**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

**FORM 10-K**

 
| **(Mark One)** |
|----------------|
| **ý**     | **ANNUAL REPORT PURSUANT TO SECTION  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |
|           | **For the fiscal year ended June 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          ** |

 

**Commission File Number: 001-16159**

 

**WATSON WYATT & COMPANY HOLDINGS**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    |   | **52-2211537**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **1717 H STREET NW  Washington, D.C.  20006-3900**         |
| (Address of principal executive offices, including zip code)    |
|                                                            |
| **(202) 715-7000**                                              |
| (Registrant’s telephone number, including area code)       |
|                                                            |   |                                 |
| Securities registered pursuant to Section 12(b) of the Act:     |

 
| **Title of  each class**                                                                     |   | **Name of  each exchange  on which registered** |   |
|----------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|
| Class A Common Stock, $0.01 par value  (32,830,219 shares outstanding as of August 31, 2003) |   | New York Stock Exchange                         |   |

 

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

 

| Yes | ý | No | o |
|-----|--------|----|---|

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.

 

| Yes | ý | No | o |
|-----|--------|----|---|

 

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

 

| Yes | ý | No | o |
|-----|--------|----|---|

 

The aggregate market value ofthe voting and non-voting common equity held by non-affiliates of theRegistrant was $713,775,775 as of December 31, 2002.

 

**DocumentsIncorporated by Reference**

 

Portions of the DefinitiveProxy Statement for the Annual Meeting of Stockholders to be held on or aboutNovember 17, 2003 are incorporated by reference into Part III of this Form10-K.

 

 

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**PART I**

 

**Item 1. Business.**

 

**Overview**

 

Watson Wyatt & CompanyHoldings, including its subsidiaries (collectively referred to as “we”, “WatsonWyatt” or the “Company”), is a global human capital consulting firm. We helpour clients enhance business performance by improving their ability to attract,retain and motivate qualified employees. We focus on delivering value-addedconsulting services that help our clients anticipate, identify and capitalizeon emerging opportunities in human capital management.  We implement this strategy through more than4,100 associates in 61 offices located in 18 countries.

 

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

 

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

 

**Benefits Group**

 

•      Retirement plans, including pension,401(k) and executive benefits plans

•      Investment consulting services to pensionplans

•      Health care, disability and other groupbenefit plans

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

•      Actuarial services

•      Strategic workforce planning

 

**Technology Solutions Group**

 

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

•      Call center strategy, design and tools

•      Strategic, research-based HR technologyand service delivery consulting

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

 

**Human Capital Group**

 

•      Compensation plans, including broad-basedand executive compensation, stock and other long-term incentive programs

•      Strategies to align workforce performancewith business objectives

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

•      Strategies for attracting, retaining andmotivating employees

•      Performance management

 

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

 

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***CompetitiveAdvantage***

 

We believe that our competitiveadvantages include our strong client relationships, our thought leadership andour experienced management team.

 

We have long-lastingrelationships with our clients, many of which have been our clients fordecades, for whom our services have grown over time.  Expanding our relationships with existing clients and identifyingnew prospects are key to our growth strategy.

 

We also believe that we are atthe forefront of many issues affecting human capital through our research,surveys and participation in policy-making. Our thought leaders are often called upon by the media and government toexpress opinions on issues affecting health care benefits, retirement plandesign and executive compensation.

 

Our senior management team isstrong, with an average tenure of 14 years with the Company and a reputationfor transparency and accountability.  Weconsider this group to be a major asset to the Company.

 

***CorporateInformation***

 

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

 

***WatsonWyatt Worldwide Alliance***

 

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

 

The Watson Wyatt Worldwidealliance maintains 88 offices in 30 countries and employs more than 6,200 associates.Watson Wyatt & Company Holdings operates 61 offices in 18 countries inNorth America, Latin America and Asia-Pacific. Watson Wyatt LLP operates 10offices in the United Kingdom and Ireland, and also operates 2 offices engagedin the insurance and financial services business in the United States. Thealliance operates 15 offices in 10 continental European countries, principallythrough a jointly-owned holding company, Watson Wyatt Holdings (Europe)Limited.  Watson Wyatt & Companyowns 25 percent of the holding company; Watson Wyatt LLP owns 75 percent.

 

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**Human Resources Consulting Industry**

 

The growing demand for employeebenefits and human capital consulting services is directly related to the increasingsize and complexity of today’s human resources programs and the societal forcesthat are stimulating their rapid change. In the United States alone, employers spend more than $6 trillionannually in direct costs of human capital programs, such as compensation andbenefits.  In 2002, U.S. employerscontributed nearly $190 billion to pension and profit-sharing plans, and morethan $325 billion to group health insurance programs, while the assets of U.S.employer-sponsored retirement plans approximated $8 trillion.

 

Employers, regardless ofgeography or industry, are facing unprecedented challenges involving themanagement of their people. Changing technology, difficult economic times,critical skill shortages and an aging population in many developed countrieshave increased competition for talented employees.  At the same time, employees’ expectations relating tocompensation, benefits and other HR services are growing.  To remain competitive, employers mustaddress these challenges effectively.

 

**Consulting Services**

 

Our North American operationsinclude three principal practice groups: Benefits, Technology Solutions andHuman Capital.  Outside North America,our operations are organized and managed on a geographic basis.  The percentage of revenues generated in thevarious groups is as follows:

 
|                                               |   | **2003** |   | **2002** |   | **2001** |   |
|----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Benefits Group                                     |   | 61       | %      | 59       | %      | 57       | %      |
| Technology Solutions Group                         |   | 14       |   | 16       |   | 14       |   |
| Human Capital Group                                |   | 7        |   | 7        |   | 8        |   |
| International                                      |   | 11       |   | 10       |   | 11       |   |
| Other (including Data Services and  Communication) |   | 7        |   | 8        |   | 10       |   |
| Total                                              |   | 100      | %      | 100      | %      | 100      | %      |

 

For more information aboutindustry segments, see Note 13 of Notes to the Consolidated FinancialStatements, included in Item 15 of this report.

 

***BenefitsGroup***

 

Our Benefits Group – with 1,665associates – consists primarily of consulting practices in retirement, groupand health care, and pension investment management.  It is our largest and most established practice, with a franchisedating to 1946.  This group works withclients to create cost-effective retirement and health care benefits programsthat help attract, retain and motivate a talented workforce.  We strive to provide tailored benefitsprograms for our clients, and we base our recommendations on extensive research.  Our Benefits Group accounted for approximately61 percent of our total segment revenues for the fiscal year ended June 30,2003.

 

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*Retirement Consulting*

 

We are one of the world’slargest advisers on retirement plans, providing actuarial and consultingservices for large defined benefit and defined contribution retirement plans.Our consultants work with clients to assess the impact that changing workforcedemographics will have on their retirement plans, corporate cash flowrequirements and retiree benefits adequacy and security.

 

In North America, andincreasingly throughout much of the developed world, organizations provideemployees with retirement security through funded pension plans, most of whichare either defined benefit or defined contribution plans.  A typical defined benefit plan ischaracterized by employer contributions and a specified future benefit to theemployee.  Such plans typically involvelarge asset pools, complex calculations to determine employer costs, fundingrequirements and sophisticated analysis to match liabilities and assets overlong periods of time. These plans are commonly referred to as pension plans. Atypical defined contribution retirement plan is characterized by employeecontributions, possible employer matching contributions and an unspecifiedfuture benefit – based on investment returns – paid to the employee.  In the United States, the most commonexample of a defined contribution plan is a 401(k) plan.

 

On August 30, 2001, we formedan alliance with Gabriel, Roeder, Smith & Company (GRS), an actuarial andbenefits consulting firm that specializes in public sector employee benefitprograms, under which we will mutually refer future business opportunities andexplore joint consulting assignments. In addition, we sold GRS our U.S.-based public sector retirementpractice.  Our relationship with GRS hasbeen strong, and we continue to work together to service a number of clients.

 

Our target market forretirement consulting is companies with large defined benefit plans, such asthe Fortune 1000, Pensions & Investments 1000 (P&I 1000), and othersimilarly-sized plans and plan sponsors. Our consultants provide actuarialservices and are the named actuaries to many of the world’s largest retirementplans, including four of the five largest corporate-sponsored defined benefitplans in the United States.  The market for actuarial consulting for theselarge companies is fragmented, and no single consulting firm significantlydominates this target market.  The WatsonWyatt / GRS Alliance has the leading retirement consulting/actuarial marketshare in the United States among the combined list of the P&I 1000 and theFortune 1000.  We are the only majorfirm in the defined benefit market to have significantly, organically grown ourmarket share in our target market over the past five years.  Additionally, our corporate client retentionrate within this group has remained very high, averaging over 98 percent.

 

Our defined benefit servicesinclude:

 

•                  Strategic plandesign

•                  Actuarialservices

•                  Fundingrecommendations

•                  Multinationalasset pooling consulting

•                  Financialreporting

•                  Valuation anddiagnostic software and systems

•                  Assistance withchanges relating to mergers, acquisitions and divestitures

•                  Complianceconsulting

•                  Administrativeservices

 

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We also help companies designand implement defined contribution plans, particularly 401(k) plans in theUnited States.

 

In both the defined benefit anddefined contribution areas, we emphasize research-based consulting to designretirement programs that align our clients’ workforces with their businessstrategies. Our products and services include:

 

•                  Pension EquityPlan – an alternative retirement plan that combines the lump-sum portability ofdefined contribution and cash balance plans desired by younger workers with abenefits formula based on the final few years of earnings, yet provides thebenefits security typical of a traditional defined benefit plan that older andlong-service employees seek

 

•                  Flex PensionPlusTM – for Canadian organizations, a tax-effective, supplementalretirement plan for attracting and retaining key employees

 

•                  PensionPathTM – in partnership with ourTechnology Solutions Group, we deliver this full-featured, web-based solutiondesigned to meet the pension administration needs of companies of all sizes

 

•                  PREpare!®– a web-based tool that enables employees to model different savings andretirement income scenarios

 

•                  Watson Wyatt401(k) Value Index® – a tool that looks beyond cost to identify thetotal value that employers and their employees derive from 401(k) plans

 

•                  PhasedRetirement Programs – a combination of programs that help clients attract andretain older workers by enabling them to balance work/life needs through agradual transition to retirement

 

•                  FASTool – aninteractive tool that allows the immediate comparison of balance sheetinformation and assumptions related to pension and retiree medical plans forlarge publicly-traded companies

 

To support our retirementconsulting services, we invest heavily in the latest technology to ensure theconsistency and efficiency of service delivery in all our offices worldwide. Wealso maintain extensive proprietary databases, Watson Wyatt COMPARISONTMand BenTrackTM, that enable our clients to track and benchmarkbenefit plan provisions in the United States and throughout the world.

 

*Group and Health Care Consulting*

 

Employers look to providehealth and welfare benefits that will help them to attract and retain qualifiedworkers and to enhance the productivity of their workforce.  Given increasing health care costs,declining employee satisfaction and the increased administrative burden forU.S. companies, this challenge has never been greater.  Globally, many health care systems arestrained by shrinking resources and increasing demand due to population agingand declining health status.  In theUnited States, these underlying forces are creating pressure for new approachesto providing health care benefits for workers and retirees – approaches thatengage patients as consumers of health care and not just passiverecipients.  These methods empoweremployees to participate more actively in the health care buying decision byputting workers in charge of spending their own health care dollars and byproviding them with the tools and information necessary to more directly managetheir health care choices.

 

Clients ask us to help themwith the design, financing, administration, communication and management oftheir health and welfare benefit plans, to effectively manage their labor costsand maximize productivity.

 

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Our services include:

 

•            Strategic plan designof health and welfare, paid time off and flexible benefit plans

•            Actuarial services

•            Health management

•            eHealth strategy andimplementation

•            Total absencemanagement

•            Vendor selection andongoing management services

•            Measurement of programeffectiveness

•            Assistance with planchanges relating to mergers, acquisitions and divestitures

 

Our approach to group benefitsconsulting is data-driven, research-based and makes use of sophisticatedconsulting tools, including:

 

•                  BenefitConnectTM– a customizable, web-based application that combines self-service employeetools with administrative and call center components to facilitate theadministration and management of health and welfare benefits

 

•                  PreViewTM– a medical benefits cost modeling system that accurately and quickly modelsmedical claims under alternative plan designs, covered populations and managedcare delivery systems

 

•                  ConsumerHealthView– a cost modeling system that assesses the short-term and long-term financialimpact of consumer-driven health plans

 

•                  Health PlanValue LibraryTM – a database of information on the cost, quality andaccessibility of health plans, used to screen and evaluate health plans

 

•                  Avoidable ClaimsAnalysis – a data analysis system that identifies opportunities for thereduction of medical claims through health management programs

 

*Investment Consulting*

 

Pension plan sponsors faceunprecedented challenges in today’s market environment.  Through our registered investment advisorsubsidiary, we offer investment consulting services that help clientsthroughout the world maximize the return on their retirement plan assets,develop governance policies and strategies, and design investment structures tosuccessfully manage financial liabilities within the context of their overallbusiness objectives.

 

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Our services include:

 

•                  Asset/liabilitymodeling and asset allocation studies

•                  Governance andinvestment policy development

•                  Investmentpolicy implementation

•                  Investmentstructure analysis

•                  Investmentmanager selection and evaluation

•                  Performanceevaluation and monitoring

 

We offer the followingintegrated services for plan sponsors:

 

•                  Watson WyattPension Risk ManagementTM – an integrated methodology for determining theappropriate amount of investment risk for a plan and allocating that riskacross all investment decisions

•                  Watson WyattAdvanced Investment Solutions*®* – fiduciary outsourcing for definedbenefit plans.  We work with the plansponsor to develop an investment policy and directly manage the implementationof that policy

 

***TechnologySolutions Group***

 

Our Technology Solutions Groupof 390 associates helps clients identify, select and implement best-fit HR andbenefits technologies in a market increasingly defined by three key dynamics:enterprise resource planning systems (ERPs), total benefits outsourcing (TBO)and point solutions.

 

Nearly every Fortune 1000corporation in North America has an ERP solution in place, most commonly for HRinformation systems. ERP vendors are aggressively expanding into broader HRservices, including benefits or compensation administration, looking forincreased revenues through upgrades and additional services offerings.  TBO providers are also expanding theirservice lines across additional HR domains and promoting a “one-stop-shop”method to benefits administration. Watson Wyatt’s technology business strategyis centered on the belief that point solutions – targeted, best-in-classapplications – are the preferred, more balanced approach to benefitsadministration. These solutions offer employers lower cost, greater flexibilityand more comprehensive options than stand-alone ERPs or total outsourcingsystems.

 

While Watson Wyatt has longprovided benefits administration solutions to our clients, we recently launchednew offerings in our core areas, including:

 

•                  PensionPathTM –This web-based solution is designed to meet the pension administration needs ofcompanies of all sizes. The offering includes case management andadministration tools to manage the entire life cycle of pension administration,from new hire to retirement, and employee self-service tools that enhanceworkers’ understanding of their retirement benefits’ future value.

 

PensionPathcan be customized on both the front- and back-end to match the client’s brandand specific service needs, while allowing employees to easily obtain pensionestimates. Much more than the typical pension calculator, PensionPath brings anextensive array of system-level tools into the hands of benefits staff,including event processing and administration, ad hoc and standard reporting,full calculations, history tracking and multi-user capabilities.

 

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•                  BenefitConnectTM– A web-based solution combining self-service tools that educate and engageemployees with administrative and call center components to reduce the burdenof health and welfare plan administration for employers.  This tool provides employers greaterflexibility and control over the cost of their health and welfare plan enrollmentand administration.

 

BenefitConnectserves the entire spectrum of potential users, including employees, planadministrators, customer representatives, HR and benefit managers, vendors andcarriers. It can be configured and branded to meet companies’ uniquerequirements and plan and vendor formats. BenefitConnect’s full functionalityhelps users manage benefits data, make eligibility calculations, facilitateannual and ongoing plan enrollment, integrate with payroll solutions andcarriers to process participant elections, and manage and track employee calls,transactions and cases. It also allows companies to create or leverage theirinternal call center with a powerful suite of web-based call center tools.

 

Other targeted point solutionsinclude:

 

•                  Reward®*–*asuite of compensation management applications that automates all aspects of paydelivery – including market pricing, compensation design and analysis andmanager self-service – for compensation planning

 

•                  eStatements –integrated, web-based applications that provide employees with a personalizedview of their compensation and benefit programs, costs and account balances

 

•                  HR ContentManagement System – a**web-basedtool that helps users manage the content creation, contribution and updating ofHR and benefits information to increase accuracy and control

 

•                  Watson Wyatt’sshared service center solution – a web-based case management tool to supportcall centers

 

We also provide clients withstrategic, research-based HR technology and service delivery consulting, whileworking with them to align their HR strategy with their business goals and touse HR technology to improve customer satisfaction and sustainable return oninvestment (ROI). Our services in this area include vendor assessments andselection and service delivery model development, including shared servicesstrategy and design.

 

Ourapproachestablishes the foundation for employee relationship management, allowing ourclients to connect their people and processes to their business strategy toimprove performance.  Our TechnologySolutions Group represented approximately 14 percent of our total segmentrevenues for the fiscal year ending June 30, 2003.

 

***HumanCapital Group***

 

Our Human Capital Group of 180associates helps clients achieve competitive advantage by aligning theirworkforce with their business strategy. This includes helping clients developand implement strategies for attracting, retaining and motivating theiremployees to maximize the return on their investment in human capital. OurHuman Capital Group represented approximately 7 percent of our total segmentrevenues for the fiscal year ended June 30, 2003.

 

Our Human Capital Group focusesin three principal areas: executive compensation, Strategic Rewards® andorganization effectiveness.

 

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*Executive Compensation*

 

We advise executives and boardsof directors on executive pay programs, including cash compensation, stockoptions and stock purchase plans, and on ways to align pay-for-performanceplans throughout the organization to increase stockholder value.

 

*Strategic Rewards®*

 

We help align an organization’srewards – including compensation, stock programs, incentives, recognitionprograms and flexible work arrangements – with its business strategies,cultural values, work design and human resources strategy.  Our Human Capital Group and Benefits Groupwork together to develop optimal total compensation programs for our clients.

 

*Organization Effectiveness*

 

We help clients to clarify andimplement business strategy, recognizing the impact of employee attitudes,commitment and effective team and leadership development on business success.We provide a wide array of services centered on organization assessment,including organization measurement and surveys. In the area of talentmanagement, we provide tools and methodologies for talent selection anddevelopment, succession planning and performance management. We also provideconsulting regarding organization design and the organization and developmentof the HR function.

 

We have created the *Watson WyattHuman Capital Index*â,a proprietary tool for demonstrating the relationship between the effectivenessof an organization’s human capital practices and the creation of superiorstockholder returns.

 

Our WorkUSA®/WorkCanadaTMdatabase includes the opinions of 10,000 North American employees surveyedindependently, reflecting a large cross-section of jobs and industry types. Ourclients compare their own employee survey results against these norms toidentify workplace perceptions and satisfaction and commitment levels.

 

***InternationalOperations***

 

We manage our operationsoutside North America geographically. These operations include 25 offices in Asia-Pacific and Latin America,employing 990 associates, which generally provide our full array of services.This segment represented approximately 11 percent of our total segment revenuesfor the fiscal year ended June 30, 2003.

 

We established our presence inAsia-Pacific in 1979 with offices in Hong Kong and Malaysia and grewsubstantially throughout the 1980s and 1990s by establishing new offices andacquiring existing firms.  We have beensuccessful in growing high-end human capital consulting services, helping ourclients with the people and cultural issues that are necessary to grow theirbusinesses.  These services have becomeincreasingly important since the 1997/1998 economic crisis.

 

We are also widely recognizedas the leader in providing compensation and benefits surveys in the region, withmore than 50 different survey products. Our retirement consulting servicescontinue to grow in the region, and we provide investment consulting servicesto some of the largest pension plans in Japan and Hong Kong. We were named HRConsultancy of the Year in Hong Kong by *China Staff* magazine for the past fiveyears in a row. In addition to our human capital and benefits consultingservices, we also market technology solutions to clients in the region.

 

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Our Latin American presencebegan in the early 1980s in Mexico and grew to include such major markets asBrazil in the 1990s. With deregulation, privatization and the influx ofmultinationals, we believe there are significant opportunities for growth in theregion, both in the benefits area – where most of our services are concentratedcurrently – and in the human capital consulting area.

 

***Other Services***

 

*CommunicationConsulting*

 

Our Communication ConsultingPractice has won numerous awards for innovative and effective communicationprograms. Our consultants combine strong creative skills with technicalexcellence on human resources issues and solid research on employee attitudesand communication effectiveness. We conduct communication audits, research andfocus groups and provide communication planning and implementation.  In addition, our consultants help employersto comply with disclosure requirements.

 

Among various communicationissues, we help clients develop and implement communication strategies for:

 

•                  ROI ofcommunication programs

•                  Changemanagement

•                  Benefits

•                  Electronicdelivery of information to employees

•                  Buildingemployee trust

 

*Watson Wyatt DataServices*

 

Watson Wyatt Data Servicesprovides a comprehensive array of global compensation, benefits and employmentpractices information that is often studied and cited by many of our clientsand competitors. In the United States, we publish and market an extensivelibrary of reports on human resources issues, and more than 8,500 organizationsparticipate in one or more of our annual surveys. Our databases containcompensation information for U.S. companies that employ over 17 millionworkers.  Detailed compensation andbenefits data is maintained for 2.7 million workers in virtually every industrysector and major metropolitan area. Outside of the United States, our worldwide alliance offers more than 70remuneration, benefits and employment practice reference guides, covering morethan 60 countries and 6 continents. In addition to our annual survey reports,we also offer many reference works intended to help practitioners create ormaintain programs in a variety of subject areas, including variable pay,performance management and personnel policies.

 

*Integrated ServiceApproach*

 

While we focus our consultingservices in the principal areas described above, we draw upon consultants fromour different practices to deliver integrated services to meet the needs of ourclients. An example is our Total Rewards approach, which encompassescompensation, benefits, career growth and company culture. We help clientsdetermine the correct mix of reward programs to attract and retain the rightemployees and to motivate them to produce desired results.  We also assemble cross-practice teams tohelp clients through mergers and acquisitions.

 

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*Sales and Marketing*

 

Our growth strategy is based ona commitment to ensuring client satisfaction through our account managementprogram.  Our approximately 100 accountmanagers focus on effectively delivering services to clients and on expandingour relationships across service lines, geographic boundaries and divisionswithin client companies.  A key elementof this program is an approach we call ClientFirstTM. Usingproprietary processes and tools, we work with clients to define their needs andexpectations before an engagement begins and then continually measure ourperformance according to agreed-upon standards.

 

We pursue new clients usingcross-disciplinary teams of consultants, as well as dedicated businessdevelopers who initiate relationships with carefully selected companies. Ourefforts to expand our accounts and our client base are supported by marketresearch, comprehensive sales training programs and extensive marketingdatabases. Our sales efforts are also supported by a full array of marketingprograms designed to raise awareness of the Watson Wyatt Worldwide brand andour reputation within our target markets. These programs promote our thoughtleadership on key human resources issues and establish us as a preferred humancapital consulting firm to many of the world’s largest companies.

 

**Clients**

 

We work with majorcorporations, emerging growth companies, government agencies and not-for-profitinstitutions in North America, Latin America and Asia-Pacific across a widevariety of industries.  Our client baseis broad and geographically diverse. For the fiscal year ended June 30, 2003, our 10 largest clientsaccounted for approximately 15 percent of our consolidated revenues, and noindividual client represented more than 4 percent of our consolidated revenues.

 

**Competition**

 

The human capital consultingbusiness is highly competitive.  Webelieve there are several barriers to entry – such as the need to assemblespecialized intellectual capital to provide expertise on a global scale – andthat we have developed competitive advantages in providing human resourcesconsulting services. However, we face intense competition from severaldifferent sources.

 

Our current and anticipatedcompetitors include:

 

•            Major humanresources-focused consulting firms that compete in serving the large employermarket worldwide, such as Mercer Human Resource Consulting, Towers Perrin andHewitt Associates.  Together, WatsonWyatt and these three firms account for approximately 40 percent of industryrevenue.

•            Smaller benefits andcompensation consulting firms, such as The Segal Company and the Hay Group

•            The human resourcesconsulting divisions of diversified professional services, financial servicesand insurance firms, such as PricewaterhouseCoopers, Deloitte & Touche,Mellon Financial Corporation, Aon and Booz Allen & Hamilton

•            Information technologyconsulting firms, such as Accenture and Bearing Point, as well asInternet/intranet development firms

•            Boutique consultingfirms comprised primarily of professionals formerly associated with the firmsmentioned above

 

The market for our services issubject to change as a result of increased regulatory, legislative, competitiveand technological developments and competition from established and newcompetitors. We believe the primary factors in selecting a human resourcesconsulting firm include reputation, the ability

 

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to provide measurable increasesto stockholder value, global scale, service quality and the ability to tailorservices to a clients’ unique needs. We believe we compete favorably withrespect to these factors.

 

**Employees**

 

As of June 30, 2003, theCompany employed 4,125 associates as follows:

 
| Benefits Group                                     |   | 1,665 |   |
|----------------------------------------------------|--------|-------|--------|
| Technology Solutions Group                         |   | 390   |   |
| Human Capital Group                                |   | 180   |   |
| International                                      |   | 990   |   |
| Other (including Data Services and  Communication) |   | 670   |   |
| Corporate                                          |   | 230   |   |
| Total                                              |   | 4,125 |   |

 

None of our associates aresubject to collective bargaining agreements. We believe relations between management and associates are good.

 

**Risk Factors**

 

In addition to the factorsdiscussed elsewhere in this report, the following are some of the importantfactors that could cause our actual results to differ materially from thoseprojected in any forward-looking statements.

