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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K/A

(Amendment No. 1)



(Mark One)

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



For the fiscal year ended December 31, 2003



OR



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



For the transition period from  to



Commission file number 0-30035



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EXULT, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 33-0831076                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|121 Innovation Drive, Suite 200 Irvine, California             |  | 92612                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



Registrants
telephone number, including area code: (949) 856-8800



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Securities registered pursuant to Section 12(b) of the Act:



|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|None                |  | None                                     



Securities
registered pursuant to Section 12(g) of the Act:



Common
Stock, $0.0001 Par Value

(Title of Class)



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. x Yes ̈No



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ̈



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



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The aggregate market value of the Common Stock of the registrant held by non-affiliates of the registrant
as of June 30, 2004, the last business day of the registrants most recently completed second fiscal quarter, was approximately $261.1 million (based upon the closing price on The Nasdaq National Market on that date).



The number of shares of Common Stock of the registrant outstanding as of June
30, 2004 was 110,327,746.



DOCUMENTS INCORPORATED BY
REFERENCE



Part III incorporates by reference certain
information from the Registrants Proxy Statement for the Annual Meeting of Stockholders to be held May 6, 2004, which the Registrant filed with the Commission on April 26, 2004.





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EXPLANATORY NOTE REGARDING THIS AMENDMENT ON FORM 10-K/A



This Amendment No. 1 to the annual report on Form 10-K is being filed solely
to reclassify an expense previously reported on our consolidated financial statements for the year ended December 31, 2001, from continuing operations to discontinued operations. In the fourth quarter of fiscal 2003, we adopted a formal plan to
dispose of our Gunn consulting operation. Accordingly, in our Form 10-K filed on March 2, 2004 (the Original Form 10-K), assets and liabilities of the Gunn consulting operation were segregated and classified as held for sale as of
December 31, 2003 and the operating results were reclassified as discontinued operations for all periods presented, including the year ended December 31, 2001. For the year ended December 31, 2001, we recorded an approximate $2.2 million non-cash
charge arising from the write-off of a Gunn research database that was determined to no longer have value. However, in the Original Form 10-K this charge was included in selling, general and administrative expense of continuing operations. In this
Amendment No. 1, this $2.2 million Gunn expense has been reclassified to discontinued operations. This reclassification is discussed in more detail in Notes 3 and 6 of Notes to Consolidated Financial Statements contained in this Amendment No. 1.



The reclassification amends only certain parts of the Original
Form 10-K, as set forth herein. Unaffected items have not been repeated in this Amendment No. 1. This report still speaks as of the filing date of the Original Form 10-K and, except as expressly stated herein, no attempt has been made to update this
report to reflect events occurring subsequent to the date of the initial filing date of the Original Form 10-K. All information contained in this Amendment No. 1 is subject to updating and supplementing as provided in our periodic reports filed with
the Securities and Exchange Commission subsequent to the date of the filing of the Original Form 10-K.



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TABLE OF CONTENTS



|                     |  |                                                                                       |  |     
|-------------------- |  | ------------------------------------------------------------------------------------- |  | ----
|                     |  |                                                                                       |  | Page
|PART II              |  |                                                                                       |  |     
|                     |  |                                                                                      
|Item 6.              |  | SELECTED FINANCIAL DATA                                                               |  | 1   
|                     |  |                                                                                      
|Item 7.              |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 3   
|                     |  |                                                                                      
|PART IV              |  |                                                                                       |  |     
|                     |  |                                                                                      
|Item 15.             |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                      |  | 17  
|                     | 
|SIGNATURES           |  | 21                                                                                   
|                     | 
|Financial Statements |  | F-1                                                                                  





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PART II



|Item 6. | SELECTED FINANCIAL DATA.
|------- | ------------------------



The selected consolidated financial data set forth in this Item as of and for the year ended December 31, 2001 been revised to reflect the
reclassification. For a discussion of the reclassification, see Notes 3 and 6 to Notes to Consolidated Financial Statements.



The following selected consolidated financial data as of and for the years ended December 31, 1999, 2000, 2001, 2002, and 2003 has been derived from our
audited consolidated financial statements and related notes. The historical results are not necessarily indicative of future results. The following data should be read in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operations and the consolidated financial statements and related notes included elsewhere herein.



|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|---------------------------------------------------- |  | ---------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                     |  | Year Ended December 31,                  |        
|                                                     |  | 1999                                     |         |   | 2000 |   |         | 2001 |  |   | 2002    |   |  | 2003 |        
|                                                     |  | (in thousands, except per share amounts) |        
|Consolidated Statement of Operations Data:           |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Revenue(2)                                           |  | $                                        | 3,993   |   |      | $ | 53,341  |      |  | $ | 257,052 |   |  | $    | 405,842 |   |  | $ | 480,322 |  
|Income (Loss) from continuing operations(1)(2)       |  |                                          | (15,151 | ) |      |   | (91,658 | )    |  |   | (72,824 | ) |  |      | (11,572 | ) |  |   | 19,560  |  
|Income (Loss) from discontinued operations(2)        |  |                                          | (61     | ) |      |   | (3,162  | )    |  |   | (1,827  | ) |  |      | 973     |   |  |   | (4,602  | )
|Net income (loss)(1)                                 |  | $                                        | (15,212 | ) |      | $ | (94,820 | )    |  | $ | (74,651 | ) |  | $    | (10,599 | ) |  | $ | 14,958  |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (loss) per share - Basic(3):              |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income (Loss) from continuing operations             |  | $                                        | (2.19   | ) |      | $ | (1.68   | )    |  | $ | (0.75   | ) |  | $    | (0.11   | ) |  | $ | 0.18    |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income (Loss) from discontinued operations           |  | $                                        | (0.01   | ) |      | $ | (0.06   | )    |  | $ | (0.02   | ) |  | $    | 0.01    |   |  | $ | (0.04   | )
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (Loss)                                    |  | $                                        | (2.20   | ) |      | $ | (1.74   | )    |  | $ | (0.77   | ) |  | $    | (0.10   | ) |  | $ | 0.14    |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (loss) per share - Diluted(3):            |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income (Loss) from continuing operations             |  | $                                        | (2.19   | ) |      | $ | (1.68   | )    |  | $ | (0.75   | ) |  | $    | (0.11   | ) |  | $ | 0.17    |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income (Loss) from discontinued operations           |  | $                                        | (0.01   | ) |      | $ | (0.06   | )    |  | $ | (0.02   | ) |  | $    | 0.01    |   |  | $ | (0.04   | )
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (Loss)                                    |  | $                                        | (2.20   | ) |      | $ | (1.74   | )    |  | $ | (0.77   | ) |  | $    | (0.10   | ) |  | $ | 0.13    |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Weighted average number of common shares outstanding |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Basic                                                |  |                                          | 6,906   |   |      |   | 54,491  |      |  |   | 96,622  |   |  |      | 105,199 |   |  |   | 106,870 |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Diluted                                              |  |                                          | 6,906   |   |      |   | 54,491  |      |  |   | 96,622  |   |  |      | 105,199 |   |  |   | 115,460 |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                     | 
|                                                     |  | December 31,                             |        
|                                                     |  | 1999                                     |         |   | 2000 |   |         | 2001 |  |   | 2002    |   |  | 2003 |        
|                                                     |  | (in thousands)                           |        
|Consolidated Balance Sheet Data:                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Cash, cash equivalents and short-term investments(4) |  | $                                        | 39,199  |   |      | $ | 99,890  |      |  | $ | 169,569 |   |  | $    | 127,297 |   |  | $ | 195,807 |  
|Working capital(4)                                   |  |                                          | 31,957  |   |      |   | 93,185  |      |  |   | 149,545 |   |  |      | 130,685 |   |  |   | 222,671 |  
|Assets held for sale(2)                              |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   | 100     |  
|Total assets                                         |  |                                          | 58,767  |   |      |   | 204,181 |      |  |   | 291,593 |   |  |      | 294,396 |   |  |   | 430,224 |  
|Long-term obligations, net of current portion        |  |                                          | 4,304   |   |      |   | 152     |      |  |   |        |   |  |      | 12,794  |   |  |   | 118,881 |  
|Convertible preferred stock                          |  |                                          | 58,768  |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total stockholders equity                           |  | $                                        | 46,110  |   |      | $ | 171,429 |      |  | $ | 233,634 |   |  | $    | 229,298 |   |  | $ | 252,414 |  
|                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  

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|(1) | Includes $16.3 million of business optimization costs in the year ended December 31, 2001, consisting of severance charges of $9.7 million (including non-cash option
acceleration charges of $3.0 million) and certain wind-up costs resulting in a $6.6 million charge (including severance costs of $5.4 million) associated with the elimination of two secondary, non-strategic processing centers. During 2002 and 2003,
we reduced the initial accrual by $2.3 million and $206,000, 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.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | In the fourth quarter of fiscal 2003, the Company adopted a formal plan to dispose of its Gunn consulting operation. Accordingly, assets and liabilities of the
consulting operation have been segregated and classified as held for sale as of December 31, 2003 and the operating results have been presented as discontinued operations for all periods presented. In the fourth quarter of fiscal 2003, the Company
recorded an impairment charge of approximately $3.3 million to reduce the carrying value of the assets of the consulting operations to their estimated fair value less estimated selling costs. During the year ended December 31, 2001, the Company
recorded an approximate $2.2 million non-cash charge arising from the write-off of a Gunn research database that was determined to no longer have value, which has been included as part of discontinued operations. For further details, please refer to
Note 3 and Note 14 of Notes to Consolidated Financial Statements included under Part II Item 8. Financial Statements and Supplementary Data for fiscal 2001, 2002 and 2003.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Management has reclassified certain 1999 and 2000 balances,
which were audited by auditors who have ceased operations. These reclassified amounts have not been audited.



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|(3) | Please refer to Note 2 and Note 11 of Notes to Consolidated Financial Statements for information regarding the method used to compute our basic and diluted net
income (loss) per share.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Certain prior-year balances have been reclassified to conform to current financial statement presentation. These reclassifications had no impact on previously
reported results of operations or shareholders equity.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|Item 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
|------- | --------------------------------------------------------------------------------------



The Managements Discussion and Analysis of Financial Condition and Results of Operations set forth in this Item 7
has been revised to reflect the reclassification. Specifically, the tabular data for 2001 set forth in the table on page 9 and the discussion of Selling, General and Administrative Expense and Net Loss from Continuing Operations for the years
ended December 31, 2002 and 2001 and Discontinued Operations were revised.



Overview



Our primary
source of revenue is fees we earn for providing our HR-led business process management services under long-term contracts. We also receive additional revenue from client projects. To date, we have generated leads for potential process management
clients primarily through our management team, existing outsourcing and consulting relationships, our board of directors, third-party consultants, contact with key executives at Global 500 corporations or direct communication from such companies in
the form of inquiry or request for proposal.



Our larger,
integrated multi-process management service contracts generally have terms of seven to ten years, encompass multiple HR and related 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 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 may be 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, 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.



Revenue under our process management contracts can be broadly divided into
two categories: revenue associated with processes that we manage directly and revenue derived from processes that we manage by using third-party vendors. We typically agree to provide a minimum savings to the client on the labor-based portion of
direct-managed processes after a pre-determined period of time, usually several months to approximately one year from contract signing. For the portion of the contract covering services previously subcontracted by the client and for which we
continue to use third-party vendors, we generally share with the clients savings we are able to achieve from the clients historical spending levels. The amount of minimum savings is determined in accordance with the terms of the applicable
contracts; in general, our fees are no greater than our clients historical cost of operating the functions assumed by us. 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. We anticipate that gross
margin associated with direct managed revenues will generally be greater than gross margin associated with third-party processes. However, our overall gross margin may vary as the mix of revenue changes between direct managed and third party.



We are contractually responsible for the delivery and
acceptability to our clients of the services we provide 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 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 services provided by 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.



When we sign a new process management contract, we typically announce our estimate of the revenue potential for that contract over its anticipated term. These estimates are intended to provide information that is
relevant to an understanding of our business, but are not a representation or guaranty regarding future performance. Initially, our information about a new clients historical volumes and costs for the HR processes we take on is imperfect, and
verification procedures that take place after contract announcement may result in reduction in our anticipated fees. Further, our revenue expectations for each contract change over its life. Once we have



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announced estimated revenue potential for a new contract, we generally do not undertake to update that estimate to reflect all of these changes. Rather, we
try to maintain a reasonably current estimate of the aggregate anticipated revenue for our entire contract base.



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 net income of $1.8
million in the fourth quarter of 2002 and net income of $15.0 million for fiscal 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 and related valuation allowance, 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 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 cumulative 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 is first determined.



Because we generally need time with a new contract before we can make reliable estimates of our costs of performance, our practice is to limit the amount
of revenue recognized on a new contract 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 until the contract reaches operational stability. We then 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.



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We have adopted EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables,
prospectively for contracts we enter into after June 30, 2003. EITF Issue 00-21 addresses the accounting, by a vendor such as us, 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. We anticipate that, in the near-term, services and deliverables to be provided under new business process management contracts will
generally be similar in nature to services and deliverables provided in connection with our existing contracts. Our market and service offering is relatively new, and certain of our services have not been sold on a stand alone basis, either by us or
our competitors. Therefore, we believe that there is not, and in the near-term will not be, sufficient evidence of fair value for certain elements of our contracts. We anticipate accounting for future multiple-element contracts that share these
characteristics as a single unit and in the same manner as we account for our existing multiple-element contracts as long as there continues to be a lack of fair value for certain elements of our contracts and some portion of these elements remain
undelivered until the completion of a contract.



However, we
are seeking to drive the HR BPO market toward a unit-based pricing methodology because we see benefits to us and to our clients of using this approach. To our clients, this would provide greater simplicity, and to us it would provide several
potential benefits including a reduction in the level of due diligence involving assessment of current client costs, and a potential strategic advantage over the majority of our current competitors. We have several proposals underway to current and
potential clients that would involve unit-based pricing. Contracts that utilize unit-based pricing may be accounted for differently than our current contracts, depending upon the exact nature of the agreement. Changing an existing contract to
unit-based pricing could require us to change our accounting methodology for that contract, and ceasing proportional cost accounting on an existing contract could result in the write-down of part or all of any unbilled receivable, certain intangible
assets or recovery of any deferred revenue related to that contract at that time. This could reduce profit in the period of the write-down, but would not necessarily affect cash flow.



Future developments in applicable accounting rules and their interpretation
may require us to adopt different accounting for long-term contracts. There can be no assurances that in the future accounting rulemaking bodies and the staff of the SEC will not determine that EITF Issue 00-21 or other standards may require us to
adopt different accounting, which may have a material adverse effect on our revenues and results of operations.



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 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 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 that we believe are probable of being achieved, 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.



A number of factors can cause our
revenue expectations for a given contract to decrease. While our client contracts generally include commitments by clients regarding service scope and pricing, there are also provisions pursuant to which billings can increase or decrease in response
to changes in the clients organization. Further, other factors give clients leverage to renegotiate price and other terms with us, such as the right to terminate for convenience, our desire to obtain additional business from the client,
looming expiration of the contract, negotiation over potential penalties associated with service level issues, and our general desire to be responsive to clients business needs. In this context, various circumstances can lead to reduction in
revenues from any particular client, including: 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 when 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



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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. 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 reflected as a reduction in revenue and gross profit 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 reflected as an increase in revenue and gross profit 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, the
proportion of the contract completed 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 loss in the period in which the loss determination was made, and the contract would then be accounted for at a zero
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 consolidated 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. As of December 31, 2003, none of the contracts that were entered into during fiscal 2003
were deemed to have achieved operational stability.



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. As a consequence, 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 increase efficiency and commensurately reduce service delivery costs over the life of our outsourcing
contracts. However, our ability to deliver additional savings that are sustainable over the life of the contract becomes more speculative in the later years due to the potential for increasing delivery costs, uncertainty regarding future efficiency
improvements and client needs, and other factors. Therefore, life-of-contract estimates generally will reflect only those reductions in our costs of service delivery that we believe are probable of being realized within a limited time following the
date of analysis. This time horizon is a function of the maturity of our business, the development of our infrastructure and other general and client-specific factors. The horizon included in the contract estimates as of December 31, 2003, includes
the estimated savings that we believe are probable of being achieved through the end of the third quarter of 2004, which are then assumed to be maintained for the remaining life of each contract. We anticipate, although no assurance can be given,
that our contract estimates as of March 31, 2004, which will be reflected in our financial results for the first quarter of 2004, could include estimated savings that we believe are probable of being achieved through March 31, 2005 (i.e. an
increase from a three-quarter horizon in the fourth quarter of 2003 to a four-quarter horizon in the first quarter of 2004). This increase of one quarter would result from the completion, perhaps as soon as the first quarter of 2004, of an updated
detailed 12 month forecast, which we believe would give us greater visibility into the longer-term contract view. We would intend to roll this forecast forward each quarter to provide us a consistent one-year outlook period. We consider efficiency
improvements and cost savings that we plan to achieve beyond the above time horizons too speculative to include in our life-of-contract cost estimates.



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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, including
project-based services for our outsourcing clients that 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 future collection 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 one or more 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 we determine such costs are
recoverable by the receipt of future contractually committed amounts. 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. If a client
contract terminates early, or changes so that such costs are no longer recoverable, then we will be required to write off unamortized Direct Contract Costs associated with that contract, resulting in a commensurate charge to earnings for the period
in which the termination charge occurs. As of December 31, 2002 and 2003, we had Direct Contract Costs of $10.7 million and $18.4 million, respectively, net of accumulated amortization.



Deferred Tax Assets



As of December 31, 2002 and 2003, we had $74.3 million and $70.2 million, respectively, of net deferred tax assets, arising primarily from our net
operating losses, which we have fully reserved through a 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 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. Assuming we are able to demonstrate a history of taxable income and to
forecast with relative certainty that we will earn taxable profits for the foreseeable future, we will record one or more adjustments to reduce the valuation allowance to recognize on a current basis 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 for that
period accordingly but should not be considered to be indicative of subsequent results. While we were profitable during the year ended December 31, 2003, we did not earn taxable profits due to differences between book and tax accounting. Thus, as a
result of continuing to not have a history of taxable profits, we continue to fully reserve through a valuation allowance the amount of the net deferred tax asset. The Company reduced its valuation allowance on its deferred net tax assets during the
year ended December 31, 2003, only to the extent that the a newly generated deferred tax liability, resulting from the net income generated in the period, will allow recovery of certain deferred tax assets. Upon utilization or expiration of the
underlying net operating loss carryforwards, or elimination of the valuation allowance, we will begin to record income tax expense and commensurately lower net income for future periods in which we are profitable or eliminate the valuation
allowance.



Important Factors That Could Affect Future
Performance



As we consider our plans to achieve our
overall 2004 business objectives and our financial targets of $575-600 million in revenue and $0.30 -$0.33 per share in earnings, we focus on certain critical drivers of revenue, cost and margins. These drivers are:



| |  | Transition of work sold during 2003
| | - | -----------------------------------



| |  | Add-ons to current clients
| | - | --------------------------



| |  | Additions of new client contracts
| | - | ---------------------------------

| |  | A shift of more work from Indirect to Direct via client focus and targeted acquisitions that can also expand and further integrate our service offerings
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Further leveraging of our infrastructure through additional volumes and business
| | - | --------------------------------------------------------------------------------



| |  | Expansion of our multi-shore delivery model including the further utilization and development of our India operations
| | - | -----------------------------------------------------------------------------------------------------------------------



We exited the fourth quarter of 2003 at an annualized revenue run rate of
approximately $480 million. Excluding certain contracts still to complete transition, we anticipate a modest reduction in that existing revenue base as contractually committed client discounts and credits come into effect. We also expect certain
project-based revenues to decrease for various reasons including reduced demand for ad-hoc projects as compared to the level performed in 2003. We anticipate some continuation in the decreases in



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the amount of temporary staffing volumes at key clients though not as pronounced as that experienced in the fourth quarter of 2003. These services are
variable and can also increase, but we are not projecting increases at this time.



We plan to obtain the new revenue needed to reach our 2004 targets from four principal sources. These are (i) the annualized impact of new business acquired at different times during 2003, including contracts with new
clients in 2003 and the revenues from the acquisition of the international outsourcing business of PwC, (ii) additional revenues from certain existing clients as we further develop our relationship and increase the scope of work provided to them,
(iii) revenues from new clients sold during 2004 and (iv) revenues from modest acquisitions anticipated to be made during 2004. Achievement of these objectives depends upon our ability to sign new clients at a pace beyond that achieved in 2003, and
depends on the timing of the sale within the year. The transition of additional work from existing clients must occur on schedule and is anticipated to create incremental unbilled revenue as those clients transition to our proportional cost
accounting methodology. The level of temporary staffing revenues is volatile and subject to short term increases and decreases, which can materially affect our growth but has little impact on profitability. Finally we must identify appropriate
acquisition candidates and complete their acquisition in a timely fashion. These acquisition candidates could have the desired effect of increasing the proportion of our revenue that is direct as opposed to indirect, thereby
helping to improve overall margins. If we are unable to achieve any of these objectives, or if the timing of these achievements is delayed significantly, we will have to look for other sources of new revenue, or we will not reach our objectives for
the year.



Excluding the effect of new business, we expect our
costs in 2004 to exceed 2003 levels because of the full year interest expense on our 2.5% Convertible Senior Notes and increases in compensation expense, principally base salary, fringe benefits, and bonus for our workforce. Further margin pressure
will result from new hiring we anticipate in order to strengthen our workforce in several key areas, increased costs associated with service quality programs and process audits conducted to help clients comply with their own internal audit
requirements, and initiation of previously agreed increases in client discounts and the anticipated reduction in the amount of high-margin project work from 2003 levels. These factors, net of any increases in unbilled revenues following the
transition of certain contracts to the proportional cost accounting methodology, will result in net income for the first quarter of 2004 being approximately flat compared to that of the fourth quarter of 2003. In order to compensate for these margin
pressures and reach our earnings target for 2004, we plan to continue to improve our mix of higher-margin direct revenue vs. lower-margin third party revenue by focusing our 2004 sales and acquisition efforts on direct
revenue sources. We also plan to expand the operations of our India service center to lower the average cost of delivery of our services, increase our overall productivity, and improve overall margins. We will also continue to focus our efforts to
drive the Six Sigma methodology throughout our business to enable us to reduce the costs of errors and rework through first- time quality. Net of these effects, and assuming we are successful at productivity improvement and further cost
reductions, we expect unbilled receivables to increase during 2004.



