**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                                  |       |                                                                                                     |
|-----------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| x                                                               |       | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                                            |       | ** **                                                                                               |
| **For the quarterly period ended December 31,  2007** |
| ** **                                                      |
| **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 File Number: 001-16159**

 

**WATSON WYATT WORLDWIDE, INC.**

(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.) |
| ** **                                                           | ** ** | ** **                             |
| ** **                                                           | ** ** | ** **                             |
| **901 N. Glebe Road**                                                | ** ** | ** **                             |
| **Arlington, VA**                                                    | ** ** | **22203**                              |
| (Address of principal executive offices)                             |       | (zip code)                             |
|                                                                 |       |                                   |
| **(703) 258-8000**                                                   |
| (Registrant’s telephone number, including area code)            |

 

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x   No o

 

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.

 

| Large accelerated filer x |   | Accelerated filer o |   | Non-accelerated  filer o |
|---------------------------|--------|---------------------|--------|--------------------------|

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o   Nox

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of January 31, 2008.

 
| **Class**                                           | ** ** | **Outstanding at January 31,  2008** |
|-----------------------------------------------------|------------|-------------------------------------------|
| Class A Common Stock, $.01 par value per share |       | 42,228,986 shares                         |

 

 

 

 

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**WATSON WYATT WORLDWIDE, INC.INDEX TO FORM 10-Q**

 

For the Three and Six Months Ended December 31,2007

 
| PART I.   | FINANCIAL  INFORMATION                                                                                                   |   |
|----------------|--------------------------------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                                     |   |
|           |                                                                                                                     |   |
| Item  1.       | Condensed  Consolidated Financial Statements (Unaudited)                                                                 |   |
|           |                                                                                                                     |   |
|           | Condensed Consolidated Statements of Operations—Three  and Six   Months Ended December 31, 2007 and 2006       | 1      |
|           |                                                                                                                     |   |
|           | Condensed Consolidated Balance  Sheets—December 31, 2007 and June   30, 2007                              | 2      |
|           |                                                                                                                     |   |
|           | Condensed Consolidated Statements of Cash Flows—Six  Months Ended   December 31, 2007 and 2006                 | 3      |
|           |                                                                                                                     |   |
|           | Condensed Consolidated Statement of Changes in  Stockholders’ Equity—  Six Months Ended December 31, 2007 | 4      |
|           |                                                                                                                     |   |
|           | Notes to the Condensed Consolidated Financial  Statements                                                                | 5      |
|           |                                                                                                                     |   |
| Item 2.        | Management’s Discussion and Analysis of Financial  Condition and Results   of Operations                            | 23     |
|           |                                                                                                                     |   |
| Item 3.        | Quantitative and Qualitative Disclosures About Market  Risk                                                              | 43     |
|           |                                                                                                                     |   |
| Item 4.        | Controls and Procedures                                                                                                  | 43     |
|           |                                                                                                                     |   |
|           |                                                                                                                     |   |
| PART II.  | OTHER  INFORMATION                                                                                                       |   |
|           |                                                                                                                     |   |
|           |                                                                                                                     |   |
| Item  1.       | Legal  Proceedings                                                                                                       | 44     |
|           |                                                                                                                     |   |
| Item  1A.      | Risk  Factors                                                                                                            | 44     |
|           |                                                                                                                     |   |
| Item 2.        | Unregistered Sales of Equity Securities and Use of  Proceeds                                                             | 44     |
|           |                                                                                                                     |   |
| Item 3.        | Defaults Upon Senior Securities                                                                                          | 45     |
|           |                                                                                                                     |   |
| Item 4.        | Submission of Matters to a Vote of Security Holders                                                                      | 45     |
|           |                                                                                                                     |   |
| Item  5.       | Other  Information                                                                                                       | 46     |
|           |                                                                                                                     |   |
| Item 6.        | Exhibits                                                                                                                 | 47     |
|           |                                                                                                                     |   |
| Signatures     |                                                                                                                     | 48     |
|           |                                                                                                                     |   |
| Certifications |                                                                                                                     | 53     |

 

----

 

**WATSON WYATT WORLDWIDE, INC.**

**CondensedConsolidated Statements of Operations**

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

(Unaudited)

 
| ** **                                                | ** ** | **Three months ended December 31,** | ** ** | **Six months ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                | ** ** | **2007**                                 | ** ** | **2006**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Revenue                                                   |       | $                                        | 447,032    |                                   | $          | 366,425 |   | $ | 848,719 |   | $ | 702,429 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Costs of providing services:                              |       |                                     |       |                                   |       |   |   |   |   |
| Salaries and  employee benefits                           |       | 249,073                                  |       | 201,045                                |       | 468,436 |   | 386,640 |   |
| Professional and  subcontracted services                  |       | 29,293                                   |       | 26,130                                 |       | 54,820 |   | 46,165 |   |
| Occupancy,  communications and other                      |       | 49,307                                   |       | 45,682                                 |       | 93,232 |   | 86,633 |   |
| General and  administrative expenses                      |       | 41,791                                   |       | 39,461                                 |       | 86,096 |   | 77,560 |   |
| Depreciation and  amortization                            |       | 17,626                                   |       | 13,923                                 |       | 34,960 |   | 26,674 |   |
|                                                      |       | 387,090                                  |       | 326,241                                |       | 737,544 |   | 623,672 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Income from operations                                    |       | 59,942                                   |       | 40,184                                 |       | 111,175 |   | 78,757 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Loss from affiliates                                      |       | (1,499                                   | )          | (638                                   | )          | (574 | ) | (867 | ) |
| Interest expense                                          |       | (1,969                                   | )          | (589                                   | )          | (4,227 | ) | (1,032 | ) |
| Interest income                                           |       | 927                                      |       | 762                                    |       | 2,771 |   | 2,212 |   |
| Other non-operating income                                |       | 186                                      |       | 68                                     |       | 275 |   | 104 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Income before income taxes                                |       | 57,587                                   |       | 39,787                                 |       | 109,420 |   | 79,174 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Provision for income taxes                                |       | 20,806                                   |       | 13,793                                 |       | 38,195 |   | 28,366 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Net income                                                |       | $                                        | 36,781     |                                   | $          | 25,994 |   | $ | 71,225 |   | $ | 50,808 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Earnings per share:                                       |       |                                     |       |                                   |       |   |   |   |   |
| Net income —  Basic                                  |       | $                                        | 0.87       |                                   | $          | 0.61 |   | $ | 1.68 |   | $ | 1.20 |   |
| Net income —  Diluted                                |       | $                                        | 0.82       |                                   | $          | 0.58 |   | $ | 1.60 |   | $ | 1.14 |   |
|                                                      |       |                                     |       |                                   |       |   |   |   |   |
| Weighted average  shares of common stock,   basic (000)   |       | 42,338                                   |       | 42,407                                 |       | 42,313 |   | 42,401 |   |
| Weighted average  shares of common stock,   diluted (000) |       | 44,649                                   |       | 44,525                                 |       | 44,652 |   | 44,545 |   |

 

See accompanying notes tothe

condensed consolidatedfinancial statements

 

1

----

 

**WATSON WYATT WORLDWIDE, INC.**

**CondensedConsolidated Balance Sheets**

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

(Unaudited)

 
| ** **                                                                                                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                    | ** ** | **2007**              | ** ** | **2007**          | ** ** |
|                                                                                                          |       |                  |       |              |       |
| **Assets**                                                                                                    | ** ** | ** **            | ** ** | ** **        | ** ** |
| Cash and cash equivalents                                                                                     |       | $                     | 103,583    |              | $          | 248,186 |   |
| Receivables from clients:                                                                                     |       |                  |       |              |       |
| Billed, net of  allowances of $10,418 and $6,216                                                              |       | 251,524               |       | 227,130           |       |
| Unbilled, at  estimated net realizable value                                                                  |       | 125,778               |       | 109,697           |       |
|                                                                                                          |       | 377,302               |       | 336,827           |       |
|                                                                                                          |       |                  |       |              |       |
| Other current assets                                                                                          |       | 77,424                |       | 51,749            |       |
| Total current  assets                                                                                         |       | 558,309               |       | 636,762           |       |
|                                                                                                          |       |                  |       |              |       |
| Fixed assets, net                                                                                             |       | 178,046               |       | 172,147           |       |
| Deferred income taxes                                                                                         |       | 69,424                |       | 66,751            |       |
| Goodwill                                                                                                      |       | 608,883               |       | 382,936           |       |
| Intangible assets, net                                                                                        |       | 235,156               |       | 211,715           |       |
| Other assets                                                                                                  |       | 59,988                |       | 59,398            |       |
|                                                                                                          |       |                  |       |              |       |
| **Total Assets**                                                                                              |       | $                     | 1,709,806  |              | $          | 1,529,709 |   |
| ** **                                                                                                    | ** ** | ** **            | ** ** | ** **        | ** ** |
| **Liabilities**                                                                                               | ** ** | ** **            | ** ** | ** **        | ** ** |
| Accounts payable  and accrued liabilities, including   discretionary compensation                             |       | $                     | 271,883    |              | $          | 303,346 |   |
| Income taxes payable and deferred                                                                             |       | 8,006                 |       | 7,062             |       |
| Total current  liabilities                                                                                    |       | 279,889               |       | 310,408           |       |
|                                                                                                          |       |                  |       |              |       |
| Revolving credit facility                                                                                     |       | 107,000               |       | 105,000           |       |
| Accrued retirement benefits                                                                                   |       | 227,241               |       | 198,677           |       |
| Deferred rent and accrued lease losses                                                                        |       | 30,366                |       | 32,686            |       |
| Contingency stock payable                                                                                     |       | 98,436                |       | —            |       |
| Other noncurrent liabilities                                                                                  |       | 104,858               |       | 95,419            |       |
|                                                                                                          |       |                  |       |              |       |
| **Total Liabilities**                                                                                         |       | 847,790               |       | 742,190           |       |
| ** **                                                                                                    | ** ** | ** **            | ** ** | ** **        | ** ** |
| 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:                                                             |       |                  |       |              |       |
| 99,000,000 shares  authorized;   42,763,451 and 42,513,451 issued and   42,316,919 and 42,430,316 outstanding |       | 428                   |       | 428               |       |
| Additional paid—in capital                                                                               |       | 398,706               |       | 395,521           |       |
| Treasury stock, at cost — 446,532 and 463,659 shares                                                     |       | (21,102               | )          | (22,251           | )          |
| Retained earnings                                                                                             |       | 397,155               |       | 336,101           |       |
| Accumulated other comprehensive income                                                                        |       | 86,829                |       | 77,720            |       |
| **Total Stockholders’ Equity**                                                                           |       | 862,016               |       | 787,519           |       |
|                                                                                                          |       |                  |       |              |       |
| **Total Liabilities and Stockholders’ Equity**                                                           |       | $                     | 1,709,806  |              | $          | 1,529,709 |   |

 

See accompanying notes tothe

condensed consolidatedfinancial statements

 

2

----

 

 

**WATSON WYATT WORLDWIDE, INC.**

**CondensedConsolidated Statements of Cash Flows**

(Thousandsof U.S. Dollars)

(Unaudited)

 
| ** **                                                                              | ** ** | **Six months ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                              | ** ** | **2007**                               | ** ** | **2006** | ** ** |
|                                                                                    |       |                                   |       |   |   |
| Cash flows from/(used in) operating activities:                                         |       |                                   |       |   |   |
| Net income                                                                              |       | $                                      | 71,225     |   | $ | 50,808 |   |
| Adjustments to  reconcile net income to net cash   (used in)/from operating activities: |       |                                   |       |   |   |
| Provision for  doubtful receivables from clients                                        |       | 7,706                                  |       | 4,932 |   |
| Depreciation                                                                            |       | 26,948                                 |       | 22,025 |   |
| Amortization of  intangible assets                                                      |       | 8,012                                  |       | 4,649 |   |
| Provision for  (benefit from) deferred income taxes                                     |       | 2,024                                  |       | 2,087 |   |
| Loss from  affiliates                                                                   |       | 574                                    |       | 867 |   |
| Other, net                                                                              |       | 1,379                                  |       | 188 |   |
| Changes in  operating assets and liabilities, net of business acquisitions:             |       |                                   |       |   |   |
| Receivables from  clients                                                               |       | (29,215                                | )          | (34,754 | ) |
| Other current  assets                                                                   |       | (13,921                                | )          | (30,197 | ) |
| Other assets                                                                            |       | 727                                    |       | 585 |   |
| Accounts payable  and accrued liabilities                                               |       | (26,682                                | )          | (57,618 | ) |
| Income taxes  payable and deferred                                                      |       | 1,431                                  |       | 6,020 |   |
| Accrued  retirement benefits                                                            |       | 4,308                                  |       | 6,180 |   |
| Deferred rent  and accrued lease losses                                                 |       | (2,320                                 | )          | (752 | ) |
| Other noncurrent  liabilities                                                           |       | (3,924                                 | )          | 5,914 |   |
| Cash flows from/  (used in) operating activities:                                       |       | 48,272                                 |       | (19,066 | ) |
|                                                                                    |       |                                   |       |   |   |
| Cash flows used in investing activities:                                                |       |                                   |       |   |   |
| Business  acquisitions and contingent consideration payments                            |       | (134,748                               | )          | (1,322 | ) |
| Purchases of  fixed assets                                                              |       | (12,844                                | )          | (18,586 | ) |
| Capitalized  software costs                                                             |       | (12,256                                | )          | (10,672 | ) |
| Investment in  PCIC                                                                     |       | (1,914                                 | )          | — |   |
| Contingent  proceeds from divestitures                                                  |       | 275                                    |       | 104 |   |
| Cash flows used  in investing activities:                                               |       | (161,487                               | )          | (30,476 | ) |
|                                                                                    |       |                                   |       |   |   |
| Cash flows used in financing activities:                                                |       |                                   |       |   |   |
| Borrowings  (repayments) under Credit Facility                                          |       | 2,000                                  |       | (30,000 | ) |
| Dividends paid                                                                          |       | (6,360                                 | )          | (6,358 | ) |
| Repurchases of  common stock                                                            |       | (28,282                                | )          | (20,065 | ) |
| Issuances of  common stock and excess tax benefit                                       |       | 7,504                                  |       | 6,814 |   |
| Cash flows used  in financing activities:                                               |       | (25,138                                | )          | (49,609 | ) |
|                                                                                    |       |                                   |       |   |   |
| Effect of exchange rates on cash                                                        |       | (6,250                                 | )          | 2,277 |   |
|                                                                                    |       |                                   |       |   |   |
| Decrease in cash and cash equivalents                                                   |       | (144,603                               | )          | (96,874 | ) |
|                                                                                    |       |                                   |       |   |   |
| Cash and cash equivalents at beginning of period                                        |       | 248,186                                |       | 165,345 |   |
|                                                                                    |       |                                   |       |   |   |
| Cash and cash equivalents at end of period                                              |       | $                                      | 103,583    |   | $ | 68,471 |   |
|                                                                                    |       |                                   |       |   |   |
| Supplemental disclosures:                                                               |       |                                   |       |   |   |
| Cash paid for  interest                                                                 |       | $                                      | 4,227      |   | $ | 1,031 |   |
| Cash paid for  income taxes, net of refunds                                             |       | $                                      | 33,808     |   | $ | 29,871 |   |

 

See accompanying notes tothe

condensed consolidatedfinancial statements

 

3

----

 

 

 

**WATSON WYATT WORLDWIDE, INC.**

**CondensedConsolidated Statement of Changes in Stockholders’ Equity**

(Thousandsof U.S. Dollars)