 

***We must continue to recruit and retainqualified consultants; our failure to do so could adversely affect our abilityto compete successfully.***

 

Our continued success and futuregrowth depend heavily upon our ability to attract and retain highly skilled andmotivated consultants. We must meet these human capital requirements if we areto deliver our sophisticated and technical services to our clients. We competeagainst many companies with greater financial resources both within ourindustry and in other industries to attract these qualified individuals. Ourfailure to recruit and retain adequate talent could reduce our competitivestrength and adversely affect our profitability.

 

***The loss of key consultants and managerscould damage or result in the loss of client relationships and adversely affectour business.***

 

Our success largely dependsupon the business generation capabilities and project execution skills of ourconsultants. In particular, our consultants’ personal relationships with ourclients are a critical element of obtaining and maintaining client engagements.Losing consultants and account managers who manage substantial clientrelationships or possess substantial experience or expertise could adverselyaffect our ability to secure and complete engagements, which would adverselyaffect our results of operations.

 

In addition, if any of our keyconsultants were to join an existing competitor or form a competing company,some of our clients could choose to use the services of that competitor insteadof our services.

 

***Competition from firms with greater resourcescould result in loss of our market share that could reduce our profitability.***

 

The markets for our principalservices are highly competitive. Our competitors currently include other humanresources consulting and actuarial firms, as well as the human resourcesconsulting divisions of diversified professional services and insurance firmsand accounting firms. Several of our competitors

 

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have greater financial,technical and marketing resources than we have, which could enhance theirability to respond more quickly to technological changes, finance acquisitions andfund internal growth.

 

New competitors or alliancesamong competitors could emerge and gain significant market share.

 

***Demand for ourservices may decrease for various reasons, including a general economicdownturn or a decline in a client’s or an industry’s financial condition, thatcould adversely affect our operating results.***

 

We can give no assurance thatthe demand for our services will continue to grow or that we will competesuccessfully with our existing competitors, new competitors or our clients’internal capabilities.  Our clients’demand for our services also may change based on their own needs and financialconditions.  When economic downturnsaffect particular clients or industry groups, they frequently reduce theirbudgets for outside consultants, which could reduce the demand for our servicesand increase price competition.

 

In addition, the demand formany of our core benefits services is affected by government regulation andtaxation of employee benefits plans. This regulation and taxation drive ourclients’ needs for compliance-related services. Significant changes in tax orsocial welfare policy or regulations could lead some employers to discontinuetheir employee benefit plans, thereby reducing the demand for our services. Asimplification of regulations or tax policy also could reduce the need for ourservices.

 

***Our clientsgenerally may terminate our services at any time, which could decreaseassociate utilization.***

 

Our clients generally mayterminate our engagements at any time. If a client reduces the scope of orterminates the use of our services with little or no notice, our associateutilization will decline. In such cases, we must rapidly re-deploy ourassociates to other engagements in order to minimize the potential negative impacton our financial performance. In addition, because much of our work isproject-based rather than recurring in nature, our associates’ utilizationdepends on our ability to continually secure additional engagements.

 

***Improper managementof our fixed-fee engagements could hurt our financial results.***

 

We enter into some of ourengagements on a negotiated fixed-fee basis. If we do not properly negotiatethe price and manage the performance of these engagements, we might incurlosses on individual engagements, and our overall financial results would beadversely affected.

 

***We are subject tomalpractice claims arising from our work, which could adversely affect ourreputation and business.***

 

Professional servicesproviders, including those in the human resources consulting industry, areincreasingly subject to claims from their clients. Clients and third partieswho are dissatisfied with our services or who claim to suffer damages caused byour services have brought and may bring lawsuits against us. The nature of ourwork, especially our actuarial services, involves assumptions and estimatesconcerning future events, the actual outcome of which we cannot know withcertainty in advance. In addition, we could make computational, softwareprogramming or data management errors.

 

Clients have sought and mayseek to hold us responsible for the financial consequences of these errors orvariances.  Given that we frequentlywork with large pension funds, relatively small percentage errors or variancescould create significant dollar variances and claims for unfundedliabilities.  The risks from suchvariances could be aggravated in an environment of declining pension fund assetvalues. In most

 

13

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cases, our exposure to liabilityon a particular engagement is substantially greater than the profit opportunitythat the engagement generates for us. For example, claims could include:

 

•                  A client’sassertion that actuarial assumptions used in a pension plan were unreasonable, leadingto plan underfunding

 

•                  A claim arisingout of the use of inaccurate data, which could lead to an underestimation ofplan liabilities

 

•                  A claim thatemployee benefit plan documents were misinterpreted or plan amendments weremisstated in plan documents, leading to overpayments to beneficiaries

 

Defending lawsuits arising outof any of our services has required and could require substantial amounts ofmanagement attention, which could affect management’s focus on operations,adversely affect our financial performance and result in increased insurancecosts. In addition to defense costs and liability exposure, malpractice claimsmay produce negative publicity that could hurt our reputation and business. Fora discussion of significant legal proceedings, please refer to “LegalProceedings” on page 18.

 

***Insurance may becomemore difficult or expensive to obtain.***

 

Insurance markets have hardenedover recent years for most classes of professional liability risk.  As claims experience has increased for professionals,and for actuaries in particular, the cost of malpractice insurance has beenincreasing substantially, and the point at which some insurers are willing tobegin covering a specific claim (i.e., the deductible or self-insuredretention) has been increasing. Availability and price of insurance is subject to many variables,including general market conditions, loss experience in related industries andin the actuarial and benefits consulting industry, and the specific claimsexperience of an individual firm. Increases in the cost of insurance couldaffect our profitability, and the unavailability of insurance to cover certainlevels of risk could have an adverse impact on our financial condition,particularly in a specific period.

 

***Our quarterly revenues may fluctuate whileour expenses are relatively fixed.***

 

Quarterly variations in ourrevenues and operating results occur as a result of a number of factors, suchas:

 

•                  The significanceof client engagements commenced and completed during a quarter

 

•                  The seasonalityof some specific types of services.  Inparticular, retirement revenues are more heavily weighted toward the secondhalf of the fiscal year, when annual actuarial valuations are required to becompleted for calendar year-end companies and the related services areperformed.  In the Technology SolutionsGroup, the distribution of work is concentrated at the end of the first fiscalquarter and through the second fiscal quarter, as there is demand from ourclients for assistance in updating systems and programs used in the annualre-enrollment of employees in benefit plans, such as flex plans. Much of theremaining business is project-oriented and is thus influenced more byparticular client needs and the availability of our workforce.

 

•                  The number ofbusiness days in a quarter, associate hiring and utilization rates and clients’ability to terminate engagements without penalty

 

•                  The size andscope of assignments

 

14

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•                  The level ofvacation and holidays taken by our associates

 

•                  General economicconditions

 

Approximately 70-75 percent ofour total operating expenses are relatively fixed, encompassing the majority ofadministrative, occupancy, communications and other expenses, depreciation and amortization,and salaries and employee benefits excluding fiscal year-end incentivebonuses.  Therefore, a variation in thenumber of client assignments or in the timing of the initiation or thecompletion of client assignments can cause significant variations in quarterlyoperating results and could result in losses. Over the most recent eight fiscal quarters, net income from continuingoperations has fluctuated from $10.1 million to $13.5 million.

 

***We depend on Watson Wyatt LLP to representour brand in the European market and could lose our position in Europe or needto modify our name if our alliance agreements were to terminate.***

 

Since 1995 we have marketed ourservices globally with Watson Wyatt LLP as Watson Wyatt Worldwide. Under ouralliance agreements with Watson Wyatt LLP:

 

•                  We operate inNorth America, Latin America and Asia-Pacific

 

•                  Watson Wyatt LLPoperates in the United Kingdom and Ireland

 

•                  Watson WyattHoldings (Europe) Limited, of which we own a 25 percent minority interest,operates in continental Europe

 

The alliance agreements withWatson Wyatt LLP generally restrict each party’s ability to enter into eachother’s geographic markets. If the alliance agreements were to terminate, wecould lose our position in Europe, which could interrupt our global developmentand impair our ability to deliver services seamlessly to clients throughout theworld.

 

In addition, a termination ofour alliance with Watson Wyatt LLP could precipitate a name change, which couldresult in confusion in our markets.

 

***Our international operations presentparticular risks that could negatively affect our business.***

 

We conduct a portion of ourbusiness from offices outside the United States. This subjects us to foreignfinancial and business risks, which could arise in the event of:

 

•                  Unusual currencyexchange rate fluctuations

 

•                  Unexpectedincreases in taxes

 

•                  New regulatoryrequirements and/or changes in policies and local laws that materially affectthe demand for our services or directly affect our foreign operations

 

•                  Unusual andunexpected monetary exchange controls

 

•                  Unusually severeor protracted recessions in foreign economies

 

•                  Civildisturbance or other catastrophic events that reduce business activity in otherparts of the world

 

15

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Any of these factors could havean adverse effect on our results of operations.

 

***Operational readiness of our globaladministrative infrastructure might not be as complete as required to manageinternational operations effectively.***

 

The management ofgeographically dispersed operations requires substantial management resources,resulting in significant ongoing expense. We have not fully integrated all ofour global operations from an administrative and reporting standpoint. We aredeveloping and implementing additional systems and management reporting to helpus manage our global operations, but we cannot predict when these systems willbe fully operational or how successful they will be. These risks could beaggravated in the event of a major business disruption caused by terroristattacks or similar events.

 

***Our business faces rapid technological change and our failure to respond to this change quickly could adversely affect our business.***

 

Increasingly, to remaincompetitive in our practice areas, we must identify and offer the most currenttechnologies and methodologies. This is particularly true of our TechnologySolutions Group, in which our success largely depends upon our ability toquickly absorb and apply technological advances in both generic applicationsand, particularly, those that are specifically required to deliver employeebenefits services. In some cases, significant technology choices andinvestments are required. If we do not respond correctly, quickly or in acost-effective manner, our business and operating results might be harmed.

 

The effort to gain technological expertise and develop new technologies in our business may require us to incur significant expenses and, in some cases, to implement them globally. If we cannot offer new technologies as quickly or effectively as our competitors, we could lose market share. We also could lose market share if our competitors develop more cost-effective technologies than we offer or develop.

 

***Our Technology Solutions Group has project-related risks that could adversely affect our financial results.***

 

Our Technology Solutions Group develops and implements computer software and systems for clients. In securing or carrying out these engagements, we may encounter inadequate project scope definitions, unforeseen technological and systems integration problems, unanticipated costs, failures to meet contractual performance objectives and other business risks. If we are not successful in defining, pricing and executing these assignments as planned, we may incur financial losses.

 

***Limited protection of our proprietary expertise, methodologies and software could harm our business.***

 

We cannot guarantee that trade secret, trademark and copyright law protections are adequate to deter misappropriation of our confidential information.  We may be unable to detect the unauthorized use of our intellectual property and take the necessary steps to enforce our rights.  Redressing infringements also may consume significant management time and financial resources.

 

***The interests of our current associates who own our common stock may differ from those of other stockholders.***

 

Our associate stockholders’ interests in our business matters, since they are also employees of the Company, may not always be consistent with the interests of our non-associate stockholders.

 

16

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***Change in associate ownership could adversely affect our firm culture.***

 

Prior to our initial public offering in 2000, we had been predominantly owned by our associates. As owners, our associates have traditionally been able to influence the direction of the firm, which promotes an entrepreneurial spirit and motivates individual performance. The amount of common stock owned by our associates may decline over time. A decline in associate ownership and an increase in non-associate influence could lower morale which could, in turn, adversely affect our business operations.

 

***We have various mechanisms in place that may prevent a change in control that a stockholder might favor.***

 

Our certificate of incorporation and bylaws contain provisions that might discourage, delay or prevent a change in control that a stockholder might favor. Our certificate of incorporation and/or bylaws:

 

•                  Authorize the issuance of preferred stock without fixed characteristics that could be issued by our Board of Directors to increase the number of outstanding shares and deter a takeover attempt

 

•                  Classify our Board of Directors with staggered, three-year terms, which may lengthen the time required to gain control of our Board of Directors

 

•                  Provide that only the President or our Board of Directors may call a special meeting of stockholders

 

•                  Prohibit stockholder action by written consent, which requires all actions to be taken at a meeting of the stockholders

 

•                  Provide that vacancies on our Board of Directors, including new directorships, may be filled only by the Directors then in office

 

•                  Require super-majority voting for the stockholders to amend our bylaws, the classified board and other provisions of our certificate of incorporation

 

•                  Prohibit a stockholder from presenting a proposal or director nomination at an annual meeting unless the stockholder provides us with sufficient advance notice

 

***The market price of our common stock may fluctuate, and the value of our shares may decline.***

 

The market price of our common stock may fluctuate because of the following:

 

•                  Changes in general conditions in the economy or the financial markets

 

•                  Variations in our quarterly operating results

 

•                  Changes in financial estimates by securities analysts

 

•                  Other developments affecting us, our industry, customers or competitors

 

•                  The operating and stock price performance of companies that investors deem comparable to us

 

•                  The number of shares available for resale in the public markets under applicable securities laws

 

17

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The entire stock market has experienced significant volatility during the past three years. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to their operating performance.

 

**Other**

 

Our annual reports on Form10-K, quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports are available, without charge, on our web site(www.watsonwyatt.com), as soon as reasonably practicable after they are filedelectronically with the SEC.  Copies arealso available, without charge, from our Investor Relations department, locatedin our corporate headquarters at 1717 H Street, NW, Washington, D.C. 20006.

 

**Item2.  Properties.**

 

We operate in 61 offices inprincipal markets throughout the world. Operations are carried out in leased offices under operating leases thatnormally do not exceed 10 years in length. We do not anticipate difficulty inmeeting our space needs at lease expiration.

 

We evaluate office capacity onan ongoing basis to meet changing needs in our markets while minimizing ouroccupancy expense.  We currently haveexcess capacity in some markets and are actively marketing certain space forsublease.  The recent economic downturnhas negatively impacted the value of such space in certain situations ascurrent lease rates have generally dropped since the time such leases weresigned.

 

The fixed assets owned byWatson Wyatt represented approximately 12 percent of total assets at June 30,2003, and consisted primarily of computer equipment, office furniture andleasehold improvements.

 

**Item3.  Legal Proceedings.**

 

From time to time, we are a party to various lawsuits, arbitrations ormediations that arise in the ordinary course of business. These disputestypically involve claims relating to the rendering of professional services oremployment matters. The matters reported on below involve the most significantpending or potential claims against us. Management believes, based on currentlyavailable information, that the results of all pending claims against us willnot have a material adverse effect on the Company.

 

*New Jersey Coalition of Auto RetailersInsurance Group Trust (NJCAR)*.  We have tentatively settled a lawsuitbrought against Watson Wyatt and five other service providers of NJCAR, aninsolvent group health insurance provider. The suit, in the U.S. District Court for the District of New Jersey,alleged that losses resulting from the insolvency are partly attributable toNJCAR’s former service providers.  Thetentative settlement is subject to reaching a satisfactory settlement agreementand approval by the state court overseeing the insolvency.

 

*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.  Theclaim against Watson Wyatt is allegedly in the $4 million range.  If the case is not resolved in mediation, weexpect a jury trial to be scheduled late this year or early next year, althougha date has not yet been set.

 

18

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**Item4.  Submission of Matters to a Vote ofSecurity Holders.**

 

None.

 

**Part II**

 

**Item 5.  Market Price of andDividends on the Registrant’s Common Equity and Related Stockholder Matters.**

 

We had three classes of commonstock outstanding after completion of our initial public offering (“IPO”) inOctober 2000: Class A, B-1 and B-2. Class A shares are freely transferable. Class B-1 and B-2 shares had transfer restrictions that expired onOctober 16, 2001, and October 16, 2002, respectively.  As a result, 9,956,140 shares of our Class B-1 common stock and12,745,015 shares of our Class B-2 common stock automatically converted intoClass A common stock on those respective dates.

 

In addition to the transferrestriction periods described above, we entered into agreements providing foradditional transfer restrictions with major stockholders, executive officersand employee directors.  As a result ofthese agreements, 3,894,528 Class A shares are currently restricted, of which1,947,272 will become freely transferable in October 2003 and 1,947,256 willbecome freely transferable in October 2004.

 

*Other Conversions*

 

In August 2002, the Boardauthorized the conversion of 123,015 Class B-2 shares for repurchase by theCompany from stockholders in September 2002 at the then-prevailing marketprice.

 

*Market Information*

 

Watson Wyatt & CompanyHoldings Class A common stock is currently traded on the New York StockExchange under the symbol WW.  Thefollowing table sets forth the range of high and low closing share prices foreach quarter of fiscal years 2003 and 2002, determined by the daily closingstock prices. 

 
|                                            |   | **2003** |   | **2002** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|
|                                            |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
|                                            |   |     |   |     |   |   |   |   |   |
| First quarter (July 1 through September 30)     |   | $        | 23.95  |     | $      | 18.30 |   | $ | 28.00 |   | $ | 14.60 |   |
| Second quarter (October 1 through December  31) |   | 22.50    |   | 17.45    |   | 22.02 |   | 15.50 |   |
| Third quarter (January 1 through March 31)      |   | 22.16    |   | 18.27    |   | 27.35 |   | 20.76 |   |
| Fourth quarter (April 1 through June 30)        |   | 23.38    |   | 19.40    |   | 27.50 |   | 22.50 |   |
|                                                 |        |          |        |          |        |  |  |  |  |  |  |  |  |

 

19

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*Holders*

 

As of August 31, 2003, there wereapproximately 4,160 shareholders of record of our Class A common stock.

 

*Dividends*

 

Under our credit facility (seeNote 9 of Notes to the Consolidated Financial Statements, included in Item 15of this report), we are required to observe certain covenants (includingrequirements as to minimum net worth) that affect the amounts available for thedeclaration or payment of dividends. Under the most restrictive of these covenants, approximately $22.8million was available for the declaration or payment of dividends as of June30, 2003.  The declaration and paymentof dividends by the Company is at the discretion of our Board of Directors anddepends on numerous factors, including, without limitation, our net earnings,financial condition, availability of capital, debt covenant limitations and ourother business needs, including those of our subsidiaries and affiliates.  Historically, while our performance wouldhave permitted the payment of dividends, we have chosen not to declaredividends every year since fiscal year 1991. In view of the current environment and recent tax law changes, theCompany will be evaluating its dividend policy.

 

*Securities Authorized for Issuance Under Equity Compensation PlanInformation*

 

Our equity compensation plansinclude the 2000 Long-term Incentive Plan, which provides for the granting ofnonqualified stock options and stock appreciation rights, the 2001 EmployeeStock Purchase Plan, the 2001 Deferred Stock Unit Plan for Selected Employeesand the Compensation Plan for Outside Directors.  We grant deferred stock units to our associates as a part oftheir annual discretionary compensation and have discontinued the issuance ofstock options.  All deferred stock unitsissued in connection with the 2001 Deferred Stock Unit Plan were fully vestedupon issuance.  All of our equitycompensation plans were approved by stockholders except for the CompensationPlan for Outside Directors.  See Note 10****ofthe Notes to the Consolidated Financial Statements for the general terms ofthese plans.

 

The following chart givesaggregate information regarding grants under all of the Company’s equitycompensation plans through June 30, 2003:

 
| **Plan Category**                                       |   | **Number of  securities to  be issued upon exercise  of outstanding options** |   | **Weighted-average  exercise price of  outstanding options** |   | **Number of  securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in the  first column)** |      |
|---------------------------------------------------------|--------|-------------------------------------------------------------------------------|--------|--------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
| Equity compensation plans approved by  stockholders     |   | 1,342,257                                                                     |   | $                                                            | 13.43  |                                                                                                                                                         | 4,067,507 |   |
| Equity compensation plans not approved by  stockholders |   | —                                                                        |   | —                                                       |   | 37,169                                                                                                                                                       |      |
| Total                                                   |   | 1,342,257                                                                     |   | $                                                            | 13.43  |                                                                                                                                                         | 4,104,676 |   |

 

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In April 2003, the Board ofDirectors approved the issuance of an additional 1,500,000 shares under the2001 Employee Stock Purchase Plan.  TheCompany will seek stockholder approval of these additional shares at our annualmeeting to be held on November 17, 2003. In addition, in April 2003, the Board of Directors approved a plan topurchase an additional 1,150,000 shares of the Company’s Class A common stockfor purposes that may include offsetting any potential dilution from sharesthat may be issued in connection with any of the Company’s stock compensationplans.

 

Additional information requiredby this item will be included in a definitive proxy statement filed within 120days after the end of the Registrant’s fiscal year.  The proxy statement is incorporated herein by this reference.

 

**Item6.  Selected Consolidated Financial Data.**

 

The table on the following pagesets forth selected consolidated financial data of Watson Wyatt as of and foreach of the years in the five-year period ended June 30, 2003.  The selected consolidated financial data asof June 30, 2003 and 2002, and for each of the three years in the period endedJune 30, 2003, were derived from the audited consolidated financial statementsof Watson Wyatt included in this Form 10-K. The selected consolidated financial data as of June 30, 2001, 2000 and1999, and for each of the years ended June 30, 2000 and 1999, were derived fromaudited consolidated financial statements of Watson Wyatt not included in thisForm 10-K.  Earnings per share data forthe periods ended June 30, 2000 and 1999, were also restated to reflect ourcorporate reorganization and two-for-one share conversion that occurred inOctober 2000 as if our corporate reorganization and two-for-one shareconversion were effective at the beginning of each period.  See Note 2 of the Consolidated FinancialStatements for further information regarding the corporate reorganization andshare conversion.

 

The consolidated financial datashould be read in conjunction with our Consolidated Financial Statements andnotes thereto and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” included in Item 7 of this Form 10-K.  Amounts are in thousands of U.S. Dollarsexcept per share data.

 

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|                                                                                 |   | **Year Ended  June 30** |       |
|--------------------------------------------------------------------------------------|--------|-------------------------|------------|
|                                                                                 |   | **2003**                |       | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| **Statement of Operations Data:**  (amounts are in thousands, except per share data) |   |                    |       |   |   |   |   |   |   |   |   |
|                                                                                 |   |                    |       |   |   |   |   |   |   |   |   |
| Revenue                                                                              |   | $                       | 709,616    |   | $ | 710,480 |   | $ | 700,189 |   | $ | 624,583 |   | $ | 556,860 |   |
| Costs of providing services:                                                         |   |                    |       |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                                                       |   | 401,274                 |       | 404,822 |   | 379,645 |   | 339,904 |   | 306,462 |   |
| Stock incentive bonus plan (a)                                                       |   | —                  |       | — |   | — |   | 30,283 |   | 22,610 |   |
| Professional and subcontracted  services                                             |   | 47,356                  |       | 48,724 |   | 54,089 |   | 49,890 |   | 47,862 |   |
| Occupancy, communications and  other                                                 |   | 106,224                 |       | 109,163 |   | 114,417 |   | 101,733 |   | 93,644 |   |
| General and administrative  expenses                                                 |   | 57,285                  |       | 55,517 |   | 57,475 |   | 54,115 |   | 48,056 |   |
| Depreciation and amortization                                                        |   | 19,621                  |       | 20,049 |   | 21,995 |   | 17,878 |   | 15,248 |   |
|                                                                                 |   | 631,760                 |       | 638,275 |   | 627,621 |   | 593,803 |   | 533,882 |   |
|                                                                                 |   |                    |       |   |   |   |   |   |   |   |   |
| Income from operations                                                               |   | 77,856                  |       | 72,205 |   | 72,568 |   | 30,780 |   | 22,978 |   |
|                                                                                 |   |                    |       |   |   |   |   |   |   |   |   |
| Income from affiliates                                                               |   | 5,787                   |       | 2,866 |   | 3,780 |   | 3,001 |   | 2,307 |   |
| Interest income (expense), net                                                       |   | 991                     |       | 1,235 |   | 1,711 |   | (53 | ) | (1,702 | ) |
| Other non-operating income                                                           |   | 761                     |       | 2,166 |   | — |   | — |   | — |   |
|                                                                                 |   |                    |       |   |   |   |   |   |   |   |   |
| Income from continuing  operations before income taxes                               |   | 85,395                  |       | 78,472 |   | 78,059 |   | 33,728 |   | 23,583 |   |
| Provision for income taxes                                                           |   | 35,015                  |       | 31,388 |   | 33,623 |   | 15,195 |   | 11,448 |   |
| Income from continuing  operations                                                   |   | 50,380                  |       | 47,084 |   | 44,436 |   | 18,533 |   | 12,135 |   |
| Discontinued operations (b)                                                          |   | 6,786                   |       | — |   | — |   | — |   | 8,678 |   |
| Net income                                                                           |   | $                       | 57,166     |   | $ | 47,084 |   | $ | 44,436 |   | $ | 18,533 |   | $ | 20,813 |   |
| Earnings per share, continuing  operations, basic                                    |   | $                       | 1.52       |   | $ | 1.43 |   | $ | 1.39 |   | $ | 0.62 |   | $ | 0.40 |   |
| Earnings per share, continuing  operations, diluted                                  |   | $                       | 1.51       |   | $ | 1.41 |   | $ | 1.37 |   | $ | 0.62 |   | $ | 0.40 |   |
| Earnings per share,  discontinued operations, basic                                  |   | $                       | 0.21       |   | $ | — |   | $ | — |   | $ | — |   | $ | 0.28 |   |
| Earnings per share,  discontinued operations, diluted                                |   | $                       | 0.21       |   | $ | — |   | $ | — |   | $ | — |   | $ | 0.28 |   |
| Earnings per share, net  income, basic                                               |   | $                       | 1.73       |   | $ | 1.43 |   | $ | 1.39 |   | $ | 0.62 |   | $ | 0.68 |   |
| Earnings per share, net  income, diluted                                             |   | $                       | 1.72       |   | $ | 1.41 |   | $ | 1.37 |   | $ | 0.62 |   | $ | 0.68 |   |
| Weighted average shares of  common stock, basic                                      |   | 32,962                  |       | 32,985 |   | 32,068 |   | 30,000 |   | 30,430 |   |
| Weighted average shares of  common stock, diluted                                    |   | 33,287                  |       | 33,421 |   | 32,363 |   | 30,000 |   | 30,430 |   |
|                                                                                 |   |                    |       |   |   |   |   |   |   |   |   |
|                                                                                 |   | **As of June  30**      | ** ** |
|                                                                                 |   | **2003**                |       | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
| **Balance Sheet Data:**                                                              |   |                    |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                            |   | $                       | 144,374    |   | $ | 95,974 |   | $ | 81,735 |   | $ | 41,410 |   | $ | 35,985 |   |
| Working capital                                                                      |   | 169,308                 |       | 123,171 |   | 96,171 |   | 16,177 |   | 11,692 |   |
| Total assets                                                                         |   | 514,462                 |       | 436,817 |   | 392,016 |   | 334,520 |   | 318,520 |   |
| Note payable                                                                         |   | —                  |       | — |   | — |   | — |   | — |   |
| Stockholders’ equity                                                            |   | 151,737                 |       | 159,221 |   | 111,885 |   | (81,109 | ) | (81,191 | ) |
| Redeemable common stock                                                              |   | —                  |       | — |   | — |   | 115,480 |   | 107,631 |   |
| Shares outstanding                                                                   |   | 32,943                  |       | 32,897 |   | 33,033 |   | 29,610 |   | 32,224 |   |

 

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(a)          Followingthe initial public offering, we terminated the stock incentive bonus plan andreplaced it with equity-based incentive plans more customary to publicly-tradedcompanies.