Our expectations related to 2004 financial performance depend upon many factors, including principally our ability to develop new business and minimize delivery cost. Changes in our estimates of cost to perform under our contracts and the
timing of new business and transition of certain existing contracts to the proportional cost accounting methodology could cause revenues to increase or decrease from todays expectations, and commensurately affect unbilled receivables and
deferred revenues. Furthermore, any changes that may be negotiated in new or existing contracts could require us to adopt different methods of revenue recognition for those contracts.



In connection with the previously announced potential merger of Bank of America Corporation and FleetBoston Financial
Corporation, Bank of America is taking many steps to prepare for integration of the combined post-merger enterprise. These include a review of major vendors to Bank of America and Fleet. In this context, in November 2003, Bank of America issued an
HR BPO Request for Information (the RFI) to us and to a provider that Fleet selected to provide HR services before the announcement of the planned merger. The RFI summarized Bank of Americas plans for a broad range of human
resources processes and functions that we currently provide to Bank of America, and for selected additional services that we do not currently provide. The RFI solicited information from us regarding our plans for ongoing development and provision of
these services, and their transition to the new integrated post-merger organization. We have provided a response to the RFI.



Bank of America has told us that their decision-making regarding HR BPO for the post-merger organization is only one of many integration projects they
have underway, and they have not given us any definitive timetable for any decisions regarding provision of the services covered by the RFI. It is possible that the level and/or scope of services we provide to Bank of America could increase,
decrease, or remain the same. In general, an increase in the level and/or scope of services we provide to the post-merger Bank of America would be a positive development for us, and a decrease in the level and/or scope of services would be negative.
However, any changes in the level and/or scope of services we provide would probably involve complex pricing and other terms and variables not yet fully evaluated or negotiated, and therefore we cannot predict with certainty the timing of any
changes or the effect of any changes upon our operating results.



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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:



|                                                                                                                          |  |       |    |  |       |    |  |       |  
|------------------------------------------------------------------------------------------------------------------------- |  | ----- | -- |  | ----- | -- |  | ----- | -
|                                                                                                                          |  | 2001  |    |  | 2002  |    |  | 2003  |  
|Revenue                                                                                                                   |  | 100.0 | %  |  | 100.0 | %  |  | 100.0 | %
|Cost of Revenue                                                                                                           |  | 112.7 |    |  | 96.3  |    |  | 90.0  |  
|Gross Profit (Loss)                                                                                                       |  | (12.7 | )  |  | 3.7   |    |  | 10.0  |  
|Selling, General and Administrative Expense                                                                               |  | 17.3  |    |  | 7.0   |    |  | 6.2   |  
|Income (Loss) from operations                                                                                             |  | (30.0 | )  |  | (3.3  | )  |  | 3.8   |  
|Investment and Interest Income, net                                                                                       |  | 1.5   |    |  | 0.5   |    |  | 0.3   |  
|Income (Loss) from continuing operations Before Provision for Income Taxes and Income (Loss) from discontinued operations |  | (28.5 | )  |  | (2.8  | )  |  | 4.1   |  
|Provision for Income Taxes                                                                                                |  |      |    |  |      |    |  |      |  
|Income (Loss) from continuing operations                                                                                  |  | (28.5 | )  |  | (2.8  | )  |  | 4.1   |  
|Income (Loss) from discontinued operations                                                                                |  | (0.6  | )  |  | 0.2   |    |  | (1.0  | )
|Net Income (Loss)                                                                                                         |  | (29.1 | )% |  | (2.6  | )% |  | 3.1   | %



During the fourth
quarter of fiscal 2003, we adopted a formal plan to dispose of our Gunn consulting operations. Accordingly, assets and liabilities of the Gunn consulting operation have been segregated and classified as held for sale and the operating results and
cash flows have been presented as discontinued operations for all periods presented. As a result, revenue derived from our business process management clients represent 100% of our continuing operating revenues in all fiscal years presented. For
further details of our discontinued operations, see Note 14 of our Notes to Consolidated Financial Statements included under Part II Item 8. Financial Statements and Supplementary Data.



We have adopted EITF Issue 00-21, Revenue Arrangements with Multiple
Deliverables, for transactions entered into after June 30, 2003. The impact of adopting EITF Issue 00-21 was not material to our financial statements.



Years Ended December 31, 2003 and 2002



Revenue.Revenue for the years ended December 31, 2003 and 2002 was $480.3 million and $405.8 million, respectively. For the year ended
December 31, 2003, three business process management clients accounted for 48%, 18% and 15%, respectively, of revenue as compared to three business process management clients accounting for 48%, 26% and 16%, respectively, of revenue for the year
ended December 31, 2002. No other client accounted for more than 10% of revenue in the 2003 and 2002 periods. Furthermore, for the years ended December 31, 2003 and 2002, 29% and 26%, respectively, of our business 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. Client usage of our staffing and learning services varies, and can decrease, and we
anticipate a reversal in 2004 of the increased staffing volumes that we experienced at certain clients in 2003. The level of activity in our staffing services is sensitive to economic conditions and may be less in demand if interest rates increase
or other economic conditions change. As described above, revenue from the highly variable volume services is recognized as the services are performed and is excluded from our contract estimates. The increase in the percentage of revenue generated
from the provision of these highly variable volume services primarily resulted from increased usage of these services under our client contracts executed prior to 2003 and was not materially impacted by the transition of service responsibility to us
under the business process management contracts executed in 2003 or the June 2003 acquisition of certain business process management contracts from PwC.



The $74.5 million revenue increase in the 2003 period as compared to the 2002 period resulted from a $41.1 million net increase in combined revenue from
our business process management contracts with Bank of America Corporation, BP p.l.c., International Paper Company, Pactiv Corporation, Prudential Financial and Unisys Corporation which were the only business process management contracts common to
both periods (Common Contracts Base); and $35.8 million from business process management contracts signed with new clients during 2003 and from certain smaller business process management contracts acquired in June 2003. Offsetting the
increase to our revenue was a $2.4 million revenue reduction as a result of the completion of one of our business process management contracts during the fourth quarter of 2002. The net increase in revenue from the clients in the Common Contracts
Base consisted of a $34.5 million increase in the provision of services with highly variable volumes together with a $15.7 million increase in project revenue partially offset by a $9.1 million decrease primarily driven by negotiated cost reductions
for certain services provided by third-party vendors. As third-party vendor costs decrease, our life-of-contract revenue decreases to the extent these costs were recoverable from the client. However, our life-of-contract margins tend to improve as a
result of the reduced costs and revenue over the remaining term of the contract and the margins are further enhanced to the extent we share in the savings from



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these cost reductions achieved in the provision of these services to our clients. Included in the Common Contracts Base revenue and operating income, for the
years ended December 31, 2003 and 2002, were $24.7 million and $13.4 million, respectively, reflecting the cumulative impact of the change in estimates in each period arising from our updated life-of-contract estimates. These cumulative adjustments
include application of our current contract estimates to inception-to-date contract costs incurred as of the beginning of the period for each contract that has reached operational stability to appropriately reflect the inception-to-date contract
profits based upon our revised margin estimates and should not be considered indicative of future results. As of December 31, 2003, none of the contracts that were entered into during 2003 were deemed to have achieved operational stability. Revenue
growth in 2004 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 years ended December 31, 2003 and 2002 was $432.6 million and $391.0 million, respectively.
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 in connection with our business process management contracts, and expenses associated with third-party vendors who provide services on our behalf for our clients within the scope of our business process management
contracts. Prior to January 1, 2003, depreciation and amortization expense had been set forth as a separate line item in our Consolidated Statements of Operations. Commencing January 1, 2003, depreciation and amortization expense is included in cost
of revenue and selling, general and administrative expense and, accordingly, the consolidated financial statements for the year ended December 31, 2002 have been reclassified to conform to the 2003 presentation. Depreciation and amortization expense
included in cost of revenue for the years ended December 31, 2003 and 2002 was $22.4 million and $14.6 million, respectively. The increase in the cost of revenue for the year ended December 31, 2003 as compared to the year ended December 31, 2002
principally resulted from the progressive transition of service responsibility to Exult under our various business process management contracts, the June 2003 acquisition of certain business process management contracts and the continuing expansion
of our infrastructure and service capacity.



Our gross profit
increased $32.9 million to $47.7 million, or 10.0% of revenue, for the year ended December 31, 2003 from $14.8 million, or 3.7% of revenue, for the year ended December 31, 2002. The gross profit from our Common Contract Base improved to $64.2
million, or 14.4% of Common Contract Base revenue, in the 2003 period from $24.1 million, or 6.0% of Common Contract Base revenue, in the 2002 period. Offsetting the gross margin improvement from the Common Contract Base was the impact of $5.8
million of start-up costs incurred and charged to expense during the 2003 period from our newly-opened India client service center; a reduction in gross profit of $1.1 million from the completion of a business process management contract in December
2002 and the combination of a net gross loss from the contracts acquired in June 2003 and the business process management contracts signed during 2003, and an increase of $0.3 million in our currently unutilized capacity as we expand our
Multi-Process OutsourcingSMcapabilities. The gross loss from the combination of contracts acquired in June 2003 and
the business process management contracts signed during 2003 arises primarily from certain transition costs incurred during the period in connection therewith and we expect all of these contracts to be profitable over the respective life of each
contract.



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 years ended December 31, 2003 and 2002 was
$29.2 million, or 6.1% of revenue, and 28.6 million, or 7.0% 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. After reclassifying the 2002 period consolidated financial statements to conform with the 2003 presentation as discussed
above, included in selling, general and administrative expense for the years ended December 31, 2003 and 2002, was $2.2 million and $3.9 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 $16.3 million; the cash portion of these 2001 charges was expected to total $13.3 million. Through December 31, 2003, we have made cash payments totaling $10.2 million and reduced the initial accrual, and
accordingly selling, general and administrative expense, by $0.2 million and $2.3 million during the years ended December 31, 2003 and 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. Excluding the impact of reduction in the initial accrual for business optimization costs, selling, general and administrative expense for the years ended December 31, 2003
and 2002 was $29.5 million, or 6.1% of revenue, and $30.9 million, or 7.6% of revenue, respectively. The reduction in selling, general and administrative expense exclusive of the impact of business optimization costs in the 2003 period compared to
the 2002 period was



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primarily the result of $1.4 million of additional compensation paid to a senior executive in the 2002 period. Future 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 years ended December 31, 2003 and 2002 consisted of
investment and interest income of $2.9 million and $3.3 million, respectively, partially offset by interest expense of $1.9 million and $1.1 million, respectively. Investment and interest income is generated primarily from short-term investing of
cash in excess of current requirements. During the years ended December 31, 2003 and 2002, we realized $0.7 million and $0.1 million in net gains from sales of short-term investments. Excluding the net gain, investment and interest income in the
2003 period was reduced versus the 2002 period primarily by the lower rates of interest in the market and also by the lower average available cash balances in the 2003 period. Interest expense is associated with certain long-term obligations in both
periods. In September and October 2003, we issued $110.0 million principal amount of our 2.50% Convertible Senior Notes due October 1, 2010 at 97% of the principal amount thereof. The discounts and offering costs totaling approximately $3.4 million
are being accreted over the remaining term of the notes to their stated maturity using the effective interest method. Accordingly, subject to reduction as a result of any conversion or redemptions of the notes, our interest expense will increase by
accretion of the related discounts and offering costs plus coupon payments of approximately $2.8 million per year. Included in interest expense for the 2003 period is the interest cost associated with the notes for the period commencing from the
issuance of the notes to December 31, 2003.



Provision
for Income Taxes. We incurred losses from our founding in 1998 through September 30, 2002, resulting in federal, state and foreign net operating loss carryforwards. We achieved our first profitable quarter for the fourth quarter of 2002 and
our profitability continued throughout 2003. Our 2003 net income resulted in the creation of additional deferred tax liabilities, which will allow us to recognize in the future the benefit of certain deferred tax assets. Accordingly, we reduced our
valuation allowance on our deferred net tax assets during the year ended December 31, 2003, to the extent the newly generated deferred tax liabilities will allow recovery of certain deferred tax assets. Therefore, no net tax provision was recorded
for the year ended December 31, 2003. Although the fourth quarter of 2002 was profitable, we incurred a net loss for the entire year ended December 31, 2002. Accordingly, no provision for income taxes was recorded for the 2002 period. As of December
31, 2003, the remaining federal and state net operating loss carryforwards expire beginning in 2019 and 2007, respectively. The foreign net operating loss may be carried forward 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. Upon utilization or expiration of the underlying net operating loss carryforwards, or elimination of the valuation allowance, we will
begin to record income tax expense and commensurately lower net income for future periods in which we are profitable.



Net Income (Loss). The foregoing resulted in net income from continuing operations for the year ended December 31, 2003, of $19.6 million,
or $0.18 per basic share and $0.17 per diluted share, compared to a net loss for the year ended December 31, 2002, of $11.6 million, or $0.11 per basic and diluted share.



Years Ended December 31, 2002 and 2001



Revenue.Revenue for the years ended December 31, 2002 and 2001, was $405.8 million and $257.0 million, respectively. The revenue increase
for the 2002 period as compared to the 2001 period principally resulted from the progressive transition of service responsibility to us under five process management contracts that were executed at various dates from December 1999 through November
2000, together with two scope expansion amendments for an existing client that were executed during 2001 plus the addition of two new process management clients in October 2001 and January 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. This resulted in a change in estimate for our contracts and
recognition of $13.4 million of additional outsourcing revenue and operating income for the year ended December 31, 2002 for those contracts. A portion of this amount would previously have been recognized as revenue under those contracts if revenue
for prior periods had not been limited to amounts billed, and a portion of this amount would not have been recognized until billed in future periods if revenue had continued to be limited to amounts billed under those contracts. As of December 31,
2002, all of our then existing long-term outsourcing contracts had reached operational stability.



For the year ended December 31, 2002, three process management clients accounted for 48%, 26% and 16%, respectively, of revenue as compared to two process
management clients accounting for 46% and 44%, respectively, of revenue for the year ended December 31, 2001. No other client accounted for more than 10% of revenue in the 2001 and 2002 periods. For the years ended December 31, 2002 and 2001, 26%
and 22%, 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. As described above, revenue from
these services is excluded from our contract estimates.



Cost of Revenue.Our cost of revenue for the years ended December 31, 2002 and 2001, was $391.0 million and $289.4 million, respectively, and our gross margin (loss) for the same periods was 3.7% and (12.7)%, respectively, of
revenue. After reclassifying the 2002 and 2001 consolidated financial statements to conform with the 2003 presentation as discussed above, included in cost of



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##### Table of Contents

revenue for the years ended December 31, 2002 and 2001, was $14.6 million and $6.0 million, respectively, of depreciation and amortization expense. The
increase in the cost of revenue for the year ended December 31, 2002 as compared to the year ended December 31, 2001 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 2002 period as compared to the 2001 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 Multi-Process OutsourcingSMoperating platform.



Selling, General and Administrative Expense. Selling, general and administrative expense for the years ended December 31, 2002 and 2001, was
$28.6 million, or 7.0% of revenue, and $44.2 million, or 17.2% of revenue, respectively. After reclassifying the 2002 and 2001 financial statements to conform with the 2003 presentation as discussed above, included in selling, general and
administrative expense for the years ended December 31, 2002 and 2001, was $3.9 million and $6.5 million, respectively, of depreciation and amortization expense. In addition, for the year ended December 31, 2001, selling, general and administrative
expense included $16.3 million of business optimization costs as discussed above. There were no similar charges for the year ended December 31, 2002; however, we reduced the initial accrual, and accordingly selling, general and administrative
expense, by $2.3 million during the year ended December 31, 2002, 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
business optimization costs, selling, general and administrative expense for the year ended December 31, 2002 and 2001 was $30.9 million, or 7.6% of revenue, and $27.9 million, or 10.9% of revenue, respectively. Exclusive of business optimization
costs, the increase in selling, general and administrative expense for the year ended December 31, 2002 as compared to the year ended December 31, 2001, primarily resulted from increased compensation expense, while the decrease in the expense as a
percentage of revenue resulted primarily from the rate of revenue growth experienced in the 2002 period.



Investment and Interest Income, net. Investment and interest income, net for the years ended December 31, 2002 and 2001 consisted of
investment and interest income of $3.3 million and $4.5 million, respectively, partially offset by interest expense of $1.1 million and $0.7 million, respectively. Investment and interest income is generated primarily from short-term investing of
cash in excess of current requirements. While the Company generally had greater available cash balances during the 2002 period as compared to the 2001 period, investment and interest income, net in the 2002 period decreased as compared to the 2001
period principally as a result of lower interest rates in the 2002 period. Interest expense is associated with certain long-term obligations in both periods and for the 2001 period debt incurred to purchase the Gunn Partners, Inc. assets in November
1999.



Income Taxes. We incurred losses from our
founding in 1998 through September 30, 2002, resulting in federal, state and foreign net operating loss carryforwards. 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 and, accordingly, no benefit from income taxes was recorded in either period.



Net Loss. The foregoing resulted in a net loss from continuing operations for the years ended December 31, 2002 and 2001, of $11.6 million,
or $0.11 per basic and diluted share, and $72.8 million, or $0.75 per basic and diluted share, respectively.



Discontinued Operations



In the fourth quarter of fiscal 2003, we determined that our Gunn consulting operations no longer fit our strategic operating objectives and accordingly adopted a formal plan to dispose of these operations within the next twelve-month
period. Accordingly, the operating results of the operations have been classified as discontinued operations for all periods presented.



For the years ended December 31, 2003, 2002 and 2001, the Gunn consulting operation generated revenue of $6.5 million, $14.6 million and $15.5 million,
respectively, resulting in net income (loss) of $(4.6) million, $0.9 million and $(1.9) million, or (1.0)%, 0.2% and (0.1)% of consolidated revenue from continuing operations, respectively. The loss from discontinued operations for the year ended
December 31, 2003 included an impairment charge of approximately $3.3 million of goodwill as a result of managements decision to dispose of certain assets and reduce the carrying value of the assets of the operation to its estimated fair value
less estimated selling costs. Such impairment charges were recorded in accordance with the provisions of SFAS 144. As of December 31, 2003, subsequent to the write-offs, the net carrying value of the remaining assets in the consulting operation was
approximately $100,000 and represents the net realizable value. This amount was classified as assets held for sale in the accompanying consolidated balance sheet as of December 31, 2003. For the year ended December 31, 2001, the $(1.9) million net
loss includes an approximate $2.2 million non-cash charge arising from the write-off of a Gunn research database, which was determined to no longer have value.



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Liquidity and Capital Resources



Since our inception in October 1998 through December 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, the net proceeds from our September 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, the exercise of stock options and warrants and participation in our employee stock purchase plan. In addition, we also raised net proceeds of $106.6 million from the sale of
convertible senior notes during September and October 2003.



During the year ended December 31, 2001, we began generating revenue from our fourth and fifth process management clients, Unisys Corporation and Bank of America Corporation, respectively, and during the year ended December 31, 2002, we
began generating revenue from our sixth and seventh process management clients, International Paper Company and Prudential Financial, respectively. We also opened our third and fourth primary client service center in January 2001 and January 2002,
respectively. By December 31, 2002, all of our then existing process management contracts had reached operational stability and we had substantially completed transition activities with respect thereto. During the year ended December 31, 2003, we
began generating revenue from several new process management clients, including BMO Financial Group, Universal Music Group, Vivendi Universal Entertainment, McKesson Corporation and Circuit City Stores, Inc., none of which had reached operational
stability as of December 31, 2003. We also began operating client service centers in Canada and India. In addition, in June 2003, we acquired several smaller business process management contracts along with two additional client service centers in
Brazil and the United Kingdom, and operating presences in continental Europe, Hong Kong and Singapore. During the years ended December 31, 2002 and 2001, we expended operating cash in support of revenue generated by our process management contracts
and to fund the transition and transformation costs associated with our new process management contracts. We also used cash during both periods to pursue additional business opportunities and the development of our corporate infrastructure.



Operating Activities of Continuing Operations



Net cash provided by operating activities for the year
ended December 31, 2003, was $23.2 million as compared to net cash used in operating activities of $5.5 million and $35.0 million for the years ended December 31, 2002 and 2001, respectively. The improvement in net cash provided by operating
activities in the 2003 period as compared to the 2002 and 2001 periods principally results from the attainment of operational stability for all of our then existing contracts by the end of 2002 in conjunction with improved efficiency in, and
leverage of, our service delivery model, resulting in net income from continuing operations of $19.6 million in the 2003 period as compared to net losses of $11.6 million and $75.0 million in the 2002 and 2001 periods, respectively. The net losses
incurred in the 2002 and 2001 periods included non-cash charges of $1.4 million and $5.2 million, respectively, from the issuance of certain warrants and options during the 2001 period as well as the write off of certain asset values in both
periods. The increase in cash provided by operating activities in the 2003 period as compared to the 2002 and 2001 periods was also due, in part, to net realized gains on sales of short-term investments, net of interest accretion of approximately
$0.5 million in the 2003 period. During 2001, accounts payable and accrued liabilities and other increased by $29.1 million, further contributing to cash flow from operating activities. Partially offsetting these sources of cash provided by
operating activities were increases in accounts receivable, net and prepaid expenses and other current assets of $25.4 million, $12.1 million and $10.4 million for the years ended December 31, 2003, 2002 and 2001, respectively, as well as a net
decrease in accounts payable and accrued liabilities and other of $0.9 million and $6.4 million, respectively, in the 2003 and 2002 periods.



Investing Activities of Continuing Operations



Net cash used in investing activities for the years ended December 31, 2003, 2002 and 2001, was $40.5 million, $99.4 million and $42.3 million,
respectively. The decrease in cash used in investing activities in the 2003 period as compared to the 2002 period and the increase in the 2002 period as compared to the 2001 period arises primarily from the impact of investments of our available
cash. Prior to December 2001, we invested substantially all of our available cash in highly liquid temporary cash investments with initial maturities of 90 days or less which we classify as cash equivalents. Commencing in December 2001, in order to
enhance our investment yield, we began to invest a portion of our available cash in financial instruments with maturity dates in excess of 90 days, which we classify as short-term investments. 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 and represent net cash provided by investing
activities of $22.6 million for the year ended December 31, 2003, as compared to net cash used in investing activities of $62.1 million and $20.2 million for the years ended December 31, 2002 and 2001, respectively. For all three periods, cash used
in investing activities was used primarily to construct and expand our client service centers and our internal systems in support of our growing business, to make payments with respect to new client contracts or expansion of existing contracts and
to fund client set up costs. In addition during 2003 as discussed above, we expended $16.6 million (net of cash acquired of $2.7 million) to purchase several smaller business process management contracts.



