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

 

**FORM 10-Q**

**(Mark One)**

** **

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

 

**For the quarterly periodended March 31, 2006**

** **

**or**

** **

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

 

**For the transition periodfrom                            to                           **

** **

**Commission File Number:001-16159**

** **

**WATSON WYATT WORLDWIDE, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                    | **52-2211537**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or other jurisdiction of incorporation or  organization) | (I.R.S. Employer  Identification No.) |
|                                                            |                                  |
| **901 N. Glebe Rd., Arlington, VA**                             | **22203**                             |
| (Address of principal executive offices)                        | (Zip Code)                            |

 

**703-258-8000**

(Registrant’s telephone number, including area code)

 

**n/a**

(Former name, former address and former fiscal year,if changed since last report)

 

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

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

Large acceleratedfiler  x                            Accelerated filer o                                Non-accelerated filer o

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes oNo x

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.
|                                            | **Class**          | ** ** |  | **Outstanding at April 28, 2006** | ** ** |
|--------------------------------------------|--------------------|------------|--|----------------------------------------|------------|
| Class A  Common Stock, $.01 par value | 42,312,725  shares |

 

 

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

For the Three and Nine Months Ended March 31,2006
| PART I.   |   | FINANCIAL INFORMATION                                                                  |   |   |   |
|----------------|--------|------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|           |   |                                                                                                       |   |   |   |
| Item  1.       |   | Consolidated Financial  Statements (Unaudited)                                    |   |   |   |
|           |   |                                                                                                       |   |   |   |
|           |   | Consolidated Statements of Operations—Three and nine  months ended March 31, 2006 and 2005       |   | 1      |   |
|           |   |                                                                                                       |   |   |   |
|           |   | Consolidated  Balance Sheets—March 31, 2006 and June 30, 2005                               |   | 2      |   |
|           |   |                                                                                                       |   |   |   |
|           |   | Consolidated Statements of Cash Flows—Nine months  ended March 31, 2006 and 2005                 |   | 3      |   |
|           |   |                                                                                                       |   |   |   |
|           |   | Consolidated Statement of Changes in Stockholders’  Equity—Nine months ended March 31, 2006 |   | 4      |   |
|           |   |                                                                                                       |   |   |   |
|           |   | Notes to the Consolidated Financial Statements                                                             |   | 5      |   |
|           |   |                                                                                                       |   |   |   |
| Item 2.        |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                |   | 25     |   |
|           |   |                                                                                                       |   |   |   |
| Item 3.        |   | Quantitative and Qualitative Disclosures About Market  Risk                                                |   | 51     |   |
|           |   |                                                                                                       |   |   |   |
| Item 4.        |   | Controls and Procedures                                                                                    |   | 51     |   |
|           |   |                                                                                                       |   |   |   |
| PART II.  |   | OTHER  INFORMATION                                                                                    |   |   |   |
|           |   |                                                                                                       |   |   |   |
| Item  1.       |   | Legal  Proceedings                                                                                         |   | 51     |   |
|           |   |                                                                                                       |   |   |   |
| Item 1A.       |   | Risk  Factors                                                                                              |   | 52     |   |
|           |   |                                                                                                       |   |   |   |
| Item 2.        |   | Unregistered Sales of Equity Securities and Use of  Proceeds                                               |   | 52     |   |
|           |   |                                                                                                       |   |   |   |
| Item 3.        |   | Defaults Upon Senior Securities                                                                            |   | 52     |   |
|           |   |                                                                                                       |   |   |   |
| Item 4.        |   | Submission of Matters to a Vote of Security Holders                                                        |   | 52     |   |
|           |   |                                                                                                       |   |   |   |
| Item  5.       |   | Other  Information                                                                                         |   | 52     |   |
|           |   |                                                                                                       |   |   |   |
| Item 6.        |   | Exhibits                                                                                                   |   | 53     |   |
|           |   |                                                                                                       |   |   |   |
| Signatures     |   | 54                                                                                                         |   |
|           |   |                                                                                                       |   |
| Certifications |   | 55                                                                                                         |   |

 

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**WATSON WYATT WORLDWIDE, INC.Consolidated Statements of Operations**(Thousands of U.S. Dollars,Except Per Share Data)
| ** **                                                                                                                                                                          | ** ** | **Three months ended March 31** | ** ** | **Nine months ended March 31** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                                          | ** ** | **(Unaudited)**                                     | ** ** | **(Unaudited)**                                    | ** ** |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Revenue                                                                                                                                                                             |       | $                                                   | 343,072    |                                               | $          | 187,560 |   | $ | 924,722 |   | $ | 538,800 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Costs of providing  services:                                                                                                                                                       |       |                                                |       |                                               |       |   |   |   |   |
| Salaries and employee benefits                                                                                                                                                      |       | 191,582                                             |       | 101,730                                            |       | 514,339 |   | 294,000 |   |
| Professional and subcontracted services                                                                                                                                             |       | 17,884                                              |       | 13,795                                             |       | 56,490 |   | 37,318 |   |
| Occupancy, communications and other                                                                                                                                                 |       | 41,689                                              |       | 27,110                                             |       | 118,229 |   | 79,111 |   |
| General and administrative expenses                                                                                                                                                 |       | 39,300                                              |       | 18,764                                             |       | 107,895 |   | 55,133 |   |
| Depreciation and amortization                                                                                                                                                       |       | 11,510                                              |       | 5,161                                              |       | 32,319 |   | 14,654 |   |
|                                                                                                                                                                                |       | 301,965                                             |       | 166,560                                            |       | 829,272 |   | 480,216 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Income from operations                                                                                                                                                              |       | 41,107                                              |       | 21,000                                             |       | 95,450 |   | 58,584 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Income from  affiliates                                                                                                                                                             |       | 310                                                 |       | 889                                                |       | 1,732 |   | 5,819 |   |
| Interest income                                                                                                                                                                     |       | 1,047                                               |       | 761                                                |       | 2,344 |   | 1,914 |   |
| Interest expense                                                                                                                                                                    |       | (1,344                                              | )          | (144                                               | )          | (3,703 | ) | (435 | ) |
| Other  non-operating (loss) income                                                                                                                                                  |       | 44                                                  |       | (1,181                                             | )          | (2,106 | ) | (1,209 | ) |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Income from  continuing operations before income taxes                                                                                                                              |       | 41,164                                              |       | 21,325                                             |       | 93,717 |   | 64,673 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Provision for  income taxes                                                                                                                                                         |       | 11,828                                              |       | 6,985                                              |       | 33,314 |   | 25,527 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Income from  continuing operations                                                                                                                                                  |       | 29,336                                              |       | 14,340                                             |       | 60,403 |   | 39,146 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Discontinued  operations:                                                                                                                                                           |       |                                                |       |                                               |       |   |   |   |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Adjustment to  reduce estimated loss on disposal of discontinued operations [less applicable  income tax expense for the three and nine months ended March 31, 2006  and 2005] |       | 1,035                                               |       | 739                                                |       | 1,035 |   | 739 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Sublease income  from discontinued operations, less applicable income tax expense for the  three and nine months ended March 31, 2006 and 2005                                 |       | 10                                                  |       | 9                                                  |       | 27 |   | 17 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Net income                                                                                                                                                                          |       | $                                                   | 30,381     |                                               | $          | 15,088 |   | $ | 61,465 |   | $ | 39,902 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Basic earnings per  share:                                                                                                                                                          |       |                                                |       |                                               |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                   |       | $                                                   | 0.69       |                                               | $          | 0.44 |   | $ | 1.47 |   | $ | 1.20 |   |
| Income from discontinued operations                                                                                                                                                 |       | 0.02                                                |       | 0.02                                               |       | 0.03 |   | 0.02 |   |
| Net income                                                                                                                                                                          |       | $                                                   | 0.71       |                                               | $          | 0.46 |   | $ | 1.50 |   | $ | 1.22 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Diluted earnings per  share:                                                                                                                                                        |       |                                                |       |                                               |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                   |       | $                                                   | 0.69       |                                               | $          | 0.44 |   | $ | 1.46 |   | $ | 1.19 |   |
| Income from discontinued operations                                                                                                                                                 |       | 0.02                                                |       | 0.02                                               |       | 0.03 |   | 0.02 |   |
| Net income                                                                                                                                                                          |       | $                                                   | 0.71       |                                               | $          | 0.46 |   | $ | 1.49 |   | $ | 1.21 |   |
|                                                                                                                                                                                |       |                                                |       |                                               |       |   |   |   |   |
| Weighted average  shares of common stock, basic (000)                                                                                                                          |       | 42,234                                              |       | 32,647                                             |       | 41,074 |   | 32,507 |   |
| Weighted average  shares of common stock, diluted (000)                                                                                                                        |       | 42,466                                              |       | 32,936                                             |       | 41,341 |   | 32,814 |   |

 

See accompanyingnotes to theconsolidated financial statements

1

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**WATSONWYATT WORLDWIDE, INC.Consolidated Balance Sheets**(Thousands of U.S. Dollars,Except Share and Per Share Data)
| ** **                                                                                                                                             | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                                             | ** ** | **2006**           | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                             | ** ** | **(Unaudited)**    | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                             | ** ** | ** **         | ** ** | ** **        | ** ** |
| Cash and cash  equivalents                                                                                                                             |       | $                  | 92,674     |              | $          | 168,076 |   |
| Receivables from  clients:                                                                                                                             |       |               |       |              |       |
|                                                                                                                                                   |       |               |       |              |       |
| Billed, net of allowances of $4,211 and $2,114                                                                                                         |       | 173,831            |       | 95,977            |       |
| Unbilled, net of allowances of $7,241 and $264                                                                                                         |       | 126,711            |       | 62,840            |       |
|                                                                                                                                                   |       | 300,542            |       | 158,817           |       |
|                                                                                                                                                   |       |               |       |              |       |
| Deferred income  taxes                                                                                                                                 |       | 19,054             |       | 24,718            |       |
| Other current  assets                                                                                                                                  |       | 34,249             |       | 12,599            |       |
| Total current assets                                                                                                                                   |       | 446,519            |       | 364,210           |       |
|                                                                                                                                                   |       |               |       |              |       |
| Investment in  affiliates                                                                                                                              |       | 10,045             |       | 30,857            |       |
| Fixed assets,  net                                                                                                                                     |       | 135,832            |       | 94,033            |       |
| Deferred income  taxes                                                                                                                                 |       | 114,885            |       | 92,915            |       |
| Goodwill                                                                                                                                               |       | 306,146            |       | 21,888            |       |
| Intangible  assets                                                                                                                                     |       | 177,926            |       | 776               |       |
| Other assets                                                                                                                                           |       | 6,752              |       | 14,000            |       |
|                                                                                                                                                   |       |               |       |              |       |
| **Total  Assets**                                                                                                                                      |       | $                  | 1,198,105  |              | $          | 618,679 |   |
| ** **                                                                                                                                             | ** ** | ** **         | ** ** | ** **        | ** ** |
| **Liabilities**                                                                                                                                        | ** ** | ** **         | ** ** | ** **        | ** ** |
| Accounts payable  and accrued liabilities, including discretionary compensation                                                                        |       | $             | 238,250    |              | $     | 122,621 |   |
| Deferred income  taxes                                                                                                                                 |       | —             |       | 283               |       |
| Income taxes  payable                                                                                                                                  |       | 21,869             |       | 4,648             |       |
| Total current liabilities                                                                                                                              |       | 260,119            |       | 127,552           |       |
|                                                                                                                                                   |       |               |       |              |       |
| Note payable                                                                                                                                           |       | 45,000             |       | —            |       |
| Accrued  retirement benefits                                                                                                                           |       | 263,342            |       | 205,029           |       |
| Deferred rent  and accrued lease losses                                                                                                                |       | 29,292             |       | 18,701            |       |
| Deferred income  taxes                                                                                                                                 |       | 361                |       | 370               |       |
| Other noncurrent  liabilities                                                                                                                          |       | 69,960             |       | 32,824            |       |
|                                                                                                                                                   |       |               |       |              |       |
| **Total  Liabilities**                                                                                                                                 |       | 668,074            |       | 384,476           |       |
| ** **                                                                                                                                             | ** ** | ** **         | ** ** | ** **        | ** ** |
| Commitments and  contingencies                                                                                                                         |       |               |       |              |       |
|                                                                                                                                                   |       |               |       |              |       |
| **Stockholders’ Equity**                                                                                                                          | ** ** | ** **         | ** ** | ** **        | ** ** |
| Preferred Stock  - No par value: 1,000,000 shares authorized; none issued and outstanding                                                              |       | —             |       | —            |       |
| Class A  Common Stock - $.01 par value: 99,000,000 shares authorized; 42,463,451 and  33,372,880 issued and 42,271,095 and 32,627,226 outstanding |       | 425                |       | 334               |       |
| Additional  paid-in capital                                                                                                                            |       | 386,535            |       | 147,948           |       |
| Treasury stock,  at cost - 192,356 and 745,654 shares                                                                                                  |       | (5,050             | )          | (18,705           | )          |
| Retained  earnings                                                                                                                                     |       | 220,052            |       | 168,075           |       |
| Accumulated  other comprehensive loss                                                                                                                  |       | (71,931            | )          | (63,449           | )          |
| **Total  Stockholders’ Equity**                                                                                                                   |       | 530,031            |       | 234,203           |       |
|                                                                                                                                                   |       |               |       |              |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                   |       | $                  | 1,198,105  |              | $          | 618,679 |   |

 

See accompanyingnotes to theconsolidated financial statements

2

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**WATSONWYATT WORLDWIDE, INC.Consolidated Statements of Cash Flows**(Thousands of U.S. Dollars)
| ** **                                                                     | ** ** | **Nine months ended March 31** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                                                                     | ** ** | **(Unaudited)**                                    | ** ** |
| Cash flows from (used  in) operating activities:                               |       |                                               |       |   |   |
| Net income                                                                     |       | $                                                  | 61,465     |   | $ | 39,902 |   |
| Adjustments to  reconcile net income to net cash used in operating activities: |       |                                               |       |   |   |
| Loss on foreign currency forward contract                                      |       | 3,602                                              |       | — |   |
| Income from discontinued operations, net of income  tax expense                |       | (1,035                                             | )          | (739 | ) |
| Provision for doubtful receivables from clients                                |       | 6,089                                              |       | 5,967 |   |
| Depreciation                                                                   |       | 26,448                                             |       | 14,426 |   |
| Amortization of intangible assets                                              |       | 5,872                                              |       | 228 |   |
| Provision for deferred income taxes                                            |       | 9,876                                              |       | 7,029 |   |
| Income from affiliates                                                         |       | (1,732                                             | )          | (5,819 | ) |
| Distributions from affiliates                                                  |       | 1,614                                              |       | 4,624 |   |
| Other, net                                                                     |       | 326                                                |       | 755 |   |
| Changes in  operating assets and liabilities (net of discontinued operations)  |       |                                               |       |   |   |
| Receivables from clients                                                       |       | (33,731                                            | )          | (22,124 | ) |
| Other current assets                                                           |       | (4,929                                             | )          | (9,996 | ) |
| Other assets                                                                   |       | (684                                               | )          | 1,091 |   |
| Accounts payable and accrued liabilities                                       |       | (31,278                                            | )          | (12,126 | ) |
| Income taxes payable                                                           |       | 16,620                                             |       | (20,824 | ) |
| Accrued retirement benefits                                                    |       | 412                                                |       | (261 | ) |
| Deferred rent and accrued lease losses                                         |       | 1,870                                              |       | 394 |   |
| Other noncurrent liabilities                                                   |       | 4,205                                              |       | (481 | ) |
| Cash flows from  operating activities:                                         |       | 65,010                                             |       | 2,046 |   |
|                                                                           |       |                                               |       |   |   |
| Cash flows (used in)  from investing activities:                               |       |                                               |       |   |   |
| Purchases of marketable securities                                             |       | —                                             |       | (469,400 | ) |
| Sales and maturities of marketable securities                                  |       | —                                             |       | 489,400 |   |
| Acquisitions                                                                   |       | (132,844                                           | )          | (517 | ) |
| Purchases of fixed assets                                                      |       | (24,153                                            | )          | (20,129 | ) |
| Capitalized software costs                                                     |       | (20,477                                            | )          | (8,840 | ) |
| Proceeds from divestitures                                                     |       | 1,496                                              |       | 28 |   |
| Cash flows used  in investing activities:                                      |       | (175,978                                           | )          | (9,458 | ) |
|                                                                           |       |                                               |       |   |   |
| Cash flows from (used  in) financing activities                                |       |                                               |       |   |   |
| Borrowings                                                                     |       | 102,000                                            |       | — |   |
| Repayments of borrowings                                                       |       | (57,000                                            | )          | — |   |
| Foreign currency forward contract                                              |       | (8,405                                             | )          | — |   |
| Dividends paid                                                                 |       | (9,487                                             | )          | (7,309 | ) |
| Repurchases of common stock                                                    |       | (3,937                                             | )          | (4,188 | ) |
| Tax benefit of exercises of stock options and other                            |       | 1,444                                              |       | 775 |   |
| Issuances of common stock - exercises of stock  options                        |       | 2,921                                              |       | 1,711 |   |
| Issuances of common stock - employee stock purchase  plan                      |       | 4,777                                              |       | 5,549 |   |
| Cash flows from (used in) financing activities                                 |       | 32,313                                             |       | (3,462 | ) |
|                                                                           |       |                                               |       |   |   |
| Effect of  exchange rates on cash                                              |       | 3,253                                              |       | 399 |   |
|                                                                           |       |                                               |       |   |   |
| Decrease in cash  and cash equivalents                                         |       | (75,402                                            | )          | (10,475 | ) |
|                                                                           |       |                                               |       |   |   |
| Cash and cash  equivalents at beginning of period                              |       | 168,076                                            |       | 136,940 |   |
|                                                                           |       |                                               |       |   |   |
| Cash and cash  equivalents at end of period                                    |       | $                                                  | 92,674     |   | $ | 126,465 |   |

 

