for the 1999 Annual Meeting of Stockholders are incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. The section titled "Executive Compensation and Related Information", except as stated therein, appearing in the Company's Definitive Proxy Statement for the 1999 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The section titled "Principal Stockholders" appearing in the Company's Definitive Proxy Statement for the 1999 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The section titled "Certain Transactions" appearing in the Company's Definitive Proxy Statement for the 1999 Annual Meeting of Stockholders is incorporated herein by reference. 15
19 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a)(1) CONSOLIDATED FINANCIAL STATEMENTS: The Company's consolidated financial statements appear in a separate section of this Annual Report on Form 10-K beginning on the pages referenced below: <TABLE> <CAPTION> Page ---- <S> <C> Report of Independent Auditors F-7 Consolidated Statements of Income for the Years Ended March 31, 1997, 1998, and 1999 F-8 Consolidated Balance Sheets as of March 31, 1998 and 1999 F-9 Consolidated Statements of Stockholders' Equity for the Years Ended March 31, 1997, 1998, and 1999 F-10 Consolidated Statements of Cash Flows for the Years Ended March 31, 1997, 1998, and 1999 F-12 Notes to Consolidated Financial Statements F-13 </TABLE> (2) FINANCIAL STATEMENT SCHEDULE: The Company's financial statement schedule appears in a separate section of this Annual Report on Form 10-K beginning on the page referenced below. All other schedules have been omitted as they are not applicable, not required or the information is included in the consolidated financial statements or the notes thereto. <TABLE> <CAPTION> Schedule Page -------- ---- <S> <C> II -- Valuation and Qualifying Accounts S-1 </TABLE> (3) EXHIBITS: <TABLE> <S> <C> <C> 3.1 Certificate of Incorporation of Incorporated herein by reference to the Company Exhibit 3.1 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 3.2 Bylaws of the Company Incorporated herein by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. </TABLE> 16
20 EXHIBITS (CONTINUED) <TABLE> <CAPTION> EXHIBIT NO. TITLE METHOD OF FILING - ------- ----- ---------------- <S> <C> <C> 10.1 Nonqualified Stock Option Incorporated herein by reference to Agreement between V. Gordon Exhibit 10.6 to the Company's Registration Clemons, the Company and North Statement on Form S-1 Registration No. Star together with all amendments 33-40629. and addendums thereto 10.2 Supplementary Agreement between Incorporated herein by reference to V. Gordon Clemons, the Company and Exhibit 10.7 to the Company's Registration North Star Statement on Form S-1 Registration No. 33-40629. 10.3 Amendment to Supplementary Incorporated herein by reference to Agreement between Mr. Clemons, the Exhibit 10.5 to the Company's Annual Company and North Star Report on Form 10-K for the fiscal year ended March 31, 1992. 10.4 Restated 1988 Executive Stock Incorporated herein by reference to Option Plan, as amended Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1995. 10.5 Form of Notice of Grant of Stock Incorporated herein by reference to Option Under the Restated 1988 Exhibit 10.7 to the Company's Annual Executive Stock Option Report on Form 10-K for the fiscal year ended March 31, 1994. 10.6 Form of Stock Option Agreement Incorporated herein by reference to under the Restated 1988 Executive Exhibit 10.8 to the Company's Annual Stock Option Plan Report on Form 10-K for the fiscal year ended March 31, 1994. 10.7 Form of Notice of Exercise under Incorporated herein by reference to the Restated 1988 Executive Stock Exhibit 10.9 to the Company's Annual Option Plan Report on Form 10-K for the fiscal year ended March 31, 1994. 10.8 Employment Agreement of V. Gordon Incorporated herein by reference to Clemons Exhibit 10.12 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. </TABLE> 17
21 <TABLE> <CAPTION> EXHIBIT NO. TITLE METHOD OF FILING - ------- ----- ---------------- <S> <C> <C> 10.9 Restated 1991 Employee Stock Incorporated herein by reference to Purchase Plan, as amended Exhibit 10.11 in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1995. 10.10 Fidelity Master Plan for Savings Incorporated herein by reference to and Investment, and amendments Exhibits 10.16 and 10.16A to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 10.11 Daniel Davis Severance Incorporated herein by reference to the Arrangement Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993. 10.15 Shareholder Rights Plan Incorporated herein by reference to the Company's Form 8-K filed on February 28, 1997. 21.1 Subsidiaries of the Company Attached. 23.1 Consent of Independent Auditors Attached. 27.1 Financial Data Schedule Attached. </TABLE> (b) REPORTS ON FORM 8-K None. 18
22 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) 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. CORVEL CORPORATION Date: June 28, 1999 By: /s/ V. GORDON CLEMONS ------------------------------------ V. Gordon Clemons Chairman and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. <TABLE> <CAPTION> SIGNATURE TITLE DATE --------- ----- ---- <S> <C> <C> /s/ V. Gordon Clemons Chairman and President June 28, 1999 - ----------------------------- V. Gordon Clemons /s/ Richard J. Schweppe Chief Financial Officer and Accounting June 28, 1999 - ----------------------------- Officer Richard J. Schweppe /s/ Peter E. Flynn Director June 28, 1999 - ----------------------------- Peter E. Flynn /s/ Steven J. Hamerslag Director June 28, 1999 - ----------------------------- Steven J. Hamerslag /s/ Judd Jessup Director June 28, 1999 - ----------------------------- Judd Jessup /s/ Jeffrey J. Michael Director June 28, 1999 - ----------------------------- Jeffrey J. Michael </TABLE> 19
