** **

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

 

**FORM 10-Q**

 

**(Mark One)**

 
| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                                                                                                     |
|------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                               |
|       |   | **For the quarterly period ended September  30, 2003**                                                                                                                                                                                                                                             |
|       |   |                                                                                                                                                                                                                                                                                               |
| **OR**     |
|       |   |                                                                                                                                                                                                                                                                                               |
| **o**      |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                                                                                                    |
|       |   |                                                                                                                                                                                                                                                                                               |
|       |   | **For the transition  period  from                     to                     ** |

** **

**CommissionFile Number: 001-16159**

 

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

 

| **Delaware**                                                    |   | **52-2211537**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
| **1717 H Street NW  Washington, D.C. 20006-3900**               |
| (Address of principal executive offices,  including zip code)   |
|                                                            |
| **(202) 715-7000**                                              |
| (Registrant’s telephone number, including  area code)      |

 

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

 

Yes ý    No o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).  Yes  ý   No  o

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of October 31, 2003.

 
| **Class**                            |   | **Number of Shares** |
|--------------------------------------|--------|----------------------|
| Class A Common Stock, $.01 par value |   | 33,255,044           |

 

 

----

 

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

 

For the Three Months Ended September 30, 2003

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

 

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statements of Operations**

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

 
|                                                                                                                            |   | **Three  months ended September 30** |    |
|---------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                                                                            |   | **2003**                             |    | **2002** |   |
|                                                                                                                            |   | **(Unaudited)**                      |    |
|                                                                                                                            |   |                                 |    |   |   |
| Revenue                                                                                                                         |   | $                                    | 170,983 |   | $ | 178,958 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Costs of providing services:                                                                                                    |   |                                 |    |   |   |
| Salaries and employee benefits                                                                                                  |   | 105,073                              |    | 101,513 |   |
| Professional and subcontracted services                                                                                         |   | 9,086                                |    | 10,818 |   |
| Occupancy, communications and other                                                                                             |   | 23,518                               |    | 26,628 |   |
| General and administrative expenses                                                                                             |   | 15,601                               |    | 14,390 |   |
| Depreciation and amortization                                                                                                   |   | 4,652                                |    | 5,079 |   |
|                                                                                                                            |   | 157,930                              |    | 158,428 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Income from operations                                                                                                          |   | 13,053                               |    | 20,530 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Income from affiliates                                                                                                          |   | 1,790                                |    | 849 |   |
| Interest income, net                                                                                                            |   | 214                                  |    | 242 |   |
| Other non-operating income                                                                                                      |   | 6,125                                |    | 520 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Income from continuing operations before income taxes                                                                           |   | 21,182                               |    | 22,141 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Provision for income taxes                                                                                                      |   | 8,685                                |    | 9,078 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Income from continuing operations                                                                                               |   | 12,497                               |    | 13,063 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Discontinued operations:                                                                                                        |   |                                 |    |   |   |
|                                                                                                                            |   |                                 |    |   |   |
| Sublease income from discontinued operations, less applicable income  tax expense for the three months ended September 30, 2003 |   | 10                                   |    | — |   |
|                                                                                                                            |   |                                 |    |   |   |
| Net income                                                                                                                      |   | $                                    | 12,507  |   | $ | 13,063 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Basic earnings per share:                                                                                                       |   |                                 |    |   |   |
| Income from continuing operations                                                                                               |   | $                                    | 0.38    |   | $ | 0.40 |   |
| Income from discontinued operations                                                                                             |   | —                               |    | — |   |
| Net income                                                                                                                      |   | $                                    | 0.38    |   | $ | 0.40 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Diluted earnings per share:                                                                                                     |   |                                 |    |   |   |
| Income from continuing operations                                                                                               |   | $                                    | 0.37    |   | $ | 0.39 |   |
| Income from discontinued operations                                                                                             |   | —                               |    | — |   |
| Net income                                                                                                                      |   | $                                    | 0.37    |   | $ | 0.39 |   |
|                                                                                                                            |   |                                 |    |   |   |
| Weighted average shares of common stock, basic (000)                                                                            |   | 33,078                               |    | 32,945 |   |
| Weighted average shares of common stock, diluted (000)                                                                          |   | 33,424                               |    | 33,291 |   |

 

See accompanying notes

 

1

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**ConsolidatedBalance Sheets**

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

 
|                                                                                                      |   | **September  30,  2003** |       | **June 30,  2003** |       |
|-----------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|--------------------|------------|
|                                                                                                      |   | **(Unaudited)**          | ** ** |               | ** ** |
| **Assets**                                                                                                |   |                     | ** ** |               | ** ** |
| Cash and cash equivalents                                                                                 |   | $                        | 118,303    |               | $          | 144,374 |   |
| Receivables from clients:                                                                                 |   |                     |       |               |       |
| Billed, net of allowances of $1,909 and $862                                                              |   | 80,291                   |       | 78,373             |       |
| Unbilled, net of allowances of $625 and $419                                                              |   | 65,971                   |       | 60,549             |       |
|                                                                                                      |   | 146,262                  |       | 138,922            |       |
|                                                                                                      |   |                     |       |               |       |
| Deferred income taxes                                                                                     |   | —                   |       | 3,885              |       |
| Other current assets                                                                                      |   | 18,935                   |       | 11,448             |       |
| Total current assets                                                                                      |   | 283,500                  |       | 298,629            |       |
|                                                                                                      |   |                     |       |               |       |
| Investment in affiliates                                                                                  |   | 27,309                   |       | 26,431             |       |
| Fixed assets, net                                                                                         |   | 59,125                   |       | 60,716             |       |
| Deferred income taxes                                                                                     |   | 102,205                  |       | 101,214            |       |
| Goodwill and intangible assets                                                                            |   | 20,816                   |       | 20,878             |       |
| Other assets                                                                                              |   | 5,994                    |       | 6,594              |       |
|                                                                                                      |   |                     |       |               |       |
| **Total Assets**                                                                                          |   | $                        | 498,949    |               | $          | 514,462 |   |
|                                                                                                      |   |                     |       |               |       |
| **Liabilities**                                                                                           |   |                     | ** ** |               | ** ** |
|                                                                                                      |   |                     |       |               |       |
| Accounts payable and accrued liabilities, including discretionary  compensation                           |   | $                        | 82,308     |               | $          | 114,013 |   |
| Income taxes payable                                                                                      |   | 621                      |       | 15,308             |       |
| Deferred income taxes                                                                                     |   | 3,104                    |       | —             |       |
| Total current liabilities                                                                                 |   | 86,033                   |       | 129,321            |       |
| Accrued retirement benefits                                                                               |   | 203,833                  |       | 195,705            |       |
| Deferred rent and accrued lease losses                                                                    |   | 5,169                    |       | 4,608              |       |
| Other noncurrent liabilities                                                                              |   | 33,547                   |       | 33,091             |       |
| **Total Liabilities**                                                                                     |   | 328,582                  |       | 362,725            |       |
|                                                                                                      |   |                     |       |               |       |
| Commitments and contingencies                                                                             |   |                     |       |               |       |
|                                                                                                      |   |                     |       |               |       |
| **Stockholders’ Equity**                                                                             |   |                     |       |               |       |
| Preferred Stock - No par value:                                                                           |   |                     |       |               |       |
| 1,000,000 shares authorized; none issued and outstanding                                                  |   | —                   |       | —             |       |
| Class A Common Stock - $.01 par value:                                                                    |   |                     |       |               |       |
| 69,000,000 shares authorized; 33,273,568 and 33,087,880 issued and  33,237,205 and 32,943,156 outstanding |   | 333                      |       | 331                |       |
| Additional paid-in capital                                                                                |   | 149,740                  |       | 145,922            |       |
| Treasury stock, at cost - 36,363   and 144,724 shares                                                |   | (743                     | )          | (2,956             | )          |
| Retained earnings                                                                                         |   | 90,024                   |       | 77,517             |       |
| Accumulated other comprehensive loss                                                                      |   | (68,987                  | )          | (69,077            | )          |
| **Total Stockholders’ Equity**                                                                       |   | 170,367                  |       | 151,737            |       |
|                                                                                                      |   |                     |       |               |       |
| **Total Liabilities and Stockholders’ Equity**                                                       |   | $                        | 498,949    |               | $          | 514,462 |   |

 

Seeaccompanying notes

 

