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

 

**FORM 10-Q**

| **(Mark One)** |
|----------------|
|           |
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|           |   |
|           | **For the quarterly  period ended March 31, 2004** |
|           |   |
| **OR**         |
|           |   |
| **o**          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|           |   |
|           | **For the transition  period from               to              ** |

 

**CommissionFile Number: 001-16159**

 

**WATSONWYATT & COMPANY HOLDINGS**(Exact name of Registrant as specified in its charter)

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

 

**1717H Street NWWashington, D.C. 20006-3900**(Address of principal executive offices, including zipcode)

**(202)715-7000**(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days:

 

Yes  ý   No  o

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

 

Yes  ý   No  o

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of April 30, 2004.

 
| **Class**                            |   | **Number of  Shares** |
|--------------------------------------|--------|-----------------------|
|                                 |   |                  |
| Class A Common Stock, $.01 par value |   | 32,201,966            |

 

 

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**WATSONWYATT & COMPANY HOLDINGSINDEX TO FORM 10-Q**

 

For the Three and Nine Months Ended March 31,2004

 
| PART I.        | FINANCIAL INFORMATION                                                                                  |   |
|----------------|--------------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                   |   |
| Item 1.        | Financial Statements (Unaudited)                                                                       |   |
|           |                                                                                                   |   |
|           | Consolidated Statements of Operations—Three  and nine months ended March 31, 2004 and 2003        |   |
|           |                                                                                                   |   |
|           | Consolidated Balance Sheets— March 31, 2004 and June 30, 2003                                     |   |
|           |                                                                                                   |   |
|           | Consolidated Statements of Cash Flows-Nine  months ended March 31, 2004 and 2003                       |   |
|           |                                                                                                   |   |
|           | Consolidated Statement of Changes in  Stockholders’ Equity— Nine months ended March 31, 2004 |   |
|           |                                                                                                   |   |
|           | Notes to the Consolidated Financial  Statements                                                        |   |
|           |                                                                                                   |   |
| Item 2.        | Management’s Discussion and Analysis of  Financial Condition and Results of Operations            |   |
|           |                                                                                                   |   |
| Item 3.        | Quantitative  and Qualitative Disclosures About Market Risk                                            |   |
|           |                                                                                                   |   |
| Item 4.        | Controls  and Procedures                                                                               |   |
|           |                                                                                                   |   |
| PART  II.      | OTHER  INFORMATION                                                                                     |   |
|           |                                                                                                   |   |
| Item 1.        | Legal Proceedings                                                                                      |   |
|           |                                                                                                   |   |
| Item 2.        | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities                      |   |
|           |                                                                                                   |   |
| Item 3.        | Defaults Upon Senior Securities                                                                        |   |
|           |                                                                                                   |   |
| Item 4.        | Submission of Matters to a Vote of Security  Holders                                                   |   |
|           |                                                                                                   |   |
| Item 5.        | Other Information                                                                                      |   |
|           |                                                                                                   |   |
| Item 6.        | Exhibits and Reports on Form 8-K                                                                       |   |
|           |                                                                                                   |   |
| Signatures     |                                                                                                   |
|           |                                                                                                   |
| Certifications |                                                                                                   |
|                |                                                                                                        |        |  |

 

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**WATSON WYATT & COMPANY HOLDINGS**

**ConsolidatedStatements of Operations**

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

 
|                                                                                                                                                                                        |   | **Three  months ended March 31** |       | **Nine  months ended March 31** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|---------------------------------|------------|
|                                                                                                                                                                                        |   | **2004**                         |       | **2003**                        |       | **2004** |   | **2003** |   |
|                                                                                                                                                                                        |   | **(Unaudited)**                  | ** ** | **(Unaudited)**                 | ** ** |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Revenue                                                                                                                                                                                     |   | $                                | 180,655    |                            | $          | 177,596 |   | $ | 521,991 |   | $ | 531,178 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Costs of providing services:                                                                                                                                                                |   |                             |       |                            |       |   |   |   |   |
| Salaries and employee benefits                                                                                                                                                              |   | 100,231                          |       | 100,584                         |       | 299,678 |   | 299,935 |   |
| Professional and subcontracted services                                                                                                                                                     |   | 11,618                           |       | 11,564                          |       | 33,317 |   | 35,424 |   |
| Occupancy, communications and other                                                                                                                                                         |   | 28,422                           |       | 27,295                          |       | 77,861 |   | 79,408 |   |
| General and administrative expenses                                                                                                                                                         |   | 15,269                           |       | 13,690                          |       | 45,860 |   | 42,895 |   |
| Depreciation and amortization                                                                                                                                                               |   | 4,091                            |       | 4,854                           |       | 14,138 |   | 15,199 |   |
|                                                                                                                                                                                        |   | 159,631                          |       | 157,987                         |       | 470,854 |   | 472,861 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Income from operations                                                                                                                                                                      |   | 21,024                           |       | 19,609                          |       | 51,137 |   | 58,317 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Income from affiliates                                                                                                                                                                      |   | 2,261                            |       | 1,322                           |       | 5,099 |   | 4,229 |   |
| Interest income, net                                                                                                                                                                        |   | 20                               |       | 150                             |       | 404 |   | 617 |   |
| Other non-operating income                                                                                                                                                                  |   | 45                               |       | —                          |       | 6,197 |   | 641 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Income from continuing operations before  income taxes                                                                                                                                      |   | 23,350                           |       | 21,081                          |       | 62,837 |   | 63,804 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Provision for income taxes                                                                                                                                                                  |   | 9,374                            |       | 8,640                           |       | 25,562 |   | 26,156 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                           |   | 13,976                           |       | 12,441                          |       | 37,275 |   | 37,648 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Discontinued operations:                                                                                                                                                                    |   |                             |       |                            |       |   |   |   |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Adjustment to reduce estimated loss on  disposal of discontinued operations [see Note 15] [less applicable income tax  expense for the three and nine months ended March 31, 2004 and 2003] |   | 592                              |       | 6,752                           |       | 592 |   | 6,752 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Sublease income from discontinued  operations, less applicable income tax expense for the three and nine months  ended March 31, 2004                                                       |   | 21                               |       | —                          |       | 47 |   | — |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Net income                                                                                                                                                                                  |   | $                                | 14,589     |                            | $          | 19,193 |   | $ | 37,914 |   | $ | 44,400 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Basic earnings per share:                                                                                                                                                                   |   |                             |       |                            |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                           |   | $                                | 0.42       |                            | $          | 0.37 |   | $ | 1.13 |   | $ | 1.14 |   |
| Income from discontinued operations                                                                                                                                                         |   | 0.02                             |       | 0.21                            |       | 0.02 |   | 0.21 |   |
| Net income                                                                                                                                                                                  |   | $                                | 0.44       |                            | $          | 0.58 |   | $ | 1.15 |   | $ | 1.35 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Diluted earnings per share:                                                                                                                                                                 |   |                             |       |                            |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                           |   | $                                | 0.42       |                            | $          | 0.37 |   | $ | 1.12 |   | $ | 1.13 |   |
| Income from discontinued operations                                                                                                                                                         |   | 0.02                             |       | 0.21                            |       | 0.02 |   | 0.21 |   |
| Net income                                                                                                                                                                                  |   | $                                | 0.44       |                            | $          | 0.58 |   | $ | 1.14 |   | $ | 1.34 |   |
|                                                                                                                                                                                        |   |                             |       |                            |       |   |   |   |   |
| Weighted average shares of common stock,  basic (000)                                                                                                                                       |   | 32,968                           |       | 32,942                          |       | 33,064 |   | 32,944 |   |
| Weighted average shares of common stock,  diluted (000)                                                                                                                                     |   | 33,288                           |       | 33,242                          |       | 33,401 |   | 33,277 |   |

 

See accompanying notes to the consolidatedfinancial statements

 

1

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**WATSON WYATT & COMPANY HOLDINGS**

**ConsolidatedBalance Sheets**

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

 
|                                                                                                      |   | **March 31,  2004** |       | **June 30,  2003** |       |
|-----------------------------------------------------------------------------------------------------------|--------|---------------------|------------|--------------------|------------|
|                                                                                                      |   | **(Unaudited)**     | ** ** |               | ** ** |
| **Assets**                                                                                                |   |                | ** ** |               | ** ** |
| Cash and cash equivalents                                                                                 |   | $                   | 153,709    |               | $          | 144,374 |   |
| Receivables from clients:                                                                                 |   |                |       |               |       |
| Billed, net of allowances of $2,510 and  $862                                                             |   | 75,059              |       | 78,373             |       |
| Unbilled, net of allowances of $867 and  $419                                                             |   | 72,042              |       | 60,549             |       |
|                                                                                                      |   | 147,101             |       | 138,922            |       |
|                                                                                                      |   |                |       |               |       |
| Deferred income taxes                                                                                     |   | 7,385               |       | 3,885              |       |
| Other current assets                                                                                      |   | 13,763              |       | 11,448             |       |
| Total current assets                                                                                      |   | 321,958             |       | 298,629            |       |
|                                                                                                      |   |                |       |               |       |
| Investment in affiliates                                                                                  |   | 29,596              |       | 26,431             |       |
| Fixed assets, net                                                                                         |   | 58,730              |       | 60,716             |       |
| Deferred income taxes                                                                                     |   | 99,822              |       | 101,214            |       |
| Goodwill and intangible assets                                                                            |   | 20,965              |       | 20,878             |       |
| Other assets                                                                                              |   | 5,368               |       | 6,594              |       |
|                                                                                                      |   |                |       |               |       |
| **Total Assets**                                                                                          |   | $                   | 536,439    |               | $          | 514,462 |   |
|                                                                                                      |   |                |       |               |       |
| **Liabilities**                                                                                           |   |                | ** ** |               | ** ** |
|                                                                                                      |   |                | ** ** |               | ** ** |
| Accounts payable and accrued liabilities,  including discretionary compensation                           |   | $                   | 93,625     |               | $          | 114,013 |   |
| Income taxes payable                                                                                      |   | 11,239              |       | 15,308             |       |
| Total current liabilities                                                                                 |   | 104,864             |       | 129,321            |       |
| Accrued retirement benefits                                                                               |   | 200,794             |       | 195,705            |       |
| Deferred rent and accrued lease losses                                                                    |   | 6,654               |       | 4,608              |       |
| Other noncurrent liabilities                                                                              |   | 30,347              |       | 33,091             |       |
|                                                                                                      |   |                |       |               |       |
| **Total Liabilities**                                                                                     |   | 342,659             |       | 362,725            |       |
|                                                                                                      |   |                |       |               |       |
| Commitments and contingencies                                                                             |   |                |       |               |       |
|                                                                                                      |   |                |       |               |       |
| **Stockholders’ Equity**                                                                             |   |                |       |               |       |
| Preferred Stock - No par value:                                                                           |   |                |       |               |       |
| 1,000,000 shares authorized; none issued  and outstanding                                                 |   | —              |       | —             |       |
| Class A Common Stock - $.01 par value:                                                                    |   |                |       |               |       |
| 69,000,000 shares authorized; 33,372,880 and  33,087,880 issued and 33,011,332 and 32,943,156 outstanding |   | 334                 |       | 331                |       |
| Additional paid-in capital                                                                                |   | 150,866             |       | 145,922            |       |
| Treasury stock, at cost - 361,548 and  144,724 shares                                                     |   | (8,555              | )          | (2,956             | )          |
| Retained earnings                                                                                         |   | 115,431             |       | 77,517             |       |
| Accumulated other comprehensive loss                                                                      |   | (64,296             | )          | (69,077            | )          |
| **Total Stockholders’ Equity**                                                                       |   | 193,780             |       | 151,737            |       |
|                                                                                                      |   |                |       |               |       |
| **Total Liabilities and Stockholders’ Equity**                                                       |   | $                   | 536,439    |               | $          | 514,462 |   |

 

See accompanying notes to the consolidatedfinancial statements

 

2

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**WATSON WYATT & COMPANY HOLDINGS**