(b)         Inthe third quarter of fiscal year 1998 we discontinued our benefits administrationoutsourcing business and recorded a $69.9 million charge to earnings in the“Discontinued operations” line.  Infiscal year 1999, and again in fiscal year 2003, we revised our estimatesrelated to the remaining future obligations and costs associated with thediscontinuation and, as a result, reduced the amount of our liability forlosses from disposal of the benefits administration outsourcing business by$15.0 million, less the associated income tax expense of $6.3 million, and by$11.4 million, less the associated income tax expense of $4.7 million,respectively.  In the fourth quarter offiscal year 2003, the Company received sublease income of approximately $40,000in excess of lease payments related to this business, resulting in a year-to-dateincome from discontinued operations of $11.5 million, less the associatedincome tax expense of $4.7 million.

 

**Item7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

 

**SpecialNote Regarding Forward-looking Statements**

 

This filing contains certainstatements that are “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995, including, but not limited tothe following: the first paragraph of Part I, Item 3 “Legal Proceedings” onpage 18; the second paragraph under “Revenue Recognition” on page 25; thesecond paragraph under “Pension Assumptions” on page 26; under the heading“Incurred But Not Reported Claims” on page 27; the first paragraph underCapital Commitments on page 34; under the heading “Risk Management” on page 35;under the subheading “Stock-based Compensation” in Note 1 “Summary ofSignificant Accounting Policies” on pages 50 and 51; in the second paragraph ofNote 10 “Employee Stock Plans and Equity” on page 63; and in the second andfourth paragraphs of Note 14 “Commitments and Contingent Liabilities” on page74.  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 statementscarefully because they contain projections of our future results of operationsor financial condition, or state other “forward-looking” information.  A number of risks and uncertainties existwhich could cause actual results to differ materially from the resultsreflected in these forward-looking statements. Such factors include but are not limited to our continued ability torecruit and retain highly qualified associates; outcomes of litigation; theability of the company to obtain professional liability insurance; asignificant decrease in the demand for the consulting services we offer as aresult of changing economic conditions or other factors; actions by competitorsoffering human resources consulting services, including public accounting andconsulting firms, technology consulting firms and internet/intranet developmentfirms; regulatory, legislative and technological developments that may affectthe demand for or costs of our services and other factors discussed under “Riskfactors” in Item 1 of this Form 10-K. These statements are based on assumptions that may not come true.  All forward-looking disclosure isspeculative by its nature.  The Companyundertakes no obligation to update any of the forward-looking informationincluded in this report, whether as a result of new information, future events,changed expectations or otherwise.

 

**General**

 

Watson Wyatt is a globalprovider of human capital consulting services. We provide services in three principal practice areas: Benefits,Technology Solutions and Human Capital consulting.  We operate from 61 offices in 18 countries throughout NorthAmerica, Asia-Pacific and Latin America. We also operate through our affiliates in Europe.  Our principal affiliates are Watson WyattLLP – which conducts operations in the United Kingdom and Ireland and in whichwe hold a 10 percent interest in a defined distribution pool and are a memberof their partnership board – and Watson Wyatt & Company Holdings (Europe)Limited, a holding company through which we conduct Continental Europeanoperations.  We own 25 percent of WatsonWyatt & Company Holdings (Europe) Limited and Watson Wyatt LLP owns theremaining 75 percent.

 

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**FinancialStatement Overview**

 

The financial statementscontained in this annual report on Form 10-K reflect Consolidated BalanceSheets as of June 30, 2003 and 2002, Consolidated Statements of Operations forthe 12-month periods ended June 30, 2003, 2002 and 2001, ConsolidatedStatements of Cash Flows for the 12-month periods ended June 30, 2003, 2002 and2001, and a Consolidated Statement of Changes in Stockholders’ Equity for the12-month periods ended June 30, 2003, 2002 and 2001.

 

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

 

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

 

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

 

Professional and subcontractedservices represent fees paid to external service providers for accounting,employment, marketing and other services. For the most recent three fiscal years, approximately 60 percent ofthese professional and subcontracted services were directly incurred on behalfof our clients and were reimbursed by them, with such reimbursements beingincluded in revenue.

 

Occupancy, communications andother expenses represent expenses for rent, utilities, supplies and telephoneto operate office locations as well as non-client-reimbursed travel byassociates, publications and professional development. General and administrativeexpenses include the operational costs and professional fees paid by corporatemanagement, general counsel, marketing, human resources, finance, research andtechnology support.

 

**CriticalAccounting Policies and Estimates**

 

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

 

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

 

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***Revenue Recognition***

 

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

 

Revenue is recognized ontime-and-materials engagements to the extent of billable rates times hoursdelivered plus expenses incurred.  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, changesin 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 indirectcosts associated with the engagement. Losses are recognized in the period in which the loss becomes probableand the amount of the loss is reasonably estimable.

 

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

 

Revenues recognized in excessof billings are recorded as unbilled accounts receivable.  Cash collections in excess of revenuesrecognized are recorded as deferred revenues until the revenue recognitioncriteria are met.  Client reimbursableexpenses, including those relating to travel, other out-of-pocket expenses, andany third-party costs, are included in revenues, and an equivalent amount ofreimbursable expenses are included in professional and subcontracted servicesas a cost of revenues.

 

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

 

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

 

***DiscretionaryCompensation***

 

The Company’s compensationprogram includes a discretionary component in the form of an annual bonus thatis determined by management and paid once per fiscal year in the form of cashand/or deferred stock units after the Company’s annual operating results arefinalized.  Quarterly, estimated annualpre-bonus profitability is reviewed by the Company and the discretionary annualbonus amount is then estimated by management. After determining the estimated annual bonus amount, the bonus is thenallocated to remaining quarterly reporting periods as a constant percentage ofestimated pre-bonus income from operations. In those quarters where the estimated annual bonus level changes, theremaining estimated annual bonus is accrued over the remaining quarters as aconstant percentage of estimated future pre-bonus income from operations.  Annual bonus levels may vary from currentexpectations as a

 

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result of changes in theCompany’s forecast of pre-bonus profitability and competitive employment marketconditions.

 

***Income Taxes***

 

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

 

***Pension Assumptions***

 

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

 

Determination of our obligationsand annual expense under the plans are based on a number of assumptions that,given the longevity of the plans, are long-term in their focus.  A change in one or a combination of theseassumptions could have a material impact on our pension benefit obligation andrelated expense.  For this reason,management employs a long-term view so that assumptions do not changefrequently in response to short-term volatility in the economy.  Any difference between actual and assumedresults is amortized into our pension expense over the average remainingservice period of participating employees. We consider several factors prior to the start of each fiscal year whendetermining the appropriate annual assumptions, including economic forecasts,historical trends, portfolio composition and peer comparisons.

 

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

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

 

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

 

The expected long-term rate ofreturn on assets assumption was lowered to 9.00 percent at the end of fiscalyear 2003 from 10.00 percent at the end of fiscal years 2002 and 2001.  Selection of the 9.00 percent

 

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return assumption was supportedby an analysis performed by the Company of the weighted average yield expectedto be achieved with the anticipated makeup of investments.  The investment makeup is heavily weightedtowards equities.

 

The investment marketperformance over the last two years has decreased the value of the assets heldin the pension plans and the decline in interest rates has increased ouraccumulated benefit obligation, resulting in the accumulated benefit obligationbecoming greater than the value of the plan assets for the U.S. and U.K.pension plans.  As a result, the Companywas required to record an additional minimum pension liability for those plansin accordance with Statement of Financial Accounting Standards No. 87“Employers’ Accounting for Pensions” (FAS 87). This resulted in an increase in the pension liability of $113.4 million,an increase in intangible assets of $0.1 million, a non-cash charge toStockholders’ Equity of $67.9 million (reflected in accumulated othercomprehensive loss) and an increase in deferred tax assets of $45.4million.  A market recovery in futureperiods, and/or an increase in long-term interest rates, could reverse aportion or all of this charge.  OurCanadian and Hong Kong pension plan assets are greater than their associatedaccumulated benefit obligation as of June 30, 2003, and thus do not require therecording of additional minimum pension liabilities.

 

***Incurred But NotReported Claims***

 

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

 

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**Resultsof Operations**

 

The following table sets forthConsolidated Statement of Operations data as a percentage of revenue for theperiods indicated:

 
|                                                   |   | **Year ended June 30** |   |
|--------------------------------------------------------|--------|------------------------|--------|
|                                                   |   | **2003**               |   | **2002** |   | **2001** |   |
|                                                   |   |                   |   |   |   |   |   |
| Revenue                                                |   | 100.0                  | %      | 100.0 | % | 100.0 | % |
|                                                   |   |                   |   |   |   |   |   |
| Costs  of providing services:                          |   |                   |   |   |   |   |   |
| Salaries  and employee benefits                        |   | 56.5                   |   | 56.9 |   | 54.3 |   |
| Professional  and subcontracted services               |   | 6.7                    |   | 6.9 |   | 7.7 |   |
| Occupancy,  communications and other                   |   | 14.9                   |   | 15.4 |   | 16.3 |   |
| General  and administrative expenses                   |   | 8.1                    |   | 7.8 |   | 8.2 |   |
| Depreciation  and amortization                         |   | 2.8                    |   | 2.8 |   | 3.1 |   |
|                                                   |   | 89.0                   |   | 89.8 |   | 89.6 |   |
|                                                   |   |                   |   |   |   |   |   |
| Income  from operations                                |   | 11.0                   |   | 10.2 |   | 10.4 |   |
|                                                   |   |                   |   |   |   |   |   |
| Income  from affiliates                                |   | 0.8                    |   | 0.4 |   | 0.5 |   |
| Interest  income, net                                  |   | 0.1                    |   | 0.1 |   | 0.2 |   |
| Other  non-operating income                            |   | 0.1                    |   | 0.3 |   | — |   |
|                                                   |   |                   |   |   |   |   |   |
| Income  from continuing operations before income taxes |   | 12.0                   |   | 11.0 |   | 11.1 |   |
|                                                   |   |                   |   |   |   |   |   |
| Provision  for income taxes                            |   | 4.9                    |   | 4.4 |   | 4.8 |   |
|                                                   |   |                   |   |   |   |   |   |
| Income  from continuing operations                     |   | 7.1                    | %      | 6.6 | % | 6.3 | % |

 

**Fiscal Year Ended June 30, 2003, Compared toFiscal Year Ended June 30, 2002**

 

***Revenue***

 

Revenue from operations was$709.6 million for fiscal year 2003, compared to $710.5 million for fiscal year2002, a decrease of $0.9 million.

 

The Benefits Group increasedrevenue by $7.4 million or 2 percent during fiscal year 2003 due to new clientwins, special project work related to the Health Insurance Portability andAccountability Act of 1996 and rising health care costs.  Revenue from our Technology Solutions Groupdecreased by $10.3 million or 10 percent, reflecting continued weakness incapital spending.  Revenue from ourHuman Capital Group decreased $0.7 million or 1 percent during fiscal year2003, but ended the year with 5 percent growth in the fourth quarter as wesecured a number of new engagements with major companies for stock programadvice and executive compensation work. Our international segment finished the fiscal year with revenue growthof $7.3 million or 11 percent, as a result of increased demand for retirementwork in Australia, New Zealand and Japan. Revenue for other practice areas in North America decreased by $8.6million or 15 percent during fiscal year 2003.

 

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On August 13, 2003, the Companyannounced a postponement of the reporting of its fourth quarter and fiscal year2003 results, pending the completion of its year-end audit and a review relatedto billing irregularities. The billing irregularities involved four clients andarose from hours inappropriately reported in client billings that did not matchthe Company’s time reporting system. Management promptly reported these issuesto the affected clients, to the Company’s Audit Committee and to itsindependent auditors.  With theassistance of outside legal counsel, the Company conducted a review of thisissue to ascertain whether similar issues were present with other clients.  No other cases were found.  As a result, the Company reduced fourthquarter fiscal 2003 revenues by $1.8 million.

 

***Salaries andEmployee Benefits***

 

Salaries and employee benefitexpenses for fiscal year 2003 were $401.3 million, compared to $404.8 millionfor fiscal year 2002, a decrease of $3.5 million or 1 percent. Salaries andemployee benefit expenses for fiscal year 2003 include severance charges of$1.8 million related to the Company’s targeted job reductions, mainly in ourHuman Capital and Technology Solutions groups, all of which has been paid toassociates under severance agreements. The decrease, exclusive of this charge, was due to a $12.0 milliondecrease in the provision for discretionary compensation and a $0.8 million decreasein base salaries as a result of headcount reductions and attrition in NorthAmerica, net of a $9.3 million increase in pension costs and modest annualsalary increases.   As a percentage ofrevenue, salaries and employee benefits decreased to 56.5 percent from 56.9percent.  Excluding severance costs,salaries and employee benefit expenses would have been 56.3 percent of revenuefor fiscal year 2003.

 

***Professional andSubcontracted Services***

 

Professional and subcontractedservices were $47.4 million for fiscal year 2003, compared to $48.7 million forfiscal year 2002, a decrease of $1.3 million or 3 percent.  As a percentage of revenue, professional andsubcontracted services decreased to 6.7 percent from 6.9 percent.  Reimbursable expenses billed to clientsincreased by $3.7 million, but were offset by decreases in legal expenses.  Professional and subcontracted services forfiscal year 2003 include severance charges of $0.2 million related to theCompany’s targeted job reductions mentioned above, all of which had been paidas of June 30, 2003.

 

***Occupancy,Communications and Other***

 

Occupancy, communications andother expenses were $106.2 million for fiscal year 2003, compared to $109.2million for fiscal year 2002, a decrease of $3.0 million or 3 percent.  The Company implemented successful costcontainment strategies during the second quarter of fiscal year 2002 which havecontinued through the current period, resulting in lower travel, telephone andother discretionary expenses for the year. These decreases were partially offset by increases in rent expense of$1.5 million.   As a percentage ofrevenue, occupancy, communications and other expenses decreased to 14.9 percentfrom 15.4 percent for fiscal year 2003.

 

***General andAdministrative Expenses***

 

General and administrativeexpenses for fiscal year 2003 were $57.3 million, compared to $55.5 million forfiscal year 2002, an increase of $1.8 million or 3 percent.  The increase is mainly due to higherinsurance expenses of $1.5 million and additional professional fees related toSarbanes-Oxley of approximately $0.4 million, partially offset by lower basesalaries of $1.0 million.  As apercentage of revenue, general and administrative expenses increase to 8.1percent from 7.8 percent.

 

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***Depreciation andAmortization***

 

Depreciation and amortizationfor fiscal year 2003 was $19.6 million, compared to $20.0 million for fiscalyear 2002, a decrease of $0.4 million or 2 percent.  As a percentage of revenue, depreciation and amortizationremained at 2.8 percent.  The decreasewas due to lower purchases of capital assets during fiscal year 2003.

 

***Interest Income, Net***

 

Interest income, net for fiscalyear 2003 was $1.0 million, compared to $1.2 million for fiscal year 2002, adecrease of $0.2 million or 17 percent. The decrease was attributable to lower interest rates earned on our cashand cash equivalents.

 

***Other Non-operatingIncome***

 

During fiscal year 2003, theCompany received cash payments of $0.6 million in connection with the sale ofour U.S.-based public retirement business. During fiscal year 2002, the Companyreceived a cash payment of $1.0 million as a result of this sale, and alsorecorded a $1.2 million gain on the sale of common stock that the Companyreceived as a result of the demutualization of a health and general insuranceprovider.

 

***Income FromAffiliates***

 

Income from affiliates forfiscal year 2003 was $5.8 million, compared to $2.9 million for fiscal year2002, an increase of $2.9 million or 100 percent.  The increase was due to improved operations of our affiliatedcaptive insurance company, Professional Consultants Insurance Company (PCIC) of$1.8 million, and improved performance of our European affiliates, Watson WyattLLP and Watson Wyatt Holdings (Europe) Limited, of $0.4 million and $0.8million, respectively.

 

***Provision for IncomeTaxes***

 

Provision for income taxes forfiscal year 2003 was $35.0 million, compared to $31.4 million for fiscal year2002.  Our effective tax rate was 41.0percent for fiscal year 2003, compared to 40.0 percent for fiscal year 2002.The change in rate was due to an increase in the effective rate on foreignincome.

 

***Income FromContinuing Operations***

 

Income from continuingoperations for fiscal year 2003 was $50.4 million, compared to $47.1 millionfor fiscal year 2002, an increase of $3.3 million or 7 percent.  As a percentage of revenue, income fromcontinuing operations increased to 12.0 percent from 11.0 percent.

 

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

 

Diluted earnings per share, incomefrom continuing operations for fiscal year 2003 was $1.51, compared to $1.41for fiscal year 2002, an increase of 7 percent.

 

***DiscontinuedOperations***

 

During the third quarter offiscal year 2003, the Company reduced the amount of its estimated liability forlosses from the exit from Wellspring, the Company’s benefits administrationoutsourcing business, by $11.4 million, net of associated tax expense of $4.7million.  During the fourth quarter offiscal year 2003, the Company received sublease income in excess of leasepayments of approximately $40,000 for the

 

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leases related to Wellspring,resulting in a year-to-date income from discontinued operations of $11.5million.  See Note 17 of the Notes to theConsolidated Financial Statements for more information related to Wellspringand the reduction of the estimated liability for losses from the exit fromWellspring.

 

**Fiscal Year Ended June 30, 2002, Compared toFiscal Year Ended June 30, 2001**

 

***Revenue***

 

Revenue from continuingoperations was $710.5 million in fiscal year 2002, compared to $700.2 millionin the prior year, an increase of $10.3 million or 1.5 percent.  Our public sector retirement business thatwe sold to Gabriel, Roeder, Smith & Company accounted for approximately$6.0 million in revenue in fiscal year 2001. The unadjusted revenue growth was comprised of a $21.0 million or 6percent increase in our Benefits Group and an $8.8 million or 9 percent increasein our Technology Solutions Group, partially offset by a $7.0 million or 13percent decrease in our Human Capital Group, a $5.1 million or 7 percentdecrease in International and a $7.5 million or 12 percent decrease in otherpractice areas in North America.

 

***Salaries andEmployee Benefits***

 

Salaries and employee benefitexpenses for fiscal year 2002 were $404.8 million, compared to $379.6 millionfor the previous fiscal year, an increase of $25.2 million or 7 percent.Salaries and employee benefit expenses for fiscal year 2001 includes the $3.5million compensation charge that the Company incurred resulting from agreementswith our employee stockholders related to our initial public offering in thesecond quarter of fiscal year 2001.  Theincrease, inclusive of this charge, was principally due to a $15.9 millionincrease in salaries, a $14.9 million increase in pension expenses and a $5.4million increase in benefits and wage taxes, partially offset by a $12.2million decrease in the provision for discretionary compensation.  As a percentage of revenue, salaries andemployee benefit expenses increased to 56.9 percent from 54.3 percent.

 

***Professional andSubcontracted Services***

 

Professional and subcontractedservices used in consulting operations for fiscal year 2002 were $48.7 million,compared to $54.1 million for fiscal year 2001, a decrease of $5.4 million or10 percent.  The decrease was mainly dueto lower reimbursable services incurred on behalf of clients of $3.1 millionand lower recruiting fees of $1.7 million. As a percentage of revenue, professional and subcontracted servicesdecreased to 6.9 percent from 7.7 percent.

 

***Occupancy,Communications and Other***

 

Occupancy, communications andother expenses for fiscal year 2002 were $109.2 million, compared to $114.4million for fiscal year 2001, a decrease of $5.2 million or 5 percent. Thedecrease was mainly due to lower travel costs of $6.8 million, lower generaloffice expenses of $2.9 million, lower dues and entertainment expense of $0.9million and decreased publication expenses of $0.6 million, partially offset byhigher rent expense of $3.6 million, which is attributable to an increase inleased space required to support our operations and higher real estate,operating and telephone expenses of $2.3 million.  As a percentage of revenue, occupancy, communications and otherexpenses decreased to 15.4 percent from 16.3 percent.

 

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***General andAdministrative Expenses***

 

General and administrativeexpenses for fiscal year 2002 were $55.5 million, compared to $57.5 million forfiscal year 2001, a decrease of $2.0 million or 3 percent. The decrease wasmainly attributable to lower travel costs of $2.3 million, lower professionalservices of $2.0 million and a lower provision for discretionary compensationof $1.4 million, partially offset by a $2.6 million increase in pension andinsurance expenses, a $0.8 million increase in promotional expenses and a $0.4million increase in base salaries.  As apercentage of revenue, general and administrative expenses decreased to 7.8percent from 8.2 percent.

 

***Depreciation andAmortization***

 

Depreciation and amortizationexpenses for fiscal year 2002 were $20.0 million, compared to $22.0 million forfiscal year 2001, a decrease of $2.0 million or 9 percent. The decrease isprimarily attributable to the Company no longer amortizing goodwill, pursuantto Statement of Financial Accounting Standards No. 142, “Goodwill and OtherIntangible Assets” (FAS 142).  As apercentage of revenue, depreciation and amortization expenses decreased to 2.8percent from 3.1 percent.

 

***Interest Income, Net***

 

Interest income, net for fiscalyear 2002 was $1.2 million, compared to $1.7 million for fiscal year 2001, adecrease of $0.5 million or 29 percent. The decrease reflects lower interest rates earned on our cash and cashequivalents.

 

***Other Non-operatingIncome***

 

Other non-operating income forfiscal year 2002 was $2.2 million, which is due to the gain on the sale of ourU.S.-based public sector retirement business of $1.0 million and a $1.2 milliongain on the sale of common stock that the Company received as a result of thedemutualization of a health and general insurance provider.

 

***Income fromAffiliates***

 

Income from affiliates forfiscal year 2002 was $2.9 million, compared to $3.8 million for fiscal year2001, a decrease of $0.9 million or 24 percent. The decrease is attributable toreduced operating income of our continental European affiliate, Watson WyattHoldings (Europe) Limited.

 

***Provision for IncomeTaxes***

 

Income taxes for fiscal year2002 were $31.4 million, compared to $33.6 million for fiscal year 2001.  Our effective tax rate was 40.0 percent forfiscal year 2002, compared to 42.9 percent for fiscal year 2001.  The change in the effective rate was due toa decrease in state taxes and a decrease in non-deductible expenses.  Our effective tax rate was also affected bydiffering foreign tax rates in various jurisdictions.

 

***Income fromContinuing Operations***

 

Income from continuingoperations for fiscal year 2002 was $47.1 million, compared to $44.4 million infiscal year 2001, an increase of $2.7 million or 6 percent.  As a percentage of revenue, income fromcontinuing operations increased to 6.6 percent from 6.3 percent.

 

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

 

Diluted earnings per share,continuing operations for fiscal year 2002 was $1.41, compared to $1.37 forfiscal year 2001, an increase of 3 percent.

 

**Liquidity and Capital Resources**

 

Our cash and cash equivalentsat June 30, 2003, totaled $144.4 million, compared to $96.0 million at June 30,2002. During fiscal year 2003, the Company paid fiscal year 2002 cash bonusesof $45.2 million, purchased fixed assets for $17.5 million, paid $36.3 millionin corporate taxes and contributed $22.0 million to our U.S. defined benefitpension plan.  These expenditures wereprincipally funded by cash generated from operating activities.

 

***Cash From OperatingActivities***

 

Cash from operating activities**forfiscal year 2003 was $74.7 million, compared to cash from operating activitiesof $51.6 million for fiscal year 2002. The variance is mainly due to lowerpayments to retirees of $6.2 million, improved collections on receivables of$9.4 million and the timing of annual payments of insurance premiums, whichcontributed $4.9 million to the increase in cash from operations.  The allowance for doubtful accountsdecreased $0.5 million from June 30, 2002, to June 30, 2003.  The number of days of accounts receivableand work in process outstanding was 72 at June 30, 2003, down from 79 at June30, 2002.

 

Cash from operating activities**forfiscal year 2002 was $51.6 million, compared to cash from operating activitiesof $43.2 million for fiscal year 2001. The Stock Incentive Bonus Plan was discontinued in fiscal year 2002,resulting in a variance of $30.3 million representing the cash payment in thethird quarter of fiscal year 2001, compared to no payment in fiscal year2002.  The remaining variance was mainlydue to the $14.3 million lower provision for discretionary compensation infiscal year 2002, compared to fiscal year 2001.  The allowance for doubtful accounts decreased $1.3 million andthe allowance for work in process decreased $0.7 million from June 30, 2001, toJune 30, 2002.  The number of days ofaccounts receivable and work in process outstanding was 79 at June 30, 2002,down from 81 at June 30, 2001.