(Unaudited)

 
| ** **                                              | ** ** | **Class A**        | ** ** | ** **       | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|------------------|------------|----------------|------------|--------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                              | ** ** | **Common**              | ** ** | ** **       | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **Stock**               | ** ** | ** **       | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **Outstanding**         | ** ** | **Class A** | ** ** | **Additional** | ** ** | **Treasury** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **(number  of shares,** | ** ** | **Common**       | ** ** | **Paid-in**    | ** ** | **Stock,**   | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **in  thousands)**      | ** ** | **Stock**        | ** ** | **Capital**    | ** ** | **at Cost**  | ** ** | **Earnings** | ** ** | **Income**        | ** ** | **Total**  | ** ** |
|                                                    |       |                    |       |             |       |           |       |         |       |         |       |              |       |       |       |
| Balance at June 30, 2007                           |       | 42,299                  |       | $                | 428        |           | $          | 395,521      |       | $            | (22,251    | )                 | $          | 336,101    |       | $ | 77,720 |   | $ | 787,519 |   |
| Adoption of FIN 48 — tax liability adjustment      |       | —                  |       | —           |       | —         |       | —       |       | (3,813       | )          | —            |       | (3,813     | )          |
| Adoption of FAS 158 — pension liability adjustment |       | —                  |       | —           |       | —         |       | —       |       | —       |       | 1,106             |       | 1,106      |       |
| Comprehensive income:                                   |       |                    |       |             |       |           |       |         |       |         |       |              |       |       |       |
| Net income                                              |       | —                  |       | —           |       | —         |       | —       |       | 71,225       |       | —            |       | 71,225     |       |
| Foreign currency  translation adjustment, net of tax    |       | —                  |       | —           |       | —         |       | —       |       | —       |       | 8,003             |       | 8,003      |       |
| Total comprehensive income                              |       |                    |       |             |       |           |       |         |       |         |       |              |       | 79,228     |       |
| Cash dividends declared                                 |       | —                  |       | —           |       | —         |       | —       |       | (6,358       | )          | —            |       | (6,358     | )          |
| Repurchases of common stock                             |       | (600                    | )          | —           |       | —         |       | (28,282      | )          | —       |       | —            |       | (28,282    | )          |
| Issuance of common stock — WisdomNet acquisition   |       | 7                       |       | —           |       | 17             |       | 360          |       | —       |       | —            |       | 377        |       |
| Issuances of common stock and excess tax benefit        |       | 611                     |       | —           |       | 3,168          |       | 29,071       |       | —       |       | —            |       | 32,239     |       |
|                                                    |       |                    |       |             |       |           |       |         |       |         |       |              |       |       |       |
| Balance at December 31, 2007                       |       | 42,317                  |       | $                | 428        |           | $          | 398,706      |       | $            | (21,102    | )                 | $          | 397,155    |       | $ | 86,829 |   | $ | 862,016 |   |

 

See accompanying notes tothe

condensed consolidatedfinancial statements

 

4

----

 

**WATSON WYATT WORLDWIDE, INC.**

 

**Notes to the CondensedConsolidated Financial Statements**

(Tabular amounts are inthousands, except per share data)

(Unaudited)

 

**Note 1 —Basis of Presentation.**

 

The accompanyingunaudited quarterly consolidated financial statements of Watson Wyatt Worldwide, Inc.and our subsidiaries (collectively referred to as “we,” “Watson Wyatt,” “WatsonWyatt Worldwide” or the “company”) are presented in accordance with the rules andregulations of the Securities and Exchange Commission (“SEC”) for quarterlyreports on Form 10-Q and therefore do not include all of the informationand footnotes required by U.S. generally accepted accounting principles. In theopinion of management, these condensed consolidated financial statementsreflect all adjustments, consisting only of normal recurring adjustments, whichare necessary for a fair presentation of the condensed consolidated financialstatements and results for the interim periods. All intercompany accounts and transactions have been eliminated inconsolidation. The condensed consolidated financial statements should be readtogether with the audited consolidated financial statements and notes theretocontained in the company’s Annual Report on Form 10-K for the fiscal yearended June 30, 2007, which is filed with the SEC and may be accessed viaEDGAR on the SEC’s web site at www.sec.gov. The year-end balance sheet data was derived from audited financialstatements.

 

Our fiscal year2008 began July 1, 2007 and ends June 30, 2008.

 

The results ofoperations for the six months ended December 31, 2007 are not necessarilyindicative of the results that can be expected for the entire fiscal yearending June 30, 2008.  The resultsreflect certain estimates and assumptions made by management includingestimated bonuses and anticipated tax liabilities that affect the amountsreported in the condensed consolidated financial statements and relatednotes.  Certain prior year amounts havebeen reclassified to conform to the current year’s presentation.

 

**Note 2 —Business Acquisitions.**

 

The company’sacquisition strategy identifies potential acquisitions that strengthen ourgeographic delivery of services to clients or enhance practices in variousparts of the world. Acquisition candidates are evaluated on their culturalconsistency with Watson Wyatt values within the company’s strategy. When thoseconditions are met, the company values potential acquisitions so as to beaccretive to earnings.

 

Assets acquiredand liabilities assumed as a result of our acquisitions are recorded at theirrespective fair values as of the business combination date.  The determination of estimated fair valuerequires management to make significant estimates and assumptions.

 

Acquisitions thatwe have completed recently include the following:

 

*Dr. Dr. HeissmannGmbH*

 

On July 20,2007, the company acquired the outstanding stock of Dr. Dr. HeissmannGmbH (“Heissmann”) for approximately $136 million (€99 million in cash plusapproximately $2.0 million in transaction costs).  Heissmann is a leading actuarial, benefits,and human resources consulting firm based in Germany with subsidiaries inIreland, Netherlands, Austria, and France. As of July 20, 2007, Heissmann employed approximately 360associates.  Annual revenue, includingsubsidiaries, was approximately $70 million (€52 million) for their fiscal yearended March 31, 2007.  The financial results of Heissmann have beenconsolidated into the company’s financial statements effective July 1,2007.

 

5

----

 

The company hasdetermined the following preliminary fair values for the assets purchased andliabilities assumed in the Heissmann acquisition:

 
| ** **                               | ** ** | **July 1, 2007  (in thousands)** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|
| Total purchase price                     |       |                                  |       | $ | 136,117 |   |
| Less net assets  acquired:               |       |                                  |       |   |   |
| Customer related  intangibles            |       | $                                     | 27,070     |   |   |   |
| Non-compete agreements                   |       | 541                                   |       |   |   |
| Trade-name intangible                    |       | 271                                   |       |   |   |
| Core/developed  technology intangibles   |       | 1,218                                 |       |   |   |
| Cash                                     |       | 12,824                                |       |   |   |
| Client receivables and  unbilled revenue |       | 18,966                                |       |   |   |
| Fixed assets                             |       | 4,589                                 |       |   |   |
| Other assets                             |       | 5,826                                 |       |   |   |
| Liabilities                              |       | (43,273                               | )          |   |   |
| Net assets acquired                      |       |                                  |       | 28,032 |   |
| Goodwill                                 |       |                                  |       | $ | 108,085 |   |
|                                          |            |                                       |            |  |  |  |  |

 

The allocation ofthe purchase price resulted in the allocation of $108.1 million to goodwill,which has been assigned to our segments as follows:

 
| ** **                                   | ** ** | **Goodwill** | ** ** |
|----------------------------------------------|------------|--------------|------------|
| Benefits Group                               |       | $            | 103,761    |   |
| Human Capital Group                          |       | 2,162        |       |
| Investment Consulting  Group                 |       | 2,162        |       |
| Allocation of goodwill  to business segments |       | $            | 108,085    |   |

 

Goodwillassociated with this transaction is not deductible for tax purposes.

 

*WisdomNet*

 

On July 2, 2007, the company acquired the net assets of WisdomNetfor $6.9 million in cash and stock, including the payoff of $0.5 million ofdebt.  WisdomNet was a Denver-basedtalent management software and consulting firm that was founded in 2001.  WisdomNet offered a proprietary line ofbusiness software products, including an end-to-end solution for managingorganizations’ talent management processes. The acquisition of WisdomNet strengthens our existing talent managementbusiness and provides strategic software that will be used to service ourclients on an ongoing basis.  As of thedate of the acquisition, WisdomNet employed 15 associates.

 

*Watson Wyatt Netherlands*

 

On February 1, 2007,Watson Wyatt B.V., an indirect wholly-owned subsidiary of the company, acquiredthe net assets of Watson Wyatt Netherlands (WWN), its long-time alliancepartner in the Netherlands.  Thefinancial results of WWN have been consolidated into the company’s financialstatements since February 1, 2007.

 

6

----

 

 

In connection with thisacquisition, payment of up to an additional €8.0 million worth of Class Ashares (approximately 250,000 shares) after January 31, 2008 is contingentupon achievement by the acquired business of certain financial performancegoals during the twelve month period ended January 31, 2008.  As of September 30, 2007, management hadconcluded that the contingencies associated with the payment of an additional250,000 shares are expected to be met. As a result, these shares are includedin fully diluted earnings per share since September 30, 2007.  The issuance of these shares will beaccounted for as additional goodwill.

 

*Watson WyattLLP*

 

On July 31, 2005,the company acquired substantially all of the assets and assumed mostliabilities of Watson Wyatt LLP (“WWLLP”) (the “WWLLP business combination”), aleading United Kingdom-based actuarial, benefits and human resources consultingpartnership. The financial results of WWLLP have been consolidated into thecompany’s financial statements since August 1, 2005.

 

In addition to theinitial purchase price, the terms of the purchase agreement called for anadditional 1,950,000 shares to be paid to the former partners of WWLLP,contingent upon the achievement by the acquired business of certain agreed-uponfinancial performance goals.  Thecontingency was met in the first quarter of fiscal year 2008 and the company’sbalance sheet reflects the accrued liability along with a correspondingincrease in goodwill.  The companyexpects that the contingent shares will be issued during fiscal year 2008.

 

7

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**Note 3 —Segment Information.**

 

We have fivereportable operating segments or practice areas as follows:

 

| (1) |   | Benefits  Group                                |
|-----|--------|------------------------------------------------|
| (2) |   | Human  Capital Group                           |
| (3) |   | Technology  and Administration Solutions Group |
| (4) |   | Investment  Consulting Group                   |
| (5) |   | Insurance  and Financial Services Group        |

 

Managementevaluates the performance of its segments and allocates resources to them basedon net operating income.

 

The table belowpresents specified information about reported segments as of and for the threemonths ended December 31, 2007:

 
| ** **                                | ** ** | **Benefits  Group** | ** ** | **Human  Capital  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **Insurance  and  Financial  Services  Group** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|---------------------|------------|---------------------------|------------|-------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable   expenses) |       | $                   | 244,096    |                      | $          | 53,450                                                |       | $                                 | 49,570     |                                           | $          | 42,362    |       | $ | 30,331 |   | $ | 419,809 |   |
| Net operating income                      |       | 63,883              |       | 12,538                    |       | 16,431                                                |       | 14,613                            |       | (296                                           | )          | 107,169   |       |
| Receivables                               |       | 254,893             |       | 51,140                    |       | 22,557                                                |       | 27,881                            |       | 30,301                                         |       | 386,772   |       |
|                                           |            |                     |            |                           |            |                                                       |            |                                   |            |                                                |            |           |            |  |  |  |  |  |  |

 

The table belowpresents specified information about reported segments as of and for the threemonths ended December 31, 2006:

 
| ** **                                | ** ** | **Benefits  Group** | ** ** | **Human  Capital  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **Insurance  and  Financial  Services  Group** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|---------------------|------------|---------------------------|------------|-------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable   expenses) |       | $                   | 196,709    |                      | $          | 45,536                                                |       | $                                 | 41,504     |                                           | $          | 32,557    |       | $ | 26,985 |   | $ | 343,291 |   |
| Net operating income                      |       | 47,923              |       | 8,322                     |       | 10,689                                                |       | 10,118                            |       | 3,261                                          |       | 80,313    |       |
| Receivables                               |       | 208,726             |       | 45,644                    |       | 21,953                                                |       | 23,526                            |       | 28,393                                         |       | 328,242   |       |
|                                           |            |                     |            |                           |            |                                                       |            |                                   |            |                                                |            |           |            |  |  |  |  |  |  |

 

 

The table belowpresents specified information about reported segments as of and for the sixmonths ended December 31, 2007:

 
| ** **                                | ** ** | **Benefits  Group** | ** ** | **Human  Capital  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **Insurance  and  Financial  Services  Group** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|---------------------|------------|---------------------------|------------|-------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable   expenses) |       | $                   | 470,665    |                      | $          | 96,164                                                |       | $                                 | 90,047     |                                           | $          | 82,306    |       | $ | 58,332 |   | $ | 797,514 |   |
| Net operating income                      |       | 120,933             |       | 18,125                    |       | 24,810                                                |       | 28,734                            |       | 1,154                                          |       | 193,756   |       |
| Receivables                               |       | 254,893             |       | 51,140                    |       | 22,557                                                |       | 27,881                            |       | 30,301                                         |       | 386,772   |       |
|                                           |            |                     |            |                           |            |                                                       |            |                                   |            |                                                |            |           |            |  |  |  |  |  |  |

 

 

 

8

----

 

The table belowpresents specified information about reported segments as of and for the sixmonths ended December 31, 2006:

 
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Human  Capital  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **Insurance  and  Financial  Services  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|---------------------------|------------|-------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable expenses) |       | $                   | 382,064    |                      | $          | 85,115                                                |       | $                                 | 78,705     |                                           | $          | 59,925    |       | $ | 53,368 |   | $ | 659,177 |   |
| Net operating income                    |       | 92,845              |       | 13,376                    |       | 19,084                                                |       | 16,684                            |       | 8,330                                          |       | 150,319   |       |
| Receivables                             |       | 208,726             |       | 45,644                    |       | 21,953                                                |       | 23,526                            |       | 28,393                                         |       | 328,242   |       |
|                                         |            |                     |            |                           |            |                                                       |            |                                   |            |                                                |            |           |            |  |  |  |  |  |  |

 

Information aboutinterest income and tax expense is not presented as a segment expense becausesuch items are not considered a responsibility of the segments’ operatingmanagement.

 

9

----

 

Reconciliations ofthe information reported by segment to the historical consolidated amountsfollow for the three and six month periods ended December 31, 2007 and2006:

 
| ** **                                                               | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                               | ** ** | **2007**                                  | ** ** | **2006**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                     |       |                                      |       |                                    |       |   |   |   |   |
| Revenue:                                                                 |       |                                      |       |                                    |       |   |   |   |   |
| Total segment revenue                                                    |       | $                                         | 419,809    |                                    | $          | 343,291 |   | $ | 797,514 |   | $ | 659,177 |   |
| Reimbursable expenses  and other not included in total   segment revenue |       | 15,687                                    |       | 12,681                                  |       | 28,246 |   | 22,965 |   |
| All other segments                                                       |       | 11,536                                    |       | 10,453                                  |       | 22,959 |   | 20,287 |   |
| Consolidated fees                                                        |       | $                                         | 447,032    |                                    | $          | 366,425 |   | $ | 848,719 |   | $ | 702,429 |   |
|                                                                     |       |                                      |       |                                    |       |   |   |   |   |
| Net Operating Income:                                                    |       |                                      |       |                                    |       |   |   |   |   |
| Total segment net  operating income                                      |       | $                                         | 107,169    |                                    | $          | 80,313 |   | $ | 193,756 |   | $ | 150,319 |   |
| Income from affiliates                                                   |       | (1,499                                    | )          | (638                                    | )          | (574 | ) | (867 | ) |
| Differences in  allocation methods(1)                                    |       | (3,120                                    | )          | (5,031                                  | )          | (3,585 | ) | (7,262 | ) |
| Gain on sale of  Business units                                          |       | —                                    |       | 68                                      |       | — |   | 104 |   |
| Discretionary  compensation                                              |       | (52,490                                   | )          | (36,460                                 | )          | (93,880 | ) | (66,380 | ) |
| All other segments                                                       |       | 3,171                                     |       | (2,361                                  | )          | 6,611 |   | (3,756 | ) |
| Other, net                                                               |       | 4,356                                     |       | 3,896                                   |       | 7,092 |   | 7,016 |   |
| Consolidated pretax  income                                              |       | $                                         | 57,587     |                                    | $          | 39,787 |   | $ | 109,420 |   | $ | 79,174 |   |
|                                                                     |       |                                      |       |                                    |       |   |   |   |   |
| Receivables:                                                             |       |                                      |       |                                    |       |   |   |   |   |
| Total segment  receivables — billed and unbilled(2)                 |       | $                                         | 386,772    |                                    | $          | 328,242 |   | $ | 386,772 |   | $ | 328,242 |   |
| All other segments                                                       |       | 6,672                                     |       | 7,159                                   |       | 6,672 |   | 7,159 |   |
| Net valuation  differences                                               |       | (16,142                                   | )          | (2,001                                  | )          | (16,142 | ) | (2,001 | ) |
| Total billed and  unbilled receivables                                   |       | 377,302                                   |       | 333,400                                 |       | 377,302 |   | 333,400 |   |
| Assets not reported by  segment (3)                                      |       | 1,332,504                                 |       | 899,061                                 |       | 1,332,504 |   | 899,061 |   |
| Consolidated assets                                                      |       | $                                         | 1,709,806  |                                    | $          | 1,232,461 |   | $ | 1,709,806 |   | $ | 1,232,461 |   |

----

(1) General and administrative, pension, and medical costs areallocated to our segments based on budgeted expenses determined at thebeginning of the fiscal year as management believes that these costs arelargely uncontrollable to the segment. To the extent that the actual expense base upon which allocations aremade differs from the forecast/budget amount, a reconciling item will becreated between internally allocated expenses and the actual expense that wereport for U.S. GAAP purposes.