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Financing Activities of Continuing Operations



We generated $107.3 million, $3.3 million and $127.0 million in cash, net
from financing activities during the years ended December 31, 2003, 2002 and 2001, respectively. We generated net proceeds of $106.6 million from the sale of our 2.5% convertible senior notes during the 2003 period and $103.8 million from the August
2001 public offering of our common stock subsequent to our initial public offering in June 2000. There were no similar transactions in the 2002 period. Also during 2001, we raised $26.0 million in cash from the sales of our common stock to two
vendors in private placement transactions. We generated cash of $3.8 million, $2.0 million and $6.0 million for the years ended December 31, 2003, 2002 and 2001, respectively, from the exercise of stock options in all three years and purchases under
our employee stock purchase plan in the 2003 and 2002 periods, as well as $1.3 million during 2002 from the issuance of long-term obligations for cash. Partially offsetting the cash generated by these activities were payments we made of $3.0
million, $1.1 million and $5.3 million with respect to our long-term obligations during the years ended December 31, 2003, 2002 and 2001, respectively. The payments made in the 2001 period included the final $5.3 million installment payment for the
purchase of the Gunn Partners, Inc. business.



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
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 December 31, 2003, we had cash and short-term investments of $195.8 million. 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, expansion of our service capabilities, new client contracts with capital investment requirements, and 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.



Operating, Investing and Financing Activities of Discontinued Operations



In the fourth quarter of fiscal 2003, we determined that
our Gunn consulting operations no longer fit our strategic operating objectives and accordingly adopted a formal plan to dispose of these operations. Accordingly, the operating results and cash flows of the operations have been reclassified as
discontinued operations for all periods presented. During the year ended December 31, 2003, net cash provided by operating activities from discontinued operations was $789,000, net cash used by investing activities from discontinued operations was
$805,000, and net cash provided by financing activities from discontinued operations was $0.



Contractual Obligations and Commercial Commitments



We have the following contractual obligations and commercial commitments for the periods indicated (in thousands):



|                                      |  |                          |        |                          |   |                          |  |            |         |       |   |     |  |   |        
|------------------------------------- |  | ------------------------ | ------ | ------------------------ | - | ------------------------ |  | ---------- | ------- | ----- | - | --- |  | - | -------
|                                      |  | Jan 1, 2004 Dec 31, 2004 |        | Jan 1, 2005 Dec 31, 2007 |   | Jan 1, 2008 Dec 31, 2010 |  | Thereafter |         | Total
|Long-Term Debt Obligations(1)         |  | $                        | 2,841  |                          | $ | 12,935                   |  | $          | 106,762 |       | $ |    |  | $ | 122,538
|Operating Leases(2)                   |  |                          | 6,688  |                          |   | 15,291                   |  |            | 10,551  |       |   | 538 |  |   | 33,068 
|Unconditional Purchase Obligations(3) |  |                          | 1,013  |                          |   | 12,352                   |  |            |        |       |   |    |  |   | 13,365 
|                                      |  |                          |        |                          |   |                          |  |            |         |       |   |     |  |   |        
|Total                                 |  | $                        | 10,542 |                          | $ | 40,578                   |  | $          | 117,313 |       | $ | 538 |  | $ | 168,971
|                                      |  |                          |        |                          |   |                          |  |            |         |       |   |     |  |   |        



|(1) | In 2003, the Company sold $110.0 million principal amount of 2.50% Convertible Senior Notes (Notes) due October 1, 2010 at 97% of the principal amount
thereof. As of December 31, 2003, the outstanding balance of the Notes was $106.7 million. The Company has entered into long-term arrangements, including capital lease arrangements, in connection with the purchase of certain current assets and fixed
assets. For more information about the Companys Long-Term Debt Obligations, see note 7 to the consolidated financial statements.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Operating lease obligations represent estimated lease payments primarily related to the Companys domestic and international office spaces and various computer
and office equipment. For more information about the Companys operating lease obligations, see note 12 to the consolidated financial statements.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | The Company has entered into various purchase commitments with third parties for certain products and services in connection with the Companys process
management services. For more information, see note 12 to the consolidated financial statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Recent Accounting Pronouncements



In July 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 and supersedes EITF 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 94-3 relates to the timing of liability recognition. Under SFAS No. 146, a liability for a cost associated with an exit or disposal
activity is recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entitys commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. 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.



In November 2002, the FASB issued Interpretation (FIN) 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements in this interpretation are effective for
financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material impact on our financial position or results of operations.



In April 2003, the FASB issued SFAS No. 149 Amendment of Statement 133 on Derivative Instruments and Hedging
Activities (SFAS 149) was issued. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The accounting and reporting requirements will be effective for contracts entered into or modified after June 30,
2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on our financial position or results of operations.



In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial Instruments with characteristics of both
liabilities and equity (SFAS 150). This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. Some of the provisions of this Statement are consistent with the current
definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements. The remaining provisions of this Statement are consistent with the FASB proposal to revise that definition to encompass certain obligations that a
reporting entity can or must settle by issuing its own equity shares, depending on the nature of the relationship established between the holder and the issuer. While the FASB still plans to revise that definition through an amendment to Concepts
Statement 6, the FASB decided to defer issuing that amendment until it has concluded its deliberations on the next phase of this project. That next phase will deal with certain compound financial instruments including puttable shares, convertible
bonds, and dual-indexed financial instruments. SFAS 150 is effective for certain financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.
The adoption of SFAS No. 150 is not expected to have a material impact on our financial position or results of operations.



In January 2003, the FASB issued FASB Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN 46, as superseded by
FIN46R, discussed below, clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (variable interest entities). Variable interest entities within the scope of FIN 46 will
be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entitys expected losses, receives a majority of its expected
returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003. For variable interest created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual
period beginning after December 15, 2003. We are currently assessing the impact of adopting FIN 46. The effective date of the provisions of FIN 46 was subsequently deferred by FIN46R, as discussed below.



In December 2003, the FASB issued a revision to Interpretation No. 46
Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (FIN46R or the Interpretation). FIN46R clarifies the application of ARB No. 51 Consolidated Financial Statements to certain
entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN46R
requires the consolidation of these entities, known as variable interest entities, by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that will absorb a majority of the entitys expected losses or receive a
majority of the entitys expected residual returns, or both.



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Among other changes, FIN46R (a) clarified some requirements of the original FIN46 which had been issued
in January 2003, (b) eased some implementation problems and (c) added new exceptions. FIN46R deferred the effective date of the Interpretation for public companies to the end of the first reporting period after March 15, 2004 except that all public
companies must, at a minimum, apply the provisions of the Interpretation to all entities that were previously considered special purpose entities under the FASB literature prior to the issuance of FIN46R by the end of the first reporting
period ending after December 15, 2003. We do not anticipate that the adoption of FIN46 will have a material impact on our financial position, cash flows or results of operations



EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables, addresses the accounting, by a vendor such as
us, 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. We adopted EITF
Issue 00-21 for transactions entered into after June 30, 2003. The impact of adopting EITF Issue 00-21 was not material to our financial statements. We anticipate that, in the near-term, services and deliverables to be provided under new business
process management contracts will generally be similar in nature to services and deliverables provided in connection with our existing contracts. Our market and service offering is relatively new, and certain of our services have not been sold on a
stand alone basis either by us or our competitors. Therefore, we believe that there is not, and in the near-term will not be, sufficient evidence of fair value for certain elements of our contracts. We anticipate accounting for future
multiple-element contracts that share these characteristics as a single unit and in the same manner as we account for our existing multiple-element contracts as long as there continues to be a lack of fair value for certain elements of our contracts
and some portion of these elements remain undelivered until the completion of a contract.



On December 17, 2003, the Staff of the SEC issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which supersedes SAB 101, Revenue Recognition in Financial Statements. SAB 104s
primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. Additionally, SAB 104 rescinds the SECs Revenue Recognition in Financial Statements Frequently Asked Questions and Answers(the FAQ) issued with SAB 101 that had been codified in SEC Topic 13, Revenue
Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance
of SAB 104. We do not anticipate that the adoption of SAB 104 will materially affect our revenue recognition policies, nor our results of operations, financial position or cash flows.



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##### Table of Contents

PART IV



|Item 15. | EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
|-------- | ------------------------------------------------------------------------------



|(a) | The following documents are filed as part of this report:
|--- | ---------------------------------------------------------



| | 1. | Index to consolidated financial statements
| | -- | ------------------------------------------



|                                                      |  |     
|----------------------------------------------------- |  | ----
|                                                      |  | Page
|Report of KPMG LLP                                    |  | F-2 
|Report of Arthur Andersen LLP                         |  | F-3 
|Consolidated Balance Sheets                           |  | F-4 
|Consolidated Statements of Operations                 |  | F-5 
|Consolidated Statement of Comprehensive Income (Loss) |  | F-5 
|Consolidated Statements of Stockholders Equity       |  | F-6 
|Consolidated Statements of Cash Flows                 |  | F-7 
|Notes to Consolidated Financial Statements            |  | F-9 



| | 2. | Financial statement schedules
| | -- | -----------------------------



|                                                                        |  |                 
|----------------------------------------------------------------------- |  | ----------------
|                                                                        |  | Page            
|Reports of KPMG LLP and Arthur Andersen LLP on Supplemental Schedule    |  | See Exhibit 99.1
|Supplemental Schedule  Schedule II  Valuation and Qualifying Accounts |  | See Exhibit 99.2



| | 3. | Exhibits
| | -- | --------



See Item (c) below.



|(b) | Reports on Form 8-K.
|--- | --------------------



On October 23, 2003, the Registrant filed a Current Report on Form 8-K with the Securities and Exchange Commission, Current Report, furnishing a copy of
the Registrants press release announcing its earnings for the quarter ended September 30, 2003.



|(c) | Exhibits.
|--- | ---------



|           |  |                                                                                                                                                                                                                                                                                                                     
|---------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1(1)     |  | Asset Purchase Agreement by and among Exult, Inc., Gunn Partners, Inc., the shareholders of Gunn Partners, Inc. and Michael Gibson dated as of November 22, 1999                                                                                                                                                    
|           | 
|2.2(1)     |  | Asset Purchase Agreement dated as of December 20, 1999 among Pactiv Corporation, Pactiv Business Services, Inc. and Exult, Inc.                                                                                                                                                                                     
|           | 
|2.3(11)    |  | Sale and Purchase Agreement, among Exult, Inc., PwC BPO BV, PwC BPO (UK) Limited, PricewaterhouseCoopers (Resources), P.W. & Co., PricewaterhouseCoopers LLP (UK), PricewaterhouseCoopers
LLP (US), PricewaterhouseCoopers Accountants NV, and PricewaterhouseCoopers Belastingadviseurs NV dated as of June 9, 2003
|           | 
|3.1(1)     |  | Fourth Amended and Restated Certificate of Incorporation of Exult, Inc.                                                                                                                                                                                                                                             
|           | 
|3.2(1)     |  | Amended and Restated Bylaws of Exult, Inc.                                                                                                                                                                                                                                                                          
|           | 
|4.1(1)     |  | See Exhibits 3.1 and 3.2 for provisions of the Exult, Inc.s Certificate of Incorporation and Bylaws defining the rights of holders of Exult, Inc.s Common Stock                                                                                                                                                   
|           | 
|4.2(1)     |  | Specimen Common Stock certificate                                                                                                                                                                                                                                                                                   
|           | 
|4.3(1)     |  | Amended and Restated Registration Rights Agreement among Exult, Inc. and the Stockholders identified therein dated December 23, 1999                                                                                                                                                                                
|           | 
|4.4(1)     |  | Amendment No. 1 to Amended and Restated Registration Rights Agreement among Exult and the Stockholders identified therein dated February 10, 2000                                                                                                                                                                   
|           | 
|4.5(13)    |  | Indenture, dated as of September 30, 2003, by and between Exult, Inc. and Bank One Trust Company, N.A., as Trustee (including Form of 2.50% Convertible Senior Notes due October 1,
2010)                                                                                                                           
|           | 
|4.6(13)    |  | Registration Rights Agreement, dated as of September 30, 2003, between Exult, Inc. and Goldman, Sachs & Co., Banc of America Securities LLC, and Morgan Stanley & Co. Incorporated, as
Initial Purchasers                                                                                                           
|           | 
|10.1.1(1)* |  | Registrants 1999 Stock Option/Stock Issuance Plan                                                                                                                                                                                                                                                                  
|           | 
|10.1.2(1)* |  | Form of Notice of Grant of Stock Option                                                                                                                                                                                                                                                                             
|           | 
|10.1.3(1)* |  | Form of Stock Option Agreement                                                                                                                                                                                                                                                                                      
|           | 
|10.1.4(1)* |  | Form of Addendum to Stock Option Agreement                                                                                                                                                                                                                                                                          
|           | 
|10.1.5(1)* |  | Form of Stock Purchase Agreement                                                                                                                                                                                                                                                                                    



17



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|                |  |                                                                                                                                                                                            
|--------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                | 
|10.1.6(1)*      |  | Form of Addendum to Stock Purchase Agreement                                                                                                                                               
|                | 
|10.1.7(1)*      |  | Form of Stock Issuance Agreement                                                                                                                                                           
|                | 
|10.1.8(1)*      |  | Form of Addendum to Stock Issuance Agreement                                                                                                                                               
|                | 
|10.2.1(1)*      |  | Registrants 1999 Special Executive Stock Option/Stock Issuance Plan                                                                                                                       
|                | 
|10.2.2(1)*      |  | Form of Notice of Grant of Stock Option                                                                                                                                                    
|                | 
|10.2.3(1)*      |  | Form of Stock Option Agreement                                                                                                                                                             
|                | 
|10.2.4(1)*      |  | Form of Addendum to Stock Option Agreement                                                                                                                                                 
|                | 
|10.2.5(1)*      |  | Form of Stock Purchase Agreement                                                                                                                                                           
|                | 
|10.2.6(1)*      |  | Form of Addendum to Stock Purchase Agreement                                                                                                                                               
|                | 
|10.2.7(1)*      |  | Form of Stock Issuance Agreement                                                                                                                                                           
|                | 
|10.2.8(1)*      |  | Form of Addendum to Stock Issuance Agreement                                                                                                                                               
|                | 
|10.3(1)*        |  | Form of Directors and Officers Indemnification Agreement                                                                                                                                 
|                | 
|10.4(1)*        |  | Founder Stock Purchase Agreement by and among BPO-US, Inc., James Madden and General Atlantic Partners, LLC dated April 1, 1999                                                            
|                | 
|10.5.1(1)*      |  | Amended and Restated Registration Rights Agreement among Exult, Inc. and the Stockholders identified therein dated December 23, 1999                                                       
|                | 
|10.5.2(1)*      |  | Amendment No. 1 to Amended and Restated Registration Rights Agreement among Exult and the Stockholders identified therein dated February 10, 2000                                          
|                | 
|10.6.1(1)       |  | Lease Agreement Venture Technology Center VI Building, The Woodlands, Montgomery County, Texas between The Woodlands Corporation and Tenneco Business Services, Inc. dated August 15,
1995 
|                | 
|10.6.2(1)       |  | Assignment and Assumption of Lease between Pactiv Business Services, Inc. (formerly known as Tenneco Business services, Inc.) and Exult, Inc. dated January 1, 2000                        
|                | 
|10.7(1)        |  | Framework Agreement dated December 7, 1999 by and between the Company and BP Amoco, p.l.c.                                                                                                 
|                | 
|10.8(1)        |  | US Country Agreement dated December 7, 1999 by and between the Company and BP America, Inc.                                                                                                
|                | 
|10.9(1)        |  | UK Country Agreement dated December 7, 1999 by and between Exult Limited and BP International Limited                                                                                      
|                | 
|10.10(1)        |  | Lease among Scottish Mutual Assurance p.l.c. and Exult Limited and Exult, Inc.                                                                                                             
|                | 
|10.11(1)*       |  | Registrants 2000 Equity Incentive Plan                                                                                                                                                    
|                | 
|10.12 (1)*      |  | Loan Agreement dated May 30, 2000 by and between Exult, Inc. and Kevin Campbell                                                                                                            
|                | 
|10.13(2)       |  | Master Services Agreement by and between Exult, Inc. and Unisys Corporation dated August 28, 2000                                                                                          
|                | 
|10.14(3)*       |  | Employment Agreement, Severance Agreement, and Stock Option Addendum for James C. Madden, V                                                                                                
|                | 
|10.15(3)*       |  | Employment Agreement, Severance Agreement, and Stock Option Addendum for Stephen M. Unterberger                                                                                            
|                | 
|10.16(3)        |  | Office Lease between Temple Property Holdings Limited and Exult Limited dated June 13, 2000                                                                                                
|                | 
|10.17(3)        |  | Unit Purchase Agreement between Exult, Inc. and Bank of America Corporation dated October 12, 2000                                                                                         
|                | 
|10.18(3)        |  | Common Stock Warrant Issued to Bank of America October 12, 2000                                                                                                                            
|                | 
|10.19.1(3)     |  | Master Services Agreement between Exult, Inc. and Bank of America Corporation dated November 21, 2000                                                                                      
|                | 
|10.19.2(5)     |  | Amendment No. 1 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated as of March 15, 2001                                                                
|                | 
|10.19.3(5)     |  | Addendum 2 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated as of September 10, 2001                                                                 
|                | 
|10.19.4(9)     |  | Addendum 3 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated May 23, 2002                                                                             
|                | 
|10.19.5(9)     |  | Addendum 4 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated June 21, 2002                                                                            
|                | 
|10.19.6(9)     |  | Addendum 5 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated July 1, 2002                                                                             
|                | 
|10.19.7(10)   |  | Addendum 6 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated November 22, 2002                                                                        
|                | 
|10.19.8(10)    |  | Amendment 2 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated December 20, 2002                                                                       
|                | 
|10.19.9(12)     |  | Amendment 3 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated as of April 14, 2003                                                                    
|                | 
|10.19.10(12)   |  | Addendum 3A to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated as of June 2, 2003                                                                      
|                | 
|10.19.11(12)  |  | Addendum 7 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated as of April 25, 2003                                                                     
|                | 
|10.19.12      |  | Addendum 8 to Master Services Agreement between Exult, Inc. and Bank of America Corporation dated as of October 6, 2003 (previously filed as an exhibit to this Annual Report on Form
10-K)
|                | 
|10.20(3)       |  | Office Space Lease between Bank of America, National Association and Exult, Inc. dated November 21, 2000                                                                                   
|                | 
|10.21(4)       |  | Common Stock Purchase Agreement by and between Exult, Inc. and Automatic Data Processing, Inc. dated as of June 11, 2001                                                                   



18



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##### Table of Contents

|              |  |                                                                                                                                                                                                                                                                               
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|              | 
|10.22(6)     |  | Human Resources Services Agreement between Exult, Inc. and International Paper Company dated as of October 18, 2001                                                                                                                                                           
|              | 
|10.23(6)     |  | Systems Services Agreement between Exult, Inc. and International Paper Company dated as of October 18, 2001                                                                                                                                                                   
|              | 
|10.24(6)     |  | Technical Services Agreement between Exult, Inc. and International Paper Company dated as of October 18, 2001                                                                                                                                                                 
|              | 
|10.25(6)     |  | Sublease between Exult, Inc. and International Paper Company dated as of January 1, 2002                                                                                                                                                                                      
|              | 
|10.26(7)*     |  | Registrants 2000 Employee Stock Purchase Plan, amended and restated as of January 1, 2002                                                                                                                                                                                    
|              | 
|10.27.1(7)*   |  | Offer Letter for Richard Jones                                                                                                                                                                                                                                                
|              | 
|10.27.2(7)*   |  | Loan Agreement dated September 1, 2000 by and between Exult, Inc. and Richard Jones                                                                                                                                                                                           
|              | 
|10.27.3(7)*   |  | Bonus Letter dated September 1, 2000 by and between Exult, Inc. and Richard Jones                                                                                                                                                                                             
|              | 
|10.28(8)     |  | Services Agreement between Exult, Inc. and The Prudential Insurance Company of America dated as of January 11, 2002                                                                                                                                                           
|              | 
|10.28.1(13)  |  | Amendment No. 2 to Services Agreement between Exult and Prudential dated as of January 11, 2002                                                                                                                                                                               
|              | 
|10.28.2(13)  |  | Amendment No. 4 to Services Agreement between Exult and Prudential dated as of January 11, 2002                                                                                                                                                                               
|              | 
|10.28.3     |  | Amendment No. 5 to Services Agreement between Exult and Prudential dated as of January 11, 2002 (previously filed as an exhibit to this Annual Report on Form 10-K)                                                                                                           
|              | 
|10.28.4     |  | First Amendment to Services Agreement between Exult and Prudential dated as of January 11, 2002 (previously filed as an exhibit to this Annual Report on Form 10-K)                                                                                                           
|              | 
|10.28.5     |  | Amendment No. 6 to Services Agreement between Exult and Prudential dated as of January 11, 2002 (previously filed as an exhibit to this Annual Report on Form 10-K)                                                                                                           
|              | 
|10.29.1(10)*  |  | Amended and Restated Employment Agreement dated December 23, 2002 by and between Exult, Inc. and Kevin M. Campbell                                                                                                                                                            
|              | 
|10.29.2(10)*  |  | Amended and Restated Severance Agreement dated December 23, 2002 by and between Exult, Inc. and Kevin M. Campbell                                                                                                                                                             
|              | 
|10.29.3(10)*  |  | Amended and Restated Stock Option Addendum dated December 23, 2002 by and between Exult, Inc. and Kevin M. Campbell                                                                                                                                                           
|              | 
|10.29.4(10)*  |  | Employment Restructuring Agreement dated December 23, 2002 by and between Exult, Inc. and Kevin M. Campbell                                                                                                                                                                   
|              | 
|10.29.5(10)*  |  | Restricted Stock Agreement dated December 23, 2002 by and between Exult, Inc. and Kevin M. Campbell                                                                                                                                                                           
|              | 
|10.30.1*      |  | Executive Employment Agreement dated as of June 27, 2000, between Exult, Inc. and Michael J. Salvino (previously filed as an exhibit to this Annual Report on Form 10-K)                                                                                                      
|              | 
|10.30.2*      |  | Stock Option Addendum dated as of August 25, 2003, between Exult, Inc. and Michael J. Salvino (previously filed as an exhibit to this Annual Report on Form 10-K)                                                                                                             
|              | 
|10.31.1(12)*  |  | Employment Agreement dated as of June 2, 2003, between Exult, Inc. and John A. Adams                                                                                                                                                                                          
|              | 
|10.31.2(12)*  |  | Severance Agreement dated as of June 2, 2003, between Exult, Inc. and John A. Adams                                                                                                                                                                                           
|              | 
|10.31.3(12)*  |  | Stock Option Addendum dated as of June 2, 2003, between Exult, Inc. and John A. Adams                                                                                                                                                                                         
|              | 
|10.31.4(12)*  |  | Indemnification Agreement dated as of June 2, 2003, between Exult, Inc. and John A. Adams                                                                                                                                                                                     
|              | 
|10.31.5(12)*  |  | Restricted Stock Agreement dated as of June 2, 2003, between Exult, Inc. and John A. Adams                                                                                                                                                                                    
|              | 
|10.31.6(13)*  |  | Amendment No. 1 to Employment Agreement dated as of September 8, 2003, by and between John A. Adams and Exult, Inc.                                                                                                                                                           
|              | 
|10.32.1     |  | Amendment #1 to, and Restatement of, Master Services Agreement, Service Agreement Number 1, and Service Agreement Number 2, between Exult Canada, Inc. and Bank of Montreal, dated as of April
23, 2003 (previously filed as an exhibit to this Annual Report on Form 10-K)   
|              | 
|10.32.2(12)   |  | Common Stock Warrant issued to Bank of Montreal on April 23, 2003                                                                                                                                                                                                             
|              | 
|10.32.3(14) |  | Guaranty dated as of April 23, 2003 between Exult, Inc. and Bank of Montreal                                                                                                                                                                                                  
|              | 
|10.33(13)     |  | Purchase Agreement dated September 24, 2003, between Exult, Inc. and Goldman, Sachs & Co., Banc of America Securities LLC, and Morgan Stanley & Co. Incorporated, as Initial
Purchasers, related to issuance of Exult Inc.s 2.5% Convertible Senior Notes due October 1, 2010
|              | 
|21.1          |  | Subsidiaries of Exult, Inc. (previously filed as an exhibit to this Annual Report on Form 10-K)                                                                                                                                                                               
|              | 
|23.1          |  | Consents of KPMG LLP and Arthur Andersen LLP                                                                                                                                                                                                                                  
|              | 
|31.1          |  | Written statement of the Chief Executive Officer of Exult, Inc. pursuant to section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                     
|              | 
|31.2          |  | Written statement of the Chief Financial Officer of Exult, Inc. pursuant to section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                     
|              | 
|32            |  | 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                                                                                                                         
|              | 
|99.1          |  | Reports of KPMG LLP and Arthur Andersen LLP on Supplemental Schedule                                                                                                                                                                                                          
|              | 
|99.2          |  | Supplemental Schedule - Schedule II - Valuation and Qualifying Accounts (previously filed as an exhibit to this Annual Report on Form 10-K)                                                                                                                                   