 

***Cash Used inInvesting Activities***

 

Cash used in investingactivities for fiscal year 2003 was $22.2 million, compared to $36.6 millionfor fiscal year 2002.  The decrease ismostly due to reduced purchases of fixed assets.

 

Cash used in investingactivities for fiscal year 2002 was $36.6 million, compared to $36.4 millionfor fiscal year 2001.

 

***Cash From/Used inFinancing Activities***

 

Cash used in financingactivities was $6.7 million for fiscal year 2003, compared to $2.6 million forfiscal year 2002. Cash used in financing activities for fiscal year 2003consisted primarily of payments of $13.8 million for the repurchase of 673,816shares of common stock, net of $6.4 million representing 393,436 shares thatthe Company re-issued under the Employee Stock Purchase Plan.

 

Cash used in financingactivities was $2.6 million for fiscal year 2002, compared to $36.8 millionfrom financing activities for fiscal year 2001. Cash flows from financingactivities for fiscal year 2001 were mainly due to proceeds from the Company’sinitial public offering in October 2000. Pursuant to a November 2001 Board authorization to repurchase shares, theCompany repurchased 190,425 shares of

 

33

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common stock on the open marketduring the third and fourth quarters of fiscal year 2002 for $4.5 million andre-issued 69,691 of these shares under the Employee Stock Purchase Plan for$1.4 million, in connection with the Company’s employee benefit plans.

 

**Capital Commitments**

 

Expenditures of capital fundswere $23.8 million for fiscal year 2003 reflecting payments for fixed assets of$17.5 million, investments in affiliates of $3.7 million and acquisitionrelated payments of $2.6 million. Anticipated commitments of capital funds are estimated at $26.8 millionfor fiscal year 2004, mainly for computer hardware purchases, officerelocations and renovations, development and upgrade of financial andretirement systems and acquisition-related payments. We expect cash fromoperations to adequately provide for these cash needs.

 

**Off-BalanceSheet Arrangements and Contractual Obligations**

 

***Operating Leases****.* We lease office space, furniture and selected computer equipment underoperating lease agreements with terms ranging from one to ten years.  Future expected payments are as follows (inthousands):

 
|                             |   | **Payments  due by period (in thousands)** |    |
|----------------------------------|--------|--------------------------------------------|---------|
| **Contractual Cash Obligations** |   | **Total**                                  |    | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   | **After 5  years** |   |
|                             |   |                                       |    |   |   |   |   |   |   |   |   |
| Lease commitments                |   | $                                          | 235,806 |   | $ | 39,432 |   | $ | 66,502 |   | $ | 50,907 |   | $ | 78,965 |   |
|                                  |        |                                            |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

***Guarantees***

 

*Wellspring Leases. *TheCompany continues to guarantee certain leases for office premises and equipmentfor Wellspring.  At June 30, 2003,minimum remaining payments guaranteed under these leases, which expire atvarious dates through 2007, totaled $24.5 million, excluding anticipatedsublease income.  See Note 17 of theNotes to the Consolidated Financial Statements for more information related toWellspring.

 

*Affiliate Agreements. *Inconnection with the establishment of our alliance with Watson Wyatt LLP in1995, 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 £1.4 million (or approximately $2.3 million based on the June 30, 2003,exchange rate) per year.  We alsogranted Watson Wyatt LLP an option to return the leased space to our UK subsidiaryin 2009.  If Watson Wyatt LLP were toexercise this option, the Company would attempt to sublease the space at thethen-current market rates.

 

*Stock Loans. *Additionally,the Company guarantees a credit facility that provided loans to associates for stockpurchased under our former Stock Purchase Program.  This Stock Purchase Program was discontinued in conjunction withour initial public offering in October 2000. As a result, amounts guaranteed under the facility permanently decreaseas the loans are repaid.  The maximumavailable borrowings and aggregate outstanding balances under this facilitywere $1.0 million at June 30, 2003, and $2.9 million at June 30, 2002.  A total of 889,000 and 2,731,000 WatsonWyatt & Company Holdings shares were pledged by stockholders tocollateralize these loans at June 30, 2003 and 2002, respectively.

 

34

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**Credit Agreement**

 

The Company has entered into a$100.0 million revolving credit facility with a syndicate of banks.  Interest rates associated with this facilityvary with LIBOR and/or the Prime Rate, and are based on our leverage ratio, asdefined by the credit agreement.  We arecharged a quarterly commitment fee, currently 0.25 percent of the facility,that varies with our financial leverage and is calculated on the unused portionof the credit facility.  No amounts wereoutstanding under the Company’s revolving credit facility as of June 30, 2003,or June 30, 2002.  Credit under thefacility is available upon demand, although the credit facility requires us toobserve certain covenants (including requirements for minimum net worth, whichact to restrict dividends and other financial and restrictive covenants) and iscollateralized with a pledge of stock of material subsidiaries.  The lenders supporting the credit facilityagreed to an amendment of the minimum net worth covenant effective June 30,2003, such that we would avoid a default that would have resulted fromrecording an additional minimum pension liability in the fourth quarter offiscal year 2003.  As a result, we werein compliance with all covenants under the credit facility as of June 30, 2003.

 

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

 

**Risk Management**

 

As a part of our overall riskmanagement program, we carry customary commercial insurance policies, includingcommercial general liability, employment practices liability, as well asclaims-made professional liability insurance with a self-insured retention of$1 million per claim, which provides coverage for professional liability claimsincluding the cost of defending such claims. Our primary insurance coverage beyond this retention is written by anaffiliated captive insurance company owned by us and two other professionalservices firms.  The first $5 million ofcoverage has a premium structure which provides that the captive insurancecompany will recover from the firm defending the claim approximately 75 percentof any loss up to $5 million.  TheCompany records an accrual for this liability. This recovery occurs through insurance premium payments in subsequentyears.  The remaining 25 percent of anyloss up to $5 million is a risk borne by the captive insurance company, which carriesreinsurance in the commercial markets for most losses above $5 million.  The Company provides for the self-insuredretention and for the prospective premium increases where specific estimatedlosses for known claims in excess of $1 million are considered probable andreasonably estimable.

 

Although the Company maintainsprofessional liability insurance coverage, this insurance does not cover claimsmade after expiration of our current insurance contracts.  Generally accepted accounting principles requirethat we record a liability for incurred but not reported (IBNR) professionalliability claims if they are estimable and probable, and for which we have notyet contracted for insurance coverage. The Company uses actuarial assumptions to estimate and record its IBNRliability and has a $12.6 million IBNR liability recorded as of June 30, 2003.

 

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

 

35

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

 

**RecentAccounting Pronouncements**

 

In June 2002, the FinancialAccounting Standards Board (FASB) issued Statement of Financial AccountingStandards No. 146, “Accounting for Costs Associated with Exit or DisposalActivities” (FAS 146).  FAS 146 providesfurther guidance regarding requirements for recognition of a liability forcosts associated with an exit or disposal activity and is effective for allexit or disposal activities initiated after December 31, 2002.  The adoption of FAS 146 has not had amaterial effect on the Company’s financial performance or condition.

 

In November 2002, the FASBissued Interpretation No. 45 (FIN 45), which clarified existing guidance fromthe FASB regarding a guarantor’s accounting for, and disclosure of, theissuance of certain types of guarantees. The disclosure provisions of the interpretation are effective for allperiods that end after December 15, 2002, and provisions for recognition andmeasurement are effective on a prospective basis for guarantees issued ormodified after December 31, 2002. Management has reviewed guarantees issued by the Company and hasprovided relevant disclosure in Note 14 based on those types of guaranteeswhich the Company currently has in place. The adoption of FIN 45 has not had a material effect on the Company’sfinancial performance or condition.

 

In January 2003, the FASBissued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable InterestEntities”, which clarifies the financial reporting guidance associated with theconsolidation of another entity.  Theconsolidation requirements of FIN 46 apply immediately to variable interestentities created after January 31, 2003 and pre-existing variable interestentities as of July 1, 2003.  Certain ofthe disclosure requirements apply in all financial statements issued afterJanuary 31, 2003, regardless of when the variable interest entity wasestablished.  Management does notbelieve that the adoption of FIN 46 will have an effect on the Company’sfinancial performance or condition.

 

In May 2003, the FASB ratifiedthe Emerging Issues Task Force’s Issue 03-3, “Applicability of EITF Abstracts,Topic No. D-79, ‘Accounting for Retroactive Insurance Contracts Purchase byEntities Other Than Insurance Enterprises,’ to Claims-Made Policies” (EITF03-3) regarding the accounting for claims-made insurance by the insured party.  Management has reviewed its claims-madeinsurance policy in light of the guidance provided by EITF 03-3 and hasconcluded that this pronouncement will require the Company to continue toaccount for its premiums to PCIC using prospective insurance accounting forpremiums paid, at least through fiscal 2004 and under the insurance aspresently structured.

 

**Subsequent Events**

 

We implemented additional jobreductions in our North American regions in July 2003.  This resulted in the elimination ofapproximately 100 positions.  The estimated$3.3 million charge to earnings related to these reductions will be included inthe Company’s financial results for the quarter ended September 30, 2003.

 

On July 9, 2003, PCIC’s Boardof Directors approved a change in premium structure for its policyholders andstockholders.  In connection with thechange in premium structure, PCIC provided each of its owners

 

36

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with a one-time credit in their2003-04 policy year in connection with benefits received from an aggregate stoploss insurance policy entered into by PCIC. PCIC’s Board determined in July 2003 that this credit would be used to“true up” each insureds’ obligation to PCIC for historical loss experience.  As a result, the Company will record a $5.6million pre-tax non-operating gain in the first quarter of fiscal year2004.  Refer to Note 4 of the Notes tothe Consolidated Financial Statements for more information regarding ourinvestment in PCIC.

 

**Item 7A. Quantitative and QualitativeDisclosures About Market Risk.**

 

We are exposed to market risksin the ordinary course of business. These risks include interest rate risk and foreign currency exchangerisk.  We have examined our exposure tothese risks and concluded that none of our exposures in these areas arematerial to fair values, cash flows or earnings.  We do not engage in any hedging of market risks with derivativeinstruments.

 

**Item 8.  Financial Statements andSupplementary Data.**

 

The financial statements andsupplementary data are included as Item 15 of this report.

 

**Item 9.  Changes in andDisagreements with Accountants on Accounting and Financial Disclosure.**

 

There are no changes inaccountants or disagreements with accountants on accounting principles andfinancial disclosures required to be disclosed in this Item 9.

 

**Item9A.  Controls and Procedures.**

 

(a) Evaluation of DisclosureControls and Procedures

 

The Chief Executive Officer andChief Financial Officer of the Company evaluated our disclosure controls andprocedures as of the end of the fiscal year ended June 30, 2003, and haveconcluded that, as of June 30, 2003, such controls and procedures have beeneffectively designed to ensure that information required to be disclosed inreports that the Company files with or submits to the SEC is recorded,processed, summarized and reported within the time periods specified in theSEC's rules and forms and is accumulated and communicated to management,including the Chief Executive Officer and Chief Financial Officer, asappropriate to allow timely decisions regarding such disclosure.

 

(b) Changes in Internal ControlOver Financial Reporting

 

No changes in our internalcontrol over financial reporting have come to management’s attention during ourlast fiscal quarter that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.  Review and evaluation of disclosure controlsand procedures is an ongoing process that we will continue to refine as weperform quarterly evaluations.

 

37

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**Part III**

 

**Item 10. Directors and Executive Officers of the Registrant.**

 

The response to this item will be included in a definitive proxystatement filed within 120 days after the end of the Registrant’s fiscalyear.  The information contained underthe headings (i) “Proposal 1: Election of Directors”, (ii) “BiographicalInformation For Other Executive Officers Of The Company” and (iii) “Section16(A) Beneficial Ownership Reporting Compliance” in the proxy statement areincorporated herein by this reference.

 

**Item 11.  Executive Compensation.**

 

The response to this item will be included in a definitive proxystatement filed within 120 days after the end of the Registrant’s fiscalyear.  The information contained underthe heading “Executive Compensation” in the proxy statement is incorporatedherein by this reference.

 

**Item 12.  Security Ownership of Certain BeneficialOwners and Management.**

 

The response to this item will be included in a definitive proxystatement filed within 120 days after the end of the Registrant’s fiscalyear.  The information contained underthe heading “Security Ownership of Certain Beneficial Owners and Management” inthe proxy statement is incorporated herein by this reference.

 

**Item 13.  Certain Relationships and RelatedTransactions.**

 

The response to this item willbe included in a definitive proxy statement filed within 120 days after the endof the Registrant’s fiscal year.  Theinformation contained under the heading “Certain Relationships and RelatedTransactions” in the proxy statement is incorporated herein by this reference.

 

**Item 14. Principal Auditor Fees and Services.**

 

The response to this item willbe included in a definitive proxy statement filed within 120 days after the endof the Registrant’s fiscal year.  Theinformation contained under the heading “Principal Accountant Fees andServices” in the proxy statement is incorporated herein by this reference.

 

38

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**Part IV**

 

**Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.**

 
| a)     | Financial Information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (1)    | Consolidated  Financial Statements of Watson Wyatt & Company Holdings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Report of Independent Auditors                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Financial  Statements:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | Consolidated Statements of Operations for  each of the three years in the period ended June 30, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Consolidated Balance Sheets at June 30, 2003 and 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   | Consolidated Statements of Cash Flows for  each of the three years in the period ended June 30, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Consolidated Statements of Changes in  Permanent Stockholders’ Equity and Redeemable Common Stock for each of the  three years in the period ended June 30, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   | Notes to the Consolidated Financial  Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (2)    | Consolidated Financial Statement Schedule  for each of the three years in the period ended June 30, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Valuation and Qualifying Accounts and Reserves (Schedule II)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | All other schedules are omitted because  they are not applicable or the required information is shown in the financial  statements or notes thereto.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (3)    | Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | See (c)  below                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| b)     | Reports on  Form 8-K                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | (i) On June  3, 2003, the Company filed a Current Report on Form 8-K, which reported that  John J. Haley, Chief Executive Officer of the Company, has adopted a written  10b5-1 Sales Plan pursuant to Securities and Exchange Commission Rule 10b5-1.  (ii) 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.  (iii) 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. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| c)     | Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | See Exhibit  Index on page 79                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| d)     | Financial  Statement Schedules                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Not  applicable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

39

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**SIGNATURES**

 

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                           |   | WATSON WYATT  & COMPANY HOLDINGS |
|--------------------------------|--------|--------------------------------------|
|                           |   | (Registrant)                         |
|                           |   |                                 |   |
| Date:  September 23, 2003 |   | By:                                  |   /s/ John J. Haley |   |
|                           |   |                                 |   John J. Haley |
|                           |   |                                 |   President and Chief Executive Officer |

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**             |   | **Title**                           |   | **Date** |
|---------------------------|--------|-------------------------------------|--------|----------|
|                      |   |                                |   |     |
| /s/ John J. Haley         |   | President,  Chief Executive Officer |   | 9/23/03  |
| John J. Haley             |   | and Director                        |   |     |
|                      |   |                                |   |     |
|                      |   |                                |   |     |
| /s/ Carl D. Mautz         |   | Vice  President and Chief           |   | 9/23/03  |
| Carl D. Mautz             |   | Financial  Officer                  |   |     |
|                      |   |                                |   |     |
|                      |   |                                |   |     |
| /s/ Peter L. Childs       |   | Controller                          |   | 9/23/03  |
| Peter L. Childs           |   |                                |   |     |
|                      |   |                                |   |     |
|                      |   |                                |   |     |
| /s/ Elizabeth M. Caflisch |   | Vice  President and Director        |   | 9/23/03  |
| Elizabeth M. Caflisch     |   |                                |   |     |
|                      |   |                                |   |     |
|                      |   |                                |   |     |
| /s/ Maureen E. Cotter     |   | Vice  President and Director        |   | 9/23/03  |
| Maureen E. Cotter         |   |                                |   |     |
|                      |   |                                |   |     |
|                      |   |                                |   |     |
| /s/ John J. Gabarro       |   | Director                            |   | 9/23/03  |
| John J. Gabarro           |   |                                |   |     |
|                      |   |                                |   |     |
|                      |   |                                |   |     |
| /s/ R. Michael McCullough |   | Director                            |   | 9/23/03  |
| R. Michael McCullough     |   |                                |   |     |
|                      |   |                                |   |     |
|                      |   |                                |   |     |
| /s/ John Philip Orbeta    |   | Vice  President and Director        |   | 9/23/03  |
| John Philip Orbeta        |   |                                |   |     |

 

40

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| /s/ Linda D. Rabbitt      |   | Director                     |   | 9/23/03 |
|---------------------------|--------|------------------------------|--------|---------|
| Linda D. Rabbitt          |   |                         |   |    |
|                      |   |                         |   |    |
|                      |   |                         |   |    |
| /s/ Gilbert T. Ray        |   | Director                     |   | 9/23/03 |
| Gilbert T. Ray            |   |                         |   |    |
|                      |   |                         |   |    |
|                      |   |                         |   |    |
| /s/ Sylvester J. Schieber |   | Vice  President and Director |   | 9/23/03 |
| Sylvester J. Schieber     |   |                         |   |    |
|                      |   |                         |   |    |
|                      |   |                         |   |    |
| /s/ John B. Shoven        |   | Director                     |   | 9/23/03 |
| John B. Shoven            |   |                         |   |    |
|                      |   |                         |   |    |
|                      |   |                         |   |    |
| /s/ Edward Manno Shumsky  |   | Vice  President and Director |   | 9/23/03 |
| Edward Manno Shumsky      |   |                         |   |    |
|                      |   |                         |   |    |
|                      |   |                         |   |    |
| /s/ Paul N. Thornton      |   | Director                     |   | 9/23/03 |
| Paul N. Thornton          |   |                         |   |    |
|                      |   |                         |   |    |
|                      |   |                         |   |    |
| /s/ Gene H. Wickes        |   | Vice  President and Director |   | 9/23/03 |
| Gene H. Wickes            |   |                         |   |    |
|                      |   |                         |   |    |
|                      |   |                         |   |    |
| /s/ John C. Wright        |   | Director                     |   | 9/23/03 |
| John C. Wright            |   |                         |   |    |

 

41

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**REPORT OF INDEPENDENT AUDITORS**

 

 

To the Board of Directors and

Stockholders of Watson Wyatt& Company Holdings:

 

In our opinion, theconsolidated financial statements listed in the index appearing under Item15(a)(1) on page 39 of this Form 10-K, present fairly, in all materialrespects, the financial position of Watson Wyatt & Company Holdings and itssubsidiaries at June 30, 2003 and 2002, and the results of their operations andtheir cash flows for each of the three years in the period ended June 30, 2003,in conformity with accounting principles generally accepted in the UnitedStates of America.  In addition, in ouropinion, the financial statement schedule listed in the index appearing underItem 15(a)(2) on page 39 of this Form 10-K presents fairly, in all materialrespects, the information set forth therein when read in conjunction with therelated consolidated financial statements. These financial statements and the financial statement schedule are theresponsibility of the Company’s management; our responsibility is to express anopinion on these financial statements and financial statement schedule based onour audits.  We conducted our audits ofthese statements in accordance with auditing standards generally accepted inthe United States of America, which require that we plan and perform the auditto obtain reasonable assurance about whether the financial statements are freeof material misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

 

PricewaterhouseCoopers LLP

 

 

Washington, D.C.

September 15, 2003

 

42

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**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statements of Operations**

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

 
|                                                                                                                                                        |   | **Year Ended  June 30** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|
|                                                                                                                                                        |   | **2003**                |       | **2002** |   | **2001** |   |
|                                                                                                                                                        |   |                    | ** ** |   | ** ** |   | ** ** |
| Revenue                                                                                                                                                     |   | $                       | 709,616    |   | $ | 710,480 |   | $ | 700,189 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Costs of providing services:                                                                                                                                |   |                    |       |   |   |   |   |
| Salaries and employee benefits                                                                                                                              |   | 401,274                 |       | 404,822 |   | 379,645 |   |
| Professional and subcontracted services                                                                                                                     |   | 47,356                  |       | 48,724 |   | 54,089 |   |
| Occupancy, communications and other                                                                                                                         |   | 106,224                 |       | 109,163 |   | 114,417 |   |
| General and administrative expenses                                                                                                                         |   | 57,285                  |       | 55,517 |   | 57,475 |   |
| Depreciation and amortization                                                                                                                               |   | 19,621                  |       | 20,049 |   | 21,995 |   |
|                                                                                                                                                        |   | 631,760                 |       | 638,275 |   | 627,621 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Income from operations                                                                                                                                      |   | 77,856                  |       | 72,205 |   | 72,568 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Income from affiliates                                                                                                                                      |   | 5,787                   |       | 2,866 |   | 3,780 |   |
| Interest income, net                                                                                                                                        |   | 991                     |       | 1,235 |   | 1,711 |   |
| Other non-operating income                                                                                                                                  |   | 761                     |       | 2,166 |   | — |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Income from continuing operations before income taxes                                                                                                       |   | 85,395                  |       | 78,472 |   | 78,059 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Provision for (benefit from) income taxes:                                                                                                                  |   |                    |       |   |   |   |   |
| Current                                                                                                                                                     |   | 39,063                  |       | 37,383 |   | 32,375 |   |
| Deferred                                                                                                                                                    |   | (4,048                  | )          | (5,995 | ) | 1,248 |   |
|                                                                                                                                                        |   | 35,015                  |       | 31,388 |   | 33,623 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Income from continuing operations                                                                                                                           |   | 50,380                  |       | 47,084 |   | 44,436 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Discontinued operations:                                                                                                                                    |   |                    |       |   |   |   |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Adjustment to reduce estimated loss on disposal of discontinued  operations, less applicable income tax expense of $4,687 for the year ended  June 30, 2003 |   | 6,786                   |       | — |   | — |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Net income                                                                                                                                                  |   | $                       | 57,166     |   | $ | 47,084 |   | $ | 44,436 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Basic earnings per share:                                                                                                                                   |   |                    |       |   |   |   |   |
| Income from continuing operations                                                                                                                           |   | $                       | 1.52       |   | $ | 1.43 |   | $ | 1.39 |   |
| Income from discontinued operations                                                                                                                         |   | 0.21                    |       | — |   | — |   |
| Net income                                                                                                                                                  |   | $                       | 1.73       |   | $ | 1.43 |   | $ | 1.39 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Diluted earnings per share:                                                                                                                                 |   |                    |       |   |   |   |   |
| Income from continuing operations                                                                                                                           |   | $                       | 1.51       |   | $ | 1.41 |   | $ | 1.37 |   |
| Income from discontinued operations                                                                                                                         |   | 0.21                    |       | — |   | — |   |
| Net income                                                                                                                                                  |   | $                       | 1.72       |   | $ | 1.41 |   | $ | 1.37 |   |
|                                                                                                                                                        |   |                    |       |   |   |   |   |
| Weighted average shares of common stock, basic (000)                                                                                                        |   | 32,962                  |       | 32,985 |   | 32,068 |   |
| Weighted average shares of common stock, diluted (000)                                                                                                      |   | 33,287                  |       | 33,421 |   | 32,363 |   |

 

See accompanying notes to the

consolidated financial statements

 

43

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**ConsolidatedBalance Sheets**

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

 
|                                                                                                      |   | **June 30,  2003** |       | **June 30,  2002** |       |
|-----------------------------------------------------------------------------------------------------------|--------|--------------------|------------|--------------------|------------|
|                                                                                                      |   |               |       |               |       |
| **Assets**                                                                                                |   |               | ** ** |               | ** ** |
| Cash and cash equivalents                                                                                 |   | $                  | 144,374    |               | $          | 95,974 |   |
| Receivables from clients:                                                                                 |   |               |       |               |       |
| Billed, net of allowances of $862 and $1,405                                                              |   | 78,373             |       | 83,311             |       |
| Unbilled, net of allowances of $419 and $431                                                              |   | 60,549             |       | 68,301             |       |
|                                                                                                      |   | 138,922            |       | 151,612            |       |
| Deferred income taxes                                                                                     |   | 3,885              |       | 7,904              |       |
| Other current assets                                                                                      |   | 11,448             |       | 17,268             |       |
| Total current assets                                                                                      |   | 298,629            |       | 272,758            |       |
| Investment in affiliates                                                                                  |   | 26,431             |       | 20,086             |       |
| Fixed assets, net                                                                                         |   | 60,716             |       | 62,552             |       |
| Deferred income taxes                                                                                     |   | 101,214            |       | 54,758             |       |
| Goodwill and intangible assets                                                                            |   | 20,878             |       | 18,430             |       |
| Other assets                                                                                              |   | 6,594              |       | 8,233              |       |
|                                                                                                      |   |               |       |               |       |
| **Total Assets**                                                                                          |   | $                  | 514,462    |               | $          | 436,817 |   |
|                                                                                                      |   |               |       |               |       |
| **Liabilities**                                                                                           |   |               | ** ** |               | ** ** |
| Accounts payable and accrued liabilities, including discretionary  compensation                           |   | $                  | 114,013    |               | $          | 134,998 |   |
| Income taxes payable                                                                                      |   | 15,308             |       | 14,589             |       |
| Total current liabilities                                                                                 |   | 129,321            |       | 149,587            |       |
| Accrued retirement benefits                                                                               |   | 195,705            |       | 84,148             |       |
| Deferred rent and accrued lease losses                                                                    |   | 4,608              |       | 3,660              |       |
| Other noncurrent liabilities                                                                              |   | 33,091             |       | 40,201             |       |
|                                                                                                      |   |               |       |               |       |
| **Total Liabilities**                                                                                     |   | 362,725            |       | 277,596            |       |
|                                                                                                      |   |               |       |               |       |
| 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; 33,087,880 and 20,212,449 issued and  32,943,156 and 20,029,115 outstanding |   | 331                |       | 202                |       |
| Class B-1 Common Stock — $.01 par value:                                                             |   |               |       |               |       |
| 15,000,000 shares authorized; none issued and outstanding                                                 |   | —             |       | —             |       |
| Class B-2 Common Stock — $.01 par value:                                                             |   |               |       |               |       |
| 15,000,000 shares authorized; none and 12,868,030 issued and  outstanding                                 |   | —             |       | 129                |       |
| Additional paid-in capital                                                                                |   | 145,922            |       | 147,034            |       |
| Treasury stock, at cost — 144,724 and 183,334 shares                                                 |   | (2,956             | )          | (3,076             | )          |
| Retained earnings                                                                                         |   | 77,517             |       | 20,351             |       |
| Accumulated other comprehensive loss                                                                      |   | (69,077            | )          | (5,419             | )          |
| **Total Stockholders’ Equity**                                                                       |   | 151,737            |       | 159,221            |       |
|                                                                                                      |   |               |       |               |       |
| **Total Liabilities and Stockholders’ Equity**                                                       |   | $                  | 514,462    |               | $          | 436,817 |   |

