**UNITEDSTATESSECURITIES 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,  2004** |
|           |   |
|           | **OR** |
|           |   |
| **o**          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |
|           |   |
|           | **For the transition period  from          to          ** |
|           |   |
|           | **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 registeredpursuant 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  (32,326,060 shares outstanding as of July 31, 2004)** |   | **New York Stock Exchange**                          |

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

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

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.

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

 

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

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

 

The aggregate market value of the voting and non-voting common equityheld by non-affiliates of the Registrant was $793,616,165 as of December 31,2003.

 

**DocumentsIncorporated by Reference**

 

Portions of the Definitive Proxy Statement for the Annual Meeting ofStockholders to be held on or about November 15, 2004 are incorporated byreference into Part III of this Form 10-K.

 

 

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**PART I**

 

**Item 1.  Business.**

 

**Overview**

 

Watson Wyatt & Company Holdings, including its subsidiaries(collectively referred to as “we”, “Watson Wyatt” or the “company”), is aglobal human capital consulting firm. We help our clients enhance businessperformance by improving their ability to attract, retain and motivatequalified employees. We focus on delivering value-added consulting servicesthat help our clients anticipate, identify and capitalize on emergingopportunities in human capital management. We implement this strategy through approximately 3,925 associates in 61offices located in 18 countries.

 

As leading economies worldwide have become more services-oriented,human capital has become increasingly important to companies and otherorganizations. The heightened competition for skilled employees, unprecedentedchanges in workforce demographics, regulatory changes related to compensationand retiree benefits, and rising employee-related costs have increased theimportance of effective human capital management. We help our clients addressthese issues by combining our expertise in human capital management withconsulting and technology, to improve the design and implementation of varioushuman resources, or HR, programs, including compensation, retirement and healthcare plans.

 

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

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

•       Health care, disability  and other group benefit plans

•  Investment consulting services  to pension plans

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

**•****      **Actuarial services

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

**•****      **Call center strategy, design and tools

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

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

•       Strategies to align  workforce performance with business objectives

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

•       Strategies for  attracting, retaining and motivating employees

•  Performance management |

 

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

 

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***CompetitiveAdvantage***

 

We believe that our competitive advantages include our strong clientrelationships, our thought leadership and our experienced management team.

 

We have long-lasting relationships with our clients, many of which havebeen our clients for decades, for whom our services have grown over time.  Expanding our relationships with existingclients and identifying new prospects are key to our growth strategy.

 

We also believe that we are at the forefront of many issues affectinghuman capital through our research, surveys and participation inpolicy-making.  Our thought leaders areoften called upon by the media and government to express opinions on issuesaffecting health care benefits, retirement plan design and executivecompensation.

 

Our senior management team is strong, with an average tenure of 14years with the company and a reputation for transparency andaccountability.  We consider this groupto be a major asset to the company.

 

***CorporateInformation***

 

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

 

***Watson WyattWorldwide Alliance***

 

Recognizing our clients’ need for consulting services worldwide, in thelate 1970s we established operations throughout Europe by acquiring local firmsand opening new offices.  In 1995, inresponse to the rapidly increasing globalization of the world economy, we madea strategic decision to strengthen our European capabilities significantly andextended our global reach. We entered into an alliance with R. Watson &Sons (now Watson Wyatt LLP), a leading United Kingdom-based actuarial, benefitsand human resources consulting partnership founded in 1878. Since 1995, we havemarketed our services globally under the Watson Wyatt Worldwide brand, sharingresources, technologies, processes and business referrals with Watson WyattLLP.

 

The Watson Wyatt Worldwide alliance maintains 88 offices in 30countries and employs more than 6,000 associates. Watson Wyatt & CompanyHoldings operates 61 offices in 18 countries in North America, Latin Americaand Asia-Pacific. Watson Wyatt LLP operates 10 offices in the United Kingdomand Ireland, and also operates 1 office engaged in the insurance and financialservices business in the United States. The alliance operates 16 offices in 10continental European countries, principally through a jointly-owned holdingcompany, Watson Wyatt Holdings (Europe) Limited.  Watson Wyatt & Company owns 25 percent of the holding company;Watson Wyatt LLP owns 75 percent.

 

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**Human ResourcesConsulting Industry**

 

The growing demand for employee benefits and human capital consultingservices is directly related to the increasing size and complexity of today’shuman resources programs and the societal forces that are stimulating theirrapid change.  In the United Statesalone, employers spend more than $6.2 trillion annually in direct costs ofhuman capital programs, such as compensation and benefits.  In 2003, U.S. employers contributed nearly$191 billion to pension and profit-sharing plans, and more than $429 billion togroup health insurance programs, while the assets of U.S. employer-sponsoredretirement plans approximated $9.3 trillion.

 

Employers, regardless of geography or industry, are facingunprecedented challenges involving the management of their people. Changingtechnology, difficult economic times, critical skill shortages and an agingpopulation in many developed countries have increased competition for talentedemployees.  At the same time, employees’expectations relating to compensation, benefits and other HR services aregrowing.  To remain competitive,employers must address these challenges effectively.

 

**Consulting Services**

 

Our North American operations include three principal practice groups:Benefits, Technology Solutions and Human Capital.  Outside North America, our operations are organized and managedon a geographic basis.  The percentageof revenues generated in the various groups is as follows:

 
|                                               |   | **2004** |   | **2003** |   | **2002** |   |
|----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Benefits Group                                     |   | 64       | %      | 61       | %      | 59       | %      |
| Technology Solutions Group                         |   | 11       |   | 14       |   | 16       |   |
| Human Capital Group                                |   | 7        |   | 7        |   | 7        |   |
| International                                      |   | 12       |   | 11       |   | 10       |   |
| Other (including Data Services and  Communication) |   | 6        |   | 7        |   | 8        |   |
| Total                                              |   | 100      | %      | 100      | %      | 100      | %      |

 

For more information about industry segments, see Note 13 of Notes tothe Consolidated Financial Statements, included in Item 15 of this report.

 

***Benefits Group***

 

Our Benefits Group – with 1,685 associates – consists primarily of consultingpractices in retirement, group and health care, and pension investmentmanagement.  It is our largest and mostestablished practice, with a franchise dating to 1946.  This group works with clients to createcost-effective retirement and health care benefits programs that help attract,retain and motivate a talented workforce. We strive to provide tailored benefits programs for our clients, and webase our recommendations on extensive research.  Our Benefits Group accounted for approximately 64 percent of ourtotal segment revenues for the fiscal year ended June 30, 2004.

 

*RetirementConsulting*

 

We are one of the world’s largest advisers on retirement plans,providing actuarial and consulting services for large defined benefit anddefined contribution retirement plans. Our consultants work with clients toassess the impact that changing workforce demographics will have on theirretirement plans, corporate cash flow requirements and retiree benefitsadequacy and security.

 

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In North America, and throughout much of the developed world,organizations provide employees with retirement security through funded pensionplans, most of which are either defined benefit or defined contributionplans.  A typical defined benefit planis characterized by employer contributions and a specified future benefit tothe employee.  Such plans typicallyinvolve large 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 formed an alliance with Gabriel, Roeder,Smith & Company (GRS), an actuarial and benefits consulting firm thatspecializes in public sector employee benefit programs, under which we mutuallyrefer future business opportunities and explore joint consultingassignments.  In addition, we sold GRSour U.S.-based public sector retirement practice.

 

Our target market for retirement consulting is companies with largedefined benefit plans, such as the Fortune 1000, Pensions & Investments1000 (P&I 1000), and other similarly-sized plans and plan sponsors. Ourconsultants provide actuarial services and are the named actuaries to many ofthe world’s largest retirement plans, including four of the five largestcorporate pension plan sponsors in the United States.  The market for actuarial consulting for these large companies isfragmented, and no single consulting firm significantly dominates this targetmarket.  Watson Wyatt is one of theleading service providers to our target market of the combined list of theP&I and Fortune 1000.  Additionally,our corporate client retention rate within this group has remained very high,averaging over 95 percent over the past two years.

 

Our defined benefit services include:

 

•                  Strategic plandesign

•                  Actuarialservices

•                  Fundingrecommendations

•                  Multinationalasset pooling consulting

•                  Financialreporting

•                  Valuation anddiagnostic software and systems

•                  Assistance withchanges relating to mergers, acquisitions and divestitures

•                  Complianceconsulting

•                  Administrativeservices

 

We also help companies design and implement defined contribution plans,particularly 401(k) plans in the United States.

 

In both the defined benefit and defined contribution areas, weemphasize research-based consulting to design retirement programs that alignour clients’ workforces with their business strategies. Our products andservices 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

 

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•                  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 retirement consulting services, we invest heavily in thelatest technology to ensure the consistency and efficiency of service deliveryin all our offices worldwide. We also maintain extensive proprietary databases,Watson Wyatt COMPARISONTM and BenTrackTM, that enable ourclients to track and benchmark benefit plan provisions in the United States andthroughout the world.

 

*Group and HealthCare Consulting*

 

Employers look to provide health and welfare benefits that will helpthem to attract and retain qualified workers and to enhance the health andproductivity of their workforce.  Givenincreasing health care costs, declining employee satisfaction and the increasedadministrative burden for U.S. companies, this challenge has never beengreater.  Globally, many health caresystems are strained by shrinking resources and increasing demand due topopulation aging and declining health status. In the United States, these underlying forces are creating pressure fornew approaches to providing health care benefits for workers and retirees –approaches that engage patients as consumers of health care and not justpassive recipients.  These methodsempower employees to participate more actively in the health care buyingdecision by putting workers in charge of spending their own health care dollarsand by providing them with the tools and information necessary to make wiserhealth purchasing decisions.

 

Clients ask us to help them with the design, financing, administration,communication and management of their health and welfare benefit plans, toimprove employee health and productivity, and to control their health-relatedbenefit costs.

 

Our services include:

 

•            Strategic plan designof health and welfare, paid time off and flexible benefit plans, includingdesigns that feature consumerism and health savings accounts

•            Retiree healthprograms

•            Health andproductivity management

•            eHealth strategy andimplementation

•            Total programmanagement

•            Vendor performance andmanagement

•            Measurement of programeffectiveness

 

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•            Assistance with planchanges relating to mergers, acquisitions and divestitures

 

Our approach to group benefits consulting is data-driven,research-based and makes use of sophisticated consulting 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

 

•                  I-E Engine – aninnovative technology that automates the vendor selection and managementprocess through five modules that support specific components of the health andwelfare benefits life cycle

 

•                  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

 

*InvestmentConsulting*

 

Pension plan sponsors face unprecedented challenges in today’s marketenvironment.  Through our registeredinvestment advisor subsidiary, we offer investment consulting services thathelp clients throughout the world maximize the return on their retirement planassets, develop governance policies and strategies, and design investmentstructures to successfully manage financial liabilities within the context oftheir overall business objectives.

 

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 following integrated 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

 

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•                  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

 

***Technology SolutionsGroup***

 

Our Technology SolutionsGroup of 320 associates helps clients identify, select and implement best-fitHR and benefits technologies in an outsourcing market increasingly defined byfour key dynamics: enterprise resource planning systems (ERPs), total benefitsoutsourcing (TBO), human resource outsourcing (HRO) and co-sourcing using pointsolutions.

 

We believe that nearly everyFortune 1000 corporation in North America has an ERP solution in place, mostcommonly for HR information systems. ERP vendors are 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 targeted towards businesses that use a mix of sourcing strategies. Combiningbest-in-class technology solutions with outsourcing services offers employerslower cost, greater flexibility and more comprehensive options than stand-aloneERPs or total outsourcing systems.

 

Watson Wyatt has longprovided benefits administration solutions to our clients.  We offer targeted applications in our coreareas, including:

 

•                  PensionPathTM –this web-based solution is designed to meet the pension administration needs ofcompanies. The offering includes case management and administration tools tomanage the entire life cycle of pension administration, from new hire toretirement, and employee self-service tools that enhance workers’ understandingof their retirement benefits’ future value.

 

PensionPath can be customized on both the front- and back-end to matchthe client’s brand and specific service needs, while allowing employees toeasily obtain pension estimates. Much more than the typical pension calculator,PensionPath brings an extensive array of system-level tools into the hands ofbenefits staff, including event processing and administration, ad hoc andstandard reporting, full calculations, history tracking and multi-usercapabilities.

 

•                  BenefitConnectTM – aweb-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 planenrollment and administration.

 

BenefitConnectserves the entire spectrum of potential users, including employees, planadministrators, customer service representatives, HR and benefit managers,vendors and carriers. It can be configured and branded to meet companies’unique requirements and plan and vendor formats. BenefitConnect’s fullfunctionality helps users manage benefits data, make eligibility calculations,facilitate annual and ongoing plan enrollment, integrate with payroll solutionsand carriers to process participant elections, and manage and track employeecalls, transactions and cases. It also allows companies to create or leveragetheir internal call center with a powerful suite of web-based call centertools.

 

•                  Reward®**–**a suite of compensationmanagement applications that automates all aspects of pay delivery – includingmarket pricing, compensation design and analysis and manager self-service – forcompensation planning.

 

•                  eStatements – integrated,web-based applications that provide employees with a personalized view of theircompensation and benefit programs, costs and account balances

 

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•                  AnswerKey – Watson Wyatt’sshared service center solution is a web-based case management tool designed tosupport the business of service center operations by effectively integratingdata and critical tools

 

We also provide clients with strategic, research-basedHR technology and service delivery consulting, while working with them to aligntheir HR strategy with their business goals and to use HR technology to improvecustomer satisfaction and sustainable return on investment (ROI). Our servicesin this area include vendor assessments and selection and service deliverymodel development, including shared services strategy and design.

 

Our approach establishes the foundation for employee relationshipmanagement, allowing our clients to connect their people and processes to theirbusiness strategy to improve performance. Our Technology Solutions Group represented approximately 11 percent ofour total segment revenues for the fiscal year ending June 30, 2004.

 

***Human Capital Group***

 

Our Human Capital Group of 155 associates helps clients achievecompetitive advantage by aligning their workforce with their business strategy.This includes helping clients develop and implement strategies for attracting,retaining and motivating their employees to maximize the return on theirinvestment in human capital. Our Human Capital Group represented approximately7 percent of our total segment revenues for the fiscal year ended June 30,2004.

 

Our Human Capital Group focuses in three principal areas: executivecompensation, Strategic Rewards® and organization effectiveness.

 

*ExecutiveCompensation*

 

We advise our clients’ management and boards of directors on executivepay programs, including cash compensation, stock options and stock purchaseplans, and on ways to align pay-for-performance plans throughout theorganization to increase stockholder value.

 

*Strategic Rewards®*

 

We help align an organization’s rewards – including compensation, stockprograms, incentives, recognition programs and flexible work arrangements –with its business strategies, cultural values, work design and human resourcesstrategy.  Our Human Capital Group andBenefits Group work together to develop optimal total compensation programs forour clients.

 

*OrganizationEffectiveness*

 

We help clients to clarify and implement business strategy, recognizingthe impact of employee attitudes, commitment and effective team and leadershipdevelopment on business success. We provide a wide array of services centeredon organization assessment, including organization measurement and surveys. Inthe area of talent management, we provide tools and methodologies for talentselection and development, succession planning and performance management. Wealso provide consulting regarding organization design and the organization anddevelopment of the HR function.

 

We have created the *Watson Wyatt Human 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.

 

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Our WorkUSA®/WorkCanadaTM database includes theopinions of 12,000 North American employees surveyed independently, reflectinga large cross-section of jobs and industry types. Our clients comparetheir own employee survey results against these norms to identify workplaceperceptions and satisfaction and commitment levels.

 

***InternationalOperations***

 

We manage our operations outside North America geographically.  These operations include 25 offices inAsia-Pacific and Latin America, employing 950 associates, which generallyprovide our full array of services. This segment represented approximately 12percent of our total segment revenues for the fiscal year ended June 30,2004.

 

We established our presence in Asia-Pacific in 1979 with offices inHong Kong and Malaysia and grew substantially throughout the 1980s and 1990s byestablishing new offices and acquiring existing firms.  We have been successful in helping ourclients with complex personnel and cultural issues that are necessary to growtheir businesses.

 

We also provide compensation and benefits surveys in the region, withmore than 50 different survey products. We are a leading provider of retirementand other employee benefit consulting services in Asia-Pacific, and we provideinvestment consulting services to some of the largest pension plans in Japanand Hong Kong.  We were named HRConsultancy of the Year in Hong Kong by *China Staff* magazine for the past sixyears in a row and this year we also received the same award for China. Inaddition to our human capital and benefits consulting services, we also markettechnology solutions to clients in the region.

 

Our Latin American presence began in the early 1980s in Mexico and grewto include such major markets as Brazil in the 1990s. With deregulation,privatization and the influx of multinationals, we believe there aresignificant opportunities for growth in the region, both in the benefits area –where most of our services are concentrated currently – and in the humancapital consulting area.

 

***Other Services***

 

*CommunicationConsulting*

 

In our communication consulting group, we help clients connect peoplewith the organization’s purpose, driving both results and behavioralchange.  Our award-winning work andground-breaking research prove that effective communication increases totalreturns to shareholders; improves service, quality and productivity levels;helps fuel growth; enhances organizational ability to manage changesuccessfully; builds employee community, trust and commitment; and educates,engages and motivates employee behavioral change.  Working with clientswho have responsibility for employee communication in human resources,corporate or line functions, our consultants combine strong creative skillswith technical excellence to create programs that range from high-levelstrategic planning to tactical implementation.

 

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We help clients develop and implement communication strategies fordiverse issues, including:

 

•                  Clarifying the financial value andscope of employee compensation and benefits and enhancing employees’appreciation of their total rewards package

 

•                  Drawing a clear line of sight betweenemployee performance and company objectives through open communication andleadership communication training

 

•                  Optimizing the use of technology incommunication through audits and best practice design

 

•                  Facilitating organizational change so thatall stakeholders fully understand the change and their role in its success

 

•                  Maintaining employee trust, confidence andcommitment through all cycles of performance

 

•                  Demonstrating the return on investment (ROI)of employee communication in achieving business objectives

 

•                  Targeting, attracting and hiring the righttalent to meet business objectives through innovative communication materials

 

*Watson Wyatt DataServices*

 

Watson Wyatt Data Services provides a comprehensive array of globalcompensation, benefits and employment practices information that is oftenstudied and cited by many of our clients and competitors. In the United States,we publish and market an extensive library of reports on human resources issues,and more than 5,000 organizations participate in one or more of our annualsurveys. Our databases contain compensation information for U.S. companies thatemploy over 10 million workers. Detailed compensation and benefits data is maintained for 2 millionworkers in virtually every industry sector and major metropolitan area.  Outside of the United States, our worldwidealliance offers more than 80 remuneration, benefits and employment practicereference guides, covering 50 countries and 6 continents. In addition to ourannual survey reports, we also offer many reference works intended to helppractitioners create or maintain programs in a variety of subject areas,including variable pay, performance management and personnel policies.

 

*Integrated ServiceApproach*

 

While we focus our consulting services in the principal areas describedabove, we draw upon consultants from our different practices to deliverintegrated services to meet the needs of our clients. An example is our TotalRewards approach, which encompasses compensation, benefits, career growth andcompany culture. We help clients determine the correct mix of reward programsto attract and retain the right employees and to motivate them to producedesired results.  We also assemblecross-practice teams to help clients through mergers and acquisitions.

 

*Sales and Marketing*

 

Our growth strategy is based on a commitment to ensuring clientsatisfaction through our account management program.  Our approximately 50 account managers focus on effectively deliveringservices to clients and on expanding our relationships across service lines,geographic boundaries and divisions within client companies.  A key element of this program is an approachwe call ClientFirstTM. Using

 

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proprietary processes and tools, we work with clients to define theirneeds and expectations before an engagement begins and then continually measureour performance according to agreed-upon standards.

 

We pursue new clients using cross-disciplinary teams of consultants, aswell as dedicated business developers who initiate relationships with carefullyselected companies. Our efforts to expand our accounts and our client base aresupported by market research, comprehensive sales training programs andextensive marketing databases. Our sales efforts are also supported by a fullarray of marketing programs designed to raise awareness of the Watson WyattWorldwide brand and our reputation within our target markets. These programspromote our thought leadership on key human resources issues and establish usas a preferred human capital consulting firm to many of the world’s largestcompanies.

 

**Clients**

 

We work with major corporations, emerging growth companies, governmentagencies and not-for-profit institutions in North America, Latin America andAsia-Pacific across a wide variety of industries.  Our client base is broad and geographically diverse.  For the fiscal year ended June 30,2004, our 10 largest clients accounted for approximately 12 percent of ourconsolidated revenues, and no individual client represented more than threepercent of our consolidated revenues.

 

**Competition**

 

The human capital consulting business is highly competitive.  We believe there are several barriers toentry – such as the need to assemble specialized intellectual capital toprovide expertise on a global scale – and that we have developed competitiveadvantages in providing human resources consulting services. However, we faceintense competition from several different sources.

 

Our current and anticipated competitors include:

 

•            Major humanresources-focused consulting firms that compete in serving the large employermarket worldwide, such as Mercer Human Resource Consulting, Towers Perrin andHewitt Associates

 

•            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,Ernst & Young, Mellon Financial Corporation, Aon, and Booz, Allen &Hamilton

 

•            Information technologyconsulting firms, such as Accenture, IBM and BearingPoint, as well asInternet/intranet development firms

 

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

 

The market for our services is subject to change as a result ofincreased regulatory, legislative, competitive and technological developmentsand competition from established and new competitors. We believe the primaryfactors in selecting a human resources consulting firm include reputation, theability to provide measurable increases to stockholder value, global scale,service quality and the ability to tailor services to a clients’ unique needs.We believe we compete favorably with respect to these factors.

 

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**Employees**

 

As of June 30, 2004, the company employed 3,925 associates asfollows:

 
| Benefits Group                                     |   | 1,685 |   |
|----------------------------------------------------|--------|-------|--------|
| Technology Solutions Group                         |   | 320   |   |
| Human Capital Group                                |   | 155   |   |
| International                                      |   | 950   |   |
| Other (including Data Services and  Communication) |   | 585   |   |
| Corporate                                          |   | 230   |   |
| Total                                              |   | 3,925 |   |

 

None of our associates are subject to collective bargainingagreements.  We believe relationsbetween management and associates are good.

 

**Risk Factors**

 

In addition to the factors discussed elsewhere in this report, thefollowing are some of the important factors that could cause our actual resultsto differ materially from those projected 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 andfuture growth depend heavily upon our ability to attract and retain highlyskilled and motivated consultants. We must meet these human capitalrequirements if we are to deliver our sophisticated and technical services toour clients. We compete against many companies with greater financial resourcesboth within our industry and in other industries to attract these qualifiedindividuals. Our failure to recruit and retain adequate talent could reduce ourcompetitive strength and adversely affect our profitability.

 

***The loss of key consultants and managers coulddamage or result in the loss of client relationships and adversely affect ourbusiness.***

 

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 have greater financial, technicaland marketing resources than we have, which could enhance their ability torespond more quickly to technological changes, finance acquisitions and fundinternal growth. New competitors or alliances among competitors could emergeand gain significant market share.

 

12

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***Demand for our services may decrease forvarious reasons, including a general economic downturn or a decline in aclient’s or an industry’s financial condition, that could adversely affect ouroperating 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 clients generally may terminate ourservices at any time, which could decrease associate 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 negativeimpact on 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 management of our fixed-feeengagements 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 be adverselyaffected.

 

***We are subject to malpractice claims arisingfrom our work, which could adversely affect our reputation and business, and weare subject to government inquiries and investigations.***

 

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 cases, our exposure to liability on a particular engagement issubstantially greater than the profit opportunity that the engagement generatesfor us.  For example, claims couldinclude:

 

•      A client’s assertion that actuarialassumptions used in a pension plan were unreasonable, leading to planunderfunding

 

13

 

•                  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. We are subject to inquiries and investigations byfederal, state or other governmental agencies regarding aspects of ourbusiness, especially regulated businesses such as investment consulting orinsurance consulting.  Such inquiries orinvestigations may consume significant management time and require additionalexpense.

 

***Insurance may become more difficult orexpensive to obtain.***

 

Insurance markets have hardenedover recent years for most classes of professional liability risk.  As claims experience has increased forprofessionals, and for actuaries in particular, the cost of malpracticeinsurance has been increasing substantially, and 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 of businessdays in a quarter, associate hiring and utilization rates and clients’ abilityto terminate engagements without penalty

 

•                  The size andscope of assignments

 

•                  The level ofvacation and holidays taken by our associates

 

•                  General economicconditions

 

14

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Approximately 70-75 percent ofour total operating expenses are relatively fixed, encompassing the majority ofadministrative, occupancy, communications and other expenses, depreciation andamortization, and salaries and employee benefits excluding fiscal year-endincentive bonuses.  Therefore, avariation in the number of client assignments or in the timing of theinitiation or the completion of client assignments can cause significantvariations in quarterly operating results and could result in losses.  Over the most recent eight fiscal quarters,net income from continuing operations has fluctuated from $10.8 million to$14.0 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

 

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

 

15

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***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 are developingand implementing additional systems and management reporting to help us manageour global operations, but we cannot predict when these systems will be fullyoperational or how successful they will be. These risks could be aggravated inthe event of a major business disruption caused by terrorist attacks or similarevents.

 

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

 

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 a cost-effectivemanner, our business and operating results might be harmed.

 

The effort to gaintechnological expertise and develop new technologies in our business mayrequire us to incur significant expenses and, in some cases, to implement themglobally. If we cannot offer new technologies as quickly or effectively as ourcompetitors, we could lose market share. We also could lose market share if ourcompetitors develop more cost-effective technologies than we offer or develop.

 

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

 

We cannot guarantee that tradesecret, trademark and copyright law protections are adequate to determisappropriation of our confidential information.  We may be unable to detect the unauthorized use of ourintellectual property and take the necessary steps to enforce our rights.  Redressing infringements also may consumesignificant management time and financial resources.