19



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##### Table of Contents

|        |  |                                            
|------- |  | -------------------------------------------
|        | 
|99.3(7) |  | Letter to SEC Pursuant to Temporary Note 3T

---

|(1) | Previously filed with the Registrants Registration Statement on Form S-1, Registration Number 333-31754, and incorporated herein by reference.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Previously filed with the Registrants quarterly report on Form 10-Q for the quarter ended September 30, 2000 and incorporated herein by reference.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Previously filed with the Registrants annual report on Form 10-K for the year ended December 31, 2000 and incorporated herein by reference.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Previously filed with the Registrants quarterly report on Form 10-Q for the quarter ended June 30, 2001 and incorporated herein by reference.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Previously filed with the Registrants quarterly report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Previously filed with the Registrants current report on Form 8-K dated October 18, 2001 and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------------------------



|(7) | Previously filed with the Registrants annual report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------



|(8) | Previously filed with the Registrants quarterly report on Form 10-Q for the quarter ended March 31, 2002 and incorporated herein by reference.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------



|(9) | Previously filed with the Registrants quarterly report on Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | Previously filed with the Registrants annual report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------



|(11) | Previously filed with the Registrants current report on Form 8-K dated June 24, 2003 and incorporated herein by reference.
|---- | ---------------------------------------------------------------------------------------------------------------------------



|(12) | Previously filed with the Registrants quarterly report on Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------



|(13) | Previously filed with the Registrants quarterly report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------



|(14) | Filed as Exhibit U to Exhibit 10.32.1 to this Annual Report on Form 10-K.
|---- | -------------------------------------------------------------------------



| | Confidential treatment has been granted with respect to certain portions of this agreement. Such portions have been omitted from this filing and have been filed separately with the
Securities and Exchange Commission.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Confidential treatment is being sought with respect to certain portions of this agreement. Such portions have been omitted from this filing and have been filed separately
with the Securities and Exchange Commission.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|* | This exhibit is a management contract or a compensatory plan or arrangement.
|- | ----------------------------------------------------------------------------



|(d) | See item (a)(2) above.
|--- | ----------------------



20



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##### Table of Contents

SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment No. 1 to Annual Report on Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly authorized.



|                   |  |  |  |                          |  |                           |  |                                                                     
|------------------ |  |  |  | ------------------------ |  | ------------------------- |  | --------------------------------------------------------------------
|                   |  |  |  | EXULT, INC. (Registrant)
|                   |  |  | 
|Date: July 9, 2004 |  |  |  | By:                      |  | /s/    JAMES C. MADDEN,
V
|                   |  |  |  |                          |  |                           |  | James C. Madden, V Chief Executive Officer and Chairman of the Board



POWER OF ATTORNEY



KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below does hereby constitute and appoint James C. Madden, V, John A. Adams and Stephen M. Unterberger, and each of them, with full power of substitution and full power to act without the other, their true and lawful
attorney-in-fact and agent to act for them in their name, place and stead, in any and all capacities, to sign any and all amendments to this annual report on Form 10-K and to file such amendments with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in order
to effectuate the same as fully, to all intents and purposes, as they might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may lawfully do or cause to be done by virtue hereof.



Pursuant to the requirements of the Securities Exchange Act of
1934, this Amendment No. 1 to Annual Report on Form 10-K/A has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|                                            |  |                                                                                 |  |             
|------------------------------------------- |  | ------------------------------------------------------------------------------- |  | ------------
|Signature                                   |  | Title                                                                           |  | Date        
|                                            |  |                                                                                
|/s/    JAMES C. MADDEN,
VJames C. Madden, V |  | Chief Executive Officer and Chairman of the
Board (principal executive officer) |  | July 9, 2004
|                                            |  |                                                                                
|/s/    JOHN A.
ADAMSJohn A.
Adams           |  | Chief Financial Officer (principal financial and
accounting officer)            |  | July 9, 2004
|                                            |  |                                                                                
|/s/    J. MICHAEL
CLINEJ. Michael
Cline     |  | Director                                                                        |  | July 9, 2004
|                                            |  |                                                                                
|/s/    STEVEN A.
DENNINGSteven A.
Denning   |  | Director                                                                        |  | July 9, 2004
|                                            |  |                                                                                
|/s/    MARK F.
DZIALGAMark F.
Dzialga       |  | Director                                                                        |  | July 9, 2004
|                                            |  |                                                                                
|/s/    THOMAS J.
NEFFThomas J.
Neff         |  | Director                                                                        |  | July 9, 2004
|                                            |  |                                                                                
|/s/    JOHN R.
OLTMANJohn R.
Oltman         |  | Director                                                                        |  | July 9, 2004
|                                            |  |                                                                                
|/s/    MARY ALICE
TAYLORMary Alice
Taylor   |  | Director                                                                        |  | July 9, 2004



21



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##### Table of Contents

|                                                    |  |          |  |             
|--------------------------------------------------- |  | -------- |  | ------------
|                                                    |  |         
|/s/    KARL M. VON DER
HEYDENKarl M. von der
Heyden |  | Director |  | July 9, 2004



22



---

##### Table of Contents

I
NDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                      |  |     
|----------------------------------------------------- |  | ----
|                                                      |  | Page
|CONSOLIDATED FINANCIAL STATEMENTS                     |  |     
|Report of KPMG LLP                                    |  | F-2 
|Report of Arthur Andersen LLP                         |  | F-3 
|Consolidated Balance Sheets                           |  | F-4 
|Consolidated Statements of Operations                 |  | F-5 
|Consolidated Statement of Comprehensive Income (Loss) |  | F-5 
|Consolidated Statements of Stockholders Equity       |  | F-6 
|Consolidated Statements of Cash Flows                 |  | F-7 
|Notes to Consolidated Financial Statements            |  | F-8 



F-1



---

##### Table of Contents

REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To
the Board of Directors and Stockholders

Exult, Inc.:



We have audited the accompanying consolidated balance sheets of Exult, Inc. and subsidiaries as of December 31, 2002 and 2003, and the related
consolidated statements of operations, comprehensive income (loss), stockholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial statements based on our audits. The consolidated financial statements of Exult, Inc. and subsidiaries for the year ended December 31, 2001 were audited by other auditors who
have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements in their report dated January 23, 2002.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for
our opinion.



In our opinion, the 2002 and 2003 consolidated
financial statements referred to above present fairly, in all material respects, the financial position of Exult, Inc. and subsidiaries as of December 31, 2002 and 2003, and the results of their operations and their cash flows for the years then
ended, in conformity with accounting principles generally accepted in the United States of America.



As discussed above, the consolidated financial statements of Exult, Inc. and subsidiaries as December 31, 2001 and for the year then ended were audited by
other auditors who have ceased operations. As described in Note 3(b), the 2001 consolidated financial statements have been adjusted to present the Gunn consulting business as a discontinued operation. We audited the adjustments described in Note 3
that were applied to adjust the 2001 consolidated financial statements, as well as certain additional disclosures in the 2001 consolidated financial statements, as described in Note 3 and Note 6. In our opinion, such adjustments and disclosures are
appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2001 consolidated financial statements of Exult, Inc. and subsidiaries other than with respect to such adjustments and
disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole.



As described in Note 3(b), the 2001 consolidated financial statements have been restated to reclassify a non-cash charge of $2.2 million from selling,
general and administrative expense to discontinued operations.



/s/ KPMG LLP

Orange County, California

January 29, 2004, except

as to Note 3(b), which is as of July 9, 2004



F-2



---

##### Table of Contents

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



The following audit report of Arthur Andersen LLP is a copy of the original
report dated January 23, 2002 rendered by Arthur Andersen LLP on our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2001, and has not been reissued by Arthur Andersen LLP since that date.
We are including this copy of the Arthur Andersen LLP audit report pursuant to Rule 2-02(e) of Regulation S-X under the Securities Act of 1933. The Arthur Andersen LLP audit report refers to consolidated balance sheets of Exult, Inc. and
subsidiaries as of December 31, 2000 and 2001, and consolidated statements of operations, stockholders equity and cash flows for each of the years ended December 31, 1999 and 2000; pursuant to the rules of the Securities and Exchange
Commission, those financial statements were included in our Annual Report on Form 10-K for the year ended December 31, 2001, but are not included in this report.



To the stockholders of Exult, Inc.:



We have audited the accompanying consolidated balance sheet of Exult, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2000 and 2001, and
the related consolidated statements of operations, stockholders equity and cash flows for the years ended December 31, 1999, 2000 and 2001. These financial statements are the responsibility of the Companys management. Our responsibility
is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated
financial position of Exult, Inc. and subsidiaries as of December 31, 2000 and 2001, and the results of their operations and their cash flows for the years ended December 31, 1999, 2000 and 2001 in conformity with accounting principles generally
accepted in the United States.



/s/ Arthur Andersen LLP

ARTHUR ANDERSEN LLP

Orange County, California

January 23, 2002



F-3



---

##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS

(amounts in thousands except per share amounts)



|                                                                                                                                                       |  |              |          |   |      |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                       |  | December 31, |         
|                                                                                                                                                       |  | 2002         |          |   | 2003 |  
|ASSETS                                                                                                                                                 |  |              |          |   |      |   |          |  
|Current Assets:                                                                                                                                        |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                              |  | $            | 42,846   |   |      | $ | 135,026  |  
|Short-term investments                                                                                                                                 |  |              | 84,451   |   |      |   | 60,781   |  
|Accounts receivable, net                                                                                                                               |  |              | 28,587   |   |      |   | 58,720   |  
|Prepaid expenses and other current assets                                                                                                              |  |              | 27,105   |   |      |   | 26,973   |  
|Assets held for sale                                                                                                                                   |  |              |         |   |      |   | 100      |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total Current Assets                                                                                                                                   |  |              | 182,989  |   |      |   | 281,600  |  
|Fixed Assets and Direct Contract Costs, net                                                                                                            |  |              | 54,105   |   |      |   | 69,010   |  
|Intangible Assets, net                                                                                                                                 |  |              | 37,564   |   |      |   | 60,213   |  
|Other Assets, net                                                                                                                                      |  |              | 19,738   |   |      |   | 19,401   |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total Assets                                                                                                                                           |  | $            | 294,396  |   |      | $ | 430,224  |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                   |  |              |          |   |      |   |          |  
|Current Liabilities:                                                                                                                                   |  |              |          |   |      |   |          |  
|Accounts payable                                                                                                                                       |  | $            | 17,683   |   |      | $ | 24,331   |  
|Accrued liabilities and other                                                                                                                          |  |              | 31,759   |   |      |   | 32,154   |  
|Current portion of long-term liabilities                                                                                                               |  |              | 2,862    |   |      |   | 2,444    |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total Current Liabilities                                                                                                                              |  |              | 52,304   |   |      |   | 58,929   |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Convertible Senior Notes                                                                                                                               |  |              |         |   |      |   | 106,713  |  
|Other Long-Term Obligations, net of current portion                                                                                                    |  |              | 12,794   |   |      |   | 12,168   |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Long-Term Liabilities, net of current portion                                                                                                          |  |              | 12,794   |   |      |   | 118,881  |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Commitments and Contingencies (Note 12)                                                                                                                |  |              |          |   |      |   |          |  
|                                                                                                                                                       |  |             
|Stockholders Equity:                                                                                                                                  |  |              |          |   |      |   |          |  
|Preferred stock, $0.0001 par value; Authorized  15,000 shares; Issued and outstanding  none at December 31, 2002 and 2003,
respectively              |  |              |         |   |      |   |         |  
|Common stock, $0.0001 par value; Authorized  500,000 shares; Issued and outstanding  106,202 and 108,711 at December 31, 2002 and
2003, respectively |  |              | 11       |   |      |   | 11       |  
|Additional paid-in capital                                                                                                                             |  |              | 424,505  |   |      |   | 430,583  |  
|Deferred compensation                                                                                                                                  |  |              | (1,928   | ) |      |   | (1,789   | )
|Accumulated other comprehensive income                                                                                                                 |  |              |          |   |      |   |          |  
|Cumulative translation adjustments                                                                                                                     |  |              | 1,285    |   |      |   | 4,018    |  
|Unrealized gain on investments                                                                                                                         |  |              | 891      |   |      |   | 99       |  
|Accumulated deficit                                                                                                                                    |  |              | (195,466 | ) |      |   | (180,508 | )
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total Stockholders Equity                                                                                                                             |  |              | 229,298  |   |      |   | 252,414  |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total Liabilities and Stockholders Equity                                                                                                             |  | $            | 294,396  |   |      | $ | 430,224  |  
|                                                                                                                                                       |  |              |          |   |      |   |          |  



See accompanying notes
to consolidated financial statements.



F-4



---

##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in thousands except per share amounts)



|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                              |  | Year Ended December 31, |        
|                                                                              |  | 2001                    |         |   | 2002 |   |         | 2003 | 
|Revenue                                                                       |  | $                       | 257,052 |   |      | $ | 405,842 |      |  | $ | 480,322 |  
|Cost of Revenue                                                               |  |                         | 289,400 |   |      |   | 391,017 |      |  |   | 432,590 |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Gross Profit (Loss)                                                           |  |                         | (32,348 | ) |      |   | 14,825  |      |  |   | 47,732  |  
|Selling, General and Administrative Expense                                   |  |                         | 44,270  |   |      |   | 28,610  |      |  |   | 29,249  |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (Loss) from Operations                                                 |  |                         | (76,618 | ) |      |   | (13,785 | )    |  |   | 18,483  |  
|Investment and Interest Income, net                                           |  |                         | 3,794   |   |      |   | 2,213   |      |  |   | 1,077   |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (Loss) from Continuing Operations before Provision for Income Taxes    |  |                         | (72,824 | ) |      |   | (11,572 | )    |  |   | 19,560  |  
|Provision for Income Taxes                                                    |  |                         |        |   |      |   |        |      |  |   |        |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (Loss) from Continuing Operations                                      |  |                         | (72,824 | ) |      |   | (11,572 | )    |  |   | 19,560  |  
|Income (Loss) from Discontinued Operations, net of Provision for Income Taxes |  |                         | (1,827  | ) |      |   | 973     |      |  |   | (4,602  | )
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Net Income (Loss)                                                             |  | $                       | (74,651 | ) |      | $ | (10,599 | )    |  | $ | 14,958  |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Net Income (Loss) per Common Share - Basic                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (Loss) from Continuing Operations                                      |  | $                       | (0.75   | ) |      | $ | (0.11   | )    |  | $ | 0.18    |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (Loss) from Discontinued Operations                                    |  | $                       | (0.02   | ) |      | $ | 0.01    |      |  | $ | (0.04   | )
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Net Income (Loss)                                                             |  | $                       | (0.77   | ) |      | $ | (0.10   | )    |  | $ | 0.14    |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Net Income (Loss) per Common Share - Diluted                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (Loss) from Continuing Operations                                      |  | $                       | (0.75   | ) |      | $ | (0.11   | )    |  | $ | 0.17    |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (Loss) from Discontinued Operations                                    |  | $                       | (0.02   | ) |      | $ | 0.01    |      |  | $ | (0.04   | )
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Net Income (Loss)                                                             |  | $                       | (0.77   | ) |      | $ | (0.10   | )    |  | $ | 0.13    |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Weighted Average Number of Common Shares Outstanding:                         |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic                                                                         |  |                         | 96,622  |   |      |   | 105,199 |      |  |   | 106,870 |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Diluted                                                                       |  |                         | 96,622  |   |      |   | 105,199 |      |  |   | 115,460 |  
|                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  



EXULT, INC. AND
SUBSIDIARIES



CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)

(amounts in thousands)



|                                         |  |                         |         |   |      |   |        |  
|---------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------ | -
|                                         |  | Year Ended December 31, |        
|                                         |  | 2002                    |         |   | 2003 |  
|Net Income (Loss)                        |  | $                       | (10,599 | ) |      | $ | 14,958 |  
|                                         |  |                         |         |   |      |   |        |  
|Other Comprehensive Income (Loss):       |  |                         |         |   |      |   |        |  
|Foreign currency translation adjustments |  |                         | 1,410   |   |      |   | 2,733  |  
|Unrealized gain (loss) on investments    |  |                         | 891     |   |      |   | (792   | )
|                                         |  |                         |         |   |      |   |        |  
|Total other comprehensive income (loss)  |  |                         | 2,301   |   |      |   | 1,941  |  
|                                         |  |                         |         |   |      |   |        |  
|Net Comprehensive Income (Loss)          |  | $                       | (8,298  | ) |      | $ | 16,899 |  
|                                         |  |                         |         |   |      |   |        |  



See accompanying notes
to consolidated financial statements.