See accompanyingnotes to theconsolidated financial statements

3

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**WATSON WYATTWORLDWIDE, INC.Consolidated Statement of Changes in Stockholders’ Equity**(Thousands of U.S. Dollars)
| ** **                                                       | ** ** | **Class A**            | ** ** | ** **       | ** ** | ** **     | ** ** | ** **       | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------|------------|------------------|------------|----------------|------------|------------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                       | ** ** | **Common**                  | ** ** | ** **       | ** ** | ** **     | ** ** | ** **       | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Stock**                   | ** ** | ** **       | ** ** | ** **     | ** ** | ** **       | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Outstanding**             | ** ** | **Class A** | ** ** | **Additional** | ** ** | **Treasury**     | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **(number of**         | ** ** | **Common**       | ** ** | **Paid-in**    | ** ** | **Stock,**       | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **shares, in   thousands)** | ** ** | **Stock**        | ** ** | **Capital**    | ** ** | **at Cost** | ** ** | **Earnings** | ** ** | **(Loss)/Income** | ** ** | **Total**  | ** ** |
| Balance at June 30, 2005                                    |       | 32,627                      |       | $                | 334        |           | $          | 147,948          |       | $            | (18,705    | )                 | $          | 168,075    |       | $ | (63,449 | ) | $ | 234,203 |   |
|                                                             |       |                        |       |             |       |           |       |             |       |         |       |              |       |       |       |
| Comprehensive income:                                            |       |                        |       |             |       |           |       |             |       |         |       |              |       |       |       |
| Net income                                                       |       |                        |       |             |       |           |       |             |       | 61,465       |       |              |       | 61,465     |       |
| Additional minimum pension liability                             |       |                        |       |             |       |           |       |             |       |         |       | 160               |       | 160        |       |
| Foreign currency translation adjustment                          |       |                        |       |             |       |           |       |             |       |         |       | (8,642            | )          | (8,642     | )          |
| Total comprehensive income                                       |       |                        |       |             |       |           |       |             |       |         |       |              |       | 52,983     |       |
| Cash dividends declared                                          |       |                        |       |             |       |           |       |             |       | (9,488       | )          |              |       | (9,488     | )          |
| Repurchases of common stock                                      |       | (141                        | )          |             |       |           |       | (3,937           | )          |         |       |              |       | (3,937     | )          |
| Issuances of common stock - employee stock purchase  plan shares |       | 184                         |       |             |       | 151            |       | 4,626            |       |         |       |              |       | 4,777      |       |
| Issuances of common stock - deferred stock units and  other      |       | 181                         |       |             |       | 718            |       | 4,555            |       |         |       |              |       | 5,273      |       |
| Issuances of common stock to outside directors                   |       | 11                          |       |             |       | 15             |       | 333              |       |         |       |              |       | 348        |       |
| Issuances of common stock - stock options                        |       | 225                         |       |             |       | (2,829         | )          | 5,750            |       |         |       |              |       | 2,921      |       |
| Acquisition of WWLLP                                             |       | 9,091                       |       | 91               |       | 238,627        |       |             |       |         |       |              |       | 238,718    |       |
| Other business acquisition                                       |       | 93                          |       |             |       | 172            |       | 2,328            |       |         |       |              |       | 2,500      |       |
| Non-qualified stock option expense                               |       |                        |       |             |       | 289            |       |             |       |         |       |              |       | 289        |       |
| Tax benefit of exercises of stock options                        |       |                        |       |             |       | 1,444          |       |             |       |         |       |              |       | 1,444      |       |
|                                                             |       |                        |       |             |       |           |       |             |       |         |       |              |       |       |       |
| Balance at March 31, 2006 (unaudited)                       |       | 42,271                      |       | $                | 425        |           | $          | 386,535          |       | $            | (5,050     | )                 | $          | 220,052    |       | $ | (71,931 | ) | $ | 530,031 |   |

 

See accompanyingnotes to theconsolidated financial statements

4

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**WATSONWYATT WORLDWIDE, INC.**

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

**Note 1 —Basis of Presentation.**

The accompanyingunaudited quarterly consolidated financial statements of Watson Wyatt Worldwide, Inc.and our subsidiaries (collectively referred to as “we,” “Watson Wyatt,” “WatsonWyatt Worldwide” or the “company”) are presented in accordance with the rules andregulations of the Securities and Exchange Commission (“SEC”) for quarterlyreports on Form 10-Q. In the opinion of management, theseconsolidated financial statements reflect all adjustments, consisting only ofnormal recurring adjustments,  which arenecessary for a fair presentation of the consolidated financial statements andresults for the interim periods. The consolidated financial statements shouldbe read together with the audited consolidated financial statements and notesthereto contained in the company’s Annual Report on Form 10-K forthe fiscal year ended June 30, 2005, which is filed with the SEC and maybe accessed via EDGAR on the SEC’s web site at www.sec.gov. The year-endbalance sheet data was derived from audited financial statements, but does notinclude all disclosures required by U.S. generally accepted accountingprinciples.

The results of operationsfor the nine months ended March 31, 2006 are not necessarily indicative ofthe results that can be expected for the entire fiscal year ending June 30,2006. The results reflect certain estimates and assumptions made by management including estimated bonusesand anticipated tax liabilities that affect the amounts reported in theconsolidated financial statements and related notes. Certain prior year amountshave been reclassified to conform to the current year’s presentation.

**Note 2 —Business Combination.**

On July 31, 2005, the company acquiredsubstantially all of the assets and assumed most liabilities of Watson WyattLLP (“WWLLP”) (the “business combination”), a leading United Kingdom-basedactuarial, benefits and human resources consulting partnership. The company andWWLLP had jointly offered services since 1995 pursuant to alliance agreementsand as a result, have business segments that are very similar in nature. SeeNote 3 for further information regarding the operating segments of the combinedcompany.

The assets acquired from WWLLP are held by the company’sprincipal U.K. subsidiary, Watson Wyatt Limited, thereby strengthening WatsonWyatt’s global market presence. The purchase price of $432.6 million consistedof £88.3 million in cash, or $156.1 million at the exchange rate in effect at August 1,2005, the issuance of 9,090,571 shares of the company’s common stock valued at$238.7 million, transaction costs of $14.6 million and additional considerationincluding debt forgiveness and investment elimination. The shares paid werevalued at $26.26 per share, which was the average of the closing market pricesof the company’s stock over five business days beginning with two business daysprior to the announcement date of January 18, 2005 and ending with the twobusiness days following the announcement date. In addition, a further 1,950,000shares may be paid to WWLLP as additional consideration after June 30,2007, contingent upon the achievement by the acquired business of certainagreed-upon financial performance goals. Watson Wyatt Limited’s results ofoperations are included in the consolidated financial statements beginning August 1,2005.

5

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*Accounting and Goodwill Allocation*

The business combinationhas been accounted for using the purchase method of accounting as prescribed inStatement of Financial Accounting Standards No. 141, “BusinessCombinations” (SFAS 141), where the assets acquired and liabilities assumed arerecorded at their respective fair values as of the combination date. As of thebusiness combination date, the company determined the following estimated fairvalues for the proportionate assets purchased and liabilities assumed. Thedetermination of estimated fair value requires management to make significantestimates and assumptions. The company hired an independent third party toassist in the valuation of assets. Although the company does not anticipate anysignificant adjustments, to the extent that the estimates used need to berefined, the company will do so upon making that determination but not laterthan one year from the business combination date.
| ** **                              | ** ** | **August 1, 2005  (in thousands)** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|
| Total purchase  price                   |       |                                              |       | $ | 432,618 |   |
| Less net assets  acquired:              |       |                                              |       |   |   |
| Trademark and trade name                |       | $                                                 | 108,000    |   |   |   |
| Customer related intangibles            |       | 60,600                                            |       |   |   |
| Core/developed technology               |       | 17,500                                            |       |   |   |
| Cash and cash equivalents               |       | 26,419                                            |       |   |   |
| Client receivables and unbilled revenue |       | 94,324                                            |       |   |   |
| Other current assets                    |       | 40,892                                            |       |   |   |
| Fixed assets                            |       | 11,270                                            |       |   |   |
| Other assets                            |       | 3,368                                             |       |   |   |
| Current liabilities                     |       | (139,381                                          | )          |   |   |
| Accrued retirement benefits             |       | (43,064                                           | )          |   |   |
| Other non current liabilities           |       | (29,240                                           | )          |   |   |
|                                    |       |                                              |       | 150,688 |   |
| Preliminary allocation  of goodwill     |       |                                              |       | $ | 281,930 |   |
|                                         |            |                                                   |            |  |  |  |  |

 

The preliminary allocation of the purchase priceresulted in the allocation of $281.9 million to goodwill, which has beenassigned to our segments as follows:
| ** **                                     | ** ** | **Goodwill** | ** ** |
|------------------------------------------------|------------|--------------|------------|
| Benefits                                       |       | $            | 136,454    |   |
| Technology and  Administration Solutions Group |       | 40,034       |       |
| Human Capital  Group                           |       | 16,070       |       |
| Insurance &  Financial Services Group |       | 52,157       |       |
| Investment  Consulting Group                   |       | 37,215       |       |
| Allocation of goodwill  to business segments   |       | $            | 281,930    |   |

 

The majority of the goodwill will be deductible in theU.K. over a period not exceeding 25 years.

6

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*Hedge Treatment*

During the third quarter of fiscal year 2005, thecompany entered into a foreign currency forward contract to offset the riskassociated with the foreign exchange (British Pound) exposure inherent in thecombination. The forward contract provided for the purchase of £88 million at afixed price of $164.5 million, with a settlement date of July 29, 2005. Inaccordance with Statement of Financial Accounting Standards No. 133, “Accountingfor Derivative Instruments and Hedging Activities” (SFAS 133), as amended andinterpreted, since the forward contract was associated with a businesscombination that is subject to the provisions of SFAS 141 and the combinationinvolved an equity method investment, the forward contract did not qualify forhedge accounting. As a result, changes in fair value associated with theforward contract were required to be recognized in the Consolidated Statementsof Operations. Consequently, a loss of $3.6 million was recognized during thefirst quarter of fiscal year 2006 and included in other non-operating income. Lossesrecognized under this forward contract since inception of the contract totaled$8.4 million.

*Pro Forma Financial Information*

The following unaudited pro forma combined statementsof operations have been provided to present illustrative combined unauditedstatements of operations for the three and nine month periods ended March 31,2006 and 2005, giving effect to the business combination as if it had beencompleted on July 1, 2005 and 2004, respectively. The unaudited historicalcombined statement of operations for the three month period ended March 31,2006 reflects the actual financial results of the combined company. The threemonth period ended March 31, 2005 combines the historical financialresults of Watson Wyatt for the three months ended March 31, 2005 with thepro forma historical financial results from WWLLP for the three months ended March 31,2005. The nine month period ended March 31, 2006 includes historicalfinancial results from July 2005 of Watson Wyatt, pro forma results of WWLLPfor the month of July 2005, combined with the results of the consolidatedentity from August 1, 2005 through March 31, 2006. The nine monthperiod ended March 31, 2005 combines the historical financial results ofWatson Wyatt for the nine months ended March 31, 2005 with the pro formahistorical financial results from WWLLP for the nine months ended March 31,2005.

The unaudited pro forma combined financial informationshows the impact of the business combination on Watson Wyatt’s historical results of operations. The unaudited proforma combined income statements are presented for illustrative purposes onlyand are not indicative of the results of operations that might have occurredhad the business combination actually taken place as of the dates specified, orthat may be expected to occur in the future. They do not assume any benefitsfrom any cost savings or synergies and do not reflect any integration coststhat the combined company realized or incurred after the combination.

7

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**Pro-Forma Combined Statements ofOperations**

(in thousands, except per share data)
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                                      | ** ** | ** **                                          | ** ** | **(Unaudited)** | ** ** | ** ** | ** ** |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Revenue                                                     |       | $                                                    | 343,072    |                                                | $          | 306,661 |   | 11.9 | % | $ | 961,641 |   | $ | 891,233 |   | 7.9 | % |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Costs of  providing services:                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                              |       | 191,582                                              |       | 176,762                                             |       | 8.4 |   | 538,379 |   | 505,098 |   | 6.6 |   |
| Professional and subcontracted services                     |       | 17,884                                               |       | 17,804                                              |       | 0.4 |   | 57,681 |   | 50,340 |   | 14.6 |   |
| Occupancy, communications and other                         |       | 41,689                                               |       | 39,618                                              |       | 5.2 |   | 121,420 |   | 114,442 |   | 6.1 |   |
| General and administrative expenses                         |       | 39,300                                               |       | 35,934                                              |       | 9.4 |   | 114,493 |   | 109,808 |   | 4.3 |   |
| Depreciation and amortization                               |       | 11,510                                               |       | 10,081                                              |       | 14.2 |   | 33,744 |   | 28,646 |   | 17.8 |   |
|                                                        |       | 301,965                                              |       | 280,199                                             |       | 7.8 |   | 865,717 |   | 808,334 |   | 7.1 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  operations                                     |       | 41,107                                               |       | 26,462                                              |       | 55.3 |   | 95,924 |   | 82,899 |   | 15.7 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income (loss)  from affiliates                              |       | 310                                                  |       | (1,306                                              | )          | 123.7 |   | 1,244 |   | (261 | ) | 576.6 |   |
| Interest  expense, net                                      |       | (297                                                 | )          | (865                                                | )          | (65.7 | ) | (1,772 | ) | (2,519 | ) | (29.7 | ) |
| Other  non-operating income (loss)                          |       | 44                                                   |       | (1,198                                              | )          | 103.7 |   | 1,496 |   | (1,226 | ) | 222.0 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  continuing operations before income taxes |       | 41,164                                               |       | 23,093                                              |       | 78.3 |   | 96,892 |   | 78,893 |   | 22.8 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Provision for income  taxes                                 |       | 11,828                                               |       | 8,263                                               |       | 43.1 |   | 34,610 |   | 27,989 |   | 23.7 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from continuing  operations                          |       | $                                                    | 29,336     |                                                | $          | 14,830 |   | 97.8 | % | $ | 62,282 |   | $ | 50,904 |   | 22.4 | % |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Basic earnings per  share:                                  |       | $                                                    | 0.69       |                                                | $          | 0.36 |   |   |   | $ | 1.52 |   | $ | 1.22 |   |   |   |
| Diluted earnings per  share:                                |       | $                                                    | 0.69       |                                                | $          | 0.35 |   |   |   | $ | 1.51 |   | $ | 1.21 |   |   |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Weighted average shares  of common stock, basic (000)       |       | 42,234                                               |       | 41,737                                              |       |   |   | 41,074 |   | 41,597 |   |   |   |
| Weighted average shares  of common stock, diluted (000)     |       | 42,466                                               |       | 42,026                                              |       |   |   | 41,341 |   | 41,904 |   |   |   |

 

8

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**Note 3 —Segment Information.**

In North America andEurope, the company is primarily organized and managed by practice. Althoughour consultants in our Asia-Pacific and Latin America offices provide servicesin these same practice areas, their operations as a whole are managedgeographically and comprise a single operating segment. As a result, we havesix reportable operating segments or practice areas as follows:

(1)   BenefitsGroup

(2)   Technologyand Administration Solutions Group

(3)   HumanCapital Group 

(4)   Insurance &Financial Services Group 

(5)   InvestmentConsulting Group

(6)   International— Comprising Asia Pacific and Latin America

Management evaluates the performance of its segmentsand allocates resources to them based on net operating income on a pre-bonus,pre-tax basis. The category previously reported as “other” has beenreclassified as “All other segments” in the reconciliation of reportablesegments to consolidated amounts as prescribed in Statement of FinancialAccounting Standards No. 131 “Disclosures about Segments of an Enterpriseand Related Information”, (SFAS 131). This includes communication and changemanagement implementation support services. Prior period amounts have beenrestated to conform to the current classification.

The table belowpresents specified information about reported segments as of and for the threemonths ended March 31, 2006. As a result, it includes the consolidatedresults from the acquired businesses, as now held by Watson Wyatt Limited:
| ** **                                         | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **International —  Asia-Pacific/  Latin America** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable  expenses) |       | $                   | 188,573    |                                                  | $          | 35,449                    |       | $                                                    | 27,568     |                              | $          | 27,847                                                           |       | $         | 20,735     |   | $ | 23,828 |   | $ | 324,000 |   |
| Net operating  income                              |       | 55,051              |       | 8,708                                                 |       | 3,469                     |       | 8,075                                                |       | 4,581                             |       | 2,122                                                            |       | 82,006    |       |
| Receivables                                        |       | 184,954             |       | 13,576                                                |       | 25,877                    |       | 28,724                                               |       | 13,479                            |       | 21,648                                                           |       | 288,258   |       |
|                                                    |            |                     |            |                                                       |            |                           |            |                                                      |            |                                   |            |                                                                  |            |           |            |  |  |  |  |  |  |  |

 

The table below presentsspecified information about reported segments as of and for the three monthsended March 31, 2005. As a result, it does not include results from WatsonWyatt Limited since the combination was not completed until July 31,2005:  
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **International —  Asia-Pacific/  Latin America** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable expenses) |       | $                   | 109,482    |                                                  | $          | 17,030                    |       | $                                                    | 14,633     |                              | $          | —                                                           |       | $         | 5,005      |   | $ | 22,190 |   | $ | 168,340 |   |
| Net operating  Income                   |       | 24,693              |       | 874                                                   |       | 3,622                     |       | —                                               |       | 136                               |       | 263                                                              |       | 29,588    |       |
| Receivables                             |       | 108,372             |       | 7,263                                                 |       | 13,487                    |       | —                                               |       | 4,301                             |       | 20,844                                                           |       | 154,267   |       |
|                                         |            |                     |            |                                                       |            |                           |            |                                                      |            |                                   |            |                                                                  |            |           |            |  |  |  |  |  |  |  |

 

9

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The table belowpresents specified information about reported segments as of and for the ninemonths ended March 31, 2006. As a result, it includes the consolidatedresults from Watson Wyatt Limited since August 1, 2005. Net operating income presented below has beenadjusted to correct amounts that were inadvertently misstated primarily in the Technologyand Administration Solutions Group for the quarter ended September 30,2005, improving margins in the Technology and Administration Solutions Groupfrom what was previously reported.
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **International —  Asia-Pacific/  Latin America** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable expenses) |       | $                   | 504,966    |                                                  | $          | 96,296                    |       | $                                                    | 80,414     |                              | $          | 65,449                                                           |       | $         | 52,626     |   | $ | 68,251 |   | $ | 868,002 |   |
| Net operating income                    |       | 130,157             |       | 24,339                                                |       | 12,217                    |       | 13,599                                               |       | 8,319                             |       | 2,797                                                            |       | 191,428   |       |
| Receivables                             |       | 184,954             |       | 13,576                                                |       | 25,877                    |       | 28,724                                               |       | 13,479                            |       | 21,648                                                           |       | 288,258   |       |
|                                         |            |                     |            |                                                       |            |                           |            |                                                      |            |                                   |            |                                                                  |            |           |            |  |  |  |  |  |  |  |

 

The table belowpresents specified information about reported segments as of and for the ninemonths ended March 31, 2005. As a result, it does not include results fromWatson Wyatt Limited since the combination was not completed until July 31,2005:
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **International —  Asia-Pacific/  Latin America** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable expenses) |       | $                   | 305,503    |                                                  | $          | 53,785                    |       | $                                                    | 41,998     |                              | $          | —                                                           |       | $         | 13,705     |   | $ | 65,487 |   | $ | 480,478 |   |
| Net operating  income                   |       | 63,280              |       | 8,975                                                 |       | 10,589                    |       | —                                               |       | 626                               |       | 2,074                                                            |       | 85,544    |       |
| Receivables                             |       | 108,372             |       | 7,263                                                 |       | 13,487                    |       | —                                               |       | 4,301                             |       | 20,844                                                           |       | 154,267   |       |
|                                         |            |                     |            |                                                       |            |                           |            |                                                      |            |                                   |            |                                                                  |            |           |            |  |  |  |  |  |  |  |

 

Information aboutinterest income and tax expense is not presented as a segment expense becausesuch items are not considered a responsibility of the segments’ operatingmanagement. Prior year data has been reclassified to be consistent with currentsegments for comparative purposes.

