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, 2001 [ ] 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 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 May 31, 2001, there were approximately 7,446,000 shares of Common Stock outstanding.
2 The Registrant does not have different classes of Common Stock and as of May 31, 2001, the aggregate market value of the Common Stock of the Registrant held by non-affiliates was approximately $161,000,000, 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. 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 2, 2001, 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 2001 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS Page ---- PART I Item 1. Business 1 Item 2. Properties 20 Item 3. Legal Proceedings 20 Item 4. Submission of Matters to a Vote of Security Holders 20 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 21 Item 6. Selected Financial Data 21 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 21 Item 7a. Quantitative and Qualitative Disclosures About Market Risk 21 Item 8. Financial Statements and Supplementary Data 22 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 22 PART III Item 10. Directors and Executive Officers of the Registrant 22 Item 11. Executive Compensation 22 Item 12. Security Ownership of Certain Beneficial Owners and Management 22 Item 13. Certain Relationships and Related Transactions 22 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 23
4 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Report includes "forward-looking statements" including, in particular, the statements about our plans, strategies and prospects under the headings Item 1. "Business," including "Risk Factors" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." Although we believe that these forward-looking statements reasonably reflect our plans, intentions and expectations, we can give no assurance that we will achieve these plans, intentions or expectations. Certain important factors that could cause actual results to differ materially from the forward-looking statements we make in this report. Representative examples of these factors include (without limitation): - general industry and economic conditions; cost of capital and capital requirements; - competition from other managed care companies; - the ability to expand certain areas of the Company's business; - shifts in customer demands; the ability of the Company to produce market-competitive software; - changes in operating expenses including employee wages, benefits and medical inflation; - changes in regulations affecting the workers' compensation, insurance and healthcare industries in general, - 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. These factors and the risk factors described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could have material adverse effects on our future results. The forward-looking statements included in this annual report on Form 10-K are made only as of the date of this annual report. We expressly disclaim any intent or obligation to update any forward-looking statements to reflect subsequent events or circumstances. PART I ITEM 1. BUSINESS. INTRODUCTION CorVel Corporation ("CorVel" or the "Company") is an independent nationwide provider of 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 1
5 auditing, preferred provider networks, utilization review, medical case management, vocational rehabilitation services, early intervention, and independent medical examinations. Such services are provided to insurance companies, government entities, third-party administrators ("TPAs"), and self-administered employers to assist them in managing the medical costs and monitoring the quality of care associated with healthcare claims. The Company, which is a Delaware corporation, has its principal executive offices located at 2010 Main Street, Suite 1020, Irvine, California, 92614. The Company's telephone number is 949-851-1473. RECENT DEVELOPMENTS During fiscal 2001, the Company introduced its CareMC marketsite (http://www.caremc.com). Care(MC) serves the healthcare and claims needs of insurers and employers managing employee absences and disability insurance losses. Care(MC) includes a website which provides for direct access to CorVel Corporation's managed care services and is also designed to function as an application service provider (ASP) through which other managed care providers will supply their services to major employers and insurers nationwide. Care(MC) was developed in response to requests from major insurers to open access for their various managed care vendors to CorVel's line of ASP services. Other features of the website include electronic communications among providers, payors, employers, managed care vendors and patients; service scheduling; purchase transactions; automated provider reimbursement adjudication and vendor billing and collections. Care(MC) offers a suite of online services, and solutions that unite multiple managed care professionals real time, and on a single website, creates a seamless, unified process for claims. This suite of solutions for managed care professionals includes: Referral Basket: Referral Basket provides access to multiple managed care professionals, suppliers, and organizations. Claims professionals can expedite case referrals and requests for service, eliminating paperwork through the use of a single, on-going electronic file. Referrals are sent to the preferred managed care provider and confirmed as received in real time. Claims Center: Claims Center helps claims professionals organize and streamline their files. Using the power of the internet, claims professionals can access comprehensive sets of information on open, closed or pending claims from multiple managed care providers. Through the CareMC Claims Center, the claims professional can interact with multiple managed care providers in real time, access and relay claims progress updates in real time, sort and search comprehensive claims data, and maintain a single, secure, electronic case file throughout the life of a claim. 2
6 Bill Review: Care(MC) Bill Review assures accuracy, accountability and timeliness by tracking costs from the time a claim begins until it is closed. Care(MC) bill review is founded on proprietary software, artificial intelligence, the integration of information from multiple resources, and instant access to information. With CareMC Bill Review, the claims professionals can record bill and cost data in real time, access bill review status instantly, review and analyze in-patient and out-patient bills, and authorize payments on-line based on fee schedules and preferred provider ("PPO") agreements. Reporting Center: Reporting Center adds value by collecting a myriad of critical details from multiple sources, then organizing and delivering that information in real time. Care(MC) helps claims professionals by sorting, simplifying and formatting comprehensive case data. Reports can be tailored to highlight individual critical cases or summarized to highlight priority trends. Through the Care(MC) Reporting Center, claims professionals can view timely status reports and cost updates, use artificial intelligence to flag priority issues, tailor reports to highlight urgent cases or summarize important trends, and perform cost and savings analyses using an advanced and integrated database. The Care(MC) suite of solutions for employers includes: Absence Manager: Absence Manager offers employers a single worksite for the reporting of all absences. Workers' compensation, short-term disability and Family Medical Leave Act ("FMLA") absences are all integrated in one