23 SELECTED CONSOLIDATED FINANCIAL DATA The following selected financial data for the five years ended March 31, 1999, have been derived from the Company's audited consolidated financial statements. The following data should be read in conjunction with the Company's Consolidated Financial Statements, the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The following amounts are in thousands, except per share data. Historical common share amounts and per share amounts have been restated to give effect to a 2-for-1 stock split paid on June 14, 1999. <TABLE> <CAPTION> Year Ended March 31, -------------------------------------------------------------------- 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> STATEMENT OF INCOME DATA: Revenues $ 95,783 $109,052 $121,704 $141,709 $165,457 Costs and Expenses: Cost of revenues 78,950 88,937 99,323 115,553 136,082 General and administrative 7,186 8,106 8,645 11,029 12,596 -------- -------- -------- -------- -------- 86,136 97,043 107,968 126,582 148,678 -------- -------- -------- -------- -------- Income before income taxes 9,647 12,009 13,736 15,127 16,779 Income tax provision 3,762 4,684 5,220 5,670 6,376 -------- -------- -------- -------- -------- Net income $ 5,885 $ 7,325 $ 8,516 $ 9,457 $ 10,403 ======== ======== ======== ======== ======== Net income per share: Basic $ 0.71 $ 0.83 $ 0.93 $ 1.13 $ 1.28 ======== ======== ======== ======== ======== Diluted $ 0.65 $ 0.79 $ 0.91 $ 1.10 $ 1.26 ======== ======== ======== ======== ======== Shares used in computing net income per share: Basic 8,276 8,870 9,170 8,386 8,155 Diluted 9,062 9,320 9,370 8,572 8,261 Return on beginning of year equity 21.5% 20.5% 18.8% 20.5% 22.7% </TABLE> <TABLE> <CAPTION> BALANCE SHEET DATA AS OF MARCH 31, 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> Cash and cash equivalents $ 13,221 $ 17,113 $ 15,665 $ 8,430 $ 9,052 Accounts receivable, net 15,868 18,394 22,294 25,633 31,562 Working capital 24,085 30,781 28,596 24,726 31,700 Total assets 43,965 53,984 58,824 60,491 68,737 Retained earnings 11,585 18,910 27,426 36,883 47,286 Total stockholders' equity 35,754 45,311 46,087 45,771 53,214 </TABLE> F-1
24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 timely completion of modifications to ensure that the Company's systems are Year 2000 compliant; 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 and health insurance benefits. Patient management services include early intervention, utilization review, medical case management, vocational rehabilitation, and independent medical examinations. Provider program revenues include fee schedule auditing, hospital bill auditing, and preferred provider referral services. The percentages of revenues attributable to patient management and provider program services for the fiscal years ended March 31, 1997, 1998, and 1999 are as follows: <TABLE> <CAPTION> 1997 1998 1999 -------- -------- -------- <S> <C> <C> <C> Patient management services 51.7% 56.1% 58.5% Provider program services 48.3% 43.9% 41.5% -------- -------- -------- 100.0% 100.0% 100.0% ======== ======== ======== </TABLE> RECENT DEVELOPMENT On May 24, 1999, the Company announced that its Board of Directors authorized a 2-for-1 common stock split in the form of a 100% stock distribution. The split was payable on June 14, 1999 to stockholders of record on May 31, 1999. Historical common share amounts, per share amounts and stock option data for all periods presented have been restated to give effect to this 100% stock distribution. F-2
25 RESULTS OF OPERATIONS 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. <TABLE> <CAPTION> YEAR ENDED MARCH 31, ---------------------------------- 1997 1998 1999 -------- -------- -------- <S> <C> <C> <C> Revenues 100.0% 100.0% 100.0% Cost of revenues 81.6 81.5 82.3 General and administrative 7.1 7.8 7.6 Income before income taxes 11.3 10.7 10.1 Net income 7.0 6.7 6.3 </TABLE> Years Ended March 31, 1997, 1998 and 1999 Revenues for fiscal 1998 increased by 16% to $142 million from $122 million in fiscal 1997, an increase of $20 million. The majority of this growth came from patient management services, which grew 27% from $63 million in fiscal year 1997 to $80 million in fiscal 1998, primarily due to two new national contracts to provide patient management services along with an increase in referrals from existing customers. Provider program services increased by $3 million from $59 million in fiscal 1997 to $62 million in fiscal 1998, an increase of 6%. Revenues for fiscal 1999 increased by 17% to $165 million from $142 million in fiscal 1998, an increase of $23 million. The majority of this growth came from patient management services, which grew 23% from $79 million in fiscal year, 1998 to $97 million in fiscal 1999, primarily due to new national contracts to provide patient management services along with an increase in referrals from existing customers. Provider program services increased by $7 million from $62 million in fiscal 1998 to $69 million in fiscal 1999, an increase of 11%. 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 $99 million in fiscal 1997 and $116 million in fiscal 1998, to $136 million in fiscal 1999, primarily due to the increases in revenues as noted above. Cost of services as a percentage of revenues was 81.6% during fiscal 1997 and 81.5% in fiscal 1998, and increased to 82.3% in 1999. During fiscal year 1999, the cost of service percentage increased primarily due to the change in mix of revenues from provider programs to patient management revenues caused by the strong growth in the patient management referrals. Patient management services have a higher cost of services percentage than that of provider programs. 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. F-3
