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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



(Mark One)

|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------



For the quarterly period ended March 31, 2003

OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------



For the transition period from



Commission file number 0-30035



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EXULT, INC.

(Exact Name of Registrant as Specified in Its Charter)



|Delaware                                                       |  | 8742                                                |  | 33-0831076                          
|-------------------------------------------------------------- |  | --------------------------------------------------- |  | ------------------------------------
|(State or Other Jurisdiction of Incorporation or Organization) |  | (Primary Standard Industrial Classification Number) |  | (I.R.S. Employer Identification No.)



121
Innovation Drive, Suite 200

Irvine, California 92612

(949) 856-8800

(Address, Including Zip Code
and Telephone Number, Including Area Code, of Registrants Principal Executive Offices)



Not Applicable

(Former name, former address and former fiscal year,
if changed since last report)



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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act). Yes  x    No ̈



APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.



|Class        |  | Outstanding at March 31, 2003
|------------ |  | -----------------------------
|Common Stock |  | 106,558,849                  



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PART I. FINANCIAL INFORMATION.



ITEM 1.  FINANCIAL STATEMENTS.



EXULT, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands except per share amounts)

(unaudited)



|                                                                                                                                                  |  | December 31, 2002 |          |   | March 31, 2003 |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | -------------- | -
|ASSETS                                                                                                                                            |  |                   |          |   |                |  
|Current Assets:                                                                                                                                   |  |                   |          |   |                |  
|Cash and cash equivalents                                                                                                                         |  | $                 | 42,846   |   |                | $
|Short-term investments                                                                                                                            |  |                   | 85,206   |   |                |  
|Accounts receivable, net                                                                                                                          |  |                   | 28,587   |   |                |  
|Prepaid expenses and other current assets (including amounts receivable from officer and
employees)                                               |  |                   | 26,350   |   |                |  
|                                                                                                                                                  |  |                   |          |   |                |  
|Total Current Assets                                                                                                                              |  |                   | 182,989  |   |                |  
|Fixed Assets and Direct Contract Costs, net                                                                                                       |  |                   | 54,105   |   |                |  
|Intangible Assets, net                                                                                                                            |  |                   | 37,564   |   |                |  
|Other Assets, net                                                                                                                                 |  |                   | 19,738   |   |                |  
|                                                                                                                                                  |  |                   |          |   |                |  
|Total Assets                                                                                                                                      |  | $                 | 294,396  |   |                | $
|                                                                                                                                                  |  |                   |          |   |                |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                              |  |                   |          |   |                |  
|Current Liabilities:                                                                                                                              |  |                   |          |   |                |  
|Accounts payable                                                                                                                                  |  | $                 | 17,683   |   |                | $
|Accrued liabilities and other                                                                                                                     |  |                   | 31,759   |   |                |  
|Current portion of long-term obligations                                                                                                          |  |                   | 2,862    |   |                |  
|                                                                                                                                                  |  |                   |          |   |                |  
|Total Current Liabilities                                                                                                                         |  |                   | 52,304   |   |                |  
|                                                                                                                                                  |  |                   |          |   |                |  
|Long-Term Obligations, net of current portion                                                                                                     |  |                   | 12,794   |   |                |  
|                                                                                                                                                  |  |                   |          |   |                |  
|Commitments and Contingencies                                                                                                                     |  |                   |          |   |                |  
|Stockholders Equity:                                                                                                                             |  |                   |          |   |                |  
|Preferred stock, $0.0001 par value; Authorized  15,000 shares; Issued and outstanding  none at December 31, 2002 and March 31, 2003             |  |                   |         |   |                |  
|Common stock, $0.0001 par value; Authorized  500,000 shares; Issued and outstanding  106,202 at December 31, 2002 and 106,559 at March 31, 2003 |  |                   | 11       |   |                |  
|Additional paid-in capital                                                                                                                        |  |                   | 424,505  |   |                |  
|Deferred compensation                                                                                                                             |  |                   | (1,928   | ) |                |  
|Accumulated other comprehensive income:                                                                                                           |  |                   |          |   |                |  
|Cumulative translation adjustments                                                                                                                |  |                   | 1,285    |   |                |  
|Unrealized gain on investments                                                                                                                    |  |                   | 891      |   |                |  
|Accumulated deficit                                                                                                                               |  |                   | (195,466 | ) |                |  
|                                                                                                                                                  |  |                   |          |   |                |  
|Total Stockholders Equity                                                                                                                        |  |                   | 229,298  |   |                |  
|                                                                                                                                                  |  |                   |          |   |                |  
|Total Liabilities and Stockholders Equity                                                                                                        |  | $                 | 294,396  |   |                | $
|                                                                                                                                                  |  |                   |          |   |                |  



See
accompanying notes to unaudited condensed consolidated financial statements.



1



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EXULT, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(amounts in thousands except per share amounts)

(unaudited)



|                                                      |  | Three Months Ended March 31,
|----------------------------------------------------- |  | ----------------------------
|                                                      |  | 2002                        
|Revenue                                               |  | $                           
|Cost of Revenue                                       |  |                             
|                                                      |  |                             
|Gross profit                                          |  |                             
|Selling, General and Administrative Expense           |  |                             
|                                                      |  |                             
|Income (loss) from operations                         |  |                             
|Investment and Interest Income, net                   |  |                             
|                                                      |  |                             
|Income (loss) before provision for income taxes       |  |                             
|Provision for Income Taxes                            |  |                             
|                                                      |  |                             
|Net income (loss)                                     |  | $                           
|                                                      |  |                             
|Net Income (Loss) per Common Share:                   |  |                             
|Basic                                                 |  | $                           
|                                                      |  |                             
|Diluted                                               |  | $                           
|                                                      |  |                             
|Weighted Average Number of Common Shares Outstanding: |  |                             
|Basic                                                 |  |                             
|                                                      |  |                             
|Diluted                                               |  |                             
|                                                      |  |                             



EXULT,
INC. AND SUBSIDIARIES



CONDENSED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(amounts in thousands)

(unaudited)



|                                                             |  | Three Months Ended March 31, |       
|------------------------------------------------------------ |  | ---------------------------- | ------
|                                                             |  | 2002                         |       
|Net Income (Loss)                                            |  | $                            | (6,624
|                                                             |  |                              |       
|Other Comprehensive Loss:                                    |  |                              |       
|Foreign currency translation adjustment                      |  |                              | (559  
|Unrealized loss on investments                               |  |                              |      
|Reclassification adjustment for gains realized in net income |  |                              |      
|                                                             |  |                              |       
|Total other comprehensive loss                               |  |                              | (559  
|                                                             |  |                              |       
|Net Comprehensive Income (Loss)                              |  | $                            | (7,183
|                                                             |  |                              |       



See
accompanying notes to unaudited condensed consolidated financial statements.



2



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EXULT, INC.
AND SUBSIDIARIES



CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)



|                                                                                                    |  | Three Months Ended March 31, |         
|--------------------------------------------------------------------------------------------------- |  | ---------------------------- | --------
|                                                                                                    |  | 2002                         |         
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |  |                              |         
|Net Income (Loss)                                                                                   |  | $                            | (6,624  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating
activities  |  |                              |         
|Depreciation and amortization                                                                       |  |                              | 4,760   
|Changes in operating assets and liabilities                                                        |  |                              |         
|Accounts receivable, net                                                                            |  |                              | (3,881  
|Prepaid expenses and other current assets                                                           |  |                              | (8,263  
|Accounts payable                                                                                    |  |                              | 4,506   
|Accrued liabilities and other                                                                       |  |                              | (6,733  
|                                                                                                    |  |                              |         
|Net cash provided by (used in) operating activities                                                 |  |                              | (16,235 
|                                                                                                    |  |                              |         
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |  |                              |         
|Expenditures for Fixed Asset Purchases and Direct Contract Costs                                    |  |                              | (5,049  
|Expenditures for Client Contract Related Intangible Assets                                          |  |                              | (13,600 
|Purchases of Investments                                                                            |  |                              | (145,358
|Proceeds from Investments                                                                           |  |                              | 85,207  
|Change in Other Assets                                                                              |  |                              | (590    
|                                                                                                    |  |                              |         
|Net cash provided by (used in) investing activities                                                 |  |                              | (79,390 
|                                                                                                    |  |                              |         
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |  |                              |         
|Proceeds from Issuance of Common Stock                                                              |  |                              | 1,643   
|Payments on Long-Term Obligations                                                                   |  |                              | (474    
|                                                                                                    |  |                              |         
|Net cash provided by (used in) financing activities                                                 |  |                              | 1,169   
|                                                                                                    |  |                              |         
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                             |  |                              | (462    
|                                                                                                    |  |                              |         
|Net Increase (Decrease) in Cash and Cash Equivalents                                                |  |                              | (94,918 
|Cash and Cash Equivalents, beginning of period                                                      |  |                              | 144,357 
|                                                                                                    |  |                              |         
|Cash and Cash Equivalents, end of period                                                            |  | $                            | 49,439  
|                                                                                                    |  |                              |         
|SUPPLEMENTAL CASH FLOW INFORMATION:                                                                 |  |                              |         
|Cash Paid During the Period for:                                                                    |  |                              |         
|Interest                                                                                            |  | $                            | 40      
|                                                                                                    |  |                              |         
|Income taxes                                                                                        |  | $                            | 120     
|                                                                                                    |  |                              |         
|SUMMARY OF NON-CASH FINANCING ACTIVITIES:                                                           |  |                              |         
|Acquisition of Fixed Assets through Capital Lease                                                   |  | $                            | 102     
|                                                                                                    |  |                              |         



See
accompanying notes to unaudited condensed consolidated financial statements.





3



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EXULT, INC. AND SUBSIDIARIES



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS



1.    Summary of
Significant Accounting Policies



Basis of
Presentation



The unaudited
condensed consolidated financial statements of Exult, Inc. and subsidiaries (Exult or the Company) have been prepared by Exults management and reflect all adjustments that, in the opinion of management, are necessary
for a fair presentation of the interim periods presented. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the results to be expected for any subsequent periods or for the entire year ending
December 31, 2003. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted under the
Securities and Exchange Commissions rules and regulations.



These unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with Exults audited consolidated financial statements and notes for the year ended December 31, 2002, which
were included in its Annual Report on Form 10-K filed with the Securities and Exchange Commission. Certain amounts in the 2002 financial statements have been reclassified to conform with the 2003 presentation.



Accounting Estimates



The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingencies at the date of the financial
statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from estimated amounts.



Segment Information and Concentration of Revenue/Credit Risk



Management has determined that the Company operates within a single operating segment. For the three months
ended March 31, 2002 and 2003, 87% and 90%, respectively, of the Companys revenue has been derived from within the United States of America with the balance being derived primarily from within the United Kingdom.



During the three months ended March 31, 2002, three of the
Companys process management clients accounted for 46%, 30% and 13%, respectively, of revenue. During the three months ended March 31, 2003, three of the Companys process management clients accounted for 49%, 22% and 16% of revenue. No
other client accounted for more than 10% of revenue in the 2002 and 2003 periods. The Company believes that the resulting concentration of credit risk in its receivables, with respect to the limited client base, is substantially mitigated by its
credit evaluation process. To date, bad debt write-offs have not been significant.



Stock-Based Compensation



The Company has elected to follow Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for employee stock options rather than
the alternative fair value accounting allowed by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock Based Compensation. APB No. 25 provides that compensation expense relative to the
Companys employee stock options is measured based on the intrinsic value of stock options granted and the Company recognizes compensation expense in its statement of operations using the straight-line method over the vesting period for fixed
awards. Under SFAS No. 123, the fair value of stock options at the date of grant is recognized in earnings over the vesting period of the options. In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure. SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation
and the effect of the method on reported results. SFAS No. 148 is effective for financial statements for fiscal years and interim periods ending after December 15, 2002. The Company adopted the disclosure provisions of SFAS No. 148 as of December
15, 2002 and continues to follow APB No. 25 in accounting for employee stock options.





