Organizational Structure
The Company's management is structured geographically with regional vice-presidents who report to the President of the Company. Each of these regional vice-presidents is responsible for all services provided by the Company in his or her particular region and for the operating results of the Company in multiple states. These regional vice presidents have area and district managers who are also responsible for all services provided by the Company in their given area and district.
Business Enterprise Segments
We operate in one reportable operating segment, managed care. The Company's services are delivered to its customers through its local offices in each region and financial information for the Company's operations follows this service delivery model. All regions provide the Company's patient management and network solutions services. Statement of Financial Accounting Standards, or SFAS, No. 131, "Disclosures about Segments of an Enterprise and Related Information," establishes standards for the way that public business enterprises report information about operating segments in annual and interim consolidated financial statements. The Company's internal financial reporting is segmented geographically, as discussed above, and managed on a geographic rather than service line basis, with virtually all of the Company's operating revenue generated within the United States.
Under SFAS 131, two or more operating segments may be aggregated into a single operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles of SFAS 131, if the segments have similar economic characteristics, and if the segments are similar in each of the following areas: 1) the nature of products and services, 2) the nature of the production processes; 3) the type or class of customer for their products and services; and 4) the methods used to distribute their products or provide their services. We believe each of the Company's regions meet these criteria as they provide the similar services and products to similar customers using similar methods of productions and similar methods to distribute their services and products.
Summary of Quarterly Results
The Company generated revenues of $77.0 million for the quarter ended December 31, 2008, an increase of $0.3 million or 0.4%, compared to revenues of $76.7 million for the quarter ended December 31, 2007. The slight increase in revenues was due to a nominal increase in network solutions. Patient management decreased by a nominal amount due to the softer claims environment. Bill volume from the December 31, 2007 to the December 31, 2008 quarter decreased 3% offset by an increase in revenue per bill by 5%.
The continued decrease in the number of jobs in the manufacturing sector and its corresponding effect on the number of workplace injuries that have become longer-term disability cases, the considerable price competition given the flat-to-declining overall workers compensation market, the increase in competition from local and regional companies, changes and the potential changes in state workers' compensation and auto managed care laws, which can reduce demand for the Company's services, have created an environment where revenue and margin growth is more difficult to attain and where revenue growth is uncertain. Additionally, the Company's technology and preferred provider network competes against other companies, some of which have more resources available. Also, some customers may handle their managed care services in-house and may reduce the amount of services which are outsourced to managed care companies such as CorVel Corporation. These factors are expected to continue to limit our revenue growth in the near future.
The Company's cost of revenues increased by $3.0 million, from $56.3 million in the December 2007 quarter to $59.3 million in the December 2008 quarter, an increase of 5.4%. This increase was primarily due to mix shift with slight revenue increases in lower margin services, which were in greater demand, along with slight revenue decreases in higher margin services, combined with rising salaries. Direct salaries increased by $0.7 million and related payroll taxes, fringe benefits, and mileage reimbursement increased by $0.4 million. Cost of services related to pharmacy services increased by $1.0 million due to an increase in revenue from these services.

The Company's general and administrative costs decreased by $0.3 million, from $10.6 million in the December 2007 quarter to $10.3 million in the December 2008 quarter, a decrease of 2.7%. This decrease is primarily due to a decrease in the Company's systems and data interface costs and capabilities that were offset by an increase in the company's legal expenses. Systems cost decreased from $6.5 million to $5.9 million as the Company leveraged system costs and IT infrastructure costs. Legal costs increased by $0.7 million due to development in existing legal proceedings.
The Company's income tax expense decreased by $0.9 million, or 25.3%, from $3.8 million, in the December 2007 quarter to $2.9 million in the December 2008 quarter. The decrease in income before income taxes was primarily due to the aforementioned increase in cost of revenues which resulted in a decrease in income before income taxes. The effective income tax rate was 39% in each of the December 2007 and December 2008 quarters.
Weighted diluted shares decreased from 14.0 million shares in the December 2007 quarter to 13.4 million shares in the December 2008 quarter, a decrease of 525,000 shares, or 3.8%. This decrease was due to the repurchase of 768,000 shares of common stock during the December 2008 quarter. The decrease was offset by the exercise of stock options during the quarter.
Diluted earnings per share decreased from $0.43 in the December 2007 quarter to $0.34 in the December 2008 quarter, a decrease of $0.09 per share, or 20.9%. The decrease in diluted earnings per share was due to the decrease in income before income taxes.
Results of Operations for the three months ended December 31, 2007 and 2008 The Company derives its revenues from providing patient management and network solutions services to payors of workers' compensation benefits, auto insurance claims and health insurance benefits. Patient management services include utilization review, medical case management, vocational rehabilitation, and claims processing. Network solutions revenues include fee schedule auditing, hospital bill auditing, independent medical examinations, diagnostic imaging review services and preferred provider referral services. The percentages of total revenues attributable to patient management and network solutions services for the quarters ended December 31, 2007 and December 31, 2008 are as follows:

                                      December 31, 2007      December 31, 2008
       Patient management services               43.5 %                 43.2 %
       Network solutions services                56.5 %                 56.8 %

The following table sets forth, for the periods indicated, the dollars and the percentage of revenues represented by certain items reflected in the Company's consolidated income statements for the quarters ended December 31, 2007 and December 31, 2008. The Company's past operating results are not necessarily indicative of future operating results.

                                                Three Months Ended         Three Months Ended                                Percentage
                                                 December 31, 2007          December 31, 2008             Change               Change

Revenue                                         $      76,679,000          $      76,962,000          $    283,000                 0.4 %
Cost of revenues                                       56,279,000                 59,300,000             3,021,000                 5.4 %

Gross profit                                           20,400,000                 17,662,000            (2,738,000 )             -13.4 %

Gross profit as percentage of revenue                        26.6 %                     22.9 %

General and administrative                             10,584,000                 10,296,000              (288,000 )              -2.7 %
General and administrative as percentage
of revenue                                                   13.8 %                     13.4 %

Income before income tax provision                      9,816,000                  7,366,000            (2,450,000 )             -25.0 %

Income before income tax provision as
percentage of revenue                                        12.8 %                      9.6 %

Income tax provision                                    3,829,000                  2,862,000              (967,000 )             -25.3 %

Net income                                      $       5,987,000          $       4,504,000          $ (1,483,000 )             -24.8 %


Weighted Shares
Basic                                                  13,813,000                 13,316,000              (497,000 )              -3.6 %
Diluted                                                13,964,000                 13,439,000              (525,000 )              -3.8 %

Earnings Per Share
Basic                                           $            0.43          $            0.34                ($0.09 )             -20.9 %
Diluted                                         $            0.43          $            0.34                ($0.09 )             -20.9 %

Revenues
Change in revenue from the quarter ended December 2007 to the quarter ended December 2008
Revenues increased from $76.7 million for the three months ended December 31, 2007 to $77.0 million for the three months ended December 31, 2008, an increase of $0.3 million or 0.4%. The increase was primarily due to an increase in the Company's network solutions revenues of $0.4 million or 0.8% from $43.3 million in the December 2007 quarter to $43.7 million in the December 2008 quarter. Bill volume from December 31, 2007 to December 31, 2008 quarter decreased 3% offset by an increase in revenue per bill by 5%. Network Solutions increases in revenue were nominal due to difficult market conditions as well as continued decreases in manufacturing jobs. Patient management was similarly affected.
The continued decrease in the number of jobs in the manufacturing sector and its corresponding effect on the number of workplace injuries that have become longer-term disability cases, the considerable price competition given the flat-to-declining overall workers compensation market, the increase in competition from local and regional companies, changes and the potential changes in state workers' compensation and auto managed care laws, which can reduce demand for the Company's services, have created an environment where revenue and margin growth is more difficult to attain and where revenue growth is uncertain. Additionally, the Company's technology and preferred provider network competes against other companies, some of which have more resources available. Also, some customers may handle their managed care services in-house and may reduce the amount of services which are

