Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2003

OR

For the transition period from              to             

Commission file number 000-50161

HEWITT HOLDINGS LLC

(Exact name of registrant as specified in its charter)

100 Half Day Road; Lincolnshire, Illinois 60069; 847-295-5000

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

N/A

(Former Name, Former Address & Former Fiscal Year, if changed since last report)

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 periods as the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

Table of Contents

HEWITT HOLDINGS LLC

FORM 10-Q

FOR THE PERIOD ENDED

DECEMBER 31, 2003

INDEX

2

Table of Contents

PART I. FINANCIAL INFORMATION

HEWITT HOLDINGS LLC

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

The accompanying notes are an integral part of these financial statements.

3

Table of Contents

HEWITT HOLDINGS LLC

CONSOLIDATED STATEMENTS OF OPERATIONS (1)

(Unaudited)

(Dollars in thousands)

The accompanying notes are an integral part of these financial statements.

4

Table of Contents

HEWITT HOLDINGS LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

The accompanying notes are an integral part of these financial statements.

5

Table of Contents

HEWITT HOLDINGS LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2003 AND 2002

(Unaudited)

(Dollars in thousands)

1. Description of Business

Hewitt Holdings LLC and Subsidiaries (“Hewitt Holdings” or the “Company”) consists of the “Property Entities” which consist of Hewitt Properties I LLC, Hewitt Properties II LLC, Hewitt Properties III LLC, Hewitt Properties IV LLC, Hewitt Properties V LLC, Hewitt Properties VI LLC, Hewitt Properties VII LLC and The Bayview Trust. Prior to July 1, 2003, Hewitt Associates, Inc. and its subsidiaries or its predecessor, Hewitt Associates LLC and Affiliates (“Hewitt Associates”) was the principal operating subsidiary of the Company. Hewitt Associates provides human resources outsourcing and consulting services. The term “owner” refers to the individuals who are current or retired owners of limited liability company interests of Hewitt Holdings.

Hewitt Holdings owns significant real estate assets directly and through its Property Entities. Substantially all of the activities of the Property Entities involve assets that are leased to Hewitt Associates on terms which at inception, were intended to be comparable to those which would have been obtained in an arm’s length transaction. The investments in these properties were funded through capital contributions of Hewitt Holdings’ owners and third-party debt. The debt is a non-recourse obligation of Hewitt Holdings’ Property Entities and is not an obligation of nor guaranteed by Hewitt Associates. The properties the Company owns are located in Illinois, Florida, and Texas.

In fiscal 2002, Hewitt Associates completed its transition to a corporate structure and initial public offering. As part of that transition, Hewitt Holdings, received 70,819,520 shares of Hewitt Associates’ Class B common stock. On July 1, 2003, Hewitt Holdings distributed the shares of Class B common stock of Hewitt Associates to its owners, with the exception of certain owners resident outside the United States who continue to hold their shares through Hewitt Holdings. The shares continue to be subject to the same restrictions with respect to voting, transfer and book to market phase-in as they were when the shares were held by Hewitt Holdings. The distribution reduced Hewitt Holdings’ majority interest in Hewitt Associates of approximately 72% at June 30, 2003, to a minority interest of approximately 2% at July 1, 2003 and December 31, 2003.

On August 6, 2003, Hewitt Associates completed a registered secondary offering of Hewitt Associates’ Class A common stock. In conjunction with Hewitt Associates’ secondary offering, the Company distributed 350,431 shares of Hewitt Associates’ Class B common stock to certain owners resident outside the United States who had held their shares through Hewitt Holdings.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q. In the opinion of management, these financial statements include all adjustments necessary to present fairly the financial position, results of operations and cash flows as of December 31, 2003, and for all periods presented. All adjustments made have been of a normal and recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The Company believes that the disclosures included are adequate and provide a fair presentation of interim period results. Interim financial statements are not necessarily indicative of the financial position or operating results for an entire year. It is suggested that these interim financial statements be read in conjunction with the audited financial statements and the notes thereto, together with management’s discussion and analysis of financial condition and results of operations, included in the Company’s Form 10-K for the fiscal year ended September 30, 2003 as filed with the Securities and Exchange Commission. Certain previously reported amounts have been reclassified to conform to the current period presentation.

6

Table of Contents

The consolidated financial statements are prepared on the accrual basis of accounting. The significant accounting policies are summarized below:

Principles of Consolidation

The accompanying consolidated financial statements reflect the operations of the Company and its majority owned subsidiaries after elimination of intercompany transactions and profits.