2

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statements of Cash Flows**

(Thousandsof U.S. Dollars)

 
|                                                                          |   | **Three  months ended September 30** |    |
|-------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                          |   | **2003**                             |    | **2002** |   |
|                                                                          |   | **(Unaudited)**                      |    |
| Cash flows from operating activities:                                         |   |                                 |    |   |   |
| Net income                                                                    |   | $                                    | 12,507  |   | $ | 13,063 |   |
| Adjustments to reconcile net income to net cash from operating  activities:   |   |                                 |    |   |   |
| Other non-operating gain related to PCIC                                      |   | (5,600                               | )       | — |   |
| Provision for doubtful receivables from clients                               |   | 2,586                                |    | 2,859 |   |
| Depreciation                                                                  |   | 4,570                                |    | 5,002 |   |
| Amortization of intangible assets                                             |   | 82                                   |    | 79 |   |
| Provision for deferred income taxes                                           |   | 5,998                                |    | — |   |
| Income from affiliates                                                        |   | (1,790                               | )       | (849 | ) |
| Distributions from affiliates                                                 |   | 1,065                                |    | 1,004 |   |
| Other, net                                                                    |   | (554                                 | )       | (358 | ) |
| Changes in operating assets and liabilities (net of discontinued  operations) |   |                                 |    |   |   |
| Receivables from clients                                                      |   | (9,926                               | )       | (6,103 | ) |
| Other current assets                                                          |   | (7,487                               | )       | 1,814 |   |
| Other assets                                                                  |   | 600                                  |    | 352 |   |
| Accounts payable and accrued liabilities                                      |   | (22,022                              | )       | (41,178 | ) |
| Income taxes payable                                                          |   | (14,687                              | )       | (993 | ) |
| Accrued retirement benefits                                                   |   | 8,128                                |    | 6,955 |   |
| Deferred rent and accrued lease losses                                        |   | 561                                  |    | 79 |   |
| Other noncurrent liabilities                                                  |   | 433                                  |    | 267 |   |
| Net cash used in operating activities                                         |   | (25,536                              | )       | (18,007 | ) |
|                                                                          |   |                                 |    |   |   |
| Cash flows used in investing activities:                                      |   |                                 |    |   |   |
| Purchases of fixed assets                                                     |   | (3,593                               | )       | (5,318 | ) |
| Proceeds from divestitures                                                    |   | 525                                  |    | 520 |   |
| Acquisitions and contingent consideration payments                            |   | (43                                  | )       | (298 | ) |
| Investment in affiliates                                                      |   | —                               |    | (1,961 | ) |
| Net cash used in investing activities                                         |   | (3,111                               | )       | (7,057 | ) |
|                                                                          |   |                                 |    |   |   |
| Cash flows from (used in) financing activities:                               |   |                                 |    |   |   |
| Issuances of common stock - exercises of stock options                        |   | 305                                  |    | 56 |   |
| Issuances of common stock - employee stock purchase plan                      |   | 1,608                                |    | 1,460 |   |
| Repurchases of common stock                                                   |   | —                               |    | (7,393 | ) |
| Net cash from (used in) financing activities                                  |   | 1,913                                |    | (5,877 | ) |
|                                                                          |   |                                 |    |   |   |
| Effect of exchange rates on cash                                              |   | 663                                  |    | (877 | ) |
|                                                                          |   |                                 |    |   |   |
| Decrease in cash and cash equivalents                                         |   | (26,071                              | )       | (31,818 | ) |
|                                                                          |   |                                 |    |   |   |
| Cash and cash equivalents at beginning of period                              |   | 144,374                              |    | 95,974 |   |
|                                                                          |   |                                 |    |   |   |
| Cash and cash equivalents at end of period                                    |   | $                                    | 118,303 |   | $ | 64,156 |   |

 

Seeaccompanying notes

 

3

----

 

**WATSO****N WYATT & COMPANYHOLDINGS**

**Consolidated Statement of Changes inStockholders’ Equity**

(Thousandsof U.S. Dollars)

(Unaudited)

 
|                                                            |   | **Class A  Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Treasury  Stock,  at Cost** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  (Loss)/Income** |   | **Total** |   |
|-----------------------------------------------------------------|--------|----------------------------|--------|----------------------------------|--------|-------------------------------|--------|------------------------|--------|------------------------------------------------------|--------|-----------|--------|
| Balance at June 30, 2003                                        |   | $                          | 331    |                             | $      | 145,922                       |   | $                      | (2,956 | )                                                    | $      | 77,517    |   | $ | (69,077 | ) | $ | 151,737 |   |
| Comprehensive income:                                           |   |                       |   |                             |   |                          |   |                   |   |                                                 |   |      |   |
| Net income                                                      |   |                       |   |                             |   |                          |   | 12,507                 |   |                                                 |   | 12,507    |   |
| Additional minimum pension liability                            |   |                       |   |                             |   |                          |   |                   |   | (28                                                  | )      | (28       | )      |
| Foreign currency translation adjustment                         |   |                       |   |                             |   |                          |   |                   |   | 118                                                  |   | 118       |   |
| Total comprehensive income                                      |   |                       |   |                             |   |                          |   |                   |   |                                                 |   | 12,597    |   |
| Issuances of common stock - employee stock purchase plan shares |   |                       |   | (293                             | )      | 1,901                         |   |                   |   |                                                 |   | 1,608     |   |
| Issuances of common stock - deferred   stock units         |   | 2                          |   | 4,081                            |   |                          |   |                   |   |                                                 |   | 4,083     |   |
| Issuances of common stock to outside directors                  |   |                       |   | 4                                |   | 33                            |   |                   |   |                                                 |   | 37        |   |
| Issuances of common stock-stock options                         |   |                       |   | 26                               |   | 279                           |   |                   |   |                                                 |   | 305       |   |
|                                                            |   |                       |   |                             |   |                          |   |                   |   |                                                 |   |      |   |
| Balance at September 30, 2003                                   |   | $                          | 333    |                             | $      | 149,740                       |   | $                      | (743   | )                                                    | $      | 90,024    |   | $ | (68,987 | ) | $ | 170,367 |   |

 

Seeaccompanying notes

 

4

----

 

**WATSONWYATT & COMPANY HOLDINGS**

 

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

(Unaudited)

**Note 1 – Basis ofPresentation.**

 

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

 

The results of operations for the three months ended September 30, 2003are not necessarily indicative of the results that can be expected for theentire fiscal year ending June 30, 2004. The results reflect certain estimates, including estimated bonuses andanticipated tax liabilities.

 

**Note 2 – CompanyBackground.**

 

Watson Wyatt & Company Holdings, together with our subsidiaries, isan international company engaged in the business of providing professionalconsultative services on a fee basis, primarily in the human resource areas ofemployee benefits and compensation, but also in other areas of specializationsuch as human capital consulting and human resource-related technologyconsulting.

 

**Note 3 – SegmentInformation.**

 

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

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

 

5

----

 

The Company evaluates the performance of its segments and allocatesresources to them based on net operating income on a pre-bonus, pre-tax basis.

 

The table below presents specified information about reported segmentsas of and for the three months ended September 30, 2003:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human   Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|----------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 103,868 |                             | $      | 20,269                     |   | $                 | 10,166 |      | $      | 18,945    |   | $ | 11,693 |   | $ | 164,941 |   |
| Net operating income/(loss)            |   | 22,041              |    | 1,413                            |   | (256                       | )      | (66               | )      | 687       |   | 23,819    |   |
| Receivables                            |   | 92,141              |    | 14,928                           |   | 8,764                      |   | 16,800            |   | 7,221     |   | 139,854   |   |
|                                        |        |                     |         |                                  |        |                            |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

The table below presents specified information about reported segmentsas of and for the three months ended September 30, 2002:

 
|                                   |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human   Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|----------------------------------------|--------|---------------------|---------|----------------------------------|--------|----------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable expenses) |   | $                   | 102,000 |                             | $      | 26,308                     |   | $                 | 11,246 |      | $      | 17,918    |   | $ | 13,953 |   | $ | 171,425 |   |
| Net operating income                   |   | 25,870              |    | 4,760                            |   | 74                         |   | 378               |   | 2,144     |   | 33,226    |   |
| Receivables                            |   | 93,982              |    | 21,358                           |   | 9,649                      |   | 14,514            |   | 9,376     |   | 148,879   |   |
|                                        |        |                     |         |                                  |        |                            |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

Information about interest income and tax expense is not presented as asegment expense because such items are not considered a responsibility of thesegments’ operating management.

 

6

----

 

Reconciliations of the information reported by segment to the consolidatedamounts follow for the three month periods ended September 30, 2003 and 2002:
|                                                                                           |   | **Three  Months Ended September 30** |    |
|------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                                           |   | **2003**                             |    | **2002** |   |
|                                                                                           |   |                                 |    |   |   |
| Revenue:                                                                                       |   |                                 |    |   |   |
| Total segment revenue                                                                          |   | $                                    | 164,941 |   | $ | 171,425 |   |
| Reimbursable expenses not included in total segment  revenue                                   |   | 5,959                                |    | 6,977 |   |
| Other, net                                                                                     |   | 83                                   |    | 556 |   |
| Consolidated revenue                                                                           |   | $                                    | 170,983 |   | $ | 178,958 |   |
|                                                                                           |   |                                 |    |   |   |
| Net Operating Income:                                                                          |   |                                 |    |   |   |
| Total segment net operating income                                                             |   | $                                    | 23,819  |   | $ | 33,226 |   |
| Income from affiliates                                                                         |   | 1,790                                |    | 849 |   |
| Differences in allocation methods for  depreciation, G&A,  medical and  pension costs |   | 1,435                                |    | (466 | ) |
| Gain on sale of business units                                                                 |   | 525                                  |    | 520 |   |
| Discretionary compensation                                                                     |   | (13,500                              | )       | (12,000 | ) |
| PCIC non-operating gain                                                                        |   | 5,600                                |    | — |   |
| Other, net                                                                                     |   | 1,513                                |    | 12 |   |
| Consolidated income from continuing operations  before income taxes                            |   | $                                    | 21,182  |   | $ | 22,141 |   |
|                                                                                           |   |                                 |    |   |   |
| Receivables:                                                                                   |   |                                 |    |   |   |
| Total segment receivables - billed and unbilled                                                |   | $                                    | 139,854 |   | $ | 148,879 |   |
| Net valuation differences                                                                      |   | 6,408                                |    | 5,977 |   |
| Total billed and unbilled receivables                                                          |   | 146,262                              |    | 154,856 |   |
| Assets not reported by segment                                                                 |   | 352,687                              |    | 253,788 |   |
| Consolidated assets                                                                            |   | $                                    | 498,949 |   | $ | 408,644 |   |

** **

**Note 4 – Targeted JobReductions.**

 

We implemented job reductions in our North American regions during thefirst quarter of fiscal year 2003.  Thisresulted in the elimination of approximately 100 positions.  The estimated $2.6 million charge toearnings related to these reductions was included in the Company’s financialresults for the quarter ended September 30, 2003. Of the $2.6 million severancecharge, $2.5 million was included in Salaries and employee benefits and $0.1million was included in Professional and subcontracted services.  As of September 30, 2003, $1.3 million underrelated severance agreements had been paid and $1.3 million remained accrued onthe Company’s financial statements.