4



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EXULT, INC.
AND SUBSIDIARIES



NOTES TO UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)



As of March 31, 2002 and 2003, the Company had options
outstanding to acquire 21,899,058 and 27,110,464 shares, respectively, of its Common Stock. The following table shows the pro forma net income (loss) as if the fair value method of SFAS No. 123 had been used to account for its employee stock-based
compensation arrangements (in thousands, except per share amounts):



|                                                                                                                                    |  | For the Three Months Ended March 31, |        
|----------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | -------
|                                                                                                                                    |  | 2002                                 |        
|Net income (loss), as reported                                                                                                      |  | $                                    | (6,624 
|Stock-based employee compensation expense included in reported net income (loss), net of
related tax effects                        |  |                                      | 226    
|Total stock-based employee compensation expense determined under fair value based method
for all awards, net of related tax effects |  |                                      | (10,750
|                                                                                                                                    |  |                                      |        
|Pro forma net loss                                                                                                                  |  | $                                    | (17,148
|                                                                                                                                    |  |                                      |        
|Net income (loss) per share:                                                                                                        |  |                                      |        
|Basic, as reported                                                                                                                  |  | $                                    | (0.06  
|                                                                                                                                    |  |                                      |        
|Diluted, as reported                                                                                                                |  | $                                    | (0.06  
|                                                                                                                                    |  |                                      |        
|Pro forma, basic and diluted                                                                                                        |  | $                                    | (0.16  
|                                                                                                                                    |  |                                      |        



The
following outlines the significant assumptions used to calculate the fair value information presented utilizing the Black-Scholes approach with ratable amortization as of March 31, 2002 and 2003:

|                        |  | 2002           |  | 2003  |  
|----------------------- |  | -------------- |  | ----- | -
|Risk-free interest rate |  | 5.63% to 6.20% |  | 2.59  | %
|Expected life           |  | 4.00           |  | 5.63  |  
|Expected volatility     |  | 77.70%         |  | 77.70 | %
|Expected dividends      |  |               |  |      |  



Recent Accounting
Pronouncements



In June 2001,
the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible assets and the associated asset retirement
costs. It applies to legal obligations associated with the retirement of assets that result from the acquisition, construction, development and/or the normal operation of an asset, except for certain obligations of lessees. SFAS No. 143 requires
that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the
carrying amount of the asset. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002, with earlier application being encouraged. The Company adopted SFAS No. 143 as of January 1, 2003. Adoption did
not have a material impact on the Companys financial condition and results of operations.



In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated
with exit or disposal activities. SFAS No. 146 supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring). The principal difference between SFAS No. 146 and EITF Issue 94-3 relates to the recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that a liability be
recognized for such costs only when the liability is incurred. In contrast, under EITF Issue 94-3, a company recognized a liability for an exit cost when it commits to an exit plan. The FASB concluded in SFAS No. 146 that an entitys commitment
to an exit plan, by itself, does not create an obligation that meets the definition of a liability. SFAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS No. 146
is effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company adopted SFAS No. 146 as of January 1, 2003. Adoption did not have a material impact on the Companys
financial condition and results of operations.





5



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EXULT, INC.
AND SUBSIDIARIES



NOTES TO UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)



Effective prospectively for arrangements entered into in
fiscal periods beginning after June 15, 2003, EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables, addresses the accounting, by a vendor, for contractual arrangements in which multiple revenue-generating activities will be
performed by the vendor. In some situations, the different revenue-generating activities (deliverables) are sufficiently separable and there exists sufficient evidence of fair values to account separately for the different deliverables (that is,
there are separate units of accounting). In other situations, some or all of the different deliverables are closely interrelated or there is not sufficient evidence of relative fair value to account separately for the different deliverables. EITF
Issue 00-21 addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. The Company has not yet determined the impact of the adoption of EITF Issue 00-21 on its consolidated
financial statements.



2. Reclassification of Depreciation and
Amortization Expense



Depreciation and
amortization expense had previously been set forth as a separate line item in the Condensed Consolidated Statements of Income (Loss) and has been reclassified to Cost of Revenue and Selling, General and Administrative Expense for all periods
presented. Accordingly, for the three months ended March 31, 2002, the effect of this reclassification was to increase Cost of Revenue by $2,511,000 and Selling, General and Administrative Expense by $1,356,000. For the three months ended March 31,
2003, Cost of Revenue and Selling, General and Administrative Expense included depreciation and amortization of $4,292,000 and $794,000, respectively.



3. Short-Term Investments



Short-term investments are comprised of available-for-sale securities at December 31, 2002 and March 31, 2003, and consist of the
following (in thousands):



|                                               |  | December 31, 2002 |         | March 31, 2003      
|---------------------------------------------- |  | ----------------- | ------- | --------------------
|                                               |  | Amortized Cost    |         | Estimated Fair Value
|Amounts Included in Cash and Cash Equivalents: |  |                   |         |                     
|Institutional money market funds               |  | $                 | 41,851  |                     
|                                               |  |                   |         |                     
|Amounts Included in Investments:               |  |                   |         |                     
|Commercial paper and other                     |  |                   | 2,917   |                     
|Corporate notes                                |  |                   | 28,520  |                     
|Asset-backed securities                        |  |                   | 21,283  |                     
|U.S. Treasuries and Agencies                   |  |                   | 31,595  |                     
|                                               |  |                   |         |                     
|                                               |  |                   | 84,315  |                     
|                                               |  |                   |         |                     
|                                               |  | $                 | 126,166 |                     
|                                               |  |                   |         |                     



The commercial paper in
which the Company invests must have a minimum rating of A-1 or P-1, as rated by Standard & Poors and Moodys, respectively. Corporate notes in which the Company invests must have a minimum rating of A-2 or P-2, as rated by Standard
& Poors and Moodys, respectively. Asset-backed securities in which the Company invests must have a minimum rating of AAA or Aaa, as rated by Standard & Poors and Moodys, respectively. As of March 31, 2003, there are
gross unrealized holding gains of $425,000 and gross unrealized holding losses of $51,000 from available-for-sale securities.





6



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EXULT, INC.
AND SUBSIDIARIES



NOTES TO UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)



Amortized cost and estimated fair market value of debt
securities classified as available-for-sale by contractual maturities at March 31, 2002 and 2003, consist of the following (in thousands):



|                          |  | December 31, 2002 |        | March 31, 2003      
|------------------------- |  | ----------------- | ------ | --------------------
|                          |  | Amortized Cost    |        | Estimated Fair Value
|Due in less than one year |  | $                 | 48,854 |                     
|Due in one to three years |  |                   | 32,538 |                     
|                          |  |                   |        |                     
|                          |  | $                 | 81,392 |                     
|                          |  |                   |        |                     



4. Unbilled
Receivables



Included in accounts receivable
as of December 31, 2002, and March 31, 2003, are $7,057,000 and $13,485,000, respectively, of unbilled receivables consisting of revenue in excess of billings on long-term outsourcing contracts. All unbilled receivables are expected to be billed
within twelve months.



5. Business Optimization Costs



The Company has incurred business
optimization costs from time to time as it implements new organization structures, technologies, processes and other changes in its business. For the year ended December 31, 2002, and the three months ended March 31, 2003, there were no business
optimization costs incurred. The following is a summary of the business optimization costs incurred during 2001, and the ending accrual balance, which is included in accrued liabilities and other, as of December 31, 2002, and March 31, 2003, (in
thousands):



|                                 |  | Accruals |        |   | Non-Cash Charges |   | Total
|-------------------------------- |  | -------- | ------ | - | ---------------- | - | -----
|Severance and Related Charges    |  | $        | 6,648  |   |                  | $ | 3,040
|Processing Centers Closure Costs |  |          | 6,621  |   |                  |   |     
|Write-off of Database            |  |          |       |   |                  |   | 2,165
|                                 |  |          |        |   |                  |   |      
|                                 |  |          | 13,269 |   |                  | $ | 5,205
|                                 |  |          |        |   |                  |   |      
|2001 Cash Payments               |  |          | (3,976 | ) |                  |   |      
|                                 |  |          |        |   |                  |   |      
|Balance at December 31, 2001     |  |          | 9,293  |   |                  |   |      
|2002 Cash Payments               |  |          | (5,118 | ) |                  |   |      
|2002 Accrual Adjustments         |  |          | (2,309 | ) |                  |   |      
|                                 |  |          |        |   |                  |   |      
|Balance at December 31, 2002     |  |          | 1,866  |   |                  |   |      
|2003 Year-to-Date Cash Payments  |  |          | (869   | ) |                  |   |      
|                                 |  |          |        |   |                  |   |      
|Balance at March 31, 2003        |  | $        | 997    |   |                  |   |      
|                                 |  |          |        |   |                  |   |      



The accrual adjustments
were made as a result of completion of certain of these arrangements at amounts less than previously estimated and changes in certain estimates with regard to the remaining arrangements. The Company expects the remaining balance to be paid out
during the next 15 months.



6. Income Taxes



The Company did not record a tax provision for the
three-month period ended March 31, 2002, as it had incurred only net operating losses as of that date. A full valuation allowance is provided against the tax benefit generated by the net operating losses



7



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EXULT, INC.
AND SUBSIDIARIES



NOTES TO UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)



because of the uncertainty of realizing the deferred tax assets associated
therewith. For the three months ended March 31, 2003, the Company did not record a tax provision as a result of partial utilization of the carry forward for income tax purposes of the Companys net operating losses. As of March 31, 2003, Exult
has $63.0 million of remaining deferred tax assets, arising primarily from its net operating losses, for which it has fully reserved through its valuation allowance as a result of the uncertainty of realizing these deferred tax assets.



7. Net Income (Loss) Per Share



The following is the calculation for net income (loss) per
share (in thousands, except per share amounts):



|                                           |  | Three Months Ended March 31,
|------------------------------------------ |  | ----------------------------
|                                           |  | 2002                        
|Basic:                                     |  |                             
|Net income (loss)                          |  | $                           
|Weighted average common shares             |  |                             
|                                           |  |                             
|Net income (loss) per common share         |  | $                           
|                                           |  |                             
|Diluted:                                   |  |                             
|Net income (loss)                          |  | $                           
|                                           |  |                             
|Weighted average common shares             |  |                             
|Stock option and warrant equivalent shares |  |                             
|                                           |  |                             
|Average common shares outstanding          |  |                             
|                                           |  |                             
|Net income (loss) per common share         |  | $                           
|                                           |  |                             



For the
three months ended March 31, 2002, the impact of all outstanding warrants and stock options to purchase Common Stock were excluded from the computations of diluted net loss per common share as their effect is antidilutive. As of March 31, 2002, the
Company had a warrant outstanding exercisable for 2,500,000 shares of Common Stock with an exercise price of $11.00 per share and options outstanding exercisable for 21,899,058 shares of Common Stock with a weighted average exercise price of $7.80
per share. For the three months ended March 31, 2003, the weighted average number of common shares outstanding used to compute diluted net income per common share excluded the effect of a warrant outstanding exercisable for 2,500,000 shares of
Common Stock with an exercise price of $11.00 per share and options outstanding exercisable for 13,672,257 shares of Common Stock with a weighted average exercise price of $10.49 per share, because such warrant and options have exercise prices in
excess of the average market value of the Companys Common Stock during the period and their effect is therefore antidilutive.



8. Commitments and Contingencies



The Company and its subsidiaries are from time to time parties to legal proceedings, lawsuits and other claims incident to their business
activities. Such matters include, among other things, assertions of contract breach and claims by persons whose employment with the Company has been terminated in connection with facilities consolidations, headcount rationalizations, outsourcing of
certain operational functions, including in some cases to offshore vendors, and other measures that the Company has undertaken and expects to continue to undertake in the ordinary course of its business. Such matters are subject to many
uncertainties and outcomes are not predictable with assurance. Consequently, management is unable to ascertain the ultimate aggregate amount of monetary liability, amounts which may be covered by insurance, or the financial impact with respect to
these matters as of March 31, 2003. However, management believes at this time that the final resolution of these matters, individually and in the aggregate, will not have a material adverse effect upon the Companys consolidated financial
position, results of operations or cash flows.





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ITEM 2. MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF                 OPERATIONS.