Investments in less than 50%-owned affiliated companies over which the Company has the ability to exercise significant influence are accounted for using the equity method of accounting. The Company applies the equity method of accounting and does not consolidate its 51% interest in Overlook Associates, an Illinois partnership, as Hewitt Holdings does not exercise control over this partnership. Overlook Associates owns and operates commercial office buildings and develops and sells vacant land in Lincolnshire, Illinois.

On July 1, 2003, the Company distributed 67,783,937 shares of Class B common stock of Hewitt Associates then held by the Company to its owners (the “Distribution”). The Distribution reduced Hewitt Holdings’ majority interest in Hewitt Associates to approximately 2% so that the Company no longer consolidates the results of Hewitt Associates, but accounts for the remaining investment in Hewitt Associates using the equity method of accounting. Prior to the Distribution, all of the assets, liabilities and earnings of Hewitt Associates and its subsidiaries were consolidated in the Company’s financial statements, and the non-affiliated investors’ Class A, Class B and Class C common stock interests in Hewitt Associates were recorded as a “Minority Interest” on the consolidated balance sheet and statement of operations for financial reporting purposes. The Company’s consolidated balance sheets at December 31, 2003 and September 30, 2003 do not reflect the consolidated assets, liabilities and capital of Hewitt Associates. However, the Company’s consolidated statement of operations and statement of cash flows for the three months ended December 31, 2002, include the consolidated results of operations of Hewitt Associates.

Prior to July 1, 2003, significant eliminating entries resulting from the consolidation of Hewitt Associates included the elimination of intercompany capital leases and the reversal of intercompany rental income and expense and the recognition of depreciation and interest expense related to the real estate under capital leases. As such, on a consolidated basis, the Company’s financial statements prior to July 1, 2003, reflect the Company’s owned real estate and related third-party debt and no intercompany lease obligations and related activities.

Revenue Recognition

HR services revenues include fees generated from outsourcing contracts and from consulting services provided to Hewitt Associates’ clients. Under outsourcing contracts, which typically have a three- to five-year term, clients generally pay an implementation fee and an ongoing service fee. In accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, Hewitt Associates recognizes revenues for non-refundable, upfront implementation fees evenly over the period between the initiation of ongoing services through the end of the contract term (on a straight-line basis). Indirect costs of implementation are expensed as incurred. However, incremental direct costs of implementation are deferred and recognized as expense over the same period that deferred implementation fees are recognized. If a client terminates an outsourcing contract prematurely, both the deferred implementation revenues and related costs are recognized in the period in which the termination occurs.

HR services revenues related to ongoing service fees and to services provided outside the scope of outsourcing contracts are recognized when persuasive evidence of an arrangement exists, services have been rendered, the fee is determinable and collectibility of the fee is reasonably assured. Ongoing service fees are typically billed and recognized on a monthly basis, typically based on the number of plan participants or services and often with a minimum monthly fee. Services provided outside the scope of outsourcing contracts are billed and recognized on a time-and-material or fixed fee basis.

Losses on outsourcing or consulting arrangements are recognized during the period in which a loss becomes probable and the amount of the loss is reasonably estimable. Contract or project losses are determined to be the amount by which the estimated direct and a portion of indirect costs exceed the estimated total revenues that will be

7

Table of Contents

generated by the arrangement. Estimates are continuously monitored during the term of the arrangement and any changes to estimates are recorded in the current period and can result in either increases or decreases to income.

Clients typically pay for consulting services either on a time-and-materials or, to a lesser degree, on a fixed-fee basis. HR services revenues are recognized under time-and-material based arrangements as services are provided. On fixed-fee engagements, HR services revenues are recognized as the services are performed, which is measured by hours incurred in proportion to total hours estimated to complete a project.

Revenues earned in excess of billings are recorded as unbilled work in process. Billings in excess of revenues earned are recorded as advanced billings to clients, a deferred revenue liability, until services are rendered.

The Company considers the criteria established by Emerging Issues Task Force (“EITF”) Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, in determining whether revenue should be recognized on a gross versus a net basis. In consideration of these criteria, the Company recognizes revenue primarily on a gross basis. Factors considered in determining if gross or net recognition is appropriate include whether Hewitt Associates is primarily responsible to the client for the services, changes the delivered product, performs part of the service delivered, has discretion on vendor selection, or bears credit risk. In accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred, reimbursements received for out-of-pocket expenses incurred are characterized as revenues and are shown as a separate component of total revenues. Similarly, related reimbursable expenses are also shown separately within operating expenses.