26 General and administrative expense increased from $8.6 million in fiscal 1997 and $11.0 million in fiscal 1998 to $12.6 million in fiscal 1999. This increase was primarily due to increased MIS staff to support the Company's implementation of a national wide area network and further electronic data interface capabilities as required by customer needs, and for increased marketing staff to support the development of the Company's national healthcard product. General and administrative expenses increased as a percentage of revenue from 7.1% of revenues in fiscal 1997 to 7.8% in fiscal 1998 and 7.6% in fiscal 1999. These percentage increases were due to the growth in general and administrative expenses as noted above, exceeded the growth in revenues. LIQUIDITY AND CAPITAL RESOURCES The Company has funded its operations and capital expenditures primarily from cash flow from operations. During fiscal 1999, net working capital increased by $7 million from $25 million at March 31, 1998 to $32 million at March 31, 1999. This increase is primarily due to the $10 million of net income earned by the Company during fiscal 1999. As of March 31, 1999, 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. The Company has no interest-bearing short-term debt. 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, 1999 along with anticipated internally generated funds will be sufficient to meet the Company's expected cash requirements for at least the next twelve months. YEAR 2000 INFORMATION SYSTEMS ISSUES Certain computer programs written with two digits rather than four to define the applicable year may experience problems handling dates near the end of and beyond the year 1999 (Year 2000 failure dates). This may cause computer applications to fail or provide erroneous results unless corrective action is taken. The Company has developed a plan to address the Year 2000 issue and, in doing so, will incur internal staff costs as well as external consulting and other expenses related to infrastructure enhancements necessary to prepare its systems for the new century. A strategy for achieving compliance for each system component has been prepared. Costs of the Company's Year 2000 Project are estimated to be approximately $2.4 million of which approximately $2.0 million has been incurred through May 31, 1999. The cost of the Year 2000 Project will be expensed as incurred. With respect to Information Technology (IT) systems, the Company's Year 2000 plan encompasses computer application systems, including those for client-server, minicomputer, and personal computer environments; and IT infrastructure, including hardware, operating system software, network technology, and voice and data communications. All of the Company proprietary systems development methodologies assure that core functions like date comparisons, date sorts, and elapsed-day calculations are standardized in shared-code libraries and/or utilities. This reduces the number of instances of redundant code to be reviewed and certified for Year 2000 compliance. F-4
27 The Company is currently conducting full system tests in a simulated post-2000 environment. It is anticipated that the certified versions of these systems will be fully implemented in all operating sites by July 31, 1999. Interoperability tests with clients' systems, if needed, commenced in the third quarter of 1998. Data formats used in EDI transmissions, unless specifically requested by the client, are Year 2000 compliant. The Company's bill review product for Windows is presently Year 2000 compatible as well as the case management software. The Company's bill review software which runs on VMS is nearing the completion of the validation testing phase with implementation scheduled prior to the end of the September 1999 quarter. The Company's software for its accounts receivable, accounts payable and general ledger is presently Year 2000 compatible and the billing software is nearing the completion of the validation testing phase with implementation scheduled prior to the end of the September 1999 quarter. Review of the non-IT systems is in the assessment phase with implementation scheduled prior to the end of the September 1999 quarter. The Company's non-IT systems are primarily comprised of systems typically found in commercial office buildings including electrical, fire alarm and suppression, security, HVAC and elevator systems. The inventory phase for non-IT systems at the Company's major facilities in is complete. The Company is currently at the beginning of the assessment phase for its non-IT systems. As part of the assessment phase, the Company is communicating with the owners/landlords of office spaces which the Company leases to determine the Year 2000 readiness of such office space. At this time, the Company has not received any notice of non-compliance problems from landlords. The Company is also communicating with its significant vendors to determine their Year 2000 readiness and, when possible, obtain written assurances that the Year 2000 problem will not materially adversely affect their ability to continue to provide supplies or services to the Company. Each of the foregoing IT and non-IT programs are being conducted in phases, described as follows: INVENTORY or AWARENESS PHASE -- Identify hardware, software, processes or devices that use or process date information. ASSESSMENT PHASE -- Identify Year 2000 date processing deficiencies and related implications. PLANNING and VALIDATION PHASE -- Determine for each deficiency an appropriate solution and budget. Schedule resources and develop testing plans. Validate the recommended solution with testing. IMPLEMENTATION PHASE -- Implement designed solutions. Conduct systems testing. The plan also includes a control element intended to ensure that changes to IT and non-IT systems do not introduce Year 2000 issues. The plan provides for contingency plans and related cost estimates, as additional information becomes available. The Company's Year 2000 Plan is subject to modification and is revised periodically as additional information is developed. The Company currently believes that its Year 2000 Plan will be completed in all material respects prior to the anticipated Year 2000 failure dates. F-5