F-5



---

##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

(amounts in thousands)



|                                                                                      |  |                             |  |              |   |        |         |     |                                        |                            |  |                       |         |  |                                    |        |   |                                |   |       |         |  |   |                      |   |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | --------------------------- |  | ------------ | - | ------ | ------- | --- | -------------------------------------- | -------------------------- |  | --------------------- | ------- |  | ---------------------------------- | ------ | - | ------------------------------ | - | ----- | ------- |  | - | -------------------- | - |  | - | -------- | - |  | - | ------- | -
|                                                                                      |  | Convertible Preferred Stock |  | Common Stock |   |        |         |     | Accumulated Other Comprehensive Income |                            |  |                       |         |  |                                    |       
|                                                                                      |  | Shares                      |  | Amount       |   | Shares |         | Par |                                        | Additional Paid-in Capital |  | Deferred Compensation |         |  | Cumulative Translation Adjustments |        |   | Unrealized Gain on Investments |   |       | Deficit |  |   | Stockholders Equity |  
|BALANCE, January 1, 2001                                                              |  |                            |  | $            |  |        | 90,956  |     | $                                      | 9                          |  | $                     | 284,393 |  | $                                  | (2,757 | ) |                                | $ |      |         |  | $ |                     |   |  | $ | (110,216 | ) |  | $ | 171,429 |  
|Issuance of common stock in public offering                                           |  |                            |  |              |  |        | 8,000   |     |                                        | 1                          |  |                       | 100,317 |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 100,318 |  
|Issuance of common stock for cash                                                     |  |                            |  |              |  |        | 2,068   |     |                                        |                           |  |                       | 26,000  |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 26,000  |  
|Exercise of stock options and warrants                                                |  |                            |  |              |  |        | 3,048   |     |                                        |                           |  |                       | 5,472   |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 5,472   |  
|Employee stock plan purchases                                                         |  |                            |  |              |  |        | 123     |     |                                        |                           |  |                       | 1,080   |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 1,080   |  
|Issuance of stock options for services                                                |  |                            |  |              |  |        |        |     |                                        |                           |  |                       | 36      |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 36      |  
|Accelerated vesting of stock options net of related unamortized deferred compensation |  |                            |  |              |  |        |        |     |                                        |                           |  |                       | 2,516   |  |                                    | 524    |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 3,040   |  
|Amortization of deferred compensation                                                 |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    | 1,035  |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 1,035   |  
|Cumulative translation adjustments                                                    |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   | (125  | )       |  |   |                     |   |  |   |         |   |  |   | (125    | )
|Net loss                                                                              |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   | (74,651  | ) |  |   | (74,651 | )
|                                                                                      |  |                             |  |              |   |        |         |     |                                        |                            |  |                       |         |  |                                    |        |   |                                |   |       |         |  |   |                      |   |  |   |          |   |  |   |         |  
|BALANCE, December 31, 2001                                                            |  |                            |  |              |  |        | 104,195 |     |                                        | 10                         |  |                       | 419,814 |  |                                    | (1,198 | ) |                                |   | (125  | )       |  |   |                     |   |  |   | (184,867 | ) |  |   | 233,634 |  
|Exercise of stock options                                                             |  |                            |  |              |  |        | 1,246   |     |                                        | 1                          |  |                       | 1,987   |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 1,988   |  
|Employee stock plan purchases                                                         |  |                            |  |              |  |        | 211     |     |                                        |                           |  |                       | 806     |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 806     |  
|Accelerated vesting of stock options net of related unamortized deferred compensation |  |                            |  |              |  |        |        |     |                                        |                           |  |                       | 258     |  |                                    | 67     |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 325     |  
|Issuance of restricted stock                                                          |  |                            |  |              |  |        | 550     |     |                                        |                           |  |                       | 1,640   |  |                                    | (1,640 | ) |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   |        |  
|Amortization of deferred compensation                                                 |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    | 843    |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 843     |  
|Cumulative translation adjustments                                                    |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   | 1,410 |         |  |   |                     |   |  |   |         |   |  |   | 1,410   |  
|Change in unrealized gain on investments                                              |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   |      |         |  |   | 891                  |   |  |   |         |   |  |   | 891     |  
|Net loss                                                                              |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   | (10,599  | ) |  |   | (10,599 | )
|                                                                                      |  |                             |  |              |   |        |         |     |                                        |                            |  |                       |         |  |                                    |        |   |                                |   |       |         |  |   |                      |   |  |   |          |   |  |   |         |  
|BALANCE, December 31, 2002                                                            |  |                            |  |              |  |        | 106,202 |     |                                        | 11                         |  |                       | 424,505 |  |                                    | (1,928 | ) |                                |   | 1,285 |         |  |   | 891                  |   |  |   | (195,466 | ) |  |   | 229,298 |  
|Exercise of stock options                                                             |  |                            |  |              |  |        | 2,210   |     |                                        |                           |  |                       | 3,146   |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 3,146   |  
|Employee stock plan purchases                                                         |  |                            |  |              |  |        | 149     |     |                                        |                           |  |                       | 637     |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 637     |  
|Issuance of restricted stock                                                          |  |                            |  |              |  |        | 150     |     |                                        |                           |  |                       | 998     |  |                                    | (998   | ) |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   |        |  
|Issuance of non-cash common stock warrant                                             |  |                            |  |              |  |        |        |     |                                        |                           |  |                       | 1,297   |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 1,297   |  
|Amortization of deferred compensation                                                 |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    | 1,137  |   |                                |   |      |         |  |   |                     |   |  |   |         |   |  |   | 1,137   |  
|Cumulative translation adjustments                                                    |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   | 2,733 |         |  |   |                     |   |  |   |         |   |  |   | 2,733   |  
|Change in unrealized gain on investments                                              |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   |      |         |  |   | (792                 | ) |  |   |         |   |  |   | (792    | )
|Net income                                                                            |  |                            |  |              |  |        |        |     |                                        |                           |  |                       |        |  |                                    |       |   |                                |   |      |         |  |   |                     |   |  |   | 14,958   |   |  |   | 14,958  |  
|                                                                                      |  |                             |  |              |   |        |         |     |                                        |                            |  |                       |         |  |                                    |        |   |                                |   |       |         |  |   |                      |   |  |   |          |   |  |   |         |  
|BALANCE, December 31, 2003                                                            |  |                            |  | $            |  |        | 108,711 |     | $                                      | 11                         |  | $                     | 430,583 |  | $                                  | (1,789 | ) |                                | $ | 4,018 |         |  | $ | 99                   |   |  | $ | (180,508 | ) |  | $ | 252,414 |  
|                                                                                      |  |                             |  |              |   |        |         |     |                                        |                            |  |                       |         |  |                                    |        |   |                                |   |       |         |  |   |                      |   |  |   |          |   |  |   |         |  



See accompanying notes
to consolidated financial statements.



F-6



---

##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)



|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | -------- | ---- |  | - | ------- | -
|                                                                                      |  | Year Ended December 31, |        
|                                                                                      |  | 2001                    |         |   | 2002 |   |          | 2003 | 
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                 |  |                         |         |   |      |   |          |      |  |   |         |  
|Net Income (Loss)                                                                     |  | $                       | (74,651 | ) |      | $ | (10,599  | )    |  | $ | 14,958  |  
|Adjustments to reconcile net income (loss) to net cash used in operating activities  |  |                         |         |   |      |   |          |      |  |   |         |  
|Depreciation and amortization                                                         |  |                         | 15,600  |   |      |   | 22,229   |      |  |   | 29,729  |  
|Discount accretion on long-term obligations                                           |  |                         |        |   |      |   |         |      |  |   | 1,079   |  
|Net realized gains, net of purchase price discount amortization                       |  |                         |        |   |      |   |         |      |  |   | 488     |  
|Charges for warrants and options                                                      |  |                         | 3,076   |   |      |   |         |      |  |   |        |  
|Write off of asset values                                                             |  |                         | 2,165   |   |      |   | 1,380    |      |  |   | 3,309   |  
|Changes in operating assets and liabilities                                          |  |                         |         |   |      |   |          |      |  |   |         |  
|Accounts receivable, net                                                              |  |                         | (1,861  | ) |      |   | (9,013   | )    |  |   | (25,911 | )
|Other receivables, prepaid expenses and other current assets                          |  |                         | (8,512  | ) |      |   | (3,102   | )    |  |   | 544     |  
|Accounts payable                                                                      |  |                         | 6,432   |   |      |   | 7,776    |      |  |   | 5,235   |  
|Accrued liabilities and other                                                         |  |                         | 22,717  |   |      |   | (14,163  | )    |  |   | (6,188  | )
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Net operating cash flows from continuing operations                                   |  |                         | (35,034 | ) |      |   | (5,492   | )    |  |   | 23,243  |  
|Net operating cash flows from discontinued operations                                 |  |                         |        |   |      |   |         |      |  |   | 789     |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Net cash provided by (used in) operating activities                                   |  |                         | (35,034 | ) |      |   | (5,492   | )    |  |   | 24,032  |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                 |  |                         |         |   |      |   |          |      |  |   |         |  
|Expenditures for Fixed Asset Purchases and Direct Contract Costs                      |  |                         | (20,957 | ) |      |   | (24,456  | )    |  |   | (27,927 | )
|Expenditures for Client Contract Related Intangible Assets                            |  |                         |        |   |      |   | (13,600  | )    |  |   | (19,485 | )
|Purchases of Outsourcing Business, net of cash acquired                               |  |                         |        |   |      |   |         |      |  |   | (16,623 | )
|Purchases of Investments                                                              |  |                         | (25,212 | ) |      |   | (239,259 | )    |  |   | (86,281 | )
|Proceeds from Investments                                                             |  |                         | 5,000   |   |      |   | 177,156  |      |  |   | 108,918 |  
|Changes in Other Assets                                                               |  |                         | (1,140  | ) |      |   | 712      |      |  |   | 877     |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Net investing cash flows from continuing operations                                   |  |                         | (42,309 | ) |      |   | (99,447  | )    |  |   | (40,521 | )
|Net investing cash flows from discontinued operations                                 |  |                         |        |   |      |   |         |      |  |   | (805    | )
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Net cash (used in) investing activities                                               |  |                         | (42,309 | ) |      |   | (99,447  | )    |  |   | (41,326 | )
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                 |  |                         |         |   |      |   |          |      |  |   |         |  
|Proceeds from Issuance of Common Stock                                                |  |                         | 126,318 |   |      |   | 1,131    |      |  |   |        |  
|Net Proceeds from Issuance of Convertible Senior Notes                                |  |                         |        |   |      |   |         |      |  |   | 106,567 |  
|Proceeds from Exercise of Stock Options                                               |  |                         | 6,028   |   |      |   | 1,988    |      |  |   | 3,783   |  
|Proceeds from Other Long-Term Obligations                                             |  |                         |        |   |      |   | 1,280    |      |  |   |        |  
|Payments on Other Long-Term Obligations                                               |  |                         | (5,349  | ) |      |   | (1,074   | )    |  |   | (3,001  | )
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Net cash provided by financing activities                                             |  |                         | 126,997 |   |      |   | 3,325    |      |  |   | 107,349 |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Effect of Exchange Rate Changes on Cash and Cash Equivalents                          |  |                         | (187    | ) |      |   | 103      |      |  |   | 2,125   |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Net Increase (Decrease) in Cash and Cash Equivalents                                  |  |                         | 49,467  |   |      |   | (101,511 | )    |  |   | 92,180  |  
|Cash and Cash Equivalents, beginning of period                                        |  |                         | 94,890  |   |      |   | 144,357  |      |  |   | 42,846  |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Cash and Cash Equivalents, end of period                                              |  | $                       | 144,357 |   |      | $ | 42,846   |      |  | $ | 135,026 |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|SUPPLEMENTAL CASH FLOW INFORMATION:                                                   |  |                         |         |   |      |   |          |      |  |   |         |  
|Cash Paid During the Period for:                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Interest                                                                              |  | $                       | 1,464   |   |      | $ | 1,056    |      |  | $ | 1,974   |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Income taxes                                                                          |  | $                       | 48      |   |      | $ | 373      |      |  | $ | 30      |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|SUMMARY OF NON-CASH INVESTING AND FINANCING ACTIVITIES:                               |  |                         |         |   |      |   |          |      |  |   |         |  
|Common Stock, Options and Warrants Issued for Services                                |  | $                       | 36      |   |      | $ | 1,640    |      |  | $ | 998     |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Acquisition of Prepaid Assets through Other Long-Term Obligations                     |  | $                       |        |   |      | $ | 9,012    |      |  | $ |        |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Acquisition of Fixed Assets through Other Long-Term Obligations                       |  | $                       | 1,621   |   |      | $ | 3,197    |      |  | $ | 1,024   |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  
|Common Stock Warrant Issued for Client Contract Related Intangible Asset              |  | $                       |        |   |      | $ |         |      |  | $ | 1,297   |  
|                                                                                      |  |                         |         |   |      |   |          |      |  |   |         |  



See accompanying notes
to consolidated financial statements.



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##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



|1. | Description of Business
|-- | -----------------------



Exult, Inc. and subsidiaries (Exult or the Company) designs, implements, and manages comprehensive web-enabled human resources
processes in support of the employees of clients, generally under long-term contracts. Exult was incorporated in the state of Delaware on October 29, 1998 and began marketing its services in 1999.



|2. | Summary of Significant Accounting Policies
|-- | ------------------------------------------



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 periods.
Actual results could differ from estimated amounts.



Principles of
Consolidation



The consolidated financial statements
include the accounts of Exult, Inc. and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.



Reclassification



Certain prior year and prior quarter balances have been reclassified to conform to current financial statement presentation. These reclassifications had
no impact on previously reported results of operations or shareholders equity.



Cash, Cash Equivalents and Short-Term Investments



The Company considers all highly liquid temporary cash investments with an initial maturity of three months or less to be cash equivalents. The carrying amount of cash equivalents approximates fair value because of the short maturity period
of these investments. The Company has evaluated its investment policies consistent with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, and
determined that substantially all of its investment securities are to be classified as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses reported in stockholders equity. The amortized
cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion is included in investment and interest income, net. Realized gains and losses, and declines in value judged to
be other-than-temporary on available-for-sale securities are included in investment and interest income, net. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as
available-for-sale are included in investment and interest income, net.



Assets Held for Sale to Clients



Assets held
for sale to clients are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. Assets held for sale to clients are included in prepaid expenses and other current assets.



Investments in unconsolidated entities.



The Company accounts for its investments in certain companies where it does
not have the ability to influence or control the entity using the cost method. Under the cost method of accounting, the investments are recorded at cost, generally at a level of ownership of less than 20%.



Fixed Assets



Fixed assets are stated at cost for purchased assets and at the lesser of the present value of minimum lease payments or
fair value for capital lease assets. Depreciation and amortization is recorded using the straight-line method over the estimated useful life of the assets. Capital lease assets are depreciated over the shorter of the estimated useful life of the
assets or the life of the lease. Significant



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



additions and improvements to fixed assets are capitalized. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation
are removed and any gain or loss is reflected in the results of operations. Maintenance, repairs and minor renewals are charged directly to expense as incurred.



Capitalized Costs



In accordance with Statement of Position 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use, the
Company expenses all costs associated with the development of internal use software other than those incurred during the application development stage. Costs related to application development are capitalized and included in Fixed Assets and Direct
Contract Costs. Such assets are amortized over the estimated useful life of the software.



The Company capitalizes certain set-up and other direct installation costs associated with client contracts to the extent that management determines such costs are recoverable from revenues to be earned under the
related contract. 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.



The Company capitalizes all incremental customer contract direct origination costs and certain non-incremental internal
customer contract direct origination costs, including direct labor, incurred subsequent to contract acquisition to the extent that management determines that such costs are recoverable. Contract acquisition is generally deemed by the Companys
management to have occurred, and therefore costs are begun to be capitalized, at the time a definitive letter of intent is executed between the Company and the customer if the Company believes the execution of a contract is probable. These costs are
included in Other Assets and are amortized over the applicable contract term. In the event a contract is not ultimately executed, or is cancelled, the balance is charged to operations at that time, to the extent that such amounts exceed amounts
recoverable from the customer.



Intangible Assets



Intangible assets consist of the portion of the purchase price of assets in
excess of the fair value of identifiable net tangible assets acquired. Goodwill and intangible assets with indefinite lives are not amortized. Amortization for all other intangible assets is computed using the straight-line method over the estimated
useful lives of the assets. Certain of the intangible assets are being amortized as a reduction of revenue over the applicable contract term.



Long-Lived Assets



In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived assets, such as property, plant,
and equipment, and intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is
recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and managements estimate
of future performance, giving consideration to existing and anticipated competitive and economic conditions. Additionally, in conjunction with the review for impairment, the remaining estimated lives of certain of the Companys long-lived
assets are assessed.



Management believes that there were no
events or changes in circumstances that would indicate that an asset might not be recoverable as of December 31, 2003, except as disclosed in Note 14 below related to the discontinued operations of the Companys Gunn consulting business.



Derivative Financial Instruments



In accordance with SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Instruments and Certain Hedging Activities, as further amended by SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, the Company recognizes all derivatives as either assets or liabilities and measures those instruments at fair market value. Derivatives that are not hedges are adjusted to fair value through earnings. If the derivative is a hedge,
changes in fair value will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings.



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##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



Revenue Recognition



The Companys primary source of revenue is fees earned for providing HR business process management services under long-term contracts. The
Company also receives revenue from client projects. The Company bills its clients on a fee-for-service basis for process management clients and on a per diem basis for certain discrete projects for its process management clients. Fee-for-service
process management contracts are generally structured so that the Company receives a fee that is no greater than the clients historical cost of operating the functions assumed by the Company. After the Company has achieved a negotiated minimum
cost reduction, in certain instances the Company may be required to share further savings with its clients in a negotiated gain sharing arrangement. The amount of savings to be shared with clients is determined on a periodic basis in accordance with
the terms of the applicable contracts.



The Company fulfills
some of its service delivery obligations through use of third-party vendors, including vendors that had previously entered into contracts directly with the Companys clients, which contracts were then assigned, or are in the process of being
assigned, to the Company in connection with the process management services. The Company is contractually responsible for the delivery and acceptability of these third-party vendor services. The Company includes in revenue all amounts for services
that it is contractually obligated to provide to its clients, whether it provides the services directly using its own personnel or through third-party vendors. In some instances, the Company pays the charges of the third-party vendors that provide
services and bills its clients for the cost of the service. In other instances, the client pays the third-party vendor directly on the Companys behalf. In either case, the Company is primarily responsible for providing the services to its
clients.



The Companys process management service
contracts generally have terms of up to ten years, encompass multiple HR administrative processes, and require the Company to provide high levels of service at reduced costs to the client. These contracts contain multiple responsibilities for the
Company, including both the Companys 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 done by the Company 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 the Company to perform this work.



Revenue on the Companys long-term process management contracts that have reached operational stability is recognized for each reporting period based
on the proportion of contract costs incurred to date to then-current estimates of total contract costs. The effect of changes to total estimated contract revenue or costs is recognized in the period in which the determination is made that facts and
circumstances dictate a change of estimate. 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 margin going forward.



Before 2002, it was the Companys practice to limit the amount of revenue recognized as described above to the amounts that have been or can be
billed as of the end of the reporting period under the terms of the contracts. This limitation was implemented earlier in the Companys history to minimize the potential impact of changes in estimates, which were more likely to be significant
before the Company had achieved operational maturity in its business and operational stability in its underlying contracts. Now that the Companys business has matured, the Companys practice is to apply the revenue limitation on a
contract-by-contract basis only until each contract achieves 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. The Company has established certain quantifiable measures to identify the point at which a contract has achieved operational stability. As of December 31, 2002, the Company had removed the revenue limitation for all of its then existing
contracts. Revised estimates of contract margins and the discontinuance of the revenue limitation resulted in a net increase to revenue of $13.4 million and $24.7 million for the year ended December 31, 2002 and 2003, respectively. As of December
31, 2003, none of the contracts that were entered into during 2003 were deemed to have achieved operational stability.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



Some of the Companys services relate to HR processes, such as staffing and learning, for which
client spending is discretionary to a significant degree. These processes are also highly sensitive to changes in client policies and strategies, as well as economic conditions and developments in the clients business and outlook. Further, the
costs of resources can change quickly depending upon changing conditions in geographic or industry markets. Accordingly, the financial results of the Companys provision of these services are more variable than for other services such as
payroll. Because of this variability, the Company does not believe it can make reasonably dependable estimates in these areas. Thus, revenue and expense for these services are recognized as the services are provided and are not included in contract
estimates.



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 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 adopted EITF Issue 00-21 for transactions entered into after June 30, 2003. The impact of adopting EITF Issue 00-21 was not material to the
Companys consolidated financial statements. Management anticipates that, in the near-term, services and deliverables to be provided under new business process management contracts will generally be similar in nature to services and
deliverables provided in connection with the Companys existing contracts. The Companys market and service offering is relatively new, and certain of the Companys services have not been sold on a stand alone basis either by the
Company or its competitors. Therefore, management believes that there is not, and in the near-term will not be, sufficient evidence of fair value for certain elements of the Companys contracts. Management anticipates accounting for future
multiple-element contracts that share these characteristics as a single unit and in the same manner as the Company accounts for its existing multiple-element contracts as long as there continues to be a lack of fair value for certain elements of our
contracts and some portion of these elements remain undelivered until the completion of a contract.



Concentration



During
the year ended December 31, 2001, two of the Companys process management clients accounted for approximately 46 percent and 44 percent of the Companys revenue. During the year ended December 31, 2002, three of the Companys process
management clients accounted for approximately 48 percent, 26 percent and 16 percent of the Companys revenue. During the year ended December 31, 2003, three of the Companys process management clients accounted for approximately 48
percent, 18 percent and 15 percent of the Companys revenue. No other client accounted for 10 percent or more of the Companys total revenue during any of these three years. If any of the Companys five largest process management
clients were to substantially reduce or stop using the Companys services, future revenues would be seriously impaired and could cause certain assets to not be recoverable. Some of these contracts are still at early stages. As such, management
believes that the Companys ability to secure future clients and revenues will be largely dependent upon managing and administering these clients HR processes effectively and efficiently, and achieving service levels and cost savings
specified in the contracts. Although these contracts are not scheduled to expire until December 2006, November 2010, October 2011, January 2012, and April 2013, the clients may terminate their contracts prior to those dates for significant
nonperformance by the Company; for any reason after December 2002, November 2001, January 2006, July 2004 and April 2006, respectively, with specified prior written notice and payment to the Company of an early termination fee, if any; or in the
event there is a change in control of the Company, as defined. As of December 31, 2003, unbilled receivables from these contracts constituted the majority of the unbilled revenue balance of $30.0 million.



The Company has, and plans to continue to enter into, fixed price or
relatively fixed priced process management contracts. These contracts typically are structured so that the Company receives fixed amounts that are generally equal to or less than the clients historical costs incurred in connection with the
services the Company is assuming. After the Company has achieved a negotiated minimum cost reduction, in certain instances the Company may be required to share further savings with its clients in a negotiated gain sharing arrangement. If the Company
miscalculates the resources or time needed to perform under these contracts or is not able to perform HR management more cost effectively than its clients, the costs of providing services could exceed the fixed amount the Company would receive. If
that occurs, the Company would lose money on the contract. The contracts also contain certain minimum service level requirements that must be met. The Company currently depends on third parties to provide a number of specialized HR services to the
clients, such as recruiting and relocation, training and temporary help services. If the Company and its third-party vendors are not able to meet these requirements, the clients can assess penalties against the Company in accordance with the terms
of the contracts. The assessment of any penalties could adversely affect future operating results.



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##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



Segment Information



Management has determined that the Company operates in only one business segment. Prior to 2000, substantially all of the Companys revenue was
derived from within the United States. For the years ended December 31, 2001, 2002 and 2003, 82 percent, 89 percent and 86 percent, respectively, of the Companys revenue was derived from within the United States with the balance for each year
being derived primarily from within the United Kingdom and, for 2003, also from within Canada, Netherlands, Hong Kong, Singapore and Brazil.



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 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 was 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. Certain disclosure requirements under SFAS No. 148 are included in Note 9 to the consolidated financial statements.



Foreign Currency Translation



The functional currency of the Companys foreign subsidiary is the
local currency. Assets and liabilities of subsidiaries with international operations are translated into U.S. dollars at year-end exchange rates, and revenues and expenses are translated at average exchange rates prevailing as they occur.
Translation adjustments are reported as a separate component of stockholders equity and included in comprehensive income (loss). Transaction gains and losses arising from transactions denominated in a currency other than the functional
currency of the entity involved are included in the consolidated statements of operations. The Company has not entered into any foreign currency exchange contracts or other related derivative financial instruments.



Income Taxes



In accordance with SFAS No. 109, the Company recognizes deferred tax assets and liabilities based on differences between the
financial reporting and tax bases of assets and liabilities using enacted tax rules and laws that are expected to be in effect when the differences are expected to be recovered. Under the Tax Reform Act of 1986, the benefits from net operating
losses carried forward may be impaired or limited in certain circumstances. A valuation allowance has been provided for deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax asset will not be realized.



Income (Loss) Per Share



Basic income (loss) per share is computed using the weighted average number
of shares of common stock outstanding during the period. Diluted earnings (loss) per share is computed using the weighted average number of shares of common stock and common stock equivalent shares outstanding during the period.