 

7

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**Note 5 – PCIC OtherNon-operating Gain.**

 

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

 

As a result of this gain, the Company also recorded a $5.6 millionsupplemental bonus accrual in the first quarter that is incremental to theCompany’s fiscal year end bonus, but will be paid in September 2004 with theregular bonus cycle.  This supplementalbonus is included in Salaries and employee benefits.

 

**Note 6 – Sale ofU.S.-based Public Sector Retirement Business.**

 

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

 

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

 

**Note 7 – Goodwill& Intangible Assets.**

 

The changes in the carrying amount of goodwill for the three monthsended September 30, 2003, are as follows: 

 
|                                |   | **Benefits  Group** |   | **Technology  Solutions  Group** |   | **Human   Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|-------------------------------------|--------|---------------------|--------|----------------------------------|--------|----------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Balance as of June 30, 2003         |   | $                   | 16,278 |                             | $      | 1,449                      |   | $                 | 69     |      | $      | 979       |   | $ | 1,214 |   | $ | 19,989 |   |
| Goodwill recorded during the period |   | —              |   | —                           |   | —                     |   | 43                |   | —    |   | 43        |   |
| Translation adjustment              |   | (6                  | )      | —                           |   | —                     |   | (4                | )      | —    |   | (10       | )      |
| Balance as of September 30, 2003    |   | $                   | 16,272 |                             | $      | 1,449                      |   | $                 | 69     |      | $      | 1,018     |   | $ | 1,214 |   | $ | 20,022 |   |

 

8

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The following table reflects changes in the net carrying amount of thecomponents of intangible assets for the three months ended September 30, 2003:

 
|                             |   | **Non-contractual  customer  relationships** |   | **Non-compete  agreements** |   | **Purchased  software** |   | **Pension** |   | **Total** |   |
|----------------------------------|--------|----------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|-------------|--------|-----------|--------|
| Balance as of June 30, 2003      |   | $                                            | 480    |                        | $      | 269                     |   | $           | 27     |      | $      | 113 |   | $ | 889 |   |
| Amortization expense             |   | (50                                          | )      | (23                         | )      | (9                      | )      | —      |   | (82       | )      |
| Translation adjustment           |   | (10                                          | )      | —                      |   | —                  |   | (3          | )      | (13       | )      |
| Balance as of September 30, 2003 |   | $                                            | 420    |                        | $      | 246                     |   | $           | 18     |      | $      | 110 |   | $ | 794 |   |

 

 

The following table reflects the carrying value of intangible assets atSeptember 30, 2003 and 2002:

 
|                                                  |   | **September  30, 2003**     |   | **September  30, 2002**         |   |
|-------------------------------------------------------|--------|-----------------------------|--------|---------------------------------|--------|
|                                                  |   | **Gross  Carrying  Amount** |   | **Accumulated    Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated    Amortization** |   |
| Intangible assets and intangible pension  asset:      |   |                        |   |                            |   |   |   |   |   |
| Non-contractual customer relationships                |   | $                           | 806    |                            | $      | 386 |   | $ | 866 |   | $ | 54 |   |
| Non-compete agreements                                |   | 672                         |   | 426                             |   | 671 |   | 336 |   |
| Purchased software                                    |   | 125                         |   | 107                             |   | 125 |   | 71 |   |
| Intangible pension asset                              |   | 110                         |   | —                          |   | — |   | — |   |
| Total intangible assets and intangible  pension asset |   | $                           | 1,713  |                            | $      | 919 |   | $ | 1,662 |   | $ | 461 |   |

 

 

The change in the grosscarrying amount of non-contractual customer relationships and the intangiblepension asset reflect translation adjustments between June 30, 2003, andSeptember 30, 2003.  These intangibleassets are denominated in the currencies of our subsidiaries outside the UnitedStates, and are translated into our reporting currency, the U.S. dollar, basedon exchange rates at the balance sheet date.

 

The weighted average remaining life of amortizable intangible assets atSeptember 30, 2003, was 2.3 years. Estimated amortization expense for fiscal year 2004 and each of thethree succeeding fiscal years is as follows:

 
| **Fiscal year ending June 30:** |   | **Amount** |   |
|---------------------------------|--------|------------|--------|
| 2004                            |   | $          | 323    |   |
| 2005                            |   | 300        |   |
| 2006                            |   | 131        |   |
| 2007                            |   | 22         |   |
|                                 |        |            |        |  |

 

9

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**Note 8 – Earnings PerShare.**

 

Basic earnings per share is calculated on the basis of the weightedaverage number of common shares outstanding during the three months endedSeptember 30, 2003.  Diluted earningsper share is calculated on the basis of the weighted average number of commonshares outstanding plus the effect of outstanding stock options and employeestock purchase plan shares using the “treasury stock” method.  The components of basic and diluted earningsper share are as follows:

 
|                                                                               |   | **Three  Months Ended September 30** |   |
|------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                               |   | **2003**                             |   | **2002** |   |
|                                                                               |   |                                 |   |   |   |
| Income from continuing operations                                                  |   | $                                    | 12,497 |   | $ | 13,063 |   |
| Discontinued operations                                                            |   | 10                                   |   | — |   |
| Net income                                                                         |   | $                                    | 12,507 |   | $ | 13,063 |   |
|                                                                               |   |                                 |   |   |   |
|                                                                               |   |                                 |   |   |   |
| Weighted average outstanding shares of common  stock                               |   | 33,078                               |   | 32,945 |   |
| Dilutive effect of employee stock options and  employee stock purchase plan shares |   | 346                                  |   | 346 |   |
| Common stock and stock equivalents                                                 |   | 33,424                               |   | 33,291 |   |
|                                                                               |   |                                 |   |   |   |
| Basic earnings per share:                                                          |   |                                 |   |   |   |
| Income from continuing operations                                                  |   | $                                    | 0.38   |   | $ | 0.40 |   |
| Discontinued operations                                                            |   | —                               |   | — |   |
| Net income                                                                         |   | $                                    | 0.38   |   | $ | 0.40 |   |
|                                                                               |   |                                 |   |   |   |
| Diluted earnings per share:                                                        |   |                                 |   |   |   |
| Income from continuing operations                                                  |   | $                                    | 0.37   |   | $ | 0.39 |   |
| Discontinued operations                                                            |   | —                               |   | — |   |
| Net income                                                                         |   | $                                    | 0.37   |   | $ | 0.39 |   |

 

10

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**Note 9 – Stock-basedCompensation.**

 

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

 

As required by FAS 123, the Company has determined pro forma net incomeand earnings per share as if the Company had accounted for its stockcompensation plans under the fair value method of FAS 123.   The Company estimated compensation expensefor its Stock Purchase Plan based on the 15 percent discounted purchase priceoffered to employees enrolled in the plan, which approximates fair value.  For the Stock Option Plan, the Company usesthe Black-Scholes option valuation model to calculate the fair value of optionsgranted for pro forma disclosure purposes.

 

The table below reflects the pro forma effect on net income andearnings per share for the three months ended September 30, 2003 and 2002 as ifthe Company were to recognize compensation expense under the fair-value-basedmethod of FAS 123:

 
|                                                                                                                                                 |   | **Three  Months Ended September 30** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                                                                                 |   | **2003**                             |   | **2002** |   |
|                                                                                                                                                 |   |                                 |   |   |   |
| Net income, as reported                                                                                                                              |   | $                                    | 12,507 |   | $ | 13,063 |   |
| Add: Stock-based compensation expenseincluded in reported net income, net of related tax effects                                                |   | 46                                   |   | 6 |   |
| Deduct: Total stock-based employeecompensation expense determined under fair-value-based method for all awards, net of related tax effects |   | (406                                 | )      | (412 | ) |
| Pro forma net income                                                                                                                                 |   | $                                    | 12,147 |   | $ | 12,657 |   |
|                                                                                                                                                 |   |                                 |   |   |   |
| **Earnings per share:**                                                                                                                              |   |                                 |   |   |   |
| Basic - as reported                                                                                                                                  |   | $                                    | 0.38   |   | $ | 0.40 |   |
| Basic - pro forma                                                                                                                                    |   | $                                    | 0.37   |   | $ | 0.38 |   |
|                                                                                                                                                 |   |                                 |   |   |   |
| Diluted - as reported                                                                                                                                |   | $                                    | 0.37   |   | $ | 0.39 |   |
| Diluted - pro forma                                                                                                                                  |   | $                                    | 0.36   |   | $ | 0.38 |   |

 

**Note 10 –Comprehensive Income.**

 

Comprehensive income includes net income, the additional minimumpension liability recorded in the fourth quarter of fiscal year 2003 andchanges in the cumulative translation adjustment gain or loss.  For the three months ended September 30,2003, comprehensive income totaled $12.6 million, compared with $12.4 millionfor the three months ended September 30, 2002.

 

11

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**Note 11 – RestrictedShares.**

 

In conjunction with our initial public offering in October 2000, weentered into agreements providing for additional transfer restrictions withmajor stockholders, executive officers and employee directors.  As a result of these agreements, 3,816,000Class A shares were restricted as of September 30, 2003.  Of these shares, 1,908,000 became freelytransferable in October 2003.  Theremaining shares will become freely transferable in October 2004.