28 Successful completion of the Company's 2000 Project is affected by many factors, including but not limited to Year 2000 readiness of the Company's key vendors and customers. The information contained in this statement is based on management's best estimates. However, there can be no guarantee that these estimated will be achieved, and actual results could differ materially from those anticipated based on factors such as availability and cost of personnel trained in this area, the ability to identify relevant computers codes, and the impact of the Company's external relationships. The possible consequences of the Company or its business partners not being fully Year 2000 compliant include temporary disruption to the delivery of services. The Company will be using contingency plans already in place related to the backing up of information systems and disaster recovery procedures. The Company will be developing additional and/or supplemental contingency plans where necessary in an effort to be prepared should a Year 2000 issue arise. F-6
29 REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors CorVel Corporation We have audited the accompanying consolidated balance sheets of CorVel Corporation as of March 31, 1998 and 1999, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended March 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CorVel Corporation at March 31, 1998 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1999, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Orange County, California May 10, 1999, except for Notes J and L, as to which the date is May 24, 1999 F-7
30 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> YEARS ENDED MARCH 31, ------------------------------------------------ 1997 1998 1999 ------------ ------------ ------------ <S> <C> <C> <C> REVENUES $121,704,000 $141,709,000 $165,457,000 COSTS AND EXPENSES Cost of revenues 99,323,000 115,553,000 136,082,000 General and administrative 8,645,000 11,029,000 12,596,000 ------------ ------------ ------------ 107,968,000 126,582,000 148,678,000 ------------ ------------ ------------ Income before income taxes 13,736,000 15,127,000 16,779,000 Income tax provision 5,220,000 5,670,000 6,376,000 ------------ ------------ ------------ NET INCOME $ 8,516,000 $ 9,457,000 $ 10,403,000 ============ ============ ============ Net income per share: Basic $ 0.93 $ 1.13 $ 1.28 ============ ============ ============ Diluted $ 0.91 $ 1.10 $ 1.26 ============ ============ ============ Shares used in computing net income per share: Basic Diluted 9,170,000 8,386,000 8,155,000 9,370,000 8,572,000 8,261,000 </TABLE> See accompanying notes to consolidated financial statements. F-8
31 CORVEL CORPORATION CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> MARCH 31, 1998 1999 ------------ ------------ <S> <C> <C> ASSETS Current Assets Cash and cash equivalents $ 8,430,000 $ 9,052,000 Accounts receivable (less allowance for doubtful accounts of $2,082,000 in 1998 and $3,015,000 in 1999) 25,633,000 31,562,000 Prepaid expenses and taxes 736,000 856,000 Deferred income taxes 2,376,000 3,223,000 ------------ ------------ Total current assets 37,175,000 44,693,000 ------------ ------------ Property and equipment, net 16,542,000 17,145,000 Other assets 6,774,000 6,899,000 ------------ ------------ $ 60,491,000 $ 68,737,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts and taxes payable $ 6,078,000 $ 6,468,000 Accrued liabilities 6,371,000 6,525,000 ------------ ------------ Total current liabilities 12,449,000 12,993,000 ------------ ------------ Deferred income taxes 2,271,000 2,530,000 Commitments and Contingencies Stockholders' Equity Common Stock, $.0001 par value: 20,000,000 shares authorized; 9,706,944 and 9,885,576 shares issued and outstanding in 1998 and 1999, respectively Paid-in Capital 30,615,000 32,918,000 Treasury Stock, at cost (1,461,200 shares in 1998, 1,747,280 shares in 1999) (21,727,000) (26,990,000) Retained Earnings Total stockholders' equity 36,883,000 47,286,000 ------------ ------------ 45,771,000 53,214,000 ------------ ------------ $ 60,491,000 $ 68,737,000 ============ ============ </TABLE> See accompanying notes to consolidated financial statements. F-9
32 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED MARCH 31, 1997, 1998, AND 1999 <TABLE> <CAPTION> COMMON STOCK COMMON STOCK- AND PAID IN TREASURY SHARES CAPITAL SHARES -------------------------------------------------- <S> <C> <C> <C> Balance - March 31, 1996 9,187,350 $ 26,401,000 - Stock issued under employee stock purchase plan 46,078 536,000 - Stock issued and income tax benefits under stock option plan, net of shares repurchased 162,278 1,185,000 - Purchase of common stock - - (714,000) Net income - - - -------------------------------------------------- Balance - March 31, 1997 9,395,706 28,122,000 (714,000) -------------------------------------------------- Stock issued under employee stock purchase plan 41,040 540,000 - Stock issued and income tax benefits under stock option plan, net of shares repurchased 270,198 1,953,000 - Purchase of common stock - - (747,200) Net income - - - -------------------------------------------------- Balance - March 31, 1998 9,706,944 30,615,000 (1,461,200) -------------------------------------------------- Stock issued under employee stock purchase plan 34,428 541,000 - Stock issued and income tax benefits under stock option plan, net of shares repurchased 144,204 1,762,000 - Purchase of common stock - - (286,080) Net income - - - -------------------------------------------------- Balance - March 31, 1999 9,885,576 $ 32,918,000 (1,747,280) ================================================== </TABLE> See accompanying notes to consolidated financial statements. F-10