During the third and fourth quarter of 2003, the Company sold $110 million
principal amount of 2.50% Convertible Senior Notes (Notes) at 97% of the principal amount thereof. Subject to certain conditions, the holders of the Notes have the right to convert their Notes into shares of the Companys common stock based on
a specified conversion rate. As discussed in Note 7, until such time that one of the conversion criteria has been met, the impact of the conversion of the Notes was excluded from the computation of net income per share.



Comprehensive Income (Loss)



Components of comprehensive income (loss) include amounts that are excluded
from net income (loss). There were no significant differences between the Companys net loss and comprehensive loss for the year ended December 31, 2001.



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##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



Recent Accounting Pronouncements



In July 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 and supersedes Emerging Issues Task Force (EITF) 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 94-3 relates to the timing of liability recognition. Under SFAS No. 146, a liability for a cost associated
with an exit or disposal activity is recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entitys commitment to an exit plan. The provisions of SFAS No. 146 are effective for
exit or disposal activities that are initiated after December 31, 2002. The Company adopted SFAS No. 146 effective January 1, 2003. The adoption of SFAS No. 146 did not have a material impact on the Companys financial position or results of
operations.



In November 2002, the FASB issued Interpretation (FIN) 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements
about its obligations under certain guarantees that it issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements in this interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material impact on the Companys financial position or results of operations.



In January 2003, the FASB issued FASB Interpretation 46 (FIN 46), Consolidation of
Variable Interest Entities. FIN 46, as superseded by FIN46R, discussed below, clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (variable interest entities).
Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entitys
expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to all new variable interest entities created or acquired after January 31, 2003. For variable interest created or acquired prior to February 1, 2003,
the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. The effective date of the provisions of FIN 46 was subsequently deferred by FIN46R, as discussed below.



In April 2003, the FASB issued SFAS No. 149 Amendment of Statement 133 on Derivative
Instruments and Hedging Activities (SFAS 149). This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively
referred to as derivatives) and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The accounting and reporting requirements will be effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. We do not anticipate that the adoption of SFAS No. 149 will have a material impact on our financial position or results of operations.



In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial Instruments
with characteristics of both liabilities and equity (SFAS 150). This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. Some of the provisions of this Statement are
consistent with the current definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements. The remaining provisions of this Statement are consistent with the FASBs proposal to revise that definition to encompass
certain obligations that a reporting entity can or must settle by issuing its own equity shares, depending on the nature of the relationship established between the holder and the issuer. While the FASB still plans to revise that definition through
an amendment to Concepts Statement 6, the FASB decided to defer issuing that amendment until it has concluded its deliberations on the next phase of this project. That next phase will deal with certain compound financial instruments including
puttable shares, convertible bonds, and dual-indexed financial instruments. SFAS No. 150 is effective for certain financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on our financial position or results of operations.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



On December 17, 2003, the Staff of the SEC issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue
Recognition, which supersedes SAB 101, Revenue Recognition in Financial Statements. SAB 104s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a
result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. Additionally, SAB 104 rescinds the SECs Revenue Recognition in Financial Statements Frequently Asked Questions and Answers(the FAQ) issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While SAB 104 reflects the issuance of EITF 00-21, the revenue recognition
principles of SAB 101 remain largely unchanged by the issuance of SAB 104. We do not anticipate that the adoption of SAB 104 will materially affect our revenue recognition policies, nor our results of operations, financial position or cash flows.



In December 2003, the FASB issued a revision to Interpretation
No. 46 Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (FIN46R or the Interpretation). FIN46R clarifies the application of ARB No. 51 Consolidated Financial Statements to
certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.
FIN46R requires the consolidation of these entities, known as variable interest entities, by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that will absorb a majority of the entitys expected losses or
receive a majority of the entitys expected residual returns, or both.



Among other changes, FIN46R (a) clarified some requirements of the original FIN46 which had been issued in January 2003, (b) eased some implementation problems and (c) added new exceptions. FIN46R deferred the
effective date of the Interpretation for public companies to the end of the first reporting period after March 15, 2004, except that all public companies must, at a minimum, apply the provisions of the Interpretation to all entities that were
previously considered special purpose entities under the FASB literature prior to the issuance of FIN46R by the end of the first reporting period ending after December 15, 2003. The Company does not anticipate that the adoption of FIN46
will have a material impact on its financial position, cash flows or results of operations.



|3. | Reclassifications and Restatement for Discontinued Operations
|-- | -------------------------------------------------------------



(a) Prior to January 1, 2003, depreciation and amortization expense was set forth as a separate line item in the Consolidated Statements of Operations.
Commencing January 1, 2003, depreciation and amortization expense is included in Cost of Revenue and Selling, General and Administrative Expense. For comparison purposes, all periods presented have been reclassified to conform with the current
periods presentation. Accordingly, for the year ended December 31, 2001, the effect of this reclassification was to increase Cost of Revenue by $5,971,000 and Selling, General and Administrative Expense by $6,501,000. For the year ended
December 31, 2002, the effect of this reclassification was to increase Cost of Revenue and Selling, General and Administrative Expense by $14,561,000 and $3,892,000, respectively. For the year ended December 31, 2003, Cost of Revenue and Selling,
General and Administrative Expense included depreciation and amortization of $22,402,000 and $2,180,000, respectively.



The 2001 consolidated statements of cash flows of the Company have also been adjusted to reflect the following reclassifications (in thousands):



|                                      |  |                              |         |   |                       |   |        |  
|------------------------------------- |  | ---------------------------- | ------- | - | --------------------- | - | ------ | -
|                                      |  | Year Ended December 31, 2001 |        
|                                      |  | As Adjusted                  |         |   | As PreviouslyReported |  
|Cash Flows from Operating Activities: |  |                              |         |   |                       |   |        |  
|Change in investments                 |  | $                            |        |   |                       | $ | 2,319  |  
|Change in other assets                |  |                              |        |   |                       |   | (1,140 | )
|Cash Flows from Investing Activities: |  |                              |         |   |                       |   |        |  
|Purchases of investments              |  |                              | (25,212 | ) |                       |   |       |  
|Proceeds from investments             |  |                              | 5,000   |   |                       |   |       |  
|Change in other assets                |  |                              | (1,140  | ) |                       |   |       |  



In addition to the
above, additional or modified disclosures for 2001 have been made as follows:



| |  | With the adoption of SFAS No.142 effective January 1, 2002, the Company was required for comparison purposes, in accordance with that statement, to disclose its net loss and net
loss per share for the year December 31, 2001 as if SFAS No. 142 had been adopted as of January 1, 2001. The disclosure is contained in Note 6.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Company expanded its disclosures in Note 6 to include the pro forma net loss per share, basic and diluted, for the year ended December 31, 2001.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------



(b) In the fourth quarter of fiscal 2003, management determined that the Gunn
consulting operation no longer fit the Companys strategic operating objectives and accordingly adopted a formal plan to dispose of this operation. As a result, the operating results of the Gunn consulting operations have been classified as
discontinued operations and prior year amounts have been reclassified accordingly to conform to the current year presentation. See Note 14 to the consolidated financial statements for more information on the Gunn consulting operations.



On July 9, 2004, management determined that a $2.2 million non-cash
charge, arising from a write-off of a Gunn research database that was determined to no longer have any value in 2001, which had been included in selling, general and administrative expense in the 2001 consolidated financial statements should have
been classified as discontinued operations. The 2001 amounts presented in the 2003 consolidated financial statements have been restated from the originally reported amounts to reclassify the $2.2 million charge from selling, general and
administrative expense to discontinued operations.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



******



Including the effect of the above described reclassification of depreciation and amortization expense
and discontinued operations of the Gunn consulting operation, the 2001 consolidated statement of income (loss) of the Company has been adjusted to reflect the following reclassification as well (in thousands):



|                                            |  |                              |         |    |              |   |         |                        |  |   |         |    |  |                       |        |   |  |   |         |  
|------------------------------------------- |  | ---------------------------- | ------- | -- | ------------ | - | ------- | ---------------------- |  | - | ------- | -- |  | --------------------- | ------ | - |  | - | ------- | -
|                                            |  | Year Ended December 31, 2001 |        
|                                            |  | AsRestated                   |         |    | Depreciation |   |         | DiscontinuedOperations |  |   | Other   |    |  | As PreviouslyReported |       
|Revenue                                     |  | $                            | 257,052 |    |              | $ |        |                        |  | $ | (15,482 | )  |  | $                     |       |   |  | $ | 272,534 |  
|Cost of Revenue                             |  |                              | 289,400 |    |              |   | 5,971   |                        |  |   | (5,991  | )  |  |                       |       |   |  |   | 289,420 |  
|Gross Profit (Loss)                         |  |                              | (32,348 | )  |              |   | 5,971   |                        |  |   | (9,491  | )  |  |                       |       |   |  |   | (16,886 | )
|Product Development Expense                 |  |                              |        |    |              |   |        |                        |  |   |        |    |  |                       | (4,630 | ) |  |   | 4,630   |  
|Selling, General and Administrative Expense |  |                              | 44,270  | *  |              |   | 6,501   |                        |  |   | (11,318 | )* |  |                       | 4,630  |   |  |   | 44,457  |  
|Depreciation and Amortization Expense       |  |                              |        |    |              |   | (12,472 | )                      |  |   |        |    |  |                       |       |   |  |   | 12,472  |  
|Loss from Operations                        |  |                              | (76,618 | )* |              |   |        |                        |  |   | (1,827  | )* |  |                       |       |   |  |   | (78,445 | )



|* | These amounts have been restated from the originally reported amounts in the 2003 consolidated financial statements to reflect a $2.2 million non-cash charge arising from a write
off of a Gunn research database that was determined to no longer have any value in 2001. This amount had been previously classified as part of selling, general and administrative expense in the 2001 consolidated financial statements. Also, see Note
6.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



|4. | Short-Term Investments
|-- | ----------------------



Short-term investments are comprised of available-for-sale securities and consist of the following (in thousands):



|                                               |  |                   |         |                      |   |                |  |                      |         |  |   |        
|---------------------------------------------- |  | ----------------- | ------- | -------------------- | - | -------------- |  | -------------------- | ------- |  | - | -------
|                                               |  | December 31, 2002 |         | December 31, 2003   
|                                               |  | Amortized Cost    |         | Estimated Fair Value |   | Amortized Cost |  | Estimated Fair Value
|Amounts Included in Cash and Cash Equivalents: |  |                   |         |                      |   |                |  |                      |         |  |   |        
|Institutional money market funds               |  | $                 | 41,851  |                      | $ | 41,851         |  | $                    | 124,911 |  | $ | 124,911
|                                               |  |                   |         |                      |   |                |  |                      |         |  |   |        
|Amounts Included in Investments:               |  |                   |         |                      |   |                |  |                      |         |  |   |        
|Commercial paper and other                     |  |                   | 2,917   |                      |   | 2,917          |  |                      | 2,669   |  |   | 2,668  
|Corporate notes                                |  |                   | 28,125  |                      |   | 28,373         |  |                      | 8,378   |  |   | 8,405  
|Asset-backed securities                        |  |                   | 21,253  |                      |   | 21,301         |  |                      | 16,687  |  |   | 16,716 
|U.S. Treasuries and Agencies                   |  |                   | 31,265  |                      |   | 31,860         |  |                      | 32,948  |  |   | 32,992 
|                                               |  |                   |         |                      |   |                |  |                      |         |  |   |        
|                                               |  |                   | 83,560  |                      |   | 84,451         |  |                      | 60,682  |  |   | 60,781 
|                                               |  |                   |         |                      |   |                |  |                      |         |  |   |        
|                                               |  | $                 | 125,411 |                      | $ | 126,302        |  | $                    | 185,593 |  | $ | 185,692
|                                               |  |                   |         |                      |   |                |  |                      |         |  |   |        



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 December 31, 2002 and 2003,
cumulative gross unrealized holding gains were $916,000 and $1,241,000, respectively, and cumulative gross unrealized holding losses were $25,000 and $1,142,000, respectively, from available-for-sale securities.



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



|                          |  |                   |        |                      |   |                |  |                      |        |  |   |       
|------------------------- |  | ----------------- | ------ | -------------------- | - | -------------- |  | -------------------- | ------ |  | - | ------
|                          |  | December 31, 2002 |        | December 31, 2003   
|                          |  | Amortized Cost    |        | Estimated Fair Value |   | Amortized Cost |  | Estimated Fair Value
|Due in Less than One Year |  | $                 | 48,854 |                      | $ | 49,128         |  | $                    | 51,088 |  | $ | 51,158
|Due in One to Three Years |  |                   | 32,538 |                      |   | 33,155         |  |                      | 6,926  |  |   | 6,956 
|                          |  |                   |        |                      |   |                |  |                      |        |  |   |       
|                          |  | $                 | 81,392 |                      | $ | 82,283         |  | $                    | 58,014 |  | $ | 58,114
|                          |  |                   |        |                      |   |                |  |                      |        |  |   |       



|5. | Long-Term Contracts: Unbilled Receivables and Deferred Revenue
|-- | --------------------------------------------------------------



Included in accounts receivable as of December 31, 2002 and 2003, are $7,057,000 and $30,032,000, respectively, of unbilled receivables consisting of
revenue in excess of billings on long-term outsourcing contracts. All unbilled receivables are expected to be recovered over the remaining respective lives of the contracts through billings made in accordance with the respective contract provisions.
Included in accrued liabilities and other as of December 31, 2003, is $696,000 of deferred revenue representing billings in excess of amounts earned on certain long-term contracts. There was no deferred revenue at December 31, 2002.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



|6. | Detail of Selected Financial Statement Caption Information (in thousands)
|-- | -------------------------------------------------------------------------



Prepaid Expenses and Other Current Assets



Prepaid expenses and other current assets consists of the following:



|                                                                            |  |              |        |      |   |       
|--------------------------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                                                            |  | December 31,
|                                                                            |  | 2002         |        | 2003
|Assets Held for Sale to Clients                                             |  | $            | 15,012 |      | $ | 14,658
|Prepaid expenses and other                                                  |  |              | 9,490  |      |   | 9,779 
|Other Receivables (including amounts receivable from officer and employees) |  |              | 2,603  |      |   | 2,536 
|                                                                            |  |              |        |      |   |       
|                                                                            |  | $            | 27,105 |      | $ | 26,973
|                                                                            |  |              |        |      |   |       



Fixed Assets and Direct Contract
Costs



Fixed assets and direct contract costs consist of
the following:



|                                                |  |               |  |              |         |   |      |   |         |  
|----------------------------------------------- |  | ------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                |  |               |  | December 31, |        
|                                                |  | Useful Life   |  | 2002         |         |   | 2003 |  
|Furniture and Fixtures                          |  | 5 years       |  | $            | 3,881   |   |      | $ | 4,614   |  
|Equipment, Computers and Software               |  | 3 to 5 years  |  |              | 55,793  |   |      |   | 75,679  |  
|Land                                            |  |               |  |              |         |   |      |   | 1,987   |  
|Leasehold Improvements                          |  | Lease term    |  |              | 6,040   |   |      |   | 7,121   |  
|Construction-in-Progress                        |  |               |  |              | 5,448   |   |      |   | 11,248  |  
|Direct Contract Costs                           |  | Contract term |  |              | 11,065  |   |      |   | 20,286  |  
|                                                |  |               |  |              |         |   |      |   |         |  
|                                                |  |               |  |              | 82,227  |   |      |   | 120,935 |  
|Less: Accumulated depreciation and amortization |  |               |  |              | (28,122 | ) |      |   | (51,925 | )
|                                                |  |               |  |              |         |   |      |   |         |  
|                                                |  |               |  | $            | 54,105  |   |      | $ | 69,010  |  
|                                                |  |               |  |              |         |   |      |   |         |  



Intangible Assets



On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets. Under SFAS No. 142, goodwill and other intangible assets with indefinite lives will not be amortized but will be tested for impairment at least annually. Upon adoption of SFAS No. 142, the Company transferred an
intangible asset (an assembled workforce) of $3,392,000, net of accumulated amortization of $2,390,000, to goodwill in accordance with that statement. The Company completed its transitional and annual impairment tests of its existing goodwill during
the three months ended June 30, 2002 and September 30, 2002 and 2003, respectively. These tests involve the use of estimates related to the fair value of the business to which the goodwill is allocated. There was no impairment loss as a result.
However, as discussed below, as a result of the Companys decision to discontinue its Gunn Consulting operation and dispose of certain assets, management has determined that the goodwill associated with the Gunn acquisition was impaired and
thus written down to its net realizable value in accordance with SFAS 144. With the adoption of SFAS No. 142, the Company ceased amortization of goodwill. If SFAS No. 142 had been adopted as of January 1, 2001, the net loss for the year ended
December 31, 2001, would have $73,479,000, or $0.76 per basic and diluted share.



The following reflects the components of intangible assets (in thousands):



|                                         |  |                     |        |                         |   |        |                   |  |                     |        |                         |   |        |                   |   |         |   |  |   |       
|---------------------------------------- |  | ------------------- | ------ | ----------------------- | - | ------ | ----------------- |  | ------------------- | ------ | ----------------------- | - | ------ | ----------------- | - | ------- | - |  | - | ------
|                                         |  | December 31, 2002   |        | December 31, 2003      
|                                         |  | GrossCarryingAmount |        | AccumulatedAmortization |   |        | NetCarryingAmount |  | GrossCarryingAmount |        | AccumulatedAmortization |   |        | NetCarryingAmount
|Intangible Assets with Finite Lives:     |  |                     |        |                         |   |        |                   |  |                     |        |                         |   |        |                   |   |         |   |  |   |       
|Client contract related                  |  | $                   | 40,315 |                         | $ | (6,271 | )                 |  | $                   | 34,044 |                         | $ | 73,745 |                   | $ | (13,612 | ) |  | $ | 60,133
|Other                                    |  |                     | 240    |                         |   | (112   | )                 |  |                     | 128    |                         |   | 240    |                   |   | (160    | ) |  |   | 80    
|                                         |  |                     |        |                         |   |        |                   |  |                     |        |                         |   |        |                   |   |         |   |  |   |       
|                                         |  |                     | 40,555 |                         |   | (6,383 | )                 |  |                     | 34,172 |                         |   | 73,985 |                   |   | (13,772 | ) |  |   | 60,213
|Intangible Assets with Indefinite Lives: |  |                     |        |                         |   |        |                   |  |                     |        |                         |   |        |                   |   |         |   |  |   |       
|Goodwill                                 |  |                     | 5,782  |                         |   | (2,390 | )                 |  |                     | 3,392  |                         |   |       |                   |   |        |   |  |   |      
|                                         |  |                     |        |                         |   |        |                   |  |                     |        |                         |   |        |                   |   |         |   |  |   |       
|                                         |  | $                   | 46,337 |                         | $ | (8,773 | )                 |  | $                   | 37,564 |                         | $ | 73,985 |                   | $ | (13,772 | ) |  | $ | 60,213
|                                         |  |                     |        |                         |   |        |                   |  |                     |        |                         |   |        |                   |   |         |   |  |   |       



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



During the year ended December 31, 2002 and 2003, the Company expended $13,600,000 and $19,485,000,
respectively, for the acquisition of intangible assets in connection with certain client contracts. In the second quarter of fiscal 2003, as discussed in Note 14, the Company acquired certain legal entities and assets and assumed certain liabilities
constituting a business process management outsourcing business. The cash purchase price of $16,623,000, including transaction costs and net of cash acquired, has been allocated to the assets acquired, including the value of purchased outsourcing
contracts of $12,467,000 which has been recorded as an intangible asset. During the year ended December 31, 2002, the Company retired intangible assets with a gross carrying value of $2,930,000 and accumulated amortization of $2,930,000. Aggregate
intangible asset amortization expense for the years ended December 31, 2001, 2002 and 2003 was $2,923,000, $938,000 and $2,262,000, respectively, and for the years ended December 31, 2001, 2002 and 2003, an additional $2,490,000, $3,781,000 and
$5,127,000, respectively, was amortized as a reduction of revenue. As of December 31, 2003, estimated intangible assets amortization for each of the five calendar years ending December 31, 2008 is approximately $8.5 million for 2004, $8.6 million
for 2005, $8.6 million for 2006, $7.6 million for 2007 and $6.8 million for 2008.



In the fourth quarter of fiscal 2003, the Company decided to discontinue its Gunn consulting operation. As a result of this determination, the Company performed an analysis to assess the net realizable value of the
Gunn assets held for sale, including the $3.4 million of goodwill associated with its acquisition of the Gunn consulting operation in November 1999. As a result of this analysis, in accordance with SFAS No. 144, the Company determined that the
goodwill remaining in the consulting operation was impaired and recorded an impairment charge of $3.3 million in the fourth quarter ended December 31, 2003. The valuation was done as of December 31, 2003, based on available market information, to
determine the sales valuation of the Gunn assets held for sale. See Note 14 for further discussion on the Gunn consulting business.



