**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                    |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                              |
|       |   | **For the quarterly period ended December 31,  2003**                                                                                                                                                             |
|       |   |                                                                                                                                                                                                              |
|       |   | **OR**                                                                                                                                                                                                            |
|       |   |                                                                                                                                                                                                              |
| **o**      |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                    |
|       |   |                                                                                                                                                                                                              |
|       |   | **For the transition period from               to                  ** |

 

**Commission FileNumber: 001-16159**

 

**WATSON WYATT & COMPANY HOLDINGS**

(Exact name of Registrant as specified in its charter)

 

| **Delaware**                                                    |   | **52-2211537**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |

 

**1717 H Street NWWashington, D.C. 20006-3900**

(Address of principal executive offices, including zip code)

 

**(202) 715-7000**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days:

 

Yes  ý         No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

 

Yes  ý        No  o

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of January 31,2004.

 
| **Class**                             |   | **Number of  Shares** |   |
|---------------------------------------|--------|-----------------------|--------|
| Class A  Common Stock, $.01 par value |   | 32,898,664            |   |

 

 

----

 

**WATSON WYATT &COMPANY HOLDINGSINDEX TO FORM 10-Q**

 

For the Three and Six Months Ended December 31, 2003

 
| PART I.        | FINANCIAL  INFORMATION                                                                             |   |
|----------------|----------------------------------------------------------------------------------------------------|--------|
|           |                                                                                               |   |
|           |                                                                                               |   |
| Item 1.        | Financial  Statements (Unaudited)                                                                  |   |
|           |                                                                                               |   |
|           | Consolidated Statements of Operations-Three  and six months ended December 31, 2003 and 2002       |   |
|           |                                                                                               |   |
|           | Consolidated Balance Sheets-December 31, 2003 and June 30, 2003                                    |   |
|           |                                                                                               |   |
|           | Consolidated Statements of Cash Flows-Six  months ended December 31, 2003 and 2002                 |   |
|           |                                                                                               |   |
|           | Consolidated Statement of Changes in  Stockholders’ Equity-Six months ended December 31, 2003 |   |
|           |                                                                                               |   |
|           | Notes to the Consolidated Financial  Statements                                                    |   |
|           |                                                                                               |   |
| Item 2.        | Management’s Discussion and Analysis of  Financial Condition and Results of Operations        |   |
|           |                                                                                               |   |
| Item 3.        | Quantitative and Qualitative Disclosures  About Market Risk                                        |   |
|           |                                                                                               |   |
| Item 4.        | Controls and Procedures                                                                            |   |
|           |                                                                                               |   |
|           |                                                                                               |   |
| PART II.       | OTHER INFORMATION                                                                                  |   |
|           |                                                                                               |   |
|           |                                                                                               |   |
| Item 1.        | Legal Proceedings                                                                                  |   |
|           |                                                                                               |   |
| Item 2.        | Changes in Securities and Use of Proceeds                                                          |   |
|           |                                                                                               |   |
| Item  3.       | Defaults  Upon Senior Securities                                                                   |   |
|           |                                                                                               |   |
| Item 4.        | Submission of Matters to a Vote of Security Holders                                                |   |
|           |                                                                                               |   |
| Item  5.       | Other  Information                                                                                 |   |
|           |                                                                                               |   |
| Item 6.        | Exhibits and Reports on Form 8-K                                                                   |   |
|           |                                                                                               |   |
| Signatures     |                                                                                               |   |
|           |                                                                                               |   |
| Certifications |                                                                                               |   |

 

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statements of Operations**

(Thousandsof U.S. Dollars, Except Per Share Data)

 
|                                                                                                                                    |   | **Three  months ended December 31** |    | **Six months  ended December 31** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------|---------|-----------------------------------|--------|
|                                                                                                                                    |   | **2003**                            |    | **2002**                          |   | **2003** |   | **2002** |   |
|                                                                                                                                    |   | **(Unaudited)**                     |    | **(Unaudited)**                   |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Revenue                                                                                                                                 |   | $                                   | 170,353 |                              | $      | 174,624 |   | $ | 341,336 |   | $ | 353,582 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Costs of providing services:                                                                                                            |   |                                |    |                              |   |   |   |   |   |
| Salaries and employee benefits                                                                                                          |   | 94,374                              |    | 97,838                            |   | 199,447 |   | 199,351 |   |
| Professional and subcontracted services                                                                                                 |   | 12,613                              |    | 13,042                            |   | 21,699 |   | 23,860 |   |
| Occupancy, communications and other                                                                                                     |   | 25,921                              |    | 25,485                            |   | 49,439 |   | 52,113 |   |
| General and administrative expenses                                                                                                     |   | 14,990                              |    | 14,815                            |   | 30,591 |   | 29,205 |   |
| Depreciation and amortization                                                                                                           |   | 5,395                               |    | 5,266                             |   | 10,047 |   | 10,345 |   |
|                                                                                                                                    |   | 153,293                             |    | 156,446                           |   | 311,223 |   | 314,874 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Income from operations                                                                                                                  |   | 17,060                              |    | 18,178                            |   | 30,113 |   | 38,708 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Income from affiliates                                                                                                                  |   | 1,048                               |    | 2,058                             |   | 2,838 |   | 2,907 |   |
| Interest income, net                                                                                                                    |   | 170                                 |    | 225                               |   | 384 |   | 467 |   |
| Other non-operating income                                                                                                              |   | 27                                  |    | 121                               |   | 6,152 |   | 641 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Income from continuing operations before  income taxes                                                                                  |   | 18,305                              |    | 20,582                            |   | 39,487 |   | 42,723 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Provision for income taxes                                                                                                              |   | 7,503                               |    | 8,438                             |   | 16,188 |   | 17,516 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Income from continuing operations                                                                                                       |   | 10,802                              |    | 12,144                            |   | 23,299 |   | 25,207 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Discontinued operations:                                                                                                                |   |                                |    |                              |   |   |   |   |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Sublease income from discontinued  operations, less applicable income tax expense for the three and six months  ended December 31, 2003 |   | 16                                  |    | —                            |   | 26 |   | — |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Net income                                                                                                                              |   | $                                   | 10,818  |                              | $      | 12,144 |   | $ | 23,325 |   | $ | 25,207 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Basic earnings per share:                                                                                                               |   |                                |    |                              |   |   |   |   |   |
| Income from continuing operations                                                                                                       |   | $                                   | 0.33    |                              | $      | 0.37 |   | $ | 0.70 |   | $ | 0.77 |   |
| Income from discontinued operations                                                                                                     |   | —                              |    | —                            |   | — |   | — |   |
| Net income                                                                                                                              |   | $                                   | 0.33    |                              | $      | 0.37 |   | $ | 0.70 |   | $ | 0.77 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Diluted earnings per share:                                                                                                             |   |                                |    |                              |   |   |   |   |   |
| Income from continuing operations                                                                                                       |   | $                                   | 0.32    |                              | $      | 0.36 |   | $ | 0.70 |   | $ | 0.76 |   |
| Income from discontinued operations                                                                                                     |   | —                              |    | —                            |   | — |   | — |   |
| Net income                                                                                                                              |   | $                                   | 0.32    |                              | $      | 0.36 |   | $ | 0.70 |   | $ | 0.76 |   |
|                                                                                                                                    |   |                                |    |                              |   |   |   |   |   |
| Weighted average shares of common stock,  basic (000)                                                                                   |   | 33,143                              |    | 32,942                            |   | 33,111 |   | 32,944 |   |
| Weighted average shares of common stock,  diluted (000)                                                                                 |   | 33,474                              |    | 33,279                            |   | 33,453 |   | 33,285 |   |

 

See accompanying notes

 

1

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**ConsolidatedBalance Sheets**

(Thousandsof U.S. Dollars, Except Share and Per Share Data)

 
|                                                                                                                                               |   | **December  31,  2003** |       | **June 30,  2003** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|--------------------|------------|
|                                                                                                                                               |   | **(Unaudited)**         |       |               |       |
| **Assets**                                                                                                                                         |   |                    | ** ** |               | ** ** |
| Cash and cash equivalents                                                                                                                          |   | $                       | 131,613    |               | $          | 144,374 |   |
| Receivables from clients:                                                                                                                          |   |                    |       |               |       |
| Billed, net of allowances of $2,037 and  $862                                                                                                      |   | 80,657                  |       | 78,373             |       |
| Unbilled, net of allowances of $646 and  $419                                                                                                      |   | 56,273                  |       | 60,549             |       |
|                                                                                                                                               |   | 136,930                 |       | 138,922            |       |
|                                                                                                                                               |   |                    |       |               |       |
| Deferred income taxes                                                                                                                              |   | 619                     |       | 3,885              |       |
| Other current assets                                                                                                                               |   | 15,657                  |       | 11,448             |       |
| Total current assets                                                                                                                               |   | 284,819                 |       | 298,629            |       |
|                                                                                                                                               |   |                    |       |               |       |
| Investment in affiliates                                                                                                                           |   | 27,724                  |       | 26,431             |       |
| Fixed assets, net                                                                                                                                  |   | 58,352                  |       | 60,716             |       |
| Deferred income taxes                                                                                                                              |   | 99,029                  |       | 101,214            |       |
| Goodwill and intangible assets                                                                                                                     |   | 21,085                  |       | 20,878             |       |
| Other assets                                                                                                                                       |   | 5,494                   |       | 6,594              |       |
|                                                                                                                                               |   |                    |       |               |       |
| **Total Assets**                                                                                                                                   |   | $                       | 496,503    |               | $          | 514,462 |   |
|                                                                                                                                               |   |                    |       |               |       |
| **Liabilities**                                                                                                                                    |   |                    | ** ** |               | ** ** |
|                                                                                                                                               |   |                    | ** ** |               | ** ** |
| Accounts payable and accrued liabilities,  including discretionary compensation                                                                    |   | $                       | 82,550     |               | $          | 114,013 |   |
| Income taxes payable                                                                                                                               |   | 152                     |       | 15,308             |       |
| Total current liabilities                                                                                                                          |   | 82,702                  |       | 129,321            |       |
|                                                                                                                                               |   |                    |       |               |       |
| Accrued retirement benefits                                                                                                                        |   | 197,469                 |       | 195,705            |       |
| Deferred rent and accrued lease losses                                                                                                             |   | 6,143                   |       | 4,608              |       |
| Other noncurrent liabilities                                                                                                                       |   | 31,923                  |       | 33,091             |       |
|                                                                                                                                               |   |                    |       |               |       |
| **Total Liabilities**                                                                                                                              |   | 318,237                 |       | 362,725            |       |
|                                                                                                                                               |   |                    |       |               |       |
| Commitments and contingencies                                                                                                                      |   |                    |       |               |       |
|                                                                                                                                               |   |                    |       |               |       |
| **Stockholders’ Equity**                                                                                                                      |   |                    |       |               |       |
| Preferred Stock - No par value:  1,000,000 shares authorized;  none issued and outstanding                                                         |   | —                  |       | —             |       |
|                                                                                                                                               |   |                    |       |               |       |
| Class A Common Stock - $.01 par value:  69,000,000 shares authorized;  33,372,880 and 33,087,880 issued and  32,980,835 and 32,943,156 outstanding |   | 334                     |       | 331                |       |
| Additional paid-in capital                                                                                                                         |   | 151,453                 |       | 145,922            |       |
| Treasury stock, at cost - 392,045 and  144,724 shares                                                                                              |   | (9,198                  | )          | (2,956             | )          |
| Retained earnings                                                                                                                                  |   | 100,842                 |       | 77,517             |       |
| Accumulated other comprehensive loss                                                                                                               |   | (65,165                 | )          | (69,077            | )          |
| **Total Stockholders’ Equity**                                                                                                                |   | 178,266                 |       | 151,737            |       |
|                                                                                                                                               |   |                    |       |               |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                                |   | $                       | 496,503    |               | $          | 514,462 |   |

 

See accompanying notes

 