 

See accompanying notes to the

consolidated financial statements

 

44

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statements of Cash Flows**

(Thousandsof U.S. Dollars)

 
|                                                                             |   | **Year Ended  June 30** |    |
|----------------------------------------------------------------------------------|--------|-------------------------|---------|
|                                                                             |   | **2003**                |    | **2002** |   | **2001** |   |
|                                                                             |   |                    |    |   |   |   |   |
| Cash flows from operating activities:                                            |   |                    |    |   |   |   |   |
| Net income                                                                       |   | $                       | 57,166  |   | $ | 47,084 |   | $ | 44,436 |   |
| Adjustments to reconcile net income to net cash from operating  activities:      |   |                    |    |   |   |   |   |
| Income from discontinued operations, net of income tax expense                   |   | (6,786                  | )       | — |   | — |   |
| Allowance for doubtful receivables from clients                                  |   | 7,859                   |    | 4,541 |   | 7,062 |   |
| Depreciation                                                                     |   | 19,205                  |    | 19,887 |   | 19,445 |   |
| Amortization of intangible assets                                                |   | 416                     |    | 162 |   | 2,550 |   |
| Provision for (benefit from) deferred income taxes                               |   | 2,994                   |    | (5,995 | ) | 1,248 |   |
| Income from affiliates                                                           |   | (5,787                  | )       | (2,866 | ) | (3,780 | ) |
| Distributions from affiliates                                                    |   | 4,831                   |    | 1,970 |   | 3,623 |   |
| Other, net                                                                       |   | (595                    | )       | (525 | ) | 2,250 |   |
| Changes in operating assets and liabilities (net of discontinued  operations)    |   |                    |    |   |   |   |   |
| Receivables from clients                                                         |   | 4,831                   |    | (4,563 | ) | (15,914 | ) |
| Other current assets                                                             |   | 5,594                   |    | (6,468 | ) | 678 |   |
| Other assets                                                                     |   | 1,639                   |    | 578 |   | 1,179 |   |
| Accounts payable and accrued liabilities                                         |   | (14,982                 | )       | (12,468 | ) | (19,341 | ) |
| Income taxes payable                                                             |   | (3,968                  | )       | 967 |   | 1,779 |   |
| Accrued retirement benefits                                                      |   | (1,855                  | )       | 6,488 |   | (1,802 | ) |
| Deferred rent and accrued lease losses                                           |   | 948                     |    | 176 |   | (1,972 | ) |
| Other noncurrent liabilities                                                     |   | 3,201                   |    | 2,616 |   | 1,731 |   |
| Net cash from operating activities                                               |   | 74,711                  |    | 51,584 |   | 43,172 |   |
| Cash flows used in investing activities:                                         |   |                    |    |   |   |   |   |
| Purchases of fixed assets                                                        |   | (17,505                 | )       | (31,557 | ) | (29,486 | ) |
| Proceeds from sale of fixed assets                                               |   | 40                      |    | 144 |   | 681 |   |
| Proceeds from divestitures                                                       |   | 1,281                   |    | 1,747 |   | 386 |   |
| Acquisitions and contingent consideration payments                               |   | (2,310                  | )       | (5,262 | ) | (7,992 | ) |
| Investments in affiliates                                                        |   | (3,661                  | )       | (1,700 | ) | — |   |
| Net cash used in investing activities                                            |   | (22,155                 | )       | (36,628 | ) | (36,411 | ) |
| Cash flows (used in) from financing activities:                                  |   |                    |    |   |   |   |   |
| Issuances of common stock — exercises of stock options                      |   | 714                     |    | 429 |   | — |   |
| Issuances of common stock — employee stock purchase plan                    |   | 6,408                   |    | 1,448 |   | — |   |
| Issuances of common stock — initial public offering and secondary  offering |   | —                  |    | — |   | 36,869 |   |
| Repurchases of common stock                                                      |   | (13,824                 | )       | (4,521 | ) | — |   |
| Net repurchases of redeemable common stock                                       |   | —                  |    | — |   | (118 | ) |
| Net cash (used in) from financing activities                                     |   | (6,702                  | )       | (2,644 | ) | 36,751 |   |
| Effect of exchange rates on cash                                                 |   | 2,546                   |    | 1,927 |   | (3,187 | ) |
| Increase in cash and cash equivalents                                            |   | 48,400                  |    | 14,239 |   | 40,325 |   |
| Cash and cash equivalents at beginning of year                                   |   | 95,974                  |    | 81,735 |   | 41,410 |   |
| Cash and cash equivalents at end of year                                         |   | $                       | 144,374 |   | $ | 95,974 |   | $ | 81,735 |   |

 

See accompanying notes to the

consolidated financial statements

 

45

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statement of Changes in Permanent Stockholders’Equity and Redeemable Common Stock**

(Thousandsof U.S. Dollars)

 
|                                                                                                                               |   | **Redeemable  Common Stock** |    |   | **Retained  Earnings  (Accumulated  Deficit)** |   | **Adjustment  for  Redemption Value  (Greater)/Less Than  Amounts Paid in by  Stockholders** |   | **Class A  Common  Stock** |   | **Class B-1  Common  Stock** |   | **Class B-2  Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Treasury  Stock,  at Cost** |   | **Accumulated  Other  Comprehensive  (Loss)/Income** |   | **Total** |   |
|------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|--------|------------------------------------------------|--------|----------------------------------------------------------------------------------------------|--------|----------------------------|--------|------------------------------|--------|------------------------------|--------|----------------------------------|--------|-------------------------------|--------|------------------------------------------------------|--------|-----------|--------|
|                                                                                                                               |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |   |   |   |   |   |
| Balance at June 30, 2000                                                                                                           |   | $                            | 115,480 |   |                                           | $      | (71,063                                                                                      | )      | $                          | (6,097 | )                            |   |                         |   |                             |   |                          |   |                                                 |   |      | $      | (3,949 | ) | $ | (81,109 | ) |
|                                                                                                                               |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Effect of repurchases of 21,540 shares of redeemable common stock                                                                  |   | (146                         | )       |   | (106                                           | )      | 106                                                                                          |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | —    |   |
| Effect of issuance of 20,000 shares of redeemable common stock                                                                     |   | 134                          |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | —    |   |
| Adjustment of redemption value for change in formula book value per  share                                                         |   |                         |    |   |                                           |   | (118                                                                                         | )      |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | (118      | )      |
| Elimination of redeemable feature of common stock and 2-for-1 share  exchange                                                      |   | (115,468                     | )       |   |                                           |   | 6,109                                                                                        |   | $                          | — |                         | $      | 148                          |   | $                                | 148    |                          | $      | 109,063                                              |   | $         | — |   |   |   | 115,468 |   |
| Reclassification for sale of 3,118,500 shares by existing  stockholders                                                            |   |                         |    |   |                                           |   |                                                                                         |   | 32                         |   | (16                          | )      | (16                          | )      |                             |   |                          |   |                                                 |   | —    |   |
| Proceeds from sale of 3,321,500 shares, net of offering costs                                                                      |   |                         |    |   |                                           |   |                                                                                         |   | 33                         |   |                         |   |                         |   | 34,993                           |   |                          |   |                                                 |   | 35,026    |   |
| Non-cash compensation charge related to the sale of 44,796 shares of  redeemable common stock prior to the initial public offering |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | 751                              |   |                          |   |                                                 |   | 751       |   |
| Reclassification for sale of 2,845,715 shares by existing  stockholders                                                            |   |                         |    |   |                                           |   |                                                                                         |   | 28                         |   | (28                          | )      |                         |   |                             |   |                          |   |                                                 |   | —    |   |
| Proceeds from sale of 104,285 shares, net of offering costs                                                                        |   |                         |    |   |                                           |   |                                                                                         |   | 1                          |   |                         |   |                         |   | 1,842                            |   |                          |   |                                                 |   | 1,843     |   |
| Comprehensive income:                                                                                                              |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Net income                                                                                                                         |   |                         |    |   | 44,436                                         |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | 44,436    |   |
| Foreign currency translation adjustment                                                                                            |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   | (4,412                                               | )      | (4,412    | )      |
| Total comprehensive income                                                                                                         |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | 40,024    |   |
|                                                                                                                               |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Balance at June 30, 2001                                                                                                           |   | —                       |    |   | (26,733                                        | )      | —                                                                                       |   | 94                         |   | 104                          |   | 132                          |   | 146,649                          |   | —                        |   | (8,361                                               | )      | 111,885   |   |
|                                                                                                                               |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Comprehensive Income:                                                                                                              |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Net income                                                                                                                         |   |                         |    |   | 47,084                                         |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | 47,084    |   |
| Foreign currency translation adjustment                                                                                            |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   | 2,942                                                |   | 2,942     |   |
| Total comprehensive income                                                                                                         |   |                         |    |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | 50,026    |   |
| Reclassification for sale of 442,500 shares by existing stockholders                                                               |   |                         |    |   |                                           |   |                                                                                         |   | 4                          |   | (4                           | )      |                         |   |                             |   |                          |   |                                                 |   | —    |   |
| Transfer restriction expiration of 9,956,140 shares                                                                                |   |                         |    |   |                                           |   |                                                                                         |   | 100                        |   | (100                         | )      |                         |   |                             |   |                          |   |                                                 |   | —    |   |
|                                                                                                                                    |        |                              |         |        |                                                |        |                                                                                              |        |                            |        |                              |        |                              |        |                                  |        |                               |        |                                                      |        |           |        |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to the

consolidatedfinancial statements

 

46

----

 

**WATSON WYATT & COMPANY HOLDINGS**

**Consolidated Statement of Changesin Permanent Stockholders’ Equity and Redeemable Common Stock**

(Thousandsof U.S. Dollars)

 
|                                                                                        |   | **Redeemable  Common Stock** |   |   | **Retained  Earnings  (Accumulated  Deficit)** |   | **Adjustment  for  Redemption Value  (Greater)/Less Than  Amounts Paid in by  Stockholders** |   | **Class A  Common  Stock** |   | **Class B-1  Common  Stock** |   | **Class B-2  Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Treasury  Stock,  at Cost** |   | **Accumulated  Other  Comprehensive  (Loss)/Income** |   | **Total** |   |
|---------------------------------------------------------------------------------------------|--------|------------------------------|--------|--------|------------------------------------------------|--------|----------------------------------------------------------------------------------------------|--------|----------------------------|--------|------------------------------|--------|------------------------------|--------|----------------------------------|--------|-------------------------------|--------|------------------------------------------------------|--------|-----------|--------|
| Conversion of 333,498 shares held by Watson Wyatt LLP for distribution  to its partners     |   |                         |   |   |                                           |   |                                                                                         |   | 3                          |   |                         |   | (3                           | )      |                             |   |                          |   |                                                 |   | —    |   |
| Distribution of 62,600 shares from Watson Wyatt LLP to Watson Wyatt  & Company Holdings |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   | (209                          | )      |                                                 |   | (209      | )      |
| Repurchase of Class A shares                                                                |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   | (4,521                        | )      |                                                 |   | (4,521    | )      |
| Issuances of common stock — exercises of common stock options                          |   |                         |   |   |                                           |   |                                                                                         |   | 1                          |   |                         |   |                         |   | 428                              |   |                          |   |                                                 |   | 429       |   |
| Issuances of common stock — employee stock purchase plan                               |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | (206                             | )      | 1,654                         |   |                                                 |   | 1,448     |   |
| Tax benefit of exercise of common stock options                                             |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | 163                              |   |                          |   |                                                 |   | 163       |   |
|                                                                                        |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Balance at June 30, 2002                                                                    |   |                         |   |   | 20,351                                         |   | —                                                                                       |   | 202                        |   | —                       |   | 129                          |   | 147,034                          |   | (3,076                        | )      | (5,419                                               | )      | 159,221   |   |
|                                                                                        |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Comprehensive loss:                                                                         |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Net income                                                                                  |   |                         |   |   | 57,166                                         |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | 57,166    |   |
| Additional minimum pension liability                                                        |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   | (67,869                                              | )      | (67,869   | )      |
| Foreign currency translation adjustment                                                     |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   | 4,211                                                |   | 4,211     |   |
| Total comprehensive loss                                                                    |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   | (6,492    | )      |
| Transfer restriction expiration of 12,745,015 shares                                        |   |                         |   |   |                                           |   |                                                                                         |   | 127                        |   |                         |   | (127                         | )      |                             |   |                          |   |                                                 |   | —    |   |
| Repurchases of common stock                                                                 |   |                         |   |   |                                           |   |                                                                                         |   | 2                          |   |                         |   | (2                           | )      |                             |   | (13,824                       | )      |                                                 |   | (13,824   | )      |
| Issuances of common stock — exercises of common stock options                          |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | (205                             | )      | 919                           |   |                                                 |   | 714       |   |
| Issuances of common stock — employee stock purchase plan                               |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | (1,347                           | )      | 7,755                         |   |                                                 |   | 6,408     |   |
| Issuances of common stock - deferred stock units                                            |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | 285                              |   | 5,021                         |   |                                                 |   | 5,306     |   |
| Issuance of common stock to outside directors                                               |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | (42                              | )      | 249                           |   |                                                 |   | 207       |   |
| Tax benefit of exercise of common stock options                                             |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   | 197                              |   |                          |   |                                                 |   | 197       |   |
|                                                                                        |   |                         |   |   |                                           |   |                                                                                         |   |                       |   |                         |   |                         |   |                             |   |                          |   |                                                 |   |      |   |
| Balance at June 30, 2003                                                                    |   |                         |   |   | $                                              | 77,517 |                                                                                         | $      | —                     |   | $                            | 331    |                         | $      | —                           |   | $                             | — |                                                 | $      | 145,922   |   | $ | (2,956 | ) | $ | (69,077 | ) | $ | 151,737 |   |
|                                                                                             |        |                              |        |        |                                                |        |                                                                                              |        |                            |        |                              |        |                              |        |                                  |        |                               |        |                                                      |        |           |        |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to the

consolidated financial statements

 

47

----

 

**WATSON WYATT &COMPANY HOLDINGS**

 

**Notes to theConsolidated Financial Statements**

**(Tabular Amounts inThousands of U.S. Dollars Except Share and Percentage Data)**

 

**Note 1 - Summary of Significant AccountingPolicies**

 

*Nature of the Business*- Watson Wyatt & Company Holdings (collectively referred to as “we”,“Watson Wyatt” or the “Company”), together with our subsidiaries, is aninternational company engaged in the business of providing professionalconsultative services on a fee basis, primarily in the human resource areas ofemployee benefits and compensation, but also in other areas of specializationsuch as human capital consulting and human resource-related technologyconsulting.

 

*Principles of Consolidation*- Our consolidated financial statements include the accounts of the Company andour majority-owned and controlled subsidiaries after elimination ofintercompany accounts and transactions. Investments in affiliated companies over which we have the ability toexercise significant influence are accounted for using the equity method.

 

*Use of Estimates*- Preparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosures of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period.  Actualresults could differ from those estimates. Estimates are used when accounting for revenue, allowances foruncollectible receivables, investments in affiliates, depreciation andamortization, profits on long-term contracts, asset write-downs, employeebenefit plans, taxes, accruals for premiums for professional liabilityinsurance, accruals for estimated losses related to reported and unreportedprofessional liability claims and discontinued operations.

 

*Reclassifications*- Certain amounts previously presented have been reclassified to conform to thecurrent presentation.

 

*Cash and Cash Equivalents*- We consider short-term, highly-liquid investments with original maturities of90 days or less to be cash equivalents. Such investments were $114.9 million at June 30, 2003, and $74.4 millionat June 30, 2002.

 

*Receivables from Clients*- Billed receivables from clients are presented at their billed amount less anallowance for doubtful accounts. Unbilled receivables are stated at fullbilling rates less an allowance for unbillable amounts.

 

*Revenue Recognition*- Revenues include fees primarily generated from consulting services providedin the areas of employee benefits, human capital strategies and relatedtechnology solutions.  We recognizerevenue from these consulting engagements either on a time-and-materials basisor on a fixed-fee basis, depending on the terms and conditions defined at theinception of an engagement with a client.

 

Revenue is recognized ontime-and-materials engagements to the extent of billable rates times hoursdelivered plus expenses incurred.  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 projectand/or changes in scope, the staffing on the engagement and/or the level ofclient participation.  This reviewrequires us to make judgments and estimates regarding the overall profitabilityand stage of project completion which, in turn, affects how we recognizerevenue.  To the extent that ourestimates

 

48

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change for a particularengagement, we record the cumulative effect of the change in the period inwhich it becomes known.  The Companyrecognizes a loss on an engagement when estimated revenue to be received forthat 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 developedvarious software programs and technologies that are provided to clients inconnection with consulting services.  Werecognize revenue for such services as time is incurred because the servicesare considered essential to the functionality of the software.

 

Revenues recognized in excessof billings are recorded as unbilled accounts receivable.  Cash collections in excess of revenuesrecognized are recorded as deferred revenues until the revenue recognitioncriteria are met.  Client reimbursableexpenses, including those relating to travel, other out-of-pocket expenses andany third-party costs, are included in revenues, and an equivalent amount ofreimbursable expenses are included in professional and subcontracted servicesas a cost of revenues.  Provisions forbad debts and related allowances are recorded as a reduction to revenues.

 

*Other Non-operating Income*- Non-operating income for the year ended June 30, 2003, included thepayment of a $0.6 million contingent gain from the sale of our U.S.-based publicplan retirement business.  Non-operatingincome for fiscal year 2002 included cash received of $1.0 million related tothis sale, and also a $1.2 million gain on the sale of common stock that theCompany received as a result of the demutualization of a health and generalinsurance provider.

 

*Foreign Currency Translation*- Gains and losses on foreign currency transactions, including settlement ofintercompany receivables and payables, are recognized currently in theConsolidated Statements of Operations.  Assetsand liabilities of our subsidiaries outside the United States are translatedinto the reporting currency, the U.S. dollar, based on exchange rates at thebalance sheet date.  Revenue andexpenses of our subsidiaries outside the United States are translated into U.S.dollars at the average exchange rates during the year.  Gains and losses on translation of ourequity interests in our subsidiaries outside the United States and onintercompany notes are reported separately as accumulated other comprehensiveloss within stockholders’ equity in the Consolidated Balance Sheets, since wedo not plan or anticipate settlement of such balances in the foreseeablefuture.

 

*Fair Value of Financial Instruments*- The carrying amount of our cash and cash equivalents, short-term investments,receivables from clients and notes and accounts payable approximates fair valuebecause of the short maturity and liquidity of those instruments.  There were no borrowings outstanding under ourrevolving credit agreement at June 30, 2003, or June 30, 2002.  There were no events of default that wouldrequire us to satisfy the guarantees described in Note 9.  We do not use derivative instruments as ahedging strategy or for any other purpose.

 

*Concentration of Credit Risk*- Financial instruments that potentially subject the Company to concentrationsof credit risk consist principally of certain cash and cash equivalents,short-term investments and receivables from clients.  We invest our excess cash in financial instruments with short-termratings no lower than A1/P1 or equivalent. Concentrations of credit risk with respect to receivables from clientsare limited due to our large number of clients and their dispersion across manyindustries and geographic regions.

 

49

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*Incurred But Not Reported (IBNR) Claims-*The Company accrues for IBNR professional liability claims that areestimable and probable, and for which we have not yet contracted for insurancecoverage.  Additionally, the Companyrecords an accrual for amounts owed to its captive insurance company.  Such amounts generally approximate 75percent of claims loss experience.

 

*Stock-based Compensation*- 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, theCompany has determined pro forma net income and earnings per share as if theCompany had accounted for its stock compensation plans under the fair valuemethod of FAS 123.  The Companyestimated compensation expense for its Stock Purchase Plan based on the 15percent discounted purchase price offered to employees enrolled in the plan,which approximates fair value.  For theStock Option Plan, the Company uses the Black-Scholes option valuation model tocalculate the fair value of options granted for pro forma disclosurepurposes.  Using the Black-Scholesmodel, the weighted average fair value of options granted during fiscal year2002 was $8.00 per option, and $5.26 per option for fiscal year 2001.  No options were granted during fiscal year2003.  The following assumptions wereused in the calculation:

 
|                    |   | **2002** |    | **2001** |   |
|-------------------------|--------|----------|---------|----------|--------|
|                    |   |     |    |     |   |
| Expected dividend yield |   | 0        | %       | 0        | %      |
| Volatility              |   | 40       | %       | 40       | %      |
| Risk free interest rate |   | 4.12     | %       | 5.79     | %      |
| Expected life           |   | 4 years  | 4 years |

 

50

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The table below reflects thepro forma effect on net income and earnings per share for fiscal years 2003,2002 and 2001, as if the Company were to recognize compensation expense underthe “fair-value-based method” of FAS 123.

 
|                                                                                                                                          |   | **Year Ended  June 30** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                                                                          |   | **2003**                |   | **2002** |   | **2001** |   |
|                                                                                                                                          |   |                    |   |   |   |   |   |
| Net income, as reported                                                                                                                       |   | $                       | 57,166 |   | $ | 47,084 |   | $ | 44,436 |   |
| Add: Stock-based compensation expense  included in reported net income, net of related tax effects                                            |   | 66                      |   | 30 |   | 22 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of related tax effects |   | (1,518                  | )      | (1,315 | ) | (707 | ) |
|                                                                                                                                          |   |                    |   |   |   |   |   |
| Pro forma net income                                                                                                                          |   | $                       | 55,714 |   | $ | 45,799 |   | $ | 43,751 |   |
|                                                                                                                                          |   |                    |   |   |   |   |   |
| Earnings per share:                                                                                                                           |   |                    |   |   |   |   |   |
| Basic — as reported                                                                                                                      |   | $                       | 1.73   |   | $ | 1.43 |   | $ | 1.39 |   |
| Basic — pro forma                                                                                                                        |   | $                       | 1.69   |   | $ | 1.39 |   | $ | 1.36 |   |
|                                                                                                                                          |   |                    |   |   |   |   |   |
| Diluted — as reported                                                                                                                    |   | $                       | 1.72   |   | $ | 1.41 |   | $ | 1.37 |   |
| Diluted — pro forma                                                                                                                      |   | $                       | 1.67   |   | $ | 1.37 |   | $ | 1.35 |   |

 

The Company does not currentlyintend to issue further stock options under the 2000 Long-term IncentivePlan.  Deferred Stock Units are nowgranted to senior employees of the Company in lieu of a portion of their annualfiscal year-end bonus.  All deferredstock units issued in connection with the 2001 Deferred Stock Unit Plan werefully vested upon issuance.  Each stockunit represents one share of common stock to the recipient.  Compensation expense is determined by thevalue of the stock at the date of the grant.

 

In December 2002, the FASBissued Statement of Financial Accounting Standards No. 148, “Accounting forStock-Based Compensation - Transition and Disclosure” (FAS 148).  FAS 148 provides additional transitionguidance for those entities that elect to expense stock options pursuant to FAS123, “Accounting for Stock-Based Compensation”.  The Company has adopted the disclosure provisions of FAS 148 andas a result provides pro forma information on a quarterly basis regardingstock-based employee compensation costs.

 

*Earnings per Share*- The computation of basic earnings per share is based upon the weightedaverage number of common shares outstanding. Diluted earnings per share is calculated on the basis of the weightedaverage number of common shares outstanding plus the effect of outstandingstock options and employee stock purchase plan shares using the “treasurystock” method.  See Note 15 foridentification of the components of basic and diluted earnings per share.

 

*Goodwill and Intangible Assets*- Watson Wyatt has historically applied the purchase method of accounting toits acquisitions.  In accordance withStatement of Financial Accounting Standards No. 142, “Goodwill and OtherIntangible Assets” (FAS 142), goodwill and indefinite-lived intangible assetsare no longer amortized, but must be assessed at least annually for impairmentbeginning in the year of adoption.  TheCompany adopted FAS 142 and completed its transitional impairment testing ofgoodwill in July

 

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2001 for all of its reportingunits and concluded that no impairment of goodwill existed.  Annual impairment tests have subsequentlybeen performed in the third quarter of the Company’s fiscal year, and theCompany has determined that no impairment of goodwill exists.  FAS 142 also provides that other intangibleassets that have finite useful lives will continue to be amortized over theiruseful lives.  See Note 11 for theimpact of this pronouncement on our financial results.

 

*Recent Accounting Pronouncements*- In June 2002, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities” (FAS 146).  FAS 146 provides further guidance regardingrequirements for recognition of a liability for costs associated with an exitor disposal activity and is effective for all exit or disposal activitiesinitiated after December 31, 2002.  Theadoption of FAS 146 has not had a material effect on the Company’s financialperformance or condition.

 

In November 2002, the FASBissued Interpretation No. 45 (FIN 45), which clarified existing guidance fromthe FASB regarding a guarantor’s accounting for, and disclosure of, theissuance of certain types of guarantees. The disclosure provisions of the interpretation are effective for allperiods that end after December 15, 2002, and provisions for recognition andmeasurement are effective on a prospective basis for guarantees issued ormodified after December 31, 2002. Management has reviewed guarantees issued by the Company and hasprovided relevant disclosure in Note 14 based on those types of guaranteeswhich the Company currently has in place. The adoption of FIN 45 has not had a material effect on the Company’sfinancial performance or condition.