outsourced to managed care companies such as CorVel Corporation. These factors are expected to continue to limit our revenue growth in the near future.
The Company believes that referral volume in patient management services and bill review volume in network solutions services may decrease or reflect nominal growth until there is growth in the number of work related injuries and workers' compensation related claims.
Cost of Revenues
The Company's cost of revenues consist of direct expenses, costs directly attributable to the generation of revenue, and field indirect costs which are incurred in the field offices of the Company. Direct costs are primarily case manager salaries, bill review analysts, related payroll taxes and fringe benefits, and costs for independent medical examination (IME) and MRI providers. Most of the Company's revenues are generated in offices which provide both patient management services and network solutions services. The largest of the field indirect costs are manager salaries and bonus, account executive base pay and commissions, administrative and clerical support, field systems personnel, PPO network developers, related payroll taxes and fringe benefits, office rent, and telephone expense. Approximately 42% of the costs incurred in the field are costs which support both the patient management services and network solutions operations of the Company's field operations, such as district managers, account executives, rent, and telephone.
Change in cost of revenue from the quarter ended December 2007 to the quarter ended December 2008
The Company's costs of revenues increased from $56.3 million in the quarter ended December 31, 2007 to $59.3 million in the quarter ended December 31, 2008, an increase of $3.0 million or 5.4%. This increase was primarily due to a mix shift toward lower margin services combined with rising salaries without price increases. The mix shift was driven by a change in customer demand in the market place. Direct salaries increased by $700,000 and related payroll taxes, fringe benefits, and mileage reimbursement increased by $400,000. Cost of services related to pharmacy services increased by $1 million due to an increase in revenue from these services.
General and Administrative Costs
Change in cost of general and administrative expense from the quarter ended December 2007 to the quarter ended December 2008 For the quarter ended December 31, 2008, general and administrative costs consisted of approximately 60% of corporate systems costs which include the corporate systems support, implementation and training, amortization of software development costs, depreciation of the hardware costs in the Company's national systems, the Company's national wide area network and other systems related costs. The remaining 40% of the general and administrative costs consisted of national marketing, national sales support, corporate legal, corporate insurance, human resources, accounting, product management, new business development and other general corporate matters.
General and administrative costs decreased from $10.6 million in the quarter ended December 31, 2007 to $10.3 million in the quarter ended December 31, 2008, a decrease of $0.3 million, or 2.7%. This decrease is primarily due to a decrease in the Company's systems and data interface costs. Systems and data interface costs decreased due to management's leveraging prior technology investments. Additionally, management was able to affect a head count reduction as well as reduced consulting costs. This reduction was offset by an increase in the company's legal expenses. Systems cost decreased from $6.5 million to $5.9 million. Legal costs increased by $0.7 million due to development in existing legal proceedings.
Income Tax Provision
The Company's income tax expense decreased by $0.9 million, or 25.3%, from $3.8 million for the quarter ended December 31, 2007 to $2.9 million for the quarter ended December 31, 2008 due to the decrease in income

before income taxes from $9.8 million to $7.4 million. The income tax expense as a percentage of income before income taxes (i.e. effective tax rate) was 39% for the three months ended December 31, 2007 and December 31, 2008. The income tax provision rates were based upon management's review of the Company's estimated annual income tax rate, including state taxes. This effective tax rate differed from the statutory federal tax rate of 35.0% primarily due to state income taxes and certain non-deductible expenses.
Results of Operations for the Nine Months Ended December 31, 2007 and December 31, 2008
The following table sets forth, for the periods indicated, the dollar amounts, dollar and percent changes, share changes, and the percentage of revenues represented by certain items reflected in the Company's consolidated income statements for the nine months ended December 31, 2007 and December 31, 2008. The Company's past operating results are not necessarily indicative of future operating results.

                                                 Nine Months Ended          Nine Months Ended                               Percentage
                                                 December 31, 2007          December 31, 2008             Change              Change

Revenue                                         $     224,526,000          $     233,018,000          $  8,492,000                3.8 %
Cost of revenues                                      167,291,000                176,564,000             9,273,000                5.5 %

Gross profit                                           57,235,000                 56,454,000              (781,000 )             (1.4 %)

Gross profit as percentage of revenue                        25.5 %                     24.2 %

General and administrative                             29,059,000                 31,825,000             2,766,000                9.5 %
General and administrative as percentage
of revenue                                                   12.9 %                     13.7 %

Income before income tax provision                     28,176,000                 24,629,000            (3,547,000 )            (12.6 %)