2

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statements of Cash Flows**

(Thousandsof U.S. Dollars)

 
|                                                                                   |   | **Six months  ended December 31** |    |
|----------------------------------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                                                   |   | **2003**                          |    | **2002** |   |
|                                                                                   |   | **(Unaudited)**                   |    |
| Cash flows (used in) from operating  activities:                                       |   |                              |    |   |   |
| Net income                                                                             |   | $                                 | 23,325  |   | $ | 25,207 |   |
| Adjustments to reconcile net income to net  cash (used in)  from operating activities: |   |                              |    |   |   |
| Other non-operating gain related to PCIC                                               |   | (5,600                            | )       | — |   |
| Provision for doubtful receivables from  clients                                       |   | 3,741                             |    | 5,387 |   |
| Depreciation                                                                           |   | 9,883                             |    | 10,203 |   |
| Amortization of intangible assets                                                      |   | 164                               |    | 142 |   |
| Provision for deferred income taxes                                                    |   | 5,451                             |    | 2,021 |   |
| Income from affiliates                                                                 |   | (2,838                            | )       | (2,907 | ) |
| Distributions from affiliates                                                          |   | 2,285                             |    | 2,033 |   |
| Other, net                                                                             |   | (536                              | )       | (814 | ) |
| Changes in operating assets and liabilities  (net of discontinued operations)          |   |                              |    |   |   |
| Receivables from clients                                                               |   | (1,749                            | )       | 4,248 |   |
| Other current assets                                                                   |   | (4,209                            | )       | 4,822 |   |
| Other assets                                                                           |   | 1,100                             |    | 212 |   |
| Accounts payable and accrued liabilities                                               |   | (21,330                           | )       | (37,051 | ) |
| Income taxes payable                                                                   |   | (15,156                           | )       | (2,520 | ) |
| Accrued retirement benefits                                                            |   | 1,764                             |    | 607 |   |
| Deferred rent and accrued lease losses                                                 |   | 1,535                             |    | 7 |   |
| Other noncurrent liabilities                                                           |   | (1,266                            | )       | 599 |   |
| Net cash (used in) from operating  activities                                          |   | (3,436                            | )       | 12,196 |   |
|                                                                                   |   |                              |    |   |   |
| Cash flows used in investing activities:                                               |   |                              |    |   |   |
| Purchases of fixed assets                                                              |   | (7,806                            | )       | (10,313 | ) |
| Proceeds from divestitures                                                             |   | 552                               |    | 1,042 |   |
| Acquisitions and contingent consideration  payments                                    |   | (113                              | )       | (366 | ) |
| Investment in affiliates                                                               |   | —                            |    | (1,961 | ) |
| Net cash used in investing activities                                                  |   | (7,367                            | )       | (11,598 | ) |
|                                                                                   |   |                              |    |   |   |
| Cash flows used in financing activities:                                               |   |                              |    |   |   |
| Issuances of common stock - exercises of  stock options                                |   | 1,179                             |    | 331 |   |
| Issuances of common stock - employee stock  purchase plan                              |   | 3,278                             |    | 3,121 |   |
| Repurchases of common stock                                                            |   | (9,776                            | )       | (8,765 | ) |
| Net cash used in financing activities                                                  |   | (5,319                            | )       | (5,313 | ) |
|                                                                                   |   |                              |    |   |   |
| Effect of exchange rates on cash                                                       |   | 3,361                             |    | 87 |   |
|                                                                                   |   |                              |    |   |   |
| Decrease in cash and cash equivalents                                                  |   | (12,761                           | )       | (4,628 | ) |
|                                                                                   |   |                              |    |   |   |
| Cash and cash equivalents at beginning of  period                                      |   | 144,374                           |    | 95,974 |   |
|                                                                                   |   |                              |    |   |   |
| Cash and cash equivalents at end of period                                             |   | $                                 | 131,613 |   | $ | 91,346 |   |

 

See accompanying notes

 

3

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statement of Changes inStockholders’ Equity**

(Thousands of U.S. Dollars)

(Unaudited)

 
|                                                             |   | **Class A  Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Treasury  Stock,  at Cost** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Loss** |   | **Total** |   |
|------------------------------------------------------------------|--------|----------------------------|--------|----------------------------------|--------|-------------------------------|--------|------------------------|--------|---------------------------------------------|--------|-----------|--------|
| Balance at June 30, 2003                                         |   | $                          | 331    |                             | $      | 145,922                       |   | $                      | (2,956 | )                                           | $      | 77,517    |   | $ | (69,077 | ) | $ | 151,737 |   |
| Comprehensive income:                                            |   |                       |   |                             |   |                          |   |                   |   |                                        |   |      |   |
| Net income                                                       |   |                       |   |                             |   |                          |   | 23,325                 |   |                                        |   | 23,325    |   |
| Additional minimum pension liability                             |   |                       |   |                             |   |                          |   |                   |   | (432                                        | )      | (432      | )      |
| Foreign currency translation adjustment                          |   |                       |   |                             |   |                          |   |                   |   | 4,344                                       |   | 4,344     |   |
| Total comprehensive income                                       |   |                       |   |                             |   |                          |   |                   |   |                                        |   | 27,237    |   |
| Repurchases of common stock                                      |   |                       |   |                             |   | (9,776                        | )      |                   |   |                                        |   | (9,776    | )      |
| Issuances of common stock - employee stock  purchase plan shares |   | 1                          |   | 1,289                            |   | 1,988                         |   |                   |   |                                        |   | 3,278     |   |
| Issuances of common stock - deferred stock  units                |   | 2                          |   | 4,081                            |   |                          |   |                   |   |                                        |   | 4,083     |   |
| Issuances of common stock to outside  directors                  |   |                       |   | 8                                |   | 70                            |   |                   |   |                                        |   | 78        |   |
| Issuances of common stock- stock options                         |   |                       |   | (297                             | )      | 1,476                         |   |                   |   |                                        |   | 1,179     |   |
| Tax benefit of exercises of stock options                        |   |                       |   | 450                              |   |                          |   |                   |   |                                        |   | 450       |   |
|                                                             |   |                       |   |                             |   |                          |   |                   |   |                                        |   |      |   |
| Balance at December 31, 2003                                     |   | $                          | 334    |                             | $      | 151,453                       |   | $                      | (9,198 | )                                           | $      | 100,842   |   | $ | (65,165 | ) | $ | 178,266 |   |

 

See accompanying notes

 

4

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**WATSON WYATT &COMPANY HOLDINGS**

**Notes to theConsolidated Financial Statements**

(Tabular amounts are in thousands, except per share data)

(Unaudited)

**Note 1 – Basis of Presentation.**

 

The accompanying unauditedquarterly consolidated financial statements of Watson Wyatt & CompanyHoldings and our subsidiaries (collectively referred to as “we,” “Watson Wyatt”or the “Company”) are presented in accordance with the rules and regulations ofthe Securities and Exchange Commission (“SEC”) for quarterly reports on Form10-Q.  In the opinion of management,these financial statements reflect all adjustments which are necessary for afair presentation of the consolidated financial statements for the interimperiods.  The consolidated financialstatements should be read in conjunction with the audited consolidatedfinancial statements and notes thereto contained in the Company’s Annual Reporton Form 10-K for the fiscal year ended June 30, 2003, which is filed with theSEC and may be accessed via EDGAR on the SEC’s web site at www.sec.gov.

 

The results of operations forthe six months ended December 31, 2003 are not necessarily indicative of theresults that can be expected for the entire fiscal year ending June 30,2004.  The results reflect certainestimates, including estimated bonuses and anticipated tax liabilities.

 

**Note 2 – Company Background.**

 

Watson Wyatt is aninternational company engaged in the business of providing professionalconsultative services on a fee basis, primarily in the human resource areas ofemployee benefits and compensation, but also in other areas of specializationsuch as human capital consulting and human resource-related technologyconsulting.

 

**Note 3 – Segment Information.**

 

In North America, the Companyis primarily organized and managed by practice.  Although our consultants in our international offices provideservices in these same practice areas, our international operations as a wholeare managed geographically and comprise a single operating segment.  Therefore, we have five reportable operatingsegments or practice areas:

 

(1)    Benefits Group

(2)    Technology Solutions Group

(3)    Human Capital Group

(4)    International

(5)    Other (including Data Services and Communication)

 

5

----

 

The Company evaluates theperformance of its segments and allocates resources to them based on netoperating income, which is income before income taxes and discretionarycompensation.

 

The table below presentsspecified information about reported segments as of and for the threemonths ended December 31, 2003:

 
|                                   |   | **Benefits  Group** |   | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 98,428 |                             | $      | 21,871                    |   | $                 | 11,622 |      | $      | 19,387    |   | $ | 10,942 |   | $ | 162,250 |   |
| Net operating income/(loss)            |   | 16,722              |   | 4,042                            |   | 2,144                     |   | (1,181            | )      | (53       | )      | 21,674    |   |
| Receivables                            |   | 82,599              |   | 11,418                           |   | 9,963                     |   | 17,368            |   | 5,671     |   | 127,019   |   |
|                                        |        |                     |        |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

The table below presentsspecified information about reported segments as of and for the three monthsended December 31, 2002:

 
|                                   |   | **Benefits  Group** |   | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 95,076 |                             | $      | 26,521                    |   | $                 | 11,940 |      | $      | 19,146    |   | $ | 11,958 |   | $ | 164,641 |   |
| Net operating income/(loss)            |   | 18,073              |   | 4,890                            |   | (547                      | )      | 946               |   | (9        | )      | 23,353    |   |
| Receivables                            |   | 82,348              |   | 18,528                           |   | 10,090                    |   | 15,343            |   | 6,835     |   | 133,144   |   |
|                                        |        |                     |        |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

6

----

 

The table below presentsspecified information about reported segments as of and for the six monthsended December 31, 2003:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 202,296 |                             | $      | 42,140                    |   | $                 | 21,788 |      | $      | 38,332    |   | $ | 22,635 |   | $ | 327,191 |   |
| Net operating income/(loss)            |   | 38,763              |    | 5,455                            |   | 1,888                     |   | (1,247            | )      | 634       |   | 45,493    |   |
| Receivables                            |   | 82,599              |    | 11,418                           |   | 9,963                     |   | 17,368            |   | 5,671     |   | 127,019   |   |
|                                        |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

The table below presentsspecified information about reported segments as of and for the six monthsended December 31, 2002:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 197,076 |                             | $      | 52,829                    |   | $                 | 23,186 |      | $      | 37,064    |   | $ | 25,911 |   | $ | 336,066 |   |
| Net operating income/(loss)            |   | 43,943              |    | 9,650                            |   | (473                      | )      | 1,324             |   | 2,135     |   | 56,579    |   |
| Receivables                            |   | 82,348              |    | 18,528                           |   | 10,090                    |   | 15,343            |   | 6,835     |   | 133,144   |   |
|                                        |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

Information about interestincome and tax expense is not presented as a segment expense because it is notconsidered a responsibility of the segments’ operating management.

 

7

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Reconciliations of theinformation reported by segment to the consolidated amounts follow for thethree and six month periods ended December 31, 2003 and 2002:

 
|                                                                                    |   | **Three  Months Ended December 31,** |    | **Six Months  Ended December 31,** |   |
|-----------------------------------------------------------------------------------------|--------|--------------------------------------|---------|------------------------------------|--------|
|                                                                                    |   | **2003**                             |    | **2002**                           |   | **2003** |   | **2002** |   |
|                                                                                    |   |                                 |    |                               |   |   |   |   |   |
| Revenue:                                                                                |   |                                 |    |                               |   |   |   |   |   |
| Total segment revenue                                                                   |   | $                                    | 162,250 |                               | $      | 164,641 |   | $ | 327,191 |   | $ | 336,066 |   |
| Reimbursable expenses not included in total  segment revenue                            |   | 8,889                                |    | 10,341                             |   | 14,848 |   | 17,318 |   |
| Other, net                                                                              |   | (786                                 | )       | (358                               | )      | (703 | ) | 198 |   |
| Consolidated revenue                                                                    |   | $                                    | 170,353 |                               | $      | 174,624 |   | $ | 341,336 |   | $ | 353,582 |   |
|                                                                                    |   |                                 |    |                               |   |   |   |   |   |
| Net Operating Income:                                                                   |   |                                 |    |                               |   |   |   |   |   |
| Total segment net operating income                                                      |   | $                                    | 21,674  |                               | $      | 23,353 |   | $ | 45,493 |   | $ | 56,579 |   |
| Income from affiliates                                                                  |   | 1,048                                |    | 2,058                              |   | 2,838 |   | 2,907 |   |
| Differences in allocation methods for  depreciation, G&A, medical and pension costs |   | 1,925                                |    | (629                               | )      | 3,360 |   | (1,095 | ) |
| Gain on sale of business units                                                          |   | 27                                   |    | 522                                |   | 552 |   | 1,042 |   |
| Discretionary compensation                                                              |   | (5,970                               | )       | (7,574                             | )      | (19,470 | ) | (19,574 | ) |
| PCIC non-operating gain                                                                 |   | —                               |    | —                             |   | 5,600 |   | — |   |
| Other, net                                                                              |   | (399                                 | )       | 2,852                              |   | 1,114 |   | 2,864 |   |
| Consolidated income before income taxes                                                 |   | $                                    | 18,305  |                               | $      | 20,582 |   | $ | 39,487 |   | $ | 42,723 |   |
|                                                                                    |   |                                 |    |                               |   |   |   |   |   |
| Receivables:                                                                            |   |                                 |    |                               |   |   |   |   |   |
| Total segment receivables - billed and  unbilled                                        |   | $                                    | 127,019 |                               | $      | 133,144 |   | $ | 127,019 |   | $ | 133,144 |   |
| Net valuation differences                                                               |   | 9,911                                |    | 8,833                              |   | 9,911 |   | 8,833 |   |
| Total billed and unbilled receivables                                                   |   | 136,930                              |    | 141,977                            |   | 136,930 |   | 141,977 |   |
| Assets not reported by segment                                                          |   | 359,573                              |    | 277,083                            |   | 359,573 |   | 277,083 |   |
| Consolidated assets                                                                     |   | $                                    | 496,503 |                               | $      | 419,060 |   | $ | 496,503 |   | $ | 419,060 |   |

 

**Note 4 – Stock-based Compensation.**

 

We have elected to followAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees” (APB 25), for stock options issued under the 2000 Long TermIncentive Plan and the 2001 Employee Stock Purchase Plan.  Compensation expense for the 2000 Long TermIncentive Plan, if any, would be recorded and measured as the differencebetween the fair market value of the stock at the date of the grant and theoption price.  The compensation expensewould be recognized over the five-year vesting period identified in theplan.  For any cash-based, non-stockawards, such as stock appreciation rights, compensation expense will berecognized over the vesting period to the extent that the market price of thestock increases.  We have elected thedisclosure-only provisions of Statement of Financial Accounting Standards No.123, “Accounting for Stock-based Compensation” (FAS 123).