 

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

 

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

 

***Change in associate ownership could adverselyaffect our firm culture.***

 

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

 

16

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

 

Our certificate of incorporationand bylaws contain provisions that might discourage, delay or prevent a changein control that a stockholder might favor. Our certificate of incorporationand/or bylaws:

 

•                  Authorize theissuance of preferred stock without fixed characteristics that could be issuedby our Board of Directors to increase the number of outstanding shares anddeter a takeover attempt

 

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

 

•                  Provide thatonly the President or our Board of Directors may call a special meeting ofstockholders

 

•                  Prohibitstockholder action by written consent, which requires all actions to be takenat a meeting of the stockholders

 

•                  Provide thatvacancies on our Board of Directors, including new directorships, may be filledonly by the Directors then in office

 

•                  Requiresuper-majority voting for the stockholders to amend our bylaws, the classifiedboard and other provisions of our certificate of incorporation

 

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

 

**Other**

 

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K and amendments to those reports are available, withoutcharge, on our web site (www.watsonwyatt.com), as soon as reasonablypracticable after they are filed electronically with the SEC.  We have also adopted a Code of BusinessConduct and Ethics applicable to all associates, senior financial employees,the principle executive officer, other officers and members of management,which is posted on our website.  WatsonWyatt’s Audit Committee, Compensation Committee and Nominating and GovernanceCommittee all operate pursuant to written charters adopted by the company’sboard of directors, copies of which are available on the company’swebsite.  Copies of all these documentsare also available, without charge, from our Investor Relations department,located in our corporate headquarters at 1717 H Street, NW, Washington, D.C.20006.

 

**Item 2.****           Properties.**

 

We operate in 61 offices in principal markets throughout theworld.  Operations are carried out inleased offices under operating leases that normally do not exceed 10 years inlength. We do not anticipate difficulty in meeting our space needs at leaseexpiration.

 

The fixed assets owned by Watson Wyatt represented approximately 13percent of total assets at June 30, 2004, and consisted primarily ofcomputer equipment, office furniture and leasehold improvements.

 

17

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**Item 3.****           LegalProceedings.**

 

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.  Managementbelieves, based on currently available information, that the results of allpending claims against us will not have a material adverse effect on thecompany.  The matters reported on belowinvolve the most significant pending or potential claims against us.

 

*IronWorkers Local 25 et al. v. Watson Wyatt & Co. *OnJuly 8, 2004, Watson Wyatt & Co. was served with an amendedcomplaint filed by a former client in the United States District Court for theEastern District of Michigan.  Thecomplaint alleges malpractice, breach of contract, and related claims in theperformance of actuarial consulting. The Complaint states that the plaintiff’s Pension Fund is underfunded asa result of the alleged deficiencies in our work.   The amount of damages sought are not specified. Weare in the process of reviewing the claim with outside counsel and preparingour response.

 

*SEC Examination of InvestmentAdvisers. *In December 2003, the Securities andExchange Commission (SEC) formally asked many of the major investmentconsulting firms, Watson Wyatt Investment Consulting among them, to providedetailed information on their business structures and practices in order todetermine if conflicts of interest with money managers exist.  In March 2004, Watson Wyatt InvestmentConsulting (WWIC) completed its responses to the SEC staff’s requests forinformation.  WWIC has received no furtherinquiry from the SEC staff on this topic since that time.

 

*Department of Justice AntitrustInvestigation. *In March 2004, the United StatesDepartment of Justice (DOJ) issued a Civil Investigative Demand (CID) to WatsonWyatt and other companies in the employee benefits industry.  The DOJ is seeking to determine whetherfirms which have entered into agreements with their clients limiting liabilityhave done so in violation of U.S. antitrust laws. Watson Wyatt has providedinformation to DOJ in response to the CID and is in the process of providingthe remaining information requested under the CID.

 

*Client Demand Letter. *On July 23, 2004, we received a demand letter from counsel for aclient alleging that errors in valuations for 2001 and subsequent yearsunderstated the liabilities of its pension plan and overstated its networth.  As a result, the client claimsit did not annuitize its defined benefit plan and redeemed its stock at aninflated price.  The letter claimsdamages “in excess of $35 million.”  Weare investigating these allegations.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders.**

 

None.

 

**Part II**

 

**Item 5.****           MarketPrice of and Dividends on the Registrant’s Common Equity and RelatedStockholder Matters.**

 

In conjunction with our initial public offering (“IPO”) inOctober 2000, we entered into agreements providing for additional transferrestrictions with major stockholders, executive officers and employeedirectors.  As a result of theseagreements, 1,947,272 Class A shares became freely transferable inOctober 2003 and 1,690,778 Class A shares are currently restricted andwill become freely transferable in October 2004.

 

18

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*Market Information*

 

Watson Wyatt & Company Holdings Class A common stock is currentlytraded on the New York Stock Exchange under the symbol WW.  The following table sets forth the range ofhigh and low closing share prices for each quarter of fiscal years 2004 and2003, determined by the daily closing stock prices.

 
|                                                      |   | **2004** |   | **2003** |   |
|-----------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                      |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
|                                                      |   |     |   |     |   |   |   |   |   |
| First quarter (July 1 through  September 30)    |   | $        | 23.49  |     | $      | 22.30 |   | $ | 23.95 |   | $ | 18.30 |   |
| Second quarter (October 1 through  December 31) |   | 24.62    |   | 22.75    |   | 22.50 |   | 17.45 |   |
| Third quarter (January 1 through  March 31)     |   | 25.43    |   | 22.68    |   | 22.16 |   | 18.27 |   |
| Fourth quarter (April 1 through  June 30)       |   | 26.88    |   | 25.13    |   | 23.38 |   | 19.40 |   |
|                                                           |        |          |        |          |        |  |  |  |  |  |  |  |  |

 

*Holders*

 

As of June 30, 2004, there were approximately 650 registeredshareholders of our Class A common stock.

 

*Dividends*

 

In May 2004, the Board of Directors of the company approved theinitiation of a quarterly cash dividend in the amount of $0.075 per share.  The first quarterly dividend payment of $2.4million was made on July 15, 2004, to shareholders of record as ofJune 30, 2004.

 

Under our credit facility (see Note 9 of Notes to the ConsolidatedFinancial Statements, included in Item 15 of this report), we are required toobserve certain covenants (including requirements for a fixed coverage charge,cashflow leverage ratio and asset coverage) that may affect the amountsavailable for the declaration or payment of dividends.  The continued payment of cash dividends inthe future is at the discretion of our Board of Directors and depends onnumerous factors, including, without limitation, our net earnings, financialcondition, availability of capital, debt covenant limitations and our otherbusiness needs, including those of our subsidiaries and affiliates.

 

*Securities Authorized for Issuance Under Equity Compensation Plans*

 

Our equity compensation plans include the 2000 Long-Term IncentivePlan, which provides for the granting of nonqualified stock options and stockappreciation rights, the 2001 Employee Stock Purchase Plan, the 2001 DeferredStock Unit Plan for Selected Employees and the Compensation Plan for OutsideDirectors.  We grant deferred stockunits to our senior associates as a part of their annual discretionarycompensation and have discontinued the issuance of stock options.  All deferred stock units issued in connectionwith the 2001 Deferred Stock Unit Plan were fully vested upon issuance.  The company expects that the deferred stockunits that will be granted in September 2004 will vest immediately.  All of our equity compensation plans havebeen approved by stockholders.  See Note10****ofthe Notes to the Consolidated Financial Statements for the general terms ofthese plans.

 

19

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The following chart gives aggregate information regarding grants underall of the Company’s equity compensation plans through June 30, 2004:

 
| **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 |   | 1,071,915                                                                      |   | $                                                            | 13.45  |                                                                                                                                                         | 4,940,129 | (1) |
|                                                |   |                                                                           |   |                                                         |   |                                                                                                                                                         |      |
| Total                                               |   | 1,071,915                                                                      |   | $                                                            | 13.45  |                                                                                                                                                         | 4,940,129 |   |

 

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(1)Includes 2,548,915 shares remaining available for future issuance under the2000 Long-Term Incentive Plan, 1,304,577 shares under the 2001 Employee StockPurchase Plan, 1,063,528 shares under the 2001 Deferred Stock Unit Plan forSelected Employees and 23,109 shares under the Compensation Plan for OutsideDirectors.

 

In August 2001, the Board of Directors adopted the company’s 2001Employee Stock Purchase Plan (the “ESPP”), which subsequently was approved bythe stockholders in November 2001. The ESPP is intended to provide employees of the company with additionalincentives by permitting them to acquire a proprietary interest in the companythrough the purchase of shares of the company’s common stock.  An additional 1,500,000 shares of commonstock were authorized and reserved for issuance under the ESPP at the 2003Annual Meeting of Stockholders in November 2003.  As discussed below, the company has repurchased shares of commonstock, one purpose of which is to offset potential dilution from shares issuedin connection with this plan.

 

*Issuer Purchases of EquitySecurities*

 

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

 
| **Period**                                       |   | **Total  Number of  Shares  Purchased** |   | **Average  Price  Paid per Share** |   | **Total  Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** |    | **Maximum  Number of  Shares that May Yet  Be Purchased Under  the Plans or Programs** |    |
|--------------------------------------------------|--------|-----------------------------------------|--------|------------------------------------|--------|-------------------------------------------------------------------------------------------|---------|----------------------------------------------------------------------------------------|---------|
| April 1, 2004, through  April 30, 2004 |   | 830,802                                 |   | $                                  | 25.25  |                                                                                      | 830,802 |                                                                                   | 928,934 |   |
| May 1, 2004, through  May 31, 2004               |   | —                                  |   | —                             |   | —                                                                                    |    | 928,934                                                                                |    |
| June 1, 2004, through  June 30, 2004   |   | —                                  |   | —                             |   | —                                                                                    |    | 928,934                                                                                |    |
| Total                                            |   | 830,802                                 |   | $                                  | 25.25  |                                                                                      | 830,802 |                                                                                   |    |   |

 

20

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In May 2003, the company announced a plan to purchase up to 1,150,000shares of our Class A common stock.  Theplan does not have an expiration date.

 

In April 2004, the company purchased 830,802 shares at a price of$25.25 for $21.0 million, as part of a publicly announced tender offer.  The tender offer expired on April 2,2004.

 

**Item 6.****           SelectedConsolidated Financial Data.**

 

The table on the following page sets forth selected consolidatedfinancial data of Watson Wyatt as of June 30, 2004 and for each of theyears in the five-year period ended June 30, 2004.  The selected consolidated financial data asof June 30, 2004 and 2003, and for each of the three years in the periodended June 30, 2004, were derived from the audited consolidated financialstatements of Watson Wyatt included in this Form 10-K.  The selected consolidated financial data asof June 30, 2002, 2001 and 2000, and for each of the years endedJune 30, 2001 and 2000, were derived from audited consolidated financialstatements of Watson Wyatt not included in this Form 10-K.  Earnings per share data for the period endedJune 30, 2000 was also restated to reflect our corporate reorganizationand two-for-one share conversion that occurred in October 2000 as if ourcorporate reorganization and two-for-one share conversion were effective at thebeginning of that period.  See Note 2 ofthe Consolidated Financial Statements for further information regarding thecorporate reorganization and share conversion.

 

The consolidated financial data should be read in conjunction with ourConsolidated Financial Statements and notes thereto and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in Item 7 of this Form 10-K. Amounts are in thousands of U.S. Dollars except per share data.

 

21

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|                                                                                  |   | **Year Ended  June 30** |    |
|---------------------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                                  |   | **2004**                     |    | **2003** |   | **2002** |   | **2001** |   | **2000** |   |
| **Statement of  Operations Data:**  (amounts are in thousands, except per share data) |   |                         |    |   |   |   |   |   |   |   |   |
|                                                                                  |   |                         |    |   |   |   |   |   |   |   |   |
| Revenue                                                                               |   | $                            | 702,005 |   | $ | 709,616 |   | $ | 710,480 |   | $ | 700,189 |   | $ | 624,583 |   |
| Costs of providing services:                                                          |   |                         |    |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                                                        |   | 396,775                      |    | 401,274 |   | 404,822 |   | 379,645 |   | 339,904 |   |
| Stock incentive bonus plan (a)                                                        |   | —                       |    | — |   | — |   | — |   | 30,283 |   |
| Professional and subcontracted services                                               |   | 49,159                       |    | 47,356 |   | 48,724 |   | 54,089 |   | 49,890 |   |
| Occupancy, communications and other                                                   |   | 105,459                      |    | 106,224 |   | 109,163 |   | 114,417 |   | 101,733 |   |
| General and administrative expenses                                                   |   | 63,631                       |    | 57,285 |   | 55,517 |   | 57,475 |   | 54,115 |   |
| Depreciation and amortization                                                         |   | 18,511                       |    | 19,621 |   | 20,049 |   | 21,995 |   | 17,878 |   |
|                                                                                  |   | 633,535                      |    | 631,760 |   | 638,275 |   | 627,621 |   | 593,803 |   |
|                                                                                  |   |                         |    |   |   |   |   |   |   |   |   |
| Income from operations                                                                |   | 68,470                       |    | 77,856 |   | 72,205 |   | 72,568 |   | 30,780 |   |
|                                                                                  |   |                         |    |   |   |   |   |   |   |   |   |
| Income from affiliates                                                                |   | 7,109                        |    | 5,787 |   | 2,866 |   | 3,780 |   | 3,001 |   |
| Interest income (expense), net                                                        |   | 743                          |    | 991 |   | 1,235 |   | 1,711 |   | (53 | ) |
| Other non-operating income                                                            |   | 6,222                        |    | 761 |   | 2,166 |   | — |   | — |   |
|                                                                                  |   |                         |    |   |   |   |   |   |   |   |   |
| Income from continuing operations before  income taxes                                |   | 82,544                       |    | 85,395 |   | 78,472 |   | 78,059 |   | 33,728 |   |
| Provision for income taxes                                                            |   | 32,605                       |    | 35,015 |   | 31,388 |   | 33,623 |   | 15,195 |   |
| Income from continuing operations                                                     |   | 49,939                       |    | 50,380 |   | 47,084 |   | 44,436 |   | 18,533 |   |
| Discontinued operations (b)                                                           |   | 654                          |    | 6,786 |   | — |   | — |   | — |   |
| Net income                                                                            |   | $                            | 50,593  |   | $ | 57,166 |   | $ | 47,084 |   | $ | 44,436 |   | $ | 18,533 |   |
| Earnings per share, continuing operations,  basic                                     |   | $                            | 1.52    |   | $ | 1.52 |   | $ | 1.43 |   | $ | 1.39 |   | $ | 0.62 |   |
| Earnings per share, continuing operations,  diluted                                   |   | $                            | 1.50    |   | $ | 1.51 |   | $ | 1.41 |   | $ | 1.37 |   | $ | 0.62 |   |
| Earnings per share, discontinued  operations, basic                                   |   | $                            | 0.02    |   | $ | 0.21 |   | $ | — |   | $ | — |   | $ | — |   |
| Earnings per share, discontinued  operations, diluted                                 |   | $                            | 0.02    |   | $ | 0.21 |   | $ | — |   | $ | — |   | $ | — |   |
| Earnings per share, net income, basic                                                 |   | $                            | 1.54    |   | $ | 1.73 |   | $ | 1.43 |   | $ | 1.39 |   | $ | 0.62 |   |
| Earnings per share, net income, diluted                                               |   | $                            | 1.52    |   | $ | 1.72 |   | $ | 1.41 |   | $ | 1.37 |   | $ | 0.62 |   |
| Weighted average shares of common stock,  basic                                       |   | 32,866                       |    | 32,962 |   | 32,985 |   | 32,068 |   | 30,000 |   |
| Weighted average shares of common stock,  diluted                                     |   | 33,207                       |    | 33,287 |   | 33,421 |   | 32,363 |   | 30,000 |   |

 
|                      |   | **As of  June 30** |    |
|---------------------------|--------|-------------------------|---------|
|                      |   | **2004**                |    | **2003** |   | **2002** |   | **2001** |   | **2000** |   |
| **Balance Sheet Data:**   |   |                    |    |   |   |   |   |   |   |   |   |
| Cash and cash equivalents |   | $                       | 156,940 |   | $ | 144,374 |   | $ | 95,974 |   | $ | 81,735 |   | $ | 41,410 |   |
| Working capital           |   | 207,455                 |    | 169,308 |   | 123,171 |   | 96,171 |   | 16,177 |   |
| Total assets              |   | 512,168                 |    | 514,462 |   | 436,817 |   | 392,016 |   | 334,520 |   |
| Note payable              |   | —                  |    | — |   | — |   | — |   | — |   |
| Dividends declared        |   | 2,441                   |    | — |   | — |   | — |   | — |   |
| Stockholders’ equity |   | 245,184                 |    | 151,737 |   | 159,221 |   | 111,885 |   | (81,109 | ) |
| Redeemable common stock   |   | —                  |    | — |   | — |   | — |   | 115,480 |   |
| Shares outstanding        |   | 32,317                  |    | 32,943 |   | 32,897 |   | 33,033 |   | 29,610 |   |
|                           |        |                         |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a)       Following the initial public offering inOctober 2000, we terminated the stock incentive bonus plan and replaced itwith equity-based incentive plans more customary to publicly-traded companies.

(b)      In fiscal year 2004 and 2003, we revisedour estimates related to the remaining future obligations and costs associatedwith the discontinuation of our benefits administration outsourcingbusiness.  As a result, we reduced theamount of our liability for losses from disposal by $11.4 million, less theassociated income tax expense of $4.7 million, and by $1.0 million, less theassociated income tax expense of $0.4 million, respectively.  In fiscal years 2004 and 2003, the companyreceived sublease income of approximately $106,000 and $40,000 in excess oflease payments related to this business, resulting in a year-to-date incomefrom discontinued operations of $1.1 million and $11.5 million, less theassociated income tax expense of $0.5 million and $4.7 million.

 

**Item 7.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

**SpecialNote Regarding Forward-Looking Statements**

 

This filing contains certain statements that are “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995, including, but not limited to the following: the first paragraph ofPart I, Item 3 “Legal Proceedings” on page 18; “the Executive Overview” on page23 through 25; the second paragraph under “Revenue Recognition” on page 26;under the heading “Pension Assumptions” on pages 27 and 28; under the heading“Incurred But Not Reported Claims” on pages 28 and 29; the paragraph underCapital Commitments on page 35; under the heading “Risk Management” on pages 36and 37; under the subheading “Stock-based Compensation” in Note 1 “Summary ofSignificant Accounting Policies” on pages 52 and 53; the projected contributiontable in Note 6 “Retirement Benefits” on page 59; the benefit payments table inNote 6 “Retirement Benefits” on page 63; the benefit payments table in Note 6“Retirement Benefits” on page 67; in the second paragraph of Note 10 “EmployeeStock Plans and Equity” on page 69; in the second paragraph under the heading“2001 Deferred Stock Unit Plan for Selected Employees” in Note 10 on page 72;and in the second and fifth paragraphs of Note 14 “Commitments and ContingentLiabilities” on pages 79 and 80.  Insome cases, you can identify these statements and other forward-lookingstatements in this filing by words such as “may,” “will,” “expect,”“anticipate,” “believe,” “estimate,” “plan,” “intend,” “continue” or similarwords. You should read these statements carefully because they containprojections of our future results of operations or financial condition, orstate other “forward-looking” information. A number of risks and uncertainties exist which could cause actualresults to differ materially from the results reflected in theseforward-looking statements.  Suchfactors include but are not limited to our continued ability to recruit andretain highly qualified associates; outcomes of litigation; the ability of thecompany to obtain professional liability insurance; a significant decrease inthe demand for the consulting services we offer as a result of changingeconomic conditions or other factors; actions by competitors offering humanresources consulting services, including public accounting and consultingfirms, technology consulting firms and internet/intranet development firms;regulatory, legislative and technological developments that may affect thedemand for or costs of our services and other factors discussed under “Riskfactors” in 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.

 

**ExecutiveOverview**

 

Watson Wyatt & Company Holdings is a global provider of humancapital consulting services.  We provideservices in three principal practice areas: Benefits, Technology Solutions andHuman Capital consulting, operating from 61 offices in 18 countries throughoutNorth America, Asia-Pacific and Latin America. We also operate through our affiliates in Europe: Watson Wyatt LLP –which conducts operations in the United Kingdom and Ireland and in which wehold a 10 percent interest in a defined distribution pool – and Watson Wyatt& Company Holdings (Europe) Limited, a holding company through which weconduct Continental European operations. We own 25 percent of Watson Wyatt & 

 

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Company Holdings (Europe) Limited and Watson Wyatt LLP owns theremaining 75 percent.  We collectivelymarket our services globally under the Watson Wyatt Worldwide brand, sharingresources, technologies, processes and business referrals with our alliancepartners.

 

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

 

*Benefits Group –*The Benefits Group,accounting for 64 percent of our fiscal year 2004 revenues, is the foundationof our business.  Retirement, the coreof our Benefits business, is less impacted by discretionary spending reductionsthan our other segments, mainly due to the recurring nature of manyprojects.  Our corporate clientretention rate within this group has remained very high, averaging over 95percent over the past two years. Revenue for our retirement practice isseasonal, with the third and fourth quarters of each fiscal year being thebusier periods.  Major revenue growthdrivers in this practice include changes in regulations, particularly thoseaffecting pension plans, leverage from other practices, an improving economy,increased global demand and increased market share.

 

*Technology Solutions Group –*Our TechnologySolutions Group, accounting for 11 percent of our fiscal year 2004 revenues,provides information technology services to our customers.  In fiscal year 2004, delays in discretionarytechnology spending resulted in lower revenues, but the backlog of work, whichis a fairly accurate indicator of future revenues, has improved over thepast two quarters.  We are seeingparticular acceptance of our scalable benefits administration solutions as analternative to total business process outsourcing.  Enhancing our applications and leveraging our other segments arevital to our growth strategy.

 

*Human Capital Group –*Our**Human Capital Group,accounting for 7 percent of our fiscal year 2004 revenues, generallyencompasses short-term projects and as a result is most sensitive to economicconditions.  Growth slowed significantlyin the second half of fiscal year 2001 and continued to contract in fiscalyears 2002, 2003 and 2004.  Presently,our Executive Compensation area is seeing vigorous demand in response to issuesrelated to stock compensation programs and changes resulting from new accountingrules, but this increase is offset by weak demand for broad-based talentmanagement consulting.

 

In the short term, our revenues are driven by many factors includingthe general state of the economy and the resulting level of discretionaryspending by our clients, the ability of our consultants to attract new clientsor cross-sell to existing clients, and the impact of new regulations in thelegal and accounting fields that most recently increased demand for ourexecutive compensation and benefits practices. During fiscal year 2004, we continued to add new target market clients,and grew revenues from existing clients.

 

The human resources consulting industry, although highly fragmented, ishighly competitive and is comprised of major human capital consulting firms,specialist firms, consulting arms of accounting firms and informationtechnology consulting firms.  Ouroverall revenues have been flat over the past three years, and it is clear thatthe competitive environment will remain challenging until the economy reboundsand companies are committed to spending on human capital projects.  To mitigate the pressures faced by theeconomic downturn, we have successfully managed costs throughout the company byleveraging our variable compensation cost structure, initiating targeted jobreductions and controlling discretionary spending.  We believe we are well-positioned to take advantage of animprovement in the overall economy.

 

In the long term, we believe that benefits spending will continue to bethe largest component of U.S. corporate spending.  We believe that the aging workforce, the projected shortfall inworkers over the next decade and changing regulations will translate intoopportunities for us.  We believe thatthe company’s

 

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financial results will depend in large part upon how well we succeed indeepening our existing client relationships through thought leadership andfocus on cross-practice solutions, actively pursuing new clients in our targetmarkets, cross selling and strategic acquisitions.  We believe that our highly fragmented industry representstremendous growth opportunities for us, because we are the only firm to offer acomprehensive line of benefits and human capital consulting as well asstrategic technology solutions.

 

**FinancialStatement Overview**

 

The financial statements contained in this annual report on Form 10-Kreflect Consolidated Balance Sheets as of June 30, 2004 and 2003,Consolidated Statements of Operations for the 12-month periods endedJune 30, 2004, 2003 and 2002, Consolidated Statements of Cash Flows forthe 12-month periods ended June 30, 2004, 2003 and 2002, and aConsolidated Statement of Changes in Stockholders’ Equity for the 12-monthperiods ended June 30, 2004, 2003 and 2002.

 

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

 

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

 

In delivering consulting services, our principal direct expenses relateto compensation of personnel. Salaries and employee benefits are comprised ofwages paid to associates, related taxes, benefit expenses such as pension,medical and insurance costs and fiscal year-end incentive bonuses.

 

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

 

Occupancy, communications and other expenses represent expenses forrent, utilities, supplies and telephone to operate office locations as well asnon-client-reimbursed travel by associates, publications and professionaldevelopment. General and administrative expenses include the operational costsand professional fees paid by corporate management, general counsel, marketing,human resources, finance, research and technology support.

 

**Critical AccountingPolicies and Estimates**

 

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

 

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experience.  Because of the useof estimates inherent in the financial reporting process, actual results coulddiffer from those estimates.  Theaccounting policies discussed below are critical to the understanding of theuse of estimates in the company’s financial statements.

 

***Revenue Recognition***

 

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

 

Revenue is recognized on time-and-materials engagements based onbillable rates times hours worked plus expenses incurred.  For fixed-fee arrangements, revenue is alsorecognized based on billable rates times hours worked plus expensesincurred.  However, for significantfixed-fee engagements in our Technology Solutions Group, we periodically reviewongoing engagements through the preparation of an estimate-to-complete.  Revenue recognition for fixed-feeengagements is affected by a number of factors that change the estimated amountof work required to complete the project such as changes in scope, the staffingon the engagement and/or the level of client participation.  These periodic engagement reviews require usto make judgments and estimates regarding the overall profitability and stageof project completion which, in turn, affect how we recognize revenue.  The company recognizes a loss on anengagement when estimated revenue to be received for that engagement is lessthan the total estimated direct and indirect costs associated with the engagement.  Losses are recognized in the period in whichthe loss becomes probable and the amount of the loss is reasonably estimable.