Income before income tax provision as
percentage of revenue                                        12.5 %                     10.6 %

Income tax provision                                   10,996,000                  9,594,000            (1,402,000 )            (12.8 %)

Net income                                      $      17,180,000          $      15,035,000          $ (2,145,000 )            (12.5 %)


Weighted Shares
Basic                                                  13,889,000                 13,632,000              (257,000 )             (1.9 %)
Diluted                                                14,062,000                 13,815,000              (247,000 )             (1.8 %)

Earnings Per Share
Basic                                           $            1.24          $            1.10                ($0.14 )            (11.3 %)
Diluted                                         $            1.22          $            1.09                ($0.13 )            (10.7 %)

Revenues
Change in revenue from the nine months ended December 2007 to the nine months ended December 2008
Revenues increased from $224.5 million for the nine months ended December 31, 2007 to $233.0 million for the nine months ended December 31, 2008, an increase of $8.5 million or 3.8%. The Company's patient management revenues increased $5.8 million or 6.2% from $95.2 million in the nine months ended December 2007 to $101.0 million in the nine months ended December 2008. This increase was partially due to the acquisition of Schaffer in June 2007 as noted above. The Company's network solutions revenues increased from $129.4 million in the nine months ended December 2007 to $132.0 million in the nine months ended December 2008, an increase of $2.6 million or 2.0%. This increase was primarily due to an increase in revenue per bill over the nine months ended December 31, 2008.

The Company's limited revenue increase, excluding the aforementioned acquisition of Schaffer, reflects the challenging market conditions the Company has experienced during the past few years. The decrease in the nation's manufacturing employment levels, which has helped lead to a decline in national workers' compensation claims, considerable price competition in a flat-to-declining overall market, an increase in competition from both larger and smaller competitors, changes and the potential changes in state workers' compensation and auto managed care laws which can reduce demand for the Company's services, have created an environment where revenue and margin growth is more difficult to attain and where revenue growth is less certain than historically experienced. Additionally, the Company's technology and preferred provider network competes against other companies, some of which have more resources available. Also, some customers may handle their managed care services in-house and may reduce the amount of services which are outsourced to managed care companies such as CorVel Corporation.
The Company believes that referral volume in patient management services and bill review volume in network solutions services will either decrease or reflect nominal growth until there is growth in the number of work related injuries and workers' compensation related claims.
Cost of Revenues
The Company's cost of revenues consist of direct expenses, costs directly attributable to the generation of revenue, and field indirect costs which are incurred in the field offices of the Company. Direct costs are primarily case manager salaries, bill review analysts, related payroll taxes and fringe benefits, and costs for independent medical examination (IME) and MRI providers. Most of the Company's revenues are generated in offices which provide both patient management services and network solutions services. The largest of the field indirect costs are manager salaries and bonus, account executive base pay and commissions, administrative and clerical support, field systems personnel, PPO network developers, related payroll taxes and fringe benefits, office rent, and telephone expense. Approximately 42% of the costs incurred in the field are costs which support both the patient management services and network solutions operations of the Company's field operations, such as district managers, account executives, rent, and telephone.
Change in cost of revenue from the nine months ended December 2007 to the nine months ended December 2008
The Company's costs of revenues increased from $167.3 million in the nine months ended December 31, 2007 to $176.6 million in the nine months ended December 31, 2008, an increase of $9.3 million or 5.5%. Direct salaries increased $2.0 million from the previous nine month period. Related payroll, fringe benefits, and mileage reimbursement increased $1.2 million from the previous nine month period. Additionally, PPO related costs increased by $1.7 million from the previous nine month period. Cost of revenues from pharmacy services increased $1.9 million due to an increase in revenues from those services.
General and Administrative Costs
Change in cost of general and administrative expense from the nine months ended December 2007 to the nine months ended December 2008 For the nine months ended December 31, 2008, general and administrative costs consisted of approximately 62% of corporate systems costs which include the corporate systems support, implementation and training, amortization of software development costs, depreciation of the hardware costs in the Company's national systems, the Company's national wide area network and other systems related costs. The remaining 38% of the general and administrative costs consisted of national marketing, national sales support, corporate legal, corporate insurance, human resources, accounting, product management, new business . . .