 

8

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As required by FAS 123, theCompany has determined pro forma net income and earnings per share as if theCompany had accounted for its stock compensation plans under the fair valuemethod of FAS 123.  The Companyestimated compensation expense for its 2001 Employee Stock Purchase Plan basedon the 15 percent discounted purchase price offered to employees enrolled inthe plan, which approximates fair value. For the 2000 Long Term Incentive Plan, the Company uses theBlack-Scholes option valuation model to calculate the fair value of optionsgranted for pro forma disclosure purposes.

 

The table below reflects thepro forma effect on net income and earnings per share for the three and sixmonths ended December 31, 2003 and 2002 as if the Company recognizedcompensation expense under the fair value method of FAS 123:

 
|                                                                                                                                          |   | **Three  Months Ended December 31,** |   | **Six Months  Ended December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                                                                                                                          |   | **2003**                             |   | **2002**                           |   | **2003** |   | **2002** |   |
|                                                                                                                                          |   |                                 |   |                               |   |   |   |   |   |
| Net income, as reported                                                                                                                       |   | $                                    | 10,818 |                               | $      | 12,144 |   | $ | 23,325 |   | $ | 25,207 |   |
| Add: Stock-based compensation expense  included in reported net income, net of related tax effects                                            |   | 31                                   |   | 6                                  |   | 77 |   | 12 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of related tax effects |   | (383                                 | )      | (388                               | )      | (798 | ) | (800 | ) |
| Pro forma net income                                                                                                                          |   | $                                    | 10,466 |                               | $      | 11,762 |   | $ | 22,604 |   | $ | 24,419 |   |
|                                                                                                                                          |   |                                 |   |                               |   |   |   |   |   |
| **Earnings per share:**                                                                                                                       |   |                                 |   |                               |   |   |   |   |   |
| Basic - as reported                                                                                                                           |   | $                                    | 0.33   |                               | $      | 0.37 |   | $ | 0.70 |   | $ | 0.77 |   |
| Basic - pro forma                                                                                                                             |   | $                                    | 0.32   |                               | $      | 0.36 |   | $ | 0.68 |   | $ | 0.74 |   |
|                                                                                                                                          |   |                                 |   |                               |   |   |   |   |   |
| Diluted - as reported                                                                                                                         |   | $                                    | 0.32   |                               | $      | 0.36 |   | $ | 0.70 |   | $ | 0.76 |   |
| Diluted - pro forma                                                                                                                           |   | $                                    | 0.31   |                               | $      | 0.35 |   | $ | 0.68 |   | $ | 0.73 |   |

 

**Note 5 – Targeted Job Reductions.**

 

We eliminated approximately 100positions in our North American region during the first quarter of fiscal year2004.  A charge to earnings of $2.6million related to these reductions was included in the Company’s financial resultsfor the quarter ended September 30, 2003. We eliminated an additional 22 positions in our North American regionduring the second quarter of fiscal year 2004, resulting in a charge toearnings of $0.7 million in the Company’s financial results for the quarterended December 31, 2003.  Of the $3.3million total severance charge, $3.2 million was included in Salaries andemployee benefits and $0.1 million was included in Professional andsubcontracted services.

 

**Note 6 – Professional Consultants InsuranceCompany (PCIC) Other Non-operating Gain.**

 

On July 9, 2003, the Board ofDirectors of PCIC, a captive insurance company of which we own 34.8 percent,decided to pass on to each of its owners a credit in their 2003-04 policy yearin connection with benefits received from an aggregate stop loss insurancepolicy entered into by PCIC.  PCIC’sBoard of Directors determined that this credit would be used to offset all or aportion of each insureds obligation to PCIC for historical lossexperience.  As a result, the Companyrecorded a $5.6 million pre-tax non-operating gain in the first quarter offiscal year 2004 and included this gain in “Other non-operating income” in theConsolidated Statements of Operations.

 

As a result of this gain, theCompany also recorded a $5.6 million supplemental bonus accrual in the firstquarter that is incremental to the Company’s fiscal year end bonus, but will bepaid in September 2004 with the regular bonus cycle.  This supplemental bonus is included in Salaries and employee benefits.

 

9

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**Note 7 – Sale of U.S.-based Public SectorRetirement Business.**

 

In fiscal year 2002, we soldour U.S.-based public sector retirement business to Gabriel, Roeder, Smith& Company (“GRS”).  The futureconsideration from the sale of the U.S.-based public sector retirement businessis contingent upon the successful transition of certain clients to GRS and upontheir retention by GRS.  Simultaneouswith the sale, we entered into an alliance agreement with GRS under which wewill mutually refer future business opportunities and explore joint consultingassignments.

 

In accordance with theterms of the sale, GRS paid the Company $0.5 million of contingent payments ineach of the first quarters of fiscal years 2003 and 2004. The amount ofadditional contractual cash payments over the upcoming three fiscal years isalso contingent upon the successful transition of certain clients to GRS andupon their retention by GRS.

 

**Note 8 – Goodwill & Intangible Assets.**

 

The changes in the carryingamount of goodwill for the six months ended December 31, 2003, are as follows: 

 
|                                |   | **Benefits  Group** |   | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|-------------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Balance as of June 30, 2003         |   | $                   | 16,278 |                             | $      | 1,449                     |   | $                 | 69     |      | $      | 979       |   | $ | 1,214 |   | $ | 19,989 |   |
| Goodwill recorded during the period |   | —              |   | —                           |   | —                    |   | 113               |   | —    |   | 113       |   |
| Translation adjustment              |   | 203                 |   | —                           |   | 4                         |   | 53                |   | —    |   | 260       |   |
| Balance as of December 31, 2003     |   | $                   | 16,481 |                             | $      | 1,449                     |   | $                 | 73     |      | $      | 1,145     |   | $ | 1,214 |   | $ | 20,362 |   |

 

Goodwill recorded during theperiod reflects contingent payments made relative to historical acquisitions inAustralia and Mexico.

 

The following table reflectschanges in the net carrying amount of the components of intangible assets forthe six months ended December 31, 2003:

 
|                            |   | **Non-contractual  customer  relationships** |   | **Non-compete  agreements** |   | **Purchased  software** |   | **Pension** |   | **Total** |   |
|---------------------------------|--------|----------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|-------------|--------|-----------|--------|
|                            |   |                                         |   |                        |   |                    |   |        |   |      |   |
| Balance as of June 30, 2003     |   | $                                            | 480    |                        | $      | 269                     |   | $           | 27     |      | $      | 113 |   | $ | 889 |   |
| Amortization expense            |   | (99                                          | )      | (47                         | )      | (18                     | )      | —      |   | (164      | )      |
| Translation adjustment          |   | (10                                          | )      | —                      |   | —                  |   | 8           |   | (2        | )      |
| Balance as of December 31, 2003 |   | $                                            | 371    |                        | $      | 222                     |   | $           | 9      |      | $      | 121 |   | $ | 723 |   |

 

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The following table reflectsthe carrying value of intangible assets at December 31, 2003 and 2002:

 
|                                                         |   | **December  31, 2003**      |   | **December  31, 2002**        |   |
|--------------------------------------------------------------|--------|-----------------------------|--------|-------------------------------|--------|
|                                                         |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Amortizable intangible assets and  intangible pension asset: |   |                        |   |                          |   |   |   |   |   |
| Non-contractual customer relationships                       |   | $                           | 807    |                          | $      | 436 |   | $ | 659 |   | $ | 86 |   |
| Non-compete agreements                                       |   | 672                         |   | 450                           |   | 672 |   | 357 |   |
| Purchased software                                           |   | 125                         |   | 116                           |   | 125 |   | 80 |   |
| Intangible pension asset                                     |   | 121                         |   | —                        |   | — |   | — |   |
| Total intangible assets and intangible  pension asset        |   | $                           | 1,725  |                          | $      | 1,002 |   | $ | 1,456 |   | $ | 523 |   |

 

The change in the grosscarrying amount of non-contractual customer relationships reflects translationadjustments between December 31, 2002 and December 31, 2003.  These intangible assets are denominated inthe functional currencies of our subsidiaries outside the United States, andare translated into our reporting currency, the U.S. dollar, based on exchangerates at the balance sheet date.

 

The weighted average remaininglife of amortizable intangible assets at December 31, 2003, was 2.0 years.  Estimated amortization expense for fiscalyear 2004 and each of the three succeeding fiscal years is as follows:

 
| **Fiscal  year ending June 30:** |   | **Amount** |   |
|----------------------------------|--------|------------|--------|
| 2004                             |   | $          | 323    |   |
| 2005                             |   | 300        |   |
| 2006                             |   | 133        |   |
| 2007                             |   | 20         |   |
|                                  |        |            |        |  |

 

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**Note 9 – Earnings Per Share.**

 

Basic earnings per share iscalculated on the basis of the weighted average number of common sharesoutstanding during the three and six months ended December 31, 2003.  Diluted earnings per share is calculated onthe basis of the weighted average number of common shares outstanding plus theeffect of outstanding stock options and employee stock purchase plan sharesusing the “treasury stock” method.  Thecomponents of basic and diluted earnings per share are as follows:

 
|                                                                               |   | **Three  Months Ended December 31,** |   | **Six Months  Ended December 31,** |   |
|------------------------------------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                                                               |   | **2003**                             |   | **2002**                           |   | **2003** |   | **2002** |   |
|                                                                               |   |                                 |   |                               |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                                    | 10,802 |                               | $      | 12,144 |   | $ | 23,299 |   | $ | 25,207 |   |
| Discontinued operations                                                            |   | 16                                   |   | —                             |   | 26 |   | — |   |
| Net income                                                                         |   | $                                    | 10,818 |                               | $      | 12,144 |   | $ | 23,325 |   | $ | 25,207 |   |
|                                                                               |   |                                 |   |                               |   |   |   |   |   |
| Weighted average outstanding shares of  common stock                               |   | 33,143                               |   | 32,942                             |   | 33,111 |   | 32,944 |   |
| Dilutive effect of employee stock options  and employee stock purchase plan shares |   | 331                                  |   | 337                                |   | 342 |   | 341 |   |
|                                                                               |   |                                 |   |                               |   |   |   |   |   |
| Common stock and stock equivalents                                                 |   | 33,474                               |   | 33,279                             |   | 33,453 |   | 33,285 |   |
|                                                                               |   |                                 |   |                               |   |   |   |   |   |
| Basic earnings per share:                                                          |   |                                 |   |                               |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                                    | 0.33   |                               | $      | 0.37 |   | $ | 0.70 |   | $ | 0.77 |   |
| Discontinued operations                                                            |   | —                               |   | —                             |   | — |   | — |   |
| Net income                                                                         |   | $                                    | 0.33   |                               | $      | 0.37 |   | $ | 0.70 |   | $ | 0.77 |   |
|                                                                               |   |                                 |   |                               |   |   |   |   |   |
| Diluted earnings per share:                                                        |   |                                 |   |                               |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                                    | 0.32   |                               | $      | 0.36 |   | $ | 0.70 |   | $ | 0.76 |   |
| Discontinued operations                                                            |   | —                               |   | —                             |   | — |   | — |   |
| Net income                                                                         |   | $                                    | 0.32   |                               | $      | 0.36 |   | $ | 0.70 |   | $ | 0.76 |   |

 

12

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**Note 10 – Comprehensive Income.**

 

Comprehensive income includesnet income, changes in the additional minimum pension liability resulting fromtranslation adjustments and changes in the cumulative translation adjustmentgain or loss.  For the three monthsended December 31, 2003, comprehensive income totaled $14.5 million, comparedwith $13.3 million for the three months ended December 31, 2002.  For the six months ended December 31, 2003,comprehensive income totaled $27.1 million, compared with $25.6 million for thesix months ended December 31, 2002.

 

**Note 11 – Restricted Shares.**

 

In conjunction with our initialpublic offering in October 2000, we entered into agreements providing fortransfer restrictions with major stockholders, executive officers and employeedirectors.  During October 2003, thesetransfer restrictions expired on 1,908,000 Class A shares.  As of December 31, 2003, 1,908,000 Class Ashares remain restricted.  These shareswill become freely transferable in October 2004.

 

**Note 12 – Guarantees.**

 

The Company historically hasprovided guarantees on an infrequent basis to third parties in the ordinarycourse of business.  The guaranteesdescribed below are currently in effect and could require the Company to makepayments to third parties under certain circumstances.