 

(2) Total segment receivables, which reflects the receivablebalances used by management to make business decisions, are included formanagement reporting purposes net of deferred revenues — cash collections andinvoices generated in excess of revenue recognized in the segment revenues.

 

(3) Assets not reported by segment for management reportingpurposes include goodwill and intangible assets of $844.0 million.

 

10

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**Note 4 —Share–based Compensation.**

 

The company has four share–based compensation plans, which aredescribed below.  These compensationplans include the 2001 Deferred Stock Unit Plan for Selected Employees, theAmended Compensation Plan for Outside Directors, the 2001 Employee StockPurchase Plan and the 2000 Long–Term Incentive Plan.  All four plans have been approved bystockholders.

 

##### *2001 Deferred Stock UnitPlan for Selected Employees*

##### * *

Deferred Stock Units — The 2001 Deferred StockUnit Plan for Selected Employees is intended to provide selected associates ofthe company with additional incentives by permitting the company to grant theman equity interest in the company in the form of restricted stock units, inlieu of a portion of their annual fiscal year end bonus.  Shares under this plan are awarded during thefirst quarter of each fiscal year. During the first quarter of fiscal year 2008, 349,118 shares of commonstock were awarded at an average market price of $47.63 for a total fair valueof $16.6 million.  During the firstquarter of fiscal year 2007, 300,552 shares of common stock were awarded at amarket price of $40.48 for a total fair value of $12.2 million.

 

SBI Program  — The Performance Share Bonus IncentiveProgram (the “SBI Program”), as approved by the company’s Board of Directorspursuant to the company’s 2001 Deferred Stock Unit Plan for Selected Employees,is a long—term stock bonus arrangement for senior executives of the company andits affiliates. The SBI program is designed to strengthen incentives and alignbehaviors to grow the business in a way that is consistent with the strategicgoals of the company.

 

Incentives under the SBI Program are providedthrough grants of deferred stock units pursuant to the company’s 2001 DeferredStock Unit Plan for Selected Employees.  Grants of deferred stock unitsare based on the value of the cash portion of the eligible participant’s fiscalyear—end bonus target and a multiplier, which is then converted into a targetnumber of deferred stock units based upon the company’s stock price as of thefiscal year end prior to grant.  Participants may vest between zero and170% of the target number of deferred stock units based on the extent to whichfinancial performance metrics are achieved over a three fiscal yearperiod.  The financial and strategic performance metrics are establishedat the beginning of each performance period.  For the fiscal years 2006through 2008 and the 2007 through 2009 performance periods, the vestingcriteria are based upon growth in earnings per share and revenue.  During the first quarter of fiscal year 2008,129,636 shares were awarded to certain senior executive officers under the SBIplan for the fiscal year 2005 through 2007 performance period, whichrepresented vesting at 170% of the target number of deferred stock units.  The receipt of 80,452 of these shares wasdeferred in conjunction with the company’s Senior Officer Deferred CompensationProgram.

 

##### *Amended Compensation Planfor Outside Directors*

##### * *

The Amended Compensation Plan for Outside Directors (the “OutsideDirector’s Plan”) provides for the cash and stock compensation of outsideDirectors.  Under the Outside Director’sPlan, outside Directors are initially paid in shares of the company’s commonstock, or in a combination of cash and shares, quarterly for services providedduring the preceding quarter.  Inaddition, outside Directors receive shares with a grant date market value of$90,000 at the end of each fiscal year for services performed during thepreceding fiscal year. Approximately $0.3 million of compensation expense wasrecorded relative to this plan during the first six months of both fiscal year2008 and fiscal year 2007.

 

*2001 Employee Stock Purchase Plan*

 

The Employee Stock Purchase Plan enables employees to purchase sharesof the company’s stock.  No compensationexpense was recognized as a result of this plan during the first six months offiscal years 2008 or 2007.

 

11

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##### *2000 Long-Term IncentivePlan*

##### * *

The company issued non-qualified stock options under the 2000 Long-TermIncentive Plan (the “Stock Option Plan”) in conjunction with its initial publicoffering in fiscal year 2001.  No optionshave been granted under the stock option plan since fiscal year 2001 and thecompany does not currently intend to issue further stock options under theStock Option Plan**.**

 

**Note 5 —Retirement Benefits.**

 

*DefinedBenefit Plans*

 

We sponsor bothqualified and non-qualified, non-contributory defined benefit pension planscovering substantially all of our associates. Under our plans in North America, benefits are based on the number ofyears of service and the associate’s compensation during the five highest paidconsecutive years of service.  Under ourplan in the U.K., benefits are based on the number of years of service and theassociate’s compensation during the three years before leaving the plan. Thenon-qualified plan, included only in North America, provides for pensionbenefits that would be covered under the qualified plan but are limited by theInternal Revenue Code.  The non-qualifiedplan has no assets and therefore is an unfunded arrangement.  The benefit liability is reflected on thebalance sheet.  The measurement date foreach of the plans is June 30.

 

*Componentsof Net Periodic Benefit Cost for Defined Benefit Pension Plans*

 

The followingtable sets forth the components of net periodic benefit cost for the company’sdefined benefit pension plan for North America and the U.K. for the three andsix month periods ended December 31, 2007 and 2006:

 
| ** **                             | ** ** | **Three Months Ended  December 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                  | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **North America**                         | ** ** | **U.K.** | ** ** | **North America** | ** ** | **U.K.** | ** ** |
| Service Cost                           |       | $                                         | 7,515      |   | $ | 2,750 |   | $ | 6,490 |   | $ | 3,277 |   |
| Interest Cost                          |       | 11,271                                    |       | 5,307 |   | 10,076 |   | 4,173 |   |
| Expected Return on Plan  Assets        |       | (13,846                                   | )          | (5,959 | ) | (11,803 | ) | (4,043 | ) |
| Amortization of  Transition Obligation |       | (17                                       | )          | — |   | (10 | ) | — |   |
| Amortization of Net  Loss/(Gain)       |       | 1,678                                     |       | (726 | ) | 2,270 |   | (219 | ) |
| Amortization of Prior  Service Cost    |       | (663                                      | )          | 4 |   | (735 | ) | — |   |
| Net Periodic Benefit  Cost             |       | $                                         | 5,938      |   | $ | 1,376 |   | $ | 6,288 |   | $ | 3,188 |   |

 

 

12

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| ** **                             | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------|------------|-----------------------------------------|------------|
| ** **                             | ** ** | **2007**                                | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **North America**                       | ** ** | **U.K.** | ** ** | **North America** | ** ** | **U.K.** | ** ** |
| Service Cost                           |       | $                                       | 14,882     |   | $ | 5,484 |   | $ | 12,714 |   | $ | 6,451 |   |
| Interest Cost                          |       | 22,392                                  |       | 10,581 |   | 20,045 |   | 8,217 |   |
| Expected Return on Plan  Assets        |       | (27,629                                 | )          | (11,882 | ) | (23,534 | ) | (7,960 | ) |
| Amortization of  Transition Obligation |       | (32                                     | )          | — |   | (20 | ) | — |   |
| Amortization of Net  Loss/(Gain)       |       | 3,064                                   |       | (1,447 | ) | 4,328 |   | (431 | ) |
| Amortization of Prior  Service Cost    |       | (1,297                                  | )          | 8 |   | (1,469 | ) | — |   |
| Net Periodic Benefit  Cost             |       | $                                       | 11,380     |   | $ | 2,744 |   | $ | 12,064 |   | $ | 6,277 |   |

 

The fiscal year2008 net periodic benefit cost is based, in part, on the following rateassumptions as of June 30, 2007 for the North America and U.K. plans:

 
| ** **                                   | ** ** | **North America** | ** ** | **U.K.** | ** ** |
|----------------------------------------------|------------|-------------------|------------|----------|------------|
| Discount rate                                |       | 6.25              | %          | 5.80     | %          |
| Expected long-term rate  of return on assets |       | 8.75              | %          | 5.69     | %          |
| Rate of increase in  compensation levels     |       | 3.84              | %          | 4.95     | %          |

 

*EmployerContributions*

 

The company made$900,000 in contributions to North American plans during the first six monthsof fiscal year 2008.  An additionalpension contribution of $15.0 million was made in January 2008.  We anticipate that $700,000 will becontributed by the company to the North American pension plans over theremainder of the fiscal year.

 

The company made$10.5 million in contributions to the U.K. plans during the first six months offiscal year 2008 and anticipates making $12.8 million in contributions over theremainder of the fiscal year.

 

*DefinedContribution Plans*

 

In the U.S., we sponsor asavings plan that provides benefits to substantially all U.S. associates with amatch to employee contributions at a rate of 50 percent of the first 6 percentup to $60,000 of associates’ eligible compensation.  The company may also make an annual profitsharing contribution to the plan in an amount that is dependant upon thecompany’s financial performance during the fiscal year.

 

In the U.K., we sponsor asavings plan that provides benefits to substantially all U.K. associates.  The company provides a basic contribution anda match to employee contributions, both of which depend on age and basesalary.  The maximum employer contributionis up to 12% of an associate’s base salary up to $180,000.

 

 

13

----

 

*HealthCare Benefits*

 

In the U.S., wesponsor a contributory health care plan that provides hospitalization, medicaland dental benefits to substantially all U.S. associates.  We accrue a liability for estimated incurredbut unreported claims based on projected use of the plan as well as prior planhistory.

 

In the U.K., wesponsor a non-contributory medical insurance plan that provides hospitalizationand medical benefits and a contributory dental plan that provides dentalbenefits to substantially all U.K. associates.

 

*PostretirementBenefits*

 

We provide certainhealth care and life insurance benefits for retired associates.  The principal plans cover associates in theU.S. and Canada who have met certain eligibility requirements. Our principalpost-retirement benefit plans are unfunded. We accrue a liability for these benefits.

 

*Componentsof Net Periodic Benefit Cost for Other Postretirement Plans*

 

The followingtable sets forth the components of net periodic benefit cost for the company’shealthcare and post-retirement plans for the three and six months ended December 31,2007 and 2006:

 
| ** **                             | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                             | ** ** | **2007**                                  | ** ** | **2006**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                   |       |                                      |       |                                    |       |   |   |   |   |
| Service cost                           |       | $                                         | 385        |                                    | $          | 406 |   | $ | 770 |   | $ | 811 |   |
| Interest cost                          |       | 681                                       |       | 649                                     |       | 1,363 |   | 1,297 |   |
| Expected return on plan  assets        |       | —                                    |       | —                                  |       | — |   | — |   |
| Amortization of  transition obligation |       | —                                    |       | —                                  |       | — |   | — |   |
| Amortization of net  gain              |       | (113                                      | )          | (39                                     | )          | (226 | ) | (78 | ) |
| Amortization of prior  service cost    |       | (166                                      | )          | (165                                    | )          | (332 | ) | (330 | ) |
| Net periodic benefit  cost             |       | $                                         | 787        |                                    | $          | 851 |   | $ | 1,575 |   | $ | 1,700 |   |

 

*EmployerContributions*

 

The company madecontributions in the form of premiums and medical claim payments to itshealthcare and post-retirement plans of $900,000 in each of the three monthsended December 31, 2007 and 2006 and contributions of $1.6 million and $1.7 million in the six monthsended December 31, 2007 and 2006, respectively.  We plan to make additional payments ofapproximately $1.5 million through the remainder of the fiscal year.

 

 

14

----

 

**Note 6 —Goodwill & Intangible Assets.**

 

The components ofgoodwill and intangible assets are outlined below for the six months ended December 31,2007:

 
| ** **                            | ** ** | **Benefits Group** | ** ** | **Human  Capital  Group** | ** ** | **Technology and Administration  Solutions  Group** | ** ** | **Investment Consulting Group** | ** ** | **Insurance and Financial  Services Group** | ** ** | **All Other  Segments** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|--------------------|------------|---------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|-------------------------|------------|-----------|------------|
| Balance as of  June 30, 2007     |       | $                  | 208,453    |                      | $          | 22,805                                              |       | $                               | 46,662     |                                        | $          | 44,897                  |       | $         | 58,905     |   | $ | 1,214 |   | $ | 382,936 |   |
| Goodwill acquired                     |       | 155,755            |       | 9,130                     |       | 15,429                                              |       | 15,155                          |       | 18,211                                      |       | —                  |       | 213,680   |       |
| Translation adjustment and  other     |       | 13,029             |       | 261                       |       | (500                                                | )          | 130                             |       | (653                                        | )          | —                  |       | 12,267    |       |
| Balance as of  December 31, 2007 |       | $                  | 377,237    |                      | $          | 32,196                                              |       | $                               | 61,591     |                                        | $          | 60,182                  |       | $         | 76,463     |   | $ | 1,214 |   | $ | 608,883 |   |

 

The followingtable reflects changes in the net carrying amount of the components ofintangible assets for the six months ended December 31, 2007:

 
| ** **                                    | ** ** | **Trademark  & trade  name** | ** ** | **Customer   related  intangible** | ** ** | **Core/developed technology** | ** ** | **Non-compete agreements** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|------------------------------------|------------|-------------------------------|------------|----------------------------|------------|-----------|------------|
| Balance as of  June 30, 2007             |       | $                                | 122,666    |                               | $          | 76,270                        |       | $                          | 12,256     |      | $          | 523 |   | $ | 211,715 |   |
| Intangible assets  acquired during the period |       | 391                              |       | 27,271                             |       | 5,548                         |       | 611                        |       | 33,821    |       |
| Amortization expense                          |       | (101                             | )          | (5,043                             | )          | (2,604                        | )          | (265                       | )          | (8,013    | )          |
| Translation adjustment                        |       | (1,290                           | )          | (978                               | )          | (93                           | )          | (6                         | )          | (2,367    | )          |
| Balance as of  December 31, 2007         |       | $                                | 121,666    |                               | $          | 97,520                        |       | $                          | 15,107     |      | $          | 863 |   | $ | 235,156 |   |

 

 

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The followingtable reflects the carrying value of intangible assets at December 31,2007 and June 30, 2007:

 
| ** **                      | ** ** | **December 31, 2007** | ** ** | **June 30, 2007** | ** ** |
|---------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                      | ** ** | **Gross**                  | ** ** | ** **             | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Carrying**               | ** ** | **Accumulated**        | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **                      | ** ** | **Amount**                 | ** ** | **Amortization**       | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Intangible assets:              |       |                       |       |                   |       |   |   |   |   |
| Trademark & trade name |       | $                          | 121,767    |                   | $          | 101 |   | $ | 122,666 |   | $ | — |   |
| Customer related intangibles    |       | 113,419                    |       | 15,899                 |       | 85,064 |   | 8,794 |   |
| Core/developed technology       |       | 24,783                     |       | 9,676                  |       | 17,935 |   | 5,679 |   |
| Non-compete                     |       | 1,213                      |       | 350                    |       | 1,028 |   | 505 |   |
| Total intangible assets         |       | $                          | 261,182    |                   | $          | 26,026 |   | $ | 226,693 |   | $ | 14,978 |   |

 

Acomponent of the change in the gross carrying amount of trademark &trade name, customer related intangibles and core/developedtechnology reflectstranslation adjustments between June 30, 2007 and December 31,2007.  These intangible assets aredenominated in the currencies of our subsidiaries outside the United States,and are translated into our reporting currency, the U.S. dollar, based onexchange rates at the balance sheet date.