The Company leases its real estate properties pursuant to operating leases. The Company records rental income for the full term of each lease on a straight-line basis. Generally, the leases provide for lessee occupancy during periods for which no rent is due or where minimum rent payments increase during the term of the lease. Accordingly, a receivable is recorded from lessees for the current difference between the straight-line rent and the rent that is contractually due from the lessee. During the three months ended December 31, 2003, 100% of the Company’s rental income was derived from leases with Hewitt Associates. Prior to the Distribution, all rental income and related receivables from Hewitt Associates were eliminated in the consolidation of Hewitt Associates.

Deferred Contract Costs and Deferred Contract Revenues

For new outsourcing services, upfront implementation efforts are required to set up a client and their human resource or benefit programs on Hewitt Associates’ systems. The direct implementation or “set up” costs and any upfront set up fees are deferred and recognized into earnings over the life of the outsourcing agreement. Specific, incremental and direct costs of implementation are deferred and recognized as primarily compensation and related expenses evenly over the period between the initiation of ongoing services through the end of the contract term. Implementation fees may be received either upfront or over the ongoing services period in the fee per participant. By deferring the upfront set up fees over the ongoing services period, all set up revenues are recognized evenly over the contract term along with the corresponding deferred contract costs.

Performance-Based Compensation

Hewitt Associates’ compensation program includes a performance-based component that is determined by Hewitt Associates’ management. Performance-based compensation is discretionary and is based on individual, team, and Hewitt Associates’ performance. Performance-based compensation is paid once per fiscal year after Hewitt Associates’ annual operating results are finalized. The amount of expense for performance-based compensation recognized at interim and annual reporting dates involves judgment, is based on quarterly and annual results as compared to internal targets, and takes into account other factors, including industry-wide results and the general economic environment. Annual performance-based compensation levels may vary from current expectations as a result of changes in the actual performance of the individual, team, or Hewitt Associates. As such, accrued amounts are subject to change in future periods if actual future performance varies from performance levels anticipated in prior interim periods.

8

Table of Contents

Use of Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, the accounting for contract and project loss reserves, performance-based compensation, the allowance for doubtful accounts, depreciation and amortization, asset impairment, taxes, and any contingencies. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates.

Stock-Based Compensation

The Company applies the intrinsic value method for accounting for stock-based compensation as outlined in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees and provides the pro forma disclosures required by SFAS No. 123, Accounting for Stock-Based Compensation as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure.

Hewitt Associates’ restricted stock awards, including restricted stock and restricted stock units, are measured using the fair market value of the stock as of the grant date and are recorded as unearned compensation on the balance sheet. As the restricted stock awards vest, the unearned compensation is amortized to compensation expense on a straight-line basis. Employer payroll taxes are also recorded as expense when they become due over the vesting period. The shares are subject to forfeiture and restrictions on sale or transfer for four years from the grant date.

Hewitt Associates also grants nonqualified stock options at an exercise price equal to the fair market value of Hewitt Associates’ stock on the grant date. Since the stock options have no intrinsic value on the grant date, no compensation expense is recorded in connection with the stock option grants. Generally, Hewitt Associates’ stock options vest 25 percent on each anniversary of the grant date, are fully vested four years from the grant date and have a term of ten years.

For purposes of pro forma disclosures, the estimated fair value of the stock options is amortized to compensation expense over the stock options’ vesting period. The Company’s pro forma income after taxes and minority interest and before owner distributions for the three months ended December 31, 2002, would have been as follows:

New Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN No. 46”), Consolidation of Variable Interest Entities, to expand upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. In December 2003, the FASB revised FIN No. 46 to provide more clarification. Until now, a company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN No. 46 changes that by requiring a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. FIN No. 46, as revised, is not expected to have a material impact on the Company’s consolidated financial statements.