10

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Reconciliations ofthe information reported by segment to the historical consolidated amountsfollow for the three and nine month periods ended March 31, 2006 and 2005:
| ** **                                                                                       | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Revenue:                                                                                         |       |                                                 |       |                                                |       |   |   |   |   |
| Total segment revenue                                                                            |       | $                                                    | 324,000    |                                                | $          | 168,340 |   | $ | 868,002 |   | $ | 480,478 |   |
| Reimbursable expenses not included in total segment revenue                                 |       | 8,376                                                |       | 9,340                                               |       | 28,331 |   | 25,619 |   |
| All other segments                                                                               |       | 8,058                                                |       | 9,082                                               |       | 26,324 |   | 31,811 |   |
| Other, net                                                                                       |       | 2,638                                                |       | 798                                                 |       | 2,065 |   | 892 |   |
| Consolidated revenue                                                                             |       | $                                                    | 343,072    |                                                | $          | 187,560 |   | $ | 924,722 |   | $ | 538,800 |   |
|                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Net Operating Income:                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Total segment net operating income                                                               |       | $                                                    | 82,006     |                                                | $          | 29,588 |   | $ | 191,428 |   | $ | 85,544 |   |
| Income from affiliates                                                                           |       | 310                                                  |       | 889                                                 |       | 1,732 |   | 5,819 |   |
| Differences in allocation methods for depreciation,  G&A, medical and pension costs (1) |       | 500                                                  |       | 5,325                                               |       | (5,887 | ) | 1,313 |   |
| Gain on sale of business units                                                                   |       | 44                                                   |       | 48                                                  |       | 1,496 |   | 20 |   |
| Interest expense                                                                                 |       | (1,344                                               | )          | (144)                                               |       | (3,703 | ) | (435) |   |
| Gain (Loss) on hedge                                                                             |       | —                                               |       | 1,392                                               |       | (3,602 | ) | 1,392 |   |
| Discretionary compensation                                                                       |       | (33,073                                              | )          | (11,400                                             | )          | (80,305 | ) | (31,813 | ) |
| WBG loss accrual                                                                                 |       | —                                               |       | (2,203                                              | )          | — |   | (2,203 | ) |
| All other  segments                                                                              |       | (1,056                                               | )          | (488                                                | )          | (2,272 | ) | 3,025 |   |
| Other, net                                                                                       |       | (6,223                                               | )          | (1,682                                              | )          | (5,170 | ) | 2,001 |   |
| Consolidated income before income taxes                                                          |       | $                                                    | 41,164     |                                                | $          | 21,325 |   | $ | 93,717 |   | $ | 64,673 |   |
|                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Receivables:                                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Total segment receivables — billed and unbilled                                             |       | $                                                    | 288,258    |                                                | $          | 154,267 |   | $ | 288,258 |   | $ | 154,267 |   |
| All other segments                                                                               |       | 5,574                                                |       | 6,670                                               |       | 5,574 |   | 6,670 |   |
| Net valuation differences (2)                                                                    |       | 6,710                                                |       | 5,054                                               |       | 6,710 |   | 5,054 |   |
| Total billed and unbilled receivables                                                            |       | 300,542                                              |       | 165,991                                             |       | 300,542 |   | 165,991 |   |
| Assets not reported by segment (3)                                                               |       | 897,563                                              |       | 369,133                                             |       | 897,563 |   | 369,133 |   |
| Consolidated  assets                                                                             |       | $                                                    | 1,198,105  |                                                | $          | 535,124 |   | $ | 1,198,105 |   | $ | 535,124 |   |

----

(1) Depreciation,general and administrative, pension, and medical costs are allocated to oursegments based on budgeted expenses determined at the beginning of the fiscalyear as management believes that these costs are largely uncontrollable to thesegment. To the extent that the actual expense base upon which allocations aremade differs from the forecast/budget amount, a reconciling item will becreated between internally allocated expenses and the actual expense that wereport for GAAP purposes.

11

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(2) Totalsegment receivables, which reflects the receivable balances used by managementto make business decisions, are included for management reporting purposes netof deferred revenues — cash collections and invoices generated in excess ofrevenue recognized in the segment revenues and cash held in suspense.

(3) Assetsnot reported by segment for management reporting purposes include goodwill andintangible assets of $484.1 million.

**Note 4 —Share-based Compensation.**

TheFinancial Accounting Standards Board (FASB) issued SFAS123(R), “Share-basedPayment” as a  revision to Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation”. SFAS 123(R) requires companies to account for share-basedpayment transactions with employees using a fair-value based method, therebyeliminating the disclosure-only provisions of SFAS 123. SFAS 123(R) becameeffective for the company as of July 1, 2005.

Thecompany has four share-based compensation plans, which are described below. Thesecompensation plans include the 2001 Employee Stock Purchase Plan, the 2001Deferred Stock Unit Plan for Selected Employees, the Amended Compensation Planfor Outside Directors and the 2000 Long-Term Incentive Plan. All four planshave been approved by stockholders.

*2001Employee Stock Purchase Plan*

Theemployee stock purchase plan enables employees to purchase shares of thecompany’s stock. No compensation expense was recognized through the thirdquarter of fiscal year 2006 as a result of this plan. Pro forma compensationexpense of $1.0 million was disclosed for the nine months ended March 31,2005.

##### *2001 Deferred Stock Unit Plan for Selected Employees*

The2001 Deferred Stock Unit Plan for Selected Employees is intended to provideselected associates of the company with additional incentives by permitting thecompany to grant them an equity interest in the company in the form ofrestricted stock units, in lieu of a portion of their annual fiscal year endbonus. Shares under this plan are awarded during the first quarter of eachfiscal year. During the first quarter of fiscal year 2006, 177,300 shares ofcommon stock, at a market price of $26.94 were awarded for a total fair valueof $4.8 million. During the first quarter of fiscal year 2005, 151,610 sharesof common stock, at a market price of $26.68 were awarded, for a total fairvalue of $4.0 million. In addition, under the 2001 Deferred Stock Unit Plan forSelected Employees, the company also awarded approximately 4,000 shares, at amarket price per share of $30.05 for a total fair value of approximately $0.2million, during the third quarter of fiscal year 2006 in connection with theChairman’s Award Program. The Chairman’s Award Program recognizes certainemployees who have made outstanding contributions to strategy execution.

On November 19,2004, the company’s Board of Directors approved a long-term bonus arrangementpursuant to the company’s 2001 Deferred Stock Unit Plan for Selected Employees.The arrangement, called the Performance Share Bonus Incentive Program (the “SBIProgram”), is a long-term stock bonus arrangement for senior executives of thecompany and its affiliates that is designed to strengthen incentives and alignbehaviors to grow the business in a way that is consistent with the strategicgoals of the company.

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Incentives under the SBIProgram are provided through grants of deferred stock units pursuant to thecompany’s 2001 Deferred Stock Unit Plan for Selected Employees. Grants ofdeferred stock units are based on the value of the cash portion of the eligibleparticipant’s fiscal year-end bonus target and a multiplier, which is thenconverted into a target number of deferred stock units based upon the company’sstock price as of the fiscal year-end prior to grant. Participants may vestbetween zero and 170% of the target number of deferred stock units based on theextent to which financial and strategic performance metrics are achieved over athree fiscal year period. The financial and strategic performance metrics areestablished at the beginning of each performance period. For the fiscal 2004through 2007 performance period, the vesting criteria are based upon earningsper share growth, market penetration and cross-selling ratios.

Nocompensation expense was recorded pursuant to this plan through the first nine monthsof fiscal year 2006. Expenses for this plan will be recognized when awards areboth probable and reasonably estimable and compensation expense will berecognized as a component of the discretionary annual bonus recorded insalaries and employee benefits.

##### *Amended Compensation Plan for Outside Directors*

TheAmended Compensation Plan for Outside Directors (the “Outside Director’s Plan”)provides for cash and stock compensation of outside Directors. Under theOutside Director’s Plan, outside Directors are initially paid in shares of thecompany’s common stock, or in a combination of cash and shares, quarterly forservices provided during the preceding quarter. Approximately $0.3 million ofcompensation expense was recorded relative to this plan during the first ninemonths of fiscal year 2006 compared to $0.2 million in the first nine months offiscal year 2005.

##### *2000 Long-Term Incentive Plan*

Thecompany issued non-qualified stock options under the 2000 Long-Term IncentivePlan (the “Stock Option Plan”) in conjunction with its initial public offeringin fiscal year 2001. No options have been granted under the stock option plansince fiscal year 2001 and the company does not currently intend to issuefurther stock options under the Stock Option Plan. For the first nine months offiscal year 2006, the company recognized $0.3 million in compensation expenserelated to the Stock Option Plan, in accordance with SFAS 123(R). For the firstnine months of fiscal year 2005, the company disclosed pro forma compensationcost of $0.7 million, related to the Stock Option Plan.

**Note 5 —Retirement Benefits.**

*DefinedBenefit Plans*

We sponsor both qualifiedand non-qualified, non-contributory defined benefit pension plans coveringsubstantially all of our associates. Under our plans in North America and HongKong, benefits are based on the number of years of service and the associates’compensation during the five highest paid consecutive years of service (subjectto grandfathering provisions under which benefits would be determined based onthe three highest paid consecutive years of service). The non-qualified plan,which exists only in North America, provides for pension benefits that would becovered under the qualified plan but are limited by the Internal Revenue Code. Thenon-qualified plan has no assets and therefore is an unfunded arrangement. Thebenefit liability is reflected on the balance sheet. The measurement date forthe plans is June 30.

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As a result of thebusiness combination described in Note 2, we have included the defined benefitpension plan disclosures for our recently acquired U.K. operations. Thedisclosures for this plan, together with our historical U.K. plan (collectively“the U.K. Plans”), are shown separately from the North America and Hong Kongplans because the related amounts, including obligations, assets and netperiodic benefit costs, are significant, and the assumptions used aresignificantly different, than all other plans sponsored by the company. Benefitsunder the U.K. plans are based on the number of years of service and theassociates’ compensation during the three years before leaving the plan. Themeasurement date for the defined benefit plan for the recently combined U.K.operations is July 31 whereas the measurement date for the historical U.K.plan is June 30.

*Components of Net PeriodicBenefit Cost for Defined Benefit Pension Plans*

The followingtable sets forth the components of net periodic benefit cost for the company’sdefined benefit pension plan for North America and Hong Kong for the three andnine month periods ended March 31, 2006 and 2005, and for the U.K. plansfor the three and nine months ended March 31, 2006:
| ** **                            | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **North America  & Hong Kong**    | ** ** | **U.K.**                                            | ** ** | **Total** | ** ** | **North America  & Hong Kong** | ** ** | **North America  & Hong Kong** | ** ** | **U.K.(1)** | ** ** | **Total** | ** ** | **North America  & Hong Kong** | ** ** |
| Service Cost                          |       | $                                                    | 7,635      |                                                | $          | 3,050 |   | $ | 10,685 |   | $ | 6,321 |   | $ | 22,854 |   | $ | 8,275 |   | $ | 31,129 |   | $ | 18,933 |   |
| Interest Cost                         |       | 9,362                                                |       | 3,798                                               |       | 13,160 |   | 8,852 |   | 28,032 |   | 10,414 |   | 38,446 |   | 26,515 |   |
| Expected Return on Plan Assets        |       | (11,170                                              | )          | (3,604                                              | )          | (14,774 | ) | (10,363 | ) | (33,447 | ) | (9,891 | ) | (43,338 | ) | (31,042 | ) |
| Amortization of Transition Obligation |       | (2                                                   | )          | —                                              |       | (2 | ) | (2 | ) | (6 | ) | — |   | (6 | ) | (5 | ) |
| Amortization of Net Loss              |       | 4,041                                                |       | —                                              |       | 4,041 |   | 1,702 |   | 12,104 |   | — |   | 12,104 |   | 5,100 |   |
| Amortization of Prior Service Cost    |       | (429                                                 | )          | —                                              |       | (429 | ) | (540 | ) | (1,290 | ) | — |   | (1,290 | ) | (1,621 | ) |
| Net Periodic  Benefit Cost            |       | $                                                    | 9,437      |                                                | $          | 3,244 |   | $ | 12,681 |   | $ | 5,970 |   | $ | 28,247 |   | $ | 8,798 |   | $ | 37,045 |   | $ | 17,880 |   |

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(1) Reflects the netperiodic benefit cost for (1) the defined benefit pension plan for ourrecently combined U.K. operations for the eight month period ending March 31,2006 and (2) the historical U.K. plan for the nine months ended March 31,2006.

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The fiscal year2006 net periodic benefit cost is based, in part, on the following rateassumptions as of June 30, 2005 for the North America and Hong Kong plansand July 31, 2005 for the U.K. plans:
| ** **                                   | ** ** | **North America  & Hong Kong** | ** ** | **U.K.** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------|------------|----------|------------|
| Discount rate                                |       | 5.25%                                             |       | 5.00%    |       |
| Expected long-term  rate of return on assets |       | 9.00%                                             |       | 5.63%    |       |
| Rate of increase in  compensation levels     |       | 3.34%                                             |       | 4.75%    |       |

 

The discount rateapplicable to the various plans varies in accordance with the interest rateenvironment in the respective host country. The expected long-term rate ofreturn on assets attributable to the various plans is based on the allocationof assets within each specific plan. Assets in the North America and Hong Kongplans are heavily weighted in equities, which are expected to generate a higherreturn than bonds, which constitute the majority of investments for the UKplans.

*Employer contributions*

The company made $0.8million in contributions to the non-U.S. plans during the third quarter offiscal year 2006 and no contributions to the U.S. plans in the third quarter. Weanticipate making $0.8 million in contributions to the non-U.S. plans in thelast quarter of fiscal year 2006. We do not anticipate making additionalcontributions to the U.S. plan for the remainder of fiscal year 2006.

The company made $2.2million in contributions to the U.K. plans during the third quarter of fiscalyear 2006 and anticipates making $4.8 million in contributions over theremainder of fiscal year 2006.

*Defined Contribution Plans*

In the U.S., we sponsor a savings plan that providesbenefits to substantially all U.S. associates with a match to employeecontributions at a rate of 50 percent of the first 6 percent up to $60,000 ofassociates’ eligible compensation. The company may also make an annual profitsharing contribution to the plan in an amount that is dependant upon thecompany’s financial performance during the fiscal year.

In the U.K., we sponsor a savings plan that providesbenefits to substantially all U.K. associates. The company provides a basic contributionand a match to employee contributions, both of which depend on age. The maximumemployer contribution is 10% up to £91,000 of associates’ eligiblecompensation.

*HealthCare Benefits*

In the U.S., wesponsor a contributory health care plan that provides hospitalization, medicaland dental benefits to substantially all U.S. associates. We accrue a liabilityfor estimated incurred but unreported claims based on projected use of the planas well as prior plan history.

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

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*PostretirementBenefits*

We provide certainhealth care and life insurance benefits for retired associates. The principalplans cover associates in the U.S. and Canada who have met certain eligibilityrequirements. Our principal post-retirement benefit plans are unfunded. Weaccrue a liability for these benefits in accordance with Statement of FinancialAccounting Standards No. 106, “Employers Accounting for PostretirementBenefits Other Than Pensions.”  We do nothave postretirement benefit plans in the U.K. and Hong Kong.

*Componentsof Net Periodic Benefit Cost for Other Postretirement Plans*

The followingtable sets forth the components of net periodic benefit cost for the company’shealthcare and post-retirement plans for the three and nine months ended March 31,2006 and 2005:
| ** **                             | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Service Cost                           |       | $                                                    | 363        |                                                | $          | 422 |   | $ | 1,271 |   | $ | 1,257 |   |
| Interest Cost                          |       | 538                                                  |       | 612                                                 |       | 1,746 |   | 1,831 |   |
| Expected return  on plan assets        |       | —                                               |       | —                                              |       | — |   | — |   |
| Amortization of  transition obligation |       | —                                               |       | 13                                                  |       | — |   | 38 |   |
| Amortization of  net loss              |       | 166                                                  |       | (142                                                | )          | 2 |   | (425 | ) |
| Amortization of  prior service cost    |       | (165                                                 | )          | (107                                                | )          | (495 | ) | (318 | ) |
| Net periodic benefit  cost             |       | $                                                    | 902        |                                                | $          | 798 |   | $ | 2,524 |   | $ | 2,383 |   |

 

*Employer contributions*

The company madecontributions in the form of premiums and medical claim payments to itshealthcare and post-retirement plans of $0.9 million in the three months ended March 31,2006 and 2005, and contributions of $2.5 million and $2.1 million in the ninemonths ended March 31, 2006 and 2005, respectively. We plan to makeadditional payments estimated to total $0.8 million through June 30, 2006.

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

The increases ingoodwill and intangible assets outlined below for the nine months ended March 31,2006 are principally attributable to the business combination during the firstquarter. See Note 2 for further details regarding the business combination. Thecompany performs its impairment tests in the fourth quarter of the company’sfiscal year, based on closing balances in the third quarter.
| ** **                         | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **Asia-Pacific/  Latin America** | ** ** | **All Other  Segments** | ** ** | **Total** | ** ** |
|------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|------------------------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|------------------------------|------------|-----------|------------|
| Balance as of June 30, 2005   |       | $                   | 16,790     |                                                  | $          | 1,449                     |       | $                                                    | 77         |                              | $          | —                                |       | $                            | —     |      | $          | 2,358 |   | $ | 1,214 |   | $ | 21,888 |   |
| Goodwill acquired during the year  |       | 143,458             |       | 40,034                                                |       | 16,070                    |       | 52,157                                               |       | 37,215                            |       | 666                                   |       | —                       |       | 289,600   |       |
| Translation Adjustment        |       | (2,464              | )          | (804                                                  | )          | (319                      | )          | (1,047                                               | )          | (747                              | )          | 39                                    |       | —                       |       | (5,342    | )          |
| Balance as of  March 31, 2006 |       | $                   | 157,784    |                                                  | $          | 40,679                    |       | $                                                    | 15,828     |                              | $          | 51,110                                |       | $                            | 36,468     |      | $          | 3,063 |   | $ | 1,214 |   | $ | 306,146 |   |

 

The followingtable reflects changes in the net carrying amount of the components ofintangible assets for the nine months ended March 31, 2006:
| ** **                                  | ** ** | **Pension** | ** ** | **Trademark &  trade name** | ** ** | **Customer  related  intangible** | ** ** | **Core/  developed  technology** | ** ** | **Non-compete  agreements** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|-------------|------------|-------------------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|-----------------------------|------------|-----------|------------|
| Balance as of  June 30, 2005           |       | $           | 608        |                                      | $          | —                            |       | $                                | 84         |                        | $          | —    |       | $ | 84 |   | $ | 776 |   |
| Intangible  assets acquired during the year |       | 28          |       | 108,000                                   |       | 60,600                            |       | 17,582                           |       | —                      |       | 186,210   |       |
| Amortization  expense                       |       | —      |       | —                                    |       | (3,439                            | )          | (2,381                           | )          | (52                         | )          | (5,872    | )          |
| Translation  adjustment                     |       | 20          |       | (1,918                                    | )          | (1,028                            | )          | (262                             | )          | —                      |       | (3,188    | )          |
| Balance as of  March 31, 2006          |       | $           | 656        |                                      | $          | 106,082                           |       | $                                | 56,217     |                        | $          | 14,939    |       | $ | 32 |   | $ | 177,926 |   |

 

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Thefollowing table reflects the carrying value of intangible assets at March 31,2006 and June 30, 2005:
| ** **                                            | ** ** | **March 31, 2006** | ** ** | **June 30, 2005** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                            | ** ** | **Gross**                    | ** ** | ** **                  | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                            | ** ** | **Carrying**                 | ** ** | **Accumulated**             | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **                                            | ** ** | **Amount**                   | ** ** | **Amortization**            | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Intangible  assets and intangible pension asset:      |       |                         |       |                        |       |   |   |   |   |
| Trademark & trade name                       |       | $                            | 106,082    |                        | $          | — |   | $ | — |   | $ | — |   |
| Customer related intangibles                          |       | 60,570                       |       | 4,353                       |       | 1,126 |   | 1,042 |   |
| Core/developed technology                             |       | 17,320                       |       | 2,381                       |       | — |   | — |   |
| Non-compete                                           |       | 672                          |       | 640                         |       | 672 |   | 588 |   |
| Intangible pension asset                              |       | 656                          |       | —                      |       | 608 |   | — |   |
| Total intangible  assets and intangible pension asset |       | $                            | 185,300    |                        | $          | 7,374 |   | $ | 2,406 |   | $ | 1,630 |   |

 

A component of the changein the gross carrying amount of trademark & trade name, customerrelated intangibles, core/developed technology and the intangible pension assetreflects foreign currency translation adjustments between June 30, 2005and March 31, 2006. These intangible assets are denominated in thecurrencies of our subsidiaries outside the United States, and are translatedinto our reporting currency, the U.S. dollar, based on exchange rates at thebalance sheet date.