 

The companyhas developed various software programs and technologies that we provide toclients in connection with consulting services.  In most instances, such software is hosted and maintained by thecompany.  Software developed to beutilized in providing services to a client, but for which the client does nothave the contractual right to take possession, is capitalized in accordancewith the AICPA’s Statement of Position 98-1 “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.”  Revenue associated with the relatedcontract, together with amortization of the related capitalized software, is recognizedover the service period.

 

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

 

In December 2003, the Securities and Exchange Commission (SEC)issued Staff Accounting Bulletin No. 104 (SAB 104), “Revenue Recognition,”which supercedes Staff Accounting Bulletin No. 101 (SAB 101), “RevenueRecognition in Financial Statements.” The primary purpose of SAB 104 is to rescind accounting guidancecontained in SAB 101 related to multiple element revenue arrangements,superceded as a result of the issuance of EITF 00-21.  While the wording of SAB 104 has changed to reflect the issuanceof EITF 00-21, the revenue recognition principles of SAB 101 remain largelyunchanged by the issuance of SAB 104. The issuance of SAB 104 has not had an effect on our revenue recognitionpolicies as they are in accordance with SAB 104.

 

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

 

We maintain allowances for doubtful accounts to reflect estimatedlosses resulting from our clients’ failure to pay for our services after theservices have been rendered, including allowances when customer disputes mayexist.  The related provision isrecorded as a reduction to revenue.  Ourallowance policy is

 

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based on the aging of our billed and unbilled client receivables andhas been developed based on our write-off history.  Facts and circumstances such as the average length of time thereceivables are past due, general market conditions, current economic trendsand our clients’ ability to pay may cause fluctuations in our valuation ofbilled and unbilled receivables.

 

***DiscretionaryCompensation***

 

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

 

An estimated annual bonus amount is initially developed at thebeginning of each fiscal year in conjunction with our budgeting process.  Quarterly, estimated annual operatingperformance is reviewed by the company and the discretionary annual bonusamount is then adjusted, if necessary, by management to reflect changes in theforecast of pre-bonus profitability for the year.  After determining the estimated annual bonus amount, the bonus isthen allocated to remaining quarterly reporting periods as a constantpercentage of estimated pre-bonus profitability.  In those quarters where the estimated annual bonus level changes,the remaining estimated annual bonus is accrued over the remaining quarters asa constant percentage of estimated future pre-bonus profitability.  Annual bonus levels may vary from currentexpectations as a result of changes in the company’s forecast of pre-bonusprofitability and competitive employment market conditions.

 

As a result of a $5.6 million pre-tax non-operating gain recorded inthe first quarter of fiscal year 2004, the company recorded a $5.6 millionsupplemental bonus accrual in the first quarter that is incremental to thecompany’s fiscal year end bonus.  Thissupplemental bonus amount, which will be paid out in September 2004 withthe regular bonus cycle, is included in salaries and employee benefits.  Management does not expect this charge torecur.

 

***Income Taxes***

 

Determining the consolidated provision for income tax expense, deferredtax assets and liabilities and the related valuation allowance involvesjudgment.  As a global company withoffices in 18 countries, we are required to calculate and provide for estimatedincome tax liabilities for each of the tax jurisdictions in which weoperate.  This process involvesestimating current tax obligations and exposures in each jurisdiction as wellas making judgments regarding the future recoverability of deferred taxassets.  Tax costs can involve complexissues and may require an extended period to resolve.  Changes in the geographic mix or estimatedlevel of annual pre-tax income, limitations on the use of the company’s foreignsubsidiary losses, changes in tax laws and changes resulting from tax auditscan all affect the overall effective income tax rate which, in turn, impactsthe overall level of income tax expense and net income.

 

***Pension Assumptions***

 

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

 

Pension and OtherPostretirement Employee Benefits (OPEB) costs and obligations are dependent onassumptions used in calculating such amounts. These assumptions include discount rates, health-care cost trend rates,benefits earned, interest cost, expected return on plan assets, mortalityrates, and other factors.  In accordancewith GAAP, actual results that differ from the assumptions are accumulated andamortized

 

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over future periods and,therefore, generally affect recognized expense and the recorded obligation infuture periods.  While managementbelieves that the assumptions used are appropriate, differences in actualexperience or changes in assumptions may affect Watson Wyatt & Company’spension and other postretirement obligations and future expense.

 

The company has establisheda discount rate of 6.25% at year-end June 30, 2004, for its U. S.pension and OPEB plans which represents a 25 basis point increase from the6.00% discount rate used for the prior year. The company’s U. S. pre-tax pension expense is forecasted todecrease from approximately $29 million in fiscal year 2004, excluding anycurtailments and settlements, to approximately $21 million in fiscal year 2005due to the approximately 19% fiscal year 2004 actual return on assets, a $10million pension contribution in fiscal year 2004 and the increase in thediscount rate.  The U.S. OPEB planexpense is expected to remain constant at $2 million for fiscal year 2005.

 

The expected long-term rate of return on assets assumption remainedunchanged at 9.00 percent at the end of fiscal year 2004.  Selection of the 9.00 percent returnassumption was supported by an analysis performed by the company of theweighted-average yield expected to be achieved with the anticipated investmentallocations.  The investment makeup isheavily weighted towards equities.  Thereturn on assets in fiscal year 2004 was 19 percent, compared to a return of 2percent in fiscal year 2003.

 

The following informationillustrates the sensitivity to a change in certain assumptions for the U. S.pension plans:

 
| **Change in  Assumption**                             |   | **Effect on  FY2005  Pre-Tax Pension Expense** |   |
|-------------------------------------------------------|--------|------------------------------------------------|--------|
| 25 basis point decrease in discount rate              |   | +$2.8 million                                  |   |
| 25 basis point increase in discount rate              |   | -$2.6 million                                  |   |
| 25 basis point decrease in expected return  on assets |   | +$1.0 million                                  |   |
| 25 basis point increase in expected return  on assets |   | -$1.0 million                                  |   |

 

The above sensitivitiesreflect the impact of changing one assumption at a time. It should be notedthat economic factors and conditions often affect multiple assumptionssimultaneously and the effects of changes in key assumptions are notnecessarily linear.

 

These changes in assumptionswould have no effect on the company’s funding requirements. In addition, atJune 30, 2004, a 25 basis point decrease in the discount rate would causethe accumulated benefit obligation to exceed the value of plan assets, therebynecessitating the recording of a minimum pension liability.  As a result, we would be required to record anincrease in the pension liability of $53.5 million, a non-cash charge tostockholders’ equity of $32.4 million and an increase in deferred tax assets of$21.1 million.  A 25 basis pointincrease in the discount rate would have no impact on the liability,stockholders’ equity or deferred tax assets since there is no unfundedaccumulated benefit obligation when using either a 6.25% or 6.50% discountrate.

 

Thecompany U.S. Other Postretirement Employee Benefits plan is relativelyinsensitive to discount rate changes due to the plan provisions that have beenestablished to control costs and as such no sensitivity results are shown inthis display.

 

***Incurred But NotReported Claims***

 

The company usesactuarial assumptions to estimate and record a liability for incurred but notreported (IBNR) professional liability claims and engaged an external actuarialfirm to assist in the calculation of

 

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these estimates.  Our estimated IBNR liability is based onlong-term trends and averages, and considers a number of factors, includingchanges in claim reporting patterns, claim settlement patterns, judicialdecisions, and legislation and economic decisions, but excludes the effect ofclaims data for large cases due to the insufficiency of actual experience withsuch cases.  Management does notcurrently expect significant fluctuations in the IBNR liability, based on thecompany’s historical claims experience. However, our estimated IBNR liability will fluctuate if claimsexperience changes over time.

 

**Results of Operations**

 

The following table setsforth Consolidated Statement of Operations data as a percentage of revenue forthe periods indicated:

 
|                                                   |   | **Year ended  June 30** |   |
|--------------------------------------------------------|--------|------------------------------|--------|
|                                                   |   | **2004**                     |   | **2003** |   | **2002** |   |
|                                                   |   |                         |   |   |   |   |   |
| Revenue                                                |   | 100.0                        | %      | 100.0 | % | 100.0 | % |
|                                                   |   |                         |   |   |   |   |   |
| Costs of providing services:                           |   |                         |   |   |   |   |   |
| Salaries and employee benefits                         |   | 56.5                         |   | 56.5 |   | 56.9 |   |
| Professional and subcontracted services                |   | 7.0                          |   | 6.7 |   | 6.9 |   |
| Occupancy, communications and other                    |   | 15.0                         |   | 14.9 |   | 15.4 |   |
| General and administrative expenses                    |   | 9.1                          |   | 8.1 |   | 7.8 |   |
| Depreciation and amortization                          |   | 2.6                          |   | 2.8 |   | 2.8 |   |
|                                                   |   | 90.2                         |   | 89.0 |   | 89.8 |   |
|                                                   |   |                         |   |   |   |   |   |
| Income from operations                                 |   | 9.8                          |   | 11.0 |   | 10.2 |   |
|                                                   |   |                         |   |   |   |   |   |
| Income from affiliates                                 |   | 1.0                          |   | 0.8 |   | 0.4 |   |
| Interest income, net                                   |   | 0.1                          |   | 0.1 |   | 0.1 |   |
| Other non-operating income                             |   | 0.9                          |   | 0.1 |   | 0.3 |   |
|                                                   |   |                         |   |   |   |   |   |
| Income from continuing operations before  income taxes |   | 11.8                         |   | 12.0 |   | 11.0 |   |
|                                                   |   |                         |   |   |   |   |   |
| Provision for income taxes                             |   | 4.7                          |   | 4.9 |   | 4.4 |   |
|                                                   |   |                         |   |   |   |   |   |
| Income from continuing operations                      |   | 7.1                          | %      | 7.1 | % | 6.6 | % |

 

**Fiscal Year EndedJune 30, 2004, Compared to Fiscal Year Ended June 30, 2003**

 

***Revenue***

 

Revenues for fiscal year 2004 were $702.0 million, a decrease of 1percent from $709.6 million in the prior period.

 

The Benefits Group increased revenue by $17.8 million or 4 percentduring fiscal year 2004 due to new client wins, as well as growth in the healthcare consulting group related to retainer contracts and consumer driven healthplan design.  Revenue from ourTechnology Solutions Group decreased by $17.3 million or 18 percent, reflectinga delay in starting certain projects as well as the exclusion of $2.7 millionof consultant time spent customizing administration systems.  Revenue from our Human Capital Group

 

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decreased $1.6 million or 3 percent during fiscal year 2004, reflectingincreased demand in executive compensation offset by weak results inorganization effectiveness consulting. Our international segment finished the fiscal year with revenue growthof $6.7 million or 9 percent.  However,revenue was up 1% after adjusting for the impact of the weakening U.S.dollar.  Revenue for other practiceareas in North America decreased by $5.9 million or 12 percent during fiscalyear 2004.

 

***Salaries andEmployee Benefits***

 

Salaries and employee benefit expenses for fiscal year 2004 were $396.8million, a decrease of 1 percent from $401.3 million in the prior period, andremained at 56.5 percent as a percentage of revenue.  Salaries and employee benefit expenses for fiscal year 2004 includeseverance charges of $3.2 million related to the company’s job reductions inNorth America, compare to severance charges of $1.8 million in fiscal year2003.  The $5.9 million decrease,exclusive of these charges, was due to lower benefits costs of $9.1 million,which reflects the suspension of the company match on our defined contributionretirement plan and reduced health care costs to the company, and to lowersalaries of $5.1 million, which reflects the company’s targeted job reductionsnet of modest salary increases.  Thesedecreases are partially offset by higher pension and post-retirement expensesof $5.7 million and by a higher accrual for discretionary compensation of $2.9million.

 

***Professional andSubcontracted Services***

 

Professional and subcontracted services were $49.2 million for fiscalyear 2004, an increase of 4 percent from $47.4 million in the prior period, andincreased as a percentage of revenue to 7.0 percent from 6.7 percent.  The increase is the result of legalprovisions recorded to meet the company’s self-insured retention where specificestimated losses are considered probable and estimable.

 

***Occupancy,Communications and Other***

 

Occupancy, communications and other expenses were $105.5 million forfiscal year 2004, a decrease of 1 percent from $106.2 million in the priorperiod, and increased as a percentage of revenue to 15.0 percent from 14.9percent.  Occupancy, communications andother expenses include a $1.9 million charge resulting from a lease terminationas further described below under Off-Balance Sheet Arrangements and ContractualObligations – Operating Leases.  Thedecrease, exclusive of this charge, reflects the company’s cost containmentmeasures, as evidenced through lower expenses in many categories includingoffice supplies, telephone, general office and promotional expenses.

 

***General andAdministrative Expenses***

 

General and administrative expenses were $63.6 million for fiscal year2004, an increase of 11 percent from $57.3 million in the prior period, andincreased as a percentage of revenue to 9.1 percent from 8.1 percent.  The increase is mainly due to higherinsurance costs of $5.5 million, a $1.3 million charge resulting from a leasetermination as further described below under Off-Balance Sheet Arrangements andContractual Obligations – Operating Leases and expenses associated withcompliance with the Sarbanes-Oxley Act of 2002 and related SEC rules of $1.4million.

 

***Depreciation andAmortization***

 

Depreciation and amortization expense was $18.5 million for fiscal year2004, a decrease of 6 percent from $19.6 million in the prior period, anddecreased as a percentage of revenue to 2.6 percent from 2.8 percent.  The decrease was due to lower capitalspending during fiscal year 2003.

 

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***Income FromAffiliates***

 

Income from affiliates was $7.1 million, an increase of 22 percent from$5.8 million in the prior period.  Theincrease was due to the company’s interest in higher operating results ofWatson Wyatt LLP of $1.0 million and WWHE of $0.2 million, partially offset bylower equity income of PCIC of $0.2 million.

 

***Interest Income, Net***

 

Interest income, net was $0.7 million for fiscal year 2004, a decreaseof 30 percent from $1.0 million in the prior period.  The decrease was attributable to lower interest rates earned onour cash and cash equivalents.

 

***Other Non-OperatingIncome***

 

Other non-operating income was$6.2 million for fiscal year 2004, which is principally attributable to the$5.6 million non-operating gain the company recorded related to PCIC which thecompany does not expect to recur.  SeeNote 18 of the Notes to the Consolidated Financial Statements for moreinformation about this non-operating gain. During fiscal years 2004 and 2003, the company also received cashpayments of $0.6 million in connection with the fiscal year 2002 sale of ourU.S.-based public retirement business to GRS. All payments received in connection with this sale were contingent uponthe successful transition of certain clients to GRS and upon their retention byGRS.

 

***Provision for IncomeTaxes***

 

Provision for income taxes was$32.6 million for fiscal year 2004, compared to $35.0 million for the priorperiod.  Our effective tax rate was 39.5percent for fiscal year 2004, compared to 41.0 percent for fiscal year2003. The change in rate was principally due to the realization of tax creditsclaimed on previously filed amended returns.

 

*** Income From Continuing Operations***

 

Income from continuing operations was $49.9 million, a decrease of 1percent from $50.4 million in the prior period.  As a percentage of revenue, income from continuing operationsremained at 7.1 percent.

 

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

 

Diluted earnings per share, income from continuing operations was $1.50for fiscal year 2004, compared to $1.51 in the prior period.  Included in the 2004 earning per shareamount is a $3.2 million lease loss, or $0.06 per share.

 

***DiscontinuedOperations***

 

Discontinued operations for fiscal years 2004 and 2003 reflect thereduction of the company’s accrual for the estimated remaining futureobligations and costs related to the exit from Wellspring by $1.0 million and$11.4 million, respectively, less the associated income tax expenses.  Also, during fiscal year 2004 and 2003, thecompany received sublease income of approximately $0.1 million and $40,000,respectively, in excess of lease payments related to Wellspring.  See Note 16 of the Notes to the ConsolidatedFinancial Statements for more information related to Wellspring.

 

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**Fiscal Year EndedJune 30, 2003, Compared to Fiscal Year Ended June 30, 2002**

 

***Revenue***

 

Revenue from operations was $709.6 million for fiscal year 2003,compared to $710.5 million in fiscal year 2002.  The Benefits Group increased revenue by $7.4 million or 2 percentduring fiscal year 2003 due to new client wins, special project work related tothe Health Insurance Portability and Accountability Act of 1996 and risinghealth care costs.  Revenue from ourTechnology Solutions Group decreased by $10.3 million or 10 percent, reflectingcontinued weakness in capital spending. Revenue from our Human Capital Group decreased $0.7 million or 1 percentduring fiscal year 2003, but ended the year with 5 percent growth in the fourthquarter as we secured a number of new engagements with major companies forstock program advice and executive compensation work.  Our international segment finished the fiscal year with revenuegrowth of $7.3 million or 11 percent, as a result of increased demand forretirement work in Australia, New Zealand and Japan.  Revenue for other practice areas in North America decreased by$8.6 million or 15 percent during fiscal year 2003.

 

***Salaries andEmployee Benefits***

 

Salaries and employee benefit expenses for fiscal year 2003 were $401.3million, a decrease of 1 percent from $404.8 million in fiscal year 2002, anddecreased as a percentage of revenue to 56.5 percent from 56.9 percent.  Salaries and employee benefit expenses forfiscal year 2003 include severance charges of $1.8 million related to thecompany’s targeted job reductions, mainly in our Human Capital and TechnologySolutions groups, all of which had been paid to associates under severanceagreements.  The decrease, exclusive ofthis charge, was due to a $12.0 million decrease in the provision fordiscretionary compensation and a $0.8 million decrease in base salaries as aresult of headcount reductions and attrition in North America, net of a $9.3million increase in pension costs and modest annual salary increases.            Excluding severancecosts, salaries and employee benefit expenses would have been 56.3 percent ofrevenue for fiscal year 2003.

 

***Professional andSubcontracted Services***

 

Professional and subcontracted services were $47.4 million for fiscalyear 2003, a decrease of 3 percent from $48.7 million in fiscal year 2002, anddecreased as a percentage of revenue 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 and other expenses were $106.2 million forfiscal year 2003, a decrease of 3 percent from $109.2 million in fiscal year2002, and decreased as a percentage of revenue to 14.9 percent from 15.4 percent.  The company implemented successful costcontainment strategies during the second quarter of fiscal year 2002 which hadcontinued through the period, resulting in lower travel, telephone and otherdiscretionary expenses for the year. These decreases were partially offset by increases in rent expense of$1.5 million.

 

***General andAdministrative Expenses***

 

General and administrative expenses for fiscal year 2003 were $57.3million, an increase of 3 percent from $55.5 million in fiscal year 2002, and increasedas a percentage of revenue to 8.1 percent from 7.8 percent.  The increase is mainly due to higherinsurance expenses of $1.5 million and additional expenses

 

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associated with compliance with the Sarbanes-Oxley Act of 2002 ofapproximately $0.4 million, partially offset by lower base salaries of $1.0million.

 

***Depreciation andAmortization***

 

Depreciation and amortization for fiscal year 2003 was $19.6 million, adecrease of 2 percent from $20.0 million in fiscal year 2002.  As a percentage of revenue, depreciation andamortization remained at 2.8 percent. The decrease was due to lower purchases of capital assets during fiscalyear 2003.

 

***Interest Income, Net***

 

Interest income, net for fiscal year 2003 was $1.0 million, a decreaseof 17 percent from $1.2 million in fiscal year 2002.  The decrease was attributable to lower interest rates earned onour cash and cash equivalents.

 

***Other Non-OperatingIncome***

 

During fiscal year 2003, the company received cash payments of $0.6million in connection with the sale of our U.S.-based public retirementbusiness. During fiscal year 2002, the company received a cash payment of $1.0million as a result of this sale, and also recorded a $1.2 million gain on thesale of common stock that the company received as a result of thedemutualization of a health and general insurance provider.

 

***Income FromAffiliates***

 

Income from affiliates for fiscal year 2003 was $5.8 million, anincrease of 100 percent from $2.9 million in fiscal year 2002.  The increase was due to improved operationsof our affiliated captive insurance company, Professional Consultants InsuranceCompany (PCIC) of $1.8 million, and the company’s interest in improved performanceof our European affiliates, Watson Wyatt LLP and Watson Wyatt Holdings (Europe)Limited, of $0.4 million and $0.8 million, respectively.

 

***Provision for IncomeTaxes***

 

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

 

***Income FromContinuing Operations***

 

Income from continuing operations for fiscal year 2003 was $50.4million, an increase of 7 percent from $47.1 million in fiscal year 2002.  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, income from continuing operations forfiscal year 2003 was $1.51, an increase of 7 percent from $1.41 in fiscal year2002.

 

***DiscontinuedOperations***

 

During the third quarter of fiscal year 2003 the company reduced theamount of its estimated liability for losses from the exit from Wellspring, theCompany’s benefits administration outsourcing business, by

 

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$11.4 million, net of associated tax expense of $4.7 million.  During the fourth quarter of fiscal year2003, the company received sublease income in excess of lease payments ofapproximately $40,000 for the leases related to Wellspring, resulting in ayear-to-date income from discontinued operations of $11.5 million.  See Note 16 of the Notes to the ConsolidatedFinancial Statements for more information related to Wellspring and thereduction of the estimated liability for losses from the exit from Wellspring.

 

**Liquidity and CapitalResources**

 

Our cash and cash equivalents at June 30, 2004, totaled $156.9million, compared to $144.4 million at June 30, 2003. During fiscal year2004, we paid $34.9 million in previously accrued discretionary compensation,$33.1 million for the repurchase of the company’s stock, $43.1 million incorporate taxes and contributed $10.0 million to our U.S. defined benefitpension plan.  These outflows of cashwere offset by positive cash flow from consulting operations.  Consistent with the company’s liquidityposition, management considers various alternative strategic uses of cashreserves including acquisitions, dividends and stock buybacks, or anycombination of these options.

 

***Cash From OperatingActivities***

 

Cash from operating activities for fiscal year 2004 was $59.5 million,compared to cash from operating activities of $74.7 million for fiscal year2003.  The variance is primarily due tothe increase in accounts receivable, the timing of insurance payments andhigher pension accruals (excluding the effect of the minimum pension liability),net of higher corporate tax payments and higher payments to retirees in fiscalyear 2004 and a lower payment of discretionary compensation in fiscal year2003.

 

The allowance for doubtful accounts increased $0.4 million and theallowance for work in process increased $0.1 million from June 30, 2003 toJune 30, 2004.  The number of daysof accounts receivable and work in process outstanding was 79 at June 30,2004, up from 72 at June 30, 2003, in part due to the impact of newbilling procedures put in place in the third quarter of 2004.

 

Cash from operating activities**for fiscal year 2003 was $74.7 million,compared to cash from operating activities of $51.6 million for fiscal year2002. The variance is mainly due to lower payments to retirees of $6.2 million,improved collections on receivables of $9.4 million and the timing of annualpayments of insurance premiums, which contributed $4.9 million to the increasein cash from operations.  The allowancefor doubtful accounts decreased $0.5 million from June 30, 2002, toJune 30, 2003.  The number of daysof accounts receivable and work in process outstanding was 72 at June 30,2003, down from 79 at June 30, 2002.

 

***Cash Used inInvesting Activities***

 

Cash used in investing activities for fiscal year 2004 was $23.2million, compared to $22.2 million for fiscal year 2003.  The increase can be primarily attributed toincreased purchases of fixed assets of $6.1 million, reduced contingentconsideration payments of $2.0 million and no additional investments in affiliates,compared to the $2.0 million investment in WWHE and the $1.7 million investmentin PCIC in fiscal year 2003.

 

Cash used in investing activities for fiscal year 2003 was $22.2million, compared to $36.6 million for fiscal year 2002.  The decrease is mostly due to reducedpurchases of fixed assets due to fewer office relocations and renovations.

 

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***Cash Used inFinancing Activities***

 

Cash used in financing activities was $24.9 million for fiscal year2004, compared to $6.7 million for fiscal year 2003.  The increase was primarily attributable to the $21.0 millionpurchase of 830,802 shares in the Company’s publicly announced tender offer.

 

Cash used in financing activities was $6.7 million for fiscal year2003, compared to $2.6 million for fiscal year 2002. Cash used in financingactivities for fiscal year 2003 consisted primarily of payments of $13.8million for the repurchase of 673,816 shares of common stock, net of $6.4million representing 393,436 shares that the company re-issued under theEmployee Stock Purchase Plan.

 

**Capital Commitments**

 

Expenditures of capital funds were $24.3 million for fiscal year2004.  Anticipated commitments ofcapital funds are estimated at $37.9 million for fiscal year 2005, mainly fordividends, computer hardware purchases, office relocations and renovations,development and upgrade of retirement and human resource systems andacquisition-related payments. We expect cash from operations to adequatelyprovide for these cash needs.

 

**Dividends**

 

In May 2004, the Board of Directors of the company approved theinitiation of a quarterly cash dividend in the amount of $0.075 per share.  The first quarterly dividend payment of $2.4million was made on July 15, 2004 to shareholders of record as ofJune 30, 2004 and is accrued on these financial statements.

 

Under our credit facility (see Note 9 of Notes to the ConsolidatedFinancial Statements, included in Item 15 of this report), we are required toobserve certain covenants (including requirements for a fixed coverage charge,cashflow leverage ratio and asset coverage) that affect the amounts availablefor the declaration or payment of dividends. The continued payment of cash dividends in the future is at thediscretion of our Board of Directors and depends on numerous factors,including, without limitation, our net earnings, financial condition,availability of capital, debt covenant limitations and our other businessneeds, including those of our subsidiaries and affiliates.