This report contains forward-looking statements that are based on our current expectations, assumptions,
estimates and projections about our company and our industry. When used in this report, the words may, will, should, predict, continue, plans, expects,
anticipates, estimates, intends and similar expressions are intended to identify forward-looking statements. These statements include, but are not limited to, statements in this report under the caption
Managements Discussion and Analysis of Financial Condition and Results of Operations and elsewhere concerning, among other things, our anticipated performance, including revenue, margin, cash flow, balance sheet and profit
expectations; size and duration of client contracts; business mix; development, implementation and scaling of our Exult Service Delivery ModelSMoperational capabilities, including transition and transformation of client processes to our systems, productivity improvements, and cost savings from strategic initiatives; performance under client
contracts; market opportunities; growth in our client base and existing contracts; client benefits and satisfaction; workforce improvements; and service center capacities.



Actual results might differ materially from the results projected due to a number of risks and uncertainties.
We are still expanding, developing and enhancing our service capabilities and must operate at greater scale than historically, transition client processes on schedule and transform those processes to reduce delivery costs while meeting contractual
service level commitments. Financial performance targets might not be achieved due to various risks including slower-than-expected process transitions or business development or higher-than-expected costs to meet service commitments or sign new
contracts. Our cash consumption may exceed expected levels if profitability does not meet expectations, strategic opportunities require cash investment, or growth exceeds current expectations. Frontlog is estimated based upon various assumptions, is
subject to change, and is not necessarily indicative of what new business we may sign. Client contracts may terminate early, and new business is not assured. These and other risks and uncertainties are described in this report under the heading
Risk Factors and in our other filings made from time to time with the Securities and Exchange Commission. The cautionary statements made in this report should be read as being applicable to all related forward-looking statements wherever
they appear. These statements are only predictions. We cannot guarantee future results, levels of activity, performance or achievements. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to
update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.



OVERVIEW



Our primary source of revenue is fees we earn for providing our HR business process management services under long-term contracts. We also
receive additional revenue from client projects and consulting services. Our process management service contracts generally have terms of 7 to 10 years, encompass multiple HR administrative processes, and require us to provide high levels of service
at reduced costs to the client. These contracts contain multiple responsibilities for us, including both our assumption of responsibility for transaction processing and administration, and transformation of the way HR work is performed over time by
the client. The transformation work we do is largely in addition to the work required to initiate and sustain service under the contract, and is ongoing for the life of the contract. Transformation activities include implementation and integration
of new systems and tools, process change and standardization, consolidation of related activities, globalization of solutions across the clients business and geographic reach, rationalization of third-party vendors to produce lower costs and
better service and service metrics, establishment of an overall integrated service delivery model and the design and implementation of performance measurements, metrics and reports that support the clients goals. The process management service
contracts also identify specific deliverables associated with the multiple elements described above, in addition to numerous deliverables that are produced for the benefit of the client in the ordinary course under the contract that are not
specifically identified in the contract. While these deliverables generally can be completed by third parties, clients choose to obligate us to perform this work to obtain the benefit of our expertise, detailed knowledge and previous success in
implementing change in complex environments.



Our
business process management contracts are generally structured so that we receive a fee that is no greater than our clients historical cost of operating the functions assumed by us. We typically agree to provide a minimum savings to the client
on the labor-based portion of the contract that we refer to as direct after about one year from contract signing, and we may be required to share further savings with our clients in negotiated gain sharing arrangements for the
indirect spend portion of the contract covering services previously subcontracted by the client. The amount of minimum savings is determined in accordance with the terms of the applicable contracts. By operating client processes on a
long-term contract basis using our service platforms and methodologies, we seek to reduce the costs of service delivery below the minimum savings provided in the contract, and recover the investment we make during the early part of the contract term
for transition and integration of client processes.



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We fulfill
some of our service delivery obligations through the use of third-party vendors, including vendors that had previously contracted directly with our clients and were then assigned, or are in the process of being assigned, to us in connection with our
process management services. We may continue to use these vendors, hire replacement vendors, or provide some of these services directly. We are contractually responsible for the delivery and acceptability to our clients of these third-party vendor
services, and we include in revenue all charges for services for which we are contractually responsible, whether we provide these services directly using our own personnel or through third-party vendors. Sometimes we pay the charges of the
third-party vendors that provide services and bill our clients for the cost of the service. Other times our client pays the third-party vendor directly on our behalf. In either case, such costs are included in our cost of revenue. In many cases our
initial cost of paying these vendors is equal to our revenue attributable to their services. We intend to realize a profit from revenue received in connection with services provided under these third-party vendor contracts, and in order to do so, we
must reduce these vendor costs by rationalizing the vendors, improving efficiencies, obtaining more favorable pricing, or performing the services ourselves at a lower cost.



We incurred a net loss of $94.8 million, $74.7 million and $10.6 million in 2000, 2001 and 2002,
respectively. While we reported profitable operations in the fourth quarter of 2002 and the first quarter of 2003, and we expect to operate profitably in the future, we may incur net losses in future periods. We anticipate ongoing significant
expenditures to fund the development and expansion of our technology and general operating infrastructures. We may also make substantial investments to pursue, obtain and transition new client contracts; to augment our service offering and process
capabilities; to develop new service center capacity to accommodate any growth we may achieve beyond the capacity of our existing service center infrastructure; and to expand geographically to better serve our clients or compete more effectively. To
the extent that revenue does not increase at a rate commensurate with our increasing costs and expenditures, our future operating results and liquidity could be materially and adversely affected.



Critical Accounting Policies and Estimates



Our discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related
to long-term service contracts, bad debts, fixed assets and direct contract costs, intangible assets, income taxes, accruals in connection with certain business optimization costs, contingencies and litigation. We base our estimates on historical
experience and on various assumptions that we believe to be reasonable under the circumstances. We may revise these estimates and judgments from time to time as a result of changes in assumptions or conditions. The following critical accounting
policies affect significant judgments and estimates used in the preparation of our consolidated financial statements.



Long-Term Contracts



General. We provide HR outsourcing services under multi-year, multi-element arrangements, which generally extend up to ten
years. These contracts are principally structured on a fee-for-service basis and provide that we receive a fee that is no greater than the clients historical cost of operating the functions assumed by us. For some components of our outsourcing
fees we provide negotiated discounts from the clients historical costs. For other components of our outsourcing fees, principally reflecting amounts previously paid by clients to third-party vendors, after we have recovered our costs and/or
achieved a negotiated minimum cost reduction, we may be required to share further savings with our clients in a negotiated gain sharing arrangement.



We recognize revenue and profit as work progresses based upon the proportion of costs incurred to the total expected costs. We maintain
for each of our contracts estimates of total revenue and cost over the respective contract term. For purposes of periodic financial reporting, we accumulate total actual costs incurred to date under the contract. The ratio of those actual costs to
our then-current estimate of total costs for the life of the contract is then applied to our then-current estimate of total revenue for the life of the contract to determine the maximum portion of total estimated revenue that should be recognized.
To the extent that revenue is recognized under this policy in excess of amounts billed under the contract, unbilled receivables will be recorded. We follow this method because reasonably dependable estimates of the revenue and costs applicable to
various stages of a contract can be made. Revisions in our contract estimates are reflected in the period in which the determination is made that facts and circumstances dictate a change of estimate. Favorable changes in estimates result in
additional revenue and profit recognition, and unfavorable changes in estimates result in a reduction of recognized revenue and profit. Provisions for estimated losses on individual contracts are made in the period in which the loss first becomes
apparent.



Our previous practice was to limit the
amount of revenue recognized as described above to the amounts that had been or could be currently billed as of the end of the reporting period under the terms of the contracts. This limitation was implemented earlier in our



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history to minimize the potential impact of changes in estimates, which were more likely to be significant
before we had achieved operational maturity in our business and operational stability in our underlying contracts. Now that our business has matured, our practice is to apply the revenue limitation on a contract-by-contract basis only until each
contract reaches operational stability, and then to adjust the cumulative revenue recognized to date for that contract to fully reflect the then-current estimates of profitability for the contract over its term. We measure the achievement of
operational stability for each contract by considering various factors, including: completion of initial transition of client processes to our service delivery infrastructure; completion of the initial software and systems integration necessary to
support our performance of services to the client; and achievement of stable operations under the contract as evidenced by the predictability of costs incurred. In addition, there may be other factors relevant to the operational stability of any
particular contract, which we consider as appropriate in determining whether to cease to apply the revenue limitation to that contract. The revenue and gross profit adjustment on a contract resulting from discontinuance of the revenue limitation may
be significant, depending on factors including the size of the contract and the cumulative costs incurred as of the date at which the contract achieved operational stability, but should not be considered indicative of future period results.



Estimates and Changes in
Estimates. Our method of accounting is intended to reflect the economic substance of our long-term outsourcing contracts. Several factors can cause variability of reported results.



We make estimates of total contract revenue and cost, and we periodically update those estimates to reflect
our evolving best estimates of the life-of-contract economics. While we believe we can make reasonably dependable estimates, all estimates are inherently uncertain and subject to change. Incorrect assumptions or erroneous perceptions of the
resources required or revenue potential of a contract may need to be corrected. Changes in circumstances may require modification of estimates that were appropriate when made. Uncertainties inherent in the performance of contracts may affect our
assessment of our contracts over time.



In an
effort to maintain appropriate estimates, our policy is to review each of our long-term, fixed-price outsourcing contracts on a regular basis, not less than annually, and to revise our estimates of revenue and cost as appropriate. Various factors
could cause us to increase our estimates of contract expense. For example, our employment expenses and fees paid to vendors will tend to increase over time and may increase significantly from time to time depending upon market conditions and other
factors. Changes in technology or competition may require us to increase infrastructure spending to maintain appropriate service capabilities. Changes in law may increase compliance costs. Our cost estimates may include the effect of some
anticipated future cost savings, in addition to savings already achieved, and anticipated future cost savings may not be realized. Other factors could cause us to decrease our estimates of contract expense. For example, improvements in service
delivery that we achieve through process engineering, application of technology, and vendor rationalization all tend to decrease contract costs.



In addition, various factors could cause us to reduce our estimates of contract revenue. For example, clients may reduce contract scope,
either by canceling processes due to performance issues or, under some circumstances, by in-sourcing processes, subject to the terms of the contract with the client. Service volumes may decrease due to contraction of the client organization. Other
factors could cause us to increase our estimates of contract revenue. For example, service volumes may increase due to growth in the clients business, and clients may increase the scope of services they acquire from us through contract
amendment.



Increases in cost estimates and
decreases in revenue estimates can have material adverse effects on our earnings. If we determine that our previous cost estimates for a contract were too low, or our previous revenue estimates were too high, we will change our estimates
appropriately in the period in which the determination is made, including the recognition of the cumulative impact of the revision. The amount by which prior period revenue and gross profit was higher than it would have been if the updated estimates
had been applied during earlier periods will be a revenue and gross profit reduction in the period that the estimates are changed, and the lower estimated contract margin will also reduce our future gross profit outlook. Conversely, if we determine
that our previous cost estimates for a contract were too high, or our previous revenue estimates were too low, the amount by which prior period revenue and gross profit was lower than it would have been if the updated estimates had been applied
during earlier periods will be a revenue and gross profit increase in the period that the estimates are changed (subject to our revenue recognition limitation if it is then still in place for that particular contract), and the higher estimated
contract margin will also increase our future gross profit outlook. The magnitude of these effects will increase proportionately with the size of the contract and the extent of the change in estimates. Some of these effects could be significant.
Further, because we have a relatively small number of contracts and high client concentration, adverse changes in estimates for a single client contract could have a material adverse effect on our results of operations.



We do not enter into contracts that are expected to result in
a loss, but from time to time increases in cost estimates or reductions in revenue estimates may result in projected negative margins on a contract. In that case, the expected life-of-contract loss would be reflected as a cost in the period in which
the loss determination was made, and the contract would then be accounted for at a zero



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margin for the remainder of its term. This could have a material adverse effect on our results of
operations in the period in which the loss determination is made and would reduce our gross profit outlook.



Policies and Practices. We apply various policies and practices, including principally the three described
below, to guide our estimates of contract revenue and cost and to produce financial statements that we believe appropriately reflect the economic substance of our outsourcing business. Over time we may modify our policies and practices and implement
new ones.