The weightedaverage remaining life of amortizable intangible assets at March 31, 2006,was 9.9 years. Estimated amortization expense for the remainder of 2006 andthereafter is as follows:
| **Fiscal year ending June 30:** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                                |       | $          | 2,125      |       |
| 2007                                                |       | 8,445      |       |
| 2008                                                |       | 8,398      |       |
| 2009                                                |       | 8,398      |       |
| 2010                                                |       | 8,398      |       |
| Thereafter                                          |       | 35,423     |       |
| Total estimated  amortization expense               |       | $          | 71,187     |       |

 

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**Note 7 —Earnings Per Share.**

Basic earnings pershare is calculated by dividing net income by the weighted average number ofcommon shares outstanding during the three and nine months ended March 31,2006 and 2005. Diluted earnings per share is calculated by dividing net incomeby the weighted average number of common shares outstanding, plus the dilutiveeffect of outstanding stock options and employee stock purchase plan sharesusing the “treasury stock” method over the same measurement period. Thecomponents of basic and diluted earnings per share are as follows:
| ** **                                                                              | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Income from  continuing operations                                                      |       | $                                                    | 29,336     |                                                | $          | 14,340 |   | $ | 60,403 |   | $ | 39,146 |   |
| Discontinued  operations                                                                |       | 1,045                                                |       | 748                                                 |       | 1,062 |   | 756 |   |
| Net income                                                                              |       | $                                                    | 30,381     |                                                | $          | 15,088 |   | $ | 61,465 |   | $ | 39,902 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average  outstanding shares of common stock                                    |       | 42,234                                               |       | 32,647                                              |       | 41,074 |   | 32,507 |   |
| Dilutive effect  of employee stock options and employee stock purchase plan shares |       | 232                                                  |       | 289                                                 |       | 267 |   | 307 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Common stock and  stock equivalents                                                     |       | 42,466                                               |       | 32,936                                              |       | 41,341 |   | 32,814 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Basic earnings per  share:                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Income from  continuing operations                                                      |       | $                                                    | 0.69       |                                                | $          | 0.44 |   | $ | 1.47 |   | $ | 1.20 |   |
| Discontinued  operations                                                                |       | 0.02                                                 |       | 0.02                                                |       | 0.03 |   | 0.02 |   |
| Net income                                                                              |       | $                                                    | 0.71       |                                                | $          | 0.46 |   | $ | 1.50 |   | $ | 1.22 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted earnings per  share:                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Income from  continuing operations                                                      |       | $                                                    | 0.69       |                                                | $          | 0.44 |   | $ | 1.46 |   | $ | 1.19 |   |
| Discontinued  operations                                                                |       | 0.02                                                 |       | 0.02                                                |       | 0.03 |   | 0.02 |   |
| Net income                                                                              |       | $                                                    | 0.71       |                                                | $          | 0.46 |   | $ | 1.49 |   | $ | 1.21 |   |

 

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**Note 8 —Variable Interest Entities.**

In January 2003, theFASB issued FASB Interpretation No. 46, “Consolidation of VariableInterest Entities,” which was later revised in December 2003 (FIN 46(R))and became effective March 31, 2004 for the company. FIN 46(R) expandsexisting accounting guidance about when a company should include in itsconsolidated financial statements the assets, liabilities, and activities ofanother entity. In general, FIN 46(R) requires a variable interest entity(VIE), as defined by FIN 46(R), to be consolidated by its primary beneficiary. Theprimary beneficiary is defined as the company that will absorb a majority ofthe VIE’s expected losses or residual returns if they occur.

We have evaluated underFIN 46(R) our consolidated subsidiaries and believe that our accountingand disclosure is in compliance with the pronouncement. Therefore, the adoptionof FIN 46(R) had no effect on the company.

The company’s Investmentin affiliates has historically consisted of investments in three entities:  WWLLP, Watson Wyatt (Europe) Limited (WWHE)and Professional Consultants Insurance Company, Inc. (PCIC). Ourinvestment in each of which was accounted for under the equity method. As aresult of our business combination the company owns substantially all of theoperations of WWLLP and WWHE through our Watson Wyatt Limited subsidiary,effective July 31, 2005. For the nine months ended March 31, 2006 thecompany has accounted for its share of earnings from WWLLP and WWHE for themonth of July 2005 under the equity method and has consolidated resultsfrom Watson Wyatt Limited for the months of August 2005 through March 2006.

As of March 31,2006, our Investment in affiliate consists solely of an equity investment inPCIC, which will continue to be accounted for under the equity method. Thecompany evaluated this investment based on FIN 46(R)’s criteria in order todetermine the applicability of FIN 46(R). Since the company is not obligated toabsorb a majority of expected losses or residual returns in this entity, thecompany is not required to consolidate this entity.

PCIC was organized in1987 as a captive insurance company under the laws of the State of Vermont. PCICprovides professional liability insurance on a claims-made basis to WatsonWyatt and two other actuarial and management consulting firms, all of whichparticipate in the program as both policyholders and stockholders. The companycurrently owns 34.15 percent of PCIC. Capital contributions to PCIC arerequired when approved by a majority of its stockholders. Management believesthat the company’s maximum financial statement exposure to loss is limited tothe carrying value of the company’s investment in PCIC of $9.1 million, combinedwith letters of credit totaling $8.0 million for which PCIC has been designatedas beneficiary, for a total maximum exposure of $17.1 million.

**Note 9 —Comprehensive Income.**

Comprehensive incomeincludes net income, changes in the additional minimum pension liabilityresulting from translation adjustments and changes in the cumulativetranslation adjustment gain or loss. For the three months ended March 31,2006, comprehensive income totaled $34.0 million, compared with $14.0 millionfor the three months ended March 31, 2005. For the nine months ended March 31,2006, comprehensive income totaled $53.0 million, compared with $42.7 millionfor the nine months ended March 31, 2005.

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**Note 10 —Revision in the Classification of Certain Securities.**

Asof the end of the third quarter of fiscal year 2005, in connection with thenrecent interpretations regarding the classification of auction rate securities,the company concluded that it was appropriate to classify its auction ratesecurities as marketable securities instead of cash and cash equivalents, whichwas the historical classification. Auction rate securities are investments thatare typically backed by preferred stock or long-term, variable-rate debtinstruments whose interest rates are reset at predetermined short-termintervals through an auction process.

AtMarch 31, 2006 and June 30, 2005, the company had no auction ratesecurities compared to $20.0 million at June 30, 2004. At the end of thethird quarter fiscal year 2005, the company revised the Consolidated Statementsof Cash Flows to reflect the gross purchases of $469.4 million and sales andmaturities of these securities of $489.4 million as cash flows from/used ininvesting activities, rather than as a component of cash and cash equivalents. Thischange in classification did not affect cash flows from operations or financingactivities in the company’s previously reported Consolidated Statements of CashFlows. This change in classification did not affect the company’s ConsolidatedStatements of Operations or Consolidated Balance Sheets for any periodpresented.

**Note 11 —Restricted Shares.**

In conjunction with ourinitial public offering in October 2000, we entered into agreementsproviding for additional transfer restrictions with major stockholders,executive officers and employee directors. At each of the first fouranniversaries of our initial public offering, an equal portion of these sharesbecame freely transferable. The final 1,665,400 Class A shares becamefreely transferable in October, 2004.

In conjunctionwith our business combination of WWLLP on July 31, 2005, we issued9,090,571 Class A shares, 4,749,797 of which are subject to salerestrictions. Sale restrictions on 2,339,761 shares will expire on the firstanniversary and the sale restrictions on the 2,410,036 shares will expire onthe second anniversary of the business combination. The payment of up to anadditional 1,950,000 Class A shares to WWLLP after June 30, 2007 iscontingent upon achievement by the acquired business of certain agreed uponfinancial performance goals. Sale of these shares, if issued, will berestricted until the fourth anniversary of the business combination. See Note 2of this report for further information regarding the business combination ofWWLLP.

**Note 12 — Guarantees.**

The company historicallyhas provided guarantees on an infrequent basis to third parties in the ordinarycourse of business. The guarantees described below are currently in effect andcould require the company to make payments to third parties under certaincircumstances.

*Business combination*.On July 31, 2005, the companyacquired substantially all of the assets and assumed most liabilities of WWLLP,the company’s long-time alliance partner. The company entered into indemnityarrangements with WWLLP relating to the business combination and also agreedthat certain indemnity obligations relating to the alliance arrangements willcontinue after the business combination. In the business combination agreement,Watson Wyatt Limited, the company’s principal U.K. subsidiary, has agreed toindemnify WWLLP against liabilities arising with respect to certain liabilitiesassumed in the business combination by Watson Wyatt Limited and also withrespect to certain tax liabilities.

Aspart of the original alliance arrangements in 1995, the company sold itsthen-existing businesses in the U.K. and Europe to the predecessor of WWLLP orits subsidiaries. The company agreed to indemnify the buyers againstliabilities arising with respect to prior acts or omissions of the businessestransferred. Furthermore, the company agreed to indemnify WWLLP againstliabilities arising with respect to acts or omissions of the company and itssubsidiaries during the alliance arrangements. These indemnities will continuefollowing the business combination.

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Thecompany is unable to estimate an amount of any potential future payments underthese arrangements because the occurrence of any of the events to which theindemnities apply is entirely speculative and the amount of any payment woulddepend upon the nature of the event triggering such indemnity. Managementbelieves that any potential payment under such indemnities should decline withthe passage of time. The company has insurance to cover liabilities arisingfrom acts or omissions by the company and its subsidiaries, and such insurancemay cover some or all of its indemnity obligations relating to prior acts oromissions. Except for such insurance, there are no provisions for recourse tothird parties, nor are any assets held by any third parties that the company asindemnitor can liquidate to recover amounts paid under such indemnities.

Inconnection with our business combination, the payment of an additional1,950,000 shares of the company’s common stock to WWLLP after June 30,2007 is contingent upon the achievement by the acquired business of agreed-uponfinancial performance goals. The value of all the contingent common stock was$64.3 million based on the NYSE closing price on April 28, 2006. Thecontingent common stock is payable by Watson Wyatt Limited and the paymentobligations are guaranteed by Watson Wyatt Worldwide, Inc.

Underthe business combination agreement, Watson Wyatt Limited is obligated to makepayments to members of WWLLP representing profits and tax payments relating toperiods before the closing date of the transaction. The company has guaranteedthese obligations and has properly reflected them on the company’s consolidatedfinancial statements as of March 31, 2006.

*Letters of Credit*.The company has outstanding letters of credit to two beneficiaries totaling$10.6  million under our existing creditfacility to guarantee payment in the event that the company fails to meet itsfinancial obligations to these beneficiaries. One letter of credit for $2.6million will expire in October 2006, while the remaining letters of credittotaling $8.0 million will remain outstanding as long as we retain an ownershipshare of our affiliated captive insurance company, PCIC. The estimated fairmarket value of these letters of credit is nominal because they have never beenused, and the company believes that future usage is remote.

*Indemnification Agreements*.The company has various agreements that provide that it may be obligated toindemnify the other party with respect to certain matters. Generally, theseindemnification clauses are included in contracts arising in the normal courseof business and in connection with the purchase and sale of certain businesses.Although it is not possible to predict the maximum potential amount of futurepayments under these indemnification agreements due to the conditional natureof the company’s obligations and the unique facts of each particular agreement,the company does not believe that any potential liability that might arise fromsuch indemnity provisions is probable or material. There are no provisions forrecourse to third parties, nor are any assets held by any third parties thatany guarantor can liquidate to recover amounts paid under such indemnities.

*Wellspring Leases*.We continue to guarantee three leases for office premises for WellspringResources, LLC (“Wellspring”), the benefits administration outsourcing businessthat we exited from in fiscal year 1998. At March 31, 2006, minimumremaining payments guaranteed under these leases, which expire at various datesthrough 2007, total $6.6 million, excluding anticipated future sublease income.See Note 14 for more information regarding our obligation to guaranteeWellspring’s leases.

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**Note 13 —Contingent Liabilities.**

Fromtime to time, we are a party to various lawsuits, arbitrations or mediationsthat arise in the ordinary course of business. We have received subpoenas andrequests for information in connection with government investigations. Thematters reported on below involve requests for information in connection withgovernment investigations and the most significant pending or potential claimsagainst us.

Wereserve for contingent liabilities based on Statement of Financial AccountingStandards No. 5, “Accounting for Contingencies” (SFAS 5) when it isdetermined that a liability, inclusive of defense costs, is probable andreasonably estimable. Management, based on currently available information, hasestablished appropriate reserves for the matters below and believes that theresults of all pending claims will not have a material adverse affect on thecompany.

*Government Investigations:*

*NewYork State Attorney General*. On December 17, 2004, the New York State Attorney General issueda subpoena to Watson Wyatt seeking information about “override” and otherinsurance placement compensation.  Preliminary data indicate that such paymentsaccounted for less than 0.2 percent of Watson Wyatt’s revenue over the fouryear period preceding the Attorney General’s inquiry. Watson Wyatt has providedinformation to the New York State Attorney General’s office in response to thesubpoena in January 2005. We have received no further inquiries from theNew York State Attorney General since responding.

*SEC Investigation of General Motors Corporation:*

In October 2005, theSecurities and Exchange Commission (SEC) elevated its inquiry into AccountingIssues Involving Pensions and Other Post-Employment Benefits at General MotorsCorporation from an informal inquiry to a formal investigation. On October 31,2005, the SEC issued Watson Wyatt, as General Motors actuary, a subpoena fordocuments and testimony related to the investigation. Watson Wyatt hasprovided, and will continue to provide, information to the SEC in response tothe subpoena and will cooperate in this investigation.

*Professional Liability Claims:*

*IronWorkers Local 25 et al. v. Watson Wyatt & Co.*On July 8, 2004, Watson Wyatt was servedwith an amended complaint filed by a former client in the United StatesDistrict Court for the Eastern District of Michigan. The complaint allegedmalpractice, breach of contract, and related claims in the performance ofactuarial consulting. The complaint stated that the plaintiff’s pension fund isunderfunded as a result of the alleged deficiencies in our work. In response toa discovery request, in January 2005 the plaintiffs disclosed that theirminimum damage claim is $53.7 million. Discovery is continuing, and plaintiff’sexpert witnesses include allegations of gross negligence and damage estimatesof $100 million. Watson Wyatt’s expert witnesses dispute the allegations ofnegligence and purported damages.

*SBC Holdings, Inc.*On July 23, 2004, we received a demand letter from counsel for aclient alleging that errors in valuations for 2001 and subsequent yearsunderstated the liabilities of its pension plan and overstated its net worth. Asa result, the client claimed it did not annuitize its defined benefit plan andredeemed its stock at an inflated price. On April 15, 2005 we filed adeclaratory action in the U.S. District Court for the Eastern District ofMichigan to compel arbitration of the matter. On May 5, 2005, SBC filed ananswer and counterclaim to the declaratory judgment action, alleging damages inexcess of $46 million. The Motion to Compel Arbitration is pending.

*Client Demand Letter.* On  February 8,2005, we received a demand letter from counsel for a client alleging failure toensure that the method for performing certain benefit calculations under thepension administration system developed by Watson Wyatt for the client wasconsistent with the method required under the client’s pension equity plan andthe summary plan description. The matter has been settled.

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*ClientDemand Letter (Canada*).On December 22, 2005, Watson Wyatt Canada received a demand letter fromcounsel representing a former client demanding C$20 million (approximately $18million) for losses alleged to be attributable to Watson Wyatt’s investment consultingadvice. We are evaluating the claim, and engaging in initial discussions withthe client’s counsel.

**Note 14 — DiscontinuedOperations.**

As discussed in Note 12, the company continues toguarantee three leases for office premises for Wellspring. In accordance withthe contractual arrangements pursuant to which Watson Wyatt divested itsinterest in Wellspring, Watson Wyatt agreed to share with State Street eithercosts or benefits arising from these facilities leased by Wellspring. Since oneof the three Wellspring leases is currently sub-leased at rates in excess of the lease rate, thecompany is contractually entitled to a share of the benefit of the excess cashflow from the sub-leases. Through the first nine months of fiscal year 2006,the company received sublease income of approximately $27,000, net of taxes, inexcess of lease payments related to this business. Since the second quarter offiscal year 2003, the leases have been generating positive cash flows of lessthan $100,000 per fiscal year. The company’s current assessment is that thepositive cash flow from the sub-leases will continue until they expire in December 2006.The company has no direct cash obligation to Wellspring in the sense that itsobligation is contingent upon the remaining space being vacated.

During the third quarterof fiscal years 2005 and 2006, the company evaluated its accrual for theestimated remaining future obligations and costs related to the exit fromWellspring. The evaluations included an analysis of occupancy rates ofWellspring, along with an analysis of real estate market conditions in citiesin which the leases exist and an assessment of probable future sublease incomefor these leases. As a result of the analysis performed, the company reducedits accrual during fiscal year 2005 by $1.25 million, less the associatedincome tax expenses. In the third quarter of fiscal year 2006 we eliminated theremaining liability of $1.75 million, less associated income tax expenses,based on our analysis and the limited duration of the remaining leaseobligations. The current term of the leases for which the company wasestimating an accrual for future obligations will begin to expire in August 2006,with the final lease ending in November 2007. The company believes that giventhe limited duration of the leases and the expected occupancy rates ofWellspring, the probability of payments being required under the leaseguarantee is remote. The adjustments are reflected in the ConsolidatedStatements of Operations for the three and nine months ended March 31,2006 and 2005 in the line “Adjustment to reduce estimated loss on disposal ofdiscontinued operations.”