 

**Off-Balance SheetArrangements and Contractual Obligations**

 

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

 
|                              |   | **Remaining  payments due by fiscal year as of June 30, 2004** |    |
|-----------------------------------|--------|---------------------------------------------------------------------|---------|
| **Contractual Cash  Obligations** |   | **Total**                                                           |    | **2005** |   | **2006  through  2007** |   | **2008  through  2009** |   | **Thereafter** |   |
| Lease commitments                 |   | $                                                                   | 264,011 |   | $ | 40,490 |   | $ | 61,481 |   | $ | 50,906 |   | $ | 111,134 |   |
|                                   |        |                                                                     |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

On April 27, 2004, the company executed a new lease agreementcommitting its Washington, D.C., office, which includes consulting andcorporate operations, to move to Northern Virginia.  The terms of the lease are expected to result in cost savingsover the 12-year term.  The companysimultaneously provided notice of early termination of its existing Washington,D.C. lease, which resulted in a $3.2

 

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million charge during the fourth quarter of fiscal year 2004.  The $3.2 million charge had no net cashimpact on the company because the company will receive a $3.2 million paymentfrom the new lessor as an incentive to enter into the new lease.  The portion of the charge applicable to ourconsulting operations, or $1.9 million, is included in Occupancy, Communicationsand Other expenses, while the portion of the charge applicable to our corporateoperations, or $1.3 million, is included in our General and Administrativeexpenses.

 

***Guarantees***

 

*Wellspring Leases*.  The Company continues to guarantee certain leasesfor office premises and equipment for Wellspring.  At June 30, 2004, minimum remaining payments guaranteedunder these leases, which expire at various dates through 2007, totaled $18.1million, excluding anticipated sublease income.  The leases are currently generating positive cash flows ofapproximately $0.1 million per fiscal year. In the third quarter of fiscal year 2004, the company reduced itsaccrual for the estimated remaining future obligations and costs related to theexit from Wellspring by $1.0 million, less the associated income taxexpenses.  Management will continue toevaluate the adequacy of these provisions and make adjustments asappropriate.  See Note 16 of the Notesto the Consolidated Financial Statements for more information related toWellspring.

 

*Affiliate Agreements*.  In connection with the establishment of ouralliance with Watson Wyatt LLP in 1995, the company agreed to guarantee WatsonWyatt LLP’s performance under a lease for office space in London that expiresin 2015.  Payments by Watson Wyatt LLPunder the lease total £1.4 million (or approximately $2.5 million based on theJune 30, 2004, exchange rate) per year. We also granted Watson Wyatt LLP an option to return the leased space toour UK subsidiary in 2009.  If WatsonWyatt LLP were to exercise this option, the company would attempt to subleasethe space at the then-current market rates.

 

**Credit Agreement**

 

In June 2004, we reduced the size of our revolving credit facilityto $50 million from $100 million in order to better align it with our businessneeds.  The facility is provided by asyndicate of banks.  Interest ratesassociated with this facility vary with LIBOR and/or the Prime Rate and arebased on our leverage ratio, as defined by the credit agreement.  We are charged a quarterly commitment fee,currently 0.20 percent of the facility, that varies with our financial leverageand is paid on the unused portion of the credit facility.  No amounts were outstanding under the company’srevolving credit facility as of June 30, 2004 or June 30, 2003.  Credit under the facility is available upondemand, although the credit facility requires us to observe certain covenants(including requirements for a fixed coverage charge, cashflow leverage ratioand asset coverage) and is collateralized with a pledge of stock of materialsubsidiaries.  We were in compliancewith all covenants under the credit facility as of June 30, 2004.

 

A portion of the revolving facility is used to support required lettersof credit issued under the credit line. As a result, $7.5 million of the facility is currently unavailable foroperating needs.  We are also charged afee for outstanding letters of credit that also fluctuates based on ourleverage ratio.  The credit facility isscheduled to mature on June 29, 2009.

 

**Risk Management**

 

As a part of our overall risk management program, we carrycustomary commercial insurance policies, including commercial generalliability, employment practices liability, and claims-made professionalliability insurance with a self-insured retention of $1 million per claim,which provides coverage for professional liability claims including the cost ofdefending such claims.  Our primaryinsurance coverage beyond this retention is written by an affiliated captiveinsurance company owned by us and two other professional services firms.  Prior to July 1, 2003, the first $5million of coverage had a premium

 

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structure which provided that the captive insurance companywould recover from the firm defending the claim approximately 75 percent of anyloss up to $5 million.  The companyrecorded an accrual for this liability. This recovery occurred through insurance premium payments in subsequentyears.  The remaining 25 percent of anyloss up to $5 million was a risk borne by the captive insurance company, whichcarried reinsurance in the commercial markets for most losses above $5 million.

 

As of July 1, 2003, PCIC has attempted to recoverthrough its premium structure the amounts it expects to pay out for membercompanies in claims losses, continuing the loss sharing formula whereby 75% ofthe losses incurred by PCIC with respect to each member are incorporated in themember’s future premium charges, and will increase such member’s premium byapproximately a like amount over the next five years. PCIC now bases premiumcalculations, which are determined annually based on experience throughMarch of each year, on relative risk of the various lines of businessperformed by each of the owner companies, past claim experience of each ownercompany, growth of each of those companies, industry risk profiles in generaland the overall insurance markets.  Asof July 1, 2004, the captive insurance company carries reinsurance for asubstantial portion of losses above $25 million.

 

Our agreements with PCIC could require additional payments toPCIC in the event that the company decided to exit PCIC and adverse claimssignificantly exceed prior expectations. If these circumstances were to occur, the company would record aliability at the time it becomes estimable and probable.

 

The company will continue to provide for the self-insuredretention where specific estimated losses for known claims in excess of $1million are considered probable and reasonably estimable.

 

Although the company maintains professional liabilityinsurance coverage, this insurance does not cover claims made after expirationof our current insurance contracts. Generally accepted accounting principles require that we record aliability for incurred but not reported (IBNR) professional liability claims ifthey are estimable and probable, and for which we have not yet contracted forinsurance coverage.  The company usesactuarial assumptions to estimate and record its IBNR liability and has a $13.2million IBNR liability recorded as of June 30, 2004.

 

Current insurance market conditions for our industry includeincreases in overall premium cost, higher self-insured retentions andreductions in aggregate excess coverages, trends that are anticipated tocontinue.  We expect these trends to bereflected in our future annual insurance renewals and, as a result, we willcontinue to assess our ability to secure future insurance coverage.  In anticipation of the possibility of futurereductions in risk transfer from PCIC to reinsurers, as well as the trendtoward a generally hardening insurance market, the firms that own PCIC,including the company, increased PCIC’s capital in fiscal years 2002 and 2003.  No capital contribution was provided duringfiscal year 2004.

 

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

 

**Recent Accounting Pronouncements**

 

In January 2003, the Financial Accounting Standards Board (FASB)issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable InterestEntities,” which clarifies the financial reporting guidance associated with theconsolidation of another entity.  InDecember 2003, the FASB revised and superceded

 

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FIN 46 with the issuance of FIN 46R in order to address certainimplementation issues.  The companyadopted FIN 46R effective March 31, 2004 and has included appropriatedisclosure in this Form 10-K.  Adoptionof the FIN 46R has not resulted in a change in our accounting.  See Note 4 of the Consolidated FinancialStatements for further information regarding the impact of adopting FIN 46R.

 

Emerging Issues Task Force Issue 00-21, “Revenue Arrangements with MultipleDeliverables” (EITF 00-21), was effective for the company beginningJuly 1, 2003.  There was no changein revenue recognized in the current portfolio of client engagements due to ouradoption of EITF 00-21.

 

InDecember 2003, the Securities and Exchange Commission (SEC) issued StaffAccounting Bulletin No. 104 (SAB 104), “Revenue Recognition,” which supercedesStaff Accounting Bulletin No. 101 (SAB 101), “Revenue Recognition in FinancialStatements.”  SAB 104’s primary purposeis to rescind accounting guidance contained in SAB 101 related to multipleelement revenue arrangements, superceded as a result of the issuance of EITF00-21.  While the wording of SAB 104 haschanged to reflect the issuance of EITF 00-21, the revenue recognitionprinciples of SAB 101 remain largely unchanged by the issuance of SAB 104.  The issuance of SAB 104 has not had aneffect on our revenue recognition policies as they are in accordance with SAB104.

 

In May 2004, the Financial Accounting Standards Board issued FASB StaffPosition (FSP) No. 106-2 “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug Improvement and Modernization Act of 2003” (the Act)(FAS 106-2), which is effective as of the first quarter beginning afterJune 15, 2004. The Act includes a prescription drug benefit under MedicarePart D as well as a federal subsidy to sponsors of retiree health care benefitplans that provide a benefit that is at least actuarially equivalent (asdefined in the Act) to Medicare Part D. The adoption of FAS 106-2 does not have a material effect on thefinancial condition or results of operations of the company.

 

In December 2003, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 132,“Employers’ Disclosures about Pensions and Other Postretirement Benefits” (FAS132).  FAS 132 revisions retain theoriginal disclosures but require additional annual disclosures about assets,obligations, cash flows and interim disclosures about net periodic benefitcosts of defined benefit pension plans and other postretirement plans.  The statement is effective for fiscal yearsending after December 15, 2003. The company has adopted FAS 132 as revised and included appropriatedisclosure in this Form 10-K.

 

In June 2004, the Emerging Issues Task Force (EITF) issued EITF02-14****“Whetheran Investor Should Apply the Equity Method of Accounting to Investments OtherThan Common Stock if the Investor Has the Ability to Exercise SignificantInfluence Over the Operating and Financial Policies of the Investee.”  This EITF indicates that an investor shouldonly apply the equity method of accounting when it has investments in eithercommon stock or in-substance common stock of a corporation, provided that theinvestor has the ability to exercise significant influence over the operatingand financial policies of the investee. The issuance of EITF 02-14 has not had an effect on our accounting forequity investments which has been in accordance with EITF 02-14.

 

**Item 7A. Quantitativeand Qualitative Disclosures About Market Risk.**

 

We are exposed to market risks in the ordinary course of business.  These risks include interest rate risk andforeign currency exchange risk.  We haveexamined our exposure to these risks and concluded that none of our exposuresin these areas are material to fair values, cash flows or earnings.  We do not engage in any hedging of marketrisks with derivative instruments.

 

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**Item 8.****           FinancialStatements and Supplementary Data.**

 

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

 

**Item 9.****           Changesin and Disagreements with Accountants on Accounting and Financial Disclosure.**

 

There are no changes in accountants or disagreements with accountantson accounting principles and financial disclosures required to be disclosed inthis Item 9.

 

**Item 9A.  Controls and Procedures.**

 

**Evaluationof Disclosure Controls and Procedures**

 

The chief executive officer(CEO) and chief financial officer (CFO) of the company evaluated our disclosurecontrols and procedures as of the end of fiscal year 2004.  They have concluded that, as of June 30,2004, such controls and procedures have been effectively designed to ensurethat information required to be disclosed in reports that the company fileswith or submits to the SEC is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms and isaccumulated and communicated to management, including the CEO and CFO, asappropriate, to allow timely decisions regarding such disclosure.

 

**Changesin Internal Control Over Financial Reporting**

 

No changes to our internalcontrol over financial reporting have occurred during the fourth quarter thathave come to management’s attention that have materially affected or arereasonably likely to materially affect our internal control over financialreporting.

 

**Compliance withSection 404 of the Sarbanes-Oxley Act of 2002**

 

Our company is required to comply with Section 404 of theSarbanes-Oxley Act of 2002 and SEC rules and Public Company AccountingOversight Board (PCAOB) standards for implementing Section 404 byJune 30, 2005.  With regards to thecompany’s continuing compliance efforts, the company has substantiallycompleted all documentation of financial and company-wide controls.  We began testing certain key controls in thefourth quarter of fiscal year 2004 in preparation for compliance withSection 404 and plan to continue testing through the first half of fiscalyear 2005 in preparation for management’s assessment in the second half offiscal year 2005.

 

**Limitationson the Effectiveness of Controls**

 

Our management, including theCEO and CFO, does not expect that our internal controls will necessarily preventall error and all fraud.  However, ourmanagement does expect that the control system provides reasonable assurancethat its objectives will be met.  Acontrol system, no matter how well designed and operated, cannot provideabsolute assurance that the control system’s objectives will be met.  In addition, the design of such internalcontrols must take into account the costs of designing and maintaining such acontrol system.  Certain inherentlimitations exist in control systems to make absolute assurances difficult,including the realities that judgments in decision-making can be faulty, thatbreakdowns can occur because of a simple error or mistake, and that individualscan circumvent controls.  The design ofany control system is based in part upon existing business conditions and riskassessments. There can be no assurance that any design will succeed inachieving its stated goals under all potential future

 

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conditions.  Over time, controlsmay become inadequate because of changes in business conditions ordeterioration in the degree of compliance with policies or procedures.  As a result, they may require change orrevision.  Because of the inherentlimitations in a control system, misstatements due to error or fraud may occurand may not be detected.  Nevertheless,management believes that the company’s internal controls over financialreporting for fiscal year 2004 were adequate.

 

**Part III**

 

**Item 10.  Directors and Executive Officers of theRegistrant.**

 

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) “Biographical InformationFor Other Executive Officers Of The Company” and (iii) “Section 16(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 will be included in a definitive proxystatement filed within 120 days after the end of the Registrant’s fiscalyear.  The information contained underthe heading “Certain Relationships and Related Transactions” in the proxystatement is incorporated herein by this reference.

 

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

 

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 “Principal Accountant Fees and Services” in the proxy statement isincorporated herein by this reference.

 

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**Part IV**

 

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

 
| a)     | Financial Information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
| (1)    | Consolidated Financial Statements of Watson Wyatt & Company  Holdings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
|   | Report of Independent Registered Public  Accounting Firm                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
|   | Financial Statements:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |
|   | Consolidated Statements of Operations for  each of the three years in the period ended June 30, 2004                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |
|   | Consolidated Balance Sheets at June 30, 2004 and 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   |
|   | Consolidated Statements of Cash Flows for  each of the three years in the period ended June 30, 2004                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |   |
|   | Consolidated Statements of Changes in  Stockholders’ Equity for each of the three years in the period ended  June 30, 2004                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
|   | Notes to the Consolidated Financial  Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
| (2)    | Consolidated Financial Statement Schedule for each of the three  years in the period ended June 30, 2004                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
|   | 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 May 6, 2004, the company filed a Current Report on Form 8-K,  which included a press release dated the same day, in which we reported our  third quarter fiscal year 2004 earnings.  (ii) On May 17, 2004, the company filed a Current Report on Form 8-K, which  announced that its board of directors has approved the initiation of a quarterly  cash dividend in the amount of $0.075 per share.  (iii) On August 12, 2004, the company filed a Current Report on Form  8-K, which included a press release dated the same day, in which we reported  our fourth quarter and fiscal year ended 2004 earnings. |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
| c)     | Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
|   | See Exhibit Index on page 85.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
| d)     | Financial Statement Schedules                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |
|   | Not applicable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |

 

41

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
|                             |   | WATSON WYATT & COMPANY HOLDINGS |
|----------------------------------|--------|-------------------------------------|
|                             |   | (Registrant)                        |
|                             |   |                                |   |
| Date:  August 17, 2004 |   | By:                                 | /s/ John J. Haley |
|                             |   |                                | John J. Haley |
|                             |   |                                | President and Chief Executive Officer |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **Signature**             |   |   | **Title**                          |   | **Date** |
|---------------------------|--------|--------|------------------------------------|--------|----------|
|                      |   |   |                               |   |     |
| /s/ John J. Haley         |   |   | President, Chief Executive Officer |   | 8/17/04  |
| John J. Haley             |   |   | and Director                       |   |     |
|                      |   |   |                               |   |     |
| /s/ Carl D. Mautz         |   |   | Vice President and Chief           |   | 8/17/04  |
| Carl D. Mautz             |   |   | Financial Officer                  |   |     |
|                      |   |   |                               |   |     |
| /s/ Peter L. Childs       |   |   | Controller                         |   | 8/17/04  |
| Peter L. Childs           |   |   |                               |   |     |
|                      |   |   |                               |   |     |
| /s/ John J. Gabarro       |   |   | Director                           |   | 8/17/04  |
| John J. Gabarro           |   |   |                               |   |     |
|                      |   |   |                               |   |     |
| /s/ R. Michael McCullough |   |   | Director                           |   | 8/17/04  |
| R. Michael McCullough     |   |   |                               |   |     |
|                      |   |   |                               |   |     |
| /s/ Linda D. Rabbitt      |   |   | Director                           |   | 8/17/04  |
| Linda D. Rabbitt          |   |   |                               |   |     |
|                      |   |   |                               |   |     |
| /s/ Gilbert T. Ray        |   |   | Director                           |   | 8/17/04  |
| Gilbert T. Ray            |   |   |                               |   |     |
|                      |   |   |                               |   |     |
| /s/ Sylvester J. Schieber |   |   | Vice President and Director        |   | 8/17/04  |
| Sylvester J. Schieber     |   |   |                               |   |     |

 

42

----

 
| /s/ John B. Shoven       |   |   | Director                    |   | 8/17/04 |
|--------------------------|--------|--------|-----------------------------|--------|---------|
| John B. Shoven           |   |   |                        |   |    |
|                     |   |   |                        |   |    |
| /s/ Edward Manno Shumsky |   |   | Vice President and Director |   | 8/17/04 |
| Edward Manno Shumsky     |   |   |                        |   |    |
|                     |   |   |                        |   |    |
| /s/ Paul N. Thornton     |   |   | Director                    |   | 8/17/04 |
| Paul N. Thornton         |   |   |                        |   |    |
|                     |   |   |                        |   |    |
| /s/ Gene H. Wickes       |   |   | Vice President and Director |   | 8/17/04 |
| Gene H. Wickes           |   |   |                        |   |    |
|                     |   |   |                        |   |    |
| /s/ John C. Wright       |   |   | Director                    |   | 8/17/04 |
| John C. Wright           |   |   |                        |   |    |

 

43

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and

Stockholders of Watson Wyatt & Company Holdings:

 

In our opinion, the accompanying consolidated balance sheets and therelated consolidated statements of operations, stockholder’s equity and cashflows present fairly, in all material respects, the financial position ofWatson Wyatt & Company Holdings and its subsidiaries at June 30, 2004and June 30, 2003, and the results of their operations and their cashflows for each of the three years in the period ended June 30, 2004 inconformity with accounting principles generally accepted in the United Statesof America.  In addition, in our opinion,the accompanying financial statement schedule II presents fairly, in allmaterial respects, the information set forth therein when read in conjunctionwith the related consolidated financial statements.  These financial statements and financialstatement schedule are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements and financial statementschedule based on our audits.  Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

PricewaterhouseCoopers LLP

 

 

Washington, D.C.

August 13, 2004

 

44

----

 

**WATSONWYATT & COMPANY HOLDINGS**

**ConsolidatedStatements of Operations**

(Thousands of U.S. Dollars, Except Per ShareData)

 
| ** **                                                                                                                                                                                        | ** ** | **Year Ended June 30** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                        | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                                                                                                        | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                                                                                                                           |       | $                           | 702,005    |   | $ | 709,616 |   | $ | 710,480 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Costs of providing services:                                                                                                                                                                      |       |                        |       |   |   |   |   |
| Salaries and employee benefits                                                                                                                                                                    |       | 396,775                     |       | 401,274 |   | 404,822 |   |
| Professional and subcontracted services                                                                                                                                                           |       | 49,159                      |       | 47,356 |   | 48,724 |   |
| Occupancy, communications and other                                                                                                                                                               |       | 105,459                     |       | 106,224 |   | 109,163 |   |
| General and administrative expenses                                                                                                                                                               |       | 63,631                      |       | 57,285 |   | 55,517 |   |
| Depreciation and amortization                                                                                                                                                                     |       | 18,511                      |       | 19,621 |   | 20,049 |   |
|                                                                                                                                                                                              |       | 633,535                     |       | 631,760 |   | 638,275 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Income from operations                                                                                                                                                                            |       | 68,470                      |       | 77,856 |   | 72,205 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Income from affiliates                                                                                                                                                                            |       | 7,109                       |       | 5,787 |   | 2,866 |   |
| Interest income, net                                                                                                                                                                              |       | 743                         |       | 991 |   | 1,235 |   |
| Other non-operating income                                                                                                                                                                        |       | 6,222                       |       | 761 |   | 2,166 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Income from continuing operations before  income taxes                                                                                                                                            |       | 82,544                      |       | 85,395 |   | 78,472 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Provision for (benefit from) income taxes:                                                                                                                                                        |       |                        |       |   |   |   |   |
| Current                                                                                                                                                                                           |       | 39,944                      |       | 39,063 |   | 37,383 |   |
| Deferred                                                                                                                                                                                          |       | (7,339                      | )          | (4,048 | ) | (5,995 | ) |
|                                                                                                                                                                                              |       | 32,605                      |       | 35,015 |   | 31,388 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                                 |       | 49,939                      |       | 50,380 |   | 47,084 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Discontinued operations:                                                                                                                                                                          |       |                        |       |   |   |   |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Adjustment to reduce estimated loss on  disposal of discontinued operations, less applicable income tax expense of  $409 and $4,671 for the years ended June 30, 2004 and June 30, 2003 |       | 592                         |       | 6,764 |   | — |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Sublease income from discontinued  operations, less applicable income tax expense of $43 and $16 for the years  ended June 30, 2004 and June 30, 2003                                   |       | 62                          |       | 22 |   | — |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Net income                                                                                                                                                                                        |       | $                           | 50,593     |   | $ | 57,166 |   | $ | 47,084 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Basic earnings per share:                                                                                                                                                                         |       |                        |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                                 |       | $                           | 1.52       |   | $ | 1.52 |   | $ | 1.43 |   |
| Income from discontinued operations                                                                                                                                                               |       | 0.02                        |       | 0.21 |   | — |   |
| Net income                                                                                                                                                                                        |       | $                           | 1.54       |   | $ | 1.73 |   | $ | 1.43 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Diluted earnings per share:                                                                                                                                                                       |       |                        |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                                 |       | $                           | 1.50       |   | $ | 1.51 |   | $ | 1.41 |   |
| Income from discontinued operations                                                                                                                                                               |       | 0.02                        |       | 0.21 |   | — |   |
| Net income                                                                                                                                                                                        |       | $                           | 1.52       |   | $ | 1.72 |   | $ | 1.41 |   |
|                                                                                                                                                                                              |       |                        |       |   |   |   |   |
| Weighted average shares of common stock,  basic (000)                                                                                                                                             |       | 32,866                      |       | 32,962 |   | 32,985 |   |
| Weighted average shares of common stock,  diluted (000)                                                                                                                                           |       | 33,207                      |       | 33,287 |   | 33,421 |   |

 

See accompanying notes to the

consolidated financial statements

 

45

----

 

**WATSONWYATT & COMPANY HOLDINGS**

**Consolidated Balance Sheets**

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

 
| ** **                                                                                                | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
|                                                                                                      |       |                    |       |                    |       |
| **Assets**                                                                                                | ** ** | ** **              | ** ** | ** **              | ** ** |
| Cash and cash equivalents                                                                                 |       | $                       | 156,940    |                    | $          | 144,374 |   |
| Receivables from clients:                                                                                 |       |                    |       |                    |       |
| Billed, net of allowances of $1,241 and  $862                                                             |       | 86,726                  |       | 78,373                  |       |
| Unbilled, net of allowances of $456 and  $419                                                             |       | 63,108                  |       | 60,549                  |       |
|                                                                                                      |       | 149,834                 |       | 138,922                 |       |
|                                                                                                      |       |                    |       |                    |       |
| Deferred income taxes                                                                                     |       | 15,052                  |       | 3,885                   |       |
| Other current assets                                                                                      |       | 11,388                  |       | 11,448                  |       |
| Total current assets                                                                                      |       | 333,214                 |       | 298,629                 |       |
|                                                                                                      |       |                    |       |                    |       |
| Investment in affiliates                                                                                  |       | 30,235                  |       | 26,431                  |       |
| Fixed assets, net                                                                                         |       | 65,438                  |       | 60,716                  |       |
| Deferred income taxes                                                                                     |       | 55,240                  |       | 101,214                 |       |
| Goodwill and intangible assets                                                                            |       | 20,909                  |       | 20,878                  |       |
| Other assets                                                                                              |       | 7,132                   |       | 6,594                   |       |
|                                                                                                      |       |                    |       |                    |       |
| **Total Assets**                                                                                          |       | $                       | 512,168    |                    | $          | 514,462 |   |
| ** **                                                                                                |       |                    |       |                    |       |
| **Liabilities**                                                                                           | ** ** | ** **              | ** ** | ** **              | ** ** |
| Accounts payable and accrued liabilities,  including discretionary compensation                           |       | $                       | 113,233    |                    | $          | 114,013 |   |
| Income taxes payable                                                                                      |       | 12,526                  |       | 15,308                  |       |
| Total current liabilities                                                                                 |       | 125,759                 |       | 129,321                 |       |
|                                                                                                      |       |                    |       |                    |       |
| Accrued retirement benefits                                                                               |       | 97,984                  |       | 195,705                 |       |
| Deferred rent and accrued lease losses                                                                    |       | 10,199                  |       | 4,608                   |       |
| Deferred income taxes                                                                                     |       | 628                     |       | —                  |       |
| Other noncurrent liabilities                                                                              |       | 32,414                  |       | 33,091                  |       |
|                                                                                                      |       |                    |       |                    |       |
| **Total Liabilities**                                                                                     |       | 266,984                 |       | 362,725                 |       |
|                                                                                                      |       |                    |       |                    |       |
| Commitments and contingencies                                                                             |       |                    |       |                    |       |
|                                                                                                      |       |                    |       |                    |       |
| **Stockholders’  Equity**                                                                            |       |                    |       |                    |       |
| Preferred Stock - No par value:                                                                           |       |                    |       |                    |       |
| 1,000,000 shares authorized; none issued  and outstanding                                                 |       | —                  |       | —                  |       |
| Class A Common Stock - $.01 par value:                                                                    |       |                    |       |                    |       |
| 69,000,000 shares authorized; 33,372,880  and 33,087,880 issued and 32,317,156 and 32,943,156 outstanding |       | 334                     |       | 331                     |       |
| Additional paid-in capital                                                                                |       | 149,508                 |       | 145,922                 |       |
| Treasury stock, at cost - 1,055,724 and  144,724 shares                                                   |       | (26,149                 | )          | (2,956                  | )          |
| Retained earnings                                                                                         |       | 125,669                 |       | 77,517                  |       |
| Accumulated other comprehensive loss                                                                      |       | (4,178                  | )          | (69,077                 | )          |
| **Total Stockholders’  Equity**                                                                      |       | 245,184                 |       | 151,737                 |       |
|                                                                                                      |       |                    |       |                    |       |
| **Total Liabilities  and Stockholders’ Equity**                                                      |       | $                       | 512,168    |                    | $          | 514,462 |   |