**ConsolidatedStatements of Cash Flows**

(Thousandsof U.S. Dollars)

 
|                                                                          |   | **Nine  months ended March 31** |       |
|-------------------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                                          |   | **2004**                        |       | **2003** |   |
|                                                                          |   | **(Unaudited)**                 | ** ** |
| Cash flows from operating activities:                                         |   |                            |       |   |   |
| Net income                                                                    |   | $                               | 37,914     |   | $ | 44,400 |   |
| Adjustments to reconcile net income to net  cash from operating activities:   |   |                            |       |   |   |
| Other non-operating gain related to PCIC                                      |   | (5,600                          | )          | — |   |
| Income from discontinued operations, net of  income tax expense               |   | (592                            | )          | (6,752 | ) |
| Provision for doubtful receivables from  clients                              |   | 5,610                           |       | 6,494 |   |
| Depreciation                                                                  |   | 13,895                          |       | 14,983 |   |
| Amortization of intangible assets                                             |   | 243                             |       | 216 |   |
| Provision for deferred income taxes                                           |   | (2,108                          | )          | (2,953 | ) |
| Income from affiliates                                                        |   | (5,099                          | )          | (4,229 | ) |
| Distributions from affiliates                                                 |   | 4,404                           |       | 3,400 |   |
| Other, net                                                                    |   | 10                              |       | (843 | ) |
| Changes in operating assets and liabilities  (net of discontinued operations) |   |                            |       |   |   |
| Receivables from clients                                                      |   | (13,789                         | )          | (2,317 | ) |
| Other current assets                                                          |   | (2,315                          | )          | 6,007 |   |
| Other assets                                                                  |   | 1,226                           |       | 1,922 |   |
| Accounts payable and accrued liabilities                                      |   | (10,080                         | )          | (27,438 | ) |
| Income taxes payable                                                          |   | (4,477                          | )          | 3,000 |   |
| Accrued retirement benefits                                                   |   | 5,089                           |       | 5,379 |   |
| Deferred rent and accrued lease losses                                        |   | 2,046                           |       | 973 |   |
| Other noncurrent liabilities                                                  |   | (1,694                          | )          | 1,221 |   |
| Net cash from operating activities                                            |   | 24,683                          |       | 43,463 |   |
|                                                                          |   |                            |       |   |   |
| Cash flows used in investing activities:                                      |   |                            |       |   |   |
| Purchases of fixed assets                                                     |   | (12,334                         | )          | (13,402 | ) |
| Proceeds from divestitures                                                    |   | 598                             |       | 1,042 |   |
| Acquisitions and contingent consideration  payments                           |   | (114                            | )          | (442 | ) |
| Investment in affiliates                                                      |   | —                          |       | (1,961 | ) |
| Net cash used in investing activities                                         |   | (11,850                         | )          | (14,763 | ) |
|                                                                          |   |                            |       |   |   |
| Cash flows used in financing activities:                                      |   |                            |       |   |   |
| Issuances of common stock - exercises of  stock options                       |   | 1,632                           |       | 458 |   |
| Issuances of common stock - employee stock  purchase plan                     |   | 5,024                           |       | 4,768 |   |
| Repurchases of common stock                                                   |   | (12,161                         | )          | (11,385 | ) |
| Net cash used in financing activities                                         |   | (5,505                          | )          | (6,159 | ) |
|                                                                          |   |                            |       |   |   |
| Effect of exchange rates on cash                                              |   | 2,007                           |       | 1,280 |   |
|                                                                          |   |                            |       |   |   |
| Increase in cash and cash equivalents                                         |   | 9,335                           |       | 23,821 |   |
|                                                                          |   |                            |       |   |   |
| Cash and cash equivalents at beginning of  period                             |   | 144,374                         |       | 95,974 |   |
|                                                                          |   |                            |       |   |   |
| Cash and cash equivalents at end of period                                    |   | $                               | 153,709    |   | $ | 119,795 |   |

 

See accompanying notes to the consolidatedfinancial statements

 

3

----

 

**WATSON WYATT & COMPANY HOLDINGS**

 

**ConsolidatedStatement of Changes in Stockholders’ Equity**

(Thousandsof U.S. Dollars)

(Unaudited)

 
|                                                             |   | **Class A  Common  Stock  Outstanding  (number of  shares)** |   | **Class A  Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Treasury  Stock,  at Cost** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------|--------|--------------------------------------------------------------|--------|----------------------------|------------|----------------------------------|------------|-------------------------------|------------|------------------------|------------|---------------------------------------------|------------|-----------|------------|
| Balance at June 30, 2003                                         |   | 32,943                                                       |   | $                          | 331        |                             | $          | 145,922                       |       | $                      | (2,956     | )                                           | $          | 77,517    |       | $ | (69,077 | ) | $ | 151,737 |   |
| Comprehensive income:                                            |   |                                                         |   |                       |       |                             |       |                          |       |                   |       |                                        |       |      |       |
| Net income                                                       |   |                                                         |   |                       |       |                             |       |                          |       | 37,914                 |       |                                        |       | 37,914    |       |
| Additional minimum pension liability                             |   |                                                         |   |                       |       |                             |       |                          |       |                   |       | (624                                        | )          | (624      | )          |
| Foreign currency translation adjustment                          |   |                                                         |   |                       |       |                             |       |                          |       |                   |       | 5,405                                       |       | 5,405     |       |
| Total comprehensive income                                       |   |                                                         |   |                       |       |                             |       |                          |       |                   |       |                                        |       | 42,695    |       |
| Repurchases of common stock                                      |   | (511                                                         | )      |                       |       |                             |       | (12,161                       | )          |                   |       |                                        |       | (12,161   | )          |
| Issuances of common stock - employee stock  purchase plan shares |   | 268                                                          |   | 1                          |       | 908                              |       | 4,115                         |       |                   |       |                                        |       | 5,024     |       |
| Issuances of common stock - deferred stock  units                |   | 178                                                          |   | 2                          |       | 4,081                            |       |                          |       |                   |       |                                        |       | 4,083     |       |
| Issuances of common stock to outside  directors                  |   | 6                                                            |   |                       |       | 10                               |       | 135                           |       |                   |       |                                        |       | 145       |       |
| Issuances of common stock- stock options                         |   | 127                                                          |   |                       |       | (680                             | )          | 2,312                         |       |                   |       |                                        |       | 1,632     |       |
| Tax benefit of exercises of stock options                        |   |                                                         |   |                       |       | 625                              |       |                          |       |                   |       |                                        |       | 625       |       |
|                                                             |   |                                                         |   |                       |       |                             |       |                          |       |                   |       |                                        |       |      |       |
| Balance at March 31, 2004                                        |   | 33,011                                                       |   | $                          | 334        |                             | $          | 150,866                       |       | $                      | (8,555     | )                                           | $          | 115,431   |       | $ | (64,296 | ) | $ | 193,780 |   |

 

See accompanying notes to the consolidatedfinancial statements

 

4

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**WATSON WYATT &COMPANY HOLDINGS**

 

**Notesto the Consolidated Financial Statements******(Tabular amounts are in thousands, except per share data)

(Unaudited)

**Note 1 – Basis ofPresentation**

 

The accompanying unaudited quarterly consolidated financial statementsof Watson Wyatt & Company Holdings and our subsidiaries (collectivelyreferred to as “we,” “Watson Wyatt” or the “Company”) are presented inaccordance with the rules and regulations of the Securities and ExchangeCommission (“SEC”) for quarterly reports on Form 10-Q.  In the opinion of management, thesefinancial statements reflect all adjustments which are necessary for a fairpresentation of the consolidated financial statements for the interimperiods.  The consolidated financialstatements should be read in conjunction with the audited consolidatedfinancial statements and notes thereto contained in the Company’s Annual Reporton Form 10-K for the fiscal year ended June 30, 2003, which is filed with theSEC and may be accessed via EDGAR on the SEC’s web site at www.sec.gov.

 

The results of operations for the nine months ended March 31, 2004 arenot necessarily indicative of the results that can be expected for the entirefiscal year ending June 30, 2004.  Theresults reflect certain estimates, including estimated bonuses and anticipatedtax liabilities.

** **

**Note 2 – CompanyBackground**

 

Watson Wyatt is an international company engaged in the business ofproviding professional consultative services on a fee basis, primarily in thehuman resource areas of employee benefits and compensation, but also in otherareas of specialization such as human capital consulting and humanresource-related technology consulting.

** **

**Note 3 – SegmentInformation**

 

In North America, the Company is primarily organized and managed bypractice.  Although our consultants inour international offices provide services in these same practice areas, ourinternational operations as a whole are managed geographically and comprise asingle operating segment.  Therefore, wehave five reportable operating segments or practice areas:

 
| (1) |   | Benefits Group                                    |
|-----|--------|---------------------------------------------------|
| (2) |   | Technology Solutions Group                        |
| (3) |   | Human Capital Group                               |
| (4) |   | International                                     |
| (5) |   | Other (including Data Services and Communication) |

 

5

----

 

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

 

The table below presents specified information about reported segmentsas of and for the three months ended March 31, 2004:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 110,029 |                             | $      | 20,258                    |   | $                 | 11,639 |      | $      | 22,088    |   | $ | 9,562 |   | $ | 173,576 |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Net operating income/(loss)            |   | 26,541              |    | 2,729                            |   | 2,085                     |   | 1,713             |   | (319      | )      | 32,749    |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Receivables                            |   | 98,713              |    | 8,830                            |   | 9,569                     |   | 19,148            |   | 5,321     |   | 141,581   |   |
|                                        |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

The table below presents specified information about reported segmentsas of and for the three months ended March 31, 2003:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 103,996 |                             | $      | 22,467                    |   | $                 | 12,216 |      | $      | 19,103    |   | $ | 10,648 |   | $ | 168,430 |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Net operating income/(loss)            |   | 26,741              |    | 3,081                            |   | 1,549                     |   | 847               |   | (586      | )      | 31,632    |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Receivables                            |   | 90,590              |    | 16,071                           |   | 9,505                     |   | 15,720            |   | 6,585     |   | 138,471   |   |
|                                        |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

6

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The table below presents specified information about reported segmentsas of and for the nine months ended March 31, 2004:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 312,325 |                             | $      | 62,398                    |   | $                 | 33,427 |      | $      | 60,420    |   | $ | 32,197 |   | $ | 500,767 |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Net operating income/(loss)            |   | 65,304              |    | 8,184                            |   | 3,973                     |   | 466               |   | 315       |   | 78,242    |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Receivables                            |   | 98,713              |    | 8,830                            |   | 9,569                     |   | 19,148            |   | 5,321     |   | 141,581   |   |
|                                        |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

The table below presents specified information about reported segmentsas of and for the nine months ended March 31, 2003:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 301,072 |                             | $      | 75,296                    |   | $                 | 35,402 |      | $      | 56,167    |   | $ | 36,559 |   | $ | 504,496 |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Net operating income/(loss)            |   | 70,684              |    | 12,731                           |   | 1,076                     |   | 2,171             |   | 1,549     |   | 88,211    |   |
|                                   |   |                |    |                             |   |                      |   |              |   |      |   |      |   |
| Receivables                            |   | 90,590              |    | 16,071                           |   | 9,505                     |   | 15,720            |   | 6,585     |   | 138,471   |   |
|                                        |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

Information about interest income and tax expense is not presented as asegment expense because it is not considered a responsibility of the segments’operating management.

 

7

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The following table includesreconciliations of the information reported by segment to the consolidatedamounts for the three and nine month periods ended March 31, 2004 and 2003:

 
|                                                                                    |   | **Three  Months Ended March 31** |    | **Nine  Months Ended March 31** |   |
|-----------------------------------------------------------------------------------------|--------|----------------------------------|---------|---------------------------------|--------|
|                                                                                    |   | **2004**                         |    | **2003**                        |   | **2004** |   | **2003** |   |
|                                                                                    |   |                             |    |                            |   |   |   |   |   |
| Revenue:                                                                                |   |                             |    |                            |   |   |   |   |   |
| Total segment revenue                                                                   |   | $                                | 173,576 |                            | $      | 168,430 |   | $ | 500,767 |   | $ | 504,496 |   |
| Reimbursable expenses not included in total  segment revenue                            |   | 6,600                            |    | 8,528                           |   | 21,448 |   | 25,846 |   |
| Other, net                                                                              |   | 479                              |    | 638                             |   | (224 | ) | 836 |   |
| Consolidated revenue                                                                    |   | $                                | 180,655 |                            | $      | 177,596 |   | $ | 521,991 |   | $ | 531,178 |   |
|                                                                                    |   |                             |    |                            |   |   |   |   |   |
| Net Operating Income:                                                                   |   |                             |    |                            |   |   |   |   |   |
| Total segment net operating income                                                      |   | $                                | 32,749  |                            | $      | 31,632 |   | $ | 78,242 |   | $ | 88,211 |   |
| Income from affiliates                                                                  |   | 2,261                            |    | 1,322                           |   | 5,099 |   | 4,229 |   |
| Differences in allocation methods for  depreciation, G&A, medical and pension costs |   | 1,551                            |    | 198                             |   | 4,911 |   | (897 | ) |
| Gain on sale of business units                                                          |   | 45                               |    | 27                              |   | 598 |   | 1,069 |   |
| Discretionary compensation                                                              |   | (9,700                           | )       | (8,147                          | )      | (29,170 | ) | (27,721 | ) |
| PCIC non-operating gain                                                                 |   | —                           |    | —                          |   | 5,600 |   | — |   |
| Other, net                                                                              |   | (3,556                           | )       | (3,951                          | )      | (2,443 | ) | (1,087 | ) |
| Consolidated income before income taxes                                                 |   | $                                | 23,350  |                            | $      | 21,081 |   | $ | 62,837 |   | $ | 63,804 |   |
|                                                                                    |   |                             |    |                            |   |   |   |   |   |
| Receivables:                                                                            |   |                             |    |                            |   |   |   |   |   |
| Total segment receivables - billed and  unbilled                                        |   | $                                | 141,581 |                            | $      | 138,471 |   | $ | 141,581 |   | $ | 138,471 |   |
| Net valuation differences                                                               |   | 5,520                            |    | 8,964                           |   | 5,520 |   | 8,964 |   |
| Total billed and unbilled receivables                                                   |   | 147,101                          |    | 147,435                         |   | 147,101 |   | 147,435 |   |
| Assets not reported by segment                                                          |   | 389,338                          |    | 306,049                         |   | 389,338 |   | 306,049 |   |
| Consolidated assets                                                                     |   | $                                | 536,439 |                            | $      | 453,484 |   | $ | 536,439 |   | $ | 453,484 |   |