**Note 15 — Recent Accounting Pronouncements.**

In June 2004, theEmerging Issues Task Force (EITF) issued EITF 02-14****“Whetheran Investor Should Apply the Equity Method of Accounting to Investments OtherThan Common Stock if the Investor Has the Ability to Exercise SignificantInfluence Over the Operating and Financial Policies of the Investee.”  This EITF indicates that an investor shouldonly apply the equity method of accounting when it has investments in eithercommon stock or in-substance common stock of a corporation, provided that theinvestor has the ability to exercise significant influence over the operatingand financial policies of the investee. The issuance of EITF 02-14 hasnot had an effect on our accounting for equity investments which has been inaccordance with EITF 02-14.

In December 2004,the Financial Accounting Standards Board (FASB) published revisions to Statementof Financial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” (SFAS 123R). SFAS 123(R) requires companies to account forshare-based payment transactions with employees using a fair-value basedmethod, thereby eliminating the disclosure-only provisions of SFAS 123. Thecompany implemented SFAS 123(R) during the first quarter of fiscal year2006 under the modified prospective method. As a result, during the first ninemonths of fiscal year 2006, compensation expense 

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totaling $0.3 millionrelated to the outstanding stock options as of July 1, 2005 has beenrecognized based on the fair values of the awards previously calculated inpreparing the pro forma disclosures in accordance with the provisions of SFAS123, less adjustments for forfeitures. The adoption of SFAS 123(R) has not had a material impact on thefinancial condition or results of operations for the company.

In April 2005, theSecurities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107,“Share-Based Payments” (SAB 107) in which the SEC expressed views regarding theinteraction between SFAS 123(R) and certain SEC rules and regulationsand provide the staff’s views regarding the valuation of share-based paymentarrangements for public companies.

On October 22, 2004,the American Jobs Creation Act (AJCA) was signed into law. The AJCA includes aprovision that allows a one-time election to exclude up to 85 percent of itsforeign unrepatriated earnings. The company has determined there would be notax benefit from repatriating its foreign earnings under the provision setforth in the AJCA.

**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS.**

**Overview**

Watson Wyatt Worldwide, Inc.,including its subsidiaries, is a global consulting firm focusing on providinghuman capital and financial management consulting services. We help our clientsenhance business performance by improving their ability to attract, retain, andmotivate qualified employees. We focus on delivering value-added consultingservices that help our clients anticipate, identify and capitalize on emergingopportunities in human capital management. We also provide independentfinancial advice regarding all aspects of life assurance and general insurance,as well as investment advice to assist our clients in developing disciplinedand efficient investment strategies to meet their investment goals. Our targetmarket clients include those companies in the Fortune 1000, Pension &Investments (P&I) 1000, the FTSE 100, and locally-defined equivalentorganizations.

As leading economiesworldwide become more services-oriented, human capital and financial managementhas become increasingly important to companies and other organizations. Theheightened competition for skilled employees, unprecedented changes inworkforce demographics, regulatory changes related to compensation and retireebenefits and rising employee-related costs have increased the importance ofeffective human capital management. Insurance and investment decisions becomeincreasingly complex and important in the face of changing economies anddynamic financial markets. We help our clients address these issues bycombining our expertise in human capital and financial management withconsulting and technology, to improve the design and implementation of varioushuman resources and financial programs, including compensation, retirement,health care, insurance and investment plans.

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**General**

On July 31,2005, the company acquired substantially all of the assets and assumed mostliabilities of WWLLP (See Note 2 for additional information regarding thecompany’s business combination of WWLLP). Prior to this date, the company andWWLLP jointly offered services under the Watson Wyatt Worldwide brand, sharingresources, technologies, processes and business referrals through an allianceestablished in 1995. As of March 31, 2006 the combined company maintains93 offices in 30 countries and employs 6,000 associates as follows:

| Benefits Group                                                  |   | 2,330 |   |
|-----------------------------------------------------------------|--------|-------|--------|
| Technology and  Administration Solutions Group                  |   | 720   |   |
| Human Capital  Group                                            |   | 410   |   |
| Insurance &  Financial Services Group                  |   | 330   |   |
| Investment  Consulting Group                                    |   | 270   |   |
| International —  Comprising Asia Pacific and Latin America |   | 830   |   |
| All Other  Segments                                             |   | 550   |   |
| Corporate                                                       |   | 560   |   |
| Total                                                           |   | 6,000 |   |

 

**PrincipalServices**

We design, develop andimplement human resource and risk management strategies and programs throughthe following closely-interrelated practice areas:

**Benefits Group**

·                  Retirementplans, including pension, 401(k) and executive benefit plans

·                  Healthcare, disability and other group benefit plans

·                  Compensation,benefits, expatriate and HR practice strategy, implementation andadministration

·                  Actuarialservices

·                  Strategicworkforce planning

**Technology and AdministrationSolutions Group**

·                  Web-basedapplications for health and welfare, pension and compensation administration

·                  Administrationoutsourcing solutions for health and welfare and pension benefits

·                  Callcenter strategy, design and tools

·                  Strategichuman resource technology and service delivery consulting

·                  Targetedonline compensation and benefits statements, content management and call centercase management solutions

**HumanCapital Group**

·                  Compensationplans, including broad-based and executive compensation, stock and otherlong-term incentive programs

·                  Strategiesto align workforce performance with business objectives

·                  Organizationeffectiveness consulting, including talent management

·                  Strategiesfor attracting, retaining and motivating employees

·                  Dataservices

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**Insurance & FinancialServices Group**

·                  Independentactuarial and strategic advice

·                  Assessmentand advice regarding financial condition and risk management

·                  Financialmodeling software tools for product design and pricing, planning andprojections, reporting, valuations and risk management

**Investment Consulting Group**

·                  Investmentconsulting services to pension plans and foundations

·                  Governanceand regulatory issues

·                  Assetallocation strategies

·                  Investmentstructure analysis, selection and evaluation of managers, and performancemonitoring

**International— Comprising Asia Pacific and Latin America Operations**

Outside of North Americaand Europe, our consultants, working in Asia Pacific and Latin America, operateon a geographic basis from 25 offices in 16 countries and provide consultingservices in the practice areas described above.

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

Our clients include manyof the world’s largest corporations as well as emerging growth companies,public institutions and nonprofit organizations.

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**Executive Overview**

Watson Wyatt is a globalconsulting firm focusing on providing human capital and financial managementconsulting services. We provide services in five principal practice areas:Benefits, Technology and Administration Solutions, Human Capital Consulting,Insurance & Financial Services, and Investment Consulting operatingfrom 93 offices in 30 countries throughout North America, Europe, Asia Pacificand Latin America. We design, develop and implement human resource and riskmanagement strategies and programs through the following closely-interrelatedpractice areas:

*Benefits Group —*The BenefitsGroup, accounting for 55 percent of our total third quarter 2006 revenues, isthe foundation of our business. Retirement, the core of our Benefits business,is less impacted by discretionary spending reductions than our other segments,mainly due to the recurring nature of client relationships. Our corporateclient retention rate within our target market remains very high.

*Technology and Administration Solutions Group —*OurTechnology and Administration Solutions Group, accounting for 10 percent of our total third quarter fiscal year2006 revenues, provides information technology services to our customers.

*Human Capital Group —*Our**Human Capital Group, accounting for 8 percent of our totalthird quarter fiscal year 2006 revenues, generally encompasses short-termprojects and as a result is most sensitive to economic conditions.

*Insurance & Financial Services Group —*OurInsurance & Financial Services Group accounts for 8 percent of ourtotal third quarter fiscal year 2006 revenues. This business is characterizedby ongoing relationships with our clients who will typically use our skills ona number of different projects.

*Investment Consulting Group —*OurInvestment Consulting Group, accounts for 6 percent of our total third quarterfiscal year 2006 revenues. This business, although relationship based, can beimpacted by volatility in investment returns, particularly as clients look tous for assistance in managing that volatility.

In the short term, ourrevenues are affected by many factors including the general state of the globaleconomy and the resulting level of discretionary spending by our clients, theability of our consultants to attract new clients or cross-sell to existingclients, and the impact of new regulations in the legal and accounting fieldsthat most recently increased demand for our executive compensation and benefitspractices.

The human resourcesconsulting industry, although highly fragmented, is highly competitive and iscomprised of major human capital consulting firms, specialist firms, consultingarms of accounting firms and information technology consulting firms. While theenvironment and pricing remain competitive, we believe that with our combinedresources the company is in a position to attract new clients and better serveexisting clients.

In the long term, webelieve that compensation and benefits spending will continue to be one of thelargest components of corporate spending around the world. We believe that theaging workforce, the projected shortfall in workers over the next decade andchanging regulations will translate into business opportunities for us. Webelieve that the company’s financial results will depend in large part upon howwell we succeed in deepening our existing client relationships through thoughtleadership and focus on cross-practice solutions, actively pursuing new clientsin our target markets, cross selling and strategic acquisitions. We also forseetremendous opportunities for growth as we expand our insurance and financialservices in North America. We believe that the highly fragmented industry inwhich we operate represents tremendous growth opportunities for us, because weoffer a unique combination of benefits and human capital consulting, financialmanagement and strategic technology and administration solutions.

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**FinancialStatement Overview**

Watson Wyatt’s fiscalyear ends June 30. The unaudited financial statements contained in thisquarterly report reflect Consolidated Balance Sheets as of the end of the thirdquarter of fiscal year 2006 (March 31, 2006) and as of the end of fiscalyear 2005 (June 30, 2005), Consolidated Statements of Operations for thethree and nine-month periods ended March 31, 2006 and 2005, ConsolidatedStatements of Cash Flows for the nine-month periods ended March 31, 2006and 2005 and a Consolidated Statement of Changes in Stockholders’ Equity forthe nine-month period ended March 31, 2006.

The company’s acquisitionof substantially all of the assets and assumption of most liabilities of WWLLPwas completed July 31, 2005 and as a result, our financial statementsreflect the consolidation of the European operations through Watson WyattLimited beginning August 1, 2005. Prior to July 31, 2005, or for onemonth of the first quarter, the company recorded its share of the results ofWWLLP and WWHE using the equity method of accounting. This income is reflectedin the “Income from affiliates” line on our income statement. Our share of theresults of our affiliated captive insurance company, PCIC, continues to berecorded using the equity method of accounting, and is also reflected in the “Incomefrom affiliates” line.

Wederive substantially all of our revenue from fees for consulting services,which generally are billed based on 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. For the third quarter of fiscal year 2006, U.S.Consulting operations comprised approximately 50 percent of consolidatedrevenue. Before and after the business combination, no single client accountedfor more than 2 percent of our consolidated revenue for any of the most recentthree 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 incentive bonuses.

Professionaland subcontracted services represent fees paid to external service providers onbehalf of the company for recruiting, independent contractors, local marketingand other services. Also included in this category are expenses related toindependent contractors, printing, graphics, duplicating and postage that areincurred on behalf of our clients and are reimbursed by them, with suchreimbursements being included in revenue (reimbursable expenses). For the threemost recent fiscal years, approximately 60 to 70 percent of professional andsubcontracted services have been reimbursable expenses compared toapproximately 47 percent in the third quarter of fiscal year 2006.

Occupancy, communicationsand other expenses represent expenses for rent, utilities, supplies andtelephone to operate office locations as well as non-client-reimbursed travelby associates, publications and professional development. This line item alsoincludes miscellaneous expenses, including gains and losses on foreign currencytransactions.

General andadministrative expenses include the operational costs, professional fees andinsurance paid by corporate management, legal, marketing, human resources,finance, research and technology support.

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**CriticalAccounting Policies and Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities,disclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period. Our estimates, judgments and assumptions are continuallyevaluated based on available information and experience. Because of the use ofestimates inherent in the financial reporting process, actual results coulddiffer from those estimates. The areas that we believe are critical accountingpolicies include revenue recognition, valuation of billed and unbilledreceivables from clients, discretionary compensation, income taxes, pensionassumptions and Incurred But Not Reported claims. The critical accountingpolicies discussed below involves making difficult, subjective or complexaccounting estimates that could have a material effect on our financialcondition and results from operations. These critical accounting policiesrequire us to make assumptions about matters that are highly uncertain at thetime of the estimate or assumption and different estimates that we could haveused or changes in the estimate that are reasonably likely to occur may have amaterial impact on our financial statements and results of operations.

***RevenueRecognition***

Revenue includes feesprimarily generated from consulting services provided in the areas of employeebenefits, human capital strategies, technology and administration solutions andfinancial management. We recognize revenue from these consulting engagementswhen hours are worked, either on a time-and-materials basis or on a fixed-feebasis, depending on the terms and conditions defined at the inception of anengagement with a client. Theterms of our contracts with clients are fixed and determinable and can only bechanged based on agreement of both parties. Individual consultants’ billingrates are principally based on a multiple of salary and compensation costs.

Revenue for fixed-feearrangements, which span multiple months, is based upon the percentage ofcompletion method. The company typically has three types of fixed-feearrangements:  annual recurring projects,projects of a short duration, and non-recurring system projects. Annualrecurring projects and the projects of short duration are typicallystraightforward and highly predictable in nature. As a result, the projectmanager and financial staff generally are able to identify, as the projectstatus is reviewed and bills are prepared monthly, the rare occasion when costoverruns could lead to the recording of an unexpected loss accrual.

Our non-recurring systemprojects are typically found in our Technology and Administration SolutionsGroup. They tend to be more complex projects that are longer in duration andsubject to more changes in scope as the project progresses than projectsundertaken in other segments. We evaluate at least quarterly, and more often asneeded, project managers’ estimates-to-complete to assure that the projects’current status is accounted for properly. Contracts are written such that, in the unexpected event that theclient terminates a contract, the company is entitled to payment for servicesperformed through termination.

Revenue recognition forfixed-fee engagements is affected by a number of factors that change theestimated amount of work required to complete the project such as changes inscope, the staffing on the engagement and/or the level of client participation.The periodic engagement evaluations require us to make judgments and estimatesregarding the overall profitability and stage of project completion that, inturn, affect how we recognize revenue. The company recognizes a loss on anengagement when estimated revenue to be received for that engagement is lessthan the total estimated direct and indirect costs associated with theengagement. Losses are recognized in the period in which the loss becomesprobable and the amount of the loss is reasonably estimable. The company has experienced certain costs in excess ofestimates from time to time. Management believes that it is rare, however, forthese excess costs to result in overall project losses.

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The company has developed various software programsand technologies that we provide to clients in connection with consultingservices. In most instances, such software is hosted and maintained by thecompany and ownership of the technology and rights to the related code remainwith the company. Software developed to be utilized in providing services to aclient, but for which the client does not have the contractual right to takepossession, is capitalized in accordance with the AICPA’s Statement of Position98-1 “Accounting for the Costs of Computer Software Developed or Obtainedfor Internal Use.”  Revenue associatedwith the related contract, together with amortization of the relatedcapitalized software, is recognized over the service period. As a result, andin accordance with EITF 00-3, we do not recognize revenue during thecustomization phase of an engagement.

Revenue recognized in excess of billings is recordedas unbilled accounts receivable. Cash collections and invoices generated inexcess of revenue recognized are recorded as deferred revenue until the revenuerecognition criteria are met. Client reimbursable expenses, including those relatingto travel, other out-of-pocket expenses and any third-party costs, are includedin revenue, and an equivalent amount of reimbursable expenses are included inprofessional and subcontracted services as a cost of revenue.

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

We maintain allowances for doubtful accounts to reflect estimatedlosses resulting from our clients’ failure to pay for our services after theservices have been rendered, including allowances when customer disputes mayexist. The related provision is generally recorded as a reduction to revenue. Ourallowance policy is based on the aging of our billed and unbilled clientreceivables and has been developed based on our write-off history. Facts andcircumstances such as the average length of time the receivables are past due,general market conditions, current economic trends and our clients’ ability topay may cause fluctuations in our valuation of billed and unbilled receivables.

***DiscretionaryCompensation***

The company’s compensation program includes a discretionary annualbonus that is determined by management and paid once per fiscal year in theform of cash and/or deferred stock units after the company’s annual operatingresults are finalized.

An estimated annual bonus amount is initially developed at thebeginning of each fiscal year in conjunction with our budgeting process. Quarterly,estimated annual operating performance is reviewed by the company and thediscretionary annual bonus amount is then adjusted, if necessary, by managementto reflect changes in the forecast of pre-bonus profitability for the year.  After determining the estimated annual bonusamount, the bonus is then allocated to remaining quarterly reporting periods asa constant percentage of estimated pre-bonus profitability. In those quarterswhere the estimated annual bonus level changes, the remaining estimated annualbonus is accrued over the remaining quarters as a constant percentage ofestimated future pre-bonus profitability. Annual bonus levels may vary fromcurrent expectations as a result of changes in the company’s forecast ofpre-bonus profitability and competitive employment market conditions.

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***Income Taxes***

Determining the consolidated provision for income tax expense, deferredtax assets and liabilities and the related valuation allowance involvessignificant judgment. As a global company, we are required to calculate andprovide for estimated income tax liabilities for each of the tax jurisdictionsin which we operate. This process involves estimating current tax obligationsand exposures in each jurisdiction as well as making significant judgmentsregarding the future recoverability of deferred tax assets. The company doesnot provide deferred taxes on cumulative earnings of foreign subsidiaries thathave been reinvested indefinitely as asserted under APB 23. Due to theavailability of foreign tax credits, it is not practicable to estimate the company’sincome tax liability that might be payable if such earnings were not reinvestedindefinitely, however, deferred taxes are provided for earnings of foreignsubsidiaries which the company plans to remit. Tax costs can involve complexissues and may require an extended period to resolve. Changes in the geographicmix or estimated level of annual pre-tax income, limitations on the use of thecompany’s foreign subsidiary losses, changes in tax laws and changes resultingfrom tax audits can all affect the overall effective income tax rate which, inturn, impacts the overall level of income tax expense and net income.

***Pension Assumptions***

We sponsor both qualified and non-qualified, non-contributory definedbenefit pension plans covering substantially all of our associates. Under ourplans in North America and Hong Kong, benefits are based on the number of yearsof service and the associates’ compensation during the five highest paidconsecutive years of service. The non-qualified plan, which exists only in NorthAmerica, provides for pension benefits that would be covered under thequalified plan but are limited by the Internal Revenue Code. The non-qualifiedplan has no assets and therefore is an unfunded arrangement. The benefitliability is reflected on the balance sheet. The measurement date for the plansis June 30.

As a result of the business combination described in Note 2, we haveincluded the defined benefit pension plan disclosures for our recently combinedU.K. operations. The disclosures for this plan, along with our historical U.K.plan, are shown separately because the amounts are significant relative to allplans and the assumptions used in the plan are significantly different thanthose used in all other plans. Under our newly acquired plan in the U.K.,benefits are based on the number of years of service and the associates’compensation during the three years before leaving the plan. The measurementdate for the plan is July 31.

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 in focus. Achange in one or a combination of these assumptions could have a materialimpact on our pension benefit obligation and related expense. For this reason,management employs a long-term view so that assumptions do not changefrequently in response to short-term volatility in the economy. Any differencebetween actual and assumed results is amortized into our pension expense overthe average remaining service period of participating employees. We considerseveral factors prior to the start of each fiscal year when determining theappropriate annual assumptions, including economic forecasts, historicaltrends, portfolio composition and peer comparisons.