 

See accompanying notes to theconsolidated financial statements

 

46

----

 

**WATSONWYATT & COMPANY HOLDINGS**

**ConsolidatedStatements of Cash Flows**

(Thousands of U.S. Dollars)

 
| ** **                                                                    | ** ** | **Year Ended June 30** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                    | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                          |       |                        |       |   |   |   |   |
| Cash flows from operating activities:                                         |       |                        |       |   |   |   |   |
| Net income                                                                    |       | $                           | 50,593     |   | $ | 57,166 |   | $ | 47,084 |   |
| Adjustments to reconcile net income to net  cash from operating activities:   |       |                        |       |   |   |   |   |
| Other non-operating gain related to PCIC                                      |       | (5,600                      | )          | — |   | — |   |
| Income from discontinued operations, net of  income tax expense               |       | (592                        | )          | (6,786 | ) | — |   |
| Provision for doubtful receivables from  clients                              |       | 5,612                       |       | 7,859 |   | 4,541 |   |
| Depreciation                                                                  |       | 18,196                      |       | 19,205 |   | 19,887 |   |
| Amortization of intangible assets                                             |       | 315                         |       | 416 |   | 162 |   |
| Provision for (benefit from) deferred  income taxes                           |       | (7,457                      | )          | 2,994 |   | (5,995 | ) |
| Income from affiliates                                                        |       | (7,109                      | )          | (5,787 | ) | (2,866 | ) |
| Distributions from affiliates                                                 |       | 5,521                       |       | 4,831 |   | 1,970 |   |
| Other, net                                                                    |       | 508                         |       | (595 | ) | (525 | ) |
| Changes in operating assets and liabilities  (net of discontinued operations) |       |                        |       |   |   |   |   |
| Receivables from clients                                                      |       | (16,524                     | )          | 4,831 |   | (4,563 | ) |
| Other current assets                                                          |       | 377                         |       | 5,594 |   | (6,468 | ) |
| Other assets                                                                  |       | (538                        | )          | 1,639 |   | 578 |   |
| Accounts payable and accrued liabilities                                      |       | 7,359                       |       | (14,982 | ) | (12,468 | ) |
| Income taxes payable                                                          |       | (3,190                      | )          | (3,968 | ) | 967 |   |
| Accrued retirement benefits                                                   |       | 6,025                       |       | (1,855 | ) | 6,488 |   |
| Deferred rent and accrued lease losses                                        |       | 5,591                       |       | 948 |   | 176 |   |
| Other noncurrent liabilities                                                  |       | 405                         |       | 3,201 |   | 2,616 |   |
| Net cash from operating activities                                            |       | 59,492                      |       | 74,711 |   | 51,584 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Cash flows used in investing activities:                                      |       |                        |       |   |   |   |   |
| Purchases of fixed assets                                                     |       | (23,629                     | )          | (17,505 | ) | (31,557 | ) |
| Proceeds from sale of fixed assets                                            |       | 157                         |       | 40 |   | 144 |   |
| Proceeds from divestitures                                                    |       | 622                         |       | 1,281 |   | 1,747 |   |
| Acquisitions and contingent consideration  payments                           |       | (321                        | )          | (2,310 | ) | (5,262 | ) |
| Investments in affiliates                                                     |       | —                      |       | (3,661 | ) | (1,700 | ) |
| Net cash used in investing activities                                         |       | (23,171                     | )          | (22,155 | ) | (36,628 | ) |
|                                                                          |       |                        |       |   |   |   |   |
| Cash flows used in financing activities:                                      |       |                        |       |   |   |   |   |
| Issuances of common stock - exercises of  stock options                       |       | 2,142                       |       | 714 |   | 429 |   |
| Issuances of common stock - employee stock  purchase plan                     |       | 6,789                       |       | 6,408 |   | 1,448 |   |
| Offering costs on repurchases of common  stock                                |       | (728                        | )          | — |   | — |   |
| Repurchases of common stock                                                   |       | (33,139                     | )          | (13,824 | ) | (4,521 | ) |
| Net cash used in financing activities                                         |       | (24,936                     | )          | (6,702 | ) | (2,644 | ) |
|                                                                          |       |                        |       |   |   |   |   |
| Effect of exchange rates on cash                                              |       | 1,181                       |       | 2,546 |   | 1,927 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Increase in cash and cash equivalents                                         |       | 12,566                      |       | 48,400 |   | 14,239 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Cash and cash equivalents at beginning of  year                               |       | 144,374                     |       | 95,974 |   | 81,735 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Cash and cash equivalents at end of year                                      |       | $                           | 156,940    |   | $ | 144,374 |   | $ | 95,974 |   |

 

See accompanying notes totheconsolidated financial statements

 

47

----

 

**WATSONWYATT & COMPANY HOLDINGS**

 

**ConsolidatedStatement of Changes in Stockholders’ Equity**

(Thousands of U.S. Dollars)

 
| ** **                                                                                  | ** ** | **Class A  Common  Stock  Outstanding  (number of  shares)** | ** ** | **Class B-1  Common  Stock  Outstanding  (number of  shares)** | ** ** | **Class B-2  Common  Stock  Outstanding  (number of  shares)** | ** ** | **Class A  Common  Stock** | ** ** | **Class B-1  Common  Stock** | ** ** | **Class B-2  Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Treasury  Stock,  at Cost** | ** ** | **Retained  Earnings  (Accumulated  Deficit)** | ** ** | **Accumulated  Other  Comprehensive  (Loss)/Income** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------|------------|------------------------------|------------|------------------------------|------------|----------------------------------|------------|-------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|-----------|------------|
| Balance at June 30, 2001                                                               |       | 9,390                                                        |       | 10,399                                                         |       | 13,244                                                         |       | $                          | 94         |                         | $          | 104                          |       | $                                | 132        |                          | $          | 146,649                                        |       | $                                                    | —     |      | $          | (26,733 | ) | $ | (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                       |       | 443                                                          |       | (443                                                           | )          |                                                           |       | 4                          |       | (4                           | )          |                         |       |                             |       |                          |       |                                           |       |                                                 |       | —    |       |
| Transfer restriction expiration of 9,956,140  shares                                        |       | 9,956                                                        |       | (9,956                                                         | )          |                                                           |       | 100                        |       | (100                         | )          |                         |       |                             |       |                          |       |                                           |       |                                                 |       | —    |       |
| Conversion of 333,498 shares held by Watson Wyatt  LLP for distribution to its partners     |       | 333                                                          |       |                                                           |       | (333                                                           | )          | 3                          |       |                         |       | (3                           | )          |                             |       |                          |       |                                           |       |                                                 |       | —    |       |
| Distribution of 62,600 shares from Watson Wyatt  LLP to Watson Wyatt & Company Holdings |       | (63                                                          | )          |                                                           |       |                                                           |       |                       |       |                         |       |                         |       |                             |       | (209                          | )          |                                           |       |                                                 |       | (209      | )          |
| Other conversion                                                                            |       | 43                                                           |       |                                                           |       | (43                                                            | )          |                       |       |                         |       |                         |       |                             |       |                          |       |                                           |       |                                                 |       |      |       |
| Repurchase of Class A shares                                                                |       | (190                                                         | )          |                                                           |       |                                                           |       |                       |       |                         |       |                         |       |                             |       | (4,521                        | )          |                                           |       |                                                 |       | (4,521    | )          |
| Issuances of common stock - exercises of common  stock options                              |       | 38                                                           |       |                                                           |       |                                                           |       | 1                          |       |                         |       |                         |       | 428                              |       |                          |       |                                           |       |                                                 |       | 429       |       |
| Issuances of common stock - employee stock  purchase plan                                   |       | 79                                                           |       |                                                           |       |                                                           |       |                       |       |                         |       |                         |       | (206                             | )          | 1,654                         |       |                                           |       |                                                 |       | 1,448     |       |
| Tax benefit of exercise of common stock options                                             |       |                                                         |       |                                                           |       |                                                           |       |                       |       |                         |       |                         |       | 163                              |       |                          |       |                                           |       |                                                 |       | 163       |       |
|                                                                                        |       |                                                         |       |                                                           |       |                                                           |       |                       |       |                         |       |                         |       |                             |       |                          |       |                                           |       |                                                 |       |      |       |
| Balance at June 30, 2002                                                               |       | 20,029                                                       |       | —                                                         |       | 12,868                                                         |       | 202                        |       | —                       |       | 129                          |       | 147,034                          |       | (3,076                        | )          | 20,351                                         |       | (5,419                                               | )          | 159,221   |       |
|                                                                                        |       |                                                         |       |                                                           |       |                                                           |       |                       |       |                         |       |                         |       |                             |       |                          |       |                                           |       |                                                 |       |      |       |
| Comprehensive loss:                                                                         |       |                                                         |       |                                                           |       |                                                           |       |                       |       |                         |       |                         |       |                             |       |                          |       |                                           |       |                                                 |       |      |       |
| Net income                                                                                  |       |                                                         |       |                                                           |       |                                                           |       |                       |       |                         |       |                         |       |                             |       |                          |       | 57,166                                         |       |                                                 |       | 57,166    |       |
|                                                                                             |            |                                                              |            |                                                                |            |                                                                |            |                            |            |                              |            |                              |            |                                  |            |                               |            |                                                |            |                                                      |            |           |            |  |  |  |  |  |  |  |  |

 

See accompanying notes totheconsolidated financial statements

 

48

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**WATSONWYATT & COMPANY HOLDINGS**

 

**ConsolidatedStatement of Changes in Stockholders’ Equity**

(Thousands of U.S. Dollars)

continued

 
| 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            |   | 12,745 |   |   |   | (12,745 | )      | 127    |   |   |   | (127   | )      |    |   |    |   |    |   |    |    | —  |   |
| Other conversion                                                 |   | 123    |   |   |   | (123    | )      |   |   |   |   |   |   |    |   |    |   |    |   |    |    |    |   |
| Repurchases of common stock                                      |   | (673   | )      |   |   |    |   | 2      |   |   |   | (2     | )      |    |   | (13,824 | )      |    |   |    |    | (13,824 | )      |
| Issuances of common stock - exercises of common  stock options   |   | 54     |   |   |   |    |   |   |   |   |   |   |   | (205    | )      | 919     |   |    |   |    |    | 714     |   |
| Issuances of common stock - employee stock  purchase plan        |   | 393    |   |   |   |    |   |   |   |   |   |   |   | (1,347  | )      | 7,755   |   |    |   |    |    | 6,408   |   |
| Issuances of common stock - deferred stock units                 |   | 259    |   |   |   |    |   |   |   |   |   |   |   | 285     |   | 5,021   |   |    |   |    |    | 5,306   |   |
| Issuance of common stock to outside directors                    |   | 13     |   |   |   |    |   |   |   |   |   |   |   | (42     | )      | 249     |   |    |   |    |    | 207     |   |
| Tax benefit of exercise of common stock options                  |   |   |   |   |   |    |   |   |   |   |   |   |   | 197     |   |    |   |    |   |    |    | 197     |   |
|                                                             |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   |    |   |    |    |    |   |
| Balance at June 30, 2003                                    |   | 32,943 |   | — |   | —  |   | 331    |   | — |   | — |   | 145,922 |   | (2,956  | )      | 77,517  |   | (69,077 | )       | 151,737 |   |
|                                                             |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   |    |   |    |    |    |   |
| Comprehensive income:                                            |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   |    |   |    |    |    |   |
| Net income                                                       |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   | 50,593  |   |    |    | 50,593  |   |
| Additional minimum pension liability                             |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   |    |   | 61,218  |    | 61,218  |   |
| Foreign currency translation adjustment                          |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   |    |   | 3,681   |    | 3,681   |   |
| Total comprehensive income                                       |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   |    |   |    |    | 115,492 |   |
| Cash dividends declared                                          |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   | (2,441  | )      |    |    | (2,441  | )      |
| Repurchases of common stock                                      |   | (1,342 | )      |   |   |    |   |   |   |   |   |   |   |    |   | (33,139 | )      |    |   |    |    | (33,139 | )      |
| Offering costs on repurchases of common stock                    |   |   |   |   |   |    |   |   |   |   |   |   |   | (728    | )      |    |   |    |   |    |    | (728    | )      |
| Issuances of common stock - employee stock  purchase plan shares |   | 359    |   |   |   |    |   | 1      |   |   |   |   |   | 420     |   | 6,368   |   |    |   |    |    | 6,789   |   |
| Issuances of common stock - deferred stock units                 |   | 178    |   |   |   |    |   | 2      |   |   |   |   |   | 4,081   |   |    |   |    |   |    |    | 4,083   |   |
| Issuances of common stock to outside directors                   |   | 14     |   |   |   |    |   |   |   |   |   |   |   | 22      |   | 330     |   |    |   |    |    | 352     |   |
| Issuances of common stock- stock options                         |   | 165    |   |   |   |    |   |   |   |   |   |   |   | (1,106  | )      | 3,248   |   |    |   |    |    | 2,142   |   |
| Tax benefit of exercises of stock options                        |   |   |   |   |   |    |   |   |   |   |   |   |   | 897     |   |    |   |    |   |    |    | 897     |   |
|                                                             |   |   |   |   |   |    |   |   |   |   |   |   |   |    |   |    |   |    |   |    |    |    |   |
| Balance at June 30, 2004                                    |   | 32,317 |   | — |   | —  |   | $      | 334    |   | $      | — |   | $       | — |    | $      | 149,508 |   | $       | (26,149 | )       | $      | 125,669 |   | $ | (4,178 | ) | $ | 245,184 |   |
|                                                                  |        |        |        |        |        |         |        |        |        |        |        |        |        |         |        |         |        |         |        |         |         |         |        |  |  |  |  |  |  |  |  |

 

(continued)

See accompanying notes to theconsolidated financial statements

 

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**WATSON WYATT & COMPANY HOLDINGS**

 

**Notes to the Consolidated FinancialStatements**

**(Tabular Amounts in Thousands of U.S. DollarsExcept Share and Percentage Data)**

 

**Note 1 - Summary of Significant Accounting Policies**

 

*Nature of the Business* - Watson Wyatt& Company Holdings (collectively referred to as “we”, “Watson Wyatt” or the“company”), together with our subsidiaries, is an international company engagedin the business of providing professional consultative services on a fee basis,primarily in the human resource areas of employee benefits and compensation,but also in other areas of specialization such as human capital consulting andhuman resource-related technology consulting. The company’s fiscal year ends on June 30th.

 

*Principles of Consolidation* - Ourconsolidated financial statements include the accounts of the company and ourmajority-owned and controlled subsidiaries after elimination of intercompanyaccounts and transactions.  Investmentsin affiliated companies over which we have the ability to exercise significantinfluence are accounted for using the equity method.

 

Effective March 31, 2004, the Company adopted the revisedinterpretation of Financial Accounting Standards Board (FASB) InterpretationNo. 46 (FIN 46), Consolidation of Variable Interest Entities, (FIN 46-R). FIN46-R requires that certain variable interest entities be consolidated by theprimary beneficiary of the entity if the equity investors in the entity do nothave the characteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties. The Company doesnot have a controlling financial interest in entities it determined to bevariable interest entities, and as a result, the Company is not the primarybeneficiary and is not required to consolidate their results.

 

*Use of Estimates* - Preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities,disclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period.  Actual results coulddiffer from those estimates.  Estimatesare used when accounting for revenue, allowances for uncollectible receivables,investments in affiliates, depreciation and amortization, profits on long-termcontracts, asset write-downs, employee benefit plans, taxes, accruals forpremiums for professional liability insurance, pension plan assumptions,accruals for estimated losses related to reported and unreported professionalliability claims and discontinued operations.

 

*Reclassifications* - Certain amountspreviously presented have been reclassified to conform to the currentpresentation.

 

*Cash and Cash Equivalents* - We considershort-term, highly-liquid investments with original maturities of 90 days or lessto be cash equivalents.  All of our cashand investments at June 30, 2004 and 2003 were deemed to be cash and cashequivalents.

 

*Receivables from Clients* - Billedreceivables from clients are presented at their billed amount less an allowancefor doubtful accounts. Unbilled receivables are stated at full billing ratesless an allowance for unbillable amounts.

 

50

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*Revenue Recognition* - Revenue includesfees primarily generated from consulting services provided in the areas ofemployee benefits, human capital strategies and related technologysolutions.  We recognize revenue fromthese consulting engagements either on a time-and-materials basis or on afixed-fee basis, depending on the terms and conditions defined at the inceptionof an engagement with a client.

 

Revenue is recognized on time-and-materials engagements based onbillable rates times hours worked plus expenses incurred.  For fixed-fee arrangements, revenue is alsorecognized based on billable rates times hours worked plus expensesincurred.  However, for significantfixed-fee engagements in our Technology Solutions Group, we periodically reviewongoing engagements through the preparation of an estimate-to-complete.  Revenue recognition for fixed-fee engagementsis affected by a number of factors that change the estimated amount of workrequired to complete the project such as changes in scope, the staffing on theengagement and/or the level of client participation.  These periodic engagement reviews require usto make judgments and estimates regarding the overall profitability and stageof project completion which, in turn, affect how we recognize revenue.  The company recognizes a loss on anengagement when estimated revenue to be received for that engagement is lessthan the total estimated direct and indirect costs associated with theengagement.  Losses are recognized in theperiod in which the loss becomes probable and the amount of the loss isreasonably estimable.

 

The companyhas developed various software programs and technologies that we provide toclients in connection with consulting services. In most instances, such software is hosted and maintained by thecompany.  Software developed to beutilized in providing services to a client, but for which the client does nothave the contractual right to take possession, is capitalized in accordancewith the AICPA’s Statement of Position 98-1 “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use,” and any revenueassociated with the related contract, together with amortization of the relatedcapitalized software, is recognized over the service period.

 

Revenuerecognized in excess of billings is recorded as unbilled accountsreceivable.  Cash collections and invoicesgenerated in excess of revenue recognized are recorded as deferred revenueuntil the revenue recognition criteria are met. Client reimbursable expenses, including those relating to travel, otherout-of-pocket expenses and any third-party costs, are included in revenue, andan equivalent amount of reimbursable expenses are included in professional andsubcontracted services as a cost of revenue.

 

Emerging Issues Task Force Issue 00-21, “Revenue Arrangements withMultiple Deliverables” (EITF 00-21), was effective for the company beginningJuly 1, 2003.  There was no changein revenue recognized in the current portfolio of client engagements due to ouradoption of EITF 00-21.

 

In December 2003, the Securities and Exchange Commission (SEC)issued Staff Accounting Bulletin No. 104 (SAB 104), “Revenue Recognition,”which supercedes Staff Accounting Bulletin No. 101 (SAB 101), “RevenueRecognition in Financial Statements.” The primary purpose of SAB 104 is to rescind accounting guidancecontained in SAB 101 related to multiple element revenue arrangements,superceded as a result of the issuance of EITF 00-21.  While the wording of SAB 104 has changed toreflect the issuance of EITF 00-21, the revenue recognition principles of SAB101 remain largely unchanged by the issuance of SAB 104.  The issuance of SAB 104 has not had an effecton our revenue recognition policies as they are in accordance with SAB 104.

 

*Other Non-operating Income*- Non-operatingincome for the year ended June 30, 2004 included the $5.6 million gain thecompany recorded related to PCIC, as further described in Note 18.  During each of fiscal years 2004 and 2003,the company also received cash payments of $0.6 million in connection with thefiscal year 2002 sale of our U.S.-based public retirement business to GRS.  All payments received in connection with thissale were contingent upon the successful transition of certain clients to GRSand upon retention of such clients by GRS.

 

51

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*Foreign Currency Translation* - Gains andlosses on foreign currency transactions, including settlement of intercompanyreceivables and payables, are recognized currently in the ConsolidatedStatements of Operations.  Assets andliabilities of our subsidiaries outside the United States are translated intothe reporting currency, the U.S. dollar, based on exchange rates at the balancesheet date.  Revenue and expenses of oursubsidiaries outside the United States are translated into U.S. dollars at theaverage exchange rates during the year. Gains and losses on translation of our equity interests in oursubsidiaries outside the United States and on intercompany notes are reportedseparately as accumulated other comprehensive loss within stockholders’ equityin the Consolidated Balance Sheets, since we do not plan or anticipatesettlement of such balances in the foreseeable future.

 

*Fair Value of Financial Instruments* - Thecarrying 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 underour revolving credit agreement at June 30, 2004 or June 30,2003.  There were no events of defaultthat would require us to satisfy the guarantees described in Note 14.  We do not use derivative instruments as ahedging strategy or for any other purpose.

 

*Concentration of Credit Risk* - Financialinstruments that potentially subject the company to concentrations of creditrisk consist principally of certain cash and cash equivalents, short-terminvestments 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.

 

*Incurred But Not Reported (IBNR) Claims -*Thecompany accrues for IBNR professional liability claims that are estimable andprobable, and for which we have not yet contracted for insurance coverage.  This liability was $13.2 million and $12.6million at June 30, 2004 and 2003, respectively.

 

*Stock-based Compensation* - We have electedto follow Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (APB 25), for stock options issued under the 2000Long-term Incentive Plan and the 2001 Employee Stock Purchase Plan.  Compensation expense for the 2000 Long-termIncentive Plan, if any, would be recorded and measured as the differencebetween the fair market value of the stock at the date of the grant and theoption price.  The compensation expensewould be recognized over the five-year vesting period identified in theplan.  We have elected thedisclosure-only provisions of Statement of Financial Accounting Standards No.123, “Accounting for Stock-Based Compensation” (FAS 123).

 

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As required by FAS 123, the company has determined pro forma net incomeand earnings per share as if the company had accounted for its stockcompensation plans under the fair value method of FAS 123. The 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-Scholes model,the weighted average fair value of options granted during fiscal year 2002 was$8.00 per option, and $5.26 per option for fiscal year 2001.  No options were granted during fiscal years2003 or 2004.  The following assumptionswere used 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  |       |

 

The table below reflects the pro forma effect on net income andearnings per share for fiscal years 2004, 2003 and 2002, as if the company wereto recognize compensation expense under the “fair-value-based method” of FAS123.

 
| ** **                                                                                                                                    | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                                                          |       |                        |       |   |   |   |   |
| Net income, as reported                                                                                                                       |       | $                           | 50,593     |   | $ | 57,166 |   | $ | 47,084 |   |
| Add: Stock-based compensation expense  included in reported net income, net of related tax effects                                            |       | 243                         |       | 66 |   | 30 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of related tax effects |       | (1,662                      | )          | (1,518 | ) | (1,315 | ) |
|                                                                                                                                          |       |                        |       |   |   |   |   |
| Pro forma net income                                                                                                                          |       | $                           | 49,174     |   | $ | 55,714 |   | $ | 45,799 |   |
|                                                                                                                                          |       |                        |       |   |   |   |   |
| Earnings per share:                                                                                                                           |       |                        |       |   |   |   |   |
| Basic - as reported                                                                                                                           |       | $                           | 1.54       |   | $ | 1.73 |   | $ | 1.43 |   |
| Basic - pro forma                                                                                                                             |       | $                           | 1.50       |   | $ | 1.69 |   | $ | 1.39 |   |
|                                                                                                                                          |       |                        |       |   |   |   |   |
| Diluted - as reported                                                                                                                         |       | $                           | 1.52       |   | $ | 1.72 |   | $ | 1.41 |   |
| Diluted - pro forma                                                                                                                           |       | $                           | 1.48       |   | $ | 1.67 |   | $ | 1.37 |   |

 

The company does not currently intend to issue further stock optionsunder the 2000 Long-term Incentive Plan. Deferred stock units are now granted to senior associates of the companyin lieu of a portion of their annual fiscal year-end bonus.  All deferred stock units issued in connectionwith the 2001 Deferred Stock Unit Plan were fully vested upon issuance.  Each stock unit represents one share ofcommon stock to the recipient. Compensation expense is determined by the value of the stock at the dateof the grant.

 

In December 2002, the FASB issued Statement of FinancialAccounting Standards No. 148, “Accounting for Stock-Based Compensation -Transition and Disclosure” (FAS 148). FAS 148 provides additional transition guidance for those entities thatelect to expense stock options pursuant to FAS 123,

 

53

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“Accounting for Stock-Based Compensation”.  The company has adopted the disclosureprovisions of FAS 148 and as a result provides pro forma information on aquarterly and annual basis regarding stock-based employee compensation costs.

 

*Earnings per Share* - The computation ofbasic earnings per share is based upon the weighted average number of commonshares outstanding.  Diluted earnings pershare is calculated on the basis of the weighted average number of commonshares outstanding plus the effect of outstanding stock options and employeestock purchase plan shares using the “treasury stock” method.  See Note 15 for identification of thecomponents of basic and diluted earnings per share.

 

*Goodwill and Intangible Assets* - WatsonWyatt has historically applied the purchase method of accounting to itsacquisitions.  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 performs its impairment tests in the third quarter of the company’sfiscal year, and 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 furtherdisclosures regarding the impact of this pronouncement on our financialresults.

