**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-K**

**(Mark One)**
|                                                                                                                 | ** ** | ** **                                                                                               |
|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| **x**                                                                                                           | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
| ** **                                                                                                      | ** ** | ** **                                                                                               |
| **For the  fiscal year ended June 30, 2006**                                                               |
| ** **                                                                                                      | ** ** | ** **                                                                                               |
| **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 WORLDWIDE, INC.**

(Exact name of registrant as specified in its charter)

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

** **

**901 N. Glebe Road**

**Arlington, VA 22203**

(Address of principal executive offices, including zipcode)

 

**(703) 258-8000**

(Registrant’s telephone number, including area code)

** **

**Securities registered pursuant toSection 12(b) of the Act:**

|                                                 | ** ** | **Name of each exchange**    |
|-------------------------------------------------|------------|------------------------------|
| **Title of each class**                         | ** ** | **on which registered**      |
| **Class A  Common Stock, $0.01 par value** |       | **New  York Stock Exchange** |

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes x    No o

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act.    Yes o   No x

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes x          No o

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

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer

Large accelerated filer x          AcceleratedFiler o          Non-acceleratedFiler o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act) Yes o   No x

The aggregate marketvalue of the registrant’s voting and non-voting common stock held bynon-affiliates of the registrant was approximately $1,174,134,281 based on theclosing price as of the last business day of the registrant’s most recentlycompleted second fiscal quarter, December 30, 2005.

**DocumentsIncorporated by Reference**

Portions of the Definitive Proxy Statement for the2006 Annual Meeting of Stockholders to be held on or about November 17,2006 are incorporated by reference into Part III of this Form 10-K.

As of July 31, 2006 there were outstanding 42,414,095shares of common stock par value $0.01 per share.

 

----

 

**WATSONWYATT WORLDWIDE, INC.INDEX TO FORM 10-K**

For the FiscalYear Ended June 30, 2006
| PART I.        |   |                                                                                                                 |   |   |
|----------------|--------|----------------------------------------------------------------------------------------------------------------------|--------|--------|
|           |   |                                                                                                                 |   |   |
| Item 1.        |   | Business                                                                                                             |   | 1      |
| Item 1A.       |   | Risk Factors                                                                                                         |   | 15     |
| Item 1B.       |   | Unresolved SEC Comments                                                                                              |   | 24     |
| Item 2.        |   | Properties                                                                                                           |   | 24     |
| Item  3.       |   | Legal  Proceedings                                                                                                   |   | 24     |
| Item 4.        |   | Submission of Matters to a Vote of Security Holders                                                                  |   | 24     |
|           |   |                                                                                                                 |   |   |
| PART II.       |   |                                                                                                                 |   |   |
|           |   |                                                                                                                 |   |   |
| Item 5.        |   | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities   |   | 24     |
| Item 6.        |   | Selected Consolidated Financial Data                                                                                 |   | 27     |
| Item 7.        |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                          |   | 29     |
| Item 7A.       |   | Quantitative and Qualitative Disclosures about Market  Risk                                                          |   | 56     |
| Item 8.        |   | Financial Statements and Supplementary Data                                                                          |   | 56     |
| Item 9.        |   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                                |   | 56     |
| Item 9A.       |   | Controls and Procedures                                                                                              |   | 56     |
|           |   |                                                                                                                 |   |   |
| PART III.      |   |                                                                                                                 |   |   |
|           |   |                                                                                                                 |   |   |
| Item 10.       |   | Directors, Executive Officers, and Audit Committee of  the Registrant                                                |   | 57     |
| Item 11.       |   | Executive Compensation                                                                                               |   | 58     |
| Item 12.       |   | Security Ownership of Certain Beneficial Owners and  Management                                                      |   | 58     |
| Item 13.       |   | Certain Relationships and Related Transactions                                                                       |   | 58     |
| Item 14.       |   | Principal Auditor Fees and Services                                                                                  |   | 58     |
|           |   |                                                                                                                 |   |   |
| PART IV.       |   |                                                                                                                 |   |   |
|           |   |                                                                                                                 |   |   |
| Item 15.       |   | Exhibits and Financial Statement Schedules                                                                           |   | 59     |
|           |   | Signatures                                                                                                           |   | 60     |
|           |   | Report of Independent Registered Public Accounting  Firm                                                             |   | 62     |
|           |   | Consolidated Financial Statements                                                                                    |   | 64     |
|           |   | Consolidated Statements of Operations—Fiscal year  ended June 30, 2006, 2005, and 2004                          |   | 64     |
|           |   | Consolidated  Balance Sheets—June 30, 2006 and June 30, 2005                                                    |   | 65     |
|           |   | Consolidated Statements of Cash Flows—Fiscal year  ended June 30, 2006, 2005, and 2004                          |   | 66     |
|           |   | Consolidated Statement of Changes in Stockholders’  Equity—Fiscal year ended June 30, 2006, 2005, and 2004 |   | 67     |
|           |   | Notes to the Consolidated Financial Statements                                                                       |   | 69     |
| Certifications |   |                                                                                                                 |   |   |

 

----

 

**PART I**

**Item1.**                          Business.

***The Company***

Watson Wyatt Worldwide,Inc. (referred herein as “Watson Wyatt”, “company”, “us”, “we”, or “WatsonWyatt & Company Holdings”) is a global consulting firm focusing onproviding human capital and financial management consulting services.  Including predecessors, we have been inbusiness since 1946. The Wyatt Company was incorporated in Delaware on February17, 1958. We conducted business as The Wyatt Company from 1958 until changingour name to Watson Wyatt & Company in connection with the establishment ofthe Watson Wyatt Worldwide alliance in 1995 with R. Watson & Sons (referredherein as “Watson Wyatt LLP” or “WWLLP”), a leading United Kingdom-basedactuarial, benefits and human resources consulting partnership founded in 1878.In 2000, we incorporated Watson Wyatt & Company Holdings to serve as aholding company with our operations conducted by our subsidiaries. To betterserve the increasingly global needs of clients, on July 31, 2005 we acquired substantially all of the assets and assumedmost liabilities of WWLLP (the “business combination”).  The company’s name was changed to WatsonWyatt Worldwide, Inc. on January 1, 2006, to reflect the company’s globalcapabilities and identity in the marketplace.

We help our clientsenhance business performance by improving their ability to attract, retain, andmotivate qualified employees. We focus on delivering consulting services thathelp our clients anticipate, identify, and capitalize on emerging opportunitiesin human capital management.  We alsoprovide independent financial advice regarding all aspects of life assuranceand general insurance, as well as investment advice to assist our clients indeveloping disciplined and efficient investment strategies to meet theirinvestment goals.  Our target marketclients include those companies in the Fortune 1000, Pension & Investments(P&I) 1000, the FTSE 100, and locally-defined equivalentorganizations.  As of June 30, 2006, we implemented thisstrategy through approximately 6,235 associates in 94 offices located in 30countries.

***Business Combination***

On July 31, 2005, the company consummated thebusiness combination with WWLLP.  Thecompany and WWLLP had jointly offered services since 1995 pursuant to allianceagreements and as a result, have business segments that are very similar innature.  The assets acquired from WWLLPare held by the company’s principal U.K. subsidiary, Watson Wyatt Limited (“WatsonWyatt Limited” or the “European business”). Watson Wyatt Limited’s results of operations are included in theconsolidated financial statements beginning August 1, 2005.  For more information regarding this businesscombination and the accounting for the company’s share of WWLLP and WatsonWyatt Holdings (Europe) Limited (“WWHE”) prior to the businesscombination, see Note 2 and Note 4, respectively, of Notes to the ConsolidatedFinancial Statements included in Item 15 of this report.

1

----

***Access to public filings, Code ofBusiness Conduct and Ethics and Board Committee Charters***

Our annual report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K and amendments tothose reports are available, without charge, on our web site(www.watsonwyatt.com) or the SEC web site (www.sec.gov), 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 principal executive officer, other officers and members of seniormanagement.  The company also has a Codeof Business Conduct and Ethics that applies to all of the Company’sdirectors.  Both codes are posted on ourwebsite.  Watson Wyatt’s Audit Committee,Compensation Committee and Nominating and Governance Committee all operatepursuant to written charters adopted by the company’s Board of Directors.  The company has also adopted a set ofCorporate Governance Guidelines, 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 901 N. Glebe Road, Arlington, VA22203.

***Certifications***

In 2005, the company submitted to the New York StockExchange (NYSE) the required annual certification that our chief executiveofficer is unaware of any violation by Watson Wyatt of the NYSE corporategovernance standards under section 303A.12(a) of the NYSE listed companymanual.  The company also filed with theSEC the CEO and CFO certifications required under section 302 of Sarbanes-OxleyAct of 2002 as an exhibit to this Form 10-K.

**Business Overview**

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

We design, develop and implement human resourcestrategies and programs through the following closely-interrelated practiceareas:

2

----

**BenefitsGroup**

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

·                  Health care, disability and other groupbenefit plans

·                  Compensation, benefits, expatriate and humanresource practice strategy, implementation and administration

·                  Actuarial services

·                  Strategicworkforce planning

**Technologyand Administration Solutions Group**

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

·                  Administration outsourcing solutions forhealth and welfare and pension benefits

·                  Call center strategy, design and tools

·                  Strategic human resources technology andservice delivery consulting

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

**Human Capital Group**

·                  Compensation plans, including broad-based andexecutive compensation, stock and other long-term incentive programs

·                  Strategies to align workforce performancewith business objectives

·                  Organization effectiveness consulting,including talent management

·                  Strategies for attracting, retaining andmotivating employees

·                  Dataservices

**Insurance& Financial Services Group**

·                  Independent actuarial and strategic advice

·                  Assessment and advice regarding financialcondition and risk management

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

**InvestmentConsulting Group**

·                  Investment consulting services to pensionplans and other institutional funds

·                  Input on governance and regulatory issues

·                  Analysis of asset allocation and investmentstrategies

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

3

----

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

Outsideof North America and Europe, our consultants in Asia-Pacific and Latin Americaoperate on a geographic basis from 27 offices in 16 countries and provideconsulting services in the practice areas described above.  Effective in fiscal year 2007, we will beginto manage and report the Asia-Pacific and Latin America operations on a practicebasis.  Consequently, the results of thissegment will be incorporated into the five practice-based segments highlightedabove.

Whilewe focus our consulting services in the areas described above, managementbelieves that one of our primary strengths is our ability to draw uponconsultants from our different practices to deliver integrated services to meetthe needs of our clients.  This includescommunication and change management implementation support services. Ourclients include many of the world’s largest corporations as well as emerginggrowth companies, public institutions and nonprofit organizations.

***Competitive Advantage***

We believe that our competitive advantages includeour global reach, strong client relationships, the depth of our professionaland technical associates, our thought leadership and our experienced managementteam.

We have long-lasting relationships with our clients,many of which have been clients for decades, for whom our services have grownover time.  Expanding our relationshipswith existing clients and identifying new prospects are key to our growthstrategy.

We also believe that we are at the forefront of manyissues affecting human capital through our research, surveys and participationin policy-making.  Our thought leadersare often called upon by the media and government to express opinions on issuesaffecting health care benefits, retirement plan design and executivecompensation.

We believe our senior management team is strong,with an average tenure of 15 years with the company and a reputation fortransparency and accountability.  Weconsider this group to be a major asset to the company.

**Human Resources Consulting Industry**

The growing demand foremployee benefits and human capital consulting services is directly related tothe increasing size and complexity of today’s human resources programs and thesocietal forces that are stimulating their rapid change.  In the United States alone, employers spent$7.0 trillion in 2005 in direct support of human capital programs, such as compensationand benefits.  In 2005, U.S. employerscontributed nearly $346 billion to pension and profit-sharing plans, and $515billion to group health insurance programs, while the assets ofemployer-sponsored defined benefit and defined contribution plans here in theUnited States were $5.02 trillion at the end of 2005 and private holdings inindividual retirement accounts were another $3.67 trillion, most of whichoriginated in an employer-sponsored retirement plan.

Employers, regardless of geography or industry, arefacing challenges involving the management of their people. Changingtechnology, shifting economic conditions, 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 human resourceservices are growing.  To remaincompetitive, employers must address these challenges effectively.

4

----

**Consulting Services**

Our global operations include six segments:Benefits, Technology and Administration Solutions,  Human Capital, Insurance and FinancialServices, Investment Consulting, and International (comprising Asia-Pacific andLatin America).  The percentage ofrevenues generated in the various groups is as follows:
| ** **                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Benefits Group                                                             |       | 58       | %          | 64       | %          | 65       | %          |
| Technology and  Administration Solutions Group                             |       | 11       |       | 10       |       | 12       |       |
| Human Capital  Group                                                       |       | 9        |       | 9        |       | 7        |       |
| Insurance &  Financial Services Group                                  |       | 8        |       | —   |       | —   |       |
| Investment  Consulting Group                                               |       | 6        |       | 3        |       | 3        |       |
| International —  Comprising Asia Pacific and Latin America Operations |       | 8        |       | 14       |       | 13       |       |
| Total                                                                      |       | 100      | %          | 100      | %          | 100      | %          |

 

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

***Benefits Group***

Our Benefits Group — our largest and mostestablished practice with 2,390 associates — consists primarily of consultingpractices in retirement and group and health care.  It is our largest and most establishedpractice that grew exponentially as a result of the business combination.  This group assists clients to createcost-effective retirement and health care benefits programs that help ourclients attract, retain and motivate a talented workforce.  We provide tailored benefits programs for ourclients, and we base our recommendations on evidence-based research.  Our Benefits Group accounted forapproximately 58 percent of our total segment revenues for the fiscal year thatended June 30, 2006.

*Retirement Consulting*

We are one of the world’s largest advisers onretirement plans, providing actuarial and consulting services for large definedbenefit and defined contribution plans. We help our clients assess the impactthat changing workforce demographics will have on their retirement plans,corporate cash flow requirements, and retiree benefits adequacy and security.

Our consultants provide actuarial services and arethe named actuaries to many of the world’s largest retirement plan sponsors. Weare the actuary to the three largest corporate pension plan sponsors in theUnited States and adviser to 48 of the 100 largest pension funds in the UnitedKingdom.  We offer clients a full rangeof integrated and innovative retirement-related consulting services to meet theneeds of companies that remain committed to offering defined benefit plans aswell as those that are re-examining their retirement benefits strategies.

For example, our Stable Value Plan in the UnitedStates is an alternative integrated retirement plan design that combines thebenefit features of defined contribution and cash balance plans with the rulesof a traditional defined benefit plan to facilitate plan redesigns in today’suncertain environment.  Combined withasset strategies, the Stable Value Plan can help our clients address thefinancial volatility they face due to the financial performance of theirpension plan.  Additionally, for clientswho want to outsource 

5

----

some or all of their pension plan management, we offerbundled, integrated solutions that combine investment consulting, pension administration,core actuarial services and communication assistance.

Our core retirement consulting services include:

·                  Strategicplan design

·                  Actuarialservices

·                  Administrativeservices

·                  Analysisand recommendations on funding and expense strategy

·                  Workforcediagnostics and analysis

·                  Definedcontribution services including discrimination testing and vendor selection

·                  Multinationalasset pooling consulting

·                  Financialreporting

·                  Valuationand diagnostic software and systems

·                  Assistancewith changes relating to mergers, acquisitions and divestitures

·                  Compliance consulting

To enhance our retirement consulting services, wededicate significant resources to technology systems and tools to ensure theconsistency and efficiency of service delivery in all our offices worldwide. Wealso maintain extensive proprietary databases such as Watson Wyatt COMPARISONTM, that enable our clients to track and benchmark benefit planprovisions throughout the world.  Ourtools and technology solutions include:

·                  PensionPath® — In partnership with our Technology and Administration Solutions Group,we deliver this full-featured, web-based solution designed to meet the pensionadministration needs of companies of all sizes.

·                  Retirement Management Online — A web portalthat links clients to a suite of Watson Wyatt tools, research and data.

·                  FASTool — An interactive tool that allows theimmediate comparison of balance sheet information and assumptions related topension and retiree medical plans for large publicly traded companies.

·                  Quick Peek® Online — A web-enabled tool thatallows pension plan sponsors to quickly and easily model a variety of financialand business situations, and project retirement plan contributions, fundedstatus and expense.

·                  DesignIT — A modeling tool for our European business clients that providescomparisons between a selection of alternative pension designs.

·                  Liability Watch — Enables our Europeanbusiness clients to keep daily track of their funding position.

*Group and Health Care Consulting*

We advise clients on the strategy, design,financing, delivery, communication, and ongoing planning and management of allhealth and welfare programs. Clients seek our evidence-based, practicalsolutions to improve employee health, satisfaction and productivity whileminimizing costs. We work closely with our clients — matching their resourcesand capabilities with our methodologies, technology, and total compensation andbenefits perspective.

6

----

Globally, many health care systems are strained byshrinking resources and increasing demand due to population aging and declininghealth status.  Our group and health careconsulting services help clients provide health and welfare benefits that helporganizations to attract and retain qualified workers and enhance the healthand productivity of their workforce.

In the United States, new approaches to providinghealth care benefits for workers and retirees — are that engaging patients asconsumers of health care and not just passive recipients.  These methods encourage employees toparticipate more actively in the health care buying decision by putting workersin charge of spending their own health care dollars and by providing them withthe tools and information necessary to make wiser health purchasing decisions.  One of these tools is BenefitConnectTM — a customizable, web-basedapplication that combines self-service employee tools with administrative andcall center components to facilitate the administration and management ofhealth and welfare benefits.

Our approach to group and health care consultingemphasizes appropriate financial incentives, health and productivity,  provider quality and effectivecommunication.  Our global services include:

·            Strategic plan design of health and welfare,paid time off and flexible benefit plans

·            Retiree health programs

·            Health and productivity management

·            Health and welfare technology solutions

·            Total program management

·            Vendor negotiations and performancemanagement

·            Measurement of program effectiveness

·            Assistance with plan changes relating tomergers, acquisitions and divestitures

***Technology and AdministrationSolutions (TAS) Group***

WatsonWyatt’s Technology and Administration Solutions Group helps organizationsoptimize the delivery of their human resources and benefit services. We do thisthrough a unique blend of domain expertise and experience in human resourcesand benefits, strong process capability and a range of enabling technologyapplications. We understand the importance of being able both to provide adviceon the appropriate solutions to meet human resource needs and to implement anddeliver those solutions on an ongoing basis, whether through outsourcedservices, in-house capabilities or a combination of the two.

OurTechnology and Administration Solutions Group of 720 associates providesconsulting, administration, outsourcing and technology services across humanresources but focusing in particular on:

*RetirementAdministration*

·                     We provide retirement administration solutions in a number ofgeographic areas, tailored to the needs of each local market. For example:

·                     In the United States, our technology solution PensionPath® includescase management and administration tools to assist plan sponsors in managingthe entire life cycle of pension administration, from new hire to retirement,and employee self-service tools that enhance workers’ understanding of theirretirement benefits’ future value. PensionPath is available whether or not Watson Wyatt providesoutsourcing services.

7

----

·                     In the United Kingdom, we are among the UK leaders in retirementadministration outsourcing services to the private sector, using highlyautomated processes and modern transactional web technology to enable membersto access their records and improve their understanding of their benefits. Ourtechnology also provides trustees and human resources with timely managementinformation and the means to monitor activity levels and reduce administrationcosts.

·                     In markets where defined contribution arrangements are more complexthan 401(k)-style defined contribution plans, we have deployed sophisticateddefined contribution technology, processes and controls. Our definedcontribution administration model in Germany and the United Kingdom leveragesweb technology and provides clients with “back office” reconciliation andinvestment manager interaction expertise, while offering the option to “flex”the front-office operations to be as comprehensive as required.  Participants can access static andtransactional data allowing them to be self-sufficient in managing theirportfolios.

*Health&Welfare/Flexible Benefits Administration*

·                     Flexible benefit plans exist in different forms in differentgeographies and we provide web-enabled flexible benefits administrationsolutions to support clients in a number of different parts of the world.

·                     In the United States, flexible benefits tend to be focused primarilyaround health and welfare arrangements. BenefitConnectTM is our flexibleweb-based health and welfare technology that we use to provide comprehensiveoutsourced support to clients. New health care consumerism support tools giveparticipants direct web-based access to their benefits information and enroll­menttools and provide modeling on a choice of medical spending, savings accountsand life insurance. They also help participants become smart consumers throughaccess to information from the internet.

·                     In the United Kingdom, we provide flexible benefits administrationservices on a stand-alone basis or linked with defined contributionadministration and the provision of total compensation statements.

*CompensationAdministration*

·                     REWARDTM is our suite of web-based applications that automatescompensation administration and pay delivery. REWARD improves compensationplanning, budgeting and data management, freeing up compensation professionalsfrom administrative work for more strategic activities.  We recently integrated our global gradingsystem methodology into REWARD, enabling companies to band and grade jobs andthen model pay ranges around local market conditions.

*OnlineCommunication*

·                     eStatements is our integrated, web-based solution that gives employeesaccess to the true value of their compensation and benefits package.  It aggregates data from a number of internalor external sources, and provides a current view of an employee’s completepackage.  It shows the value of anorganization’s human resource programs, fosters smarter plan participation andbenefit consumerism, and offers organizations another vehicle to promote planfeatures, provide support and deliver other focused information.

8

----

*CallCenter Support*

·                     AnswerKeyTM is our shared service center solution. Our technologysupports the business of service center operations by effectively integratingdata and critical tools. Using web-based technology, it consolidates data frommultiple sources, offering employees and human resource service center staff asingle point of contact, faster response times and more accurateinformation.  We recently added theEmployee Inquiry module, which enables employees to open cases, check casestatus, access knowledge base information and request fulfillment items.

*BenefitsPortals*

·                     By implementing our hosted benefits portals we can help to ensure aseamless experience for employees needing to use multiple human resource andbenefits applications or multiple information sources. Our hosted portals canbecome a central reference point and knowledge base for Pension and humanresource managers, administrators and members.

Allof the above are point solutions — applications or services that serve aparticular need once clients have identified and prioritized their needs. Veryoften our involvement starts at a much earlier level. We provide clients withstrategic, research-based human resource technology and service deliveryadvisory services to help them determine their strategy for delivering humanresource services. We work with them to align their human resources deliverystrategy with their business goals. We use human resource and benefitstechnologies, those mentioned above and others, to help our clients improvesatisfaction levels and have a sustainable return on investment (ROI). Ourservices in this area include human resource transformation consulting, vendormanagement, and service delivery model development, including shared servicesstrategy and design.

OurTechnology and Administration Solutions Group represented approximately 11percent of our total segment revenues for the fiscal year ended June 30,2006.

***Human Capital Group***

Our Human Capital Group of 425 associates helpsclients implement strategies that achieve a competitive advantage by aligningtheir workforce with their business strategy. This includes helping clientsdevelop and implement strategies for attracting, retaining and motivating theiremployees resulting in a maximized return on the clients investment in humancapital.  The Human Capital Group alsoutilizes our  Watson Wyatt Data Servicespractice which is a group of 128 associates to provide data, services andanalysis regarding compensation and benefits around the world.  Our Human Capital Group representedapproximately 9 percent of our total segment revenues for the fiscal year thatended June 30, 2006.

Our Human Capital Group focuses in four principalareas: executive compensation, Strategic Rewards*®*, sales management and rewards, andorganization effectiveness.

9

----

*Executive Compensation*

We advise our clients’ management and boards ofdirectors on executive pay programs, including cash compensation, stock optionsand stock purchase plans, and on ways to align pay-for-performance plansthroughout the organization to improve stockholder value. We help clientsunderstand and value all the components of their executives’ compensation,including base pay, bonus, incentives, options, and retirement and otherexecutive perks.  Our expertise instock-based plan design and in valuation methodologies and procedures allows usto help U.S. clients, for instance, comply with complex accounting standardssuch as FAS 123(R) and recently promulgated SEC rules regarding executivecompensation disclosure.

*Strategic Rewards**®*

We help align an organization’s rewards — includingcompensation, stock programs, incentives, recognition programs and flexiblework arrangements — with its business strategies, cultural values, work designand human resources strategy.  Our HumanCapital Group and Benefits Group work together to develop optimal totalcompensation programs for our clients.

*Sales Management and Rewards*

We help maximize the performance of our clients’sales and services teams across the globe. By considering the full spectrum ofrewards, we help motivate our clients’ sales forces to maintain and expandcritical relationships while executing the organization’s go-to-marketstrategy.

*Organization Effectiveness*

We help clients clarify and implement businessstrategy, recognizing the impact of employee attitudes, commitment, andeffective team and leadership development on business success. We provide awide array of services centered on organization assessment, includingorganization measurement and surveys. In the area of talent management, weprovide tools and methodologies for talent selection and development,succession planning and performance management. We also provide consultingregarding organization design and the organization and development of the humanresource function.

We have created the *Watson WyattHuman Capital Index*â, a proprietary tool for demonstrating therelationship between the effectiveness of an organization’s human capitalpractices and the creation of superior stockholder returns.

Our WorkUSA®/WorkCanadaTM database includes the opinionsof 12,000 North American employees surveyed independently, reflecting a largecross-section of jobs and industry types. Our clients compare their ownemployee survey results against these norms to identify workplace perceptionsand satisfaction and commitment levels.

10

----

*Watson Wyatt Data Services*

WatsonWyatt Data Services (WWDS) provides a wide range of employment practicesinformation to the global employer community. WWDS’s client base includeslocal and multi-national companies in more than 80 countries.

Toserve the global marketplace, WWDS has begun a consolidation of eightstrategically located data centers around the globe into one business unit tofacilitate the solicitation, analysis and compilation of data on theremuneration and benefits paid to millions of employees. Our centers around theworld publish this data in dozens of annual compensation and benefit surveyreports on everything from local pay issues to the most complex of globalpay equity concerns. WWDS also publishes reference materials that helphuman resources practitioners attract, retain and reward exceptional employees.These guides cover a variety of subject areas, including variable pay,performance management and personnel policies on a local, regional and globalbasis.

***Insurance and Financial ServicesGroup***

Our Insurance & Financial Services consultingteam of approximately 325 associates advises insurance companies and otherfinancial institutions on strategic and financial issues. Clients include majormultinational financial groups; life, non-life and health insurance companies;re-insurers; banks and regulators. Our Insurance and Financial Services Grouprepresented approximately 8 percent of our total segment revenues for thefiscal year that ended June 30, 2006.

Our services include:

·                  Development and review of business strategy,including market entry studies and business plan design

·                  Provision of strategic and actuarial adviceto buyers or sellers of financial institutions

·                  Advice on a wide range of financialmanagement issues, including risk and value management, asset liabilitymodeling, statutory reporting, embedded value and market consistent valuations

We have also developed arange of leading-edge actuarial modeling software products, including VIPitech,Pretium and Simulum. These are used internally for consulting projects andlicensed to clients around the world.

***Investment Consulting Group***

Our Investment Consulting Group, with approximately270 associates, assists pension plan sponsors and other institutionalinvestment clients in achieving success in meeting their investment goals. Thisinvolves helping to maximize the risk-adjusted return through the developmentof governance policies and investment strategies. Our work involves helping ourclients with the design and implementation of investment arrangements to managefinancial liabilities within the context of overall organizational objectives.Our Investment Consulting Group represented approximately 6 percent of ourtotal segment revenues for the fiscal year that ended June 30, 2006.

11

----

Our services include:

·                  Asset/liability modeling and asset allocationstudies

·                  Governance and investment policy development

·                  Investment policy implementation

·                  Investment structure analysis

·                  Investment manager selection and evaluation

·                  Performance evaluation and monitoring

We offer the following integrated services for ourclients:

·                  Watson Wyatt Pension Risk ManagementTM — anintegrated methodology for determining the appropriate amount of investmentrisk for a plan and allocating that risk across investment decisions

·                  Watson Wyatt Advanced Investment Solutions® —taking a more proactive responsibility for the investment arrangements ofdefined benefit plans and other institutional funds, a service referred to insome markets as fiduciary outsourcing. We work with the plan sponsor to develop an investment policy and helpto manage the implementation of that policy.

***International Operations***

Our international segment is comprised of operationsin 27 offices in Asia-Pacific and Latin America, employing approximately 970associates, which generally provide our full array of services. This segmentrepresented approximately 8 percent of our total segment revenues for thefiscal year that ended June 30, 2006.

We established our presence in Asia-Pacific in 1979with offices in Hong Kong and Malaysia, and grew substantially throughout the1980s and 1990s by establishing 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 inthe region, with more than 50 different survey products, as of the fiscal yearend. We are a leading provider of retirement and other employee benefitconsulting services in Asia-Pacific, and we provide investment consultingservices to some of the largest pension plans in Japan and Hong Kong.  We were named HR Consulting Firm of the Yearin Hong Kong by *China Staff* magazine for the pastseven years in a row.  In addition to ourhuman capital and benefits consulting services, we also market technologysolutions to clients in the region.

Our Latin American presence began in the early 1980sin Mexico and grew to include such major markets as Brazil in the 1990s.  We have most recently opened new offices inChile and Uruguay.  With deregulation,privatization and the influx of multinational corporations, we believe thereare significant opportunities for growth in the region, both in the benefitsarea — where most of our services are concentrated currently — and in the humancapital consulting area.

12

----

***Other Services***

*Communication Consulting*

Our communication consulting practice helps clientsproduce financial results through strategies that align employee behavior withbusiness success.  Our award-winning workand ground-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.

We help clients develop and implement communicationstrategies for diverse issues, including:

·                  Clarifying the value and scope ofemployee compensation and benefits and enhancing employees’ appreciation oftheir total rewards opportunities

·                  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 their role in business success

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

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

·                  Supporting management in efforts to target,attract and hire the right talent to meet business objectives throughinnovative communication programs

***Integrated Service Approach***

While we focus our consulting services in theprincipal areas described above, we draw upon consultants from our differentpractices to deliver integrated services to meet the needs of our clients. Anexample is our Total Rewards approach, which encompasses compensation,benefits, career growth and company culture. We help clients determine thecorrect mix of reward programs to attract and retain the right employees and tomotivate them to produce desired results. We also assemble cross-practice teams to help clients through mergersand acquisitions.

13

----

***Sales and Marketing***

Our growth strategy is based on a commitment toensuring client satisfaction through our account management program.  Our account managers focus on effectivelydelivering services to clients and on expanding our relationships acrossservice lines, geographic boundaries and divisions within clientcompanies.  A key element of this programis an approach we call ClientFirstTM.Using 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 usingcross-disciplinary teams of consultants, as well as dedicated client developerswho initiate relationships with carefully selected companies. Our efforts toexpand our accounts and our client base are supported by market research, comprehensivesales training programs and extensive marketing databases. Our sales effortsare also supported by a full array of marketing programs designed to raiseawareness of the Watson Wyatt Worldwide brand and our reputation within ourtarget markets. These programs promote our thought leadership on key humanresources issues, and establish us as a preferred human capital consulting firmto many of the world’s largest companies.

**Clients**

We work with major corporations, emerging growthcompanies, government agencies and not-for-profit institutions in NorthAmerica, Europe, Latin America and Asia-Pacific across a wide variety ofindustries.  Our client base is broad andgeographically diverse.  For the fiscalyear that ended June 30, 2006, our 10 largest clients accounted forapproximately 7 percent of our consolidated revenues, and no individual clientrepresented more than 1 percent of our consolidated revenues.

**Competition**

The human capital consulting industry is highlycompetitive.  We believe there are severalbarriers to entry — such as the need to assemble specialized intellectualcapital to provide expertise on a global scale — and that we have developedcompetitive advantages in providing human resources consulting services.However, we face intense competition from several different sources.

Our current and anticipated competitors include:

·            Major human resources-focused consultingfirms that compete in serving the large employer market worldwide, includingHewitt Associates, Mercer Human Resource Consulting and Towers Perrin

·            Smaller benefits and compensation consultingfirms, including the Hay Group and The Segal Company

·            The human resources consulting and/or planadministration divisions of diversified professional services, financialservices and insurance firms, including Aon, Deloitte & Touche,Ernst & Young, Fidelity, Citistreet, PricewaterhouseCoopers and TheVanguard Group

·            Information technology services firms,including Accenture, ACS, ADP, BearingPoint, ExcellerateHRO and IBM, as well asInternet/intranet development firms

·            Boutique consulting firms consistingprimarily of professionals formerly associated with the firms mentioned above

14

----

The market for our services is subject to change asa result of increased regulatory, legislative, competitive and technologicaldevelopments and competition from established and new competitors. We believethe primary factors in selecting a human resources consulting firm includereputation, the ability to provide measurable increases to shareholder 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.

**Employees**

As of June 30, 2006, the company employedapproximately 6,235 associates as follows:

| Benefits Group                                                                |   | 2,390 |   |
|-------------------------------------------------------------------------------|--------|-------|--------|
| Technology and  Administration Solutions Group                                |   | 720   |   |
| Human Capital  Group                                                          |   | 425   |   |
| Insurance &  Financial Services Group                                     |   | 325   |   |
| Investment  Consulting Group                                                  |   | 270   |   |
| International —  Consisting of Asia-Pacific and Latin America Operations |   | 970   |   |
| All Other  Segments                                                           |   | 545   |   |
| Corporate                                                                     |   | 590   |   |
| Total                                                                         |   | 6,235 |   |

 

None of our associates are subject to collectivebargaining agreements.  We believerelations between management and associates are good.

**Item 1A** – RiskFactors

In addition to the factors discussed elsewhere inthis report, the following are some of the important factors that could causeour actual results to differ materially from those projected in anyforward-looking statements. These risk factors should be carefully consideredin evaluating our business.  Thedescriptions below are not the only risks and uncertainties that we face,additional risks and uncertainties that are presently unknown to us, may alsoimpair our business operations and if any of the risks and uncertainties belowor other risks were to occur, our business operations, financial condition orresults of operations could be materially and adversely impacted.

***Watson Wyatt’s success will continue to depend on its ability torecruit and retain qualified consultants, including those employed in recentlyacquired businesses; our failure to do so could adversely affect our ability tocontinue to integrate acquired businesses and to compete successfully******.***

Watson Wyatt’s successdepends on its ability to attract, retain and motivate qualified personnelgenerally, including executive officers, key management personnel andconsultants. We cannot assure that we will be able to attract and retainqualified consultants, management and other personnel necessary for thedelivery of our sophisticated and technical services to clients.

15

----

With respect to the businesscombination in the first quarter of fiscal year 2006 in particular, WatsonWyatt’s ongoing success also is subject to Watson Wyatt’s ability to retainWatson Wyatt Limited key personnel. If Watson Wyatt Limited’s key personnelchoose not to stay with Watson Wyatt as integration continues, we mayexperience substantial disruption in our efforts to integrate the Europeanbusiness, which could adversely affect our performance.