 

**Note 4 – Stock-basedCompensation**

 

We have elected to follow Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” (APB 25), for stock options issuedunder the 2000 Long-term Incentive Plan and the 2001 Employee Stock PurchasePlan.  Compensation expense for the 2000Long-term Incentive Plan, if any, would be recorded and measured as thedifference between the fair market value of the stock at the date of the grantand the option price.  The compensationexpense would be recognized over the five-year vesting period identified in theplan.  For any cash-based, non-stockawards, such as stock appreciation rights, compensation expense is recognizedover the vesting period to the extent that the market price of the stockincreases.  We have elected thedisclosure-only provisions of Statement of Financial Accounting Standards No.123, “Accounting for Stock-based Compensation” (FAS 123).

 

8

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As required by FAS 123, the Company has determined pro forma net incomeand earnings per share as if the Company had accounted for its stockcompensation plans under the fair value method of FAS 123.  The Company estimated compensation expensefor its 2001 Employee Stock Purchase Plan based on the 15 percent discountedpurchase price offered to employees enrolled in the plan, which approximatesfair value.  For the 2000 Long-termIncentive Plan, the Company uses the Black-Scholes option valuation model tocalculate the fair value of options granted for pro forma disclosure purposes.

 

The table below reflects the pro forma effect on net income andearnings per share for the three and nine months ended March 31, 2004 and 2003as if the Company recognized compensation expense under the fair value methodof FAS 123:

 
|                                                                                                                                          |   | **Three  Months Ended March 31** |   | **Nine  Months Ended March 31** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                                                                                                                          |   | **2004**                         |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                                                                                                                          |   |                             |   |                            |   |   |   |   |   |
| Net income, as reported                                                                                                                       |   | $                                | 14,589 |                            | $      | 19,193 |   | $ | 37,914 |   | $ | 44,400 |   |
| Add: Stock-based compensation expense  included in reported net income, net of related tax effects                                            |   | 36                               |   | 23                              |   | 113 |   | 35 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of related tax effects |   | (361                             | )      | (384                            | )      | (1,159 | ) | (1,184 | ) |
|                                                                                                                                          |   |                             |   |                            |   |   |   |   |   |
| Pro forma net income                                                                                                                          |   | $                                | 14,264 |                            | $      | 18,832 |   | $ | 36,868 |   | $ | 43,251 |   |
|                                                                                                                                          |   |                             |   |                            |   |   |   |   |   |
| **Earnings per share:**                                                                                                                       |   |                             |   |                            |   |   |   |   |   |
| Basic - as reported                                                                                                                           |   | $                                | 0.44   |                            | $      | 0.58 |   | $ | 1.15 |   | $ | 1.35 |   |
| Basic - pro forma                                                                                                                             |   | $                                | 0.43   |                            | $      | 0.57 |   | $ | 1.12 |   | $ | 1.31 |   |
|                                                                                                                                          |   |                             |   |                            |   |   |   |   |   |
| Diluted - as reported                                                                                                                         |   | $                                | 0.44   |                            | $      | 0.58 |   | $ | 1.14 |   | $ | 1.34 |   |
| Diluted - pro forma                                                                                                                           |   | $                                | 0.43   |                            | $      | 0.57 |   | $ | 1.10 |   | $ | 1.30 |   |

 

**Note5 – Retirement Benefits**

* *

*Defined Benefit Plans*

 

We sponsor both qualified and non-qualified, non-contributory definedbenefit pension plans covering substantially all of our associates.  Under our principal plans (United States,Canada, Hong Kong and U.K.), benefits are based on the number of years ofservice and the associates’ compensation during the three highest paidconsecutive years of service.  Thenon-qualified plan provides for pension benefits that would be covered underthe qualified plan but are limited by the Internal Revenue Code.  The non-qualified plan has no assets andtherefore is an unfunded arrangement which benefit liability is reflected onthe balance sheet.  Included in theresults is our U.K. plan, which is inactive but is part of the additionalminimum pension liability reported on the Consolidated Balance Sheets.  The measurement date for the plans is June30.

 

9

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*Components of Net Periodic Benefit Cost forDefined Benefit Pension Plans*

 

The following table sets forth the componentsof net periodic benefit cost for the Company’s U.S. and non-U.S. definedbenefit pension plans for the three and nine months ended March 31, 2004 and2003:

 
|                                  |   | **Three  Months Ended March 31** |   | **Nine  Months Ended March 31** |   |
|---------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                  |   | **2004**                         |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                  |   |                             |   |                            |   |   |   |   |   |
| Service Cost                          |   | $                                | 6,682  |                            | $      | 6,550 |   | $ | 20,046 |   | $ | 19,651 |   |
| Interest Cost                         |   | 8,398                            |   | 8,391                           |   | 25,193 |   | 25,173 |   |
| Expected return on plan assets        |   | (8,958                           | )      | (9,367                          | )      | (26,875 | ) | (28,100 | ) |
| Amortization of transition obligation |   | (1                               | )      | 50                              |   | (3 | ) | 149 |   |
| Amortization of net loss              |   | 2,975                            |   | 1,190                           |   | 8,926 |   | 3,570 |   |
| Amortization of prior service cost    |   | (670                             | )      | 145                             |   | (2,009 | ) | 436 |   |
| Net periodic benefit cost             |   | $                                | 8,426  |                            | $      | 6,959 |   | $ | 25,278 |   | $ | 20,879 |   |

 

*Employercontributions*

 

The Company made $10.8 million and $12.8 million in contributions toits U.S. and non-U.S. qualified pension plans during each of the nine monthsended March 31, 2004 and 2003, respectively. We anticipate making contributions to the non-U.S. qualified plans ofapproximately $1.8 million in the fourth quarter of fiscal year 2004.  During the fourth quarter of fiscal year2003, we made additional contributions of $11.5 million to the U.S. andnon-U.S. qualified pension plans.

* *

*Defined Contribution Plans*

 

We sponsor a savings plan that providesbenefits to substantially all U.S. associates. Prior to July 1, 2003, wematched employee contributions at 50 percent of the first 6 percent of totalpay, which included base salary, overtime and annual performance-basedbonuses.  Vesting of the Company matchoccurs after three years for new employees and is 100 percent for all employeeshired before January 1, 1997.  EffectiveJuly 1, 2003, the Company match has been suspended.

* *

*Health Care Benefits*

 

We sponsor a contributory health care planthat provides hospitalization, medical and dental benefits to substantially allU.S. associates.  We accrue a liabilityfor estimated incurred but unreported claims based on projected use of the planas well as prior plan history.

* *

*Postretirement Benefits*

 

We provide certain health care and lifeinsurance benefits for retired associates. The principal plans cover associates in the U.S. and Canada who have metcertain eligibility requirements. Our principal post-retirement benefit plansare unfunded.  We accrue a liability forthese benefits.

 

10

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*Components of Net Periodic Benefit Cost for Other Postretirement plans*

 

The following table sets forth the componentsof net periodic benefit cost for the Company’s healthcare and post-retirementplans for the three and nine months ended March 31, 2004 and 2003:

 
|                                  |   | **Three  Months Ended March 31** |   | **Nine  Months Ended March 31** |   |
|---------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                  |   | **2004**                         |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                  |   |                             |   |                            |   |   |   |   |   |
| Service cost                          |   | $                                | 418    |                            | $      | 442 |   | $ | 1,253 |   | $ | 1,327 |   |
| Interest cost                         |   | 583                              |   | 629                             |   | 1,749 |   | 1,886 |   |
| Expected return on plan assets        |   | —                           |   | —                          |   | — |   | — |   |
| Amortization of transition obligation |   | 12                               |   | 12                              |   | 35 |   | 35 |   |
| Amortization of net gain              |   | (145                             | )      | (129                            | )      | (434 | ) | (387 | ) |
| Amortization of prior service cost    |   | (67                              | )      | (116                            | )      | (200 | ) | (348 | ) |
| Net periodic benefit cost             |   | $                                | 801    |                            | $      | 838 |   | $ | 2,403 |   | $ | 2,513 |   |

 

*Employercontributions*

 

The Company made $1.9 million in contributions in the form of premiumsand medical claim payments to its healthcare and post-retirement plans duringeach of the nine months ended March 31, 2004 and 2003.  We plan to make additional paymentsestimated to total $0.7 million through the end of June 30, 2004.

 

**Note 6 – Targeted JobReductions**

 

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

 

**Note 7 – SubsequentEvents**

 

Subsequent to the end of the third fiscal quarter, the Companycompleted a tender offer for shares of its Class A common stock, through whichthe Company purchased 830,802 shares of its Class A shares at a purchase priceof $25.25.  The aggregate purchase priceof the shares purchased through the tender offer was $21.0 million, notincluding modest fees and expenses.

 

On April 27, 2004, the Company executed a new lease agreementcommitting its Washington D.C. office, which includes consulting and corporateoperations, to move to northern Virginia. The Company simultaneously provided notice of early termination of itsexisting Washington D.C. lease which will result in a $3.2 million chargeduring the fourth quarter of fiscal year 2004. The $3.2 million charge will have no net cash impact on the Companybecause the Company will receive a $3.2 million payment from the new lessor asan incentive to enter into the new lease.

 

11

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**Note 8 – Goodwill and Intangible Assets**

 

The changes in the carrying amount of goodwill for the nine monthsended March 31, 2004, are as follows: 

 
|                                |   | **Benefits  Group** |   | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|-------------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
|                                |   |                |   |                             |   |                      |   |              |   |      |   |      |   |
| Balance as of June 30, 2003         |   | $                   | 16,278 |                             | $      | 1,449                     |   | $                 | 69     |      | $      | 979       |   | $ | 1,214 |   | $ | 19,989 |   |
|                                |   |                |   |                             |   |                      |   |              |   |      |   |      |   |
| Goodwill recorded during the period |   | —              |   | —                           |   | —                    |   | 114               |   | —    |   | 114       |   |
|                                |   |                |   |                             |   |                      |   |              |   |      |   |      |   |
| Translation adjustment              |   | 143                 |   | —                           |   | 3                         |   | 69                |   | —    |   | 215       |   |
|                                |   |                |   |                             |   |                      |   |              |   |      |   |      |   |
| Balance as of March 31, 2004        |   | $                   | 16,421 |                             | $      | 1,449                     |   | $                 | 72     |      | $      | 1,162     |   | $ | 1,214 |   | $ | 20,318 |   |

 

Goodwill recorded during the period reflects contingent payments maderelative to historical acquisitions in Australia and Mexico.