Revenue Limitation until
Operational Stability.As described above, we limit revenue recognized for each contract to amounts billed or billable until the contract reaches operational stability. Therefore, client contracts can contribute negative margins until
operational stability is achieved. In the quarter in which contract operational stability is achieved, there generally is a change of estimate for the contract resulting in a one-time recognition of cumulative additional revenue and income
attributable to the application of estimated life-of-contract margin to costs incurred in prior periods. This change of estimate typically increases unbilled receivables and has a positive effect on our revenue and operating results for the period
in which it occurs, but should not be considered to be an appropriate indication of future results.



Revenue recognition for variable services.Some services included in our process management contracts, such as staffing and
learning, can have high variability in service volumes because client spending in these areas is discretionary to a significant degree, and highly sensitive to changes in client policies and strategies, as well as economic conditions and
developments in the clients business and outlook. Clients may choose to reduce or avoid such expenditures, which reduces our service volumes and revenue. Further, our costs for these resources can change quickly depending upon changing
conditions in geographic or industry markets. Accordingly, our financial results from provision of these services are more variable than for other services such as payroll. Because of this variability, we do not believe we can make reasonably
dependable estimates in these areas, so revenue and cost for these services are not included in contract estimates. Revenues and costs for these variable services are recognized in the period the services are performed and are not impacted by our
long-term contract estimates.



Limited horizon
for estimates.We intend to achieve cost savings over the life of our outsourcing contracts. However, the achievement of such savings becomes more speculative in the later years due to the potential for increasing delivery costs, uncertainty
regarding client needs, and other factors. Therefore, contract estimates generally will reflect only those reductions in our costs of service delivery that we expect to realize within a limited time following the date of analysis.



Short-Term Arrangements



In addition to our outsourcing contracts that extend over
long periods of time, we provide our customers services on a short-term basis. These include consulting services primarily to non-outsourcing clients, which services are generally structured on a per diem basis, and project-based services for our
outsourcing clients, which services may be structured on a per diem or fee-for-service basis. For these short-term arrangements, we recognize revenue as services are performed provided there is evidence of an arrangement, we have met our delivery
obligation, the fee is deemed fixed or determinable, and collectibility is reasonably assured.



Allowance for Doubtful Accounts



We maintain an allowance for doubtful accounts for estimated losses resulting from inability of our clients to make required payments. If the financial condition of our clients were to deteriorate,
resulting in an impairment of their ability to make payments, additional allowances may be required.



Direct Contract Costs



We capitalize certain set-up and other direct installation costs (Direct Contract Costs) to the extent that management determines such costs are recoverable. Capitalized set-up and other
direct installation costs are included in Fixed Assets and Direct Contract Costs and are amortized over the applicable contract term. As of December 31, 2002, and March 31, 2003, we had Direct Contract Costs of $10.7 million and $11.1 million,
respectively, net of accumulated amortization.



Deferred Tax
Assets



As of December 31, 2002, and March
31, 2003, we had $64.9 million and $63.0 million, respectively, of net deferred tax assets, arising primarily from our net operating losses, for which we have fully reserved through the valuation allowance. We record a valuation allowance to reduce
our deferred tax assets to the amount that is more likely than not to be realized. We have considered



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future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for
the valuation allowance and we continue to monitor our ability to realize our deferred tax assets. As we begin to demonstrate consistent profitability, we may record one or more adjustments to reduce the valuation allowance to reflect our
anticipated use of our deferred tax assets to reduce our future income tax liabilities. Each such adjustment will be recorded in the period that we determine it is more likely than not that we can recover all or a portion of our deferred tax assets.
Each adjustment will increase income by an amount equal to the portion of the valuation allowance that we then determine we are more likely than not to recover. We were profitable during the quarter ended March 31, 2003, and we were able to use a
portion of our deferred tax assets arising from our cumulative net operating losses to reduce our provision for income taxes to zero for the quarter.



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RISK FACTORS



Any of the following risks and
uncertainties could adversely affect our business, financial condition or results of operations. Other risks and uncertainties may also have an adverse effect on our business. The risks described in this report, and other risks that may become
apparent from time to time, should be considered in assessing the Companys prospects.



We have a relatively brief operating history and our future operating results are uncertain.



We entered into our first process management contract in December 1999. Our success depends on our ability to provide a high quality,
cost-effective service offering, operate it profitably, produce satisfactory results for our clients and attract new clients. While we have met our objectives to date and we believe our clients value our services, we have not been in operation long
enough to judge whether we can continue to accomplish all of these objectives, particularly in an increasingly complex and competitive marketplace. Accordingly, our future operating results are uncertain.



We currently depend on a small number of clients for most of our revenue.
If any of these clients were to substantially reduce or stop using our services, or if we experience significant, repeated performance failures in providing services to these clients, our reputation and future revenues would be seriously impaired.



We have six outsourcing clients, and we
anticipate that revenue from Bank of America Corporation, BP p.l.c., International Paper Company, and Prudential Financial will represent a substantial portion of our revenue through 2003 and possibly in future periods. For fiscal 2002 and the first
quarter of 2003, these clients collectively accounted for approximately 92% and 95%, respectively, of our revenue. We believe our ability to secure future clients and revenues will be largely dependent upon our ability to perform and achieve the
contracted service levels and cost savings for our current clients.



Each of our process management contracts can be terminated for material breach, significant or repeated performance failures or in certain instances for convenience upon required notice and, in many cases, payment of
specified early termination penalties. The early termination penalties provided for under these contracts are designed to help defray the expenses we incur in implementing the contract, including diligence, transition, set-up and installation costs,
and may provide some compensation to us, but they are not adequate substitutes for the revenue or profit that could be lost as a result of contract termination.



As our business matures, the original terms of our major contracts will begin to expire. For example, our
agreements for services to BP in the U.S. and U.K. will expire late in 2004. We anticipate seeking to renew contracts as they expire, but clients are not obligated to renew and various factors, including changes in the client organization or in the
market for HR outsourcing services, could cause clients to take services back in-house or contract with other vendors. Further, we might choose not to bid on renewal, or not to bid aggressively, due to limited profit opportunity with the client,
changes in our business model, or other factors.



If any of our major clients were to substantially reduce or stop using our services, or if we experience significant, repeated performance failures, our reputation and future revenues would be seriously impaired. We expect to face
similar risks with other significant clients until our business is more firmly established.



Our client contracts and vendor relationships may not yield the results we expect.



Our revenue expectations may decrease.We maintain estimates of our aggregate anticipated annual revenue for our entire contract
base. We may from time to time disclose some of these estimates. All of these estimates change as our contracts evolve, and a number of factors can cause our revenue expectations to decrease. These factors include client financial difficulties or
business contractions that lead to reductions in workforce or discretionary spending on services such as staffing and training; amendments agreed to by us which reduce the scope or revenue for services; early termination of client contracts in whole
or part, whether resulting from adverse developments in the clients business or the clients exercise of discretion; insourcing or retention by the client of processes previously contracted to us (subject to our approval as required under
the terms of the contract); non-assignment to us of third-party vendor contracts that we initially envisioned taking over from the client; and other circumstances within the clients organization. In addition, our receipt of revenue under any
particular contract may be delayed if transition of the clients processes to our infrastructure takes longer than anticipated. While our contracts with our clients may contemplate further expansion, this may not occur, and if it does occur,
significant additional expenditures by us may be required to fund such expansion. In addition, our process management contracts generally permit our clients to impose financial penalties against us for specified material performance failures.



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We might
not be able to achieve the cost savings required to sustain and increase profits under our contracts. Our business model inherently places ongoing pressure on our operating margins. We provide our direct outsourcing services over long terms for
fixed fees that are generally equal to or less than our clients historical costs to provide for themselves the services we contract to deliver. Additionally, our contracts generally require one or more reductions of this fixed fee during the
contract term, often beginning upon completion of process transitions or approximately one year after we commence services, irrespective of our cost of providing these services. As a result, we bear the risk of increases in the cost of delivering HR
process management services to our clients, and our margins associated with particular contracts will depend on our ability to control our costs of performance under those contracts and meet our service commitments cost-effectively. Over time,
vendor costs and our own internal operating expenses will tend to increase as we invest in additional infrastructure and implement new technologies to maintain our competitive position and meet our client service commitments. Further, taking over
services previously delivered by vendors involves further increases to our internal operating expense. We must respond by continuously improving our service efficiency and vendor management and continuing to grow our business so that our costs are
spread over an increasing revenue base. If we stop improving, our ability to sustain and increase profitability will be jeopardized.



Achieving the efficiency we need to sustain and increase our profitably depends upon our ability to continue to develop our process
operations and our ESDMSMinto a standardized management system that can be operated from our client service centers
and extended to multiple clients with limited client-specific adaptation and modification. The actual cost reductions we are able to achieve will vary by client for a variety of reasons, including the scope of services we agree to provide and the
existing state of our clients departments and processes. If we miscalculate the resources or time we need to perform under any of our contracts, or if our transformation efforts are not as successful as we anticipate, the costs of providing
our services could exceed the fees we receive from our clients, and we could lose money.



Our use of vendors presents liability risks and margin pressures.A significant part of our revenue (including somewhat more than half of our process management outsourcing revenue for the
period ended March 31, 2003) is attributable to services we offer to our clients which we fulfill through the use of third-party vendors that provide specialized services, such as temporary staffing, training, learning content, benefits
administration and relocation services. We select some of these vendors and assume others from relationships established by our clients before contracting with us. These vendors may act as subcontractors or vendors to us or provide services directly
to our clients under our control; in either case, we have contractual responsibility for the delivery and acceptability of these services, and errors or omissions, service failures, breach of contract or insolvency by our vendors could cause us to
have liability to our clients. This liability could exceed the limits of liability the vendors have to us. If our clients are not satisfied with the services provided by these third-party vendors, they may be entitled to recover penalties or to
terminate their agreements with us, which could seriously harm our business.



Further, target operating margins are more difficult to achieve in the portion of our revenue attributable to third-party vendors. Our third-party vendor business is composed of several different types
of processes across numerous vendors. In many cases, our initial cost of paying these vendors is equal to our revenue attributable to their services. In order to generate target operating margins and realize a profit from revenue received in
connection with these third-party vendor contracts, we must reduce these vendor costs by rationalizing and consolidating the vendors, improving efficiencies, obtaining more favorable pricing, or performing the services ourselves at a lower cost.
This may involve delay as existing contracts run their course and we attempt to renegotiate with or replace these vendors. In addition, at the conclusion of these third-party contracts, we must negotiate new third-party contracts, or provide these
services ourselves, at the same or more favorable rates in order to generate our target operating margins. We may need our clients consent to substitute new vendors or ourselves for previous vendors, either because of contractual provisions or
operational concerns. We are still developing our third-party vendor management capabilities, and our efforts may lead to varying results depending upon the process, vendor, and client involved and other factors. To date, our operating
margins on the portion of our revenue attributable to services provided through third-party vendors have been limited. Accordingly, until we are able to develop substantial portions of our third-party vendor business to the point that it generates
meaningful operating margins, our overall margins and profitability will rely upon strong performance in the direct process management and project and consulting services that make up the balance of our revenue.



Our ESDMSMis evolving and requires ongoing development.



We are still developing the Exult Service Delivery ModelSMinfrastructure, including our MultiDeliverySMoperational methodology, and our ability to continue to deliver and expand our broad process management solution depends upon our continued ability to assemble and manage our own systems and capabilities and third-party
vendors into an integrated and efficient delivery platform. Our clients use disparate information systems and operating methods, and transitioning their processes to our operating platforms requires significant technology and process integration. We
often must adapt or develop new systems and processes to



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accommodate various clients needs. Clients employees may access and utilize our
myHRSMsolution and systems through interfaces that require significant development and integration of many
independent programs and complex functions, as well as ongoing revision, adaptation and maintenance. If we fail to develop a clients service delivery infrastructure in accordance with the specifications and delivery milestones agreed upon, or
if we are unable to complete development of scalable systems and achieve the functionality we expect, our ability to deliver our services and achieve our business objectives in general could be seriously impaired.