***The loss of key consultants and managers could damage or result in the loss of client relationships and adversely affect our business.***

Our success largely depends upon the businessgeneration capabilities and project execution skills of our consultants. Inparticular, our consultants’ personal relationships with our clients are acritical element of obtaining and maintaining client engagements. Losingconsultants and account managers who manage substantial client relationships orpossess substantial experience or expertise could adversely affect our abilityto secure and complete engagements, which would adversely affect our results ofoperations.

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

***Acceleration ofthe shift by employers from defined benefit plans to defined contribution planscould adversely affect our business and our operating results.***

We currently provide clients with actuarial and consulting services relating to both defined benefit and defined contribution plans.  Defined benefit pension plans generally require more actuarial services than defined contribution plans because defined benefit plans typically involve large asset pools, complex calculations to determine employer costs, funding requirements and sophisticated analysis to match liabilities and assets over long periods of time.  If organizations shift to defined contribution plans more rapidly than we anticipate, our business operations and related operating results could be adversely affected.

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

The markets for our principal services are highly competitive. Our competitors currently include other human resources consulting and actuarial firms, as well as the human resources consulting divisions of diversified professional services and insurance firms and accounting firms. Several of our competitors have greater financial, technical and marketing resources than we have, which could enhance their ability to respond more quickly to technological changes, finance acquisitions and fund internal growth. New competitors or alliances among competitors could emerge and gain significant market share.  In order to respond to increased competition and pricing pressure, we might have to lower our prices, which would have an adverse effect on our revenues and profit margin.

16

----

***Demand for our services may decrease for various reasons, including a general economic downturn, a decline in a client’s or an industry’s financial condition, or a decline in define benefit pension plans that could adversely affect our operating results.***

We can give no assurance that the demand for our services will continue to grow or that we will compete successfully 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 financial conditions.  When economic downturns affect particular clients or industry groups, they frequently reduce their budgets for outside consultants, which could reduce the demand for our services and increase price competition.

In addition, the demand for many of our core benefits services is affected by government regulation and taxation of employee benefits plans. This regulation and taxation drive our clients’ needs for compliance-related services. Significant changes in tax or social welfare policy or regulations could lead some employers to discontinue their employee benefit plans, including defined benefit pension plans, thereby reducing the demand for our services. A simplification of regulations or tax policy also could reduce the need for our services.

***Our clients generally may terminate our services at any time, which could decrease associate utilization.***

Our clients generally may terminate our engagements at any time. If a client reduces the scope of, or terminates the use of our services with little or no notice, our associate utilization will decline. In such cases, we must rapidly re-deploy our associates to other engagements in order to minimize the potential negative impact on our financial performance.  In addition, because much of our work is project-based rather than recurring in nature, our associates’ utilization depends on our ability to continually secure additional engagements.

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

We enter into some of our engagements on a negotiated fixed-fee basis. If we do not properly negotiate the price and manage the performance of these engagements, we might incur losses on individual engagements, and our overall financial results could be adversely affected.

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

Professional services providers, including those in the human resources consulting industry, are increasingly subject to claims from their clients. Clients and third parties who are dissatisfied with our services or who claim to suffer damages caused by our services have brought and may bring lawsuits against us. The nature of our work, especially our actuarial services, involves assumptions and estimates concerning future events, the actual outcome of which we cannot know with certainty in advance. In addition, we could make computational, software programming or data management errors.

Clients have sought and may seek to hold us responsible for the financial consequences of these errors or variances.  Given that we frequently work with large pension funds and other large financial entities, such as insurance companies, relatively small percentage errors or variances could create significant dollar variances and claims for unfunded liabilities.  The risks from such variances could be aggravated in an environment of declining pension fund asset values. In most cases, our exposure to liability on a particular engagement is substantially greater than the profit opportunity that the engagement generates for us.  For example, claims could include:

17

----

·                  A client’s assertion that actuarial assumptions used in a pension plan was unreasonable, leading to plan underfunding;

·                  A claim arising out of the use of inaccurate data, which could lead to an underestimation of plan liabilities;

·                  A claim that employee benefit plan documents were misinterpreted or plan amendments were misstated in plan documents, leading to overpayments to beneficiaries; and

·                  A claim that reserves or premium requirements of insurance company clients were understated.

Defending lawsuits arising out of any of our services has required and could require substantial amounts of management attention, which could affect management’s focus on operations, adversely affect our financial performance and result in increased insurance costs. In addition to defense costs and liability exposure, malpractice claims may produce negative publicity that could hurt our reputation and business. We have been subject to inquiries and investigations by federal, state or other governmental agencies regarding aspects of our business, especially regulated businesses such as investment consulting or insurance consulting.  Such inquiries or investigations may consume significant management time and require additional expense. For a discussion of significant legal proceedings, please refer to Note 14 of Notes to the Consolidated Financial Statements.

***Insurance may become more difficult or expensive to obtain******.***

Insurance markets havehardened over recent years for some classes of professional liabilityrisk.  As the number of claims hasincreased against professionals and against actuaries in particular, the costof malpractice insurance has trended upward, deductibles or self-insuredretentions may have increased and reinsurance attachment points may continue torise.  Availability and price ofinsurance are subject to many variables, including general market conditions,loss experience in related industries and in the actuarial and benefitsconsulting industry, and the specific claims experience of an individual firm.Because we now provide services in a larger geographic market as a result ofthe business combination, we therefore may be exposed to a greater number ofclaims arising from our expanded operations. In the future there can be no assurance that we will continue to be ableto obtain insurance on comparable terms to what it has obtained in the past.Increases in the cost of insurance could affect our profitability and theunavailability of insurance to cover certain levels of risk could have anadverse effect on our financial condition, particularly in a specific period.

***As a result of the acquisition of Watson Wyatt Limited, we are engaged,through subsidiaries, in the insurance and financial services consultingbusiness, which may carry greater risk of liability than our current lines ofbusiness.***

We intend to continue andgrow the business of providing consulting services to insurance and financialservices companies. The risk of malpractice claims from this line of businessmay be greater than from some of our current lines of business and claims maybe for significant amounts.

18

----

***Our quarterly revenues may fluctuate while our expenses are relatively fixed.***

Quarterly variations in our revenues and operating results occur as a result of a number of factors, such as:

·                  The significance of client engagements commenced and completed during a quarter;

·                  The seasonality of some specific types of services.  In particular, retirement revenues are more heavily weighted toward the second half of the fiscal year, when annual actuarial valuations are required to be completed for calendar year end companies and the related services are performed.  In the Technology and Administration Solutions Group, the distribution of work is concentrated at the end of the first fiscal quarter and through the second fiscal quarter, as there is demand from our clients for assistance in updating systems and programs used in the annual re-enrollment of employees in benefit plans, such as flex plans. Much of the remaining business is project-oriented and is thus influenced more by particular client needs and the availability of our workforce;

·                  The number of business days in a quarter, associate hiring and utilization rates and clients’ ability to terminate engagements without penalty;

·                  The size and scope of assignments; and

·                  General economic conditions.

Approximately 70-75 percent of our total operating expenses are relatively fixed, encompassing the majority of administrative, occupancy, communications and other expenses, depreciation and amortization, and salaries and employee benefits excluding fiscal year end incentive bonuses.  Therefore, a variation in the number of client assignments or in the timing of the initiation or the completion of client assignments can cause significant variations in quarterly operating results and could result in losses.  Over the most recent eight fiscal quarters, net income from continuing operations has fluctuated from $11.1 million to $29.3 million.

***If we do notsuccessfully integrate Watson Wyatt Limited , we may not realize the expectedbenefits of the acquisition.***

We expect that the business combination completed inJuly 2005 will continue to result in business opportunities and new prospectsfor growth through new and expanded client relationships and an integratedcapital structure that facilitates business development on a global scale. Thecompany may not fully realize these expected business opportunities and growthprospects. Integrating the European business and Watson Wyatt involves theintegration of businesses that, while participating in a business alliance, hadpreviously operated independently and under different governance andorganizational structures. The difficulties of integrating the operations ofthese businesses include:

·            The challenge of effecting integration whilecarrying on ongoing business;

·            Demonstrating to existing and potentialclients that the acquisition will not adversely affect customer servicestandards or business focus;

·            The necessity of coordinating what werepreviously geographically separate organizations;

·            The potential incompatibilities within thebusiness cultures of the two companies; and

·            The possibility that key managers,consultants and other personnel may not be satisfied or happy at Watson Wyattas the integration proceeds, may elect to leave.

19

----

***If we are unableto fully integrate Watson Wyatt Limited’s internal controls and systems intoour operations, our business may suffer.***

Wehave spent significant resources integrating financial systems and reviewingand implementing improvements to our internal controls.  Effective internal controls are essential toproviding reliable financial information regarding our financial condition andresults from operations, as well as for effectively detering fraud.  We cannot be certain that the Europeanbusiness operations have effective internal systems controls and that, uponfull integration, will be adequate.  Anyfailure in the integration of systems, or implementation of new or improvedcontrols, could adversely affect our results of operation and financial condition,or cause us to fail to meet our reporting obligations.

***IntegratingWatson Wyatt Limited may interrupt other activities of Watson Wyatt.***

The continuing process of integrating operationscould cause an interruption of or loss of momentum in the activities of one ormore of Watson Wyatt’s businesses after the acquisition. Members of our seniormanagement may be required to devote considerable amounts of time to thisintegration process, which will decrease the time they will have to manage thecompany’s business, service existing clients, attract new clients and attractand retain highly skilled and motivated consultants.

We now have significantly more assets and employeesthan we did before the acquisition. The integration process will require us tosignificantly expand the scope of our operational and financial systems, whichwill increase our operating complexity. Implementing uniform controls, systemsand procedures may be costly and time-consuming, and there can be no assurancethat our efforts to implement such controls, systems and procedures will besuccessful. Management’s failure to effectively operate the company  could have a material adverse impact on ourbusiness, financial condition and operating results as well as our ability tomeet reporting requirements to the SEC and under Section 404 of theSarbanes-Oxley Act of 2002.

***We are subject to risks of doingbusiness internationally.***

Since the business combination, an increased portionof our business is located outside of the United States. As a result, asignificant portion of our business operations are subject to foreign financialand business risks, which could arise in the event of:

·                  currency exchange rate fluctuations;

·                  unexpected increases in taxes;

·                  new regulatory requirements and/or changes inpolicies and local laws that materially affect the demand for our services ordirectly affect our foreign operations;

·                  local economic and political conditions,including unusual severe or protracted recessions in foreign economies;

·                  unusual and unexpected monetary exchangecontrols; or

·                  civil disturbance or other catastrophicevents that reduce business activity in other parts of the world.

These factors may lead to decreased sales or profitsand therefore may have a material adverse effect on our business, financialcondition and operating results.

20

----

 

***Operational readiness of our global administrative infrastructure might not be as complete as required to manage international operations effectively.***

The management of geographically dispersed operations requires substantial management resources, resulting in significant ongoing expense. We have not fully integrated all of our global operations from an administrative and reporting standpoint. In addition, we have not yet integrated the businesses acquired into our administrative and reporting process.  We are developing and implementing additional systems and management reporting to help us manage our global operations, but we cannot predict when these systems will be fully operational or how successful they will be. Our global operations may require additional resources to complete integration of our administrative and reporting. These risks could be aggravated in the event of a major business disruption caused by terrorist attacks or similar events.

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

Increasingly, to remain competitive in our practice areas, we must identify and offer the most current technologies and methodologies. This is particularly true of our Technology and Administration Solutions Group, in which our success largely depends upon our ability to quickly absorb and apply technological advances in both generic applications and, particularly, those that are specifically required to deliver employee benefits services. In some cases, significant technology choices and investments are required. If we do not respond correctly, quickly or in a cost-effective manner, our business and operating results might be harmed.

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

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

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

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

The business interests of our employee stockholders may not always be consistent with the interests of our non-employee stockholders.

21

----

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

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

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

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

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

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

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

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

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

***Our stock price may decline due to thelarge number of shares of common stock eligible for future sale.***

The market price of ourcommon stock could decline as a result of sales of a large number of shares ofour common stock in the market as a result of the business combination.  Immediately after the business combinationand Watson Wyatt Limited’s distribution of consideration paid in theacquisition, Watson Wyatt Limited members and retired members heldapproximately 22% of our  outstandingcommon stock (without taking into account shares that may be issued as part ofthe contingent stock consideration).  Ourcommon stock to be transferred to voting members in connection with theacquisition that are not subsequently distributed to non-voting members aresubject to contractual restrictions on transfer.

Common stock distributed tonon-voting members is expected to be distributed over time through two trustsin four equal installments. The first occurred in August 2005 at the closing ofthe business combination.  Subsequentinstallments are on the first, second and fourth anniversaries of the closing.  The first anniversary installment occurred inAugust 2006. However, the timing and amount of distributions from the trusts tonon-voting members are matters for the trustees and cannot be enforced byWatson Wyatt or Watson Wyatt Limited.  Weunderstand that the former non-voting members of WWHE will have an immediatebeneficial entitlement to the shares in the trusts regardless of subsequentemployment and that these shares will be paid out from the trusts over athree-year period.  Common stock to betransferred to retired members will not be subject to any transferrestrictions.

22

----

Assuming execution by formerWWHE voting members of stock transfer agreements and distribution of shares tonon-voting members over time, of the 11,040,571 total shares that may be issuedin connection with the business combination (including contingent stockconsideration), 4,340,774 shares, or approximately 10% of outstanding commonstock, were freely transferable immediately after the closing of theacquisition.  Additionally, 2,339,761shares were transferable after the first anniversary of the acquisition, and2,410,036 will be transferable after the second anniversary.  Any shares issued as contingent considerationwill be transferable after the fourth anniversary of the acquisition; up to1,950,000 shares of common stock are potentially payable as contingentconsideration.  In addition, in the eventof a change in control of Watson Wyatt, all stock transfer restrictions willexpire.

***Our discretion to operate the European business isrestricted at least until mid-2007, which may adversely affect our ability tomaximize the performance and results of operations of the European business.***

We agreed to certain covenants in connection withthe business combination in July 2005, that are described in a businesstransfer agreement that restrict our discretion in operating the Europeanbusiness until final determination of the amount of contingentconsideration.  During this period, wegenerally must operate the European business in the ordinary course in the samemanner as operated before consummation of the acquisition.  Additional restrictions until the contingentconsideration is determined include prohibitions on material changes to theterms or conditions of any category of employment if such changes would have amaterial adverse effect on fiscal year 2007 staff costs of the Europeanbusiness, among other things.  We arerequired to appoint (in consultation with Watson Wyatt Limited), empower andmaintain a management team that is required to be incentivized to deliversuperior financial performance and shareholder return and increased revenues,with emphasis on meeting conditions for payment of contingent stockconsideration and certain employee bonuses. Such requirements and prohibitions will limit our discretion inoperating the European business until mid-2007, and may adversely affect ourability to maximize the performance of the European business or to achieve allof the potential benefits of the acquisition.

***We have limited recourse against Watson Wyatt Limitedfor breaches of the business transfer agreement.***

Weentered into the business transfer agreement with Watson Wyatt Limited thatamong other things relied upon warranties from Watson Wyatt Limited regardingthe European business. These warranties include warranties regarding a varietyof aspects of the European business, including the character and nature of theassets and liabilities, tax matters, employee-related matters and mattersrelating to accounts and financial information.

WatsonWyatt Limited’s potential liability for breaches of such warranties is limitedin a number of respects.  The aggregateamount of such liability is limited to $25 million.  In addition, except with respect to tax-relatedwarranty claims, claims generally must be made within 18 months after consummationof the acquisition.  Significantly, oursole method of recovery for losses incurred as a result of warranty claims isthrough set off against the contingent stock consideration.  Because contingent consideration will bepayable only if certain performance thresholds are satisfied, we cannot beassured of having adequate recourse against Watson Wyatt Limited for lossesincurred as a result of inaccurate warranties.

23

----

Wealso will have limited practical recourse against Watson Wyatt Limited for otherbreaches of the business transfer agreement or for indemnity claims under theagreement.  Currently, Watson WyattLimited has minimal business operations and assets.  As a result, even if we were found to beentitled to indemnification or damages resulting from a breach by Watson WyattLimited of the business transfer agreement, we cannot be assured that WatsonWyatt Limited will have adequate funds to satisfy any such claim.

**Item 1B.**                 Unresolved SECComments

None.

**Item 2.**                          Properties.

As of June 30, 2006, we operated in 94 officesin principal markets throughout the world. Operations of each of our segments are carried out in leased officesunder operating leases that typically do not exceed 10 years in length. We donot anticipate difficulty in meeting our space needs at lease expiration.

The fixed assets owned by Watson Wyatt representedapproximately 12 percent of total assets at June 30, 2006, and consistedprimarily of computer equipment and software, office furniture and leaseholdimprovements.

**Item 3.**                          LegalProceedings.

Fromtime to time, we are a party to various lawsuits, arbitrations or mediationsthat arise in the ordinary course of business. The disclosure called for by Item 3 regarding our legal proceedings isincorporated by reference herein from Note 14 “Contingent Liabilities,” of theNotes to the Consolidated Financial Statements in this Form 10-K for the yearended June 30, 2006.

**Item 4.**                          Submissionof Matters to a Vote of Security Holders.

None.

**Part II**

**Item 5.**                          Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities.

In conjunction with our business combination ofWWLLP in the first quarter of fiscal year 2006, we issued 9,090,571Class A shares, 4,749,797 of which are subject to sale restrictions.  Sale restrictions on these shares will expireas follows:

| Expiration Date | ** ** | **Number of Shares** | ** ** |
|----------------------|------------|--------------------------------|------------|
| July 31, 2006        |       | 2,339,761                      |       |
| July 31, 2007        |       | 2,410,036                      |       |

 

24

----

The payment of up to an additional 1,950,000Class A shares after June 30, 2007 is contingent upon achievement bythe acquired business of certain agreed-upon financial performance goals.  Sale of these shares, if issued, will berestricted until July 31, 2009.  See Note2 of Notes to the Consolidated Financial Statements included in Item 15 of thisreport for further information regarding the business combination of WWLLP.

In conjunction with our initial public offering inOctober 2000, we entered into agreements providing for additional transferrestrictions with major stockholders, executive officers and employeedirectors.  At each of the first fouranniversaries of our initial public offering, a portion of these shares becamefreely transferable.  The final 1,665,400Class A shares became freely transferable in October 2004.

*Market Information*

Watson Wyatt Worldwide, Inc. Class A commonstock is currently traded on the New York Stock Exchange under the symbolWW.  The following table sets forth therange of high and low closing share prices for each quarter of fiscal years2006 and 2005, determined by the daily closing stock prices.
| ** **                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
|                                                      |       |     |       |     |       |   |   |   |   |
| First quarter  (July 1 through September 30)    |       | $        | 28.62      |     | $          | 25.76 |   | $ | 26.87 |   | $ | 24.17 |   |
| Second quarter  (October 1 through December 31) |       | 28.56    |       | 25.36    |       | 27.48 |   | 25.21 |   |
| Third quarter  (January 1 through March 31)     |       | 32.58    |       | 27.95    |       | 28.16 |   | 25.58 |   |
| Fourth quarter  (April 1 through June 30)       |       | 36.34    |       | 31.92    |       | 27.55 |   | 24.90 |   |
|                                                           |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

*Holders*

As of June 30, 2006, there were approximately464 registered shareholders of our Class A common stock.

*Dividends*

In May 2004, the Board of Directors of thecompany approved the initiation of a quarterly cash dividend in the amount of$0.075 per share.  Total dividends paidin fiscal years 2006 and 2005 were $12.7 million and $9.8 million,respectively.

During fiscal year 2006 and in conjunction with thebusiness combination, the company amended and restated its credit facility (seeNote 9 of Notes to the Consolidated Financial Statements, included in Item 15of this report).  This credit facilityrequires us to observe certain covenants, including requirements for minimumnet worth, which act to restrict 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.

25

----

##### *SecuritiesAuthorized for Issuance Under Equity Compensation Plans*

Our equity compensation plans include the 2000Long-Term Incentive Plan, which provides for the granting of nonqualified stockoptions and stock appreciation rights, the 2001 Employee Stock Purchase Plan,the 2001 Deferred Stock Unit Plan for Selected Employees and the AmendedCompensation Plan for Outside Directors. We grant deferred stock units to certain senior associates through theWatson Wyatt & Company Performance Share Bonus Incentive Program as apart of their annual discretionary compensation and have discontinued theissuance of stock options.  All deferredstock units issued in connection with the 2001 Deferred Stock Unit Plan werefully vested upon issuance.  The companyanticipates that the deferred stock units expected to be granted inSeptember 2006 will vest immediately. All of our equity compensation plans have been approved bystockholders.  See Note 10****of the Notes to the Consolidated Financial Statements forthe general terms of these plans.

The following chart gives aggregate informationregarding grants under all of the company’s equity compensation plans throughJune 30, 2006:
| **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 |       | 543,615                                                                                                          |       | $                                                                           | 13.65      |                                                                                                                                                                                                                | 4,058,940  | (1) |
|                                                |       |                                                                                                             |       |                                                                        |       |                                                                                                                                                                                                                |       |
| Total                                               |       | 543,615                                                                                                          |       | $                                                                           | 13.65      |                                                                                                                                                                                                                | 4,058,940  |   |

----

(1)             Includes2,548,915 shares remaining available for future issuance under the 2000Long-Term Incentive Plan, 684,122 shares under the 2001 Employee Stock PurchasePlan, 730,643 shares under the 2001 Deferred Stock Unit Plan for SelectedEmployees, and 95,260 shares under the Amended Compensation Plan for OutsideDirectors.

In August 2001, the Board of Directors adoptedthe company’s 2001 Employee Stock Purchase Plan (the “ESPP”), whichsubsequently was approved by the stockholders in November 2001.  The ESPP is intended to provide employees ofthe company with additional incentives by permitting them to acquire aproprietary interest in the company through the purchase of shares of thecompany’s common stock.  With regard tothe Amended Compensation Plan for Outside Directors, an additional 75,000shares of common stock were authorized and reserved for issuance at the 2005Annual Meeting of Stockholders in November 2005.

26

----

*Issuer Purchases of Equity Securities*

The company has repurchased shares of common stock,one purpose of which is to offset potential dilution from shares issued inconnection with the company’s benefit plans. In May 2003, the company announced a plan to purchase up to1,150,000 shares of our Class A common stock.  The plan does not have an expirationdate.  The table below presents specifiedinformation about the company’s stock repurchases during the fourth quarter offiscal year 2006 and the remaining number of shares that may be purchased underthe plan:
| **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,  2006, through April 30, 2006 |       | —                                               |       | $                                                | —     |                                                                                                                             | —     |                                                                                                                                    | 498,034    |   |
| May 1,  2006, through May 31, 2006     |       | 9,500                                                |       | 35.27                                            |       | 9,500                                                                                                                            |       | 488,534                                                                                                                                 |       |
| June 1,  2006, through June 30, 2006   |       | —                                               |       | —                                           |       | —                                                                                                                           |       | 488,534                                                                                                                                 |       |
| Total                                            |       | 9,500                                                |       | $                                                | 35.27      |                                                                                                                             | 9,500      |                                                                                                                                    |       |   |

 

In July 2006, the company announced a plan topurchase up to an additional 1,500,000 shares of our Class A common stockfor the purposes outlined above.  Theplan does not have an expiration date.

**Item 6.**                          SelectedConsolidated Financial Data.

Thetable on the following page sets forth selected consolidated financialdata of Watson Wyatt as of June 30, 2006 and for each of the years in thefive-year period ended June 30, 2006. The selected consolidated financial data as of June 30, 2006 and2005, and for each of the three years in the period ended June 30, 2006,were derived from the audited consolidated financial statements of Watson Wyattincluded in this Form 10-K.  Theselected consolidated financial data as of June 30, 2004, 2003 and 2002,and for each of the years ended June 30, 2003 and 2002, were derived fromaudited consolidated financial statements of Watson Wyatt not included in thisForm 10-K.  The consolidatedfinancial data should be read in conjunction with our Consolidated FinancialStatements and notes thereto.

Thebusiness combination with WWLLP was completed July 31, 2005 and as a result,our financial statements reflect the consolidation of the European operationsbeginning August 1, 2005.  Pro formainformation regarding the business combination is included in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inItem 7 of this Form 10-K.  Amountsare in thousands of U.S. Dollars except per share data.

27

----

 
| ** **                                                   | ** ** | **Year Ended June 30** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Statement of Operations Data:**                            |       |                                  |       |   |   |   |   |   |   |   |   |
| (amounts are in  thousands, except per share data)           |       |                                  |       |   |   |   |   |   |   |   |   |
| Revenue                                                      |       | $                                     | 1,271,811  |   | $ | 737,421 |   | $ | 702,005 |   | $ | 709,616 |   | $ | 710,480 |   |
| Costs of providing  services:                                |       |                                  |       |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                               |       | 699,049                               |       | 397,252 |   | 396,775 |   | 401,274 |   | 404,822 |   |
| Professional and subcontracted services                      |       | 84,165                                |       | 57,810 |   | 49,159 |   | 47,356 |   | 48,724 |   |
| Occupancy, communications and other                          |       | 164,140                               |       | 106,752 |   | 105,459 |   | 106,224 |   | 109,163 |   |
| General and administrative expenses                          |       | 147,122                               |       | 74,612 |   | 63,631 |   | 57,285 |   | 55,517 |   |
| Depreciation and amortization                                |       | 44,918                                |       | 20,210 |   | 18,511 |   | 19,621 |   | 20,049 |   |
|                                                         |       | 1,139,394                             |       | 656,636 |   | 633,535 |   | 631,760 |   | 638,275 |   |
| Income from  operations                                      |       | 132,417                               |       | 80,785 |   | 68,470 |   | 77,856 |   | 72,205 |   |
|                                                         |       |                                  |       |   |   |   |   |   |   |   |   |
| Income from  affiliates                                      |       | 1,135                                 |       | 7,146 |   | 7,109 |   | 5,787 |   | 2,866 |   |
| Interest income                                              |       | 4,325                                 |       | 2,833 |   | 1,636 |   | 1,793 |   | 1,940 |   |
| Interest expense                                             |       | (4,093                                | )          | (661 | ) | (893 | ) | (802 | ) | (705 | ) |
| Other  non-operating (loss) income                           |       | (2,081                                | )          | (7,404 | ) | 6,222 |   | 761 |   | 2,166 |   |
| Income from  continuing operations before income taxes       |       | 131,703                               |       | 82,699 |   | 82,544 |   | 85,395 |   | 78,472 |   |
| Provision for  income taxes                                  |       | 45,585                                |       | 31,303 |   | 32,605 |   | 35,015 |   | 31,388 |   |
| Income from  continuing operations                           |       | 86,118                                |       | 51,396 |   | 49,939 |   | 50,380 |   | 47,084 |   |
| Discontinued  operations (a)                            |       | 1,073                                 |       | 766 |   | 654 |   | 6,786 |   | — |   |
| Net income                                                   |       | $                                     | 87,191     |   | $ | 52,162 |   | $ | 50,593 |   | $ | 57,166 |   | $ | 47,084 |   |
| Earnings per  share, continuing operations, basic            |       | $                                     | 2.08       |   | $ | 1.58 |   | $ | 1.52 |   | $ | 1.52 |   | $ | 1.43 |   |
| Earnings per  share, continuing operations, diluted (b) |       | $                                     | 1.99       |   | $ | 1.56 |   | $ | 1.50 |   | $ | 1.51 |   | $ | 1.41 |   |
| Earnings per  share, discontinued operations, basic          |       | $                                     | 0.03       |   | $ | 0.02 |   | $ | 0.02 |   | $ | 0.21 |   | $ | — |   |
| Earnings per  share, discontinued operations, diluted        |       | $                                     | 0.02       |   | $ | 0.02 |   | $ | 0.02 |   | $ | 0.21 |   | $ | — |   |
| Earnings per  share, net income, basic                       |       | $                                     | 2.11       |   | $ | 1.60 |   | $ | 1.54 |   | $ | 1.73 |   | $ | 1.43 |   |
| Earnings per  share, net income, diluted (b)            |       | $                                     | 2.01       |   | $ | 1.58 |   | $ | 1.52 |   | $ | 1.72 |   | $ | 1.41 |   |
| Dividend  declared per share                                 |       | $                                     | 0.30       |   | $ | 0.30 |   | $ | 0.07 |   | $ | — |   | $ | — |   |
| Weighted average  shares of common stock, basic              |       | 41,393                                |       | 32,541 |   | 32,866 |   | 32,962 |   | 32,985 |   |
| Weighted average shares  of common stock, diluted            |       | 43,297                                |       | 32,845 |   | 33,207 |   | 33,287 |   | 33,421 |   |

 

28

----

 
| ** **                          | ** ** | **As of June 30** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2006**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Balance Sheet Data:**             |       |                             |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents          |       | $                                | 165,345    |   | $ | 168,076 |   | $ | 136,940 |   | $ | 115,674 |   | $ | 87,974 |   |
| Working capital                     |       | 197,312                          |       | 236,658 |   | 207,455 |   | 169,308 |   | 123,171 |   |
| Total assets                        |       | 1,240,359                        |       | 618,679 |   | 512,168 |   | 514,462 |   | 436,817 |   |
| Note payable                        |       | 30,000                           |       | — |   | — |   | — |   | — |   |
| Dividends  declared                 |       | 12,667                           |       | 9,756 |   | 2,441 |   | — |   | — |   |
| Stockholders’  equity (c) |       | 648,761                          |       | 234,203 |   | 245,184 |   | 151,737 |   | 159,221 |   |
| Shares outstanding                  |       | 42,386                           |       | 32,627 |   | 32,317 |   | 32,943 |   | 32,897 |   |
|                                     |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(a)             Infiscal year 2003, 2004, 2005 and 2006, we revised our estimates related to theremaining future obligations and costs associated with the discontinuation ofour benefits administration outsourcing business.  As a result, we reduced the amount of ourliability for losses from disposal by $11.4 million, less the associated incometax expense of $4.7 million, by $1.0 million, less the associated income taxexpense of $0.4 million, by $1.25 million, less the associated income taxexpense of $0.5 million, and by $1.75 million, less the associated income taxexpense of $0.7 million, respectively. In fiscal years 2003, 2004, 2005 and 2006, the company received subleaseincome of approximately $40,000, $106,000, $44,000 and $64,000 in excess oflease payments related to this business. These items resulted in a year-to-date income from discontinuedoperations of $11.5 million, $1.1 million, $1.3 million, and $1.8 million, lessthe associated income tax expense of $4.7 million, $0.4 million, $0.5 million,and $0.7 million, respectively.

(b)            Thediluted earnings per share calculation assumes that the 1,950,000 contingentshares related to the business combination have been issued and outstandingsince July 31, 2005.

(c)             Stockholders’equity includes the after-tax effect of the recording of a minimum pensionliability in fiscal year 2006, 2005 and 2004 of $6,711, $68,379 and $6,651respectively.

**Item 7.**                          Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

**Special Note 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: Note 6 -  Retirement Benefits; Note 11 — Goodwill andIntangible Assets; Note 14 — Commitments and Contingent Liabilities; theExecutive Overview; Critical Accounting Policies and Estimates; the discussionof our capital expenditures; Off-Balance Sheet Arrangements and ContractualObligations; Risk Management; and Part II, Item 1 “Legal Proceedings”.  You can identify these statements and otherforward-looking statements in this filing by words such as “may”, “will,”, “expect”,“anticipate”, “believe”, “estimate”, “plan”, “intend”, “continue”, or similarwords, expressions, or the negative of such terms or other comparableterminology. You should read these statements carefully because they containprojections of our future results of operations or financial condition, orstate other “forward-looking” information. A number of risks and uncertaintiesexist which could cause actual results to differ materially from the resultsreflected in these forward-looking statements. Such factors include but are not limited to:

·                  our ability to integrate the business ofWWLLP into our own business, processes and systems, and achieve the anticipatedresults;

·                  our continued ability to recruit and retainqualified associates;

·                  the success of our marketing, clientdevelopment and sales programs after the business combination;

·                  our ability to maintain client relationshipsand to attract new clients after the business combination;

·                  declines in demand for our services;

·                  outcomes of litigation;

·                  demographic changes and projections inworkforce;

·                  the ability of the company to obtainprofessional liability insurance;

29

----

·                  a significant decrease in the demand for theconsulting, actuarial and other 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;

·                  our ability to achieve cost reductions afterthe business combination;

·                  foreign currency exchange and interest ratefluctuations;

·                  exposure to WWLLP liabilities that have notbeen expressly assumed;

·                  general economic and business conditions thatadversely affect us or our clients after the business combination;

·                  the level of capital resources required forfuture acquisitions and business opportunities;

·                  regulatory developments abroad anddomestically that impact our business practice;

·                  legislative and technological developmentsthat may affect the demand for or costs of our services;

and other factors discussed under “Risk Factors” in Item 1 of this Form10-K.  These statements are based onassumptions that may not come true.  Allforward-looking disclosure is speculative by its nature.  The company undertakes no obligation or dutyto update any of the forward-looking information included in this report,whether as a result of new information, future events, changed expectations orotherwise.

**Executive Overview**

Watson Wyatt is a global consulting firm focusing onproviding human capital and financial consulting services.  We provide services in five principalpractice areas: Benefits, Technology and Administration Solutions, Human CapitalConsulting, Insurance and Financial Services, and Investment Consulting,operating from 30 countries throughout North America, Europe, Asia Pacific andLatin America.  During fiscal year 2006,Watson Wyatt and WWLLP consummated a business combination.  As a result, the company assumed 100% ownershipof WWLLP and WWHE effective July 31, 2005.

We design, develop and implement human resourcestrategies and programs through the following closely-interrelated practiceareas:

*BenefitsGroup —*The BenefitsGroup, accounting for 58 percent of our total fiscal year 2006 revenues, is thefoundation of our business.  Retirement,the core of our Benefits business, is less impacted by discretionary spendingreductions than our other segments, mainly due to the recurring nature ofclient relationships.  Our corporateclient retention rate within our target market has remained very high. Revenuefor our retirement practice is seasonal, with the third and fourth quarters ofeach fiscal year being the busier periods. Major revenue growth drivers in this practice include changes inregulations, particularly those affecting pension plans in the U.K., leveragefrom other practices, an improving economy, increased global demand andincreased market share.

*Technologyand Administration Solutions Group —*Our Technology and Administration Solutions Group, accounting for 11percent of our total fiscal year 2006 revenues, provides information technologyservices to our customers.