 

The following table reflects changes in the net carrying amount of thecomponents of intangible assets for the nine months ended March 31, 2004:

 
|                         |   | **Non-contractual  customer  relationships** |   | **Non-compete  agreements** |   | **Purchased  software** |   | **Pension** |   | **Total** |   |
|------------------------------|--------|----------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|-------------|--------|-----------|--------|
|                         |   |                                         |   |                        |   |                    |   |        |   |      |   |
| Balance as of June 30, 2003  |   | $                                            | 480    |                        | $      | 269                     |   | $           | 27     |      | $      | 113 |   | $ | 889 |   |
|                         |   |                                         |   |                        |   |                    |   |        |   |      |   |
| Amortization expense         |   | (150                                         | )      | (69                         | )      | (24                     | )      | —      |   | (243      | )      |
|                         |   |                                         |   |                        |   |                    |   |        |   |      |   |
| Translation adjustment       |   | (10                                          | )      | (1                          | )      | —                  |   | 12          |   | 1         |   |
|                         |   |                                         |   |                        |   |                    |   |        |   |      |   |
| Balance as of March 31, 2004 |   | $                                            | 320    |                        | $      | 199                     |   | $           | 3      |      | $      | 125 |   | $ | 647 |   |

 

12

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The following table reflects the carrying value of intangible assets atMarch 31, 2004 and 2003:

 
|                                                         |   | **March 31,  2004**         |   | **March 31,  2003**           |   |
|--------------------------------------------------------------|--------|-----------------------------|--------|-------------------------------|--------|
|                                                         |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Amortizable intangible assets and  intangible pension asset: |   |                        |   |                          |   |   |   |   |   |
| Non-contractual customer relationships                       |   | $                           | 807    |                          | $      | 487 |   | $ | 696 |   | $ | 131 |   |
| Non-compete agreements                                       |   | 672                         |   | 473                           |   | 672 |   | 380 |   |
| Purchased software                                           |   | 125                         |   | 122                           |   | 125 |   | 89 |   |
| Intangible pension asset                                     |   | 125                         |   | —                        |   | — |   | — |   |
| Total intangible assets and intangible  pension asset        |   | $                           | 1,729  |                          | $      | 1,082 |   | $ | 1,493 |   | $ | 600 |   |

 

Thechange in the gross carrying amount of non-contractual customer relationshipsreflects translation adjustments between March 31, 2003 and March 31,2004.  These intangible assets aredenominated in the functional currencies of our subsidiaries outside the UnitedStates, and are translated into our reporting currency, the U.S. dollar, basedon exchange rates at the balance sheet date.

 

The weighted average remaining life of amortizable intangible assets atMarch 31, 2004 was 1.8 years.  Estimatedamortization expense for fiscal year 2004 and each of the three succeedingfiscal years is as follows:

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

 

13

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**Note 9 – Earnings Per Share**

 

Basic earnings per share is calculated on the basis of the weightedaverage number of common shares outstanding during the three and nine monthsended March 31, 2004.  Diluted earningsper share is calculated on the basis of the weighted average number of commonshares outstanding plus the effect of outstanding stock options and employeestock purchase plan shares using the “treasury stock” method.  The components of basic and diluted earningsper share are as follows:

 
|                                                                               |   | **Three  Months Ended March 31** |   | **Nine  Months Ended March 31** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                                                               |   | **2004**                         |   | **2003**                        |   | **2004** |   | **2003** |   |
| Income from continuing operations                                                  |   | $                                | 13,976 |                            | $      | 12,441 |   | $ | 37,275 |   | $ | 37,648 |   |
| Discontinued operations                                                            |   | 613                              |   | 6,752                           |   | 639 |   | 6,752 |   |
| Net income                                                                         |   | $                                | 14,589 |                            | $      | 19,193 |   | $ | 37,914 |   | $ | 44,400 |   |
|                                                                               |   |                             |   |                            |   |   |   |   |   |
| Weighted average outstanding shares of  common stock                               |   | 32,968                           |   | 32,942                          |   | 33,064 |   | 32,944 |   |
| Dilutive effect of employee stock options  and employee stock purchase plan shares |   | 320                              |   | 300                             |   | 337 |   | 333 |   |
| Common stock and stock equivalents                                                 |   | 33,288                           |   | 33,242                          |   | 33,401 |   | 33,277 |   |
|                                                                               |   |                             |   |                            |   |   |   |   |   |
| Basic earnings per share:                                                          |   |                             |   |                            |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                                | 0.42   |                            | $      | 0.37 |   | $ | 1.13 |   | $ | 1.14 |   |
| Discontinued operations                                                            |   | 0.02                             |   | 0.21                            |   | 0.02 |   | 0.21 |   |
| Net income                                                                         |   | $                                | 0.44   |                            | $      | 0.58 |   | $ | 1.15 |   | $ | 1.35 |   |
|                                                                               |   |                             |   |                            |   |   |   |   |   |
| Diluted earnings per share:                                                        |   |                             |   |                            |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                                | 0.42   |                            | $      | 0.37 |   | $ | 1.12 |   | $ | 1.13 |   |
| Discontinued operations                                                            |   | 0.02                             |   | 0.21                            |   | 0.02 |   | 0.21 |   |
| Net income                                                                         |   | $                                | 0.44   |                            | $      | 0.58 |   | $ | 1.14 |   | $ | 1.34 |   |

 

**Note10 – Investment in Affiliates**

 

In January 2003, the FASB issued FASB Interpretation No. 46,“Consolidation of Variable Interest Entities,” which was later revised inDecember 2003 (FIN 46R) and effective March 31, 2004 for the Company.  This interpretation of Accounting ResearchBulletin No. 51, “Consolidated Financial Statements,” addresses consolidationby business enterprises of variable interest entities.  FIN 46R introduces the concept of a variableinterest entity and requires consolidation by the primary beneficiary wherethere is a controlling financial interest in a variable interest entity orwhere the variable interest entity does not have sufficient equity at risk tofinance its activities without additional subordinated financial support fromother parties.

 

Investment in Affiliates consists of equity investments in threeentities, Watson Wyatt Holdings (Europe) Limited (WWHE), Watson Wyatt LLP(WWLLP) and Professional Consultants Insurance Company Inc. (PCIC), each ofwhich is accounted for under the equity method.  The Company evaluated each of these

 

14

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entities based on FIN 46R’s criteria in order to determine theapplicability of FIN 46R and the Company’s current assessment is that of thethree entities, WWHE and PCIC are considered to be variable interestentities.  The Company has concluded,however, that it does not have a controlling financial interest in WWHE or PCICand as a result, the Company is not the primary beneficiary and is not requiredto consolidate their results.

 

On April 1, 1995, the Company transferred its United Kingdom (“U.K.”)operations to WWLLP, an actuarial partnership based in the U.K., and received abeneficial interest in WWLLP and a 10% interest in a defined profit pool ofWWLLP.  The Company also transferred itsContinental European operations to WWHE as a newly-formed holding company,jointly owned and controlled by the Company and WWLLP, in exchange for 50.1% ofits shares. Effective July 1, 1998, the Company sold one-half of its investmentin WWHE to WWLLP.  WWHE is now jointlyowned and controlled by the Company (25%) and WWLLP (75%).  While Watson Wyatt & Company, WWLLP, andWWHE remain separate legal entities, the companies have marketed their servicesglobally under the Watson Wyatt Worldwide brand, sharing resources,technologies, processes and business referrals.  Management believes that the Company’s maximum financialstatement exposure to loss is limited to the carrying value of the Company’sinvestment in WWHE of $6.9 million as of March 31, 2004.

 

PCIC was organized in 1987 as a captiveinsurance company under the laws of the State of Vermont.  PCIC provides professional liabilityinsurance on a claims-made basis to three actuarial and management consultingfirms, all of which participate in the program as both policyholders andstockholders.  The Company currentlyowns 34.8 percent of PCIC.  Capitalcontributions to PCIC are required when approved by a majority of itsstockholders.  Management believes thatthe Company’s maximum financial statement exposure to loss is limited to thecarrying value of the Company’s investment in PCIC of $5.7 million, combinedwith letters of credit totaling $4.9 million for which PCIC has been designatedas beneficiary, for a total maximum exposure of $10.6 million.

 

**Note 11 –Comprehensive Income**

 

Comprehensive income includes net income, changes in the additionalminimum pension liability resulting from translation adjustments and changes inthe cumulative translation adjustment gain or loss.  For the three months ended March 31, 2004, comprehensive incometotaled $15.5 million, compared with $20.4 million for the three months endedMarch 31, 2003.  For the nine monthsended March 31, 2004, comprehensive income totaled $42.7 million, compared with$46.1 million for the nine months ended March 31, 2003.

 

**Note 12 – RestrictedShares**

 

In conjunction with our initial public offering in October 2000, weentered into agreements providing for transfer restrictions with majorstockholders, executive officers and employee directors.  During October 2003, these transfer restrictionsexpired on 1,908,000 Class A shares.  Asof March 31, 2004, 1,730,000 Class A shares remain restricted.  These shares will become freely transferablein October 2004.

 

**Note 13 – Guarantees**

 

The Company historically has provided guarantees on an infrequent basisto third parties in the ordinary course of business.  The guarantees described below are currently in effect and couldrequire the Company to make payments to third parties under certaincircumstances.

* *

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

 

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*Affiliate Agreements*.  In 1995, we entered into an allianceagreement with R. Watson & Sons, a United Kingdom-based actuarial, benefitsand human resources consulting partnership (now WWLLP), the predecessor ofwhich was founded in 1878.  Included inthe agreements between the Company and WWLLP (the “Alliance Agreements”) arevarious indemnities and guarantees relating to the performance of the Companyand its subsidiaries, some of which became part of WWHE, as to such matters astax liabilities, liabilities for prior acts or omissions arising from theoperation of the UK and European businesses prior to the alliance and failureto perform various obligations under the Alliance Agreements.  In addition, certain events, such as a saleof material parts of our business, could require the Company to either purchasefrom or sell to WWLLP an interest in our European business and/or repurchasethe shares of the Company’s stock currently held by WWLLP.  The Company is unable to estimate an amountof any potential future payments under these contractual arrangements becausethe potential occurrence of any of the events to which the indemnities apply isentirely speculative, there is no history of payments and the dollar amount, ifany, would be dependent upon the nature of the event triggering such indemnity.Management believes that any potential for payment under such indemnities andguarantees should decline with the passage of time.  There are no provisions for recourse to third parties, nor areany assets held by any third parties that the Company as guarantor canliquidate to recover amounts paid under such indemnities.

 

The Company owns 25 percent of WWHE and WWLLP owns the remaining 75percent.  Additional capital for WWHE,if required, may be provided by both owners based on their respective ownershipinterests.  If either the Company orWWLLP does not provide its pro rata share of any additional capital invested inWWHE, that party’s respective ownership interest will be reduced accordingly.

 

In connection with the establishment of our alliance with WWLLP, theCompany agreed to guarantee WWLLP’s performance under a lease for office spacein London that expires in 2015. Payments by WWLLP under the lease total approximately £1.4 million (orapproximately $2.6 million based on the March 31, 2004, exchange rate) peryear.  We also granted WWLLP an optionto return the leased space to our UK subsidiary in 2009.  If WWLLP exercises this option, the Companywould attempt to sublease the space at the then-current market rates.

* *

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

* *

*Wellspring Leases*.  We continue to guarantee three leases foroffice premises for Wellspring Resources, LLC (“Wellspring”), the benefitsadministration outsourcing business that we exited from in fiscal year 1998.  At March 31, 2004, minimum remainingpayments guaranteed under these leases, which expire at various dates through2007, total $19.7 million, excluding anticipated future sublease income.  See Note 15 for more information regardingour obligation to guarantee Wellspring’s leases.

 

**Note 14 – ContingentLiabilities**

 

From time totime, we are a party to various lawsuits, arbitrations or mediations that arisein the ordinary course of business. These disputes typically involve claims relating to the rendering ofprofessional services or employment matters.  Management believes, based on currently available information,that the results of all pending claims against us will not have a materialadverse affect on the Company.  The mattersreported on below involve the most significant pending or potential claimsagainst us.  These matters did notsignificantly impact the quarter’s financial results.

 

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*New JerseyCoalition of Auto Retailers Insurance Group Trust (NJCAR).*   The claims have been settled andthe suit has been dismissed.

 

*Toussaint, et al. v. James, et al.*  The claim has been settled and the suit hasbeen dismissed.

 

*IronWorkers Local 25 et al. v. Watson Wyatt & Co. *OnApril 19, 2004, Watson Wyatt & Co. was served with a complaint filedby a former client in the United States District Court for the Eastern Districtof Michigan.  The complaint allegesnegligence and negligent supervision in the preparation of an actuarialvaluation.  The amount of damages soughtare not specified.

** **

**Note 15 – DiscontinuedOperations**

 

As discussed in Note 13, the Company continues to guarantee threeleases for office premises for Wellspring. Through the first nine months of fiscal year 2004, the Company receivedsublease income of approximately $79,000 in excess of lease payments related tothis business.  Since the second quarterof fiscal year 2003, the leases have been generating positive cash flows ofapproximately $0.1 million per fiscal year.