9

Table of Contents

3. Distribution of Hewitt Associates Shares

On July 1, 2003, the Company distributed 67,783,937 shares of Hewitt Associates’ Class B common stock it held to its owners (the “Distribution”). The Distribution reduced Hewitt Holdings’ majority interest in Hewitt Associates to approximately 2% so that the Company no longer consolidates the results of Hewitt Associates, but accounts for the remaining investment in Hewitt Associates using the equity method of accounting. As a result, the Company’s consolidated balance sheets at December 31, 2003 and September 30, 2003 do not reflect the consolidated assets, liabilities and capital of Hewitt Associates and the Company’s statements of operations and cash flows for the three months ended December 31, 2003 do not reflect the operations of Hewitt Associates. However, the Company’s statements of operations and cash flows for the three months ended December 31, 2002, do include the operations of Hewitt Associates. The following unaudited pro forma results give effect to the de-consolidation as if it had occurred on October 1, 2002, the beginning of fiscal 2003, and exclude any non-recurring adjustments, to allow for comparability.

The Hewitt Associates historical results in the following pro forma consolidated income statements reflect Hewitt Associates’ results for the three months ended December 31, 2002. The information presented is not necessarily indicative of the results of operations that might have occurred had the events described above actually taken place as of the dates specified. The pro forma adjustments are based upon available information and assumptions that management believes are reasonable. This information and the accompanying notes should also be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report and our Annual Report on Form 10-K.

10

Table of Contents

Hewitt Holdings LLC

Pro Forma Consolidated Income Statements

(unaudited)

11

Table of Contents

4. Other Comprehensive Income

The following table presents the pre-tax and after-tax components of the Company’s other comprehensive income for the periods presented:

5. Related Party Transactions

The Company entered into real estate operating leases with Hewitt Associates and its subsidiaries on terms which at inception, were intended to be comparable to those which would have been obtained in an arm’s length transaction. The investments in the properties were funded through capital contributions by Hewitt Holdings’ owners and third-party debt. The debt is reflected on the Company’s balance sheet and is not an obligation of, nor guaranteed by, Hewitt Associates.

In June 2002, Hewitt Associates entered into a 15-year capital lease with The Bayview Trust to lease office space in Newport Beach, California. On March 7, 2003, The Bayview Trust sold the property in Newport Beach, California, and Hewitt Associates’ lease was assigned to the third-party purchaser of the building.

From May 31, 2002, through September 30, 2007, Hewitt Associates LLC, a subsidiary of Hewitt Associates, Inc., will provide certain support services to Hewitt Holdings, primarily in the financial, real estate and legal departments, as may be requested by Hewitt Holdings from time to time. Hewitt Holdings will pay Hewitt Associates LLC an annual fee of $50 for basic services. Hewitt Associates LLC may charge Hewitt Holdings separately for additional services on a time and materials basis. Through December 31, 2003, fees for all services Hewitt Associates LLC has provided under the services agreement, totaling $35 for the three months ended December 31, 2003 and $13 for the comparable prior year period, have been paid by Hewitt Holdings.

12

Table of Contents

6. Client Receivables and Unbilled Work in Process

Client receivables and unbilled work in process, net of allowances, at December 31, 2003 and September 30, 2003, consisted of the following:

7. Legal Proceedings

The Company is occasionally subject to lawsuits and claims arising in the normal conduct of business. Management does not expect the outcome of any pending claim to have a material adverse affect on the business, financial condition or results of operations of the Company.

Hewitt Associates provides indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products or receipt of our services. The Company evaluates estimated losses for such indemnifications under SFAS 5, Accounting for Contingencies, as interpreted by FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others. Management considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. As of December 31, 2003, the Company had no outstanding claims and was not subject to any pending litigation alleging that the Company’s products or services infringe the intellectual property rights of any third parties.

8. Stock-Based Compensation Plans

Hewitt Associates has a Global Stock and Incentive Compensation Plan (the “Plan”) for its employees and directors. The Plan is administered by the Compensation and Leadership Committee of the Board of Directors of the Company (the “Committee”). Under the Plan, employees and directors may receive awards of nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and cash-based awards, and employees can also receive incentive stock options. A total of 25,000,000 shares of Class A common stock have been reserved for issuance under the Plan. Through the Distribution date, only restricted stock and restricted stock units and nonqualified stock options had been granted.

In connection with its initial public offering in June 2002, Hewitt Associates granted 5,789,908 shares of Class A restricted stock and restricted stock units to employees. The restricted stock and restricted stock units have substantially the same terms, except the holders of restricted stock units do not have voting rights. The one-time initial public offering-related awards were valued at $110,141 on the June 27, 2002, grant date (a weighted price of $19.02 per share) and 37% were amortized on a straight-line basis as non-cash compensation expense from the grant date until December 31, 2002 and 63% are being amortized on a straight-line basis as non-cash compensation expense over four years following the grant date. As a result of the Distribution and subsequent de-consolidation of Hewitt Associates, the Company did not recognize any compensation expense for the initial public offering restricted stock awards in the three months ended December 31, 2003. For the three months ended December 31, 2002, compensation expense for the initial public offering restricted stock awards was $24,885, representing amortization and applicable payroll taxes for the period.