*HumanCapital Group —*Our**Human Capital Group, accounting for 9 percent of our totalfiscal year 2006 revenues, generally encompasses short-term projects and as aresult is most sensitive to economic conditions.

30

----

*Insurance and Financial ServicesGroup —*Our Insurance& Financial Services Group accounts for 8 percent of our total fiscal year2006 revenues. This business is characterized by ongoing relationships with ourclients who will typically use our skills on a number of different projects.

*InvestmentConsulting Group -*OurInvestment Consulting Group accounts for 6 percent of our total fiscal year2006 revenues.  This business, althoughrelationship based, can be impacted by volatility in investment returns,particularly as clients look to us for assistance in managing that volatility.

In the short term, our revenues are driven by manyfactors including the general state of the global economy and the resultinglevel of discretionary spending by our clients, the ability of our consultantsto attract new clients or cross-sell to existing clients, and the impact of newregulations in the legal and accounting fields that most recently increaseddemand for our executive compensation and benefits practices.

The human resources consulting industry, althoughhighly fragmented, is highly competitive and is comprised of major humancapital consulting firms, specialist firms, consulting arms of accounting firmsand information technology consulting firms. We believe 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 takeadvantage of an improvement in the overall economy.

In the long term, we believe that benefits spendingwill continue to be the largest component of U.S. corporate spending.  We believe that the aging workforce, theprojected shortfall in workers over the next decade and changing regulationswill translate into opportunities for us. We believe that the company’s financial results will depend in largepart upon how well we succeed in deepening our existing client relationshipsthrough thought leadership and focus on cross-practice solutions, activelypursuing new clients in our target markets, cross selling and strategicacquisitions.  We believe that thehighly- fragmented industry in which we operate represents tremendous growthopportunities for us, because we offer a unique combination of benefits andhuman capital consulting as well as strategic technology solutions.

**Financial Statement Overview**

Thebusiness combination was completed July 31, 2005 and as a result, our financialstatements reflect the consolidation of the European operations through WatsonWyatt Limited beginning August 1, 2005. Prior to July 31, 2005, or for one month of the first quarter, thecompany recorded its share of the results of WWLLP and WWHE using the equitymethod of accounting.  This income isreflected in the “Income from affiliates” line on our income statement.  Our share of the results of our affiliatedcaptive insurance company, PCIC, continues to be recorded using the equitymethod of accounting, and is also reflected in the “Income from affiliates”line.

We derive substantially all of our revenue from feesfor consulting services, which generally are billed at standard hourly rates oron a fixed-fee basis.  Clients aretypically invoiced on a monthly basis with revenue recognized as services areperformed. For the previous three fiscal years, revenue from U.S. consultingoperations has comprised approximately 80 percent of consolidated revenue. Forthe fiscal year 2006, U.S. operations comprised approximately 50 percent ofconsolidated revenue. Before and after the business combination, no singleclient accounted for more than four percent of our consolidated revenue for anyof the most recent three fiscal years.

31

----

In delivering consulting services, our principaldirect expenses relate to compensation of personnel. Salaries and employeebenefits are comprised of wages paid to associates, related taxes, benefitexpenses such as pension, medical and insurance costs and fiscal year endincentive bonuses.

Professional and subcontracted services representfees paid to external service providers for employment, marketing and otherservices. For the most recent three fiscal years, approximately 60 to 70percent of these professional and subcontracted services were directly incurredon behalf of our clients and were reimbursed by them, with such reimbursementsbeing included in revenue.

Occupancy, communications and other expensesrepresent expenses for rent, utilities, supplies and telephone to operateoffice locations as well as non-client-reimbursed travel by associates,publications and professional development.

General and administrative expenses include theoperational costs and professional fees paid by corporate management, generalcounsel, marketing, human resources, finance, research and technology support.

**Critical Accounting Policies and Estimates**

Thepreparation of consolidated 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 assumptionsare continually evaluated based on available information and experience. Becauseof the use of estimates inherent in the financial reporting process, actualresults could differ from those estimates. The areas that we believe arecritical accounting policies include revenue recognition, valuation of billedand unbilled receivables from clients, discretionary compensation, incometaxes, pension assumptions, Incurred But Not Reported claims, and goodwill andintangible assets. The critical accounting policies discussed below involvesmaking difficult, subjective or complex accounting estimates that could have amaterial effect on our financial condition and results from operations. Thesecritical accounting policies require us to make assumptions about matters thatare highly uncertain at the time of the estimate or assumption and differentestimates that we could have used or changes in the estimate that arereasonably likely to occur may have a material impact on our financialstatements and results of operations.

***Revenue Recognition***

Revenue includes fees primarily generated fromconsulting services provided in the areas of employee benefits, human capitalstrategies and related technology solutions. We recognize revenue from theseconsulting engagements when hours are worked, either on a time-and-materialsbasis or on a fixed-fee basis, depending on the terms and conditions defined atthe inception of an engagement with a client. The terms of our contracts withclients are fixed and determinable and can only be changed based on agreementof both parties. Individual consultants’ billing rates are principally based ona multiple of salary and compensation costs.

Revenue for fixed-fee arrangements, which spanmultiple months, is based upon the percentage of completion method.**The company typically has three types of fixed-feearrangements: annual recurring projects, projects of a short duration, andnon-recurring system projects. Annual recurring projects and the projects ofshort duration are typically straightforward and highly predictable in nature. Asa result, the project manager and financial staff are able to identify, as theproject status is reviewed and bills are prepared monthly, the occasions whencost overruns could lead to the recording of a loss accrual.

32

----

Our non-recurring system projects are typicallyfound in our Technology and Administration Solutions Group. They tend to bemore complex projects that are longer in duration and subject to more changesin scope as the project progresses than projects undertaken in other segments. Weevaluate, at least quarterly, and more often as needed, project managers’estimates to complete to assure that the projects’ current status is accountedfor properly. Our Technology and Administration Solutions Group contractsgenerally provide that if the client terminates a contract, the company isentitled to payment for services performed through termination.

Revenue recognition for fixed-fee engagements isaffected 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. The periodic engagement evaluationsrequire us to make judgments and estimates regarding the overall profitabilityand stage of project completion that, in turn, affect how we recognize revenue.The company recognizes a loss on an engagement when estimated revenue to bereceived for that engagement is less than the total estimated direct andindirect costs associated with the engagement. Losses are recognized in theperiod in which the loss becomes probable and the amount of the loss isreasonably estimable. The company has experienced certain costs in excess ofestimates from time to time. Management believes that it is rare, however, forthese excess costs to result in overall project losses.

Thecompany has developed various software programs and technologies that weprovide to clients in connection with consulting services. In most instances,such software is hosted and maintained by the company and ownership of thetechnology and rights to the related code remain with the company. Softwaredeveloped to be utilized in providing services to a client, but for which theclient does not have the contractual right to take possession, is capitalizedin accordance with the AICPA’s Statement of Position 98-1 “Accounting for theCosts of Computer Software Developed or Obtained for Internal Use.” Revenueassociated with the related contract, together with amortization of the relatedcapitalized software, is recognized over the service period. As a result we donot recognize revenue during the customization phase of an engagement.

Revenuerecognized in excess of billings is recorded as unbilled accounts receivable. Cashcollections and invoices generated in excess of revenue recognized are recordedas deferred revenue until the revenue recognition criteria are met. Clientreimbursable expenses, including those relating to travel, other out-of-pocketexpenses and any third-party costs, are included in revenue, and an equivalentamount of reimbursable expenses are included in professional and subcontractedservices as a cost of revenue.

***Valuation of Billed and Unbilled Receivables from Clients***

We maintain allowances for doubtful accounts toreflect estimated losses resulting from our clients’ failure to pay for ourservices after the services have been rendered, including allowances whencustomer disputes may exist. The related provision is generally recorded as areduction to revenue. Our allowance policy is based on the aging of our billedand unbilled client receivables and has been developed based on our write-offhistory. 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.

***Discretionary Compensation***

The company’s compensation program includes adiscretionary annual bonus that is determined by management and paid once perfiscal year in the form of cash and/or deferred stock units after the company’sannual operating results are finalized.

33

----

An estimated annual bonus amount is initiallydeveloped at the beginning of each fiscal year in conjunction with ourbudgeting process. Quarterly, estimated annual operating performance isreviewed by the company and the discretionary annual bonus amount is thenadjusted, if necessary, by management to reflect changes in the forecast ofpre-bonus profitability for the year. After determining the estimated annualbonus amount, the bonus is then allocated to remaining quarterly reportingperiods as a constant percentage of estimated pre-bonus profitability. In thosequarters where the estimated annual bonus level changes, the remainingestimated annual bonus is accrued over the remaining quarters as a constantpercentage of estimated future pre-bonus profitability. Annual bonus levels mayvary from current expectations as a result of changes in the company’s forecastof pre-bonus profitability and competitive employment market conditions.

As a result of a $5.6 million pre-tax non-operatinggain recorded in the first quarter of fiscal year 2004 related to PCIC, ourcaptive insurance company, the company recorded a $5.6 million supplementalbonus accrual in the first quarter that is incremental to the company’s fiscalyear end bonus. This supplemental bonus amount, which was paid out inSeptember 2004 with the regular bonus cycle, is included in salaries andemployee benefits. Management does not expect this gain or charge to recur.

***Income Taxes***

Determining the consolidated provision forincome tax expense, deferred tax assets and liabilities and the relatedvaluation allowance involves significant judgment. As a global company, we arerequired to calculate and provide for estimated income tax liabilities for eachof the tax jurisdictions in which we operate. This process involves estimatingcurrent tax obligations and exposures in each jurisdiction as well as makingsignificant judgments regarding the future recoverability of deferred taxassets.

We apply an estimated annual effective taxrate to our quarterly operating results to determine the provision for incometax expenses. In the event there is a significant unusual or infrequent itemrecognized in our quarterly operating results, the tax attributable to thatitem is recorded in the interim period in which it occurs. Our effective taxrate for fiscal year 2006 was 34.6 percent compared with 37.9 percent forfiscal year 2005.

The company does not provide deferred taxeson cumulative earnings of foreign subsidiaries that have been reinvestedindefinitely as asserted under APB 23. Due to the availability of foreign taxcredits, it is not practicable to estimate the company’s income tax liabilitythat might be payable if such earnings were not reinvested indefinitely.Deferred taxes are provided for earnings of foreign subsidiaries which thecompany plans to remit. If future events, including material changes inestimates of cash, working capital and long-term investment requirements,necessitate that these earnings be distributed, an additional provision forwithholding taxes may apply, which could materially affect our future effectivetax rate.

Tax costs can involve complex issues and mayrequire an extended period to resolve. Changes in the geographic distributionor estimated level of annual pre-tax income, limitations on the use of thecompany’s foreign subsidiary losses, changes in tax laws and changes resultingfrom tax audits can all affect the overall effective income tax rate which, inturn, impacts the overall level of income tax expense and net income.

34

----

We evaluate reserves each quarter and adjustthe tax reserves and the related interest in light of changing facts andcircumstances regarding the probability of realizing tax benefits, such as theprogress of a tax audit or the expiration of a statute of limitations. We believethe estimates and assumptions used to support our evaluation of tax benefitrealization are reasonable. However, final determinations of prior-year taxliabilities could be materially different than estimates reflected in assetsand liabilities and historical income tax provisions. The outcome of thesefinal determinations could have a material effect on our income tax provisionor net income in the period in which that determination is made. The companybelieves its tax positions comply with applicable tax law and that it hasadequately provided for any known tax contingencies.

***Pension Assumptions***

We sponsor both qualified and non-qualified,non-contributory defined benefit pension plans covering substantially all ofour associates. Under our plans in North America and Hong Kong, benefits arebased on the number of years of service and the associates’ compensation duringthe five highest paid consecutive years of service. The non-qualified plan,which exists only in North America, provides for pension benefits that would becovered under the qualified plan but are limited by the Internal Revenue Code. Thenon-qualified plan has no assets and therefore is an unfunded arrangement. Thebenefit liability is reflected on the balance sheet. The measurement date forthe plans is June 30.

As a result of the business combinationdescribed in Note 2, we have included the defined benefit pension plandisclosures for our combined U.K. operations. The disclosures for the newlyacquired U.K. plan, along with our historical U.K. plan, are shown separatelybecause the amounts are significant relative to all plans and the assumptionsused in the plan are significantly different than those used in all otherplans. Under our newly acquired plan in the U.K., benefits are based on thenumber of years of service and the associates’ compensation during the threeyears before leaving the plan. The measurement date for the plan is June 30.

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

*North America and Hong Kong*

The following assumptions were used at the end of the past three fiscalyears in the valuation of our North American plans, which comprises themajority of the North America and Hong Kong defined benefit pension plans:

|                                              | ** ** | **Year Ended June 30** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Discount rate                                |       | 6.25%                                 |       | 5.25% |   | 6.25% |   |
| Expected  long-term rate of return on assets |       | 8.75%                                 |       | 9.00% |   | 9.00% |   |
| Rate of increase in  compensation levels     |       | 3.84%                                 |       | 3.34% |   | 3.34% |   |

 

35

----

The 6.25 percent discount rate assumption used at the end of fiscalyear 2006 represents a 100 basis point increase from the 5.25 percent discountrate used at the end of fiscal year 2005 and represents the same discount rateused at the end of fiscal year 2004. The company’s 2006 discount rateassumption was determined by matching future pension benefit payments withexpected future AA bond yields for the same periods.

The expected long-term rate of return onassets assumption decreased to 8.75 percent per annum representing a 25 basispoint decrease from the 9 percent rate used in fiscal years 2005 and 2004. Selectionof the return assumption at 8.75 percent per annum was supported by an analysisperformed by the company of the weighted average yield expected to be achievedwith the anticipated makeup of investments. The investment makeup is heavilyweighted towards equities. The actual return on assets for fiscal year 2006 was9.4 percent, compared to a return of 10.0 percent for fiscal year 2005.

The following information illustrates thesensitivity to a change in certain assumptions for the U.S. pension plans:

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

 

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

*United Kingdom*

The following assumptions were used at fiscal year end 2006, July 31,2005, or the date of the business combination and the valuation of our U.K.plan, and April 30, 2005, the former WWLLP fiscal year end:

|                                              | ** ** | **June 30,  2006** | ** ** | **July 31,  2005** | ** ** | **April 30,  2005** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-------------------------|------------|--------------------------|------------|
| Discount rate                                |       | 5.10%                   |       | 5.00%                   |       | 5.30%                    |       |
| Expected  long-term rate of return on assets |       | 5.69%                   |       | 5.63%                   |       | 5.76%                    |       |
| Rate of increase in  compensation levels     |       | 4.75%                   |       | 4.75%                   |       | 4.75%                    |       |

 

The 5.10 percent discount rate assumption used at the end of fiscalyear 2006 represents a 10 basis point increase over the rate used at July 31,2005 and represents a 20 basis point reduction from the discount rate at April30, 2005. The discount rate is set in relation to yields on AA Europeancorporate bonds at the measurement date and this reduction reflects thereduction in yields between these two dates.

36

----

The expected long-term rateof return on assets assumption increased 6 basis points to 5.69 percent perannum for fiscal year 2006. The rate of return was lowered from April 30, 2005to July 31, 2005 and was supported by an analysis performed by the company ofthe weighted average return expected to be achieved with the anticipated makeupof investments which is heavily weighted towards bonds. The actual return onassets through fiscal year 2006 was 7.8 percent.

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

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

 

The differences in the discount rates andcompensation levels for the plans above can be attributed to the differinginterest rate environments associated with the currencies and economies towhich the plans are subject. The differences in the expected return on assetsare primarily driven by the respective asset allocation in each plan, coupledwith the return expectations for assets in the respective currencies. The NorthAmerican plans are approximately 74 percent invested in equities, which onaverage provide a higher return than bonds, which is the favored investment forthe U.K. plans.

***Incurred But Not Reported Claims***

The companyuses actuarial assumptions to estimate and record a liability for incurred butnot reported (IBNR) professional liability claims and engaged an externalactuarial firm to assist in the calculation of these estimates. Our estimatedIBNR liability is based on long-term trends and averages, and considers anumber of factors, including changes in claim reporting patterns, claimsettlement patterns, judicial decisions, and legislation and economicdecisions, but excludes the effect of claims data for large cases due to theinsufficiency of actual experience with such cases. Management does notcurrently expect significant fluctuations in the IBNR liability, based on thecompany’s historical claims experience. However, our estimated IBNR liabilitywill fluctuate if claims experience changes over time.

37

----

***Goodwill and Intangible Assets***

Inapplying the purchase method of accounting for business combinations, amountsassigned to identifiable assets and liabilities acquired have been based onestimated fair values as of the date of the acquisitions, with the remainderrecorded as goodwill. Estimates of fair value have been based primarily uponfuture cash flow projections discounted to present value using a risk adjusteddiscount rate. We evaluate our goodwill for impairment annually and wheneverindicators of impairment exist. The evaluation is based upon a comparison ofthe estimated fair value of the reporting unit to which the goodwill has beenassigned to the sum of the carrying value of the net assets for that reportingunit. The fair values used in this evaluation are estimated based upon amultiple of revenue for the reporting unit. This revenue multiple is based onour experience and knowledge. Intangible assets are initially valued at fair marketvalue using generally accepted valuation methods appropriate for the type ofintangible asset. Intangible assets with definite lives are amortized overtheir estimated useful lives and are reviewed for impairment if indicators ofimpairment arise. The evaluation of impairment would be based upon a comparisonof the carrying amount of the intangible asset to the estimated futureundiscounted net cash flows expected to be generated by the asset. If estimatedfuture undiscounted net cash flows are less than the carrying amount of theasset, the asset would be considered impaired. The impairment expense would be determinedby comparing the estimated fair value of the intangible asset to its carryingvalue, with any shortfall from fair value recognized as an expense in thecurrent period.

38

----

**Resultsof Operations**

The followingtable sets forth Consolidated Statement of Operations data as a percentage ofrevenue for the periods indicated:
| ** **                                             | ** ** | **Year ended June 30** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                             | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                   |       |                                  |       |   |   |   |   |
| Revenue                                                |       | 100.0                                 | %          | 100.0 | % | 100.0 | % |
|                                                   |       |                                  |       |   |   |   |   |
| Costs of  providing services:                          |       |                                  |       |   |   |   |   |
| Salaries and employee benefits                         |       | 55.0                                  |       | 53.9 |   | 56.5 |   |
| Professional and subcontracted services                |       | 6.6                                   |       | 7.8 |   | 7.0 |   |
| Occupancy, communications and other                    |       | 12.9                                  |       | 14.5 |   | 15.0 |   |
| General and administrative expenses                    |       | 11.6                                  |       | 10.1 |   | 9.1 |   |
| Depreciation and amortization                          |       | 3.5                                   |       | 2.7 |   | 2.6 |   |
|                                                   |       | 89.6                                  |       | 89.0 |   | 90.2 |   |
|                                                   |       |                                  |       |   |   |   |   |
| Income from  operations                                |       | 10.4                                  |       | 11.0 |   | 9.8 |   |
|                                                   |       |                                  |       |   |   |   |   |
| Income from  affiliates                                |       | 0.1                                   |       | 1.0 |   | 1.0 |   |
| Interest income                                        |       | 0.3                                   |       | 0.2 |   | 0.2 |   |
| Interest expense                                       |       | (0.3                                  | )          | (0.0 | ) | (0.1 | ) |
| Other  non-operating (loss)/income                     |       | (0.2                                  | )          | (1.0 | ) | 0.9 |   |
|                                                   |       |                                  |       |   |   |   |   |
| Income from  continuing operations before income taxes |       | 10.3                                  |       | 11.2 |   | 11.8 |   |
|                                                   |       |                                  |       |   |   |   |   |
| Provision for  income taxes                            |       | 3.6                                   |       | 4.2 |   | 4.7 |   |
|                                                   |       |                                  |       |   |   |   |   |
| Income from continuing  operations                     |       | 6.7                                   | %          | 7.0 | % | 7.1 | % |

 

**FiscalYear Ended June 30, 2006, Compared to Fiscal Year Ended June 30, 2005**

***Revenue***

Revenuesfor fiscal year 2006 were $1.27 billion, an increase of $534 million, or 72percent, from $737 million in fiscal year 2005. Of the increase, $481 millionis due to the business combination. The remaining increase of $53 millionrelates to the historical company.

Theincreases in the historical company segment revenue for fiscal year 2006 ascompared to fiscal year 2005 are as follows.

·                  BenefitsGroup increased revenues $35.6 million, or 8 percent, over fiscal year 2005 dueto increased demand from existing clients around plan design and administrationas well as revenues from new clients.

39

----

·                  Technologyand Administration Solutions Group increased revenues $7.8 million, or 12percent, over fiscal year 2005, largely due to an increase in the number ofprojects that went into service during the fiscal year. The company beginsrecognizing revenue after projects go into service. No revenues are recognizedduring project implementation. At June 30, 2006, the Company had 56 projects inservice and 53 projects in implementation. At June 30, 2005, beforeconsummation of the business combination, the company had 10 projects inservice and 29 projects in implementation.

·                  HumanCapital Group increased revenues $17.5 million over fiscal year 2005 primarilydue to the $13.6 million reclassification of Watson Wyatt Data Services fromOther into this segment, as well as continuing demand for executivecompensation consulting.

·                  InvestmentConsulting Group increased revenues $3.0 million, or 16 percent, over fiscalyear 2005 due to an increase in pension funding and asset performanceconsulting.

·                  International,consisting of Asia Pacific and Latin America, increased revenues $3.7 million,or 4 percent, over fiscal year 2005. Revenue growth excluding the New Zealanddivestiture in the first quarter of fiscal year 2006 was 9 percent primarilydue to strong demand for our services in Australia, Korea, Mexico and Brazil.

***Salaries and Employee Benefits***

Salariesand employee benefit expenses for fiscal year 2006 were $699.0 million, anincrease of $301.7 million from $397.3 million in fiscal year 2005, andincreased as a percentage of revenue to 55 percent from 53.9 percent. Theincrease was mainly due to the additional salary and benefit expenses of $271.5million related to the business combination. The increase in the historicalcompany was due to higher salaries of $23.5 million, partially due to a $1.4 millionLong Term Incentive Plan accrual as well as an increase in associates by 4.5percent. Also included is higher accrual for discretionary compensation of $7.3million, higher pension expense of $9.0 million, and higher benefits expense of$6.3 million, partially offset by the capitalization of time spent customizingin-house administration systems of $15.9 million, in accordance with AICPA’sStatement of Position 98-1, “Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use”.

***Professional and SubcontractedServices***

Professionaland subcontracted services were $84.2 million for fiscal year 2006, an increaseof $26.4 million, or 45.6 percent, from $57.8 million in the prior period, anddecreased as a percentage of revenue to 6.6 percent from 7.8 percent. Theincrease was mainly due to the additional professional and subcontractedservices expenses of $21.0 million related to the business combination. Theincrease in the historical company was attributable to higher reimbursableexpenses incurred on behalf of clients as well as higher contracting costs.

40

----

***Occupancy, Communications andOther***

Occupancy,communications and other expenses were $164.1 million for fiscal year 2006, anincrease of $57.3 million or 53.7 percent from $106.8 million during fiscalyear 2005, and decreased as a percentage of revenue to 12.9 percent from 14.5percent.  The increase was mainly due tothe additional occupancy, communications, and other expenses of $47.0 millionrelated to the business combination. The increase in the historical company wasmainly due to increased travel expense of $2.6 million, higher dues andentertainment of $1.3 million, higher general office of $3.7 million,  and miscellaneous expenses of $6.2 million,partially offset by a reduction in rent of $3.5 million which is partially dueto lease terminations in both periods and lease restructuring during fiscalyear 2006.

***General and AdministrativeExpenses***

Generaland administrative expenses were $147.1 million for fiscal year 2006, anincrease of $72.5 million or 97.2 percent from $74.6 million during fiscal year2005, and increased as a percentage of revenue to 11.6 percent from 10.1percent.  The increase was mainly due tothe additional general and administrative expenses of $69.2 million related tothe business combination.  The increasein the historical company was mainly due to higher travel costs of $0.5million, higher insurance premiums of $1.1 million, higher salaries andbenefits expense of $3.6, partially offset by a decrease in general officeexpense of $0.9 million as well as miscellaneous decreases of $0.9 million.

***Depreciation and Amortization***

Depreciationand amortization expense was $44.9 million for fiscal year 2006, an increase of$24.7 million or 122.3 percent from $20.2 million during fiscal year 2005, andincreased as a percentage of revenue to 3.5 percent from 2.7 percent.  The increase was mainly due to the additionaldepreciation and amortization expense of $15.3 million related to the businesscombination. The increase in the historical company was due to depreciation onmajor software placed in service during fiscal year 2006 to support ourBenefits and Technology and Administration Solutions Group.

***Income From Affiliates***

Incomefrom affiliates was $1.1 million for fiscal year 2006 compared to $7.1 millionfor fiscal year 2005.  The fiscal year2005 income reflects our share of income from WWLLP and WWHE, which wereconsidered to be affiliates of the company for the entire fiscal year.  The fiscal year 2006 amount reflects ourshare of income from these affiliates only for the first month of fiscal year2006, after which time the business combination was consummated.

***Interest Income***

Interestincome was $4.3 million for fiscal year 2006, an increase of $1.5 million from$2.8 million during fiscal year 2005. The increase was due to higher interest earned on our investments as aresult of higher interest rates.

***Interest Expense***

Interestexpense was $4.1 million for fiscal year 2006, an increase of $3.4 million from$0.7 million during fiscal year 2005. The increase was due to debt incurred as a result of the businesscombination.

41

----

***Other Non-Operating (Loss) Income***

During fiscal year 2006, the company recorded a $3.6 million lossassociated with a foreign exchange forward contract entered into in conjunctionwith the business combination, partially offset by a $1.4 million gainrecognized by the company on the sale of its New Zealand operations.  During fiscal year 2005, the company recordeda $4.8 million loss associated with a foreign exchange forward contract enteredinto in conjunction with the business combination, recognized a settlement costof $2.2 million related to a claim by aformer joint venture partner, and spent $0.4 million to externaladvisors for strategic consulting. Non-operating income for fiscal year 2004 includes a $5.6 million gainthe company recorded in the first quarter of fiscal year 2004 related toPCIC.  See Note 18 of the Notes to theConsolidated Financial Statements for more information about this non-operatinggain.  During fiscal year 2004, thecompany 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 thepurchaser and upon their retention by the purchaser.

***Provision for Income Taxes***

Provisionfor income taxes was $45.6 million forfiscal year 2006, compared to $31.3 million for the prior period.  Our effective tax rate was 34.6 percent forfiscal year 2006, compared to 37.9 percent for fiscal year 2005.  The change in rate was principally due todecreases in tax reserves and the distribution of geographic income.

***Income From Continuing Operations***

Incomefrom continuing operations was $86.1 million, an increase of 68 percent from$51.4 million during fiscal year 2005. As a percentage of revenue, income from continuing operations for fiscalyear 2006 decreased to 6.7 percent from 7.0 percent.

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

Dilutedearnings per share, income from continuing operations was $1.99 for fiscal year2006, compared to $1.56 for fiscal year 2005. The diluted earnings per sharecalculation assumes that the 1,950,000 contingent shares related to thebusiness combination have been issued and outstanding since July 31, 2005.

***Discontinued Operations***

During1998, the company exited from its benefits administration outsourcing business,Wellspring Resources, LLC (“Wellspring”). Discontinued operations for fiscal years 2006 and 2005 reflect thereduction of the company’s accrual for the estimated remaining futureobligations and costs related to the exit from Wellspring by $1.75 million and$1.25 million, respectively, less the associated income tax expenses.  Also, during fiscal year 2006 and 2005, thecompany received sublease income of approximately $64,000 and $44,000,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.

42

----

**FiscalYear Ended June 30, 2005, Compared to Fiscal Year Ended June 30, 2004**

***Revenue***

Revenuesfor fiscal year 2005 were $737 million, an increase of $35 million, or 5percent, from $702 million in fiscal 2004. The variations in segment revenue for fiscal 2005 as compared to fiscalyear 2004 are as follows.

·                  Benefitsincreased revenues $15.9 million, or 4 percent, over fiscal year 2004 due tonew client wins in the retirement and healthcare consulting practices, as wellas an increase in revenues from existing clients.

·                  Technologyand Administration Solutions decreased revenues $10.8 million, or 14 percent,over fiscal year 2004, largely due to the deferral of $13.7 million ofconsultant time spent customizing administration systems for clients.  Overall consulting activity increased infiscal year 2005 as compared to fiscal year 2004.  At June 30, 2005, the Company had 10 projectsin service and 29 projects in implementation. At June 30, 2004, the Company had 8 projects in implementation.

·                  HumanCapital Group increased revenues $11.6 million, or 26 percent, over fiscal year2004 primarily due to increased demand for executive compensation consulting,strategic rewards consulting, and government consulting projects.

·                  InvestmentConsulting increased revenues $1.5 million, or 9 percent, over fiscal year 2004due to an increase in pension funding and asset performance consulting.

·                  International,consisting of Asia Pacific and Latin America, increased revenues $7.4 million,or 9 percent, over fiscal year 2004. Revenue growth after adjusting for the impact of the weakening U.S.dollar was 5 percent primarily due to increased demand for our services inChina, the Philippines, Taiwan, Mexico and Brazil.

***Salaries and Employee Benefits***

Salariesand employee benefit expenses for fiscal year 2005 were $397.3 million, anincrease of $0.5 million from $396.8 million in fiscal year 2004, and decreasedas a percentage of revenue to 53.9 percent from 56.5 percent.  Salaries and employee benefit expenses forfiscal year 2004 included severance charges of $3.2 million related to jobreductions in North America and the $5.6 million supplemental bonus related toPCIC.  Exclusive of these charges,salaries and employee benefit expenses increased $9.3 million, or 2.4%.  The increase, exclusive of these charges, wasmainly due to a higher accrual for discretionary compensation of $13.6 million,higher salaries of $6.8 million, higher profit sharing expenses of $3.1million, which reflects the re-instatement of the company’s 401(k) match, andhigher benefits expense of $3.1 million, partially offset by the capitalizationof time spent customizing in-house administration systems of $10.0 million, inaccordance with AICPA’s Statement of Position 98-1, “Accounting for the Costsof Computer Software Developed or Obtained for Internal Use”, and lower pensionand post-retirement costs of $7.4 million.

***Professional and SubcontractedServices***

Professionaland subcontracted services were $57.8 million for fiscal year 2005, an increaseof 17 percent from $49.2 million in the prior period, and increased as apercentage of revenue to 7.8 percent from 7.0 percent.  The increase is attributable to higherreimbursable expenses incurred on behalf of clients.

43

----

***Occupancy, Communications andOther***

Occupancy,communications and other expenses were $106.8 million for fiscal year 2005, anincrease of 1 percent from $105.5 million during fiscal year 2004, anddecreased as a percentage of revenue to 14.5 percent from 15.0 percent.  The increase in expenses is mainly due tomiscellaneous expenses, including travel, promotional expenses, officesupplies, repairs and maintenance and dues and entertainment, partially offsetby a reduction in rent and utilities, which is partially due to a leasetermination during fiscal year 2004.

***General and AdministrativeExpenses***

Generaland administrative expenses were $74.6 million for fiscal year 2005, anincrease of 17 percent from $63.6 million during fiscal year 2004, andincreased as a percentage of revenue to 10.1 percent from 9.1 percent.  The increase is mainly due to higherinsurance costs of $6.1 million, higher expenses of $1.3 million associatedwith compliance with the Sarbanes-Oxley Act of 2002 and related SEC rules, andincreased legal expenses of $2.0 million, primarily related to work associatedwith prior government investigations initiated and concluded during fiscal year2005.

***Depreciation and Amortization***

Depreciationand amortization expense was $20.2 million for fiscal year 2005, an increase of9 percent from $18.5 million during fiscal year 2004, and increased as apercentage of revenue to 2.7 percent from 2.6 percent.  The increase was due to depreciation on majorsoftware placed in service in March 2005 to support our Benefits segment.

***Income From Affiliates***

Incomefrom affiliates remained at $7.1 million for fiscal year 2005 compared tofiscal year 2004.  During fiscal year2005, our share of operating results of Watson Wyatt LLP increased $1.0 million,our share of operating results of WWHE increased $0.4 million, and our equityincome in PCIC decreased $1.5 million.

***Interest Income, Net***

Interestincome, net was $2.2 million for fiscal year 2005, an increase of $1.5 millionfrom $0.7 million during fiscal year 2004. The increase was due to higher interest earned on our investments as aresult of higher interest rates and lower expenses due to the reduced size ofthe credit agreement in existence during fiscal year 2005.

44

----

***Other Non-Operating (Loss) Income***

During fiscal year 2005, the company recorded a $4.8 million lossassociated with a foreign exchange forward contract entered into in conjunctionwith the acquisition of WWLLP (see Note 2 of the Notes to the ConsolidatedFinancial Statements), recognized a settlement cost of $2.2 million related toa claim by a former joint venturepartner, and spent $0.4 million to external advisors for strategicconsulting.  Non-operating income forfiscal year 2004 includes a $5.6 million gain the company recorded in the firstquarter of fiscal year 2004 related to PCIC. See Note 18 of the Notes to the Consolidated Financial Statements formore information about this non-operating gain. During fiscal year 2004, the company also received cash payments of $0.6million in connection with the fiscal year 2002 sale of our U.S.-based publicretirement business to GRS.  All paymentsreceived in connection with this sale were contingent upon the successfultransition of certain clients to the purchaser and upon their retention by thepurchaser.

***Provision for Income Taxes***

Provisionfor income taxes was $31.3 million forfiscal year 2005, compared to $32.6 million for the prior period.  Our effective tax rate was 37.9 percent forfiscal year 2005, compared to 39.5 percent for fiscal year 2004.  The change in rate was principally due to therecognition of US foreign tax credits and the favorable mix of geographicincome.

***Income From Continuing Operations***

Incomefrom continuing operations was $51.4 million, an increase of 3 percent from$49.9 million during fiscal year 2004. As a percentage of revenue, income from continuing operations decreasedto 7.0 percent from 7.1 percent.

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

Dilutedearnings per share, income from continuing operations was $1.56 for fiscal year2005, compared to $1.50 for fiscal year 2004.

***Discontinued Operations***

Discontinuedoperations for fiscal years 2005 and 2004 reflect the reduction of the company’saccrual for the estimated remaining future obligations and costs related to theexit from Wellspring by $1.25 million and $1.0 million, respectively, less theassociated income tax expenses.  Also,during fiscal year 2005 and 2004, the company received sublease income ofapproximately $44,000 and $106,000, respectively, in excess of lease paymentsrelated to Wellspring.  See Note 16 ofthe Notes to the Consolidated Financial Statements for more information relatedto Wellspring.