 

In January 2003, the FASBissued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable InterestEntities,” which clarifies the financial reporting guidance associated with theconsolidation of another entity.  Theconsolidation requirements of FIN 46 apply immediately to variable interestentities created after January 31, 2003 and pre-existing variable interestentities as of July 1, 2003.  Certain ofthe disclosure requirements apply in all financial statements issued afterJanuary 31, 2003, regardless of when the variable interest entity wasestablished.  Management does notbelieve that the adoption of FIN 46 will have an effect on the Company’sfinancial performance or condition.

 

In May 2003, the FASB ratifiedthe Emerging Issues Task Force’s Issue 03-3, “Applicability of EITF Abstracts,Topic No. D-79, ‘Accounting for Retroactive Insurance Contracts Purchase byEntities Other Than Insurance Enterprises,’ to Claims-Made Policies” (EITF03-3) regarding the accounting for claims-made insurance by the insuredparty.  Management has reviewed itsclaims-made insurance policy in light of the guidance provided by EITF 03-3 andhas concluded that this pronouncement will require the Company to continue to accountfor its premiums to PCIC using prospective insurance accounting for premiumspaid, at least through fiscal 2004 and under the insurance as presentlystructured.

 

**Note 2 - Initial Public Offering and CommonStock**

 

In October 2000, we completedan initial public offering (“IPO”) of our Class A common stock. In conjunctionwith this offering, on October 16, 2000, we completed changes in our corporatestructure involving the merger of Watson Wyatt & Company with WW MergerSubsidiary, Inc., a wholly-owned subsidiary of Watson Wyatt & CompanyHoldings.  As a result, Watson Wyatt& Company is now a wholly-owned subsidiary of Watson Wyatt & CompanyHoldings.

 

At the time of thereorganization, each share of Watson Wyatt & Company’s redeemable commonstock was converted into one share of Class B-1 common stock and one share ofClass B-2 common stock of Watson Wyatt & Company Holdings. The Class Bcommon stock was divided into two classes to accommodate different transferrestriction periods.  A total of 9,956,140Class B-1 and 12,745,015 Class B-2

 

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shares were automaticallyconverted to Class A shares as the relevant 12- and 24 -month transferrestrictions expired on October 16, 2001 and 2002.

 

In conjunction with our initialpublic offering, we entered into agreements providing for additional transferrestrictions with major stockholders, executive officers and employeedirectors.  The agreements restricttransfers of all shares held by such persons immediately following theoffering, and the restrictions terminate as to 25 percent of such shares oneach of the first, second, third and fourth anniversaries of the consummationof the public offering.  As a result ofthese agreements, 3,894,528 Class A shares are currently restricted, of which1,947,272 will become freely transferable in October 2003 and 1,947,256 willbecome freely transferable in October 2004.

 

The two-for-one shareconversion and the elimination of the redeemable feature of Watson Wyatt &Company’s redeemable common stock has been reflected in the weighted averageshares of common stock included on the Consolidated Statements of Operationsfor the year ended June 30, 2001, as if the conversion were effective at thebeginning of the period.

 

**Note3 - Cash Flow Information**

 

Net cash from operatingactivities in the Consolidated Statements of Cash Flows includes cash paymentsfor the following:

 
|             |   | **Year Ended June 30** |   |
|------------------|--------|------------------------|--------|
|             |   | **2003**               |   | **2002** |   | **2001** |   |
|             |   |                   |   |   |   |   |   |
| Interest expense |   | $                      | 787    |   | $ | 1,376 |   | $ | 1,491 |   |
| Income taxes     |   | 36,272                 |   | 36,574 |   | 30,660 |   |
|                  |        |                        |        |  |  |  |  |  |  |  |

 

**Note4 - Investments in Affiliates**

 

Although we operate globally asan alliance with our affiliates, the revenues and operating expenses in theConsolidated Statements of Operations only reflect the results of operations ofWatson Wyatt & Company Holdings. Our share of the results of our affiliates, recorded using the equitymethod of accounting, is reflected in the “Income from affiliates” line, in theConsolidated Statements of Operations.

 

Entities accounted for underthe equity method and our investments in those affiliates are as follows:

 
|                                              |   | **June 30** |   |
|---------------------------------------------------|--------|-------------|--------|
|                                              |   | **2003**    |   | **2002** |   |
|                                              |   |        |   |   |   |
| Watson Wyatt LLP                                  |   | $           | 15,268 |   | $ | 14,171 |   |
| Watson Wyatt Holdings (Europe) Limited            |   | 6,274       |   | 4,375 |   |
| Professional Consultants Insurance Company,  Inc. |   | 4,889       |   | 1,540 |   |
|                                              |   |        |   |   |   |
| Total investment in affiliates                    |   | $           | 26,431 |   | $ | 20,086 |   |

 

53

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*Watson Wyatt LLP and Watson Wyatt Holdings (Europe) Limited*

 

Our principal affiliates areWatson Wyatt LLP (Watsons) and Watson Wyatt Holdings (Europe) Limited(WWHE).  Our interest in Watsons is aninvestment in a limited liability partnership with a 10 percent interest inWatsons’ defined profit pool.  We own 25percent of WWHE while Watsons owns the remaining 75 percent.  We retain the ability to exercisesignificant influence over Watsons and WWHE. As of June 30, 2003, we had net receivables from Watsons and WWHE of$0.4 million and $0.4 million, respectively. As of June 30, 2002, we had net receivables from Watsons and WWHE of$0.9 million and $0.5 million, respectively.

 

Our investment balance in WWHEreflects our initial investment, our 25 percent share of their cumulative netloss and a note receivable that we carry on our balance sheet at $7.8million.  The note is collateralized bythe assets and performance of WWHE and calls for principal and unpaid interestto be paid in 2020.  In light of thehistorical performance of WWHE, the Company has not recognized interest incomefor the note.  If the Company had recognizedinterest income for the note, its carrying value, including accrued unpaidinterest, would approximate £12.7 million, or approximately $21 million, as ofJune 30, 2003.  We evaluate the WWHEinvestment on a quarterly and annual basis and have determined that the currentcarrying value of the WWHE investment is recoverable.  We provided a capital infusion to WWHE of £1.25 million(approximately $2.0 million) in the first quarter of fiscal year 2003.

 

*ProfessionalConsultants Insurance Company, Inc.*

 

Professional Consultants Insurance Company, Inc. (PCIC), was organizedin 1987 as a captive insurance company under the laws of the State ofVermont.  PCIC provides professionalliability insurance on a claims-made basis to three actuarial and managementconsulting firms, all of which participate in the program as both policyholdersand stockholders.

 

Capital contributions to PCIC are required when approved by a majorityof its stockholders.  Our initialinvestment included a $500,000 cash contribution and a $1,500,000 letter ofcredit.  In July 2002, the stockholdersagreed to provide additional capital contributions in exchange for additionalshares.  As payment for those shares, inJuly 2002 we contributed $1,700,000 in cash and provided a letter of credit for$1,700,000, and in June 2003, we contributed an additional $1,700,000 in cashand provided an additional letter of credit for $1,700,000.  As of June 30, 2003, the Company hasdesignated PCIC as the beneficiary on a total of $4.9 million of letters ofcredit.  Our ownership interest in PCICas of June 30, 2003 and 2002, was 34.8 percent and 27.4 percent, respectively.

 

The current president of PCIC is our Vice President and GeneralCounsel.  This role is held on arotating basis by a designated individual from the respective owner firms,without compensation from PCIC.

 

The Company’s pre-tax income from affiliates includes the following:

 
|                                |   | **Year Ended  June 30** |   |
|-------------------------------------|--------|-------------------------|--------|
|                                |   | **2003**                |   | **2002** |   | **2001** |   |
|                                |   |                    |   |   |   |   |   |
| Equity in income from  affiliates   |   | $                       | 5,787  |   | $ | 2,866 |   | $ | 3,991 |   |
| Amortization of basis  differential |   | —                  |   | — |   | (211 | ) |
|                                |   |                    |   |   |   |   |   |
| Income from affiliates              |   | $                       | 5,787  |   | $ | 2,866 |   | $ | 3,780 |   |

 

54

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Combined summarized balance sheet information at June 30 for theCompany’s affiliates follows: 

 
|                                            |   | **2003** |    | **2002** |   |
|-------------------------------------------------|--------|----------|---------|----------|--------|
|                                            |   |     |    |     |   |
| Current assets                                  |   | $        | 204,451 |     | $      | 155,488 |   |
| Noncurrent assets                               |   | 128,744  |    | 163,090  |   |
|                                            |   |     |    |     |   |
| Total assets                                    |   | $        | 333,195 |     | $      | 318,578 |   |
|                                            |   |     |    |     |   |
| Current liabilities                             |   | $        | 77,008  |     | $      | 64,090 |   |
| Noncurrent liabilities                          |   | 149,650  |    | 185,020  |   |
| Stockholders’ equity                       |   | 106,537  |    | 69,468   |   |
|                                            |   |     |    |     |   |
| Total liabilities and stockholders’ equity |   | $        | 333,195 |     | $      | 318,578 |   |

 

Income from affiliates includes our proportionate share of income fromthese equity investments.  Combinedsummarized operating results for the years ended June 30, reported by theaffiliates, follow:

 
|                |   | **2003** |    | **2002** |   | **2001** |   |
|---------------------|--------|----------|---------|----------|--------|----------|--------|
|                |   |     |    |     |   |     |   |
| Revenue             |   | $        | 354,890 |     | $      | 291,951  |   | $ | 254,699 |   |
| Operating expenses  |   | 254,752  |    | 223,422  |   | 187,395  |   |
|                |   |     |    |     |   |     |   |
| Income before taxes |   | 100,138  |    | 68,529   |   | 67,304   |   |
|                |   |     |    |     |   |     |   |
| Net income          |   | $        | 97,607  |     | $      | 68,997   |   | $ | 65,784 |   |

 

**Note 5 - Fixed Assets**

 

Furniture, fixtures, equipmentand leasehold improvements are recorded at cost and presented net ofaccumulated depreciation or amortization. Furniture, fixtures and equipment are depreciated using straight-lineand accelerated methods over lives ranging from three to seven years.  Leasehold improvements are amortized on astraight-line basis over the shorter of the lease terms or the assets’ lives.

 

The components of fixed assetsare:

 
|                                             |   | **June 30** |    |
|--------------------------------------------------|--------|-------------|---------|
|                                             |   | **2003**    |    | **2002** |   |
|                                             |   |        |    |   |   |
| Furniture,  fixtures and equipment               |   | $           | 106,820 |   | $ | 101,286 |   |
| Leasehold  improvements                          |   | 46,376      |    | 45,002 |   |
|                                             |   | 153,196     |    | 146,288 |   |
| Less:  accumulated depreciation and amortization |   | (92,480     | )       | (83,736 | ) |
|                                             |   |        |    |   |   |
| Fixed  assets, net                               |   | $           | 60,716  |   | $ | 62,552 |   |

 

55

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**NOTE6 - RETIREMENT BENEFITS**

 

*Defined Benefit Plans*

 

We sponsor both qualified andnon-qualified, non-contributory defined benefit pension plans coveringsubstantially all of our associates. Under our principal plans (United States, Canada, Hong Kong and U.K.),benefits are based on the number of years of service and the associates’compensation during the three highest paid consecutive years of service.  The non-qualified plan provides for pensionbenefits that would be covered under the qualified plan but are limited by theInternal Revenue Code.  Thenon-qualified plan has no assets and therefore is an unfunded arrangement whichis reflected in the balance sheet. Included in the results is our U.K. plan, which is inactive but is partof the additional minimum pension liability reported on the ConsolidatedBalance Sheets.

 

Funding is based on actuariallydetermined contributions and is limited to amounts that are currentlydeductible for tax purposes. Since funding calculations are based on differentmeasurements than those used for accounting purposes, pension contributions arenot equal to net periodic pension cost. The excess of net periodic pension cost over such contributions anddirect benefit payments under non-qualified plan provisions is accrued by theCompany. In the second and fourth quarters of fiscal year 2003, the Companymade voluntary pension contributions to its U.S. plan of $12.0 million and$10.0 million, respectively. The Company made no voluntary pension contributionto the U.S. plan in fiscal year 2002. The Company made contributions to itsHong Kong plan in fiscal years 2003 and 2002 of $1.1 million and $1.9 million,respectively, and to its U.K. plan in fiscal years 2003 and 2002 of $1.1million and $0.2 million, respectively.

 

The fair value of plan assetsis based on the market value of domestic equity, international equity and fixedincome securities that are in the pension portfolio.  To the extent the expected return on the pension portfolio variesfrom the actual return, there is an unrecognized gain or loss.

 

The non-current portions ofaccrued costs related to our principal retirement plans reflected in theCompany’s Consolidated Balance Sheets are:

 
|                                         |   | **June 30** |    |
|----------------------------------------------|--------|-------------|---------|
|                                         |   | **2003**    |    | **2002** |   |
|                                         |   |        |    |   |   |
| Defined  benefit retirement plans            |   | $           | 143,730 |   | $ | 32,481 |   |
| Canadian  Separation Allowance Plan          |   | 4,847       |    | 4,670 |   |
| Postretirement  benefits other than pensions |   | 47,128      |    | 46,997 |   |
|                                         |   |        |    |   |   |
| Accrued  retirement benefits                 |   | $           | 195,705 |   | $ | 84,148 |   |

 

The assumptions used in thevaluation for the U.S. plan, which comprises the majority of the principaldefined benefit pension plans, included the following at the end of the pastthree fiscal years:

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

 

56

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The Company calculates the netperiodic benefit costs for a given fiscal year based on assumptions establishedat the end of the previous fiscal year. Actuarial gains and losses associated with changing any of theseassumptions are not recognized immediately; instead they are accumulated aspart of the unrecognized net loss/(gain) balance and amortized into the netperiodic pension expense over the average remaining service period ofparticipating employees.

 

Net periodic pension costconsists of the following components reflected as expense in the Company’sConsolidated Statements of Operations:

 
|                                             |   | **Year Ended  June 30** |   |
|--------------------------------------------------|--------|-------------------------|--------|
|                                             |   | **2003**                |   | **2002** |   | **2001** |   |
|                                             |   |                    |   |   |   |   |   |
| Service cost                                     |   | $                       | 26,201 |   | $ | 27,751 |   | $ | 25,432 |   |
| Interest cost                                    |   | 33,564                  |   | 32,540 |   | 29,645 |   |
| Expected  return on plan assets                  |   | (37,466                 | )      | (41,506 | ) | (46,303 | ) |
| Amortization  of transition obligation           |   | 199                     |   | 213 |   | 202 |   |
| Amortization  of net unrecognized losses/(gains) |   | 4,760                   |   | (164 | ) | (8,360 | ) |
| Amortization  of prior service cost              |   | 582                     |   | 545 |   | 2,018 |   |
|                                             |   |                    |   |   |   |   |   |
| Net periodic pension cost                        |   | $                       | 27,840 |   | $ | 19,379 |   | $ | 2,634 |   |

 

The following table summarizesbenefit obligations associated with the qualified and non-qualified plans:

 
|                                               |   | **June 30,  2003** |    | **June 30,  2002** |   |
|----------------------------------------------------|--------|--------------------|---------|--------------------|--------|
|                                               |   | **Qualified**      |    | **Non-qualified**  |   | **Qualified** |   | **Non-qualified** |   |
|                                               |   |               |    |               |   |   |   |   |   |
| Accumulated benefit obligation                     |   | $                  | 458,596 |               | $      | 63,740 |   | $ | 343,751 |   | $ | 48,029 |   |
|                                               |   |               |    |               |   |   |   |   |   |
| Projected benefit obligation at  beginning of year |   | $                  | 393,038 |               | $      | 74,829 |   | $ | 355,077 |   | $ | 107,252 |   |
| Service cost                                       |   | 20,055             |    | 6,146              |   | 19,508 |   | 8,243 |   |
| Interest cost                                      |   | 28,054             |    | 5,510              |   | 25,767 |   | 6,772 |   |
| Actuarial losses/(gains)                           |   | 62,070             |    | 6,626              |   | (3,784 | ) | (29,608 | ) |
| Benefit payments                                   |   | (14,026            | )       | (4,708             | )      | (13,134 | ) | (10,073 | ) |
| Plan amendments                                    |   | (10,422            | )       | (9,786             | )      | 6,101 |   | (7,169 | ) |
| Other                                              |   | 2,506              |    | 330                |   | 1,967 |   | (610 | ) |
| Foreign currency adjustment                        |   | 4,950              |    | 1,371              |   | 1,536 |   | 22 |   |
| Projected benefit obligation at  end of year       |   | $                  | 486,225 |               | $      | 80,318 |   | $ | 393,038 |   | $ | 74,829 |   |

 

Plan amendments are changes inthe pension plan that will either increase or decrease future retirementbenefits for work performed in prior periods. In fiscal year 2003, we amended the plans for early retirementeligibility provisions, early retirement factors and the averaging period forpay.  In fiscal year 2002, we amendedthe plans to reflect the changes to the maximum benefit and compensation limitsunder the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) enacted inJune 2001.  The unrecognized priorservice cost is the cumulative prior service costs and benefits from amendmentsto the pension plans that have not yet been recognized in the financialstatements.

 

57

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The following table summarizesplan assets associated with the qualified and non-qualified plans:

 
|                                            |   | **June 30,  2003** |    | **June 30,  2002** |   |
|-------------------------------------------------|--------|--------------------|---------|--------------------|--------|
|                                            |   | **Qualified**      |    | **Non-qualified**  |   | **Qualified** |   | **Non-qualified** |   |
|                                            |   |               |    |               |   |   |   |   |   |
| Fair value of plan assets at  beginning of year |   | $                  | 386,830 |               | $      | — |   | $ | 430,664 |   | $ | — |   |
| Actual return on plan assets                    |   | 3,036              |    | —             |   | (34,097 | ) | — |   |
| Company contributions                           |   | 24,281             |    | 4,708              |   | 2,029 |   | 10,073 |   |
| Benefit payments                                |   | (14,026            | )       | (4,708             | )      | (13,134 | ) | (10,073 | ) |
| Foreign currency adjustment                     |   | 5,218              |    | —             |   | 1,368 |   | — |   |
| Fair value of plan assets at  end of year       |   | $                  | 405,339 |               | $      | — |   | $ | 386,830 |   | $ | — |   |

 

The following table summarizesthe funding status associated with the qualified and non-qualified plans:

 
|                                        |   | **June 30,  2003** |    | **June 30,  2002** |   |
|---------------------------------------------|--------|--------------------|---------|--------------------|--------|
|                                        |   | **Qualified**      |    | **Non-qualified**  |   | **Qualified** |   | **Non-qualified** |   |
|                                        |   |               |    |               |   |   |   |   |   |
| Funded status at end of year                |   | $                  | (80,886 | )                  | $      | (80,318 | ) | $ | (6,208 | ) | $ | (74,829 | ) |
| Unrecognized prior service cost             |   | (11,269            | )       | (3,872             | )      | (1,643 | ) | 7,309 |   |
| Unrecognized net loss/(gain)                |   | 157,476            |    | (9,425             | )      | 63,403 |   | (17,737 | ) |
| Unrecognized transition  obligation/(asset) |   | (301               | )       | 263                |   | (103 | ) | 297 |   |
| Net amount recognized                       |   | $                  | 65,020  |               | $      | (93,352 | ) | $ | 55,449 |   | $ | (84,960 | ) |

 

The unrecognized amountsrepresent the actual changes in the estimated PBO and plan assets that have notyet been recognized in either the balance sheet or the income statement.  Any differences between actual and assumedresults are amortized into the net periodic pension expense over the averageremaining service period of participating employees.

 

The Company recorded anadditional minimum pension liability of $113.4 million, an intangible asset of$0.1 million, a reduction to Stockholders’ Equity of $67.9 million (reflectedin accumulated other comprehensive loss) and an increase in deferred tax assetsof $45.4 million.  A marketdeterioration in future periods, and/or a decrease in long-term interest rates,could make the additional minimum pension liability larger.  Likewise, a market recovery in futureperiods, and/or an increase in long-term interest rates, could reverse aportion or all of this charge.  OurCanadian and Hong Kong pension plan assets are greater than their associatedaccumulated benefit obligation as of June 30, 2003, and thus do not require therecording of additional minimum pension liabilities.

 

58

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The table below summarizes theamounts reflected in our Consolidated Balance Sheets for the period indicated:

 
|                                                               |   | **June 30** |    |
|--------------------------------------------------------------------|--------|-------------|---------|
|                                                               |   | **2003**    |    | **2002** |   |
|                                                               |   |        |    |   |   |
| Prepaid (accrued) benefit cost                                     |   | $           | (40,424 | ) | $ | 55,449 |   |
| Accrued benefit liability                                          |   | (7,967      | )       | — |   |
| Intangible asset                                                   |   | 113         |    | — |   |
| Accumulated other comprehensive  loss, prior to income tax benefit |   | 113,298     |    | — |   |
| Net amount recognized                                              |   | $           | 65,020  |   | $ | 55,449 |   |

 

*Defined Contribution Plans*

 

We sponsor a savings plan thatprovides benefits to substantially all U.S. associates.  Under such plan, we have matched employeecontributions at 50 percent of the first 6 percent of total pay, which includesbase salary, overtime and annual performance-based bonuses.  Vesting of the Company match occurs afterthree years for new employees and is 100 percent for all employees hired beforeJanuary 1, 1997.  The expense in fiscalyears 2003, 2002 and 2001 was $7.4 million, $7.9 million and $6.6 million,respectively.  Effective July 1, 2003,the Company match has been suspended. Under the plan, we also have the ability to make discretionaryprofit-sharing contributions.  We madeno profit-sharing contributions during fiscal years 2003, 2002 and 2001.  We also sponsor a Canadian SeparationAllowance Plan (CSAP) that provides retirement benefits to substantially allCanadian associates.  The CSAP is anunfunded benefit plan; as such, the amounts due to associates are recorded as aliability in the Consolidated Balance Sheets of the Company.  CSAP expense for fiscal years 2003, 2002 and2001 amounted to $264,000, $328,000 and $357,000, respectively.

 

*Health Care Benefits*

 

We sponsor a contributoryhealth care plan that provides hospitalization, medical and dental benefits tosubstantially all U.S. associates.  Weaccrue a liability for estimated incurred but unreported claims based on projecteduse of the plan as well as prior plan history. The liability totaled $2.7 million and $3.4 million at June 30, 2003,and June 30, 2002, respectively, and is included in accounts payable andaccrued liabilities in the Consolidated Balance Sheets.

 

*Postretirement Benefits*

 

We provide certain health careand life insurance benefits for retired associates.  The principal plans cover associates in the U.S. and Canada whohave met certain eligibility requirements. Our principal plans are unfunded.

 

59

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Assumptions used in thevaluation for the U.S. plan, which comprises the majority of the principalpostretirement plans, included the following over the past three fiscal years:

 
|                                                                  |   | **Year Ended  June 30** |   |
|-----------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                  |   | **2003**                |   | **2002** |   | **2001** |   |
|                                                                  |   |                    |   |   |   |   |   |
| Health care cost  trend, accumulated benefit obligation:              |   |                    |   |   |   |   |   |
| Pre-65  benefits (decreasing to 5.00% for 2009 and thereafter)        |   | 10.00                   | %      | 7.00 | % | 7.50 | % |
| Post-65  benefits (decreasing to 5.00% for 2009 and thereafter)       |   | 10.00                   | %      | 7.60 | % | 8.30 | % |
| Discount rate,  accumulated benefit obligation postretirement benefit |   | 6.00                    | %      | 7.25 | % | 7.25 | % |

 

Actuarial gains and lossesassociated with changing any of the assumptions are accumulated as part of theunrecognized net gain balance which is amortizedand included in the net periodic postretirement costs over the averageremaining service period of participating employees, which is approximately 16years.

 

A one percentage point changein the assumed health care cost trend rates would have the following effect:

 
|                                                                         |   | **1%  Increase** |   | **1%  Decrease** |   |
|------------------------------------------------------------------------------|--------|------------------|--------|------------------|--------|
|                                                                         |   |             |   |             |   |
| Effect on net periodic  postretirement benefit cost in fiscal year 2003      |   | $                | 288    |             | $      | (261 | ) |
| Effect on accumulated  postretirement benefit obligation as of June 30, 2003 |   | 1,951            |   | (1,821           | )      |
|                                                                              |        |                  |        |                  |        |  |  |

 

Net periodic postretirementbenefit cost consists of the following components reflected as expense in theCompany’s Consolidated Statements of Operations:

 
|                                     |   | **Year Ended  June 30** |   |
|------------------------------------------|--------|-------------------------|--------|
|                                     |   | **2003**                |   | **2002** |   | **2001** |   |
|                                     |   |                    |   |   |   |   |   |
| Service cost                             |   | $                       | 1,769  |   | $ | 1,771 |   | $ | 1,814 |   |
| Interest cost                            |   | 2,514                   |   | 2,362 |   | 2,294 |   |
| Amortization  of transition obligation   |   | 46                      |   | 44 |   | 45 |   |
| Amortization  of net unrecognized gains  |   | (516                    | )      | (877 | ) | (835 | ) |
| Amortization  of prior service cost      |   | (464                    | )      | (129 | ) | (128 | ) |
|                                     |   |                    |   |   |   |   |   |
| Net periodic postretirement benefit cost |   | $                       | 3,349  |   | $ | 3,171 |   | $ | 3,190 |   |

 

60

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The following table sets forththe changes in the accumulated postretirement benefit obligation:

 
|                                    |   | **June 30** |   |
|-----------------------------------------|--------|-------------|--------|
|                                    |   | **2003**    |   | **2002** |   |
|                                    |   |        |   |   |   |
| Benefit obligation at beginning of year |   | $           | 38,488 |   | $ | 34,986 |   |
| Service cost                            |   | 1,769       |   | 1,771 |   |
| Interest cost                           |   | 2,514       |   | 2,362 |   |
| Participant contributions               |   | 171         |   | 260 |   |
| Actuarial losses (gains)                |   | 5,147       |   | 549 |   |
| Benefit payments                        |   | (3,088      | )      | (2,338 | ) |
| Plan amendments                         |   | (6,653      | )      | — |   |
| Other                                   |   | 441         |   | 856 |   |
| Foreign currency adjustment             |   | 757         |   | 42 |   |
| Benefit obligation at end of year       |   | $           | 39,546 |   | $ | 38,488 |   |

 

Plan amendments are changes inthe postretirement plan that will either increase or decrease future benefitsfor work performed in prior periods.  Infiscal year 2003, we amended the plan to include changes in the prescriptiondrug plan, changes in pre-65 medical benefits and revisions to contributionschedules for existing and future retirees.