33 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED MARCH 31, 1997, 1998, AND 1999 <TABLE> <CAPTION> TOTAL TREASURY RETAINED SHAREHOLDERS' SHARES - COST EARNINGS EQUITY ------------------------------------------------------ <S> <C> <C> <C> Balance - March 31, 1996 $ - $ 18,910,000 $ 45,311,000 Stock issued under employee stock purchase plan - - 536,000 Stock issued and income tax benefits under stock option plan, net of shares repurchased - - 1,185,000 Purchase of common stock (9,461,000) - (9,461,000) Net income - 8,516,000 8,516,000 ------------------------------------------------------ Balance - March 31, 1997 (9,461,000) 27,426,000 46,087,000 ------------------------------------------------------ Stock issued under employee stock purchase plan - - 540,000 Stock issued and income tax benefits under stock option plan - - 1,953,000 Purchase of common stock (12,266,000) - (12,266,000) Net income - 9,457,000 9,457,000 ------------------------------------------------------ Balance - March 31, 1998 (21,727,000) 36,883,000 45,771,000 ------------------------------------------------------ Stock issued under employee stock purchase plan - - 541,000 Stock issued and income tax benefits under stock option plan, net of shares repurchased - - 1,762,000 Purchase of common stock (5,263,000) - (5,263,000) Net income - 10,403,000 10,403,000 ------------------------------------------------------ Balance - March 31, 1999 $ (26,990,000) $ 47,286,000 $ 53,214,000 ====================================================== </TABLE> See accompanying notes to consolidated financial statements. F-11
34 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> Years Ended March 31, ------------------------------------------------------ 1997 1998 1999 ------------ ------------ ------------ <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 8,516,000 $ 9,457,000 $ 10,403,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,215,000 5,349,000 6,344,000 Deferred income taxes 420,000 137,000 (588,000) Loss on write down and disposal of property and equipment 96,000 124,000 37,000 Changes in operating assets and liabilities: Accounts receivable (3,900,000) (3,339,000) (5,929,000) Prepaid taxes and expenses 421,000 (612,000) (120,000) Accounts and taxes payable 3,546,000 (525,000) 390,000 Accrued liabilities 384,000 1,741,000 154,000 Other assets (1,607,000) (1,069,000) (482,000) ------------ ------------ ------------ Net cash provided by operating activities 12,091,000 11,263,000 10,209,000 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment (5,799,000) (8,725,000) (6,627,000) ------------ ------------ ------------ Net cash used in investing activities (5,799,000) (8,725,000) (6,627,000) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds and tax benefits from exercise of stock options 1,721,000 2,493,000 2,303,000 Purchase of common stock (9,461,000) (12,266,000) (5,263,000) ------------ ------------ ------------ Net cash used in financing activities (7,740,000) (9,773,000) (2,960,000) ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents (1,448,000) (7,235,000) 622,000 Cash and cash equivalents at beginning of year 17,113,000 15,665,000 8,430,000 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 15,665,000 $ 8,430,000 $ 9,052,000 ============ ============ ============ </TABLE> See accompanying notes to consolidated financial statements. F-12
35 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 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 subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements. Actual results could differ from those estimates. Cash and Cash Equivalents: Cash and cash equivalents consists of short-term highly-liquid investments with maturities of 90 days or less when purchased. The carrying amounts of the Company's financial instruments approximate their relative fair values at March 31, 1998 and 1999. 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. Accounts receivable includes $1,582,000 and $1,979,000 of unbilled receivables at March 31, 1998 and 1999, respectively. No one customer accounted for more than 10% of consolidated revenues during the years ended March 31, 1997, 1998 and 1999. Property and Equipment: Additions to property and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line and accelerated methods over the estimated useful lives of the related assets which range from three to seven 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. F-13
36 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Other Assets: Other assets consists primarily of the excess of the purchase price over the estimated fair value of the net assets of businesses acquired (goodwill) and is being amortized using the straight-line method over periods not exceeding 40 years. Goodwill amounted to $5,546,000 (net of accumulated amortization of $1,088,000) at March 31, 1998 and 5,869,000 (net of accumulated amortization of $1,237,000) at March 31, 1999. Concentrations of Credit Risk: The Company performs periodic credit evaluations of its customers' financial condition and does not require collateral. One customer accounted for 13% of the Company's accounts receivable balance in 1999. No other customer accounted for 10% of accounts receivable in 1998 or 1999. Receivables are generally due within 60 days. Credit losses relating to customers in the workers' compensation insurance industry consistently have been within management's expectations. Income Taxes: The consolidated financial statements reflect the application of Statement of Financial Accounting Standards No. 109 - "Accounting for Income Taxes". 