 

*Letters of Credit*.  The Company has two outstanding letters ofcredit totaling $7.5 million under our existing credit facility to guaranteepayment to beneficiaries in the event that the Company fails to meet itsfinancial obligations to these beneficiaries. One letter of credit for $2.6 million will expire in October 2006, whilethe second letter of credit for $4.9 million will remain outstanding as long aswe retain an ownership share of our affiliated captive insurance company,PCIC.  The estimated fair market valueof these letters of credit is nominal because they have never been used, andthe Company believes that future usage is remote.

 

*Affiliate Agreements*.  In 1995, we entered into an allianceagreement with R. Watson & Sons, a United Kingdom-based actuarial, benefitsand human resources consulting partnership (now Watson Wyatt LLP or WWLLP), thepredecessor of which was founded in 1878. Included in the agreements between the Company and WWLLP (the “AllianceAgreements”) are various indemnities and guarantees relating to the performanceof the Company and its subsidiaries, some of which became part of Watson WyattHoldings (Europe), Ltd. (WWHE), as to such matters as tax liabilities,liabilities for prior acts or omissions arising from the operation of the UKand European businesses prior to the alliance and failure to perform variousobligations under the Alliance Agreements. In addition, certain events, such as a sale of material parts of ourbusiness, could require the Company to either purchase from or sell to WWLLP aninterest in our European business and/or repurchase the shares of the Company’sstock currently held by WWLLP.  TheCompany is unable to estimate an amount of any potential future payments underthese contractual arrangements because the potential occurrence of any of theevents to which the indemnities apply is entirely speculative, there is nohistory of payments and the dollar amount, if any, would be dependent upon thenature of the event triggering such indemnity. Management believes that anypotential for payment under such indemnities and guarantees should decline withthe passage of time.  There are noprovisions for recourse to third parties, nor are any assets held by any thirdparties that the Company as guarantor can liquidate to recover amounts paidunder such indemnities.

 

The Company owns 25 percent ofWWHE and WWLLP owns the remaining 75 percent. Additional capital for WWHE, if required, may be provided by both ownersbased on their respective ownership interests. If either the Company or WWLLP does not provide its pro rata share ofany additional capital invested in WWHE, that party’s respective ownership interestwill be reduced accordingly.

 

13

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In connection with theestablishment of our alliance with Watson Wyatt LLP, the Company agreed toguarantee Watson Wyatt LLP’s performance under a lease for office space inLondon that expires in 2015.  Paymentsby Watson Wyatt LLP under the lease total approximately £1.4 million (orapproximately $2.5 million based on the December 31, 2003, exchange rate) peryear.  We also granted Watson Wyatt LLPan option to return the leased space to our UK subsidiary in 2009.  If Watson Wyatt LLP exercises this option,the Company would attempt to sublease the space at the then-current marketrates.

 

*Indemnification Agreements*.  The Company has various agreements thatprovide that it may be obligated to indemnify the other party with respect tocertain matters.  Generally, theseindemnification clauses are included in contracts arising in the normal courseof business and in connection with the purchase and sale of certain businesses.  Although it is not possible to predict themaximum potential amount of future payments under these indemnificationagreements due to the conditional nature of the Company’s obligations and theunique facts of each particular agreement, the Company does not believe thatany potential liability that might arise from such indemnity provisions isprobable or material.  There are noprovisions for recourse to third parties, nor are any assets held by any thirdparties that any guarantor can liquidate to recover amounts paid under suchindemnities.

 

*Wellspring Leases*.  We continue to guarantee three leases foroffice premises for Wellspring Resources, LLC (“Wellspring”), the benefitsadministration outsourcing business that we exited from in fiscal year 1998.  At December 31, 2003, minimum remainingpayments guaranteed under these leases, which expire at various dates through2007, total $21.3 million, excluding anticipated future sublease income.

 

**Note 13 – Contingent Liabilities.**

 

From time to time, we are a party to variouslawsuits, arbitrations or mediations that arise in the ordinary course ofbusiness.  These disputes typicallyinvolve claims relating to the rendering of professional services or employmentmatters.  The matters reported on belowinvolve the most significant pending or potential claims against us.  Management believes, based on currentlyavailable information, that the results of all pending claims against us willnot have a material adverse affect on the Company.  The Company does not believe that it is exposed to any material,additional financial risk with regard to these matters because the Company’sself-insured retention has been met for both matters, and any liability abovethe retention is expected to be covered by our insurance.

 

*New Jersey Coalition of Auto Retailers Insurance Group Trust (NJCAR).*  All parties to the lawsuit have executed the settlement agreement, whichwas approved by state court on December 5, 2003.

 

*Toussaint, et al. v. James, et al.*  The parties tentatively settledthis matter on December 23, 2003.  Adefinitive settlement agreement is pending execution by all of the parties.

 

**Note 14 – Discontinued Operations.**

 

As discussed in Note 12 above,the Company continues to guarantee three leases for office premises forWellspring.  We believe we have adequateprovisions for any remaining costs associated with our obligations related tothis business.  Management will continueto evaluate the adequacy of these provisions and make adjustments asappropriate.  Through the first sixmonths of fiscal year 2004, the Company received sublease income ofapproximately $44,000 in excess of lease payments related to thisbusiness.  Since the second quarter offiscal year 2003, the leases have been generating positive cash flows ofapproximately $0.1 million per fiscal year.

 

14

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**Note 15 – RecentAccounting Pronouncements.**

 

In January 2003, the FinancialAccounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46), “Consolidationof Variable Interest Entities,” which clarifies the financial reportingguidance associated with the consolidation of another entity.  Immediate consolidation requirements of FIN46 were not applicable to the Company since the Company did not create variableinterest entities after January 31, 2003. In December 2003, the FASB revised and superceded FIN 46 with theissuance of FIN 46R in order to address certain implementation issues.  FIN 46R will be required to be adopted bythe Company effective March 31, 2004. Management does not believe that the adoption of FIN 46R will have aneffect on the Company’s financial performance or condition.

 

Emerging Issues Task ForceIssue 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21),was effective for the Company beginning July 1, 2003.  Beginning July 1, 2003, the Company will apply such requirementsprospectively to multiple deliverable arrangements, which include arrangementsinvolving installation and customization of technology solution products soldtogether with on-going services offered by the Company.  Based on the types of arrangements enteredinto historically, the Company does not expect that adoption of EITF 00-21 willhave a material effect on the accounting for such arrangements.

 

In December 2003, the Securities and ExchangeCommission (SEC) issued Staff Accounting Bulletin No. 104 (SAB 104), “RevenueRecognition,” which supercedes Staff Accounting Bulletin No. 101 (SAB 101),“Revenue Recognition in Financial Statements.” SAB 104’s primary purpose is to rescind accounting guidance contained inSAB 101 related to multiple element revenue arrangements, superceded as aresult of the issuance of EITF 00-21. While the wording of SAB 104 has changed to reflect the issuance of EITF00-21, the revenue recognition principles of SAB 101 remain largely unchangedby the issuance of SAB 104.  Theissuance of SAB 104 has not had an effect on our revenue recognition policiesas they are in accordance with SAB 104.

 

**Note 16 – Adoption of Amendments to the ESPP.**

 

In August 2001, the board of directorsadopted the Company’s 2001 Employee Stock Purchase Plan (the “ESPP”), whichsubsequently was approved by the stockholders in November 2001.  The ESPP is intended to provide employees ofthe Company with additional incentives by permitting them to acquire aproprietary interest in the Company through the purchase of shares of theCompany’s common stock.  An additional1,500,000 shares of common stock were authorized and reserved for issuanceunder the ESPP at the 2003 Annual Meeting of Stockholders in November 2003.

 

**ITEM2****.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

**Overview**

 

Watson Wyatt & CompanyHoldings, including its subsidiaries, is a global human capital consultingfirm. We help our clients enhance business performance by improving theirability to attract, retain and motivate qualified employees. We focus ondelivering value-added consulting services that help our clients anticipate,identify and capitalize on emerging opportunities in human capitalmanagement.  We implement this strategythrough 3,890 associates in 60 offices located in 18 countries.

 

As leading economies worldwidebecome more services-oriented, human capital has become increasingly importantto companies and other organizations. The heightened competition for skilledemployees, unprecedented changes in workforce demographics, regulatory changesrelated to compensation and retiree benefits and rising employee-related costs haveincreased the importance of effective human capital management. We help ourclients address these issues by combining our expertise in human capitalmanagement with consulting and technology, to improve the design andimplementation of various

 

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human resources, or HR,programs, including compensation, retirement and health care plans.

 

**Corporate Information**

 

Including predecessors, we havebeen in business since 1946.  The WyattCompany was incorporated in Delaware on February 17, 1958.  We conducted business as The Wyatt Companyuntil changing our corporate name to Watson Wyatt & Company in connectionwith the establishment of the Watson Wyatt Worldwide alliance in 1995.  Watson Wyatt & Company Holdings wasincorporated in Delaware on January 7, 2000, and conducts business through itsprincipal operating subsidiary, Watson Wyatt & Company.

 

**General**

 

As of December 31, 2003, weemployed 3,890 associates as follows:

 
| Benefits Group                                      |   | 1,630 |   |
|-----------------------------------------------------|--------|-------|--------|
| Technology Solutions Group                          |   | 350   |   |
| Human Capital Group                                 |   | 155   |   |
| International                                       |   | 950   |   |
| Other (including Data Services  &Communication) |   | 590   |   |
| Corporate                                           |   | 215   |   |
| Total                                               |   | 3,890 |   |

 

**Principal Services**

 

We design, develop andimplement HR strategies and programs through the following closely-interrelatedpractice areas:

 
| **Benefits Group**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |   | **Technology  Solutions Group**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   | **Human  Capital Group**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| •                  Retirement  plans, including pension, 401(k) and executive benefits plans

•                  Investment  consulting services to pension plans

•                  Health care,  disability and other group benefit plans

•                  Global  compensation, benefits, expatriate and HR practice strategy, implementation  and administration

•                  Actuarial  services

•                  Strategic  workforce planning |   | •                  Web-based  applications for health and welfare, pension and compensation administration

•                  Call center  strategy, design and tools 

•                  Strategic,  research-based HR technology and service delivery consulting

•                  Targeted  online compensation and benefits statements, content management and call  center case management solutions |   | •                  Compensation  plans, including broad-based and executive compensation,  stock and other long-term incentive  programs

•                    Strategies  to align workforce performance with business objectives

•                    Organization  effectiveness consulting, including talent management, through organization  and employee research

•                    Strategies  for attracting, retaining and motivating employees

•                    Performance  management |   |

 

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Our clients include many of theworld’s largest corporations as well as emerging growth companies, publicinstitutions and nonprofit organizations.

 

**International Operations**

 

Outside of North America, ourconsultants, working in Asia-Pacific and Latin America, operate on a geographicbasis from 25 offices in 16 countries and provide consulting services in thepractice areas described above.

 

**Other**

 

While we focus our consultingservices in the areas described above, management believes that one of ourprimary strengths is our ability to draw upon consultants from our differentpractices to deliver integrated services to meet the needs of our clients.

 

**Watson Wyatt Worldwide Alliance**

 

Recognizing our clients’ needfor consulting services worldwide, in the late 1970s we established operationsthroughout Europe by acquiring local firms and opening new offices.  In 1995, in response to the rapidlyincreasing globalization of the world economy, we made a strategic decision tostrengthen our European capabilities significantly and extend our global reach.We entered into an alliance with R. Watson & Sons (which subsequentlybecame Watson Wyatt Partners, now Watson Wyatt LLP), a leading UnitedKingdom-based actuarial, benefits and human resources consulting partnershipfounded in 1878. Since 1995, we have marketed our services globally under theWatson Wyatt Worldwide brand, sharing resources, technologies, processes andbusiness referrals with Watson Wyatt LLP.

 

The Watson Wyatt Worldwidealliance maintains 88 offices in 30 countries and employs over 6,000associates. Watson Wyatt & Company Holdings operates 60 offices in 18countries in North America, Latin America and Asia-Pacific. Watson Wyatt LLPoperates 10 offices in the United Kingdom and Ireland, and also operates 2offices engaged in the insurance and financial services business in the UnitedStates. The alliance operates 16 offices in 10 continental European countries,principally through a jointly-owned holding company, Watson Wyatt Holdings(Europe) Limited.  Watson Wyatt &Company owns 25 percent of the holding company; Watson Wyatt LLP owns 75percent.

 

**Financial Statement Overview**

 

Watson Wyatt’s fiscal year endsJune 30. The financial statements contained in this quarterly report reflectConsolidated Balance Sheets as of the end of the second quarter of fiscal year2004 (December 31, 2003) and as of the end of fiscal year 2003 (June 30, 2003),Consolidated Statements of Operations for the three- and six-month periodsended December 31, 2003 and 2002, Consolidated Statements of Cash Flows for thesix-month periods ended December 31, 2003 and 2002 and a Consolidated Statementof Changes in Stockholders’ Equity for the six-month period ended December 31,2003.