 

The weightedaverage remaining life of amortizable intangible assets at December 31,2007, was 9.3 years.  Future estimatedamortization expense is as follows:

 

 

| **Fiscal year ending June 30:** | ** ** | **Amount** | ** ** |
|--------------------------------------|------------|------------|------------|
| 2008                                 |       | $          | 7,647      |   |
| 2009                                 |       | 15,294     |       |
| 2010                                 |       | 14,619     |       |
| 2011                                 |       | 10,897     |       |
| 2012                                 |       | 10,569     |       |
| Thereafter                           |       | 54,756     |       |
| Total                                |       | $          | 113,782    |   |

 

 

16

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**Note 7 —Earnings Per Share.**

 

Basic earnings pershare are calculated on the basis of the weighted average number of commonshares outstanding during the three and six month periods ended December 31,2007 and 2006.  Diluted earnings pershare is calculated by dividing net income by the weighted average number ofcommon shares outstanding, plus the dilutive effect of outstanding stockoptions, stock-based compensation plans, and employee stock purchase planshares using the “treasury stock” method over the same measurement period.  The components of basic and diluted earningsper share are as follows:

 
| ** **                                                                         | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                  | ** ** | **2006**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                               |       |                                      |       |                                    |       |   |   |   |   |
| Net income                                                                         |       | $                                         | 36,781     |                                    | $          | 25,994 |   | $ | 71,225 |   | $ | 50,808 |   |
|                                                                               |       |                                      |       |                                    |       |   |   |   |   |
| Weighted average  outstanding shares of common stock                               |       | 42,338                                    |       | 42,407                                  |       | 42,313 |   | 42,401 |   |
| Dilutive effect of  employee stock options and employee stock purchase plan shares |       | 2,311                                     |       | 2,118                                   |       | 2,339 |   | 2,144 |   |
|                                                                               |       |                                      |       |                                    |       |   |   |   |   |
| Common stock and stock  equivalents                                                |       | 44,649                                    |       | 44,525                                  |       | 44,652 |   | 44,545 |   |
|                                                                               |       |                                      |       |                                    |       |   |   |   |   |
| Basic earnings per  share:                                                         |       |                                      |       |                                    |       |   |   |   |   |
| Net income                                                                         |       | $                                         | 0.87       |                                    | $          | 0.61 |   | $ | 1.68 |   | $ | 1.20 |   |
| Diluted earnings per  share:                                                       |       |                                      |       |                                    |       |   |   |   |   |
| Net income                                                                         |       | $                                         | 0.82       |                                    | $          | 0.58 |   | $ | 1.60 |   | $ | 1.14 |   |

 

The dilutedearnings per share calculation for the three and six month periods ended December 31,2007 assumes that 250,000 contingent shares related to the WWN and 1,950,000contingent shares related to the WWLLP business combinations had been issuedand outstanding for the entire three and six month periods ended December 31,2007.  See Note 10 of this report forfurther information regarding the WWN contingent shares.

 

**Note 8 —Variable Interest Entities.**

 

FASBInterpretation No. 46, “Consolidation of Variable Interest Entities,” asrevised (FIN 46(R)), expands existing accounting guidance about when a companyshould include in its consolidated financial statements the assets,liabilities, and activities of another entity. In general, FIN 46(R) requiresa variable interest entity (VIE), as defined by FIN 46(R), to be consolidatedby its primary beneficiary. The primary beneficiary is defined as the companythat will absorb a majority of the VIE’s expected losses or residual returns ifthey occur.

 

As of December 31,2007, our sole affiliate investment consists of an equity investment inProfessional Consultants Insurance Company, Inc. (PCIC), which willcontinue to be accounted for under the equity method. The company evaluatedthis investment in order to determine the applicability of FIN 46(R). Since thecompany is not obligated to absorb a majority of expected losses or residualreturns in this entity, the company is not required to consolidate this entity.

 

 

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PCIC was organized in 1987 as a captive insurance company under thelaws of the State of Vermont.  PCICprovides professional liability insurance on a claims-made basis to threeactuarial and management consulting firms, all of which participate in theprogram as both policyholders and stockholders.

 

Capital contributions to PCIC are required when approved by a majorityof its stockholders.  In July 2007,the Shareholders of PCIC approved a requirement for an additional capitalcontribution.  As a result, the companycontributed an additional $1.9 million of capital to PCIC and increased theamount of the letter of credit provided to PCIC by $2.6 million in lieu of ahigher cash capital contribution.  Fromthe time PCIC was organized through December 31, 2007, we have providedcapital contributions to PCIC through cash contributions totaling $7.3 millionand through letters of credit totaling $10.6 million.  Our ownership interest in PCIC as of December 31,2007 and 2006 was 36.43 percent and 34.15 percent, respectively.

 

Management believes that the company’s maximum financial statementexposure regarding its investment in PCIC as of December 31, 2007 islimited to the carrying value of the company’s investment in PCIC of $4.4million, combined with letters of credit totaling $10.6 million, for a totalmaximum exposure of $15.0 million.

 

**Note 9 — Comprehensive Income.**

 

Comprehensiveincome includes net income and changes in the cumulative translation adjustmentgain or loss.  For the three months endedDecember 31, 2007, comprehensive income totaled $24.0 million comparedwith $50.6 million for the three months ended December 31, 2006.  For the six months ended December 31,2007, comprehensive income totaled $79.2 million, compared with $82.0 millionfor the six months ended December 31, 2006.

 

**Note 10 — Restricted Shares.**

 

In conjunctionwith our business acquisition of Watson Wyatt LLP (WWLLP) on July 31,2005, we issued 9,090,571 Class A shares, 4,749,797 of which were subjectto sale restrictions.  On July 31,  2006, and July 31,  2007, sale restrictions expired on 2,339,761shares and 2,410,036 shares, respectively.  As of September 30, 2007, thecontingencies associated with the payment of an additional 1,950,000 Class Ashares were met.  The company expectsthat the contingent shares will be issued during fiscal year 2008. Sale ofthese shares will be restricted until July 31, 2009.

 

In conjunctionwith our acquisition of WWN on February 1, 2007, we issued 252,285 Class Acommon shares which were subject to contractual transfer restrictions.  Transfer restrictions will expire on 50% ofthese shares on each of February 1, 2008 and 2009.  The payment of up to an additional €8.0million of Class A shares (approximately 250,000 shares) after January 31,2008 is contingent upon achievement by the acquired business of certainfinancial performance goals during the twelve month period ended January 31,2008.  Sale of these shares, if issued,will also be subject to contractual transfer restrictions that will expire on50% of these shares on each of the first and second anniversaries of issuanceof the shares. The diluted earnings per share calculation assumes thesecontingent shares had been issued at the beginning of fiscal year 2008.  See Note 2 of this report for furtherinformation regarding the business combination of WWN.

 

**Note 11 —Guarantees.**

 

The company hashistorically provided guarantees on an infrequent basis to third parties in theordinary course of business.  Theguarantees described below are currently in effect and could require thecompany to make payments to third parties under certain circumstances.

 

 

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*Letters ofCredit*.  The company has an outstanding letter ofcredit to a third party totaling $10.6 million which represents capitalcommitted to our captive insurance company, PCIC.  This letter of credit will remain outstandingas long as we retain an ownership share of PCIC. The company has also provideda $5.0 million Australian dollar-denominated letter of credit (US $4.4 million)to an Australian governmental agency as required by local regulations. Theestimated fair market value of these letters of credit is immaterial becausethey have never been used, and the company believes that future usage isremote.

 

*IndemnificationAgreements*.  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.

 

**Note 12 —Contingent Liabilities.**

 

***Legal Proceedings*****: **From time to time, we are a party to variouslawsuits, arbitrations or mediations that arise in the ordinary course ofbusiness. The matter reported below is the most significant pending claimagainst us.

 

We carry substantial professional liability insurance with aself-insured retention of $1 million per occurrence, which provides coveragefor professional liability claims including the cost of defending such claims.We reserve for contingent liabilities based on Statement of FinancialAccounting Standards No. 5, “Accounting for Contingencies” (FAS 5) when itis determined that a liability, inclusive of defense costs, is probable andreasonably estimable. Management believes, based on currently availableinformation including the existence of professional liability insurance, thatthe results of all pending claims against the company will not have a materialadverse effect on the results of operations, but litigation is subject to manyfactors which are difficult to predict so there can be no assurance that in theevent of a material unfavorable result in one or more of such matters, we willnot incur material costs.

 

*Watson Wyatt v. SBC Holdings, Inc. (Stroh BreweryCompany): *  On July 23,2004, we received a demand letter from Stroh’s counsel alleging that errors invaluations for 2001 and subsequent years understated the liabilities of itspension plan and overstated the company’s net worth.  As a result, Strohclaimed it did not annuitize its defined benefit plan and redeemed its stock atan inflated price.  On April 15, 2005, Watson Wyatt filed a petitionin federal court to compel arbitration of the matter. Subsequently, Stroh filedan answer and counterclaim, alleging damages in excess of $46 million. The court granted in part and denied in part our motion for summary judgment,and in January 2008 the Sixth Circuit Court of Appeals reversed, holdingthat the entire claim is subject to arbitration.

 

***Government Subpoenas andInvestigations:*** We also have receivedsubpoenas and requests for information in connection with the followinggovernment investigations:

 

*Department of Labor Investigation:*  On November 17, 2006, Watson WyattInvestment Consulting Inc. (“WWIC”) received a subpoena from the United StatesDepartment of Labor (“DOL”) in connection with its investigation into thecompensation of consultants and other investment advisers.  WWIC hasresponded to the subpoena and continues to cooperate with the DOL.

 

 

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*Government Inquiry intoExecutive Compensation Disclosure*: On May 11, 2007, wereceived an “Information Request” from the House Oversight and GovernmentAffairs Committee (the “Committee”). The Information Request asked Watson Wyattto identify all clients in the 2007 Fortune 250 for which we provided executivecompensation consulting in addition to any other services between 2002 and2006. The letter also requested the disclosure of revenues from executivecompensation consulting and from “other services”. The stated purpose of therequest was for a better understanding of “concerns that a compensationconsultant’s on-going business relationships with a company could compromisethe independence of the advice consultants provide to the company’s board aboutexecutive compensation.” Identical requests were made to the CEO’s of at leastfive other consulting firms, all of which were posted on the Committee’swebsite. After contacting each affected client, we responded to the InformationRequest by its May 23, 2007 due date by identifying clients and revenuesfor those that consented to disclosure. On June 29, 2007, we received asubpoena from the Committee compelling the identification of the remainingclients and revenues. We complied with the subpoena on July 10, 2007,after first providing final notice to all clients.  On December 5, 2007, the Committee helda hearing on the role played by compensation consultants in determining the paypackages of senior executives at the largest publicly traded corporations.  We received a request to appear but respondedwith a letter respectfully declining due to scheduling conflicts that could notbe cleared on such short notice.  Thehearing concluded without any clear next steps. We have not heard from the Committee since the hearing.

 

**Note 13 — IncomeTaxes.**

** **

The company adopted the provisions of FIN 48 on July 1, 2007.  The cumulative effect of adopting FIN 48 wasa $13.0 million increase in the liability for uncertain tax positions, a $9.1million increase to deferred tax assets, a $0.1 million decrease to othercomprehensive income and a $3.8 million decrease to retained earnings at July 1,2007.

 

Upon adoption, the gross liability for income taxes associated withuncertain tax positions at July 1, 2007 was $16.3 million.  This liability can be reduced by $8.4 millionof offsetting deferred tax benefits associated with timing differences, foreigntax credits and the federal tax benefit of state income taxes.  The net difference of $7.9 million, if recognized,would have a $7.5 million favorable impact on the company’s effective tax rateand would increase other comprehensive income by $0.4 million.   At December 31, 2007, the grossliability for income taxes associated with uncertain tax positions was $11.2million.  This liability can be reducedby $2.6 million of offsetting deferred tax benefits associated with foreign taxcredits and the federal tax benefit of state income taxes.  The net difference of $8.6 million, ifrecognized, would have an $8.3 million favorable impact on the company’seffective tax rate and would increase other comprehensive income by $0.3million.

 

Interest and penalties related to income tax liabilities are includedin income tax expense.  The company hadaccrued interest of $1.8 million and penalties of $1.4 million at July 1,2007.  At December 31, 2007 thecompany had accrued interest of $1.9 million and penalties of $0.5 million,totaling $2.4 million.

 

During the six months ended December 31, 2007, the gross taxliability for uncertain tax positions decreased by $5.1 million.  This decrease was primarily related to a $5.9million decrease due to a change in accounting method which the company filedwith the Internal Revenue Service (“IRS”) in October 2007 to change themethod of accounting for accrued expenses owed to foreign affiliates. Since theaccounting method change was filed voluntarily, the IRS will not assess tax,interest or penalties related to the position claimed in prior taxreturns.  The $5.9 million decrease inthe gross tax liability relates to a deferred tax item and did not impact thecompany’s effective tax rate.  Grossaccrued interest and penalties related to this tax position decreased $1.3million which, net of federal tax benefits, resulted in a $1.2 million impacton the effective tax rate in the period ended December 31, 2007.

 

 

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The company believes it is reasonably possible that there will be a$1.1 million decrease in the gross tax liability for uncertain tax positionswithin the next 12 months based upon potential settlements and the expirationof statutes of limitations in various tax jurisdictions.

 

The company and its subsidiaries conduct business globally and aresubject to income tax in the US and in many states and foreign jurisdictions.  The company is currently under examination inseveral tax jurisdictions.  The last taxyear examined and settled with the IRS was fiscal year ending June 30,2003.  A summary of the tax years thatremain subject to examination in the company’s major tax jurisdictions are:

 

| ** **                           | ** ** | **Open Tax Years  (fiscal year ending)** | ** ** |
|--------------------------------------|------------|------------------------------------------|------------|
| United States — Federal         |       | 2004 and forward                         |       |
| United States — Various  States |       | 2003 and forward                         |       |
| Canada — Federal                |       | 2003 and forward                         |       |
| Germany                              |       | 2002 and forward                         |       |
| United Kingdom                       |       | 2005 and forward                         |       |

 

**Note 14 — Recent AccountingPronouncements**.

 

In September 2006, the Financial Accounting Standards Board (“FASB”)published Statement of Financial Accounting Standards No.157, “Fair ValueMeasurements” (FAS 157).  FAS 157 definesfair value, establishes a framework for measuring fair value in generallyaccepted accounting principles and expands disclosures about fair valuemeasurements. FAS 157 applies under other accounting pronouncements thatrequire or permit fair value measurements and accordingly, does not require anynew fair value measurements. FAS 157 is effective for fiscal years beginningafter November 15, 2007. The company does not believe the adoption of FAS157 will have a material impact on its consolidated financial statements.

 

In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN48”), “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109” (“FAS 109”), which clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FAS No. 109, “Accounting for Income Taxes.”  FIN48 prescribes a recognition threshold and measurement attribute for thefinancial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return.  This Interpretation also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition.  This Interpretation iseffective for fiscal years beginning after December 15, 2006 so it becameeffective for the company in the first quarter of fiscal year 2008, which beganon July 1, 2007.  See Note 13 of this report for further informationregarding the company’s adoption of FIN 48.

 

In February 2007, the FASB published Statement of FinancialAccounting Standards No.159, “The Fair Value Option for Financial Assets andFinancial Liabilities—including an amendment of FASB Statement No. 115”(FAS 159).  FAS 159 allows entities tochoose to measure eligible financial assets and liabilities at fair value thatare not otherwise required to be measured at fair value. If a company electsthe fair value option for an eligible item, changes in that item’s fair valuein subsequent reporting periods must be recognized in current earnings. FAS 159is effective for fiscal years beginning after November 15, 2007,provided the entity alsoelects to apply the provisions of FAS 157, “Fair Value Measurements”. Thecompany does not believe the adoption of FAS 159 will have a material impact onits consolidated financial statements.

 

 

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In December 2007, the FASB issued Statement of FinancialAccounting Standards No. 141 (revised 2007), “Business Combinations” (FAS141(R)) which is a revision of FAS 141, “Business Combinations”.  This Statement establishes principles andrequirements for how an acquirer: recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed and anynoncontrolling interest in the acquiree; recognizes and measures the goodwillacquired in the business combination or a gain from a bargain purchase; anddetermines what information to disclose to enable users of the financialstatements to evaluate the nature and financial effects of the businesscombination. We will be required to comply with the provisions of FAS 141(R) foracquisitions that occur on or after July 1, 2009. The Statement wouldapply prospectively to any future business combinations and therefore theimpact would be determined when a business combination occurs.

 

**Note 15 —Exit From Taft Hartley Consulting Business.**

 

***Exit from Taft-Hartley consulting business***— On October 18, 2007, the company announced itsintention to exit its U.S. “Taft-Hartley” retirement consulting business andits Canadian private sector, negotiated costs, trusteed plan business duringfiscal year 2008.  The transition willaffect approximately 70 retirement clients, accounting for approximately $15million in annual revenue.  Two newlycreated companies, which will be owned and operated by individuals who wereformerly Watson Wyatt associates, are expected to service these clients in theU.S. and Canada respectively, to the extent that these new companies aresuccessful in transitioning these clients. These associates, who focus onmulti-employer retirement plans, moved to the new companies on February 1,2008.  Watson Wyatt has no ownership inthese new companies, but will be compensated for release of certain non-competeobligations through receipt of a percentage of the new companies’ revenues fromclients that transfer from the company for the next five years.  The transition was completed January 31,2008 and is expected to result in a $0.03 to $0.05 reduction in the company’sfully diluted earnings per share in fiscal year 2008.  Additionally, the company may incur up to $1.5million in one-time restructuring charges related to this transition in fiscalyear 2008.