45

----

**Pro Forma Analysis**

Fora more meaningful comparison of financial results, the following table presentsthe company’s unaudited pro forma results for the the year ended June 30, 2006and 2005 as if the combination and consolidation had occurred at the beginningof each period.  Results for the fiscalyear 2006 reflect actual results from August 2005 forward in addition to proforma results for July 2005.  The dilutedearnings per share calculation assumes that the 1,950,000 contingent sharesrelated to the business combination had been issued at the beginning of eachperiod.

Inour opinion, information for the pro forma results for the fiscal years endedJune 30, 2006 and 2005 contain all adjustments necessary to fairly present thisinformation. Operating results for any period are not necessarily indicative ofresults for any future periods. The unaudited pro forma combined incomestatement is presented for illustrative purposes only and is not indicative ofthe results of operations that might have occurred had the combination actuallytaken place as of the dates specified, or that may be expected to occur in thefuture.

46

----

 

**Pro-Forma Combined Statements ofOperations**

(in thousands, except per share data)
| ** **                                                  | ** ** | **Year Ended June 30,** | ** ** | **Percent of Revenue** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------|------------|
| ** **                                                  | ** ** | ** **                             | ** ** | ** **                       | ** ** | **%** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | **2006**                               | ** ** | **2005**                         | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                        | ** ** | ** **                       | ** ** | **(Unaudited)** | ** ** |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Revenue                                                     |       | $                                      | 1,308,730  |                             | $          | 1,206,674 |   | 8.5 |   | 100 | % | 100 | % |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Costs of providing  services:                               |       |                                   |       |                             |       |   |   |   |   |   |   |
| Salaries and employee benefits                              |       | 723,089                                |       | 677,456                          |       | 6.7 |   | 55.3 |   | 56.1 |   |
| Professional and subcontracted services                     |       | 85,356                                 |       | 75,656                           |       | 12.8 |   | 6.5 |   | 6.3 |   |
| Occupancy, communications and other                         |       | 167,331                                |       | 157,096                          |       | 6.5 |   | 12.8 |   | 13.0 |   |
| General and administrative expenses                         |       | 153,720                                |       | 148,678                          |       | 3.4 |   | 11.8 |   | 12.3 |   |
| Depreciation and amortization                               |       | 46,343                                 |       | 38,653                           |       | 19.9 |   | 3.5 |   | 3.2 |   |
|                                                        |       | 1,175,839                              |       | 1,097,539                        |       | 7.1 |   | 89.9 |   | 90.9 |   |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Income from  operations                                     |       | 132,891                                |       | 109,135                          |       | 21.8 |   | 10.1 |   | 9.1 |   |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Income from  affiliates                                     |       | 647                                    |       | 185                              |       | 249.7 |   | 0.05 |   | 0.02 |   |
| Interest  (expense)/income, net                             |       | (181                                   | )          | (1,026                           | )          | (82.4 | ) | (0.01 | ) | (0.1 | ) |
| Other  non-operating income (loss)                          |       | 1,521                                  |       | (2,638                           | )          | (157.7 | ) | 0.12 |   | (0.22 | ) |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Income from continuing  operations before income taxes |       | 134,878                                |       | 105,656                          |       | 27.7 |   | 10.3 |   | 8.8 |   |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Provision for  income taxes                                 |       | 46,881                                 |       | 40,044                           |       | 17.1 |   | 3.6 |   | 3.3 |   |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Income from  continuing operations                          |       | $                                      | 87,997     |                             | $          | 65,612 |   | 34.1 |   | 6.7 |   | 5.5 |   |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Basic earnings per  share:                                  |       | $                                      | 2.13       |                             | $          | 1.58 |   |   |   |   |   |   |   |
| Diluted earnings per  share:                                |       | $                                      | 2.03       |                             | $          | 1.50 |   |   |   |   |   |   |   |
|                                                        |       |                                   |       |                             |       |   |   |   |   |   |   |
| Weighted average  shares of common stock, basic (000)  |       | 41,393                                 |       | 41,632                           |       |   |   |   |   |   |   |
| Weighted average  shares of common stock, diluted (000)     |       | 43,297                                 |       | 43,723                           |       |   |   |   |   |   |   |

 

47

----

**Pro Forma Fiscal Year Ended June 30, 2006 Compared to Fiscal Year EndedJune 30, 2005**

*** Revenue***

Proforma revenues for fiscal year 2006 were $1.31 billion, an increase of $102million, or 8 percent, from $1.21 billion in pro forma revenues for fiscal year2005.

·                  Benefitsincreased revenues $50.2 million, or 8 percent, over fiscal year 2005,primarily due to the impact of regulatory changes in the U.K.  Revenues also increased from new client winsthat occurred in the prior year as well as increasing demand for plan designwork.

·                  Technologyand Administration Solutions increased revenues $11.4 million, or 10 percent,over fiscal year 2005, largely due to an increase in the number of U.S.technology projects that went into service during the fiscal year and due tocontinued growth in the European administration operations.  In accordance with EITF 00-3, “Application ofAICPA Statement of Position 97-2 to Arrangements that Include the Right to UseSoftware Stored on Another Entity’s Hardware” (EITF 00-3), the company beginsrecognizing revenue after U.S. technology projects go into service.  No revenues are recognized during projectimplementation.  At June 30, 2006, thecompany had 56 U.S. technology projects in service and 53 inimplementation.  At June 30, 2005, thecompany had 10 U.S. technology projects in service and 29 in implementation.

·                  HumanCapital Group increased revenues $19.6 million, or 22 percent, over fiscal year2005 primarily due to the $13.6 million reclassification of Watson Wyatt DataServices from Other into this segment, as well as continuing demand forexecutive compensation consulting. Excluding the reclassification of WWDS, revenue grew 7 percent.

·                  Insuranceand Financial Services increased revenues $14.2 million, or 18 percent, overfiscal year 2005 due to continuing work around legislative changes andexpansion of our operations in Amsterdam.

·                  InvestmentConsulting increased revenues $8.2 million, or 12 percent, over fiscal year2005 due to an increase in demand for investment strategy and fund managerselection services.

·                  International,consisting of Asia Pacific and Latin America, increased revenues $3.7 million,or 4 percent, over fiscal year 2005. Revenue growth excluding the New Zealand divestiture in the firstquarter of fiscal year 2006 was 7 percent primarily due to strong demand forour services in Australia, Korea, Mexico and Brazil.

***Salaries and Employee Benefits.***

Salariesand employee benefit expenses for fiscal year 2006 were $723.1 million,compared to $677.5 million for fiscal year 2005, an increase of $45.6 millionor 6.7 percent. The increase was mainly due to higher salaries and benefits of$37.2 million, a higher accrual for discretionary compensation and otherbenefits of $18.4 million, partially offset by the capitalization of time spentcustomizing in-house administration systems of $15.9 million, in accordancewith AICPA’s Statement of Position 98-1, “Accounting for the Costs of ComputerSoftware Developed or Obtained for Internal Use.”  As a percentage of revenue, salaries andemployee benefits decreased to 55.3 percent from 56.1 percent.

48

----

***Professional and SubcontractedServices.***

Professionaland subcontracted services used in consulting operations for fiscal year 2006were $85.4 million, compared to $75.7 million for fiscal year 2005, an increaseof $9.7 million or 12.8 percent. As a percentage of revenue, professional andsubcontracted services increased to 6.5 percent from 6.3 percent.  For both periods the increase is principallyattributable to higher reimbursable expenses incurred on behalf of clients, aswell as increased recruiting fees and temporary staff.

***Occupancy, Communications andOther.***

Occupancy,communications and other expenses for fiscal year 2006 were $167.3 millioncompared to $157.1 million for fiscal year 2005, an increase of $10.2 millionor 6.5 percent.  The increase isprincipally attributable to miscellaneous expenses such as travel, repairs andmaintenance, general office, and dues partially offset by a decrease in rentand utilities.  As a percentage ofrevenue, occupancy, communications and other decreased to 12.8 percent from 13percent.

***    General and Administrative Expenses.***

Generaland administrative expenses for fiscal year 2006 were $153.7 million, comparedto $148.7 million for fiscal year 2005, an increase of $5.0 million or 3.4percent.  The increase is mainly due toincreased salaries and benefits of $8.2 million, an increase of $1.3 millionfor miscellaneous items such as travel, rent, and insurance, increasedprofessional service expenses of $1.1 million offset by decreases inpublications, general office, equipment rental, and other miscellaneousexpenses of $5.0 million.  As apercentage of revenue, general and administrative expense decreased to 11.8percent from 12.3 percent.

  ***  Depreciation and Amortization.***

Depreciationand amortization for fiscal year 2006 was $46.3 million, compared to $38.7million for fiscal year 2005, an increase of $7.6 million or 19.6 percent.   As a percentage of revenue, depreciation andamortization increased to 3.5 percent from 3.2 percent. For both periods theincrease is mainly due to depreciation on internally developed software used tosupport our Benefits and Technology and Administration Solutions Groups.

***  Income From Affiliates.***

Incomefrom affiliates for fiscal year 2006 was $0.6 million, compared to $0.2 millionfor fiscal year 2005, a increase of $0.4 million.  The income in both periods relates to ourshare of operating results of PCIC.

***   InterestExpense, Net.***

Interestexpense, net for fiscal year 2006 was $0.2 million, compared to $1.0 millionfor fiscal year 2005. The net expense in both periods was due to debt incurredas a result of the business combination net of interest income earned onremaining cash balances.

    ***Other Non-operatingExpenses.***

Othernon-operating expenses for fiscal year 2006 includes a $1.4 million gainrecognized by the company on the sale of its New Zealand operations. Includedin other non-operating expense for fiscal year 2005 was a settlement cost of$2.2 million related to a claim by a former joint venture partner.

49

----

***   Provisionfor Income Taxes.***

Provisionfor income taxes for the fiscal year 2006 was $46.9 million, compared to $40.0million for fiscal year 2005. Our effective tax rate was 34.8 percent forfiscal year 2006 and 37.9 percent for fiscal year 2005.  The tax rate decrease is due to thegeographic distribution of income and decreases in tax reserves.  The company has not provided U.S. deferredtaxes on cumulative earnings of foreign subsidiaries that have been reinvestedindefinitely, which also includes foreign subsidiaries affiliated with ourrecent  business combination.  We record a tax benefit on foreign net operatingloss carryovers and foreign deferred expenses only if it is more likely thannot that a benefit will be realized.

***   Income From ContinuingOperations.***

Incomefrom continuing operations for fiscal year 2006 was $88.0 million, compared to$65.6 million for fiscal year 2005.  As apercentage of revenue, income from continuing operations increased to 6.7percent from 5.4 percent.

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

Dilutedearnings per share, income from continuing operations for fiscal year 2006 was$2.03, compared to $1.50 for fiscal year 2005. The diluted earnings per share calculation assumes that the 1,950,000contingent shares related to the business combination had been issued at thebeginning of each period.

**Liquidityand Capital Resources**

Ourcash and cash equivalents and marketable securities at June 30, 2006 totaled$165.3 million, compared to $168.1 million at June 30, 2005. During fiscal year2006, we used approximately $135.0 million of cash for our businesscombination of WWLLP (see Note 2 of Notes to the Consolidated FinancialStatements).  During fiscal year 2006, wepaid previously accrued discretionary compensation of $73.7 million; we repaid$72.0 million of borrowings under our credit facility; paid $29.9 million ofaccrued bonuses in accordance with the WWLLP purchase agreement; spent $38.0million in capital expenditures and paid $12.7 million in dividends duringfiscal year 2006.  Subsequent to June 30,2006, we paid the remaining $30.0 million of borrowings outstanding under ourcredit facility.  These outflows of cashwere funded by cash flow from current consulting operations, from existing cashbalances and from borrowings under our revolving credit facility.  Consistent with the company’s liquidityposition, management considers various alternative strategic uses of cashreserves including stock buybacks, dividends and acquisitions, or anycombination of these options. The company believes that it has sufficientresources to fund operations through the next twelve months.

50

----

***Cash From Operating Activities***

Cashfrom operating activities for fiscal year 2006 was $169.1 million, compared tocash from operating activities of $68.1 million for fiscal year 2005.

Theallowance for doubtful accounts increased $1.6 million and the allowance forwork in process increased $4.6 million from June 30, 2006 to June 30,2005.  The number of days of accountsreceivable and work in process outstanding was 78 at June 30, 2006, down from80 at June 30, 2005.

Cashfrom operating activities for fiscal year 2005 was $68.1 million, compared tocash from operating activities of $59.5 million for fiscal year 2004.

***Cash Used in Investing Activities***

Cash used in investingactivities for the fiscal year 2006 was $202.3 million, compared to $29.7million used in investing activities for fiscal year 2005.  The difference can be primarily attributed tothe business combination and other acquisition related payments totaling $137.8million, higher costs associated with the capitalization of time spent customizingin-house administration systems of $13.4 million in accordance with AICPA’sStatement of Position 98-1and higher purchases of fixed assets of $3.4million,  net of $20.0 million net salesof Dutch auction rate securities during fiscal year 2005.

Cashused in investing activities for fiscal year 2005 was $29.7 million, comparedto $14.5 million for fiscal year 2004. The increase can be primarily attributed to higher purchases of fixedassets of $11.1 million and costs associated with the capitalization of timespent customizing in-house administration systems of $14.3 million, inaccordance with AICPA’s Statement of Position 98-1, and higher net sales andmaturities of marketable securities of $11.3 million.

***Cash From (Used in) FinancingActivities***

Cashfrom financing activities was $16.9 million for fiscal year 2006, compared to$9.0 million used in financing activities during fiscal year 2005.  The increase was primarily attributable tonet borrowings and repayments of $30.0 million. Subsequent to June 30, 2006, we paid the remaining $30.0 millionof borrowings outstanding under our credit facility.

Cashused in financing activities was $9.0 million for fiscal year 2005, compared to$25.0 million for fiscal year 2004.  Thedecrease was primarily attributable to fewer repurchases of common stock, whichwas mainly due to the tender offer during fiscal year 2004 discussed below andin Note 10, partially offset by dividends paid during fiscal year 2005.

**CapitalCommitments**

Expendituresof capital funds were $38.0 million for fiscal year 2006.  Anticipated commitments of capital funds forWatson Wyatt are estimated at $50.0 million for fiscal year 2007. We expectcash from operations to adequately provide for these cash needs.

51

----

**Dividends**

InMay 2004, the Board of Directors of the company approved the initiation of aquarterly cash dividend in the amount of $0.075 per share.  Total dividends paid in fiscal year 2006 were$12.7 million.

Underour credit facility in effect as of June 30, 2006 (see Note 9 of Notes to theConsolidated Financial Statements included in Item 15 of this report), we arerequired to observe certain covenants (including requirements for a fixedcoverage charge, cash flow leverage ratio and asset coverage) that affect theamounts available 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 income, financialcondition, availability of capital, debt covenant limitations and our otherbusiness needs, including those of our subsidiaries and affiliates.

**Off-BalanceSheet Arrangements and Contractual Obligations**
| ** **                                                      | ** ** | **Remaining payments by fiscal year due as of June 30, 2006** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| **Contractual Cash  Obligations (in thousands)** | ** ** | **Total**                                                                                                       | ** ** | **Less than  1 Year** | ** ** | **2-3 Years** | ** ** | **4-5 Years** | ** ** | **More than  5 Years** | ** ** |
| Lease  commitments                                              |       | $                                                                                                               | 361,393    |   | $ | 52,153 |   | $ | 91,057 |   | $ | 77,234 |   | $ | 140,949 |   |
| Revolving Credit  Facility                                      |       | 30,000                                                                                                          |       | 30,000 |   | — |   | — |   | — |   |
| Total                                                           |       | $                                                                                                               | 391,393    |   | $ | 82,153 |   | $ | 91,057 |   | $ | 77,234 |   | $ | 140,949 |   |

 

***Operating Leases***.  We lease office space,furniture and selected computer equipment under operating lease agreements withterms ranging from one to ten years. Management has determined that there isnot a large concentration of leases that will expire in any one fiscalyear.  Consequently, managementanticipates that any increase in future rent expense will be mainly marketdriven.

***Pension Contributions***.  Contributions to our variouspension plans for fiscal year 2007 are projected to be approximately $25.0million.

***Guarantees***

*WellspringLeases*.  The company continues to guarantee certainleases for office premises and equipment for Wellspring.  At June 30, 2006, minimum remaining paymentsguaranteed under these leases, which expire at various dates through 2007,totaled $5.0 million, excluding anticipated sublease income.  The leases are currently generating positivecash flows of less than $0.1 million per fiscal year.  During the third quarter of fiscal year 2006,the company evaluated its accrual for the estimated remaining futureobligations and costs related to the exit from Wellspring.  Based on our analysis and the limitedduration of the remaining lease obligations, the company eliminated itsremaining liability of $1.75 million, less the associated income taxexpense.  See Note 16 of the Notes to theConsolidated Financial Statements for more information related to Wellspring.

52

----

*BusinessCombination.*  On July 31, 2005, the company acquiredsubstantially all of the assets and assumed most liabilities of WWLLP, thecompany’s long-time alliance partner. The company entered into indemnity arrangements with WWLLP relating tothe business combination and also agreed that certain indemnity obligationsrelating to the alliance arrangements will continue after the businesscombination.  In the business combinationagreement, Watson Wyatt Limited, the company’s principal U.K. subsidiary, hasagreed to indemnify WWLLP against liabilities arising with respect to certainliabilities assumed in the business combination by Watson Wyatt Limited andalso with respect to certain tax liabilities.

Aspart of the original alliance arrangements in 1995, the company sold itsthen-existing businesses in the U.K. and Europe to the predecessor of WWLLP orits subsidiaries.  The company agreed toindemnify the buyers against liabilities arising with respect to prior acts oromissions of the businesses transferred. Furthermore, the company agreed to indemnify WWLLP against liabilitiesarising with respect to acts or omissions of the company and its subsidiariesduring the alliance arrangements.  Theseindemnities continue following the business combination.

Thecompany is unable to estimate an amount of any potential future payments underthese arrangements because the occurrence of any of the events to which theindemnities apply is entirely speculative and the amount of any payment woulddepend upon the nature of the event triggering such indemnity. Managementbelieves that any potential for payment under such indemnities should declinewith the passage of time.  The companyhas insurance to cover liabilities arising from acts or omissions by thecompany and its subsidiaries, and such insurance may cover some or all of itsindemnity obligations relating to prior acts or omissions.  Except for such insurance, there are noprovisions for recourse to third parties, nor are any assets held by any thirdparties that the company as indemnitor can liquidate to recover amounts paidunder such indemnities.

Inconnection with our business combination, the payment of an additional1,950,000 shares of the company’s common stock to WWLLP after June 30, 2007 iscontingent upon the achievement by the acquired business of agreed-uponfinancial performance goals for the fiscal year ended June 30, 2007. The valueof all the contingent common stock was $64.3 million based on the NYSE closingprice on July 31, 2006. The contingent common stock is payable by Watson WyattLimited and the payment obligations are guaranteed by the company.

Underthe business combination agreement, Watson Wyatt Limited is obligated to makepayments to members of WWLLP representing profits and tax payments relating toperiods before the closing date of the transaction. The company has guaranteedthese obligations and has properly reflected them on the company’s consolidatedfinancial statements as of June 30, 2006.

**CreditAgreement**

InJuly 2005, the company amended and restated its credit facility to provide fora new revolving credit facility in an aggregate principal amount of $300million credit facility.  This facilitywas provided by a syndicate of banks. Interest rates associated with this facility vary with LIBOR and/or thePrime Rate and are based on our leverage ratio, as defined by the creditagreement.  The company also pays a 0.13%commitment fee on the unused portion of the facility.  Credit under the facility is available upondemand, although the credit facility requires us to observe certain covenants(including requirements for minimum net worth, which act to restrict dividends,cash flow leverage ratio and a fixed coverage charge).  As of June 30, 2006 and 2005, the company had$30 million and $0 million, respectively, outstanding under the facility. Thisfacility is scheduled to mature on June 30, 2010.

53

----

Aportion of the revolving facility is used to support required letters of creditissued under the credit line.  As aresult, $10.6 million of the facility was unavailable for operating needs as ofJune 30, 2006.  We are also charged a feefor outstanding letters of credit that also fluctuates based on our leverageratio.

OnJune 5, 2006, Watson Wyatt Australia Pty Ltd, an indirect subsidiary of thecompany, entered into a $5.0 million Australian dollar-denominated letter of creditfacility with a financial institution in Australia for the purpose of providinga letter of credit to a governmental agency as guarantee for ongoing businessin their investment consulting practice. As of June 30, 2006, $5 million AUD ($3.7 million USD) was outstandingunder the facility, which carries a rate of 1.00%.

**RiskManagement**

As a part of ouroverall risk management program, we carry customary commercial insurancepolicies, including commercial general liability, employment practices liability,and claims-made professional liability insurance with a self-insured retentionof $1 million per claim. Until June 30, 2006, this program provided coveragefor professional liability claims against the company and its non-Europeansubsidiaries not previously owned by WWLLP, including the cost of defendingsuch claims.  Our primary insurancecoverage beyond this retention is written by an affiliated captive insurancecompany (PCIC) owned by us and two other professional services firms. As ofJuly 1, 2006, this program covers claims made against the acquired Europeanoperations and predecessor firms, as well as the individual partners of WatsonWyatt LLP and Watson Wyatt Partners.

In formulatingits premium structure, PCIC estimates the amount it expects to pay for losses(and loss expenses) for all the members as a whole and then allocates thatamount to the member firms based on the individual member’s expectedlosses.  PCIC bases premium calculations,which are determined annually based on experience through March of each year,on relative risk of the various lines of business performed by each of theowner companies, past claim experience of each owner company, growth of each ofthose companies, industry risk profiles in general and the overall insurancemarkets.  As of July 1, 2006, the captiveinsurance company carries reinsurance for 90% of losses it insures above $25million.

Our agreementswith PCIC could require additional payments to PCIC in the event that thecompany decided to exit PCIC and adverse claims significantly exceed priorexpectations.  If these circumstanceswere to occur, the company would record a liability at the time it becomesestimable and probable.

The company willcontinue to provide for the self-insured retention where specific estimatedlosses and loss expenses for known claims in excess of $1 million areconsidered probable and reasonably estimable. Prior to June 30, 2006, oursubsidiary, Watson Wyatt Limited, maintained customary commercial insurancepolicies, including claims-made professional liability insurance covering ourEuropean subsidiaries as well as certain predecessor companies, including WWLLPand Watson Wyatt Partners.  This programcarried a self-insured retention of £2 million in the aggregate and £100,000per claim, including the cost of defending such claims.  Thisprogram expired on its own terms as of June 30, 2006 and was replaced by thecombined program described above.

Although thecompany maintains professional liability insurance coverage, this insurancedoes not cover claims made after expiration of our current insurancecontracts.  Generally accepted accountingprinciples require that we record a liability for incurred but not reported(IBNR) professional liability claims if they are estimable and probable, andfor which we have not yet contracted for insurance coverage.  The company uses actuarial assumptions toestimate and record its IBNR liability and has a $33.9 million IBNR liabilityrecorded as of June 30, 2006.

54

----

Recent insurancemarket conditions for our industry include increases in overall premium cost,higher self-insured retentions and constraints on aggregate excess coverages,trends that are anticipated to continue. We expect these recent conditions to recur periodically and to bereflected in our future annual insurance renewals.  As a result, we will continue to assess ourability to secure future insurance coverage. In anticipation of the possibility of future reductions in risk transferfrom PCIC to re-insurers, as well as the hardening insurance market conditionsin recent years, the firms that own PCIC, including the company, have increasedPCIC’s capital in recent years, with the most recent capital contributions byWatson Wyatt ($1.5 million in cash and a letter of credit for $3.1 million fromthe company) being made in July 2005.

In light ofincreasing worldwide litigation, including litigation against professionals,the company has implemented a requirement that all client relationships bedocumented by engagement letters containing specific risk mitigation clausesthat were not included in all historical client agreements.  Nearly 100 percent of the company’s U.S.corporate clients have signed engagement letters including mitigation clauses,and initiatives to maintain that process both in the United States and completeit elsewhere are underway. The company has disengaged from certain clientrelationships where satisfactory engagement terms could not be achieved.

**RecentAccounting Pronouncements**

InDecember 2004, the Financial Accounting Standards Board (FASB) publishedrevisions to Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (FAS 123R). FAS 123(R) requires companies to account for share-based paymenttransactions with employees using a fair-value based method, therebyeliminating the disclosure-only provisions of FAS 123.  The companyimplemented FAS 123(R) during the first quarter of fiscal year 2006 under themodified prospective method.  As aresult, during the fiscal year 2006, compensation expense totaling $0.3 millionrelated to the outstanding stock options as of July 1, 2005 has been recognizedbased on the fair values of the awards previously calculated in preparing thepro forma disclosures in accordance with the provisions of FAS 123, lessadjustments for forfeitures.  Theadoption of FAS 123(R) has not had a material impact on the financial conditionor results of operations for the company.

InApril 2005, the Securities and Exchange Commission (SEC) issued StaffAccounting Bulletin No. 107, “Share-Based Payments” (SAB 107) in which the SECexpressed views regarding the interaction between FAS 123(R) and certain SECrules and regulations and provide the staff’s views regarding the valuation ofshare-based payment arrangements for public companies.  The application of SAB 107 has not had amaterial impact on the financial condition or results of operations for thecompany.

InJune 2006, the FASB issued FIN 48, Accounting for Uncertainty in IncomeTaxes-an interpretation of FASB Statement No. 109, Accounting for Income Taxes,which clarifies the accounting for uncertainty in income taxes.  FIN 48 prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return.  The interpretation requires that the companyrecognize in the financial statements, the impact of a tax position, if thatposition is more likely than not of being sustained on audit, based on thetechnical merits of the position.  FIN 48also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods and disclosure.  The provisions of FIN 48 are effective forfiscal years after December 15, 2006 with the cumulative effect of the changein accounting principle recorded as an adjustment to opening retainedearnings.  The company is currentlyevaluating the impact of adopting FIN 48 on the financial statements.

55

----

OnOctober 22, 2004, the American Jobs Creation Act (AJCA) was signed intolaw.  The AJCA includes a  provisionthat allows a one-time election to exclude up to 85 percent of foreignunrepatriated earnings.

Thecompany has determined there would be no tax benefit from repatriating itsforeign earnings under the provision set forth in the AJCA.

**Item 7A.  Quantitative andQualitative Disclosures About Market Risk.**

Weare 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.  See Note 2 of the Notes to the Consolidated FinancialStatements for further information regarding our handling of foreign currencyexchange rate risk associated with the business combination.

**Item 8.     Financial Statementsand Supplementary Data.**

Thefinancial statements and supplementary data are included as Item 15 of thisreport.

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

Thereare no changes in accountants or disagreements with accountants on accountingprinciples and financial disclosures required to be disclosed in this Item 9.

**Item 9A.  Controls andProcedures.**

**Evaluation of Disclosure Controls and Procedures**

An evaluation was performed under the supervisionand with the participation of our principal executive officer, principalfinancial officer and senior management, of the effectiveness of the design andoperation of our disclosure controls and procedures as such term is defined inrules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”). Based upon that evaluation, our principal executive officer, principalfinancial officer, and senior management concluded that our disclosure controlsand procedures were effective in providing reasonable assurance that theinformation required to be disclosed in our periodic reports were filed withinthe time periods specified in the SEC’s rules and forms as of June 30, 2006.

**Changes in Internal Control Over Financial Reporting**

There were no significantchanges in our internal control over financial reporting in the fourth quarterof 2006 that materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

**Management’s Report on Internal Control over Financial Reporting**

Internal control overfinancial reporting refers to the process designed by, or under the supervisionof, our Chief Executive Officer and Chief Financial Officer, and overseen byour board of directors, management and other personnel, to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles, and includes those policies and proceduresthat:

(1)          Pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of the assets of the company;

56

----

(2)          Providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and

(3)          Providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the company’s assets that could have amaterial effect on the financial statements.

Internal control overfinancial reporting cannot provide absolute assurance of achieving financialreporting objectives because of its inherent limitations. Internal control overfinancial reporting is a process that involves human diligence and complianceand is subject to lapses in judgment and breakdowns resulting from humanfailures. Internal control over financial reporting also can be circumvented bycollusion or improper management override. Because of such limitations, thereis a risk that material misstatements may not be prevented or detected on atimely basis by internal control over financial reporting. However, theseinherent limitations are known features of the financial reporting process.Therefore, it is possible to design into the process safeguards to reduce,though not eliminate, this risk.

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting for the company. Management has used the framework set forth in thereport entitled Internal Control-Integrated Framework published by theCommittee of Sponsoring Organizations (COSO) of the Treadway Commission toevaluate the effectiveness of the company’s internal control over financialreporting.

Based on this evaluation,management has concluded that the company’s internal control over financialreporting was effective as of June 30, 2006.

Management has excludedWatson Wyatt Limited from its assessment of internal control over financialreporting as of June 30, 2006 because it was acquired by the company in apurchase business combination completed during fiscal year 2006.  The assets, liabilities and results ofoperations of Watson Wyatt Limited represent approximately 53%, 42% and 37%,respectively, of the company’s consolidated total assets, total liabilities andtotal revenues, respectively, as of and for the year ended June 30, 2006.

Our independent registeredpublic accounting firm, PricewaterhouseCoopers LLP, has issued a report onmanagement’s assessment of our internal control over financial reporting.  This report is included herein.

**Part III**

**Item 10.  Directors, ExecutiveOfficers, and Audit Committee of the Registrant.**

On July 19, 2006, the Board of Directors of Watson Wyatt Worldwide,Inc. elected Dr. Brendan R. O’Neill to serve as a member of the company’s Boardof Directors, to fill an existing vacancy in Class II, with a term expiring atthe Annual Stockholders’ meeting in 2008.

Further response to this item will be included in adefinitive proxy statement filed within 120 days after the end of the company’sfiscal year, and that information is incorporated herein by this reference.

57

----

**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 company’s fiscal year, andthat information is incorporated herein by this reference.

**Item 12.  Security Ownership ofCertain Beneficial Owners and Management.**

The response to this item will be included in a definitive proxystatement filed within 120 days after the end of the company’s fiscal year, andthat information is incorporated herein by this reference.

**Item 13.  Certain Relationshipsand Related Transactions.**

Theresponse to this item will be included in a definitive proxy statement filedwithin 120 days after the end of the company’s fiscal year, and thatinformation is incorporated herein by this reference.

**Item 14.  Principal Auditor Feesand Services.**

Theresponse to this item will be included in a definitive proxy statement filedwithin 120 days after the end of the Company’s fiscal year, and thatinformation is incorporated herein by this reference.

58

----

**Part IV**

**Item 15.  Exhibits and FinancialStatement Schedules**
| a)     |   | Financial Information                                                                                                                                |   |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |   |                                                                                                                                                 |   |   |
| (1)    |   | Consolidated Financial Statements of Watson Wyatt  Worldwide, Inc.                                                                                   |   |   |
|   |   |                                                                                                                                                 |   |   |
|   |   | 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, 2006                                                |   |   |
|   |   | Consolidated  Balance Sheets at June 30, 2006 and 2005                                                                                               |   |   |
|   |   | Consolidated  Statements of Cash Flows for each of the three years in the period ended June  30, 2006                                                |   |   |
|   |   | Consolidated  Statements of Changes in Stockholders’ Equity for each of the three years in  the period ended June 30, 2006                      |   |   |
|   |   | Notes to the  Consolidated Financial Statements                                                                                                      |   |   |
|   |   |                                                                                                                                                 |   |   |
| (2)    |   | Consolidated Financial Statement Schedule for each  of the three years in the period ended June 30, 2006                                             |   |   |
|   |   |                                                                                                                                                 |   |   |
|   |   | 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 (b) below.                                                                                                                                       |   |   |
|   |   |                                                                                                                                                 |   |   |
| b)     |   | Exhibits                                                                                                                                             |   |   |
|   |   |                                                                                                                                                 |   |   |
|   |   | See Exhibit Index on page 111.                                                                                                                       |   |   |
|   |   |                                                                                                                                                 |   |   |
| c)     |   | Financial Statement Schedules                                                                                                                        |   |   |
|   |   |                                                                                                                                                 |   |   |
|   |   | Not applicable.                                                                                                                                      |   |   |

 

59

----

**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
|                        |   | WATSON WYATT WORLDWIDE, INC. |
|------------------------|--------|------------------------------|
|                   |   | (Registrant)                 |
|                   |   |                         |   |   |
| Date: August 17,  2006 |   | By:                          |   | /s/ John J. Haley |
|                   |   |                         |   | John J. Haley |
|                   |   |                         |   | President and Chief Executive Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
| Signature                    | ** ** | **Title**                          | ** ** | **Date** |
|------------------------------|------------|------------------------------------|------------|----------|
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ John J.  Haley           |       | President, Chief Executive Officer |       | 8/17/06  |
| John J. Haley                |       | and Director                       |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Carl D.  Mautz           |       | Vice President and Chief           |       | 8/17/06  |
| Carl D. Mautz                |       | Financial Officer                  |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Peter L.  Childs         |       | Controller                         |       | 8/17/06  |
| Peter L. Childs              |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ John J.  Gabarro         |       | Director                           |       | 8/17/06  |
| John J. Gabarro              |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ R. Michael  McCullough   |       | Director                           |       | 8/17/06  |
| R. Michael  McCullough       |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Linda D.  Rabbitt        |       | Director                           |       | 8/17/06  |
| Linda D. Rabbitt             |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/Chandrasekhar  Ramamurthy |       | Vice President and Director        |       | 8/17/06  |
| Chandrasekhar  Ramamurthy    |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Gilbert T.  Ray          |       | Director                           |       | 8/17/06  |
| Gilbert T. Ray               |       |                               |       |     |
|                         |       |                               |       |     |

 

60

----

 
| /s/ John B. Shoven  |   | Director                    |   | 8/17/06 |
|---------------------|--------|-----------------------------|--------|---------|
| John B. Shoven      |   |                        |   |    |
|                |   |                        |   |    |
|                |   |                        |   |    |
| /s/ Roger Urwin     |   | Vice President and Director |   | 8/17/06 |
| Roger Urwin         |   |                        |   |    |
|                |   |                        |   |    |
|                |   |                        |   |    |
| /s/ Gene H.  Wickes |   | Vice President and Director |   | 8/17/06 |
| Gene H. Wickes      |   |                        |   |    |
|                |   |                        |   |    |
|                |   |                        |   |    |
| /s/ John C.  Wright |   | Director                    |   | 8/17/06 |
| John C. Wright      |   |                        |   |    |

 

61

----

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

Tothe Board of Directors and Stockholders Watson Wyatt Worldwide, Inc.