 

*Recent Accounting Pronouncements* - In January 2003,the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.46 (FIN 46), “Consolidation of Variable Interest Entities,” which clarifies thefinancial reporting guidance associated with the consolidation of another entity.  In December 2003, the FASB revised andsuperceded FIN 46 with the issuance of FIN 46R in order to address certainimplementation issues.  The companyadopted FIN 46R effective March 31, 2004 and has included appropriatedisclosure in this Form 10-K.  Adoptionof the FIN 46R has not resulted in a change in our accounting.  See Note 4 of the notes to the ConsolidatedFinancial Statements for further information regarding the impact of adoptingFIN 46R.

 

In May 2004, the Financial Accounting Standards Board issued FASB StaffPosition (FSP) No. 106-2 “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug Improvement and Modernization Act of 2003” (the Act)(FAS 106-2), which is effective as of the first quarter beginning after June 15,2004. The Act includes a prescription drug benefit under Medicare Part D aswell as a federal subsidy to sponsors of retiree health care benefit plans thatprovide a benefit that is at least actuarially equivalent (as defined in theAct) to Medicare Part D.  The adoption ofFAS 106-2 does not have a material effect on the financial condition or resultsof operations of the company.

 

In December 2003, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 132,“Employers’ Disclosures about Pensions and Other Postretirement Benefits” (FAS132).  FAS 132 revisions retain theoriginal disclosures but require additional annual disclosures about assets,obligations, cash flows and interim disclosures about net periodic benefitcosts of defined benefit pension plans and other postretirement plans.  The statement is effective for fiscal yearsending after December 15, 2003.  Thecompany has adopted FAS 132 as revised and included appropriate disclosures inNote 6 of this Form 10-K.

 

In June 2004, the Emerging Issues Task Force (EITF) issued EITF02-14****“Whether an Investor Should Apply theEquity Method of Accounting to Investments Other Than Common Stock if theInvestor Has the Ability to Exercise Significant Influence Over the Operatingand Financial Policies of the Investee.” This EITF indicates that an investor should only apply the equity methodof accounting when it has investments in either common stock or in-substancecommon stock of a corporation, provided that the investor has the ability toexercise significant influence over the operating and financial policies of the

 

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investee.  The issuance of EITF02-14 has not had an effect on our accounting for equity investments which hasbeen in accordance with EITF 02-14.

 

**Note 2 - Initial Public Offering and Common Stock**

 

In October 2000, we completed an initial public offering (“IPO”)of our Class A common stock. In conjunction with this offering, each share ofWatson Wyatt & Company’s redeemable common stock was converted into oneshare of Class B-1 common stock and one share of Class B-2 common stock ofWatson Wyatt & Company Holdings. The Class B common stock was divided intotwo classes to accommodate different transfer restriction periods.  A total of 9,956,140 Class B-1 and 12,745,015Class B-2 shares were automatically converted to Class A shares as the relevant12- and 24 -month transfer restrictions expired in October 2001 and 2002.

 

In conjunction with our initial public offering, we also entered intoagreements providing for additional transfer restrictions with majorstockholders, executive officers and employee directors.  As a result of these agreements, 1,947,272Class A shares became freely transferable in October 2003, and 1,690,778Class A shares are currently restricted and will become freely transferable inOctober 2004.

 

In April 2004, the company completed a tender offer for shares ofits Class A common stock, through which the company purchased 830,802 shares ofits Class A shares at a purchase price of $25.25 per share.  The aggregate purchase price of the sharespurchased through the tender offer was $21.0 million, excluding $0.7 millionfees and expenses.

 

**Note 3 - Cash Flow Information**

 

Net cash from operating activities in the Consolidated Statements ofCash Flows includes cash payments for the following:

 
| ** **       | ** ** | **Year Ended June 30** | ** ** |
|------------------|------------|-----------------------------|------------|
| ** **       | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|             |       |                        |       |   |   |   |   |
| Interest expense |       | $                           | 780        |   | $ | 787 |   | $ | 1,376 |   |
| Income taxes     |       | 43,077                      |       | 36,272 |   | 36,574 |   |
|                  |            |                             |            |  |  |  |  |  |  |  |

 

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**Note 4 - Investments in Affiliates**

 

Although we operate globally as an alliance with our affiliates, therevenues and operating expenses in the Consolidated Statements of Operationsreflect only the results of operations of Watson Wyatt & CompanyHoldings.  Our share of the results ofour affiliates, recorded using the equity method of accounting, is reflected inthe “Income from affiliates” line in the Consolidated Statements of Operations.

 

Entities accounted for under the equity method and our investments inthose affiliates are as follows:

 
| ** **                                        | ** ** | **June 30** | ** ** |
|---------------------------------------------------|------------|------------------|------------|
| ** **                                        | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                              |       |             |       |   |   |
| Watson Wyatt LLP                                  |       | $                | 17,119     |   | $ | 15,268 |   |
| Watson Wyatt Holdings (Europe) Limited            |       | 6,799            |       | 6,274 |   |
| Professional Consultants Insurance Company,  Inc. |       | 6,317            |       | 4,889 |   |
|                                              |       |             |       |   |   |
| Total investment in affiliates                    |       | $                | 30,235     |   | $ | 26,431 |   |

 

# ***Watson Wyatt LLP and Watson WyattHoldings (Europe) Limited***

 

Our principal affiliates are Watson Wyatt LLP (WWLLP) and Watson WyattHoldings (Europe) Limited (WWHE).  OnApril 1, 1995, the company transferred its United Kingdom (“U.K.”)operations to WWLLP, an actuarial partnership based in the U.K., and received abeneficial interest in WWLLP and a 10% interest in a defined profit pool of WWLLP.  The company also transferred its ContinentalEuropean operations to WWHE as a newly formed holding company, jointly ownedand controlled by the Company and WWLLP, in exchange for 50.1% of its shares.Effective July 1, 1998, the company sold one-half of its investment inWWHE to WWLLP.  WWHE is now jointly ownedand controlled by the company (25%) and WWLLP (75%).  While Watson Wyatt & Company, WWLLP, andWWHE remain separate legal entities, the companies have marketed their servicesglobally under the Watson Wyatt Worldwide brand, sharing resources,technologies, processes and business referrals. We retain the ability to exercise significant influence over WWLLP andWWHE.  As of June 30, 2004, we hadnet receivables from WWLLP and WWHE of $0.2 million and $0.2 million,respectively.  As of June 30, 2003,we had net receivables from WWLLP and WWHE of $0.4 million and $0.4 million,respectively.

 

Our investment balance in WWHE reflects our initial investment, our 25percent share of their cumulative net loss and a note receivable that we carryon our balance sheet at $9.0 million. The note is collateralized by the assets and performance of WWHE andcalls for principal and unpaid interest to be paid by 2020.  In light of the historical performance of WWHE,the company has not recognized interest income for the note.  If the company had recognized interest incomefor the note, its carrying value, including accrued unpaid interest, wouldapproximate £13.7 million, or approximately $25 million, as of June 30,2004.  Management believes that thecompany’s maximum financial statement exposure to loss is limited to thecarrying value of the company’s investment in WWHE of $6.8 million as ofJune 30, 2004.  We evaluate the WWHEinvestment on a quarterly and annual basis and have determined that the currentcarrying value of the WWHE investment is recoverable.

 

*Professional Consultants 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.

 

56

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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 ofcredit for $1,700,000, and in June 2003, we contributed an additional$1,700,000 in cash and provided an additional letter of credit for$1,700,000.  As of June 30, 2004,the company has designated PCIC as the beneficiary on a total of $4.9 millionof letters of credit.  Our ownershipinterest in PCIC as of June 30, 2004 and 2003 was 34.8 percent.  Management believes that the company’smaximum financial statement exposure to loss of its investment in PCIC islimited to the carrying value of the company’s investment in PCIC of $6.3million, combined with letters of credit totaling $4.9 million for which PCIChas been designated as beneficiary, for a total maximum exposure of $11.2million.

 

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

 
| ** **                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |
| Current assets                                  |       | $        | 272,757    |     | $          | 204,451 |   |
| Noncurrent assets                               |       | 116,815  |       | 128,744  |       |
|                                            |       |     |       |     |       |
| Total assets                                    |       | $        | 389,572    |     | $          | 333,195 |   |
|                                            |       |     |       |     |       |
| Current liabilities                             |       | $        | 77,166     |     | $          | 77,008 |   |
| Noncurrent liabilities                          |       | 162,669  |       | 149,650  |       |
| Stockholders’ equity                       |       | 149,737  |       | 106,537  |       |
|                                            |       |     |       |     |       |
| Total liabilities and stockholders’ equity |       | $        | 389,572    |     | $          | 333,195 |   |

 

Income from affiliates includes our proportionate share of income fromthese equity investments.  Combinedsummarized operating results (prior to distribution of profits) reported by theaffiliates for the years ended June 30 are as follows:

 
| ** **          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|
|                |       |     |       |     |       |     |       |
| Revenue             |       | $        | 423,783    |     | $          | 354,890  |       | $ | 291,951 |   |
| Operating expenses  |       | 294,260  |       | 254,752  |       | 223,422  |       |
|                |       |     |       |     |       |     |       |
| Income before taxes |       | 129,523  |       | 100,138  |       | 68,529   |       |
|                |       |     |       |     |       |     |       |
| Net income          |       | $        | 127,152    |     | $          | 97,607   |       | $ | 68,997 |   |

 

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

 

57

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The company evaluated each of WWLLP, WWHE and PCIC based on FIN 46R’scriteria in order to determine the applicability of FIN 46R.  The company’s current assessment is that, ofthe three entities, WWHE and PCIC are considered to be variable interestentities.  The company has concluded,however, that it is not the primary beneficiary of WWHE or PCIC and, as a result,the Company is not required to consolidate their results.

 

**Note 5 - Fixed Assets**

 

Furniture, fixtures, equipment and leasehold improvements are recordedat cost and presented net of accumulated depreciation or amortization.  Furniture, fixtures and equipment aredepreciated using straight-line and accelerated methods over lives ranging fromthree to seven years.  Leaseholdimprovements are amortized on a straight-line basis over the shorter of thelease terms or the assets’ lives.

 

The components of fixed assets are:

 
| ** **                                       | ** ** | **June 30** | ** ** |
|--------------------------------------------------|------------|------------------|------------|
| ** **                                       | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                             |       |             |       |   |   |
| Furniture, fixtures and equipment                |       | $                | 112,002    |   | $ | 106,820 |   |
| Leasehold improvements                           |       | 44,454           |       | 46,376 |   |
|                                             |       | 156,456          |       | 153,196 |   |
| Less: accumulated depreciation and  amortization |       | (91,018          | )          | (92,480 | ) |
|                                             |       |             |       |   |   |
| Fixed assets, net                                |       | $                | 65,438     |   | $ | 60,716 |   |

 

**Note 6 – Retirement Benefits**

 

*Defined Benefit Plans*

 

We sponsor both qualified and non-qualified, non-contributory definedbenefit pension plans covering substantially all of our associates.  Under our principal plans (United States,Canada, Hong Kong and U.K.), benefits are based on the number of years ofservice and the associates’ compensation during the five highest paidconsecutive years of service.  Thenon-qualified plan provides for pension benefits that would be covered underthe qualified plan but are limited by the Internal Revenue Code.  The non-qualified plan has no assets andtherefore is an unfunded arrangement which is reflected in the balancesheet.  Included in the results is ourU.K. plan, which is inactive but is part of the additional minimum pensionliability reported on the Consolidated Balance Sheets.  The measurement date for the plans isJune 30.

 

58

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Funding is based on actuarially determined contributions and is limitedto amounts that are currently deductible for tax purposes. Since fundingcalculations are based on different measurements than those used for accountingpurposes, pension contributions are not equal to net periodic pensioncost.  The excess of net periodic pensioncost over such contributions and direct benefit payments under non-qualifiedplan provisions is accrued by the company. The following table sets forth our projected voluntary pensioncontributions for fiscal year 2005, as well as the voluntary pension contributionsto our various plans in fiscal years 2004 and 2003:

 
| ** ** | ** ** | **2005 (Projected)** | ** ** | **2004 (Actual)** | ** ** | **2003 (Actual)** | ** ** |
|------------|------------|----------------------|------------|-------------------|------------|-------------------|------------|
|       |       |                 |       |              |       |              |       |
| U.S.       |       | 10,000               |       | 10,000            |       | 22,000            |       |
| Canada     |       | 2,700                |       | 46                |       | —            |       |
| U.K.       |       | 1,300                |       | 1,262             |       | 1,134             |       |
| Hong Kong  |       | 800                  |       | 1,039             |       | 1,147             |       |

 

The fair value of plan assets is based on the market value of domesticequity, international equity and fixed income securities that are in thepension portfolio.  To the extent theexpected return on the pension portfolio varies from the actual return, thereis an unrecognized gain or loss.

 

The non-current portions of accrued costs related to our principalretirement plans reflected in the company’s Consolidated Balance Sheets are:

 
| ** **                                  | ** ** | **June 30** | ** ** |
|---------------------------------------------|------------|------------------|------------|
| ** **                                  | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                        |       |             |       |   |   |
| Defined benefit retirement plans            |       | $                | 44,313     |   | $ | 143,730 |   |
| Canadian Separation Allowance Plan          |       | 4,878            |       | 4,847 |   |
| Postretirement benefits other than pensions |       | 48,793           |       | 47,128 |   |
|                                        |       |             |       |   |   |
| Accrued retirement benefits                 |       | $                | 97,984     |   | $ | 195,705 |   |

 

The assumptions used in the valuation for the U.S. plan, whichcomprises the majority of the principal defined benefit pension plans, includedthe following at the end of the past three fiscal years:

 
| ** **                                                   | ** ** | **Year Ended June 30** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                   | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                         |       |                        |       |   |   |   |   |
| Discount rate,  Projected Benefit Obligation                 |       | 6.25                        | %          | 6.00 | % | 7.25 | % |
|                                                         |       |                        |       |   |   |   |   |
| Discount rate,  Net Periodic Benefit Cost                    |       | 6.00                        | %          | 7.25 | % | 7.25 | % |
|                                                         |       |                        |       |   |   |   |   |
| Expected long-term rate of return on assets                  |       | 9.00                        | %          | 9.00 | % | 10.00 | % |
|                                                         |       |                        |       |   |   |   |   |
| Rate of  increase in compensation, PBO                       |       | 3.34                        | %          | 3.09 | % | 4.34 | % |
|                                                         |       |                        |       |   |   |   |   |
| Rate of increase  in compensation, Net Periodic Benefit Cost |       | 3.09                        | %          | 4.34 | % | 4.34 | % |

 

The 6.25 percent discount rate assumption used at the end of fiscalyear 2004 represents a 25 basis point increase from the 6.00 percent discountrate used at the end of fiscal years 2003. The company’s 2004 discount rate assumption was determined by matchingfuture pension benefit payments with expected future AA bond yields for thesame periods.

 

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The expected long-term rate of return on assets assumption remained at9.00 percent at June 30, 2004. Continuation of the 9.00 percent return assumption was supported by ananalysis performed by the company of the weighted average yield expected to beachieved with the anticipated makeup of investments.  The investment makeup is heavily weightedtowards equities.

 

The company calculates the net periodic benefit costs for a givenfiscal year based on assumptions established at the end of the previous fiscalyear.  Actuarial gains and losses associatedwith changing any of these assumptions are not recognized immediately; insteadthey are accumulated as part of the unrecognized net loss/(gain) balance andamortized into the net periodic pension expense over the average remainingservice period of participating employees.

 

Net periodic pension cost consists of the following componentsreflected as expense in the company’s Consolidated Statements of Operations:

 
| ** **                                       | ** ** | **Year Ended June 30** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                             |       |                        |       |   |   |   |   |
| Service cost                                     |       | $                           | 26,674     |   | $ | 26,201 |   | $ | 27,751 |   |
| Interest cost                                    |       | 33,490                      |       | 33,564 |   | 32,540 |   |
| Expected return on plan assets                   |       | (35,831                     | )          | (37,466 | ) | (41,506 | ) |
| Amortization of transition obligation            |       | (4                          | )          | 199 |   | 213 |   |
| Amortization of net unrecognized losses/ (gains) |       | 11,406                      |       | 4,760 |   | (164 | ) |
| Amortization of prior service cost               |       | (2,169                      | )          | 582 |   | 545 |   |
|                                             |       |                        |       |   |   |   |   |
| Net periodic  pension cost                       |       | $                           | 33,566     |   | $ | 27,840 |   | $ | 19,379 |   |

 

The following table summarizes benefit obligations associated with thequalified and non-qualified plans:

 
| ** **                                        | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **Qualified**          | ** ** | **Non-qualified**      | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                              |       |                   |       |                   |       |   |   |   |   |
| Accumulated benefit obligation                    |       | $                      | 469,549    |                   | $          | 61,172 |   | $ | 458,596 |   | $ | 63,740 |   |
|                                              |       |                   |       |                   |       |   |   |   |   |
| Projected benefit obligation at beginning of year |       | $                      | 486,225    |                   | $          | 80,318 |   | $ | 393,038 |   | $ | 74,829 |   |
| Service cost                                      |       | 21,081                 |       | 5,593                  |       | 20,055 |   | 6,146 |   |
| Interest cost                                     |       | 28,704                 |       | 4,786                  |       | 28,054 |   | 5,510 |   |
| Actuarial losses/(gains)                          |       | (15,828                | )          | 297                    |       | 62,070 |   | 6,626 |   |
| Benefit payments                                  |       | (15,608                | )          | (1,476                 | )          | (14,026 | ) | (4,708 | ) |
| Plan amendments                                   |       | —                 |       | —                 |       | (10,422 | ) | (9,786 | ) |
| Settlements                                       |       | —                 |       | (10,542                | )          | — |   | — |   |
| Other                                             |       | 1,580                  |       | (613                   | )          | 2,506 |   | 330 |   |
| Foreign currency adjustment                       |       | 2,574                  |       | 128                    |       | 4,950 |   | 1,371 |   |
| Projected benefit obligation at end of year       |       | $                      | 508,728    |                   | $          | 78,491 |   | $ | 486,225 |   | $ | 80,318 |   |

 

60

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Plan amendments are changes in the pension plan that will eitherincrease or decrease future retirement benefits for work performed in priorperiods.  In fiscal year 2003, we amendedthe plans for early retirement eligibility provisions, early retirement factorsand the averaging period for pay.  Infiscal year 2002, we amended the plans to reflect the changes to the maximumbenefit and compensation limits under the Economic Growth and Tax ReliefReconciliation Act (EGTRRA) enacted in June 2001.  The unrecognized prior service cost is thecumulative prior service costs and benefits from amendments to the pensionplans that have not yet been recognized in the financial statements.

 

The table below provides information for the U.S. qualified pensionplan with an accumulated benefit obligation in excess of plan assets in fiscalyear 2003.  In fiscal year 2004, the U.S.qualified plan assets were greater than the accumulated benefitobligation.  The non-qualified amountsreflect only the U.S. and Canadian plans and are unfunded.

 
| ** **                     | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
|--------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                     | ** ** | **Qualified**          | ** ** | **Non-qualified**      | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                           |       |                   |       |                   |       |   |   |   |   |
| Projected Benefit Obligation   |       | $                      | 440,820    |                   | $          | 78,491 |   | $ | 425,418 |   | $ | 80,318 |   |
| Accumulated Benefit Obligation |       | 406,397                |       | 61,172                 |       | 401,471 |   | 63,740 |   |
| Fair value of plan assets      |       | 407,776                |       | —                 |       | 346,551 |   | — |   |
|                                |            |                        |            |                        |            |  |  |  |  |  |  |  |  |

 

The table below provides information for the UK pension plan with anaccumulated benefit obligation in excess of plan assets in fiscal years 2004and 2003.

 
| ** **                     | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
|--------------------------------|------------|------------------------|------------|------------------------|------------|
|                           |       |                   |       |                   |       |
| Projected Benefit Obligation   |       | $                      | 25,997     |                   | $          | 21,959 |   |
| Accumulated Benefit Obligation |       | 25,997                 |       | 21,959                 |       |
| Fair value of plan assets      |       | 19,107                 |       | 15,315                 |       |
|                                |            |                        |            |                        |            |  |  |

 

The Canada and Hong Kong qualified plans each had assets greater thanthe accumulated benefit obligation.

 

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The following table summarizes plan assets associated with thequalified and non-qualified plans:

 
| ** **                                      | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **Qualified**          | ** ** | **Non-qualified**      | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                            |       |                   |       |                   |       |   |   |   |   |
| Fair value of  plan assets at beginning of year |       | $                      | 405,339    |                   | $          | — |   | $ | 386,830 |   | $ | — |   |
| Actual return  on plan assets                   |       | 71,986                 |       | —                 |       | 3,036 |   | — |   |
| Company  contributions                          |       | 12,347                 |       | 12,018                 |       | 24,281 |   | 4,708 |   |
| Benefit  payments                               |       | (15,628                | )          | (12,018                | )          | (14,026 | ) | (4,708 | ) |
| Foreign  currency adjustment                    |       | 1,978                  |       | —                 |       | 5,218 |   | — |   |
| Fair value of  plan assets at end of year       |       | $                      | 476,022    |                   | $          | — |   | $ | 405,339 |   | $ | — |   |

 

The following table, and the narrative that follows, provideinformation relating to the weighted-average asset allocations at June 30,2004 and 2003 and the investment strategy for the company’s U.S. definedbenefit pension plan, which comprises the majority of our define benefitpension plans:

 
| ** **        | ** ** | **Plan Assets at June 30** | ** ** |
|-------------------|------------|---------------------------------|------------|
| ** **        | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| Asset Category    |       |                            |       |   |   |
|              |       |                            |       |   |   |
| Equity securities |       | 83.2                            | %          | 82.5 | % |
| Debt securities   |       | 16.3                            | %          | 17.1 | % |
| Real estate       |       | 0.0                             | %          | 0.0 | % |
| Other             |       | 0.5                             | %          | 0.4 | % |
|              |       |                            |       |   |   |
| Total             |       | 100                             | %          | 100 | % |

 

The investment objectives of the company’s qualified pension plan aredesigned to generate returns that will enable the plan to meet its futureobligations. The precise amount for which these obligations will be settleddepends on future events, including the life expectancy of the plan’s membersand salary inflation. The obligations are estimated using actuarialassumptions, based on the current economic environment.

 

The pension plan seeks to achieve total returns both sufficient to meetexpected future obligations as well as returns greater than its policy benchmarkreflecting the target weights of the asset classes used in its targetedstrategic asset allocation.  The plan’stargeted strategic allocation to each asset class was determined through anAsset-Liability Modeling study to evaluate long-term asset-allocationstrategy.  This comprehensive studyprovides an evaluation of the projected status of asset and liability measuresfor the plan under a range of both positive and negative environments.  The study includes a number of differentasset mixes, spanning a range of diversification and potential equityexposures.

 

In evaluating the strategic asset allocation choices, an emphasis isplaced on the long-term characteristics of each individual asset class, and thebenefits of diversification among multiple asset classes. Consideration is alsogiven to the proper long-term level of risk for the plan, particularly withrespect to the long-term nature of the plan’s liabilities, the impact of assetallocation on investment results, and the corresponding impact on thevolatility and magnitude of plan contributions and expense and the impactcertain actuarial techniques may have on the plan’s recognition of investmentexperience.  The currently adoptedstrategic asset allocation targets 85 percent in equity securities and 15percent in debt securities including additional allocations within specificasset classes of these broad categories.

 

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The company monitors investment performance and portfoliocharacteristics on a quarterly basis to ensure that managers are meetingexpectations with respect to their investment approach.  With the exception of securities issued bythe U.S. Government and its agencies, no single issue is to comprise more than5 percent of the portfolio’s value although index fund managers are exempt fromthe security weighting constraints. There are also various restrictions andcontrols placed on managers including prohibition from investing in companystock.

 

The expected return on assets assumption is developed in conjunctionwith advisors and using the company’s asset model that reflects a combinationof rigorous historical analysis and the forward looking views of the financialmarkets as revealed through the yield on long-term bonds, the price earningsratios of the major stock market indices and long-term inflation. Amounts aretested for reasonableness against their historical averages. The assumption waslowered from 10.0 percent to 9.0 percent for the fiscal year beginningJuly 1, 2003. The expected return on assets assumption is intended to be along-term assumption and is not expected to be modified frequently.  The return on assets in fiscal year 2004 was19 percent, compared to a return of 2 percent in fiscal year 2003.

 

The following benefit payments for our defined benefit pension plan,which reflect expected future service, as appropriate, are expected to be paid:

 

| **Fiscal  Year**   | ** ** | **Benefit  Payments** | ** ** |
|--------------------|------------|-----------------------|------------|
|               |       |                  |       |
| 2005               |       | $                     | 19,148     |   |
| 2006               |       | 20,670                |       |
| 2007               |       | 22,772                |       |
| 2008               |       | 24,951                |       |
| 2009               |       | 28,430                |       |
| Years 2010 -  2014 |       | 179,260               |       |
|               |       | $                     | 295,231    |   |

 

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

 
| ** **                                 | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
|--------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **Qualified**          | ** ** | **Non-qualified**      | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                       |       |                   |       |                   |       |   |   |   |   |
| Funded status at end of year               |       | $                      | (32,702    | )                      | $          | (78,491 | ) | $ | (80,886 | ) | $ | (80,318 | ) |
| Unrecognized prior service cost            |       | (9,375                 | )          | (3,579                 | )          | (11,269 | ) | (3,872 | ) |
| Unrecognized net loss/(gain)               |       | 95,876                 |       | (7,721                 | )          | 157,476 |   | (9,425 | ) |
| Unrecognized transition obligation/(asset) |       | (247                   | )          | 209                    |       | (301 | ) | 263 |   |
| Net amount recognized                      |       | $                      | 53,552     |                   | $          | (89,582 | ) | $ | 65,020 |   | $ | (93,352 | ) |

 

The unrecognized amounts represent the actual changes in the estimatedPBO and plan assets that have not yet been recognized in either the balancesheet or the income statement.  Anydifferences between actual and assumed results are amortized into the netperiodic pension expense over the average remaining service period ofparticipating employees.