 

**Note 12 – Guarantees.**

 

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

 

*Letters of Credit*.  The Company has two outstanding letters ofcredit totaling $7.5 million under our existing credit facility to guaranteepayment to beneficiaries in the event that the Company fails to meet itsfinancial obligations to these beneficiaries. One letter of credit for $2.6 million will expire in October 2006, whilethe second letter of credit for $4.9 million will remain outstanding as long aswe retain an ownership share of our affiliated captive insurance company,Professional Consultants Insurance Company. The estimated fair market value of these letters of credit is nominal.

 

*Stock Loans*.  The Company also guarantees a creditfacility which provides loans to associates for stock purchased under ourformer Stock Purchase Program.  ThisStock Purchase Program was discontinued in conjunction with our initial publicoffering in October 2000.  As a result,the amounts guaranteed under this facility permanently decrease as the loansare repaid.  The maximum availableborrowings and aggregate outstanding balances under this facility were $0.9million at September 30, 2003, and $1.0 million at June 30, 2003.  A total of 900,000 and 989,000 Watson Wyatt& Company Holdings shares were pledged by stockholders to collateralizethese loans at September 30, 2003, and June 30, 2003, respectively.

 

*Affiliate Agreements*.  In 1995, we entered into an allianceagreement with R. Watson & Sons, a United Kingdom-based actuarial, benefitsand human resources consulting partnership (now Watson Wyatt LLP or WWLLP), thepredecessor of which was founded in 1878. Included in the agreements between the Company and WWLLP (the “AllianceAgreements”) are various indemnities and guarantees relating to the performanceof the Company and its subsidiaries, some of which became part of Watson WyattHoldings (Europe), Ltd. (WWHE), as to such matters as tax liabilities,liabilities for prior acts or omissions arising from the operation of the UKand European businesses prior to the alliance and failure to perform variousobligations under the Alliance Agreements. In addition, certain events, such as a sale of material parts of ourbusiness, could require the Company to either purchase from or sell to WWLLP aninterest in our European business, and/or repurchase the shares of theCompany’s stock currently held by WWLLP. The Company is unable to estimate an amount of any potential futurepayments under these contractual arrangements since the potential occurrence ofany of the events to which the indemnities apply is entirely speculative, thereis no history of payments and the dollar amount, if any, would be dependentupon the nature of the event triggering such indemnity. Management believesthat any potential for payment under such indemnities and guarantees should declinewith the passage of time.  There are noprovisions for recourse to third parties, nor are any assets held by any thirdparties that the Company as guarantor can liquidate to recover amounts paidunder such indemnities.

 

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

 

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In connection with the establishment of our alliance with Watson WyattLLP, the Company agreed to guarantee Watson Wyatt LLP’s performance under alease for office space in London that expires in 2015.  Payments by Watson Wyatt LLP under the leasetotal approximately £1.4 million (or approximately $2.3 million per year basedon the September 30, 2003, exchange rate). We also granted Watson Wyatt LLP an option to return the leased space toour UK subsidiary in 2009.  If WatsonWyatt LLP exercises this option, the Company would attempt to sublease thespace at the then-current market rates.

 

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

 

*Wellspring Leases*.  We continue to guarantee three leases foroffice premises for Wellspring Resources, LLC (“Wellspring”), the benefitsadministration outsourcing business that we exited from in fiscal year1998.  At September 30, 2003, minimumremaining payments guaranteed under these leases, which expire at various datesthrough 2007, total $22.9 million, excluding anticipated future subleaseincome.

 

**Note 13 – ContingentLiabilities.**

 

**From time to time, we are a party to various lawsuits,arbitrations or mediations that arise in the ordinary course of business.  These disputes typically involve claimsrelating to the rendering of professional services or employment matters.  Management believes, based on currentlyavailable information, that the results of all pending claims against us willnot have a material adverse affect on the Company.**

** **

*New Jersey Coalitionof Auto Retailers Insurance Group Trust (NJCAR).*  A settlement agreement has been executed by all parties to the lawsuitbrought against Watson Wyatt and five other service providers of NJCAR, aninsolvent group health insurance provider.  The suit alleged that lossesresulting from the insolvency are partly attributable to NJCAR’s former serviceproviders.   If no objections are filed, the settlement agreement isscheduled to be approved by the state court presiding over NJCAR’s insolvencyproceedings on December 5, 2003.

 

*Toussaint, et al.,v. James, et al.*  Union leaders, in theircapacity as the trustees of a pension plan for the union leadership, broughtsuit in December 2001 in the U.S. District Court for the Southern District ofNew York against the former union leaders and Watson Wyatt, alleging damagessuffered in reliance on our actuarial work and breaches of fiduciary dutiesowed by the former union leaders.  The claim against Watson Wyatt isallegedly in the $4 million range.  If the case is not resolved inmediation, a jury trial is scheduled for February 28, 2004.

 

**Note 14 –Discontinued Operations.**

 

The Company continues to guarantee three leases for office premises forWellspring Resources, LLC (“Wellspring”), the benefits administrationoutsourcing business that we exited from in fiscal year 1998.  We believe we have adequate provisions forany remaining costs associated with our obligations related to thisbusiness.  During the second quarter offiscal year 2003, we began to receive de minimis positive cash flows related tothese leases.  In the first quarter offiscal year 2004, the Company received sublease income of approximately $17,000in excess of lease payments related to this business.

 

13

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**Note 15 – RecentAccounting Pronouncements.**

** **

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),“Consolidation of Variable Interest Entities”, which clarifies the financialreporting guidance associated with the consolidation of another entity.  The consolidation requirements of FIN 46applied immediately to variable interest entities created after January 31,2003, and as disclosed in the Company’s Annual Report on Form 10-K,pre-existing variable interest entities as of July 1, 2003.  However, at the October 8, 2003 meeting ofthe Financial Accounting Standards Board (the “Board”), the Board decided toissue a final FASB Staff Position 46-6, Effective Date of FASB InterpretationNo. 46, Consolidation of Variable Interest Entities (“Final FSP”).  The Final FSP provides a broad deferral ofthe latest date by which all public entities must apply FIN 46 to certainvariable interest entities and is effective for the Company as of December 31,2003.  Management does not believe thatthe adoption of FIN 46 will have an effect on the Company’s financialperformance or condition.

 

Emerging Issues Task Force’s Issue 00-21, “Revenue Arrangements withMultiple Deliverables” (EITF 00-21), was effective for the Company beginningJuly 1, 2003.  As of July 1, 2003, theCompany has applied such requirements prospectively to multiple deliverablearrangements, which include arrangements involving installation andcustomization of technology solution products sold together with on-goingservices offered by the Company.  Theadoption of EITF 00-21 has not had a material effect on the Company’s financialperformance or condition.

 

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

**Overview**

 

Watson Wyatt & Company Holdings, including its subsidiaries, is aglobal human capital consulting firm. We help our clients enhance businessperformance by improving their ability to attract, retain and motivatequalified employees. We focus on delivering value-added consulting servicesthat help our clients anticipate, identify and capitalize on emergingopportunities in human capital management. We implement this strategy through 3,975 associates in 60 officeslocated in 18 countries.

 

As leading economies worldwide become more services-oriented, humancapital has become increasingly important to companies and other organizations.The heightened 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. We help our clients address these issues bycombining our expertise in human capital management with consulting andtechnology, to improve the design and implementation of various humanresources, or HR, programs, including compensation, retirement and health careplans.

 

**Corporate Information**

 

Including predecessors, we have been in business since 1946.  The Wyatt Company was incorporated inDelaware on February 17, 1958.  Weconducted business as The Wyatt Company until changing our corporate name toWatson Wyatt & Company in connection with the establishment of the WatsonWyatt Worldwide alliance in 1995. Watson Wyatt & Company Holdings was incorporated in Delaware onJanuary 7, 2000, and conducts business through its principal operatingsubsidiary, Watson Wyatt & Company.

 

14

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**General**

 

As of September 30, 2003, we employed 3,975 associates as follows:

 
| Benefits Group                                      |   | 1,660 |   |
|-----------------------------------------------------|--------|-------|--------|
| Technology Solutions Group                          |   | 365   |   |
| Human Capital Group                                 |   | 160   |   |
| International                                       |   | 970   |   |
| Other (including Data Services  &Communication) |   | 600   |   |
| Corporate                                           |   | 220   |   |
| Total                                               |   | 3,975 |   |

 

 

**Principal Services**

 

We design, develop and implement HR strategies and programs through thefollowing closely-interrelated practice areas:

 
| **Benefits Group**                                                                                                                           |   | **Technology  Solutions Group**                                                                                                                           |   | **Human  Capital Group**                                                                                                                                        |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| •      Retirement  plans, including pension, 401(k) and executive benefits plans                               |   | •      Web-based  applications for health and welfare, pension and compensation administration                              |   | •      Compensation  plans, including broad-based and executive compensation,  stock and other long-term incentive  programs |
| •      Investment  consulting services to pension plans                                                        |   | •      Call  center strategy, design and tools                                                                              |   | •      Strategies  to align workforce performance with business objectives                                                        |
| •      Health  care, disability and other group benefit plans                                                  |   | •      Strategic,  research-based HR technology and service delivery consulting                                             |   | •      Organization  effectiveness consulting, including talent management, through organization  and employee research           |
| •      Global  compensation, benefits, expatriate and HR practice strategy, implementation  and administration |   | •      Targeted  online compensation and benefits statements, content management and call  center case management solutions |   | •      Strategies  for attracting, retaining and motivating employees                                                             |
| •      Actuarial  services                                                                                     |   |                                                                                                                                                      |   | •      Performance  management                                                                                                    |
| •      Strategic  workforce planning                                                                           |   |                                                                                                                                                      |   |                                                                                                                                                            |

 

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

 

We believe that our extensive experience, global presence, dedicationto long-term client relationships and recognized reputation for quality provideus with significant competitive advantages. We focus on delivering value-addedconsulting services that help our clients anticipate, identify and capitalizeon emerging opportunities in human capital management.