The Committee also granted 4,041,393 nonqualified stock options to purchase shares of Hewitt Associates Class A common stock prior to the Distribution. The option prices were determined by the Committee, provided that for options issued to participants in the United States, the option price could not be less than 100% of the fair market value of the shares on the date the option was granted and no option was exercisable later than the tenth aniversary of its grant. The nonqualified stock options granted vest over a period of four years.

13

Table of Contents

9. Intangible Assets

The Company tests intangible assets for impairment whenever indicators of impairment arise. During the three months ended December 31, 2003 and for the year ended September 30, 2003, no impairments on intangible assets were recognized.

Intangible assets with definite useful lives are amortized over their respective estimated useful lives. The following is a summary of intangible assets at December 31, 2003 and September 30, 2003:

Amortization expense related to definite-lived intangible assets for the three months ended December 31, 2003 and 2002, are as follows:

Estimated amortization expense related to intangible assets at September 30, 2003, is $62 in each of the five years that end September 30, 2008 and $595 for years thereafter.

10. Segment Data

As a result of the Distribution and subsequent de-consolidation of Hewitt Associates, Inc., Hewitt Holdings has one business segment consisting of its real estate operations.

Prior to July 1, 2003, pursuant to SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company determined that it had two reportable segments, Outsourcing and Consulting, based on similarities among the Hewitt Associates’ operating units including homogeneity of services, service delivery methods, and use of technology.

Hewitt Associates operates many of the administrative and support functions of its business through the use of centralized shared service operations to provide an economical and effective means of supporting the outsourcing and consulting businesses. These shared services include information systems, human resources, general office support and space management, overall corporate management, finance and legal services. Additionally, Hewitt Associates utilizes a client development group that markets the entire spectrum of its services and devotes resources to maintaining existing client relationships. The compensation and related expenses, other operating expenses, and selling, general and administrative expenses of the administrative and marketing functions are not allocated to the business segments, rather, they are included in unallocated shared costs. The costs of information services, human resources and the direct client delivery activities provided by the client development function are, however, allocated to the Outsourcing and Consulting segments on a specific identification basis or based on usage or headcount.

14

Table of Contents

The table below presents information about the Company’s reportable segments for the three months ended December 31, 2002:

15

Table of Contents

The following information should be read in conjunction with the information contained in our consolidated financial statements and related notes presented earlier in this Quarterly Report on Form 10-Q. Please also refer to our consolidated financial statements and related notes and the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for additional information. In addition to historical information, this Quarterly Report on Form 10-Q may contain forward-looking statements that involve risks, uncertainties and assumptions, which could cause actual results to differ materially from management’s expectations. Please see additional risks and uncertainties described below and in the “Notes Regarding Forward-Looking Statements” which appears later in this section.

We use the terms “Hewitt Holdings” and “the Company” to refer to Hewitt Holdings LLC and its subsidiaries. We use the term “Hewitt Associates” to refer to the business of Hewitt Associates, Inc. and its subsidiaries. We use the term “Property Entities” to refer to Hewitt Holdings’ wholly-owned subsidiaries, Hewitt Properties I LLC, Hewitt Properties II LLC, Hewitt Properties III LLC, Hewitt Properties IV LLC, Hewitt Properties V LLC, Hewitt Properties VI LLC, Hewitt Properties VII LLC and The Bayview Trust.

We use the term “owner” to refer to the individuals who are current or retired members of Hewitt Holdings. These individuals (with the exception of our retired owners) became employees of Hewitt Associates upon the completion of Hewitt Associates’ transition to a corporate structure on May 31, 2002.

All references to years, unless otherwise noted, refer to our fiscal years, which end on September 30. For example, a reference to “2004”or “fiscal 2004” means the twelve-month period that ends September 30, 2004. All references to percentages contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” refer to calculations based on the amounts in our consolidated financial statements, presented earlier in this Quarterly Report on Form 10-Q. Certain prior period amounts have been reclassified to conform with the current year presentation.