 

During fiscal year 2003, the value of the assets held in the pensionplans decreased and the decline in interest rates increased our accumulatedbenefit obligation, resulting in the accumulated benefit obligation

 

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becoming greater than the value of the plan assets for the U.S. andU.K. pension plans.  The company wastherefore required to record an additional minimum pension liability for thoseplans at June 30, 2003, in accordance with Statement of Financial AccountingStandards No. 87 “Employers’ Accounting for Pensions” (FAS 87).  This resulted in an increase in the pensionliability of $113.4 million, an increase in intangible assets of $0.1 million,a non-cash charge to Stockholders’ Equity of $67.9 million (reflected inaccumulated other comprehensive loss) and an increase in deferred tax assets of$45.4 million as of June 30, 2003.

 

In fiscal year 2004, the value of the assets held in the pension plansin the U.S. increased due to market appreciation, resulting in the value of theplan assets becoming greater than the accumulated benefit obligation, therebyeliminating the requirement to record an additional minimum pension liabilityfor the U.S. plans. This resulted in a decrease in the pension liability of$105.4 million, a reduction in the charge to Stockholders’ Equity of $62.4million (reflected in accumulated other comprehensive loss) and a decrease indeferred tax assets of $43.1 million as of June 30, 2004. The value of theassets held in the pension plan in the U.K. remained below the accumulated benefitobligation, resulting in the accumulated benefit obligation remaining greaterthan the value of the plan assets for U.K. pension plan.  An additional liability of $1.7 million, anon-cash charge to Stockholders’ Equity of $1.2 million (reflected in accumulatedother comprehensive loss) and an increase in deferred tax assets of $0.5million as of June 30, 2004 was recorded for the U.K. increase.  The remaining balances related to the minimumpension liability as of June 30, 2004 are a pension liability of $9.6million, an intangible asset of $0.1 million, an accumulated othercomprehensive loss of $6.7 million (reflected in Stockholders’ Equity) and adeferred tax asset of $2.9 million.

 

Our Canadian and Hong Kong pension plan assets were greater than theirassociated accumulated benefit obligation as of June 30, 2004 and 2003 andthus did not require the recording of additional minimum pension liabilities ineither period.

 

The table below summarizes the amounts reflected in our ConsolidatedBalance Sheets for the period indicated:

 
| ** **                             | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
|----------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **Qualified**          | ** ** | **Non-qualified**      | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                   |       |                   |       |                   |       |   |   |   |   |
| Prepaid (accrued) benefit cost         |       | $                      | 53,552     |                   | $          | — |   | $ | (40,424 | ) | $ | — |   |
| Accrued benefit liability              |       | (9,625                 | )          | (89,582                | )          | (7,967 | ) | (93,352 | ) |
| Intangible assets                      |       | 124                    |       | —                 |       | 113 |   | — |   |
| Accumulated other comprehensive income |       | 9,501                  |       | —                 |       | 113,298 |   | — |   |
| Net amounts recognized                 |       | $                      | 53,552     |                   | $          | (89,582 | ) | $ | 65,020 |   | $ | (93,352 | ) |

 

*Defined Contribution Plans*

 

We sponsor a savings plan that provides benefits to substantially allU.S. associates. Effective July 1, 2003, the company match wassuspended.  Under the plan in previousyears, we have matched employee contributions at 50 percent of the first 6 percentof total pay, which includes base salary, overtime and annual performance-basedbonuses.  Vesting of the company matchoccurs after three years for new employees and is 100 percent for all employeeshired before January 1, 1997.  Theexpense in fiscal years 2003 and 2002 was $7.4 million and $7.9 million,respectively.  Under the plan, we alsohave the ability to make discretionary profit-sharing contributions.  We made no profit-sharing contributionsduring fiscal

 

64

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years 2004, 2003 and 2002.  Wealso sponsor a Canadian Separation Allowance Plan (CSAP) that providesretirement benefits to substantially all Canadian associates.  The CSAP is an unfunded benefit plan; assuch, the amounts due to associates are recorded as a liability in the ConsolidatedBalance Sheets of the company.  CSAPexpense for fiscal years 2004, 2003 and 2002 amounted to $243,000, $264,000 and$328,000, respectively.

 

EffectiveJuly 1, 2004, the company reinstituted a match to employee contributionsat a rate of 50% of the first 6% up to $60,000 of associates’ eligiblecompensation.  The company will also makean annual profit sharing contribution to the plan in an amount that isdependant upon the company’s financial performance during the fiscal year.

 

*Health Care Benefits*

 

We sponsor a contributory health care plan that provideshospitalization, medical and dental benefits to substantially all U.S.associates.  We accrue a liability forestimated incurred but unreported claims based on projected use of the plan aswell as prior plan history.  Theliability totaled $2.3 million and $2.7 million at June 30, 2004, andJune 30, 2003, respectively, and is included in accounts payable andaccrued liabilities in the Consolidated Balance Sheets.

 

*Postretirement Benefits*

 

We provide certain health care and life insurance benefits for retiredassociates.  The principal plans coverassociates in the U.S. and Canada who have met certain eligibilityrequirements. Our principal plans are unfunded.

 

Assumptions used in the valuation for the U.S. plan, which comprisesthe majority of the principal postretirement plans, included the following overthe past three fiscal years:

 
| ** **                                                            | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                            | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                  |       |                        |       |   |   |   |   |
| Health care cost trend, accumulated benefit obligation:               |       |                        |       |   |   |   |   |
| Pre-65 benefits  (decreasing to 5.00% for 2008 and thereafter)        |       | 9.00                        | %          | 10.00 | % | 7.00 | % |
| Post-65 benefits  (decreasing to 5.00% for 2008 and thereafter)       |       | 9.00                        | %          | 10.00 | % | 7.60 | % |
| Discount rate, accumulated  benefit obligation postretirement benefit |       | 6.25                        | %          | 6.00 | % | 7.25 | % |

 

Actuarial gains and lossesassociated with changing any of the assumptions are accumulated as part of theunrecognized net gain balance which is amortized and included in the netperiodic postretirement costs over the average remaining service period ofparticipating employees, which is approximately 16 years.  The health care trend assumptions above havebeen graded down one year.

 

65

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A one percentage point change in the assumed health care cost trendrates would have the following effect:

 
| ** **                                                                        | ** ** | **1% Increase** | ** ** | **1% Decrease** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
|                                                                              |       |            |       |            |       |
| Effect on net periodic  postretirement benefit cost in fiscal year 2004           |       | $               | 272        |            | $          | (218 | ) |
| Effect on accumulated  postretirement benefit obligation as of June 30, 2004 |       | 2,402           |       | (1,863          | )          |
|                                                                                   |            |                 |            |                 |            |  |  |

 

Net periodic postretirement benefit cost consists of the followingcomponents reflected as expense in the company’s Consolidated Statements ofOperations:

 
| ** **                                | ** ** | **Year Ended June 30** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                      |       |                        |       |   |   |   |   |
| Service cost                              |       | $                           | 1,686      |   | $ | 1,769 |   | $ | 1,771 |   |
| Interest cost                             |       | 2,300                       |       | 2,514 |   | 2,362 |   |
| Amortization of transition obligation     |       | 47                          |       | 46 |   | 44 |   |
| Amortization of net unrecognized gains    |       | (274                        | )          | (516 | ) | (877 | ) |
| Amortization of prior service cost        |       | (624                        | )          | (464 | ) | (129 | ) |
|                                      |       |                        |       |   |   |   |   |
| Net periodic  postretirement benefit cost |       | $                           | 3,135      |   | $ | 3,349 |   | $ | 3,171 |   |

 

The following table sets forth the changes in the accumulatedpostretirement benefit obligation:

 
| ** **                              | ** ** | **June 30** | ** ** |
|-----------------------------------------|------------|------------------|------------|
| ** **                              | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                    |       |             |       |   |   |
| Benefit obligation at beginning of year |       | $                | 39,545     |   | $ | 38,488 |   |
| Service cost                            |       | 1,686            |       | 1,769 |   |
| Interest cost                           |       | 2,300            |       | 2,514 |   |
| Participant contributions               |       | 207              |       | 171 |   |
| Actuarial losses (gains)                |       | (1,794           | )          | 5,147 |   |
| Benefit payments                        |       | (2,637           | )          | (3,088 | ) |
| Plan amendments                         |       | —           |       | (6,653 | ) |
| Other                                   |       | 769              |       | 441 |   |
| Foreign currency adjustment             |       | 74               |       | 757 |   |
| Benefit obligation at end of year       |       | $                | 40,150     |   | $ | 39,546 |   |

 

Plan amendments are changes in the postretirement plan that will eitherincrease or decrease future benefits for work performed in prior periods.  In fiscal year 2003, we amended the plan toinclude changes in the prescription drug plan, changes in pre-65 medicalbenefits and revisions to contribution schedules for existing and futureretirees.

 

66

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The following table sets forth the changes in the company contributionsand benefit payments for the postretirement plan:

 
| ** **                                     | ** ** | **June 30** | ** ** |
|------------------------------------------------|------------|------------------|------------|
| ** **                                     | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                           |       |             |       |   |   |
| Fair value of plan assets at beginning of year |       | $                | —     |   | $ | — |   |
| Company contributions                          |       | 2,430            |       | 2,917 |   |
| Participant contributions                      |       | 207              |       | 171 |   |
| Benefit payments                               |       | (2,637           | )          | (3,088 | ) |
| Fair value of plan assets at end of year       |       | $                | —     |   | $ | — |   |

 

The following benefit payments for our postretirement plan, whichreflect expected future service, as appropriate, are expected to be paid:

 

| **Fiscal  Year**   | ** ** | **Benefit  Payments** | ** ** |
|--------------------|------------|-----------------------|------------|
|               |       |                  |       |
| 2005               |       | $                     | 2,125      |   |
| 2006               |       | 2,233                 |       |
| 2007               |       | 2,293                 |       |
| 2008               |       | 2,394                 |       |
| 2009               |       | 2,506                 |       |
| Years 2010 -  2014 |       | 14,875                |       |
|               |       | $                     | 26,426     |   |

 

The following table sets forth the changes in the funded status in thepostretirement plan:

 
| ** **                           | ** ** | **June 30** | ** ** |
|--------------------------------------|------------|------------------|------------|
| ** **                           | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                 |       |             |       |   |   |
| Funded status at end of year         |       | $                | (40,150    | ) | $ | (39,546 | ) |
| Unrecognized net gain                |       | (4,987           | )          | (4,244 | ) |
| Unrecognized prior service cost      |       | (6,508           | )          | (7,134 | ) |
| Unrecognized transition obligation   |       | 426              |       | 468 |   |
| Net accrued postretirement liability |       | $                | (51,219    | ) | $ | (50,456 | ) |

 

The unrecognized prior service cost represents the cumulative priorservice costs and benefits from amendments to the postretirement plan which hasnot yet been recognized in the financial statements.  Previous amendments are being amortized andincluded in the net periodic postretirement benefit costs over the averageremaining service period of participating employees, which is approximatelyeight years.

 

Based on the Financial Accounting Standards Board Staff Position No. 106-2“Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug Improvement and Modernization Act of 2003” (FAS 106-2), plans meeting thedefinition of actuarial equivalence can begin to reflect drug subsidies thatwill be provided in 2006 under Medicare (Part D).  The liabilities determined as ofJune 30, 2004 for disclosure purposes reflect these changes. The adoptionof FAS 106-2 does not have a material effect on liabilities above.

 

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**Note 7 - Accounts Payable and Accrued Liabilities**

 

Accounts payable and accrued liabilities consist of:

 
| ** **                                                                                           | ** ** | **June 30** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                           | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                                                                                 |       |             |       |   |   |
| Accounts payable and accrued liabilities                                                             |       | $                | 35,617     |   | $ | 44,333 |   |
| Accrued salaries and bonuses                                                                         |       | 42,655           |       | 41,816 |   |
| Current portion of defined  benefit retirement plans and postretirement benefits other than pensions |       | 7,170            |       | 3,754 |   |
| Accrued vacation                                                                                     |       | 15,482           |       | 15,610 |   |
| Advance billings deferred revenue                                                                    |       | 9,868            |       | 8,500 |   |
| Dividends payable                                                                                    |       | 2,441            |       | — |   |
| Total accounts payable and accrued liabilities                                                       |       | $                | 113,233    |   | $ | 114,013 |   |

 

**Note 8 - Leases**

 

We lease office space, furniture and selected computer equipment underoperating lease agreements with terms generally ranging from one to tenyears.  We have entered into subleaseagreements for some of our excess leased space. Rental expense was $56.1 million, $52.8 million, and $51.1 million forfiscal years 2004, 2003 and 2002, respectively, inclusive of operating expensesrelated to such space and equipment. Sublease income was $0.6 million, $0.5 million and $3.4 million forfiscal years 2004, 2003 and 2002, respectively. We have no subleases extending beyond fiscal year 2005.

 

Future minimum lease payments for operating lease commitments andanticipated cash inflows for sublease income are:

 
| **Fiscal  Year** | ** ** | **Lease  Commitments** | ** ** |
|------------------|------------|------------------------|------------|
|             |       |                   |       |
| 2005             |       | $                      | 40,490     |   |
| 2006             |       | 31,647                 |       |
| 2007             |       | 29,834                 |       |
| 2008             |       | 26,773                 |       |
| 2009             |       | 24,133                 |       |
| Thereafter       |       | 111,134                |       |
| Total            |       | $                      | 264,011    |   |

 

We evaluate officecapacity on an ongoing basis to meet changing needs in our markets whileminimizing our occupancy expense.

 

On April 27, 2004, the company executed a new lease agreementcommitting its Washington, D.C. office, which includes consulting and corporateoperations, to move to Northern Virginia. The company simultaneously provided notice of early termination of itsexisting Washington, D.C. lease, which resulted in a $3.2 million charge duringthe fourth quarter of fiscal year 2004. The $3.2 million charge had no net cash impact on the company becausethe company will receive a $3.2 million payment from the new lessor as anincentive to enter into the new lease.

 

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**Note 9 - Line of Credit**

 

In June 2004, we reduced the size of our revolving credit facilityto $50 million from $100 million in order to better align it with our businessneeds.  The facility is provided by asyndicate of banks.  Interest ratesassociated with this facility vary with LIBOR and/or the Prime Rate and arebased on our leverage ratio, as defined by the credit agreement.  We are charged a quarterly commitment fee,currently 0.20 percent of the facility that varies with our financial leverageand is paid on the unused portion of the credit facility.  No amounts were outstanding under the company’srevolving credit facility as of June 30, 2004 or June 30, 2003.  Credit under the facility is available upondemand, although the credit facility requires us to observe certain covenants(including requirements for a fixed coverage charge, cashflow leverage ratioand asset coverage) and is collateralized with a pledge of stock of materialsubsidiaries.  We were in compliance withall covenants under the credit facility as of June 30, 2004.

 

A portion of the revolving facility is used to support required lettersof credit issued under the credit line. As a result, $7.5 million of the facility is currently unavailable foroperating needs.  We are also charged afee for outstanding letters of credit that also fluctuates based on ourleverage ratio.  The credit facility isscheduled to mature on June 29, 2009.

 

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

 

*2000 Long-Term Incentive Plan*

 

In June 2000, the company adopted the Watson Wyatt & CompanyHoldings 2000 Long-Term Incentive Plan (the “Stock Option Plan”), whichprovides for the granting of non-qualified stock options and stock appreciationrights (collectively referred to as “awards”) to full-time associates of thecompany and to non-associate members of the Board of Directors.  The total number of shares of common stockawards that may be granted under the Stock Option Plan is 4,500,000shares.  Prior to adopting the StockOption Plan, the company had no outstanding options.

 

The stock option agreements have a seven-year life and vest 20 percentat each option anniversary date over a five-year period.  All options under the Stock Option Plan weregranted with an exercise price equal to the stock’s fair market value on thedate of grant.  Generally, the number ofoptions granted to associates was based on a percentage of annualcompensation.  The company does notcurrently intend to issue further stock options under the Stock Option Plan.

 

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The table below presents stock option activity since the inception ofthe 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      |   |
| Granted                           |       | —                |       | —                                 |       |
| Exercised                         |       | (164                  | )          | 12.91                                  |       |
| Forfeited                         |       | (106                  | )          | 13.91                                  |       |
| Expired                           |       | —                |       | —                                 |       |
|                              |       |                  |       |                                   |       |
| Outstanding at June 30, 2004 |       | 1,072                 |       | 13.45                                  |       |

 

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At June 30, 2004, there were 600,091 options exercisable at aweighted average price of $13.41.  Thetable below presents additional information about the options outstanding andexercisable at June 30, 2004:

 
| ** **                    | ** ** | **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               |       | 952,091                 |       | $                                      | 12.50      |   | 3.2 |   | 534,525 |   | $ | 12.50 |   |
| $15.01 - $20.00               |       | 40,871                  |       | $                                      | 17.89      |   | 3.5 |   | 23,759 |   | $ | 17.94 |   |
| $20.01 - $25.00               |       | 76,833                  |       | $                                      | 22.48      |   | 3.5 |   | 40,935 |   | $ | 22.37 |   |
| $25.01 - $30.00               |       | 2,120                   |       | $                                      | 26.50      |   | 4.0 |   | 872 |   | $ | 26.50 |   |
|                          |       |                    |       |                                   |       |   |   |   |   |   |   |
| $10.00 - $30.00               |       | 1,071,915               |       | $                                      | 13.45      |   | 3.2 |   | 600,091 |   | $ | 13.41 |   |

 

*2001 Employee Stock Purchase Plan*

 

The 2001 Employee Stock Purchase Plan (the “Stock Purchase Plan”) wasapproved at the annual stockholders’ meeting in November 2001.  The Stock Purchase Plan, which qualifies asan “employee stock purchase plan” under Section 423 of the InternalRevenue Code of 1986 of the United States of America, originally provided forthe issuance of up to 750,000 shares of the company’s common stock.  In April 2003, the Board of Directorsapproved an additional 1,500,000 shares for issuance under this plan.  The company gained stockholder approval forissuance of these additional shares at our annual meeting inNovember 2003.  Full-time andregular part-time employees are eligible to participate in the Stock PurchasePlan through payroll deductions of up to 10 percent of each participant’scompensation, subject to certain restrictions. Under the plan, four three-month offering periods are to be held duringeach fiscal year beginning each November 1, February 1, May 1 andAugust 1.  A summary of stockpurchased under the Stock Purchase Plan is shown below for fiscal years 2004and 2003:

 
| ** **                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|
|                                     |       |     |       |     |       |
| Aggregate purchase price (in 000’s) |       | $        | 6,789      |     | $          | 6,408 |   |
| Shares purchased (in 000’s)         |       | 360      |       | 393      |       |
| Employee participants                    |       | 1,138    |       | 1,175    |       |
|                                          |            |          |            |          |            |  |  |

 

The purchase price for shares of common stock to be purchased duringany offering period is the lower of 85 percent of the fair market value ofcommon stock on the beginning date and ending date of each offeringperiod.  Shares of common stock acquiredpursuant to the Stock Purchase Plan may not be disposed of by the participantfor at least three months following the exercise date.

 

##### *2001 DeferredStock Unit Plan for Selected Employees*

 

In November 2001, the 2001 Deferred Stock Unit Plan for SelectedEmployees (the “Stock Unit Plan”) was approved at the annual meeting ofstockholders.  The Stock Unit Plan isintended to provide senior associates of the company with additional incentivesby permitting the company to grant them an equity

 

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interest in the company in the form of deferred stock units, in lieu ofa portion of their annual fiscal year end bonus, typically paid inSeptember of each year. Each stock unit represents one share of commonstock.  The total number of sharesauthorized for issuance in payment of deferred stock units under the Stock UnitPlan is 1,500,000 shares.

 

Deferred stock units were granted in September 2002 and 2003 andvested immediately.  The company expectsthat the deferred stock units to be granted in September 2004 will vestimmediately. Vesting of future awards is at the discretion of the company, withsuch determination being made prior to issuance of the deferred stock units.

 

## *CompensationPlan for Outside Directors*

 

In November 2001, the Board ofDirectors approved the Compensation Plan for Outside Directors (the “OutsideDirector’s Plan”) 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 provided during the preceding quarter.  The total number of shares reserved forissuance under the Outside Director’s Plan is 50,000.  In August 2003, the Board of Directorsapproved amendments to the plan that included an increase in the compensationof the outside Directors and provided for an annual grant of companystock.  The Company gained stockholderapproval of amendments to the plan at our annual meeting in November 2003.  Compensation expense recognized pursuant tothis plan was $0.6 million and $0.2 million in fiscal year 2004 and 2003,respectively.

 

*Dividends*

 

In May 2004, the Board of Directors of the company approved theinitiation of a quarterly cash dividend in the amount of $0.075 per share.  The first quarterly dividend payment of $2.4million was made on July 15, 2004 to shareholders of record as ofJune 30, 2004 and is accrued on these financial statements.

 

Under our credit facility (see Note 9 of Notes to the ConsolidatedFinancial Statements, included in Item 15 of this report), we are required toobserve certain covenants (including requirements for a fixed coverage charge,cashflow leverage ratio and asset coverage) that affect the amounts availablefor the declaration or payment of dividends. The continued payment of cash dividends in the future is at thediscretion of our Board of Directors and depends on numerous factors,including, without limitation, our net earnings, financial condition,availability of capital, debt covenant limitations and our other businessneeds, including those of our subsidiaries and affiliates.

 

72

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**Note 11 - Goodwill and Intangible Assets**

 

The changes in the carrying amount of goodwill for the fiscal yearsended June 30, 2003 and 2004, are as follows:

 
| ** **                          | ** ** | **Benefits  Group** | ** ** | **Technology  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **International** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------|------------|---------------------|------------|----------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|-----------|------------|
|                                |       |                |       |                             |       |                      |       |              |       |      |       |      |       |
| 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 |   |
| Goodwill recorded during the period |       | —              |       | —                           |       | —                    |       | 114               |       | —    |       | 114       |       |
| Impairment losses                   |       | —              |       | —                           |       | —                    |       | —            |       | —    |       | —    |       |
| Translation adjustment              |       | 53                  |       | —                           |       | 1                         |       | (9                | )          | —    |       | 45        |       |
|                                |       |                |       |                             |       |                      |       |              |       |      |       |      |       |
| Balance as of June 30, 2004    |       | $                   | 16,331     |                             | $          | 1,449                     |       | $                 | 70         |      | $          | 1,084     |       | $ | 1,214 |   | $ | 20,148 |   |

 

The following table reflects changes in the net carrying amount of the componentsof intangible assets for the fiscal years ended June 30, 2003 and 2004:

 
| ** **                                    | ** ** | **Non-Contractual  Customer  Relationships** | ** ** | **Non-Compete  Agreements** | ** ** | **Purchased  Software** | ** ** | **Pension** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|-------------|------------|-----------|------------|
|                                          |       |                                         |       |                        |       |                    |       |        |       |      |       |
| 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 |   |
| Intangible assets recorded during the  period |       | 206                                          |       | —                      |       | —                  |       | —      |       | 206       |       |
| Amortization expense                          |       | (198                                         | )          | (92                         | )          | (25                     | )          | —      |       | (315      | )          |
| Translation adjustment                        |       | (29                                          | )          | (1                          | )          | —                  |       | 11          |       | (19       | )     |
| Balance as of June 30, 2004              |       | $                                            | 459        |                        | $          | 176                     |       | $           | 2          |      | $          | 124 |   | $ | 761 |   |

 

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The following table reflects the carrying value of intangible assets atJune 30, 2004 and 2003:

 
| ** **                                                   | ** ** | **Fiscal year 2004**        | ** ** | **Fiscal year 2003**          | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                                                   | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortizable intangible assets and  intangible pension asset: |       |                        |       |                          |       |   |   |   |   |
| Non-contractual customer relationships                       |       | $                           | 962        |                          | $          | 503 |   | $ | 778 |   | $ | 298 |   |
| Non-compete agreements                                       |       | 672                         |       | 496                           |       | 672 |   | 403 |   |
| Purchased software                                           |       | 125                         |       | 123                           |       | 125 |   | 98 |   |
| Intangible pension asset                                     |       | 124                         |       | —                        |       | 113 |   | — |   |
|                                                         |       |                        |       |                          |       |   |   |   |   |
| Total amortizable intangible assets                          |       | $                           | 1,883      |                          | $          | 1,122 |   | $ | 1,688 |   | $ | 799 |   |

 

The change in the grosscarrying amount of non-contractual customer relationships reflects translationadjustments.

 

The weighted averageremaining life of amortizable intangible assets at June 30, 2004, was 3.4years.  Future estimated amortizationexpense is as follows:

 
| **Fiscal year ending June 30** | ** ** | **Amount** | ** ** |
|-------------------------------------|------------|------------|------------|
| 2005                                |       | $          | 314        |   |
| 2006                                |       | 156        |       |
| 2007                                |       | 50         |       |
| 2008                                |       | 29         |       |
| 2009                                |       | 29         |       |
| Thereafter                          |       | 59         |       |
|                                     |            |            |            |  |

 

**Note 12 - Income Taxes**

 

Deferred income tax assets and liabilities reflect the effect oftemporary differences between the assets and liabilities recognized forfinancial reporting purposes and the amounts recognized for income taxpurposes.  The company recognizesdeferred tax assets if it is more likely than not that a benefit will berealized.