 

The following table sets forththe changes in the Company contributions and benefit payments for the postretirementplan:

 
|                                           |   | **June 30** |   |
|------------------------------------------------|--------|-------------|--------|
|                                           |   | **2003**    |   | **2002** |   |
|                                           |   |        |   |   |   |
| Fair value of plan assets at beginning of year |   | $           | — |   | $ | — |   |
| Company contributions                          |   | 2,917       |   | 2,078 |   |
| Participant contributions                      |   | 171         |   | 260 |   |
| Benefit payments                               |   | (3,088      | )      | (2,338 | ) |
| Fair value of plan assets at end of year       |   | $           | — |   | $ | — |   |

 

The following table sets forththe changes in the funded status in the postretirement plan:

 
|                                 |   | **June 30** |    |
|--------------------------------------|--------|-------------|---------|
|                                 |   | **2003**    |    | **2002** |   |
|                                 |   |        |    |   |   |
| Funded status at end of year         |   | $           | (39,546 | ) | $ | (38,488 | ) |
| Unrecognized net gain                |   | (4,244      | )       | (10,477 | ) |
| Unrecognized prior service cost      |   | (7,134      | )       | (948 | ) |
| Unrecognized transition obligation   |   | 468         |    | 495 |   |
| Net accrued postretirement liability |   | $           | (50,456 | ) | $ | (49,418 | ) |

 

The unrecognized prior servicecost represents the cumulative prior service costs and benefits from amendmentsto the postretirement plan which have not yet been recognized in the financialstatements.

 

61

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Previous amendments are being amortized and included in the netperiodic postretirement benefit costs over the average remaining serviceperiod of participating employees, which is approximately eight years.

 

**Note 7 - Accounts Payable and AccruedLiabilities**

** **

Accountspayable and accrued liabilities consist of:

 
|                                                                                                 |   | **June 30** |    |
|------------------------------------------------------------------------------------------------------|--------|-------------|---------|
|                                                                                                 |   | **2003**    |    | **2002** |   |
|                                                                                                 |   |        |    |   |   |
| Accounts payable and accrued liabilities                                                             |   | $           | 44,333  |   | $ | 46,212 |   |
| Accrued salaries and bonuses                                                                         |   | 41,816      |    | 56,080 |   |
| Current portion of defined benefit retirement plans and  postretirement benefits other than pensions |   | 3,754       |    | 3,198 |   |
| Accrued vacation                                                                                     |   | 15,610      |    | 15,313 |   |
| Advance billings deferred revenue                                                                    |   | 8,500       |    | 14,195 |   |
| Total accounts payable and accrued liabilities                                                       |   | $           | 114,013 |   | $ | 134,998 |   |

 

**Note 8 - Leases**

 

We lease office space,furniture and selected computer equipment under operating lease agreements withterms generally ranging from one to ten years. We have entered into sublease agreements for some of our excess leasedspace.  Rental expense was $52.8million, $51.1 million, and $46.6 million for fiscal years 2003, 2002 and 2001,respectively, inclusive of operating expenses related to such space andequipment.  Sublease income was $0.5million, $3.4 million and $3.8 million for fiscal years 2003, 2002 and 2001,respectively.

 

Future minimum lease paymentsfor operating lease commitments and anticipated cash inflows for subleaseincome are:

 

| **Fiscal  Year** |   | **Lease  Commitments** |    | **Sublease  Income** |   |
|------------------|--------|------------------------|---------|----------------------|--------|
|             |   |                   |    |                 |   |
| 2004             |   | $                      | 39,432  |                 | $      | 224 |   |
| 2005             |   | 35,292                 |    | 15                   |   |
| 2006             |   | 31,210                 |    | —               |   |
| 2007             |   | 26,902                 |    | —               |   |
| 2008             |   | 24,005                 |    | —               |   |
| Thereafter       |   | 78,965                 |    | —               |   |
|             |   | $                      | 235,806 |                 | $      | 239 |   |

 

Weevaluate office capacity on an ongoing basis to meet changing needs in ourmarkets while minimizing our occupancy expense.  The Company currently has excess capacity in several markets andis actively marketing certain space for sublease.  The current economic downturn has generally caused lease rates todecline since the time such leases were signed, which may cause the Company torecognize losses to the extent that the Company enters into sublease agreementsand future minimum lease payments exceed future sublease income.

 

62

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**Note 9 - Line of Credit**

** **

The Company has a $100.0million revolving credit facility with a syndicate of banks.  Interest rates associated with this facilityvary with LIBOR and/or the Prime Rate and are based on our leverage ratio, asdefined by the credit agreement.  We arecharged a quarterly commitment fee, currently 0.25 percent of the facility thatvaries with our financial leverage and is paid on the unused portion of thecredit facility.  No amounts wereoutstanding under the Company’s revolving credit facility as of June 30, 2003,or June 30, 2002.  Credit under thefacility is available upon demand, although the credit facility requires us toobserve certain covenants (including requirements for minimum net worth, whichact to restrict dividends and other financial and restrictive covenants) and iscollateralized with a pledge of stock of material subsidiaries.  The lenders supporting the credit facilityagreed to an amendment of the minimum net worth covenant effective June 30,2003, such that we would avoid a default that would have resulted fromrecording an additional minimum pension liability in the fourth quarter offiscal year 2003.  As a result, we werein compliance with all covenants under the credit facility as of June 30, 2003.

 

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

 

Additionally, the Companyguarantees a credit facility that provided loans to associates for stockpurchased under our former Stock Purchase Program.  This program was discontinued in conjunction with our initialpublic offering in October 2000.  As aresult, the facility permanently decreases as the loans are repaid.  The maximum available borrowings andaggregate outstanding balances under this facility were $1.0 million and $2.9million at June 30, 2003, and June 30, 2002, respectively.  A total of 889,000 and 2,731,000 WatsonWyatt & Company Holdings shares were pledged by stockholders tocollateralize these loans at June 30, 2003, and June 30, 2002, respectively.

 

**Note 10 - Employee Stock Plans and Equity**

 

*2000 Long-term Incentive Plan*

 

On June 26, 2000, the Companyadopted the Watson Wyatt & Company Holdings 2000 Long-term Incentive Plan(the “Stock Option Plan”), which provides for the granting of non-qualifiedstock options and stock appreciation rights (collectively referred to as“awards”) to full-time associates of the Company and to non-associate membersof the Board of Directors.  The totalnumber of shares of Common Stock awards that may be granted under the StockOption Plan is 4,500,000 shares.  Priorto adopting the Stock Option Plan, the Company had no outstanding options.

 

The stock option agreementshave a seven-year life and vest 20 percent at each option anniversary date overa five-year period.  All options underthe Stock Option Plan were granted with an exercise price equal to the stock’sfair market value on the date of grant. Generally, the number of options granted to associates was based on apercentage of annual compensation.  TheCompany does not currently intend to issue further stock options under theStock Option Plan.

 

63

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The table below presents stockoption activity since the inception of the plan:

 
|                         |   | **Number of  Shares** |   | **Weighted  Average  Exercise  Price** |   |
|------------------------------|--------|-----------------------|--------|----------------------------------------|--------|
|                         |   | **(in 000’s)**   |   |                                   |   |
|                         |   |                  |   |                                   |   |
| Outstanding at June 30, 2000 |   | —                |   | $                                      | — |   |
| Granted                      |   | 1,932                 |   | 13.41                                  |   |
| Exercised                    |   | —                |   | —                                 |   |
| Forfeited                    |   | (157                  | )      | 12.90                                  |   |
| Expired                      |   | —                |   | —                                 |   |
|                         |   |                  |   |                                   |   |
| Outstanding at June 30, 2001 |   | 1,775                 |   | $                                      | 13.45  |   |
| Granted                      |   | 19                    |   | 21.76                                  |   |
| Exercised                    |   | (38                   | )      | 12.63                                  |   |
| Forfeited                    |   | (217                  | )      | 13.79                                  |   |
| Expired                      |   | —                |   | —                                 |   |
|                         |   |                  |   |                                   |   |
| Outstanding at June 30, 2002 |   | 1,539                 |   | $                                      | 13.51  |   |
| Granted                      |   | —                |   | —                                 |   |
| Exercised                    |   | (54                   | )      | 12.63                                  |   |
| Forfeited                    |   | (143                  | )      | 14.60                                  |   |
| Expired                      |   | —                |   | —                                 |   |
|                         |   |                  |   |                                   |   |
| Outstanding at June 30, 2003 |   | 1,342                 |   | $                                      | 13.43  |   |

 

At June 30, 2003, there were519,609 options exercisable at a weighted average price of $13.32.  The table below presents additionalinformation about the options outstanding and exercisable at June 30, 2003:

 
|                         |   | **Outstanding  Options** |   | **Exercisable  Options**               |   |
|------------------------------|--------|--------------------------|--------|----------------------------------------|--------|
| **Range of  Exercise Price** |   | **Number  of  Shares**   |   | **Weighted  Average  Exercise  Price** |   | **Average  Remaining  Contractual  Life (years)** |   | **Number  of  Shares** |   | **Weighted  Average  Exercise  Price** |   |
|                         |   | **(in 000’s)**      |   |                                   |   |   |   | **(in 000’s)** |   |   |   |
|                         |   |                     |   |                                   |   |   |   |   |   |   |   |
| $10.00 - $15.00              |   | 1,195                    |   | $                                      | 12.50  |   | 4.2 |   | 468 |   | $ | 12.50 |   |
| $15.01 - $20.00              |   | 53                       |   | 18.06                                  |   | 4.6 |   | 21 |   | 18.13 |   |
| $20.01 - $25.00              |   | 92                       |   | 22.50                                  |   | 4.7 |   | 31 |   | 22.32 |   |
| $25.01 - $30.00              |   | 2                        |   | 26.50                                  |   | 5.1 |   | — |   | — |   |
|                         |   |                     |   |                                   |   |   |   |   |   |   |   |
| $10.00 - $30.00              |   | 1,342                    |   |                                   |   |   |   | 520 |   |   |   |
|                              |        |                          |        |                                        |        |  |  |  |  |  |  |  |  |

 

64

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*2001 Employee Stock Purchase Plan*

 

The 2001 Employee StockPurchase Plan (the “Stock Purchase Plan”) was approved at the annualstockholders’ meeting on November 5, 2001. The Stock Purchase Plan, which is intended to qualify as an “employeestock purchase plan” under Section 423 of the Internal Revenue Code of 1986 ofthe United States of America, originally provided for the issuance of up to750,000 shares of the Company’s common stock. In April 2003, the Board of Directors approved an additional 1,500,000shares for issuance under this plan. The Company will seek stockholder approval of these additional shares atour annual meeting to be held on November 17, 2003.  Full-time and regular part-time employees are eligible toparticipate in the Stock Purchase Plan through payroll deductions of up to 10percent of each participant’s compensation, subject to certain restrictions.  Under the plan, four three-month offeringperiods are to be held during each fiscal year beginning each November 1,February 1, May 1 and August 1.  Asummary of stock purchased under the Stock Purchase Plan is shown below forfiscal years 2003 and 2002:

 
|                                     |   | **2003** |   | **2002** |   |
|------------------------------------------|--------|----------|--------|----------|--------|
|                                     |   |     |   |     |   |
| Aggregate purchase price (in 000’s) |   | $        | 6,408  |     | $      | 1,448 |   |
| Shares purchased (in 000’s)         |   | 393      |   | 79       |   |
| Employee participants                    |   | 1,175    |   | 1,040    |   |
|                                          |        |          |        |          |        |  |  |

 

The purchase price for sharesof common stock to be purchased during any offering period is the lower of 85percent of the fair market value of common stock on the beginning date andending date of each offering period. Shares of common stock acquired pursuant to the Stock Purchase Plan maynot be disposed of by the participant for at least three months following theexercise date.

 

*2001 Deferred Stock Unit Plan for Selected Employees*

 

On November 5, 2001, the 2001Deferred Stock Unit Plan for Selected Employees (the “Stock Unit Plan”) wasapproved at the annual meeting of stockholders.  The Stock Unit Plan is intended to provide senior associates ofthe Company with additional incentives by permitting the Company to grant theman equity interest in the Company in the form of deferred stock units, in lieuof a portion of their annual fiscal year end bonus, typically paid in Septemberof each year. Each stock unit represents one share of common stock.  The total number of shares authorized forissuance in payment of deferred stock units under the Stock Unit Plan is1,500,000 shares.

 

Deferred stock units weregranted in September 2002 and 2003 and vested immediately.  Vesting of future awards is at thediscretion of the Company, with such determination being made prior to issuanceof the deferred stock units.

 

65

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*Compensation Plan for Outside Directors*

 

In November 2001, the Board ofDirectors approved the Compensation Plan for Outside Directors (the “Director'sPlan”) which provides for the cash and stock compensation of outsideDirectors.  Under the Director's Plan,outside Directors are initially paid in shares of the Company's common stock,or in a combination of cash and shares, quarterly (at the completed quarter-endshare price) for services during the preceding quarter.  The total number of shares reserved forissuance under the Director's Plan is 50,000 shares.  In August 2003, the Board of Directors approved amendments to thePlan that included an increase in the compensation of the outside Directors andan annual grant of Company stock.  TheCompany will seek stockholder approval of amendments to the Plan at our annualmeeting to be held on November 17, 2003.

 

**Note 11 - Goodwill and Intangible Assets**

 

The following table reflectsconsolidated results adjusted as though the adoption of FAS 142 occurred as ofJuly 1, 2000:

 
|                                             |   | **Year ended  June 30** |   |
|--------------------------------------------------|--------|-------------------------|--------|
|                                             |   | **2003**                |   | **2002** |   | **2001** |   |
|                                             |   |                    |   |   |   |   |   |
| Net income, as reported                          |   | $                       | 57,166 |   | $ | 47,084 |   | $ | 44,436 |   |
| Goodwill amortization, net of tax                |   | —                  |   | — |   | 1,408 |   |
| Equity method goodwill amortization, net of  tax |   | —                  |   | — |   | 119 |   |
|                                             |   |                    |   |   |   |   |   |
| Net income, as adjusted                          |   | $                       | 57,166 |   | $ | 47,084 |   | $ | 45,963 |   |
|                                             |   |                    |   |   |   |   |   |
| Basic earnings per share, as reported            |   | $                       | 1.73   |   | $ | 1.43 |   | $ | 1.39 |   |
| Goodwill amortization, net of tax                |   | —                  |   | — |   | 0.05 |   |
| Equity method goodwill amortization, net of  tax |   | —                  |   | — |   | — |   |
|                                             |   |                    |   |   |   |   |   |
| Basic earnings per share, as adjusted            |   | $                       | 1.73   |   | $ | 1.43 |   | $ | 1.44 |   |
|                                             |   |                    |   |   |   |   |   |
| Diluted earnings per share, as reported          |   | $                       | 1.72   |   | $ | 1.41 |   | $ | 1.37 |   |
| Goodwill amortization, net of tax                |   | —                  |   | — |   | 0.05 |   |
| Equity method goodwill amortization, net of  tax |   | —                  |   | — |   | — |   |
|                                             |   |                    |   |   |   |   |   |
| Diluted earnings per share, as adjusted          |   | $                       | 1.72   |   | $ | 1.41 |   | $ | 1.42 |   |

 

66

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The changes in the carryingamount of goodwill for the fiscal years ended June 30, 2002 and 2003, are asfollows:

 
|                                |   | **Benefits  Group** |   | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|-------------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
|                                |   |                |   |                             |   |                      |   |              |   |      |   |      |   |
| Balance as of June 30, 2001         |   | $                   | 10,807 |                             | $      | 724                       |   | $                 | 59     |      | $      | 19        |   | $ | 1,214 |   | $ | 12,823 |   |
| Goodwill recorded during the period |   | 3,888               |   | 225                              |   | —                    |   | 283               |   | —    |   | 4,396     |   |
| Impairment loss                     |   | —              |   | —                           |   | —                    |   | —            |   | —    |   | —    |   |
| Translation adjustment              |   | (11                 | )      | —                           |   | —                    |   | (58               | )      | —    |   | (69       | )      |
| Balance as of June 30, 2002         |   | $                   | 14,684 |                             | $      | 949                       |   | $                 | 59     |      | $      | 244       |   | $ | 1,214 |   | $ | 17,150 |   |
| Goodwill recorded during the period |   | 1,154               |   | 500                              |   | —                    |   | 656               |   | —    |   | 2,310     |   |
| Impairment losses                   |   | —              |   | —                           |   | —                    |   | —            |   | —    |   | —    |   |
| Translation adjustment              |   | 440                 |   | —                           |   | 10                        |   | 79                |   | —    |   | 529       |   |
|                                |   |                |   |                             |   |                      |   |              |   |      |   |      |   |
| Balance as of June 30, 2003         |   | $                   | 16,278 |                             | $      | 1,449                     |   | $                 | 69     |      | $      | 979       |   | $ | 1,214 |   | $ | 19,989 |   |

 

The following table reflectschanges in the net carrying amount of the components of intangible assets forthe fiscal years ended June 30, 2002 and 2003:

 
|                                          |   | **Non-contractual  customer  relationships** |   | **Non-compete  agreements** |   | **Purchased  software** |   | **Pension** |   | **Total** |   |
|-----------------------------------------------|--------|----------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|-------------|--------|-----------|--------|
|                                          |   |                                         |   |                        |   |                    |   |        |   |      |   |
| Balance as of June 30, 2001                   |   | $                                            | — |                        | $      | 453                     |   | $           | 98     |      | $      | — |   | $ | 551 |   |
| Intangible assets recorded during the  period |   | 891                                          |   | —                      |   | —                  |   | —      |   | 891       |   |
| Amortization expense                          |   | (25                                          | )      | (92                         | )      | (45                     | )      | —      |   | (162      | )      |
| Translation adjustment                        |   | —                                       |   | —                      |   | —                  |   | —      |   | —    |   |
| Balance as of June 30, 2002                   |   | $                                            | 866    |                        | $      | 361                     |   | $           | 53     |      | $      | — |   | $ | 1,280 |   |
| Intangible assets recorded during the  period |   | —                                       |   | —                      |   | —                  |   | 113         |   | 113       |   |
| Amortization expense                          |   | (298                                         | )      | (92                         | )      | (26                     | )      | —      |   | (416      | )      |
| Translation adjustment                        |   | (88                                          | )      | —                      |   | —                  |   | —      |   | (88       | )      |
| Balance as of June 30, 2003                   |   | $                                            | 480    |                        | $      | 269                     |   | $           | 27     |      | $      | 113 |   | $ | 889 |   |

 

67

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The following table reflectsthe carrying value of intangible assets at June 30, 2002 and 2003:

 
|                                                         |   | **Fiscal  year 2003**       |   | **Fiscal  year 2002**         |   |
|--------------------------------------------------------------|--------|-----------------------------|--------|-------------------------------|--------|
|                                                         |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Amortizable intangible assets and  intangible pension asset: |   |                        |   |                          |   |   |   |   |   |
| Non-contractual customer relationships                       |   | $                           | 778    |                          | $      | 298 |   | $ | 891 |   | $ | 25 |   |
| Non-compete agreements                                       |   | 672                         |   | 403                           |   | 672 |   | 311 |   |
| Purchased software                                           |   | 125                         |   | 98                            |   | 125 |   | 72 |   |
| Intangible pension asset                                     |   | 113                         |   | —                        |   | — |   | — |   |
|                                                         |   |                        |   |                          |   |   |   |   |   |
| Total amortizable intangible assets                          |   | $                           | 1,688  |                          | $      | 799 |   | $ | 1,688 |   | $ | 408 |   |

 

The change in the gross carrying amount of non-contractualcustomer relationships reflects translation adjustments.

 

The weighted average remaining life of amortizableintangible assets at June 30, 2003, was 2.5 years.  Estimated amortization expense for fiscal year 2004 and each ofthe three succeeding fiscal years is as follows:

 

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

 

**Note 12 - Income Taxes**

 

Deferredincome tax assets and liabilities reflect the effect of temporary differencesbetween the assets and liabilities recognized for financial reporting purposesand the amounts recognized for income tax purposes.  The Company recognizes deferred tax assets if it is more likelythan not that a benefit will be realized.

 

The components of the income tax provision forcontinuing operations include:

 
|                              |   | **Year Ended  June 30** |   |
|-----------------------------------|--------|-------------------------|--------|
|                              |   | **2003**                |   | **2002** |   | **2001** |   |
|                              |   |                    |   |   |   |   |   |
| Current tax  expense:             |   |                    |   |   |   |   |   |
| U.S.                              |   | $                       | 26,159 |   | $ | 29,620 |   | $ | 21,441 |   |
| State and  local                  |   | 6,234                   |   | 6,367 |   | 5,653 |   |
| Foreign                           |   | 6,670                   |   | 1,396 |   | 5,281 |   |
|                              |   | 39,063                  |   | 37,383 |   | 32,375 |   |
| Deferred tax  (benefit) expense:  |   |                    |   |   |   |   |   |
| U.S.                              |   | (827                    | )      | (5,076 | ) | 1,010 |   |
| State and  local                  |   | (331                    | )      | (1,434 | ) | 81 |   |
| Foreign                           |   | (2,890                  | )      | 515 |   | 157 |   |
|                              |   | (4,048                  | )      | (5,995 | ) | 1,248 |   |
| Total  provision for income taxes |   | $                       | 35,015 |   | $ | 31,388 |   | $ | 33,623 |   |

 

68

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Deferredincome tax assets (liabilities) included in the Consolidated Balance Sheets atJune 30, 2003, and June 30, 2002, are comprised of the following:

 
|                                     |   | **June 30** |    |
|------------------------------------------|--------|-------------|---------|
|                                     |   | **2003**    |    | **2002** |   |
|                                     |   |        |    |   |   |
| Change in accounting method              |   | $           | (10,149 | ) | $ | (20,353 | ) |
| Foreign temporary differences            |   | (629        | )       | (1,120 | ) |
| Other                                    |   | (933        | )       | (2,345 | ) |
| Gross deferred tax liabilities           |   | (11,711     | )       | (23,818 | ) |
|                                     |   |        |    |   |   |
| Depreciation and amortization            |   | 1,387       |    | 5,974 |   |
| Accrued retirement benefits              |   | 81,333      |    | 37,909 |   |
| Deferred rent                            |   | 1,789       |    | 1,627 |   |
| Foreign temporary differences            |   | 6,639       |    | 3,737 |   |
| Foreign net operating loss carryforwards |   | 4,676       |    | 3,264 |   |
| Discontinued operations exit costs       |   | 1,634       |    | 6,272 |   |
| Tax credit carryforwards                 |   | —      |    | 167 |   |
| Other accrued liabilities                |   | 10,893      |    | 11,682 |   |
| Accrued compensation                     |   | 15,670      |    | 21,311 |   |
|                                     |   |        |    |   |   |
| Gross deferred tax assets                |   | 124,021     |    | 91,943 |   |
| Deferred tax assets valuation allowance  |   | (7,211      | )       | (5,463 | ) |
| Net deferred tax asset                   |   | $           | 105,099 |   | $ | 62,662 |   |

 

At June 30, 2003, we had unused loss carryforwards for tax purposes invarious jurisdictions outside the U.S. amounting to $15,731,000, of which$4,154,000 can be indefinitely carried forward under local statutes.  The remaining foreign loss carryforwardswill expire, if unused, in varying amounts from 2004 through 2011.  The valuation allowance includes the taxeffect of foreign net operating loss carryforwards $(4,676,000) and the taxeffect of certain foreign temporary expenses $(2,535,000).

 

The net change in the valuationallowance of $1,748,000 in fiscal year 2003 and $(448,000) in fiscal year 2002is due primarily to the tax effect of the change in realizable foreign taxcredits, foreign net operating losses and deferred foreign expenses.

 

Domestic andforeign components of income from continuing operations before income taxes foreach of the three years ended June 30 are as follows:

 
|     |   | **2003** |   | **2002** |   | **2001** |   |
|----------|--------|----------|--------|----------|--------|----------|--------|
|     |   |     |   |     |   |     |   |
| Domestic |   | $        | 76,686 |     | $      | 73,786   |   | $ | 64,694 |   |
| Foreign  |   | 8,709    |   | 4,686    |   | 13,365   |   |
|     |   |     |   |     |   |     |   |
|     |   | $        | 85,395 |     | $      | 78,472   |   | $ | 78,059 |   |

 

69

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The Company has not providedfor deferred income taxes on undistributed earnings of foreign subsidiaries asthese undistributed earnings are considered permanently invested in theseentities.