 

15

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**InternationalOperations**

 

Outside of North America, our consultants, working in Asia-Pacific andLatin America, operate on a geographic basis from 25 offices in 16 countriesand provide consulting services in the practice areas described above.

 

**Other**

 

While we focus our consulting services in the areas described above,management believes that one of our primary strengths is our ability to drawupon consultants from our different practices to deliver integrated services tomeet the needs of our clients. Examples include the Communication Group andData Services.

 

**Watson WyattWorldwide Alliance**

 

Recognizing our clients’ need for consulting services worldwide, in thelate 1970s we established operations throughout Europe by acquiring local firmsand opening new offices.  In 1995, inresponse to the rapidly increasing globalization of the world economy, we madea strategic decision to strengthen our European capabilities significantly andextend our global reach. We entered into an alliance with R. Watson & Sons(which subsequently became Watson Wyatt Partners, now Watson Wyatt LLP), aleading United Kingdom-based actuarial, benefits and human resources consultingpartnership founded in 1878. Since 1995, we have marketed our services globallyunder the Watson Wyatt Worldwide brand, sharing resources, technologies,processes and business referrals with Watson Wyatt LLP.

 

The Watson Wyatt Worldwide alliance maintains 88 offices in 30countries and employs close to 6,100 associates. Watson Wyatt & CompanyHoldings operates 60 offices in 18 countries in North America, Latin Americaand Asia-Pacific. Watson Wyatt LLP operates 10 offices in the United Kingdomand Ireland, and also operates 2 offices engaged in the insurance and financialservices business in the United States. The alliance operates 16 offices in 10continental European countries, principally through a jointly-owned holdingcompany, Watson Wyatt Holdings (Europe) Limited.  Watson Wyatt & Company owns 25 percent of the holdingcompany; Watson Wyatt LLP owns 75 percent.

 

**Financial StatementOverview**

 

Watson Wyatt’s fiscal year ends June 30. The financial statementscontained in this quarterly report reflect Consolidated Balance Sheets as ofthe end of the first quarter of fiscal year 2004 (September 30, 2003) and as ofthe end of fiscal year 2003 (June 30, 2003), Consolidated Statements ofOperations for the three-month periods ended September 30, 2003 and 2002,Consolidated Statements of Cash Flows for the three-month periods endedSeptember 30, 2003 and 2002 and a Consolidated Statement of Changes inStockholders’ Equity for the three-month period ended September 30, 2003.

 

We operate globally as an alliance with our affiliates.  However, the revenues and operating expensesin the Consolidated Statements of Operations reflect solely the results ofoperations of Watson Wyatt & Company Holdings. Our share of the results ofour affiliates, recorded using the equity method of accounting, is reflected inthe “Income from affiliates” line. Our affiliates are Watson Wyatt LLP, WatsonWyatt Holdings (Europe) Limited and Professional Consultants Insurance Company,Inc. (PCIC), our captive insurance company.

 

We derive substantially all of our revenue from fees for consultingservices, which generally are billed at standard hourly rates or on a fixed-feebasis.  Clients are typically invoicedon a monthly basis with revenue recognized as services are performed. For themost recent three fiscal years, revenue from U.S. consulting operations hascomprised approximately 80 percent of consolidated revenue. No single clientaccounted for more than 4 percent of our consolidated revenue for any of themost recent three fiscal years.

 

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In delivering consulting services, our principal direct expenses relateto compensation of personnel.

 

Salaries and employee benefits are comprised of wages paid toassociates, related taxes, benefit expenses such as pension, medical andinsurance costs and fiscal year-end incentive bonuses.

 

Professional and subcontracted services represent fees paid to externalservice providers for auditing, employment, marketing and other services.  For the most recent three fiscal years,approximately 60 percent of these professional and subcontracted services weredirectly incurred on behalf of our clients and were reimbursed by them, withsuch reimbursements being included in revenue.

 

Occupancy, communications and other expenses represent expenses forrent, utilities, supplies and telephone to operate office locations as well asnon-client-reimbursed travel by associates, publications and professionaldevelopment.

 

General and administrative expenses include the operational costs andprofessional fees paid by corporate management, general counsel, marketing,human resources, finance, research and technology support.

 

**CriticalAccounting Policies and Estimates**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, disclosures of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenue andexpenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated basedon available information and experience. Because of the use of estimates inherent in the financial reportingprocess, actual results could differ from those estimates.

 

We have reviewed the accounting estimates used in the preparation ofour financial statements and have determined that the following accountingpolicies are critical to the understanding of the use of estimates in theCompany’s financial statements:

 

*   **RevenueRecognition***

 

Revenue includes fees primarily generated from consulting servicesprovided in the areas of employee benefits, human capital strategies andrelated technology solutions.  Werecognize revenue from these consulting engagements either on a time-and-materialsbasis or on a fixed-fee basis, depending on the terms and conditions defined atthe inception of an engagement with a client.

 

Revenue is recognized on time-and-materials engagements to the extentof billable rates times hours delivered plus expenses incurred.  For fixed-fee arrangements, revenue is alsorecognized based on the extent of billable rates times hours delivered plusexpenses incurred.  However, forfixed-fee engagements, we periodically review ongoing engagements in order toassess the accuracy of our estimates-to-complete.  Revenue recognition is affected by a number of factors includinga change in the estimated amount of effort required to complete the project,changes in scope, the staffing on the engagement and/or the level of clientparticipation.  This review requires usto make judgments and estimates regarding the overall profitability and stageof project completion which, in turn, affects how we recognize revenue.  To the extent that our estimates change fora particular engagement, we record the cumulative effect of the change in theperiod in which it becomes known.  TheCompany recognizes a loss on an engagement when estimated revenue to bereceived for that engagement is less than total estimated direct and indirect costsassociated with the engagement.  Lossesare recognized in the period in which the loss becomes probable and the amountof the loss is reasonably estimable.

 

The Company has developed various software programs and technologiesthat are provided to clients in connection with consulting services.  We recognize revenue for such services astime is incurred because the services are considered essential to thefunctionality of the software.

 

17

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Revenue recognized in excess of billings is recorded as unbilledaccounts receivable.  Cash collectionsin excess of revenue recognized are recorded as deferred revenue until therevenue recognition criteria are met. Client reimbursable expenses, including those relating to travel, otherout-of-pocket expenses, and any third-party costs, are included in revenue, andan equivalent amount of reimbursable expenses are included in professional andsubcontracted services as a cost of revenue.

 

Emerging Issues Task Force’s Issue 00-21, “Revenue Arrangements withMultiple Deliverables” (EITF 00-21), was effective for the Company beginningJuly 1, 2003.  As of July 1, 2003, theCompany has applied such requirements prospectively to multiple deliverablearrangements, which include arrangements involving installation andcustomization of technology solution products sold together with on-goingservices offered by the Company.  Theadoption of EITF 00-21 has not had a material effect on the Company’s financialperformance or condition.

 

***   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 isrecorded 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 and circumstances may change thatwould require us to alter our estimates of the collectibility of specificbilled and unbilled client receivables.

 

*   **DiscretionaryCompensation***

 

The Company’s compensation program includes a discretionary componentin the form of an annual bonus that is determined by management and paid onceper fiscal year in the form of cash and/or deferred stock units after theCompany’s annual operating results are finalized.  Quarterly, estimated annual pre-bonus profitability is reviewedby the Company and the discretionary annual bonus amount is then estimated bymanagement.  After determining theestimated annual bonus amount, the bonus is then allocated to remainingquarterly reporting periods as a constant percentage of estimated pre-bonusincome from operations.  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 income from operations.  Annual bonus levels may vary from current expectations as aresult of changes in the Company’s forecast of pre-bonus profitability andcompetitive employment market conditions.

 

As a result of a $5.6 million pre-tax non-operating gain recorded inthe first quarter of fiscal year 2004, the Company recorded a $5.6 millionsupplemental bonus accrual in the first quarter that is incremental to theCompany’s fiscal year end bonus, but will be paid out in September 2004 withthe regular bonus cycle.  Thissupplemental bonus is included in Salaries and employee benefits.

 

***   IncomeTaxes***

 

Determining the consolidated provision for income tax expense, deferredtax assets and liabilities and the related valuation allowance involvesjudgment.  As a global company withoffices in 18 countries, we are required to calculate and provide for estimatedincome tax liabilities for each of the tax jurisdictions where we operate.  This process involves estimating current taxobligations and exposures in each jurisdiction as well as making judgmentsregarding the future recoverability of deferred tax assets.  Tax costs can involve complex issues and mayrequire an extended period to resolve. Changes in the geographic mix or estimated level of annual pre-taxincome, revisions to tax positions taken as a result of further analysis andconsultation, changes in tax laws and changes resulting from tax audits can allaffect the overall effective income tax rate, which, in turn, impacts theoverall level of income tax expense and net income.

 

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***   PensionAssumptions***

 

We sponsor both qualified and non-qualified, non-contributory definedbenefit pension plans covering substantially all of our associates.  Under our principal plans (United States,Canada, Hong Kong and the United Kingdom), benefits are based on ourassociates’ years of service and compensation during the three highest paidconsecutive years of service.