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 is 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 due to the effect of stock options. Stock Option Plans: The Company applies the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123) and accordingly, is continuing to account for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Recent Accounting Pronouncements: In 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). The Company has determined it currently operates in one reportable segment as defined in SFAS No. 131. Each of the Company's products and services have similar long-term financial performance and have similar economic characteristics. All of the Company's products and services relate to programs that provide the Company's customers with a single source for all of their managed care needs, providing comprehensive, cost-effective and innovative solutions. F-14
37 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides guidance on an accounting for the costs of computer software developed or obtained for internal use. Specifically, certain internal payroll and payroll related costs should be capitalized during the application development stage of a project and depreciated over the computer software's useful life. The Company will implement SOP 98-1 as of April 1, 1999 and does not believe that implementation will have a material impact on its financial statements. In fiscal 1999, the Company adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this statement had no impact on the Company's net income or stockholders' equity. SFAS No. 130 requires unrealized gains or losses on the Company's available-for-sale securities, which prior to adoption were reported separately in stockholders' equity, to be included in other comprehensive income. NOTE B - PROPERTY AND EQUIPMENT Property and equipment consists of the following at March 31: <TABLE> <CAPTION> 1998 1999 ------------ ------------ <S> <C> <C> Office equipment and computers $ 24,930,000 $ 29,618,000 Computer software 7,808,000 9,434,000 Leasehold improvements 1,154,000 1,349,000 ------------------------------- 33,892,000 40,401,000 Less: accumulated depreciation and amortization 17,350,000 23,256,000 ------------------------------- $ 16,542,000 $ 17,145,000 =============================== </TABLE> NOTE C - ACCRUED LIABILITIES Accrued liabilities consists of the following at March 31: <TABLE> <CAPTION> 1998 1999 ------------ ------------ <S> <C> <C> Payroll and related benefits $ 3,303,000 $ 4,630,000 Self-insurance reserves 650,000 645,000 Other 2,418,000 1,250,000 ------------------------------ $ 6,371,000 $ 6,525,000 ============================== </TABLE> F-15
38 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENT MARCH 31, 1999 NOTE D - INCOME TAXES The income tax provision consists of the following for the three years ended March 31: <TABLE> <CAPTION> 1997 1998 1999 ------------ ------------ ------------ <S> <C> <C> <C> Current - Federal $ 4,212,000 $ 4,955,000 $ 6,337,000 Current - State 588,000 346,000 627,000 -------------------------------------------------- Subtotal 4,800,000 5,301,000 6,964,000 -------------------------------------------------- Deferred - Federal 368,000 345,000 (537,000) Deferred - State 52,000 24,000 (51,000) -------------------------------------------------- Subtotal 420,000 369,000 (588,000) -------------------------------------------------- $ 5,220,000 $ 5,670,000 $ 6,376,000 ================================================== </TABLE> Income tax benefits associated with the exercise of stock options were $228,000, $1,212,000 and $289,000 for fiscal 1997, 1998, and 1999, respectively. 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: <TABLE> <CAPTION> 1997 1998 1999 ------------ ------------ ------------ <S> <C> <C> <C> Income taxes at federal statutory rate $ 4,808,000 $ 5,294,000 $ 5,873,000 State income taxes, net of federal benefit 423,000 453,000 471,000 Goodwill amortization 40,000 42,000 45,000 Other (51,000) (119,000) (13,000) ---------------------------------------------------- $ 5,220,000 $ 5,670,000 $ 6,376,000 ==================================================== </TABLE> Income taxes paid totaled $1,683,000, $5,690,000 and $4,787,000 for the years ended March 31, 1997, 1998, and 1999, respectively. F-16
39 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE D - INCOME TAXES (CONTINUED) Deferred taxes at March 31, 1998 and 1999 are: <TABLE> <CAPTION> 1998 1999 ------------ ------------ <S> <C> <C> Deferred tax assets: Accrued liabilities not currently deductible $ 1,427,000 $ 1,756,000 Allowance for doubtful accounts 814,000 1,371,000 Other 135,000 96,000 ------------ ------------ Deferred assets 2,376,000 3,223,000 Deferred tax liabilities: Excess of tax under book basis of fixed assets (2,271,000) (2,530,000) ------------ ------------ Deferred liability (2,271,000) (2,530,000) ------------ ------------ Net deferred tax asset $ 105,000 $ 693,000 ============ ============ </TABLE> NOTE E - STOCK OPTION PLANS The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25) and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB No. 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Under the Company's Restated 1988 Executive Stock Option Plan, ("the Plan") as amended, options for up to 3,470,000 shares of the Company's common stock may be granted to key employees, nonemployee 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 are generally exercisable beginning one year from the date of grant and vest monthly thereafter for three years. F-17