 

During the third quarter of fiscal years 2003 and 2004, the Company evaluatedits accrual for the estimated remaining future obligations and costs related tothe exit from Wellspring.  Theevaluations included an analysis of occupancy rates of Wellspring, along withan analysis of real estate market conditions in cities in which the leasesexist and an assessment of probable future sublease income for theseleases.  As a result of the analysisperformed during fiscal years 2003 and 2004, the Company reduced its accrual by$14.7 million and $1.0 million, respectively, less the associated income taxexpenses.  Such adjustments arereflected in the Consolidated Statement of Operations for the third quarter offiscal years 2003 and 2004 in the line “Adjustment to reduce estimated loss ondisposal of discontinued operations.” The remaining noncurrent liability of $3.0 million representsmanagement’s estimate of potential future cash outflows related to guaranteesassociated with Wellspring leases.

** **

**Note 16 – RecentAccounting Pronouncements**

 

In January 2003, the Financial Accounting Standards Board (FASB) issuedFASB Interpretation No. 46 (FIN 46), “Consolidation of Variable InterestEntities,” which clarifies the financial reporting guidance associated with theconsolidation of another entity. Immediate consolidation requirements of FIN 46 were not applicable tothe Company since the Company did not create variable interest entities afterJanuary 31, 2003.  In December 2003, theFASB revised and superceded FIN 46 with the issuance of FIN 46R in order toaddress certain implementation issues. The Company adopted FIN 46R effective March 31, 2004.  See Note 10 regarding the adoption of FIN46R.

 

Emerging Issues Task Force Issue 00-21, “Revenue Arrangements withMultiple Deliverables” (EITF 00-21), was effective for the Company beginningJuly 1, 2003.  Beginning July 1, 2003,the Company has applied such requirements prospectively to multiple deliverablearrangements, which include arrangements involving installation andcustomization of technology solution products sold together with on-goingservices offered by the Company.  Basedon the types of arrangements entered into historically, the Company does notexpect that adoption of EITF 00-21 will have a material effect on theaccounting for such arrangements.

 

In December2003, the Securities and Exchange Commission (SEC) issued Staff AccountingBulletin No. 104 (SAB 104), “Revenue Recognition,” which supercedes StaffAccounting Bulletin No. 101 (SAB 101), “Revenue Recognition in FinancialStatements.”  SAB 104’s primary purposeis to rescind accounting guidance contained in SAB 101 related to multipleelement revenue arrangements, superceded as a result of the issuance of EITF00-21.  While the wording of SAB 104 haschanged to reflect the

 

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issuance ofEITF 00-21, the revenue recognition principles of SAB 101 remain largelyunchanged by the issuance of SAB 104. The issuance of SAB 104 has not had an effect on our revenue recognitionpolicies as they are in accordance with SAB 104.

 

In December 2003, the Financial Accounting Standards Board issued FASBStaff Position (FSP) No. FAS 106-1 - Accounting and Disclosure RequirementsRelated to the Medicare Prescription Drug Improvement and Modernization Act of2003 (the Act) (FAS 106-1). The Act includes a prescription drug benefit underMedicare Part D as well as a federal subsidy to sponsors of retiree health carebenefit plans that provide a benefit that is at least actuarially equivalent(as defined in the Act) to Medicare Part D. In accordance with FAS 106-1, theCompany has elected to defer the recognition of the effects of the Act on theconsolidated financial statements until pending authoritative guidance on thefederal subsidy is issued by the FASB. As a result, measures of the net periodiccost of our post-retirement plans included in the Financial Statements andaccompanying Notes do not include the effect of FAS 106-1 on the plans.  The Company does not believe that adoptionof FAS 106-1 will have a material effect on the financial condition of theCompany.

 

**Note 17**–**Adoption ofAmendments to the ESPP**

 

In August 2001, the Board of Directors adopted the Company’s 2001Employee Stock Purchase Plan (the “ESPP”), which subsequently was approved bythe stockholders in November 2001.  TheESPP is intended to provide employees of the Company with additional incentivesby permitting them to acquire a proprietary interest in the Company through thepurchase of shares of the Company’s common stock.  An additional 1,500,000 shares of common stock were authorizedand reserved for issuance under the ESPP at the 2003 Annual Meeting ofStockholders in November 2003.

 

**Note 18 –Professional Consultants Insurance Company (PCIC) Other Non-operating Gain**

 

On July 9, 2003, the Board of Directors of PCIC, a captive insurancecompany of which we own 34.8 percent, decided to pass on to each of its ownersa credit in their 2003-04 policy year in connection with benefits received froman aggregate stop loss insurance policy entered into by PCIC.  PCIC’s Board of Directors determined thatthis credit would be used to offset all or a portion of each insured’sobligation to PCIC for historical loss experience.  As a result, the Company recorded a $5.6 million pre-tax non-operatinggain in the first quarter of fiscal year 2004 and included this gain in “Othernon-operating income” in the Consolidated Statements of Operations.

 

As a result of this gain, the Company also recorded a $5.6 millionsupplemental bonus accrual in the first quarter of fiscal year 2004 that is incrementalto the Company’s fiscal year end bonus, but will be paid in September 2004 withthe regular bonus cycle.  Thissupplemental bonus is included in Salaries and employee benefits.

 

**Note 19 – Sale ofU.S.-based Public Sector Retirement Business**

 

In fiscal year 2002, we sold our U.S.-based public sector retirementbusiness to Gabriel, Roeder, Smith & Company (“GRS”).  The future consideration from the sale ofthe U.S.-based public sector retirement business is contingent upon thesuccessful transition of certain clients to GRS and upon their retention byGRS.  Simultaneous with the sale, weentered into an alliance agreement with GRS under which we will mutually referfuture business opportunities and explore joint consulting assignments.

 

In accordance with the terms of thesale, GRS paid the Company $0.5 million of contingent payments in each of thefirst quarters of fiscal years 2003 and 2004. The amount of additionalcontractual cash payments over the upcoming three fiscal years is alsocontingent upon the successful transition of certain clients to GRS and upontheir retention by GRS.

 

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

 

**Overview**

 

Watson Wyatt & CompanyHoldings, including its subsidiaries, is a global human capital consultingfirm. We help our clients enhance business performance by improving theirability to attract, retain and motivate qualified employees. We focus ondelivering value-added consulting services that help our clients anticipate,identify and capitalize on emerging opportunities in human capital management.  We implement this strategy through 3,880associates in 61 offices located in 18 countries.

 

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

 

**General**

 

As of March 31, 2004, weemployed 3,880 associates as follows:

 
| Benefits Group                                       |   | 1,635 |   |
|------------------------------------------------------|--------|-------|--------|
| Technology Solutions Group                           |   | 330   |   |
| Human Capital Group                                  |   | 150   |   |
| International                                        |   | 965   |   |
| Other (including Data Services &  Communication) |   | 575   |   |
| Corporate                                            |   | 225   |   |
| Total                                                |   | 3,880 |   |

 

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**Principal Services**

 

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

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

•      Health care, disability  and other group benefit plans

•      Investment consulting  services to pension plans

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

•      Actuarial services

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

•      Call center strategy,  design and tools

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

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

•      Strategies to align  workforce performance with business objectives

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

•      Strategies for attracting,  retaining and motivating employees

•      Performance management |   |

 

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

 

**International Operations**

 

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

 

**Other**

 

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

 

**Watson Wyatt Worldwide Alliance**

 

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

 

The Watson Wyatt Worldwidealliance maintains 88 offices in 30 countries and employs over 6,000associates. Watson Wyatt & Company Holdings operates 61 offices in 18countries in North America, Latin America and Asia-Pacific. Watson Wyatt LLPoperates 10 offices in the United Kingdom and

 

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Ireland, and also operates 1office engaged in the insurance and financial services business in the UnitedStates. The alliance operates 16 offices in 10 continental European countries,principally through a jointly-owned holding company, Watson Wyatt Holdings(Europe) Limited.  Watson Wyatt &Company owns 25 percent of the holding company; Watson Wyatt LLP owns 75 percent.

 

**Financial Statement Overview**

 

Watson Wyatt’s fiscal year endsJune 30. The financial statements contained in this quarterly report includeConsolidated Balance Sheets as of the end of the third quarter of fiscal year2004 (March 31, 2004) and as of the end of fiscal year 2003 (June 30, 2003),Consolidated Statements of Operations for the three and nine month periodsended March 31, 2004 and 2003, Consolidated Statements of Cash Flows for thenine month periods ended March 31, 2004 and 2003 and a Consolidated Statementof Changes in Stockholders’ Equity for the nine month period ended March 31,2004.

 

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

 

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

 

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

 

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

 

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

 

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

 

**CriticalAccounting Policies and Estimates**

 

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

 

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

 

***   RevenueRecognition***

 

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

 

Revenue is recognized ontime-and-materials engagements based on billable rates times hours worked plusexpenses incurred.  For fixed-fee arrangements,revenue is also recognized based on billable rates times hours worked plusexpenses incurred.  However, forsignificant fixed-fee engagements in our Technology Solutions Group, weperiodically review ongoing engagements in order to assess the accuracy of ourestimates-to-complete.  Revenuerecognition for fixed-fee engagements is affected by a number of factorsincluding a change in the estimated amount of effort required to complete theproject, changes in scope, the staffing on the engagement and/or the level ofclient participation.  This reviewrequires us to make judgments and estimates regarding the overall profitabilityand stage of project completion which, in turn, affect how we recognize revenue.  To the extent that our estimates change fora particular engagement, we record the cumulative effect of the change in theperiod in which it becomes known.  TheCompany recognizes a loss on an engagement when estimated revenue to bereceived for that engagement is less than total estimated direct and indirectcosts associated with the engagement. Losses are recognized in the period in which the loss becomes probableand the amount of the loss is reasonably estimable.

 

The Company has developed various softwareprograms and technologies that are provided to clients in connection withconsulting services.  We generallyrecognize revenue for such services as time is incurred because the servicesare considered essential to the functionality of the software.  Software developed to be utilized in providingservices to a client, but for which the client does not have the contractualright to take possession, is capitalized in accordance with the AICPA’sStatement of Position 98-1 “Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use” and any revenue associated with therelated contract is recognized over the service period.

 

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

 

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

 

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

 

We maintain allowances fordoubtful accounts to reflect estimated losses resulting from our clients’failure to pay for our services after the services have been rendered,including allowances when customer disputes may exist.  The related provision is recorded as areduction to revenue.  Our allowancepolicy is based on the aging of our billed and unbilled client receivables andhas been developed based on our write-off history.  Facts and circumstances such as the average length of time thereceivables are past due, general market conditions, current economic trends andour client’s ability to pay may cause fluctuations in our valuation of billedand unbilled receivables.

 

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*   **Discretionary Compensation***

 

The Company’s compensationprogram includes a discretionary annual bonus that is determined by managementand paid once per fiscal year in the form of cash and/or deferred stock unitsafter the Company’s annual operating results are finalized.

 

An estimated annual bonusamount is initially developed at the beginning of each fiscal year inconjunction 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 pre-bonusprofitability for the year.   Afterdetermining the estimated annual bonus amount, the bonus is then allocated toremaining quarterly reporting periods as a constant percentage of estimatedpre-bonus profitability.  In thosequarters where the estimated annual bonus level changes, the remainingestimated annual bonus is accrued over the remaining quarters as a constantpercentage of estimated future pre-bonus profitability.  Annual bonus levels may vary from currentexpectations as a result of changes in the Company’s forecast of pre-bonusprofitability and competitive employment market conditions.

 

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

 

*   **Income Taxes***

 

Determining the consolidatedprovision for income tax expense, deferred tax assets and liabilities and therelated valuation allowance involves judgment. As a global company with offices in 18 countries, we are required tocalculate and provide for estimated income tax liabilities for each of the taxjurisdictions in which we operate.  Thisprocess involves estimating current tax obligations and exposures in eachjurisdiction as well as making judgments regarding the future recoverability ofdeferred tax assets.  Tax costs caninvolve complex issues and may require an extended period to resolve.  Changes in the geographic mix or estimatedlevel of annual pre-tax income, limitations on the use of the Company’s foreignsubsidiary losses, changes in tax laws and changes resulting from tax auditscan all affect the overall effective income tax rate, which, in turn, impactsthe overall level of income tax expense and net income.

 

*   **Pension Assumptions***

 

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

 

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

 

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

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

 

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

 

The expected long-term rate ofreturn on assets assumption was lowered to 9.00 percent at the end of fiscalyear 2003 from 10.00 percent at the end of fiscal years 2002 and 2001.  Selection of the 9.00 percent returnassumption was supported by an analysis performed by the Company of the weightedaverage yield expected to be achieved with the anticipated makeup ofinvestments.  The investment makeup isheavily weighted towards equities.  Thereturn on assets through the first nine months of fiscal year 2004 has been14.0%, compared to a return of (13.0)% in fiscal year 2003.