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*NorthAmerica and Hong Kong*

The followingassumptions were used at the end of the past three fiscal years in thevaluation of our North American plans, which comprises the majority of theNorth America and Hong Kong defined benefit pension plans:
| ** **                                   | ** ** | **Year Ended June 30** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Discount rate                                |       | 5.25%                                 |       | 6.25% |   | 6.00% |   |
| Expected  long-term rate of return on assets |       | 9.00%                                 |       | 9.00% |   | 9.00% |   |
| Rate of increase in  compensation levels     |       | 3.34%                                 |       | 3.34% |   | 3.09% |   |

 

The 5.25 percentdiscount rate assumption used at the end of fiscal year 2005 represents a 100basis point decrease from the 6.25 percent discount rate used at the end offiscal year 2004 and represents a 75 basis point reduction from the 6.00percent discount rate used at the end of fiscal year 2003. The company’s 2005discount rate assumption was determined by matching future pension benefitpayments with expected future AA bond yields for the same periods.

The expectedlong-term rate of return on assets assumption remained at 9.00 percent perannum for the past three fiscal years. The rate of return was lowered in fiscalyear 2003 to 9.00 percent from 10.00 percent at the end of fiscal year 2002. Selectionof the return assumption at 9.00 percent per annum was supported by an analysisperformed by the company of the weighted average yield expected to be achievedwith the anticipated makeup of investments. The investment makeup is heavilyweighted towards equities. The return on assets through the first nine monthsof fiscal year 2006 has been 8.7 percent, compared to a return of 4.8 percentin the first nine months of fiscal year 2005.

Thefollowing information illustrates the sensitivity to a change in certainassumptions for the U.S. pension plans:

| Change in Assumption                        | ** ** | ** **     | ** ** | **Effect on FY2006   Pre-Tax Pension Expense** | ** ** |
|-------------------------------------------------------|------------|----------------|------------|-------------------------------------------------------------------------|------------|
| 25 basis point  decrease in discount rate             |       | +$3.3  million |       |
| 25 basis point  increase in discount rate             |       | -$3.2  million |       |
| 25 basis point  decrease in expected return on assets |       | +$1.0  million |       |
| 25 basis point increase  in expected return on assets |       | -$1.0 million  |       |

 

Theabove sensitivities reflect the impact of changing one assumption at a time. Itshould be noted that economic factors and conditions often affect multipleassumptions simultaneously and the effects of changes in key assumptions arenot necessarily linear. The company’s U.S. Other Postretirement EmployeeBenefits Plan is relatively insensitive to discount rate changes due to theplan provisions that have been established to control costs and as such nosensitivity results are shown in this display.

33

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*UnitedKingdom*

The followingassumptions were used at April 30, 2005, the former WWLLP fiscal year end,and July 31, the date of the business combination and the valuation of ourU.K. plan:
| ** **                                   | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|----------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                   | ** ** | **2005**          | ** ** | **2005**           | ** ** |
| Discount rate                                |       | 5.00%             |       | 5.30%              |       |
| Expected  long-term rate of return on assets |       | 5.63%             |       | 5.76%              |       |
| Rate of increase in  compensation levels     |       | 4.75%             |       | 4.75%              |       |

 

The 5.00 percentdiscount rate assumption used at the end of July 31, 2005 represents a 30basis point reduction from the discount rate at April 30, 2005. Thediscount rate is set having regard to yields on AA corporate bonds at themeasurement date and this reduction reflects the reduction in yields betweenthese two dates.

The expectedlong-term rate of return on assets assumption was reduced slightly from April 30,2005 to July 31, 2005 and was supported by an analysis performed by thecompany of the weighted average return expected to be achieved with theanticipated makeup of investments which is heavily weighted towards bonds. Thereturn on assets through the first eight months of fiscal year 2006 has been9.8 percent.

Thefollowing information illustrates the sensitivity to a change in certainassumptions for the U.K. pension plans:

| Change in Assumption                        | ** ** | ** **     | ** ** | **Effect on FY2006   Pre-Tax Pension Expense** | ** ** |
|-------------------------------------------------------|------------|----------------|------------|-------------------------------------------------------------------------|------------|
| 25 basis point  decrease in discount rate             |       | +$1.3  million |       |
| 25 basis point  increase in discount rate             |       | -$1.2  million |       |
| 25 basis point  decrease in expected return on assets |       | +$0.5  million |       |
| 25 basis point increase  in expected return on assets |       | -$0.5 million  |       |

 

***Incurred But Not Reported Claims***

The company uses actuarial assumptions to estimate and record aliability for incurred but not reported (IBNR) professional liability claimsand engaged an external actuarial firm to assist in the calculation of theseestimates. 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. Managementdoes not currently expect significant fluctuations in the IBNR liability, basedon the company’s historical claims experience. However, our estimated IBNRliability will fluctuate if claims experience changes over time.

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**Resultsof Operations**

The table belowsets forth our Consolidated Statements of Operations data for continuingoperations for the periods indicated:

**Consolidated Statements of Operations**(in thousands)
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                                      | ** ** | ** **                                          | ** ** | **(Unaudited)** | ** ** | ** ** | ** ** |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Revenue                                                     |       | $                                                    | 343,072    |                                                | $          | 187,560 |   | 82.9 | % | $ | 924,722 |   | $ | 538,800 |   | 71.6 | % |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Costs of  providing services:                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                              |       | 191,582                                              |       | 101,730                                             |       | 88.3 |   | 514,339 |   | 294,000 |   | 74.9 |   |
| Professional and subcontracted services                     |       | 17,884                                               |       | 13,795                                              |       | 29.6 |   | 56,490 |   | 37,318 |   | 51.4 |   |
| Occupancy, communications and other                         |       | 41,689                                               |       | 27,110                                              |       | 53.8 |   | 118,229 |   | 79,111 |   | 49.4 |   |
| General and administrative expenses                         |       | 39,300                                               |       | 18,764                                              |       | 109.4 |   | 107,895 |   | 55,133 |   | 95.7 |   |
| Depreciation and amortization                               |       | 11,510                                               |       | 5,161                                               |       | 123.0 |   | 32,319 |   | 14,654 |   | 120.5 |   |
|                                                        |       | 301,965                                              |       | 166,560                                             |       |   |   | 829,272 |   | 480,216 |   |   |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  operations                                     |       | 41,107                                               |       | 21,000                                              |       |   |   | 95,450 |   | 58,584 |   |   |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  affiliates                                     |       | 310                                                  |       | 889                                                 |       | (65.1 | ) | 1,732 |   | 5,819 |   | (70.2 | ) |
| Interest income                                             |       | 1,047                                                |       | 761                                                 |       | 37.6 |   | 2,344 |   | 1,914 |   | 22.5 |   |
| Interest expense                                            |       | (1,344                                               | )          | (144                                                | )          | 833.3 |   | (3,703 | ) | (435 | ) | 751.3 |   |
| Other  non-operating income (loss)                          |       | 44                                                   |       | (1,181                                              | )          | 103.7 |   | (2,106 | ) | (1,209 | ) | (74.2 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  continuing operations before income taxes |       | 41,164                                               |       | 21,325                                              |       |   |   | 93,717 |   | 64,673 |   |   |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Provision for income  taxes                                 |       | 11,828                                               |       | 6,985                                               |       | 69.3 |   | 33,314 |   | 25,527 |   | 30.5 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  continuing operations                          |       | $                                                    | 29,336     |                                                | $          | 14,340 |   | 104.6 | % | $ | 60,403 |   | $ | 39,146 |   | 54.3 | % |

 

**Three andNine Months Ended March 31, 2006 Compared to the Three and Nine MonthsEnded March 31, 2005**

As a result of the August 1,2005 effective date of our business combination of WWLLP, the three monthsended March 31, 2006 includes the consolidated operating results of WatsonWyatt Limited, whereas the operating results for the three months ended March 31,2005 do not include comparative consolidated operating results. The nine monthsended March 31, 2006 includes the consolidated operating results of WatsonWyatt Limited for the months of August 2005 through March 2006,whereas the operating results for the nine months ended March 31, 2005 donot include comparative consolidated results. The analysis below highlights thechanges between the Consolidated Statements of Operations for the three andnine months ended March 31, 2006 and 2005 and segregates the effects ofthe business combination from the company’s results without the impact ofWatson Wyatt Limited’s consolidated results (the historical company).

35

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***Revenue.***

Revenuefrom operations for the third quarter of fiscal year 2006 was $343.1 million,an increase of $155.5 million, or 83 percent, from $187.6 million in the priorperiod. Of the increase, $143.5 million is attributable to the business combination.The remaining increase of $12.0 million relates to the historical company.

·                  The Benefits Group increased revenues $8.5million, or 8 percent over prior-year third quarter revenues, related toincreased demand from existing clients around plan design and administration aswell as revenues from new clients.

·                  Revenue from our Technology andAdministration Solutions Group increased $2.1 million or 12 percent as comparedto prior-year third quarter revenues, largely due to a number of projects whichwent into service during the quarter and for which the company was able tobegin recognizing revenues. In accordance with EITF 00-3, “Application ofAICPA Statement of Position 97-2 to Arrangements that Include the Rightto Use Software Stored on Another Entity’s Hardware” (EITF 00-3), revenuefor certain contracts for which the company provides a hosting arrangement isrecognized over the hosting period.

·                  Revenue from our Human Capital Groupincreased $3.2 million during the third quarter of fiscal year 2006, primarilydue to the $3.0 million reclassification of Watson Wyatt Data Servicesrevenues, as well as continuing demand for executive compensation consulting.

·                  Revenue from our Insurance and FinancialServices Group was $27.8 million during the third quarter of fiscal year 2006. Thereis no prior year comparable figure as this segment was aquired through thebusiness combination.

·                  Revenue from our Investment Consultingpractice was up $1.2 million or 23 percent due to an increase in pension fundingand asset performance consulting.

·                  Our International segment, comprisingAsia-Pacific and Latin America, finished the quarter with revenue growth of$1.6 million or 7 percent. Revenue growth excluding the New Zealand divestiturein the first quarter of fiscal year 2006 was 13% due primarily to strong demandin Australia, Korea, Mexico, and Brazil.

Revenuefrom operations for the first nine months of fiscal year 2006 was $924.7million, an increase of $385.9 million, or 72 percent, from $538.8 million inthe prior period. Of the increase, $343.7 million is attributable to thebusiness combination. The remaining increase of $42.2 million relates to thehistorical company.

·                  The Benefits Group increased revenues $28.6million, or 9 percent during the first nine months of fiscal year 2006revenues, related to new client wins that occurred in the prior year andincreasing demand for plan design work.

·                  Revenue from our Technology andAdministration Solutions Group increased $2.4 million as compared to the firstnine months of fiscal year 2005, largely due to a number of projects which wentinto service during the nine months and for which the company was able to beginrecognizing revenues. In accordance with EITF 00-3, “Application of AICPAStatement of Position 97-2 to Arrangements that Include the Right to UseSoftware Stored on Another Entity’s Hardware” (EITF 00-3), revenue forcertain contracts for which the company provides a hosting arrangement isrecognized over the hosting period.

36

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·                  Revenue from our Human Capital Groupincreased $12.5 million partially due to the $9.5 million reclassification ofWatson Wyatt Data Services revenues, as well as continuing demand for executive compensation consulting.

·                  Revenue from our Investment Consultingpractice was up $2.7 million or 20 percent due to an increase in pensionfunding and asset performance consulting.

·                  Our International segment, comprising AsiaPacific and Latin America, had revenue growth of $2.8 million or 4 percentduring the first nine months of fiscal 2006.

***Salaries and Employee Benefits*.**

Salaries and employeebenefit expenses for the third quarter of fiscal year 2006 were $191.6 millioncompared to $101.7 million for the third quarter of fiscal year 2005, anincrease of $89.9 million or 88 percent. The increase was mainly due toadditional salary and benefit expenses of $79.7 million related to the businesscombination. The increase in the historical company was due to higher salariesof $7.6 million, increased pension costs of $3.1 million, a higher accrual fordiscretionary compensation of $1.7 million and higher other benefits of $1.0million, partially offset by the increased capitalization of time spentcustomizing in-house administration systems of $3.3 million, in accordance withAICPA’s Statement of Position 98-1, “Accounting for the Costs of ComputerSoftware Developed or Obtained for Internal Use.”  As a percentage of revenue, salaries andemployee benefits increased to 55.8 percent from 54.2 percent.

Salaries and employeebenefit expenses for the first nine months of fiscal year 2006 were $514.3million compared to $294.0 million for the first nine months of fiscal year2005, an increase of $220.3 million or 75 percent. The increase was mainly dueto additional salary and benefit expenses of $198.8 million related to thebusiness combination. The increase in the historical company was due to highersalaries of $16.2 million, increased pension costs of $9.3 million, a higheraccrual for discretionary compensation of $5.1 million and higher otherbenefits of $3.1 million including profit sharing and the re-instatement of the401(k) match, partially offset by the increased capitalization of timespent customizing in-house administration systems of $12.5 million, inaccordance with AICPA’s Statement of Position 98-1, “Accounting for theCosts of Computer Software Developed or Obtained for Internal Use.”  As a percentage of revenue, salaries andemployee benefits increased to 55.6 percent from 54.6 percent.

***Professional and SubcontractedServices*.**

Professional andsubcontracted services used in consulting operations for the third quarter offiscal year 2006 were $17.9 million, compared to $13.8 million for the thirdquarter of fiscal year 2005, an increase of $4.1 million or 30 percent. The increasewas partially due to additional professional and subcontracted service expensesof $2.7 million related to the business combination. The increase in thehistorical company was attributable to $1.1 million higher reimbursableexpenses incurred on behalf of clients as well as a $0.2 million increase inlegal expense. As a percentage of revenue, professional and subcontractedservices decreased from 7.4 percent to 5.2 percent.

Professional andsubcontracted services used in consulting operations for the first nine monthsof fiscal year 2006 were $56.5 million, compared to $37.3 million for the firstnine months of fiscal year 2005, an increase of $19.2 million or 51 percent. Theincrease was mainly due to additional professional and subcontracted service expensesof $8.7 million related to the business combination. The increase in thehistorical company was attributable to $7.1 million higher reimbursableexpenses incurred on behalf of clients as well as $3.4 million of legalexpense. As a percentage of revenue, professional and subcontracted servicesdecreased from 6.9 percent to 6.1 percent.

37

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***Occupancy, Communications andOther.***

Occupancy, communicationsand other expenses for the third quarter of fiscal year 2006 were $41.7 millioncompared to $27.1 million for the third quarter of fiscal year 2005, anincrease of $14.6 million or 54 percent. The increase is mainly due toadditional occupancy, communication and other expenses of $13.9 million relatedto the business combination. The increase of $0.6 million associated with thehistorical company was principally attributable to miscellaneous expenses suchas travel, dues and entertainment, and effects of foreign exchange, offset by adecrease in rent expense. As a percentage of revenue, occupancy, communicationsand other decreased from 14.5 percent to 12.2 percent.

Occupancy, communicationsand other expenses for the first nine months of fiscal year 2006 were $118.2million compared to $79.1 million for the first nine months of fiscal year2005, an increase of $39.1 million or 49 percent. The increase was mainly dueto additional occupancy, communication, and other expenses of $34.8 millionrelated to the business combination. The increase of $4.3 million associatedwith the historical company was principally attributable to miscellaneousexpenses such as travel, repairs and maintenance, dues and entertainment,foreign exchange, and general office expenses, offset by decreases in equipmentrental, rent expenses, telephone and publications. As a percentage of revenue,occupancy, communications and other decreased from 14.7 percent to 12.8percent.

***General and AdministrativeExpenses.***

General andadministrative expenses for the third quarter of fiscal year 2006 were $39.3million, compared to $18.8 million for the third quarter of fiscal year 2005,an increase of $20.5 million or 109 percent. The increase is mainly due toadditional general and administrative expenses of $19.2 million related to thebusiness combination. The increase of $1.3 million in the historical company ismainly due to increased salaries and benefits of $1.0 million, an increase intravel, insurance, and telephone expenses of $0.6 million offset by decreasedrent expense of $0.3 million. As a percentage of revenue, general andadministrative expense increased from 10.0 percent to 11.4 percent.

General andadministrative expenses for the first nine months of fiscal year 2006 were$107.9 million, compared to $55.1 million for the first nine months of fiscalyear 2005, an increase of $52.8 million or 96 percent. The increase is mainlydue to additional general and administrative expenses of $51.0 million relatedto the business combination. The increase of $1.8 million in the historicalcompany is mainly due to higher salaries and benefits of $2.7 million andhigher travel and insurance expense of $0.6 million offset by a decrease inrent and publication costs of $0.7 million and a decrease in general officeexpenses of $0.8 million. As a percentage of revenue, general andadministrative expense increased from 10.2 percent to 11.7 percent.

***Depreciation and Amortization.***

Depreciation andamortization for the third quarter of fiscal year 2006 was $11.5 million,compared to $5.2 million for the third quarter of fiscal year 2005, an increaseof $6.3 million or 121 percent. The increase is due to additional depreciationand amortization expense of $4.0 million related to the business combination,which includes $2.1 million in amortization of intangible assets established inconjunction with the business combination, and a $2.3 million increase in thehistorical company expense due to depreciation of internally developed softwareused to support our Benefits Group and Technology and Administration SolutionsGroup. As a percentage of revenue, depreciation and amortization increased from2.8 percent to 3.4 percent.

Depreciation andamortization for the first nine months of fiscal year 2006 was $32.3 million,compared to $14.7 million for the first nine months of fiscal year 2005, anincrease of $17.6 million or 120 percent. The increase is due to additionaldepreciation and amortization expense of $11.2 million related to the businesscombination and a $6.4 million increase in the historical company expense dueto depreciation of internally developed software used to support our BenefitsGroup and Technology and Administration Solutions Group. As a percentage ofrevenue, depreciation and amortization increased from 2.7 percent to 3.5percent.

38

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***Income From Affiliates.***

Income from affiliatesfor the third quarter of fiscal year 2006 was $0.3 million, compared to $0.9million for the third quarter of fiscal year 2005, a decrease of $0.6 million. Incomefrom affiliates for the first nine months of fiscal year 2006 was $1.7 million,compared to $5.8 million for the first nine months of fiscal year 2005, adecrease of $4.1 million. The decrease in both periods was due to the absenceof income from affiliates related to the business combination in the firstquarter of fiscal year 2006.

***Interest Income.***

Interest income for thethird quarter of fiscal year 2006 was $1.0 million, compared to interest incomeof $0.8 million for the third quarter of fiscal year 2005. Interest income forthe first nine months of fiscal year 2006 was $2.3 million, compared to $1.9million for the first nine months of fiscal year 2005, an increase of $0.4million. The increase relates to higher returns on the investment of cashbalances caused by rising short-term interest rates.

***Interest Expense.***

Interest expense for thethird quarter of fiscal year 2006 was $1.3 million, compared to $0.1 millionfor the third quarter of fiscal year 2005. Interest expense for the first ninemonths of fiscal year 2006 was $3.7 million, compared to $0.4 million for thefirst nine months of fiscal year 2005, an increase of $3.3 million. Theincrease in both periods was due to debt incurred as a result of the businesscombination.

***Other Non-Operating Loss.***

Other non-operating loss for the first nine months of fiscalyear 2006 includes a loss of $3.6 million on a foreign exchange forwardcontract entered into in conjunction with the business combination, partiallyoffset by a $1.4 million gain recognized by the company on the sale of its NewZealand operations.