40 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE E - STOCK OPTION PLANS (CONTINUED) In addition to the aforementioned Plan, the Company's President was issued an option to purchase 1,500,000 shares of common stock at an exercise price of $.0001 per share in January 1988. As of March 31, 1999, all of these options have vested and have been exercised. Summarized information for all stock options for the past three fiscal years follows: <TABLE> <CAPTION> 1997 1998 1999 ---------- ---------- ---------- <S> <C> <C> <C> Options outstanding at the Beginning of the year 846,822 911,664 761,932 Options granted 252,900 205,500 219,100 Options exercised (162,278) (317,874) (149,554) Options cancelled (25,780) (37,358) (35,072) ---------- ---------- ---------- Options outstanding at the end of the year 911,664 761,932 796,406 ========== ========== ========== During the year, weighted average price of options: Granted $ 14.24 $ 16.16 $ 18.09 Exercised $ 5.86 $ 5.14 $ 10.55 Cancelled $ 11.40 $ 13.82 $ 15.20 At the end of the year: Price range of outstanding options $ .0001- $ 5.38- $ 8.50- $ 15.75 $ 18.88 $ 18.88 Weighted average price per share $ 9.89 $ 13.38 $ 15.13 Options available for future grants 577,768 809,626 625,598 Exercisable options 489,762 335,790 333,764 </TABLE> F-18
41 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE E - STOCK OPTION PLANS (CONTINUED) The following table summarizes the status of stock options outstanding and exercisable at March 31, 1999: <TABLE> <CAPTION> Outstanding Exercisable Weighted Options- Exercisable Options - Average Weighted Options - Weighted Number of Remaining Average Number of Average Range of Outstanding Contractual Exercise Exercisable Exercise Exercise Prices Options Life Price Options Price --------------- ----------- ----------- ----------- ------------ ----------- <S> <C> <C> <C> <C> <C> $ 8.50 - $13.25 199,882 1.83 years $ 11.38 174,310 $ 11.24 13.38 - 14.81 205,192 3.52 years 14.18 95,176 14.51 15.31 - 17.81 194,832 4.24 years 16.72 49,336 15.98 18.00 - 18.88 196,500 4.67 years 18.36 14,942 18.82 ---------------------------------------------------------------------------------- Total 796,406 3.56 years $ 15.13 333,764 $ 13.21 ================================================================================== </TABLE> The Company has adopted the disclosure-only provisions of SFAS No. 123. Had compensation cost for the Company's stock option and stock purchase plans been recorded consistent with the provisions of SFAS No. 123, net income, net income per share-basic and net income per common share-diluted would have been for the three fiscal years ending March 31, 1999: <TABLE> <CAPTION> 1997 1998 1999 ------------- ------------- ------------- <S> <C> <C> <C> Net income - adjusted $ 8,315,000 $ 9,185,000 $ 9,971,000 Net income per share - basic $ 0.91 $ 1.10 $ 1.22 Net income per share - diluted $ 0.89 $ 1.07 $ 1.21 </TABLE> The weighted average fair values at date of grant for options during fiscal 1997, 1998, and 1999 were $4.34, $4.65, and $6.28, respectively. The fair value of each plan 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: <TABLE> <CAPTION> 1997 1998 1999 ------- ------- ------- <S> <C> <C> <C> Expected volatility .41 .34 .28 Risk free interest rate 6.4% 5.5% 5.7% </TABLE> The assumptions for all three years reflect no dividend yield and a weighted average option life of 4.7 years. F-19
42 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE E - STOCK OPTION PLANS (CONTINUED) The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjecting assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The aforementioned results are not likely to be representative of the effects of applying SFAS No. 123 on reported net income for future years as these amounts reflect the expense for only one to three years of vesting. NOTE F - EMPLOYEE STOCK PURCHASE PLAN The Company maintains an Employee Stock Purchase Plan which allows 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 85% of the closing sale price of shares as quoted on NASDAQ on the first or last day of such purchase period, whichever is lower. Employees are allowed to participate up to 20% of their gross pay. A maximum of 500,000 shares has been authorized for issuance under the plan, as amended. As of March 31, 1999, 304,000 shares had been issued pursuant to the plan. Summarized plan information is as follows: <TABLE> <CAPTION> 1997 1998 1999 -------- -------- -------- <S> <C> <C> <C> Employee contributions $536,000 $540,000 $541,000 Shares acquired 46,078 41,040 34,428 Average purchase price $ 11.63 $ 13.16 $ 15.71 </TABLE> NOTE G - TREASURY STOCK The Company's Board of Directors has approved a plan to repurchase up to 2,200,000 shares of the Company's outstanding common stock. 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, 1997, 1998 and 1999 are as follows: <TABLE> <CAPTION> 1997 1998 1999 Cumulative ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Shares repurchased 714,000 747,200 286,080 1,747,280 Cost $ 9,461,000 $12,266,000 $ 5,263,000 $26,990,000 Average price $ 13.25 $ 16.42 $ 18.40 $ 15.45 </TABLE> The repurchased shares were recorded as treasury stock, at cost, and is available for general corporate purposes. The repurchases were financed from cash generated from operations. F-20