Overview

On July 1, 2003, Hewitt Holdings distributed the shares of Hewitt Associates’ Class B common stock to its owners, with the exception of certain owners resident outside the United States who will continue to hold their shares through Hewitt Holdings (the “Distribution”). Following the Distribution, Hewitt Holdings’ ownership in Hewitt Associates decreased to approximately 2%. As such, Hewitt Holdings applies the equity method of accounting for its investment in Hewitt Associates so that only Hewitt Holdings’ share of Hewitt Associates’ earnings will be recognized as Hewitt Holdings’ other income. Beginning on July 1, 2003, Hewitt Holdings’ only business is owning, financing and leasing real estate assets which are primarily used by Hewitt Associates in operating its business. As a result of the Distribution and subsequent de-consolidation of Hewitt Associates, Hewitt Holdings’ consolidated balance sheet as of September 30, 2003 does not reflect the consolidated assets, liabilities and equity of Hewitt Associates. However, the Company’s consolidated statement of operations and statement of cash flows for the three months ended December 31, 2002, include Hewitt Associates’ results.

Prior to the Distribution, Hewitt Associates was the principal operating business of the Company. Hewitt Holdings’ total revenues were comprised of Hewitt Associates’ HR services revenues. Hewitt Holdings’ third-party rental income was not material in relation to consolidated revenue in fiscal 2003. In fiscal 2004, rental revenues from Hewitt Associates make up all of Hewitt Holdings’ revenues.

16

Table of Contents

Segments

Prior to the Distribution and de-consolidation of Hewitt Associates, the Company had two reportable segments:

While we report revenues and direct expenses based on these two segments, Hewitt Associates presents its offering to clients as a continuum of human resources services.

Subsequent to the Distribution, Hewitt Holdings has one business segment consisting of its real estate operations.

Critical Accounting Policies and Estimates

Revenues

We lease our real estate properties pursuant to operating leases. We record rental income for the full term of each lease on a straight-line basis. However, generally, the leases provide for lessee occupancy during periods for which no rent is due or where minimum rental payments increase during the term of the lease. Accordingly, a receivable is recorded from lessees for the current difference between the straight-line rent and the rent that is contractually due from the lessee. During the three months ended December 31, 2003, 100% of our rental income was derived from leases with Hewitt Associates. Prior to July 1, 2003, the date we distributed the majority of our shares in Hewitt Associates, all rental income and related receivables from Hewitt Associates were eliminated in the consolidation of Hewitt Associates.

Long-Lived Assets Held and Used

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the undiscounted future cash flows from the long-lived asset are less than the carrying value, we recognize a loss equal to the difference between the carrying value and the discounted future cash flows of the asset.

Our estimate of future cash flows will be based on our experience, knowledge, and typically third-party advice or market data. However, these estimates can be affected by other factors and economic conditions that can be difficult to predict.

Estimates

Various assumptions and other factors underlie the determination of significant accounting estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, known facts, current and expected economic conditions. We periodically reevaluate these significant factors and make adjustments when facts and circumstances dictate, however, actual results may differ from estimates.

17

Table of Contents

Historical Results of Operations

The following table sets forth our historical results of operations as a percentage of net revenues. The information for each of the three-month periods is derived from unaudited consolidated financial statements which were prepared on the same basis as the annual consolidated financial statements. In our opinion, information for the three months ended December 31, 2003 and 2002 contains all adjustments, consisting only of normal recurring adjustments necessary to fairly present this information. Operating results for any period are not necessarily indicative of results for any future periods.

As a result of the Distribution and subsequent de-consolidation of Hewitt Associates, the results of operations for the three months ended December 31, 2003 and 2002 are not comparable. The results for the three months ended December 31, 2003 do not include the operating results of Hewitt Associates. The results for the three months ended December 31, 2002 include the operating results of Hewitt Associates. For a more meaningful comparison, the following table presents historical operations for the three months ended December 31, 2003 to the pro forma results

18

Table of Contents

for the three months ended December 31, 2002. The information for each of the three-month periods is derived from unaudited consolidated financial statements, which were prepared on the same basis as the annual consolidated financial statements. In our opinion, information for the three months ended December 31, 2003 and the pro forma results for the three months ended December 31, 2002 contains all adjustments, consisting only of normal recurring adjustments necessary to fairly present this information. Operating results for any period are not necessarily indicative of results for any future periods. We refer you to Note 3 in the consolidated financial statements for more information on the pro forma results from operations.