 

We operate globally as analliance with our affiliates.  However,the revenues and operating expenses in the Consolidated Statements ofOperations reflect solely the results of operations of Watson Wyatt &Company Holdings. Our share of the results of our affiliates, recorded usingthe equity method of accounting, is reflected in the “Income from affiliates” line.Our affiliates are Watson Wyatt LLP, Watson Wyatt Holdings (Europe) Limited andProfessional Consultants Insurance Company, Inc. (PCIC), our captive insurancecompany.

 

We derive substantially all ofour revenue from fees for consulting services, which generally are billed basedon time and materials or on a fixed-fee basis. Clients are typically invoiced on a monthly basis with revenuerecognized as services are performed. For the most recent three fiscal years,revenue from U.S. consulting operations has comprised approximately 80 percentof consolidated revenue. No single client accounted for more than 4 percent ofour consolidated revenue for any of the most recent three

 

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fiscal years.

 

In delivering consultingservices, our principal direct expenses relate to compensation of personnel.Salaries and employee benefits are comprised of wages paid to associates,related taxes, benefit expenses such as pension, medical and insurance costsand fiscal year-end discretionary bonuses.

 

Professional and subcontractedservices represent fees paid to external service providers for employment,marketing and other services.  For themost recent three fiscal years, approximately 60 percent of these professionaland subcontracted services were directly incurred on behalf of our clients andwere reimbursed by them, with such reimbursements being included in revenue.

 

Occupancy, communications andother expenses represent expenses for rent, utilities, supplies and telephoneto operate office locations as well as non-client-reimbursed travel byassociates, publications and professional development.

 

General and administrativeexpenses include the operational costs and professional fees paid by corporatemanagement, general counsel, marketing, human resources, finance, research,technology support and professional liability insurance.

 

**CriticalAccounting Policies and Estimates**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reporting period.  Our estimates, judgments and assumptions arecontinually evaluated based on available information and experience.  Because of the use of estimates inherent inthe financial reporting process, actual results could differ from thoseestimates.

 

We have reviewed the accountingestimates used in the preparation of our financial statements and havedetermined that the following accounting policies are critical to theunderstanding of the use of estimates in the Company’s financial statements:

 

***Revenue Recognition***

 

Revenue includes fees primarilygenerated from consulting services provided in the areas of employee benefits,human capital strategies and related technology solutions.  We recognize revenue from these consultingengagements either on a time-and-materials basis or on a fixed-fee basis,depending on the terms and conditions defined at the inception of an engagementwith a client.

 

Revenue is recognized ontime-and-materials engagements based on billable rates times hours worked plusexpenses incurred.  For fixed-feearrangements, revenue is also recognized based on billable rates times hoursworked plus expenses incurred.  However,for significant fixed-fee engagements in our Technology Solutions Group, weperiodically review ongoing engagements in order to assess the accuracy of ourestimates-to-complete.  Revenuerecognition for fixed fee engagements is affected by a number of factorsincluding a change in the estimated amount of effort required to complete theproject, changes in scope, the staffing on the engagement and/or the level ofclient participation.  This reviewrequires us to make judgments and estimates regarding the overall profitabilityand stage of project completion which, in turn, affect how we recognizerevenue.  To the extent that ourestimates change for a particular engagement, we record the cumulative effectof the change in the period in which it becomes known.  The Company recognizes a loss on anengagement when estimated revenue to be received for that engagement is lessthan total estimated direct and indirect costs associated with theengagement.  Losses are recognized inthe period in which the loss becomes probable and the amount of the loss isreasonably estimable.

 

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The Company has developedvarious software programs and technologies that are provided to clients inconnection with consulting services.  Wegenerally recognize revenue for such services as time is incurred because theservices are considered essential to the functionality of the software.

 

Revenue recognized in excess ofbillings is recorded as unbilled accounts receivable.  Cash collections in excess of revenue recognized are recorded asdeferred revenue until the revenue recognition criteria are met.  Client reimbursable expenses, includingthose relating to travel, other out-of-pocket expenses, and any third-partycosts, are included in revenue, and an equivalent amount of reimbursableexpenses are included in professional and subcontracted services as a cost ofrevenue.

 

Emerging Issues Task ForceIssue 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21),was effective for the Company beginning July 1, 2003.  Beginning July 1, 2003, the Company will apply such requirementsprospectively to multiple deliverable arrangements, which include arrangementsinvolving installation and customization of technology solution products soldtogether with on-going services offered by the Company.  The adoption of EITF 00-21 has not had amaterial effect on the Company’s financial performance or condition.

 

***Valuation of Billedand Unbilled Receivables from Clients***

 

We maintain allowances fordoubtful accounts to reflect estimated losses resulting from our clients’failure to pay for our services after the services have been rendered,including allowances when customer disputes may exist.  The related provision is recorded as areduction to revenue.  Our allowancepolicy is based on the aging of our billed and unbilled client receivables andhas been developed based on our write-off history.  Facts and circumstances may change that would require us to alterour estimates of the collectibility of specific billed and unbilled clientreceivables.

 

***DiscretionaryCompensation***

 

The Company’s compensationprogram includes a discretionary annual bonus that is determined by managementand paid once per fiscal year in the form of cash and/or deferred stock unitsafter the Company’s annual operating results are finalized.  Quarterly, estimated annual pre-bonusprofitability is reviewed by the Company and the discretionary annual bonusamount is then estimated by management. After determining the estimated annual bonus amount, the bonus is thenallocated to remaining quarterly reporting periods as a constant percentage ofestimated pre-bonus profitability.  Inthose quarters where the estimated annual bonus level changes, the remainingestimated annual bonus is accrued over the remaining quarters as a constant percentageof estimated future pre-bonus profitability. Annual bonus levels may vary from current expectations as a result ofchanges in the Company’s forecast of pre-bonus profitability and competitiveemployment market conditions.

 

As a result of a $5.6 millionpre-tax non-operating gain recorded in the first quarter of fiscal year 2004,the Company recorded a $5.6 million supplemental bonus accrual in the firstquarter that is incremental to the Company’s fiscal year end bonus.  This supplemental bonus amount, which willbe paid out in September 2004 with the regular bonus cycle, is included inSalaries and employee benefits.

 

***Income Taxes***

 

Determining the consolidatedprovision for income tax expense, deferred tax assets and liabilities and therelated valuation allowance involves judgment. As a global company with offices in 18 countries, we are required tocalculate and provide for estimated income tax liabilities for each of the taxjurisdictions in which we operate.  Thisprocess involves estimating current tax obligations and exposures in eachjurisdiction as well as making judgments regarding the future recoverability ofdeferred tax assets.  Tax costs caninvolve complex issues and may require an extended period to resolve.  Changes in the geographic mix or estimatedlevel of annual pre-tax income, revisions to tax positions taken as a result offurther analysis and consultation, changes in tax laws and changes resultingfrom tax audits can all affect the overall effective income tax rate, which, inturn, impacts the overall level of income tax expense and

 

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net income.

 

***Pension Assumptions***

 

We sponsor both qualified andnon-qualified, non-contributory defined benefit pension plans coveringsubstantially all of our associates. Under our principal plans (United States, Canada, Hong Kong and theUnited Kingdom), benefits are based on our associates’ years of service andcompensation during the three highest-paid consecutive years of service.

 

Determination of ourobligations and annual expense under the plans is based on a number ofassumptions that, given the longevity of the plans, are long-term infocus.  A change in one or a combinationof these assumptions could have a material impact on our pension benefitobligation and related expense.  Forthis reason, management employs a long-term view so that assumptions do notchange frequently in response to short-term volatility in the economy.  Any difference between actual and assumedresults is amortized into our pension expense over the average remainingservice period of participating employees. We consider several factors prior to the start of each fiscal year whendetermining the appropriate annual assumptions, including economic forecasts,historical trends, portfolio composition and peer comparisons.

 

The following assumptions wereused at the end of the past three fiscal years in the valuation of our U.S.plan, which comprises the majority of the principal defined benefit pensionplans:

 
|                                        |   | **Year Ended  June 30** |   |
|---------------------------------------------|--------|-------------------------|--------|
|                                        |   | **2003**                |   | **2002** |   | **2001** |   |
| Discount rate                               |   | 6.00                    | %      | 7.25 | % | 7.25 | % |
| Expected long-term rate of return on assets |   | 9.00                    | %      | 10.00 | % | 10.00 | % |
| Rate of increase in compensation levels     |   | 3.09                    | %      | 4.34 | % | 5.34 | % |

 

The 6.00 percent discount rateassumption used at the end of fiscal year 2003 represents a 125 basis pointreduction from the 7.25 percent discount rate used at the end of fiscal years2002 and 2001.  The Company’s 2003discount rate assumption was determined by matching future pension benefitpayments with expected future AA bond yields for the same periods.

 

The expected long-term rate ofreturn on assets assumption was lowered to 9.00 percent at the end of fiscalyear 2003 from 10.00 percent at the end of fiscal years 2002 and 2001.  Selection of the 9.00 percent returnassumption was supported by an analysis performed by the Company of theweighted average yield expected to be achieved with the anticipated makeup ofinvestments.  The investment makeup isheavily weighted towards equities.  Thereturn on assets through the first six months of fiscal year 2004 has been13.0%, compared to a return of (1.0)% in fiscal year 2003.

 

During fiscal year 2003, thevalue of the assets held in the pension plans decreased and the decline ininterest rates increased our accumulated benefit obligation, resulting in theaccumulated benefit obligation becoming greater than the value of the planassets for the U.S. and U.K. pension plans. The Company was therefore required to record an additional minimumpension liability for those plans at June 30, 2003, in accordance withStatement of Financial Accounting Standards No. 87 “Employers’ Accounting forPensions” (FAS 87).  This resulted in anincrease in the pension liability of $113.4 million, an increase in intangibleassets of $0.1 million, a non-cash charge to Stockholders’ Equity of $67.9million (reflected in accumulated other comprehensive loss) and an increase indeferred tax assets of $45.4 million as of June 30, 2003.  A market recovery in future periods, and/oran increase in long-term interest rates, could reverse a portion or all of thischarge.  Alternatively, future marketdeclines and/or a decrease in long-term interest rates would result in anaddition to this amount.  Our Canadianand Hong Kong pension plan assets were greater than their associatedaccumulated benefit obligation as of June 30, 2003, and thus did

 

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not require the recording ofadditional minimum pension liabilities.

 

***Incurred But NotReported Claims***

 

The Company uses actuarial assumptions to estimate andrecord a liability for incurred but not reported (IBNR) professional liabilityclaims and engaged an external actuarial firm to assist in the calculation ofthese estimates.  Our estimated IBNR liabilityis based on long-term trends and averages, and considers a number of factors,including changes in claim reporting patterns, claim settlement patterns,judicial decisions, and legislation and economic decisions, but excludes theeffect of claims data for large cases due to the insufficiency of actualexperience with such cases.  Managementdoes not currently expect significant fluctuations in the IBNR liability, basedon the Company’s historical claims experience. However, our estimated IBNR liability will fluctuate if claimsexperience changes over time.

 

 

**Results of Operations.**

 

The table below sets forthConsolidated Statements of Operations data for continuing operations as apercentage of revenue for the periods indicated:

 
|                                                   |   | **Three  Months Ended December 31,** |   | **Six Months  Ended December 31,** |   |
|--------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                                   |   | **2003**                             |   | **2002**                           |   | **2003** |   | **2002** |   |
|                                                   |   |                                 |   |                               |   |   |   |   |   |
| Revenue                                                |   | 100.0                                | %      | 100.0                              | %      | 100.0 | % | 100.0 | % |
|                                                   |   |                                 |   |                               |   |   |   |   |   |
| Costs of providing services:                           |   |                                 |   |                               |   |   |   |   |   |
| Salaries and employee benefits                         |   | 55.4                                 |   | 56.0                               |   | 58.3 |   | 56.5 |   |
| Professional and subcontracted services                |   | 7.4                                  |   | 7.5                                |   | 6.4 |   | 6.7 |   |
| Occupancy, communications and other                    |   | 15.2                                 |   | 14.6                               |   | 14.5 |   | 14.7 |   |
| General and administrative expenses                    |   | 8.8                                  |   | 8.5                                |   | 9.0 |   | 8.3 |   |
| Depreciation and amortization                          |   | 3.2                                  |   | 3.0                                |   | 2.9 |   | 2.9 |   |
|                                                   |   | 90.0                                 |   | 89.6                               |   | 91.1 |   | 89.1 |   |
|                                                   |   |                                 |   |                               |   |   |   |   |   |
| Income from operations                                 |   | 10.0                                 |   | 10.4                               |   | 8.9 |   | 10.9 |   |
|                                                   |   |                                 |   |                               |   |   |   |   |   |
| Income from affiliates                                 |   | 0.6                                  |   | 1.2                                |   | 0.8 |   | 0.9 |   |
| Interest income, net                                   |   | 0.1                                  |   | 0.1                                |   | 0.1 |   | 0.1 |   |
| Other non-operating income                             |   | —                               |   | 0.1                                |   | 1.8 |   | 0.2 |   |
|                                                   |   |                                 |   |                               |   |   |   |   |   |
| Income from continuing operations before  income taxes |   | 10.7                                 |   | 11.8                               |   | 11.6 |   | 12.1 |   |
|                                                   |   |                                 |   |                               |   |   |   |   |   |
| Provision for income taxes                             |   | 4.4                                  |   | 4.8                                |   | 4.8 |   | 5.0 |   |
|                                                   |   |                                 |   |                               |   |   |   |   |   |
| Income from continuing operations                      |   | 6.3                                  | %      | 7.0                                | %      | 6.8 | % | 7.1 | % |

 

 

**Three and Six Months Ended December 31, 2003,Compared to the Three and Six Months Ended December 31, 2002**

 

***Executive Overview***

 

Revenues for the quarter weredown from the second quarter of fiscal year 2003, although in line with ourexpectations.  Our Benefits Groupcontinued to grow as we were named lead actuary during the quarter for a numberof clients within the Fortune 1000 and P&I 1000.  Offsetting this growth was continued weakness in our TechnologySolutions and Human Capital Groups. These groups are more sensitive to economic downturns and the resultingtight corporate budgets.  Although theeconomy has shown signs of

 

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recovery, there is typically alag between when a company’s results improve and when a company will be willingto spend large amounts on the types of discretionary projects that would beserviced by these two groups.  Webelieve that spending will resume when companies become confident that aneconomic recovery is more firmly in place.