Other Assets



Other assets consists of the following:



|                                     |  |              |        |      |   |       
|------------------------------------ |  | ------------ | ------ | ---- | - | ------
|                                     |  | December 31,
|                                     |  | 2002         |        | 2003
|Prepaid Rent, net of current portion |  | $            | 12,669 |      | $ | 10,079
|Investments                          |  |              | 3,000  |      |   | 3,000 
|Other                                |  |              | 4,069  |      |   | 6,322 
|                                     |  |              |        |      |   |       
|                                     |  | $            | 19,738 |      | $ | 19,401
|                                     |  |              |        |      |   |       



Accrued Liabilities and other



Accrued liabilities consists of the following:



|                                                         |  |              |        |      |   |       
|-------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                                         |  | December 31,
|                                                         |  | 2002         |        | 2003
|Accrued Employee Compensation Benefits and Related Costs |  | $            | 6,927  |      | $ | 6,907 
|Accrued Technology Costs                                 |  |              | 3,174  |      |   | 4,446 
|Accrued Outsourcing Third-Party Arrangements             |  |              | 11,719 |      |   | 12,604
|Accrued Severance and Related Costs                      |  |              | 3,122  |      |   | 600   
|Deferred Revenue                                         |  |              |       |      |   | 696   
|Other Accrued Liabilities                                |  |              | 6,817  |      |   | 6,901 
|                                                         |  |              |        |      |   |       
|                                                         |  | $            | 31,759 |      | $ | 32,154
|                                                         |  |              |        |      |   |       



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##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



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. Included in selling, general and administrative expense for the year ended December 31, 2001, are $9,688,000 of severance costs (including non-cash option acceleration charges of
$3,040,000), and certain wind-up costs totaling $6,621,000 (including severance costs of $5,412,000) associated with the elimination of two secondary processing centers. For the years ended December 31, 2002 and 2003, no similar charges were
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 (in thousands):



|                                 |  |          |        |   |                 |   |       |       |  |   |        |  
|-------------------------------- |  | -------- | ------ | - | --------------- | - | ----- | ----- |  | - | ------ | -
|                                 |  | Accruals |        |   | Non-CashCharges |   |       | Total | 
|Severance and Related Charges    |  | $        | 6,648  |   |                 | $ | 3,040 |       |  | $ | 9,688  |  
|Processing Centers Closure Costs |  |          | 6,621  |   |                 |   |      |       |  |   | 6,621  |  
|                                 |  |          |        |   |                 |   |       |       |  |   |        |  
|                                 |  |          | 13,269 |   |                 | $ | 3,040 | *     |  | $ | 16,309 | *
|                                 |  |          |        |   |                 |   |       |       |  |   |        |  
|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 Cash Payments               |  |          | (1,088 | ) |                 |   |       |       |  |   |        |  
|2003 Accrual Adjustments         |  |          | (206   | ) |                 |   |       |       |  |   |        |  
|                                 |  |          |        |   |                 |   |       |       |  |   |        |  
|Balance at December 31, 2003     |  | $        | 572    |   |                 |   |       |       |  |   |        |  
|                                 |  |          |        |   |                 |   |       |       |  |   |        |  



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 six
months.



|* | These amounts have been adjusted from the originally reported amounts in the 2003 consolidated financial statements to reflect a $2.2 million non-cash charge arising from a write
off of a Gunn research database that was determined to no longer have any value in 2001. This $2.2 million amount had been previously classified as part of selling, general and administrative expense in the 2001 consolidated financial statements and
is now classified as discontinued operations (see Note 3(b)).
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



|7. | Long-Term Liabilities
|-- | ---------------------



2.50% Convertible Senior Notes



On September 30, 2003, the Company sold $100.0 million principal amount of its newly issued 2.50% Convertible Senior Notes (Notes) due October
1, 2010 to certain initial purchasers for resale to qualified institutional buyers in reliance on Rule 144A under the United States Securities Act of 1933. On October 9, 2003, the Company sold an additional $10.0 million principal amount of Notes
pursuant to an option held by the initial purchasers. The initial purchasers purchased the Notes from the Company at 97% of the principal amount thereof. The net proceeds received by the Company were $106.6 million after the initial purchasers
discount and sales commissions and other expenses of approximately $3.0 million and $0.4 million, respectively. Interest is payable in cash on each April 1 and October 1 commencing April 1, 2004. The Notes are senior unsecured obligations of the
Company and rank equally with all of the Companys existing and future senior unsecured indebtedness. The indenture under which the Notes have been issued does not restrict the incurrence of debt by the Company.



All Notes that have not been repurchased or converted must be repaid with any
accrued unpaid interest on October 1, 2010, subject to acceleration under certain circumstances, including events of default and insolvency, as described in the indenture. No sinking fund is provided for the Notes. Commencing October 5, 2008, the
Company has the option at any time to redeem all, or a portion, of the Notes for cash at 100% of the principal amount of the Notes plus accrued unpaid interest. On October 1, 2008, each holder of the Notes has the one-time right to require the
Company to purchase all or a portion of such holders Notes for cash at a purchase price of 100% of the principal amount plus accrued unpaid interest. Furthermore, upon a change in control (as defined in the indenture governing the Notes), each
holder has the right, subject to certain conditions and restrictions, to require the Company to repurchase all or a portion of such holders Notes at a purchase price of 100% of the principal amount plus accrued unpaid interest.



Subject to certain conditions, the holders of the Notes have the right to
convert their Notes, in whole or part, into shares of the Companys common stock at an initial rate of 85.0340 shares of common stock per $1,000 principal amount of Notes (which is equivalent to a conversion price of approximately $11.76 per
share) (Conversion Price). Based upon the current conversion price, the Notes will be convertible into 9,353,741 shares of Common Stock. The Conversion Price is subject to anti-dilution adjustment under various circumstances. The
conditions triggering the conversion right include: (i) if on or before March 31, 2008, the closing sale price of the Companys common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading
day of any fiscal quarter is more than 110% of the then current Conversion Price, the Notes may be converted during the following fiscal quarter; (ii) if, on any date after March 31, 2008, the closing sale price of the Companys common stock is
more than 110% of the then current Conversion Price, then the Notes may be converted at all times thereafter; and, (iii) if the Company elects to call some portion or all of the Notes after October 5, 2008, then the portion being called for
redemption may be converted. The Notes are also convertible in certain other circumstances, including certain simultaneous market conditions in which the trading price for the Notes is less than 95% of the conversion value of the Notes (based upon
the value of the Companys common stock), certain mergers or sales of assets, and other events constituting a change in control of the Company. Until such time that one of the above conversion criteria has been met, the impact of such
conversion will be excluded from the computation of net income per share on a diluted basis.



The Company has agreed to register the resale of the Notes and the sale of the shares of common stock issuable upon conversion of the Notes pursuant to a shelf registration statement filed with the U.S. Securities and
Exchange Commission. If the registration statement is not declared effective by March 26, 2004, or if the Company does not keep it available for requisite periods, then the Company may be required to pay liquidated damages to the holders of the
Notes and shares received upon conversion. The liquidated damages would be in the form of payment (in addition to any interest that may be payable) on the principal amount or value of the securities entitled to registration, at a rate per annum
equal to 0.25% or 0.50%, depending on the circumstances. The liquidated damages provision represents an embedded derivative as defined in SFAS No. 133, which management believes does not have material value.



The Company recorded the Notes at the net proceeds received and is accreting
the value of the discount and costs and expenses over the remaining term of the Notes to their stated maturity value using the effective interest method. At December 31, 2003, the estimated fair value of the Notes based on quoted market prices was
approximately $106.4 million.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



Other Long-Term Obligations



The Company purchased certain current assets and fixed assets totaling $9,012,000 and $1,024,000, respectively, under
various long-term arrangements, including capital lease arrangements. These long-term arrangements require periodic payments through May 2008 and the related asset values were established by computing the present value of the future payments using
the interest rate appropriate at the inception of each transaction. Interest for these transactions range from 2.9 percent to 19.5 percent. The future minimum payments under these arrangements comprising other long-term liabilities at December 31,
2003 consist of the following:



|                                                    |  |   |        |  
|--------------------------------------------------- |  | - | ------ | -
|2004                                                |  | $ | 2,841  |  
|2005                                                |  |   | 12,320 |  
|2006                                                |  |   | 429    |  
|2007                                                |  |   | 186    |  
|2008                                                |  |   | 49     |  
|Thereafter                                          |  |   |       |  
|                                                    |  |   |        |  
|Total Future Payments                               |  |   | 15,825 |  
|Less: Interest portion                              |  |   | (1,213 | )
|                                                    |  |   |        |  
|Present Value of Payments                           |  |   | 14,612 |  
|Current Portion of Other Long-Term Liabilities      |  |   | (2,444 | )
|                                                    |  |   |        |  
|Other Long-Term Liabilities, net of current portion |  | $ | 12,168 |  
|                                                    |  |   |        |  



|8. | Stockholders Equity
|-- | --------------------



Preferred Stock



The Companys Board of Directors is authorized to issue from time to time, without further vote or action by the stockholders, up to an aggregate of
15,0000,000 shares of Preferred Stock, $0.0001 par value per share, in one or more series and to fix or alter the designations, rights and any qualifications, limitations or restrictions of the shares of each series, including dividend rights,
dividend rates, conversion rights, voting rights, term of redemption, including sinking fund provisions, redemption price or prices, liquidation preferences and the number of shares constituting any series or designations of a series. As of December
31, 2003, there is no Preferred Stock issued and outstanding.



Common Stock



The Company is authorized to issue up to 500,000,000
shares of Common Stock, $0.0001 par value per share. Certain stockholders who purchased their shares prior to the Companys June 2000 initial public offering have registration rights associated with their stock.



Capital Transactions



On October 12, 2000, Exult and Bank of America signed a non-binding Memorandum of Understanding providing the framework for
a broad business relationship, including the provision of business process management services to Bank of America by Exult. The business relationship and process management services transaction were subject to ongoing negotiations and the Memorandum
of Understanding established a 60-day time period to reach a definitive agreement. Upon executing the Memorandum of Understanding, Bank of America acquired 5,000,000 investment units, each unit consisting of one share of Exult Common Stock and a
warrant to buy one additional share of Exult Common Stock. Each warrant was exercisable for three years at $11.00 per share. The purchase price for the 5,000,000 units was $55,000,000, of which $11,000,000 was paid in cash and the remainder in
prepaid rent and intangible assets. In connection with the issuance of the warrants, the Company incurred a charge of $29,900,000 during the fourth quarter of 2000. In November 2001, warrants exercisable for 2,500,000 shares of Common Stock were
exercised using the cashless exercise feature resulting in the net issuance of 766,078 shares of Common Stock. The remaining warrants expired unexercised in October 2003.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



In June 2001, one of the Companys third-party vendors purchased 1,538,461 shares of the
Companys Common Stock at fair market value for $20,000,000 in cash. If the amount of business directed by the Company to this vendor reaches specified levels by July 2005, the Company may require the vendor to purchase for cash up to an
additional $30,000,000 of the Companys Common Stock in installments at the then respective fair market values during that period. The per share purchase price for future installments, if any, is derived from a formula designed to approximate
the fair market value of a share of Common Stock for a 30-day period ending each date the third-party vendor is notified by the Company. As of December 31, 2003, none of the levels have been attained.



In August 2001, the Company completed a public offering of its Common Stock
issuing 8,000,000 shares. The Company received net consideration after the underwriting discount and offering costs of $100,318,000 for the issuance of the shares at a gross offering price of $13.34 per share.



In September 2001, another of the Companys third-party vendors
purchased 504,200 shares of the Companys Common Stock at fair market value for $6,000,000 in cash.



On April 23, 2003, Exult entered into an agreement to provide business process management services to BMO Financial Group. In connection with the
outsourcing services arrangement, the Company issued BMO Financial Group a fully vested warrant to purchase up to 1,000,000 shares of the Companys common stock. The warrant expires in April 2008 and may not be exercised prior to April 2005.
The warrant may only be exercised in its entirety, must be exercised in a single transaction and must be exercised on a cashless, net issuance basis. The exercise price is derived from a formula with a minimum exercise price of $7.55 per share. The
warrant has been recorded at its fair value of $1.3 million calculated by utilizing the Black-Scholes methodology as of the date of issuance and is included in intangible assets. The intangible asset is being amortized as a reduction of revenue over
the term of the related outsourcing contract.



Common Stock and Stock Option
Deferred Compensation



The Company recorded aggregate
deferred compensation from issuances of 550,000 shares and 150,000 shares of restricted Common Stock during the years ended December 31, 2002 and 2003, respectively. There were no similar transactions during the year ended December 31, 2001. The
550,000 shares were issued in December 2002 in connection with a certain retention arrangement entered into with one of the Companys executive officers and vest in various quarterly consecutive installments commencing in June 2003 through
September 2005, contingent upon the executives continued employment. The 550,000 shares of restricted stock were valued at $1,640,000, or $2.98 per share, the closing price of the Common Stock on the last trading day prior to the issuance of
the shares, and the related deferred compensation is being amortized to expense using the straight-line method over the 33-month vesting period. The 150,000 shares were issued in June 2003 in connection with the hiring of one of the Companys
executive officers and vest over a 48-month period with 25 percent of the shares vesting upon completion of one year of service from the date of grant, and with the remainder vesting on a monthly basis over a 36 month period measured from the first
anniversary of the grant date, contingent upon the executives continued employment with the Company. The 150,000 shares of restricted stock were valued at $998,000, or $6.65 per share, the closing price of the Common Stock on the last trading
day prior to the issuance of the shares, and the related deferred compensation is being amortized to expense using the straight-line method over the 48-month vesting period. Both grants of restricted stock are subject to accelerated vesting in
certain circumstances.



Employee Stock Purchase Plan



In May 2000, the Company adopted the 2000 Employee Stock Purchase Plan
(2000 Stock Purchase Plan). Under the 2000 Stock Purchase Plan, employees may elect to participate by contributing to the plan a portion, not in excess of 10 percent, of their after-tax compensation. The purchase price per share of Exult
Common Stock is the lesser of the fair market value of a share of Exult Common Stock on the first day of the period or the fair market value of a share of Exult Common Stock on the last day of the period, minus a 15 percent discount. The total
number of shares available for purchase under the 2000 Stock Purchase Plan may not exceed 2,000,000 shares. As of December 31, 2003, 516,423 shares have been issued under the 2000 Stock Purchase Plan generating net cash proceeds of $2,896,000.



|9. | Stock Option Plans
|-- | ------------------



1999 Stock Option/Stock Issuance Plan



In May 1999, the Company adopted the 1999 Stock Option/Stock Issuance Plan (1999 Plan). The 1999 Plan was comprised of two separate equity programs: (i) the Discretionary Option Grant Program, under which
eligible persons could, at the discretion of the Plan administrator, be granted options to purchase shares of Common Stock, and (ii) the Stock Issuance Program under which eligible



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



persons could, at the discretion of the Plan administrator, be issued shares of Common Stock directly, either through the immediate purchase of such shares
or as a bonus for services rendered to the Company. Upon the expiration, termination for any reason, or cancellation of unexercised stock options, the shares of Common Stock subject thereto will again be available for issuance under the terms of the
2000 Equity Incentive Plan. Upon any change in the outstanding Common Stock without the Companys receipt of consideration, appropriate adjustments shall be made to each outstanding option.



Eligible participants in the Plan were employees, non-employee members of the
board of directors of the Company, or any parent or subsidiary thereof, and consultants and other advisors who provide services to the Company, or any parent or subsidiary thereof. The Plan is administered by the compensation committee of the
Companys board of directors.



The options were issued as
incentive stock options (as defined by the Internal Revenue Code of 1986) or as nonqualified options. Options under the Plan were granted at prices not less than 85 percent of the fair market value at the date of option grant and could become
exercisable in installments ranging up to 10 years from the date of grant. If the optionee is a 10 percent stockholder, the exercise price could not be less than 110 percent of the fair market value at the date of option grant. As of December 31,
1999, the non-qualified stock options and incentive stock options are immediately exercisable by the optionee. Upon exercise, and subject to Internal Revenue Service limitations for incentive stock options, the option shares are initially unvested
and subject to repurchase by the Company upon termination of employment or services, at the option exercise price per share. The optionee shall acquire a vested interest in, and the Companys repurchase right shall lapse with respect to, 25
percent of the optionees shares upon completion of one year of service from the date of grant, and the remainder shall vest either on an annual basis or on a monthly basis over a 36-month period measured from the first anniversary of the grant
date. At December 31, 2003, there were 7,354 shares subject to repurchase.



1999 Special Executive Stock Option Plan



On
November 19, 1999, the Company adopted the Special Executive Stock Option Plan (Executive Plan). Participation in the Executive Plan was limited to officers and other highly compensated employees. The Executive Plan provided that the
exercise price for all options must be at least 85 percent of the fair market of the option shares at the time of the option grant. Furthermore, no option may have a term in excess of ten years, and each option will be subject to early termination
following the optionees cessation of services with the Company. The Executive Plan also provides that the exercise price for the shares of Common Stock subject to option grants may be paid in cash or in shares of Common Stock valued at fair
market value on the exercise date. Options vest over a period determined by the Companys board of directors. Since December 1999, no options have been granted under this plan.



2000 Equity Incentive Plan



In May 2000, the Company adopted the 2000 Equity Incentive Plan (2000 Plan). The 2000 Plan is the successor program to the 1999 Plan and the
Executive Plan and terminates in May 2010. The 2000 Plan provides various equity incentive programs, including discretionary option grants for employees, consultants and directors and automatic option grants for non-employee directors. The initial
number of shares available for grant under the 2000 Plan is 20,000,000 shares, which includes shares subject to outstanding awards under the 1999 Plan and the Executive Plan as of the adoption date of the 2000 Plan. The share reserve under the 2000
Plan automatically increases on the first trading day in January of each year, beginning with calendar year 2001, by an amount equal to 5 percent of the total number of shares of Exult Common Stock outstanding on the last trading day in December of
the immediately prior year, but in no event will any such annual increase exceed 6,000,000 shares. In accordance with this provision, the share reserve increased by 4,548,000 shares, 5,209,757 shares, 5,282,421 shares and 5,425,129 shares in January
2001, 2002, 2003 and 2004, respectively. Shares subject to awards that expire or are otherwise cancelled or terminated are again available for future grant. At December 31, 2003, prior to the January 2004 reserve increase, there are 1,911,518 shares
available for future grant under the 2000 Plan.



The 2000 Plan
is administered by the Companys Board of Directors (Plan Administrator). The Plan Administrator generally determines which eligible individuals receive option grants or other awards, the time or times when the awards are made, the
number of shares subject to each award, the exercise price or other amount payable in connection with an award, the status of any granted option as either an incentive stock option or a non-statutory stock option under the federal tax laws, the
vesting schedule to be in effect for each award, and the maximum term for which any award is to remain outstanding. The exercise price for any options and the issue price for shares granted pursuant to the 2000 Plan may be paid in cash, vested
shares in certain circumstances, and a net-issuance basis. In addition, no participant in the 2000 Plan may be granted stock options, separately exercisable stock appreciation rights and direct stock issuances for more than 1,000,000 shares of
Common Stock per calendar year.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



In certain circumstances involving an acquisition or merger of the Company, a sale of substantially
all of the Companys assets, a change in more than 30 percent of the ownership of the Company, or a change in control of the Companys board of directors, all vesting of awards under the 1999 Plan, the Executive Plan and the 2000 Plan may
be accelerated or extended.



The following is a summary of
transactions relating to the 1999 Plan, the Executive Plan and the 2000 Plan:



|                                         |  |            |   |  |                                 |      
|---------------------------------------- |  | ---------- | - |  | ------------------------------- | -----
|                                         |  | Shares     |   |  | Weighted Average Exercise Price
|Options Outstanding at January 1, 2001   |  | 16,844,266 |   |  | $                               | 5.29 
|Granted                                  |  | 7,662,257  |   |  |                                 | 12.27
|Exercised                                |  | (2,446,343 | ) |  |                                 | 2.52 
|Canceled                                 |  | (2,382,599 | ) |  |                                 | 10.08
|                                         |  |            |   |  |                                 |      
|Options Outstanding at December 31, 2001 |  | 19,677,581 |   |  |                                 | 7.58 
|Granted                                  |  | 8,405,000  |   |  |                                 | 6.07 
|Exercised                                |  | (1,246,040 | ) |  |                                 | 1.60 
|Canceled                                 |  | (2,943,134 | ) |  |                                 | 11.11
|                                         |  |            |   |  |                                 |      
|Options Outstanding at December 31, 2002 |  | 23,893,407 |   |  |                                 | 6.93 
|Granted                                  |  | 6,821,000  |   |  |                                 | 5.70 
|Exercised                                |  | (2,210,119 | ) |  |                                 | 1.42 
|Canceled                                 |  | (2,703,940 | ) |  |                                 | 7.83 
|                                         |  |            |   |  |                                 |      
|Options Outstanding at December 31, 2003 |  | 25,800,348 |   |  | $                               | 6.86 
|                                         |  |            |   |  |                                 |      
|Options Exercisable at December 31, 2003 |  | 15,532,503 |   |  | $                               | 7.29 
|                                         |  |            |   |  |                                 |      



Of the options exercisable as of
December 31, 2003, options exercisable for 14,605,019 shares are vested.



Summarized information about stock options outstanding as of December 31, 2003, is as follows:



|                     |  |                         |  |                                |  |                      |       |                                |        |                      |   |      
|-------------------- |  | ----------------------- |  | ------------------------------ |  | -------------------- | ----- | ------------------------------ | ------ | -------------------- | - | -----
|                     |  | Outstanding             |  | Exercisable                   
|Exercise Price Range |  | RemainingLife(in years) |  | Number ofOptions(in thousands) |  | AverageExercisePrice |       | Number ofOptions(in thousands) |        | AverageExercisePrice
|$  0.11 to $ 1.57    |  | 4.92                    |  | 3,592                          |  | $                    | 0.87  |                                | 3,592  |                      | $ | 0.87 
|$  1.73 to $ 2.83    |  | 8.28                    |  | 3,340                          |  | $                    | 2.71  |                                | 1,274  |                      | $ | 2.59 
|$  2.93 to $ 2.98    |  | 8.98                    |  | 815                            |  | $                    | 2.98  |                                | 210    |                      | $ | 2.98 
|$  3.18 to $ 4.55    |  | 9.11                    |  | 2,909                          |  | $                    | 4.46  |                                | 533    |                      | $ | 4.34 
|$  4.93 to $ 7.71    |  | 9.39                    |  | 2,712                          |  | $                    | 7.04  |                                | 311    |                      | $ | 6.47 
|$  7.96 to $ 8.38    |  | 7.24                    |  | 1,802                          |  | $                    | 8.32  |                                | 1,282  |                      | $ | 8.34 
|$  8.50 to $ 8.74    |  | 8.07                    |  | 2,896                          |  | $                    | 8.74  |                                | 2,069  |                      | $ | 8.74 
|$  8.75 to $10.00    |  | 6.89                    |  | 3,277                          |  | $                    | 9.78  |                                | 2,755  |                      | $ | 9.80 
|$10.06 to $14.85     |  | 7.09                    |  | 3,121                          |  | $                    | 12.26 |                                | 2,320  |                      | $ | 12.36
|$14.90 to $19.00     |  | 6.93                    |  | 1,336                          |  | $                    | 15.29 |                                | 1,186  |                      | $ | 15.25
|$  0.11 to $ 19.00   |  | 7.55                    |  | 25,800                         |  | $                    | 6.86  |                                | 15,532 |                      | $ | 7.29 
|                     |  |                         |  |                                |  |                      |       |                                |        |                      |   |      



The following table
shows pro forma net loss as if the fair value method had been used to account for stock-based compensation expense (in thousands except per share amounts):



|                               |  |              |         |   |      |   |         |      |  |   |         |  
|------------------------------ |  | ------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                               |  | December 31, |        
|                               |  | 2001         |         |   | 2002 |   |         | 2003 | 
|Net Income (Loss), as reported |  | $            | (74,651 | ) |      | $ | (10,599 | )    |  | $ | 14,958  |  
|Pro Forma Adjustment           |  |              | (21,162 | ) |      |   | (24,412 | )    |  |   | (25,463 | )
|                               |  |              |         |   |      |   |         |      |  |   |         |  
|Pro Forma Net Loss             |  | $            | (95,813 | ) |      | $ | (35,011 | )    |  | $ | (10,505 | )
|                               |  |              |         |   |      |   |         |      |  |   |         |  
|Pro forma Net Loss per Share:  |  |              |         |   |      |   |         |      |  |   |         |  
|Basic                          |  | $            | (0.99   | ) |      | $ | (0.33   | )    |  | $ | (0.10   | )
|                               |  |              |         |   |      |   |         |      |  |   |         |  
|Diluted                        |  | $            | (0.99   | ) |      | $ | (0.33   | )    |  | $ | (0.10   | )
|                               |  |              |         |   |      |   |         |      |  |   |         |  



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



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



|                        |  |                |  |                |  |       
|----------------------- |  | -------------- |  | -------------- |  | ------
|                        |  | 2001           |  | 2002           |  | 2003  
|Risk-Free Interest Rate |  | 5.63% to 6.20% |  | 5.63% to 6.20% |  | 2.97% 
|Expected Life           |  | 4.00           |  | 4.00           |  | 4.00  
|Expected Volatility     |  | 77.70%         |  | 77.70%         |  | 77.70%
|Expected Dividends      |  |               |  |               |  |      



|10. | Income Taxes
|--- | ------------



The domestic and international components of income (loss) before income taxes are as follows (in millions):



|                           |  |              |       |   |      |   |       |      |  |   |      |  
|-------------------------- |  | ------------ | ----- | - | ---- | - | ----- | ---- |  | - | ---- | -
|                           |  | December 31, |      
|                           |  | 2001         |       |   | 2002 |   |       | 2003 | 
|United States              |  | $            | (58.3 | ) |      | $ | (5.3  | )    |  | $ | 17.6 |  
|International              |  |              | (16.4 | ) |      |   | (5.3  | )    |  |   | (2.6 | )
|                           |  |              |       |   |      |   |       |      |  |   |      |  
|Income (Loss) before taxes |  | $            | (74.7 | ) |      | $ | (10.6 | )    |  | $ | 15.0 |  
|                           |  |              |       |   |      |   |       |      |  |   |      |  



The Company did not
record a tax provision for the years ended December 31, 2001, 2002 and 2003, as it had incurred only tax net operating losses as of these dates. A full valuation allowance has been provided against the tax benefit generated by the net operating
losses and all other net deferred tax assets because of the uncertainty associated with their realization.