patient management process. Care(MC) documents up-to-the-minute employee absences, expedites compliance with government and insurer reporting requirements, and can individualized case management activities to follow a specified preference. Disability Manager: Disability Manager gives employers a comprehensive overview of short-term disability and workers' compensation exposures, as well as the details of each lost-time case. Through Disability Manager, employers can express their preferences regarding the administration of their benefit program, and track the progress and status of disability claims. Employment Services: Employment Services helps administer a wide range of medical evaluation strategic to the employment process for work groups susceptible to higher rates of injury or absence. Care(MC) expedites requests for service and coordinates the scheduling of appointments using an efficient, easy-to-use website. Employers can monitor the status of scheduled activities online and in real time, using the services provided. They can reduce the cost and complexity of conducting physicals, fitness for duty testing or other evaluations. Reporting Center: The Care(MC) Reporting Center provides real time access to the status of the employer's benefit management program. The employer can be informed daily regarding summarized information, as well as trends and analytic perspectives. Such information is especially useful in understanding the underlying causes of medical issues and unexpected outcomes, so the employer can react to emerging problems immediately. 3
7 CURRENT YEAR DEVELOPMENT - BOARD AUTHORIZES INCREASE IN STOCK REPURCHASE PROGRAM During fiscal 2001, the Company announced that its Board of Directors had approved a 1,000,000 share expansion to its existing stock repurchase plan. Including this expansion, the total number of shares authorized to repurchase has now been increased to 3,400,000 shares. Since commencing this program in the fall of 1996, the Company has repurchased approximately 2,808,000 common shares through March 31, 2001, equal to 27% of its outstanding stock at a cost of approximately $54 million. These repurchases were funded from the Company's operating earnings and have reduced the Company's current common shares outstanding to 7,489,000 shares. INDUSTRY OVERVIEW Workers' compensation is a federally-mandated, state-legislated, comprehensive insurance program that requires employers to fund medical expenses, lost wages and other costs resulting from work-related injuries and illnesses. Since their introduction in the early 1900's, these programs have been expanded to all fifty states and the District of Columbia. Each state is responsible for implementing and regulating its own program. Consequently, workers' compensation benefits and arrangements vary on a state-by-state basis and are often highly complex. Workers' compensation plans generally require employers to fund all of an employee's costs of medical treatment and a significant portion of lost wages, legal fees and other associated costs. Typically, work-related injuries are broadly defined, and injured or ill employees are entitled to extensive benefits. Employers are required to provide first-dollar coverage with no co-payment or deductible due from the injured or ill employee for medical treatment and, in many states, there is no lifetime limit on expenses. However, in exchange for providing this coverage for employees, employers are not subject to litigation by employees for benefits in excess of those provided by the relevant state statute. In most states, the extensive benefits coverage (for both medical costs and lost wages) is provided through the purchase of commercial insurance from private insurance companies, participation in state-run insurance funds or employer self-insurance. Provider reimbursement methods vary on a state-by-state basis. A majority of states have adopted fee schedules pursuant to which all health care providers are uniformly reimbursed. The fee schedules are set by each state and generally prescribe the maximum amounts that may be reimbursed for a designated procedure. In states without fee schedules, health care providers are reimbursed based on usual customary and reasonable fees charged in the particular state in which the services are provided. 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 4
8 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. 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 HMO's and PPO's. However, in many states, employers have the right to direct employees to a specific primary healthcare provider during the onset of a workers' compensation case, subject to the right of the employee to change physicians after a specific period. 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 benefits programs. 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. Managed care techniques are intended to control the cost of healthcare services and to measure the performance of providers through intervention and on-going review of services proposed and actually provided. Managed care techniques were originally developed to stem the rising costs of group medical care. Historically, employers were slow to apply managed care techniques to workers' compensation costs primarily because the aggregate costs are relatively small compared to costs associated with group health benefits and because state-by-state regulations related to workers' compensation are far more complex than those related to group health. However, in recent years, employers and insurance carriers have been increasing their focus on applying managed care techniques to control their worker's compensation costs. An increasing number of states have adopted legislation encouraging the use of workers' compensation managed care organizations ("MCO's") in an effort to allow employers to control their workers' compensation costs. MCO laws generally provide employers an opportunity to channel injured employees into provider networks. In certain states, MCO laws require licensed MCO's to offer certain specified services, such as utilization management, case management, peer review and provider bill review. Most of the MCO laws adopted to date establish a framework within which a company such as the Company can provide its customers a full range of managed care services for greater cost control. Auto Managed Care and Group Health Managed Care Medical expenses are one of the largest components of auto insurers' costs and ultimately drive the premiums charged to policyholders. Effective management of these costs, combined with an optimal managed care program, is the key to reducing costs and achieving customer satisfaction. The Company's Auto Managed Care Program offers a continuum of services that facilitate patient recovery and medical costs containment. 5