 

74

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The components of the income tax provision for continuing operationsinclude:

 
| ** **                       | ** ** | **Year Ended June 30** | ** ** |
|----------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                             |       |                        |       |   |   |   |   |
| Current tax expense:             |       |                        |       |   |   |   |   |
| U.S.                             |       | $                           | 28,543     |   | $ | 26,159 |   | $ | 29,620 |   |
| State and local                  |       | 7,350                       |       | 6,234 |   | 6,367 |   |
| Foreign                          |       | 4,051                       |       | 6,670 |   | 1,396 |   |
|                             |       | 39,944                      |       | 39,063 |   | 37,383 |   |
| Deferred tax (benefit) expense:  |       |                        |       |   |   |   |   |
| U.S.                             |       | (6,483                      | )          | (827 | ) | (5,076 | ) |
| State and local                  |       | (1,828                      | )          | (331 | ) | (1,434 | ) |
| Foreign                          |       | 972                         |       | (2,890 | ) | 515 |   |
|                             |       | (7,339                      | )          | (4,048 | ) | (5,995 | ) |
| Total provision for income taxes |       | $                           | 32,605     |   | $ | 35,015 |   | $ | 31,388 |   |

 

Deferred income tax assets (liabilities) included in the ConsolidatedBalance Sheets at June 30, 2004, and June 30, 2003, are comprised ofthe following:

 
| ** **                               | ** ** | **June 30** | ** ** |
|------------------------------------------|------------|------------------|------------|
| ** **                               | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                     |       |             |       |   |   |
| Depreciation and amortization            |       | $                | (2,789     | ) | $ | — |   |
| Change in accounting method              |       | —           |       | (10,149 | ) |
| Foreign temporary differences            |       | (628             | )          | (629 | ) |
| Other                                    |       | (1,317           | )          | (933 | ) |
| Gross deferred tax liabilities           |       | (4,734           | )          | (11,711 | ) |
|                                     |       |             |       |   |   |
| Depreciation and amortization            |       | —           |       | 1,387 |   |
| Accrued retirement benefits              |       | 41,742           |       | 81,333 |   |
| Deferred rent                            |       | 3,627            |       | 1,789 |   |
| Foreign temporary differences            |       | 7,568            |       | 6,639 |   |
| Foreign net operating loss carryforwards |       | 6,449            |       | 4,676 |   |
| Discontinued operations exit costs       |       | 1,226            |       | 1,634 |   |
| Other accrued liabilities                |       | 8,595            |       | 10,893 |   |
| Accrued compensation                     |       | 15,703           |       | 15,670 |   |
| Deferred revenue                         |       | 375              |       | — |   |
|                                     |       |             |       |   |   |
| Gross deferred tax assets                |       | 85,285           |       | 124,021 |   |
| Deferred tax assets valuation allowance  |       | (10,887          | )          | (7,211 | ) |
| Net deferred tax asset                   |       | $                | 69,664     |   | $ | 105,099 |   |

 

At June 30, 2004, we had unused loss carryforwards for taxpurposes in various jurisdictions outside the U.S. amounting to $21.0 millionof which $7.1 million can be indefinitely carried forward under localstatutes.  The remaining foreign losscarryforwards will expire, if unused, in varying amounts from 2005 through2012.  The valuation allowance includesthe tax effect of foreign net operating loss carryforwards $(6.4) million andthe tax effect of certain foreign temporary expenses $(4.4) million.

 

75

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The net change in the valuation allowance of $3.7 million in fiscalyear 2004 and $1.7 million in fiscal year 2003 is due primarily to the taxeffect of the change in foreign net operating losses and deferred foreignexpenses.

 

Domestic and foreign components of income from continuing operationsbefore income taxes for each of the three years ended June 30 are asfollows:

 
| ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
|       |       |     |       |     |       |     |       |
| Domestic   |       | $        | 72,488     |     | $          | 76,686   |       | $ | 73,786 |   |
| Foreign    |       | 10,056   |       | 8,709    |       | 4,686    |       |
|       |       |     |       |     |       |     |       |
|       |       | $        | 82,544     |     | $          | 85,395   |       | $ | 78,472 |   |

 

The company has not provided U.S. deferred taxes on cumulative earningsof foreign subsidiaries that have been reinvested indefinitely.  These earnings relate to ongoing operationsand at June 30, 2004 were approximately $75 million.  Due to the availability of U.S. foreign taxcredits, it is not practicable to estimate the U.S. federal income taxliability that might be payable if such earnings were not reinvestedindefinitely.  Deferred taxes have beenprovided for earnings of foreign subsidiaries which the company plans to remit.

 

The reported income tax provision differs from the amounts that wouldhave resulted had the reported income before income taxes been taxed at theU.S. federal statutory rate.  Theprincipal reasons for the differences between the amounts provided and thosethat would have resulted from the application of the U.S. federal statutory taxrate are as follows:

 
| ** **                                                     | ** ** | **Year Ended June 30** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                     | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                           |       |                        |       |   |   |   |   |
| Tax provision at U.S. federal statutory tax rate of 35 percent |       | $                           | 28,890     |   | $ | 29,888 |   | $ | 27,465 |   |
| Increase (reduction) resulting from:                           |       |                        |       |   |   |   |   |
| Foreign income subject to  (lower) higher foreign tax rates    |       | (117                        | )          | (541 | ) | (1,491 | ) |
| Tax benefit of foreign losses  reserved, net                   |       | 1,146                       |       | 1,272 |   | 1,762 |   |
| State income taxes, net of  federal tax effect                 |       | 3,152                       |       | 3,416 |   | 3,206 |   |
| Non-deductible expenses                                        |       | 838                         |       | 802 |   | 839 |   |
| Tax credits                                                    |       | (2,030                      | )          | (409 | ) | (452 | ) |
| Other                                                          |       | 726                         |       | 587 |   | 59 |   |
|                                                           |       |                        |       |   |   |   |   |
| Income tax provision                                           |       | $                           | 32,605     |   | $ | 35,015 |   | $ | 31,388 |   |

 

**Note 13 - Segment Information**

 

In North America, the company is primarily organized and managed bypractice.  Although our consultants inour international offices provide services in these same practice areas, ourinternational

 

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operations as a whole are managed geographically and comprise a singleoperating segment.  Therefore, we havefive reportable operating segments:

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

 

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

 

The table below presents specifiedinformation about reported segments as of and for the year ended June 30,2004:

 
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Technology  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **International** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|----------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|-----------|------------|
| Revenue  (net of reimbursable expenses) |       | $                   | 425,477    |                             | $          | 77,114                    |       | $                 | 44,872     |      | $          | 83,129    |       | $ | 41,780 |   | $ | 672,372 |   |
| Net operating  income                   |       | 91,559              |       | 8,141                            |       | 5,076                     |       | 3,319             |       | 533       |       | 108,628   |       |
| Interest  expense                       |       | 599                 |       | 23                               |       | 76                        |       | 5                 |       | 31        |       | 734       |       |
| Depreciation  and amortization          |       | 9,306               |       | 2,246                            |       | 1,008                     |       | 2,471             |       | 3,031     |       | 18,062    |       |
| Receivables                             |       | 103,392             |       | 9,330                            |       | 8,978                     |       | 18,034            |       | 5,420     |       | 145,154   |       |
|                                         |            |                     |            |                                  |            |                           |            |                   |            |           |            |           |            |  |  |  |  |  |  |

 

The table below presents specifiedinformation about reported segments as of and for the year 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 table below presents specifiedinformation about reported segments as of and for the year 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   |       |
|                                         |            |                     |            |                                  |            |                           |            |                   |            |           |            |           |            |  |  |  |  |  |  |

 

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A reconciliation of the information reportedby segment to the consolidated amounts follows for the years ended June 30(in thousands):

 
| ** **                                                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                    |       |     |       |     |       |     |       |
| *Revenue:*                                                                              |       |     |       |     |       |     |       |
| Total segment  revenue                                                                  |       | $        | 672,372    |     | $          | 672,677  |       | $ | 677,532 |   |
| Reimbursable  expenses not included in segment revenue                                  |       | 30,965   |       | 32,997   |       | 29,266   |       |
| Other, net                                                                              |       | (1,332   | )          | 3,942    |       | 3,682    |       |
| Consolidated  revenue                                                                   |       | $        | 702,005    |     | $          | 709,616  |       | $ | 710,480 |   |
|                                                                                    |       |     |       |     |       |     |       |
| *Net Operating Income:*                                                                 |       |     |       |     |       |     |       |
| Total segment  income                                                                   |       | $        | 108,628    |     | $          | 118,510  |       | $ | 126,269 |   |
| Income from  affiliates                                                                 |       | 7,109    |       | 5,787    |       | 2,866    |       |
| Differences in  allocation methods for depreciation, G&A, pension and medical costs |       | 4,705    |       | (2,357   | )          | (1,715   | )          |
| Other  non-operating income                                                             |       | 6,222    |       | 761      |       | 2,166    |       |
| Discretionary  bonuses                                                                  |       | (38,870  | )          | (36,026  | )          | (49,058  | )          |
| Other, net                                                                              |       | (5,250   | )          | (1,280   | )          | (2,056   | )          |
|                                                                                    |       |     |       |     |       |     |       |
| Consolidated  pretax income                                                             |       | $        | 82,544     |     | $          | 85,395   |       | $ | 78,472 |   |
|                                                                                    |       |     |       |     |       |     |       |
| *Interest Expense:*                                                                     |       |     |       |     |       |     |       |
| Total segment  expense                                                                  |       | $        | 734        |     | $          | 748      |       | $ | 2,007 |   |
| Differences in  allocation method                                                       |       | 159      |       | 54       |       | (1,302   | )          |
| Consolidated  interest expense                                                          |       | $        | 893        |     | $          | 802      |       | $ | 705 |   |
|                                                                                    |       |     |       |     |       |     |       |
| *Depreciation & Amortization:*                                                      |       |     |       |     |       |     |       |
| Total segment  expense                                                                  |       | $        | 18,062     |     | $          | 23,147   |       | $ | 21,486 |   |
| Goodwill and  other intangible asset amortization, not allocated to segments            |       | 315      |       | 416      |       | 162      |       |
| Differences in  allocation method and other                                             |       | 134      |       | (3,942   | )          | (1,599   | )          |
| Consolidated  depreciation and amortization expense                                     |       | $        | 18,511     |     | $          | 19,621   |       | $ | 20,049 |   |
|                                                                                    |       |     |       |     |       |     |       |
| *Receivables:*                                                                          |       |     |       |     |       |     |       |
| Total segment  receivables                                                              |       | $        | 145,154    |     | $          | 129,349  |       | $ | 138,825 |   |
| Net valuation  differences                                                              |       | 4,680    |       | 9,573    |       | 12,787   |       |
| Total billed  and unbilled receivables                                                  |       | 149,834  |       | 138,922  |       | 151,612  |       |
| Assets not  reported by segment                                                         |       | 362,334  |       | 375,540  |       | 285,205  |       |
| Consolidated  assets                                                                    |       | $        | 512,168    |     | $          | 514,462  |       | $ | 436,817 |   |

 

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The following represents total revenue andlong-lived assets information by geographic area as of and for the years endedJune 30:

 
| ** **    | ** ** | **Revenue** | ** ** | **Long-lived Assets** | ** ** |
|---------------|------------|-------------|------------|-----------------------|------------|
| ** **    | ** ** | **2004**    | ** ** | **2003**              | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|          |       |        |       |                  |       |   |   |   |   |   |   |   |   |
| United States |       | $           | 565,228    |                  | $          | 580,428 |   | $ | 588,138 |   | $ | 90,385 |   | $ | 79,579 |   | $ | 74,260 |   |
| Foreign       |       | 136,777     |       | 129,188               |       | 122,342 |   | 33,329 |   | 35,040 |   | 35,041 |   |
|          |       | $           | 702,005    |                  | $          | 709,616 |   | $ | 710,480 |   | $ | 123,714 |   | $ | 114,619 |   | $ | 109,301 |   |

 

Revenue is based on the country of domicile for the legal entity thatoriginated the revenue.  Exclusive of theUnited States, revenue from no single country constituted more than 10 percentof consolidated revenues.  Revenue fromno single customer constituted more than 3 percent of consolidated revenues.

 

**Note 14 - Commitments and Contingent Liabilities**

 

The company historically has provided guarantees on an infrequent basisto third parties in the ordinary 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 beneficiaries in the event that the company fails to meet itsfinancial obligations to these beneficiaries. One letter of credit for $2.6 million will expire in October 2006,while the second letter of credit for $4.9 million will remain outstanding aslong as we retain an ownership share of our affiliated captive insurancecompany, PCIC.  The estimated fair marketvalue of these letters of credit is nominal because they have never been used,and the company believes that future usage is remote.

 

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

 

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

 

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In connection with the establishment of our alliance with WWLLP, thecompany agreed to guarantee WWLLP’s performance under a lease for office spacein London that expires in 2015.  Paymentsby WWLLP under the lease total approximately £1.4 million (or approximately$2.5 million based on the June 30, 2004, exchange rate) per year.  We also granted WWLLP an option to return theleased space to our UK subsidiary in 2009. If WWLLP exercises this option, the company would attempt to subleasethe space at the then-current market 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, 2004, minimumremaining payments guaranteed under these leases, which expire at various datesthrough 2007, total $18.1 million, excluding anticipated future subleaseincome.  See Note 16 for more informationregarding our obligation to guarantee Wellspring’s leases.

 

*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. Management believes, based on currently available information, that theresults of all pending claims against us will not have a material adverseeffect on the company.  The mattersreported on below involve the most significant pending or potential claimsagainst us.  These matters did notsignificantly impact financial results for fiscal year 2004.

 

*IronWorkers Local 25 et al. v. Watson Wyatt & Co. *On July 8, 2004, Watson Wyatt & Co. was served with anamended complaint filed by a former client in the United States District Courtfor the Eastern District of Michigan. The complaint alleges malpractice, breach of contract, and relatedclaims in the performance of actuarial consulting.  The Complaint states that the plaintiff’s PensionFund is underfunded as a result of the alleged deficiencies in our work.  The amount of damages sought are notspecified. We are in the process of reviewing the claim, with outside counseland preparing our response.

 

*SECExamination of Investment Advisers. *InDecember 2003, the Securities and Exchange Commission (SEC) formally askedmany of the major investment consulting firms, Watson Wyatt InvestmentConsulting among them, to provide detailed information on their businessstructures and practices in order to determine if conflicts of interest withmoney managers exist.  In March 2004,Watson Wyatt Investment Consulting (WWIC) completed its responses to the SECstaff’s requests for information.  WWIChas received no further inquiry from the SEC staff on this topic since thattime.

 

*Departmentof Justice Antitrust Investigation.  *In March 2004, the United StatesDepartment of Justice (DOJ) issued a Civil Investigative Demand (CID) to WatsonWyatt and other companies in the employee benefits industry.  The DOJ is seeking to determine whetheractuarial firms which have entered into agreements with their clients limitingliability have done so in violation of U.S. antitrust laws. Watson Wyatt hasprovided information to DOJ in response to the CID and is in the process ofproviding the remaining information requested under the CID.

 

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*ClientDemand Letter. *On July 23, 2004, we received a demandletter from counsel for a client alleging that errors in valuations for 2001and subsequent years understated the liabilities of its pension plan andoverstated its net worth.  As a result,the client claims it did not annuitize its defined benefit plan and redeemedits stock at an inflated price.  Theletter claims damages “in excess of $35 million.”  We are investigating these allegations.

 

**Note 15 - Earnings Per Share**

 

Basic earnings per share is calculated on the basis of the weightedaverage number of common shares outstanding during the year.  Diluted earnings per share is calculated onthe basis of the weighted average number of common shares outstanding plus theeffect of outstanding stock options and employee stock purchase plan sharesusing the “treasury stock” method.  Thecomponents of basic and diluted earnings per share are as follows:

 
| ** **                                                                         | ** ** | **Year Ended June 30** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                               |       |                        |       |   |   |   |   |
| Income from continuing operations                                                  |       | $                           | 49,939     |   | $ | 50,380 |   | $ | 47,084 |   |
| Income from discontinued operations                                                |       | 654                         |       | 6,786 |   | — |   |
| Net income                                                                         |       | $                           | 50,593     |   | $ | 57,166 |   | $ | 47,084 |   |
|                                                                               |       |                        |       |   |   |   |   |
| Weighted average outstanding shares of  common stock                               |       | 32,866                      |       | 32,962 |   | 32,985 |   |
| Dilutive effect of employee stock options  and employee stock purchase plan shares |       | 341                         |       | 325 |   | 436 |   |
|                                                                               |       |                        |       |   |   |   |   |
| Common stock and stock equivalents                                                 |       | 33,207                      |       | 33,287 |   | 33,421 |   |
|                                                                               |       |                        |       |   |   |   |   |
| Basic earnings per share                                                           |       |                        |       |   |   |   |   |
| Income from continuing operations                                                  |       | $                           | 1.52       |   | $ | 1.52 |   | $ | 1.43 |   |
| Income from discontinued operations                                                |       | 0.02                        |       | 0.21 |   | — |   |
| Basic earnings per share, net income                                               |       | $                           | 1.54       |   | $ | 1.73 |   | $ | 1.43 |   |
|                                                                               |       |                        |       |   |   |   |   |
| Diluted earnings per share                                                         |       |                        |       |   |   |   |   |
| Income from continuing operations                                                  |       | $                           | 1.50       |   | $ | 1.51 |   | $ | 1.41 |   |
| Income from discontinued operations                                                |       | 0.02                        |       | 0.21 |   | — |   |
| Diluted earnings per share, net income                                             |       | $                           | 1.52       |   | $ | 1.72 |   | $ | 1.41 |   |

 

There were 2,120 outstanding stock optionsfor the year ended June 30, 2004, that were not included in the dilutedearnings per share calculation because their effect would have beenantidilutive.

 

**Note 16 - Discontinued Operations**

 

The company continues to guarantee three leases for office premises forWellspring.  During fiscal year 2004, thecompany received sublease income of approximately $0.1 million in excess oflease payments related to this business. Since the second quarter of fiscal year 2003, the leases have beengenerating positive cash flows of approximately $0.1 million per fiscal year.

 

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During the third quarter of fiscal years 2003 and 2004, the companyevaluated its accrual for the estimated remaining future obligations and costsrelated to the exit from Wellspring.  Theevaluations included an analysis of occupancy rates of Wellspring, along withan analysis of real estate market conditions in cities in which the leasesexist and an assessment of probable future sublease income for theseleases.  As a result of the analysisperformed during fiscal years 2003 and 2004, the company reduced its accrual by$11.4 million and $1.0 million, respectively, less the associated income taxexpenses.  Such adjustments are reflectedin the Consolidated Statement of Operations for the third quarter of fiscalyears 2003 and 2004 in the line “Adjustment to reduce estimated loss ondisposal of discontinued operations.” The remaining noncurrent liability of $3.0 million representsmanagement’s estimate of potential future cash outflows related to guaranteesassociated with Wellspring leases.

 

**Note 17 - Targeted Job Reductions**

 

We eliminated approximately 100 positions in our North American regionduring the first quarter of fiscal year 2004. A charge to earnings of $2.6 million related to these reductions wasincluded in the company’s financial results for the quarter endedSeptember 30, 2003.  We eliminatedan additional 22 positions in our North American region during the secondquarter of fiscal year 2004, resulting in a charge to earnings of $0.7 millionin the company’s financial results for the quarter ended December 31,2003.  Of the $3.3 million of totalseverance charges, $3.2 million was included in salaries and employee benefitsand $0.1 million was included in professional and subcontracted services duringfiscal year 2004.

 

Also, we eliminated approximately 70 positions in our North Americanregion during the second quarter of fiscal year 2003.  A charge to earnings of $2.0 million relatedto these reductions was included in the company’s financial results for thequarter ended December 31, 2002.  Ofthe $2.0 million severance charge, $1.8 million was included in salaries andemployee benefit expenses and $0.2 million was included in professional and subcontractedservices.

 

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

 

On July 9, 2003, the Board of Directors of PCIC, a captiveinsurance company of which we own 34.8 percent, decided to pass on to each ofits owners a credit in their 2003-04 policy year in connection with benefitsreceived from an aggregate stop loss insurance policy entered into byPCIC.  PCIC’s Board of Directorsdetermined that this credit would be used to offset all or a portion of eachinsured’s obligation to PCIC for historical loss experience.  As a result, the Company recorded a $5.6million pre-tax non-operating gain in the first quarter of fiscal year 2004 andincluded this gain in “Other non-operating income” in the ConsolidatedStatements of Operations.

 

As a result of this gain, the Company also recorded a $5.6 millionsupplemental bonus accrual in the first quarter of fiscal year 2004 that isincremental to the Company’s fiscal year end bonus, but will be paid inSeptember 2004 with the regular bonus cycle.  This supplemental bonus is included inSalaries and employee benefits.

 

**Note 19 - Sale of U.S.-Based Public Sector Retirement Business**

 

In fiscal year 2002, we sold our U.S.-based public sector retirementbusiness to Gabriel, Roeder, Smith & Company (“GRS”).  The future consideration from the sale of theU.S.-based public sector retirement business is contingent upon the successfultransition of certain clients to GRS and upon their retention by GRS.  Simultaneous with the sale, we entered intoan alliance agreement with GRS under which we will mutually refer futurebusiness opportunities and explore joint consulting assignments.

 

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In accordance with the terms of the sale, GRS paid theCompany $0.5 million of contingent payments in each of the first quarters offiscal years 2003 and 2004. The amount of additional contractual cash paymentsover the upcoming three fiscal years is also contingent upon the successfultransition of certain clients to GRS and upon their retention by GRS.

 

**Note 20 - Quarterly Financial Data (unaudited)**

 

Unaudited, summarized financial data by quarter for the years endedJune 30, 2004 and 2003, is as follows (in thousands, except per shareamounts):

 
| ** **                                             | ** ** | **2004 Quarter Ended** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **September 30**  | ** ** | **December 31** | ** ** | **March 31** | ** ** | **June 30** | ** ** |
|                                                   |       |                   |       |   |   |   |   |   |   |
| Revenue                                                |       | $                      | 170,983    |   | $ | 170,353 |   | $ | 180,655 |   | $ | 180,014 |   |
| Income from  operations                                |       | 13,053                 |       | 17,060 |   | 21,024 |   | 17,333 |   |
| Income from  continuing operations before income taxes |       | 21,182                 |       | 18,305 |   | 23,350 |   | 19,707 |   |
| Income from  continuing operations                     |       | 12,497                 |       | 10,802 |   | 13,976 |   | 12,664 |   |
| Discontinued  operations                               |       | 10                     |       | 16 |   | 613 |   | 15 |   |
| Net income                                             |       | 12,507                 |       | 10,818 |   | 14,589 |   | 12,679 |   |
| Earnings per  share:                                   |       |                   |       |   |   |   |   |   |   |
| Continuing  operations, basic                          |       | 0.38                   |       | 0.33 |   | 0.42 |   | 0.39 |   |
| Continuing  operations, diluted                        |       | 0.37                   |       | 0.32 |   | 0.42 |   | 0.39 |   |
| Discontinued  operations, basic                        |       | —                 |       | — |   | 0.02 |   | — |   |
| Discontinued  operations, diluted                      |       | —                 |       | — |   | 0.02 |   | — |   |
| Net income,  basic                                     |       | 0.38                   |       | 0.33 |   | 0.44 |   | 0.39 |   |
| Net income,  diluted                                   |       | 0.37                   |       | 0.32 |   | 0.44 |   | 0.39 |   |
|                                                        |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                             | ** ** | **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 |   |
|                                                        |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 

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**WATSON WYATT & COMPANY HOLDINGS**

**Schedule II**

**Valuation and Qualifying Accounts andReserves**

(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, 2004                |       |
|                                         |       |                              |       |                                                   |       |                                      |       |           |       |                         |       |
| Allowance for  Uncollectible accounts        |       | $                                 | 862        |                                                   | $          | 5,468                                     |       | $              | —     |                         | $          | (5,089 | ) | $ | 1,241 |   |
|                                         |       |                              |       |                                                   |       |                                      |       |           |       |                         |       |
| Allowance for  Unbillable accounts           |       | 419                               |       | 37                                                     |       | —                                    |       | —         |       | 456                          |       |
|                                         |       |                              |       |                                                   |       |                                      |       |           |       |                         |       |
| Valuation allowance  for deferred tax assets |       | 7,211                             |       | —                                                 |       | 3,676                                     | (1)        | —         |       | 10,887                       |       |
|                                         |       |                              |       |                                                   |       |                                      |       |           |       |                         |       |
| 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                        |       |

 

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(1)                                  Thenet increase is primarily due to the tax effect of the change in realizableforeign net operating losses and other foreign temporary differences.

 

(2)                                  Thenet decrease is primarily due to the tax effect of the change in realizableforeign tax credits, foreign net operating loss carryforwards and other foreigntemporary differences.

 

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**Item 15(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 |   | Credit Agreement Among Suntrust Bank and Others dated June 30,  2004(8)                                                                                                                            |
| 10.2 |   | Senior Officer Deferred Compensation Plan(4)                                                                                                                                                            |
| 10.3 |   | Form of agreement among Watson Wyatt & Company, Watson Wyatt  & Company Holdings and employee directors, executive officers and  significant stockholders restricting the transfer of shares(3) |
| 10.4 |   | 2001 Deferred Stock Unit Plan for Selected Employees(5)                                                                                                                                                 |
| 10.5 |   | Compensation Plan for Outside Directors(6)                                                                                                                                                              |
| 10.6 |   | Lease between Watson Wyatt & Company and Arlington Office,  L.L.C., dated April 27, 2004(7)                                                                                                    |
| 21   |   | Subsidiaries of Watson Wyatt & Company Holdings(8)                                                                                                                                                  |
| 23   |   | Consent of the Company’s Independent Registered Public Accounting  Firm(8)                                                                                                                         |
| 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(8)                    |
| 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(8)                    |
| 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           |

 

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

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

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

(5)                                  Incorporatedby reference from Registrant’s Form DEF14A, filed on October 17, 2003

(6)                                  Incorporatedby reference from Registrant’s Form S-8, filed on December 19, 2001

(7)                                  Incorporatedby reference from Registrant’s Form 10-Q, filed on May 7, 2004

(8)                                  Filedwith this Form 10-K

 

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