***Provision for Income Taxes.***

Provision for incometaxes for the first nine months of fiscal year 2006 was $33.3 million, comparedto $25.5 million for the first nine months of fiscal year 2005. Our effectivetax rate was 35.5 percent for the first nine months of fiscal year 2006 and39.5 percent for the first nine months of fiscal year 2005. The tax ratedecrease is due to the geographic mix of income and reductions in tax reservesdue to the expiration of certain statutes of limitations. The company has notprovided U.S. deferred taxes on cumulative earnings of foreign subsidiariesthat have been reinvested indefinitely, which also includes foreignsubsidiaries affiliated with our recent business combination. We record a tax benefit on foreign net operatingloss carryovers and foreign deferred expenses only if it is more likely thannot that a benefit will be realized.

***Income From ContinuingOperations.***

Income from continuingoperations for the third quarter of fiscal year 2006 was $29.3 million,compared to $14.3 million for the third quarter of fiscal year 2005. As apercentage of revenue, income from continuing operations increased from 7.6percent to 8.6 percent. Income from continuing operations for the first ninemonths of fiscal year 2006 was $60.4 million, compared to $39.1 million for thefirst nine months of fiscal year 2005. As a percentage of revenue, income fromcontinuing operations decreased from 7.3 percent to 6.5 percent.

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

Diluted earnings pershare, income from continuing operations for the third quarter of fiscal year2006 was $0.69, compared to $0.44 for the third quarter of fiscal year 2005. Dilutedearnings per share, income from continuing operations for the first nine monthsof fiscal year 2006 was $1.46, compared to $1.19 for the first nine months of fiscal year 2005.

39

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***Discontinued Operations.***

The company received sublease income through the firstnine months of fiscal year 2006 of approximately $27,000, net of taxes, inexcess of lease payments related to Wellspring, compared to $17,000, net oftaxes, in the prior period.

Also, discontinued operationsfor the third quarter of fiscal years 2006 and 2005 reflect the reduction ofthe company’s accrual for the estimated remaining future obligations and costsrelated to the exit from Wellspring by $1.75 million and $1.25 million,respectively, less the associated income tax expenses. See Note 14 of the Notesto the Consolidated Financial Statements for more information related toWellspring.

**Pro FormaAnalysis**

For a more meaningfulcomparison of financial results, the following table presents the company’sunaudited financial results for the three months ended March 31, 2006 andthe unaudited pro forma results for the nine months ended March 31, 2006compared with the unaudited pro forma results for the three and nine monthsended March 31, 2005 as if the combination and consolidation had occurredat the beginning of each period.

In our opinion,information for the nine months ended March 31, 2006 and the pro formaresults for the nine months ended March 31, 2005 contain all adjustments,consisting only of normal recurring adjustments necessary to fairly presentthis information. Operating results for any period are not necessarilyindicative of results for any future periods. The unaudited pro forma combinedincome statement is presented for illustrative purposes only and is notindicative of the results of operations that might have occurred had thecombination actually taken place as of the dates specified, or that may beexpected to occur in the future.

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**Pro-Forma Combined Statements of Operations**(in thousands, except per share data)
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                                      | ** ** | ** **                                          | ** ** | **(Unaudited)** | ** ** | ** ** | ** ** |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Revenue                                                     |       | $                                                    | 343,072    |                                                | $          | 306,661 |   | 11.9 | % | $ | 961,641 |   | $ | 891,233 |   | 7.9 | % |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Costs of providing  services:                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                              |       | 191,582                                              |       | 176,762                                             |       | 8.4 |   | 538,379 |   | 505,098 |   | 6.6 |   |
| Professional and subcontracted services                     |       | 17,884                                               |       | 17,804                                              |       | 0.4 |   | 57,681 |   | 50,340 |   | 14.6 |   |
| Occupancy, communications and other                         |       | 41,689                                               |       | 39,618                                              |       | 5.2 |   | 121,420 |   | 114,442 |   | 6.1 |   |
| General and administrative expenses                         |       | 39,300                                               |       | 35,934                                              |       | 9.4 |   | 114,493 |   | 109,808 |   | 4.3 |   |
| Depreciation and amortization                               |       | 11,510                                               |       | 10,081                                              |       | 14.2 |   | 33,744 |   | 28,646 |   | 17.8 |   |
|                                                        |       | 301,965                                              |       | 280,199                                             |       | 7.8 |   | 865,717 |   | 808,334 |   | 7.1 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  operations                                     |       | 41,107                                               |       | 26,462                                              |       | 55.3 |   | 95,924 |   | 82,899 |   | 15.7 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income (loss)  from affiliates                              |       | 310                                                  |       | (1,306                                              | )          | 123.7 |   | 1,244 |   | (261 | ) | 576.6 |   |
| Interest expense,  net                                      |       | (297                                                 | )          | (865                                                | )          | (65.7 | ) | (1,772 | ) | (2,519 | ) | (29.7 | ) |
| Other  non-operating income (loss)                          |       | 44                                                   |       | (1,198                                              | )          | 103.7 |   | 1,496 |   | (1,226 | ) | 222.0 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from  continuing operations before income taxes |       | 41,164                                               |       | 23,093                                              |       | 78.3 |   | 96,892 |   | 78,893 |   | 22.8 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Provision for income  taxes                                 |       | 11,828                                               |       | 8,263                                               |       | 43.1 |   | 34,610 |   | 27,989 |   | 23.7 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Income from continuing  operations                          |       | $                                                    | 29,336     |                                                | $          | 14,830 |   | 97.8 | % | $ | 62,282 |   | $ | 50,904 |   | 22.4 | % |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Basic earnings  per share:                                  |       | $                                                    | 0.69       |                                                | $          | 0.36 |   |   |   | $ | 1.52 |   | $ | 1.22 |   |   |   |
| Diluted earnings  per share:                                |       | $                                                    | 0.69       |                                                | $          | 0.35 |   |   |   | $ | 1.51 |   | $ | 1.21 |   |   |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Weighted average shares  of common stock, basic (000)       |       | 42,234                                               |       | 41,737                                              |       |   |   | 41,074 |   | 41,597 |   |   |   |
| Weighted average  shares of common stock, diluted (000)     |       | 42,466                                               |       | 42,026                                              |       |   |   | 41,341 |   | 41,904 |   |   |   |

 

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**Pro FormaThree and Nine Months Ended March 31, 2006 Compared to the Three and NineMonths Ended March 31, 2005**

***  Revenue***

Pro forma revenue for thethird quarter of fiscal year 2006 was $343.1 million, an increase of 12 percentor $36.4 million from $306.7 million in the prior period.

·                  The Benefits Group increased revenue $21.1million or 13 percent during the third quarter of fiscal year 2006, primarilydue to the impact of regulatory changes in the U.K., some of which impacted ourclients later than expected. The Group also benefited from new client wins thatoccurred in the prior year and increasing demand for plan design work.

·                  Revenue from our Technology andAdministration Solutions Group increased $3.7 million or 12 percent as comparedto prior-year pro forma third quarter revenues, largely due to the projectswhich went into service during the quarter and for which the company was ableto begin recognizing revenues as well as continued growth of the Europeanadministration operations. As of March 31, 2006, the company had 44projects in implementation and 39 in the service delivery phase, for a total of83 projects.  This compares to 51projects in implementation and 25 in the service delivery phase, or 76 totalprojects, as of December 31, 2005. In accordance with EITF 00-3, “Applicationof AICPA Statement of Position 97-2 to Arrangements that Include theRight to Use Software Stored on Another Entity’s Hardware” (EITF 00-3),revenue for certain contracts for which the company provides a hostingarrangement is recognized over the hosting period.

·                  Revenue from our Human Capital Groupincreased $4.8 million or 21 percent during the third quarter of fiscal year2006, partially due to the reclassification of Watson Wyatt Data Services  (WWDS) revenues, as well as continuing demandfor executive compensation consulting. Excluding the reclassification of WWDS,revenue grew 8%.

·                  Revenue from our Insurance &Financial Services Group was up $4.2 million or 18 percent, due to continuingwork around legislative changes and expansion of our operations in Amsterdam.

·                  Revenue from our Investment Consulting Group wasup $2.8 million or 15 percent due to an increase in demand for investmentstrategy and fund manager selection services.

·                  Our International segment, comprisingAsia-Pacific and Latin America, finished the quarter with revenue growth of$1.6 million or 7 percent. Results were strong in Australia and were partiallyoffset by the company’s divestiture from New Zealand in the first quarter offiscal year 2006.

Pro forma revenue for thefirst nine months of fiscal year 2006 was $961.6 million, an increase of 8percent or $70.4 million from $891.2 million in the prior period.

·                  The Benefits Group increased revenue $40.0million or 9 percent during the first nine months of fiscal year 2006,primarily due to the impact of regulatory changes in the U.K., some of whichimpacted our clients later than expected. The Group also benefited from newclient wins that occurred in the prior year and increasing demand for plandesign work.

·                  Revenue from our Technology andAdministration Solutions Group increased $4.6 million or 5 percent as comparedto prior-year pro forma revenues for the first nine months, largely due to anumber of projects which went into service during the period and for which thecompany was able to begin recognizing revenues as well as continued growth ofthe European administration operations. As of March 31, 2006, the companyhad 44 projects in implementation and 39 in the 

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                        service delivery phase, for a total of 83 projects.  This compares to 16 projects in implementationand 7 in the service delivery phase, or 23 total projects, as of March 31,2005. In accordance with EITF 00-3, “Application of AICPA Statement ofPosition 97-2 to Arrangements that Include the Right to Use SoftwareStored on Another Entity’s Hardware” (EITF 00-3), revenue for certaincontracts for which the company provides a hosting arrangement is recognizedover the hosting period.

·                  Revenue from our Human Capital Groupincreased $12.7 million or 19 percent during the first nine months of fiscalyear 2006, partially due to the reclassification of Watson Wyatt Data Servicesrevenues, as well as continuing demand for executive compensation consulting.

·                  Revenue from our Insurance &Financial Services Group was up $8.1 million or 14 percent, due to continuingwork around legislative changes and expansion of our operations in Amsterdam.

·                  Revenue from our Investment Consulting Group wasup $4.9 million or 10 percent due to an increase in demand for investmentstrategy and fund manager selection services.

·                  Our International segment, comprisingAsia-Pacific and Latin America, had revenue growth of $2.7 million or 4 percentduring the first nine months of fiscal year 2006, reflecting growth inAustralia, Taiwan and China offset in part by the divestiture of our NewZealand business in the first quarter of fiscal year 2006.

***  Salaries and Employee Benefits*.**

Salaries and employeebenefit expenses for the third quarter of fiscal year 2006 were $191.6 million,compared to $176.8 million for the third quarter of fiscal year 2005, anincrease of $14.8 million or 8 percent. The increase was mainly due to highersalaries of $8.3 million, increased pension and post-retirement costs of $3.0million, a higher accrual for discretionary compensation of $6.2 million,partially offset by a decrease for the capitalization of time spent customizingin-house administration systems of $3.3 million, in accordance with AICPA’sStatement of Position 98-1, “Accounting for the Costs of ComputerSoftware Developed or Obtained for Internal Use.”  As a percentage of revenue, salaries andemployee benefits decreased from 57.6 percent to 55.8 percent.

Salaries and employeebenefit expenses for the first nine months of fiscal year 2006 were $538.4million, compared to $505.1 million for the first nine months of fiscal year2005, an increase of $33.3 million or 7 percent.  The increase was mainly due to higher salariesof $21.7 million, a higher accrual for discretionary compensation of $12.5 million,increased pension and post-retirement costs of $4.6 million, and increasedother benefits of $3.4 million, partially offset by the capitalization of timespent customizing in-house administration systems of $12.5 million, inaccordance with AICPA’s Statement of Position 98-1, “Accounting for theCosts of Computer Software Developed or Obtained for Internal Use.”  As a percentage of revenue, salaries andemployee benefits decreased from 57.0 percent to 56.0 percent.

***  Professional and Subcontracted Services*.**

Professional andsubcontracted services used in consulting operations were at $17.9 million forthe third quarter of fiscal year 2006 and $17.8 million for the thirdquarter of fiscal year 2005. Professional and subcontracted services used inconsulting operations for the first nine months of fiscal year 2006 were $57.7 million,compared to $50.3 million for the first nine months of fiscal year 2005, an increaseof $7.4 million or 15 percent. As a percentage of year to date revenue,professional and subcontracted services increased from 5.6 percent to 6.0percent. For both periods the increase is principally attributable to higherreimbursable expenses incurred on behalf of clients, as well as increasedrecruiting fees and temporary staff.

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

Occupancy, communicationsand other expenses for the third quarter of fiscal year 2006 were $41.7 millioncompared to $39.6 million for the third quarter of fiscal year 2005, anincrease of $2.1 million or 5 percent. The increase is principally attributableto miscellaneous expenses such as travel, repairs and maintenance, and dues andentertainment expenses partially offset by a decrease in rent and utilities. Asa percentage of revenue, occupancy, communications and other decreased from 12.9percent to 12.2 percent.

Occupancy, communicationsand other expenses for the first nine months of fiscal year 2006 were $121.4million compared to $114.4 million for the first nine months of fiscal year2005, an increase of $7.0 million or 6 percent. The increase is principallyattributable to miscellaneous expenses such as travel, repairs and maintenance,general office, and dues partially offset by a decrease in rent and utilities. Asa percentage of revenue, occupancy, communications and other decreased from12.8 percent to 12.6 percent.

***  General and Administrative Expenses.***

General andadministrative expenses for the third quarter of fiscal year 2006 were $39.3million, compared to $35.9 million for the third quarter of fiscal year 2005,an increase of $3.4 million or 9 percent. The increase is mainly due tosalaries and benefits of $4.0 million, professional services fees of $1.1million offset by decreases in general office, promotion, publications,equipment rental, travel, and technology expenses of $1.7 million. As apercentage of revenue, general and administrative expense decreased from 11.7percent to 11.4 percent.

General and administrativeexpenses for the first nine months of fiscal year 2006 were $114.5 million,compared to $109.8 million for the first nine months of fiscal year 2005, anincrease of $4.7 million or 4 percent. The increase is mainly due to increasedsalaries and benefits of $6.8 million and increased professional serviceexpenses of $1.1 million offset by a decrease of $1.6 million in technologyservices and a decrease in general office, travel, equipment rental, andpublications expense of $1.6 million. As a percentage of revenue, general andadministrative expense decreased from 12.3 percent to 11.9 percent.

***  Depreciation and Amortization.***

Depreciation andamortization for the third quarter of fiscal year 2006 was $11.5 million,compared to $10.1 million for the third quarter of fiscal year 2005, anincrease of $1.4 million or 14 percent. As a percentage of revenue,depreciation and amortization increased from 3.3 percent to 3.4 percent.

Depreciation andamortization for the first nine months of fiscal year 2006 was $33.7 million,compared to $28.6 million for the first nine months of fiscal year 2005, anincrease of $5.1 million or 18 percent.  As a percentage of revenue, depreciation andamortization increased from 3.2 percent to 3.5 percent. For both periods the increaseis mainly due to depreciation on internally developed software used to supportour Benefits and Technology and Administration Solutions Groups.

***  Income From Affiliates.***

Income from affiliatesfor the third quarter of fiscal year 2006 was $0.3 million, compared to a lossof $1.3 million for the third quarter of fiscal year 2005, a decrease of $1.6 million.Income from affiliates for the first nine months of fiscal year 2006 was $1.2million, compared to a loss of $0.3 million for the first nine months of fiscalyear 2005, an increase of $1.5 million. The change in both periods relates toour share of operating results of PCIC.

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***  Interest Expense, Net.***

Interest expense, net forthe third quarter of fiscal year 2006 was $0.3 million, compared to $0.9 millionfor the third quarter of fiscal year 2005. Interest expense, net for the firstnine months of fiscal year 2006 was $1.8 million, compared to $2.5 million forthe first nine months of fiscal year 2005.  The net expense in both periods was due todebt incurred as a result of the business combination net of interest incomeearned on remaining cash balances.

***  Other Non-operating Expenses.***

Other non-operating expenses in the first nine months offiscal year 2006 includes a $1.4 million gain recognized by the company on thesale of its New Zealand operations.

***  Provision for Income Taxes.***

Provision for incometaxes for the first nine months of fiscal year 2006 was $34.6 million, comparedto $28.0 million for the first nine months of fiscal year 2005. Our effectivetax rate was 35.7 for the first nine months of fiscal year 2006 and 35.5for the first nine months of fiscal year 2005. The tax rate increase is due tothe geographic mix of income and reductions in tax reserves due to theexpiration of certain statutes of limitations. The company has not providedU.S. deferred taxes on cumulative earnings of foreign subsidiaries that havebeen reinvested indefinitely, which also includes foreign subsidiariesaffiliated with our recent  businesscombination. We record a tax benefit on foreign net operating loss carryoversand foreign deferred expenses only if it is more likely than not that a benefitwill be realized.

***  Income From Continuing Operations.***

Income from continuingoperations for the third quarter of fiscal year 2006 was $29.3 million,compared to $14.8 million for the third quarter of fiscal year 2005. As apercentage of revenue, income from continuing operations increased from 4.8percent to 8.6 percent. Income from continuing operations for the first ninemonths of fiscal year 2006 was $62.3 million, compared to $50.9 million for thefirst nine months of fiscal year 2005. As a percentage of revenue, income fromcontinuing operations increased from 5.7 percent to 6.5 percent.

***  Earnings Per Share, Income From ContinuingOperations.***

Diluted earnings pershare, income from continuing operations for the third quarter of fiscal year2006 was $0.69, compared to $0.35 for the third quarter of fiscal year 2005. Dilutedearnings per share, income from continuing operations for the first nine monthsof fiscal year 2006 was $1.51, compared to $1.21 for the first nine months offiscal year 2005.

***  Discontinued Operations.***

The company receivedsublease income through the first nine months of fiscal year 2006 ofapproximately $27,000, net of taxes, in excess of lease payments related toWellspring, compared to $17,000, net of taxes, in the prior period.

**Liquidityand Capital Resources**

The followinganalysis is based on the company’s historical consolidated financialstatements.

Our cash and cashequivalents at March 31, 2006, totaled $92.7 million, compared to $168.1million at June 30, 2005. The decrease in cash from June 30, 2005 to March 31,2006 was mainly attributable to our business combination of WWLLP (see Note 2of Notes to the Consolidated Financial Statements), representing a cash use ofapproximately $130 million. Cash flows from July 1, 2005 through March 31,2006 also reflects a typical pattern of cash flow for the company due to thepayment of previously accrued 

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discretionarycompensation which totaled $73.7 million during the first nine months of fiscalyear 2006. We also repaid $57 million of borrowings under our credit facilityduring the first nine months of fiscal year 2006, paid $29.9 million of accruedbonuses in accordance with the WWLLP purchase agreement, spent $24.2 million incapital expenditures and paid $9.5 million in dividends during the first ninemonths of fiscal year 2006. Subsequent to March 31, 2006, we paid anadditional $15.0 million of borrowings under our credit facility. Theseoutflows of cash were funded by cash flow from current consulting operations,from existing cash balances and from borrowings under our revolving creditfacility. Consistent with the company’s liquidity position, managementconsiders various alternative strategic uses of cash reserves including stockbuybacks, dividends and acquisitions, or any combination of these options. Thecompany believes that it has sufficient resources to fund operations throughthe next twelve months.