9 The Company's Group Health Program also includes a continuum of services designed to control healthcare expenditures while advocating quality care for employees. Employee health benefit programs demand broad, flexible provider choice with assisted access to the healthcare system. BUSINESS STRATEGY The Company believes that payors and employers impacted by the escalating medical costs of workers' compensation, group health, and auto insurance will increasingly require services and programs to manage such costs. The Company's business strategy is to offer a range of services through a national network of branch offices, supported by information management systems, to respond to such need on both a local and national level. Breadth of Service A key element of the Company's strategy is to capitalize on its background and specialization in workers' compensation, established initially in the area of case management, to offer a range of services, including bill review, PPO's and independent medical examinations ("IME's"), to assist insurance carriers, TPA's and self-administered employers in managing the cost of workers' compensation and monitoring the quality of care provided. The Company plans to continue to expand its range of services to respond to the needs of its customers. National Branch Office Network An integral part of the Company's strategy is to offer services at the local or regional level where workers' compensation claims are administered. Each office has access to centralized services and software developed at the Company's corporate offices and is capable of responding to the particular regulatory environment in which it operates. The Company adds branch offices by identifying target markets, generally geographically contiguous to an existing market, where it believes it can successfully introduce one or more of its services. The Company may also establish new offices in response to the needs of national customers. In addition to expanding the number of branch office locations, the Company expects to add existing services as well as new services to its branch offices. Informational Management Capabilities The Company's strategy also includes the continued development of software and its computer system network capable of supporting the review and management of medical information on the internet. Claims and patient data can be entered from field locations, processed by the Company and made available for consolidated reporting or for automated interfacing to customer computer systems. 6
10 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 workers' 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. The provider programs offered by the Company include automated medical fee auditing, preferred provider services, and retrospective utilization review. MedCheck - CorVel's Proprietary Bill Review System 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. 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 online 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 7
11 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 o PPO management o Internet based reporting tools o Pharmacy review In addition to providing the MedCheck software suite, CorVel also supports insurers and administrators with a full array of outsource capabilities. The Company provides a proprietary national PPO, as well as case managers both on-site and from telephonic hub operations. These systems can be interfaced to insurers through the Company's wide area network (WAN) as well as through its website 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. This interface automates the reimbursement of provider reimbursements, allows for the application of all MedCheck fees to the individual claim file and eliminates the need for manual redundant data entry of MedCheck results by the carriers' claims personnel. 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. Recent MedCheck Development During fiscal 2001, the Company announced the release of its MedCheck, version 3.5 software, which adjudicates medical reimbursement for workers' compensation, automobile, and group health claims. Casualty claims are typically managed through many geographically dispersed offices. MedCheck, version 3.5, is web-enabled, allowing claims to be submitted electronically, as well as through traditional paper processes. Version 3.5, includes expanded PPO administration features and browser-based interfaces for both claims processing and reporting. The product had been previously expanded to include features unique to the processing of automobile claims. The current release is focused on applications in the workers' compensation market, and is of particular interest to State Funds, municipalities and other large insurance and TPA payors. CorVel customers can utilize MedCheck's service bureau capabilities to outsource their bill review processing needs. However, they can also process varying portions of their workload from their own sites, or utilize MedCheck on an ASP basis. In this latter mode the claims administration organization can access the software over the Internet and process all, or a portion of their claims, themselves. The use of ASP processing allows payors to benefit from all of MedCheck's capabilities without having to invest in computer systems, software support, and maintenance or the administration of the many information databases critical to proper medical reimbursement adjudication. 8
12 MedCheck includes automated processing capabilities. CorVel's AI module ("First Review") is designed to evaluate incoming medical bills, apply medical protocols and reimbursement guidelines and complete the reimbursement of the medical professional, all automatically. MedCheck 2000 is architected so that customers can seamlessly blend outsourced processing with work performed internally. Claims professionals, as well as various levels of management can easily access real-time reports of claims history. In addition to these AI features, MedCheck's development reflects CorVel's experience as one of the leading managed care companies in the country. 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. Preferred Provider Services PPO's 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 PPO's 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. Some of the features of the Company's PPO network services include: national networks for all coverages, board certified physicians, automated provider credentialing, patient channeling, online provider look-up and printable directories. The Company offers online provider look-up on its website (http://www.corvel.com) or the Company's eCommerce website (http://www.caremc.com) where users can locate providers in their area, see a map, get door to door driving directions or print an entire directory. CorVel also offers 24 hour, toll free telephonic access via its Interactive Voice Response (IVR) System. Hospital Inpatient and Outpatient Bill Review Services The Company expanded its line of bill review services by adding unique capabilities for reviewing hospital inpatient and outpatient medical reimbursement. CorVel offers cost containment by applying a clinical medical review to hospital claims conducted by registered nurses. Our nurse reviewers use a proprietary nationwide database of usual and customary charges. This database provides usual and customary charges for the detailed charges, which are specified on the itemized hospital bill. Access to hospital charge master line items through this database enables CorVel to track billing trends throughout the nation, while streamlining the nurse review process. 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 different 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 9