 

Determination of our obligations and annual expense under the plans arebased on a number of assumptions that, given the longevity of the plans, arelong-term in their focus.  A change inone or a combination of these assumptions could have a material impact on ourpension benefit obligation and related expense.  For this reason, management employs a long-term view so thatassumptions do not change frequently in response to short-term volatility inthe economy.  Any difference betweenactual and assumed results is amortized into our pension expense over theaverage remaining service period of participating employees.  We consider several factors prior to thestart of each fiscal year when determining the appropriate annual assumptions,including economic forecasts, historical trends, portfolio composition and peercomparisons.

 

The following assumptions were used at the end of the past three fiscalyears in the valuation of our U.S. plan, which comprises the majority of theprincipal defined benefit pension plans:

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

 

The 6.00 percent discount rate assumptionused at the end of fiscal year 2003 represents a 125 basis point reduction fromthe 7.25 percent discount rate used at the end of fiscal years 2002 and2001.  The Company’s 2003 discount rateassumption was determined by matching future pension benefit payments withexpected future AA bond yields for the same periods.

 

The expected long-term rate of return on assetsassumption was lowered to 9.00 percent at the end of fiscal year 2003 from10.00 percent at the end of fiscal years 2002 and 2001.  Selection of the 9.00 percent returnassumption was supported by an analysis performed by the Company of theweighted average yield expected to be achieved with the anticipated makeup ofinvestments.  The investment makeup isheavily weighted towards equities.

 

The investment market performance over thelast two years has decreased the value of the assets held in the pension plansand the decline in interest rates has increased our accumulated benefitobligation, resulting in the accumulated benefit obligation becoming greaterthan the value of the plan assets for the U.S. and U.K. pension plans.  The Company was therefore required to recordan additional minimum pension liability for those plans at June 30, 2003, inaccordance with Statement of Financial Accounting Standards No. 87 “Employers’Accounting for Pensions” (FAS 87).  Thisresulted in an increase in the pension liability of $113.4 million, an increasein intangible assets of $0.1 million, a non-cash charge to Stockholders’ Equityof $67.9 million (reflected in accumulated other comprehensive loss) and anincrease in deferred tax assets of $45.4 million as of June 30, 2003.  A market recovery in future periods, and/oran increase in long-term interest rates, could reverse a portion or all of thischarge.  Alternatively, future marketdeclines and/or a decrease in long-term interest rates would result in anaddition to this amount.  Our Canadianand Hong Kong pension plan assets were greater than their associatedaccumulated benefit obligation as of June 30, 2003, and thus did not requirethe recording of additional minimum pension liabilities.

 

19

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***   IncurredBut 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 liabilityis based on long-term trends and averages, and considers a number of factors,including changes in claim reporting patterns, claim settlement patterns,judicial decisions, and legislation and economic decisions, but excludes theeffect of claims data for large cases due to the insufficiency of actualexperience with such cases.  Managementdoes not currently expect significant fluctuations in the IBNR liability, basedon the Company’s historical claims experience. However, our estimated IBNR liability will fluctuate if claimsexperience changes over time.

 

**Results ofOperations.**

 

The table below sets forth Consolidated Statements of Operations datafor continuing operations as a percentage of revenue for the periods indicated:

 
|                                                   |   | **Three  Months Ended September 30** |   |
|--------------------------------------------------------|--------|--------------------------------------|--------|
|                                                   |   | **2003**                             |   | **2002** |   |
|                                                   |   |                                 |   |   |   |
| Revenue                                                |   | 100.0                                | %      | 100.0 | % |
|                                                   |   |                                 |   |   |   |
| Costs of providing services:                           |   |                                 |   |   |   |
| Salaries and employee benefits                         |   | 61.5                                 |   | 56.8 |   |
| Professional and subcontracted services                |   | 5.3                                  |   | 6.0 |   |
| Occupancy, communications and other                    |   | 13.8                                 |   | 14.9 |   |
| General and administrative expenses                    |   | 9.1                                  |   | 8.0 |   |
| Depreciation and amortization                          |   | 2.7                                  |   | 2.8 |   |
|                                                   |   | 92.4                                 |   | 88.5 |   |
|                                                   |   |                                 |   |   |   |
| Income from operations                                 |   | 7.6                                  |   | 11.5 |   |
|                                                   |   |                                 |   |   |   |
| Income from affiliates                                 |   | 1.1                                  |   | 0.1 |   |
| Interest income, net                                   |   | 0.1                                  |   | 0.3 |   |
| Other non-operating income                             |   | 3.6                                  |   | 0.5 |   |
|                                                   |   |                                 |   |   |   |
| Income from continuing operations before income  taxes |   | 12.4                                 |   | 12.4 |   |
|                                                   |   |                                 |   |   |   |
| Provision for income taxes                             |   | 5.1                                  |   | 5.1 |   |
|                                                   |   |                                 |   |   |   |
| Income from continuing operations                      |   | 7.3                                  | %      | 7.3 | % |

 

 

**Three Months EndedSeptember 30, 2003, Compared to the Three Months Ended September 30, 2002**

 

***   Revenue*.**

 

Revenue from operations for the first quarter of fiscal year 2004 was$171.0 million, compared to $179.0 million for the first quarter of fiscal year2003, a decrease of $8.0 million or 4 percent.

 

The Benefits Group increased revenue by $1.9 million or 2 percentduring the first quarter of fiscal year

 

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2004 due to new client wins, partially offset by the absence of specialproject work of $3.0 million, which was performed during the first quarter ofthe previous fiscal year.  Revenue fromour Technology Solutions Group decreased by $6.0 million or 23 percent,reflecting continued weakness in capital spending.  Revenue from our Human Capital Group decreased $1.0 million or 9percent during the first quarter of fiscal year 2004, reflecting lowerheadcount and completion of special work related to executive compensation thatoccurred in the second half of fiscal year 2003.  Our international segment finished the quarter with revenuegrowth of $1.0 million or 6 percent. However, revenue was flat on a constant currency basis.  Revenue for other practice areas in NorthAmerica decreased by $2.3 million or 16 percent during the first quarter offiscal year 2004.

 

***   Salariesand Employee Benefits*.**

 

Salaries and employee benefit expenses for the first quarter of fiscalyear 2004 were $105.1 million, compared to $101.5 million for the first quarterof fiscal year 2003, an increase of $3.6 million or 4 percent.  Salaries and employee benefit expenses forthe first quarter of fiscal year 2004 include severance charges of $2.5 millionrelated to job reductions in North America. Of this amount, $1.3 million has been paid to associates under severanceagreements through the first quarter of fiscal year 2004.  The increase, exclusive of this charge, wasdue to higher pension expenses of $2.2 million and a higher accrual fordiscretionary compensation of $1.3 million, which includes the $5.6 millionsupplemental bonus, partially offset by lower benefits costs of $2.2 millionthat reflect the suspension of the company match on our defined contributionretirement plan.  As a percentage ofrevenue, salaries and employee benefits increased from 56.8 percent to 61.5percent.

 

***   Professionaland Subcontracted Services*.**

 

Professional and subcontracted services used in consulting operationsfor the first quarter of fiscal year 2004 were $9.1 million, compared to $10.8million for the first quarter of fiscal year 2003, a decrease of $1.7 millionor 16 percent.  The decrease resultedfrom lower reimbursable expenses incurred on behalf of clients, and continuedcost control measures.  As a percentageof revenue, professional and subcontracted services decreased from 6.0 percentto 5.3 percent.

 

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

 

Occupancy, communications and other expenses for the first quarter offiscal year 2004 were $23.5 million, compared to $26.6 million for the firstquarter of fiscal year 2003, a decrease of $3.1 million or 12 percent.  The decrease reflects the Company’scontinued cost containment measures, as evidenced through lower expenses in allcategories including travel, rent, office supplies, telephone and businesstaxes.  As a percentage of revenue,occupancy, communications and other decreased from 14.9 percent to 13.8percent.

 

***   Generaland Administrative Expenses.***

 

General and administrative expenses for the first quarter of fiscal year2004 were $15.6 million, compared to $14.4 million for the first quarter offiscal year 2003, an increase of $1.2 million or 8 percent.  The increase is mainly due to higherinsurance costs.  As a percentage ofrevenue, general and administrative expenses increased from 8.0 percent to 9.1percent.

 

***   Depreciationand Amortization.***

 

Depreciation and amortization for the first quarter of fiscal year 2004was $4.7 million, compared to $5.1 million for the first quarter of fiscal year2003, a decrease of $0.4 million or 8 percent. The decrease is mainly attributable to lower levels of capitalexpenditures.  As a percentage ofrevenue, depreciation and amortization decreased from 2.8 percent to 2.7percent.

 

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***   IncomeFrom Affiliates.***

 

Income from affiliates for the first quarter of fiscal year 2004 was$1.8 million, compared to $0.8 million for the first quarter of fiscal year2003, an increase of $1.0 million or 125 percent.   The increase was due to improved operations of Watson WyattHoldings (Europe) Limited (WWHE) of $0.7 million and improved results of ouraffiliated captive insurance company, Professional Consultants InsuranceCompany (PCIC), of $0.3 million, partially offset by lower operating results ofWatson Wyatt LLP of $0.2 million.

 

***   InterestIncome, Net.***

 

Interest income, net for the first quarter of fiscal year 2004 was $0.2million, unchanged from the prior year.