Wehave completed integrated audits of Watson Wyatt Worldwide, Inc.’s 2006 and2005 consolidated financial statements and of its internal control overfinancial reporting as of June 30, 2006 and an audit of its 2004 consolidatedfinancial statements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States).  Our opinions, based on ouraudits, are presented below.

Consolidatedfinancial statements and financial statement schedule

Inour opinion, the consolidated financial statements listed in the accompanyingindex present fairly, in all material respects, the financial position ofWatson Wyatt Worldwide, Inc. and its subsidiaries at June 30, 2006 and 2005,and the results of their operations and their cash flows for each of the threeyears in the period ended June 30, 2006 in conformity with accountingprinciples generally accepted in the United States of America.  Inaddition, in our opinion, the financial statement schedule listed in theaccompanying index presents fairly, in all material respects, the informationset forth therein when read in conjunction with the related consolidated financialstatements.  These financial statements and financial statement scheduleare the responsibility of the Company’s management.  Our responsibility isto express an opinion on these financial statements and financial statementschedule based on our audits.  We conducted our audits of these statementsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit of financial statements includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used and significantestimates made by management, and evaluating the overall financial statementpresentation.  We believe that our audits provide a reasonable basis forour opinion.

Internalcontrol over financial reporting

Also,in our opinion, management’s assessment, included in *Management’sReport on Internal Control Over Financial Reporting* appearing underItem 9A, that the Company maintained effective internal control over financialreporting as of June 30, 2006 based on criteria established in *Internal Control — Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of June 30, 2006 basedon criteria established in *Internal Control —Integrated Framework* issued by the COSO.  The Company’smanagement is responsible for maintaining effective internal control over financialreporting and for its assessment of the effectiveness of internal control overfinancial reporting.  Our responsibility is to express opinions onmanagement’s assessment and on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit. We conducted our audit ofinternal control over financial reporting in accordance with the standards ofthe Public Company Accounting Oversight Board (United States).  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects.  An audit of internal control overfinancial reporting includes obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

62

----

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles.  A company’s internalcontrol over financial reporting includes those policies and procedures that(i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Asdescribed in *Management’s Report in Internal Control overFinancial Reporting*, management has excluded Watson Wyatt Limitedfrom its assessment of internal control over financial reporting as of June 30,2006 because it was acquired by the company in a purchase business combinationduring fiscal year 2006.  We have alsoexcluded Watson Wyatt Limited from our audit of internal control over financialreporting.  Watson Wyatt Limited is awholly-owned subsidiary whose total assets, total liabilities, and totalrevenues represent 53%, 42%, and 37%, respectively, of the related consolidatedfinancial statement amounts as of and for the year ended June 30, 2006.

PricewaterhouseCoopersLLP McLean, Virginia August 17, 2006

63

----

 

**WATSON WYATT WORLDWIDE, INC.**

**Consolidated Statements of Operations**

(Thousands of U.S. Dollars,Except Per Share Data)
| ** **                                                                                                                                                      | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                      | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Revenue                                                                                                                                                         |       | $                                     | 1,271,811  |   | $ | 737,421 |   | $ | 702,005 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Costs of  providing services:                                                                                                                                   |       |                                  |       |   |   |   |   |
| Salaries and employee benefits                                                                                                                                  |       | 699,049                               |       | 397,252 |   | 396,775 |   |
| Professional and subcontracted services                                                                                                                         |       | 84,165                                |       | 57,810 |   | 49,159 |   |
| Occupancy, communications and other                                                                                                                             |       | 164,140                               |       | 106,752 |   | 105,459 |   |
| General and administrative expenses                                                                                                                             |       | 147,122                               |       | 74,612 |   | 63,631 |   |
| Depreciation and amortization                                                                                                                                   |       | 44,918                                |       | 20,210 |   | 18,511 |   |
|                                                                                                                                                            |       | 1,139,394                             |       | 656,636 |   | 633,535 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Income from  operations                                                                                                                                         |       | 132,417                               |       | 80,785 |   | 68,470 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Income from  affiliates                                                                                                                                         |       | 1,135                                 |       | 7,146 |   | 7,109 |   |
| Interest income                                                                                                                                                 |       | 4,325                                 |       | 2,832 |   | 1,635 |   |
| Interest expense                                                                                                                                                |       | (4,093                                | )          | (660 | ) | (892 | ) |
| Other  non-operating (loss) income                                                                                                                              |       | (2,081                                | )          | (7,404 | ) | 6,222 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Income from  continuing operations before income taxes                                                                                                          |       | 131,703                               |       | 82,699 |   | 82,544 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Provision for  income taxes                                                                                                                                     |       | 45,585                                |       | 31,303 |   | 32,605 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Income from  continuing operations                                                                                                                              |       | 86,118                                |       | 51,396 |   | 49,939 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Discontinued  operations:                                                                                                                                       |       |                                  |       |   |   |   |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Adjustment to  reduce estimated loss on disposal of discontinued operations (less applicable  income tax expense for the years ended June 30, 2006, 2005, 2004) |       | 1,028                                 |       | 739 |   | 592 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Sublease income  from discontinued operations, less applicable income tax expense for the  years ended June 30, 2006, 2005, 2004                                |       | 45                                    |       | 27 |   | 62 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Net income                                                                                                                                                      |       | $                                     | 87,191     |   | $ | 52,162 |   | $ | 50,593 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Basic earnings  per share:                                                                                                                                      |       |                                  |       |   |   |   |   |
| Income from continuing operations                                                                                                                               |       | $                                     | 2.08       |   | $ | 1.58 |   | $ | 1.52 |   |
| Income from discontinued operations                                                                                                                             |       | 0.03                                  |       | 0.02 |   | 0.02 |   |
| Net income                                                                                                                                                      |       | $                                     | 2.11       |   | $ | 1.60 |   | $ | 1.54 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Diluted earnings  per share:                                                                                                                                    |       |                                  |       |   |   |   |   |
| Income from continuing operations                                                                                                                               |       | $                                     | 1.99       |   | $ | 1.56 |   | $ | 1.50 |   |
| Income from discontinued operations                                                                                                                             |       | 0.02                                  |       | 0.02 |   | 0.02 |   |
| Net income                                                                                                                                                      |       | $                                     | 2.01       |   | $ | 1.58 |   | $ | 1.52 |   |
|                                                                                                                                                            |       |                                  |       |   |   |   |   |
| Weighted average  shares of common stock, basic (000)                                                                                                           |       | 41,393                                |       | 32,541 |   | 32,866 |   |
| Weighted average shares  of common stock, diluted (000)                                                                                                         |       | 43,297                                |       | 32,845 |   | 33,207 |   |

 

See accompanying notes tothe

consolidated financialstatements

64

----

 

**WATSON WYATT WORLDWIDE, INC.**

**Consolidated Balance Sheets**

(Thousands of U.S. Dollars,Except Share Data)
| ** **                                                                                                     | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                     | ** ** | **2006**          | ** ** | **2005**          | ** ** |
|                                                                                                           |       |              |       |              |       |
| **Assets**                                                                                                     | ** ** | ** **        | ** ** | ** **        | ** ** |
| Cash and cash  equivalents                                                                                     |       | $                 | 165,345    |              | $          | 168,076 |   |
| Receivables from  clients:                                                                                     |       |              |       |              |       |
|                                                                                                           |       |              |       |              |       |
| Billed, net of allowances of $3,678 and $2,114                                                                 |       | 180,533           |       | 95,977            |       |
| Unbilled, net of allowances of $5,348 and $700                                                                 |       | 123,044           |       | 62,840            |       |
|                                                                                                           |       | 303,577           |       | 158,817           |       |
|                                                                                                           |       |              |       |              |       |
| Deferred income  taxes                                                                                         |       | 567               |       | 24,718            |       |
| Other current  assets                                                                                          |       | 24,158            |       | 12,599            |       |
| Total current assets                                                                                           |       | 493,647           |       | 364,210           |       |
|                                                                                                           |       |              |       |              |       |
| Investment in  affiliates                                                                                      |       | 8,564             |       | 30,857            |       |
| Fixed assets,  net                                                                                             |       | 147,738           |       | 94,033            |       |
| Deferred income  taxes                                                                                         |       | 70,417            |       | 92,915            |       |
| Goodwill                                                                                                       |       | 324,041           |       | 21,888            |       |
| Intangible  assets, net                                                                                        |       | 187,075           |       | 776               |       |
| Other assets                                                                                                   |       | 8,877             |       | 14,000            |       |
|                                                                                                           |       |              |       |              |       |
| **Total  Assets**                                                                                              |       | $                 | 1,240,359  |              | $          | 618,679 |   |
| ** **                                                                                                     | ** ** | ** **        | ** ** | ** **        | ** ** |
| **Liabilities**                                                                                                | ** ** | ** **        | ** ** | ** **        | ** ** |
| Accounts payable  and accrued liabilities, including discretionary compensation                                |       | $                 | 288,396    |              | $          | 122,621 |   |
| Deferred income  taxes                                                                                         |       | 168               |       | 283               |       |
| Income taxes  payable                                                                                          |       | 7,771             |       | 4,648             |       |
| Total current liabilities                                                                                      |       | 296,335           |       | 127,552           |       |
|                                                                                                           |       |              |       |              |       |
| Note payable                                                                                                   |       | 30,000            |       | —            |       |
| Accrued  retirement benefits                                                                                   |       | 162,505           |       | 205,029           |       |
| Deferred rent  and accrued lease losses                                                                        |       | 28,982            |       | 18,701            |       |
| Deferred income  taxes                                                                                         |       | 480               |       | 370               |       |
| Other noncurrent  liabilities                                                                                  |       | 73,296            |       | 32,824            |       |
|                                                                                                           |       |              |       |              |       |
| **Total  Liabilities**                                                                                         |       | 591,598           |       | 384,476           |       |
| ** **                                                                                                     | ** ** | ** **        | ** ** | ** **        | ** ** |
| Commitments and  contingencies (Note 14)                                                                       |       |              |       |              |       |
|                                                                                                           |       |              |       |              |       |
| **Stockholders’ Equity**                                                                                  | ** ** | ** **        | ** ** | ** **        | ** ** |
| Preferred Stock - No  par value:                                                                               |       |              |       |              |       |
| 1,000,000 shares authorized; none issued and  outstanding                                                      |       | —            |       | —            |       |
| Class A Common Stock -  $.01 par value:                                                                        |       |              |       |              |       |
| 99,000,000 shares authorized; 42,463,451 and  33,372,880 issued and 42,385,513 and 32,627,226 outstanding |       | 425               |       | 334               |       |
| Additional  paid-in capital                                                                                    |       | 386,392           |       | 147,948           |       |
| Treasury stock,  at cost - 77,938 and 745,654 shares                                                           |       | (2,134            | )          | (18,705           | )          |
| Retained  earnings                                                                                             |       | 242,599           |       | 168,075           |       |
| Accumulated  other comprehensive income (loss)                                                                 |       | 21,479            |       | (63,449           | )          |
| **Total  Stockholders’ Equity**                                                                           |       | 648,761           |       | 234,203           |       |
|                                                                                                           |       |              |       |              |       |
| **Total Liabilities and  Stockholders’ Equity**                                                           |       | $                 | 1,240,359  |              | $          | 618,679 |   |

 

See accompanying notes tothe

consolidated financialstatements

65

----

 

**WATSON WYATT WORLDWIDE, INC.**

**Consolidated Statements of Cash Flows**

(Thousands of U.S. Dollars)

 
| ** **                                                                    | ** ** | **Year ended June 30** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                    | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                          |       |                                  |       |   |   |   |   |
| Cash flows from  operating activities:                                        |       |                                  |       |   |   |   |   |
| Net income                                                                    |       | $                                     | 87,191     |   | $ | 52,162 |   | $ | 50,593 |   |
| Adjustments to reconcile net income to net cash from  operating activities:   |       |                                  |       |   |   |   |   |
| Loss on foreign currency forward contract                                     |       | 3,602                                 |       | 4,803 |   | — |   |
| Other non-operating gain related to PCIC                                      |       | —                                |       | — |   | (5,600 | ) |
| Income from discontinued operations, net of income  tax expense               |       | (1,028                                | )          | (739 | ) | (592 | ) |
| Provision for doubtful receivables from clients                               |       | 4,966                                 |       | 5,563 |   | 5,612 |   |
| Depreciation                                                                  |       | 36,763                                |       | 19,899 |   | 18,196 |   |
| Amortization of intangible assets                                             |       | 8,155                                 |       | 311 |   | 315 |   |
| Provision for (benefit from) deferred income taxes                            |       | 33,692                                |       | (4,587 | ) | (7,457 | ) |
| Income from affiliates                                                        |       | (1,136                                | )          | (7,146 | ) | (7,109 | ) |
| Distributions from affiliates                                                 |       | 1,614                                 |       | 6,131 |   | 5,521 |   |
| Other, net                                                                    |       | 449                                   |       | 866 |   | 508 |   |
| Changes in operating assets and liabilities (net of  discontinued operations) |       |                                  |       |   |   |   |   |
| Receivables from clients                                                      |       | (27,196                               | )          | (14,546 | ) | (16,524 | ) |
| Other current assets                                                          |       | 7,181                                 |       | (488 | ) | 377 |   |
| Other assets                                                                  |       | (2,000                                | )          | (6,868 | ) | (538 | ) |
| Accounts payable and accrued liabilities                                      |       | 5,238                                 |       | 9,532 |   | 7,359 |   |
| Income taxes payable                                                          |       | 760                                   |       | (8,601 | ) | (3,190 | ) |
| Accrued retirement benefits                                                   |       | 4,148                                 |       | 2,101 |   | 6,025 |   |
| Deferred rent and accrued lease losses                                        |       | 1,561                                 |       | 8,502 |   | 5,591 |   |
| Other noncurrent liabilities                                                  |       | 5,163                                 |       | 1,189 |   | 405 |   |
| Cash flows from operating activities:                                         |       | 169,123                               |       | 68,084 |   | 59,492 |   |
|                                                                          |       |                                  |       |   |   |   |   |
| Cash flows used  in investing activities:                                     |       |                                  |       |   |   |   |   |
| Purchases of marketable securities                                            |       | —                                |       | (469,400 | ) | (277,600 | ) |
| Sales and maturities of marketable securities                                 |       | —                                |       | 489,400 |   | 286,300 |   |
| Acquisitions                                                                  |       | (137,784                              | )          | (812 | ) | (321 | ) |
| Purchases of fixed assets                                                     |       | (38,060                               | )          | (34,648 | ) | (23,472 | ) |
| Capitalized software costs                                                    |       | (27,743                               | )          | (14,296 | ) | — |   |
| Proceeds from divestitures                                                    |       | 1,296                                 |       | 20 |   | 622 |   |
| Cash flows used in investing activities:                                      |       | (202,291                              | )          | (29,736 | ) | (14,471 | ) |
|                                                                          |       |                                  |       |   |   |   |   |
| Cash flows from  (used in) financing activities:                              |       |                                  |       |   |   |   |   |
| Borrowings                                                                    |       | 102,000                               |       | — |   | — |   |
| Repayments of borrowings                                                      |       | (72,000                               | )          | — |   | — |   |
| Foreign currency forward contract                                             |       | (8,405                                | )          | — |   | — |   |
| Dividends paid                                                                |       | (12,667                               | )          | (9,756 | ) | — |   |
| Repurchases of common stock                                                   |       | (4,272                                | )          | (9,358 | ) | (33,139 | ) |
| Offering costs on repurchases of common stock                                 |       | —                                |       | — |   | (728 | ) |
| Tax benefit of exercises of stock options and other                           |       | 2,034                                 |       | — |   | — |   |
| Issuances of common stock - exercises of stock  options                       |       | 3,911                                 |       | 1,992 |   | 2,142 |   |
| Issuances of common stock - employee stock purchase  plan                     |       | 6,255                                 |       | 8,078 |   | 6,789 |   |
| Cash flows from (used in) financing activities:                               |       | 16,856                                |       | (9,044 | ) | (24,936 | ) |
|                                                                          |       |                                  |       |   |   |   |   |
| Effect of  exchange rates on cash                                             |       | 13,581                                |       | 1,832 |   | 1,181 |   |
|                                                                          |       |                                  |       |   |   |   |   |
| (Decrease)/increase  in cash and cash equivalents                             |       | (2,731                                | )          | 31,136 |   | 21,266 |   |
|                                                                          |       |                                  |       |   |   |   |   |
| Cash and cash  equivalents at beginning of period                             |       | 168,076                               |       | 136,940 |   | 115,674 |   |
|                                                                          |       |                                  |       |   |   |   |   |
| Cash and cash  equivalents at end of period                                   |       | $                                     | 165,345    |   | $ | 168,076 |   | $ | 136,940 |   |

 

See accompanying notes tothe

consolidated financialstatements

66

----

**WATSONWYATT WORLDWIDE, INC.**

**Consolidated Statement of Changes in Stockholders’ Equity**

(Thousands of U.S. Dollars)
| ** **                                                       | ** ** | **Class A**             | ** ** | ** **               | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|-------------------------|------------|----------------------|------------|---------------------|------------|-------------------|------------|------------|------------|
| ** **                                                       | ** ** | **Common**                   | ** ** | ** **               | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Stock**                    | ** ** | ** **               | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Outstanding**              | ** ** | **Accumulated**          | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **(number of  shares,** | ** ** | **Class A  Common** | ** ** | **Additional  Paid-in** | ** ** | **Treasury  Stock,** | ** ** | **Other  Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **in thousands)**       | ** ** | **Stock**                | ** ** | **Capital**             | ** ** | **at Cost**     | ** ** | **Earnings**        | ** ** | **(Loss)/Income** | ** ** | **Total**  | ** ** |
|                                                             |       |                         |       |                     |       |                    |       |                 |       |                |       |              |       |       |       |
| 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, net of tax                |       | —                       |       | —                   |       | —                  |       | —               |       | —              |       | 61,218            |       | 61,218     |       |
| Foreign currency translation  adjustment, net of tax             |       | —                       |       | —                   |       | —                  |       | —               |       | —              |       | 3,681             |       | 3,681      |       |
| Total comprehensive income                                       |       |                         |       |                     |       |                    |       |                 |       |                |       |              |       | 115,492    |       |
| Cash dividends                                                   |       | —                       |       | —                   |       | —                  |       | —               |       | (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    |       |
|                                                             |       |                         |       |                     |       |                    |       |                 |       |                |       |              |       |       |       |
| Comprehensive  income:                                           |       |                         |       |                     |       |                    |       |                 |       |                |       |              |       |       |       |
| Net income                                                       |       | —                       |       | —                   |       | —                  |       | —               |       | 52,162              |       | —            |       | 52,162     |       |
| Additional minimum pension  liability, net of tax                |       | —                       |       | —                   |       | —                  |       | —               |       | —              |       | (61,728           | )          | (61,728    | )          |
| Foreign currency  translation adjustment, net of tax             |       | —                       |       | —                   |       | —                  |       | —               |       | —              |       | 2,457             |       | 2,457      |       |
| Total comprehensive loss                                         |       |                         |       |                     |       |                    |       |                 |       |                |       |              |       | (7,109     | )          |
| Cash dividends                                                   |       | —                       |       | —                   |       | —                  |       | —               |       | (9,756              | )          | —            |       | (9,756     | )          |
| Repurchases of common stock                                      |       | (365                         | )          | —                   |       | —                  |       | (9,358               | )          | —              |       | —            |       | (9,358     | )          |
| Issuances of common stock -  employee stock purchase plan shares |       | 362                          |       | —                   |       | (936                    | )          | 9,014                |       | —              |       | —            |       | 8,078      |       |
| Issuances of common stock -  deferred stock units           |       | 151                          |       | —                   |       | 276                     |       | 3,769                |       | —              |       | —            |       | 4,045      |       |
| Issuances of common stock  to outside directors             |       | 8                            |       | —                   |       | 16                      |       | 209                  |       | —              |       | —            |       | 225        |       |
| Issuances of common stock -  stock options                       |       | 154                          |       | —                   |       | (1,818                  | )          | 3,810                |       | —              |       | —            |       | 1,992      |       |
| Tax benefit of exercises of  stock options                       |       | —                       |       | —                   |       | 902                     |       | —               |       | —              |       | —            |       | 902        |       |
|                                                             |       |                         |       |                     |       |                    |       |                 |       |                |       |              |       |       |       |
| Balance at June 30, 2005                                         |       | 32,627                       |       | $                        | 334        |                    | $          | 147,948              |       | $                   | (18,705    | )                 | $          | 168,075    |       | $ | (63,449 | ) | $ | 234,203 |   |

67

----

**WATSONWYATT WORLDWIDE, INC.**

**Consolidated Statement of Changes in Stockholders’ Equity**

(Thousands of U.S. Dollars)

 
| ** **                                                       | ** ** | **Class A**                   | ** ** | ** **               | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------|------------|--------------------------|------------|-------------------------|------------|----------------------|------------|---------------------|------------|-------------------|------------|------------|------------|
| ** **                                                       | ** ** | **Common**                         | ** ** | ** **               | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Stock**                          | ** ** | ** **               | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Outstanding**                    | ** ** | **Accumulated**          | ** ** | ** **              | ** ** | ** **           | ** ** | ** **          | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **(number of   shares,** | ** ** | **Class A  Common** | ** ** | **Additional  Paid-in** | ** ** | **Treasury  Stock,** | ** ** | **Other  Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **in thousands)**             | ** ** | **Stock**                | ** ** | **Capital**             | ** ** | **at Cost**     | ** ** | **Earnings**        | ** ** | **(Loss)/Income** | ** ** | **Total**  | ** ** |
|                                                             |       |                               |       |                     |       |                    |       |                 |       |                |       |              |       |       |       |
| Comprehensive income:                                            |       |                               |       |                     |       |                    |       |                 |       |                |       |              |       |       |       |
| Net income                                                       |       | —                             |       | —                   |       | —                  |       | —               |       | 87,191              |       | —            |       | 87,191     |       |
| Additional minimum pension  liability, net of tax                |       | —                             |       | —                   |       | —                  |       | —               |       | —              |       | 61,662            |       | 61,662     |       |
| Foreign currency  translation adjustment, net of tax             |       | —                             |       | —                   |       | —                  |       | —               |       | —              |       | 23,266            |       | 23,266     |       |
| Total comprehensive income                                       |       | —                             |       | —                   |       | —                  |       | —               |       | —              |       | —            |       | 172,119    |       |
| Cash dividends declared                                          |       | —                             |       | —                   |       | —                  |       | —               |       | (12,667             | )          | —            |       | (12,667    | )          |
| Repurchases of common stock                                      |       | (150                               | )          | —                   |       | —                  |       | (4,272               | )          | —              |       | —            |       | (4,272     | )          |
| Issuances of common stock -  employee stock purchase plan shares |       | 228                                |       | —                   |       | 405                     |       | 5,850                |       | —              |       | —            |       | 6,255      |       |
| Issuances of common stock -  deferred stock units and other      |       | 181                                |       | —                   |       | 721                     |       | 4,553                |       | —              |       | —            |       | 5,274      |       |
| Issuances of common stock  to outside directors             |       | 14                                 |       | —                   |       | 21                      |       | 356                  |       | —              |       | —            |       | 377        |       |
| Issuances of common stock -  stock options                       |       | 302                                |       | —                   |       | (3,845                  | )          | 7,756                |       | —              |       | —            |       | 3,911      |       |
| Acquisition of WWLLP                                             |       | 9,091                              |       | 91                       |       | 238,627                 |       | —               |       | —              |       | —            |       | 238,718    |       |
| Other business acquisition                                       |       | 93                                 |       | —                   |       | 172                     |       | 2,328                |       | —              |       | —            |       | 2,500      |       |
| Non-qualified stock option  expense                              |       | —                             |       | —                   |       | 307                     |       | —               |       | —              |       | —            |       | 307        |       |
| Tax benefit of exercises of  stock options                       |       | —                             |       | —                   |       | 2,036                   |       | —               |       | —              |       | —            |       | 2,036      |       |
|                                                             |       |                               |       |                     |       |                    |       |                 |       |                |       |              |       |       |       |
| Balance at June 30, 2006                                         |       | 42,386                             |       | $                        | 425        |                    | $          | 386,392              |       | $                   | (2,134     | )                 | $          | 242,599    |       | $ | 21,479 |   | $ | 648,761 |   |
|                                                                  |            |                                    |            |                          |            |                         |            |                      |            |                     |            |                   |            |            |            |  |  |  |  |  |  |

 

See accompanying notes tothe

consolidated financialstatements

68

----

**WATSON WYATT WORLDWIDE, INC.**

**Notes to the ConsolidatedFinancial Statements(Tabular Amounts in Thousands of U.S. Dollars Except Share and Percentage Data)**

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

*Natureof the Business* -Watson Wyatt Worldwide, Inc. (collectively referred to as “we”, “Watson Wyatt”or the “company”), together with our subsidiaries, is an international companyengaged in the business of providing professional consultative services on afee basis, primarily in the human resource areas of employee benefits andcompensation, but also in other areas of specialization such as human capitalconsulting and human resource-related technology consulting.  The company’s fiscal year ends on June 30th.

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

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

*Reclassifications* - Certain amounts previously presented havebeen reclassified to conform to the current presentation.

*Cashand Cash Equivalents*- We consider short-term, highly-liquid investments with original maturities of90 days or less to be cash equivalents. All of our cash and investments at June 30, 2006 were deemed to be cashand cash equivalents.

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

*RevenueRecognition* -Revenue includes fees primarily generated from consulting services provided inthe areas of employee benefits, human capital strategies and related technologysolutions.  We recognize revenue fromthese consulting engagements when hours are worked, 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.  The terms of our contracts with clients arefixed and determinable and can only be changed based on agreement of bothparties.  Individual consultants’ billingrates are principally based on a multiple of salary and compensation costs.

69

----

Revenuefor fixed-fee arrangements, which span multiple months, is based upon thepercentage of completion method.* *The company typically has threetypes of fixed-fee arrangements:  annualrecurring projects, projects of a short duration, and non-recurring systemprojects.  Annual recurring projects andthe projects of short duration are typically straightforward and highlypredictable in nature.  As a result, theproject manager and financial staff are able to identify, as the project statusis reviewed and bills are prepared monthly, the rare occasion when costoverruns could lead to the recording of a loss accrual.

Ournon-recurring system projects are typically found in our Technology andAdministration Solutions Group.  Theytend to be more complex projects that are longer in duration and subject tomore changes in scope as the project progresses than projects undertaken inother segments. We evaluate, at least quarterly, and more often as needed,project managers’ estimates to complete to assure that the projects’ currentstatus is properly accounted for. Contracts are written such that, in the unexpected event that thecustomer terminates a contract, the company gets paid for work performedthrough termination.

Revenuerecognition for fixed-fee engagements is affected by a number of factors thatchange the estimated amount of work required to complete the project such aschanges in scope, the staffing on the engagement and/or the level of clientparticipation.  The periodic engagementevaluations require us to make judgments and estimates regarding the overallprofitability and stage of project completion that, in turn, affect how werecognize revenue.  The companyrecognizes a loss on an engagement when estimated revenue to be received forthat engagement is less than the total estimated direct and indirect costsassociated with the engagement.  Lossesare recognized in the period in which the loss becomes probable and the amountof the loss is reasonably estimable.  Thecompany has experienced certain costs in excess of estimates from time totime.  It is rare, however, for theseexcess costs to result in overall project losses.

The company has developedvarious software programs and technologies that we provide to clients inconnection with consulting services.  Inmost instances, such software is hosted and maintained by the company and ownershipof the technology and rights to the related code remain with the company. Softwaredeveloped to be utilized in providing services to a client, but for which theclient does not have the contractual right to take possession, is capitalizedin accordance with the AICPA’s Statement of Position 98-1 “Accounting for theCosts of Computer Software Developed or Obtained for Internal Use.”  Revenue associated with the related contract,together with amortization of the related capitalized software, is recognizedover the service period.  As a result,and in accordance with EITF 00-3, we do not recognize revenue during thecustomization phase of an engagement.

Revenue recognized in excessof billings is recorded as unbilled accounts receivable.  Cash collections and invoices generated in excessof revenue recognized are recorded as deferred revenue until the revenuerecognition criteria are met.  Clientreimbursable expenses, including those relating to travel, other out-of-pocketexpenses and any third-party costs, are included in revenue, and an equivalentamount of reimbursable expenses are included in professional and subcontractedservices as a cost of revenue.

*ForeignCurrency Translation*- Gains and losses on foreign currency transactions, including settlement ofintercompany receivables and payables, are recognized currently in the “Occupancy,communications and other” line of our Consolidated Statements ofOperations.  Assets and liabilities ofour subsidiaries outside the United States are translated into the reportingcurrency, the U.S. dollar, based on exchange rates at the balance sheetdate.  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 anticipate settlementof such balances in the foreseeable future.

70

----

*FairValue of Financial Instruments* - The carrying amount of our cash and cash equivalents, short-terminvestments, receivables from clients and notes and accounts payableapproximates fair value because of the short maturity and liquidity of thoseinstruments.  There were borrowings of$30 million outstanding under our revolving credit agreement at June 30, 2006and no borrowings as of June 30, 2005. There were no events of default that would require us to satisfy theguarantees described in Note 14.

*Concentrationof Credit Risk* -Financial instruments that potentially subject the company to concentrations ofcredit risk consist principally of certain cash and cash equivalents,short-term investments and receivables from clients.  We invest our excess cash in financialinstruments with short-term ratings no lower than A1/P1 or equivalent.  Concentrations of credit risk with respect toreceivables from clients are limited due to our large number of clients andtheir dispersion across many industries and geographic regions.

*IncurredBut Not Reported (IBNR) Claims**-*The companyaccrues for IBNR professional liability claims that are estimable and probable,and for which we have not yet contracted for insurance coverage.  This liability was $33.9 million and $13.9million at June 30, 2006 and 2005, respectively, with the growth beingattributable to the business combination.

*Stock-based Compensation* - In December 2004, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (FAS 123(R)). FAS 123(R) requires companies to account for share-based paymenttransactions with employees using a fair-value based method, therebyeliminating the disclosure-only provisions of FAS 123.  FAS 123(R) becameeffective for the company as of July 1, 2005. FAS 123(R) was implemented usingthe modified prospective method.

During fiscal year 2004 and 2005, the company elected to follow APB 25in accounting for its share-based compensation plans, in accordance with FAS123.  As a result, the company disclosedpro forma compensation cost as if the company had accounted for its share-basedcompensation plans using a fair value based method.

71

----

Thetable below reflects the effect on net income and earnings per share for fiscalyear 2005 and 2004, as if the company were to recognize compensation expenseunder the “fair-value-based method” of FAS 123.
| ** **                                                                                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                          |       |     |       |     |       |
| Net income, as reported                                                                                                                       |       | $        | 52,162     |     | $          | 50,593 |   |
| Add: Stock-based  compensation expense included in reported net income, net of related tax  effects                                           |       | 241      |       | 243      |       |
| Deduct: Total  stock-based employee compensation expense determined under fair-value-based  method for all awards, net of related tax effects |       | (1,411   | )          | (1,662   | )          |
| Pro forma net  income                                                                                                                         |       | $        | 50,992     |     | $          | 49,174 |   |
|                                                                                                                                          |       |     |       |     |       |
| Earnings per share:                                                                                                                           |       |     |       |     |       |
| Basic - as reported                                                                                                                           |       | $        | 1.60       |     | $          | 1.54 |   |
| Basic - pro forma                                                                                                                             |       | $        | 1.57       |     | $          | 1.50 |   |
|                                                                                                                                          |       |     |       |     |       |
| Diluted - as reported                                                                                                                         |       | $        | 1.58       |     | $          | 1.52 |   |
| Diluted - pro  forma                                                                                                                          |       | $        | 1.55       |     | $          | 1.48 |   |

 

Duringfiscal year 2006, the company recognized compensation expense of $2.1 million,or $.03 per diluted share, in connection with our share-based compensationplans.  This does not include any expenserelated to the 2001 Deferred Stock Unit Plan for Selected Employees, as expenserelated to shares awarded under this plan is recorded as a component of thecompany’s accrual for discretionary compensation.

Thetotal income tax benefit recognized in the income statement for the exercise ofnonqualified stock options and the award of stock purchase plan shares was $2.1million for fiscal year 2006, which has been reported in the ConsolidatedStatements of Cash Flows.

Thecompany repurchases shares of common stock to offset potential dilution fromshares issued in connection with the company’s share-based compensation plans.

*Earningsper Share* - Thecomputation of basic earnings per share is based upon the weighted averagenumber of common shares outstanding. Diluted earnings per share is calculated on the basis of the weightedaverage number of common shares outstanding plus the effect of outstandingstock options and employee stock purchase plan shares using the “treasury stock”method.  See Note 15 for identificationof the components of basic and diluted earnings per share.  The diluted earnings per share calculationassumes that the 1,950,000 contingent shares related to the businesscombination had been issued at the date of the business combination.

72

----

*Goodwill and Intangible Assets* - Goodwill is not amortized but is reviewedfor impairment annually or more frequently if indicators arise. The evaluationis based upon a comparison of the estimated fair value of the reporting unit towhich the goodwill has been assigned to the sum of the carrying value of theassets and liabilities for that reporting unit. The fair values used in thisevaluation are estimated based upon a multiple of revenue for the reportingunit. Intangible assets with definite lives are amortized over their estimateduseful lives and are reviewed for impairment if indicators of impairment arise.The evaluation of impairment would be based upon a comparison of the carryingamount of the intangible asset to the estimated future undiscounted net cashflows expected to be generated by the asset. If estimated future undiscountednet cash flows are less than the carrying amount of the asset, the asset wouldbe considered impaired. The impairment expense would be determined by comparingthe estimated fair value of the intangible asset to its carrying value, withany shortfall from fair value recognized as an expense in the current period.

*RecentAccounting Pronouncements* - In December 2004, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (FAS 123(R)). FAS 123(R) requires companies to account for share-based paymenttransactions with employees using a fair-value based method, therebyeliminating the disclosure-only provisions of FAS 123.   The companyimplemented FAS 123(R) during the first quarter of fiscal year 2006 under the modifiedprospective method.  As a result, duringthe fiscal year 2006, compensation expense totaling $0.3 million related to theoutstanding stock options as of July 1, 2005 has been recognized based on thefair values of the awards previously calculated in preparing the pro formadisclosures in accordance with the provisions of FAS 123, less adjustments forforfeitures.  The adoption of FAS 123(R)has not had a material impact on the financial condition or results ofoperations for the company.