** **

**Note 16 — SubsequentEvent.**

** **

***Accounting for PCIC***— PCIC, the company’scaptive insurance company (as further described in Note 8), notified WatsonWyatt in January 2008 that it had increased reserves during the quarterended December 31, 2007 in response to unusually rapid development of oneexisting claim against one of its participating firms.

** **

**As a result of the claimdevelopment (and not to any change in reserving methodology), PCIC hasdetermined that it will experience an unusually large loss for the quarterended December 31, 2007.  Thecompany’s share of this loss is $3.2 million, as determined under the equitymethod of accounting that the company employs relative to PCIC.  The company has included this loss in itsresults for the quarter ended December 31, 2007.**

** **

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

**ExecutiveOverview**

 

**General**

 

Watson Wyatt is aglobal consulting firm focusing on providing human capital and financialconsulting services. We provide services in five principal practice areas:Benefits, Human Capital Consulting, Technology and Administration Solutions,Investment Consulting, and Insurance and Financial Services operating from 105offices in 32 countries throughout North America, Europe, Asia-Pacific andLatin America. The company employed approximately 7,220 and 6,670 associates asof December 31, 2007 and June 30, 2007 respectively, in the followingpractice areas:

 

| ** **                                     | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                     | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| Benefits Group                                 |       | 3,270                 |       | 2,900             |       |
| Human Capital Group                            |       | 835                   |       | 885               |       |
| Technology and  Administration Solutions Group |       | 830                   |       | 735               |       |
| Investment Consulting  Group                   |       | 450                   |       | 395               |       |
| Insurance &  Financial Services Group |       | 425                   |       | 390               |       |
| Other (including  Communication)               |       | 805                   |       | 785               |       |
| Corporate                                      |       | 605                   |       | 580               |       |
| Total                                          |       | 7,220                 |       | 6,670             |       |

 

We help ourclients enhance business performance by improving their ability to attract,retain, and motivate qualified employees. We focus on delivering consultingservices that help our clients anticipate, identify and capitalize on emergingopportunities in human capital management. We also provide independent financial advice regarding all aspects oflife assurance and general insurance, as well as investment advice to assistour clients in developing disciplined and efficient investment strategies tomeet their investment goals.  Our targetmarket clients include those companies in the Fortune 1000, Pension &Investments (P&I) 1000, the FTSE 100, and equivalent organizations inmarkets around the world.

 

As leadingeconomies worldwide become more services-oriented, human capital and financialmanagement has become increasingly important to companies and otherorganizations. The heightened competition for skilled employees, unprecedentedchanges in workforce demographics, regulatory changes related to compensationand retiree benefits and rising employee-related costs have increased theimportance of effective human capital management.  Insurance and investment decisions havebecome increasingly complex and important in the face of changing economies anddynamic financial markets.  We help ourclients address these issues by combining our expertise in human capital andfinancial management with consulting and technology, to improve the design andimplementation of various human resources and financial programs, includingcompensation, retirement, health care, insurance and investment plans.

 

The humanresources consulting industry, although highly fragmented, is highlycompetitive and is comprised of major human capital consulting firms,specialist firms, consulting arms of accounting firms and informationtechnology consulting firms.

 

 

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In the short term,our revenues are driven by many factors including the impact of new regulationsin the legal and accounting fields that most recently increased demand for ourexecutive compensation and benefits practices, the general state of the globaleconomy and the resulting level of discretionary spending by our clients andthe ability of our consultants to attract new clients or cross-sell to existingclients.  In the long term, we expectthat the company’s financial results will depend in large part upon how well wesucceed in deepening our existing client relationships through thoughtleadership and focus on cross-practice solutions, actively pursuing new clientsin our target markets, cross selling and strategic acquisitions.  We believe that the highly fragmentedindustry in which we operate represents tremendous growth opportunities for us,because we offer a unique combination of benefits and human capital consultingas well as strategic technology solutions.

 

**PrincipalServices**

 

We design, develop and implement human resource and risk managementstrategies and programs through the following closely-interrelated practiceareas:

 

**Benefits Group****—**The BenefitsGroup, accounting for 55 percent of our total second quarter fiscal year 2008revenues, is the foundation of our business. Retirement, the core of our Benefits Group business, lags reduction indiscretionary spending compared to our other segments, mainly due to therecurring nature of client relationships. Our corporate client retention rate within our target market hasremained very high. Revenue for our retirement practice is seasonal, with thesecond and third quarters of each fiscal year being the busier periods.  Major revenue growth drivers in this practiceinclude changes in regulations, leverage from other practices, increased globaldemand and increased market share.  Services provided through the Benefits Group include the following:

 

·                  Design and management of benefit programs

·                  Actuarial services including development offunding and risk management strategies

·                  Expatriate and international human resourcestrategies

·                  Mergers and acquisitions

·                  Strategic workforce planning

·                  Compliance and governance

 

**Human Capital Group** — Our**Human CapitalGroup (HCG), accounting for 12 percent of our total second quarter fiscal year2008 revenues, generally encompasses short-term projects, although thepercentage of recurring projects has grown in the U.S. as a result of newregulations in the legal and accounting field. As a result, sensitivity of this segment to cyclical economicfluctuations may diminish.  Servicesprovided through HCG include the following:

 

·                  Advice concerning compensation plans,including broad-based and executive compensation, stock and other long-termincentive programs

·                  Strategies to align workforce performance with business objectives

·                  Organization effectiveness consulting,including talent management

·                  Strategies for attracting, retaining andmotivating employees

·                  Data services

 

 

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**Technology and Administration Solutions Group****—**Our Technology and Administration Solutions Group(TAS), accounting for 11 percent of our total second quarter fiscal year 2008revenues, provides information technology services to our clients.  Revenue for TAS is relatively stable,compared to what it had historically experienced in an economic downturn, becauseof its long term contracts associated with the administration business.  Income in this segment is slightly greater inthe first half of the fiscal year because of the timing of the typicalenrollment season for benefits.  Servicesprovided through the TAS Group include the following:

 

·                  Web-based applications for health andwelfare, pension and compensation administration

·                  Administration outsourcing solutions forhealth and welfare and pension benefits

·                  Call center strategy, design and tools

·                  Strategic human resource technology andservice delivery consulting

·                  Targeted online compensation and benefitsstatements, content management and call center case management solutions

 

**Investment Consulting Group****—**Our Investment Consulting Group accountsfor 9 percent of our total second quarter fiscal year 2008 revenues.  This business, although relationship based,can be affected by an increasingly complex investment landscape as well as byvolatility in investment returns, particularly as clients look to us forassistance in managing that volatility. Services provided through our Investment Consulting Group include thefollowing:

 

·                  Investment consulting services to pensionplans and other institutional funds

·                  Input on governance and regulatory issues

·                  Analysis of asset allocation andinvestment strategies

·                  Investment structure analysis, selectionand evaluation of managers, and performance monitoring

 

**Insurance & Financial Services Group** — Our Insurance & FinancialServices Group (I&FS) accounts for 7 percent of our total second quarterfiscal year 2008 revenues. This business is largely a project-based businessand therefore could be cyclical. Services provided through I&FS include the following:

 

·                  Independent actuarial and strategicadvice

·                  Assessment and advice regarding financialcondition and risk management

·                  Financial modeling software tools forproduct design and pricing, planning and projections, reporting, valuations andrisk management

 

While we focus ourconsulting services in the areas described above, management believes that oneof our primary strengths is our ability to draw upon consultants from ourdifferent practices to deliver integrated services to meet the needs of ourclients.  This capability includescommunication and change management implementation support services.

 

**FinancialStatement Overview**

 

Watson Wyatt’sfiscal year ends June 30. The financial statements contained in thisquarterly report reflect Condensed Consolidated Balance Sheets as of the end ofthe second quarter of fiscal year 2008 (December 31, 2007) and as of theend of fiscal year 2007 (June 30, 2007), Condensed Consolidated Statementsof Operations for the three and six month periods ended December 31, 2007and 2006, Condensed Consolidated Statements of Cash Flows for the six monthperiods ended December 31, 2007 and 2006 and a Condensed ConsolidatedStatement of Changes in Stockholders’ Equity for the six month period ended December 31,2007.

 

 

 

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We derive substantially all of our revenue from fees for consultingservices, which generally are billed based on time and materials or on afixed-fee basis.  Clients are typicallyinvoiced on a monthly basis with revenue generally recognized as services areperformed.  No single client accountedfor more than 2 percent of our consolidated revenue for any of the most recentthree fiscal years.

 

For the six months ended December 31, 2007 and fiscal years ended June 30,2007 and 2006, the company’s top six markets based on percentage ofconsolidated revenue were as follows:

 

| ** **            | ** ** | **Six Months** | ** ** | **Fiscal Year** | ** ** |
|-----------------------|------------|----------------|------------|-----------------|------------|
| **Geographic Region** | ** ** | **2008**       | ** ** | **2007**        | ** ** | **2006** | ** ** |
| United States         |       | 39             | %          | 44              | %          | 44 | % |
| United Kingdom        |       | 31             |       | 31              |       | 32 |   |
| Germany               |       | 5              |       | 1               |       | 1 |   |
| Canada                |       | 4              |       | 4               |       | 5 |   |
| Netherlands           |       | 3              |       | 1               |       | 1 |   |
| Greater China         |       | 2              |       | 2               |       | 1 |   |

 

In deliveringconsulting services, our principal direct expenses relate to compensation ofpersonnel. Salaries and employee benefits are comprised of wages paid toassociates, related taxes, benefit expenses such as pension, medical andinsurance costs, and fiscal year-end incentive bonuses.

 

Professional andsubcontracted services represent fees paid to external service providers foremployment, marketing and other services. For the most recent three fiscalyears, approximately 50 to 60 percent of these professional and subcontractedservices were directly incurred on behalf of our clients and were reimbursed bythem, with such reimbursements being included in revenue. For the secondquarter of fiscal year 2008, approximately 55 percent of professional andsubcontracted services represent these reimbursable services.

 

Occupancy,communications and other expenses represent expenses for rent, utilities,supplies and telephone to operate office locations as well asnon-client-reimbursed travel by associates, publications and professionaldevelopment. This line item also includes miscellaneous expenses, includinggains and losses on foreign currency transactions.

 

General andadministrative expenses include the operational costs, professional fees andinsurance paid by corporate management, general counsel, marketing, humanresources, finance, research and technology support.

 

 

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**Critical Accounting Policies and Estimates**

 

The preparation of condensed consolidated financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, disclosures of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenue and expenses during the reporting period. Our estimates,judgments and assumptions are continually evaluated based on availableinformation and experience. Because of the use of estimates inherent in thefinancial reporting process, actual results could differ from those estimates.The areas that we believe are critical accounting policies include revenuerecognition, valuation of billed and unbilled receivables from clients,discretionary compensation, income taxes, pension assumptions, incurred but notreported claims, and goodwill and intangible assets. The critical accountingpolicies discussed below involve making difficult, subjective or complexaccounting estimates that could have a material effect on our financialcondition and results of operations. These critical accounting policies requireus to make assumptions about matters that are highly uncertain at the time ofthe estimate or assumption and different estimates that we could have used orchanges in the estimate that are reasonably likely to occur may have a materialimpact on our financial statements and results of operations.

 

***RevenueRecognition***

 

Revenue includesfees primarily generated from consulting services provided.  We recognize revenue from these consultingengagements when hours are worked, either on a time-and-materials basis or on afixed-fee basis, depending on the terms and conditions defined at the inceptionof an engagement with a client.  We haveterms and conditions with our clients that support our engagements.  These terms and conditions can only bechanged upon agreement by both parties. Individual consultants’ billing ratesare principally based on a multiple of salary and compensation costs.

 

Revenue forfixed-fee arrangements, which span multiple months, is based upon thepercentage of completion method.* *The company typically has threetypes of fixed-fee arrangements:  annualrecurring projects, projects of a short duration, and non-recurring systemprojects.  Annual recurring projects andthe projects of short duration are typically straightforward and highlypredictable in nature.  As a result, theproject manager and financial staff are able to identify, as the project statusis reviewed and bills are prepared monthly, the occasions when cost overrunscould lead to the recording of a loss accrual.

 

Our systemprojects are typically found in our Technology and Administration SolutionsGroup.  They tend to be more complexprojects that are longer in duration and subject to more changes in scope asthe project progresses than projects undertaken in other segments. We evaluateat least quarterly, and more often as needed, project managers’estimates-to-complete to assure that the projects’ current status is accountedfor properly.  Our Technology andAdministration Solutions Group contracts generally providethat if the client terminates a contract, the company is entitled to paymentfor services performed through termination.

 

Revenuerecognition for fixed-fee engagements is affected by a number of factors thatchange the estimated amount of work required to complete the project such aschanges in scope, the staffing on the engagement and/or the level of clientparticipation.  The periodic engagementevaluations require us to make judgments and estimates regarding the overallprofitability and stage of project completion that, in turn, affect how werecognize revenue.  The companyrecognizes a loss on an engagement when estimated revenue to be received forthat engagement is less than the total estimated direct and indirect costsassociated with the engagement.  Lossesare recognized in the period in which the loss becomes probable and the amountof the loss is reasonably estimable.  Thecompany has experienced certain costs in excess of estimatesfrom time to time.  Management believesthat it is rare, however, for these excess costs to result in overall projectlosses.

 

 

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The company has developedvarious software programs and technologies that we provide to clients inconnection with consulting services.  Inmost instances, such software is hosted and maintained by the company andownership of the technology and rights to the related code remain with thecompany.  Software developed to beutilized in providing services to a client, but for which the client does nothave the contractual right to take possession, is capitalized in accordancewith the AICPA’s Statement of Position 98-1 “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.”  Revenue associated with the related contract,together with amortization of the related capitalized software, is recognizedover the service period.  As a result wedo not recognize revenue during the implementation phase of an engagement.

 

Revenue recognized inexcess of billings is recorded as unbilled accounts receivable.  Cash collections and invoices generated inexcess of revenue recognized are recorded as deferred revenue until the revenuerecognition criteria are met.  Clientreimbursable expenses, including those relating to travel, other out-of-pocketexpenses and any third-party costs, are included in revenue, and an equivalentamount of reimbursable expenses are included in professional and subcontractedservices as a cost of revenue.

 

***Valuationof Billed and Unbilled Receivables from Clients***

 

We maintainallowances for doubtful accounts to reflect estimated losses resulting from ourclients’ 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 such as the averagelength of time the receivables are past due, general market conditions, currenteconomic trends and our clients’ ability to pay may cause fluctuations in ourvaluation of billed and unbilled receivables.

 

***DiscretionaryCompensation***

 

The company’scompensation program includes a discretionary annual bonus that is determinedby management and paid once per fiscal year in the form of cash and/or deferredstock units after the company’s annual operating results are finalized.

 

An estimatedannual bonus amount is initially developed at the beginning of each fiscal yearin conjunction with our budgeting process. Quarterly, estimated annual operating performance is reviewed by thecompany and the discretionary annual bonus amount is then adjusted, ifnecessary, by management to reflect changes in the forecast of net income forthe year. In those quarters where the estimated annual bonus level changes, theremaining estimated annual bonus is accrued over the remaining quarters as a constantpercentage of estimated future net income. Annual bonus levels may vary from current expectations as a result ofchanges in the company’s forecast of net income and competitive employmentmarket conditions.

 

 

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***IncomeTaxes***

 

Determining theconsolidated provision for income tax expense, deferred tax assets andliabilities and the related valuation allowance involves judgment.  As a global company, 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 significant judgments regarding the futurerecoverability of deferred tax assets. The company does not provide deferred taxes on cumulative earnings offoreign subsidiaries that have been reinvested indefinitely as asserted underAccounting Principles Board (APB) 23, “Accounting for Income Taxes — SpecialAreas”.  Due to the availability offoreign tax credits, it is not practicable to estimate the company’s income taxliability that might be payable if such earnings were not reinvestedindefinitely, however, deferred taxes are provided for earnings of foreignsubsidiaries which the company plans to remit. Tax costs can involve complex issues and may require an extended periodto resolve.  Changes in the geographicmix or estimated level of annual pre-tax income, limitations on the use of thecompany’s foreign subsidiary losses, 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 net income.