 

***   OtherNon-operating Income.***

 

Other non-operating income for thefirst quarter of fiscal year 2004 was $6.1 million, compared to $0.5 millionfor the first quarter of fiscal year 2003. The increase is mainly due to the $5.6 million non-operating gain theCompany recorded related to PCIC, our captive insurance company.  See Note 5 of the Notes to the ConsolidatedFinancial Statements for more information about this non-operating gain.  During the first quarter of fiscal year 2004and 2003, the Company also received cash payments of $0.5 million in connectionwith the fiscal year 2002 sale of our U.S.-based public retirementbusiness.  All payments received inconnection with the sale of our U.S.-based public retirement practice werecontingent upon the successful transition of certain clients of GRS and upontheir retention by GRS.

 

***   Provisionfor Income Taxes.***

 

Provision for income taxes for the first quarter of fiscal year 2004was $8.7 million, compared to $9.1 million for the first quarter of fiscal year2003. Our effective tax rate was 41.0 percent for the first three months offiscal year 2004 and 2003.  We record atax benefit on foreign net operating loss carryovers and foreign deferredexpenses only if it is more likely than not that a benefit will be realized.

 

***   IncomeFrom Continuing Operations.***

 

Income from continuing operations for the first quarter of fiscal year2004 was $12.5 million, compared to $13.1 million for the first quarter offiscal year 2003, a decrease of $0.6 million or 5 percent.  As a percentage of revenue, income fromcontinuing operations remained at 7.3 percent.

 

***   EarningsPer Share, Income From Continuing Operations.***

 

Diluted earnings per share, income from continuing operations for thefirst quarter of fiscal year 2004 was $0.37, compared to $0.39 for the firstquarter of fiscal year 2003.

 

***   DiscontinuedOperations.***

 

In the first quarter of fiscal year 2004, the Company received subleaseincome of approximately $17,000 in excess of lease payments related toWellspring.  See Note 14 of the Notes tothe Consolidated Financial Statements for more information related toWellspring and the reduction of the provision.

 

**Liquidity and CapitalResources**

 

Our cash and cash equivalents at September 30, 2003, totaled $118.3million, compared to $144.4 million at June 30, 2003, representing a decreaseof $26.1 million through the first quarter of fiscal year 2004.  The decrease in cash from June 30, 2003, toSeptember 30, 2003, follows a typical pattern of cash flows for the Companythat is attributable to the payment of bonuses in the first quarter related tothe prior year’s fiscal year end bonus accrual.

 

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Our non U.S. operations do not materially impact liquidity or capitalresources as they are substantially self-sufficient for their working capital needs.  At September 30, 2003, $28.1 million of thetotal cash balance of $118.3 million was held outside of North America, whichwe have the ability to utilize, if necessary. There are no significantrepatriation restrictions other than local or U.S. taxes associated withrepatriation.

 

*   **Cash Used inOperating Activities.***

 

Cash used in operating activities**for the first three months of fiscal year2004 was $25.5 million, compared to cash used in operating activities of $18.0million for the first three months of fiscal year 2003.  The variance is mainly due to the timing ofinsurance payments, which contributed $8.9 million to the increase in cash usedin operations, and higher tax payments of $6.9 million, partially offset by alower payment of discretionary compensation of $10.1 million.  The allowance for doubtful accountsincreased $1.0 million and the allowance for work in process increased $0.2million from June 30, 2003, to September 30, 2003. The number of days ofaccounts receivable and work in process outstanding was 78 at September 30,2003, compared to 72 at June 30, 2003 and 80 at September 30, 2002.

 

*   **Cash Used inInvesting Activities.***

 

Cash used in investing activities for the first quarter of fiscal year2004 was $3.1 million, compared to $7.1 million for the first quarter of fiscalyear 2003.  The decrease can beprimarily attributed to lower purchases of fixed assets of $1.7 million and theabsence of additional investments in affiliates compared to the first quarterof fiscal year 2003.

 

Expenditures of capital funds were $3.6 million for the first threemonths of fiscal year 2004.  Anticipatedcommitments of capital funds are estimated at $23.2 million for the remainderof fiscal year 2004, mainly for computer hardware purchases, office relocationsand renovations, development and upgrade of financial and retirement systemsand acquisition-related payments. We expect cash from operations to adequatelyprovide for these cash needs.

 

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

 

Cash from financing activities for the first quarter of fiscal year2004 was $1.9 million, compared to cash used in financing activities of $5.9million for the first quarter of fiscal year 2003.  The difference can be attributed to the absence of common stockrepurchases in the first quarter of fiscal year 2004 compared to the firstquarter of fiscal year 2003.

 

**Off-Balance SheetArrangements and Contractual Obligations**

 

***Operating Leases***.  We lease office space, furniture andselected computer equipment under operating lease agreements with terms rangingfrom one to ten years.  Future expectedpayments are as follows:

 
|                              |   | **Payments  due by period** |    |
|-----------------------------------|--------|-----------------------------|---------|
| **Contractual Cash  Obligations** |   | **Total**                   |    | **Less than  1  year** |   | **1-3 years** |   | **3-5 years** |   | **After 5  years** |   |
| Lease commitments                 |   | $                           | 244,605 |   | $ | 29,388 |   | $ | 68,284 |   | $ | 54,326 |   | $ | 92,607 |   |
|                                   |        |                             |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Management has determined that there is not a large concentration ofleases that will expire in any one fiscal year.  Consequently, management anticipates that any increase in futurerent expense will be mainly market driven.

 

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***Guarantees***

 

*Wellspring Leases*.  The Company continues to guarantee certainleases for office premises and equipment for Wellspring.  At September 30, 2003, minimum remainingpayments guaranteed under these leases, which expire at various dates through2007, totaled $22.9 million, excluding anticipated sublease income.  See Note 14 of the Notes to the ConsolidatedFinancial Statements for more information related to Wellspring.

 

*Affiliate Agreements*.  In connection with the establishment of ouralliance with Watson Wyatt LLP in 1995, the Company agreed to guarantee WatsonWyatt LLP’s performance under a lease for office space in London that expiresin 2015.  Payments by Watson Wyatt LLPunder the lease total £1.4 million (or approximately $2.3 million based on theSeptember 30, 2003, exchange rate) per year. We also granted Watson Wyatt LLP an option to return the leased space toour UK subsidiary in 2009.  If WatsonWyatt LLP were to exercise this option, the Company would attempt to subleasethe space at the then-current market rates.

 

*Stock Loans*.  The Company guarantees a credit facilitythat provided loans to associates for stock purchased under our former StockPurchase Program.  This Stock PurchaseProgram was discontinued in conjunction with our initial public offering inOctober 2000.  As a result, amountsguaranteed under the facility permanently decrease as the loans are repaid.  The maximum available borrowings andaggregate outstanding balances under this facility were $0.9 million atSeptember 30, 2003, and $1.0 million at June 30, 2003.  A total of 900,000 and 989,000 Watson Wyatt& Company Holdings shares were pledged by stockholders to collateralizethese loans at September 30, 2003, and June 30, 2003, respectively.

 

**Credit Agreement**

 

The Company has entered into a $100.0 million revolving credit facilitywith a syndicate of banks.  Interestrates associated with this facility vary with LIBOR and/or the Prime Rate, andare based on our leverage ratio, as defined by the credit agreement.  We are charged a quarterly commitment fee,currently 0.25 percent of the facility, that varies with our financial leverageand is calculated on the unused portion of the credit facility.  No amounts were outstanding under theCompany’s revolving credit facility as of September 30, 2003, or June 30,2003.  Credit under the facility isavailable upon demand, although the credit facility requires us to observecertain covenants (including requirements for minimum net worth, which act torestrict dividends and other financial and restrictive covenants) and iscollateralized with a pledge of stock of material subsidiaries.  We were in compliance with all covenantsunder the credit facility as of September 30, 2003.

 

A portion of the revolving facility is used to support required lettersof credit issued under the credit line. As a result, $7.5 million of the facility is currently unavailable foroperating needs.  We are also charged afee for outstanding letters of credit that also fluctuates based on ourleverage ratio.  The credit facility isscheduled to expire on June 25, 2005.

 

**Risk Management**

 

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

 

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** **

As of July 1, 2003, PCICattempts to recover through its premium structure the amounts it expects to payout for member companies in claims losses. It bases premium calculations, whichare determined annually based on experience through March of each year, onrelative risk of the various lines of business performed by each of the ownercompanies, past claim experience of each owner company, growth of each of thosecompanies, industry risk profiles in general and the overall insurance markets.In addition, our agreements with PCIC could require additional payments to PCICin the event that the Company decided to exit PCIC and adverse claimssignificantly exceed prior expectations. If these circumstances were to occur, the Company would record aliability at the time it becomes estimable and probable.  

 

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

** **

**Although the Company maintains professional liabilityinsurance coverage, this insurance does not cover claims made after expirationof our current insurance contracts. Generally accepted accounting principles require that we record a liabilityfor incurred 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 actuarialassumptions to estimate and record its IBNR liability and has a $12.8 millionIBNR liability recorded as of September 30, 2003.**

** **

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

** **

**In light of increasing worldwide litigation, includinglitigation against professionals, the Company has been implementing arequirement that all client relationships be documented by engagement letterscontaining specific risk mitigation clauses that were not included in allhistorical client agreements.  Nearly100 percent of the Company’s U.S. corporate clients have signed engagementletters including mitigation clauses, and initiatives to complete that processin the United States and elsewhere are underway. The Company has disengagedfrom certain client relationships where satisfactory engagement terms could notbe achieved.**

** **

**Recent AccountingPronouncements**

** **

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),“Consolidation of Variable Interest Entities”, which clarifies the financialreporting guidance associated with the consolidation of another entity.  The consolidation requirements of FIN 46applied immediately to variable interest entities created after January 31,2003, and as disclosed in the Company’s Annual Report on Form 10-K,pre-existing variable interest entities as of July 1, 2003.  However, at the October 8, 2003 meeting ofthe Financial Accounting Standards Board (the “Board”), the Board decided toissue a final FASB Staff Position 46-6, Effective Date of FASB InterpretationNo. 46, Consolidation of Variable Interest Entities (“Final FSP”).  The Final FSP provides a broad deferral ofthe latest date by which all public entities must apply FIN 46 to certainvariable interest entities and is effective for the Company as of December 31,2003.  Management does not believe thatthe adoption of FIN 46 will have an effect on the Company’s financialperformance or condition.