InApril 2005, the Securities and Exchange Commission (SEC) issued StaffAccounting Bulletin No. 107, “Share-Based Payments” (SAB 107) in which the SECexpressed views regarding the interaction between FAS 123(R) and certain SECrules and regulations and provide the staff’s views regarding the valuation ofshare-based payment arrangements for public companies.  The application of SAB 107 has not had amaterial impact on the financial condition or results of operations for thecompany.

InJune 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes”-aninterpretation of FASB Statement No. 109, “Accounting for Income Taxes”, whichclarifies the accounting for uncertainty in income taxes.  FIN 48 prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return.  The Interpretation requires that the companyrecognize in the financial statements, the impact of a tax position, if thatposition is more likely than not of being sustained on audit, based on thetechnical merits of the position.  FIN 48also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods and disclosure.  The provisions of FIN 48 are effective forfiscal years after December 15, 2006 with the cumulative effect of the changein accounting principle recorded as an adjustment to opening retainedearnings.  The company is currentlyevaluating the impact of adopting FIN 48 on the financial statements.

OnOctober 22, 2004, the American Jobs Creation Act (AJCA) was signed intolaw.  The AJCA includes a provision that allows a one-time election toexclude up to 85 percent of foreign unrepatriated earnings. The company hasdetermined there would be no tax benefit from repatriating its foreign earningsunder the provision set forth in the AJCA.

73

----

**Note 2- Business Combination**

On July 31, 2005, the company consummated the businesscombination with WWLLP.  The assetsacquired from WWLLP are held by the company’s principal U.K. subsidiary, WatsonWyatt Limited (the “European business”). The European business results of operations are included in theconsolidated financial statements beginning August 1, 2005 and are not includedin the company’s results for the fiscal year ended June 30, 2005.  Results of WWLLP’s operations for the monthof July 2005 and for fiscal years 2005 and 2004 are included in “income fromaffiliates”. The company and WWLLP had jointly offered services since 1995pursuant to alliance agreements and as a result, have business segments thatare very similar in nature.  See Note 4and 13, respectively, for further information regarding the related accountingand operating segments of the combined company.

We believe the European business has strengthenedWatson Wyatt’s global market presence. The purchase price of $437.0 millionconsisted of £88.3 million in cash, or $156.1 million at the exchange rate ineffect at August 1, 2005, the issuance of 9,090,571 shares of the company’scommon stock valued at $238.7 million, transaction costs of $20.5 million andadditional consideration including debt forgiveness and investmentelimination.  The shares paid were valuedat $26.26 per share, which was the average of the closing market prices of thecompany’s stock over five business days beginning with two business days priorto the announcement date of January 18, 2005 and ending with the two businessdays following the announcement date.  Inaddition, a further 1,950,000 shares may be paid to WWLLP as additionalconsideration after June 30, 2007, contingent upon the achievement by theacquired business of certain agreed-upon financial performance goals.  If the contingent shares are issued they willbe accounted for as goodwill.

74

----

*Purchase Price Allocation*

The business combination has been accounted for usingthe purchase method of accounting as prescribed in Statement of FinancialAccounting Standards No. 141, “Business Combinations” (FAS 141), where theassets acquired and liabilities assumed are recorded at their respective fairvalues as of the combination date.  As ofthe business combination date, the company determined the following estimatedfair values for the proportionate assets purchased and liabilitiesassumed.  The determination of estimatedfair value requires management to make significant estimates and assumptions.The company hired an independent third party to assist in the valuation ofassets.
| ** **                              | ** ** | **August 1, 2005  (in thousands)** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|
| Total purchase  price                   |       |                                              |       | $ | 437,042 |   |
| Less net assets  acquired:              |       |                                              |       |   |   |
| Trademark and trade name                |       | $                                                 | 108,000    |   |   |   |
| Customer related intangibles            |       | 60,600                                            |       |   |   |
| Core/developed technology               |       | 17,500                                            |       |   |   |
| Cash and cash equivalents               |       | 31,230                                            |       |   |   |
| Client receivables and unbilled revenue |       | 111,305                                           |       |   |   |
| Other current assets                    |       | 47,153                                            |       |   |   |
| Fixed assets                            |       | 13,068                                            |       |   |   |
| Other assets                            |       | 3,795                                             |       |   |   |
| Current liabilities                     |       | (154,854                                          | )          |   |   |
| Accrued retirement benefits             |       | (49,046                                           | )          |   |   |
| Other non current liabilities           |       | (33,657                                           | )          |   |   |
|                                    |       |                                              |       | 155,094 |   |
| Allocation of goodwill                  |       |                                              |       | $ | 281,948 |   |
|                                         |            |                                                   |            |  |  |  |  |

 

The allocation of the purchase price resulted in theallocation of $281.9 million to goodwill, which has been assigned to oursegments as follows:
| ** **                                     | ** ** | **Goodwill** | ** ** |
|------------------------------------------------|------------|--------------|------------|
| Benefits                                       |       | $            | 136,463    |   |
| Technology and  Administration Solutions Group |       | 40,037       |       |
| Human Capital  Group                           |       | 16,071       |       |
| Insurance &  Financial Services Group      |       | 52,160       |       |
| Investment  Consulting Group                   |       | 37,217       |       |
| Allocation of goodwill  to business segments   |       | $            | 281,948    |   |

 

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

75

----

*Hedge Treatment*

During the third quarter of fiscal year 2005, thecompany entered into a foreign currency forward contract to offset the riskassociated with the foreign exchange (British Pound) exposure inherent in thecombination.  The forward contract providedfor the purchase of £88 million at a fixed price of $164.5 million, with asettlement date of July 29, 2005.  Inaccordance with Statement of Financial Accounting Standards No. 133, “Accountingfor Derivative Instruments and Hedging Activities” (FAS 133), as amended andinterpreted, since the forward contract was associated with a businesscombination that is subject to the provisions of FAS 141 and the combinationinvolved an equity method investment, the forward contract did not qualify forhedge accounting.  As a result, changesin fair value associated with the forward contract were required to berecognized in the Consolidated Statements of Operations.  Consequently, a loss of $3.6 million wasrecognized during the first quarter of fiscal year 2006 and included in othernon-operating income.  Total lossesrecognized under this forward contract were $8.4 million.

*Pro Forma Financial Information*

The following unaudited pro forma combined statementsof operations have been provided to present illustrative combined unauditedstatements of operations for the years ended June 30, 2006 and 2005, givingeffect to the business combination as if it had been completed on July 1, 2005and 2004, respectively.  The unauditedhistorical combined statement of operations for the three month period endedJune 30, 2006 reflects the actual financial results of the combinedcompany.  The three month period endedJune 30, 2005 combines the historical financial results of Watson Wyatt for thethree months ended June 30, 2005 with the pro forma historical financialresults from WWLLP for the three months ended June 30, 2005.  The year ended June 30, 2006 includeshistorical financial results from July 2005 of Watson Wyatt, pro forma resultsof WWLLP for the month of July 2005, combined with the results of theconsolidated entity from August 1, 2005 through June 30, 2006.  The year ended June 30, 2005 combines thehistorical financial results of Watson Wyatt for the year ended June 30, 2005with the pro forma historical financial results from WWLLP for the year endedJune 30, 2005.

The unaudited pro forma combined financial informationshows the impact of the business combination on Watson Wyatt’s historical results of operations.  The unaudited pro forma combined incomestatements are presented for illustrative purposes only and are not indicativeof the results of operations that might have occurred had the businesscombination actually taken place as of the dates specified, or that may beexpected to occur in the future.  They donot assume any benefits from any cost savings or synergies and do not reflectany integration costs that the combined company realized or incurred after thecombination.

76

----

 

**Pro-Forma Combined Statements ofOperations**

(in thousands, except per share data)
| ** **                                              | ** ** | **Year Ended June 30,** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                              | ** ** | ** **                             | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                                              | ** ** | **2006**                               | ** ** | **2005** | ** ** | **Change** | ** ** |
| ** **                                              | ** ** | **(Unaudited)**                        | ** ** | ** ** | ** ** |
|                                                    |       |                                   |       |   |   |   |   |
| Revenue                                                 |       | $                                      | 1,308,730  |   | $ | 1,206,674 |   | 8.5 |   |
|                                                    |       |                                   |       |   |   |   |   |
| Costs of providing  services:                           |       |                                   |       |   |   |   |   |
| Salaries and employee benefits                          |       | 723,089                                |       | 677,456 |   | 6.7 |   |
| Professional and subcontracted services                 |       | 85,356                                 |       | 75,656 |   | 12.8 |   |
| Occupancy, communications and other                     |       | 167,331                                |       | 157,096 |   | 6.5 |   |
| General and administrative expenses                     |       | 153,720                                |       | 148,678 |   | 3.4 |   |
| Depreciation and amortization                           |       | 46,343                                 |       | 38,653 |   | 19.9 |   |
|                                                    |       | 1,175,839                              |       | 1,097,539 |   | 7.1 |   |
|                                                    |       |                                   |       |   |   |   |   |
| Income from  operations                                 |       | 132,891                                |       | 109,135 |   | 21.8 |   |
|                                                    |       |                                   |       |   |   |   |   |
| Income from  affiliates                                 |       | 647                                    |       | 185 |   | 249.7 |   |
| Interest  (expense)/income, net                         |       | (181                                   | )          | (1,026 | ) | (82.4 | ) |
| Other  non-operating income (loss)                      |       | 1,521                                  |       | (2,638 | ) | (157.7 | ) |
|                                                    |       |                                   |       |   |   |   |   |
| Income from  continuing operations before income taxes  |       | 134,878                                |       | 105,656 |   | 27.7 |   |
|                                                    |       |                                   |       |   |   |   |   |
| Provision for  income taxes                             |       | 46,881                                 |       | 40,044 |   | 171 |   |
|                                                    |       |                                   |       |   |   |   |   |
| Income from  continuing operations                      |       | $                                      | 87,997     |   | $ | 65,612 |   | 34.1 |   |
|                                                    |       |                                   |       |   |   |   |   |
| Basic earnings per  share:                              |       | $                                      | 2.13       |   | $ | 1.58 |   |   |   |
| Diluted earnings per  share:                            |       | $                                      | 2.03       |   | $ | 1.50 |   |   |   |
|                                                    |       |                                   |       |   |   |   |   |
| Weighted average  shares of common stock, basic (000)   |       | 41,393                                 |       | 41,632 |   |   |   |
| Weighted average shares  of common stock, diluted (000) |       | 43,297                                 |       | 43,723 |   |   |   |

 

77

----

**Note 3- Cash Flow Information**

Netcash from operating activities in the Consolidated Statements of Cash Flowsincludes cash payments for the following:
| ** **       | ** ** | **Year Ended June 30** | ** **                                |
|------------------|------------|---------------------------------------|-------------------------------------------|
| ** **       | ** ** | **2006**                              | ** **                                | **2005** | ** ** | **2004** | ** ** |
|             |       |                                  |                                      |   |   |   |   |
| Interest expense |       | $                                     |       3,822 |   | $ |       662 |   | $ |       780 |   |
| Income taxes     |       | 21,578                                |                                      | 43,373 |   | 43,077 |   |
|                  |            |                                       |                                           |  |  |  |  |  |  |  |

 

**Note 4 -Investments in Affiliates**

Thecompany has historically operated globally as an alliance with ouraffiliates.  The company’s investment inaffiliates in fiscal year 2005 and 2004 included our investments in threeentities:  WWLLP, WWHE and PCIC.  As a result of the business combinationdescribed in Note 2, WWLLP and WWHE ceased to be affiliates during fiscal year2006 and began to be included in the company’s consolidated results from theeffective date of the business combination. PCIC remains an affiliate of the company as of June 30, 2006.  Our share of the results of our affiliates,recorded using the equity method of accounting, is reflected in the “Incomefrom affiliates” line in the Consolidated Statements of Operations.

Entitiesaccounted for under the equity method and our investments in those affiliatesas of June 30, 2006 and 2005 are as follows:
| ** **                                        | ** ** | **June 30** | ** **                                      |
|---------------------------------------------------|------------|------------------|-------------------------------------------------|
| ** **                                        | ** ** | **2006**         | ** **                                      | **2005** | ** ** |
|                                              |       |             |                                            |   |   |
| Watson Wyatt LLP                                  |       | $                | —                                          |   | $ | 17,583 |   |
| Watson Wyatt  Holdings (Europe) Limited           |       | —           |                                            | 6,998 |   |
| Professional  Consultants Insurance Company, Inc. |       | 8,564            |                                            | 6,276 |   |
|                                              |       |             |                                            |   |   |
| Total investment in  affiliates                   |       | $                |        8,564 |   | $ |      30,857 |   |

 

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

WWLLP and WWHE were the company’s principal affiliates from April 1,1995 through the date of the business combination, which was effective July 31,2005.  During that timeframe, the companyrecorded its share of results from these entities as “Income from affiliates”and thus the first month of fiscal year 2006 (July 2005) has been accounted forunder the equity method, and included in “Income from affiliates” while theresults for the remainder of the fiscal year are included in our consolidatedresults.  Our investment in these twoentities was eliminated in conjunction with the accounting for the businesscombination.

78

----

*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.

Capital contributions to PCIC are required when approved by a majorityof its stockholders.  From the time PCICwas organized through June 30, 2006, we have contributed $5.4 million in cashand have designated PCIC as the beneficiary on a total of $8.0 million ofletters of credit. Our ownership interest in PCIC as of June 30, 2006 and 2005was 34.15 and 34.8 percent, respectively. 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 $8.6million, combined with letters of credit totaling $8.0 million for which PCIChas been designated as beneficiary, for a total maximum exposure of $16.6million.

Fiscal year 2006 includes the company’s only affiliate, PCIC, comparedto fiscal year 2005 which includes affiliates PCIC, WWLLP, and WWHE.  Combined summarized balance sheet informationat June 30 for all of the company’s affiliates is as follows:
| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |
| Current assets                                   |       | $        | 98,011     |     | $          | 287,166 |   |
| Noncurrent assets                                |       | 101,518  |       | 166,616  |       |
|                                             |       |     |       |     |       |
| Total assets                                     |       | $        | 199,529    |     | $          | 453,782 |   |
|                                             |       |     |       |     |       |
| Current liabilities                              |       | $        | 20,831     |     | $          | 123,550 |   |
| Noncurrent liabilities                           |       | 155,107  |       | 200,866  |       |
| Stockholders’ equity                        |       | 23,591   |       | 129,366  |       |
|                                             |       |     |       |     |       |
| Total  liabilities and stockholders’ equity |       | $        | 199,529    |     | $          | 453,782 |   |

 

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:
| ** **           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------|------------|----------|------------|----------|------------|----------|------------|
|                 |       |     |       |     |       |     |       |
| Revenue              |       | $        | 33,313     |     | $          | 495,264  |       | $ | 423,783 |   |
| Operating  expenses  |       | 26,391   |       | 373,423  |       | 294,260  |       |
|                 |       |     |       |     |       |     |       |
| Income before  taxes |       | 6,922    |       | 121,841  |       | 129,523  |       |
|                 |       |     |       |     |       |     |       |
| Net income           |       | $        | 4,568      |     | $          | 121,612  |       | $ | 127,152 |   |

 

79

----

The company adopted FIN 46(R) in March 2004. FIN 46(R) expands existingaccounting guidance about when a company should include in its consolidatedfinancial statements the assets, liabilities, and activities of anotherentity.  In general, FIN 46(R) requires avariable interest entity (VIE), as defined by FIN 46(R), to be consolidated byits primary beneficiary.  The primarybeneficiary is defined as the company that will absorb a majority of the VIE’sexpected losses or residual returns if they occur.  Since the company is not obligated to absorba majority of expected losses or residual returns in the entities it determinedto be variable interest entities, the company is not required to consolidatethese entities.  Therefore, the adoptionof FIN 46(R) had no effect on the company.

**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.  Leasehold improvementsare amortized on a straight-line basis over the shorter of the lease terms orthe asset lives.

The components of fixed assets are:
| ** **                                       | ** ** | **June 30** | ** ** |
|--------------------------------------------------|------------|------------------|------------|
| ** **                                       | ** ** | **2006**         | ** ** | **2005** | ** ** |
|                                             |       |             |       |   |   |
| Furniture,  fixtures and equipment               |       | $                | 104,367    |   | $ | 85,994 |   |
| Computer  software                               |       | 99,630           |       | 58,184 |   |
| Leasehold  improvements                          |       | 66,241           |       | 52,695 |   |
|                                             |       | 270,238          |       | 196,873 |   |
| Less:  accumulated depreciation and amortization |       | (122,500         | )          | (102,840 | ) |
|                                             |       |             |       |   |   |
| Fixed assets,  net                               |       | $                | 147,738    |   | $ | 94,033 |   |

 

Total unamortized computer software costs were $74.2 million and $45.1million as of June 30, 2006 and 2005, respectively.  Total amortization expense for computersoftware was $12.9 million and $5.1 million for fiscal year 2006 and 2005,respectively.

**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 and Hong Kong), benefits are based on the number of years of service andthe associates’ compensation during the five highest paid consecutive years ofservice.  The non-qualified plan providesfor pension benefits that would be covered under the qualified plan but arelimited by the Internal Revenue Code. The non-qualified plan has no assets and therefore is an unfundedarrangement which is reflected in the balance sheet.  The measurement date for the plans is June30.  In March 2006, the company amendedits U.S. pension plan to remove long-term disability benefits from the planeffective July 1, 2006.  These benefitswill thereafter be provided through an insurance provider.  Given the significance of this amendment, thecompany remeasured the pension plan effective March 31, 2006.  The remeasurement caused pension expense todecrease by $4.0 million during the fourth quarter of fiscal year 2006.

80

----

Asa result of the business combination described in Note 2, we have included thedefined benefit pension plan disclosures for our U.K. operations.  The disclosures for this plan, along withthose of our historical U.K. plan, are shown separately because the amounts aresignificant relative to all plans and the assumptions used in the plan aresignificantly different than those used in all other plans. Under our newlyacquired plan in the U.K., benefits are based on the number of years of serviceand the associates’ compensation during the three years before leaving theplan. The measurement date for the plan is July 31.

Determination of our obligations and annual expense under the plans isbased on a number of assumptions that, given the longevity of the plans, arelong-term in focus.  A change in one or acombination of these assumptions could have a material impact on our pensionbenefit obligation and related expense. For this reason, management employs a long-term view so that assumptionsdo not change frequently in response to short-term volatility in theeconomy.  Any difference between actualand assumed results is amortized into our pension expense over the average remainingservice period of participating employees. We consider several factors prior to the start of each fiscal year whendetermining the appropriate annual assumptions, including economic forecasts,historical trends, portfolio composition and peer comparisons.

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  pension contributions for fiscal year 2007, aswell as the pension contributions to our various plans in fiscal years 2006 and2005:
| ** ** | ** ** | **2007  (Projected)** | ** **               | **2006  (Actual)** | ** ** | **2005  (Actual)**       | ** ** |
|------------|------------|-----------------------|--------------------------|--------------------|------------|--------------------------|------------|
| U.S.       |       | $                     |    10,000 |               | $          |    15,000 |       | $ |    10,000 |   |
| Canada     |       | 2,500                 |                     | 2,747              |       | 2,431                    |       |
| Hong Kong  |       | 1,100                 |                     | 1,023              |       | 1,009                    |       |
| U.K.       |       | 12,000                |                     | 11,039             |       | 848                      |       |
|            |            |                       |                          |                    |            |                          |            |  |  |  |

 

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, which vary by country. To the extent the expected return on the pension portfolio varies fromthe actual return, there is 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** | ** **                |
|----------------------------------------------|------------|------------------|---------------------------|
| ** **                                   | ** ** | **2006**         | ** **                | **2005** | ** ** |
|                                         |       |             |                      |   |   |
| Defined benefit  retirement plans            |       | $                |    103,489 |   | $    151,990 |   |
| Canadian  Separation Allowance Plan          |       | 3,766            |                      | 4,067 |   |
| Postretirement  benefits other than pensions |       | 55,250           |                      | 48,972 |   |
|                                         |       |             |                      |   |   |
| Accrued retirement  benefits                 |       | $                |    162,505 |   | $ |    205,029 |   |
|                                              |            |                  |                           |  |  |  |  |

 

81

----

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** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                         |       |                                  |       |   |   |   |   |
| Discount rate, Projected Benefit Obligation                  |       | 6.25%                                 |       | 5.25% |   | 6.25% |   |
| Discount rate, Net Periodic Benefit Cost                     |       | 5.25%                                 |       | 6.25% |   | 6.00% |   |
| Expected  long-term rate of return on assets                 |       | 8.75%                                 |       | 9.00% |   | 9.00% |   |
| Rate of increase in compensation, PBO                        |       | 3.84%                                 |       | 3.34% |   | 3.34% |   |
| Rate  of increase in compensation, Net Periodic Benefit Cost |       | 3.34%                                 |       | 3.34% |   | 3.09% |   |

 

The 6.25 percent discount rate assumption used at the end of fiscalyear 2006 represents a 100 basis point increase from the 5.25 percent discountrate used at the end of fiscal year 2005 and represents the same discount rateused at the end of fiscal year 2004.  Thecompany’s 2006 discount rate assumption was determined by matching futurepension benefit payments with expected future AA bond yields for the sameperiods.

The expected long-term rate of return on assets assumption decreased to8.75 percent per annum representing a 25 basis point decrease from the 9percent rate utilized in fiscal years 2005 and 2004.  Selection of the return assumption at 8.75percent per annum was supported by an analysis performed by the company of theweighted average yield expected to be achieved with the anticipated makeup ofinvestments.  The investment makeup isheavily weighted towards equities.  Thereturn on assets for fiscal year 2006 was 9.4 percent, compared to a return of10.0 percent for fiscal year 2005.

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 lossesassociated with changing any of these assumptions are not recognizedimmediately; instead they are accumulated as part of the unrecognized net loss(gain) balance and amortized into the net periodic pension expense over theaverage remaining service 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, 2006** | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------|------------|
| ** **                              | ** ** | **North  America &**                    | ** ** | ** **                            | ** ** | ** ** | ** ** | **North America & Hong Kong** | ** ** |
| ** **                              | ** ** | **Hong Kong**                               | ** ** | **U.K.**                              | ** ** | **TOTAL** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                    |       |                                             |       |                                  |       |   |   |   |   |   |   |
| Service cost                            |       | $                                                | 30,515     |                                  | $          | 11,007 |   | $ | 41,522 |   | $ | 25,202 |   | $ | 26,674 |   |
| Interest cost                           |       | 37,421                                           |       | 14,319                                |       | 51,740 |   | 36,457 |   | 33,490 |   |
| Expected return on plan assets          |       | (44,647                                          | )          | (13,717                               | )          | (58,364 | ) | (42,580 | ) | (35,831 | ) |
| Amortization of transition obligation   |       | (9                                               | )          | —                                |       | (9 | ) | (7 | ) | (4 | ) |
| Amortization of net unrecognized losses |       | 16,155                                           |       | 294                                   |       | 16,449 |   | 6,989 |   | 11,406 |   |
| Amortization of prior service cost      |       | (1,718                                           | )          | 11                                    |       | (1,707 | ) | (2,161 | ) | (2,169 | ) |
|                                    |       |                                             |       |                                  |       |   |   |   |   |   |   |
| Net periodic pension  cost              |       | $                                                | 37,717     |                                  | $          | 11,914 |   | $ | 49,631 |   | $ | 23,900 |   | $ | 33,566 |   |

 

82

----

The following table summarizes benefit obligationsassociated with the qualified plans:
| ** **                                        | ** ** | **June 30, 2006**                   | ** ** | **June 30, 2005** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | **North  America &  Hong Kong** | ** ** | **U.K.**                    | ** ** | **Total** | ** ** | **North  America &  Hong Kong** | ** ** |
|                                              |       |                                          |       |                        |       |   |   |   |   |
| Accumulated benefit obligation                    |       | $                                             | 526,563    |                        | $          | 289,131 |   | $ | 815,694 |   | $ | 592,823 |   |
|                                              |       |                                          |       |                        |       |   |   |   |   |
| Projected benefit obligation at beginning of year |       | $                                             | 615,838    |                        | $          | 312,481 |   | $ | 928,319 |   | $ | 508,725 |   |
| Service cost                                      |       | 24,514                                        |       | 11,007                      |       | 35,521 |   | 19,896 |   |
| Interest cost                                     |       | 32,369                                        |       | 14,319                      |       | 46,688 |   | 31,518 |   |
| Actuarial (gains)/losses                          |       | (70,534                                       | )          | (1,330                      | )          | (71,864 | ) | 85,607 |   |
| Benefit payments                                  |       | (17,981                                       | )          | (3,869                      | )          | (21,850 | ) | (16,975 | ) |
| Plan amendments                                   |       | (11,999                                       | )          | —                      |       | (11,999 | ) | — |   |
| Change in assumptions                             |       | (1,484                                        | )          | —                      |       | (1,484 | ) | 10,042 |   |
| Settlements                                       |       | 305                                           |       | —                      |       | 305 |   | 253 |   |
| Other                                             |       | —                                        |       | 1,380                       |       | 1,380 |   | 845 |   |
| Foreign currency adjustment                       |       | 4,530                                         |       | 10,874                      |       | 15,404 |   | 2,794 |   |
| Projected  benefit obligation at end of year      |       | $                                             | 575,558    |                        | $          | 344,862 |   | $ | 920,420 |   | $ | 642,705 |   |

 

The following table summarizes benefit obligations associated with theNorth America non-qualified plans.  HongKong and U.K. do not have non-qualified plans.
| ** **                                        | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | **Non-  Qualified**         | ** ** | **Non-  Qualified**         | ** ** |
| Accumulated  benefit obligation                   |       | $                           | 74,454     |                        | $          | 73,131 |   |
|                                              |       |                        |       |                        |       |
| Projected benefit obligation at beginning of year |       | $                           | 92,613     |                        | $          | 78,490 |   |
| Service cost                                      |       | 6,001                       |       | 5,306                       |       |
| Interest cost                                     |       | 5,052                       |       | 5,031                       |       |
| Actuarial losses                                  |       | 3,999                       |       | 13,740                      |       |
| Benefit payments                                  |       | (9,574                      | )          | (1,418                      | )          |
| Change in assumptions                             |       | 132                         |       | 1,389                       |       |
| Settlements                                       |       | —                      |       | (11,100                     | )          |
| Plan  Amendments                                  |       | (2,972                      | )          | —                      |       |
| Foreign  currency adjustment                      |       | 1,538                       |       | 1,175                       |       |
| Projected benefit obligation at end of year       |       | $                           | 96,789     |                        | $          | 92,613 |   |

 

83

----

The table below provides information for the U.S. qualified pensionplan with an accumulated benefit obligation in excess of plan assets in fiscalyear 2005.  In fiscal year 2006, the U.S.qualified plan assets were greater than the accumulated benefit obligation.
| ** **                      | ** ** | **June 30, 2006**                   | ** ** | **June 30, 2005** | ** ** |
|---------------------------------|------------|-----------------------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **North  America &  Hong Kong** | ** ** | **U.K.**                    | ** ** | **Total** | ** ** | **North  America &  Hong Kong** | ** ** |
|                            |       |                                          |       |                        |       |   |   |   |   |
| Projected  Benefit Obligation   |       | $                                             | 575,558    |                        | $          | 344,862 |   | $ | 920,420 |   | $ | 554,746 |   |
| Accumulated  Benefit Obligation |       | 526,563                                       |       | 289,131                     |       | 815,694 |   | 512,162 |   |
| Fair Value of Plan Assets       |       | $                                             | 557,531    |                        | $          | 294,154 |   | $ | 851,685 |   | $ | 445,002 |   |

 

The non-qualified amounts reflect only the U.S. and Canadian plans andare unfunded.
| ** **                      | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|---------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **Non-  Qualified**         | ** ** | **Non-  Qualified**         | ** ** |
| Projected Benefit  Obligation   |       | $                           | 96,789     |                        | $          | 92,613 |   |
| Accumulated  Benefit Obligation |       | 74,454                      |       | 73,131                      |       |
| Fair Value of Plan Assets       |       | $                           | —     |                        | $          | — |   |

 

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

The table below provides information for the historical U.K. pensionplan with an accumulated benefit obligation in excess of plan assets in fiscalyears 2006 and 2005.
| ** **                      | ** ** | **June 30,  2006** | ** **               | **June 30,  2005** | ** ** |
|---------------------------------|------------|-------------------------|--------------------------|-------------------------|------------|
|                            |       |                    |                     |                    |       |
| Projected  Benefit Obligation   |       | $                       |    30,164 |                    | $          |    26,867 |   |
| Accumulated  Benefit Obligation |       | 30,164                  |                     | 26,867                  |       |
| Fair Value of Plan Assets       |       | 26,057                  |                     | 21,147                  |       |
|                                 |            |                         |                          |                         |            |  |  |

 

The newly acquired U.K. plan had assets greater than the accumulatedbenefit obligation.

84

----

The following table summarizes plan assets associated with thequalified plans:
| ** **                                     | ** ** | **June 30, 2006**                   | ** ** | **June 30, 2005** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **North  America &  Hong Kong** | ** ** | **U.K.**                    | ** ** | **Total** | ** ** | **North  America &  Hong Kong** | ** ** |
|                                           |       |                                          |       |                        |       |   |   |   |   |
| Fair value of plan assets at beginning of year |       | $                                             | 505,740    |                        | $          | 254,513 |   | $ | 760,253 |   | $ | 476,022 |   |
| Actual return on plan assets                   |       | 46,291                                        |       | 21,742                      |       | 68,033 |   | 49,537 |   |
| Company contributions                          |       | 18,770                                        |       | 11,039                      |       | 29,809 |   | 14,288 |   |
| Benefit payments                               |       | (17,981                                       | )          | (3,869                      | )          | (21,850 | ) | (16,975 | ) |
| Participant contributions                      |       | —                                        |       | 1,380                       |       | 1,380 |   | 845 |   |
| Foreign currency adjustment                    |       | 4,711                                         |       | 9,349                       |       | 14,060 |   | 3,170 |   |
| Fair  value of plan assets at end of year      |       | $                                             | 557,531    |                        | $          | 294,154 |   | $ | 851,685 |   | $ | 526,888 |   |

 

The following table, and the narrative that follows, provideinformation relating to the weighted-average asset allocations at June 30, 2006and 2005 and the investment strategy for the company’s U.S. and U.K. definedbenefit pension plan, which comprises the majority of our defined benefitpension plans:
| ** **         | ** ** | **North America Plan  Assets at June 30,** | ** ** | **U.K. Plan Assets  at June 30,** | ** ** |
|--------------------|------------|---------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **         | ** ** | **2006**                                                            | ** ** | **2005**                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Asset Category     |       |                                                                |       |                                                  |       |   |   |   |   |
| Equity  securities |       | 73.7                                                                | %          | 84.5                                                  | %          | 26.0 | % | 25.0 | % |
| Debt securities    |       | 26.0                                                                |       | 15.5                                                  |       | 57.0 |   | 65.0 |   |
| Real estate        |       | 0.0                                                                 |       | 0.0                                                   |       | 14.0 |   | 10.0 |   |
| Other              |       | 0.3                                                                 |       | 0.0                                                   |       | 3.0 |   | 0.0 |   |
| Total              |       | 100.0                                                               | %          | 100.0                                                 | %          | 100.0 | % | 100.0 | % |

 

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 policybenchmark reflecting the target weights of the asset classes used in itstargeted strategic asset allocation.  Theplan’s targeted strategic allocation to each asset class was determined throughan Asset-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 different assetmixes, spanning a range of diversification and potential equity exposures.

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 for each of the plans is displayed above.

85

----

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 actual return on assets for the U.S. planin fiscal year 2006 was 9.4 percent, compared to a return of 10.2 percent infiscal year 2005. The actual return on assets for the U.K. plan in fiscal year2006 was 7.8 percent.

Benefit payments for our defined benefit pension plan, which reflectexpected future service, as appropriate, are expected to be paid as follows:

| Fiscal Year  | ** ** | **Benefit Payments**                     | ** ** |
|-------------------|------------|-----------------------------------------------|------------|
| ** **        | ** ** | **North  America &  Hong Kong** | ** ** | **U.K.** | ** ** | **Total** | ** ** |
| 2007              |       | $                                             | 24,994     |   | $ | 4,808 |   | $ | 29,802 |   |
| 2008              |       | 26,880                                        |       | 4,993 |   | 31,873 |   |
| 2009              |       | 31,897                                        |       | 5,363 |   | 37,260 |   |
| 2010              |       | 31,195                                        |       | 5,918 |   | 37,113 |   |
| 2011              |       | 33,768                                        |       | 6,288 |   | 40,056 |   |
| Years 2012 - 2016 |       | 217,279                                       |       | 39,760 |   | 257,039 |   |
|              |       | $                                             | 366,013    |   | $ | 67,130 |   | $ | 433,143 |   |

 

The following table summarizes the funding status associated with thequalified and non-qualified plans:
| ** **                                 | ** ** | **June 30, 2006**                   | ** ** | **June 30, 2005** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **North  America &  Hong Kong** | ** ** | **U.K.**                    | ** ** | **Total** | ** ** | **North  America &  Hong Kong** | ** ** |
|                                       |       |                                          |       |                        |       |   |   |   |   |
| Funded status at end of year               |       | $                                             | (18,027    | )                           | $          | (50,708 | ) | $ | (68,735 | ) | $ | (115,815 | ) |
| Unrecognized prior service cost            |       | (17,904                                       | )          | 115                         |       | (17,789 | ) | (7,489 | ) |
| Unrecognized net loss/(gain)               |       | 84,951                                        |       | (675                        | )          | 84,276 |   | 177,824 |   |
| Unrecognized transition obligation/(asset) |       | (160                                          | )          | —                      |       | (160 | ) | (209 | ) |
| Net  amount recognized                     |       | $                                             | 48,860     |                        | $          | (51,268 | ) | $ | (2,408 | ) | $ | 54,311 |   |

 

86

----

The following table summarizes the funding status associated with theNorth America non-qualified plans. Hong Kong and UK do not have non-qualifiedplans.
| ** **                                 | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **Non-  Qualified**         | ** ** | **Non-  Qualified**         | ** ** |
| Funded  status at end of year              |       | $                           | (96,789    | )                           | $          | (92,613 | ) |
| Unrecognized prior service cost            |       | (5,826                      | )          | (3,248                      | )          |
| Unrecognized net loss/(gain)               |       | 10,664                      |       | 7,679                       |       |
| Unrecognized transition obligation/(asset) |       | 115                         |       | 166                         |       |
| Net  amount recognized                     |       | $                           | (91,836    | )                           | $          | (88,016 | ) |

 

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.