 

During fiscal year 2003, thevalue of the assets held in the pension plans decreased and the decline ininterest rates increased our accumulated benefit obligation, resulting in theaccumulated benefit obligation becoming greater than the value of the plan assetsfor the U.S. and U.K. pension plans. The Company was therefore required to record an additional minimumpension liability for those plans at June 30, 2003, in accordance withStatement of Financial Accounting Standards No. 87 “Employers’ Accounting forPensions” (FAS 87).  This resulted in anincrease in the pension liability of $113.4 million, an increase in intangibleassets of $0.1 million, a non-cash charge to Stockholders’ Equity of $67.9million (reflected in accumulated other comprehensive loss) and an increase indeferred tax assets of $45.4 million as of June 30, 2003.  A market recovery in future periods, and/oran increase in long-term interest rates, could reverse a portion or all of thischarge.  Alternatively, future marketdeclines and/or a decrease in long-term interest rates would result in anaddition to this amount.  Our Canadianand Hong Kong pension plan assets were greater than their associatedaccumulated benefit obligation as of June 30, 2003, and thus did not requirethe recording of additional minimum pension liabilities.

 

***   IncurredBut Not Reported Claims***

 

The Company usesactuarial assumptions to estimate and record a liability for incurred but notreported (IBNR) professional liability claims and engaged an external actuarialfirm to assist in the calculation of these estimates.  Our estimated IBNR liability is based on long-term trends andaverages, and considers a number of factors, including changes in claimreporting patterns, claim settlement patterns, judicial decisions, andlegislation and economic decisions, but excludes the effect of claims data forlarge cases due to 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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**Results of Operations**

 

The table below sets forthConsolidated Statements of Operations data for continuing operations as apercentage of revenue for the periods indicated:
|                                                   |   | **Three  Months Ended March 31** |   | **Nine  Months Ended March 31** |   |
|--------------------------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                                   |   | **2004**                         |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                                   |   |                             |   |                            |   |   |   |   |   |
| Revenue                                                |   | 100.0                            | %      | 100.0                           | %      | 100.0 | % | 100.0 | % |
|                                                   |   |                             |   |                            |   |   |   |   |   |
| Costs of providing services:                           |   |                             |   |                            |   |   |   |   |   |
| Salaries and employee benefits                         |   | 55.5                             |   | 56.7                            |   | 57.4 |   | 56.4 |   |
| Professional and subcontracted services                |   | 6.4                              |   | 6.5                             |   | 6.4 |   | 6.7 |   |
| Occupancy, communications and other                    |   | 15.7                             |   | 15.4                            |   | 14.9 |   | 14.9 |   |
| General and administrative expenses                    |   | 8.5                              |   | 7.7                             |   | 8.8 |   | 8.1 |   |
| Depreciation and amortization                          |   | 2.3                              |   | 2.7                             |   | 2.7 |   | 2.9 |   |
|                                                   |   | 88.4                             |   | 89.0                            |   | 90.2 |   | 89.0 |   |
|                                                   |   |                             |   |                            |   |   |   |   |   |
| Income from operations                                 |   | 11.6                             |   | 11.0                            |   | 9.8 |   | 11.0 |   |
|                                                   |   |                             |   |                            |   |   |   |   |   |
| Income from affiliates                                 |   | 1.3                              |   | 0.8                             |   | 0.9 |   | 0.8 |   |
| Interest income, net                                   |   | —                           |   | 0.1                             |   | 0.1 |   | 0.1 |   |
| Other non-operating income                             |   | —                           |   | —                          |   | 1.2 |   | 0.1 |   |
|                                                   |   |                             |   |                            |   |   |   |   |   |
| Income from continuing operations before  income taxes |   | 12.9                             |   | 11.9                            |   | 12.0 |   | 12.0 |   |
|                                                   |   |                             |   |                            |   |   |   |   |   |
| Provision for income taxes                             |   | 5.2                              |   | 4.9                             |   | 4.9 |   | 4.9 |   |
|                                                   |   |                             |   |                            |   |   |   |   |   |
| Income from continuing operations                      |   | 7.7                              | %      | 7.0                             | %      | 7.1 | % | 7.1 | % |

 

 

**Three and Nine Months Ended March 31, 2004,Compared to the Three and Nine Months Ended March 31, 2003**

 

***   ExecutiveOverview***

 

Revenues for the quarter wereup 2% from the third quarter of fiscal year 2003, reflecting acceleratinggrowth in our Retirement business due to new client wins and modest revenuegrowth for existing clients.  OurTechnology Solutions Group’s backlog continues to increase as its rate of revenuedecline moderates.  The Human CapitalGroup’s profitability doubled on strong executive compensation growth, althoughweaker performance was experienced in other parts of the practice.

 

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

 

*   **Revenue***

 

Revenue from operations for thethird quarter of fiscal year 2004 was $180.7 million, compared to $177.6million for the third quarter of fiscal year 2003, an increase of $3.1 millionor 2 percent.

 

The Benefits Group increased revenue by $6.0million or 6 percent during the third quarter of fiscal year 2004 as wecontinued to benefit from a large number of new client wins and grow revenueswith existing clients, in part due to consulting associated with continuinglegislative activity regarding cash balance plans and pension fundingassumptions.  Revenue from ourTechnology Solutions Group decreased by

 

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$2.2 million or 10 percent, abetter than expected performance for the quarter that reflects new client winsduring the previous quarter. Revenue from our Human Capital Group decreased$0.6 million or 5 percent.  Our revenuesin this segment continue to be largely driven by increased work in ourexecutive compensation business, offset by a decrease in demand for generalorganization effectiveness consulting. Our international segment finished the quarter with revenue growth of$3.0 million or 16 percent, reflecting favorable exchange rates and improvedresults in Australia and Mexico. Revenue for other practice areas in North America decreased by $1.0million or 9 percent during the third quarter of fiscal year 2004.

 

Revenue from operations for thefirst nine months of fiscal year 2004 was $522.0 million, compared to $531.2million for the first nine months of fiscal year 2003, a decrease of $9.2million or 2 percent.

 

The Benefits Group increasedrevenue by $11.2 million or 4 percent during the first nine months of fiscalyear 2004 due to new client wins, as well as growth in existing clients.  Revenue from our Technology Solutions Groupdecreased by $12.9 million or 17 percent, which the Company believes reflects alag between when a company’s results improve and when it is willing to spendlarge amounts on discretionary projects. Revenue from our Human Capital Group decreased $2.0 million or 6 percentduring the first nine months of fiscal year 2004, reflecting increased demandin executive compensation offset by weak results in organization effectivenessconsulting.  Our international segmentfinished the nine months with fiscal year to date revenue growth of $4.2million or 7 percent.  However, revenuewas down one percent after adjusting for the impact of the weakening U.S.dollar.  Revenue for other practiceareas in North America decreased by $4.4 million or 12 percent during the firstnine months of fiscal year 2004.

 

*   **Salaries and Employee Benefits***

 

Salaries and employee benefitexpenses for the third quarter of fiscal year 2004 were $100.2 million,compared to $100.6 million for the third quarter of fiscal year 2003, adecrease of $0.4 million.  The decreasewas mainly due to lower benefits costs of $2.2 million, which reflect thesuspension of the Company match on our defined contribution retirement plan andlower health care costs to the Company, and lower salaries of $0.4 million,which reflect the Company’s targeted job reductions net of modest salaryincreases.  These decreases werepartially offset by a higher accrual for discretionary compensation of $1.5million and higher pension and post retirement expenses of $1.0 million.  As a percentage of revenue, salaries andemployee benefits decreased from 56.7 percent to 55.5 percent.

 

Salaries and employee benefitexpenses for the first nine months of fiscal year 2004 were $299.7 million,compared to $299.9 million for the first nine months of fiscal year 2003, adecrease of $0.2 million.  Salaries andemployee benefit expenses for the first nine months of fiscal year 2004 includeseverance charges of $3.9 million related to job reductions in NorthAmerica.  The decrease, exclusive ofthis charge, was mainly due to lower benefits costs of $7.2 million, whichreflect the suspension of the Company match on our defined contributionretirement plan and health care costs to the Company, and lower salaries of$2.6 million, which reflect the Company’s targeted job reductions net of modestsalary increases.  These decreases arepartially offset by higher pension and post-retirement expenses of $3.9 millionand a higher accrual for discretionary compensation of $1.4 million.  As a percentage of revenue, salaries andemployee benefits increased from 56.4 percent to 57.4 percent.

 

*   **Professional and Subcontracted Services***

 

Professional and subcontractedservices used in consulting operations for the third quarters of fiscal years2004 and 2003 were $11.6 million.  As apercentage of revenue, professional and subcontracted services decreased from6.5 percent to 6.4 percent.

 

Professional and subcontractedservices used in consulting operations for the first nine months of fiscal year2004 were $33.3 million, compared to $35.4 million for the first nine months offiscal year 2003, a decrease of $2.1 million or 6 percent.  The decrease in both periods resulted fromlower reimbursable

 

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expenses incurred on behalf ofclients and continued cost control measures. As a percentage of revenue, professional and subcontracted servicesdecreased from 6.7 percent to 6.4 percent.

 

*   **Occupancy, Communications and Other***

 

Occupancy, communications andother expenses for the third quarter of fiscal year 2004 were $28.4 million,compared to $27.3 million for the third quarter of fiscal year 2003, anincrease of $1.1 million or 4 percent. The increase was mainly due to higher travel and business tax expenses.  As a percentage of revenue, occupancy,communications and other increased from 15.4 percent to 15.7 percent.

 

Occupancy, communications andother expenses for the first nine months of fiscal year 2004 were $77.9million, compared to $79.4 million for the first nine months of fiscal year2003, a decrease of $1.5 million or 2.0 percent.  The decrease reflects the Company’s cost containment measures, asevidenced through lower expenses in many categories including office supplies,telephone and promotional expenses.  Asa percentage of revenue, occupancy, communications and other remained at 14.9percent.

 

Occupancy, communication andother expenses in the fourth quarter of fiscal year 2004 will include a $3.2million charge resulting from a lease termination as further described belowunder Off-Balance Sheet Arrangements and Contractual Obligations – OperatingLeases.

 

*   **General and Administrative Expenses***

 

General and administrativeexpenses for the third quarter of fiscal year 2004 were $15.3 million, comparedto $13.7 million for the third quarter of fiscal year 2003, an increase of $1.6million or 12 percent.  As a percentageof revenue, general and administrative expenses increased from 7.7 percent to8.5 percent.

 

General and administrativeexpenses for the first nine months of fiscal year 2004 were $45.9 million,compared to $42.9 million for the first nine months of fiscal year 2003, anincrease of $3.0 million or 7 percent. As a percentage of revenue, general and administrative expenses increasedfrom 8.1 percent to 8.8 percent.  Theincrease in both periods is mainly due to higher insurance costs and expensesassociated with compliance with the Sarbanes-Oxley Act of 2002 and related SECrules.

 

*   **Depreciation and Amortization***

 

Depreciation and amortizationfor the third quarter of fiscal year 2004 was $4.1 million, compared to $4.9million for the third quarter of fiscal year 2003, a decrease of $0.8 millionor 16 percent.  As a percentage ofrevenue, depreciation and amortization decreased from 2.7 percent to 2.3percent.

 

Depreciation and amortizationfor the first nine months of fiscal year 2004 was $14.1 million, compared to$15.2 million for the first nine months of fiscal year 2003, a decrease of $1.1million or 7 percent.  The decrease inboth periods is mainly due to lower capital asset purchases in fiscal years2002 and 2003.  As a percentage ofrevenue, depreciation and amortization decreased from 2.9 percent to 2.7percent.

 

*   **Income From Affiliates***

 

Income from affiliates for thethird quarter of fiscal year 2004 was $2.3 million, compared to $1.3 millionfor the third quarter of fiscal year 2003, an increase of $1.0 million or 77percent.   The increase was due to theCompany’s interest in higher operating results of Watson Wyatt LLP of $1.5million and higher equity income of PCIC of $0.2 million, partially offset bythe Company’s interest in lower operating results of Watson Wyatt Holdings(Europe) Limited (WWHE) of $0.8 million.

 

Income from affiliates for thefirst nine months of fiscal year 2004 was $5.1 million, compared to $4.2million for the first nine months of fiscal year 2003, an increase of $0.9million or 21 percent.   The increasewas due to the Company’s interest in higher operating results of Watson WyattLLP of $0.9 million and WWHE of $0.3 million, partially offset by lower equityincome of PCIC of $0.5 million.

 

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*   **Interest Income, Net***

 

Interest income, net for thethird quarter of fiscal year 2004 was $20,000, compared to $0.2 million for thethird quarter of fiscal year 2003. Interest income, net for the first nine months of fiscal year 2004 was$0.4 million, compared to $0.6 million for the first nine months of fiscal year2003, a decrease of $0.2 million or 33 percent.