Our non U.S. operationsare substantially self-sufficient for their working capital needs. At March 31,2006, $60.5 million of the total cash balance of $92.7 million was held outsideof North America, which we have the ability to utilize, if necessary. There areno significant repatriation restrictions other than local or U.S. taxesassociated with repatriation.

***  Cash From Operating Activities.***

Cash from operatingactivities for the first nine months of fiscal year 2006 was $65.0 million,compared to cash from operating activities of $2.8 million for the first ninemonths of fiscal year 2005. The increase in cash is primarily due to anincrease in cash from operations as well as to the timing of income taxpayments and accruals.

The allowance fordoubtful accounts increased $2.1 million and the allowance for work in processincreased $7.0 million from June 30, 2005, to March 31, 2006, whichis mainly due to the business combination in the first quarter. The number ofdays of accounts receivable and work in process outstanding was 83 at March 31,2006, compared to 80 at June 30, 2005.

***  CashUsed in Investing Activities.***

Cash used in investingactivities for the first nine months of fiscal year 2006 was $176.0 million,compared to $9.5 million used in investing activities for the first nine monthsof fiscal year 2005. The difference can be primarily attributed to the businesscombination and contingent consideration payments of $132.8 million, higherpurchases of fixed assets of $4.0 million and higher costs associated with thecapitalization of time spent customizing in-house administration systems of$11.6 million, in accordance with AICPA’s Statement of Position 98-1.

***  Cash From (Used in) Financing Activities.***

Cash from financingactivities for the first nine months of fiscal year 2006 was $32.3 million,compared to cash used in financing activities of $3.5 million for the firstnine months of fiscal year 2005. The increase can be attributed to $102.0million of borrowings related to the business combination, net of repayments of$57.0 million, offset by $8.4 million recognized under the forward contractdiscussed in Note 2 of the Notes to the Consolidated Financial Statements, and$2.2 million in higher dividends paid during the first nine months of fiscalyear 2006.

Capital expenditures were$45 million for the first nine months of fiscal year 2006. Anticipatedcommitments of capital expenditures are estimated at $15 million for theremainder of fiscal year 2006, mainly for dividends, computer hardwarepurchases, office relocations and renovations, development and upgrade offinancial and retirement systems and business combination-related payments. Weexpect cash from operations to adequately provide for these cash needs. Thecompany anticipates that commitments of capital funds over the next twelvemonths will include approximately $13 million in dividends and $50 million inpurchases of fixed assets.

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**Off-BalanceSheet Arrangements and Contractual Obligations**

The followingtable shows the company’s approximate contractual obligations, includinginterest, and commitments to make future payments as of March 31, 2006: 
| ** **                                                          | ** ** | **Remaining payments by fiscal year due as of March 31, 2006** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|
| **Contractual Cash Obligations (in thousands)** | ** ** | ** **                                                                                                       | ** ** | **Total** | ** ** | **Remaining  2006** | ** ** | **2007  through  2008** | ** ** | **2009  through  2010** | ** ** | **Thereafter** | ** ** |
| Lease  commitments                                                  |       | $                                                                                                                | 373,936    |   | $ | 13,443 |   | $ | 101,663 |   | $ | 83,908 |   | $ | 174,922 |   |
| Revolving Credit  Facility                                          |       | 46,950                                                                                                           |       | 450 |   | 46,500 |   | 0 |   | 0 |   |
| Total                                                               |       | $                                                                                                                | 420,886    |   | $ | 13,893 |   | $ | 148,163 |   | $ | 83,908 |   | $ | 174,922 |   |
|                                                                     |            |                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

***Guarantees***

*Wellspring Leases*.The company continues to guarantee certain leases for office premises andequipment for Wellspring. At March 31, 2006, minimum remaining paymentsguaranteed under these leases, which expire at various dates through 2007,totaled $6.6 million, excluding anticipated sublease income. See Notes 12 and14 of the Notes to the Consolidated Financial Statements for more informationrelated to Wellspring.

*Business Combination*.On July 31, 2005, the companyacquired substantially all the assets and assumed most liabilities of WWLLP,the company’s long-time alliance partner. The company entered into indemnityarrangements with WWLLP relating to the business combination and also agreedthat certain indemnity obligations relating to the alliance arrangements willcontinue after the business combination. In the business combination agreement,Watson Wyatt Limited, the company’s principal U.K. subsidiary, has agreed toindemnify WWLLP against liabilities arising with respect to certain liabilitiesassumed in the business combination by Watson Wyatt Limited and also withrespect to certain tax liabilities.

Aspart of the original alliance arrangements in 1995, the company sold itsthen-existing businesses in the U.K. and Europe to the predecessor of WWLLP orits subsidiaries. The company agreed to indemnify the buyers againstliabilities arising with respect to prior acts or omissions of the businessestransferred. Furthermore, the company agreed to indemnify WWLLP againstliabilities arising with respect to acts or omissions of the company and itssubsidiaries during the alliance arrangements. These indemnities continuefollowing the business combination.

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Thecompany is unable to estimate an amount of any potential future payments underthese arrangements because the occurrence of any of the events to which theindemnities apply is entirely speculative and the amount of any payment woulddepend upon the nature of the event triggering such indemnity. Managementbelieves that any potential for payment under such indemnities should declinewith the passage of time. The company has insurance to cover liabilitiesarising from acts or omissions by the company and its subsidiaries, and suchinsurance may cover some or all of its indemnity obligations relating to prioracts or omissions. Except for such insurance, there are no provisions forrecourse to third parties, nor are any assets held by any third parties thatthe company as indemnitor can liquidate to recover amounts paid under suchindemnities.

Inconnection with our business combination, the payment of an additional1,950,000 shares of the company’s common stock to WWLLP after June 30,2007 is contingent upon the achievement by the acquired business of agreed-uponfinancial performance goals for the fiscal year ended June 30, 2007. The valueof all the contingent common stock was $64.3 million based on the NYSE closingprice on April 28, 2006. The contingent common stock is payable by WatsonWyatt Limited and the payment obligations are guaranteed by the company.

Underthe business combination agreement, Watson Wyatt Limited is obligated to makepayments to members of WWLLP representing profits and tax payments relating toperiods before the closing date of the transaction. The company has guaranteedthese obligations and has properly reflected them on the company’s consolidatedfinancial statements as of March 31, 2006.

**Credit Agreement**

DuringJuly 2005 the company amended and restated its credit facility to providefor a new revolving credit facility in an aggregate principal amount of $300million provided by a syndicate of banks. The credit facility was furtheramended effective September 2005 in order to correct the wording of adefinition in the credit agreement. Interest rates associated with thisfacility vary with LIBOR and/or the Prime Rate and are based on our leverageratio, as defined by the credit agreement. We are charged a quarterlycommitment fee, currently 0.15 percent of the facility, which varies with ourfinancial leverage and is paid on the unused portion of the credit facility. Borrowingsunder this facility were $45.0 million as of March 31, 2006. Credit underthe facility is available upon demand, although the credit facility requires usto observe certain covenants (including requirements for minimum net worth,which act to restrict dividends, cash flow leverage ratio and a fixed coveragecharge) and is collateralized with a pledge of stock of material subsidiaries. Wewere in compliance with all covenants under the credit facility as of March 31,2006. This facility is scheduled to mature on June 30, 2010.

Subsequentto March 31, 2006, we paid an additional $15 million of borrowings underour credit facility.

Aportion of the revolving facility is used to support required letters of creditissued under the credit line. As a result, $10.6 million of the facility wasunavailable for operating needs as of March 31, 2006. We are also chargeda fee for outstanding letters of credit that also fluctuates based on ourleverage ratio.

**RiskManagement**

Asa part of our overall risk management program, we carry customary commercialinsurance policies, including commercial general liability, employmentpractices liability, and claims-made professional liability insurance with aself-insured retention of $1 million per claim, which provides coverage forprofessional liability claims againstthe company and its non-European subsidiaries not previously owned by WWLLP**,**including the cost of defendingsuch claims. Our primary insurance coverage beyond this retention is written byan affiliated captive insurance company (PCIC) owned by us and two otherprofessional services firms.

Informulating its premium structure, PCIC estimates the amount it expects to payfor losses (and loss expenses) for all the members as a whole and thenallocates that amount to the member firms based on the individual member’sexpected losses. PCIC bases premium calculations, which are determined annuallybased on experience through March of each year, on relative risk of thevarious lines of business 

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performedby each of the owner companies, past claim experience of each owner company,growth of each of those companies, industry risk profiles in general and theoverall insurance markets. As of July 1, 2005, the captive insurancecompany carries reinsurance for 100% of losses it insures above $25 million, inany reasonably foreseeable loss scenarios.

Ouragreements with PCIC could require additional payments to PCIC in the eventthat the company decided to exit PCIC and adverse claims significantly exceedprior expectations. If these circumstances were to occur, the company wouldrecord a liability at the time it becomes estimable and probable.

Thecompany will continue to provide for the self-insured retention where specificestimated losses and loss expenses for known claims in excess of $1 million areconsidered probable and reasonably estimable.****In addition, oursubsidiary, Watson Wyatt Limited, maintains customary commercial insurancepolicies, including claims-made professional liability insurance covering ourEuropean subsidiaries as well as certain predecessor companies, including WWLLPand Watson Wyatt Partners. This program carries a self-insured retention of £2million in the aggregate and £100,000 per claim, including the cost ofdefending such claims.

Althoughthe company maintains professional liability insurance coverage, this insurancedoes not cover claims made after expiration of our current insurance contracts.Generally accepted accounting principles require that we record a liability forincurred but not reported (IBNR) professional liability claims if they areestimable and probable, and for which we have not yet contracted for insurancecoverage. The company uses actuarial assumptions to estimate and record itsIBNR liability and has a $32.1 million IBNR liability recorded as of March 31,2006.

Recentinsurance market conditions for our industry include increases in overallpremium cost, higher self-insured retentions and constraints on aggregateexcess coverages, trends that are anticipated to continue. We expect theserecent conditions to recur periodically and to be reflected in our futureannual insurance renewals. As a result, we will continue to assess our abilityto secure future insurance coverage. In anticipation of the possibility of futurereductions in risk transfer from PCIC to re-insurers, as well as the hardeninginsurance market conditions in recent years, the firms that own PCIC, includingthe company, have increased PCIC’s capital in recent years, with the company’smost recent capital contribution being made in July 2005 in the form of$1.5 million in cash and a letter of credit for $3.1 million.

Inlight of increasing worldwide litigation, including litigation againstprofessionals, the company has established a policy that all clientrelationships be documented by engagement letters containing specific riskmitigation clauses that were not included in all historical client agreements. Substantiallyall of the company’s U.S.****and U.K.****corporateclients have signed engagement letters that include risk mitigation clauses. Initiativesto maintain that process in the United States and the United Kingdom, and tocomplete the process elsewhere are underway. The company has disengaged fromcertain client relationships where satisfactory engagement terms could not beachieved.

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**DisclaimerRegarding Forward-looking Statements**

This filingcontains certain statements that are “forward-looking statements” within themeaning of the Private Securities Litigation Reform Act of 1995, including, butnot limited to the following: Note 5 — Retirement Benefits; Note 6 — Goodwilland Intangible Assets; Note 12 — Guarantees; Note 13 — Contingent Liabilities;the Executive Overview; Critical Accounting Policies and Estimates; thediscussion of our capital expenditures; Off-Balance Sheet Arrangements andContractual Obligations; Risk Management; and Part II, Item 1 “LegalProceedings”. You can identify these statements and other forward-lookingstatements in this filing by words such as “may”, “will,”, “expect”, “anticipate”,“believe”, “estimate”, “plan”, “intend”, “continue”, or similar words,expressions, or the negative of such terms or other comparable terminology. Youshould read these statements carefully because they contain projections of ourfuture results of operations or financial condition, or state other “forward-looking”information. A number of risks and uncertainties exist which could cause actualresults to differ materially from the results reflected in theseforward-looking statements. Such factors include but are not limited to:

·                  ourability to integrate the business of WWLLP into our own business, processes andsystems, and achieve the anticipated results;

·                  ourcontinued ability to recruit and retain qualified associates;

·                  thesuccess of our marketing, client development and sales programs after thebusiness combination;

·                  ourability to maintain client relationships and to attract new clients after thebusiness combination;

·                  declinesin demand for our services;

·                  outcomesof litigation;

·                  demographicchanges and projections in workforce;

·                  theability of the company to obtain professional liability insurance;

·                  asignificant decrease in the demand for the consulting, actuarial and otherservices we offer as a result of changing economic conditions or other factors;

·                  actionsby competitors offering human resources consulting services, including publicaccounting and consulting firms, technology consulting firms andinternet/intranet development firms;

·                  ourability to achieve cost reductions after the business combination;

·                  foreigncurrency exchange and interest rate fluctuations;

·                  exposureto WWLLP liabilities that have not been expressly assumed;

·                  generaleconomic and business conditions that adversely affect us or our clients afterthe business combination;

·                  thelevel of capital resources required for future acquisitions and businessopportunities;

·                  regulatorydevelopments abroad and domestically that impact our business practice;

·                  legislativeand technological developments that may affect the demand for or costs of ourservices;

and other factorsdiscussed under “Risk Factors” in the company’s Annual Report on Form 10-Kdated August 24, 2005, and the proxy statement/prospectus filed on June 23,2005, both of which are on file with the Securities and Exchange Commission. Thesestatements are based on assumptions that may not come true. All forward-lookingdisclosure is speculative by its nature. The company undertakes no obligationor duty to update any of the forward-looking information included in thisreport, whether as a result of new information, future events, changedexpectations or otherwise.

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**ITEM 3. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

We are exposed to marketrisks in the ordinary course of business. These risks include interest raterisk and foreign currency exchange risk. We have examined our exposure to theserisks and concluded that none of our exposures in these areas are material tofair values, cash flows or earnings*.*

See Note 2 of the Notes to the Consolidated FinancialStatements for further information regarding our handling of risk associatedwith the business combination.

**ITEM 4. CONTROLSAND PROCEDURES.**

**Evaluationof Disclosure Controls and Procedures**

An evaluation was performed under the supervision andwith the participation of our management, including the chief executiveofficer, or CEO, and chief financial officer, or CFO, of the effectiveness ofthe design and operation of our disclosure controls and procedures (as definedin Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934). Based on that evaluation, our management,including the CEO and CFO, concluded that our disclosure controls andprocedures were effective at a reasonable assurance level as of March 31,2006.

**Changes in Internal Control OverFinancial Reporting**

There were no significantchanges in our internal control over financial reporting in the quarter ended March 31,2006 that materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

**Limitations on the Effectiveness of Controls**

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

**PART II.OTHER INFORMATION**

**ITEM 1. LEGALPROCEEDINGS.**

Fromtime to time, we are a party to various lawsuits, arbitrations or mediationsthat arise in the ordinary course of business. The disclosure called for byItem 1 regarding our legal proceedings is incorporated by reference herein fromNote 13 “Contingent Liabilities,” of the Notes to the Consolidated FinancialStatements in this Form 10-Q for the quarter ending March 31,2006.

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**ITEM 1A. RISK FACTORS**

There are no materialchanges from risk factors as previously disclosed in our Annual Report on Form 10-K(File No. 001-16159) filed on August 24, 2005.

**ITEM 2. UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

The company did not engage in any unregistered sales of equitysecurities during the quarter.

**Issuer Purchases of Equity Securities**

The table below presents specified information aboutthe Company’s stock repurchases and repurchase plans:
| **Period**                                            | ** ** | ** ** | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number of  Shares that May Yet  Be Purchased Under  the Plans or Programs** | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1,  2006 through January 31, 2006   |       | —     |       | $                                                    | —     |                                             | —     |                                                                                                                             | 472,234    |                                                                                                                                    |
| February 1,  2006 through February 28, 2006 |       | 49,200     |       | 29.81                                                |       | 49,200                                           |       | 423,034                                                                                                                          |       |
| March 1,  2006 through March 31, 2006       |       | —     |       | —                                               |       | —                                           |       | 423,034                                                                                                                          |       |
| Total                                                 |       | 49,200     |       | $                                                    | 29.81      |                                             | 49,200     |                                                                                                                             |       |                                                                                                                                    |

 

In addition, during thefirst quarter of fiscal year 2006, the company’s Board of Directors approvedthe repurchase of up to 75,000 shares of our Class A common stock to bere-issued in connection with our Amended Compensation Plan for OutsideDirectors. Shares that the company repurchases are generally issued in connectionwith the company’s employee benefit plans.

**ITEM 3. DEFAULTSUPON SENIOR SECURITIES.**

**None.**

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

None.

**ITEM 5.OTHER INFORMATION.**

On January 1, 2006, thecompany changed its name to “Watson Wyatt Worldwide, Inc.”  Thechange in name was effected pursuant to a merger of Watson Wyatt Worldwide, Inc.,a Delaware corporation and wholly-owned subsidiary of the company, with andinto the company, with the company surviving. In connection with the merger,the name of the company was changed to “Watson Wyatt Worldwide, Inc.”   The Company will continue to trade on theNYSE under its existing symbol, WW.

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Mr. Paul Thornton, aclass I director, advised the company of his resignation as a director effectiveas of January 23, 2006. On February 10, 2006, the Board of Directorsof the company appointed Mr. Roger C. Urwin as a director to fill thevacancy created when Mr. Thornton resigned from the board.

**ITEM 6.EXHIBITS.**
| 3.1  | Amended and Restated Certificate of Incorporation of  Watson Wyatt Worldwide, Inc.(1)                                                                                                       |
|------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2  | Amended and Restated Bylaws of Watson Wyatt  Worldwide, Inc.(1)                                                                                                                             |
| 4    | Form of Certificate Representing Common  Stock(1)                                                                                                                                           |
| 31.1 | Certification of Chief Executive Officer Pursuant to  Securities Exchange Act Rules 13a-14 and 15d-14, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(2)        |
| 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(2)        |
| 32   | Certification of Chief Executive Officer and Chief  Financial Officer Pursuant to Title 18, U.S.C. Section 1350, adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(2) |

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(1)   Incorporated by reference from Registrant’s Form 8-K,filed on January 3, 2006

(2)   Filed with this Form 10-Q

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**Signatures**

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

Watson WyattWorldwide, Inc.(Registrant)
| /s/ John J. Haley   |   | May 10, 2006       |
|---------------------|--------|-------------------------|
| Name:               |   | John J. Haley           |   | Date |
| Title:              |   | President and           |   |   |
|                |   | Chief Executive Officer |   |   |
|                |   |                    |   |   |
| /s/ Carl D. Mautz   |   | May 10, 2006       |
| Name:               |   | Carl D. Mautz           |   | Date |
| Title:              |   | Vice President and      |   |   |
|                |   | Chief Financial Officer |   |   |
|                |   |                    |   |   |
| /s/ Peter L. Childs |   | May 10, 2006       |
| Name:               |   | Peter L. Childs         |   | Date |
| Title:              |   | Controller              |   |   |

 

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