 

Emerging Issues Task Force’s Issue 00-21, “Revenue Arrangements withMultiple Deliverables” (EITF 00-21), was effective for the Company beginningJuly 1, 2003.  As of July 1, 2003, theCompany has applied such requirements prospectively to multiple deliverablearrangements, which include arrangements involving installation andcustomization of technology solution products sold together with on-goingservices offered by the Company.  Theadoption of EITF 00-21 has not had a material effect on the Company’s financialperformance or condition.

 

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**Disclaimer RegardingForward-looking Statements**

 

This filing contains certain statements that are “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995, including, but not limited to the following: Note 7 on page 8 and 9;Note 11 on page 12; Note 12 on pages 12 and 13; Note 13 on page 13; CriticalAccounting Policies and Estimates on pages 17 through 20; the discussion of ourcapital commitments on page 23; and Part II, Item 1 “Legal Proceedings” on page27.  In some cases, you can identifythese statements and other forward-looking statements in this filing by wordssuch as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “plan,”“intend,” “continue,” or similar words. You should read these statements carefullybecause they contain projections of our future results of operations orfinancial condition, or state other “forward-looking” information. A number ofrisks and uncertainties exist which could cause actual results to differmaterially from the results reflected in these forward-looking statements. Suchfactors include, but are not limited to, our continued ability to recruit andretain highly qualified associates, outcomes of litigation, a significantdecrease in the demand for the consulting services we offer as a result ofchanging economic conditions or other factors, actions by competitors offeringhuman resources consulting services, including public accounting and consultingfirms, technology consulting firms and internet/intranet development firms,regulatory, legislative and technological developments that may affect thedemand for or costs of our services and other factors discussed under “riskfactors” in our Annual Report on Form 10-K for the fiscal year ended June 30,2003, which was filed with the SEC on September 23, 2003, and may be accessedvia EDGAR on the SEC’s web site at www.sec.gov. These statements are based onassumptions that may not come true. All forward-looking disclosure isspeculative by its nature. The Company undertakes no obligation to update anyof the forward-looking information included in this report, whether as a resultof new information, future events, changed expectations or otherwise.

 

** **

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

We are exposed to market risks in the ordinary course of business.These risks include interest rate risk and foreign currency exchange risk. Wehave examined our exposure to these risks and concluded that none of ourexposures in these areas are material to fair values, cash flows or earnings*.*

 

 

**ITEM 4. CONTROLS AND PROCEDURES.**

 

(a) Evaluation of Disclosure Controls andProcedures

 

The Chief Executive Officer and Chief Financial Officer of the Companyevaluated our disclosure controls and procedures as of the end of the firstquarter of fiscal year 2004 and have concluded that, as of September 30, 2003,such controls and procedures have been effectively designed to ensure thatinformation required to be disclosed in reports that the Company files with orsubmits to the SEC is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms and is accumulated andcommunicated to management, including the Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding suchdisclosure.

 

(b) Changes in Internal Control Over Financial Reporting

 

No changes in our internal control over financial reporting have cometo management’s attention during our first fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.  Review andevaluation of disclosure controls and procedures is an ongoing process that wewill continue to refine as we perform quarterly evaluations.

 

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**PART II.  OTHER INFORMATION**

 

 

**ITEM 1. LEGAL PROCEEDINGS.**

 

**From time to time, we are a party to various lawsuits,arbitrations or mediations that arise in the ordinary course of business.  These disputes typically involve claimsrelating to the rendering of professional services or employment matters.  Management believes, based on currentlyavailable information, that the results of all pending claims against us willnot have a material adverse affect on the Company.**

 

*New Jersey Coalitionof Auto Retailers Insurance Group Trust (NJCAR).*  A settlement agreement has been executed by all parties to the lawsuitbrought against Watson Wyatt and five other service providers of NJCAR, aninsolvent group health insurance provider.  The suit alleged that lossesresulting from the insolvency are partly attributable to NJCAR’s former serviceproviders.   If no objections are filed, the settlement agreement isscheduled to be approved by the state court presiding over NJCAR’s insolvencyproceedings on December 5, 2003.

 

*Toussaint, et al. v.James, et al.*  Union leaders, in their capacityas the trustees of a pension plan for the union leadership, brought suit inDecember 2001 in the U.S. District Court for the Southern District of New Yorkagainst the former union leaders and Watson Wyatt, alleging damages suffered inreliance on our actuarial work and breaches of fiduciary duties owed by theformer union leaders.  The claim against Watson Wyatt is allegedly in the$4 million range.  If the case is not resolved in mediation, a jury trialis scheduled for February 28, 2004.

 

 

**ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.**

 

**RestrictedShares**

 

In conjunction with our initial public offering in October 2000, weentered into agreements providing for additional transfer restrictions withmajor stockholders, executive officers and employee directors.  As a result of these agreements, 3,816,000Class A shares were currently restricted as of September 30, 2003.  Of these shares, 1,908,000 became freelytransferable in October 2003.  Theremaining shares will become freely transferable in October 2004.

 

In September 2003, the Company issued 185,688 shares in connection withits employee benefit plans.

 

 

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

 

 

**None.**

 

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.**

 

 

None.

 

 

I**TEM 5. OTHERINFORMATION.**

 

 

None.

 

27

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

 

** **
| a.     |   | Exhibits                                                                                                                                                                                                                  |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                      |
| 3.1    |   | Amended and Restated Certificate of Incorporation of Watson Wyatt  & Company Holdings(1)                                                                                                                              |
|   |   |                                                                                                                                                                                                                      |
| 3.2    |   | Amended and Restated Bylaws of Watson Wyatt & Company Holdings(2)                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                      |
| 4      |   | Form of Certificate Representing Common Stock(1)                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                      |
| 10.1   |   | Amended Credit Agreement Among Bank of America, N.A., and Others  dated June 25, 2002(3)                                                                                                                                  |
|   |   |                                                                                                                                                                                                                      |
| 10.2   |   | Credit Agreement Among Bank of America, N.A., and Others dated June  25, 2002(3)                                                                                                                                          |
|   |   |                                                                                                                                                                                                                      |
| 10.3   |   | Consent of Bank of America, N.A.(5)                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                      |
| 10.4   |   | Agreement with David B. Friend, M.D., dated October 22, 1999(1)                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                      |
| 10.5   |   | Senior Officer Deferred Compensation Plan(5)                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                      |
| 10.6   |   | Form of agreement among Watson Wyatt & Company, Watson Wyatt  & Company Holdings and employee directors, executive officers and  significant stockholders restricting the transfer of shares(4)                   |
|   |   |                                                                                                                                                                                                                      |
| 31.1   |   | Certification of Chief Executive Officer Pursuant to Securities  Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002(6)                                           |
|   |   |                                                                                                                                                                                                                      |
| 31.2   |   | Certification of Chief Financial Officer Pursuant to Securities  Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002(6)                                           |
|   |   |                                                                                                                                                                                                                      |
| 32.1   |   | Certification of Chief Executive Officer Pursuant to Title 18, U.S.C.  Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002(6)                                                                |
|   |   |                                                                                                                                                                                                                      |
| 32.2   |   | Certification of Chief Financial Officer Pursuant to Title 18, U.S.C.  Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002(6)                                                                |
|   |   |                                                                                                                                                                                                                      |
| b.     |   | Reports on Form 8-K                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                      |
|   |   | (i) On August 14, 2003, the Company filed a Current Report on Form  8-K, which included a press release dated the same day and which provided  notification of a delay in the reporting of our fiscal year 2003 earnings. |
|   |   |                                                                                                                                                                                                                      |
|   |   | (ii) On September 18, 2003, the Company filed a Current Report on  Form 8-K, which included a press release dated the same day, in which we  reported our fiscal year 2003 earnings.                                      |
|   |   |                                                                                                                                                                                                                      |
|   |   | (iii) On November 5, 2003, the Company filed a Current Report on Form  8-K, which included a press release dated the same day, in which we reported  our first quarter fiscal year 2004 earnings.                         |

 

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

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

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

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

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

(6)                Filed withthis Form 10-Q

 

28

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**Signatures**

 

Pursuant to the requirements of the Securities and Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.

 

Watson Wyatt & Company Holdings(Registrant)

 

 
| /S/ John J. Haley   |                                        | November 14, 2003 |
|---------------------|---------------------------------------------|-------------------|
| Name:               | John J. Haley                               | Date              |
| Title:              | President and Chief  Executive Officer      |              |
|                |                                        |              |
| /S/ Carl D. Mautz   |                                        | November 14, 2003 |
| Name:               | Carl D. Mautz                               | Date              |
| Title:              | Vice President and Chief  Financial Officer |              |
|                |                                        |              |
| /S/ Peter L. Childs |                                        | November 14, 2003 |
| Name:               | Peter L. Childs                             | Date              |
| Title:              | Controller                                  |              |
|                     |                                             |                   |  |

 

29

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