 

*   **Other Non-operating Income***

 

Other non-operating income for the first nine months offiscal year 2004 was $6.2 million, which is principally attributable to the$5.6 million non-operating gain the Company recorded related to PCIC.  See Note 18 of the Notes to the ConsolidatedFinancial Statements for more information about this non-operating gain.  During the first nine months of fiscal years2004 and 2003, the Company also received cash payments of $0.6 million inconnection with the fiscal year 2002 sale of our U.S.-based public retirementbusiness to GRS.  All payments receivedin connection with this sale were contingent upon the successful transition ofcertain clients to GRS and upon their retention by GRS.

 

*   **Provision for Income Taxes***

 

Provision for income taxes forthe first nine months of fiscal year 2004 was $25.6 million, compared to $26.2million for the first nine months of fiscal year 2003. Our effective tax ratewas 40.7 percent for the first nine months of fiscal year 2004 and 41.0 percentfor the first nine months of fiscal year 2003.

 

*   **Income From Continuing Operations***

 

Income from continuingoperations for the third quarter of fiscal year 2004 was $14.0 million,compared to $12.4 million for the third quarter of fiscal year 2003, anincrease of $1.6 million or 13 percent. As a percentage of revenue, income from continuing operations increasedfrom 7.0 percent to 7.7 percent.  Incomefrom continuing operations for the first nine months of fiscal year 2004 was$37.3 million, compared to $37.6 million for the first nine months of fiscalyear 2003, a decrease of $0.3 million or 1 percent.  As a percentage of revenue, income from continuing operationsremained at 7.1 percent.

 

*   **Earnings Per Share, Income FromContinuing Operations***

 

Diluted earnings per share,income from continuing operations for the third quarter of fiscal year 2004 was$0.42, compared to $0.37 for the third quarter of fiscal year 2003.  Diluted earnings per share, income fromcontinuing operations for the first nine months of fiscal year 2004 was $1.12,compared to $1.13 for the first nine months of fiscal year 2003.

 

*   **Discontinued Operations***

 

Through the first nine monthsof fiscal year 2004, the Company received sublease income of approximately$79,000 in excess of lease payments related to Wellspring.

 

Also, discontinued operationsfor the third quarter of fiscal years 2004 and 2003 reflect the reduction ofthe Company’s accrual for the estimated remaining future obligations and costsrelated to the exit from Wellspring by $1.0 million and $14.7 million,respectively, less the associated income tax expenses.  See Note 15 of the Notes to the ConsolidatedFinancial Statements for more information related to Wellspring.

 

**Liquidity and Capital Resources**

 

Our cash and cash equivalentsat March 31, 2004 totaled $153.7 million, compared to $144.4 million at June30, 2003, representing an increase of $9.3 million.  The increase in cash from June 30, 2003 to March 31, 2004 followsa typical pattern of cash flows for the Company that is attributable to thepayment of bonuses in the first fiscal quarter related to the prior year’sfiscal year-end bonus accrual.

 

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During the first nine months offiscal year 2004, we paid $34.9 million in previously accrued discretionarycompensation, $31.5 million in corporate taxes and contributed $10.0 million toour U.S. defined benefit pension plan. These outflows of cash were offset by positive cash flow from consultingoperations.  Consistent with theCompany’s liquidity position, management considers various alternativestrategic uses of cash reserves including acquisitions, dividends and stockbuybacks, or any combination of these options.

 

Our non-U.S. operations do notmaterially impact liquidity or capital resources as they are substantiallyself-sufficient for their working capital needs.  At March 31, 2004, $25.4 million of the total cash balance of$153.7 million was held outside of North America, which we have the ability to utilize,if necessary. There are no significant restrictions other than local or U.S.taxes associated with repatriation.

 

*   **Cash From Operating Activities***

 

Cash from operating activities**forthe first nine months of fiscal year 2004 was $24.7 million, compared to cashfrom operating activities of $43.5 million for the first nine months of fiscalyear 2003.  The variance is mainly dueto higher receivables from clients of $13.8 million, higher corporate taxpayments of $5.5 million and higher payments to retirees of $5.6 million,partially offset by a lower payment of discretionary compensation of $13.5million.

 

The allowance for doubtfulaccounts increased $1.6 million and the allowance for work in process increased$0.4 million from June 30, 2003, to March, 31, 2004. The number of days ofaccounts receivable and work in process outstanding was 78 at March 31, 2004,compared to 72 at June 30, 2003 and 76 at March 31, 2003.

 

*   **Cash Used in Investing Activities***

 

Cash used in investingactivities for the first nine months of fiscal year 2004 was $11.9 million,compared to $14.8 million for the first nine months of fiscal year 2003.  The decrease can be primarily attributed toa $2.0 million investment in affiliates in fiscal year 2003 and lower purchasesof fixed assets of $1.1 million.

 

Expenditures of capital fundswere $12.8 million for the first nine months of fiscal year 2004.  Anticipated commitments of capital funds areestimated at $6.7 million for the remainder of fiscal year 2004, mainly forcomputer hardware purchases, office relocations and renovations, developmentand upgrade of financial and retirement systems and acquisition-relatedpayments. We expect cash from operations to adequately provide for these cashneeds.

 

*   **Cash Used in Financing Activities***

 

Cash used in financingactivities for the first nine months of fiscal year 2004 was $5.5 million,compared to $6.2 million for the first nine months of fiscal year 2003.  The decrease was mainly associated with purchasesof common stock by associates through the Company’s Employee Stock PurchasePlan and Long-term Incentive Plan, partially offset by repurchases of 510,900shares of common stock.

 

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**Off-Balance Sheet Arrangements andContractual Obligations**

 

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

 
|                              |   | **Remaining  payments due by fiscal year as of March 31, 2004** |    |
|-----------------------------------|--------|-----------------------------------------------------------------|---------|
| **Contractual Cash  Obligations** |   | **Total**                                                       |    | **2004** |   | **2005  through  2006** |   | **2007  through  2008** |   | **Thereafter** |   |
| Lease commitments                 |   | $                                                               | 226,058 |   | $ | 9,608 |   | $ | 70,088 |   | $ | 56,356 |   | $ | 90,006 |   |
|                                   |        |                                                                 |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

On April 27, 2004, the Companyexecuted a new lease agreement committing its Washington D.C. office, whichincludes consulting and corporate operations, to move to northernVirginia.  The terms of the lease areexpected to result in cost savings over the 12 year term.  The Company simultaneously provided noticeof early termination of its existing Washington D.C. lease which will result ina $3.2 million charge during the fourth quarter of fiscal year 2004.  The $3.2 million charge will have no netcash impact on the Company because the Company will receive a $3.2 millionpayment from the new lessor as an incentive to enter into the new lease.

 

***Guarantees***

 

*Wellspring Leases*.  The Company continues to guarantee certainleases for office premises and equipment for Wellspring.  At March 31, 2004, minimum remainingpayments guaranteed under these leases, which expire at various dates through2007, totaled $19.7 million, excluding anticipated sublease income.  The leases are currently generating positivecash flows of approximately $0.1 million per fiscal year.  In the third quarter of fiscal year 2004,the Company reduced its accrual for the estimated remaining future obligationsand costs related to the exit from Wellspring by $1.0 million, less theassociated income tax expenses Management will continue to evaluate the adequacy of these provisionsand make adjustments as appropriate. See Notes 13 and 15 of the Notes to the Consolidated FinancialStatements for more information related to Wellspring.

 

*Affiliate Agreements*.  In connection with the establishment of ouralliance with Watson Wyatt LLP in 1995, the Company agreed to guarantee WatsonWyatt LLP’s performance under a lease for office space in London that expiresin 2015.  Payments by Watson Wyatt LLPunder the lease total £1.4 million (or approximately $2.6 million based on theMarch 31, 2004, exchange rate) per year. We also granted Watson Wyatt LLP an option to return the leased space toour UK subsidiary in 2009.  If WatsonWyatt LLP were to exercise this option, the Company would attempt to subleasethe space at the then-current market rates.

 

**Credit Agreement**

 

The Company has a $100.0million revolving credit facility with a syndicate of banks.  Interest rates associated with this facilityvary with LIBOR and/or the Prime Rate and are based on our leverage ratio, asdefined by the credit agreement.  We arecharged a quarterly commitment fee, currently 0.25 percent of the facility,that varies with our financial leverage and is calculated on the unused portionof the credit facility.  No amounts wereoutstanding under the Company’s revolving credit facility as of March 31, 2004,or June 30, 2003.  Credit under thefacility is available upon demand, although the credit facility requires us toobserve certain covenants (including requirements for minimum net worth, whichact to restrict dividends and other financial and restrictive covenants) and iscollateralized with a pledge of stock of material subsidiaries.  We were in compliance with all covenantsunder the credit facility as of March 31, 2004.

 

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

 

**Risk Management**

 

**As a part of our overall riskmanagement program, we carry customary commercial insurance policies, includingcommercial general liability, employment practices liability, and claims-madeprofessional liability insurance with a self-insured retention of $1 millionper claim, which provides coverage for professional liability claims includingthe cost of defending such claims.  Ourprimary insurance coverage beyond this retention is written by an affiliatedcaptive insurance company owned by us and two other professional servicesfirms.  Prior to July 1, 2003, the first$5 million of coverage had a premium structure which provided that the captiveinsurance company would recover from the firm defending the claim approximately75 percent of any loss up to $5 million. The Company recorded an accrual for this liability.  This recovery occurred through insurancepremium payments in subsequent years. The remaining 25 percent of any loss up to $5 million was a risk borneby the captive insurance company, which carried reinsurance in the commercialmarkets for most losses above $5 million.**

** **

**As of July 1, 2003, PCIC attemptsto recover through its premium structure the amounts it expects to pay out formember companies in claims losses. It bases premium calculations, which aredetermined annually based on experience through March of each year, on relativerisk of the various lines of business performed by each of the owner companies,past claim experience of each owner company, growth of each of those companies,industry risk profiles in general and the overall insurance markets.**

** **

**Our agreements with PCIC couldrequire additional payments to PCIC in the event that the Company decided toexit PCIC and adverse claims significantly exceed prior expectations.  If these circumstances were to occur, theCompany would record a liability at the time it becomes estimable and probable.**

** **

**The Company will continue toprovide for the self-insured retention where specific estimated losses forknown claims in excess of $1 million are considered probable and reasonablyestimable.**

** **

**Although the Company maintainsprofessional liability insurance coverage, this insurance does not cover claimsmade after expiration of our current insurance contracts.  Generally accepted accounting principlesrequire that we record a liability for incurred but not reported (IBNR) professionalliability claims if they are estimable and probable, and for which we have notyet contracted for insurance coverage. The Company uses actuarial assumptions to estimate and record its IBNRliability and has a $13.1 million IBNR liability recorded as of March 31, 2004.**

** **

**Current insurance market conditionsinclude increases in premium cost, higher self-insured retentions andreductions in aggregate excess coverages, trends that are anticipated tocontinue.  We expect these trends to bereflected in our future annual insurance renewals, and as a result, we willcontinue to assess our ability to secure future insurance coverage.  In anticipation of the possibility of futurereductions in risk transfer from PCIC to reinsurers, as well as the trendtoward a generally hardening insurance market, the firms that own PCIC,including the Company, increased PCIC’s capital in fiscal years 2002 and 2003.**

** **

**In light of increasing worldwidelitigation, including litigation against professionals, the Company has beenimplementing a requirement that all client relationships be documented byengagement letters containing specific risk mitigation clauses that were notincluded in all historical client agreements. Nearly 100 percent of the Company’s U.S. corporate clients have signedengagement letters including mitigation clauses, and initiatives to completethat process both in the United States and elsewhere are underway. The Companyhas disengaged from certain client relationships where satisfactory engagementterms could not be achieved.**

 

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**RecentAccounting Pronouncements**

** **

In January 2003, the FinancialAccounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46),“Consolidation of Variable Interest Entities,” which clarifies the financialreporting guidance associated with the consolidation of another entity.  Immediate consolidation requirements of FIN46 were not applicable to the Company since the Company did not create variableinterest entities after January 31, 2003. In December 2003, the FASB revised and superceded FIN 46 with theissuance of FIN 46R in order to address certain implementation issues.  The Company adopted FIN 46R effective March31, 2004.  See Note 10 regarding theimpact of adopting FIN 46R.

 

Emerging Issues Task Force Issue00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21), waseffective for the Company beginning July 1, 2003.  Beginning July 1, 2003, the Company will apply such requirementsprospectively to multiple deliverable arrangements, which include arrangementsinvolving installation and customization of technology solution products soldtogether with on-going services offered by the Company.  Based on the types of arrangements enteredinto historically, the Company does not expect that adoption of EITF 00-21 willhave a material impact on the accounting for such arrangements.