 

***PensionAssumptions***

 

We sponsor both qualified and non-qualified, non-contributory definedbenefit pension plans in North America and the U.K. that cover approximately85% of our associates.  Under our plansin North America, benefits are based on the number of years of service and theassociates’ compensation during the five highest paid consecutive years ofservice.  Under our plan in the U.K., benefits are based on thenumber of years of service and the associates’ compensation during the threeyears before leaving the plan.  The non-qualified plan, included only in NorthAmerica, provides for pension benefits that would be covered under thequalified plan but are limited by the Internal Revenue Code.  The non-qualified plan has no assets andtherefore is an unfunded arrangement. The benefit liability is reflected on the balance sheet.  The measurement date for each of the plans isJune 30.

 

Determination of our obligations and annual expense under the plans isbased on a number of assumptions that, given the longevity of the plans, arelong-term in focus.  A change in one or acombination of these assumptions could have a material impact on our pensionbenefit obligation and related expense. For this reason, management employs a long-term view so that assumptionsdo not change frequently in response to short-term volatility in theeconomy.  Any difference between actualand assumed results is amortized into our pension expense over the averageremaining service period of participating employees.  We consider several factors prior to thestart of each fiscal year when determining the appropriate annual assumptions,including economic forecasts, relevant benchmarks, historical trends, portfoliocomposition and peer comparisons.

 

*NorthAmerica*

 

The followingassumptions were used at the end of the past three fiscal years in thevaluation of our North American plans:

 
| ** **                                   | ** ** | **Year Ended June 30** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Discount rate                                |       | 6.25                        | %          | 6.25 | % | 5.25 | % |
| Expected long-term rate  of return on assets |       | 8.75                        | %          | 8.75 | % | 9.00 | % |
| Rate of increase in  compensation levels     |       | 3.84                        | %          | 3.84 | % | 3.34 | % |

 

 

 

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The 6.25 percent discount rate assumption used at the end of fiscalyear 2007 is unchanged from fiscal year 2006 and represents a 100 basis pointincrease from the 5.25 percent discount rate used at the end of fiscal year2005.  The company’s discount rateassumptions were determined by matching future pension benefit payments withexpected future U.S. AA corporate bond yields for the same periods.

 

The expected long-term rate of return on assets assumption remained at8.75 percent per annum, unchanged from fiscal year 2006 and 25 basis pointslower than the 9.00 percent rate used in fiscal year 2005. Selection of thereturn assumption at 8.75 percent per annum was supported by an analysisperformed by the company of the weighted average yield expected to be achievedwith the anticipated makeup of investments. The investment makeup is heavily weighted towards equities.  The return on assets through the first sixmonths of fiscal year 2008 was less than 1 percent, compared to a return of 9.7percent in the first six months of fiscal year 2007.

 

The following information illustrates thesensitivity to a change in certain assumptions for the U.S. pension plans:

 
| **Change in Assumption**                              | ** ** | **Effect on FY2008   Pre-Tax Pension Expense** | ** **    |
|-------------------------------------------------------|------------|------------------------------------------------|---------------|
| 25 basis point decrease  in discount rate             |       | $                                              | +3.3 million  |   |
| 25 basis point increase  in discount rate             |       | $                                              | (3.2) million |   |
| 25 basis point decrease  in expected return on assets |       | $                                              | +1.0 million  |   |
| 25 basis point increase  in expected return on assets |       | $                                              | (1.0) million |   |

 

 

The above sensitivities reflect the impact of changing one assumptionat a time. It should be noted that economic factors and conditions often affectmultiple assumptions simultaneously and the effects of changes in key assumptionsare not necessarily linear. The company’s U.S. Other Postretirement EmployeeBenefits Plan is relatively insensitive to discount rate changes due to theplan provisions that have been established to control costs and as such nosensitivity results are shown in the table above.

 

*UnitedKingdom*

 

The following assumptions were used in the valuation of our U.K. planat June 30, 2007 and 2006 and July 31, 2005, the date of the businesscombination with WWLLP:

 
| ** **                                   | ** ** | **Period Ended**  | ** ** |
|----------------------------------------------|------------|-------------------|------------|
| ** **                                   | ** ** | **June 30,** | ** ** | **June 30,** | ** ** | **July 31,** | ** ** |
| ** **                                   | ** ** | **2007**          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Discount rate                                |       | 5.80              | %          | 5.10 | % | 5.00 | % |
| Expected long-term rate  of return on assets |       | 5.69              | %          | 5.63 | % | 5.63 | % |
| Rate of increase in  compensation levels     |       | 4.95              | %          | 4.75 | % | 4.75 | % |

 

 

 

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The 5.80 percent discount rate assumption used at the end of June 30,2007 represents a 70 basis point increase over the rate used at fiscal year2006 and an 80 basis point increase over the discount rate at July 31,2005. The discount rate is set having regard to yields on European AA corporatebonds at the measurement date and this increase reflects the change in yieldsbetween these two dates.

 

The expected long-term rate of return on assets assumption increased to5.69 percent per annum for fiscal year 2007 from 5.63 percent per annum forfiscal year 2006.  The rate of return wassupported by an analysis performed by the company of the weighted averagereturn expected to be achieved with the anticipated makeup of investments whichis heavily weighted towards bonds.   Thereturn on assets through the first six months of fiscal year 2008 has been 5.0percent, compared to a return of 5.3 percent in the first six months of fiscalyear 2007.

 

The following information illustrates the sensitivity to a change incertain assumptions for the U.K. pension plans:

 
| **Change in Assumption**                              | ** ** | **Effect on FY2008   Pre-Tax Pension Expense** | ** **    |
|-------------------------------------------------------|------------|------------------------------------------------|---------------|
| 25 basis point decrease  in discount rate             | ** ** | $                                              | +1.3 million  | ** ** |
| 25 basis point increase  in discount rate             |       | $                                              | (1.2) million |   |
| 25 basis point decrease  in expected return on assets |       | $                                              | +0.5 million  |   |
| 25 basis point increase  in expected return on assets |       | $                                              | (0.5) million |   |

 

 

The differences in the discount rate andcompensation level assumption used for the North American and U.K. plans abovecan be attributed to the differing interest rate environments associated withthe currencies and economies to which the plans are subject.  The differences in the expected return onassets are primarily driven by the respective asset allocation in each plan,coupled with the return expectations for assets in the respectivecurrencies.  The North American plans areapproximately 65 percent invested in equities, which on average provide ahigher return than bonds, which is the favored investment for the U.K. plans.

 

*** Incurred But Not Reported Claims***

 

The company uses actuarialassumptions to estimate and record a liability for incurred but not reported(IBNR) professional liability claims. Our estimated IBNR liability is based on long-term trends and averages,and considers a number of factors, including changes in claim reportingpatterns, claim settlement patterns, judicial decisions, and legislation andeconomic decisions, but excludes the effect of claims data for large cases dueto the insufficiency of actual experience with such cases.  Management does not currently expectsignificant fluctuations in the IBNR liability, based on the company’shistorical claims experience.  However,our estimated IBNR liability will fluctuate if claims experience changes overtime.

 

 

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***Goodwilland Intangible Assets***

*** ***

In applying the purchase method of accounting for ourbusiness combinations, amounts assigned to identifiable assets and liabilitiesacquired have been based on estimated fair values as of the date of theacquisitions, with the remainder recorded as goodwill. Intangible assets areinitially valued at fair market value using generally accepted valuationmethods appropriate for the type of intangible asset. We evaluate our goodwill forimpairment annually and whenever indicators of impairment exist. The evaluationis based upon a comparison of the estimated fair value of the reporting unit towhich the goodwill has been assigned to the sum of the carrying value of thenet assets for that reporting unit. The fair values used in this evaluation areestimated based upon a multiple of revenue for the reporting unit. This revenuemultiple is based on our experience and knowledge of our own and othertransactions in the marketplace. Intangible assets with definite lives areamortized over their estimated useful lives and are reviewed for impairment ifindicators of impairment arise. The evaluation of impairment would be basedupon a comparison of the carrying amount of the intangible asset to theestimated future undiscounted net cash flows expected to be generated by theasset. If estimated future undiscounted net cash flows are less than thecarrying amount of the asset, the asset would be considered impaired. Theimpairment expense would be determined by comparing the estimated fair value ofthe intangible asset to its carrying value, with any shortfall from fair valuerecognized as an expense in the current period.

 

 

 

 

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**Resultsof Operations**

 

The table belowsets forth our historical Condensed Consolidated Statements of Operations dataas a percentage of change between periods indicated:

 

**Condensed Consolidated Statements of Operations**

(in thousands)

 
| ** **                              | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                              | ** ** | ** **                                | ** ** | ** **                              | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                              | ** ** | **2007**                                  | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** |
| ** **                              | ** ** | **(Unaudited)**                           | ** ** | **(Unaudited)**                         | ** ** |
|                                    |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Revenue                                 |       | $                                         | 447,032    |                                    | $          | 366,425 |   | 22.0 | % | $ | 848,719 |   | $ | 702,429 |   | 20.8 | % |
|                                    |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Costs  of providing services:           |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Salaries  and employee benefits         |       | 249,073                                   |       | 201,045                                 |       | 23.9 |   | 468,436 |   | 386,640 |   | 21.2 |   |
| Professional  and subcontractedServices |       | 29,293                                    |       | 26,130                                  |       | 12.1 |   | 54,820 |   | 46,165 |   | 18.7 |   |
| Occupancy,  communications andOther     |       | 49,307                                    |       | 45,682                                  |       | 7.9 |   | 93,232 |   | 86,633 |   | 7.6 |   |
| General  and administrative expenses    |       | 41,791                                    |       | 39,461                                  |       | 5.9 |   | 86,096 |   | 77,560 |   | 11.0 |   |
| Depreciation  and amortization          |       | 17,626                                    |       | 13,923                                  |       | 26.6 |   | 34,960 |   | 26,674 |   | 31.1 |   |
|                                    |       | 387,090                                   |       | 326,241                                 |       | 18.7 |   | 737,544 |   | 623,672 |   | 18.3 |   |
|                                    |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Income  from operations                 |       | 59,942                                    |       | 40,184                                  |       | 49.2 |   | 111,175 |   | 78,757 |   | 41.2 |   |
|                                    |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Loss  from affiliates                   |       | (1,499                                    | )          | (638                                    | )          | 135.0 |   | (574 | ) | (867 | ) | (33.8 | ) |
| Interest  expense                       |       | (1,969                                    | )          | (589                                    | )          | 234.3 |   | (4,227 | ) | (1,032 | ) | 309.6 |   |
| Interest  income                        |       | 927                                       |       | 762                                     |       | 21.7 |   | 2,771 |   | 2,212 |   | 25.3 |   |
| Other  non-operating income             |       | 186                                       |       | 68                                      |       | 173.5 |   | 275 |   | 104 |   | 164.4 |   |
|                                    |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Income  before income taxes             |       | 57,587                                    |       | 39,787                                  |       | 44.7 |   | 109,420 |   | 79,174 |   | 38.2 |   |
|                                    |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Provision for income taxes              |       | 20,806                                    |       | 13,793                                  |       | 50.8 |   | 38,195 |   | 28,366 |   | 34.7 |   |
|                                    |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Net Income                              |       | $                                         | 36,781     |                                    | $          | 25,994 |   | 41.5 | % | $ | 71,225 |   | $ | 50,808 |   | 40.2 | % |

 

**Three andSix Months Ended December 31, 2007 Compared to the Three and Six MonthsEnded December 31, 2006**

*** ***

***Revenue.***

 

Revenues for the second quarter of fiscal year 2008 were $447.0million, an increase of $80.6 million, or 22.0 percent from $366.4 million inthe second quarter of fiscal year 2007.  This increase includes revenues from our recent acquisitions ofHeissmann and WWN of$33.2 millionas well as the impact of changes in foreign currency exchange rates, whichaccount for 9.7 and 3.5 percentage points, respectively, of the increase.  Excluding these factors, revenues for thesecond quarter of fiscal year 2008 grew by 9.9 percent.

 

 

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The average exchange rate used to translate our revenues earned inBritish Pounds increased to 2.0421 for the second quarter of fiscal year 2008from 1.9260 for the second quarter of fiscal year 2007, and the averageexchange rate used to translate our revenues earned in Euros increased to1.4493 for the second quarter of fiscal year 2008 from 1.2972 for the secondquarter of fiscal year 2007.  Theappreciation of the British Pound and the Euro resulted in $11 million of theincrease in revenues in the second quarter of fiscal year 2008.  The average exchange rate used to translateour revenues earned in Canadian dollars also appreciated 12 percent compared tothe second quarter of fiscal year 2007 and resulted in $2 million of the increasein revenues during the quarter.  Changesin the value of other foreign currencies in Asia-Pacific and Latin Americarelative to the U.S. dollar resulted in $2 million of the increase in thesecond quarter of fiscal year 2008 revenues.

 

The increases in our segment revenue for the second quarter of fiscalyear 2008 as compared to the second quarter of fiscal year 2007 are as follows:

 

·                  Benefits increased revenues$47.4 million, or 24.1 percent, over the second quarter of fiscal year2007.  This increase includes the impactof acquisitions and changes in foreign currency exchange rates which accountfor 15.4 and 3.8 percentage points, respectively, of the increase.  Revenues for the Benefits practice for thesecond quarter of fiscal year 2008 grew by 4.9 percent after excluding thesefactors.   This remaining increase isattributable to increased demand for our services, particularly in NorthAmerica and Europe.

 

·                  Human Capital increasedrevenues $7.9 million, or 17.4 percent, over the second quarter of fiscal year2007.  Revenue growth after excluding theimpact of changes in foreign currency exchange rates was 15.1 percent.  This increase is primarily due to increaseddemand for our executive compensation consulting practice and our data servicesbusiness.

 

·                  Technology andAdministration Solutions increased revenues $8.1 million, or 19.4 percent, overthe second quarter of fiscal year 2007. Revenue growth after excluding the impact of changes in foreign currencyexchange rates was 17.0 percent.  Thisincrease is largely due to system modifications made to pension administrationsystems as clients implemented provisions of the Pension Protection Act as wellas to an increase in the number of health and welfare projects that are inon-going service delivery in the U.S.  AtDecember 31, 2007, the company had 111 projects in on-going servicedelivery and 60 projects in implementation. At December 31, 2006, the company had 75 projects in on-goingservice delivery and 60 projects in implementation.

 

·                  Investment Consultingincreased revenues $9.8 million, or 30.1 percent, over the second quarter offiscal year 2007.  Revenue growth afterexcluding the impact of changes in foreign currency exchange rates was 24.6percent.  This increase is primarily dueto an increase in demand for our investment strategy advice.

 

·                  Insurance and FinancialServices increased revenues $3.4 million, or 12.4 percent, over the secondquarter of fiscal year 2007.  Revenuegrowth after excluding the impact of changes in foreign currency exchange rateswas 7.6 percent.  This increase isprimarily due to an increase in demand for our services in Continental Europeand Asia-Pacific.

 

Revenues for the six months ended December 31, 2007 were $848.7million, an increase of $146.3 million, or 20.8 percent, from $702.4 millionfor the six months ended December 31, 2006.  This increase includes revenues from ourrecent acquisitions of Heissmann and WWN of$57.2 million as well as the impact ofchanges in foreign currency exchange rates, which account for 8.1 and 4.1percentage points, respectively, of the increase.  Excluding these factors, revenues for the sixmonths ended December 31, 2007 grew by 9.1 percent.

 

 

 

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The average exchange rate used to translate our revenues earned inBritish Pounds increased to 2.0325 for the six months ended December 31,2007 from 1.9036 for the six months ended December 31, 2006, and theaverage exchange rate used to translate our revenues earned in Euros increasedto 1.4116 for the six months ended December 31, 2007 from 1.2895 for thesix months ended December 31, 2006. The appreciation of the British Pound and the Euro resulted in $21million of the increase in revenues in the first six months of fiscal year2008.  The average exchange rate used totranslate our revenues earned in Canadian dollars also appreciated 11 percentcompared to the six months ended December 31, 2006 and resulted in $3million of the increase in revenues during the six months ended December 31,2007.  Changes in the value of otherforeign currencies in Asia-Pacific and Latin America relative to the U.S.dollar resulted in $3 million of the increase in revenues for the six monthsended December 31, 2007.