13 year, and add to the Company's line of in-patient medical review and PPO activities. Some of the features of this service include: hospital line item bill review, fee negotiation, application of PPO contracts, and usual & customary review. Objectives of the service include: o Assure that billed charges are usual and customary o Confirm services were medically necessary o Reduce claim costs through negotiated agreements o Substantiate, by report, charges over usual and customary o Support the payor and patient in all appeals Check Processing CorVel has the capability to provide checkwriting services for its customers. The provider payment check can be added to the bill analysis (EOB) to produce one combined document, which is mailed to the provider. Utilization Management Utilization Management programs preview proposed ambulatory care to determine: appropriateness, frequency, duration, and setting. Utilizing experienced RN's, proprietary medical treatment protocols, and "expert systems" technology, unnecessary treatments and associated costs are avoided. Processes in Utilization Management include: review injury, diagnosis, and treatment plan; contact and negotiate provider's treatment requirements, certifying appropriateness of treatment parameters and/or additional treatment requests; and respond to provider requests for additional treatment. Precertification of Hospitalization The pre-admission certification program is a review service, which verifies the medical necessity of proposed hospital admissions, and determines the appropriate length of stay. The CorVel staff of nurses and reviewers, assisted by an automated medical rules/protocols system and backed up by physician consultants, individually evaluates every hospital admissions request. Pre-certification objectives include the following: determine appropriateness of proposed or emergent hospitalization; determine the medical necessity for hospital admission/inpatient care: explore alternatives to inpatient treatment; if inpatient care is required, determine the appropriate length of stay and monitor the patient's condition throughout the hospitalization to prevent unnecessary inpatient days; channel the patient to a CorVel PPO provider/facility; and develop and implement a timely discharge plan. 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 10
14 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. PATIENT MANAGEMENT SERVICES In addition to its provider program services, the Company offers a range of patient management services, which involve working on a one-on-one basis with injured employees and their various health care professionals, employers and insurance company adjusters. Patient management services are designed both to assist in maximizing medical improvement and, where appropriate, to expedite return to work. The 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. During fiscal 2000, the Company announced the release of version 4.8 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 Advocacy suite of services include: first notice of loss, early intervention, utilization management, telephonic case management, on-site case management, independent medical examinations, peer review and vocational rehabilitation. 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. 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. The medical management components of CorVel's program focuses on medical intervention, management and appropriateness. 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 11
15 alternatives, including transferring the patient from a hospital to an alternative care facility. The program is geared towards offering the injured party prompt access to appropriate medical providers who will provide quality cost-effective medical care within the guidelines established and accepted within the medical community. Case managers may coordinate the services or care required and may arrange for special pricing of the required services. Early Telephonic Case Management Through the claims interface and artificial intelligence process and/or call center, the need for Medical Case Management is defined. Case Management facilitates and promotes patient care, which minimizes fragmentation, facilitates patient progression through the healthcare system, attends to the needs of the patient, and represents a merging of clinical and financial interests, systems, and outcomes. The Case Manager, through contact with the patient and/or family, personalizes an often impersonal healthcare system, transmits the insurer's concern for the patient, and facilitates communication between the patient, insurer, and healthcare providers. 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. CorVel offers vocational services to evaluate the claimant's education, training, and experience. 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. By working with the employer, they can provide job modification or light-duty alternatives until the physician lifts the claimant's physical limitations. In addition, CorVel can evaluate participial payment claims if the claimant returns to work in a new position, working for less than their pre-injury wage. Early Intervention The earlier the Company becomes involved in an episode of care, the greater the impact on the healthcare outcome. The Company's early intervention program begins a series of steps that promote an employee's timely return-to-work including immediate telephonic assessment to ensure that an appropriate course of treatment is established and adhered to through the entire episode of care. CorVel's early intervention program features: automated, immediate notification, immediate patient assessment, clinical protocols and guidelines, channeling to preferred providers, private labeling options, and telephonic case management. 12
16 Independent Medical Examinations The Company arranges for an IME 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. IME's are focused to answer specific requirements including relationships of diagnosis to specific injury, accident or illness, further treatment recommendations, extent of permanent impairment or disability, and other information as needed. 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 produces preliminary reports within five days, and final reports within ten days of examination. The Company provides IMEs through a network of independent physicians. The IME services include IME's, Second Opinions, Peer Reviews, Chart Reviews, Legal Testimony, Physical Capacity Exams, Pre-employment Physicials, and Fitness for Duty Exams. Durable Medical Equipment Network CorCare DME (durable medical equipment) provides, through CorVel's eCommerce CareMC, a fully automated equipment ordering and status management system. Orders are fulfilled using local, preferred equipment distributors and billing and reimbursement for each transaction is automatically processed. CorCare DME offers: web-based ordering, call center convenience, preferred pricing, status management through CareMC, and automated billing and reimbursement. 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, 2000, or 2001. 13
17 COMPETITION AND MARKET CONDITIONS The healthcare 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. 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. 14
18 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. 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 that 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. 15
19 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. In addition, if the Company is thereafter merged into another entity, or if 50% or more of the Company's consolidated assets or earning power are sold, then the Right will entitle its holder to buy common shares of the acquiring entity having a market value equal to two times the then-current exercise price of the Right. The Company's Board of Directors may exchange or redeem the Rights under certain conditions. EMPLOYEES As of March 31, 2001, CorVel had approximately 3,000 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". 16
20 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. 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. 17
21 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 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. 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 18