43 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE H - COMMITMENTS AND CONTINGENCIES The Company leases office facilities under noncancelable operating leases. Future minimum rental commitments under operating leases at March 31, 1999 are $5,772,000 in fiscal 2000, $4,705,000 in fiscal 2001, $3,736,000 in fiscal 2002, $2,168,000 in fiscal 2003, $813,000 in fiscal 2004, and $123,000 thereafter. Total rental expense of $4,573,000, $4,683,000, and $6,064,000 was charged to operations for the years ended March 31, 1997, 1998, and 1999, respectively. The Company is involved in litigation arising in the normal course of business. The Company believes that resolution of these matters will not result in any payment that, in the aggregate, would be material to the financial position and results of the operations of the Company. NOTE I - 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 $135,000, $143,000, and $155,000, were charged to operations for the years ended March 31, 1997, 1998 and 1999, respectively. NOTE J - SHAREHOLDER RIGHTS PLAN During fiscal 1997, the Company's Board of Directors approved the adoption of a Shareholder Rights Plan. The Rights Plan, which is similar to rights plans adopted by numerous other public companies, provides for a dividend distribution to CorVel stockholders of one preferred stock purchase "Right" for each outstanding share of CorVel's common stock. The Rights are designed to assure that all stockholders 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 $62.50 per Right, as adjusted for the 2-for-1 stock split in the form of a 100% stock dividend, paid on June 14, 1999, and subject to subsequent adjustment. Initially, the Rights will trade with the company's common stock, and will not be exercisable until the occurrence of certain takeover-related events. The issuance of the Rights has no dilutive effect on the Company's earnings per share. F-21
44 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE K - QUARTERLY RESULTS The following is a summary of unaudited results of operations for the two years ended March 31, 1998 and 1999: <TABLE> <CAPTION> Net income Net income FISCAL YEAR ENDED MARCH 31, 1998: per basic per diluted Gross Net common common Revenues Margin income share share -------- ------ ------ ---------- ----------- <S> <C> <C> <C> <C> <C> First Quarter $34,024,000 $ 6,467,000 $ 2,275,000 $ .27 $ .26 Second Quarter 34,683,000 6,475,000 2,381,000 .28 .28 Third Quarter 35,558,000 6,595,000 2,395,000 .29 .28 Fourth Quarter 37,444,000 6,619,000 2,406,000 .29 .29 FISCAL YEAR ENDED MARCH 31, 1999: First Quarter $39,552,000 $ 7,210,000 $ 2,501,000 $.30 $.30 Second Quarter 40,474,000 7,148,000 2,556,000 .32 .31 Third Quarter 42,030,000 7,354,000 2,624,000 .33 .32 Fourth Quarter 43,401,000 7,663,000 2,722,000 .33 .33 </TABLE> NOTE L - SUBSEQUENT EVENT - STOCK SPLIT On May 24, 1999, the Company announced that its Board of Directors authorized a 2-for-1 common stock split in the form of a 100% stock dividend. The additional shares were distributed on June 14, 1999 to stockholders of record on May 31, 1999. Historical common share amounts, per share amounts and stock option data for all periods presented have been restated to reflect this change in the Company's capital structure. F-22
45 Schedule II CORVEL CORPORATION VALUATION AND QUALIFYING ACCOUNTS <TABLE> <CAPTION> Additions Balance at Charged to Beginning of Costs and Balance at Year Expenses Deductions End of Year ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> ALLOWANCE FOR DOUBTFUL ACCOUNTS: Year Ended March 31, 1997: $ 1,268,000 $ 1,763,000 $ (1,345,000) $ 1,686,000 Year Ended March 31, 1998: 1,686,000 2,437,000 (2,041,000) 2,082,000 Year Ended March 31, 1999: 2,082,000 2,085,000 (1,152,000) 3,015,000 </TABLE> S-1
46 EXHIBIT INDEX <TABLE> <CAPTION> EXHIBIT NO. TITLE - - METHOD OF FILING PAGE - ------- -------------------------- ---- <S> <C> <C> 3.1 Certificate of Incorporation of the Company - - Incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 3.2 Bylaws of the Company - - Incorporated herein by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 10.1 Nonqualified Stock Option Agreement between V. Gordon Clemons, the Company and North Star together with all amendments and addendums thereto - - Incorporated herein by reference to Exhibit 10.6 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 10.2 Supplementary Agreement between V. Gordon Clemons, the Company and North Star - - Incorporated herein by reference to Exhibit 10.7 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 10.3 Amendment to Supplementary Agreement between Mr. Clemons, the Company and North Star - - Incorporated herein by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1992. 10.4 Restated 1988 Executive Stock Option Plan, as amended - Incorporated herein by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1995. 10.5 Form of Notice of Grant of Stock Option Under the Restated 1988 Executive Stock Option Plan - - Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1994. 10.6 Form of Stock Option Agreement under the Restated 1988 Executive Stock Option Plan - - Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1994. </TABLE>
47 EXHIBIT INDEX (CONTINUED) <TABLE> <CAPTION> EXHIBIT NO. TITLE - - METHOD OF FILING PAGE - ------- -------------------------- ---- <S> <C> <C> 10.7 Form of Notice of Exercise under the Restated 1988 Executive Stock Option Plan - - Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1994. 10.8 Employment Agreement of V. Gordon Clemons - - Incorporated herein by reference to Exhibit 10.12 to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 10.9 Restated 1991 Employee Stock Purchase Plan, as amended - Incorporated herein by reference to Exhibit 10.11 in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1995. 10.10 Fidelity Master Plan for Savings and Investments, and amendments Incorporated herein by reference to Exhibit 10.16 and 10.16A to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 10.11 Daniel Davis Severance Arrangement - - Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993. 10.12 Shareholder Rights Plan - - Incorporated herein by reference to the Company's 8-K filed on February 28, 1997. 21.1 Subsidiaries of the Company - - Attached. 23.1 Consent of Independent Auditors - - Attached 27.1 Financial Data Schedule - - Attached. </TABLE>