 

The reported income taxprovision differs from the amounts that would have resulted had the reportedincome before income taxes been taxed at the U.S. federal statutory rate.  The principal reasons for the differencesbetween the amounts provided and those that would have resulted from theapplication of the U.S. federal statutory tax rate are as follows:

 
|                                                            |   | **Year Ended  June 30** |   |
|-----------------------------------------------------------------|--------|-------------------------|--------|
|                                                            |   | **2003**                |   | **2002** |   | **2001** |   |
|                                                            |   |                    |   |   |   |   |   |
| Tax provision  at U.S. federal statutory tax rate of 35 percent |   | $                       | 29,888 |   | $ | 27,465 |   | $ | 27,321 |   |
| Increase  (reduction) resulting from:                           |   |                    |   |   |   |   |   |
| Foreign income  subject to (lower) higher foreign tax rates     |   | (541                    | )      | (1,491 | ) | (148 | ) |
| Tax benefit of  foreign losses reserved, net                    |   | 1,272                   |   | 1,762 |   | 908 |   |
| State income  taxes, net of federal tax effect                  |   | 3,416                   |   | 3,206 |   | 3,727 |   |
| Non-deductible  amortization and other expenses                 |   | 802                     |   | 839 |   | 2,317 |   |
| Tax credits                                                     |   | (409                    | )      | (452 | ) | (1,042 | ) |
| Other                                                           |   | 587                     |   | 59 |   | 540 |   |
|                                                            |   |                    |   |   |   |   |   |
| Income tax  provision                                           |   | $                       | 35,015 |   | $ | 31,388 |   | $ | 33,623 |   |

 

**Note13 - Segment Information**

 

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

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

 

The Company evaluates theperformance of its segments and allocates resources to them based on netoperating income on a pre-bonus, pre-tax basis.  Certain prior-year data has been reclassified to be consistentwith current classifications for comparative purposes.

 

70

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The tablebelow presents specified information about reported segments as of and for theyear ended June 30, 2003:

 
|                                    |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|-----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable  expenses) |   | $                   | 407,676 |                             | $      | 94,367                    |   | $                 | 46,476 |      | $      | 76,435    |   | $ | 47,723 |   | $ | 672,677 |   |
| Net operating income                    |   | 99,390              |    | 12,652                           |   | 1,223                     |   | 3,843             |   | 1,402     |   | 118,510   |   |
| Interest expense                        |   | 575                 |    | 48                               |   | 77                        |   | 11                |   | 37        |   | 748       |   |
| Depreciation and amortization           |   | 11,208              |    | 3,475                            |   | 1,494                     |   | 2,544             |   | 4,426     |   | 23,147    |   |
| Receivables                             |   | 85,161              |    | 13,333                           |   | 8,080                     |   | 16,425            |   | 6,350     |   | 129,349   |   |
|                                         |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

The tablebelow presents specified information about reported segments as of and for theyear ended June 30, 2002:

 
|                                    |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|-----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable  expenses) |   | $                   | 400,307 |                             | $      | 104,700                   |   | $                 | 47,155 |      | $      | 69,092    |   | $ | 56,278 |   | $ | 677,532 |   |
| Net operating income (loss)             |   | 110,091             |    | 19,971                           |   | (6,216                    | )      | 647               |   | 1,776     |   | 126,269   |   |
| Interest expense                        |   | 1,415               |    | 212                              |   | 211                       |   | 5                 |   | 164       |   | 2,007     |   |
| Depreciation and amortization           |   | 9,759               |    | 3,205                            |   | 1,655                     |   | 2,378             |   | 4,489     |   | 21,486    |   |
| Receivables                             |   | 89,569              |    | 16,094                           |   | 9,140                     |   | 15,159            |   | 8,863     |   | 138,825   |   |
|                                         |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

The tablebelow presents specified information about reported segments as of and for theyear ended June 30, 2001:

 
|                                    |   | **Benefits  Group** |    | **Technology  Solutions  Group** |   | **Human  Capital  Group** |   | **International** |   | **Other** |   | **Total** |   |
|-----------------------------------------|--------|---------------------|---------|----------------------------------|--------|---------------------------|--------|-------------------|--------|-----------|--------|-----------|--------|
| Revenue (net of reimbursable  expenses) |   | $                   | 379,296 |                             | $      | 95,926                    |   | $                 | 54,225 |      | $      | 74,240    |   | $ | 63,785 |   | $ | 667,472 |   |
| Net operating income                    |   | 97,823              |    | 23,779                           |   | 3,807                     |   | 11,351            |   | 5,852     |   | 142,612   |   |
| Interest expense                        |   | 1,927               |    | 268                              |   | 311                       |   | 23                |   | 224       |   | 2,753     |   |
| Depreciation and amortization           |   | 8,575               |    | 2,492                            |   | 1,447                     |   | 2,070             |   | 2,398     |   | 16,982    |   |
| Receivables                             |   | 89,761              |    | 15,109                           |   | 10,972                    |   | 17,113            |   | 10,291    |   | 143,246   |   |
|                                         |        |                     |         |                                  |        |                           |        |                   |        |           |        |           |        |  |  |  |  |  |  |

 

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Areconciliation of the information reported by segment to the consolidatedamounts follows for the years ended June 30 (in thousands):

 
|                                                                                    |   | **2003** |    | **2002** |   | **2001** |   |
|-----------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
|                                                                                    |   |     |    |     |   |     |   |
| *Revenue:*                                                                              |   |     |    |     |   |     |   |
| Total segment revenue                                                                   |   | $        | 672,677 |     | $      | 677,532  |   | $ | 667,472 |   |
| Reimbursable expenses not  included in segment revenue                                  |   | 32,997   |    | 29,266   |   | 32,363   |   |
| Other, net                                                                              |   | 3,942    |    | 3,682    |   | 354      |   |
| Consolidated revenue                                                                    |   | $        | 709,616 |     | $      | 710,480  |   | $ | 700,189 |   |
|                                                                                    |   |     |    |     |   |     |   |
| *Net Operating Income:*                                                                 |   |     |    |     |   |     |   |
| Total segment income                                                                    |   | $        | 118,510 |     | $      | 126,269  |   | $ | 142,612 |   |
| Income from affiliates                                                                  |   | 5,787    |    | 2,866    |   | 3,780    |   |
| Differences in allocation  methods for depreciation, G&A, pension and medical costs |   | (2,357   | )       | (1,715   | )      | (2,996   | )      |
| Other non-operating income                                                              |   | 761      |    | 2,166    |   | —   |   |
| Discretionary bonuses                                                                   |   | (36,026  | )       | (49,058  | )      | (63,326  | )      |
| IPO-related compensation charge                                                         |   | —   |    | —   |   | (3,480   | )      |
| Other, net                                                                              |   | (1,280   | )       | (2,056   | )      | 1,469    |   |
|                                                                                    |   |     |    |     |   |     |   |
| Consolidated pretax income                                                              |   | $        | 85,395  |     | $      | 78,472   |   | $ | 78,059 |   |
|                                                                                    |   |     |    |     |   |     |   |
| *Interest Expense:*                                                                     |   |     |    |     |   |     |   |
| Total segment expense                                                                   |   | $        | 748     |     | $      | 2,007    |   | $ | 2,753 |   |
| Differences in allocation  method                                                       |   | 54       |    | (1,302   | )      | (1,609   | )      |
| Consolidated interest expense                                                           |   | $        | 802     |     | $      | 705      |   | $ | 1,144 |   |
|                                                                                    |   |     |    |     |   |     |   |
| *Depreciation & Amortization:*                                                      |   |     |    |     |   |     |   |
| Total segment expense                                                                   |   | $        | 23,147  |     | $      | 21,486   |   | $ | 16,982 |   |
| Goodwill and other intangible  asset amortization, not allocated to segments            |   | 416      |    | 162      |   | 2,550    |   |
| Differences in allocation  method and other                                             |   | (3,942   | )       | (1,599   | )      | 2,463    |   |
| Consolidated depreciation and  amortization expense                                     |   | $        | 19,621  |     | $      | 20,049   |   | $ | 21,995 |   |
|                                                                                    |   |     |    |     |   |     |   |
| *Receivables:*                                                                          |   |     |    |     |   |     |   |
| Total segment receivables                                                               |   | $        | 129,349 |     | $      | 138,825  |   | $ | 143,246 |   |
| Net valuation differences                                                               |   | 9,573    |    | 12,787   |   | 8,344    |   |
| Total billed and unbilled  receivables                                                  |   | 138,922  |    | 151,612  |   | 151,590  |   |
| Assets not reported by segment                                                          |   | 375,540  |    | 285,205  |   | 240,426  |   |
| Consolidated assets                                                                     |   | $        | 514,462 |     | $      | 436,817  |   | $ | 392,016 |   |

 

72

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Thefollowing represents total revenue and long-lived assets information bygeographic area as of and for the years ended June 30:

 
|          |   | **Revenue** |    | **Long-lived Assets** |   |
|---------------|--------|-------------|---------|-----------------------|--------|
|          |   | **2003**    |    | **2002**              |   | **2001** |   | **2003** |   | **2002** |   | **2001** |   |
|          |   |        |    |                  |   |   |   |   |   |   |   |   |   |
| United States |   | $           | 580,428 |                  | $      | 588,138 |   | $ | 571,269 |   | $ | 79,579 |   | $ | 74,260 |   | $ | 66,624 |   |
| Foreign       |   | 129,188     |    | 122,342               |   | 128,920 |   | 35,040 |   | 35,041 |   | 24,373 |   |
|          |   | $           | 709,616 |                  | $      | 710,480 |   | $ | 700,189 |   | $ | 114,619 |   | $ | 109,301 |   | $ | 90,997 |   |

 

Revenue is based on the countryof domicile for the legal entity that originated the revenue.  Exclusive of the United States, revenue fromno single country constituted more than 10 percent of consolidatedrevenues.  Revenue from no singlecustomer constituted more than 4 percent of consolidated revenues.

 

**Note 14 - Commitments and ContingentLiabilities**

 

The Company has occasionallyprovided guarantees to third parties in the normal course of business.  The guarantees described below are currentlyin effect and could require the Company to make payments to third parties undercertain circumstances.

 

*Letters of Credit*.  The Company has two outstanding letters ofcredit totaling $7.5 million under our existing credit facility to guaranteepayment to the beneficiaries in the event that the Company fails to meet itsfinancial obligations to the 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 that provided loans to associates for stock purchased under our formerStock Purchase Program.  This StockPurchase Program was discontinued in conjunction with our initial publicoffering in October 2000.  As a result,the amounts guaranteed under this facility will permanently decrease as theloans are repaid.  The maximum availableborrowings and aggregate outstanding balances under this facility were $1.0million at June 30, 2003, and $2.9 million at June 30, 2002.  A total of 889,000 and 2,731,000 WatsonWyatt & Company Holdings shares were pledged by stockholders tocollateralize these loans at June 30, 2003, and June 30, 2002, 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 shoulddecline with the passage of time.

 

73

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There are no provisions forrecourse to third parties, nor are any assets held by any third parties thatthe Company as guarantor can liquidate to recover amounts paid under suchindemnities.

 

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

 

In connection with theestablishment of our alliance with Watson Wyatt LLP, the Company agreed toguarantee Watson Wyatt LLP’s performance under a lease for office space inLondon that expires in 2015.  Paymentsby Watson Wyatt LLP under the lease total approximately £1.4 million (orapproximately $2.3 million based on the June 30, 2003, exchange rate) peryear.  We also granted Watson Wyatt LLPan option to return the leased space to our UK subsidiary in 2009.  If Watson Wyatt LLP were to exercise thisoption, the Company would attempt to sublease the space at the then-currentmarket rates.

 

*Indemnification Agreements*.  The Company has various agreements thatprovide that it may be obligated to indemnify the other party with respect tocertain matters.  Generally, theseindemnification clauses are included in contracts arising in the normal courseof business and in connection with the purchase and sale of certainbusinesses.  Although it is not possibleto predict the maximum potential amount of future payments under theseindemnification agreements due to the conditional nature of the Company’sobligations and the unique facts of each particular agreement, the Company doesnot believe that any potential liability that might arise from such indemnityprovisions is probable or material. There are no provisions for recourse to third parties, nor are anyassets held by any third parties that any guarantor can liquidate to recoveramounts paid under such indemnities.

 

*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 June 30, 2003, minimumremaining payments guaranteed under these leases, which expire at various datesthrough 2007, totaled $24.5 million, excluding anticipated future subleaseincome. These leases are also jointly and severally guaranteed by the Company’sformer partner in Wellspring, State Street Bank and Trust Company. Theestimated loss from the potential exercise of these guarantees was included inthe fiscal year 1998 loss accrual recorded in connection with our exit from thebenefits administration outsourcing business. Wellspring-related activity isreflected on the Statements of Operations and of Cash Flows as discontinuedoperations.  See Note 17 of the Notes tothe Consolidated Financial Statements for more information related toWellspring.

 

*Legal proceedings*.  From time to time, we are a party to variouslawsuits, arbitrations or mediations that arise in the ordinary course ofbusiness. These disputes typically involve claims relating to the rendering ofprofessional services or employment matters. The matters reported on belowinvolve the most significant pending or potential claims against us. Managementbelieves, based on currently available information, that the results of allpending claims against us will not have a material adverse effect on theCompany.

 

New Jersey Coalition of Auto Retailers Insurance GroupTrust (NJCAR) – We have tentatively settled a lawsuit brought against Watson Wyattand five other service providers of NJCAR, an insolvent group health insuranceprovider.  The suit, in the U.S.District Court for the District of New Jersey, alleged that losses resultingfrom the insolvency are partly attributable to NJCAR’s former serviceproviders.  The tentative settlement issubject to reaching a satisfactory settlement agreement and approval by thestate court overseeing the insolvency.

 

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Toussaint, et al. v. James, etal – Union leaders, in their capacity as the trustees of a pension plan for theunion leadership, brought suit in December 2001 in the U.S. District Court forthe Southern District of New York against the former union leaders and WatsonWyatt, alleging damages suffered in reliance on our actuarial work and breachesof fiduciary duties owed by the former union leaders.  The claim against Watson Wyatt is allegedly in the $4 millionrange.  If the case is not resolved inmediation, we expect a jury trial to be scheduled late this year or early nextyear, although a date has not yet been set.

 

**Note 15 - Earnings Per Share**

 

Basic earnings per share iscalculated on the basis of the weighted average number of common sharesoutstanding during the year ended June 30, 2003.  Diluted earnings per share is calculated on the basis of theweighted average number of common shares outstanding plus the effect ofoutstanding stock options and employee stock purchase plan shares using the“treasury stock” method.  The componentsof basic and diluted earnings per share are as follows:

** **
|                                                                               |   | **Year Ended  June 30** |   |
|------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                               |   | **2003**                |   | **2002** |   | **2001** |   |
|                                                                               |   |                    |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                       | 50,380 |   | $ | 47,084 |   | $ | 44,436 |   |
| Income from discontinued operations                                                |   | 6,786                   |   | — |   | — |   |
| Net income                                                                         |   | $                       | 57,166 |   | $ | 47,084 |   | $ | 44,436 |   |
|                                                                               |   |                    |   |   |   |   |   |
| Weighted average outstanding shares of  common stock                               |   | 32,962                  |   | 32,985 |   | 32,068 |   |
| Dilutive effect of employee stock options  and employee stock purchase plan shares |   | 325                     |   | 436 |   | 295 |   |
|                                                                               |   |                    |   |   |   |   |   |
| Common stock and stock equivalents                                                 |   | 33,287                  |   | 33,421 |   | 32,363 |   |
|                                                                               |   |                    |   |   |   |   |   |
| Basic earnings per share                                                           |   |                    |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                       | 1.52   |   | $ | 1.43 |   | $ | 1.39 |   |
| Income from discontinued operations                                                |   | 0.21                    |   | — |   | — |   |
| Basic earnings per share, net income                                               |   | $                       | 1.73   |   | $ | 1.43 |   | $ | 1.39 |   |
|                                                                               |   |                    |   |   |   |   |   |
| Diluted earnings per share                                                         |   |                    |   |   |   |   |   |
| Income from continuing operations                                                  |   | $                       | 1.51   |   | $ | 1.41 |   | $ | 1.37 |   |
| Income from discontinued operations                                                |   | 0.21                    |   | — |   | — |   |
| Diluted earnings per share, net income                                             |   | $                       | 1.72   |   | $ | 1.41 |   | $ | 1.37 |   |

 

Therewere 93,173 outstanding stock options for the year ended June 30, 2003, thatwere not included in the diluted earnings per share calculation because theireffect would have been antidilutive.

 

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**Note 16 - Quarterly Financial Data(unaudited)**

 

Unaudited, summarized financialdata by quarter for the years ended June 30, 2003 and 2002, is as follows (inthousands, except per share amounts): 

 
|                                                   |   | **2003  Quarter Ended** |
|--------------------------------------------------------|--------|-------------------------|
|                                                   |   | **September  30**  |   | **December  31** |   | **March 31** |   | **June 30** |   |
|                                                   |   |                    |   |   |   |   |   |   |   |
| Revenue                                                |   | $                       | 178,958 |   | $ | 174,624 |   | $ | 177,596 |   | $ | 178,438 |   |
| Income from operations                                 |   | 20,530                  |   | 18,178 |   | 19,609 |   | 19,539 |   |
| Income from continuing  operations before income taxes |   | 22,141                  |   | 20,582 |   | 21,081 |   | 21,591 |   |
| Income from continuing operations                      |   | 13,063                  |   | 12,144 |   | 12,441 |   | 12,732 |   |
| Discontinued operations                                |   | —                  |   | — |   | 6,752 |   | 34 |   |
| Net income                                             |   | 13,063                  |   | 12,144 |   | 19,193 |   | 12,766 |   |
| Earnings per share:                                    |   |                    |   |   |   |   |   |   |   |
| Continuing operations, basic                           |   | 0.40                    |   | 0.37 |   | 0.37 |   | 0.39 |   |
| Continuing operations, diluted                         |   | 0.39                    |   | 0.36 |   | 0.37 |   | 0.38 |   |
| Discontinued operations, basic                         |   | —                  |   | — |   | 0.21 |   | — |   |
| Discontinued operations,  diluted                      |   | —                  |   | — |   | 0.21 |   | — |   |
| Net income, basic                                      |   | 0.40                    |   | 0.37 |   | 0.58 |   | 0.39 |   |
| Net income, diluted                                    |   | 0.39                    |   | 0.36 |   | 0.58 |   | 0.38 |   |
|                                                        |        |                         |  |  |  |  |  |  |  |  |  |  |  |

 
|                                                   |   | **2002  Quarter Ended** |
|--------------------------------------------------------|--------|-------------------------|
|                                                   |   | **September  30**       |   | **December  31** |   | **March 31** |   | **June 30** |   |
|                                                   |   |                    |   |   |   |   |   |   |   |
| Revenue                                                |   | $                       | 172,456 |   | $ | 174,897 |   | $ | 180,382 |   | $ | 182,745 |   |
| Income from operations                                 |   | 20,345                  |   | 15,183 |   | 17,412 |   | 19,265 |   |
| Income from continuing  operations before income taxes |   | 22,479                  |   | 16,830 |   | 18,507 |   | 20,656 |   |
| Net income                                             |   | 13,488                  |   | 10,096 |   | 11,107 |   | 12,393 |   |
| Earnings per share:                                    |   |                    |   |   |   |   |   |   |   |
| Continuing operations, basic                           |   | 0.41                    |   | 0.31 |   | 0.34 |   | 0.38 |   |
| Continuing operations, diluted                         |   | 0.40                    |   | 0.30 |   | 0.33 |   | 0.37 |   |
| Net income, basic                                      |   | 0.41                    |   | 0.31 |   | 0.34 |   | 0.38 |   |
| Net income, diluted                                    |   | 0.40                    |   | 0.30 |   | 0.33 |   | 0.37 |   |
|                                                        |        |                         |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 17 - Discontinued Operations**

 

The Company continues toguarantee three leases for office premises for Wellspring Resources, LLC(“Wellspring”), the benefits administration outsourcing business that we exitedfrom in fiscal year 1998.  These leasesare also jointly and severally guaranteed by the Company’s former partner inWellspring, State Street Bank and Trust Company. The estimated loss from thepotential exercise of these guarantees was originally included in the fiscalyear 1998 loss accrual recorded in connection with the disposal of the benefitsadministration outsourcing business.  AtJune 30, 2003, minimum remaining payments guaranteed under these leases, whichexpire at various dates through 2007, total $24.5 million, excludinganticipated future sublease income.

 

As a result of de minimispositive cash flows that began in the second quarter of fiscal year 2003related to these leases, the Company reevaluated its accrual for the estimatedremaining future obligations and costs related to the exit fromWellspring.  The evaluation included ananalysis of occupancy rates of

 

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Wellspring, along with ananalysis of real estate market conditions in cities in which the leases existand an estimate of probable future sublease income for these leases.  As a result of this analysis, the Companyreduced the amount of its estimated accrual for losses from disposal of thebenefits administration outsourcing business in the third quarter of fiscalyear 2003 by $11.4 million, less the associated income tax expense of $4.7million.  In the fourth quarter offiscal year 2003, the Company received a nominal amount of sublease income inexcess of lease payments for these leases. Such adjustments are reflected in the Consolidated Statement ofOperations for fiscal year 2003 in the line “Adjustment to reduce estimatedloss on disposal of discontinued operations.” The remaining noncurrent liability of $4.0 million representsmanagement’s estimate of potential future cash out flows related to guaranteesassociated with Wellspring leases.

 

**Note 18 - Targeted Job Reductions**

 

We implemented targeted jobreductions in our North American Technology Solutions Group and Human CapitalGroup during the second quarter of fiscal year 2003.  This resulted in the elimination of 72 positions, orapproximately 2 percent of our workforce, and a severance charge of $2.0 millionthat was included in our results for the quarter ended December 31, 2002.  Of the $2.0 million severance charge, $1.8million was included in salaries and employee benefit expenses and $0.2 millionwas included in professional and subcontracted services.  As of June 30, 2003, amounts due under relatedseverance agreements had been paid.

 

**Note 19 - Subsequent Events**

 

We implemented additional jobreductions in our North American regions in July 2003.  This resulted in the elimination ofapproximately 100 positions.  Theestimated $3.3 million charge to earnings related to these reductions will beincluded in the Company’s financial results for the quarter ended September 30,2003.

 

On July 9, 2003, PCIC’s Boardof Directors approved a change in premium structure for its policyholders andstockholders.  In connection with thechange in premium structure, PCIC provided each of its owners with a one-timecredit 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 “true up” each insureds’ obligation to PCIC forhistorical loss experience.   As aresult, the Company will record a $5.6 million pre-tax non-operating gain inthe first quarter of fiscal year 2004. Refer to Note 4 for more information regarding our investment in PCIC.

 

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**WATSONWYATT & COMPANY HOLDINGSSchedule IIValuation and Qualifying Accounts and Reserves**(Thousands of U.S. Dollars)

 
| **Description**                             |   | **Balance at  Beginning of Year** |   | **Additions  Charged Against  (Credited to)  Revenue** |   | **Additions  Charged to  Other Accounts** |   | **Deductions** |   | **Balance at  End of  Year** |   |
|---------------------------------------------|--------|-----------------------------------|--------|--------------------------------------------------------|--------|-------------------------------------------|--------|----------------|--------|------------------------------|--------|
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Year Ended  June 30, 2003                   |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Allowance for Uncollectible accounts        |   | $                                 | 1,405  |                                                   | $      | 7,871                                     |   | $              | — |                         | $      | (8,414 | ) | $ | 862 |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Allowance for Unbillable accounts           |   | 431                               |   | (12                                                    | )      | —                                    |   | —         |   | 419                          |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Valuation allowance for deferred tax assets |   | 5,463                             |   | —                                                 |   | 1,748                                     | (1)    | —         |   | 7,211                        |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Year Ended  June 30, 2002                   |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Allowance for Uncollectible accounts        |   | $                                 | 2,695  |                                                   | $      | 5,240                                     |   | $              | — |                         | $      | (6,530 | ) | $ | 1,405 |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Allowance for Unbillable accounts           |   | 1,130                             |   | (699                                                   | )      | —                                    |   | —         |   | 431                          |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Valuation allowance for deferred tax assets |   | 5,911                             |   | —                                                 |   | (448                                      | )(2)   | —         |   | 5,463                        |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Year Ended  June 30, 2001                   |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Allowance for uncollectible accounts        |   | $                                 | 2,832  |                                                   | $      | 6,608                                     |   | $              | — |                         | $      | (6,745 | ) | $ | 2,695 |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Allowance for unbillable accounts           |   | 676                               |   | 454                                                    |   | —                                    |   | —         |   | 1,130                        |   |
|                                        |   |                              |   |                                                   |   |                                      |   |           |   |                         |   |
| Valuation allowance for deferred tax assets |   | 5,179                             |   | —                                                 |   | 732                                       | (3)    | —         |   | 5,911                        |   |

 

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(1)          The net increase is primarily due to the taxeffect of the change in realizable net operating losses and other foreigntemporary differences.

 

(2)          The net decrease is primarily due to the taxeffect of the change in realizable foreign tax credits, foreign net operatingloss carryforwards and other foreign temporary differences.

 

(3)          The net increase is primarily due to the taxeffect of the change in realizable foreign net operating losses, foreign taxcredits and other foreign temporary differences.

 

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**Item15(c).  Exhibit Index.**

** **
| 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.(6)                                                                                                                                                                     |
| 10.4 |   | Agreement  with David B. Friend, M.D., dated October 22, 1999(1)                                                                                                                                         |
| 10.5 |   | Senior  Officer Deferred Compensation Plan(6)                                                                                                                                                            |
| 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(5) |
| 10.7 |   | 2001 Deferred  Stock Unit Plan for Selected Employees(7)                                                                                                                                                 |
| 10.8 |   | Compensation  Plan for Outside Directors(8)                                                                                                                                                              |
| 21   |   | Subsidiaries  of Watson Wyatt & Company Holdings(9)                                                                                                                                                  |
| 23   |   | Consent of  the Company’s Independent Auditors(9)                                                                                                                                                   |
| 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(9)                         |
| 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(9)                         |
| 32   |   | Certification  of Chief Executive Officer and Chief Financial Officer Pursuant to Title 18,  U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002(9)                  |

 

 

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

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

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

(4)                    Incorporated by reference fromRegistrant’s Form 10-Q, filed on November 14, 2000

(5)                    Incorporated by reference fromRegistrant’s Form S-3/A, Amendment No. 5 (File No. 33-394973), filed onSeptember 14, 2000

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

(7)                    Incorporated by reference fromRegistrant’s Form DEF14A, filed on October 5, 2001

(8)                    Incorporated by reference fromRegistrant’s Form S8, filed on December 19, 2001

(9)                    Filed with this Form 10-K

 

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