 

Expenses continue to decline asa result of the Company’s cost reduction efforts, affecting expense categoriessuch as salaries, employee benefits, rent, travel, and office supplies.  These reductions have been partially offset byincreased pension and professional liability insurance expense.

 

***Revenue***

 

Revenue from operations for thesecond quarter of fiscal year 2004 was $170.4 million, compared to $174.6million for the second quarter of fiscal year 2003, a decrease of $4.2 millionor 2 percent.

 

The Benefits Group increased revenue by $3.3million or 3 percent during the second quarter of fiscal year 2004 as wecontinued to benefit from a large number of new client wins and grow revenueswith existing clients, in part due to consulting associated with continuing legislativeactivity regarding cash balance plans and pension funding assumptions.  Revenue from our Technology Solutions Groupdecreased by $4.6 million or 17 percent, a slightly better performance thanexpected due to a number of new client wins with which we were able to beginwork during the quarter.  Overall,however, these results reflect the lag between when a company’s results improveand when it is willing to spend large amounts on discretionary projects.  Revenue from our Human Capital Groupdecreased $0.3 million or 3 percent, reflecting increased demand in executivecompensation offset by weak results in organization effectiveness consulting aswell as from continued hesitancy of companies to engage special project workduring a period of tight financial budgets. Our revenues in this segment are largely being driven by increased workin our executive compensation business, offset by a decrease in demand forgeneral organization effectiveness consulting. Our international segment finished the quarter with revenue growth of$0.3 million or 2 percent.  However,revenue was down 6% after adjusting for the impact of favorable exchangerates.  Revenue for other practice areasin North America decreased by $1.1 million or 9 percent during the secondquarter of fiscal year 2004.

 

Revenue from operations for thefirst six months of fiscal year 2004 was $341.3 million, compared to $353.6million for the first six months of fiscal year 2003, a decrease of $12.3million or 3 percent.

 

The Benefits Group increasedrevenue by $5.2 million or 3 percent during the first six months of fiscal year2004 due to new client wins, as well as growth in existing clients.  Revenue from our Technology Solutions Groupdecreased by $10.7 million or 20 percent, reflecting the lag between when acompany’s results improve and when it is willing to spend large amounts ondiscretionary projects.  Revenue fromour Human Capital Group decreased $1.4 million or 6 percent during the firstsix months of fiscal year 2004, reflecting increased demand in executivecompensation offset by weak results in organization effectivenessconsulting.  Our international segmentfinished the six months with fiscal year to date revenue growth of $1.2 millionor 3 percent.  However, revenue was down5% after adjusting for the impact of favorable exchange rates.  Revenue for other practice areas in NorthAmerica decreased by $3.3 million or 13 percent during the first six months offiscal year 2004.

 

***Salaries andEmployee Benefits***

 

Salaries and employee benefitexpenses for the second quarter of fiscal year 2004 were $94.4 million,compared to $97.8 million for the second quarter of fiscal year 2003, adecrease of $3.4 million or 3 percent. Salaries and employee benefit expenses for the second quarter of fiscalyear 2004 include severance charges of $0.7 million related to job reductionsin North America.  The decrease,exclusive of this charge, was mainly due to lower benefits costs of $2.8million, which reflect the suspension of the company match on our definedcontribution retirement plan and the higher proportion of health care costspaid by our associates, a lower accrual for discretionary compensation of $1.4million and lower salaries of $1.2 million, which reflect the Company’stargeted job reductions net of modest salary increases, partially offset byhigher pension costs of $0.9 million. Pension expense for fiscal year 2004 was reduced

 

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by $2.0 million as the pensionvaluation was finalized with lower headcounts and higher pension contributionsthan what had been utilized for the valuation at June 30, 2003.  As a result, pension costs for the quarterended December 31, 2003 reflect one-half of this reduction, or $1.0million.  As a percentage of revenue,salaries and employee benefits decreased from 56.0 percent to 55.4 percent.

 

Salaries and employee benefitexpenses for the first six months of fiscal year 2004 and 2003 were $199.4million.  Salaries and employee benefitexpenses for the first six months of fiscal year 2004 include severance chargesof $3.2 million related to job reductions in North America.  The decrease, exclusive of this charge, wasmainly due to lower benefits costs of $5.0 million, which reflect thesuspension of the company match on our defined contribution retirement plan andthe higher proportion of health care costs paid by our associates and lowersalaries of $1.5 million, which reflect the Company’s targeted job reductionsnet of modest salary increases, partially offset by higher pension costs of$3.2 million.  As a percentage ofrevenue, salaries and employee benefits increased from 56.5 percent to 58.3percent.

 

***Professional andSubcontracted Services***

 

Professional and subcontractedservices used in consulting operations for the second quarter of fiscal year2004 were $12.6 million, compared to $13.0 million for the second quarter offiscal year 2003, a decrease of $0.4 million or 3 percent.  As a percentage of revenue, professional andsubcontracted services decreased from 7.5 percent to 7.4 percent.

 

Professional and subcontractedservices used in consulting operations for the first six months of fiscal year2004 were $21.7 million, compared to $23.9 million for the first six months offiscal year 2003, a decrease of $2.2 million or 9 percent.  The decrease in both periods resulted fromlower reimbursable expenses incurred on behalf of clients, and continued costcontrol measures.  As a percentage ofrevenue, professional and subcontracted services decreased from 6.7 percent to6.4 percent.

 

***Occupancy,Communications and Other***

 

Occupancy, communications andother expenses for the second quarter of fiscal year 2004 were $25.9 millioncompared to $25.5 million for the second quarter of fiscal year 2003, anincrease of $0.4 million or 2 percent. As a percentage of revenue, occupancy, communications and otherincreased from 14.6 percent to 15.2 percent.

 

Occupancy, communications andother expenses for the first six months of fiscal year 2004 were $49.4 million,compared to $52.1 million for the first six months of fiscal year 2003, adecrease of $2.7 million or 5 percent. The decrease reflects the Company’s cost containment measures, asevidenced through lower expenses in all categories including travel, officesupplies, telephone and business taxes. As a percentage of revenue, occupancy, communications and otherdecreased from 14.7 percent to 14.5 percent.

 

***General andAdministrative Expenses***

 

General and administrativeexpenses for the second quarter of fiscal year 2004 were $15.0 million,compared to $14.8 million for the second quarter of fiscal year 2003, anincrease of $0.2 million or 1 percent. As a percentage of revenue, general and administrative expensesincreased from 8.5 percent to 8.8 percent.

 

General and administrativeexpenses for the first six months of fiscal year 2004 were $30.6 million,compared to $29.2 million for the first six months of fiscal year 2003, anincrease of $1.4 million or 5 percent. As a percentage of revenue, general and administrative expensesincreased from 8.3 percent to 9.0 percent. The increase in both periods is mainly due to higher insurance costs andexpenses associated with compliance with the Sarbanes-Oxley Act of 2002 andrelated SEC rules.

 

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***Depreciation andAmortization***

 

Depreciation and amortizationfor the second quarter of fiscal year 2004 was $5.4 million, compared to $5.3million for the second quarter of fiscal year 2003, an increase of $0.1 millionor 2 percent.  Depreciation andamortization expenses include an acceleration of depreciation of $0.6 millionrecorded due to a lease termination. The decrease, exclusive of this accelerated depreciation, is mainly dueto lower capital asset purchases in fiscal year 2002 and 2003.  As a percentage of revenue, depreciation andamortization increased from 3.0 percent to 3.2 percent.

 

Depreciation and amortizationfor the first six months of fiscal year 2004 was $10.0 million, compared to$10.3 million for the first six months of fiscal year 2003, a decrease of $0.3million or 3 percent.  The decrease ismainly due to lower capital asset purchases in fiscal year 2002 and 2003.  As a percentage of revenue, depreciation andamortization remained at 2.9 percent.

 

***Income FromAffiliates***

 

Income from affiliates for thesecond quarter of fiscal year 2004 was $1.0 million, compared to $2.1 millionfor the second quarter of fiscal year 2003, a decrease of $1.1 million or 52percent.   The decrease was due to lowerequity income of our affiliated captive insurance company, ProfessionalConsultants Insurance Company (PCIC) of $1.0 million, and lower operatingresults of Watson Wyatt LLP of $0.3 million, partially offset by improvedoperations of Watson Wyatt Holdings (Europe) Limited (WWHE) of $0.4 million.

 

Income from affiliates for thefirst six months of fiscal year 2004 was $2.8 million, compared to $2.9 millionfor the first six months of fiscal year 2003, a decrease of $0.1 million or 3percent.   The decrease was due to lowerincome from PCIC of $0.6 million and lower operating results of Watson WyattLLP of $0.6 million, partially offset by improved operations of WWHE of $1.0million.

 

***Interest Income, Net***

 

Interest income, net for thesecond quarter of fiscal year 2004 was $0.2 million, unchanged from the prioryear.  Interest income, net for thefirst six months of fiscal year 2004 was $0.4 million, compared to $0.5 millionfor the first six months of fiscal year 2003, a decrease of $0.1 million or20%.

 

***Other Non-operatingIncome***

 

Other non-operatingincome for the first six months of fiscal year 2004 was $6.2 million, comparedto $0.6 million for the first six months of fiscal year 2003.  The increase is mainly due to the $5.6million non-operating gain the Company recorded related to PCIC.  See Note 6 of the Notes to the ConsolidatedFinancial Statements for more information about this non-operating gain.  During the first six months of fiscal years2004 and 2003, the Company also received cash payments of $0.6 million inconnection with the fiscal year 2002 sale of our U.S.-based public retirementbusiness to GRS.  All payments receivedin connection with this sale were contingent upon the successful transition ofcertain clients to GRS and upon their retention by GRS.

 

***Provision for IncomeTaxes***

 

Provision for income taxes forthe first six months of fiscal year 2004 was $16.2 million, compared to $17.5million for the first six months of fiscal year 2003. Our effective tax ratewas 41.0 percent for the first six months of fiscal years 2004 and 2003.

 

***Income FromContinuing Operations***

 

Income from continuingoperations for the second quarter of fiscal year 2004 was $10.8 million,compared to $12.1 million for the second quarter of fiscal year 2003, adecrease of $1.3 million or 11 percent. As a percentage of revenue, income from continuing operations decreasedfrom 7.0 percent to

 

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6.3 percent.  Income from continuing operations for thefirst six months of fiscal year 2004 was $23.3 million, compared to $25.2million for the first six months of fiscal year 2003, a decrease of $1.9million or 8 percent.  As a percentageof revenue, income from continuing operations decreased from 7.1 percent to 6.8percent.

 

***Earnings Per Share,Income From Continuing Operations***

 

Diluted earnings per share,income from continuing operations for the second quarter of fiscal year 2004was $0.32, compared to $0.36 for the second quarter of fiscal year 2003.  Diluted earnings per share, income fromcontinuing operations for the first six months of fiscal year 2004 was $0.70,compared to $0.76 for the first six months of fiscal year 2003.

 

***DiscontinuedOperations***

 

Through the first six months offiscal year 2004, the Company received sublease income of approximately $44,000in excess of lease payments related to Wellspring.  See Note 14 of the Notes to the Consolidated Financial Statementsfor more information related to Wellspring.

 

**Liquidity and Capital Resources**

 

Our cash and cash equivalentsat December 31, 2003, totaled $131.6 million, compared to $144.4 million atJune 30, 2003, representing a decrease of $12.8 million through the secondquarter of fiscal year 2004.  Thedecrease in cash from June 30, 2003 to December 31, 2003 follows a typicalpattern of cash flows for the Company that is attributable to the payment ofbonuses in the first quarter related to the prior year’s fiscal year end bonusaccrual.  During the first six months offiscal year 2004, we paid $34.9 million in previously accrued discretionarycompensation and $25.5 million in corporate taxes and contributed $10.0 millionto our U.S. defined benefit pension plan. These outflows of cash were offset by positive cash flow from consultingoperations.  Consistent with theCompany’s liquidity position, management considers various alternativestrategic uses of cash reserves including acquisitions, dividends and stockbuybacks, or any combination of these options.