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, thereby eliminatingthe requirement to record an additional minimum pension liability for the U.S.plans. This resulted in a decrease in the pension liability recorded in theprevious year of $105.4 million, a reduction in the charge to Stockholders’Equity of $62.4 million (reflected in accumulated other comprehensive loss) anda decrease in deferred tax assets of $43.1 million as of June 30, 2004. Thevalue of the assets held in the pension plan in the U.K. remained below theaccumulated benefit obligation, resulting in the accumulated benefit obligationremaining greater than 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 inaccumulated other comprehensive loss) and an increase in deferred tax assets of$0.5 million as of June 30, 2004 was recorded for the U.K.

In fiscal year 2005, the decline in interest rates caused ouraccumulated benefit obligation to increase, resulting in the accumulated benefitobligation becoming greater than the value of the plan assets for the U.Spension plans.  Our Canadiannon-qualified plan had a liability recorded in the financial statements thatwas less than its accumulated benefit obligation.  As a result, in both scenarios above, thecompany was required to record an additional minimum pension liability forthose plans in accordance with Statement of Financial Accounting Standards No.87 “Employers’ Accounting for Pensions” (FAS 87).  This resulted in an increase in the pensionliability of $103.7 million, an increase in intangible assets of $0.6 million,a non-cash charge to Stockholders’ Equity of $61.3 million (reflected inaccumulated other comprehensive loss) and an increase in deferred tax assets of$42.4 million.  Our U.K. plan currentlyhas an additional minimum pension liability recorded of $9.1 million at June30, 2005.  Our Canadian and Hong Kongqualified pension plan assets were greater than their associated accumulatedbenefit obligation as of June 30, 2005 and 2004 and thus did not require therecording of additional minimum pension liabilities in either period.

87

----

In fiscal year 2006, the rise in interest rates was the principalreason for the decrease in our accumulated benefit obligation, resulting in planassets becoming greater than the accumulated benefit obligation for the U.Spension plans.  As a result, the companyis no longer required to record a minimum pension liability.  Elimination of the prior year’s minimumpension liability resulted in a decrease in the pension liability of $103.7million, a reduction in the charge to Stockholders’ Equity of $61.3 million(reflected in accumulated other comprehensive loss) and a decrease in deferredtax assets of $42.4 million as of June 30, 2006. Our Canadian non-qualifiedplan liability recorded in the financial statements remained less than itsaccumulated benefit obligation, although the amount of the difference decreasedin fiscal year 2006, resulting in an decrease in the pension liability of$760,000, a decrease in intangible assets of $78,000, a reduction in the chargeto Stockholders’ Equity of $403,000 (reflected in accumulated othercomprehensive loss) and a decrease in deferred tax assets of $279,000.  The value of the assets held in thehistorical 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. historical pension plan.  Our historical U.K. plan currently has an additionalminimum pension liability recorded of $9.0 million at June 30, 2006.  Our Canadian and Hong Kong qualified pensionplan assets were greater than their associated accumulated benefit obligationsas of June 30, 2006 and 2005 and thus did not require the recording ofadditional minimum pension liabilities in either period.

As of June 30, 2006, our Consolidated Balance Sheets reflect therecording of a minimum pension liability of $10.2 million, an intangible assetof $0.6 million, an accumulated other comprehensive loss of $6.7 million(reflected in Stockholders’ Equity) and a deferred tax asset of $2.9 million.

The table below summarizes the amounts reflected in our ConsolidatedBalance Sheets for the period indicated:
| ** **                             | ** ** | **June 30, 2006**                   | ** ** | **June 30, 2005** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **North  America &  Hong Kong** | ** ** | **U.K.**                    | ** ** | **Total** | ** ** | **North  America &  Hong Kong** | ** ** |
|                                   |       |                                          |       |                        |       |   |   |   |   |
| Prepaid (accrued) benefit cost         |       | $                                             | 48,860     |                        | $          | (51,268 | ) | $ | (2,408 | ) | $ | 54,311 |   |
| Accrued benefit liability              |       | —                                        |       | (9,154                      | )          | (9,154 | ) | (112,842 | ) |
| Intangible assets                      |       | —                                        |       | 115                         |       | 115 |   | 122 |   |
| Accumulated other comprehensive income |       | —                                        |       | 9,039                       |       | 9,039 |   | 112,720 |   |
| Net  amounts recognized                |       | $                                             | 48,860     |                        | $          | (51,268 | ) | $ | (2,408 | ) | $ | 54,311 |   |

 
| ** **                             | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **Non-  Qualified**         | ** ** | **Non-  Qualified**         | ** ** |
| Prepaid  (accrued) benefit cost        |       | $                           | —     |                        | $          | — |   |
| Accrued benefit liability              |       | (92,950                     | )          | (89,723                     | )          |
| Intangible assets                      |       | 456                         |       | 486                         |       |
| Accumulated other comprehensive income |       | 658                         |       | 1,221                       |       |
| Net  amounts recognized                |       | $                           | (91,836    | )                           | $          | (88,016 | ) |

 

88

----

*Defined Contribution Plans*

We sponsor a savings plan that provides benefits to substantially allU.S. associates.  The company provides amatch to employee contributions at a rate of 50% of the first 6% up to $60,000of associates’ eligible compensation.  Thecompany will also make an annual profit sharing contribution to the plan in anamount that is dependant upon the company’s financial performance during thefiscal year.  The company contributed$3.4 million, $3.0 million, and $0 in fiscal years 2006, 2005, and 2004respectively.

We also sponsor a Canadian Separation Allowance Plan (CSAP) thatprovides retirement 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 theConsolidated Balance Sheets of the company. CSAP expense for fiscal years 2006, 2005 and 2004 amounted to $187,000,$192,000 and $243,000, respectively.

*Health Care Benefits*

We sponsor a contributory health care plan that provides hospitalization,medical and dental benefits to substantially all U.S. associates.  We accrue a liability for estimated incurredbut unreported claims based on projected use of the plan as well as prior planhistory.  The liability totaled $2.3million at June 30, 2006 and 2005, 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** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                  |       |                                  |       |   |   |   |   |
| Health  care cost trend, accumulated benefit obligation:              |       |                                  |       |   |   |   |   |
| Pre-65 benefits (decreasing to 5.00% for 2010 and thereafter)         |       | 9.00%                                 |       | 10.00% |   | 9.00% |   |
| Post-65 benefits (decreasing to 5.00% for 2010 and thereafter)        |       | 9.00%                                 |       | 10.00% |   | 9.00% |   |
| Discount  rate, accumulated benefit obligation postretirement benefit |       | 6.25%                                 |       | 5.25% |   | 6.25% |   |

 

Actuarial gains and losses associated with changing any of theassumptions are accumulated as part of the unrecognized net gain balance whichis amortized and included in the netperiodic postretirement costs over the average remaining service periodof participating employees, which is approximately 16 years.

89

----

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 2006       |       | $                | 341        |             | $          | (234 | ) |
| Effect  on accumulated postretirement benefit obligation as of June 30, 2006 |       | $                | 2,700      |             | $          | (2,201 | ) |

 

Net periodic postretirement benefit cost consists of the followingcomponents reflected as expense in the company’s Consolidated Statements ofOperations:
| ** **                                      | ** ** | **Year Ended June 30** | ** **              |
|-------------------------------------------------|------------|---------------------------------------|-------------------------|
| ** **                                      | ** ** | **2006**                              | ** **              | **2005** | ** ** | **2004** | ** ** |
|                                            |       |                                  |                    |   |   |   |   |
| Service cost                                    |       | $                                     |    1,703 |   | $ |    1,556 |   | $ |    1,686 |   |
| Interest cost                                   |       | 2,334                                 |                    | 2,414 |   | 2,300 |   |
| Amortization of transition obligation           |       | —                                |                    | 77 |   | 47 |   |
| Amortization of net unrecognized losses/(gains) |       | 5                                     |                    | (362 | ) | (274 | ) |
| Amortization of prior service cost              |       | (660                                  | )                       | (659 | ) | (624 | ) |
|                                            |       |                                  |                    |   |   |   |   |
| Net periodic  postretirement benefit cost       |       | $                                     | 3,382                   |   | $ | 3,026 |   | $ | 3,135 |   |

 

The following table sets forth the changes in the accumulatedpostretirement benefit obligation:
| ** **                              | ** ** | **June 30** | ** **               |
|-----------------------------------------|------------|------------------|--------------------------|
| ** **                              | ** ** | **2006**         | ** **               | **2005** | ** ** |
|                                    |       |             |                     |   |   |
| Benefit obligation at beginning of year |       | $                |    42,046 |   | $ |    40,150 |   |
| Service cost                            |       | 1,703            |                     | 1,556 |   |
| Interest cost                           |       | 2,334            |                     | 2,414 |   |
| Participant contributions               |       | 1,613            |                     | 266 |   |
| Actuarial gains                         |       | (1,710           | )                        | (870 | ) |
| Benefit payments                        |       | (3,332           | )                        | (3,186 | ) |
| Other                                   |       | —           |                     | 1,011 |   |
| Foreign currency adjustment             |       | 942              |                     | 705 |   |
| Benefit  obligation at end of year      |       | $                | 43,596                   |   | $ | 42,046 |   |

 

90

----

The following table sets forth the changes in the company contributionsand benefit payments for the postretirement plan:
| ** **                                     | ** ** | **June 30** | ** ** |
|------------------------------------------------|------------|------------------|------------|
| ** **                                     | ** ** | **2006**         | ** ** | **2005** | ** ** |
|                                           |       |             |       |   |   |
| Fair value of plan assets at beginning of year |       | $                | —     |   | $ | — |   |
| Company contributions                          |       | 1,719            |       | 2,920 |   |
| Participant contributions                      |       | 1,613            |       | 266 |   |
| Benefit payments                               |       | (3,332           | )          | (3,186 | ) |
| 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** | ** ** |
|-------------------|------------|-----------------------|------------|
|              |       |                  |       |
| 2007              |       | $                     | 2,490      |   |
| 2008              |       | 2,595                 |       |
| 2009              |       | 2,676                 |       |
| 2010              |       | 2,802                 |       |
| 2011              |       | 2,935                 |       |
| Years 2012 - 2016 |       | 16,209                |       |
|              |       | $                     | 29,707     |   |

 

The following table sets forth the changes in the funded status in thepostretirement plan:
| ** **                            | ** ** | **June 30** | ** ** |
|---------------------------------------|------------|------------------|------------|
| ** **                            | ** ** | **2006**         | ** ** | **2005** | ** ** |
|                                  |       |             |       |   |   |
| Funded status at end of year          |       | $                | (43,597    | ) | $ | (42,046 | ) |
| Unrecognized prior service cost       |       | (5,506           | )          | (6,149 | ) |
| Unrecognized net gain                 |       | (7,874           | )          | (3,701 | ) |
| Unrecognized transition obligation    |       | —           |       | — |   |
| Net  accrued postretirement liability |       | $                | (56,977    | ) | $ | (51,896 | ) |

 

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 MedicarePrescription Drug Improvement and Modernization Act of 2003” (FAS 106-2), plansmeeting the definition of actuarial equivalence can begin to reflect drugsubsidies that will be provided in 2006 under Medicare (Part D).  The liabilities determined as of June 30,2006 for disclosure purposes reflect these changes. The adoption of FAS 106-2did not have a material effect on liabilities above.

91

----

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

Accounts payable and accrued liabilities consist of:
| ** **                                                                                           | ** ** | **June 30** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                           | ** ** | **2006**         | ** ** | **2005** | ** ** |
|                                                                                                 |       |             |       |   |   |
| Accounts payable and accrued liabilities                                                             |       | $                | 88,157     |   | $ | 37,707 |   |
| Accrued salaries and bonuses                                                                         |       | 116,633          |       | 49,055 |   |
| Current portion of defined benefit retirement plans and postretirement  benefits other than pensions |       | 13,299           |       | 4,531 |   |
| Accrued vacation                                                                                     |       | 25,095           |       | 15,716 |   |
| Advance billings deferred revenue                                                                    |       | 42,053           |       | 13,172 |   |
| Dividends payable                                                                                    |       | 3,159            |       | 2,440 |   |
| Total  accounts payable and accrued liabilities                                                      |       | $                | 288,396    |   | $ | 122,621 |   |

 

**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 $74.8 million, $51.8 million, and $56.1 million forfiscal years 2006, 2005 and 2004, respectively, inclusive of operating expensesrelated to such space and equipment. Sublease income was $0.7 million, $0 million and $0.6 million for fiscalyears 2006, 2005 and 2004, respectively.

Future minimum lease payments for Watson Wyatt’s operating leasecommitments and anticipated cash inflows for sublease income are:

|                      | ** ** | **Lease**       | ** ** |
|----------------------|------------|-----------------|------------|
| **Fiscal Year** | ** ** | **Commitments** | ** ** |
|                 |       |            |       |
| 2007                 |       | $               | 52,153     |   |
| 2008                 |       | 47,639          |       |
| 2009                 |       | 43,418          |       |
| 2010                 |       | 39,639          |       |
| 2011                 |       | 37,595          |       |
| Thereafter           |       | 140,949         |       |
| Total                |       | $               | 361,393    |   |

 

Weevaluate office capacity on an ongoing basis to meet changing needs in ourmarkets with a goal of minimizing our occupancy expense.

92

----

**Note 9 - Line of Credit**

InJuly 2005, the company amended and restated its credit facility to provide fora new revolving credit facility in an aggregate principal amount of $300million credit facility.  This facilitywas provided by a syndicate of banks. Interest rates associated with this facility vary with LIBOR and/or thePrime Rate and are based on our leverage ratio, as defined by the creditagreement.  The company also pays a 0.13%commitment fee on the unused portion of the facility.  Credit under the facility is available upondemand, although the credit facility requires us to observe certain covenants(including requirements for minimum net worth, which act to restrict dividends,cash flow leverage ratio and a fixed coverage charge).  As of June 30, 2006 and 2005, the company had$30 million and $0 million, respectively, outstanding under the facility. Thisfacility is scheduled to mature on June 30, 2010.

Aportion of the revolving facility is used to support required letters of creditissued under the credit line.  As aresult, $10.6 million of the facility was unavailable for operating needs as ofJune 30, 2006.  We are also charged a feefor outstanding letters of credit that also fluctuates based on our leverageratio.

OnJune 5, 2006, Watson Wyatt Australia Pty Ltd entered into a $5.0 millionAustralian dollar-denominated letter of credit facility with a financialinstitution in Australia for the purpose of providing a letter of credit to agovernmental agency as guarantee for ongoing business in their investmentconsulting practice.  As of June 30,2006, $5 million AUD ($3.7 million USD) was outstanding under the facility,which carries a rate of 1.00%.

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

*Share-basedCompensation Plans*

Thecompany has four share-based compensation plans, which are describedbelow.  These compensation plans includethe 2000 Long-Term Incentive Plan, which provides for the granting of non-qualifiedstock options, the 2001 Employee Stock Purchase Plan, the 2001 Deferred StockUnit Plan for Selected Employees and the Amended Compensation Plan for OutsideDirectors.  All four plans have beenapproved by stockholders.

*2001 Employee Stock Purchase Plan*

The 2001 Employee Stock Purchase Plan (the “Stock Purchase Plan”) wasapproved at the annual stockholders’ meeting in November 2001.  Full-time and regular part-time employees areeligible to participate in the Stock Purchase Plan through payroll deductionsof up to 10 percent of each participant’s compensation, subject to certainrestrictions.  Offering periods are heldmonthly.  Shares of common stock acquiredpursuant to the Stock Purchase Plan may not be disposed of by the participantfor at least three months following the date of purchase.

Certain provisions of the Stock Purchase Plan were revised by the Boardof Directors in February 2005.  Prior tothese changes, under the plan, offering periods were held every three monthsbeginning each November 1, February 1, May 1 and August 1.  The purchase price for shares of common stockpurchased during offering periods was 85 percent of the lower of the fairmarket value of common stock on the beginning or ending date of each offeringperiod.  Subsequent to changes approvedby the Board of Directors, offering periods are now held monthly.  Additionally, the purchase price for sharesis now calculated as 95 percent of the fair market value of common stock as ofthe ending date of each offering period.

93

----

As a result of the changes to the Stock Purchase Plan discussed above,the company is not required to recognize compensation cost due to the award ofshares under the Stock Purchase Plan during fiscal year 2006.  During fiscal year 2005, the company disclosedpro forma compensation cost related to the 15% discount, which approximatedfair value.  During fiscal year 2006,approximately 200,000 shares were issued under this plan.  During fiscal year 2005, approximately350,000 shares were issued under this plan for a total fair value of $1.0million.  During fiscal year 2004,approximately 350,000 shares were issued under this plan for a total fair valueof $1.2 million.  

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

Deferred Stock Units - 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 interest in the company inthe form of deferred stock units, in lieu of a portion of their annual fiscalyear end bonus, typically paid in September of each year. Each stock unitrepresents one share of common stock at the market price on the date ofgrant.  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 have been granted annually since September 2002and have vested immediately in each year. Vesting of future awards is at the discretion of the company, with suchdetermination being made prior to issuance of the deferred stock units.

During fiscal year 2006, 177,300 shares of common stock, at a marketprice of $26.94 were awarded for a total fair value of $4.8 million.  In fiscal year 2005, 151,610 shares of commonstock, at a market price of $26.68 were awarded, for a total fair value of $4.0million.  In fiscal year 2004, 177,502shares of common stock, at a market price of $22.90 were awarded, for a totalfair value of $4.1 million.  

SBI Program - On November 19, 2004, the company’s Boardof Directors approved a long-term bonus arrangement pursuant to the company’s2001 Deferred Stock Unit Plan for Selected Employees.  The arrangement,called the Performance Share Bonus Incentive Program (the “SBI Program”), is along-term stock bonus arrangement for senior executives of the company and itsaffiliates that is designed to strengthen incentives and align behaviors togrow the business in a way that is consistent with the strategic goals of thecompany.

Incentives under the SBIProgram are provided through grants of deferred stock units pursuant to thecompany’s 2001 Deferred Stock Unit Plan for Selected Employees.  Grants ofdeferred stock units are based on the value of the cash portion of the eligibleparticipant’s fiscal year-end bonus target and a multiplier, which is thenconverted into a target number of deferred stock units based upon the company’sstock price as of the fiscal year-end prior to grant.  Participants mayvest between zero and 170% of the target number of deferred stock units basedon the extent to which financial and strategic performance metrics are achievedover a three fiscal year period.  The financial and strategic performancemetrics are established at the beginning of each performance period.  Forthe fiscal 2005 through 2007 performance period, the vesting criteria are basedupon earnings per share growth, market penetration and cross-sellingratios.  For the fiscal 2006 through 2008performance period, the vesting criteria are based upon growth in earnings pershare and revenue.

94

----

Compensationexpenses of $1.4 million was recorded pursuant to this plan through fiscal year2006.  Expenses for this plan arerecognized when awards are both probable and reasonably estimable.  The compensation expense associated withthese plans is recognized as a component of salaries and employee benefits.

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

In November 2001, the Board of Directors approvedthe Amended Compensation Plan for Outside Directors (the “Outside Director’sPlan”) which provides for the cash and stock compensation of outsideDirectors.  Under the Outside Director’sPlan, outside Directors are initially paid in shares of the company’s commonstock, or in a combination of cash and shares, quarterly (at the completedquarter-end share price, which approximates fair value) for services providedduring the preceding quarter.  The totalnumber of shares reserved for issuance under the Outside Director’s Plan wasoriginally 50,000.  An additional 25,000and 75,000 shares of common stock were authorized and reserved for issuance atthe 2004 and 2005 Annual Meeting of Stockholders, respectively.

During fiscal year 2006, 14,000 shares of common stock were awarded fora total fair value of $375,000.  Infiscal year 2005, 8,000 shares of common stock were awarded, for a total fairvalue of $225,000.  In fiscal year 2004,12,000 shares of common stock were awarded, for a total fair value of $300,000.

##### *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 4,500,000 shares.

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.  Therefore, the intrinsicvalue of options granted are $0 in accordance with APB 25.  Generally, the number of options granted toassociates was based on a percentage of annual compensation.  The company does not currently intend toissue further stock options under the Stock Option Plan.

For the Stock Option Plan, the Company uses the Black-Scholes optionvaluation model to calculate the fair value of options granted.  Using the Black-Scholes model, the weightedaverage fair value of options granted during fiscal year 2002 was $8.00 peroption, and $5.26 per option for fiscal year 2001.  The following assumptions were used in thecalculation 

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

 

95

----

As discussed above, during fiscal year 2004 and 2005, the companyelected to follow APB 25 in accounting for its Stock Option Plan, in accordancewith FAS 123.  As a result, in fiscalyear 2004 and 2005, the company disclosed pro forma compensation cost of $1.1million and $0.9 million, respectively, related to nonqualified stock options.  For fiscal year 2006, the company recognized$0.3 million in compensation expense related to the Stock Option Plan, inaccordance with FAS 123(R).

The table below presents stock option activity and number and weightedaverage exercise prices for fiscal year 2006:
| ** **                            | ** ** | ** **               | ** ** | **Weighted** | ** ** | **Average**           | ** ** |
|---------------------------------------|------------|--------------------------|------------|--------------|------------|-----------------------|------------|
| ** **                            | ** ** | ** **               | ** ** | **Average**  | ** ** | **Remaining**         | ** ** |
| ** **                            | ** ** | **Number of**       | ** ** | **Exercise** | ** ** | **Contractual**       | ** ** |
| ** **                            | ** ** | **Shares**               | ** ** | **Price**    | ** ** | **Life (years)** | ** ** |
| ** **                            | ** ** | **(in 000’s)** | ** ** | ** **   | ** ** | ** **            | ** ** |
|                                  |       |                     |       |         |       |                  |       |
| Outstanding at  June 30, 2005         |       | 859                      |       | $            | 13.49      |                  |       |   |
| Granted                               |       | —                   |       | —       |       |                  |       |
| Exercised                             |       | (302                     | )          | 13.10        |       |                  |       |
| Forfeited                             |       | (13                      | )          | 15.40        |       |                  |       |
| Expired                               |       | —                   |       | —       |       |                  |       |
|                                  |       |                     |       |         |       |                  |       |
| Outstanding at  June 30, 2006         |       | 544                      |       | $            | 13.65      |                  | 1.3        |   |
| Exercisable Options at  June 30, 2006 |       | 537                      |       |         |       | 1.3                   |       |

 

The total fair value of options vested during fiscal year 2006 and 2005was $1.0 million and $1.2 million, respectively. Cash received from the exerciseof nonqualifed stock options for fiscal year 2006 was $4.0 million.

**Note 11 - Goodwill and Intangible Assets**

The increases in goodwill and intangible assets outlined below for thefiscal year ended June 30, 2006 are principally attributable to the businesscombination during the first quarter. See Note 2 for further details regarding the business combination.  The carrying amount of goodwill for thefiscal years ended June 30, 2005 and 2006, are as follows:
| ** **                        | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Investment  Consulting  Group** | ** ** | **Insurance &  Financial  Services  Group** | ** ** | **Asia Pacific/  Latin  America** | ** ** | **All Other  Segments** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|-----------------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|------------------------------|------------|-----------|------------|
| Balance as of June 30, 2005       |       | $                   | 16,790     |                                                  | $          | 1,449                     |       | $                                 | 77         |                                                 | $          | —                                 |       | $                            | —     |      | $          | 2,358 |   | $ | 1,214 |   | $ | 21,888 |   |
| Goodwill acquired during the year |       | 143,439             |       | 40,037                                                |       | 16,071                    |       | 37,217                            |       | 52,160                                               |       | 808                                    |       | —                       |       | 289,732   |       |
| Impairment losses                 |       | —              |       | —                                                |       | —                    |       | —                            |       | —                                               |       | —                                 |       | —                       |       | —    |       |
| Other translation adjustment      |       | 6,284               |       | 1,682                                                 |       | 682                       |       | 1,563                             |       | 2,191                                                |       | 19                                     |       | —                       |       | 12,421    |       |
| Balance as of  June 30, 2006      |       | $                   | 166,513    |                                                  | $          | 43,168                    |       | $                                 | 16,830     |                                                 | $          | 38,780                                 |       | $                            | 54,351     |      | $          | 3,185 |   | $ | 1,214 |   | $ | 324,041 |   |

 

96

----

The following table reflects changes in the net carrying amount of thecomponents of intangible assets for the fiscal years ended June 30, 2005 and2006:
| ** **                                  | ** ** | **Trademark  & trade  name** | ** ** | **Customer  related  intangible** | ** ** | **Core/  developed  technology** | ** ** | **Non-compete  agreements** | ** ** | **Pension** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|-----------------------------|------------|-------------|------------|-----------|------------|
| Balance as of  June 30, 2005                |       | $                                     | —     |                              | $          | 84                               |       | $                           | —     |        | $          | 84        |       | $ | 608 |   | $ | 776 |   |
| Intangible  assets acquired during the year |       | 108,000                               |       | 60,600                            |       | 17,635                           |       | —                      |       | —      |       | 186,235   |       |
| Other(1)                                    |       | —                                |       | —                            |       | —                           |       | —                      |       | (78         | )          | (78       | )          |
| Amortization  expense                       |       | —                                |       | (4,748                            | )          | (3,344                           | )          | (63                         | )          | —      |       | (8,155    | )          |
| Translation  adjustment                     |       | 4,966                                 |       | 2,610                             |       | 682                              |       | —                      |       | 39          |       | 8,297     |       |
| Balance as of June 30,  2006                |       | $                                     | 112,966    |                              | $          | 58,546                           |       | $                           | 14,973     |        | $          | 21        |       | $ | 569 |   | $ | 187,075 |   |

----

(1)             Reduction in pensionasset due to current year valuation for the Canadian pension plans.

The following table reflects the carrying value of intangible assets atJune 30, 2006 and 2005:
| ** **                                            | ** ** | **Fiscal year 2006** | ** ** | **Fiscal year 2005** | ** ** |
|-------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                            | ** ** | **Gross  Carrying  Amount**    | ** ** | **Accumulated  Amortization**  | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Intangible assets and  intangible pension assets:     |       |                           |       |                           |       |   |   |   |   |
| Trademark & trade  name                           |       | $                              | 112,966    |                           | $          | — |   | $ | — |   | $ | — |   |
| Customer related  intangibles                         |       | 64,210                         |       | 5,664                          |       | 1,001 |   | 917 |   |
| Core/developed technology                             |       | 18,443                         |       | 3,470                          |       | 125 |   | 125 |   |
| Non-compete                                           |       | 672                            |       | 651                            |       | 672 |   | 588 |   |
| Intangible pension  asset                             |       | 569                            |       | —                         |       | 608 |   | — |   |
| Total intangible  assets and intangible pension asset |       | $                              | 196,860    |                           | $          | 9,785 |   | $ | 2,406 |   | $ | 1,630 |   |

 

A component of the changein the gross carrying amount of trademark & trade name, customer relatedintangibles, core/developed technology and the intangible pension assetreflects foreign currency translation adjustments between June 30, 2005 andJune 30, 2006.  These intangible assetsare denominated in the currencies of our subsidiaries outside the UnitedStates, and are translated into our reporting currency, the U.S. dollar, basedon exchange rates at the balance sheet date.

97

----

The weighted average remaining life of amortizable intangible assets atJune 30, 2006, was 9.7 years.  Futureestimated amortization expense is as follows:

| Fiscal year ending June 30 | ** ** | **Amount** | ** ** |
|------------------------------------------------|------------|------------|------------|
| 2007                                           |       | $          | 8,989      |   |
| 2008                                           |       | 8,943      |       |
| 2009                                           |       | 8,943      |       |
| 2010                                           |       | 8,943      |       |
| 2011                                           |       | 5,587      |       |
| Thereafter                                     |       | 32,135     |       |
| Total estimated  amortization expense          |       | $          | 73,540     |   |

 

**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.

The components of the income tax provision for continuing operationsinclude:
| ** **                        | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                              |       |                                  |       |   |   |   |   |
| Current  tax (benefit) expense:   |       |                                  |       |   |   |   |   |
| U.S.                              |       | $                                     | (1,112     | ) | $ | 21,917 |   | $ | 30,696 |   |
| State and local                   |       | 1,402                                 |       | 4,221 |   | 7,975 |   |
| Foreign                           |       | 12,371                                |       | 7,587 |   | 4,051 |   |
|                              |       | 12,661                                |       | 33,725 |   | 42,722 |   |
| Deferred  tax (benefit) expense:  |       |                                  |       |   |   |   |   |
| U.S.                              |       | 23,297                                |       | (1,151 | ) | (8,636 | ) |
| State and local                   |       | 5,166                                 |       | (156 | ) | (2,453 | ) |
| Foreign                           |       | 4,461                                 |       | (1,115 | ) | 972 |   |
|                              |       | 32,924                                |       | (2,422 | ) | (10,117 | ) |
| Total  provision for income taxes |       | $                                     | 45,585     |   | $ | 31,303 |   | $ | 32,605 |   |

 

98

----

Deferred income tax assets (liabilities) included in the ConsolidatedBalance Sheets at June 30, 2006, and June 30, 2005, are comprised of thefollowing:
| ** **                               | ** ** | **June 30** | ** ** |
|------------------------------------------|------------|------------------|------------|
| ** **                               | ** ** | **2006**         | ** ** | **2005** | ** ** |
|                                     |       |             |       |   |   |
| Prepaid                                  |       | $                | (1,339     | ) | $ | (867 | ) |
| Depreciation and amortization            |       | (16,462          | )          | (11,575 | ) |
| Goodwill                                 |       | (4,268           | )          | — |   |
| Change in accounting method              |       | (40              | )          | (80 | ) |
| Other                                    |       | (1,673           | )          | (1,012 | ) |
| Gross deferred tax liabilities           |       | (23,782          | )          | (13,534 | ) |
|                                     |       |             |       |   |   |
| Accrued retirement benefits              |       | 63,789           |       | 83,955 |   |
| Deferred rent                            |       | 5,488            |       | 4,300 |   |
| Other                                    |       | 9,440            |       | 10,231 |   |
| Foreign net operating loss carryforwards |       | 17,990           |       | 7,297 |   |
| Discontinued operations exit costs       |       | —           |       | 715 |   |
| Accrued liability                        |       | 15,335           |       | 10,946 |   |
| Capitalized expenditure                  |       | 941              |       | 1,030 |   |
| Accrued compensation                     |       | 475              |       | 24,604 |   |
| Deferred revenue                         |       | 4,501            |       | 386 |   |
| Foreign Tax Credit Carryforwards         |       | —           |       | 599 |   |
| Gross deferred tax assets                |       | 117,959          |       | 144,063 |   |
| Deferred tax assets valuation allowance  |       | (23,841          | )          | (13,549 | ) |
| Net  deferred tax asset                  |       | $                | 70,336     |   | $ | 116,980 |   |

 

At June 30, 2006, we had unused loss carryforwards for tax purposes invarious jurisdictions outside the U.S. amounting to $56.1 million of which$26.8 million can be indefinitely carried forward under local statutes.  The remaining foreign loss carryforwards willexpire, if unused, in varying amounts from 2007 through 2014.  The valuation allowance includes the taxeffect of foreign net operating loss carryforwards of $17.1 million and the taxeffect of certain foreign temporary expenses of $6.7 million.

The net change in the valuation allowance of $1.1 million in fiscalyear 2006 and $2.7 million in fiscal year 2005 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 as follows:
| ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
|       |       |     |       |     |       |     |       |
| Domestic   |       | $        | 73,672     |     | $          | 69,003   |       | $ | 72,488 |   |
| Foreign    |       | 58,031   |       | 13,696   |       | 10,056   |       |
|       |       |     |       |     |       |     |       |
|       |       | $        | 131,703    |     | $          | 82,699   |       | $ | 82,544 |   |

 

99

----

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, 2006 were approximately $192 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 toremit.  If future events, includingmaterial changes in estimates of cash, working capital and long-term investmentrequirements, necessitate that these earnings be distributed, an additionalprovision for withholding taxes may apply, which could materially affect ourfuture effective tax rate.

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** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                           |       |                                  |       |   |   |   |   |
| Tax provision at U.S. federal statutory tax rate of 35 percent |       | $                                     | 46,096     |   | $ | 28,944 |   | $ | 28,890 |   |
| Increase  (reduction) resulting from:                          |       |                                  |       |   |   |   |   |
| Foreign income tax rate  differential, net                     |       | (5,974                                | )          | 1,110 |   | 1,029 |   |
| State income taxes, net of  federal tax effect                 |       | 4,720                                 |       | 1,787 |   | 3,152 |   |
| Non-deductible expenses                                        |       | 6,205                                 |       | (782 | ) | 838 |   |
| Tax credits                                                    |       | (2,812                                | )          | (443 | ) | (2,030 | ) |
| Other                                                          |       | (2,650                                | )          | 687 |   | 726 |   |
|                                                           |       |                                  |       |   |   |   |   |
| Income  tax provision                                          |       | $                                     | 45,585     |   | $ | 31,303 |   | $ | 32,605 |   |

 

**Note 13 - Segment Information**

In North America and Europe, the company isprimarily organized and managed by practice. Although our consultants in our Asia Pacific and Latin America officesprovide services in these same practice areas, their operations as a whole aremanaged geographically and comprise a single operating segment.  Therefore, we have six reportable operatingsegments as follows:

(1)            Benefits Group

(2)            Technology andAdministration Solutions Group

(3)            Human Capital Group

(4)            Insurance &Financial Services Group

(5)            Investment ConsultingGroup

(6)            International— Comprising Asia Pacific and Latin America Operations

Effective in fiscal year2007, we will begin to report the Asia-Pacific and Latin America operations ona practice basis.  Consequently, theresults of this segment will be incorporated into the five practice-basedsegments highlighted above.

100

----

Management evaluates theperformance of its segments and allocates resources to them based on netoperating income on a pre-bonus, pre-tax basis. The category previously reported as “other” has been reclassified as “Allother segments” in the reconciliation of reportable segments to consolidatedamounts as prescribed in Statement of Financial Accounting Standards No. 131 “Disclosuresabout Segments of an Enterprise and Related Information”, (FAS 131).  This includes communication and changemanagement implementation support services. Prior period amounts have been restated to conform to the currentclassification.