22 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. 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 be 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 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 19
23 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 more recent fiscal years has been 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 seven 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. 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, 2001. 20
24 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 2000 and 2001 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: High Low ------ ------ FISCAL YEAR ENDED MARCH 31, 2000: Quarter Ended June 30, 1999: $21.63 $17.50 Quarter Ended September 30, 1999: 26.25 20.25 Quarter Ended December 31, 1999: 24.00 16.94 Quarter Ended March 31, 2000: 29.00 21.38 FISCAL YEAR ENDED MARCH 31, 2001: Quarter Ended June 30, 2000: $29.69 $22.75 Quarter Ended September 30, 2000: 29.50 25.05 Quarter Ended December 31, 2000: 37.88 25.50 Quarter Ended March 31, 2001: 37.25 31.50 The last sales price for the Company's Common Stock as reported by NASDAQ on May 31, 2001 was $35.80. As of May 31, 2001, there were 750 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 27. 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 28. ITEM 7a. QUANTITATIVE AND QUALITITATIVE 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. 21
25 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 31 and 23, respectively. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. During fiscal 2001, the Company changed its independent accountants from Ernst & Young LLP to Grant Thornton LLP. There were no disagreements with Ernst & Young LLP on any accounting, principles or practices, financial statement disclosure, or auditing scope or procedures. 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 2001 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 2001 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 2001 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 2001 Annual Meeting of Stockholders is incorporated herein by reference. 22
26 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: Page ---- Report of Independent Certified Public Accountants 31 Consolidated Statements of Income for the Years Ended March 31, 1999, 2000, and 2001 33 Consolidated Balance Sheets as of March 31, 2000 and 2001 34 Consolidated Statements of Stockholders' Equity for the Years Ended March 31, 1999, 2000, and 2001 35 Consolidated Statements of Cash Flows for the Years Ended March 31, 1999, 2000, and 2001 37 Notes to Consolidated Financial Statements 38 (2) FINANCIAL STATEMENT SCHEDULE: The Company's consolidated financial statements, as listed under Item 14(a)(1), appears in a separate section of the Annual Report on Form 10-K beginning on page 31. The Company's financial statement schedule is as follows: Schedule II - Valuation and Qualifying Accounts <TABLE> <CAPTION> Additions Balance at Charged to Beginning Costs and Balance at of Year Expenses Deductions End of Year ---------- ---------- ----------- ----------- <S> <C> <C> <C> <C> ALLOWANCE FOR DOUBTFUL ACCOUNTS: Year Ended March 31, 1999: $2,082,000 $2,085,000 $(1,152,000) $3,015,000 Year Ended March 31, 2000: 3,015,000 2,901,000 (2,521,000) 3,395,000 Year Ended March 31, 2001: 3,395,000 2,584,000 (2,592,000) 3,387,000 </TABLE> 23
27 (3) EXHIBITS: EXHIBITS <TABLE> <CAPTION> EXHIBIT NO. TITLE METHOD OF FILING - ------- ----- ---------------- <S> <C> <C> 3.1 Certificate of Incorporation of the Incorporated herein by reference to Exhibit 3.1 to Company 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 Incorporated herein by reference to Exhibit 10.6 to between V. Gordon Clemons, the Company the Company's Registration Statement on Form S-1 and North Star together with all Registration No. 33-40629. amendments and addendums thereto 10.2 Supplementary Agreement between Incorporated herein by reference to Exhibit 10.7 to V. Gordon Clemons, the Company and the Company's Registration Statement on Form S-1 North Star Registration No. 33-40629. 10.3 Amendment to Supplementary Agreement Incorporated herein by reference to Exhibit 10.5 between Mr. Clemons, the Company and to the Company's Annual Report on Form 10-K for North Star the fiscal year ended March 31, 1992. 10.4 Restated 1988 Executive Stock Option Incorporated herein by reference to Exhibit 10.6 to Plan, as amended 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 Incorporated herein by reference to Exhibit 10.8 to Under the Restated 1988 Executive Stock the Company's Annual Report on Form 10-K for the Option Plan fiscal year ended March 31, 1994. 10.6 Form of Stock Option Agreement under the Incorporated herein by reference to Exhibit 10.8 to Restated 1988 Executive Stock Option the Company's Annual Report on Form 10-K for the Plan fiscal year ended March 31, 1994. </TABLE> 24
28 EXHIBITS (CONTINUED) <TABLE> <CAPTION> EXHIBIT NO. TITLE METHOD OF FILING - ------- ----- ---------------- <S> <C> <C> 10.7 Form of Notice of Exercise under the Incorporated herein by reference to Exhibit 10.9 to Restated 1988 Executive Stock Option the Company's Annual Report on Form 10-K for the Plan fiscal year ended March 31, 1994. 10.8 Employment Agreement of V. Gordon Incorporated herein by reference to Exhibit 10.12 Clemons to the Company's Registration Statement on Form S-1 Registration No. 33-40629. 10.9 Restated 1991 Employee Stock Purchase Incorporated herein by reference to Exhibit 10.11 Plan, as amended 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 Incorporated herein by reference to Exhibits 10.16 Investment, and amendments 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. 10.15 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. 23.2 Consent of Independent Auditors Attached. </TABLE> (b) REPORTS ON FORM 8-K The Company filed a report on Form 8-K on April 5, 2001 to change the Company's independent auditors from Ernst & Young LLP to Grant Thornton LLP beginning with the audit for the fiscal year ended March 31, 2001. 25
29 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 27, 2001 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 27, 2001 - ----------------------------- V. Gordon Clemons /s/ Richard J. Schweppe Chief Financial Officer and June 27, 2001 - ----------------------------- Accounting Officer Richard J. Schweppe /s/ Peter E. Flynn Director June 27, 2001 - ----------------------------- Peter E. Flynn /s/ Steven J. Hamerslag Director June 27, 2001 - ----------------------------- Steven J. Hamerslag /s/ Judd Jessup Director June 27, 2001 - ----------------------------- Judd Jessup /s/ Jeffrey J. Michael Director June 27, 2001 - ----------------------------- Jeffrey J. Michael </TABLE> 26
30 SELECTED CONSOLIDATED FINANCIAL DATA The following selected financial data for the five years ended March 31, 2001, 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. <TABLE> <CAPTION> YEAR ENDED MARCH 31, ---------------------------------------------------------------- 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> STATEMENT OF INCOME DATA: Revenues $121,704 $141,709 $165,457 $186,765 $209,554 Costs and Expenses: Cost of revenues 99,323 115,553 136,082 152,710 172,010 General and administrative 8,645 11,029 12,596 14,752 16,389 -------- -------- -------- -------- -------- 107,968 126,582 148,678 167,462 188,399 -------- -------- -------- -------- -------- Income before income taxes 13,736 15,127 16,779 19,303 21,155 Income tax provision 5,220 5,670 6,376 7,336 7,933 ======== ======== ======== ======== ======== Net income $ 8,516 $ 9,457 $ 10,403 $ 11,967 $ 13,222 ======== ======== ======== ======== ======== Net income per share: Basic $ 0.93 $ 1.13 $ 1.28 $ 1.49 $ 1.74 ======== ======== ======== ======== ======== Diluted $ 0.91 $ 1.10 $ 1.26 $ 1.47 $ 1.70 ======== ======== ======== ======== ======== Shares used in computing net income per share: Basic 9,170 8,386 8,155 8,021 7,599 Diluted 9,370 8,572 8,261 8,151 7,781 Return on beginning of year equity 18.8% 20.5% 22.7% 22.5% 23.9% Return on beginning of year assets 15.8% 16.1% 17.2% 17.4% 18.6% <CAPTION> BALANCE SHEET DATA AS OF MARCH 31, 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> Cash and cash equivalents $ 15,665 $ 8,430 $ 9,052 $ 5,643 $ 9,457 Accounts receivable, net 22,294 25,633 31,562 35,874 34,316 Working capital 28,596 24,726 31,700 34,396 35,130 Total assets 58,824 60,491 68,737 71,187 77,565 Retained earnings 27,426 36,883 47,286 59,253 72,475 Treasury stock 9,461 21,727 26,990 39,956 53,903 Total stockholders' equity 46,087 45,771 53,214 55,293 58,718 </TABLE> 27