 

Our non-U.S. operations do notmaterially impact liquidity or capital resources as they are substantiallyself-sufficient for their working capital needs.  At December 31, 2003, $27.5 million of the total cash balance of$131.6 million was held outside of North America, which we have the ability to utilize,if necessary. There are no significant restrictions other than local or U.S.taxes associated with repatriation.

 

***Cash (Used in) FromOperating Activities***

 

Cash used in operatingactivities* *forthe first six months of fiscal year 2004 was $3.4 million, compared to cashfrom operating activities of $12.2 million for the first six months of fiscalyear 2003.  The variance is mainly dueto the timing of insurance payments, which contributed $9.0 million to cashused in operations and higher payments of corporate taxes of $7.1 million.

 

The allowance for doubtfulaccounts increased $1.2 million and the allowance for work in process increased$0.2 million from June 30, 2003, to December 31, 2003. The number of days ofaccounts receivable and work in process outstanding was 72 at December 31, 2003,compared to 72 at June 30, 2003 and 74 at December 31, 2002.

 

***Cash Used inInvesting Activities***

 

Cash used in investingactivities for the first six months of fiscal year 2004 was $7.4 million,compared to $11.6 million for the first six months of fiscal year 2003.  The decrease can be primarily attributed tolower purchases of fixed assets of $2.5 million and the absence of additionalinvestments in affiliates compared to the first quarter of fiscal year 2003.

 

Expenditures of capital fundswere $8.2 million for the first six months of fiscal year 2004.  Anticipated commitments of capital funds areestimated at $15.3 million for the remainder of fiscal year 2004, mainly

 

25

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for computer hardware purchases,office relocations and renovations, development and upgrade of financial andretirement systems and acquisition-related payments. We expect cash fromoperations to adequately provide for these cash needs.

 

***Cash Used inFinancing Activities***

 

Cash used in financingactivities for the first six months of fiscal year 2004 and 2003 was $5.3million, mainly associated with repurchases of common stock, offset bypurchases of common stock by associates through the Company’s Employee StockPurchase Plan and Long-term Incentive Plan. The Company repurchased  413,400shares of common stock during fiscal year 2004 to reduce dilution resultingfrom the issuance of shares in connection with the Company’s employee benefitplans.

 

**Off-Balance Sheet Arrangements and ContractualObligations**

 

***OperatingLeases***.  Welease office space, furniture and selected computer equipment under operatinglease agreements with terms ranging from one to ten years.  Future expected payments are as follows:

 
|                              |   | **Payments  due by period** |    |
|-----------------------------------|--------|-----------------------------|---------|
| **Contractual Cash  Obligations** |   | **Total**                   |    | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   | **After 5  years** | ** ** |
| Lease commitments                 |   | $                           | 233,973 |   | $ | 19,326 |   | $ | 69,665 |   | $ | 55,740 |   | $ | 89,242 |   |
|                                   |        |                             |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Management has determined thatthere is not a large concentration of leases that will expire in any one fiscalyear.  Consequently, managementanticipates that any increase in future rent expense will be mainly marketdriven.

 

***Guarantees***

 

*Wellspring Leases*.  The Company continues to guarantee certainleases for office premises and equipment for Wellspring.  At December 31, 2003, minimum remainingpayments guaranteed under these leases, which expire at various dates through2007, totaled $21.3 million, excluding anticipated sublease income.  The leases are currently generating positivecash flows of approximately $0.1 million per fiscal year.  Management will continue to evaluate theadequacy of these provisions and make adjustments as appropriate.  See Note 14 of the Notes to the ConsolidatedFinancial Statements for more information related to Wellspring.

 

*Affiliate Agreements*.  In connection with the establishment of ouralliance with Watson Wyatt LLP in 1995, the Company agreed to guarantee WatsonWyatt LLP’s performance under a lease for office space in London that expiresin 2015.  Payments by Watson Wyatt LLPunder the lease total £1.4 million (or approximately $2.5 million based on theDecember 31, 2003, exchange rate) per year. We also granted Watson Wyatt LLP an option to return the leased space toour UK subsidiary in 2009.  If WatsonWyatt LLP were to exercise this option, the Company would attempt to subleasethe space at the then-current market rates.

 

**Credit Agreement**

 

The Company has a $100.0million revolving credit facility with a syndicate of banks.  Interest rates associated with this facilityvary with LIBOR and/or the Prime Rate and are based on our leverage ratio, asdefined by the credit agreement.  We arecharged a quarterly commitment fee, currently 0.25 percent of the facility,that varies with our financial leverage and is calculated on the unused portionof the credit facility.  No amounts wereoutstanding under the Company’s revolving credit facility as of December 31,2003, or June 30, 2003.  Credit underthe facility is available upon demand, although the credit facility

 

26

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requires us to observe certaincovenants (including requirements for minimum net worth, which act to restrictdividends and other financial and restrictive covenants) and is collateralizedwith a pledge of stock of material subsidiaries.  We were in compliance with all covenants under the creditfacility as of December 31, 2003.

 

A portion of the revolvingfacility is used to support required letters of credit issued under the creditline.  As a result, $7.5 million of thefacility is currently unavailable for operating needs.  We are also charged a fee for outstandingletters of credit that fluctuates based on our leverage ratio.  The credit facility is scheduled to expireon June 25, 2005.

 

**Risk Management**

 

**As a part of our overall risk management program, we carrycustomary commercial insurance policies, including commercial generalliability, employment practices liability, and claims-made professionalliability insurance with a self-insured retention of $1 million per claim,which provides coverage for professional liability claims including the cost ofdefending such claims.  Our primaryinsurance coverage beyond this retention is written by an affiliated captiveinsurance company owned by us and two other professional services firms.  Prior to July 1, 2003, the first $5 millionof coverage had a premium structure which provided that the captive insurancecompany would recover from the firm defending the claim approximately 75percent of any loss up to $5 million. The Company recorded an accrual for this liability.  This recovery occurred through insurancepremium payments in subsequent years. The remaining 25 percent of any loss up to $5 million was a risk borneby the captive insurance company, which carried reinsurance in the commercialmarkets for most losses above $5 million.**

** **

**As of July 1, 2003, PCIC attempts to recover through itspremium structure the amounts it expects to pay out for member companies inclaims losses. It bases premium calculations, which are determined annuallybased on experience through March of each year, on relative risk of the variouslines of business performed by each of the owner companies, past claimexperience of each owner company, growth of each of those companies, industryrisk profiles in general and the overall insurance markets.**

** **

**Our agreements with PCIC could require additional paymentsto PCIC in the event that the Company decided to exit PCIC and adverse claimssignificantly exceed prior expectations. If these circumstances were to occur, the Company would record aliability at the time it becomes estimable and probable.**

** **

**The Company will continue to provide for the self-insuredretention where specific estimated losses for known claims in excess of $1million are considered probable and reasonably estimable.**

** **

**Although the Company maintains professional liabilityinsurance coverage, this insurance does not cover claims made after expirationof our current insurance contracts. Generally accepted accounting principles require that we record aliability for incurred but not reported (IBNR) professional liability claims ifthey are estimable and probable, and for which we have not yet contracted forinsurance coverage.  The Company usesactuarial assumptions to estimate and record its IBNR liability and has a $12.9million IBNR liability recorded as of December 31, 2003.**

** **

**Current insurance market conditions include increases inpremium cost, higher self-insured retentions and reductions in aggregate excesscoverages, trends that are anticipated to continue.  We expect these trends to be reflected in our future annualinsurance renewals, and as a result, we will continue to assess our ability tosecure future insurance coverage.  Inanticipation of the possibility of future reductions in risk transfer from PCICto reinsurers, as well as the trend toward a generally hardening insurancemarket, the firms that own PCIC, including the Company, have been increasingPCIC’s capital in fiscal years 2002 and 2003.**

** **

**In light of increasing worldwide litigation, includinglitigation against professionals, the Company has been implementing arequirement that all client relationships be documented by engagement letterscontaining specific risk mitigation clauses that were not included in allhistorical client agreements.**

** **

**27**

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** **

**Nearly 100 percent of the Company’s U.S. corporate clientshave signed engagement letters including mitigation clauses, and initiatives tocomplete that process in the United States and elsewhere are underway. TheCompany has disengaged from certain client relationships where satisfactoryengagement terms could not be achieved.**

** **

**Recent AccountingPronouncements**

** **

In January 2003, the FinancialAccounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46),“Consolidation of Variable Interest Entities,” which clarifies the financialreporting guidance associated with the consolidation of another entity.  Immediate consolidation requirements of FIN46 were not applicable since the Company did not create variable interestentities after January 31, 2003.  InDecember 2003, the FASB revised and superceded FIN 46 with the issuance of FIN46R in order to address certain implementation issues.  FIN 46R will be required to be adopted bythe Company effective March 31, 2004. Management does not believe that the adoption of FIN 46R will have aneffect on the Company’s financial performance or condition.

 

Emerging Issues Task ForceIssue 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21),was effective for the Company beginning July 1, 2003.  Beginning July 1, 2003, the Company will apply such requirementsprospectively to multiple deliverable arrangements, which include arrangementsinvolving installation and customization of technology solution products soldtogether with on-going services offered by the Company.  Based on the types of arrangements enteredinto historically, the Company does not expect that adoption of EITF 00-21 willhave a material impact on the accounting for such arrangements.

 

In December 2003, the Securities and ExchangeCommission (SEC) issued Staff Accounting Bulletin No. 104 (SAB 104), “RevenueRecognition,” which supercedes Staff Accounting Bulletin No. 101 (SAB 101), “RevenueRecognition in Financial Statements.” SAB 104’s primary purpose is to rescind accounting guidance contained inSAB 101 related to multiple element revenue arrangements, superceded as aresult of the issuance of EITF 00-21. While the wording of SAB 104 has changed to reflect the issuance of EITF00-21, the revenue recognition principles of SAB 101 remain largely unchangedby the issuance of SAB 104.  Theissuance of SAB 104 has not had an effect on our revenue recognition policiesas they are in accordance with SAB 104.

 

**Disclaimer Regarding Forward-lookingStatements**

 

This filing contains certainstatements that are “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995, including, but not limited tothe following: Note 8 on page 10 and 11; Note 12 on page 13 and 14; Note 13 onpage 14; Note 14 on page 14; the “Executive Overview” on page 21; CriticalAccounting Policies and Estimates on pages 18 through 21; the discussion of ourcapital commitments on pages 25 and 26; and Part II, Item 1 “Legal Proceedings”on page 31.  In some cases, you canidentify these statements and other forward-looking statements in this filingby words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate,”“plan,” “intend,” “continue,” or similar words. You should read thesestatements carefully because they contain projections of our future results ofoperations or financial condition, or state other “forward-looking”information. A number of risks and uncertainties exist which could cause actualresults to differ materially from the results reflected in theseforward-looking statements. Such factors include, but are not limited to, ourcontinued ability to recruit and retain highly qualified associates; outcomesof litigation; a significant decrease in the demand for the consulting serviceswe offer as a result of changing economic conditions or other factors; actionsby competitors offering human resources consulting services, including publicaccounting and consulting firms, technology consulting firms andinternet/intranet development firms; regulatory, legislative and technologicaldevelopments that may affect the demand for or costs of our services; and otherfactors discussed under “risk factors” in our Annual Report on Form 10-K forthe fiscal year ended June 30, 2003, which was filed with the SEC on September23, 2003, and may be accessed via EDGAR on the SEC’s web site at www.sec.gov.These statements are based on assumptions that may not come true. All forward-lookingdisclosure is speculative by its nature. The Company undertakes no obligationto update

 

28

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any of the forward-lookinginformation included in this report, whether as a result of new information,future events, changed expectations or otherwise.

 

**ITEM3****.  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

We are exposed to market risksin the ordinary course of business, although our risk profile has not changedduring the period covered by this form 10-Q. These risks include interest raterisk and foreign currency exchange risk. We have examined our exposure to theserisks and have concluded that none of our exposures in these areas is materialto fair values, cash flows or earnings*.*

 

**ITEM4****.  CONTROLS ANDPROCEDURES.**

 

**Evaluation of Disclosure Controls and Procedures**

 

The Chief Executive Officer(CEO) and Chief Financial Officer (CFO) of the Company evaluated our disclosurecontrols and procedures as of the end of the second quarter of fiscal year2004. They have concluded that, as of December 31, 2003, such controls andprocedures have been effectively designed to ensure that information requiredto be disclosed in reports that the Company files with or submits to the SEC isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms and is accumulated and communicated to management,including the CEO and CFO, as appropriate, to allow timely decisions regardingsuch disclosure.

 

**Changes in Internal Control Over Financial Reporting**

 

As part of the Company’s compliance withSection 404 of the Sarbanes-Oxley Act of 2002 and related SEC rules, theCompany is conducting a review of our internal control over financialreporting, including information technology systems.   This review includes the documentation of all significantprocesses pertaining to the preparation and disclosure of the Company’sfinancial information, identification of potential financial risks and relatedkey controls, assessment of the adequacy of existing controls, and design anddocumentation of new and/or revised controls where necessary.  In the third and fourth fiscal quarters of2004, we expect to test key controls to ensure that they are adequate andfunctioning consistently.