The table below presentsspecified information about reported segments as of and for the year ended June30, 2006.  As a result, it includes theconsolidated results from the acquired businesses since July 31, 2005, as nowheld by Watson Wyatt Limited:
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services Group** | ** ** | **Investment  Consulting  Group** | ** ** | **International —  Asia Pacific/  Latin America** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|----------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable expenses) |       | $                   | 689,310    |                                                  | $          | 129,605                   |       | $                                                        | 110,421    |                              | $          | 91,407                                                                |       | $         | 74,372     |   | $ | 94,171 |   | $ | 1,189,286 |   |
| Net operating  income                   |       | 177,984             |       | 30,706                                                |       | 16,336                    |       | 17,696                                                   |       | 11,827                            |       | 5,688                                                                 |       | 260,237   |       |
| Interest expense                        |       | 2,586               |       | 321                                                   |       | 559                       |       | 252                                                      |       | 198                               |       | 32                                                                    |       | 3,948     |       |
| Depreciation  & Amortization        |       | 12,353              |       | 9,537                                                 |       | 1,617                     |       | 1,388                                                    |       | 1,210                             |       | 2,726                                                                 |       | 28,831    |       |
| Receivables                             |       | 181,766             |       | 15,868                                                |       | 27,995                    |       | 26,850                                                   |       | 15,688                            |       | 26,075                                                                |       | 294,242   |       |
|                                         |            |                     |            |                                                       |            |                           |            |                                                          |            |                                   |            |                                                                       |            |           |            |  |  |  |  |  |  |  |

 

The table below presentsspecified information about reported segments as of and for the year ended June30, 2005.  As a result, it does notinclude results from Watson Wyatt Limited since the combination was notcompleted until July 31, 2005:  
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services Group** | ** ** | **Investment  Consulting  Group** | ** ** | **International —  Asia Pacific/  Latin America** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|----------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable expenses) |       | $                   | 422,336    |                                                  | $          | 66,340                    |       | $                                                        | 56,456     |                              | $          | —                                                                |       | $         | 19,016     |   | $ | 90,498 |   | $ | 654,646 |   |
| Net operating income                    |       | 99,566              |       | 7,404                                                 |       | 13,647                    |       | —                                                   |       | 1,468                             |       | 5,941                                                                 |       | 128,026   |       |
| Interest expense                        |       | 996                 |       | 137                                                   |       | 110                       |       | —                                                   |       | 62                                |       | 12                                                                    |       | 1,317     |       |
| Depreciation  & Amortization        |       | 8,407               |       | 1,777                                                 |       | 967                       |       | —                                                   |       | 392                               |       | 2,681                                                                 |       | 14,224    |       |
| Receivables                             |       | 103,837             |       | 5,006                                                 |       | 12,517                    |       | —                                                   |       | 4,004                             |       | 17,897                                                                |       | 143,261   |       |
|                                         |            |                     |            |                                                       |            |                           |            |                                                          |            |                                   |            |                                                                       |            |           |            |  |  |  |  |  |  |  |

 

101

----

The table below presentsspecified information about reported segments as of and for the year ended June30, 2004.  As a result, it does notinclude results from Watson Wyatt Limited since the combination was not completeduntil July 31, 2005:  
| ** **                              | ** ** | **Benefits  Group** | ** ** | **Technology  and  Administration  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **Insurance &  Financial  Services Group** | ** ** | **Investment  Consulting  Group** | ** ** | **International —  Asia Pacific/  Latin America** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|---------------------------|------------|----------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------|------------|-----------|------------|
| Revenue (net of  reimbursable expenses) |       | $                   | 407,956    |                                                  | $          | 77,114                    |       | $                                                        | 44,872     |                              | $          | —                                                                |       | $         | 17,521     |   | $ | 83,129 |   | $ | 630,592 |   |
| Net operating  income                   |       | 89,014              |       | 8,141                                                 |       | 5,076                     |       | —                                                   |       | 2,545                             |       | 3,319                                                                 |       | 108,095   |       |
| Interest expense                        |       | 565                 |       | 23                                                    |       | 76                        |       | —                                                   |       | 34                                |       | 5                                                                     |       | 703       |       |
| Depreciation  & Amortization        |       | 8,921               |       | 2,246                                                 |       | 1,008                     |       | —                                                   |       | 385                               |       | 2,471                                                                 |       | 15,031    |       |
| Receivables                             |       | 99,836              |       | 9,330                                                 |       | 8,978                     |       | —                                                   |       | 3,556                             |       | 18,034                                                                |       | 139,734   |       |
|                                         |            |                     |            |                                                       |            |                           |            |                                                          |            |                                   |            |                                                                       |            |           |            |  |  |  |  |  |  |  |

 

102

----

A reconciliation of the information reported bysegment to the consolidated amounts follows for the years ended June 30 (inthousands):
| ** **                                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                                    |       |     |       |     |       |     |       |
| *Revenue:*                                                                                              | * *   | * * | * *   | * * | * *   | * * | * *   |
| Total segment revenue                                                                                   |       | $        | 1,189,286  |     | $          | 654,646  |       | $ | 630,592 |   |
| Reimbursable expenses not included in segment revenue                                                   |       | 51,925   |       | 37,941   |       | 30,965   |       |
| All other segments                                                                                      |       | 34,140   |       | 42,719   |       | 41,780   |       |
| Other, net                                                                                              |       | (3,540   | )          | 2,115    |       | (1,332   | )          |
| Consolidated revenue                                                                                    |       | $        | 1,271,811  |     | $          | 737,421  |       | $ | 702,005 |   |
|                                                                                                    |       |     |       |     |       |     |       |
| *Net  Operating Income:*                                                                                | * *   | * * | * *   | * * | * *   | * * | * *   |
| Total segment income                                                                                    |       | $        | 260,237    |     | $          | 128,026  |       | $ | 108,095 |   |
| Income from affiliates                                                                                  |       | 1,135    |       | 7,146    |       | 7,109    |       |
| Differences in allocation methods for depreciation, G&A, pension  and medical costs (1)   |       | (4,694   | )          | 3,538    |       | 4,705    |       |
| Interest Expense                                                                                        |       | (4,093   | )          | (661     | )          | (893     | )          |
| Loss on hedge                                                                                           |       | (3,602   | )          | (4,807   | )          | —   |       |
| Other non-operating income                                                                              |       | 1,521    |       | (2,597   | )          | 6,222    |       |
| Discretionary bonuses                                                                                   |       | (108,671 | )          | (47,403  | )          | (38,870  | )          |
| All other segments                                                                                      |       | (3,977   | )          | 4,549    |       | 533      |       |
| Other, net                                                                                              |       | (6,153   | )          | (5,092   | )          | (4,357   | )          |
|                                                                                                    |       |     |       |     |       |     |       |
| Consolidated pretax income                                                                              |       | $        | 131,703    |     | $          | 82,699   |       | $ | 82,544 |   |
|                                                                                                    |       |     |       |     |       |     |       |
| *Interest  Expense:*                                                                                    | * *   | * * | * *   | * * | * *   | * * | * *   |
| Total segment expense                                                                                   |       | $        | 3,948      |     | $          | 1,317    |       | $ | 703 |   |
| All other segments                                                                                      |       | 104      |       | 61       |       | 31       |       |
| Differences in allocation method                                                                        |       | 41       |       | (717     | )          | 159      |       |
| Consolidated interest expense                                                                           |       | $        | 4,093      |     | $          | 661      |       | $ | 893 |   |
|                                                                                                    |       |     |       |     |       |     |       |
| *Depreciation  & Amortization:*                                                                     | * *   | * * | * *   | * * | * *   | * * | * *   |
| Total segment expense                                                                                   |       | $        | 28,831     |     | $          | 14,224   |       | $ | 15,031 |   |
| All other segments                                                                                      |       | 2,521    |       | 2,573    |       | 3,031    |       |
| Intangible asset amortization, not allocated to segments                                                |       | 8,155    |       | 311      |       | 315      |       |
| Differences in allocation method and other                                                              |       | 5,411    |       | 3,102    |       | 134      |       |
| Consolidated depreciation and amortization expense                                                      |       | $        | 44,918     |     | $          | 20,210   |       | $ | 18,511 |   |
|                                                                                                    |       |     |       |     |       |     |       |
| *Receivables:*                                                                                          | * *   | * * | * *   | * * | * *   | * * | * *   |
| Total segment receivables                                                                               |       | $        | 294,242    |     | $          | 143,261  |       | $ | 139,734 |   |
| All other segments                                                                                      |       | 4,945    |       | 9,855    |       | 5,420    |       |
| Net valuation differences (2)                                                                           |       | 4,390    |       | 5,701    |       | 4,680    |       |
| Total billed and unbilled receivables                                                                   |       | 303,577  |       | 158,817  |       | 149,834  |       |
| Assets not reported by segment                                                                          |       | 936,782  |       | 459,862  |       | 362,334  |       |
| Consolidated  assets                                                                                    |       | $        | 1,240,359  |     | $          | 618,679  |       | $ | 512,168 |   |

----

(1)Depreciation, general and administrative, pension, and medical costs areallocated to our segments based on budgeted expenses determined at thebeginning of the fiscal year as management believes that these costs arelargely uncontrollable to the segment. To the extent that the actual expense base upon which allocations aremade differs from the forecast/budget amount, a reconciling item will becreated between internally allocated expenses and the actual expense that wereport for GAAP purposes.

(2) Total segment receivables, which reflect the receivable balancesused by management to make business decisions, are included for managementreporting purposes net of deferred revenues.

103

----

The following represents total revenue andlong-lived assets information by geographic area as of and for the years endedJune 30:
| ** **     | ** ** | **Revenue** | ** ** | **Long-lived Assets** | ** ** |
|----------------|------------|-------------|------------|----------------------------|------------|
| ** **     | ** ** | **2006**    | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|           |       |        |       |                       |       |   |   |   |   |   |   |   |   |
| United States  |       | $           | 649,109    |                       | $          | 587,670 |   | $ | 565,228 |   | $ | 157,780 |   | $ | 120,910 |   | $ | 90,385 |   |
| United Kingdom |       | 345,732     |       | —                     |       | — |   | 493,942 |   | — |   | — |   |
| Rest of World  |       | 276,970     |       | 149,751                    |       | 136,777 |   | 24,675 |   | 40,644 |   | 33,329 |   |
|           |       | $           | 1,271,811  |                       | $          | 737,421 |   | $ | 702,005 |   | $ | 676,397 |   | $ | 161,554 |   | $ | 123,714 |   |

 

Revenue is based on the country of domicile for the legal entity thatoriginated the revenue.  Exclusive of theUnited States and the U.K., revenue from no single country constituted morethan 10 percent of consolidated revenues. Revenue from no single customer constituted more than four percent ofconsolidated 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 threeoutstanding letters of credit totaling $14.3 million under our existing creditfacility to guarantee payment to beneficiaries in the event that the companyfails to meet its financial obligations to these beneficiaries.  One letter of credit for $2.6 million willexpire in October 2006, while the second letter of credit for $8.0 million willremain outstanding as long as we retain an ownership share of our affiliatedcaptive insurance company, PCIC.  Thecompany has also provided a $5.0 million Australian dollar-denominated letterof credit (US $3.7 million) to an Australian governmental agency as required bylocal regulations.  The estimated fairmarket value of these letters of credit is immaterial because they have neverbeen used, and the company believes that probability of future usage is remote.

*Indemnification Agreements*.  The company has variousagreements that provide that it may be obligated to indemnify the other partywith respect to certain matters. Generally, these indemnification clauses are included in contractsarising in the normal course of business and in connection with the purchaseand sale of certain businesses.  Althoughit is not possible to predict the maximum potential amount of future paymentsunder these indemnification agreements due to the conditional nature of thecompany’s obligations and the unique facts of each particular agreement, thecompany does not believe that any potential liability that might arise fromsuch indemnity provisions is probable or material.  There are no provisions for recourse to thirdparties, nor are any assets held by any third parties that any guarantor canliquidate to recover amounts paid under such indemnities.

104

----

*WellspringLeases*.  We continue to guarantee three leases foroffice premises for Wellspring Resources, LLC (“Wellspring”), the benefitsadministration outsourcing business that we exited from in fiscal year 1998.  At June 30, 2006, minimum remaining paymentsguaranteed under these leases, which expire at various dates through 2007,total $5.0 million, excluding anticipated future sublease income.  During the third quarter of fiscal year 2006,the company evaluated its accrual for the estimated remaining futureobligations and costs related to the exit from Wellspring.  Based on our analysis and the limitedduration of the remaining lease obligations, the company reduced its remainingliability of $1.75 million, less the associated income tax expense.  See Note 16 for more information regardingour obligation to guarantee Wellspring’s leases.

*Legal Proceedings:* From time to time, we are a party to various lawsuits, arbitrations ormediations that arise in the ordinary course of business.  We have received subpoenas and requests forinformation in connection with government investigations.  The mattersreported on below involve the most significant pending or potential claimsagainst us.

We carry substantial professional liability insurance with aself-insured retention of $1 million per occurrence, which provides coveragefor professional liability claims including the cost of defending such claims.We reserve for contingent liabilities based on Statement of FinancialAccounting Standards No. 5, “Accounting for Contingencies” (FAS 5) when itis determined that a liability, inclusive of defense costs, is probable andreasonably estimable.  Managementbelieves, based on currently available information, that the results of allpending claims against the company will not have a material adverse effect onthe results of operations.

*IronWorkers Local 25 et al. v. Watson Wyatt & Co. *On July 8, 2004, Watson Wyatt was served with an amended complaintfiled by a former client in the United States District Court for the EasternDistrict of Michigan.  The complaintalleged malpractice, breach of contract, and related claims in the performanceof actuarial consulting.  The complaintstated that the plaintiff’s pension fund is underfunded as a result of thealleged deficiencies in our work.  Inresponse to a discovery request, in January 2005 the plaintiffs disclosed thattheir minimum damage claim is $53.7 million. Discovery is continuing, and plaintiff’s expert witnesses include allegationsof gross negligence and damage estimates of $100 million. Watson Wyatt’s expertwitnesses dispute the allegations of negligence and that Watson Wyatt causedsuch purported damages.  The trial datehas been continued until April 2007.

*SBC Holdings, Inc. *On July 23, 2004, we received a demand letterfrom counsel for a client alleging that errors in valuations for 2001 andsubsequent years understated the liabilities of its pension plan and overstatedits net worth.  As a result, the clientclaimed it did not annuitize its defined benefit plan and redeemed its stock atan inflated price.  On April 15, 2005, wefiled a declaratory action in the U.S. District Court for the Eastern Districtof Michigan to compel arbitration of the matter.  On May 5, 2005, SBC filed an answer andcounterclaim to the declaratory judgment action, alleging damages in excess of$46 million.  On June 30, 2006, the Courtruled that disputes involving events prior to the parties’ agreement toarbitrate would be litigated, and those involving events after such agreement,were subject to arbitration.  The Court’sruling may be appealed to the Sixth Circuit.

105

----

**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** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                               |       |                                  |       |   |   |   |   |
| Income from  continuing operations                                                 |       | $                                     | 86,118     |   | $ | 51,396 |   | $ | 49,939 |   |
| Income from  discontinued operations                                               |       | 1,073                                 |       | 766 |   | 654 |   |
| Net income                                                                         |       | $                                     | 87,191     |   | $ | 52,162 |   | $ | 50,593 |   |
|                                                                               |       |                                  |       |   |   |   |   |
| Weighted average  outstanding shares of common stock                               |       | 41,393                                |       | 32,541 |   | 32,866 |   |
| Contingency  Stock                                                                 |       | 1,787                                 |       | — |   | — |   |
| Dilutive effect  of employee stock options and employee stock purchase plan shares |       | 117                                   |       | 304 |   | 341 |   |
|                                                                               |       |                                  |       |   |   |   |   |
| Common stock and  stock equivalents                                                |       | 43,297                                |       | 32,845 |   | 33,207 |   |
|                                                                               |       |                                  |       |   |   |   |   |
| Basic earnings per  share                                                          |       |                                  |       |   |   |   |   |
| Income from  continuing operations                                                 |       | $                                     | 2.08       |   | $ | 1.58 |   | $ | 1.52 |   |
| Income from  discontinued operations                                               |       | 0.03                                  |       | 0.02 |   | 0.02 |   |
| Basic earnings  per share, net income                                              |       | $                                     | 2.11       |   | $ | 1.60 |   | $ | 1.54 |   |
|                                                                               |       |                                  |       |   |   |   |   |
| Diluted earnings per  share                                                        |       |                                  |       |   |   |   |   |
| Income from  continuing operations                                                 |       | $                                     | 1.99       |   | $ | 1.56 |   | $ | 1.50 |   |
| Income from  discontinued operations                                               |       | 0.02                                  |       | 0.02 |   | 0.02 |   |
| Diluted earnings per  share, net income                                            |       | $                                     | 2.01       |   | $ | 1.58 |   | $ | 1.52 |   |

 

Outstanding stock options for the year ended June 30,2006, 2005, and 2004 were 0, 1,920, and 2,120, respectively, that were notincluded in the diluted earnings per share calculation because their effectwould have been antidilutive. The diluted earnings per share calculation assumes that the 1,950,000contingent shares related to the business combination had been issued at thedate of business combination.

106

----

**Note 16 - Discontinued Operations**

As discussed in Note 14, the company continues to guarantee threeleases for office premises for Wellspring. In accordance with the contractual arrangements pursuant to which WatsonWyatt divested its interest in Wellspring, Watson Wyatt agreed to share withanother party either costs or benefits arising from these facilities leased byWellspring.  Since one of the threeWellspring leases is currently sub-leased at rates in excess of the lease rate,the company is contractually entitled to a share of the benefit of the excesscash flow from the sub-leases. During fiscal year 2006, the company receivedsublease income of approximately $64,000 in excess of lease payments related tothis business.  Since the second quarterof fiscal year 2003, the leases have been generating positive cash flows ofless than $100,000 per fiscal year. The company’s current assessment is thatthe positive cash flow from the sub-leases will continue until they expire inDecember 2006. The company has no direct cash obligation to Wellspring in thesense that its obligation is contingent upon the remaining space being vacated.

During the third quarter of fiscal years 2004, 2005 and 2006, thecompany evaluated its accrual for the estimated remaining future obligationsand costs related to the exit from Wellspring. The evaluations included an analysis of occupancy rates of Wellspring,along with an analysis of real estate market conditions in cities in which theleases exist and an assessment of probable future sublease income for theseleases.  As a result of the analysisperformed during fiscal years 2004, 2005 and 2006, the company reduced itsaccrual by $1.0 million, $1.25 million and $1.75 million, respectively, lessthe associated income tax expenses.  Suchadjustments are reflected in the Consolidated Statement of Operations for thethird quarter of each fiscal year in the line “Adjustment to reduce estimatedloss on disposal of discontinued operations.”

**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 ended September 30,2003.  We eliminated an additional 22positions in our North American region during the second quarter of fiscal year2004, resulting in a charge to earnings of $0.7 million in the company’sfinancial results for the quarter ended December 31, 2003.  Of the $3.3 million of total severancecharges, $3.2 million was included in salaries and employee benefits and $0.1million was included in professional and subcontracted services during fiscalyear 2004.

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

PCIC is a captive insurance company registered in the state of Vermontowned by us and two other professional services firms.  The member companies make equity investmentsto PCIC as necessary in order for PCIC to comply with capital requirementsunder Vermont law.

Annual premiums paid by the company are expensed ratably over the policyperiod of each fiscal year.  Prior toJuly 1, 2003, the first $5 million of coverage had a premium structure whichprovided that the captive insurance company would recover from the firmdefending the claim approximately 75% of any loss up to $5 million.  Premiums were established by PCIC based onexpected losses.  To the extent PCIC’sactual losses exceeded premiums paid, the company would record a liability, asrecovery by PCIC of such excess losses would occur through insurance premiumsin subsequent years.  Subsequent to July1, 2003, PCIC still utilizes a premium rating formula which incorporates theinsureds’ loss history. To the extent an individual firm’s losses are greateror lesser than originally projected, future premiums may be increased ordecreased by up to 75% of the difference. On a quarterly basis, the company evaluates, pursuant with its agreementwith PCIC and through inquiry with PCIC, if any liability should beaccrued.  PCIC bases premiumcalculations, which are determined annually based on experience through Marchof each year, on relative risk of the various lines of business performed byeach of the owner companies, past claim experience of each owner company,growth of each of those companies, industry risk profiles in general and theoverall insurance markets.

107

----

PCIC, in order to limit its consolidated risk, purchased an aggregatestop loss policy from a third party re-insurer. The stop loss policy provided for recovery by PCIC itself of all lossesbeyond a specific threshold.  Thisthreshold was exceeded in the first half of calendar year 2003, therebyproviding PCIC with a benefit in the amount of the loss experienced in excessof the threshold.

On July 9, 2003, the Board of Directors of PCIC decided to pass on toeach of its owners a credit in their 2003-04 policy year in connection withbenefits received 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.   The amount of the Company’s obligation toPCIC prior to the credit was $5.6 million. The Company’s obligation to PCIC resulted from actual PCIC lossesrelative to the Company’s claims exceeding premiums paid by the Company, asrecovery by PCIC of such excess losses would occur contractually throughinsurance premiums in the subsequent years. As of June 30, 2003, the Company’s balance sheet reflected a liabilityto PCIC for $5.6 million resulting from such excess losses.  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 was paid in September2004 with the regular bonus cycle.  Thissupplemental bonus is included in Salaries and employee benefits.

108

----

**Note 19 - Quarterly Financial Data (unaudited)**

Unaudited, summarized financial data by quarter for the years endedJune 30, 2006 and 2005, is as follows (in thousands, except per share amounts):
| ** **                                            | ** ** | **2006 Quarter Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **September 30**            | ** ** | **December 31** | ** ** | **March 31** | ** ** | **June 30** | ** ** |
|                                                  |       |                             |       |   |   |   |   |   |   |
| Revenue                                               |       | $                                | 265,886    |   | $ | 315,764 |   | $ | 343,072 |   | $ | 347,089 |   |
| Income from operations                                |       | 25,406                           |       | 28,937 |   | 41,107 |   | 36,967 |   |
| Income from continuing operations before income taxes |       | 24,807                           |       | 27,746 |   | 41,164 |   | 37,986 |   |
| Income from continuing operations                     |       | 13,892                           |       | 17,175 |   | 29,336 |   | 25,715 |   |
| Discontinued operations                               |       | 9                                |       | 8 |   | 1,045 |   | 11 |   |
| Net income                                            |       | 13,901                           |       | 17,183 |   | 30,381 |   | 25,726 |   |
| Earnings  per share:                                  |       |                             |       |   |   |   |   |   |   |
| Continuing operations, basic                          |       | 0.36                             |       | 0.41 |   | 0.69 |   | 0.61 |   |
| Continuing operations, diluted                        |       | 0.36                             |       | 0.41 |   | 0.69 |   | 0.58 |   |
| Discontinued operations, basic                        |       | —                           |       | — |   | 0.02 |   | — |   |
| Discontinued operations,  diluted (a)                 |       | —                           |       | — |   | 0.02 |   | — |   |
| Net income, basic                                     |       | 0.36                             |       | 0.41 |   | 0.71 |   | 0.60 |   |
| Net income, diluted                                   |       | 0.36                             |       | 0.41 |   | 0.71 |   | 0.58 |   |
|                                                       |            |                                  |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                            | ** ** | **2005 Quarter Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **September 30**            | ** ** | **December 31** | ** ** | **March 31** | ** ** | **June 30** | ** ** |
|                                                  |       |                             |       |   |   |   |   |   |   |
| Revenue                                               |       | $                                | 175,391    |   | $ | 175,849 |   | $ | 187,560 |   | $ | 198,621 |   |
| Income from operations                                |       | 20,665                           |       | 16,919 |   | 21,000 |   | 22,201 |   |
| Income from continuing operations before income taxes |       | 23,354                           |       | 19,994 |   | 21,325 |   | 18,026 |   |
| Income from continuing operations                     |       | 13,751                           |       | 11,055 |   | 14,340 |   | 12,250 |   |
| Discontinued operations                               |       | 2                                |       | 6 |   | 748 |   | 10 |   |
| Net income                                            |       | 13,753                           |       | 11,061 |   | 15,088 |   | 12,260 |   |
| Earnings  per share:                                  |       |                             |       |   |   |   |   |   |   |
| Continuing operations, basic                          |       | 0.42                             |       | 0.34 |   | 0.44 |   | 0.38 |   |
| Continuing operations, diluted                        |       | 0.42                             |       | 0.34 |   | 0.44 |   | 0.37 |   |
| Discontinued operations, basic                        |       | —                           |       | — |   | 0.02 |   | — |   |
| Discontinued operations,  diluted                     |       | —                           |       | — |   | 0.02 |   | — |   |
| Net income, basic                                     |       | 0.42                             |       | 0.34 |   | 0.46 |   | 0.37 |   |
| Net income, diluted                                   |       | 0.42                             |       | 0.34 |   | 0.46 |   | 0.37 |   |
|                                                       |            |                                  |            |  |  |  |  |  |  |  |  |  |  |

----

(a)          The diluted earnings per share calculationassumes that the 1,950,000 contingent shares related to the businesscombination have been issued and outstanding since July 31, 2005.

109

----

**WATSON WYATT WORLDWIDE, INC.****ScheduleIIValuation and Qualifying Accounts and Reserves**(Thousands of U.S. Dollars)
| **Description**                              | ** ** | **Balance at  Beginning  of Year** | ** ** | **Additions  Charged  Against  (Credited to)  Revenue** | ** ** | **Additions  Charged to  Other  Accounts** | ** ** | **Additions  Resulting  From  Acquisitions** | ** ** | **Deductions** | ** ** | **Balance at  End of  Year** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|----------------|------------|----------------------------------------|------------|
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Year Ended June  30, 2006                    |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Allowance for  uncollectible accounts        |       | $                                            | 2,114      |                                                         | $          | 5,680                                           |       | $                                            | —     |           | $          | 1,574                                  |       | $ | (5,690) |   | $ | 3,678 |   |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Allowance for unbillable  accounts           |       | 700                                          |       | (942                                                         | )          | —                                          |       | 5,590                                        |       | —         |       | 5,348                                  |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Valuation  allowance for deferred tax assets |       | 13,549                                       |       | —                                                       |       | —                                          |       | 11,386                                       |       | (1,094         | )          | 23,841                                 |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Year Ended June  30, 2005                    |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Allowance for  uncollectible accounts        |       | $                                            | 1,241      |                                                         | $          | 5,479                                           |       | $                                            | —     |           | $          | —                                 |       | $ | (4,606) |   | $ | 2,114 |   |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Allowance for  unbillable accounts           |       | 730                                          |       | (30                                                          | )          | —                                          |       | —                                       |       | —         |       | 700                                    |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Valuation  allowance for deferred tax assets |       | 10,887                                       |       | —                                                       |       | 2,662                                           |       | —                                       |       | —         |       | 13,549                                 |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Year Ended June  30, 2004                    |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Allowance for uncollectible  accounts        |       | $                                            | 862        |                                                         | $          | 5,468                                           |       | $                                            | —     |           | $          | —                                 |       | $ | (5,089) |   | $ | 1,241 |   |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Allowance for unbillable  accounts           |       | 678                                          |       | 52                                                           |       | —                                          |       | —                                       |       | —         |       | 730                                    |       |
|                                         |       |                                         |       |                                                         |       |                                            |       |                                         |       |           |       |                                   |       |
| Valuation allowance for  deferred tax assets |       | 7,211                                        |       | —                                                       |       | 3,676                                           |       | —                                       |       | —         |       | 10,887                                 |       |

----

(1)     The net increase is primarily due to the tax effect of the change inrealizable foreign net operating losses and other foreign temporarydifferences.

110

----

**ITEM 6. EXHIBITS.**
| 3.1   |   | Amended and Restated Certificate of Incorporation of  Watson Wyatt Worldwide, Inc.(1)                                                                                                                                                                                                                                                                                                                                  |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2   |   | Amended and Restated Bylaws of Watson Wyatt  Worldwide, Inc.(1)                                                                                                                                                                                                                                                                                                                                                        |
| 4     |   | Form of Certificate Representing Common  Stock(1)                                                                                                                                                                                                                                                                                                                                                                      |
| 10.1  |   | Amended and Restated Revolving Credit Agreement  Among Suntrust Bank and Others dated July 11, 2005(9)                                                                                                                                                                                                                                                                                                                 |
| 10.2  |   | Senior Officer Deferred Compensation Plan(2)                                                                                                                                                                                                                                                                                                                                                                                |
| 10.3  |   | 2001 Deferred Stock Unit Plan for Selected  Employees(3)                                                                                                                                                                                                                                                                                                                                                                    |
| 10.4  |   | Amended Compensation Plan for Outside Directors(11)                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5  |   | Deed of Lease between Watson Wyatt &  Company and Arlington Office, LLC, dated April 27, 2004(4)                                                                                                                                                                                                                                                                                                              |
| 10.6  |   | Watson Wyatt & Company Performance Share  Bonus Incentive Program(5)                                                                                                                                                                                                                                                                                                                                               |
| 10.7  |   | First Amendment to Deed of Lease between Watson  Wyatt & Company and Arlington Office L.L.C., dated April 22,  2005(6)                                                                                                                                                                                                                                                                                        |
| 10.8  |   | Business Transfer Agreement, dated as of  April 15, 2005, by and among Watson Wyatt & Company Holdings,  Watson Wyatt LLP, Watson Wyatt (UK) Acquisitions 2 Limited and The Wyatt  Company Holdings Limited(7)                                                                                                                                                                                                |
| 10.9  |   | Form of Employment Agreement between Watson  Wyatt Limited and each of Chandrasekhar Ramamurthy, Paul N. Thornton and  Roger C. Urwin(7)                                                                                                                                                                                                                                                                               |
| 10.10 |   | Distribution Agreement, dated as of April 15,  2005, by and among Watson Wyatt LLP, The Wyatt Company Holdings Limited, The  Wyatt Company (UK) Limited, Wyatt Trustee Limited and Watson Wyatt Limited(7)                                                                                                                                                                                                             |
| 10.11 |   | Deed of Termination and Amendment and Restatement of  Indemnities Relating to the Alliance Documents, dated as of April 15,  2005, by and among The Wyatt Company Holdings Limited, Watson Wyatt LLP,  Watson Wyatt & Company, Watson Wyatt Holdings Limited, Watson Wyatt  Holdings (Europe) Limited, The Wyatt Company (UK) Limited and Wyatt Trustee  Limited (in its capacity as Wyatt Partner)  (7) |
| 10.12 |   | Deed of Contribution, dated as of April 15,  2005, by and among Watson Wyatt LLP, Watson Wyatt Limited and Watson  Wyatt & Company Holdings(8)                                                                                                                                                                                                                                                                |
| 10.13 |   | Bonuses Deed, dated as of April 15, 2005, by and  among Watson Wyatt LLP, Watson Wyatt Limited and Watson Wyatt &  Company Holdings(7)                                                                                                                                                                                                                                                                        |
| 10.14 |   | Form of P.I. Claims Deed by and among the P.I.  Trustees, Watson Wyatt LLP, Watson Wyatt Limited and Watson Wyatt &  Company Holdings(8)                                                                                                                                                                                                                                                                      |
| 10.15 |   | Form of Stock Transfer Agreement by and between  Watson Wyatt & Company Holdings, Watson Wyatt (UK) Acquisitions 2  Limited and Watson Wyatt Limited and each of Watson Wyatt LLP and each voting  member(7)                                                                                                                                                                                                  |
| 10.16 |   | Watson Wyatt Incentive Compensation Plan 2005(15)                                                                                                                                                                                                                                                                                                                                                                           |
| 10.17 |   | Form of Indemnification Agreement among Watson  Wyatt & Company Holdings and each of its directors and Section   16 officers(11)                                                                                                                                                                                                                                                                         |
| 10.18 |   | Amendment to the Credit Agreement Among Suntrust  Bank and Others dated September 30, 2005(12)                                                                                                                                                                                                                                                                                                                         |
| 10.19 |   | First Amendment to Lease Between Watson Wyatt &  Company and Arlington Office LLC dated November 14, 2005 (16)                                                                                                                                                                                                                                                                                                |
| 10.20 |   | FY06 Performance Share Bonus Incentive Program (14)                                                                                                                                                                                                                                                                                                                                                                         |
| 10.21 |   | Trust Deed and Rules of the Watson Wyatt Share  Incentive Plan 2005 (U.K.) (13)                                                                                                                                                                                                                                                                                                                                             |
| 10.22 |   | Watson Wyatt Share Incentive Plan 2005 Deed of  Amendment (U.K.) (13)                                                                                                                                                                                                                                                                                                                                                       |
| 10.23 |   | Trust Deed and Rules of the Watson Wyatt Ireland  Share Participation Scheme (13)                                                                                                                                                                                                                                                                                                                                           |
| 10.24 |   | Share Purchase Plan 2005 (Spain) (13)                                                                                                                                                                                                                                                                                                                                                                                       |
| 21    |   | Subsidiaries of Watson Wyatt Worldwide, Inc.(13)                                                                                                                                                                                                                                                                                                                                                                       |
| 23    |   | Consent of the Company’s Independent Registered  Public Accounting Firm(13)                                                                                                                                                                                                                                                                                                                                            |
| 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(13)                                                                                                                                                                                                                                  |
| 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(13)                                                                                                                                                                                                                                  |
| 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(13)                                                                                                                                                                                                                           |

----

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

(2)             Incorporated byreference from Registrant’s Form 10-K, filed on August 20, 2001

(3)             Incorporated byreference from Registrant’s Form DEF14A, filed on October 5, 2001

(4)             Incorporated byreference from Registrant’s Form 10-Q, filed on May 7, 2004

(5)             Incorporated byreference from Registrant’s Form 10-Q, filed on February 9, 2005

(6)             Incorporated byreference from Registrant’s Form 10-Q, filed on May 10, 2005

(7)             Incorporated byreference from Registrant’s Form S-4 (File No. 33-3124629), filed onMay 4, 2005

(8)             Incorporated byreference from Registrant’s Form S-4/A, Amendment No. 1 (FileNo. 33-3124629) filed onJune 13, 2005

(9)             Incorporated byreference from Registrant’s Form 8-K, filed on July 14, 2005

(10)       Incorporated by referencefrom Registrant’s Form 8-K, filed on August 25, 2005

(11)       Incorporated by referencefrom Registrant’s Form 8-K, filed on October 4, 2005

(12)       Incorporated by referencefrom Registrant’s Form 10-Q, filed on November 9, 2005

(13)       Filed with thisForm 10-K

(14)       Incorporated by referencefrom Registrant’s Form 8-K, filed on May 16, 2006

(15)       Incorporated by referencefrom Registrant’s Form 8-K, filed on November 17, 2005

(16)       Incorporated by referencefrom Registrant’s Form 10-Q, filed on February 9, 2006

111

----