 

The increases in our segment revenue for the six months ended December 31,2007 as compared to the six months ended December 31, 2006 are as follows:

 

·                  Benefits increased revenues$88.6 million, or 23.2 percent, over the six months ended December 31,2006.  This increase includes the impactof acquisitions and changes in foreign currency exchange rates which accountfor 14.3 and 4.0 percentage points, respectively, of the increase.  Revenues for the Benefits practice for thesix months ended December 31, 2007 grew by 4.9 percent after excludingthese factors.   This remaining increaseis attributable to increased demand for our services, particularly in NorthAmerica and Europe.

 

·                  Human Capital Groupincreased revenues $11.1 million, or 13.0 percent, over the six months ended December 31,2006.  Revenue growth after excluding theimpact of changes in foreign currency exchange rates was 10.7 percent.  This increase is primarily due to increaseddemand for our executive compensation consulting practice and our data servicesbusiness.

 

·                  Technology andAdministration Solutions increased revenues $11.3 million, or 14.4 percent,over the six months ended December 31, 2006.  Revenue growth after excluding the impact ofchanges in foreign currency exchange rates was 11.6 percent.  This increase is largely due to systemmodifications made to pension administration systems as clients implementedprovisions of the Pension Protection Act as well as to an increase in thenumber of health and welfare projects that are in on-going service delivery inthe U.S.  At December 31, 2007, thecompany had 111 projects in on-going service delivery and 60 projects inimplementation.  At December 31,2006, the company had 75 projects in on-going service delivery and 60 projectsin implementation.

 

·                  Investment Consultingincreased revenues $22.4 million, or 37.3 percent, over the six months ended December 31,2006.  Revenue growth after excluding theimpact of changes in foreign currency exchange rates was 30.9 percent.  This increase is primarily due to an increasein demand for our investment strategy advice.

 

·                  Insurance and Financial Services increasedrevenues $5.0 million, or 9.3 percent, over the six months ended December 31,2006.  Revenue growth after excluding theimpact of changes in foreign currency exchange rates was 4.0 percent.  This increase is primarily due to an increasein demand for our services in Continental Europe and Asia-Pacific.

 

 

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***Salariesand Employee Benefits.***

 

Salaries andemployee benefit expenses for the second quarter of fiscal year 2008 were$249.1 million compared to $201.0 million for the second quarter of fiscal year2007, an increase of $48.1 million or 23.9 percent.  Of this increase $19.7 million, or 9.8percentage points, can be attributed to the inclusion of recently acquiredentities in our consolidated financials. An additional 5.3 percentage points can be attributed to the strengtheningforeign currencies.  The remainingincrease, inclusive of the impact of foreign currencies, is principally due to$12.8 million of salary and wage tax increases, higher accrual fordiscretionary compensation expense of $11.3 million, as well as an increase inother benefits, including pension  As apercentage of revenue, salaries and employee benefits increased to 55.7 percentfrom 54.9 percent.

 

Salaries andemployee benefit expenses for the first six months of fiscal year 2008 were$468.4 million compared to $386.6 million for the first six months of fiscalyear 2007, an increase of $81.8 million or 21.2 percent.  Of this increase $38.1 million, or 9.9percentage points, can be attributed to the inclusion of recently acquiredentities in our consolidated financials. An additional 5.2 percentage points can be attributed to thestrengthening foreign currencies.  Theremaining increase, inclusive of the impact of foreign currencies, isprincipally due to $27.2 million of salary and wage tax increases, $18.9million of discretionary compensation, partially offset by decreases in otherbenefits, including pension.  As apercentage of revenue, salaries and employee benefits remained at 55.0 percentfor both periods.

 

***Professionaland Subcontracted Services*****.**

 

Professional andsubcontracted services expenses for the second quarter of fiscal year 2008 were$29.3 million compared to $26.1 million for the second quarter of fiscal year2007, an increase of $3.2 million or 12.1 percent.  Of this increase, 5.6 percentage points canbe attributed to the strengthening foreign currencies.  The remaining difference, inclusive of theimpact of foreign currencies, can be attributed to an increase in reimbursableexpenses incurred on behalf of clients. As a percentage of revenue, professional and subcontracted servicesdecreased to 6.6 percent from 7.1 percent.

 

Professional andsubcontracted services used in consulting operations for the first six monthsof fiscal year 2008 were $54.8 million, compared to $46.2 million for the firstsix months of fiscal year 2007, an increase of $8.6 million or 18.7percent.  Of this increase, 5.7percentage points can be attributed to the strengthening foreigncurrencies.  The remaining difference,inclusive of the impact of foreign currencies, can be attributed to an increasein reimbursable expenses incurred on behalf of clients.  As a percentage of revenue, professional andsubcontracted services decreased to 6.4 percent from 6.6 percent.

 

***Occupancy,Communications and Other.***

 

Occupancy,communications and other expenses for the second quarter of fiscal year 2008were $49.3 million compared to $45.7 million for the second quarter of fiscalyear 2007, an increase of $3.6 million or 7.9 percent.  Of this increase $4.0 million, or 8.8percentage points, can be attributed to the inclusion of recently acquiredentities in our consolidated financials. An additional 4.4 percentage points can be attributed to thestrengthening foreign currencies.  The remainingincrease, inclusive of the impact of foreign currencies, is principally due toincreases in travel, rent, and telephone. As a percentage of revenue, occupancy, communications and otherdecreased to 11.0 percent from 12.5 percent.

 

Occupancy,communications and other expenses for the first six months of fiscal year 2008were $93.2 million compared to $86.6 million for the first six months of fiscalyear 2007, an increase of $6.6 million or 7.6 percent.  Of this increase $9.5 million, or 11.0percentage points, can be attributed to the inclusion of recently acquiredentities in our consolidated financials. An additional 4.0 percentage points can be attributed to thestrengthening foreign currencies.  Theremaining increase, inclusive of the impact of foreign currencies, isprincipally due to increases in travel, rent, telephone expenses.  As a percentage of revenue, occupancy,communications and other decreased to 11.0 percent from 12.3 percent.

 

 

 

36

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***Generaland Administrative Expenses.***

 

General andadministrative expenses for the second quarter of fiscal year 2008 were $41.8million, compared to $39.5 million for the second quarter of fiscal year 2007,an increase of $2.3 million or 5.8 percent, 2.7 percentage points of which canbe attributed to the strengthening of the European currencies. The increase,including the impact of foreign currencies, is primarily due to higher salariesand employee benefits and repairs and maintenance expenses, partially offset bya decrease in professional services, rent and professional developmentexpenses.  As a percentage of revenue,general and administrative expense decreased to 9.3 percent from 10.8 percent.

 

General andadministrative expenses for the first six months of fiscal year 2008 were $86.1million, compared to $77.6 million for the first six months of fiscal year2007, an increase of $8.5 million or 11.0 percent, 3.8 percentage points ofwhich can be attributed to the strengthening of the European currencies.  The increase, including the impact of foreigncurrencies, is primarily due to additional salary and employee benefits,equipment rental and repairs and maintenance expenses, partially offset by adecrease in rent expense.  As apercentage of revenue, general and administrative expense decreased to 10.1percent from 11.0 percent.

 

***Depreciationand Amortization.***

 

Depreciation andamortization for the second quarter of fiscal year 2008 was $17.6 million,compared to $13.9 million for the second quarter of fiscal year 2007, anincrease of $3.7 million or 26.6 percent. Of this increase $1.3 million, or 9.4 percentage points, can beattributed to the inclusion of recently acquired entities in our consolidatedfinancials.  An additional 3.5 percentagepoints can be attributed to the strengthening foreign currencies.  The remaining increase, inclusive of theimpact of foreign currencies, is principally due to a $1.2 million increase indepreciation of fixed and intangible assets and a $1.2 million increase indepreciation of internally developed software used to support our Benefits andTechnology and Administration Solutions Groups. As a percentage of revenue, depreciation and amortization increased to3.9 percent from 3.8 percent.

 

Depreciation andamortization for the first six months of fiscal year 2008 was $35.0 million,compared to $26.7 million for the first six months of fiscal year 2007, anincrease of $8.3 million or 31.1 percent. Of this increase $2.4 million, or 9.0 percentage points, can beattributed to the inclusion of recently acquired entities in our consolidated financials.  An additional 3.6 percentage points can beattributed to the strengthening foreign currencies.  The remaining increase, inclusive of theimpact of foreign currencies, is principally due to $2.7 million increase indepreciation of fixed and intangible assets and a $3.3 million increase indepreciation of internally developed software used to support our Benefits andTechnology and Administration Solutions Groups. As a percentage of revenue, depreciation and amortization increased to4.1 percent from 3.8 percent.

 

***LossFrom Affiliates.***

 

As of July 1, 2007, the captive insurance company carriesreinsurance for losses it insures above $25 million.  Since losses incurred by PCIC below thislevel are not covered by reinsurance, but are direct expenses of PCIC, reserveadjustments and actual outcomes of specific claims of any PCIC member firmcarry through into Watson Wyatt’s financial results as income or loss fromaffiliates through our 36.43% ownership of PCIC.  Thus, from time to time, the impacts of PCIC’sreserve development may result in fluctuations in Watson Wyatt’s earnings.

 

Loss fromaffiliates for the second quarter of fiscal year 2008 was $1.5 million,compared to $0.6 million for the second quarter of fiscal year 2007, anincrease of $0.9 million.  PCIC’s losses,and consequently our share of those losses, are the result of a substantialincrease in PCIC’s reserves during the quarter ended December 31, 2007.

 

 

37

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Loss fromaffiliates for the first six months of fiscal year 2008 was $0.6 millioncompared to $0.9 million for the first six months of fiscal year 2007.

 

***InterestExpense.***

 

Interest expensefor the second quarter of fiscal year 2008 was $2.0 million, compared to $0.6million for the second quarter of fiscal year 2007.  Interest expense for the first six months offiscal year 2008 was $4.2 million, compared to $1.0 million for the first sixmonths of fiscal year 2007.  The increasein both periods was due to a higher average debt balance stemming from recentacquisition-related payments.

 

***InterestIncome.***

 

Interest incomefor the second quarter of fiscal year 2008 was $0.9 million, compared to $0.8million for the second quarter of fiscal year 2007. Interest income for thefirst six months of fiscal year 2008 was $2.8 million, compared to $2.2 millionfor the first six months of fiscal year 2007. The increase is mainly due to a higher average cash balance in thecurrent period compared to the prior period, combined with higher short-terminterest rates in the United States and Europe.

 

***Provisionfor Income Taxes.***

 

Provision forincome taxes for the first six months of fiscal year 2008 was $38.2 million,compared to $28.4 million for the first six months of fiscal year 2007. Oureffective tax rate was 34.9 percent for the first six months of fiscal year2008 and 35.8 percent for the first six months of fiscal year 2007.  The tax rate decrease is due to thegeographic mix of income and the release of tax reserves.  The company has not provided U.S. deferredtaxes on cumulative earnings of foreign subsidiaries that have been reinvestedindefinitely, which also includes foreign subsidiaries affiliated with ourrecent acquisitions.  We record a taxbenefit on foreign net operating loss carryovers and foreign deferred expensesonly if it is more likely than not that a benefit will be realized.

 

***NetIncome.***

 

Net income for thesecond quarter of fiscal year 2008 was $36.8 million, compared to $26.0 millionfor the second quarter of fiscal year 2007. As a percentage of revenue, net income increased to 8.2 percent from 7.1percent. Net income for the first six months of fiscal year 2008 was $71.2million, compared to $50.8 million for the first six months of fiscal year2007.  As a percentage of revenue, incomefrom  operations increased to 8.4 percentfrom 7.2 percent.

 

***EarningsPer Share.***

 

Diluted earningsper share, income from operations for the second quarter of fiscal year 2008was $0.82, compared to $0.58 for the second quarter of fiscal year 2007.  Diluted earnings per share, income from  operations for the first six months of fiscalyear 2008 was $1.60, compared to $1.14 for the first six months of fiscal year2007. The diluted earnings per share calculation for the three and six monthsof fiscal year 2008 assumes that the 250,000 contingent shares related to theWWN and 1,950,000 contingent shares related to the WWLLP business acquisitionshad been issued and outstanding for the entire three and six month periodsended December 31, 2007.

 

 

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**Liquidity and Capital Resources**

 

Our cash and cashequivalents at December 31, 2007 totaled $103.6 million, compared to$248.2 million at June 30, 2007. The decrease in cash from June 30, 2007 to December 31, 2007was principally attributable to the payment during the first quarter of fiscalyear 2008 of $139 million of previously accrued discretionary compensation aswell as payment for the Heissmann and WisdomNet acquisitions of approximately$135 million.  We also paid $33.8 millionin corporate taxes, $12.8 million in capital expenditures and $6.4 million individends during the first six months of fiscal year 2008.  These payments were funded by cash flow fromcurrent consulting operations, from existing cash balances and from borrowingsunder our revolving credit facility. Consistent with the company’s liquidity position, management considersvarious alternative strategic uses of cash reserves including acquisitions,dividends and stock buybacks, or any combination of these options. The companybelieves that it will generate sufficient resources to fund operations and paydown debt through the next twelve months.

 

Our non U.S.operations are substantially self-sufficient for their working capital needs.  At December 31, 2007, $88.0 million ofthe total cash balance of $103.6 million was held outside of North America,which we have the ability to utilize, if necessary. There are no significantrepatriation restrictions other than local or U.S. taxes associated withrepatriation.

 

***CashFrom/(Used in) Operating Activities.***

 

Cash fromoperating activities for the first six months of fiscal year 2008 was $48.3million, compared to cash used in operating activities of $19.1 million for thefirst six months of fiscal year 2007. The difference is primarily attributable to $20.5 million of net incomeand a higher increase in the discretionary compensation accrual.

 

The allowance fordoubtful accounts increased $4.2 million from June 30, 2007 to December 31,2007. The number of days of accounts receivable and work in process outstandingwas 79 at December 31, 2007, compared to 83 at June 30, 2007.

 

***CashUsed in Investing Activities.***

 

Cash used ininvesting activities for the first six months of fiscal year 2008 was $161.5million, compared to $30.5 million used in investing activities for the firstsix months of fiscal year 2007.  Thedifference can be attributed to acquisition and contingent considerationpayments, primarily for Heissmann, of $134.7 million in the first six months offiscal year 2008 compared to $1.3 million in the first six months of fiscalyear 2007.

 

Expenditures ofcapital funds were $12.8 million for the first six months of fiscal year2008.  Anticipated commitments of capitalfunds are estimated at $36 million for the remainder of fiscal year 2008. Weexpect cash from operations to adequately provide for these cash needs.

 

***CashUsed in Financing Activities.***

 

Cash used infinancing activities for the first six months of fiscal year 2008 was $25.1 million,compared to cash used in financing activities of $49.6 million for the firstsix months of fiscal year 2007.  Thischange is primarily attributable to activity under our credit facility whichincluded net borrowings of $2.0 million in the first six months of fiscal year2008 compared to a net repayment of $30 million in the first six months offiscal year 2007.  Additionally, duringthe first six months of fiscal year 2008, the company repurchased $28.3 millionof common stock, compared to $20.1 million of common stock during the sameperiod in fiscal year 2007.

 

 

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**Off-BalanceSheet Arrangements and Contractual Obligations**

 
| ** **                                      | ** ** | **Remaining payments due by  fiscal year as of December 31, 2007** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| **Contractual Cash Obligations (in thousands)** | ** ** | **Total**                                                               | ** ** | **Remaining  2008** | ** ** | **2009  through  2010** | ** ** | **2011  through  2012** | ** ** | **Thereafter****(1)** | ** ** |
| Lease commitments                               |       | $                                                                       | 362,239    |   | $ | 33,021 |   | $ | 112,078 |   | $ | 86,122 |   | $ | 131,018 |   |
| Revolving Credit  Facility                      |       | 117,423                                                                 |       | 2,200 |   | 115,223 |   | — |   | — |   |
| Pension Contributions                           |       | 206,579                                                                 |       | 28,525 |   | 85,885 |   | 92,169 |   | — |   |
| Total                                           |       | $                                                                       | 686,241    |   | $ | 63,746 |   | $ | 313,186 |   | $ | 178,291 |   | $ | 131,018 |   |

----

**(1) ** Pension contributions cannot be estimated for thiscategory because there is not a definite ending date and there could belegislation changes which could affect contribution requirements.

 

***OperatingLeases.***  We lease office space, furniture and selectedcomputer equipment under operating lease agreements with terms ranging from oneto ten years. Management has determined that there is not a large concentrationof leases that will expire in any one fiscal year.  Consequently, management anticipates that anyincrease in future rent expense will be mainly market driven.