The tax benefits associated with employee exercise of non-qualified stock options, disqualifying dispositions of stock acquired with incentive stock
options, and disqualifying dispositions of stock acquired under the employee stock purchase plan generally reduce taxes currently payable. However, no tax benefits were recorded to additional paid-in capital in 2003, 2002 and 2001 because their
realization was not believed to be more likely than not. Consequently, a valuation allowance was recorded against the entire benefit. Benefits to be recognized in the future related to stock option deductions are approximately $9.6
million.



The components of the Companys net deferred
income tax assets are as follows (in thousands):



|                                |  |              |         |   |      |   |         |      |  |   |         |  
|------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                |  | December 31, |        
|                                |  | 2001         |         |   | 2002 |   |         | 2003 | 
|Deferred Tax Assets:            |  |              |         |   |      |   |         |      |  |   |         |  
|Net operating loss carryforward |  | $            | 56,848  |   |      | $ | 68,616  |      |  | $ | 75,694  |  
|Accruals and reserves, net      |  |              | 8,658   |   |      |   | 1,496   |      |  |   | 784     |  
|Other deferred assets           |  |              | 172     |   |      |   | 329     |      |  |   | 87      |  
|Capitalized contract costs      |  |              | 11,422  |   |      |   | 10,140  |      |  |   | 8,860   |  
|Depreciation and amortization   |  |              | 2,826   |   |      |   | 1,189   |      |  |   | 2,683   |  
|                                |  |              |         |   |      |   |         |      |  |   |         |  
|                                |  |              | 79,926  |   |      |   | 81,770  |      |  |   | 88,108  |  
|Less: Valuation allowance       |  |              | (74,244 | ) |      |   | (74,287 | )    |  |   | (70,172 | )
|                                |  |              |         |   |      |   |         |      |  |   |         |  
|Total deferred tax assets       |  |              | 5,682   |   |      |   | 7,483   |      |  |   | 17,936  |  
|                                |  |              |        
|Deferred Tax Liabilities:       |  |              |         |   |      |   |         |      |  |   |         |  
|Unbilled Receivable             |  |              |        |   |      |   | (2,699  | )    |  |   | (13,235 | )
|Other                           |  |              | (5,682  | ) |      |   | (4,784  | )    |  |   | (4,701  | )
|                                |  |              |         |   |      |   |         |      |  |   |         |  
|Total deferred tax liabilities  |  |              | (5,682  | ) |      |   | (7,483  | )    |  |   | (17,936 | )
|Other Deferred Assets           |  | $            |        |   |      | $ |        |      |  | $ |        |  
|                                |  |              |         |   |      |   |         |      |  |   |         |  



At December 31, 2003,
the Company had federal, state and foreign net operating loss carryforwards of approximately $158.2 million, $131.6 million and $31.9 million, respectively. The federal and state net operating loss carryforwards will begin expiring in the years 2019
and 2007, respectively. The foreign net operating loss may be carried forward indefinitely. The realization of future tax benefits from utilization of the net operating loss carryforwards may be subject to certain limitations as a result of
ownership changes that have occurred and may occur in the future.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



During 2003, the Company did not repatriate earnings from any of its foreign subsidiaries. The net
undistributed earnings from foreign subsidiaries at December 31, 2003, on which no U.S. tax has been provided, amounted to approximately $1.1 million. The net undistributed earnings are intended to finance local operating requirements. Accordingly,
an additional United States tax provision has not been provided on these earnings.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



|11. | Net Income (Loss) Per Share
|--- | ---------------------------



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



|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                            |  | Year Ended December 31, |        
|                                                            |  | 2001                    |         |   | 2002 |   |         | 2003 | 
|Numerator                                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (loss) from Continuing Operations                    |  | $                       | (72,824 | ) |      | $ | (11,572 | )    |  | $ | 19,560  |  
|Income (loss) from Discontinued Operations                  |  |                         | (1,827  | ) |      |   | 973     |      |  |   | (4,602  | )
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Net income (loss)                                           |  | $                       | (74,651 | ) |      | $ | (10,599 | )    |  | $ | 14,958  |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Denominator                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic:                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Weighted average common shares                              |  |                         | 96,622  |   |      |   | 105,199 |      |  |   | 106,870 |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (loss) from Continuing Operations per common share   |  | $                       | (0.75   | ) |      | $ | (0.11   | )    |  | $ | 0.18    |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (loss) from Discontinued Operations per common share |  | $                       | (0.02   | ) |      | $ | 0.01    |      |  | $ | (0.04   | )
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Net income (loss) per common share                          |  | $                       | (0.77   | ) |      | $ | (0.10   | )    |  | $ | 0.14    |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Diluted:                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Weighted average common shares                              |  |                         | 96,622  |   |      |   | 105,199 |      |  |   | 106,870 |  
|Stock option equivalent shares                              |  |                         |        |   |      |   |        |      |  |   | 8,590   |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Average common shares outstanding                           |  |                         | 96,622  |   |      |   | 105,199 |      |  |   | 115,460 |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (loss) from Continuing Operations per common share   |  | $                       | (0.75   | ) |      | $ | (0.11   | )    |  | $ | 0.17    |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Income (loss) from Discontinued Operations per common share |  | $                       | (0.02   | ) |      | $ | 0.01    |      |  | $ | (0.04   | )
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Net income (loss) per common share                          |  | $                       | (0.77   | ) |      | $ | (0.10   | )    |  | $ | 0.13    |  
|                                                            |  |                         |         |   |      |   |         |      |  |   |         |  



For the years ended
December 31, 2001 and 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 was antidilutive. As of December 31, 2001, the
Company had a warrant outstanding for 2,500,000 shares of Common Stock with an exercise price of $11.00 per share and options outstanding for 19,677,581 shares of Common Stock with a weighted average exercise price of $7.58 per share. As of December
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 for 23,893,407 shares of Common Stock with a weighted average exercise price of $6.93
per share.



For the year ended December 31, 2003, the weighted
average number of shares outstanding used to compute diluted net income per share excluded the effect of a warrant outstanding exercisable of 1,000,000 shares of Common Stock with an exercise price of $7.55 per share and options outstanding
exercisable for 13,200,739 shares of Common Stock with a weighted average exercise price of $10.56 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. In addition, until such time that one of the conversion criteria has been met, the impact of the conversion of the Companys 2.50% Convertible Senior Notes issued during 2003 will be excluded
from the computation of net income per share. Based upon the current conversion price, the 2.50% Convertible Senior Notes would be convertible into 9,353,741 shares of Common Stock.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



|12. | Commitments and Contingencies
|--- | -----------------------------



Lease Obligations



The Company leases space in the building it uses as its international headquarters under a noncancellable operating lease agreement, which expires in June
2008, and leases space in the building it uses as its European headquarters under a noncancellable operating lease agreement, which expires in June 2010. The Company also leases space to house its processing and shared service center staffs in
Canada, India, North Carolina, Scotland, Tennessee and Texas under noncancellable operating lease agreements expiring in June 2005, June 2006, November 2010, March 2010, October 2011 and March 2006, respectively. Under the lease agreement for the
Scotland facility, the landlord or the Company may terminate the agreement in March 2005 with 12 months prior notice, and the landlord has provided that notice. The Company also leases certain amounts of limited office space for various employees
and office equipment under operating lease agreements expiring through January 2012.



Future minimum rental commitments under all operating leases as of December 31, 2003, are as follows (in thousands):



|                              |  |   |       
|----------------------------- |  | - | ------
|Year Ending December 31,      |  |  
|2004                          |  | $ | 6,688 
|2005                          |  |   | 6,113 
|2006                          |  |   | 4,860 
|2007                          |  |   | 4,318 
|2008                          |  |   | 4,053 
|Thereafter                    |  |   | 7,036 
|                              |  |   |       
|Future Minimum Lease Payments |  | $ | 33,068
|                              |  |   |       



Rental expense for the
years ended December 31, 2001, 2002 and 2003, was $7,800,000, $8,652,000 and $8,681,000, respectively.



Purchase Commitments



The Company has entered into various purchase commitment agreements with third parties for certain software application products and services in connection with the Companys process management service offerings. Under these
agreements, the Company is required to make aggregate minimum payments of $1,013,000, $72,000, $4,780,000, and $7,500,000 upon receipt of the products and services for the years ended December 31, 2004, 2005, 2006, and 2007, respectively. Certain of
these agreements provide the Company with the ability to cancel the respective agreement for convenience upon the payment of a fee.



Legal Proceedings, Lawsuits and Other Claims



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, claims for indemnity arising in the course of the Companys business 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 recoverable from third parties, or the financial impact with respect to these matters as of December 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.



|13. | Related Party Transactions
|--- | --------------------------



The Company entered into employment agreements with key management personnel. These agreements provide for a defined level of compensation and additional
compensation in the form of discretionary bonuses. The agreements also provide for severance benefits in the event of termination without cause or in connection with a change in control, as defined.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



As of December 31, 2003, the Company had a full recourse loan outstanding to one of its executive
officers with a total original principle of $1,150,000 made in various draws during 2000. Interest accrues on the various draws at rates ranging from 4.00 percent to 6.40 percent per annum. The loan and accrued interest is to be forgiven, provided
the executive remains employed by the Company, in three equal annual increments that began in March 31, 2003. The forgiveness of the loan and accrued interest is being amortized as additional compensation with the amortization being included in
selling, general and administrative expense. As of December 31, 2002 and 2003, the carrying value of the loan is $800,000 and $479,000, respectively, and is included in prepaid expenses and other current assets. This loan was made in 2000 and is
therefore grandfathered under the Sarbanes-Oxley Act of 2002.



In December 2002, the Company entered into a retention arrangement with this executive. Pursuant to this arrangement, the executive has agreed not to resign from the Company without good reason (as defined in his modified employment
agreement) before December 31, 2005, in exchange for certain cash payments and a grant of restricted stock. The cash payments are expected to total approximately $3.0 million, approximately $2.5 million of which was expensed during 2002 with the
balance expensed in 2003 when it was earned. The restricted stock grant comprises 550,000 shares that are scheduled to vest in ten consecutive quarterly installments beginning June 2003, contingent upon the executives continued employment. The
value of the restricted stock on the date of grant, $1,640,000, is being amortized to expense over the vesting period.



As of December 31, 2003, the Company had a full recourse loan outstanding to one of its executive officers with a total original principle of 342,000
British pounds sterling or approximately $514,000 made in various draws during 2001 and 2002. Interest accrues on the various draws at a rate of 6.25 percent per annum. Provided that the executive remains employed by the Company, the loan and
accrued interest thereon is repayable in four increments as follows: one-fourth of the then outstanding balance on January 31, 2002, one-third of the then outstanding balance loan balance on January 30, 2003, one-half of the then outstanding loan
balance on January 30, 2004 and the balance of the then outstanding loan balance on January 30, 2005. Upon termination of the executives employment with the Company, the entire then outstanding loan balance and accrued interest thereon will
become due and payable. As of December 31, 2002 and 2003, the carrying value of the loan is $440,000 and $324,000, respectively, and is included in prepaid expenses and other current assets. This loan was made in 2000 and is therefore grandfathered
under the Sarbanes-Oxley Act of 2002.



In September 2003, the
Company purchased a 1/8thfractional aircraft interest for approximately $519,000 from Flight Options, LLC, an
independent operator of fractional aircraft ownership programs. The purchase price was the standard fair market value list price maintained by Flight Options. This interest, which was previously owned by the Companys Chief Executive Officer,
had been made available to the Company. Flight Options purchased the interest from the Companys Chief Executive Officer at the same price contemporaneously with the sale of the interest by Flight Options to the Company.



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EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



|14. | Acquisition and Divestiture
|--- | ---------------------------



Acquisition



On June 9, 2003, the Company acquired from a single group of affiliated sellers certain legal entities and assets and assumed certain liabilities
constituting a business process management outsourcing business that the Company intends to continue to operate. The results of operations of the acquired business for the period from June 10, 2003 through December 31, 2003, are included in the
Companys consolidated statements of operations. The cash purchase price, including transaction costs and net of $2,666,000 of cash acquired, was $16,623,000. The allocation of the purchase price to the assets acquired, including the excess of
net tangible assets acquired over liabilities assumed, is as follows (in thousands):



|                            |  |   |       
|--------------------------- |  | - | ------
|Current Assets              |  | $ | 5,242 
|Fixed Assets                |  |   | 6,453 
|Intangible Assets           |  |   | 12,647
|Other Assets                |  |   | 97    
|                            |  |   |       
|Total Assets Acquired       |  |   | 24,439
|Current Liabilities Assumed |  |   | 7,816 
|                            |  |   |       
|Net Assets Acquired         |  | $ | 16,623
|                            |  |   |       



The value attributed to each purchased
outsourcing contract has been recorded as an intangible asset. The intangible assets will be amortized as cost of revenue over the remaining terms (ranging up to approximately six years) of the purchased contracts.



Discontinued operations



In the fourth quarter of fiscal 2003, management determined that the Gunn consulting operation no longer fit the
Companys strategic operating objectives and accordingly adopted a formal plan to dispose of this operation within the next twelve-month period. Accordingly, the operating results of the operations have been classified as discontinued
operations for all periods presented.



For the years ended
December 31, 2003, 2002 and 2001, the Gunn consulting operation generated revenue of $6.5 million, $14.5 million and $15.6 million, respectively, resulting in net income (loss) of $(4.6) million, $1.0 million and $(1.9) million, or (1.0)%, 0.2% and
0.6% of consolidated revenue from continuing operations, respectively. The loss from discontinued operations for the year ended December 31, 2003, included an impairment charge of approximately $3.3 million relating to goodwill. As a result of
managements determination to discontinue its Gunn consulting operation, the Company performed an analysis to assess the net realizable value of the Gunn assets, including the $3.4 million of goodwill associated with the acquisition of the Gunn
consulting operation in November 1999. Based on a valuation that was done as of December 31, 2003, using on available market information, to determine the sales valuation of the Gunn assets held for sale, the Company determined that the consulting
operation was impaired and in accordance with SFAS 144, recorded the impairment charge related to the goodwill in the fourth quarter of 2003. Such impairment charges were recorded in accordance with the provisions of SFAS 144. As of December 31,
2003, subsequent to the write-offs, the net carrying value of the remaining assets in the consulting operation was approximately $100,000 and represents managements estimate of the net realizable value. This amount was classified as assets
held for sale in the accompanying consolidated balance sheet. During the year ended December 31, 2001, the Company recorded an approximate $2.2 million non-cash charge arising from the write-off of a Gunn research database that was determined to no
longer have value, which has been included as part of discontinued operations in 2001 (See Note 3(b)).



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##### Table of Contents

EXULT, INC. AND SUBSIDIARIES



Notes to Consolidated Financial Statements



15. Selected Quarterly Financial Data (unaudited)



The following table sets forth selected quarterly financial data for the
eight quarters ended December 31, 2003 (in thousands, except per share amounts):



|                                                                        |  |                 |        |   |              |   |        |                   |  |   |                  |   |  |   |        
|----------------------------------------------------------------------- |  | --------------- | ------ | - | ------------ | - | ------ | ----------------- |  | - | ---------------- | - |  | - | -------
|                                                                        |  | Quarter Ended 
|                                                                        |  | March 31,2002   |        |   | June 30,2002 |   |        | September 30,2002 |  |   | December 31,2002
|Revenue                                                                 |  | $               | 91,087 |   |              | $ | 96,694 |                   |  | $ | 99,675           |   |  | $ | 118,386
|Gross Profit (Loss)(1)                                                  |  |                 | (1,234 | ) |              |   | (574   | )                 |  |   | 4,938            |   |  |   | 11,695 
|Income (Loss) from Continuing Operations(1)                             |  |                 | (6,710 | ) |              |   | (5,100 | )                 |  |   | (1,342           | ) |  |   | 1,580  
|Income (Loss) from Discontinued Operations                              |  |                 | 86     |   |              |   | 572    |                   |  |   | 84               |   |  |   | 231    
|Net Income (Loss)                                                       |  |                 | (6,624 | ) |              |   | (4,528 | )                 |  |   | (1,258           | ) |  |   | 1,811  
|Income (Loss) per Share from Continuing Operations, basic and diluted   |  | $               | (0.06  | ) |              | $ | (0.05  | )                 |  | $ | (0.02            | ) |  | $ | 0.02   
|                                                                        |  |                 |        |   |              |   |        |                   |  |   |                  |   |  |   |        
|Income (Loss) per Share from Discontinued Operations, basic and diluted |  | $               | 0.00   |   |              | $ | 0.01   |                   |  | $ | 0.00             |   |  | $ | 0.00   
|                                                                        |  |                 |        |   |              |   |        |                   |  |   |                  |   |  |   |        
|Net Income (Loss) per Share, basic and diluted                          |  | $               | (0.06  | ) |              | $ | (0.04  | )                 |  | $ | (0.02            | ) |  | $ | 0.02   
|                                                                        |  |                 |        |   |              |   |        |                   |  |   |                  |   |  |   |        



|(1) | Commencing January 1, 2003, depreciation and amortization expense is included in Cost of Revenue and Selling, General and Administrative Expense. For comparison
purposes, 2002 quarterly financial data have been reclassified to conform to the current year presentation.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                              |  |                 |         |   |              |   |         |                   |  |   |                  |   |  |   |         |  
|------------------------------------------------------------- |  | --------------- | ------- | - | ------------ | - | ------- | ----------------- |  | - | ---------------- | - |  | - | ------- | -
|                                                              |  | Quarter Ended  |        
|                                                              |  | March 31,2003   |         |   | June 30,2003 |   |         | September 30,2003 |  |   | December 31,2003 |  
|Revenue                                                       |  | $               | 112,166 |   |              | $ | 120,494 |                   |  | $ | 129,716          |   |  | $ | 117,946 |  
|Gross Profit                                                  |  |                 | 9,869   |   |              |   | 12,099  |                   |  |   | 12,000           |   |  |   | 13,764  |  
|Income from Continuing Operations                             |  |                 | 4,033   |   |              |   | 4,679   |                   |  |   | 4,866            |   |  |   | 5,982   |  
|Income (Loss) from Discontinued Operations                    |  |                 | (122    | ) |              |   | (90     | )                 |  |   | (461             | ) |  |   | (3,929  | )
|Net Income                                                    |  |                 | 3,912   |   |              |   | 4,589   |                   |  |   | 4,405            |   |  |   | 2,052   |  
|Income (Loss) per Share from Continuing Operations, basic     |  | $               | 0.04    |   |              | $ | 0.04    |                   |  | $ | 0.04             |   |  | $ | 0.06    |  
|                                                              |  |                 |         |   |              |   |         |                   |  |   |                  |   |  |   |         |  
|Income (Loss) per Share from Discontinued Operations, basic   |  | $               | 0.00    |   |              | $ | 0.00    |                   |  | $ | 0.00             |   |  | $ | (0.04   | )
|                                                              |  |                 |         |   |              |   |         |                   |  |   |                  |   |  |   |         |  
|Net Income (Loss) per Share, basic                            |  | $               | 0.04    |   |              | $ | 0.04    |                   |  | $ | 0.04             |   |  | $ | 0.02    |  
|                                                              |  |                 |         |   |              |   |         |                   |  |   |                  |   |  |   |         |  
|Income (Loss) per Share from Continuing Operations, diluted   |  | $               | 0.03    |   |              | $ | 0.04    |                   |  | $ | 0.05             |   |  | $ | 0.05    |  
|                                                              |  |                 |         |   |              |   |         |                   |  |   |                  |   |  |   |         |  
|Income (Loss) per Share from Discontinued Operations, diluted |  | $               | 0.00    |   |              | $ | 0.00    |                   |  | $ | (0.01            | ) |  | $ | (0.03   | )
|                                                              |  |                 |         |   |              |   |         |                   |  |   |                  |   |  |   |         |  
|Net Income (Loss) per Share, diluted                          |  | $               | 0.03    |   |              | $ | 0.04    |                   |  | $ | 0.04             |   |  | $ | 0.02    |  
|                                                              |  |                 |         |   |              |   |         |                   |  |   |                  |   |  |   |         |  



F-31