 

As a result of this review, we have identified financial processeswhere existing internal controls require strengthening, or new controls need tobe established to enhance the effectiveness of existing controls.  The Company’s standard for evaluating andremediating internal controls is to ensure that there is less than a remotelikelihood of a misstatement of the Company’s annual or interim financialstatements that is more than inconsequential in amount and will not beprevented or detected by the Company. The resulting changes to our internal controls have been disclosed toour independent auditors and to the Audit Committee of the Board of Directorsof the Company and are summarized below:

 

*Billing Process*.  The Company established abilling committee to recommend improvements to the Company’s billing practicesand controls over the billing process. As of December 31, 2003, the committee had designed controls over thebilling process which formalized financial review of each bill to ensure conformancewith accounting records and client agreements. These controls will be implemented throughout the Company.

 

*Secondary Review.*  Work performed in conjunctionwith several significant financial processes – including inter-companyaccounting, prepaid expenses, tax, financial consolidations, equity investmentaccounting, discontinued operations and analytical reviews of results  – is now formally subjected to a secondaryreview and sign-off.  The performance ofthese controls is documented.

 

29

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*Information Technology Controls*. Controls over access to our information technology systems were enhancedin the following fashion:

 

(i)                                     Password security was strengthened byrequiring minimum lengths, forcing periodic changes, and disabling access aftera limited number of unsuccessful logon attempts.  Access to financial applications generally must firstauthenticate at the enterprise level, prior to gaining access to financialapplications.

 

(ii)                                  Controls for approving changes inapplications software and moving those changes to production have beenstrengthened.

 

(iii)                               Security over access to application softwarehas been improved.

 

*Capital Asset Inventories. *The Companynow requires that every geographic location perform a physical inventory of itsfixed assets on an annual basis instead of on a rotating basis.

 

As we continue to document key processes andidentify key controls in compliance with the Sarbanes-Oxley Act of 2002, we mayfind it necessary to enhance existing, or introduce new disclosure and internalcontrols.

 

**Compliance with Section 404 of the Sarbanes-Oxley Act of 2002**

 

Our Company is required to comply withSection 404 of the Sarbanes-Oxley Act of 2002 and SEC rules and Public CompanyAccounting Oversight Board (PCAOB) standards for implementing Section 404 byJune 30, 2004.  Our compliance effortsare currently based on a draft PCAOB standard. As a result, we have had to make a number of decisions based onassumptions, which may or may not conform to the final PCAOB standard.  Thus, our ability to fully comply with theSarbanes-Oxley Act of 2002 may be affected by changes to the draft PCAOBstandard.  In addition, the timing ofthe issuance of such final standards may impact the Company’s ability to complyas a result of the effort associated with evaluating the final standard andadjusting our compliance efforts, if necessary.

 

**Limitations on the Effectiveness of Controls**

 

Our management, including the CEO and CFO, does not expect that our internal controls will necessarily prevent all error and all fraud.  A control system, no matter how well designed and operated, cannot provide absolute assurance that the control system’s objectives will be met.   In addition, the design of such internal controls must take into account the costs of designing and maintaining such control system.  Certain inherent limitations exist in control systems to make absolute assurances difficult, including the realities that judgments in decision-making can be faulty, that breakdowns can occur because of a simple error or mistake, and that individuals can circumvent controls.  The design of any control system is based in part upon existing business conditions and risk assessments. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Over time, controls may become inadequate because of changes in business conditions or deterioration in the degree of compliance with policies or procedures.  As a result, they may require change or revision.  Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and may not be detected.  Nevertheless, management believes that the Company’s internal controls over financial reporting for the second quarter of fiscal year 2004 are adequate.

 

30

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**PARTII****.  OTHERINFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS.**

 

From time to time, we are a party to variouslawsuits, arbitrations or mediations that arise in the ordinary course ofbusiness.  These disputes typicallyinvolve claims relating to the rendering of professional services or employmentmatters.  Management believes, based oncurrently available information, that the results of all pending claims againstus will not have a material adverse affect on the Company.  The matters reported on below involve themost significant pending or potential claims against us.  These matters did not impact the quarter’sfinancial results and management does not believe they will expose the Companyto further financial risk because the Company’s self-insured retention has beenmet for both matters.

 

*New Jersey Coalition of Auto Retailers Insurance Group Trust (NJCAR).*  All parties to the lawsuit have executed the settlement agreement, whichwas approved by state court on December 5, 2003.

 

*Toussaint, et al. v. James, et al.*  The parties tentativelysettled this matter on December 23, 2003. A definitive settlement agreement is pending execution by all of theparties.

 

**ITEM 2.  CHANGES INSECURITIES AND USE OF PROCEEDS.**

 

**RestrictedShares**

 

In conjunction with our initialpublic offering in October 2000, we entered into agreements providing fortransfer restrictions with major stockholders, executive officers and employeedirectors.  During October 2003, thesetransfer restrictions expired on 1,908,000 Class A shares.  As of December 31, 2003, 1,908,000 Class Ashares remain restricted.  These shareswill become freely transferable in October 2004.

 

Through the first six months offiscal year 2004, the Company issued 285,000 shares in connection with itsemployee benefit plans.

 

**ITEM 3.  DEFAULTS UPONSENIOR SECURITIES.**

 

**None.**

 

31

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**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.**

 

At the fourth annual meeting of thestockholders of the Company, held on November 17, 2003, the following matterswere submitted to a vote of stockholders: (1) the election of two Class IIImembers of the Board of Directors; (2) the approval of amendments to the 2001Employee Stock Purchase Plan (“ESPP”); and (3) the approval of the AmendedCompensation Plan for Outside Directors.

 

Proxies representing 27,845,617 shares werereceived (total shares outstanding as of the Record Date were 33,237,205), andthe results of the meeting were as follows with respect to each mattersubmitted to a vote of stockholders.

 

*Election of Class III Directors*

 

Pursuant to the Company’s Amended andRestated Certificate of Incorporation, the directorships are divided into threeclasses, Class I, Class II and Class III. The directorships in Class I willexpire as of the annual stockholders’ meeting in 2004 and every three yearsthereafter, the directorships in Class II will expire as of the annual stockholders’meeting in 2005 and every three years thereafter, and the directorships inClass III expired as of the annual stockholders’ meeting in 2003 and willexpire every three years thereafter. As the term of each of the classes ofdirectors expires, directors of the Company will be elected to serve for athree-year period and until their respective successors have been duly electedand qualified.  Of the proxies received, the votes were as follows:

 
| **Nominees for Class III Directors**                          |   | **For**    |         | **Withheld** |         |
|---------------------------------------------------------------|--------|------------|--------------|--------------|--------------|
| *Term expiring at the annual meeting of stockholders in 2003* |   |       | *** *** |         | *** *** |
| Gilbert T. Ray                                                |   | 26,983,424 |         | 862,193      |         |
| John B. Shoven                                                |   | 26,988,756 |         | 856,861      |         |

 

The directors serving in Class I and Class IIand their remaining terms are as follows:

 
| **Class I Directors**                                          |   |
|----------------------------------------------------------------|--------|
| *Term  expiring at the annual meeting of stockholders in 2004* |   |
| R. Michael McCullough                                          |   |
| Sylvester J. Schieber                                          |   |
| Edward Manno Shumsky                                           |   |
| Paul N. Thornton                                               |   |

 

32

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| **Class II Directors**                                         |   |
|----------------------------------------------------------------|--------|
| *Term  expiring at the annual meeting of stockholders in 2005* |   |
| John J. Gabarro                                                |   |
| John J. Haley                                                  |   |
| Linda D. Rabbitt                                               |   |
| Gene H. Wickes                                                 |   |
| John C. Wright                                                 |   |

* *

*Adoption of Amendments to the ESPP*

 

In August 2001, the board of directorsadopted the ESPP, which subsequently was approved by the stockholders inNovember 2001.  The ESPP is intended toprovide employees of the Company with additional incentives by permitting themto acquire a proprietary interest in the Company through the purchase of sharesof the Company’s common stock.  Anadditional 1,500,000 shares of common stock were authorized and reserved forissuance under the ESPP at the 2003 Annual Meeting of Stockholders.

 

Of the proxies received, the votes were asfollows:

 
| **For**    |   | **Against** |   | **Abstain** |   |
|------------|--------|-------------|--------|-------------|--------|
| 19,553,595 |   | 1,917,791   |   | 514,616     |   |

 

*Approval of the Amended Compensation Plan for OutsideDirectors*

 

The Amended Compensation Plan for OutsideDirectors is intended to provide compensation for the Company’s outsidedirectors through a combination of cash and stock grants.  Under the plan, outside directors are paid aquarterly retainer and committee and meeting fees and receive an annual stockgrant for services rendered as directors.

 

Of the proxies received, the votes were asfollows:

 
| **For**    |   | **Against** |   | **Abstain** |   |
|------------|--------|-------------|--------|-------------|--------|
| 18,927,632 |   | 3,005,751   |   | 52,619      |   |

 

**I****TEM 5. OTHER INFORMATION.**

 

None.

 

33

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

** **
| a.     |   | Exhibits                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 3.1    |   | Amended and  Restated Certificate of Incorporation of Watson Wyatt & Company  Holdings(1)                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 3.2    |   | Amended and  Restated Bylaws of Watson Wyatt & Company Holdings(2)                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 4      |   | Form of  Certificate Representing Common Stock(1)                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.1   |   | Amended  Credit Agreement Among Bank of America, N.A., and Others dated June 25,  2002(3)                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.2   |   | Credit  Agreement Among Bank of America, N.A., and Others dated June 25, 2002(3)                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.3   |   | Consent of  Bank of America, N.A.(5)                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.4   |   | Agreement  with David B. Friend, M.D., dated October 22, 1999(1)                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.5   |   | Senior  Officer Deferred Compensation Plan(5)                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.6   |   | Form of  agreement among Watson Wyatt & Company, Watson Wyatt & Company  Holdings and employee directors, executive officers and significant  stockholders restricting the transfer of shares(4)                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 31.1   |   | Certification  of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14  and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002(6)                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 31.2   |   | Certification  of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14  and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002(6)                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 32.1   |   | Certification  of Chief Executive Officer Pursuant to Title 18, U.S.C. Section 1350(6)                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 32.2   |   | Certification  of Chief Financial Officer Pursuant to Title 18, U.S.C. Section 1350(6)                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| b.     |   | Reports on  Form 8-K                                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
|   |   | (i) On  November 5, 2003, the Company filed a Current Report on Form 8-K, which  included a press release dated the same day, in which we reported our first  quarter fiscal year 2004 earnings.                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
|   |   | (ii) On  November 12, 2003, the Company filed a Current Report on Form 8-K, to report  that Walter W. Bardenwerper, Vice President, General Counsel and Secretary,  has adopted a written 10b5-1 Sales Plan pursuant to SEC Rule 10b5-1.                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
|   |   | (iii) On  December 5, 2003, the Company filed a Current Report on Form 8-K, to report  that Watson Wyatt & Company Holdings, Inc. adopted a written 10b5-1 Share  Repurchase Plan pursuant to SEC Rule 10b5-1 for purposes which may include  offsetting any potential dilution from shares which may be issued in  connection with the Company’s employee benefit plans. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
|   |   | (iv) On  February 5, 2004, the Company filed a Current Report on Form 8-K, which  included a press release dated the same day, in which we reported our second  quarter fiscal year 2004 earnings.                                                                                                                                                                                 |

 

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(1)   Incorporated by reference fromRegistrant’s Form S-3/A, Amendment No. 1 (File No. 33-394973), filed on March17, 2000

(2)   Incorporated by reference fromRegistrant’s Form 10-Q, filed on May 2, 2001

(3)   Incorporated by reference fromRegistrant’s Form 10-K, filed on September 25, 2002

(4)          Incorporated by reference from Registrant’sForm S-3/A, Amendment No. 5 (File No. 33-394973), filed on September 14, 2000

(5)   Incorporated by reference fromRegistrant’s Form 10-K, filed on August 15, 2001

(6)   Filed with this Form 10-Q

 

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**Signatures**

 

Pursuant to the requirements ofthe Securities and Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

Watson Wyatt & CompanyHoldings(Registrant)

 

 
| /S/ John J.  Haley   |                      | February 5,  2004 |   |
|----------------------|---------------------------|-------------------|--------|
| Name:                | John J.  Haley            | Date              |   |
| Title:               | President  and Chief      |              |   |
|                 | Executive  Officer        |              |   |
|                 |                      |              |   |
| /S/ Carl D.  Mautz   |                      | February 5,  2004 |   |
| Name:                | Carl D.  Mautz            | Date              |   |
| Title:               | Vice  President and Chief |              |   |
|                 | Financial  Officer        |              |   |
|                 |                      |              |   |
| /S/ Peter L.  Childs |                      | February 5,  2004 |   |
| Name:                | Peter L.  Childs          | Date              |   |
| Title:               | Controller                |              |   |
|                      |                           |                   |        |  |

 

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