 

***CreditAgreement. ***The company hasa credit facility provided by a syndicate of banks in an aggregate principalamount of $300 million.  Interest ratesassociated with this facility vary with LIBOR and/or the Prime Rate and arebased on our leverage ratio, as defined by the credit agreement.  We are charged a quarterly commitment fee,currently 0.125 percent of the facility, which varies with our financialleverage and is paid on the unused portion of the credit facility.  Borrowings under this facility were $107.0compared to no borrowings as of December 31, 2006, primarily due toacquisitions.  Credit under the facilityis available upon demand, although the credit facility requires us to observecertain covenants (including requirements relating to our leverage ratio andfixed coverage charge ratio) and is collateralized with a pledge of stock ofmaterial subsidiaries.  We were incompliance with all covenants under the credit facility as of December 31,2007. This facility is scheduled to mature on June 30, 2010.

 

A portion of the revolving facility is used to support a requiredletter of credit.  As a result, $10.6million of the facility was unavailable for operating needs as of December 31,2007.  We are also charged a fee foroutstanding letter of credit that also fluctuates based on our leverage ratio.

 

***Guarantees***

 

*Business Combination*.    In connection with the WWLLP businesscombination, the company will issue an additional 1,950,000 shares of thecompany’s common stock as the acquired business has achieved the agreed-uponfinancial performance goals which satisfy the requirements of the contingentpayment. The company expects to issue these shares during fiscal year2008.  The value of these shares was$98.4 million based on the NYSE closing price on June 30, 2007. Thecontingent consideration is payable by Watson Wyatt Limited and the paymentobligations are guaranteed by Watson Wyatt Worldwide, Inc.

 

 

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**RiskManagement**

 

As a part of our overall risk management program, we carry customarycommercial insurance policies, including commercial general liability,employment practices liability, and claims-made professional liabilityinsurance with a self-insured retention of $1 million per claim, which providescoverage for professional liability claims of the company and its subsidiaries,including the cost of defending such claims. Our primary professional liability insurance coverage beyond ourself-insured retention amount is written by an affiliated captive insurancecompany (PCIC) owned by us and two other professional services firms.

 

In formulating its premium structure, PCIC estimates the amount itexpects to pay for losses (and loss expenses) for all the members as a wholeand then allocates that amount to the member firms based on the individualmember’s expected losses.  PCIC basespremium calculations, which are determined annually based on experience throughMarch of each year, on relative risk of the various lines of businessperformed by each of the owner companies, past claim experience of each ownercompany, growth of each of those companies, industry risk profiles in generaland the overall insurance markets.

 

As of July 1, 2007, the captive insurance company carriesreinsurance for losses it insures above $25 million.  Since losses incurred by PCIC below this levelare not covered by reinsurance, but are direct expenses of PCIC, reserveadjustments and actual outcomes of specific claims of any PCIC member firmcarry through into Watson Wyatt’s financial results as income or loss fromaffiliates through our 36.43% ownership of PCIC.  Thus from time to time the impacts of PCIC’sreserve development may result in fluctuations in Watson Wyatt’s earnings.

 

Our agreements with PCIC could require additional payments to PCIC inthe 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 probable and reasonably estimable.

 

The company will continue to provide for the self-insured retentionwhere specific estimated losses and loss expenses for known claims in excess of$1 million are considered probable and reasonably estimable.  Although the company maintains professionalliability insurance coverage, this insurance does not cover claims made afterexpiration of our current insurance contracts. Generally accepted accounting principles require that we record aliability for incurred but not reported (IBNR) professional liability claims ifthey are probable and reasonably estimable, and for which we have not yetcontracted for insurance coverage.  Thecompany uses actuarial assumptions to estimate and record its IBNR liabilityand has a $38.0 million IBNR liability recorded as of December 31, 2007.

 

Insurancemarket conditions for our industry and the company include increases in overallpremium cost.  In addition, beginning in2005 PCIC raised the reinsurance attachment point from $15 million to $25million. Trends toward higher self-insured retentions and constraints onaggregate excess coverages for this class of insurance coverage are anticipatedto continue or to recur periodically, and to be reflected in our future annualinsurance renewals.  As a result, we willcontinue to assess our ability to secure future insurance coverage and wecannot assure that such coverage will continue to be available indefinitely inthe event of specific adverse claims experience, adverse loss trends, marketcapacity constraints or other factors. In anticipation of the possibility of future reductions in risk transferfrom PCIC to re-insurers, as well as the hardening insurance market conditionsin recent years, the firms that own PCIC, including the company, have increasedPCIC’s capital in the past and we will continue to re-assess capital requirementson a regular basis.

 

 

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In light ofincreasing worldwide litigation, including litigation against professionals,the company has implemented a requirement that all client relationships bedocumented by engagement letters containing specific risk mitigation clausesthat were not included in all historical client agreements.  Nearly 100 percent of the company’s U.S.****and U.K.****corporate clients have signed engagementletters including mitigation clauses, and initiatives to maintain that processin the United States and the United Kingdom and complete it elsewhere areunderway.

 

**DisclaimerRegarding Forward-looking Statements**

 

This filingcontains a number of  “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995, including, but not limited to the following: Note 5 -  Retirement Benefits; Note 6 — Goodwill andIntangible Assets; Note 10 — Restricted Shares; Note 11 — Guarantees; Note 12 —Contingent Liabilities; Note 13 — Income Taxes; Note 15 — Exit From TaftHartley Consulting Business; the Executive Overview; Critical AccountingPolicies and Estimates; the discussion of our capital expenditures; Off-BalanceSheet Arrangements and Contractual Obligations; Risk Management; and Part II,Item 1 “Legal Proceedings”.  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, expressions or the negative of suchterms or other comparable terminology. You should read these statementscarefully because they contain projections of our future results of operationsor financial condition, or state other “forward-looking” information. A numberof risks and uncertainties exist which could cause actual results to differmaterially from the results reflected in these forward-looking statements.  Such factors include but are not limited to:

 

·              our ability to integrateacquired businesses into our own business, processes and systems, and achievethe anticipated results;

·              our continued ability to recruit and retain qualifiedassociates;

·              the success of our marketing, client development andsales programs after our acquisitions;

·              our ability to maintain client relationships and toattract new clients after our acquisitions;

·              declines in demand for our services;

·              the successful exit from themulti-employer retirement business;

·              outcomes of pending or future litigation and theavailability and capacity of professional liability insurance to fund theoutcome of pending cases or future judgments or settlements;

·              our ability to obtain professional liabilityinsurance;

·              a significant decrease in the demand for theconsulting, actuarial and other services we offer as a result of changingeconomic conditions or other factors;

·              actions by competitors offering human resourcesconsulting services, including public accounting and consulting firms, technologyconsulting firms and Internet/intranet development firms;

·              our ability to achieve cost reductions after ourrecent acquisitions;

·              foreign currency exchange and interest ratefluctuations;

·              exposure to liabilities that have not been expresslyassumed in our acquisition transactions;

·              general economic and business conditions thatadversely affect us or our clients;

·              the level of capital resources required for futureacquisitions and business opportunities;

·              regulatory developments abroad and domestically thatimpact our business practice;

·              legislative and technological developments that mayaffect the demand for or costs of our services;

 

and other factorsdiscussed under “Risk Factors” in the company’s 2007 Annual Report on Form 10-Kfiled with the SEC on August 24, 2007. These statements are based on assumptions that may not come true.  All forward-looking disclosure is speculativeby its nature.  The company undertakes noobligation to update any of the forward-looking information included in thisreport, whether as a result of new information, future events, changedexpectations or otherwise.

 

 

 

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**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Weare exposed to market risks in the ordinary course of business.  These risks include interest rate risk,foreign currency exchange and translation risk.

 

**InterestRate Risk**

 

Theprimary objective of our investment activities is to preserve principal whileat the same time maximizing yields without significantly increasing risk. Toachieve this objective, we maintain our portfolio in mainly short termsecurities that are recorded on the balance sheet at fair value.

 

**Foreign Currency Risk**

 

Internationalnet revenues result from transactions by our foreign operations and aretypically denominated in the local currency of each country. These operationsalso incur most of their expenses in the local currency. Accordingly, ourforeign operations use the local currency as their functional currency and ourprimary international operations use the British Pound, and to a lesser extent,the Euro. Our international operations are subject to risks typical ofinternational operations, including, but not limited to, differing economicconditions, changes in political climate, differing tax structures, otherregulations and restrictions, and foreign exchange rate volatility.  Accordingly, our future results could beadversely impacted by changes in these or other factors.

 

**Translation Exposure**

 

Foreignexchange rate fluctuations may adversely impact our consolidated financialposition as well as our consolidated results of operations and may adverselyimpact our financial position as the assets and liabilities of our foreignoperations are translated into U.S. dollars in preparing our condensedconsolidated balance sheet. Additionally, foreign exchange rate fluctuationsmay adversely impact our condensed consolidated results of operations asexchange rate fluctuations on transactions denominated in currencies other thanour functional currencies result in gains and losses that are reflected in ourcondensed consolidated statement of income.

 

Weconsolidate our international subsidiaries by converting them into U.S. dollarsin accordance with Statement of Financial Accounting Standards No. 52, “ForeignCurrency Translation” (“FAS 52”). The results of operations and our financialposition will fluctuate when there is a change in foreign currency exchangerates.

 

**ITEM 4. CONTROLS AND PROCEDURES.**

 

**Evaluationof Disclosure Controls and Procedures**

 

Anevaluation was performed under the supervision and with the participation ofour management, including the chief executive officer, or CEO, and chieffinancial officer, or CFO, of the effectiveness of the design and operation ofour disclosure controls and procedures. Based on that evaluation, ourmanagement, including the CEO and CFO, concluded that our disclosure controlsand procedures were effective as of December 31, 2007.

 

**Changesin Internal Control Over Financial Reporting**

 

There were nosignificant changes in our internal control over financial reporting in thequarter ended December 31, 2007 that materially affected, or arereasonably likely to materially affect, our internal control over financial reporting.

 

 

43

 

**Limitations on the Effectiveness of Controls**

 

Our management, including the CEO and CFO, does not expect that our disclosure controls and procedures will necessarily prevent all error and all fraud.  However, our management does expect that the control system provides reasonable assurance that its objectives will be met.  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 a 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, the disclosure controls and procedures are designed to provide reasonable assurance of achieving their stated objectives, and the CEO and CFO have concluded that the disclosure controls and procedures are effective at a reasonable assurance level.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS.**

 

From time to time, we are a party to variouslawsuits, arbitrations or mediations that arise in the ordinary course ofbusiness. The disclosure called for by Part II, Item 1, regarding ourlegal proceedings is incorporated by reference herein from Note 12 “ContingentLiabilities,” of the Notes to the Condensed Consolidated Financial Statementsin this Form 10-Q for the quarter ended December 31, 2007.

 

**ITEM 1A. RISK FACTORS.**

 

There are no material changes from the riskfactors previously disclosed in our 2007 Annual Report on Form 10-K (File No. 001-16159)filed on August 24, 2007.

 

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

 

None.

 

 

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**Issuer Purchases of Equity Securities**

 

The table below presentsspecified information about the company’s stock repurchases and repurchaseplans:

 
| **Period**                                            | ** ** | **Total Number of  Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number of  Shares that May Yet   Be Purchased Under   the Plans or Programs** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| October 1, 2007  through October 31, 2007   |       | 102,200                                |       | $                                 | 47.73      |                                                                                          | 102,200    |                                                                                         | 1,311,334  |   |
| November 1, 2007  through November 31, 2007 |       | 98,900                                 |       | 47.21                             |       | 98,900                                                                                        |       | 1,212,434                                                                                    |       |
| December 1, 2007  through December 31, 2007 |       | 100,100                                |       | 46.46                             |       | 100,100                                                                                       |       | 1,112,334                                                                                    |       |
| Total                                                 |       | 301,200                                |       |                              |       | 301,200                                                                                       |       |                                                                                         |       |
|                                                       |            |                                        |            |                                   |            |                                                                                               |            |                                                                                              |            |  |

 

During the first quarter of fiscal year 2007, thecompany’s Board of Directors approved the repurchase of up to 1,500,000 sharesof our Class A Common Stock.  Sharesthat the company repurchases are primarily issued in connection with thecompany’s employee benefit plans.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES.**

 

**None.**

** **

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

** **

Atthe eighth annual meeting of the stockholders of the Company, held on November 16,2007, the following matters were submitted to a vote of stockholders: (1) theelection of nine members of the Board of Directors; and (2) theratification of the selection of Deloitte & Touche LLP as the company’sindependent registered public accounting firm for the fiscal year ending June 30,2008.

 

Proxiesrepresenting 35,948,530 shares were received (total shares outstanding as ofthe Record Date were  42,478,625) and the results of the meeting are asfollows with respect to each matter submitted to a vote of stockholders.

 

 Electionof Directors

 

 Nine nominees stood for election to serve a one-year term expiring at the 2008Annual Meeting of Stockholders, or until his or her successor shall have beenelected and qualified.

 

 

 

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Ofthe proxies received, the votes were as follows:

 
| **Nominees for Directors**                                    | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|--------------|------------|
|                                                          |       |       |       |         |       |
| Term expiring at the  annual meeting of stockholders in 2008: |       |       |       |         |       |
|                                                          |       |       |       |         |       |
| John J. Gabarro                                               |       | 35,357,323 |       | 591,207      |       |
| John J. Haley                                                 |       | 34,960,137 |       | 988,393      |       |
| R. Michael McCullough                                         |       | 35,021,521 |       | 927,009      |       |
| Kevin L. Meehan                                               |       | 34,160,489 |       | 1,788,041    |       |
| Brendan R. O’Neill                                       |       | 34,791,119 |       | 1,157,411    |       |
| Linda D. Rabbitt                                              |       | 35,360,633 |       | 587,897      |       |
| Chandrasekhar  Ramamurthy                                     |       | 34,420,528 |       | 1,528,002    |       |
| Gilbert T. Ray                                                |       | 34,934,935 |       | 1,013,595    |       |
| John C. Wright                                                |       | 35,164,567 |       | 783,963      |       |

 

*Ratification of the selection of Deloitte & Touche LLP as thecompany’s independent registered public accounting firm for the fiscal yearending June 30, 2008.*

 

TheAudit Committee selected Deloitte & Touche LLP to serve as the company’sindependent registered public accounting firm for the fiscal year ending June 30,2008.  Although ratification by theCompany’s shareholders is not required under the company’s Bylaws or otherwise,the Board submitted the selection of Deloitte & Touche LLP to ourstockholders for ratification because we value our stockholders’ views on thecompany’s independent registered public accounting firm - and as a matter ofgood corporate governance.

 

Ofthe proxies received, the votes were as follows:

 

| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 35,486,100 |       | 90,057      |       | 372,373     |       |

 

**ITEM 5.OTHER INFORMATION.**

 

None.

 

 

46

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**ITEM 6. EXHIBITS.**

 
| 10.1 |   | Contingent Stock  Amendment to Business Transfer Agreement dated April 15, 2005 (1)                                                                                                         |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 21   |   | Subsidiaries of Watson  Wyatt Worldwide, Inc.(1)                                                                                                                                            |
| 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(1)       |
| 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(1)       |
| 32   |   | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to Title 18, U.S.C. Section 1350,  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1) |

----

(1)     Filed with this Form 10-Q

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

47

----

 

**Signatures**

 

Pursuant to therequirements of the Securities and Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

Watson WyattWorldwide, Inc.(Registrant)

 

 
| /s/  John J. Haley   |                     | February 8,  2008 |
|----------------------|--------------------------|------------------------|
|                 |                     |                   |
| Name:                | John  J. Haley           |                   | Date |
|                 |                     |                   |
| Title:               | President  and           |                   |   |
|                 |                     |                   |
|                 | Chief  Executive Officer |                   |   |
|                 |                     |                   |
| /s/  Carl D. Mautz   |                     | February 8,  2008 |
|                 |                     |                   |
| Name:                | Carl  D. Mautz           |                   | Date |
|                 |                     |                   |
| Title:               | Vice  President and      |                   |   |
|                 |                     |                   |
|                 | Chief  Financial Officer |                   |   |
|                 |                     |                   |
| /s/  Peter L. Childs |                     | February 8,  2008 |
|                 |                     |                   |
| Name:                | Peter  L. Childs         |                   | Date |
|                 |                     |                   |
| Title:               | Controller               |                   |   |
|                      |                          |                        |  |  |  |  |  |  |  |  |