31 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 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, 1999, 2000, and 2001 are as follows: 1999 2000 2001 ----- ----- ----- Patient management services 58.5% 59.9% 59.3% Provider program services 41.5% 40.1% 40.7% ----- ----- ----- 100.0% 100.0% 100.0% ===== ===== ===== 28
32 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. YEAR ENDED MARCH 31, --------------------------------- 1999 2000 2001 ----- ----- ----- Revenues 100.0% 100.0% 100.0% Cost of revenues 82.3 81.8 82.1 Gross profit 17.7 18.2 17.9 General and administrative 7.6 7.9 7.8 Income before income taxes 10.1 10.3 10.1 Net income 6.3 6.4 6.3 Years Ended March 31, 1999, 2000 and 2001 Revenues for fiscal 2000 increased by 13% to $187 million from $165 million in fiscal 1999, an increase of $22 million. The majority of this growth came from patient management services, which grew 15% from $97 million in fiscal year 1999 to $112 million in fiscal 2000, 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 $6 million from $69 million in fiscal 1999 to $75 million in fiscal 2000, an increase of 9%. Revenues for fiscal 2001 increased by 12% to $210 million from $187 million in fiscal 2000, an increase of $23 million. The majority of this growth came from patient management services, which grew 11% from $112 million in fiscal year 2000 to $124 million in fiscal 2001, primarily due to an increase in referrals from existing customers. Provider program services increased by $10 million from $75 million in fiscal 2000 to $85 million in fiscal 2001, an increase of 13%. This increase is primarily due to the increased volume of bills processed along with continued growth in the Company's provider network. 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 $136 million in fiscal 1999 and $153 million in fiscal 2000, to $172 million in fiscal 2001, primarily due to the increases in revenues as noted above. 29
33 Cost of services as a percentage of revenues was 82.3% during fiscal 1999 and 81.8% in fiscal 2000, and increased to 82.1% in fiscal 2001. During fiscal 2001, the cost of revenue percentage increased due to improved margins in the provider programs business offset by declining margins in the patient management business due to the percentage increase in costs exceeding the percentage increase in prices. 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. General and administrative expense increased from $13 million in fiscal 1999 and $15 million in fiscal 2000 to $16 million in fiscal 2001. This increase was primarily due to increased MIS staff to support the Company's implementation of CareMC and further electronic data interface capabilities as required by customer needs. General and administrative expenses were 7.6%, 7.9%, and 7.8% for the years ended March 31, 1999, 2000 and 2001, respectively. LIQUIDITY AND CAPITAL RESOURCES The Company has funded its operations and capital expenditures primarily from cash flow from operations. During fiscal 2000, net working capital increased by $1 million from $34 million at March 31, 2000 to $35 million at March 31, 2001. This increase is primarily due to the $13 million of net income earned by the Company during fiscal 2001 offset by repurchase of the Company's common stock. As of March 31, 2001, 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, 2001 along with anticipated internally generated funds will be sufficient to meet the Company's expected cash requirements for at least the next twelve months. 30
34 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Stockholders and Board of Directors CorVel Corporation We have audited the accompanying consolidated balance sheet of CorVel Corporation as of March 31, 2001, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides 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, 2001, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. We have also audited Schedule II of CorVel Corporation for the year ended March 31, 2001. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein. /s/ Grant Thornton LLP Portland, Oregon May 11, 2001 31
35 REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors CorVel Corporation We have audited the accompanying consolidated balance sheet of CorVel Corporation as of March 31, 2000, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the two years in the period ended March 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule 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, 2000, and the consolidated results of its operations and its cash flows for each of the two years in the period ended March 31, 2000, 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 9, 2000 32
36 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> YEARS ENDED MARCH 31, ---------------------------------------------- 1999 2000 2001 ------------ ------------ ------------ <S> <C> <C> <C> REVENUES $165,457,000 $186,765,000 $209,554,000 COSTS AND EXPENSES Cost of revenues 136,082,000 152,710,000 172,010,000 General and administrative 12,596,000 14,752,000 16,389,000 ------------ ------------ ------------ 148,678,000 167,462,000 188,399,000 ------------ ------------ ------------ Income before income taxes 16,779,000 19,303,000 21,155,000 Income tax provision 6,376,000 7,336,000 7,933,000 ------------ ------------ ------------ NET INCOME $ 10,403,000 $ 11,967,000 $ 13,222,000 ============ ============ ============ Net income per share: Basic $ 1.28 $ 1.49 $ 1.74 ============ ============ ============ Diluted $ 1.26 $ 1.47 $ 1.70 ============ ============ ============ Shares used in computing net income per share: Basic 8,155,000 8,021,000 7,599,000 Diluted 8,261,000 8,151,000 7,781,000 </TABLE> See accompanying notes to consolidated financial statements. 33
37 CORVEL CORPORATION CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> MARCH 31, ------------------------------ 2000 2001 ------------ ------------ <S> <C> <C> ASSETS Current Assets Cash and cash equivalents $ 5,643,000 $ 9,457,000 Accounts receivable (less allowance for doubtful accounts of $3,395,000 in 2000 and $3,387,000 in 2001) 35,874,000 34,316,000 Prepaid expenses and taxes 1,931,000 2,465,000 Deferred income taxes 3,833,000 4,130,000 ------------ ------------ Total current assets 47,281,000 50,368,000 ------------ ------------ Property and equipment, net 16,631,000 20,071,000 Other assets 7,275,000 7,126,000 ------------ ------------ $ 71,187,000 $ 77,565,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts and taxes payable $ 5,310,000 $ 3,006,000 Accrued liabilities 7,575,000 12,232,000 ------------ ------------ Total current liabilities 12,885,000 15,238,000 ------------ ------------ Deferred income taxes 3,009,000 3,609,000 Commitments and Contingencies Stockholders' Equity Common Stock, $.0001 par value: 20,000,000 shares authorized; 10,079,001 and 10,296,469 shares issued and outstanding in 2000 and 2001, respectively 1,000 1,000 Paid-in Capital 35,995,000 40,145,000 Treasury Stock, at cost (2,333,340 shares in 2000 and 2,807,940 shares in 2001) (39,956,000) (53,903,000) Retained Earnings Total stockholders' equity 59,253,000 72,475,000 ------------ ------------ 55,293,000 58,718,000 ------------ ------------ $ 71,187,000 $ 77,565,000 ============ ============ </TABLE> See accompanying notes to consolidated financial statements 34