Our proportional cost method of accounting relies upon assumptions,
estimates and policies that may change over time; such changes may have significant adverse effects on our reported results of operations.



Use of proportional cost accounting requires us to make assumptions and estimates and implement relevant policies. Assumptions affect
various matters, including when reasonably dependable estimates of revenue and cost under any particular contract can be made. Estimates of life-of-contract revenue and cost form the basis of reported operating results. Policies dictate crucial
matters such as how and when estimates are made and revised and how costs are allocated. These assumptions, estimates and policies involve the exercise of judgment and discretion, which may evolve over time in light of operational experience,
regulatory direction, developments in accounting principles, and other factors. Further, initially foreseen effects could change over time as a result of changes in assumptions, estimates and policies. Application of, and changes in, assumptions,
estimates and policies may result in adverse changes in periodic financial results.



From the time we begin providing services under a long-term outsourcing contract until the contract reaches operational stability, we limit the amount of revenue recognized under our proportional cost
methodology to amounts that have been or can be currently billed under the terms of the contract. Once the contract reaches operational stability, we discontinue this limitation and adjust the cumulative revenue recognized to date for that contract
to fully reflect the then-current estimates of profitability for the contract over its term. Thereafter, we recognize revenue and profit as work progresses based upon the proportion of costs incurred to total expected costs for the life of the
contract. Each of our multi-year outsourcing contracts can generally be expected to contribute to unbilled receivables once the revenue recognition limitation is discontinued for that contract because early implementation costs will generally result
in recognition of revenue in excess of contract billings early in the contract term. The amount of unbilled receivables associated with that contract is then expected to diminish gradually over the remainder of the contract term as billings exceed
revenue recognized. However, if a contract were to terminate early, any remaining unbilled receivable and any other client-specific capitalized costs associated with that contract would be recognized as a cost in the period in which termination
occurs, to the extent that they exceed termination payments we are entitled to recover. Termination payments may not be sufficient to defray the entire unbilled receivable and any other client-specific capitalized costs, and the net write-off may be
significant and could have a material adverse effect on our results of operations. As of March 31, 2003, we had unbilled receivables of approximately $13.5 million. We expect unbilled receivables to increase as our business grows.



Proportional cost accounting requires us to maintain estimates
of life-of-contract revenue and cost for each of our multi-year outsourcing contracts. All estimates are inherently uncertain and subject to change to correct inaccurate assumptions and reflect changes in circumstances. In an effort to maintain
appropriate estimates, we review each of our long-term outsourcing contracts on a regular basis. If we determine that our cost estimates for a contract are too low, or our revenue estimates are too high, we will change our estimates in the period in
which the determination is made, resulting in the recognition in that period of the cumulative portion of the revision that applies to prior periods. The amount by which prior period revenue and gross profit was higher than it would have been if the
updated estimates had been applied during prior periods would result in a reduction of revenue and gross profit in the period that the estimates are changed, and the lower estimated margin would reduce our future gross profit outlook. The magnitude
of these effects would increase proportionately with the size of the contract, the extent of the change in estimates, and the duration of the prior period to which the updated estimates must be applied. Some of these effects could be significant.
Further, because we have a relatively small number of long-term outsourcing contracts and high client concentration, changes in estimates for a single client contract could have a material adverse effect on our results of operations.



New standards may affect our accounting.



Accounting rulemaking bodies and the staff of the SEC have
promulgated new rules and interpretations related to accounting for long-term service contracts, including the recently released Emerging Issues Task Force Issue 00-21, Revenue Arrangements with Multiple Deliverables. We believe, based
upon our analysis and consultation with our advisors, that our accounting for our existing long-term contracts is not inconsistent with these new rules and interpretations. We have not yet determined the impact of adoption of Emerging Issues Task
Force Issue 00-21 may have on our accounting for any future long-term contracts that we obtain. However, developments in applicable accounting rules and their interpretation may require us to adopt different accounting for long-term contracts.



16



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Capacity constraints and
the length of our new client sales and integration cycles may limit our revenue growth.



We expect most of our future revenue growth to come from new client engagements. However, because the size of our client engagements tends to be relatively large and new client transition can be
complex, our ability to take on multiple new client engagements concurrently is limited. This may limit our revenue growth until we have developed to the point that our services can be extended more rapidly across a greater number of clients.



Our client contracts involve significant
commitments and cannot be made without a lengthy, mutual due diligence process during which we identify the potential clients service needs and costs, and our ability to meet those needs and provide specified cost savings. We must devote
significant management time and other resources to each due diligence process over a period of six months or more, and we can conduct at most only a few of these due diligence undertakings at one time. This lengthy due diligence process limits our
revenue growth, and we have invested significant time and expense in some potential client relationships that have not resulted in contracts. It is possible that future client due diligence processes could result in a decision by us or the potential
client not to enter into a contract after we have made significant investments of time and resources.



After a new client contract is signed, we generally convert the clients HR processes to our systems and infrastructure. This
transition period can take from three months to over one year and may involve unanticipated difficulties and delays. Transition usually takes longer for greenfield clients that have not centralized their HR operations than for
brownfield clients that have consolidated HR operations that we can take over in place. We cannot realize the full efficiencies of providing services to the client through our infrastructure until this transition is complete. Therefore,
any increase in our revenues that could be expected from new agreements will generally be delayed for several months after the contract is signed, and it could take a significant amount of time for new agreements to contribute significantly to
profits or cash flow. We attempt to negotiate long-term contracts in order to give us time to complete the transition and earn a profit, but if implementation of our service model is delayed, or if the client terminates our engagement early for
convenience or because we do not meet our service commitments, we might experience no return, and possibly a loss, on our substantial investment of time and resources in that client.



Our new business objectives may not be realized.



Our sales pipeline consists of potential expansions of contracts with existing clients, as well as potential
contracts with new clients. From time to time, we publicly discuss our estimated frontlog in order to provide investors with information that is relevant to an understanding of our business. Frontlog represents our estimate of revenue potential from
client prospects with which we are in advanced stages of discussion regarding an outsourcing contract, as characterized by a confidentiality agreement, a letter of intent, a very small group of serious bidders, or other factors. Our frontlog
estimates are based upon our assumptions regarding potential scope and pricing, and assume an average ten-year contract term. Frontlog estimates are not representations; the sales cycle for our services is long and complex and the frontlog is fluid,
so the frontlog does not represent any assurance of future revenue and it is impossible to predict in advance which prospects may become clients or how quickly contracts may be signed or implemented.



There is no assurance that we will sustain profitability and positive cash
flows.



The fourth quarter of 2002 and the
first quarter of 2003 were our first profitable quarters since our formation. We have not yet had a profitable fiscal year, and the creation of our business has consumed significant amounts of cash. We incurred net losses of $94.8 million, $74.7
million and $10.6 million for the years ended December 31, 2000, 2001 and 2002, respectively. We may incur net losses in future periods. While we do not enter into contracts for which we expect to incur a loss, and although we estimate and model
each of our client contracts to be individually profitable, we cannot be certain that we can sustain or increase profitability on a quarterly or annual basis in the future. Further, our ability to sustain positive cash flow depends upon a number of
factors, including fuller utilization of our infrastructure and achievement of additional scale in our business. Cash flow can vary significantly from quarter to quarter for various reasons, including investments we make in connection with new
client transitions and strategic initiatives and timing differences between our receipt of payments from our clients and payments to our vendors.



From time to time we make projections about our future operating results, including the amount of potential profitability and cash flows.
These projections are estimates intended to provide information that is relevant to an understanding of our business, but are not a representation or guaranty regarding future performance. The timing and magnitude of any profitability and positive
cash flows we may achieve depends upon a number of factors including those set forth in these Risk Factors and in our other filings with the SEC.



Due to economic conditions, we failed to achieve some of the revenue growth we had originally anticipated in 2002. In order to compensate
for this and to enhance our ability to reach our goal of achieving profitability for the fourth quarter of 2002 and beyond,



17



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we implemented various cost reduction programs in 2002. These programs included overhead facilities
consolidations and limited headcount reductions that may need to be reversed to support long-term growth, as well as various reductions in manager discretionary compensation and discretionary employee benefit programs that are not sustainable in the
long run. Accordingly, our future profitability depends upon revenue increases as well as efficient operations.



We may need additional capital, which might not be available or might dilute existing stockholders.



For the years ended December 31, 2000, 2001 and 2002, we used cash of $56.2 million, $35.0 million and $5.5 million, respectively, in
operating activities and $23.8 million, $21.4 million and $38.1 million, respectively, to fund expenditures for direct contract costs and acquire property, plant and equipment as well as certain intangible assets. Ongoing development and expansion
of our infrastructure and service capacity, acquiring new client contracts and transitioning their services requires significant capital investment. We may need to raise additional funds through public or private debt or equity financings in order
to maintain adequate cash balances to satisfy the expectations of prospective clients; finance acquisitions, new client contracts with capital investment requirements, and other strategic opportunities; and address operating issues. If we are
required to raise additional funds through the issuance of equity securities, the percentage ownership of our existing stockholders would be reduced. Further, such equity securities may be sold at prices below those paid by existing stockholders,
and have rights, preferences or privileges senior to those of our common stock. We cannot be certain that we will be able to raise additional funds on favorable terms, or at all, and if we need additional funds but cannot obtain them, our ability to
fund our operations or strategic initiatives may be impaired.



To succeed we must hire, assimilate and retain key personnel, open new client service centers, assimilate our clients personnel and systems and expand our own systems and controls.



To sustain and increase profitability, we must extend our
service model across many client organizations and gain additional critical mass in the size and breadth of our operations. Our ability to achieve growth depends upon the following essential elements:



| |  |  | The market for skilled employees is competitive, and we must be able to hire, train and retain key personnel including managers, human resources specialists, web and
Internet technologists and programmers, business development and process management specialists and technical and customer support personnel.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We currently have five client service centers, in North Carolina, Tennessee, Texas, Scotland and our developing center in India. These centers are designed to handle
our existing client demands, and have capacity to handle anticipated near-term growth in our service volumes, but we will need to open new client service centers to handle the long-term growth we anticipate. We must devote substantial financial and
management resources to launch and operate new centers successfully, and we may not select appropriate locations for these centers, open them in time to meet our client service commitments or manage them profitably.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As we assume responsibility for the existing HR departments of our clients, we must be able to assimilate certain HR personnel from these clients and integrate
disparate systems, procedures, controls and infrastructures.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | If we do not manage growth effectively, our ability to perform under our contracts may be jeopardized and our reputation may be harmed.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



Our quarterly financial results may vary and cause our stock price to
fluctuate.



Our quarterly financial results
have varied in the past and are likely to vary significantly in the future. It is possible that in some future quarter or quarters our financial results will be below the revenue or profit or cash flow expectations of public market analysts or
investors. If so, the market price of our common stock may decline significantly. Factors that may cause our results to fluctuate include but are not limited to:



| |  |  | the growth of the market for our HR services and our ability to obtain new client contracts;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | our ability to continue to execute successfully on client contracts;
| | - |  | --------------------------------------------------------------------



| |  |  | the length of the sales and integration cycle for our new clients;
| | - |  | ------------------------------------------------------------------



| |  |  | cancellations or reductions in the scope of our contracts;
| | - |  | ----------------------------------------------------------



18



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| |  |  | delays in transitioning various client processes to our infrastructure;
| | - |  | -----------------------------------------------------------------------



| |  |  | changes we may make in our estimates of revenues and costs pursuant to our proportional cost method of accounting for our outsourcing contracts;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to develop and implement additional service offerings and technologies;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | our ability to successfully market and sell to our clients complementary third-party products and offerings that we have purchased in advance of client orders;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the introduction of comprehensive HR services by new and emerging competitors;
| | - |  | ------------------------------------------------------------------------------



| |  |  | changes in our pricing policies or those of our competitors;
| | - |  | ------------------------------------------------------------



| |  |  | our ability to manage costs, including personnel costs, support services costs and third-party vendor costs;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | the timing and cost of strategic initiatives and openings or expansions of client service centers; and
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | our ability to sustain overall profitability.
| | - |  | ---------------------------------------------



We have in the past purchased assets and hired personnel from our clients. We expect to continue such transactions from time to time in
the future. Client asset acquisitions may result in amortization expense and other charges. In addition, rationalizing headcount and facilities consolidation following transition of client processes to our systems may result in severance and closing
expenses. As our business evolves, we may from time to time incur costs for severance and infrastructure consolidation, as well as costs relating to the implementation of new organization structures, technologies, processes and other changes in our
business. These costs will reduce our reported earnings. Our service delivery infrastructure is represented by significant tangible and intangible assets reflected on our balance sheet. Our existing assets and infrastructure can accommodate some
growth in our business, and we expect our capacity to increase in the future, both as a result of acquisitions of new assets and efficiency improvements in our Exult Service Delivery ModelSM. We try to maintain sufficient assets and capacity to support reasonably anticipated business growth without carrying excessive assets or idle capacity. To
the extent that we might in the future determine that our assets or the capacity of our service delivery infrastructure exceed our reasonably anticipated needs, it may be necessary to take a charge to operations for excess assets or capacity, which
would reduce our reported earnings.