 

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

 

In December 2003, the FinancialAccounting Standards Board issued FASB Staff Position (FSP) No. FAS 106-1“Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug Improvement and Modernization Act of 2003” (the Act) (FAS 106-1). The Actincludes a prescription drug benefit under Medicare Part D as well as a federalsubsidy to sponsors of retiree health care benefit plans that provide a benefitthat is at least actuarially equivalent (as defined in the Act) to MedicarePart D. In accordance with FAS 106-1, the Company has elected to defer therecognition of the effects of the Act on the consolidated financial statementsuntil pending authoritative guidance on the federal subsidy is issued by theFASB. As a result, measures of the net periodic cost of our post-retirementplans included in the Financial Statements and accompanying Notes do notreflect effects of FAS 106-1 on the plans. The Company does not believe that adoption of  FAS 106-1 will have a material effect on the financial conditionof the Company.

 

**Disclaimer Regarding Forward-lookingStatements**

 

This filing contains certainstatements that are “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995, including, but not limited tothe following: Note 8 on page 12; Note 12 on page 15; Note 13 on pages 15 and16 ; Note 14 on page 16; Critical Accounting Policies and Estimates on pages 21through 24; the “Executive Overview” on page 25; the discussion of our capitalcommitments under “Cash Used in Investing Activities” on page 29; thediscussion of expected costs savings under “Operating Leases” on page 30; andPart II, Item 1 “Legal Proceedings” on page 34.  In some cases, you can identify these statements and otherforward-looking statements in this filing by words such as “may,” “will,”“expect,” “anticipate,” “believe,” “estimate,” “plan,” “intend,” “continue,” orsimilar words. You should read these statements carefully because they containprojections of our future results of operations or financial condition, orstate other “forward-looking” information. A number of risks and uncertaintiesexist which could cause actual results to differ materially from the resultsreflected in these forward-looking statements. Such factors include, but arenot limited to, our

 

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continued ability to recruitand retain highly qualified associates; outcomes of litigation; a significantdecrease in the demand for the consulting services we offer as a result ofchanging economic conditions or other factors; actions by competitors offeringhuman resources consulting services, including public accounting and consultingfirms, technology consulting firms and internet/intranet development firms;regulatory, legislative and technological developments that may affect thedemand for or costs of our services; and other factors discussed under “riskfactors” in our Annual Report on Form 10-K for the fiscal year ended June 30,2003, which was filed with the SEC on September 23, 2003, and may be accessedvia EDGAR on the SEC’s web site at www.sec.gov. These statements are based onassumptions that may not come true. All forward-looking disclosure is speculativeby its nature. The Company undertakes no obligation to update any of theforward-looking information included in this report, whether as a result of newinformation, future events, changed expectations or otherwise.

 

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

 

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

 

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

 

**Evaluation of Disclosure Controls andProcedures**

 

The Chief Executive Officer (CEO) and Chief FinancialOfficer (CFO) of the Company evaluated our disclosure controls and proceduresas of the end of the third quarter of fiscal year 2004.  They have concluded that, as of March 31,2004, such controls and procedures have been effectively designed to ensurethat information required to be disclosed in reports that the Company fileswith or submits to the SEC is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms and isaccumulated and communicated to management, including the CEO and CFO, asappropriate, to allow timely decisions regarding such disclosure.

 

**Changes in Internal Control OverFinancial Reporting**

 

No changes to our internal control over financial reportinghave occurred during the third quarter that have come to management’s attentionthat have materially affected, or are reasonably likely to materially affectour internal control over financial reporting.

 

**Compliance with Section 404 of the Sarbanes-OxleyAct of 2002**

 

Our Company is required tocomply with Section 404 of the Sarbanes-Oxley Act of 2002 and SEC rules andPublic Company Accounting Oversight Board (PCAOB) standards for implementingSection 404 by June 30, 2005.  Withregards to the Company’s continuing compliance efforts, the Company hassubstantially completed all documentation of financial and company-widecontrols.  We will begin testing ofcertain key controls in the fourth quarter in preparation for compliance withSection 404 and plan to continue testing through the first half of fiscal year2005 in preparation for management’s assessment in the second half of fiscalyear 2005.

 

**Limitations on the Effectiveness of Controls**

 

Our management, including the CEO and CFO, does not expect that our internal controls will necessarily prevent all error and all fraud.  A control system, no matter how well designed and operated, cannot provide absolute assurance that the control system’s objectives will be met.   In addition, the design of

 

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such internal controls musttake into account the costs of designing and maintaining such controlsystem.  Certain inherent limitationsexist in control systems to make absolute assurances difficult, including therealities that judgments in decision-making can be faulty, that breakdowns canoccur because of a simple error or mistake, and that individuals can circumventcontrols.  The design of any controlsystem is based in part upon existing business conditions and risk assessments.There can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions. Over time, controls may become inadequate because of changes in businessconditions or deterioration in the degree of compliance with policies orprocedures.  As a result, they mayrequire change or revision.  Because ofthe inherent limitations in a control system, misstatements due to error orfraud may occur and may not be detected. Nevertheless, management believes that the Company’s internal controlsover financial reporting for the third quarter of fiscal year 2004 areadequate.

 

**PARTII****.  OTHERINFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

From time to time, we are a party to variouslawsuits, arbitrations or mediations that arise in the ordinary course ofbusiness.  These disputes typicallyinvolve claims relating to the rendering of professional services or employmentmatters.  Management believes, based oncurrently available information, that the results of all pending claims againstus will not have a material adverse affect on the Company.  The matters reported on below involve themost significant pending or potential claims against us.  These matters did not significantly impactthe quarter’s financial results.

 

*New Jersey Coalition of Auto Retailers InsuranceGroup Trust (NJCAR).*  The claims have been settled and the suit has been dismissed.

 

*Toussaint, et al. v. James, etal.*  The claim has beensettled and the suit has been dismissed.

 

*Iron Workers Local 25 et al. v. Watson Wyatt &Co. *On April 19, 2004, Watson Wyatt &Co. was served with a complaint filed by a former client in the United StatesDistrict Court for the Eastern District of Michigan.  The complaint alleges negligence and negligent supervision in thepreparation of an actuarial valuation. The amount of damages sought are not specified.

 

**ITEM 2.  CHANGES INSECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

**Restricted Shares**

 

In conjunction with our initialpublic offering in October 2000, we entered into agreements providing fortransfer restrictions with major stockholders, executive officers and employeedirectors.  During October 2003, thesetransfer restrictions expired on 1,908,000 Class A shares.  As of March 31, 2004, 1,730,000 Class Ashares remain restricted.  These shareswill become freely transferable in October 2004.

 

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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 (or  Units)  Purchased** |   | **Average  Price  Paid per Share (or  Unit)** |   | **Total  Number of  Shares (or Units)  Purchased as Part  of Publicly  Announced Plans  or Programs** |   | **Maximum  Number  (or Approximate  Dollar Value) of  Shares (or Units) that  May Yet Be  Purchased Under the  Plans or Programs (1)  (2)** |    |
|--------------------------------------------|--------|-----------------------------------------------------|--------|-----------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|---------|
| January 1, 2004 through January 31, 2004   |   | 97,500                                              |   | $                                             | 24.47  |                                                                                                  | 97,500 |                                                                                                                                        | 928,184 |   |
| February 1, 2004 through February 29, 2004 |   | —                                              |   | —                                        |   | —                                                                                                |   | 928,184                                                                                                                                     |    |
| March 1, 2004 through March 31, 2004       |   | —                                              |   | —                                        |   | —                                                                                                |   | 4,528,184                                                                                                                                   |    |
| Total                                      |   | 97,500                                              |   | $                                             | 24.47  |                                                                                                  | 97,500 |                                                                                                                                        |    |   |

 

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(1)   InMay 2003, the Company announced a plan to purchase up to 1,150,000 shares ofour Class A common stock.

 

(2)   OnMarch 8, 2004, the Company announced the commencement of a tender offer forshares of our Class A common stock, through which we offered to purchase forcash up to 3,600,000 shares, not to exceed $85 million. The tender offerexpired on April 2, 2004 and we repurchased 830,802 shares at a purchase priceof $25.25, for $21.0 million from selling stockholders.

 

**ITEM 3.  DEFAULTS UPONSENIOR SECURITIES**

 

**None.**

** **

**ITEM 4. SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS**

** **

None.

 

I**TEM5. OTHER INFORMATION**

 

None.

 

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

 

** **
| a.     |   | Exhibits                                                                                                                                                                                                 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                     |
| 3.1    |   | Amended and  Restated Certificate of Incorporation of Watson Wyatt & Company  Holdings(1)                                                                                                            |
|   |   |                                                                                                                                                                                                     |
| 3.2    |   | Amended and  Restated Bylaws of Watson Wyatt & Company Holdings(2)                                                                                                                                   |
|   |   |                                                                                                                                                                                                     |
| 4      |   | Form of  Certificate Representing Common Stock(1)                                                                                                                                                        |
|   |   |                                                                                                                                                                                                     |
| 10.1   |   | Amended  Credit Agreement Among Bank of America, N.A., and Others dated June 25,  2002(3)                                                                                                                |
|   |   |                                                                                                                                                                                                     |
| 10.2   |   | Credit  Agreement Among Bank of America, N.A., and Others dated June 25, 2002(3)                                                                                                                         |
|   |   |                                                                                                                                                                                                     |
| 10.3   |   | Consent of  Bank of America, N.A.(5)                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                     |
| 10.4   |   | Agreement  with David B. Friend, M.D., dated October 22, 1999(1)                                                                                                                                         |
|   |   |                                                                                                                                                                                                     |
| 10.5   |   | Senior  Officer Deferred Compensation Plan(5)                                                                                                                                                            |
|   |   |                                                                                                                                                                                                     |
| 10.6   |   | Form of  agreement among Watson Wyatt & Company, Watson Wyatt & Company  Holdings and employee directors, executive officers and significant  stockholders restricting the transfer of shares(4) |
|   |   |                                                                                                                                                                                                     |
| 10.7   |   | Lease  between Watson Wyatt & Company and Arlington Office, L.L.C., dated April  27, 2004(6)                                                                                                         |
|   |   |                                                                                                                                                                                                     |
| 31.1   |   | Certification  of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14  and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002(6)                         |
|   |   |                                                                                                                                                                                                     |
| 31.2   |   | Certification  of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14  and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002(6)                         |
|   |   |                                                                                                                                                                                                     |
| 32.1   |   | Certification  of Chief Executive Officer Pursuant to Title 18, U.S.C. Section 1350(6)                                                                                                                   |
|   |   |                                                                                                                                                                                                     |
| 32.2   |   | Certification  of Chief Financial Officer Pursuant to Title 18, U.S.C. Section 1350(6)                                                                                                                   |
|   |   |                                                                                                                                                                                                     |
| b.     |   | Reports on  Form 8-K                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                     |
|   |   | (i) On  February 5, 2004, the Company filed a Current Report on Form 8-K, which  included a press release dated the same day, in which we reported our second  quarter fiscal year 2004 earnings.        |
|   |   |                                                                                                                                                                                                     |
|   |   | (ii) On May  6, 2004, the Company filed a Current Report on Form 8-K, which included a  press release dated the same day, in which we reported our third quarter  fiscal year 2004 earnings.             |

 

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(1)                 Incorporatedby reference from Registrant’s Form S-3/A, Amendment No. 1 (File No.33-394973), filed on March 17, 2000

(2)                 Incorporatedby reference from Registrant’s Form 10-Q, filed on May 2, 2001

(3)                 Incorporatedby reference from Registrant’s Form 10-K, filed on September 25, 2002

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

(5)                 Incorporatedby reference from Registrant’s Form 10-K, filed on August 15, 2001

(6)                 Filedwith this Form 10-Q

 

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**Signatures**

 

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

 

Watson Wyatt & CompanyHoldings(Registrant)

 

 
| /S/ John J.  Haley   |                                         | May 7, 2004 |   |
|----------------------|----------------------------------------------|-------------|--------|
| Name:                | John J.  Haley                               | Date        |
| Title:               | President  and Chief  Executive Officer      |        |
|                 |                                         |        |
| /S/ Carl D.  Mautz   |                                         | May 7, 2004 |   |
| Name:                | Carl D.  Mautz                               | Date        |
| Title:               | Vice  President and Chief  Financial Officer |        |
|                 |                                         |        |
| /S/ Peter L.  Childs |                                         | May 7, 2004 |   |
| Name:                | Peter L.  Childs                             | Date        |
| Title:               | Controller                                   |        |
|                      |                                              |             |        |  |

 

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