38 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED MARCH 31, 1999, 2000, AND 2001 <TABLE> <CAPTION> COMMON COMMON COMMON STOCK AND STOCK- STOCK- PAID IN TREASURY SHARES AMOUNT CAPITAL SHARES ---------- ---------- ----------- ---------- <S> <C> <C> <C> <C> Balance - March 31, 1998 9,706,944 $ 1,000 $30,614,000 (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 1,000 32,917,000 (1,747,280) ---------- ---------- ----------- ---------- Stock issued under employee stock purchase plan 34,800 -- 588,000 -- Stock issued and income tax benefits under stock option plan, net of shares repurchased 158,625 -- 2,490,000 -- Purchase of common stock -- -- -- (586,060) Net income -- -- -- -- ---------- ---------- ----------- ---------- Balance - March 31, 2000 10,079,001 1,000 35,995,000 (2,333,340) ---------- ---------- ----------- ---------- Stock issued under employee stock purchase plan 30,072 -- 687,000 -- Stock issued and income tax benefits under stock option plan, net of shares repurchased 187,396 -- 3,463,000 -- Purchase of common stock -- -- -- (474,600) Net income -- -- -- -- ---------- ---------- ----------- ---------- Balance - March 31, 2001 10,296,469 $ 1,000 $40,145,000 (2,807,940) ========== ========== =========== ========== </TABLE> See accompanying notes to consolidated financial statements. 35
39 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED YEARS ENDED MARCH 31, 1999, 2000, AND 2001 <TABLE> <CAPTION> SHARES - RETAINED TOTAL COST EARNINGS SHAREHOLDERS' ------------ ----------- ------------ <S> <C> <C> <C> 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 ------------ ----------- ------------ Stock issued under employee stock purchase plan -- -- 588,000 Stock issued and income tax benefits under stock option plan -- -- 2,490,000 Purchase of common stock (12,966,000) -- (12,966,000) Net income -- 11,967,000 11,967,000 ------------ ----------- ------------ Balance - March 31, 2000 (39,956,000) 59,253,000 55,293,000 ------------ ----------- ------------ Stock issued under employee stock purchase plan -- -- 687,000 Stock issued and income tax benefits under stock option plan, net of shares repurchased -- -- 3,463,000 Purchase of common stock (13,947,000) -- (13,947,000) Net income -- 13,222,000 13,222,000 ------------ ----------- ------------ Balance - March 31, 2001 $(53,903,000) $72,475,000 $ 58,718,000 ============ =========== ============ </TABLE> See accompanying notes to consolidated financial statements. 36
40 CORVEL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> Years Ended March 31, ------------------------------------------------------ 1999 2000 2001 ------------ ------------ ------------ <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 10,403,000 $ 11,967,000 $ 13,222,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 6,344,000 6,965,000 6,759,000 Deferred income taxes (588,000) (131,000) 303,000 Loss on write down and (gain) on disposal of property and equipment 37,000 192,000 (45,000) Changes in operating assets and liabilities: Accounts receivable (5,929,000) (4,312,000) 1,558,000 Prepaid expenses and taxes (120,000) (1,075,000) (534,000) Accounts and taxes payable 390,000 (1,158,000) (2,304,000) Accrued liabilities 154,000 1,050,000 4,657,000 Other assets (482,000) (779,000) 149,000 ------------ ------------ ------------ Net cash provided by operating activities 10,209,000 12,719,000 23,765,000 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment (6,627,000) (6,240,000) (10,154,000) ------------ ------------ ------------ Net cash used in investing activities (6,627,000) (6,240,000) (10,154,000) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds and tax benefits from exercise of stock options 2,303,000 3,078,000 4,150,000 Purchase of common stock (5,263,000) (12,966,000) (13,947,000) ------------ ------------ ------------ Net cash used in financing activities (2,960,000) (9,888,000) (9,797,000) ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents 622,000 (3,409,000) 3,814,000 Cash and cash equivalents at beginning of year 8,430,000 9,052,000 5,643,000 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 9,052,000 $ 5,643,000 $ 9,457,000 ============ ============ ============ </TABLE> See accompanying notes to consolidated financial statements. 37
41 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 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 conforming with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements. Actual results could differ from those estimates. 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, 2000 and 2001. 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 $2,486,000 and $3,749,000 of unbilled receivables at March 31, 2000 and 2001, respectively. No one customer accounted for more than 10% of consolidated revenues during the years ended March 31, 1999, 2000 and 2001. 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. 38
42 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 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 $6,013,000 (net of accumulated amortization of $1,736,000) at March 31, 2000 and $5,978,000 (net of accumulated amortization of $1,672,000) at March 31, 2001. Concentrations of Credit Risk: The Company performs periodic credit evaluations of its customers' financial condition and does not require collateral. No other single customer accounted for 10% of accounts receivable in 2000 or 2001. 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 Company provides for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities as measured by the enacted tax rates which are expected to be in effect when these differences reverse. Income tax expense is the tax payable for the period and the change during the period in net deferred tax assets and liabilities. Earnings Per Share: Earnings per common share-basic is based on the weighted average number of common shares outstanding during the period. Earnings per common shares-diluted 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. 39
43 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities, which is effective for 2000. SFAS 133 will require the Company to record all derivatives on the balance sheet at fair value. For derivatives that are hedges, changes in the fair value of derivatives will be offset by the changes in the fair value of the hedged assets, liabilities or firm commitments. The new standard, as amended by SFAS 137 and SFAS 138, is effective for fiscal years beginning after June 15, 2000. The Company believes the impact of adopting this standard will not be material to results of operations or equity. NOTE B - PROPERTY AND EQUIPMENT Property and equipment consists of the following at March 31: <TABLE> <CAPTION> 2000 2001 ----------- ----------- <S> <C> <C> Office equipment and computers $30,851,000 $27,560,000 Computer software 13,735,000 14,201,000 Leasehold improvements 1,460,000 1,731,000 ----------- ----------- 46,046,000 43,492,000 Less: accumulated depreciation and amortization 29,415,000 23,421,000 ----------- ----------- $16,631,000 $20,071,000 =========== =========== </TABLE> NOTE C - ACCRUED LIABILITIES Accrued liabilities consists of the following at March 31: 2000 2001 ----------- ----------- Payroll and related benefits $ 4,495,000 $ 9,401,000 Self-insurance accruals 829,000 1,610,000 Other 2,251,000 1,221,000 ----------- ----------- $ 7,575,000 $12,232,000 =========== =========== 40