We could experience
damages, service interruptions or failures at our client service centers or in our computer and telecommunications systems.



Our business could be interrupted by damage to or disruption of our client service centers, computer and telecommunications equipment and
software systems from fire, power loss, hardware or software malfunctions, penetration by computer hackers, computer viruses, natural disasters, vendor performance failures or insolvency, and other causes. We may lose data. Our clients
businesses may be harmed by any system or equipment failure we experience. As a result of any of the foregoing, our relationships with our clients may be impaired, we may lose clients, our ability to attract new clients may be adversely affected and
we could be exposed to contract liability. We cannot be certain that we will be able to route calls and other operations from an affected center to another in the event service is disrupted and we may not be able to recover data used in our
operations. In addition, in the event of widespread damage or failures at our facilities, we cannot guarantee that the disaster recovery plans we have in place will protect our business.



We could experience fraud or theft.



Our services involve access to systems and accounts containing confidential personal data and monies of
clients and their personnel. Notwithstanding our efforts, complete security is difficult to achieve. Dishonest acts by our employees, client employees or vendor personnel could expose us to liability, damage our reputation, and impair our client
relationships.



We are subject to risks associated with
our international operations.



We believe
multinational capabilities will be important as the competitive market for outsourcing evolves and our business strategy includes international expansion. We have broadened the geographic scope of services we deliver to our clients from United
States



19



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and United Kingdom operations to Indian operations in the first quarter of 2003, and we expect to continue
to expand our international operations in the future as we take on additional large, multinational clients. Overseas expansion requires capital investment and presents significant risks and operational challenges. Foreign legal and regulatory
requirements, affecting business operations in general as well as human resources processes in particular, may be complex and require significant investment in compliance capabilities. We do not yet have the expertise required to deal effectively
with different countries workplace practices, and developing this expertise could be expensive and time consuming. Tariffs and other trade barriers, high taxes, political instability, and international currency exchange rates and related
issues may increase the cost and risks associated with overseas operations. We must design and operate web sites and other service delivery components that are accessible by employees of overseas clients, and differing technology standards and
Internet regulations may affect access to and operation of our web sites and our clients web sites. If we address our need to develop overseas service delivery capabilities by entering into strategic relationships with local overseas
providers, our client service in those areas will depend upon third parties and our ability to address potentially complex systems integration, service delivery, and relationship issues. Because of these and other factors, overseas operations will
require significant financial and management resources and may be more prone to service delivery errors and delays, which could damage our reputation and jeopardize contracts.



We use overseas vendors to assist in our business, including to provide services to our clients overseas and
to take advantage of lower overseas labor costs for some support functions. We expect to increase this practice. Some clients and potential clients may resist our use of overseas vendors because of concerns about service quality, data security,
legal and cultural issues, and other reasons. Overseas vendors may be difficult to manage and require significant investments in monitoring and systems integration. If we have disputes with overseas vendors it may be difficult for us to enforce our
rights, and replacing overseas vendors may involve delay and expense.



One of our service centers is in India, and some of our vendors are also located there. In the future, we may open new service centers or work with new vendors in other areas of political instability. Acts of war, terrorism
or political unrest could disrupt our facilities or operations or those of our vendors and impair our service delivery capabilities, resulting in additional expense, damage to our reputation and potential material adverse effects on our business,
results of operations and financial condition.



Recruitment
and retention of key employees may be difficult and expensive.



We believe that our success is dependent upon the leadership and operational skills of our senior management team and other key employees. In general, the employment of our key personnel may be terminated by either us or the
employee at any time, for any reason without cause or advance notice subject to severance benefit obligations under some circumstances. Due to the competitive nature of our industry and other factors, we may not be able to retain all of our senior
managers and key personnel. If any of these individuals were unable or unwilling to continue working for us, we could have difficulty finding a replacement and our business could be harmed.



We have relied heavily upon stock options to supplement
compensation for many of our employees, particularly at higher levels. Our stock price has been volatile, and a number of our existing stock options have exercise prices above our current stock price. If stock options become less effective as a
recruitment or retention device due to public market conditions, trends in our stock price or other factors, we may need to rely more heavily upon cash compensation. This could significantly increase our costs of doing business. Further, because we
have relied heavily upon stock options, treating options as an expense, in response to legal or regulatory requirements or evolving business practices, would significantly increase our reported costs.



The market for our services and our revenue growth depends on our ability
to use the Internet as a means of delivering human resources services.



We rely on the Internet as a mechanism for delivering our services to our clients and achieving efficiencies in our service model, and this reliance exposes us to various risks.



| |  |  | We use public networks to transmit and store extremely confidential information about our clients and their employees. We may be required to expend significant
capital and other resources to address security breaches. We cannot be certain that our security measures will be adequate and security breaches could disrupt our operations, damage our reputation and expose us to litigation and possible liability.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our target clients may not continue to be receptive to human resources services delivered over the Internet because of concerns over transaction security, user
privacy, the reliability and quality of Internet service and other reasons. In addition, growth in
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



20



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Internet traffic may cause performance and reliability to decline. Interruptions in
Internet service and infrastructure delays could interfere with our ability to use the Internet to support our ESDMSM, which could disrupt our service delivery and expose us to contractual service credit penalties or damages for breach. Further, repeated Internet service failures could impair our revenue growth and results of operations.



| |  |  | Laws and regulations may be adopted relating to Internet user privacy, pricing, usage fees and taxes, content, distribution and characteristics and quality of
products and services. This could decrease the popularity or impede the expansion of the Internet and decrease demand for our services. Moreover, the applicability of existing laws to the Internet is uncertain with regard to many important issues,
including property ownership, intellectual property, export of encryption technology, libel and personal privacy. The application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the application of
existing laws and regulations to the Internet and other online services, could also harm our business.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We must keep our computing and communications infrastructure on pace with changing technologies.



Our success depends on our sophisticated computer, Internet
and telecommunications systems. We have invested significantly in our technological infrastructure and anticipate that it will be necessary to continue to do so in the future to remain competitive. These technologies are evolving rapidly and are
characterized by short product life cycles, which require us to anticipate technological changes and developments. Our success in designing and delivering high quality, cost-effective services that add value for our clients depends, in part, upon
our ability to adapt our processes to incorporate new and improved software applications, communications systems and other technologies and devices. If we fail to adapt to technological developments, our clients may experience service implementation
delays or our services may become non-competitive or obsolete.



We rely on third-party vendors for software. If their products are not available or are inadequate, our business could be seriously harmed.



Our service delivery capability incorporates and relies on software owned by third parties that we license
directly or use through existing license arrangements between our clients and the vendor. If these vendors change or fail to maintain a product that we are using or do not permit use by us or our vendors, or if these agreements are terminated or not
renewed, we might have to delay or discontinue our services until equivalent technology can be found, licensed and installed.



The markets we serve are evolving and increasingly competitive and our competitors may have much greater resources to commit to growth, new technology
and marketing.



We expect growth in demand
for integrated HR process management services to continue to result in increased competition, and we believe these factors will lead to rapid and significant changes in the market we serve. Our ability to compete effectively depends in part upon our
ability to anticipate market developments. If we are unable to react quickly to changes in the market, if the market fails to develop in the ways we expect, or if our services do not achieve additional market acceptance, then we are unlikely to
maintain our leadership position or to achieve or sustain profitability.



Our current and potential competitors include in-house HR departments of our target clients, as well as technology outsourcers, single-service providers, and consulting firms that are expanding their
offerings to include broad HR offerings. We expect that the predicted growth of the HR outsourcing market will attract and motivate more competitors to assume responsibility for broad integration of HR processes.



Several of our existing or potential competitors have
substantially greater financial, technical and marketing resources, larger customer bases, greater name recognition and more established relationships with their customers and key product and service suppliers than we do. Our competitors may be able
to:



| |  |  | develop and expand their delivery infrastructure and service offerings more quickly;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | adapt better to new or emerging technologies and changing client needs;
| | - |  | -----------------------------------------------------------------------



| |  |  | take advantage of acquisitions and other opportunities more readily;
| | - |  | --------------------------------------------------------------------



| |  |  | establish operations in overseas markets more rapidly than we can;
| | - |  | ------------------------------------------------------------------



21



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| |  |  | devote greater resources to the marketing and sale of their services; and
| | - |  | -------------------------------------------------------------------------



| |  |  | adopt more aggressive pricing policies and provide clients with additional benefits at lower overall costs.
| | - |  | -----------------------------------------------------------------------------------------------------------



The capabilities described above might enable competitors to
overtake us. In addition, we believe there will be future consolidation in our market, which could increase competition in ways that may be adverse to us.



We operate in a complex regulatory environment, and failure to comply with applicable laws and regulations could adversely affect our business.



Corporate human resources operations are
subject to a number of laws and regulations, including those applicable to payroll practices, benefits administration, employment practices and data privacy. Because our clients have employees in states across the United States and in various
countries around the world, we must perform our services in compliance with the legal and regulatory requirements of multiple jurisdictions. Some of these laws and regulations may be difficult to ascertain or interpret, may change, and may be
inconsistent with our business practices. Violation of laws and regulations could subject us to fines and penalties, damage our reputation, constitute breach of our client contracts and impair our ability to do business in various jurisdictions or
according to our established processes.



The
European Commissions Directive on Data Privacy limits transfer of personal data outside the European Union. In order to receive personal data about our clients European employees and fulfill our service commitments, we have elected to
comply with the Safe Harbor Principles established by the United States Department of Commerce, in collaboration with the European Commission, to provide adequate protection for personal data about European Union residents. Because we
process HR data, we are required by the Safe Harbor Principles to submit to the jurisdiction of the European Union Data Protection Authorities (DPAs). Specifically, we must cooperate with the DPAs in the investigation and resolution of
complaints brought under the Safe Harbor Principles by European citizens and comply with any corrective advice and remedial or compensatory measures they dictate. In addition, operation under the Safe Harbor Principles subjects us to the
jurisdiction of the Federal Trade Commission. If we fail to process personal data in accordance with these principles, we could be subject to legal penalties under the Federal Trade Commission Act and foreign privacy laws. We could also lose our
ability to move personal data from the European Union to the United States, which would significantly impair our ability to fulfill our contractual commitments to our clients. We expect to have to comply with similar laws of other foreign
jurisdictions in which we do business in the future.



Our business is also increasingly affected by privacy legislation in the United States. Although the United States does not have comprehensive privacy legislation like the EU and many other countries, a variety of new federal and
state laws are beginning to present compliance challenges. For example, the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA) has new privacy regulations that will impact our business operations. HIPAAs
privacy regulations protect individually identifiable health information relating to the mental and physical health condition of individuals. This law grants consumers expanded control over the access and use of their protected health information.
Covered entities may only use an individuals protected health information for purposes related to health care and all disclosures of health information must be limited to the minimum necessary for the purpose of the disclosure. In addition,
covered entities must have proper security measures and policies to guard data integrity, confidentiality and availability. As a service provider to our clients for the processing of protected health care information, we are required to enter into
written agreements with affected clients to ensure our compliance with HIPAA. Similarly, we are obligated to pass through similar compliance obligations to our vendors and subcontractors that assist us with the handling of health information for the
benefit of our clients.