44 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENT MARCH 31, 2001 NOTE D - INCOME TAXES The income tax provision consists of the following for the three years ended March 31: 1999 2000 2001 ----------- ----------- ---------- Current - Federal $ 6,337,000 $ 6,745,000 $7,010,000 Current - State 627,000 722,000 620,000 ----------- ----------- ---------- Subtotal 6,964,000 7,467,000 7,630,000 ----------- ----------- ---------- Deferred - Federal (537,000) (118,000) 277,000 Deferred - State (51,000) (13,000) 26,000 ----------- ----------- ---------- Subtotal (588,000) (131,000) 303,000 ----------- ----------- ---------- $ 6,376,000 $ 7,336,000 $7,933,000 =========== =========== ========== Income tax benefits associated with the exercise of stock options were $289,000, $577,000 and $673,000 for fiscal 1999, 2000, and 2001, 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> 1999 2000 2001 ----------- ---------- ----------- <S> <C> <C> <C> Income taxes at federal statutory rate $ 5,873,000 $6,756,000 $ 7,404,000 State income taxes, net of federal benefit 471,000 465,000 646,000 Goodwill amortization 45,000 115,000 47,000 Other (13,000) -- (164,000) ----------- ---------- ----------- $ 6,376,000 $7,336,000 $ 7,933,000 =========== ========== =========== </TABLE> Income taxes paid totaled $4,787,000, $9,307,000 and $7,570,000 for the years ended March 31, 1999, 2000, and 2001, respectively. 41
45 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 NOTE D - INCOME TAXES (CONTINUED) Deferred taxes at March 31, 2000 and 2001 are: 2000 2001 ----------- ----------- Deferred tax assets: Accrued liabilities not currently deductible $ 2,432,000 $ 2,806,000 Allowance for doubtful accounts 1,207,000 1,321,000 Other 194,000 3,000 ----------- ----------- Deferred assets 3,833,000 4,130,000 Deferred tax liabilities: Excess of tax under book basis of fixed assets (2,619,000) (3,067,000) Other (390,000) (542,000) ----------- ----------- Deferred liability (3,009,000) (3,609,000) ----------- ----------- Net deferred tax asset $ 824,000 $ 521,000 =========== =========== 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. 42
46 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 NOTE E - STOCK OPTION PLANS (CONTINUED) In addition to the 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, 2001, all of these options have vested and have been exercised. Summarized information for all stock options for the past three fiscal year follows: <TABLE> <CAPTION> 1999 2000 2001 -------- -------- -------- <S> <C> <C> <C> Options outstanding at the Beginning of the year 761,932 796,406 789,343 Options granted 219,100 175,500 193,700 Options exercised (149,554) (164,313) (187,396) Options cancelled (35,072) (18,250) (58,984) -------- -------- -------- Options outstanding at the end of the year 796,406 789,343 736,663 ======== ======== ======== During the year, weighted average price of options: Granted $ 18.09 $ 21.13 $ 28.54 Exercised $ 10.55 $ 12.41 $ 15.08 Cancelled $ 15.20 $ 17.52 $ 19.54 At the end of the year: Price range of outstanding options $ 8.50- $ 8.50- $ 8.50- $ 18.88 $ 23.63 $ 34.75 Weighted average price per share $ 15.13 $ 16.99 $ 20.30 Options available for future grants 625,598 468,348 334,579 Exercisable options 333,764 339,889 321,627 </TABLE> 43
47 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 NOTE E - STOCK OPTION PLANS (CONTINUED) The following table summarizes the status of stock options outstanding and exercisable at March 31, 2001: <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 - $15.50 175,720 2.92 years $13.59 127,781 $13.55 17.44 - 18.00 151,575 2.31 years 17.84 93,998 17.82 18.09 - 23.63 221,721 3.56 years 20.33 99,848 19.77 26.25 - 34.75 186,700 4.78 years 28.59 - - ------- ---------- ------ ------- ------ Total 735,716 3.39 years $20.09 321,627 $16.73 ======= ========== ====== ======= ====== </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 2000 2001 ---------- ----------- ----------- Net income - adjusted $9,971,000 $11,406,000 $12,584,000 Net income per share - basic $1.22 $1.42 $1.66 Net income per share - diluted $1.21 $1.40 $1.62 The weighted average fair values at date of grant for options during fiscal 1999, 2000, and 2001, were $6.28, $6.56, and $9.59, 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: 1999 2000 2001 ---- ---- ---- Expected volatility .28 .37 .41 Risk free interest rate 5.7% 6.6% 4.8% The assumptions for all three years reflect no dividend yield and a weighted average option life of 4.7 years. 44
48 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 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. 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, 339,000 shares had been issued pursuant to the plan. Summarized plan information is as follows: 1999 2000 2001 -------- -------- -------- Employee contributions $541,000 $588,000 $687,000 Shares acquired 34,428 34,800 30,072 Average purchase price $15.71 $16.90 $22.85 NOTE G - TREASURY STOCK The Company's Board of Directors has approved a plan to repurchase up to 3,400,000 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, 1999, 2000 and 2001 are as follows: 1999 2000 2001 Cumulative ----------- ----------- ----------- ----------- Shares repurchased 286,080 586,060 474,600 2,807,940 Cost $ 5,263,000 $12,966,000 $13,947,000 $53,903,000 Average price $18.40 $22.12 $29.38 $19.20 45
49 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 NOTE G - TREASURY STOCK (CONTINUED) 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. NOTE H - COMMITMENTS AND CONTINGENCIES The Company leases office facilities under noncancelable operating leases. Future minimum rental commitments under operating leases at March 31, 2001 are $7,202,000 in fiscal 2002, $5,574,000 in fiscal 2003, $3,878,000 in fiscal 2004, $2,757,000 in fiscal 2005, $1,802,000 in fiscal 2006, and $827,000 thereafter. Total rental expense of $6,100,000, $7,100,000, and $8,685,000 was charged to operations for the years ended March 31, 1999, 2000, and 2001, 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 $155,000, $199,000, and $224,000, were charged to operations for the years ended March 31, 1999, 2000 and 2001, respectively. 46
50 CORVEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2001 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. NOTE K - QUARTERLY RESULTS The following is a summary of unaudited results of operations for the two years ended March 31, 2000 and 2001: <TABLE> <CAPTION> Net income Net income FISCAL YEAR ENDED MARCH per basic per diluted 31, 2000: Gross Net common common Revenues Margin Income share share ----------- ----------- ----------- ---------- ----------- <S> <C> <C> <C> <C> <C> First Quarter $45,705,000 $ 8,251,000 $ 2,877,000 $.35 .35 Second Quarter 45,865,000 8,406,000 2,970,000 .37 .36 Third Quarter 46,269,000 8,487,000 3,013,000 .38 .38 Fourth Quarter 48,926,000 8,911,000 3,107,000 .40 .39 FISCAL YEAR ENDED MARCH 31, 2001: First Quarter $50,557,000 9,328,000 $3,227,000 $.42 $.41 Second Quarter 51,658,000 9,347,000 3,272,000 .43 .42 Third Quarter 52,241,000 9,059,000 3,328,000 .44 .43 Fourth Quarter 55,098,000 9,810,000 3,395,000 .45 .44 </TABLE> 47
51 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>
52 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. 23.2 Consent of Independent Auditors - Attached. </TABLE>