We may undertake acquisitions that
may limit our ability to manage and maintain our business, may result in adverse accounting treatment and may be difficult to integrate into our business.



We expect to pursue acquisitions under appropriate circumstances. We cannot provide any assurance that we will be able to complete any
acquisitions, or that any acquisitions we may complete will enhance our business. Any acquisition we do complete could subject us to a number of risks, including:



| |  |  | diversion of our managements attention;
| | - |  | ----------------------------------------



| |  |  | inability to integrate the acquired company and its employees into our organization effectively, and to retain key personnel of the acquired business;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



22



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| |  |  | inability to retain the acquired companys customers;
| | - |  | -----------------------------------------------------



| |  |  | additional costs incurred in connection with headcount rationalizations; and
| | - |  | ----------------------------------------------------------------------------



| |  |  | exposure to legal claims for activities of the acquired business prior to acquisition.
| | - |  | --------------------------------------------------------------------------------------



Client satisfaction or performance problems with an acquired business also could affect our reputation as a
whole. In addition, any acquired business could significantly underperform relative to our expectations.



We must protect our intellectual property and avoid infringing upon the intellectual property rights of others.



We may not be able to detect or deter unauthorized use of our intellectual property. If third parties
infringe upon or misappropriate our trade secrets, copyrights, trademarks, service marks, trade names or proprietary information, our business could be seriously harmed. In addition, although we believe that our proprietary rights do not infringe
upon the intellectual property rights of others, other parties may assert that we have violated their intellectual property rights. These claims, even if not true, could result in significant legal and other costs and may be a distraction to
management. In addition, protection of intellectual property in many foreign countries is weaker and less reliable than in the United States. If our business expands into additional foreign countries, risks associated with protecting our
intellectual property will increase.



Our executive officers,
directors and their affiliates control the company.



Our executive officers, directors and their respective affiliates have the right to vote a majority of our outstanding common stock as of March 12, 2003. As a result, these stockholders, acting together, have the ability to control
matters requiring stockholder approval, including the election of directors and mergers, consolidations and sales of all or substantially all of our assets. These stockholders may have interests that differ from other investors and they may approve
actions that other investors vote against or reject actions that other investors have voted to approve. In addition, this concentration of ownership may also have the effect of preventing, discouraging or deferring a change in control of Exult,
which, in turn, could depress the market price of our common stock.



Our stock price is likely to be highly volatile.



The price at which our common stock trades has fluctuated significantly and is likely to continue to be highly volatile. From our IPO in June 2000 through March 31, 2003, the sales price of our stock, as reported on the
Nasdaq National Market, has ranged from a low of $1.97 to a high of $19.85. We are a relatively new company without a history of profits, and we utilize the Internet and a technology infrastructure to deliver our services. The share prices for other
companies with similar characteristics have at times increased to levels that bore no relationship to their operating performance, and at other times have declined dramatically, even without apparent changes in their business.



In addition, the stock market in general has from time to time
experienced significant price and volume fluctuations that have affected the market prices for companies like ours. In the past, this kind of market price volatility has often resulted in securities class action litigation against companies
comparable to ours. Securities litigation could result in substantial costs and divert our managements attention and resources.



Substantial sales of our common stock by our existing investors could cause our stock price to decline.



The majority of our outstanding shares are in the hands of
their original purchasers and can be sold publicly pursuant to Rule 144. These investors may seek to sell their shares, and sales of large numbers of shares in the same time period could cause the market price of our common stock to decline
significantly. These sales also might make it more difficult for us to sell securities in the future at a time and price that we deem appropriate.



Our charter documents and Delaware law could deter a takeover effort.



Provisions of our certificate of incorporation and bylaws, including those that provide for a classified
board of directors, authorized but unissued shares of common and preferred stock and notice requirements for stockholder meetings, and Delaware law regarding the ability to conduct specific types of mergers within specified time periods, could make
it more difficult for a third party to acquire us, even if doing so would provide our stockholders with a premium to the market price of their common stock. A classified board of



23



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directors may inhibit acquisitions in general, and a tender offer not endorsed by our board of directors
in particular, because only one-third of our directors are reelected annually, thereby requiring two annual meetings before a majority of our directors could be replaced. The authorization of undesignated preferred stock gives our board of directors
the ability to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of the company. If a change in control or change in management is delayed or prevented, the market price
of our common stock could decline.



24



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RESULTS OF
OPERATIONS



Because of the rapidly evolving
nature of our business and our limited operating history, we believe that period to period comparisons of our operating results, including our revenue, expenses, gross profit and expenses as a percentage of revenue, should not be relied upon as an
indication of our future performance. The following table sets forth statement of operations data expressed as a percentage of revenue for the periods indicated:



|                                                |  | Three Months Ended March 31, |   
|----------------------------------------------- |  | ---------------------------- | --
|                                                |  | 2002                         |   
|Revenue                                         |  | 100.0                        | % 
|Cost of Revenue                                 |  | 98.8                         |   
|                                                |  |                              |   
|Gross profit                                    |  | 1.2                          |   
|Selling, General and Administrative Expense     |  | 8.9                          |   
|                                                |  |                              |   
|Income (loss) from operations                   |  | (7.7                         | ) 
|Investment and Interest Income, net             |  | 0.7                          |   
|                                                |  |                              |   
|Income (loss) before provision for income taxes |  | (7.0                         | ) 
|Provision for Income Taxes                      |  |                             |   
|                                                |  |                              |   
|Net income (loss)                               |  | (7.0                         | )%
|                                                |  |                              |   



Three Months Ended
March 31, 2002 and 2003



Revenue. Revenue for the three months ended March 31, 2002 and 2003, was $95.0 million and $114.1 million, respectively. The 2002 amount included $91.0 million, or 96%, of revenue derived from seven business process
management clients (one of which is no longer a client), and the 2003 amount included $112.1 million, or 98%, of revenue derived from six business process management clients. The balance of our 2002 and 2003 revenue primarily consisted of consulting
revenue generated from various clients.



The
revenue increase for the 2003 period as compared to the 2002 period principally resulted from the progressive transition of service responsibility to us under two process management contracts that were executed in October 2001 and January 2002,
together with various scope expansions with respect to several clients, partially offset by the completion of one of our business process management contracts during the fourth quarter of 2002. In addition, as a result of the maturation of our
business, we determined during the third quarter of 2002 that it was no longer necessary to limit revenue recognition to amounts billed once a contract has reached operational stability. As of December 31, 2002, all of our existing long-term
outsourcing contracts had reached operational stability.



We make estimates of total contract revenue and cost, and we periodically update those estimates to reflect our evolving best estimates of the life-of-contract economics.This periodic update resulted in recognition of $6.2
million of net additional outsourcing revenue and operating income for the three months ended March 31, 2003 reflecting the cumulative impact of our change in estimates in the March 31, 2003 quarter.



For the three months ended March 31, 2002, three process
management clients accounted for 46%, 30% and 13%, respectively, of revenue as compared to three process management clients accounting for 49%, 22%and 16%, respectively, of revenue for the three months ended March 31, 2003. No other client accounted
for more than 10% of revenue in the 2002 and 2003 periods. For the three months ended March 31, 2002 and 2003, 24% and 30%, respectively, of our process management revenue was generated from the provision of services with more highly variable
volumes, such as staffing and learning, which depend upon client discretionary spending. The increase in the percentage of revenue generated from the provision of these services primarily resulted from increased usage of these services and was not
materially impacted by the transition of service responsibility to us under the two process management contracts executed in October 2001 and January 2002, respectively. As described above, revenue from these services is excluded from our contract
estimates. Transition of our existing base of business is substantially complete, so revenue growth in 2003 and future periods will depend primarily upon our ability to obtain new clients and sell additional services to existing clients.



Cost of Revenue. Our cost of
revenue for the three months ended March 31, 2002 and 2003, was $93.9 million and $102.8 million, respectively, and our gross margin for the same periods was 1.2% and 9.9%, respectively, as a percentage of revenue. Cost of revenue consists primarily
of compensation and benefits paid to our employees who are directly involved in providing our services, computer and communications equipment and services costs, facilities costs, depreciation and amortization of capitalized expenditures incurred



25



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in connection with our process management contracts, and expenses associated with third-party vendors who
provide services on our behalf for our clients within the scope of our process management contracts. Prior to January 1, 2003, depreciation and amortization expense had been set forth as a separate line item in our Condensed Consolidated Statements
of Income (Loss) and has been reclassified to cost of revenue and selling, general and administrative expense for the three months ended March 31, 2002 and 2003. Accordingly, depreciation and amortization included in cost of revenue for the three
months ended March 31, 2002 and 2003, was $2.5 million and $4.3 million, respectively. The increase in the cost of revenue for the three months ended March 31, 2003 as compared to the three months ended March 31, 2002 principally resulted from the
progressive transition of service responsibility to Exult under our various process management contracts and the continuing expansion of our infrastructure and service capacity. The improvement in our gross margin in the 2003 period as compared to
the 2002 period reflects the increased leverage achieved through higher utilization of our client service centers and other service delivery systems combined with the impact of continuing cost controls and efficiency programs instituted in
connection with our Exult Service Delivery Model. Operating expense will tend to increase to support any growth we may achieve, and our profitability depends upon our ability to scale our business by leveraging existing resources across a broader
revenue base and limiting increases in operating expense associated with new business to levels significantly below our clients historical costs of operating the processes we assume. Significant expansion of capacity in connection with new
contracts may delay our achievement of this scale. We have incurred, and may incur in the future, negative gross margins as we continue to transition and transform our clients HR processes.



Selling, General and Administrative Expense.
Selling, general and administrative expense for the three months ended March 31, 2002 and 2003, was $8.4 million, or 8.9% as a percentage of revenue, and $8.3 million, or 7.2% as a percentage of revenue, respectively. Selling, general and
administrative expense generally consists of compensation for employees engaged in developing product features and service delivery capabilities; marketing, promoting and selling our services; and management and administrative activities. Selling,
general and administrative expense also includes third-party consulting and marketing expenditures; facilities and office costs; legal, accounting and recruiting fees and expenses; and certain depreciation and amortization of capitalized
expenditures. Included in selling, general and administrative expense for the three months ended March 31, 2002 and 2003, was $1.4 million and $0.8 million, respectively, of depreciation and amortization expense from certain capitalized costs and
compensation deferrals. In addition, selling, general and administrative expense may include business optimization costs that are incurred during the period. We call these charges business optimization costs because they reflect our
pursuit of strategies intended to enhance our efficiency and profitability as our operating scale increases and our business progresses toward operational maturity. For the year ended December 31, 2001, selling, general and administrative expense
included business optimization costs totaling $18.5 million, the cash portion of these 2001 charges totaled $13.3 million. Through March 31, 2003, we have made cash payments totaling $10.0 million and reduced the initial accrual, and accordingly
selling, general and administrative expense, by $0.3 million and $2.3 million during the three months ended March 31, 2002 and year ended December 31, 2002, respectively, as a result of completion of certain of these arrangements at amounts less
than previously estimated and changes in estimates with regard to the remaining arrangements. Exclusive of the impact of reducing the initial accrual for business optimization costs, selling, general and administrative expense for the three months
ended March 31, 2002 was $8.7 million, or 9.1% as a percentage of revenue. Exclusive of business optimization costs, the decrease in selling, general and administrative expense for the three months ended March 31, 2003 as compared to the three
months ended March 31, 2002, primarily resulted from a reduction in certain intangible asset amortization, and the decrease in the expense as a percentage of revenue was also further impacted by our rate of revenue growth. Further improvement in
selling, general and administrative expense as a percentage of revenue depends upon revenue growth and leveraging existing infrastructure over a broader revenue base.



Investment and Interest Income, net. Investment and interest income, net for the three months
ended March 31, 2002 and 2003 consisted of investment and interest income of $0.7 million and $1.1 million, respectively, partially offset by interest expense of $0.1 million and $0.3 million, respectively. Investment and interest income is
generated primarily from short-term investing of cash in excess of current requirements. During the three months ended March 31, 2003, we realized $0.4 million in gains from sales of short-term investments. There were no similar sales during the
three months ended March 31, 2002. We generally had greater available cash balances during the 2002 period as compared to the 2003 period, and excluding the gains from sales of short-term investments during the 2003 period, investment and interest
income in the 2003 period decreased as compared to the 2002 period principally as a result of lower interest rates in the 2003 period and to a lesser degree from the reduced amount of cash available for investment. Interest expense is associated
with certain long-term obligations in both periods.



Provision for Income Taxes. We have incurred losses since our founding in 1998 through September 30, 2002, resulting in federal, state and foreign net operating loss carryforwards. We incurred our first profitable
quarters for the fourth quarter of 2002 and the first quarter of 2003 that utilized a portion of these net operating loss carryforwards. The remaining federal and state net operating loss carryforwards expire beginning in 2018 and 2005,
respectively. The foreign net operating loss may be carried forward



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indefinitely. A full valuation allowance has been provided against the tax benefit generated by the net
operating losses because of the uncertainty of realizing the deferred tax assets.



Net Income (Loss). The foregoing resulted in a net loss for the three months ended March 31, 2002, of $6.6 million, or $0.06 per basic and diluted share, and net income for the three
months ended March 31, 2003, of $3.9 million, or $0.04 and $0.03 per basic and diluted share, respectively.



Liquidity and Capital Resources



Since our inception in October 1998 through March 31, 2003, we have financed our operations primarily with equity contributions, including net cash received from private placement sales of our capital
stock totaling $169.5 million from inception, the net proceeds from our June 2000 initial public offering and the August 2001 follow-on public offering totaling $157.0 million, and, to a lesser extent, by cash generated from our business and the
exercise of stock options and warrants.



During
the three months ended March 31, 2002, we began generating revenue from our sixth and seventh process management clients, International Paper and Prudential Financial, respectively. We also opened our fourth primary client service center in January
2002. By December 31, 2002, all of our process management contracts had reached operational stability and we had substantially completed transition activities with respect thereto. During the three-month periods ended March 31, 2002 and 2003, we
expended operating cash in support of revenue generated by our process management contracts and, with respect to the 2002 period, to fund the transition and transformation costs associated with these process management contracts. We also used cash
during both periods to pursue additional business opportunities and the development of our corporate infrastructure.Net cash used in operating activities for the three months ended March 31, 2002, was $16.2 million and net cash provided by operating
activities was $9.5 million for the three months ended March 31, 2003. The improvement in net cash provided by operating activities in the 2003 period as compared to the 2002 period principally results from the attainment of operational stability
for all of our contracts by the end of 2002 in conjunction with improved efficiency in, and leverage of, our service delivery model. Net cash used in investing activities for the three months ended March 31, 2002 was $79.4 million and net cash
provided by investing activities was $4.9 million for the three months ended March 31, 2003. The increase in cash provided by investing activities in the 2003 period as compared to the 2002 period arises primarily from investments of the
Companys available cash. Commencing in December 2001, and continuing throughout 2002, in order to enhance its investment yield, the Company began to invest a portion of its available cash in financial instruments with maturity dates in excess
of 90 days. These financial instruments consist primarily of U.S. government debt securities and high-grade investment quality debt securities with maturities of less than three years. Accordingly, the transactions in such securities are included in
investing activities in the 2002 and 2003 periods and represent net cash used in investing activities of $60.2 million for the three months ended March 31, 2002, and net cash provided by investing activities $11.9 million for the three months ended
March 31, 2003. The balance of cash used in investing activities for the 2002 and 2003 periods was used primarily to construct and expand our client service centers and our internal systems, to make certain payments with respect to new client
contracts or expansion of existing contracts and to fund certain client set up costs. Excluding the transactions in cash equivalents and short-term investments, net cash used in investing activities for the three months ended March 31, 2002 and
2003, was $19.2 million and $7.1 million, respectively. The decrease in net cash used in investing activities excluding cash equivalents and short-term investment transactions is principally the result of increased new client activity in the 2002
period as compared to the 2003 period. We generated $1.2 million and used $0.6 million in cash, net from financing activities during the three months ended March 31, 2002 and 2003, respectively. We generated cash of $1.6 million and $0.4 million for
the three months ended March 31, 2002 and 2003, respectively, from the exercise of stock options and purchases under our employee stock purchase plan while we made payments of $0.5 million and $1.0 million, respectively under our long-term
obligations.



We may generate negative
cash flow from operations in the future. We also expect to continue our investments in fixed assets and direct contract costs to support the expansion and renovation of our facilities, including our existing client service centers, to make certain
payments with regard to new client acquisitions, and to purchase related computer and other equipment necessary to support our client contracts and growth. In addition, from time to time in the ordinary course of business, we evaluate potential
acquisitions of related businesses, assets, services and technologies. Such acquisitions, if completed, may require significant cash expenditures.



As of March 31, 2003, we had cash and marketable securities of $129.1 million. Cash consumption in the third and fourth quarters of 2002
and first quarter of 2003 benefited from favorable changes in working capital components which may not be sustainable. Cash consumption therefore may increase in the second quarter of 2003. However, we believe that our cash on hand will be
sufficient to satisfy our working capital requirements for at least the next 12 months. If we experience rapid growth or unanticipated expenses, we may need to raise additional funds through public or private debt or equity financings in order to
maintain adequate cash balances to satisfy the expectations of prospective clients; finance acquisitions, new client contracts with capital investment requirements, and



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other strategic opportunities; and address operating issues. We cannot be certain that we will be able to
raise additional funds on favorable terms, or at all, and if we need additional funds but cannot obtain them, our ability to fund our operations or strategic initiatives may be impaired.



Contractual Obligations and Commercial Commitments



The Company has the following contractual obligations and commercial commitments for the periods indicated
(in thousands):



|                                   |  | April 1, 2003 Through December 31, 2005 |        | January 1, 2006 through December 31, 2007 |   | Thereafter |  | Total
|---------------------------------- |  | --------------------------------------- | ------ | ----------------------------------------- | - | ---------- |  | -----
|Long-Term Obligations              |  | $                                       | 14,493 |                                           | $ | 123        |  | $    
|Operating Leases                   |  |                                         | 15,427 |                                           |   | 9,133      |  |      
|Unconditional Purchase Obligations |  |                                         | 1,710  |                                           |   | 11,000     |  |      
|                                   |  |                                         |        |                                           |   |            |  |      
|                                   |  | $                                       | 31,630 |                                           | $ | 20,256     |  | $    
|                                   |  |                                         |        |                                           |   |            |  |      



Certain of the
agreements provide the Company with the ability to cancel the respective agreement for convenience upon the payment of a fee.



Recent Accounting Pronouncements



In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Accounting Standards (SFAS) No.
143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of assets that result from the acquisition, construction, development and/or the normal operation of an asset, except for certain obligations of lessees. SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the asset.
SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002, with earlier application encouraged. We adopted SFAS No. 143 effective January 1, 2003. The adoption of SFAS No. 143 did not have a material
impact on our financial position or results of operations.



In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal
activities. SFAS No. 146 supersedes EITF Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The principal difference
between SFAS No. 146 and EITF Issue 94-3 relates to the recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that a liability be recognized for such costs only when the liability is incurred. In
contrast, under EITF Issue 94-3, a company recognized a liability for an exit cost when it committed to an exit plan. The FASB concluded in SFAS No. 146 that an entitys commitment to an exit plan, by itself, does not create an obligation that
meets the definition of a liability. SFAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. We adopted SFAS No. 146 effective January 1, 2003. The adoption of SFAS No. 146 did not have a material impact on our financial position or results of operations.



Effective prospectively for arrangements entered into in
fiscal periods beginning after June 15, 2003, Emerging Issues Task Force (EITF) Issue 00-21, Revenue Arrangements with Multiple Deliverables, addresses the accounting, by a vendor, for contractual arrangements in which
multiple revenue-generating activities will be performed by the vendor. In some situations, the different revenue-generating activities (deliverables) are sufficiently separable and there exists sufficient evidence of fair values to account
separately for the different deliverables (that is, there are separate units of accounting). In other situations, some or all of the different deliverables are interrelated closely or there is not sufficient evidence of fair value to account
separately for the different deliverables. EITF Issue 00-21 addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. The Company has not yet determined the impact of the
adoption of EITF Issue 00-21 on its consolidated financial statements.



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ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.



Interest Rate
Sensitivity



At March 31, 2003, our
investment portfolio consisted primarily of fixed income securities totaling $70.4 million. The carrying amount of these securities approximates fair market value. These securities are subject to interest rate risk and will decline in value if
market rates increase. If market rates were to increase immediately and uniformly by 10% from levels as of March 31, 2003, the decline in the fair value of the portfolio would not be material to our financial position.



ITEM 4. CONTROLS AND PROCEDURES.



Evaluation of disclosure controls and procedures.
Based on their evaluation, as of a date within 90 days of the filing of this Quarterly Report on Form 10-Q, the Companys Chief Executive Officer and Chief Financial Officer have concluded that they are unaware of any reason to believe that the
Companys disclosure controls and procedures (as defined in Rule 13a-14 promulgated under the Securities Exchange Act of 1934) are not effective in timely alerting them to material information relating to the Company (including its consolidated
subsidiaries) that is required to be included in the Companys periodic filings.



Changes in internal controls. There were no significant changes in the Companys internal controls or in other factors that could significantly affect these controls subsequent to the date
of the evaluation referred to above, including any corrective actions with regard to significant deficiencies and material weaknesses.



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PART II.
OTHER INFORMATION.



ITEM 1. LEGAL PROCEEDINGS.



The Company and its subsidiaries are from
time to time parties to legal proceedings, lawsuits and other claims incident to their business activities. Such matters include, among other things, assertions of contract breach and claims by persons whose employment with the Company has been
terminated in connection with facilities consolidations, headcount rationalizations, outsourcing of certain operational functions, including in some cases to offshore vendors, and other measures that the Company has undertaken and expects to
continue to undertake in the ordinary course of its business. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, management is unable to ascertain the ultimate aggregate amount of monetary
liability, amounts which may be covered by insurance, or the financial impact with respect to these matters as of March 31, 2003. However, based on its knowledge at the time of this report management believes that the final resolution of these
matters, individually and in the aggregate, will not have a material adverse effect upon the Companys consolidated financial position, results of operations or cash flows.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.



(a) Exhibits.



The following Exhibits are incorporated herein by reference.



|Exhibit Number |  | Description                                                                                                                                           
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*           |  | Fourth Amended and Restated Certificate of Incorporation of Exult, Inc.                                                                               
|3.2*           |  | Amended and Restated Bylaws of Exult, Inc.                                                                                                            
|99             |  | Written statement of the Chief Executive Officer and Chief Financial Officer of Exult, Inc. pursuant to section 906 of
the Sarbanes-Oxley Act of 2002.

---

|* |  | Previously filed with the Companys Registration Statement on Form S-1 Registration No. 333-31754, and incorporated herein by reference.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------



(b) Reports on Form 8-K.



Current Report on Form 8-K dated February 11, 2003, reporting
that the Chief Executive Officer and Chief Financial Officer of the Company filed a certificate pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 related to the Companys Annual Report on Form 10-K for the fiscal year ended December 31,
2002.



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SIGNATURES



Pursuant to the requirements of the
Securities Act of 1934, as amended, the undersigned has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 24th day of April, 2003.



EXULT, INC.By:

/s/    JAMES C. MADDEN,
VJames C. Madden, V Chief Executive Officer, President, and Chairman of the Board (principal executive officer)




By:

/s/    MICHAEL F.
HENNMichael F. Henn Executive Vice President, Treasurer and Chief
Financial Officer (principal financial officer)




By:

/s/    ROBERT G.
MCGRAWRobert G. McGraw Vice President, Finance and Chief Accounting
Officer (principal accounting officer)




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CERTIFICATIONS



I, James C. Madden, V,
certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Exult, Inc.;
|-- |  | ------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                    
|--------------------
|Date: April 24, 2003
|                    



32



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I, Michael F. Henn, certify
that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Exult, Inc.;
|-- |  | ------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                    
|--------------------
|Date: April 24, 2003
|                    



33